1 00:00:09,760 --> 00:00:13,200 Speaker 1: Hello, and welcome to another episode of the Odd Thoughts podcast. 2 00:00:13,280 --> 00:00:17,599 Speaker 1: I'm Tracy Allowitt and I'm Joe. So, Joe, we've talked 3 00:00:17,680 --> 00:00:21,600 Speaker 1: before on this podcast about passive investing, right, I seem 4 00:00:21,640 --> 00:00:24,640 Speaker 1: to remember that. I'm sure we must have. In fact, 5 00:00:24,680 --> 00:00:27,200 Speaker 1: I didn't. Are there any other types of investing anymore? 6 00:00:29,480 --> 00:00:31,760 Speaker 1: If we talked about investing, I'm sure we talked about 7 00:00:31,760 --> 00:00:36,159 Speaker 1: passive investing. No, you're absolutely right, But I'm trying to 8 00:00:36,200 --> 00:00:38,920 Speaker 1: think now, I guess that means we haven't talked about 9 00:00:39,080 --> 00:00:44,440 Speaker 1: the sort of basis of passive investing, which is index construction. Right. 10 00:00:44,520 --> 00:00:47,520 Speaker 1: If you're going to invest passively, you need to be 11 00:00:47,640 --> 00:00:51,880 Speaker 1: investing essentially in some sort of index or benchmark exactly, right. 12 00:00:51,960 --> 00:00:54,000 Speaker 1: So you could say, oh, I'm not going to make 13 00:00:54,040 --> 00:00:57,960 Speaker 1: any choices in my investment, I'm just going to invest 14 00:00:58,000 --> 00:01:00,640 Speaker 1: in the market. But even that has to have some definition. 15 00:01:01,200 --> 00:01:04,600 Speaker 1: If it's the SNP five hundred, then whoever designed the 16 00:01:04,720 --> 00:01:09,120 Speaker 1: SMP five hundred is ultimately the one constructing your portfolio. 17 00:01:09,720 --> 00:01:13,520 Speaker 1: So ultimately someone is making a decision, even if you 18 00:01:13,560 --> 00:01:16,200 Speaker 1: think you're sort of trying to take human discretion out 19 00:01:16,240 --> 00:01:19,440 Speaker 1: of the process. Right, And there's really been an explosion 20 00:01:19,600 --> 00:01:23,679 Speaker 1: in all types of indices recently, sort of growing in 21 00:01:23,760 --> 00:01:26,480 Speaker 1: tandem with the big growth that we've seen in passive 22 00:01:26,480 --> 00:01:30,039 Speaker 1: investing in general. One thing that gets bandied around quite 23 00:01:30,080 --> 00:01:32,920 Speaker 1: a lot is that there are now more indices in 24 00:01:33,000 --> 00:01:36,399 Speaker 1: the world than there are individual stocks, which, you know, 25 00:01:36,520 --> 00:01:38,680 Speaker 1: stop and think about that for a moment. It's it's 26 00:01:38,680 --> 00:01:41,679 Speaker 1: pretty amazing, although I guess, you know, you could say, 27 00:01:42,280 --> 00:01:44,600 Speaker 1: given the amount of stocks available in the world, there's 28 00:01:44,600 --> 00:01:47,880 Speaker 1: sort of an infinite number of combinations that you could 29 00:01:47,880 --> 00:01:51,080 Speaker 1: get at that point. But it does suggest that something 30 00:01:51,120 --> 00:01:54,160 Speaker 1: that was supposed to be a simple reflection of a 31 00:01:54,200 --> 00:01:58,600 Speaker 1: particular market has sort of morphed into something else, right. 32 00:01:58,640 --> 00:02:02,520 Speaker 1: I think Bloomberg uh Eric Belcoon has had a really 33 00:02:02,560 --> 00:02:06,480 Speaker 1: interesting column this week, you know, pointing out that, you know, 34 00:02:06,520 --> 00:02:10,000 Speaker 1: there's only really twelve notes on an octave, but there's 35 00:02:10,120 --> 00:02:12,960 Speaker 1: hundreds of millions of songs, and I think that's a 36 00:02:13,000 --> 00:02:20,240 Speaker 1: pretty good analogy for the relationship between individual components and indexes. 