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Speaker 1: Bloomberg Audio Studios, Podcasts, radio news. This is Master's in

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Speaker 1: Business with Barry rid Holts on Bloomberg Radio. Hey this

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Speaker 1: weekend on the podcast, I have an extra special guest.

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Speaker 1: Mike Green and I have been chopping it up on

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Speaker 1: Twitter arguing over passive versus active, and I thought, well,

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Speaker 1: why are we wasting this on Twitter as it circles

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Speaker 1: the drain. Why don't we just have a conversation in

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Speaker 1: the studio about his beef with passive, Why he thinks

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Speaker 1: it's a structural threat to the market, and the advice

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Speaker 1: that he gave to David Einhorn about it that helped

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Speaker 1: lead Einhorn to start really kicking the benchmark's butt again

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Speaker 1: for the past couple of years. I found this conversation

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Speaker 1: to be both interesting and surprising. Some of the things

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Speaker 1: Mike said about investing, like what would you tell your

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Speaker 1: friends and family to put your money into. He says,

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Speaker 1: it's hard to argue against the low cost and the

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Speaker 1: performance of indexing, but that doesn't mean regulators should overlook

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Speaker 1: the potential threat. I'm kind of unconvinced by the argument.

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Speaker 1: There have been a series of arguments over the years

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Speaker 1: against passive. What makes the discussion with Green so interesting

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Speaker 1: is he's the guy that identified the structural problem leading

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Speaker 1: to the destabilization of the VICS. If you recall back

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Speaker 1: in twenty eighteen Val mcgeddon, he was on the right

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Speaker 1: side of that trade, made hundreds of millions of dollars

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Speaker 1: for his firm in identifying a structural problem that was

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Speaker 1: about to blow up. Now, I don't believe the market

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Speaker 1: structure is subject to the same risks as a single

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Speaker 1: inverse trading instrument, but he makes a really compelling case

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Speaker 1: for this is important. We have to pay attention to this,

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Speaker 1: and we have to understand why this is potentially a

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Speaker 1: risky asset with no further ado. My discussion with simplifies

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Speaker 1: Mike Green.

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Speaker 2: Verry, thank you for having me.

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Speaker 1: So let's start out a little bit with your background

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Speaker 1: before we get into your really interesting career Wharton at

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Speaker 1: the University of Pennsylvania. You're also a CFA holder. What

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Speaker 1: was the initial career plan?

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Speaker 2: Well, the initial career plan actually, so I grew up

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Speaker 2: on a farm in northern California. My initial career plan

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Speaker 2: was that I was going to go into science. I

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Speaker 2: actually studied physics as a young man, and then recognized

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Speaker 2: that I was not actually nearly talented enough in physics

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Speaker 2: to do anything of note, and so transition, like many

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Speaker 2: people did in my generation, into finance.

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Speaker 1: Similar similar story. I'm always fascinating when to hear people

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Speaker 1: who were great in high school at mathematics or physics

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Speaker 1: and then go to university and say, oh, I'm only

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Speaker 1: pretty good at that. I'm in the same camp. Camp you.

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Speaker 1: You've had a fairly entrepreneurial background, not just in finance

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Speaker 1: over the past decade or two, but you founded or

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Speaker 1: co founded value add Software in the nineteen nineties. Tell

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Speaker 1: us a little bit about that experience.

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Speaker 2: Sure, so that was actually an outgrowth from my experience

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Speaker 2: coming out of Wharton, And you mentioned the you know,

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Speaker 2: the transition of people who tended to be skilled at

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Speaker 2: math or physics into finance. We forget that there weren't

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Speaker 2: personal computers on everybody's desk back then. We forget that

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Speaker 2: most people didn't have the skill set around Excel et cetera.

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Speaker 1: We did.

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Speaker 2: Excel didn't even exist when I started. It was VisiCalc

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Speaker 2: and lotus, right, and so in the nineteen nineties I

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Speaker 2: developed the late nineteen eighties early nineteen nineties, I developed

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Speaker 2: a skill set around valuation in particularly discount of cash

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Speaker 2: flow or residual income type models. Along with a couple

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Speaker 2: of peers out of the consulting industry, we built a

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Speaker 2: company that was focused on valuation, initially actually targeting corporate

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Speaker 2: strategic planning departments, so working with companies like PepsiCo or

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Speaker 2: others that were looking to either divest business units or

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Speaker 2: to make acquisitions and needed to have mechanism to think

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Speaker 2: about the valuation of these. That's what value added Software

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Speaker 2: was originally. It also was the path for me into

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Speaker 2: the asset management space because coincidentally, Mitch Julis of Canyon

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Speaker 2: Partners was researching on the Internet in the early days

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Speaker 2: of the Internet for valuation engines and insights, stumbled across

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Speaker 2: our stuff and reached out and said, hey, could you

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Speaker 2: link this to the public equity databases like compustats so

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Speaker 2: we could use it for valuing stocks. That actually is

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Speaker 2: exactly what we ended up doing. We were one of

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Speaker 2: the last to get what's called the value added license

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Speaker 2: to the Compustat database, and so that then led to

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Speaker 2: the sale of that business in the late nineteen nineties

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Speaker 2: to Credit Swiss, And.

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Speaker 1: Then you end up actually at Kenyon Capital. Previously I

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Speaker 1: had Dominic Neil as a guest. But you stood up.

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Speaker 1: They're an LA outfit. You stood up the New York

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Speaker 1: office and ran about five billion dollars for them. Tell

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Speaker 1: us what it was like doing that a couple of

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Speaker 1: years before the financial crisis blew up.

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Speaker 2: Well, it was very tight to the financial crisis, and

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Speaker 2: so I'll tell you candidly that I I thought there

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Speaker 2: was a very reasonable chance that I was going to

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Speaker 2: be out on my so the technical term in the

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Speaker 2: financial crisis. You mentioned dominicqu Miels is one of the

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Speaker 2: fantastically talented people at Canyon Partners. She was based out

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Speaker 2: in Los Angeles, and from kind of that nineteen ninety

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Speaker 2: six introduction to Mitch and Josh, they repeatedly tried to

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Speaker 2: get me to go to work for them in Los Angeles.

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Speaker 2: And finally, I think it was two thousand and three

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Speaker 2: or four, I ran into Mitch on the street on

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Speaker 2: actually on fifty seventh, just around the corner from where

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Speaker 2: we are right now, and he said, hey, you know,

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Speaker 2: we're thinking about opening a New York office. Is it

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Speaker 2: US or is it Los Angeles? And the answer was

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Speaker 2: it was Los Angeles. I didn't want to be in

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Speaker 2: Los Angeles. My wife doesn't like to drive. I actually

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Speaker 2: came like within inches of accepting a Canyon Partner's offer

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Speaker 2: back in nineteen ninety eight. And then I'm going from

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Speaker 2: dinner at Mitch Julis's house to the airport. It's eleven

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Speaker 2: o'clock at night on a Friday, but bumper to bumper traffic,

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Speaker 2: and all I could think is, if I do this,

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Speaker 2: I'm done. My wife is going to leave me in

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Speaker 2: about two and a half minutes. And so we just

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Speaker 2: made a meeting of the minds. When they decided to

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Speaker 2: branch out to New York City, it provided the perfect

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Speaker 2: opportunity to transition to Canyon Partners. Initially I joined to

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Speaker 2: help them manage their equity portfolio. My background in the

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Speaker 2: asset management space was originally going to small cap value,

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Speaker 2: and Canyon Partners really gave me the platform that allowed

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Speaker 2: me to branch that out into multiple different areas.

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Speaker 1: How do you more from small cap value into things

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Speaker 1: like derivatives and FX.

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Speaker 2: So my actual background was originally in derivatives. My first

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Speaker 2: job on Wall Street, when I was still at the

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Speaker 2: Universit Pennsylvania, was trading crude oil futures to offset option

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Speaker 2: positions for spear leads in Kellogg. So I had a

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Speaker 2: background in derivatives. The opportunities to trade derivatives and be

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Speaker 2: involved in the hedge fund space was something that really

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Speaker 2: had not emerged, at least for me in New York

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Speaker 2: until Canyon Partners provided that opportunity. But if you look

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Speaker 2: at when I sold my software company in the late

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Speaker 2: nineteen nineties, we had this huge disconnect where I'm a

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Speaker 2: value investor, I'm somebody who's focused on evaluation and small

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Speaker 2: caps and small cap value in particular, we're trading at

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Speaker 2: this incredible discount, and so I actually went into small

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Speaker 2: cap looking at it from the same standpoint that a

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Speaker 2: macro investor might and say, this is an area that

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Speaker 2: has real resources and opportunity, and the valuations are totally

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Speaker 2: mispriced relative to what we're seeing in the broader market.

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Speaker 2: I just got lucky, candidly that the dot com bubble

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Speaker 2: broke about six months after I made that transition. If

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Speaker 2: it had gone on for another two years, I might

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Speaker 2: not be sitting here to talk to you today.

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Speaker 1: Right Hey, listen, smart as good luck is better, luck

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Speaker 1: is better, definitely absolutely true. So after a successful run

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Speaker 1: a Canyon, you stand up your own fund ice Farm Capital,

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Speaker 1: you're seated by Soros Fund Management. So I met him

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Speaker 1: once briefly. I think I was honest at his apartment

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Speaker 1: of Park Avenue for some event. But tell us what

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Speaker 1: it was like working with the people at Soros.

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Speaker 2: Well, So again the Soros guys, in particular Scott Bessett

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Speaker 2: had actually rejoined Soros as the CIO. At that point,

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Speaker 2: he was the lead analyst for a stand Ruck and Miller,

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Speaker 2: and so he was returning to Soros. He basically tried

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Speaker 2: to build a stable of outside managers that he thought

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Speaker 2: were interesting and presented interesting ideas. Initially, same thing as

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Speaker 2: canyon partner is basically meaning.

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Speaker 1: A non correlated multi strategy. Let's spread it across a

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Speaker 1: lot of different ideas, disciplines, approaches, and hopefully some of

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Speaker 1: them are working most of the time.

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Speaker 2: One hundred percent. That's exactly the idea. And so Scott

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Speaker 2: actually approached me about joining Soros, and I turned him

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Speaker 2: down with the observation I've already got a great job.

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Speaker 2: He immediately picked up on that that the word job

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Speaker 2: probably came across tapping into my entrepreneurial background, and he said, well,

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Speaker 2: if you don't want to change jobs, would you be

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Speaker 2: interested in running your own firm, We'll see you. That's

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Speaker 2: what led to Ice Farm Capital. The name, actually, I

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Speaker 2: funnily enough, comes from a vacation property that I used

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Speaker 2: to own. We sold it when we moved to California

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Speaker 2: to follow in the rest of the career. But I

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Speaker 2: owned a nineteenth century ice harvesting operation, which sound insane

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Speaker 2: until you actually stop and think about all the characteristics

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Speaker 2: of what the world would have looked like in nineteen hundred.

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Speaker 2: Ice was very much a business like cable television. Back then,

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Speaker 2: you actually didn't own your ice box. You leased your

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Speaker 2: ice box from the ice company. The iceman cometh right.

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Speaker 2: The iceman was somebody who would deliver the ice on

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Speaker 2: a regular basis, alongside cheese and various other components. And

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Speaker 2: believe it or not, that was the seventh largest business

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Speaker 2: in the United States in nineteen hundred and by nineteen

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Speaker 2: thirty five, with the invention of air conditioning and modern

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Speaker 2: refrigeration techniques, primarily by carrier, the entire industry is gone

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Speaker 2: and everything files for bankruptcy. And so we actually picked

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Speaker 2: up a vacation property that's just outside of exciting vacation

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Speaker 2: destination just outside of Scranton, Pennsylvania, that was in the

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Speaker 2: Pocono Foothills. It was effectively a property that is between

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Speaker 2: two three thousand foot mountains and so in the northeast

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Speaker 2: it constantly stays cool. It was fed by five artesian springs,

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Speaker 2: and so this is the fantastic, most perfect place to

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Speaker 2: grow ice and see ice farm. And we had like

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Speaker 2: railroad tracks that went to New York and Philadelphia, et

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Speaker 2: they're all abandon long since abandoned, but that was the

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Speaker 2: genesis of the name. We're always looking for a name.

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Speaker 2: Toron the te launcha farm.

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Speaker 1: No, that's great, and there's if you look at every

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Speaker 1: Greek mythological creature or god, like, all the names have

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Speaker 1: been taken. It's pretty it's pretty hilarious. So let's talk

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Speaker 1: about the next gig. You have Teal Macro. You're managing

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Speaker 1: the personal capital of Peter Teal, which I found fascinating

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Speaker 1: because people have a tendency to read into the politics

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Speaker 1: of the investors. The New York Post famously does this

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Speaker 1: all the time. But you know, the politics is capital

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Speaker 1: is capital, whether it's coming from source management or Teal

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Speaker 1: tell Us a little bit about what it was like

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Speaker 1: working with Peter Teel Well.

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Speaker 2: So those are pretty much the two extremes, right, one

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Speaker 2: certainly perceived as you know, right wing in one way,

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Speaker 2: and the others perceived is very much left wing. I

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Speaker 2: don't care about the politics component. I care a lot

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Speaker 2: about politics per se, but I very strongly believe that

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Speaker 2: we're able to have our own opinions. There is a

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Speaker 2: degree of discussion around those types of components in any setting, right,

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Speaker 2: and so it is important that at least you're able

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Speaker 2: to entertain that. Peter is unbelievably brilliant, right. He is

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Speaker 2: one of these people who I think has a very

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Speaker 2: intuitive grasp of order in the universe and tries to

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Speaker 2: take positions that exploit those underlying dynamics. His you know,

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Speaker 2: familiarity with Rene Gerrard and the dynamic of mimicry and

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Speaker 2: people's desire to imitate what other people have or to

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Speaker 2: try to obtain what other people value. I think it's

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Speaker 2: kind of his underpinning philosophy and has proved to be

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Speaker 2: really really powerful in terms of identifying where the puck

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Speaker 2: is going. You know, Peter built a phenomenal pool of

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Speaker 2: capital that it was a real privilege to have the

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Speaker 2: opportunity to work with him on.

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Speaker 1: And he was an early investor. People sometimes forget he

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Speaker 1: was early in Facebook, he was early in I think

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Speaker 1: was Uber. I mean, he was in the right place

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Speaker 1: at the right time more often than we were talking

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Speaker 1: about Lucky at a certain point. It's like, hey, you

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Speaker 1: know once or twice as a coincidence, but at a

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Speaker 1: certain point there's a certain set of insights and skills there.

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Speaker 2: Yeah, I don't think Luck plays nearly as much of

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Speaker 2: a role as people would like to think because it

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Speaker 2: relates to Peter. I do think that a lot of

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Speaker 2: the dynamics that we saw coming out of Silicon Valley,

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Speaker 2: Peter was one of the first people to say, hey, wait,

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Speaker 2: let's try to treat this like a business as compared

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Speaker 2: to purely a scientific experiment. And so he was part

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Speaker 2: of that early crop of venture capitalists in that late

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Speaker 2: nineteen nineties time period. Then I think started to think

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Speaker 2: about it less on the pure technology front and more

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Speaker 2: on exactly as I was referring to with rhine Asia,

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Speaker 2: are the aspirational dynamics, Like what do people really want? Right?

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Speaker 2: Very few people want to quote unquote get onto a smartphone.

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Speaker 2: They want to be able to connect with their friends,

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Speaker 2: they want to be able to do math, they want

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Speaker 2: to be able to get their email, they want to

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Speaker 2: be able to do their work away from the office,

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Speaker 2: et cetera. That awareness that that world was transitioning to

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Speaker 2: the online space, I think is really what Peter's key

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Speaker 2: observation was, And now it's interesting to watch him as

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Speaker 2: he recognizes I think in a lot of ways that

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Speaker 2: people want other things in life, not necessarily just technology.

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Speaker 1: There's a whole long conversation about the evils of how

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Speaker 1: we use tech. But before I leave the teal macro,

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Speaker 1: I got to ask you about the famous vommageddon trade

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Speaker 1: in twenty eighteen. You had identified in advance that there

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Speaker 1: were some structural problems with XIV, and on behalf of

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Speaker 1: that funds you made a bet that, hey, this thing

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Speaker 1: is going to blow up. Tell us a little bit

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Speaker 1: about that trade.

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Speaker 2: Sure, so, XIV, which has been reintroduced in various forums,

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Speaker 2: was just an inverse of the VIX index.

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Speaker 1: Meaning when market volatility went down, that should go up.

