WEBVTT - Research Affiliates Founder & Chairman Rob Arnott Talks New ETF

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<v Speaker 1>Bloomberg Audio Studios, Podcasts, Radio News.

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<v Speaker 2>This conversation going now with Rob are Not. He is

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<v Speaker 2>chairman and founder at Research Affiliates, joining us on set.

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<v Speaker 2>Great to see you in person, Rob, Yeah, thank.

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<v Speaker 3>You both very very much for wearing green to celebrate

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<v Speaker 3>the launch of our new ETF in the crowded space

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<v Speaker 3>of cap weighted indexing.

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<v Speaker 2>Well, you made my transition for me, so I thank

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<v Speaker 2>you for that. Let's talk about this ETF that you

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<v Speaker 2>launched last week, the Research Affiliates cap Weighted US ETF.

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<v Speaker 2>This tracks the Research Affiliates cap Weighted index and Rob,

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<v Speaker 2>you made the bold claim that this could represent a

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<v Speaker 2>new future for passive investing. Tell us about this product.

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<v Speaker 3>It's actually very straightforward. Cap Weighted indexing has an enormous

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<v Speaker 3>achilles heel. People think active versus passive. Cap weighted indexes

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<v Speaker 3>are passive. Yeah they are, but no they're not. There's

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<v Speaker 3>four or five percent turnover per anum on average, So

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<v Speaker 3>ninety five percent of the portfolio is blissfully uncaring about

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<v Speaker 3>whether the stocks are going up or down, whether the

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<v Speaker 3>businesses are flourishing or floundering, and four to five percent

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<v Speaker 3>is traded. That four five percent is active and boy

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<v Speaker 3>is it wild active. It would make Kathy Wood blush.

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<v Speaker 3>It buys stocks at an average of twice the market multiple.

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<v Speaker 3>It sells stocks that are deeply out of favor, unloved,

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<v Speaker 3>and typically half the market multiple. It chases a frothy

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<v Speaker 3>emerging growth strategy. All we're doing is saying, wait a minute.

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<v Speaker 3>This leads to flip flops. For every new tesla and

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<v Speaker 3>video that gets found and added to the index, there's

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<v Speaker 3>a dozen companies that come along that look super promising,

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<v Speaker 3>that turn out to fall short of lofty expectations and

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<v Speaker 3>crash right back out of the index in five to

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<v Speaker 3>ten years. We call these flip flops. They do enormous damage.

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<v Speaker 3>What if you just add a little bit of patience.

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<v Speaker 3>You add stocks to the index when the business is

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<v Speaker 3>big enough to matter. Not that the five hundred largest

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<v Speaker 3>market cap stocks the five hundred largest businesses, and you

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<v Speaker 3>sell stocks when their business is no longer large enough

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<v Speaker 3>to matter. Now, if you do that, you slow down

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<v Speaker 3>the trading, you have lower turnover. It's more passive than

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<v Speaker 3>conventional cap weighted indexes. And when you go back over

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<v Speaker 3>the last thirty four years, you find this really simple

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<v Speaker 3>change boost returns by sixty nine basis points per annum

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<v Speaker 3>with about one percent tracking error.

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<v Speaker 4>Yeah no, so okay, this is our aus at ETF

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<v Speaker 4>that tracks the index that would do this correct. And

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<v Speaker 4>it is actively managed, so you're basically having a person

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<v Speaker 4>time the market.

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<v Speaker 3>Is that right? It is not actively managed. It is

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<v Speaker 3>every bit as passive as the Russell one thousand. It's

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<v Speaker 3>more passive than the S and P, which is managed

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<v Speaker 3>by committee. It has turnover that's lower than the Russell

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<v Speaker 3>one thousand. It has turnover that's almost identical to the

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<v Speaker 3>S and P five hundred, and the turnover doesn't chase

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<v Speaker 3>fads and bubbles and doesn't bail out of a stock

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<v Speaker 3>when it's wildly out of favor. That's where the value

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<v Speaker 3>added comes. It is a passive strategy.

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<v Speaker 1>Looking at the holdings here, it looks a lot like

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<v Speaker 1>the S and P. I mean, you've gotten a video Microsoft, Apple,

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<v Speaker 1>They're all there. Let's talk about strategy, right, This is

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<v Speaker 1>a case for the S and P. We qualified, but

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<v Speaker 1>the committee who knows who they are, decided no, we

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<v Speaker 1>don't like it. It's also not in yours. So it's

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<v Speaker 1>interesting there talk a little bit about what really is

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<v Speaker 1>passive and what determines whether a thock gets in here,

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<v Speaker 1>and maybe strategy is a good example. Why isn't in here?

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<v Speaker 3>Well, I love your framing this. In terms of active

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<v Speaker 3>versus passive, there is no such thing as a passive portfolio.