37 00:02:20,639 --> 00:02:23,960 Speaker 1: And of course there's essentially an infinite number of ways 38 00:02:24,040 --> 00:02:28,080 Speaker 1: that you can arrange them and wait the components and 39 00:02:28,200 --> 00:02:31,919 Speaker 1: wait them by size or factor or whatever. So it's 40 00:02:31,960 --> 00:02:35,600 Speaker 1: not surprising that there is an incredible amount of interest 41 00:02:35,760 --> 00:02:40,200 Speaker 1: and important place on a index construction these days, right, 42 00:02:40,240 --> 00:02:44,359 Speaker 1: and people thinking about this indexation kind of issue or 43 00:02:44,440 --> 00:02:48,240 Speaker 1: explosion and indices, it tends to either be of of 44 00:02:48,280 --> 00:02:51,200 Speaker 1: that sort of ilk where people think, oh, well, it's 45 00:02:51,240 --> 00:02:53,880 Speaker 1: it's natural that this is happening because we have these 46 00:02:54,000 --> 00:02:57,280 Speaker 1: different varieties of indexes that you can build using different 47 00:02:57,280 --> 00:03:01,359 Speaker 1: types of stocks. But there's another extreme dream end of this, 48 00:03:01,639 --> 00:03:04,240 Speaker 1: and you know people who actually find it quite worrying 49 00:03:04,320 --> 00:03:07,200 Speaker 1: and quite dangerous for one reason or another. End. Today 50 00:03:07,639 --> 00:03:10,320 Speaker 1: we're going to be speaking with someone who is firmly 51 00:03:10,680 --> 00:03:14,080 Speaker 1: at that end of the discussion. I can't wait. This 52 00:03:14,160 --> 00:03:17,720 Speaker 1: is a really important topic. I joked in the beginning 53 00:03:17,880 --> 00:03:21,200 Speaker 1: that is there any other type of investing besides passive 54 00:03:21,280 --> 00:03:26,440 Speaker 1: because it really does feel like that is swallowing everything. 55 00:03:26,520 --> 00:03:29,280 Speaker 1: And I think there's a real existential question about the 56 00:03:29,400 --> 00:03:33,600 Speaker 1: role of what used to be called discretionary investing. And 57 00:03:33,720 --> 00:03:37,800 Speaker 1: so I think there's it's a great it's a great 58 00:03:38,040 --> 00:03:43,080 Speaker 1: timely and timeless topic for us. Yes, indeed, all right, 59 00:03:43,160 --> 00:03:46,440 Speaker 1: So without further ado, our guest for this episode is 60 00:03:46,480 --> 00:03:50,920 Speaker 1: Intego Fraser Jenkins. He is a quantitative strategist over at 61 00:03:50,960 --> 00:03:55,800 Speaker 1: Bernstein you may remember him listeners as the guy who 62 00:03:55,840 --> 00:03:59,560 Speaker 1: wrote The Silent Road to Serfdom why passive investing is 63 00:03:59,600 --> 00:04:02,800 Speaker 1: worse than Marxism. So, I promise this is going to 64 00:04:02,880 --> 00:04:05,880 Speaker 1: be an interesting discussion. And Ago, thank you so much 65 00:04:05,880 --> 00:04:07,840 Speaker 1: for coming on, but thank you for having me on. 66 00:04:08,200 --> 00:04:12,360 Speaker 1: So and I guess my my first question is you've 67 00:04:12,400 --> 00:04:15,800 Speaker 1: written quite a few notes about indexing at this point 68 00:04:15,840 --> 00:04:18,920 Speaker 1: in time. Your latest one is sort of unusual in 69 00:04:18,960 --> 00:04:21,880 Speaker 1: the field of analyst