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Speaker 2: It should go up. The irony, of course, is that

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Speaker 2: like most of these trades that's out there, it's not

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Speaker 2: quite what people thought it was right. So the actual

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Speaker 2: source of profitability in that trade is not the level

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Speaker 2: of the VIX, but the shape of the vul's surface.

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Speaker 1: Right, just describe define what you mean by that.

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Speaker 2: So the structure of the vall's surface is generally upward sloping,

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Speaker 2: meaning that people are more uncertain and priced greater uncertainty

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Speaker 2: about events far off into the future as compared to

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Speaker 2: events that are relatively nearby right now. When that inverts,

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Speaker 2: when the VIC spikes on a risk off event, that

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Speaker 2: actually means that you're suddenly if you're inverse, right, so

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Speaker 2: you're shorting this dynamic. You're shorting stuff that is low

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Speaker 2: priced is rolling up to high price. Right. That's really

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Speaker 2: bad on the flip side of that equation. In a

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Speaker 2: normal what's called a contango construction in the VIX, if

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Speaker 2: you are shorting six month volatility or two month volatility

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Speaker 2: and buying it back as one month volatility, you're typically

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Speaker 2: selling it around fifteen and buying it back around twelve.

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Speaker 2: That's a crazy return when you think about it that

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Speaker 2: that's happening every single month. You're basically generating twenty close

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Speaker 2: to twenty five percent right in that trade on a

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Speaker 2: monthly basis. When you run that full strength, it gives

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Speaker 2: the dynamics of something like the XIV, which rose six

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Speaker 2: hundred percent in twenty seventeen. Right now, my observation was

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Speaker 2: twofold one was that because of the growth of this strategy,

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Speaker 2: it had actually gotten so large that it was consuming

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Speaker 2: all of the liquidity in the UX futures, the vic's futures.

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Speaker 2: On normal trading days it was about seventy percent of

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Speaker 2: the daily volume. Was simply the rebalancing of these things.

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Speaker 1: Wow, that's huge.

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Speaker 2: So the passive component of that, which will feed into

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Speaker 2: a discussion we'll have later on, had just become so

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Speaker 2: large that it relied on liquidity that was not necessarily

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Speaker 2: going to be there.

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Speaker 1: Right, very similar to the financial crisis, where people had

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Speaker 1: long term debts but it was so much cheaper to

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Speaker 1: finance that with short term paper. Hey, we'll just roll

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Speaker 1: it over.

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Speaker 2: Every thirty days one hundred percent. That's exactly the same

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Speaker 2: underlying dynamic. And by the way, the model for the

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Speaker 2: trade that I built was actually going back and reading

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Speaker 2: Paul Tudor Jones analysis leading into the crash in nineteen

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Speaker 2: eighty seven folio insurance components. Right, it was the exact

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Speaker 2: same trade. So like down to the point the portfolio

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Speaker 2: insurance was consuming somewhere around thirty to forty percent of

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Speaker 2: the volume on the S and P five hundred on

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Speaker 2: a normal basis. Paul's observation, Paul Tuder Jones' observation was

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Speaker 2: that in an event that actually exacerbated volatility, the trading

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Speaker 2: quantity that they would need was far greater than the

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Speaker 2: market could supply. I had the exact same insight, exact

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Speaker 2: same view, and simply pointed out that, like, look, there's

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Speaker 2: a misunderstanding of an inverse product. You think, like a

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Speaker 2: normal stock, it's getting safer and safer and safer as

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Speaker 2: it goes higher in price. But that's the exact opposite.

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Speaker 2: And so what you were actually building was a bimodal distribution,

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Speaker 2: meaning two homps to the distribution where there was a

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Speaker 2: smaller and smaller probability that everything was okay, and a

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Speaker 2: bigger and bigger probability that all I think technical term

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Speaker 2: is all hell was about to break loose.

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Speaker 1: Right.

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Speaker 2: We basically came to the conclusion there was roughly a

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Speaker 2: ninety five percent chance it was going to go to zero.

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Speaker 2: Over a two year period. We ended up buying. This

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Speaker 2: is one of the wonderful things about financial markets and

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Speaker 2: degrees of completeness. There were options available with a two

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Speaker 2: year time horizon that allowed us to.

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Speaker 1: An amazing leverage. So how much how much were you

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Speaker 1: putting at risk at that moment that Hey, this this

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Speaker 1: analysis is correct and the timing this should happen within

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Speaker 1: two years.

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Speaker 2: So we were actually ultimately limited by the liquidity in

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Speaker 2: the space, but it was large enough that we were

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Speaker 2: able to put a sizeable amount of amount and make

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Speaker 2: a meaningful.

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Speaker 1: Long So you made this trade on behalf of Teal

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Speaker 1: macro put any of your own capital into it also.

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Speaker 2: Well, that's one of the funny things that everybody discovers

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Speaker 2: is you go through this industry, is that when your

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Speaker 2: compensation is tied to the outcome of the trade, you

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Speaker 2: can absolutely express components of it. But the reality is

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Speaker 2: is that we're all massively underinvested in things like equities,

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Speaker 2: et cetera.

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Speaker 1: Because so much of your income is that you know,

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Speaker 1: I've had that exact conversation, Hey, why don't you own

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Speaker 1: more common stocks? You talk about passive investing this and that,

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Speaker 1: I don't know, how about ninety five percent of my

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Speaker 1: net worth is up in market related investments.

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Speaker 2: You're in the same leg one hundred percent, and it's

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Speaker 2: hard for people to understand that. So it's great to

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Speaker 2: have the opportunity to actually share that. I mean, our

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Speaker 2: industry tends to be among the most conservative investors out there,

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Speaker 2: precisely because we look at it and we're like, wait

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Speaker 2: a second, if this risk goes wrong, not only do

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Speaker 2: I lose my assets, but I lose my job.

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Speaker 1: Right, it's double concent trade risk. There were lots of

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Speaker 1: rumors about that trade at the time. Some people said

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Speaker 1: it was fifty million, one hundred million, two hundred million.

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Speaker 1: I don't know what you're allowed to talk about, but

365
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Speaker 1: it's safe to say this was a big eight or

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Speaker 1: nine figure trend profit, right, this was a giant win.

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Speaker 2: Yeah, the notional amount of the trade was about a

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Speaker 2: quarter billion dollars and we did well.

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Speaker 1: I'm going to guess you don't have to sit. You

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Speaker 1: don't have to admit or deny the following. But if

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Speaker 1: the if that was your notational one hundred isn't a

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Speaker 1: ridiculous profit margin. That's Barry saying it. That's not Mike.

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Speaker 1: So any compliance people listening, I'm just spit bowling here.

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Speaker 1: A couple of months ago, I had David Einhorn on

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Speaker 1: and he made some news basically saying passive has broken

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Speaker 1: the markets, and kind of snuck by after he dropped

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Speaker 1: that bomb. Was he credited you with helping him understand

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Speaker 1: how passive has changed market structures and forcing him to

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Speaker 1: become as a value investor, more of a let's call

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Speaker 1: it a deep value investor, and his performance has since rebounded. So,

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Speaker 1: given that Einhorn has credited you with this insight, tell

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Speaker 1: us how you came about to this belief.

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Speaker 2: Sure, so the XIV trade was actually part of a

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Speaker 2: broader research into the dynamics of passive And if I'm

385
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Speaker 2: going to run through that language and help explain it,

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Speaker 2: the single biggest contributor to that research was actually a

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Speaker 2: twenty sixteen paper by Los A. Peterson at AQR Brilliant individual.

388
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Speaker 2: He wrote a paper called sharpening the Arithmetic of Active Management. Right.

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Speaker 2: That paper refers back to the foundational literature of Bill Sharp,

390
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Speaker 2: who wrote the famous paper in nineteen ninety one the

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Speaker 2: Arithmetic of active management, which is the source of any

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Speaker 2: statement that you hear which is active simply owns the

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Speaker 2: same stocks as passive because it charges less. Therefore, passive

394
00:20:19,720 --> 00:20:22,920
Speaker 2: will outperform over time. Right, The argument is very straightforward.

395
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Speaker 2: There's an assumption of completeness and markets. What Lasse pointed

396
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Speaker 2: out in his paper was that passive had to transact

397
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Speaker 2: during periods in which there was index rebalancing, and so

398
00:20:34,480 --> 00:20:38,200
Speaker 2: in that period they ceased to be passive investors. They

399
00:20:38,240 --> 00:20:42,160
Speaker 2: became active investors, and that became an opportunity for outperformance. Now,

400
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Speaker 2: the reason that that became interesting to me was I

401
00:20:45,400 --> 00:20:49,320
Speaker 2: recognized one additional feature that Lasse had not highlighted, which

402
00:20:49,359 --> 00:20:52,359
Speaker 2: is that passive investors are always transacting because of the

403
00:20:52,440 --> 00:20:55,880
Speaker 2: dynamics of flow. So you get your paycheck, you put

404
00:20:55,960 --> 00:21:00,000
Speaker 2: six percent aside that flows into various Vanguard funds. There

405
00:21:00,119 --> 00:21:02,560
Speaker 2: transacting on a daily basis, And just to put it

406
00:21:02,600 --> 00:21:05,600
Speaker 2: in perspective, over the past couple of years, Vanguard has

407
00:21:05,680 --> 00:21:08,600
Speaker 2: averaged somewhere in the neighborhood of three hundred billion dollars

408
00:21:08,600 --> 00:21:11,879
Speaker 2: worth of inflows every single year. That's the equivalent of

409
00:21:11,920 --> 00:21:15,159
Speaker 2: a large hedge fund every single day having to deploy

410
00:21:15,200 --> 00:21:17,720
Speaker 2: its capital into the market. And so when you think

411
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Speaker 2: about this dynamic of is passive actually passive, it's really

412
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Speaker 2: important to understand that the definition of passive as it stated,

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Speaker 2: and this is true for the XIV, it's true for

414
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Speaker 2: the S and P five hundred, in any form of

415
00:21:30,080 --> 00:21:33,600
Speaker 2: index fund the definition of passive is somebody who never transacts.

416
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Speaker 2: If they transact every single day, then they're actually a

417
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Speaker 2: different animal.

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Speaker 1: So let me push back on that definition a little bit,

419
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Speaker 1: because I don't want us because you and I are

420
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Speaker 1: going to disagree about some things, but I want us

421
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Speaker 1: to have some fundamental agreement. My definition of passive is

422
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Speaker 1: rather than trying to time the market or pick specific stocks,

423
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Speaker 1: or have a concentrated portfolio, meaning a high active share

424
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Speaker 1: so you don't look like the index, you're just going

425
00:22:00,520 --> 00:22:03,320
Speaker 1: to default to a broad index, whether it's the S

426
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Speaker 1: and P five hundred or the Vanguard Total Market, which

427
00:22:07,200 --> 00:22:09,120
Speaker 1: I think is eight hundred, and then there's an even

428
00:22:09,240 --> 00:22:12,359
Speaker 1: larger one that's a few thousand, and I'm going to

429
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Speaker 1: own the whole market. And what that will allow me

430
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Speaker 1: to do is have minimal trading costs, minimal tax costs,

431
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Speaker 1: and avoid all the behavioral problems that comes with active management.

432
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Speaker 1: And so I'm going to own this in a four

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Speaker 1: oh one k. It'll be a mutual funds in a

434
00:22:28,400 --> 00:22:31,760
Speaker 1: taxable account, it'll be an ETF and I'll let that run.

435
00:22:31,880 --> 00:22:36,119
Speaker 1: So I don't think you're that disagreeing with that definition

436
00:22:36,280 --> 00:22:38,960
Speaker 1: or how far off is my definition from yours.

437
00:22:39,480 --> 00:22:42,560
Speaker 2: Well, the only difference in our definitions is actually the

438
00:22:42,560 --> 00:22:45,800
Speaker 2: process of how you get to hold it. Right, So

439
00:22:45,880 --> 00:22:49,320
Speaker 2: the natural conclusion that you're making is actually consistent with

440
00:22:49,480 --> 00:22:52,879
Speaker 2: Sharp's paper, which is the idea that passive investors hold

441
00:22:53,000 --> 00:22:55,840
Speaker 2: every security. The problem is how do you get in

442
00:22:55,920 --> 00:22:58,120
Speaker 2: to hold those securities and how do you get out

443
00:22:58,119 --> 00:22:59,400
Speaker 2: when the time comes to sell them.

444
00:23:00,000 --> 00:23:02,439
Speaker 1: No, you're not disagreeing at all. You set up your

445
00:23:02,480 --> 00:23:04,840
Speaker 1: four o one K, or you set up your investment plan,

446
00:23:05,160 --> 00:23:07,919
Speaker 1: and whether you're making a purchase and putting it away

447
00:23:08,400 --> 00:23:11,159
Speaker 1: or dollar cost averaging in your four oh one K

448
00:23:11,400 --> 00:23:14,480
Speaker 1: or in any other My partner Josh calls this the

449
00:23:14,520 --> 00:23:18,560
Speaker 1: relentless bid. The constant flow of money into four oh

450
00:23:18,560 --> 00:23:24,480
Speaker 1: one k or iras have operated as a little bit

451
00:23:24,480 --> 00:23:27,200
Speaker 1: of a floor on the market. You know, the dot

452
00:23:27,240 --> 00:23:32,480
Speaker 1: com financial crisis and pandemic crash is notwithstanding. Most of

453
00:23:32,520 --> 00:23:36,480
Speaker 1: the time there you can count on positive inflows to equities.

454
00:23:37,359 --> 00:23:40,800
Speaker 2: Well, yes, right, I think that's correct. And I do

455
00:23:40,840 --> 00:23:42,719
Speaker 2: think you used a term that I think is really interesting,

456
00:23:42,760 --> 00:23:43,680
Speaker 2: the relentless bid.

457
00:23:43,840 --> 00:23:44,080
Speaker 1: Yeah.

458
00:23:44,080 --> 00:23:46,960
Speaker 2: Absolutely, And so when you start thinking about each of

459
00:23:46,960 --> 00:23:49,120
Speaker 2: those individual components that you're talking about, first of all,

460
00:23:49,160 --> 00:23:51,840
Speaker 2: just it's really important to understand that all the literature

461
00:23:51,880 --> 00:23:55,439
Speaker 2: that exists around active versus passive, and the idea that

462
00:23:55,480 --> 00:24:00,320
Speaker 2: passive doesn't meaningfully change markets actually presumes that it's simply

463
00:24:00,359 --> 00:24:02,760
Speaker 2: a hold that there is no transaction activity.

464
00:24:02,760 --> 00:24:05,600
Speaker 1: It goes I mean other than I mean, obviously, it's

465
00:24:05,640 --> 00:24:08,560
Speaker 1: not like, Okay, everybody in nineteen ninety nine buy stocks

466
00:24:08,600 --> 00:24:10,680
Speaker 1: and then no one buys stocks for the next thirty years.

467
00:24:10,960 --> 00:24:15,720
Speaker 1: There's a continual the economy continues to grow, people earn wages,

468
00:24:15,800 --> 00:24:19,360
Speaker 1: whether it's a retirement account or a tax deferred account

469
00:24:19,440 --> 00:24:23,399
Speaker 1: or just an investment account. The average mom and pop

470
00:24:23,440 --> 00:24:27,320
Speaker 1: investor throws money into the market on a regular basis

471
00:24:27,359 --> 00:24:31,200
Speaker 1: and takes money out of the market when it's needed

472
00:24:31,240 --> 00:24:32,159
Speaker 1: for other purposes.

473
00:24:32,680 --> 00:24:36,560
Speaker 2: So the fascinating thing about that is, first, I completely agree, right,

474
00:24:36,600 --> 00:24:39,199
Speaker 2: and I think that's actually part of the language that

475
00:24:39,280 --> 00:24:43,120
Speaker 2: gets confused and lost on this. And so again, anytime

476
00:24:43,160 --> 00:24:46,440
Speaker 2: you're transacting, you're not passive. When you decide to buy

477
00:24:46,800 --> 00:24:50,159
Speaker 2: with your weekly contributions. You're not passive. What you're actually

478
00:24:50,200 --> 00:24:53,399
Speaker 2: doing is you're transacting in a systematic fashion. So you

479
00:24:53,400 --> 00:24:57,880
Speaker 2: are a systematic algorithmic investor that has a very simple rule,

480
00:24:57,960 --> 00:25:01,040
Speaker 2: what do I buy? I buy everything? What price? Should

481
00:25:01,040 --> 00:25:03,080
Speaker 2: I buy it? At? Whatever price the market is offering

482
00:25:03,080 --> 00:25:05,600
Speaker 2: me that's presumed to be the right price right now.