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<v Speaker 3>Portfolio has turnover. That turnover can be based on rules

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<v Speaker 3>as at Russell, it can be based on committee decisions

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<v Speaker 3>as at SMP. Better to define passive as sitting placidly

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<v Speaker 3>and going with the flow. Well, the sitting placidly and

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<v Speaker 3>going with the flow applies to ninety five percent of

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<v Speaker 3>the portfolio. It's also interesting that our strategy has ninety

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<v Speaker 3>five percent overlap with the S and P. Five hundred

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<v Speaker 3>percent of the holdings are identical. The difference is at

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<v Speaker 3>the margins. There are companies that are not yet big

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<v Speaker 3>businesses that don't make it onto our index. Pallanteer is

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<v Speaker 3>the largest market cap stock that we don't own, but

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<v Speaker 3>it's not a big business. Trades at one hundred times

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<v Speaker 3>it's annual sales. And at the other end of the spectrum,

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<v Speaker 3>there are companies that are big businesses that aren't in

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<v Speaker 3>the S and P because they've never been popular or

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<v Speaker 3>frothy enough to make it into there there's a wonderful

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<v Speaker 3>example of flip flops a Dillard's department store. It's been

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<v Speaker 3>a member of the S and P five hundred and

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<v Speaker 3>five times in the last thirty years. It's been kicked

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<v Speaker 3>out four times, it's come back in four times. Every

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<v Speaker 3>time it's by high sell low. Now here's an astonishing fact.

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<v Speaker 3>If you owned Dillards during the thirteen years in the

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<v Speaker 3>last thirty five that it wasn't in the Russell one thousand,

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<v Speaker 3>you would have made sixty seven times your money. If

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<v Speaker 3>you owned it during the twenty three years that it

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<v Speaker 3>was in the Russell one thousand, you would have made

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<v Speaker 3>ninety nine percent negative loss. You would have a penny

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<v Speaker 3>left of every dollar you started with. So a six

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<v Speaker 3>thousand to one ratio of wealth owning it when it's

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<v Speaker 3>not in the index versus owning it when it's not

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<v Speaker 3>just absolutely mind blowing.

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<v Speaker 2>Well, Rob, you bring a Dillards, which is an incredible

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<v Speaker 2>example of this. But bringing it back to I mean

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<v Speaker 2>this ETF you said it has ninety five percent overlap

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<v Speaker 2>with the S and P five hundred. So we're talking

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<v Speaker 2>about large cap names here. How does this effect look

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<v Speaker 2>when you think about midcaps? When you think about small caps.

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<v Speaker 2>Do you have the same sort of flip flopping that

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<v Speaker 2>you might see when it comes to the S and

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<v Speaker 2>P five hundred.

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<v Speaker 3>You do, but it's more powerful at the large cap

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<v Speaker 3>end of the spectrum. Think of it this way. When

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<v Speaker 3>Dillard's is not in the Russell one thousand, it is

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<v Speaker 3>in the Russell two thousand and So what we find

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<v Speaker 3>is is that every time Dillard's is added, it's added

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<v Speaker 3>after an average of a fifty percent outperformance year five

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<v Speaker 3>thousand basis points. Then it underperforms by an average of

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<v Speaker 3>six thousand basis points and gets kicked back out. Then

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<v Speaker 3>it snaps back by an average of two hundred and

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<v Speaker 3>ten percentage points of outperformance, fifty percent of that in

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<v Speaker 3>the last year before it's added, and then it's kicked out.

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<v Speaker 3>Leather rids repeat. It's wild rob.

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<v Speaker 4>Before we let you go, we got to ask you

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<v Speaker 4>about the president's proposal. It's not official, but this idea

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<v Speaker 4>that companies report earnings every six months, then every three months.

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<v Speaker 4>As an investor, what do you think of something like that.

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<v Speaker 3>I'm a libertarian. I prefer to let people and businesses

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<v Speaker 3>do what they want. I think a requirement of every

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<v Speaker 3>three months fine. Lift the requirement. If a company wants

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<v Speaker 3>to report every six months, every twelve months, that's fine.

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<v Speaker 3>Publicly traded it out a report at least once in

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<v Speaker 3>a while, but a requirement for quarterly reporting increases short termism.

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<v Speaker 3>I've often said that I will never ever work for

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<v Speaker 3>a publicly traded company. Again, I've been saying that for

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<v Speaker 3>a quarter century, and the reason is regulatory distraction and

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<v Speaker 3>short termism. I can think about business rouse the new ETFRUS.

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<v Speaker 3>We're pricing it at zero for the first year. The

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<v Speaker 3>beauty in that is scale. If we get in one

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<v Speaker 3>hundred billion dollars, multiply that by a zero fee, and

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<v Speaker 3>that's a lot more money than one hundred million dollars

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<v Speaker 3>time zero, Right, I'm joking. We're able to do that

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<v Speaker 3>because we look past the coming quarter. We want to

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<v Speaker 3>create a revolution in indexing. And if we create a

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<v Speaker 3>revolution in indexing and it succeeds, it'll be a big

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<v Speaker 3>money maker in ten years. I don't care if it's

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<v Speaker 3>a big money maker in five years. I certainly don't

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<v Speaker 3>care about the first year.

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<v Speaker 2>Yeah, and certainly not the first three months. Rob. Fantastic

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<v Speaker 2>to get some time with you, as always, that is

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<v Speaker 2>Rob or Not of Research Affiliates, talking about, of course,

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<v Speaker 2>his new ETF ticker rus