research. You know, it was called 70 00:04:21,920 --> 00:04:25,520 Speaker 1: fund Management Strategy the man who created the last index, 71 00:04:25,560 --> 00:04:29,440 Speaker 1: and it's sort of a fictional slash historical look at 72 00:04:29,520 --> 00:04:35,800 Speaker 1: index creation. How did you focus on this particular topic. Yes, so, 73 00:04:35,880 --> 00:04:40,200 Speaker 1: when we think about the way investment works at the moment, 74 00:04:40,240 --> 00:04:43,560 Speaker 1: I think this five trillion switch from active a passive 75 00:04:43,600 --> 00:04:45,840 Speaker 1: has taken place in last decade is one of the 76 00:04:45,880 --> 00:04:48,880 Speaker 1: biggest changes that we've seen, and I think that passive 77 00:04:48,920 --> 00:04:51,240 Speaker 1: as a lot of further to grow. I think that 78 00:04:51,320 --> 00:04:53,560 Speaker 1: some people have interpreted some of our previous work, because 79 00:04:53,600 --> 00:04:55,960 Speaker 1: that's the one you just mentioned earlier, as us being 80 00:04:56,000 --> 00:04:58,880 Speaker 1: anti passive in some way. I wouldn't describe myself anti 81 00:04:58,880 --> 00:05:03,240 Speaker 1: passive because passive is and more to democratize access to 82 00:05:03,279 --> 00:05:06,360 Speaker 1: capital markets than any other invention in investing in the 83 00:05:06,440 --> 00:05:10,159 Speaker 1: last couple of decades. But it does change the calculus 84 00:05:10,200 --> 00:05:12,919 Speaker 1: for investors, both at the micro level, for an individual 85 00:05:12,920 --> 00:05:16,800 Speaker 1: investor and for society overall. And so if an individual investor, 86 00:05:17,240 --> 00:05:20,640 Speaker 1: there's a question of how active and passive interact with 87 00:05:20,680 --> 00:05:23,920 Speaker 1: each other in their overall holdings. For society of all 88 00:05:23,960 --> 00:05:27,640 Speaker 1: are big implications for capital allocation and for stewardship. And 89 00:05:27,720 --> 00:05:29,279 Speaker 1: I think that what it all comes down to is 90 00:05:29,400 --> 00:05:34,039 Speaker 1: the relationship between a fund buyer and an asset manager 91 00:05:34,600 --> 00:05:37,400 Speaker 1: is changing and as further to change, and that's been 92 00:05:37,480 --> 00:05:41,520 Speaker 1: driven to something sent by the increase in passive options 93 00:05:42,080 --> 00:05:44,240 Speaker 1: that are out there. Now you mentioned we've written about 94 00:05:44,279 --> 00:05:46,040 Speaker 1: this in research notes in the past. We want to 95 00:05:46,080 --> 00:05:48,839 Speaker 1: say a bit bit different here by writing a work 96 00:05:48,839 --> 00:05:51,640 Speaker 1: of fiction, um, I mean, firstly hopefully a bit more fun. 97 00:05:51,640 --> 00:05:53,840 Speaker 1: It allows us to use kind of language is not 98 00:05:53,920 --> 00:05:56,920 Speaker 1: possible in a normal style side research note, but also 99 00:05:56,960 --> 00:06:01,760 Speaker 1: allows us to approach the active assive split from a 100 00:06:01,800 --> 00:06:06,400 Speaker 1: few different perspectives. Where do you see this showing up? 101 00:06:06,480 --> 00:06:09,720 Speaker 1: So it's one thing to talk about changes in governance, 102 00:06:09,839 --> 00:06:13,880 Speaker 1: it's another thing to talk about changes in capital allocation 103 00:06:14,040 --> 00:06:16,440 Speaker 1: and how that goes about. But when you look at 104 00:06:16,480 --> 