483
00:25:06,080 --> 00:25:08,960
Speaker 2: Anytime you buy, you've traded portfolios that are several hundred

484
00:25:09,000 --> 00:25:12,320
Speaker 2: million to billion dollars in size. Anytime you attempt a

485
00:25:12,359 --> 00:25:16,199
Speaker 2: transaction like that, you're going to influence the prices. And

486
00:25:16,240 --> 00:25:19,680
Speaker 2: that's really what distinguishes the difference. That's what David is highlighting.

487
00:25:19,720 --> 00:25:24,640
Speaker 2: As more and more investors transition to this systematic algorithmic

488
00:25:24,680 --> 00:25:28,359
Speaker 2: investment that simply says did you give me cash? If so,

489
00:25:28,440 --> 00:25:31,919
Speaker 2: then buy? Did you ask for cash? If so, then sell?

490
00:25:32,240 --> 00:25:32,920
Speaker 1: That starts to.

491
00:25:32,960 --> 00:25:36,520
Speaker 2: Change the market behavior in a measurable and meaningful fashion.

492
00:25:37,040 --> 00:25:40,239
Speaker 2: It actually causes two things to happen. One is it

493
00:25:40,280 --> 00:25:43,639
Speaker 2: creates a momentum bid because what do I choose to buy?

494
00:25:44,000 --> 00:25:47,040
Speaker 2: I choose to buy whatever the market is pricing it at.

495
00:25:47,240 --> 00:25:49,920
Speaker 2: So things that went up since I had my last purchase,

496
00:25:50,040 --> 00:25:52,600
Speaker 2: I buy more of as a proportion of my assets,

497
00:25:52,960 --> 00:25:56,199
Speaker 2: I buy less of things that went down. The second

498
00:25:56,200 --> 00:25:59,560
Speaker 2: thing that it ultimately does is it creates conditions under

499
00:25:59,600 --> 00:26:04,320
Speaker 2: which a transition from cash rich portfolios that are ultimately

500
00:26:04,640 --> 00:26:07,800
Speaker 2: option like in their characteristics. So I, as a discretionary

501
00:26:07,800 --> 00:26:11,400
Speaker 2: portfolio manager, if you hand me cash, I can look

502
00:26:11,400 --> 00:26:13,320
Speaker 2: at the market and say, you know what, thank you

503
00:26:13,359 --> 00:26:15,720
Speaker 2: for the cash. I'm going to hold it in my portfolio.

504
00:26:16,080 --> 00:26:18,399
Speaker 2: I'm going to use this as an opportunity for me

505
00:26:18,480 --> 00:26:21,240
Speaker 2: to reduce my exposure to the market. Or I could

506
00:26:21,320 --> 00:26:23,639
Speaker 2: choose to use it to buy something without having to

507
00:26:23,680 --> 00:26:24,359
Speaker 2: sell something.

508
00:26:24,840 --> 00:26:29,080
Speaker 1: Given that, what are the risks to the US economy

509
00:26:29,160 --> 00:26:34,160
Speaker 1: and to the markets from too much passive investments flowing

510
00:26:34,200 --> 00:26:35,280
Speaker 1: in to equities?

511
00:26:35,640 --> 00:26:39,960
Speaker 2: So the key risk ultimately lies in that very simple language, Right,

512
00:26:40,280 --> 00:26:42,640
Speaker 2: did you give me cash? Ift? So then buy? Did

513
00:26:42,640 --> 00:26:44,840
Speaker 2: you ask for cash? Iifts? So then sell? And I

514
00:26:44,880 --> 00:26:46,280
Speaker 2: just want to pause for a second and go through

515
00:26:46,280 --> 00:26:47,919
Speaker 2: a little bit of financial history here, because I think

516
00:26:47,920 --> 00:26:51,280
Speaker 2: it's really important for people to understand this. Things that

517
00:26:51,320 --> 00:26:53,960
Speaker 2: we think of as having always been there, things like

518
00:26:53,960 --> 00:26:56,920
Speaker 2: four to oh one ks and iras are actually very

519
00:26:56,960 --> 00:27:00,119
Speaker 2: recent inventions, and there have been dramatic changes around on

520
00:27:00,119 --> 00:27:03,760
Speaker 2: their implementation within your investment career and my investment career,

521
00:27:03,760 --> 00:27:05,280
Speaker 2: which are roughly similar in duration.

522
00:27:05,760 --> 00:27:09,720
Speaker 1: It actually predates US, but had not become popular like

523
00:27:09,800 --> 00:27:12,520
Speaker 1: it had existed for about twenty years before people start

524
00:27:12,560 --> 00:27:15,000
Speaker 1: to figure out, wait, I could put this money away

525
00:27:15,200 --> 00:27:17,720
Speaker 1: and have a grow tax free. It really took a

526
00:27:17,760 --> 00:27:21,080
Speaker 1: few decades before the market kind of came to grips

527
00:27:21,119 --> 00:27:21,320
Speaker 1: with that.

528
00:27:21,400 --> 00:27:23,600
Speaker 2: Yeah, I mean so just very quickly. Iras were actually

529
00:27:23,600 --> 00:27:26,920
Speaker 2: created in nineteen seventy two to facilitate a key risk

530
00:27:26,960 --> 00:27:30,040
Speaker 2: that nobody had ever imagined before, which is, if you

531
00:27:30,080 --> 00:27:33,000
Speaker 2: were a union employee who was fired in the nineteen

532
00:27:33,040 --> 00:27:36,520
Speaker 2: seventy one recession and you received a lump sum settlement

533
00:27:36,600 --> 00:27:40,320
Speaker 2: of your pension, you suddenly that was treated as earned

534
00:27:40,320 --> 00:27:43,240
Speaker 2: income in that year, you were subject to the seventy

535
00:27:43,280 --> 00:27:46,560
Speaker 2: five percent marginal attacks ray. It was absolutely insane and

536
00:27:46,600 --> 00:27:50,120
Speaker 2: devastating to many individuals, and so the IRA was created

537
00:27:50,119 --> 00:27:53,400
Speaker 2: to facilitate the rollover of those on a tax deferred basis,

538
00:27:53,600 --> 00:27:55,920
Speaker 2: so you could maintain those assets even if you lost

539
00:27:55,960 --> 00:27:59,520
Speaker 2: your job. Right. The second tool that was introduced was

540
00:27:59,520 --> 00:28:02,440
Speaker 2: the four one K, which refers to a specific provision

541
00:28:02,440 --> 00:28:06,440
Speaker 2: of the tax code that created the defined contribution. Right,

542
00:28:06,640 --> 00:28:09,159
Speaker 2: if you launch yourself all the way back to nineteen

543
00:28:09,200 --> 00:28:10,760
Speaker 2: eighty one and the start of the Bowl market in

544
00:28:10,800 --> 00:28:12,680
Speaker 2: nineteen eighty two, the start of the Bowl market in

545
00:28:12,840 --> 00:28:17,640
Speaker 2: US equities following the election of Reagan. The total assets

546
00:28:17,640 --> 00:28:21,680
Speaker 2: in those two were about one hundred billion dollars in each. Right, today,

547
00:28:22,000 --> 00:28:26,240
Speaker 2: iras I believe are around seventeen trillion and four oh

548
00:28:26,280 --> 00:28:28,080
Speaker 2: one k's are somewhere in the neighborhood of eight to

549
00:28:28,200 --> 00:28:32,040
Speaker 2: nine trillion. Right, these are the single largest pools of

550
00:28:32,080 --> 00:28:37,440
Speaker 2: assets on the planet. Is the American retirement system. There

551
00:28:37,560 --> 00:28:41,280
Speaker 2: is a subsequent change in two thousand and six called

552
00:28:41,280 --> 00:28:44,840
Speaker 2: the Pension Protection Act that one tried to push more

553
00:28:44,880 --> 00:28:47,640
Speaker 2: and more people into four oh one k's, right by

554
00:28:47,680 --> 00:28:50,520
Speaker 2: making it what's called an opt out framework as compared

555
00:28:50,560 --> 00:28:51,560
Speaker 2: to an opt in right.

556
00:28:51,600 --> 00:28:54,120
Speaker 1: You can blame Dick Taylor and Nudge for that.

557
00:28:54,120 --> 00:28:56,680
Speaker 2: One hundred percent the Nudge dynamics and trying to create

558
00:28:56,720 --> 00:29:00,000
Speaker 2: the ownership economy, and those have been on net quite

559
00:29:00,120 --> 00:29:03,560
Speaker 2: positive components to them, but they have meaningfully changed the

560
00:29:03,600 --> 00:29:05,960
Speaker 2: structure of how flows enter the market.

561
00:29:05,880 --> 00:29:07,680
Speaker 1: Cause to the QFIDS right.

562
00:29:08,160 --> 00:29:11,400
Speaker 2: So QDIA is is what QDI is so the qualified

563
00:29:11,400 --> 00:29:15,760
Speaker 2: default investment alternative. If you're going to default somebody into participating,

564
00:29:16,160 --> 00:29:18,800
Speaker 2: you no longer leave it up to them to say, hey,

565
00:29:18,840 --> 00:29:20,600
Speaker 2: what do you want to buy? You actually have to

566
00:29:20,640 --> 00:29:23,200
Speaker 2: select something that you're going to put them into. And

567
00:29:23,280 --> 00:29:26,280
Speaker 2: so the Pension Protection Act also introduced this idea of

568
00:29:26,320 --> 00:29:30,880
Speaker 2: qualified default investment alternatives that provided a liability protected mechanism

569
00:29:31,040 --> 00:29:34,480
Speaker 2: for HR managers or CFOs to declare, this is where

570
00:29:34,480 --> 00:29:38,080
Speaker 2: we're going to default people into. Initially those were balanced funds,

571
00:29:38,160 --> 00:29:39,840
Speaker 2: so this is part of the key growth of PIMCO,

572
00:29:39,920 --> 00:29:42,719
Speaker 2: which had skill set in both in both equities and

573
00:29:42,800 --> 00:29:45,680
Speaker 2: fixed income. So the growth of balanced funds was a

574
00:29:45,720 --> 00:29:48,400
Speaker 2: really really key characteristic of that two thousand and six

575
00:29:48,760 --> 00:29:52,200
Speaker 2: to twenty twelve market. And then in twenty twelve they

576
00:29:52,280 --> 00:29:55,280
Speaker 2: changed the QDIA to what's called a target date fund,

577
00:29:55,280 --> 00:29:57,880
Speaker 2: which is what about eighty five percent of Americans now

578
00:29:57,960 --> 00:30:00,600
Speaker 2: default into in their retirement assets.

579
00:30:00,800 --> 00:30:02,760
Speaker 1: Right. What the way it used to be is you

580
00:30:02,800 --> 00:30:06,400
Speaker 1: would start out a company, even if they had a match,

581
00:30:07,240 --> 00:30:09,080
Speaker 1: you had to go out and do the paperwork. You

582
00:30:09,120 --> 00:30:13,240
Speaker 1: had to go out and choose a fund, even if

583
00:30:13,320 --> 00:30:16,800
Speaker 1: they said as joining a company, you automatically get a

584
00:30:16,800 --> 00:30:19,800
Speaker 1: four oh one K. Cash would just pile up in

585
00:30:19,840 --> 00:30:23,160
Speaker 1: there if you didn't give some form of diffraction. So

586
00:30:24,120 --> 00:30:27,320
Speaker 1: essentially what was designed to say, Hey, you got to

587
00:30:27,320 --> 00:30:30,040
Speaker 1: get off your button, do something. We're gonna make it.

588
00:30:30,280 --> 00:30:33,280
Speaker 1: We're gonna make sure you're investing in something. It's up

589
00:30:33,320 --> 00:30:34,640
Speaker 1: to you to go in and change it to what

590
00:30:34,680 --> 00:30:38,200
Speaker 1: you want. It's kind of shocking and in some ways

591
00:30:40,120 --> 00:30:44,080
Speaker 1: just reminding us of the strength of behavioral finance that

592
00:30:44,160 --> 00:30:46,320
Speaker 1: people are so lazy, just like would you put me

593
00:30:46,360 --> 00:30:48,440
Speaker 1: in okay, great, and they don't even think twice about

594
00:30:48,440 --> 00:30:49,080
Speaker 1: it one.

595
00:30:49,000 --> 00:30:51,280
Speaker 2: Hundred percent, And that actually is exactly what we see.

596
00:30:51,360 --> 00:30:55,040
Speaker 2: So it's also a very bifurcated experience where those who

597
00:30:55,040 --> 00:30:57,840
Speaker 2: were older and who already defaulted into four oh one

598
00:30:57,920 --> 00:30:59,880
Speaker 2: K plans and made the choice to go into those

599
00:31:00,200 --> 00:31:03,600
Speaker 2: one K plans, they typically would choose from a universe

600
00:31:03,640 --> 00:31:06,920
Speaker 2: of active managers. Right. That's the world that largely existed

601
00:31:06,960 --> 00:31:09,960
Speaker 2: prior to two thousand and six. The passive share at

602
00:31:10,000 --> 00:31:12,800
Speaker 2: that point was still quite low when I entered the industry,

603
00:31:12,800 --> 00:31:14,280
Speaker 2: when I first started, you know, cutting my teeth on

604
00:31:14,280 --> 00:31:16,240
Speaker 2: this stuff. It's hard for people to remember, but passive

605
00:31:16,320 --> 00:31:19,640
Speaker 2: was still roughly one percent market share in nineteen ninety two.

606
00:31:20,120 --> 00:31:23,200
Speaker 1: Vanguard formed in nineteen seventy four. They didn't get to

607
00:31:23,240 --> 00:31:27,240
Speaker 1: a trillion dollars till pretty much after the financial crisis.

608
00:31:27,720 --> 00:31:30,360
Speaker 1: I have a thesis that have said, you know, from

609
00:31:30,400 --> 00:31:33,880
Speaker 1: the nineties implosion and then are just a raft of scandals,

610
00:31:34,240 --> 00:31:37,760
Speaker 1: the accounting scandal, the Anaal scandal, the IPO spinning scandal,

611
00:31:37,800 --> 00:31:39,920
Speaker 1: the just go down the whole list, and then burning

612
00:31:40,000 --> 00:31:43,600
Speaker 1: made off and then the financial crisis. My general sense

613
00:31:43,640 --> 00:31:47,160
Speaker 1: has been lots of mom and pop investors have said,

614
00:31:47,920 --> 00:31:50,120
Speaker 1: we just don't want to get involved in that mess.

615
00:31:50,480 --> 00:31:52,920
Speaker 1: Just let me buy the market and forget about it.

616
00:31:52,960 --> 00:31:56,960
Speaker 1: And for those folks, it's worked out. And those folks

617
00:31:56,960 --> 00:32:00,520
Speaker 1: are very often my clients. So let me pose this

618
00:32:00,600 --> 00:32:04,240
Speaker 1: question to you. If you're having a discussion with a

619
00:32:04,280 --> 00:32:08,280
Speaker 1: fiduciary who runs a few billion dollars in client assets,

620
00:32:09,200 --> 00:32:15,440
Speaker 1: convince me to shift those accounts away from either broad

621
00:32:15,520 --> 00:32:20,080
Speaker 1: indexes or passive generally to something more active. Why should

622
00:32:20,120 --> 00:32:22,760
Speaker 1: I move their accounts elsewhere?

623
00:32:23,240 --> 00:32:25,760
Speaker 2: Quick answer is you shouldn't. And that's actually a part

624
00:32:25,800 --> 00:32:29,520
Speaker 2: of the problem is that the individual choice should be

625
00:32:29,560 --> 00:32:32,760
Speaker 2: to bypassive right the problem is is when all of

626
00:32:32,800 --> 00:32:36,400
Speaker 2: the individuals bypassive, we actually change the structure of the

627
00:32:36,400 --> 00:32:39,400
Speaker 2: market and so it no longer represents what it historically did.

628
00:32:39,720 --> 00:32:41,520
Speaker 1: And by the way, let me interrupt you and just say,

629
00:32:41,760 --> 00:32:45,480
Speaker 1: we obviously have huge swaths of fixed income and muni

630
00:32:45,560 --> 00:32:49,480
Speaker 1: bonds as part of that portfolio, and we also own

631
00:32:49,560 --> 00:32:54,760
Speaker 1: a variety of non passive holdings, some with a value tilt,

632
00:32:54,800 --> 00:32:58,600
Speaker 1: some with a momentum tilt, some international. So it's not like,

633
00:32:58,880 --> 00:33:00,840
Speaker 1: all right, we're going to try a fee and just

634
00:33:00,880 --> 00:33:03,000
Speaker 1: load up on the S and P five hundred. It's

635
00:33:03,040 --> 00:33:06,480
Speaker 1: obviously a lot more significant than that. But given what

636
00:33:06,520 --> 00:33:11,560
Speaker 1: you're saying that fiduciary should be looking for low cost

637
00:33:11,840 --> 00:33:15,040
Speaker 1: at least in a COREN satellite setup, how do you

638
00:33:15,080 --> 00:33:18,920
Speaker 1: go about reducing the risks to what you see as

639
00:33:19,360 --> 00:33:23,640
Speaker 1: market structure problems caused by a simple default to passive.