00:06:19,200 Speaker 1: the market, you still see some stocks doing well. You 105 00:06:19,279 --> 00:06:23,400 Speaker 1: still see some stocks doing badly, some companies thriving. Can 106 00:06:23,440 --> 00:06:27,360 Speaker 1: you point to something happening in the market that's sort 107 00:06:27,360 --> 00:06:31,440 Speaker 1: of independently observable and say, okay, here is a change 108 00:06:31,760 --> 00:06:35,719 Speaker 1: in the way markets behave that we can associate with 109 00:06:36,320 --> 00:06:39,680 Speaker 1: all the money leaving active and flowing into passive. I 110 00:06:39,720 --> 00:06:43,640 Speaker 1: think the biggest issue here is just it's a question 111 00:06:43,640 --> 00:06:46,320 Speaker 1: of what an investor expects to get out of an 112 00:06:46,360 --> 00:06:50,160 Speaker 1: active manager, and I think we've seen some miss beans 113 00:06:50,200 --> 00:06:52,800 Speaker 1: have blown up about that in the last decade or so. 114 00:06:52,800 --> 00:06:56,600 Speaker 1: So the idea the one could charge for beta as 115 00:06:56,880 --> 00:07:00,320 Speaker 1: as an active manager UM has been obviously deep anked 116 00:07:00,360 --> 00:07:03,440 Speaker 1: some time ago with the role of passive broad index funds. 117 00:07:03,760 --> 00:07:06,640 Speaker 1: I think the next stage really is the idea of 118 00:07:06,720 --> 00:07:11,160 Speaker 1: charging for factor beta in sense active managers who are 119 00:07:11,280 --> 00:07:14,400 Speaker 1: actually just consistently hugging some factors in the market, well, 120 00:07:14,760 --> 00:07:17,120 Speaker 1: and now you can buy those factors the current going 121 00:07:17,200 --> 00:07:19,760 Speaker 1: rates four basis points. I think smart beta will be 122 00:07:19,800 --> 00:07:22,200 Speaker 1: free within a year or so, based in terms of 123 00:07:22,200 --> 00:07:24,960 Speaker 1: headline fee if nothing else UM, And so that really 124 00:07:25,000 --> 00:07:27,240 Speaker 1: kind of focused attention on on what the point of 125 00:07:27,240 --> 00:07:29,880 Speaker 1: an active manager is, and so I think that's where 126 00:07:29,880 --> 00:07:34,480 Speaker 1: the biggest change comes here. I think there's been perhaps 127 00:07:34,560 --> 00:07:38,200 Speaker 1: a mistaken belief that because it's very easy to measure 128 00:07:38,600 --> 00:07:42,360 Speaker 1: headline fee, that has become the key determinant in so 129 00:07:42,440 --> 00:07:44,600 Speaker 1: many fund allocation decisions. And when you look at the 130 00:07:44,640 --> 00:07:48,480 Speaker 1: allocations both with an active and with impassive in the 131 00:07:48,520 --> 00:07:51,440 Speaker 1: last few years, more than a hundred percent the net 132 00:07:51,480 --> 00:07:54,800 Speaker 1: flow has gone the cheapest of active funds and the 133 00:07:54,880 --> 00:07:58,800 Speaker 1: cheapest of passive funds. Now, on one hand, that's great, 134 00:07:58,840 --> 00:08:03,160 Speaker 1: and it's allowed asset owners to lower their overall cost 135 00:08:03,400 --> 00:08:08,640 Speaker 1: of employing asset managers, But headline fee only really matters 136 00:08:08,640 --> 00:08:11,640 Speaker 1: to extent that it influences the quality of the net 137 00:08:11,640 --> 00:08:14,480 Speaker 1: of fee outcome, and I think that there needs to 138 00:08:14,520 --> 00:08:17,720 Speaker 1: be a focusing on the minds about what kind of 139 00:08:17,800 --> 