640
00:33:24,000 --> 00:33:26,000
Speaker 2: So this is actually the core of the issue, and

641
00:33:26,000 --> 00:33:27,360
Speaker 2: it's part of the reason why I spend so much

642
00:33:27,360 --> 00:33:28,680
Speaker 2: time talking about it, and it's part of what I

643
00:33:28,760 --> 00:33:30,920
Speaker 2: made David aware of in that conversation. To go back

644
00:33:30,960 --> 00:33:33,640
Speaker 2: to it is there's very little the individual or the

645
00:33:33,640 --> 00:33:36,080
Speaker 2: individual ria can do to change this. This is a

646
00:33:36,120 --> 00:33:39,640
Speaker 2: regulatory framework, and it is controlled by the vanguards and

647
00:33:39,640 --> 00:33:42,600
Speaker 2: black rocks who are spending far more on lobbying than

648
00:33:42,600 --> 00:33:45,880
Speaker 2: the rest of the industry combined. So part of what's

649
00:33:45,920 --> 00:33:49,520
Speaker 2: really happening is the political choice to push you into

650
00:33:49,520 --> 00:33:52,720
Speaker 2: these vehicles. The political choice to make it the only

651
00:33:52,960 --> 00:33:57,320
Speaker 2: acceptable alternative under the rubric of offering safe, low cost

652
00:33:57,400 --> 00:34:02,640
Speaker 2: investments to people is understandable. We all want that desire. Certainly,

653
00:34:02,640 --> 00:34:03,800
Speaker 2: that's your desire as well.

654
00:34:04,120 --> 00:34:07,200
Speaker 1: I mean, is it an overwhelming amount of academic literature

655
00:34:07,240 --> 00:34:12,200
Speaker 1: that says, you know, some active managers managed to outperform,

656
00:34:12,600 --> 00:34:14,520
Speaker 1: but by the time you get to ten years and

657
00:34:14,560 --> 00:34:18,040
Speaker 1: take in taxes and costs and fees, you would have

658
00:34:18,080 --> 00:34:21,920
Speaker 1: been better off impassive. The more people who find their

659
00:34:21,960 --> 00:34:26,799
Speaker 1: way into passive vehicles, doesn't that create more opportunities for

660
00:34:26,840 --> 00:34:30,680
Speaker 1: people like David Einhorn. Isn't the greater the percentage of

661
00:34:30,719 --> 00:34:35,320
Speaker 1: passive ownership, the more inefficiencies there are, And therefore shouldn't

662
00:34:35,320 --> 00:34:39,480
Speaker 1: we see active sort of reassert itself, perhaps at a

663
00:34:39,520 --> 00:34:42,520
Speaker 1: lower fee than the past. But aren't there more and

664
00:34:42,560 --> 00:34:46,279
Speaker 1: more opportunities for people who have a skill set to

665
00:34:46,400 --> 00:34:49,719
Speaker 1: identify inefficiencies Wherever they pop up.

666
00:34:50,239 --> 00:34:52,479
Speaker 2: So I'm really glad you asked me that question, because

667
00:34:52,520 --> 00:34:54,759
Speaker 2: this is the traditional model and the way that people

668
00:34:54,800 --> 00:34:56,680
Speaker 2: think about it, and it's exactly what I focused on

669
00:34:56,719 --> 00:34:59,960
Speaker 2: with David Right. The immediate reaction to the idea of

670
00:35:00,080 --> 00:35:04,959
Speaker 2: the growth of this non thoughtful entity passive right makes

671
00:35:04,960 --> 00:35:08,000
Speaker 2: it seem like those who are thoughtful should have an advantage.

672
00:35:08,560 --> 00:35:11,120
Speaker 2: The problem is is in the theories that lead you to

673
00:35:11,200 --> 00:35:15,200
Speaker 2: that articulation. So what you're referring to is broadly called

674
00:35:15,239 --> 00:35:18,680
Speaker 2: the Grossman Stiglitz paradox, the dynamic that the more people

675
00:35:18,760 --> 00:35:21,239
Speaker 2: choose not to put an effort into the market and

676
00:35:21,320 --> 00:35:25,160
Speaker 2: divining prices, the greater the incentive and the opportunity set

677
00:35:25,280 --> 00:35:28,200
Speaker 2: is for those who are choosing to put that into

678
00:35:28,320 --> 00:35:31,360
Speaker 2: the market. It's what they call the impossibility of perfectly

679
00:35:31,440 --> 00:35:36,120
Speaker 2: efficient markets. The problem again goes into the details of

680
00:35:36,160 --> 00:35:39,560
Speaker 2: the assumption of the model. So really what Grossman Stiglitz

681
00:35:39,640 --> 00:35:41,840
Speaker 2: is all about is the wisdom of crowds. You're familiar

682
00:35:41,840 --> 00:35:46,200
Speaker 2: with the micromobison examples of these, or the articulation that

683
00:35:46,239 --> 00:35:48,439
Speaker 2: we're all familiar with. You go to the county fair,

684
00:35:48,520 --> 00:35:51,839
Speaker 2: the giant jar of jellybeans, and you're supposed to guess

685
00:35:51,840 --> 00:35:53,719
Speaker 2: how many jelly beans there are in there? Right, any

686
00:35:53,800 --> 00:35:57,160
Speaker 2: individual has a very low probability of success. But when

687
00:35:57,160 --> 00:35:59,799
Speaker 2: we aggregate all the guesses and we take the mean

688
00:35:59,840 --> 00:36:02,160
Speaker 2: of that, it tends to be pretty darn close to

689
00:36:02,200 --> 00:36:05,520
Speaker 2: that answer. And that's composed of absolute nerds like me

690
00:36:05,560 --> 00:36:07,359
Speaker 2: who are like, well, what's the diameter and how big

691
00:36:07,400 --> 00:36:09,279
Speaker 2: as a jelly bean and all that sort of stuff, right,

692
00:36:09,280 --> 00:36:12,319
Speaker 2: and people who are making just total wild guesses. Right.

693
00:36:13,600 --> 00:36:16,680
Speaker 2: The problem is that model the wisdom of crowds actually

694
00:36:16,760 --> 00:36:19,920
Speaker 2: requires everybody to have what's called equal endowment or the

695
00:36:20,000 --> 00:36:23,320
Speaker 2: same number of votes. And that's actually what Grossmuns Stiglitz

696
00:36:23,400 --> 00:36:25,880
Speaker 2: relies on as well, is the idea that the wisdom

697
00:36:25,920 --> 00:36:28,919
Speaker 2: of crowds is caused by the dynamic of each individual

698
00:36:28,960 --> 00:36:32,839
Speaker 2: making those choices and the market in its totality being

699
00:36:32,880 --> 00:36:35,480
Speaker 2: able to guide towards that and so that incentive where

700
00:36:35,520 --> 00:36:39,440
Speaker 2: prices get pushed off. If I'm the same size and

701
00:36:39,480 --> 00:36:41,720
Speaker 2: I have the same number of votes as everybody else,

702
00:36:42,160 --> 00:36:44,239
Speaker 2: I can guide the market back to that. That's the

703
00:36:44,320 --> 00:36:45,360
Speaker 2: opportunity set.

704
00:36:45,840 --> 00:36:50,360
Speaker 1: Why wouldn't that work in equity markets where people with

705
00:36:50,600 --> 00:36:54,239
Speaker 1: more votes more dollars have a greater incentive to get

706
00:36:54,239 --> 00:36:55,680
Speaker 1: the number of jelly beans correct.

707
00:36:55,840 --> 00:36:58,440
Speaker 2: So that's actually exactly what isn't the case. So what's

708
00:36:58,480 --> 00:37:00,560
Speaker 2: actually happening is we're giving more, We're in more of

709
00:37:00,600 --> 00:37:05,240
Speaker 2: a vote to somebody who doesn't care right. As a result,

710
00:37:05,880 --> 00:37:10,280
Speaker 2: Vanguard and Blackrock, because of their daily transactions, the size

711
00:37:10,320 --> 00:37:12,680
Speaker 2: of those transactions has gotten to the point, even though

712
00:37:12,680 --> 00:37:15,080
Speaker 2: they're not actively trading on a day to day basis,

713
00:37:15,520 --> 00:37:19,280
Speaker 2: that relentless bid that your partner refers to is actually

714
00:37:19,360 --> 00:37:22,800
Speaker 2: changing the structure of the market. It's changing that price behavior.

715
00:37:23,280 --> 00:37:24,719
Speaker 2: It's the same thing as if we went to the

716
00:37:24,760 --> 00:37:27,719
Speaker 2: county fair and they said everybody guesses, and then the

717
00:37:27,760 --> 00:37:31,319
Speaker 2: mayor gets to guess ten thousand times whose vote's going

718
00:37:31,360 --> 00:37:31,760
Speaker 2: to count.

719
00:37:32,320 --> 00:37:34,440
Speaker 1: So I did a lot of prep work for this.

720
00:37:34,680 --> 00:37:38,160
Speaker 1: You and I have had disagreements on Twitter about passive

721
00:37:38,239 --> 00:37:42,080
Speaker 1: versus active. I think our disagreements are less than I

722
00:37:42,239 --> 00:37:49,000
Speaker 1: previously realized. I think we both understand the advantages of

723
00:37:49,280 --> 00:37:52,759
Speaker 1: low cost indexing. But let's talk about some of the

724
00:37:52,840 --> 00:37:54,759
Speaker 1: recent data that's come out. I know you're a big

725
00:37:54,760 --> 00:37:58,799
Speaker 1: fan of a lot of research that's out there. Last week,

726
00:37:58,960 --> 00:38:02,920
Speaker 1: Eric Balchunis, who is the etf. Wizard at Bloomberg Intelligence

727
00:38:03,719 --> 00:38:07,759
Speaker 1: put out a report Passive investing worries appear overblown as

728
00:38:07,960 --> 00:38:12,640
Speaker 1: active as in control, and his key takeaway was when

729
00:38:12,640 --> 00:38:15,440
Speaker 1: you looked at the S and P five hundred stocks

730
00:38:15,880 --> 00:38:19,000
Speaker 1: and you broke them into quintiles with the most or

731
00:38:19,040 --> 00:38:24,799
Speaker 1: the least passive ownership, the least owned quintile beat all

732
00:38:24,920 --> 00:38:27,759
Speaker 1: the rest over one three and five years. So if

733
00:38:27,800 --> 00:38:32,160
Speaker 1: that's the case, doesn't that prove the active managers are

734
00:38:32,719 --> 00:38:36,280
Speaker 1: still doing okay and the struck market structure is behaving

735
00:38:36,320 --> 00:38:36,920
Speaker 1: as it should.

736
00:38:37,280 --> 00:38:39,560
Speaker 2: So it'd be nice if that was the case. Unfortunately,

737
00:38:39,600 --> 00:38:42,520
Speaker 2: the analysis was deeply flawed. I pointed this out in

738
00:38:42,600 --> 00:38:46,080
Speaker 2: responses to Eric. Would you discover if you actually dig

739
00:38:46,120 --> 00:38:49,320
Speaker 2: into that analysis? This is that the least passively owned

740
00:38:49,600 --> 00:38:53,320
Speaker 2: stocks are the Apples, Microsoft, in videos, et cetera, the

741
00:38:53,320 --> 00:38:55,000
Speaker 2: world the largest company, meaning the.

742
00:38:54,920 --> 00:38:59,680
Speaker 1: Active managers are buying those big magnificent seven socks.

743
00:38:59,560 --> 00:39:02,399
Speaker 2: Except that or not. And so the reason why that

744
00:39:02,480 --> 00:39:03,759
Speaker 2: disconnect comes.

745
00:39:03,520 --> 00:39:06,200
Speaker 1: Is because you hold on, I have to stop you there, Sure,

746
00:39:06,719 --> 00:39:11,920
Speaker 1: every concentrated portfolio I've looked at, every active manager, you

747
00:39:12,080 --> 00:39:15,480
Speaker 1: have to really go down the list to get to

748
00:39:15,560 --> 00:39:22,120
Speaker 1: people who don't have some combination of Nvidia, Microsoft, Netflix, go,

749
00:39:22,520 --> 00:39:24,160
Speaker 1: you know, go down the list of the top ten.

750
00:39:24,600 --> 00:39:26,960
Speaker 1: They all seem to own United Health. Now, if they're

751
00:39:27,000 --> 00:39:29,760
Speaker 1: not closet indexers, if they don't own three hundred stocks,

752
00:39:30,120 --> 00:39:33,800
Speaker 1: maybe they stop after ten or twenty. But those big

753
00:39:33,920 --> 00:39:37,240
Speaker 1: big cap dare I call them nifty to fifty stocks,

754
00:39:38,000 --> 00:39:40,759
Speaker 1: they seem to be the favorites of the active managers.

755
00:39:41,000 --> 00:39:41,839
Speaker 1: Make the other case.

756
00:39:42,160 --> 00:39:44,480
Speaker 2: So it actually turns out that the active managers, and

757
00:39:44,520 --> 00:39:47,040
Speaker 2: this is almost exactly why we see some of the

758
00:39:47,080 --> 00:39:51,080
Speaker 2: dynamics that we talk about active managers skew towards smaller stocks.

759
00:39:51,480 --> 00:39:54,919
Speaker 2: Simply by definition, right, the Russell two thousand has two

760
00:39:54,960 --> 00:39:57,560
Speaker 2: thousand out of the roughly thirty five hundred stocks available

761
00:39:57,600 --> 00:40:00,759
Speaker 2: publicly traded, it's about four percent of the toll market cap.

762
00:40:01,080 --> 00:40:02,840
Speaker 2: So somebody has to actually go out and own that.

763
00:40:02,960 --> 00:40:04,960
Speaker 2: We know it's not Vanguard, we know it's not Black Rock.

764
00:40:05,000 --> 00:40:07,279
Speaker 2: They're not owning it in any different proportion or any

765
00:40:07,320 --> 00:40:10,319
Speaker 2: meaningfully different proportion to what they're owning everything else. Through

766
00:40:10,360 --> 00:40:13,160
Speaker 2: a total market type index. There are some wrinkles around that,

767
00:40:13,239 --> 00:40:16,240
Speaker 2: but in rough terms, that's the case. You are absolutely

768
00:40:16,239 --> 00:40:19,799
Speaker 2: correct that there is representation of Apple or Microsoft. But

769
00:40:19,880 --> 00:40:22,560
Speaker 2: that actually hits on a slightly different component, which is

770
00:40:23,000 --> 00:40:25,080
Speaker 2: if you are going to compete with the S and

771
00:40:25,080 --> 00:40:28,680
Speaker 2: P five hundred. Paradoxically, you do have to own those names.

772
00:40:28,880 --> 00:40:31,680
Speaker 2: You don't have to own Delta Airlines nobody cares, right,

773
00:40:31,719 --> 00:40:34,120
Speaker 2: but you do have to have exposure to the Apples,

774
00:40:34,160 --> 00:40:38,240
Speaker 2: microsofts etstead of their world. But almost no active manager

775
00:40:38,600 --> 00:40:41,760
Speaker 2: can carry them in the size that a passive vehicle

776
00:40:41,800 --> 00:40:43,560
Speaker 2: can because of concentration limits.

777
00:40:43,680 --> 00:40:45,759
Speaker 1: Why how much is Tesla in the S and P

778
00:40:45,880 --> 00:40:49,359
Speaker 1: five hundred, or Netflix or Nvidia? None of them are

779
00:40:49,400 --> 00:40:53,840
Speaker 1: more than ten percent. Didn't the SMP and the Nasdaq

780
00:40:53,840 --> 00:40:56,600
Speaker 1: one hundred change those rules like ten fifteen years ago?