00:08:21,440 Speaker 1: outcome people want from investment decisions. Um and this sort 140 00:08:21,480 --> 00:08:24,600 Speaker 1: of just fit into a much bigger picture, which is 141 00:08:25,120 --> 00:08:27,920 Speaker 1: last thirty five years, Exus and got Up bonds have 142 00:08:27,960 --> 00:08:29,720 Speaker 1: gone up, and they've managed to do so in a 143 00:08:29,720 --> 00:08:33,319 Speaker 1: way that's given a negative correlation between them. So an 144 00:08:33,320 --> 00:08:38,319 Speaker 1: extraordinarily benign set of circumstances, and that's as least been 145 00:08:38,480 --> 00:08:41,199 Speaker 1: part of the reason why at least of the hindspee 146 00:08:41,240 --> 00:08:44,079 Speaker 1: made sense for people to allocate from acts of the passive. 147 00:08:44,520 --> 00:08:46,920 Speaker 1: I think that if one projects forward from here and says, well, 148 00:08:47,320 --> 00:08:49,319 Speaker 1: there are a number of reasons to suspect that what 149 00:08:49,480 --> 00:08:52,800 Speaker 1: might be in a lower return world across asset classes 150 00:08:53,320 --> 00:08:55,640 Speaker 1: um and it raised the question of well, what is 151 00:08:55,640 --> 00:08:58,160 Speaker 1: the outcome people want? What is the real benchmark that 152 00:08:58,320 --> 00:09:02,000 Speaker 1: investors care about? That real benchmark probably ultimately comes down 153 00:09:02,000 --> 00:09:06,200 Speaker 1: to trying to fund retirement, healthcare cost, school fees, etcetera. 154 00:09:06,559 --> 00:09:10,720 Speaker 1: All those things trade more like CPI than like a 155 00:09:10,800 --> 00:09:16,360 Speaker 1: capital market return. The question is, can um asset owners 156 00:09:16,400 --> 00:09:20,240 Speaker 1: come to active managers and buy a return stream the 157 00:09:20,280 --> 00:09:23,000 Speaker 1: net of fees will beat that UM. That in my 158 00:09:23,040 --> 00:09:26,120 Speaker 1: mind's an active decision, but it's been somewhat subsumed by 159 00:09:26,120 --> 00:09:28,800 Speaker 1: everyone assuming that the right thing to go and do 160 00:09:28,920 --> 00:09:32,160 Speaker 1: is to hire a series of active managers who can 161 00:09:32,160 --> 00:09:35,440 Speaker 1: perform a relative to a very specific benchmark in a 162 00:09:35,480 --> 00:09:39,440 Speaker 1: series of pigeonholes across the market. Mhm, So could you 163 00:09:39,480 --> 00:09:43,040 Speaker 1: maybe step back for a second and describe how we 164 00:09:43,200 --> 00:09:47,400 Speaker 1: got from you know, a sort of a relatively simple 165 00:09:47,600 --> 00:09:50,600 Speaker 1: or simpler place where we had the Dow Jones index. 166 00:09:50,640 --> 00:09:52,960 Speaker 1: I mean, when the Dow Jones index was invented, it 167 00:09:53,040 --> 00:09:56,120 Speaker 1: had I think something like a dozen stocks in it. 168 00:09:56,600 --> 00:09:59,800 Speaker 1: And now we're at this place where we have hundreds, 169 00:09:59,840 --> 00:10:03,079 Speaker 1: if not thousands, of different industries and benchmarks of all 170 00:10:03,080 --> 00:10:06,640 Speaker 1: different types of flavors, smart, beata, factor investing, whatever you 171 00:10:06,720 --> 00:10:11,640 Speaker 1: want to call it. How did we actually get here? Yeah? So, um. 172 00:10:11,679 --> 00:10:15,280 Speaker 1: In the background to doing this note, was spent some 173 00:10:15,360 --> 00:10:17,680 Speaker 1: times reading the early work