781
00:40:57,440 --> 00:41:00,200
Speaker 2: So ten to fifteen years ago they changed to you

782
00:41:00,360 --> 00:41:03,680
Speaker 2: market from market cap weighted to float adjusted weights. I

783
00:41:03,719 --> 00:41:07,160
Speaker 2: think that's what you're referring to. But actually, interestingly enough,

784
00:41:07,280 --> 00:41:09,760
Speaker 2: this is part of the dynamic and where regulation plays

785
00:41:09,800 --> 00:41:12,520
Speaker 2: a role. Entities like the S and P five hundred

786
00:41:12,600 --> 00:41:16,719
Speaker 2: Growth Fund are far more concentrated than is legally allowed

787
00:41:16,760 --> 00:41:19,359
Speaker 2: by the forty Act by which they're governed. They are

788
00:41:19,480 --> 00:41:23,040
Speaker 2: too concentrated relative to that they've been given dispensation by

789
00:41:23,080 --> 00:41:26,560
Speaker 2: regulators because they're index investors. And this is where the

790
00:41:26,600 --> 00:41:30,280
Speaker 2: analysis that Eric was highlighting is flawed, because what's actually

791
00:41:30,320 --> 00:41:33,080
Speaker 2: happening when you see the high levels of index ownership

792
00:41:33,440 --> 00:41:36,200
Speaker 2: for an individual name, what's happening is that you're picking

793
00:41:36,320 --> 00:41:39,520
Speaker 2: up a sector fund for example. This is very notorious

794
00:41:39,560 --> 00:41:41,920
Speaker 2: in rets. It's also very clear in things like a

795
00:41:42,000 --> 00:41:46,319
Speaker 2: technology index, the XLK for example, or the xl in

796
00:41:46,360 --> 00:41:50,680
Speaker 2: the energy space XLE is I believe forty percent Exonomobile,

797
00:41:50,719 --> 00:41:54,080
Speaker 2: forty percent Chevron, right, nobody can actually run an active

798
00:41:54,120 --> 00:41:58,320
Speaker 2: portfolio that looks anything remotely are that's pretty crazy?

799
00:41:58,680 --> 00:42:02,520
Speaker 1: Yeah? That that that that's absolutely ridiculous.

800
00:42:02,880 --> 00:42:05,200
Speaker 2: Just very quickly. That is actually what Eric is picking up.

801
00:42:05,200 --> 00:42:07,319
Speaker 2: And I would argue that those are not actually what

802
00:42:07,360 --> 00:42:09,600
Speaker 2: we're talking about when we talk about passive precisely the

803
00:42:09,640 --> 00:42:12,040
Speaker 2: definition you and I were talking about. If you're a

804
00:42:12,120 --> 00:42:15,640
Speaker 2: passive or systematic index investor, you're not saying, well, I'm

805
00:42:15,640 --> 00:42:18,160
Speaker 2: going to overweight energy, I'm going to allocate to an

806
00:42:18,160 --> 00:42:21,239
Speaker 2: individual indust industry and sort of turn around and then

807
00:42:21,360 --> 00:42:25,240
Speaker 2: say that those stocks that are most passively owned don't

808
00:42:25,320 --> 00:42:29,120
Speaker 2: exhibit this type of behavior. Is to confuse those two dynamics.

809
00:42:29,320 --> 00:42:34,120
Speaker 1: So also with an Eric's research piece was something that said, hey,

810
00:42:34,160 --> 00:42:36,200
Speaker 1: we went back and looked at draw downs of ten

811
00:42:36,280 --> 00:42:38,680
Speaker 1: percent or more of the components in the S and

812
00:42:38,760 --> 00:42:42,520
Speaker 1: P five hundred. The stocks with the highest passive ownership

813
00:42:43,120 --> 00:42:47,600
Speaker 1: didn't weren't subject to greater volatility or larger draw downs

814
00:42:47,640 --> 00:42:50,360
Speaker 1: than any of the rest of the ownership, which is

815
00:42:50,400 --> 00:42:53,200
Speaker 1: a big part of the argument that hey, the structure

816
00:42:53,239 --> 00:42:56,200
Speaker 1: is damaged and when it finally breaks, these passively owned

817
00:42:56,239 --> 00:42:57,560
Speaker 1: vehicles are going to be a disaster.

818
00:42:58,360 --> 00:43:01,960
Speaker 2: So there's two separate components. So one is that again,

819
00:43:02,040 --> 00:43:04,680
Speaker 2: the issue is how you're defining the passively held. So

820
00:43:04,719 --> 00:43:08,040
Speaker 2: if by definition I've already gravitated to saying the least

821
00:43:08,120 --> 00:43:11,960
Speaker 2: passively held are the Microsoft Apples, etc. The world, I'm

822
00:43:11,960 --> 00:43:16,080
Speaker 2: going to come to that conclusion. But the unfortunate answer.

823
00:43:16,120 --> 00:43:18,200
Speaker 1: Well, what about the most passively held?

824
00:43:18,440 --> 00:43:21,520
Speaker 2: Those actually, ironically are the most passively held. And the

825
00:43:21,560 --> 00:43:24,360
Speaker 2: reason that they're actually the most passively held is precisely

826
00:43:24,400 --> 00:43:28,760
Speaker 2: this issue of concentration risk. Most active managers can't hold

827
00:43:28,800 --> 00:43:31,279
Speaker 2: those names in the size that's required. If I'm a

828
00:43:31,320 --> 00:43:34,319
Speaker 2: small cap manager or I'm a diversified fund manager, I

829
00:43:34,360 --> 00:43:36,799
Speaker 2: typically have to run with one hundred names in my portfolio.

830
00:43:37,200 --> 00:43:39,919
Speaker 2: One hundred names in my portfolio to be equal weight

831
00:43:40,000 --> 00:43:42,600
Speaker 2: to Apple, for example, in the index, it have to

832
00:43:42,680 --> 00:43:46,319
Speaker 2: far outweigh everything else in my portfolio I offer as

833
00:43:46,360 --> 00:43:49,719
Speaker 2: an active manager, typically very little value added to the

834
00:43:49,760 --> 00:43:53,880
Speaker 2: insights on something like Apple, and so the institutional space

835
00:43:54,440 --> 00:43:58,839
Speaker 2: or most asset selectors, asset allocators are going to look

836
00:43:58,840 --> 00:44:01,520
Speaker 2: for managers that are trying to add value. Otherwise, why

837
00:44:01,560 --> 00:44:04,080
Speaker 2: not just bypassive? Why not go with a low cost solution.

838
00:44:04,880 --> 00:44:08,880
Speaker 1: So that kind of raises the question about what is

839
00:44:08,880 --> 00:44:15,080
Speaker 1: the solution to this. I brought up Balchunis, but I recall, oh,

840
00:44:15,120 --> 00:44:18,840
Speaker 1: maybe it's ten years ago. He wrote a column that

841
00:44:18,920 --> 00:44:22,600
Speaker 1: he eventually turned into a book called the Vanguard Effect,

842
00:44:22,760 --> 00:44:25,000
Speaker 1: and he figured out that over the course of the

843
00:44:25,040 --> 00:44:30,760
Speaker 1: previous twenty thirty years, Vanguard has taken about a trillion

844
00:44:30,840 --> 00:44:33,759
Speaker 1: dollars in fees out of the market. Now, it didn't

845
00:44:33,800 --> 00:44:35,720
Speaker 1: all go to Vanguard. They got took about one hundred

846
00:44:35,760 --> 00:44:39,560
Speaker 1: billion dollars in fees, but it forced everybody else to

847
00:44:39,760 --> 00:44:41,840
Speaker 1: compress their fees, to lower their fees in order to

848
00:44:41,880 --> 00:44:49,280
Speaker 1: be competitive, and ultimately saved. Ultimately saved investors are trillion dollars.

849
00:44:49,280 --> 00:44:52,680
Speaker 1: So the question is, how do we not go back

850
00:44:52,719 --> 00:44:58,960
Speaker 1: to the bad old days of expensive, underperforming active managers

851
00:44:59,520 --> 00:45:04,960
Speaker 1: given the the alternative that we've created. And keep in mind,

852
00:45:06,280 --> 00:45:09,879
Speaker 1: Vanguard and Blackrock didn't you know, they weren't born whole

853
00:45:09,920 --> 00:45:13,560
Speaker 1: cloth into a vacuum. They came about following a lot

854
00:45:13,560 --> 00:45:17,640
Speaker 1: of academic research and a lot of pricing underperforming active

855
00:45:17,680 --> 00:45:20,880
Speaker 1: managers in the seventies, eighties, nineties. So how do we

856
00:45:21,000 --> 00:45:24,400
Speaker 1: not go back to those days and yet still have

857
00:45:24,440 --> 00:45:26,920
Speaker 1: an opportunity to fix the market structure?

858
00:45:27,360 --> 00:45:29,600
Speaker 2: Yeah? I know. So there's a whole bunch of different

859
00:45:29,600 --> 00:45:31,480
Speaker 2: components to what you hit on. The first is this

860
00:45:31,600 --> 00:45:34,920
Speaker 2: idea of cost savings associated with Vanguard. First of all,

861
00:45:34,920 --> 00:45:38,719
Speaker 2: I absolutely agree with Eric's analysis that the low cost introduction,

862
00:45:38,840 --> 00:45:42,600
Speaker 2: the introduction of the mutual structure was absolutely part of

863
00:45:42,640 --> 00:45:46,040
Speaker 2: the success of Vanguard, and the push towards lower fees

864
00:45:46,360 --> 00:45:49,440
Speaker 2: has been absolutely critical. But remember the vast majority of

865
00:45:49,480 --> 00:45:52,799
Speaker 2: the time that Vanguard was actually running, fifty basis points

866
00:45:52,840 --> 00:45:55,719
Speaker 2: would have been considered really cheap fees, right, that's right, right,

867
00:45:55,760 --> 00:45:58,560
Speaker 2: And initially introduced, I believe the fees on the Vanguard

868
00:45:58,600 --> 00:46:02,040
Speaker 2: funds were about seventy five basis points zero point seventy

869
00:46:02,080 --> 00:46:04,719
Speaker 2: five percent as compared to most active managers who are

870
00:46:04,760 --> 00:46:07,000
Speaker 2: between one and a half and two percent, right, So

871
00:46:07,080 --> 00:46:10,480
Speaker 2: that pulling down was absolutely critical. Today you're at a

872
00:46:10,480 --> 00:46:13,200
Speaker 2: point where the three basis point candidately, it just doesn't

873
00:46:13,239 --> 00:46:16,399
Speaker 2: mean it's free, it's factally free. It's effectively free. And

874
00:46:16,719 --> 00:46:19,040
Speaker 2: one of the reasons that it's able to be effectively

875
00:46:19,080 --> 00:46:22,040
Speaker 2: free is because they are hidden subsidies within the industry,

876
00:46:22,080 --> 00:46:24,520
Speaker 2: which ironically are affecting things like the CPI numbers that

877
00:46:24,560 --> 00:46:29,240
Speaker 2: we see where securities lending is actually what's paying for Vanguard, right, meaning.

878
00:46:29,040 --> 00:46:31,600
Speaker 1: People want to short stocks, they borrow it, they borrow

879
00:46:31,680 --> 00:46:35,320
Speaker 1: paying a feele. You go to black Rock and Vanguard, Absolutely,

880
00:46:35,440 --> 00:46:37,600
Speaker 1: those are the two that you go to. That's that's

881
00:46:37,800 --> 00:46:40,960
Speaker 1: you know, it's real money when you're running trillions of dollars,

882
00:46:41,480 --> 00:46:45,239
Speaker 1: but when you're three or four basis points or five

883
00:46:45,280 --> 00:46:49,320
Speaker 1: basis points and don't forget, Vanguard is about thirty percent

884
00:46:49,480 --> 00:46:52,560
Speaker 1: active funds. Black Rock is a little more forty something

885
00:46:52,719 --> 00:46:56,960
Speaker 1: percent active funds. So they have an abandon that space.

886
00:46:57,480 --> 00:47:01,040
Speaker 1: And when you look outside of their core or you know,

887
00:47:01,200 --> 00:47:04,200
Speaker 1: S and P five hundred or for Vanguard, it's VTI

888
00:47:04,400 --> 00:47:07,200
Speaker 1: or Voo, or you have a run of total markets

889
00:47:07,280 --> 00:47:10,360
Speaker 1: or total global markets. US are global. There are some

890
00:47:10,480 --> 00:47:14,759
Speaker 1: higher fee products ten twenty thirty basis points, but it's

891
00:47:14,840 --> 00:47:18,360
Speaker 1: the scale, trillions and trillions of dollars that have allowed

892
00:47:18,400 --> 00:47:21,080
Speaker 1: them to take a fund like that down to three

893
00:47:21,120 --> 00:47:22,800
Speaker 1: basis points or four basis points.

894
00:47:22,880 --> 00:47:25,320
Speaker 2: So that's actually exactly the point that I would emphasize,

895
00:47:25,360 --> 00:47:28,719
Speaker 2: which is that we have allowed the industry to change

896
00:47:29,280 --> 00:47:32,719
Speaker 2: so dramatically from that thought experiment of Grossmann Stiglus, in

897
00:47:32,760 --> 00:47:36,040
Speaker 2: which everybody was roughly the same size. Marril was bigger,

898
00:47:36,080 --> 00:47:38,520
Speaker 2: but it was a whole bunch of individual brokers who

899
00:47:38,560 --> 00:47:42,640
Speaker 2: were able to do whatever they individually wanted to. Right now,

900
00:47:42,680 --> 00:47:45,040
Speaker 2: what you've effectively done is you've created an industry that,

901
00:47:45,120 --> 00:47:48,840
Speaker 2: like so many other industries, has become remarkably concentrated. And

902
00:47:48,880 --> 00:47:50,840
Speaker 2: so one of the iron news is when Eric is

903
00:47:50,880 --> 00:47:53,920
Speaker 2: talking about passive share, the way that that calculation is

904
00:47:53,960 --> 00:47:58,120
Speaker 2: done is simply by adding up Vanguard, Black Rock, et cetera.

905
00:47:58,400 --> 00:48:01,960
Speaker 2: Right now, that actually was the focus of a research

906
00:48:02,000 --> 00:48:05,520
Speaker 2: piece that I actually inspired. I challenged to Harvard professors,

907
00:48:05,920 --> 00:48:09,720
Speaker 2: actually a Harvard professor and a PhD candidate. Alex Chinko

908
00:48:09,800 --> 00:48:13,280
Speaker 2: was the PhD candidate. Marco Salmon was the Harvard professor.

909
00:48:13,840 --> 00:48:15,920
Speaker 2: I was the adjudicant on a paper that they'd written

910
00:48:15,960 --> 00:48:18,200
Speaker 2: where they did an analysis on the impact of passive.

911
00:48:18,280 --> 00:48:20,040
Speaker 2: I very much agreed with the work that they had

912
00:48:20,080 --> 00:48:24,200
Speaker 2: done this public record, but they had done their scaling

913
00:48:24,280 --> 00:48:26,040
Speaker 2: of the impact by looking at it and saying the

914
00:48:26,040 --> 00:48:28,400
Speaker 2: share of passive is fifteen percent roughly what Eric was

915
00:48:28,440 --> 00:48:28,960
Speaker 2: working off of.

916
00:48:29,120 --> 00:48:32,360
Speaker 1: Right. In other words, when you look at ETFs mutual funds,

917
00:48:32,920 --> 00:48:36,719
Speaker 1: passive is about fifty percent of mutual funds. Now it's

918
00:48:36,719 --> 00:48:40,600
Speaker 1: over fifty percent, but the non funds, the direct ownership

919
00:48:41,239 --> 00:48:45,560
Speaker 1: is primarily active. You're saying that is somewhat overstated.

920
00:48:45,680 --> 00:48:47,839
Speaker 2: It is very much overstated. So it actually turns out

921
00:48:48,120 --> 00:48:50,400
Speaker 2: the statistics that people are using for that is very quickly.

922
00:48:50,400 --> 00:48:53,160
Speaker 2: The mutual fund or forty act industry is about thirty

923
00:48:53,200 --> 00:48:56,080
Speaker 2: five percent of the equity market in total. A little

924
00:48:56,080 --> 00:48:58,000
Speaker 2: bit more than half of that, as you're pointing out,

925
00:48:58,200 --> 00:49:00,880
Speaker 2: is passive in its structure, and so we can multip

926
00:49:00,960 --> 00:49:05,920
Speaker 2: plates round up to right. That's the quick answer in

927
00:49:05,960 --> 00:49:08,280
Speaker 2: terms of how much is passive. But remember passive actually

928
00:49:08,360 --> 00:49:10,920
Speaker 2: got started even before Bogel, it got started in the

929
00:49:10,920 --> 00:49:13,799
Speaker 2: institutional space as well as Fargo that was first in

930
00:49:13,880 --> 00:49:16,319
Speaker 2: the passive space. And so it actually turns out that

931
00:49:16,400 --> 00:49:20,120
Speaker 2: away from the retail space, passive is even larger in

932
00:49:20,160 --> 00:49:23,480
Speaker 2: the institutional space, and that's the area under the iceberg

933
00:49:23,840 --> 00:49:27,400
Speaker 2: that you're missing, right. So Marco Salmon and Alex Chinko's

934
00:49:27,440 --> 00:49:30,239
Speaker 2: work focused on exactly that they went and they did.