of Dow and Paul and 174 00:10:17,679 --> 00:10:21,920 Speaker 1: it's kind of fascinating to see the motivation behind the 175 00:10:21,960 --> 00:10:24,560 Speaker 1: work that they did. Um. The work of down Poor 176 00:10:24,720 --> 00:10:27,800 Speaker 1: was firmly in the camp of financial journalism, not in 177 00:10:27,840 --> 00:10:31,720 Speaker 1: the camp of investing. UM. So people may complain about 178 00:10:32,080 --> 00:10:35,360 Speaker 1: price witted industries, but it was perfectly sensible decision for 179 00:10:35,440 --> 00:10:38,880 Speaker 1: Dow if he wanted to report on the movement of 180 00:10:38,920 --> 00:10:41,120 Speaker 1: the market the day before, seeming to add up prices 181 00:10:41,120 --> 00:10:43,480 Speaker 1: and divide them by the number of stocks that he 182 00:10:43,600 --> 00:10:48,840 Speaker 1: was using apartment anything else. Without modern calculating machines, it 183 00:10:48,960 --> 00:10:51,960 Speaker 1: was hard to do that work any other way. UM. 184 00:10:51,960 --> 00:10:54,199 Speaker 1: And that was a fair way to give a sense 185 00:10:54,240 --> 00:10:58,200 Speaker 1: of broad market movements. You can go back before that, 186 00:10:58,360 --> 00:11:02,080 Speaker 1: the work of Poor and his work on the history 187 00:11:02,120 --> 00:11:06,040 Speaker 1: of railroads in the US. It doesn't seem like ones 188 00:11:06,600 --> 00:11:09,520 Speaker 1: reading a work of an index constructor when one picks 189 00:11:09,600 --> 00:11:11,120 Speaker 1: up that book. But I would argue that one is 190 00:11:11,200 --> 00:11:14,800 Speaker 1: because he has this massive enumeration of facts, which in 191 00:11:14,800 --> 00:11:17,480 Speaker 1: this case miles of new track laid each year and 192 00:11:17,559 --> 00:11:21,400 Speaker 1: dividends paid by railroad companies. And it's basically a prose 193 00:11:21,600 --> 00:11:25,240 Speaker 1: version of an index, I would argue, I guess as 194 00:11:25,240 --> 00:11:29,320 Speaker 1: one roller clocks forward, the question of indexing became kind 195 00:11:29,360 --> 00:11:32,760 Speaker 1: of critical for solving the agency problem, which is always inherent. 196 00:11:33,240 --> 00:11:35,800 Speaker 1: If one goes out and hires an asset manager to 197 00:11:35,880 --> 00:11:38,280 Speaker 1: run assets for you, how do I know I'm getting 198 00:11:38,280 --> 00:11:41,200 Speaker 1: good value for money from this asset manager. How do 199 00:11:41,240 --> 00:11:44,000 Speaker 1: I know they're doing something for me that I couldn't 200 00:11:44,040 --> 00:11:47,520 Speaker 1: get more cheaply somewhere else. And of course that's become 201 00:11:48,080 --> 00:11:52,480 Speaker 1: a very broadly embedded as the as the idea of 202 00:11:52,559 --> 00:11:55,559 Speaker 1: needing to perform a board market index, and that's driven 203 00:11:55,600 --> 00:12:00,600 Speaker 1: the initial role of passive um. But once one accepts 204 00:12:00,600 --> 00:12:04,520 Speaker 1: that idea that an index could be a rules driven 205 00:12:04,559 --> 00:12:07,040 Speaker 1: approach to selecting kind of companies, as you said in 206 00:12:07,080 --> 00:12:11,560 Speaker 1: your introduction to this piece, then suddenly the possibilities are endless. 