935
00:49:30,640 --> 00:49:33,800
Speaker 2: They did an actual experiment where they tracked what fraction

936
00:49:33,880 --> 00:49:38,040
Speaker 2: of shares had to trade in response to an index rebalancing,

937
00:49:38,640 --> 00:49:40,440
Speaker 2: and the answer is around forty percent.

938
00:49:40,760 --> 00:49:43,520
Speaker 1: Right now, I've seen some pushback to that that says

939
00:49:43,520 --> 00:49:45,279
Speaker 1: there's a lot of end to day trading, there's a

940
00:49:45,320 --> 00:49:48,319
Speaker 1: lot of people who are either front running or piggybacking

941
00:49:48,360 --> 00:49:51,840
Speaker 1: those trades, and you can credit all of that forty

942
00:49:51,840 --> 00:49:56,680
Speaker 1: percent rebalance number to passive and so that's how they

943
00:49:56,760 --> 00:49:59,360
Speaker 1: end up with. Fidelity had to study. I want to

944
00:49:59,360 --> 00:50:01,640
Speaker 1: say it was twenty twenty seven or twenty eight percent.

945
00:50:02,560 --> 00:50:05,400
Speaker 1: Somebody else had another study that twenty three percent. But

946
00:50:06,320 --> 00:50:09,760
Speaker 1: let's give you thirty percent. So if it's thirty percent

947
00:50:09,800 --> 00:50:13,400
Speaker 1: going to forty percent, going to fifty percent, when fifty

948
00:50:13,440 --> 00:50:16,879
Speaker 1: percent of the market is purely passive. Doesn't that mean

949
00:50:16,920 --> 00:50:20,279
Speaker 1: that folks like David Einhorn are just going to clean up?

950
00:50:20,760 --> 00:50:24,160
Speaker 1: Doesn't it create? Isn't it homeostatic and going back and forth?

951
00:50:24,480 --> 00:50:27,879
Speaker 2: So if it were a stable situation, absolutely the case.

952
00:50:28,480 --> 00:50:30,960
Speaker 2: The problem is is that when you talk about going

953
00:50:31,000 --> 00:50:34,400
Speaker 2: from thirty percent to thirty five percent to forty percent,

954
00:50:34,719 --> 00:50:36,480
Speaker 2: what you actually have is the scenario that we have

955
00:50:36,560 --> 00:50:39,400
Speaker 2: in markets today. We're more than one hundred percent of

956
00:50:39,440 --> 00:50:42,480
Speaker 2: the flows, which is actually what determines the majority of

957
00:50:42,480 --> 00:50:46,759
Speaker 2: transaction activity is passive in its construction. Right Again, the

958
00:50:46,880 --> 00:50:51,440
Speaker 2: active space is losing assets, it's seeing net redemptions. The

959
00:50:51,520 --> 00:50:54,879
Speaker 2: passive space is actually receiving more than one hundred percent

960
00:50:54,920 --> 00:50:57,040
Speaker 2: of the inflows. And if you go back and you

961
00:50:57,040 --> 00:51:00,319
Speaker 2: think about the dynamics of Andrew Lowe stating ninety percent

962
00:51:00,440 --> 00:51:03,520
Speaker 2: or John Bogel himself highlighting the between eighty and ninety percent,

963
00:51:03,600 --> 00:51:06,480
Speaker 2: markets begin to break down, it's important to recognize that

964
00:51:06,640 --> 00:51:10,279
Speaker 2: ninety percent of the trading activity no longer has a

965
00:51:10,320 --> 00:51:13,680
Speaker 2: fundamental component to it. That's actually research that was done

966
00:51:13,680 --> 00:51:17,000
Speaker 2: by JP Morgan as of twenty seventeen, and all the

967
00:51:17,040 --> 00:51:21,240
Speaker 2: components that you're talking about the arbitrage, the normalization, et cetera.

968
00:51:21,280 --> 00:51:24,120
Speaker 2: All of those are done in the facilitation of that

969
00:51:24,360 --> 00:51:27,560
Speaker 2: end of day market on closing balance is tied to

970
00:51:27,600 --> 00:51:29,720
Speaker 2: the mutual fund, ETF orders, et cetera.

971
00:51:30,760 --> 00:51:34,799
Speaker 1: So what do you think about not traditional passive, but

972
00:51:35,400 --> 00:51:38,759
Speaker 1: some of the concentrated portfolios. I had andrews Lemons of

973
00:51:38,760 --> 00:51:41,520
Speaker 1: Morgan Stanley on not too long ago. He runs a

974
00:51:41,560 --> 00:51:45,440
Speaker 1: twenty or a thirty name portfolio that has done pretty well.

975
00:51:45,840 --> 00:51:50,400
Speaker 1: We continue to see people like Bill Miller slag the

976
00:51:50,600 --> 00:51:55,359
Speaker 1: active side of the industry, calling them mostly closet indexers,

977
00:51:55,680 --> 00:51:57,799
Speaker 1: and said, if you want to beat the market, you

978
00:51:57,880 --> 00:52:00,799
Speaker 1: have to look different from the market. You have all

979
00:52:00,800 --> 00:52:04,279
Speaker 1: sorts of things like smart beta and thematic investing, and

980
00:52:04,600 --> 00:52:08,799
Speaker 1: I know simplify as an India based ETF. There's a

981
00:52:08,840 --> 00:52:11,719
Speaker 1: lot of choices for people who want to run let's

982
00:52:11,760 --> 00:52:15,799
Speaker 1: call it a core and satellite type of portfolio, where hey,

983
00:52:15,800 --> 00:52:18,719
Speaker 1: our core is going to be look very similar to

984
00:52:18,760 --> 00:52:20,960
Speaker 1: the market, but we're going to put our own stink

985
00:52:21,040 --> 00:52:23,640
Speaker 1: on it because we want to have exposure to Japan,

986
00:52:23,719 --> 00:52:27,959
Speaker 1: exposure to India, exposure to momentum, blah blah blah. Isn't

987
00:52:28,000 --> 00:52:30,799
Speaker 1: that the sort of the direction things seem to be heading.

988
00:52:30,560 --> 00:52:33,399
Speaker 2: In, not at all. So yeah, so there's a lot

989
00:52:33,440 --> 00:52:36,120
Speaker 2: of highlight around the growth of active ets. For example,

990
00:52:36,160 --> 00:52:37,520
Speaker 2: they're about twenty five percent.

991
00:52:37,360 --> 00:52:40,320
Speaker 1: Become used right now, and they are capturing some flow.

992
00:52:40,560 --> 00:52:42,920
Speaker 2: They are capturing some flow, but they haven't become huge.

993
00:52:42,960 --> 00:52:46,719
Speaker 1: Let's actually be really become bigger. So I'm overstating it.

994
00:52:47,080 --> 00:52:49,760
Speaker 1: They're much bigger today than they were five years.

995
00:52:49,600 --> 00:52:52,160
Speaker 2: Ago, with the offset being that the mutual fund and

996
00:52:52,200 --> 00:52:55,520
Speaker 2: hedge fund spaces are much smaller. Fair, right, So what

997
00:52:55,520 --> 00:52:58,000
Speaker 2: you've actually had is a net decrease in the quantity

998
00:52:58,040 --> 00:53:01,000
Speaker 2: of active but it's instructive. Everybody points out like, oh

999
00:53:01,040 --> 00:53:03,640
Speaker 2: look how robust the space is and how wonderful it is. Right.

1000
00:53:04,120 --> 00:53:07,440
Speaker 2: The simple reality is is that nobody can actually afford

1001
00:53:07,520 --> 00:53:10,359
Speaker 2: to acknowledge many of the concerns that I'm highlighting. It's

1002
00:53:10,400 --> 00:53:14,200
Speaker 2: really very straightforward. There is no such thing as passive investing.

1003
00:53:14,760 --> 00:53:16,280
Speaker 2: Everybody is an active investor.

1004
00:53:16,400 --> 00:53:19,320
Speaker 1: Well, they're an active trader when they're deploying the capital,

1005
00:53:20,000 --> 00:53:24,080
Speaker 1: but they're not actively selecting stocks. They're relying on an index.

1006
00:53:24,080 --> 00:53:27,839
Speaker 2: Which actually is a decision process as an of course.

1007
00:53:27,760 --> 00:53:29,640
Speaker 1: Right, right, I did a column a couple of years ago,

1008
00:53:29,760 --> 00:53:32,960
Speaker 1: how passive? How active is you're passive? Where Hey, even

1009
00:53:33,000 --> 00:53:35,759
Speaker 1: the S and P five hundred, someone decided it's going

1010
00:53:35,800 --> 00:53:38,359
Speaker 1: to be market cap weighted. Someone decided what the rules are,

1011
00:53:38,600 --> 00:53:41,680
Speaker 1: and there's regularly additions and deletions that seem to be

1012
00:53:42,040 --> 00:53:44,600
Speaker 1: You remember when Tesla was added, that seemed to be

1013
00:53:44,640 --> 00:53:50,080
Speaker 1: an editorial decision, not a systematic algorithm deciding.

1014
00:53:50,520 --> 00:53:53,839
Speaker 2: Well, it actually technically was a very systematic decision, right,

1015
00:53:53,920 --> 00:53:56,960
Speaker 2: And so we actually Tesla was a fascinating example on

1016
00:53:57,040 --> 00:53:59,920
Speaker 2: this because we actually had received a lot of speculation

1017
00:54:00,040 --> 00:54:01,880
Speaker 2: and around it. The rules for inclusion in the S

1018
00:54:01,880 --> 00:54:04,360
Speaker 2: and P. Five hundred are pretty straightforward. You need to

1019
00:54:04,400 --> 00:54:05,960
Speaker 2: be all of sufficient size and you need to have

1020
00:54:06,000 --> 00:54:09,840
Speaker 2: at least five consecutive quarters of profitability. So once Tesla

1021
00:54:09,960 --> 00:54:14,600
Speaker 2: began actually reporting profits and then moving towards that fifth quarter,

1022
00:54:15,000 --> 00:54:17,520
Speaker 2: it became very clear that on a pure size basis,

1023
00:54:17,600 --> 00:54:19,600
Speaker 2: they were going to be the next player to be included,

1024
00:54:19,880 --> 00:54:22,000
Speaker 2: and the size that they were going to be included

1025
00:54:22,000 --> 00:54:25,160
Speaker 2: in was going to require an insane amount of passive buying.

1026
00:54:25,400 --> 00:54:27,200
Speaker 1: There was a ton of front running, also a ton

1027
00:54:27,239 --> 00:54:28,400
Speaker 1: of active running.

1028
00:54:28,280 --> 00:54:30,880
Speaker 2: The exact same thing just happened with SMCI, for example.

1029
00:54:30,920 --> 00:54:32,440
Speaker 1: Well, they're a lot smaller.

1030
00:54:32,640 --> 00:54:34,920
Speaker 2: It doesn't really matter, though, So I'm glad.

1031
00:54:34,719 --> 00:54:38,399
Speaker 1: You brought up Tesla. We're recording this on the first

1032
00:54:38,480 --> 00:54:43,439
Speaker 1: day of May of two months ago. Tesla, originally part

1033
00:54:43,440 --> 00:54:46,960
Speaker 1: of the Magnificent seven, down sixty five percent from its

1034
00:54:46,960 --> 00:54:51,160
Speaker 1: recent highs. Doesn't seem like active flows or passive flows

1035
00:54:51,480 --> 00:54:55,200
Speaker 1: were helping Tesla. And then over the last month, you know,

1036
00:54:55,320 --> 00:54:59,040
Speaker 1: they cut a deal in China, they kind of explained

1037
00:54:59,040 --> 00:55:03,120
Speaker 1: away some issues with the self driving problems. They cut prices,

1038
00:55:03,160 --> 00:55:07,479
Speaker 1: and suddenly they're back to only down fifty percent, which

1039
00:55:07,520 --> 00:55:10,480
Speaker 1: is a big move when you're down sixty five percent.

1040
00:55:11,080 --> 00:55:15,360
Speaker 1: Doesn't that belie the whole argument that passive is destroying

1041
00:55:16,640 --> 00:55:20,399
Speaker 1: price discovery. Obviously, a bunch of active managers figured out

1042
00:55:20,840 --> 00:55:24,879
Speaker 1: Tesla was way too richly priced back in twenty one,

1043
00:55:25,480 --> 00:55:28,399
Speaker 1: and after it got whacked by two thirds, someone else

1044
00:55:28,440 --> 00:55:30,839
Speaker 1: turned around and said, all right, this has gone too far.

1045
00:55:31,000 --> 00:55:34,160
Speaker 1: This is not a worthless company heading to bankruptcy. We

1046
00:55:34,200 --> 00:55:37,680
Speaker 1: want to own it. Isn't there plenty of price discovery

1047
00:55:37,680 --> 00:55:38,080
Speaker 1: going on?

1048
00:55:38,520 --> 00:55:40,799
Speaker 2: So, unfortunately, I think the answer to that is no, Right,

1049
00:55:40,840 --> 00:55:42,920
Speaker 2: there's always going to be a subjective component to that

1050
00:55:42,960 --> 00:55:45,000
Speaker 2: I would highlight. When you look at something like Tesla,

1051
00:55:45,040 --> 00:55:46,960
Speaker 2: there's a couple of things that are really interesting. One

1052
00:55:47,040 --> 00:55:51,319
Speaker 2: is who is the largest seller of Tesla besides Elon? No,

1053
00:55:51,400 --> 00:55:53,839
Speaker 2: that's exactly the right. Oh okay, so well, I did

1054
00:55:53,880 --> 00:55:56,120
Speaker 2: Tesla go down over that time period in which he

1055
00:55:56,160 --> 00:55:58,000
Speaker 2: was acquiring Twitter because he had to sell a ton

1056
00:55:58,080 --> 00:55:59,040
Speaker 2: of Tesla shares.

1057
00:56:00,160 --> 00:56:02,399
Speaker 1: There are a lot of other reasons, Like I will

1058
00:56:02,440 --> 00:56:06,040
Speaker 1: make a fundamental case for you, the yeah, Elon sold some,

1059
00:56:06,800 --> 00:56:10,480
Speaker 1: he didn't sell enough to whack it two thirds. Their

1060
00:56:10,560 --> 00:56:13,000
Speaker 1: cars are kind of along in the tooth that they

1061
00:56:13,040 --> 00:56:16,800
Speaker 1: haven't really introduced an upgraded Even the X and Y

1062
00:56:16,960 --> 00:56:21,400
Speaker 1: look very much like the models, and I'm sorry, the

1063
00:56:21,400 --> 00:56:24,560
Speaker 1: Model three and the Model Y look like the S

1064
00:56:24,640 --> 00:56:30,720
Speaker 1: and the X. China has become an ongoing problem. Five

1065
00:56:30,840 --> 00:56:33,640
Speaker 1: years ago, they were a decade ahead of everybody in

1066
00:56:33,680 --> 00:56:36,560
Speaker 1: the software. Now they're I don't know, three, four or

1067
00:56:36,600 --> 00:56:39,759
Speaker 1: five years ahead of everybody. And there's a boat ton

1068
00:56:39,800 --> 00:56:47,200
Speaker 1: of competition. It's not just for GM, BMW, Mercedes, Audi, Volkswagon, Volvo,

1069
00:56:47,640 --> 00:56:51,760
Speaker 1: Renault go down the list. You could buy an Evy, Rolls,

1070
00:56:51,840 --> 00:56:55,520
Speaker 1: Royce and Maserati if you want. Everybody is piled into

1071
00:56:55,560 --> 00:57:00,640
Speaker 1: the space. So fundamentally, you can make a case Elon

1072
00:57:00,719 --> 00:57:04,399
Speaker 1: sold a bunch of stock, but suddenly it's a more

1073
00:57:04,480 --> 00:57:09,040
Speaker 1: challenging environment and the stock had become overpriced. That's the

1074
00:57:09,239 --> 00:57:15,960
Speaker 1: argument I would make that that that Tesla had become overvalued,

1075
00:57:16,280 --> 00:57:18,920
Speaker 1: and it seems like the market picked up on a

1076
00:57:18,920 --> 00:57:21,360
Speaker 1: lot of it, especially what did a peak at at

1077
00:57:21,360 --> 00:57:24,200
Speaker 1: one point two one point three trillion. That kind of

1078
00:57:24,320 --> 00:57:27,400
Speaker 1: suggested we're going to own the EV space for the

1079
00:57:27,400 --> 00:57:28,200
Speaker 1: next decade.

1080
00:57:28,560 --> 00:57:30,560
Speaker 2: It wasn't even just own the EV space. So first

1081
00:57:30,560 --> 00:57:31,960
Speaker 2: of all, I actually agree with you, and I think

1082
00:57:32,000 --> 00:57:35,400
Speaker 2: most fundamental managers would agree with you that Tesla was overvalued.

1083
00:57:35,960 --> 00:57:39,720
Speaker 2: But the simple reality is overvaluation doesn't actually affect anything.

1084
00:57:40,280 --> 00:57:44,040
Speaker 2: What affects things is people actually executing trades. Right.

1085
00:57:44,080 --> 00:57:47,760
Speaker 1: The only so how much did Elon sell? I mean it,

1086
00:57:47,760 --> 00:57:51,120
Speaker 1: it didn't seem like he sold what did he overpaid

1087
00:57:51,160 --> 00:57:51,840
Speaker 1: for Twitter?

1088
00:57:53,360 --> 00:57:53,520
Speaker 2: Right?

1089
00:57:53,600 --> 00:57:56,080
Speaker 1: And he didn't pay for that wasn't all Tesla stock

1090
00:57:56,560 --> 00:57:58,200
Speaker 1: it was I think he had to pay ten or

1091
00:57:58,200 --> 00:58:01,480
Speaker 1: twenty percent of it. It's called ten billion out of

1092
00:58:01,560 --> 00:58:04,440
Speaker 1: one point two trillion. Shouldn't have crushed the stock.

1093
00:58:04,640 --> 00:58:06,960
Speaker 2: So let's use Bitcoin as an example for a second,

1094
00:58:07,240 --> 00:58:09,960
Speaker 2: how much money has flowed into the Bitcoin ETFs.

1095
00:58:10,720 --> 00:58:14,040
Speaker 1: I don't know, sixty billion dollars over the past decade.

1096
00:58:14,280 --> 00:58:16,440
Speaker 2: Well, not over over the past decade, but in particular

1097
00:58:16,480 --> 00:58:17,880
Speaker 2: since the introduction in January.

1098
00:58:18,080 --> 00:58:21,720
Speaker 1: Oh god, you look at the blackrock ETF It was

1099
00:58:21,800 --> 00:58:25,440
Speaker 1: at five billion dollars in a month, and it's probably

1100
00:58:25,480 --> 00:58:27,280
Speaker 1: close to ten billion dollars now.

1101
00:58:27,160 --> 00:58:29,560
Speaker 2: Right, So this's been about forty billion dollars worth of

1102
00:58:29,560 --> 00:58:34,120
Speaker 2: inflows against a bitcoin valuation or a market cap of

1103
00:58:34,160 --> 00:58:37,240
Speaker 2: bitcoin going into it of about four hundred billion dollars

1104
00:58:37,640 --> 00:58:41,000
Speaker 2: and it costs US sixty five percent appreciation, So forty

1105
00:58:41,080 --> 00:58:44,280
Speaker 2: billion dollars non linear? Yeah, that's fair. Same thing's true

1106
00:58:44,280 --> 00:58:48,760
Speaker 2: on Tesla, right, Everything happens at the margin. By the way,

1107
00:58:49,080 --> 00:58:52,000
Speaker 2: why did Amazon sell off so firmly over the past

1108
00:58:52,000 --> 00:58:52,480
Speaker 2: couple of years.

1109
00:58:52,480 --> 00:58:55,960
Speaker 1: Sous Bezos departed and the company is a shell of

1110
00:58:56,160 --> 00:58:58,480
Speaker 1: the delightful retailer it once was.

1111
00:58:58,560 --> 00:59:00,760
Speaker 2: Wouldn't that be awesome if it was true? Accept It

1112
00:59:00,800 --> 00:59:03,840
Speaker 2: really boils down to Mackenzie Scott selling her shares.

1113
00:59:04,200 --> 00:59:06,440
Speaker 1: There's a lot of that. So let me shift gears

1114
00:59:06,440 --> 00:59:10,480
Speaker 1: on you. Since we're talking about structure, I want to

1115
00:59:10,640 --> 00:59:13,200
Speaker 1: change things up and for a one more thing at

1116
00:59:13,240 --> 00:59:17,120
Speaker 1: you about structure, because I'm enjoying this conversation. So a

1117
00:59:17,160 --> 00:59:19,360
Speaker 1: couple of years ago we started working with the folks

1118
00:59:19,360 --> 00:59:23,920
Speaker 1: at O'Shaughnessey Asset Management, who rolled out a product called Canvas,

1119
00:59:23,960 --> 00:59:28,040
Speaker 1: which was a direct indexing product. Directly indexing has been

1120
00:59:28,040 --> 00:59:32,200
Speaker 1: around for decades. It to me, it's never been particularly impressive.

1121
00:59:32,960 --> 00:59:35,960
Speaker 1: And O'Shaughnessy had a couple of things going for them

1122
00:59:35,960 --> 00:59:39,919
Speaker 1: that nobody else did. They over their course of twenty

1123
00:59:40,000 --> 00:59:44,720
Speaker 1: thirty years, created their own incredibly clean database that they

1124
00:59:44,720 --> 00:59:46,920
Speaker 1: had built out that was you know, you have to

1125
00:59:47,120 --> 00:59:51,960
Speaker 1: look at CRISP maybe as the or compustat in the

1126
00:59:51,960 --> 00:59:54,360
Speaker 1: old days is and the only thing that's close. But

1127
00:59:54,440 --> 00:59:57,840
Speaker 1: it was really very specific to them. And second, you

1128
00:59:57,880 --> 01:00:01,040
Speaker 1: know the team at O'shaughnessee and I've had all these

1129
01:00:01,080 --> 01:00:07,120
Speaker 1: folks on between Patrick O'Shaughnessy and Jim who famously wrote

1130
01:00:07,120 --> 01:00:08,800
Speaker 1: the book What Works on Wall Street are really a

1131
01:00:08,880 --> 01:00:12,480
Speaker 1: first quant book for the public. They created a form

1132
01:00:12,480 --> 01:00:15,400
Speaker 1: of direct indexing that as someone who's been a skeptic,

1133
01:00:15,880 --> 01:00:18,800
Speaker 1: Dave Nottig and I have disagreed about this for years

1134
01:00:19,120 --> 01:00:20,880
Speaker 1: when we first saw this, and I want to say

1135
01:00:20,920 --> 01:00:23,680
Speaker 1: twenty nineteen, it's like, oh, I get it. You can

1136
01:00:23,760 --> 01:00:28,200
Speaker 1: do so much more now. And of the four point

1137
01:00:28,240 --> 01:00:31,280
Speaker 1: whatever billion dollars we run, over a billion is on

1138
01:00:31,360 --> 01:00:35,520
Speaker 1: the Canvas platform now owned by Franklin Templeton. And what

1139
01:00:35,560 --> 01:00:38,400
Speaker 1: we have discovered is if you have any sort of

1140
01:00:39,760 --> 01:00:41,720
Speaker 1: this is a long way to go, but I'll get there.

1141
01:00:42,240 --> 01:00:46,200
Speaker 1: If you have any sort of potential capital gains, you've

1142
01:00:46,240 --> 01:00:51,520
Speaker 1: inherited a portfolio, you've sold to business, you have a

1143
01:00:51,560 --> 01:00:54,280
Speaker 1: bunch of founder's stock, you have a bunch of IPO stock,

1144
01:00:54,760 --> 01:00:58,880
Speaker 1: and you want to diversify out of that core portfolio.

1145
01:00:59,000 --> 01:01:03,200
Speaker 1: But the capital game are going to be fairly weighty.

1146
01:01:03,320 --> 01:01:07,400
Speaker 1: You could use direct indexing to tax loss, harvest and

1147
01:01:08,080 --> 01:01:12,200
Speaker 1: order of magnitude better results than if you own half

1148
01:01:12,240 --> 01:01:16,680
Speaker 1: a dozen ETFs or mutual funds. Just and first quarter

1149
01:01:16,800 --> 01:01:21,680
Speaker 1: of twenty twenty, anytime you have a thirty plus percent

1150
01:01:22,240 --> 01:01:26,840
Speaker 1: decrease that fits nicely in the range of the calendar quarter.

1151
01:01:27,320 --> 01:01:30,440
Speaker 1: You know, instead of being seventy five eighty basis points,

1152
01:01:30,760 --> 01:01:34,919
Speaker 1: it's three hundred O'Shaughnessy has case studies four hundred, five

1153
01:01:35,000 --> 01:01:40,840
Speaker 1: hundred based points. Giant game changer. Long ask question, short

1154
01:01:41,600 --> 01:01:46,400
Speaker 1: conclusion is do things like direct indexing, which have always

1155
01:01:46,480 --> 01:01:48,680
Speaker 1: been a small part of the market, but seem to

1156
01:01:48,720 --> 01:01:53,200
Speaker 1: be catching a bid now? Might this interfere with that

1157
01:01:53,360 --> 01:01:58,240
Speaker 1: relentless bid of passive? Can something like this change the

1158
01:01:58,320 --> 01:02:01,760
Speaker 1: game for what you see as a structural problem in passive?

1159
01:02:03,120 --> 01:02:05,000
Speaker 2: So it is a very long question with a lot

1160
01:02:05,000 --> 01:02:07,560
Speaker 2: of different components to it. First, direct and next thing

1161
01:02:07,680 --> 01:02:10,000
Speaker 2: is almost by definition always going to be relatively small.

1162
01:02:10,000 --> 01:02:12,800
Speaker 2: It's a tax arbitrage strategy. It requires people to start

1163
01:02:12,800 --> 01:02:15,680
Speaker 2: with a lot and then try to maintain most of

1164
01:02:15,720 --> 01:02:18,160
Speaker 2: it right, And so the return differentials that you're quoting

1165
01:02:18,160 --> 01:02:21,440
Speaker 2: there are obviously a tax advantaged return differential. It's not

1166
01:02:21,840 --> 01:02:23,880
Speaker 2: the absolute levels of performance.

1167
01:02:23,480 --> 01:02:25,840
Speaker 1: That's right, understand. Let me let me clarify. I'm referring

1168
01:02:25,880 --> 01:02:28,800
Speaker 1: to the tax al for returns yep over and above

1169
01:02:28,840 --> 01:02:31,200
Speaker 1: what you get from the market, and it's not aimed

1170
01:02:31,240 --> 01:02:34,480
Speaker 1: at market performance in its own way. It is a

1171
01:02:34,480 --> 01:02:38,560
Speaker 1: form of I don't want to call it passive because

1172
01:02:38,600 --> 01:02:42,000
Speaker 1: it's not, but it apes passive investments or whatever funds

1173
01:02:42,000 --> 01:02:42,520
Speaker 1: you want to put.

1174
01:02:42,640 --> 01:02:45,200
Speaker 2: What it's doing is it's seeking diversification, right, So it

1175
01:02:45,200 --> 01:02:48,200
Speaker 2: really doesn't. What you're doing is you're taking heavily appreciated

1176
01:02:48,240 --> 01:02:51,520
Speaker 2: individual positions and you're then diversifying it into a market.

1177
01:02:51,520 --> 01:02:56,280
Speaker 2: Expos's exactly right. The ability to arbitrage your individual tax

1178
01:02:56,320 --> 01:02:59,640
Speaker 2: positions falls way outside the dynamics of market efficiency. Right,

1179
01:02:59,720 --> 01:03:02,120
Speaker 2: every individual is going to have their own components. We

1180
01:03:02,120 --> 01:03:05,440
Speaker 2: could get into tons of conversations around exactly that issue,

1181
01:03:05,440 --> 01:03:08,480
Speaker 2: and that actually almost perfectly fits with what the critical

1182
01:03:08,480 --> 01:03:11,200
Speaker 2: point that I would make is. It's not so much

1183
01:03:11,240 --> 01:03:14,160
Speaker 2: that passive itself is a terrible thing. It's actually the

1184
01:03:14,480 --> 01:03:18,880
Speaker 2: idea of a systematically algorithmic investment in which the simple

1185
01:03:19,800 --> 01:03:22,800
Speaker 2: determining algorithm is did you give me cash? If so,

1186
01:03:22,880 --> 01:03:25,760
Speaker 2: then buy? Did you ask for cash? If so, then sell?

1187
01:03:26,000 --> 01:03:29,720
Speaker 2: That actually can diversify a market, It creates a different mechanism,

1188
01:03:30,000 --> 01:03:32,440
Speaker 2: and it can actually lower volatility. And candidly, I think

1189
01:03:32,440 --> 01:03:35,400
Speaker 2: we saw that up to a certain point of market share,

1190
01:03:35,480 --> 01:03:38,720
Speaker 2: around twenty five percent market share. It actually turns out

1191
01:03:38,800 --> 01:03:43,000
Speaker 2: perversely that passive is beneficial to the market. It's once

1192
01:03:43,040 --> 01:03:46,280
Speaker 2: you go past that point that it starts contributing to

1193
01:03:46,320 --> 01:03:51,600
Speaker 2: higher volatility, much higher correlations, and the risk of severe

1194
01:03:51,680 --> 01:03:54,440
Speaker 2: left tail events, which brings us full circle back to

1195
01:03:54,480 --> 01:03:55,880
Speaker 2: the XIV type dynamic.

1196
01:03:56,280 --> 01:03:58,600
Speaker 1: So then let me ask you one final question before

1197
01:03:58,640 --> 01:04:02,920
Speaker 1: we jump to our favorite questions. Who has the burden

1198
01:04:03,640 --> 01:04:10,720
Speaker 1: for dealing with the challenges of passive attracting so much

1199
01:04:10,760 --> 01:04:15,880
Speaker 1: in assets? Shouldn't it be on the active managers to

1200
01:04:15,920 --> 01:04:20,360
Speaker 1: reduce their costs, put up better performance numbers over longer

1201
01:04:20,360 --> 01:04:24,160
Speaker 1: periods of time, and take advantage of all of these

1202
01:04:24,160 --> 01:04:29,320
Speaker 1: inefficiencies passive creates. Isn't this a system that should heal

1203
01:04:29,400 --> 01:04:33,800
Speaker 1: itself if active managers start to perform, lower their fees

1204
01:04:34,240 --> 01:04:35,600
Speaker 1: and attract more capital.

1205
01:04:36,000 --> 01:04:38,760
Speaker 2: So the answer is very quickly no. And unfortunately this

1206
01:04:38,760 --> 01:04:40,560
Speaker 2: brings us back to the question you had asked of,

1207
01:04:40,640 --> 01:04:44,560
Speaker 2: doesn't it get easier? And ironically what ends up happening mathematically?

1208
01:04:44,640 --> 01:04:49,640
Speaker 2: What occurs That constant bid that you're describing perversely changes

1209
01:04:49,680 --> 01:04:52,160
Speaker 2: the return profile of the market and it actually turns

1210
01:04:52,200 --> 01:04:54,480
Speaker 2: it into a This is difficult for people to see

1211
01:04:54,520 --> 01:04:58,960
Speaker 2: over radio, but I'm drawing a convex upward sloping curve right.

1212
01:04:59,400 --> 01:05:04,240
Speaker 2: It pushes valuations higher over time. Now, perversely, what we

1213
01:05:04,320 --> 01:05:06,760
Speaker 2: call alpha in the industry, which is typically how we

1214
01:05:06,840 --> 01:05:11,560
Speaker 2: evaluate individual managers, it turns out, is actually over time,

1215
01:05:12,400 --> 01:05:16,080
Speaker 2: just the intercept on a Y equals mx plus p

1216
01:05:16,320 --> 01:05:18,880
Speaker 2: and linear equation. Right, So I know this is hard

1217
01:05:18,920 --> 01:05:23,000
Speaker 2: for people, just like mentally, imagine your back in high school.

1218
01:05:23,040 --> 01:05:25,720
Speaker 2: It's your freshman year and you're doing a Y equals

1219
01:05:25,800 --> 01:05:30,320
Speaker 2: mx plus bograph and algebra. Right, what happens? That's the

1220
01:05:30,360 --> 01:05:34,440
Speaker 2: same thing as saying the portfolio return equals the market

1221
01:05:34,480 --> 01:05:39,200
Speaker 2: return x times of beta plus alpha. The residual in

1222
01:05:39,240 --> 01:05:42,960
Speaker 2: that the intercept in that if I curve that surface

1223
01:05:43,040 --> 01:05:46,080
Speaker 2: and I try to use a linear equation to solve it,

1224
01:05:46,080 --> 01:05:49,919
Speaker 2: it actually mechanically pushes the alpha's negative. The intercepts get

1225
01:05:49,920 --> 01:05:50,880
Speaker 2: pushed negative.

1226
01:05:51,360 --> 01:05:51,480
Speaker 1: Right.

1227
01:05:51,520 --> 01:05:53,480
Speaker 2: You can run this experiment with yourself. Just draw a

1228
01:05:53,520 --> 01:05:57,160
Speaker 2: positively curved line and then draw a series of straight

1229
01:05:57,240 --> 01:06:01,760
Speaker 2: lines that bisect it or intersect it. Understand how hard

1230
01:06:01,800 --> 01:06:02,160
Speaker 2: this is?

1231
01:06:02,240 --> 01:06:05,160
Speaker 1: Over No, by the way I see the curve, I

1232
01:06:05,200 --> 01:06:08,280
Speaker 1: see the intersect. Okay, where I would just push back

1233
01:06:08,320 --> 01:06:11,880
Speaker 1: on the algebras simply and he seated one of your

1234
01:06:11,880 --> 01:06:17,440
Speaker 1: early accounts. Soros's concept of reflexivity should say that the

1235
01:06:17,480 --> 01:06:21,440
Speaker 1: bigger passive gets it creates the more opportunities for active

1236
01:06:21,480 --> 01:06:22,760
Speaker 1: and therefore.

1237
01:06:22,560 --> 01:06:25,439
Speaker 2: It does in exactly the way that the XIV did,

1238
01:06:25,480 --> 01:06:27,920
Speaker 2: and that's why I chose the XIV for that trade,

1239
01:06:28,360 --> 01:06:31,280
Speaker 2: because it had already gotten to the levels of passive

1240
01:06:31,560 --> 01:06:34,200
Speaker 2: that I could very clearly see it happening almost immediately.

1241
01:06:34,240 --> 01:06:36,680
Speaker 1: So last question before I we do a speed round

1242
01:06:36,680 --> 01:06:40,520
Speaker 1: of my favorite five questions, what's the trade that will

1243
01:06:40,600 --> 01:06:45,280
Speaker 1: capitalize on the damage that passive is doing to market structure.

1244
01:06:45,600 --> 01:06:49,439
Speaker 2: So the quick answer is, unfortunately, if I'm right, you'll

1245
01:06:49,440 --> 01:06:51,760
Speaker 2: have an XIV type event for the S and P

1246
01:06:51,880 --> 01:06:55,320
Speaker 2: five hundred. I realize, how ridiculous. So you want to.

1247
01:06:55,120 --> 01:06:58,960
Speaker 1: Buy out of the money puts on the SPX going

1248
01:06:59,040 --> 01:07:00,320
Speaker 1: out as far as the leaps.

1249
01:07:00,640 --> 01:07:03,200
Speaker 2: Somebody will eventually win on that. But it is very

1250
01:07:03,200 --> 01:07:05,120
Speaker 2: stochastic in its framework.

1251
01:07:04,760 --> 01:07:06,840
Speaker 1: Meaning you don't know if this is next year, five

1252
01:07:06,920 --> 01:07:09,720
Speaker 1: years from now. You look at it as an eventuality.

1253
01:07:10,200 --> 01:07:13,200
Speaker 1: I look at it as a tail risk that the

1254
01:07:13,280 --> 01:07:15,360
Speaker 1: market itself hopefully corrects.

1255
01:07:15,760 --> 01:07:17,920
Speaker 2: And I would absolutely agree with you if that, if

1256
01:07:17,920 --> 01:07:21,400
Speaker 2: it could correct it, the problem is, and I'll share

1257
01:07:21,480 --> 01:07:24,160
Speaker 2: this with your audience, right. I presented this type of

1258
01:07:24,200 --> 01:07:27,160
Speaker 2: work to the FED. I've presented it to the IMF

1259
01:07:27,320 --> 01:07:30,400
Speaker 2: Financial Stability Group every single time, going in and saying

1260
01:07:30,440 --> 01:07:33,400
Speaker 2: please tell me why I'm wrong, And unfortunately the answer

1261
01:07:33,480 --> 01:07:37,680
Speaker 2: is you're right right. They actually acknowledge that. My reaction

1262
01:07:37,760 --> 01:07:40,320
Speaker 2: to that was fantastic. How can I help? What can

1263
01:07:40,360 --> 01:07:43,120
Speaker 2: we do? And their answer is there's nothing we can do.

1264
01:07:43,240 --> 01:07:47,360
Speaker 2: That's both the Vanguard and Blackrock control the regulatory apparatus.

1265
01:07:47,760 --> 01:07:50,440
Speaker 2: If we raise an alarm prior to the event happening,

1266
01:07:50,800 --> 01:07:52,280
Speaker 2: all that happens is we get fired.

1267
01:07:52,640 --> 01:07:55,600
Speaker 1: Huh. So let me ask you one or two other

1268
01:07:55,720 --> 01:08:01,000
Speaker 1: questions then related to those entities. So you said some

1269
01:08:01,080 --> 01:08:05,080
Speaker 1: of the models that BLS and NBR use are flawed.

1270
01:08:05,920 --> 01:08:08,920
Speaker 1: I'm a big fan of George Box's statement all models

1271
01:08:08,920 --> 01:08:14,480
Speaker 1: are wrong, but some are useful. NBER should declare a

1272
01:08:14,520 --> 01:08:17,600
Speaker 1: recession in first quarter twenty twenty three. I'm kind of

1273
01:08:17,640 --> 01:08:20,840
Speaker 1: paraphrasing something you said. Tell us why you think last

1274
01:08:20,880 --> 01:08:24,360
Speaker 1: year should have been declared a recession or NBR might

1275
01:08:24,400 --> 01:08:25,400
Speaker 1: declare to recession.

1276
01:08:26,479 --> 01:08:28,960
Speaker 2: I think in hindsight we might ultimately declare because we

1277
01:08:28,960 --> 01:08:31,640
Speaker 2: did see a combination of an increase in unemployment, we

1278
01:08:31,680 --> 01:08:35,320
Speaker 2: saw a decrease in industrial production, and we saw broad

1279
01:08:35,479 --> 01:08:39,720
Speaker 2: deterioration in terms of the economy. Things like leading economic indicators, etc.

1280
01:08:40,320 --> 01:08:44,519
Speaker 2: Are all consistent with historical recessions. Now, whether we choose

1281
01:08:44,600 --> 01:08:47,320
Speaker 2: to acknowledge that really boils down to the depth at

1282
01:08:47,360 --> 01:08:49,639
Speaker 2: which it occurred. And so the NBR looks at three

1283
01:08:49,680 --> 01:08:53,240
Speaker 2: separate components. They talk about how broad it is, how

1284
01:08:53,280 --> 01:08:55,439
Speaker 2: long it's occurring, and how deep the draw down is,

1285
01:08:55,520 --> 01:08:57,320
Speaker 2: And so the debate can be around how deep the

1286
01:08:57,400 --> 01:09:00,280
Speaker 2: draw down was at that point. I think the bigger

1287
01:09:00,560 --> 01:09:03,360
Speaker 2: issue that most people are struggling with is actually around

1288
01:09:03,360 --> 01:09:06,559
Speaker 2: things like the employment numbers, where there's been a very

1289
01:09:06,720 --> 01:09:10,120
Speaker 2: substantive change in how we calculate that data. What's called

1290
01:09:10,160 --> 01:09:13,439
Speaker 2: the birth death adjustment model, which was designed to reduce

1291
01:09:13,960 --> 01:09:18,360
Speaker 2: the need for periodic reassessments of what the levels of

1292
01:09:18,400 --> 01:09:21,559
Speaker 2: employment were in the economy tied to new business formation.

1293
01:09:22,120 --> 01:09:24,960
Speaker 2: There was an attempt to do that in a statistical framework,

1294
01:09:25,240 --> 01:09:28,000
Speaker 2: and unfortunately that statistical framework is now broken down now.

1295
01:09:28,280 --> 01:09:33,599
Speaker 1: I remember the two thousands BLS was showing some quarters

1296
01:09:33,640 --> 01:09:37,200
Speaker 1: where one hundred percent of the job creation for the

1297
01:09:37,240 --> 01:09:40,840
Speaker 1: month was due to birth death adjustments, and a lot

1298
01:09:40,840 --> 01:09:42,960
Speaker 1: of people called them out on it, and they subsequently

1299
01:09:43,000 --> 01:09:49,839
Speaker 1: made adjustments to their model. I've seen in certain reports,

1300
01:09:49,840 --> 01:09:53,200
Speaker 1: in certain commentary, Hey, you look at the past twelve months,

1301
01:09:53,240 --> 01:09:57,120
Speaker 1: it's all been adjustments. I'm not seeing that in the data.

1302
01:09:57,160 --> 01:09:59,640
Speaker 1: I'm seeing a lot of new job creation. Yeah, if

1303
01:09:59,640 --> 01:10:02,559
Speaker 1: you look at the household survey, it's slipped and there's

1304
01:10:02,560 --> 01:10:07,160
Speaker 1: a lot of new part time jobs. But the new

1305
01:10:07,520 --> 01:10:10,800
Speaker 1: work from home remote hybrid model lets a lot of

1306
01:10:10,800 --> 01:10:14,920
Speaker 1: people work part time and still do childcare. Whatever. Tell

1307
01:10:14,920 --> 01:10:16,519
Speaker 1: me what's wrong with the BLS model.

1308
01:10:17,200 --> 01:10:19,439
Speaker 2: Well, so the biggest issue with the BLS model is

1309
01:10:19,479 --> 01:10:23,559
Speaker 2: actually the conversion of those new businesses to jobs. Right, So,

1310
01:10:24,080 --> 01:10:26,760
Speaker 2: in particular, if you take a job in let's just

1311
01:10:26,800 --> 01:10:29,559
Speaker 2: say food service, right, or you create a job for

1312
01:10:29,640 --> 01:10:33,200
Speaker 2: yourself in food service by forming an independent company so

1313
01:10:33,240 --> 01:10:35,759
Speaker 2: that you can deduct some of your expenses for tax

1314
01:10:35,840 --> 01:10:40,840
Speaker 2: purposes for your job as a door dash driver. Right. Ironically,

1315
01:10:40,960 --> 01:10:44,080
Speaker 2: that falls into a category food service that's treated as

1316
01:10:44,160 --> 01:10:47,400
Speaker 2: high propensity to create additional jobs. And so this's a

1317
01:10:47,400 --> 01:10:50,000
Speaker 2: statistical model that then turns around and says, well, you

1318
01:10:50,120 --> 01:10:55,200
Speaker 2: started this DoorDash business called mike LLC, what's the prospect

1319
01:10:55,200 --> 01:10:57,200
Speaker 2: that that's going to create new jobs? Because of its

1320
01:10:57,320 --> 01:11:00,280
Speaker 2: sac code, it's actually treated as a high perpen city

1321
01:11:00,360 --> 01:11:04,880
Speaker 2: job formation, and it's assigned additional jobs in the establishment payroll.

1322
01:11:05,080 --> 01:11:07,720
Speaker 1: What about all the Uber drivers and Lyft drivers out there.

1323
01:11:07,800 --> 01:11:10,400
Speaker 2: So I actually think this is actually a fascinating dynamic.

1324
01:11:10,120 --> 01:11:14,080
Speaker 1: Because what you said we used to call those people unemployed.

1325
01:11:13,960 --> 01:11:16,320
Speaker 2: We did actually used to call those people unemployed. And

1326
01:11:16,400 --> 01:11:18,960
Speaker 2: so again, these are revisions that have happened within the

1327
01:11:19,000 --> 01:11:21,519
Speaker 2: data sets, and it's all very similar to this type

1328
01:11:21,560 --> 01:11:24,000
Speaker 2: of discussion that we're having, where it's in the details

1329
01:11:24,040 --> 01:11:26,439
Speaker 2: that ultimately matter. In two thousand and eight, we didn't

1330
01:11:26,439 --> 01:11:28,680
Speaker 2: have Uber, right, It's important to recognize that. So if

1331
01:11:28,680 --> 01:11:31,800
Speaker 2: you wanted to go drive New York City taxi, that

1332
01:11:31,840 --> 01:11:35,320
Speaker 2: was an entirely different job. You didn't even have Uber

1333
01:11:35,320 --> 01:11:38,080
Speaker 2: in twenty ten. What you really had was the Uber

1334
01:11:38,320 --> 01:11:42,120
Speaker 2: X introduced in competition. Would Lyft in twenty twelve. This

1335
01:11:42,320 --> 01:11:44,120
Speaker 2: or way out of the recession at this point. That

1336
01:11:44,200 --> 01:11:46,920
Speaker 2: changes the dynamics. But you used to be able to

1337
01:11:46,960 --> 01:11:49,600
Speaker 2: be unemployed and go get a cash paying job. I

1338
01:11:49,600 --> 01:11:51,880
Speaker 2: could go bartend at your bar, for example. You'd be like, Hey,

1339
01:11:51,920 --> 01:11:55,639
Speaker 2: I'm an LPIOD. I'll pay you under the table, right, Okay,

1340
01:11:55,800 --> 01:11:58,280
Speaker 2: you pocket some of your receipts, you sell some beer

1341
01:11:58,320 --> 01:12:00,799
Speaker 2: for cash, you pay me with it. Nobody knows anything

1342
01:12:00,800 --> 01:12:04,320
Speaker 2: from the government standpoint, those rules actually began to change

1343
01:12:04,400 --> 01:12:07,320
Speaker 2: quite significantly. In twenty twelve, we introduced what's called the

1344
01:12:07,360 --> 01:12:11,400
Speaker 2: ten ninety nine I think it's kay that changed the

1345
01:12:11,600 --> 01:12:14,960
Speaker 2: reporting crew requirements around that type of business. It made

1346
01:12:15,000 --> 01:12:17,760
Speaker 2: it much easier and much more electronic. And then in

1347
01:12:17,800 --> 01:12:21,479
Speaker 2: twenty twenty one we actually substantively changed the rules. We

1348
01:12:21,520 --> 01:12:24,120
Speaker 2: went from being able to treat up to twenty thousand

1349
01:12:24,160 --> 01:12:27,679
Speaker 2: dollars in income as independent and not requiring filing taxes

1350
01:12:28,040 --> 01:12:31,000
Speaker 2: to six hundred dollars. Well, when you go from twenty

1351
01:12:31,040 --> 01:12:33,320
Speaker 2: thousand to six hundred, you catch a whole bunch of

1352
01:12:33,400 --> 01:12:36,080
Speaker 2: new businesses and that's really what's showing up in the

1353
01:12:36,080 --> 01:12:36,880
Speaker 2: employment numbers.

1354
01:12:36,960 --> 01:12:40,559
Speaker 1: Huh, really fascinating stuff. Thank you, Mike for being so

1355
01:12:40,680 --> 01:12:43,800
Speaker 1: generous with your time. We have been speaking with Mike Green.

1356
01:12:44,320 --> 01:12:48,599
Speaker 1: He is the chief strategist at Simplify Asset Management, helping

1357
01:12:48,640 --> 01:12:52,200
Speaker 1: to oversee twenty eight funds with over four billion dollars

1358
01:12:52,240 --> 01:12:56,040
Speaker 1: in assets. If you enjoy this conversation, check out any

1359
01:12:56,080 --> 01:13:00,000
Speaker 1: of the five hundred we've had over the past ten years.

1360
01:13:00,840 --> 01:13:04,840
Speaker 1: You can find those at iTunes, Spotify, YouTube, wherever you

1361
01:13:04,960 --> 01:13:09,600
Speaker 1: find your favorite podcast. Speaking of podcasts, check out my

1362
01:13:09,680 --> 01:13:14,839
Speaker 1: new podcast, At the Money, short conversations with experts about

1363
01:13:14,880 --> 01:13:17,840
Speaker 1: your money, earning it, spending it, and most of all,

1364
01:13:18,160 --> 01:13:22,080
Speaker 1: investing it. Find that wherever you find your favorite podcasts

1365
01:13:22,200 --> 01:13:25,320
Speaker 1: or here in the Masters and Business feed, I would

1366
01:13:25,360 --> 01:13:27,479
Speaker 1: be remiss if I did not thank the crackstaff that

1367
01:13:27,560 --> 01:13:32,400
Speaker 1: helps put these conversations together each week. Sarah Livesey is

1368
01:13:32,439 --> 01:13:37,000
Speaker 1: my audio engineer. Attico Vaalbroun is my project manager. Anna

1369
01:13:37,120 --> 01:13:40,559
Speaker 1: Luke is my producer. Sage Bauman is the head of

1370
01:13:40,640 --> 01:13:45,920
Speaker 1: podcasts here at Bloomberg. Sean Russo is my head of research.

1371
01:13:46,840 --> 01:13:50,759
Speaker 1: I'm Barry Rittons. You've been listening to Masters in Business

1372
01:13:51,320 --> 01:13:55,519
Speaker 1: on Bloomberg Radio.