207 00:12:11,559 --> 00:12:14,520 Speaker 1: And who's to say that a given definition of broad 208 00:12:14,559 --> 00:12:18,400 Speaker 1: index is the benchmarks people have and there are a 209 00:12:18,440 --> 00:12:23,320 Speaker 1: massive number of other ways of doing that. The question, 210 00:12:23,360 --> 00:12:27,800 Speaker 1: I think, then becomes confused about whether one is right 211 00:12:27,880 --> 00:12:31,520 Speaker 1: in a given circumstance to get rid of an active 212 00:12:31,559 --> 00:12:34,520 Speaker 1: manager and replace them with a passive manager, which you 213 00:12:34,559 --> 00:12:35,880 Speaker 1: know that would be the right thing to go and 214 00:12:35,920 --> 00:12:39,559 Speaker 1: do if that active manager was doing nothing other than 215 00:12:39,720 --> 00:12:42,760 Speaker 1: hugging a passive index. But that gets confused with a 216 00:12:42,800 --> 00:12:45,599 Speaker 1: broader question of well, what is the end outcome that 217 00:12:45,760 --> 00:12:47,640 Speaker 1: people want to have? And I think there's been almost 218 00:12:47,720 --> 00:12:51,720 Speaker 1: a inversion in the direction of causation, if I can 219 00:12:52,080 --> 00:12:54,880 Speaker 1: say that, in the way people think about industries. The 220 00:12:54,920 --> 00:12:58,640 Speaker 1: initial industries were there to report on what had happened 221 00:12:58,679 --> 00:13:01,360 Speaker 1: in the market the day before. Now the construction of 222 00:13:01,400 --> 00:13:04,400 Speaker 1: new induseries, particularly on the smart beta induseries, are actually 223 00:13:04,400 --> 00:13:09,400 Speaker 1: directing capital allocation um and become a the essentially a 224 00:13:09,400 --> 00:13:14,400 Speaker 1: forward looking a guide to where equity capital goes. Right. 225 00:13:14,480 --> 00:13:17,160 Speaker 1: I think about this a lot. So you know, we're 226 00:13:17,160 --> 00:13:20,120 Speaker 1: talking about smart beta, So for people who aren't necessarily 227 00:13:20,160 --> 00:13:24,319 Speaker 1: familiar with it. This idea that there are factors within 228 00:13:24,480 --> 00:13:29,720 Speaker 1: stocks that by some sort of researchers have you know, 229 00:13:29,800 --> 00:13:33,000 Speaker 1: characterized out performance, whether it's stocks that are cheap on 230 00:13:33,040 --> 00:13:38,160 Speaker 1: a pe basis, or stocks that exhibit high levels of momentum, 231 00:13:38,600 --> 00:13:42,760 Speaker 1: things like that. And so this idea is that, well, 232 00:13:43,080 --> 00:13:45,199 Speaker 1: why not just invest in a E T F for 233 00:13:45,280 --> 00:13:48,120 Speaker 1: an index that capture all those things, and don't you 234 00:13:48,160 --> 00:13:50,679 Speaker 1: don't have to do the work. One thing I wonder 235 00:13:50,720 --> 00:13:54,240 Speaker 1: about is like, Okay, you make a interesting and important 236 00:13:54,280 --> 00:13:57,160 Speaker 1: point that the issue for investors shouldn't be fees per se, 237 00:13:57,200 --> 00:14:02,200 Speaker 1: but that return negative fees. That still raises the question 238 00:14:02,280 --> 00:14:04,760 Speaker 1: of that even if there are active managers who can 239 00:14:04,840 --> 00:14:10,680 Speaker 1: deliver superior performance negative fees, does the individual investor have 240 00:14:10,800 --> 00:14:16,720 Speaker 1: any way to identify them? Um. I think the investor 241 00:14:16,800 --> 00:14:20,080 Speaker 1: needs to be clear about what kind of return stream 242 00:14:20,120 --> 00:14:23,680 Speaker 1: they want from their active manager. So I think it's 243 00:14:23,720 --> 00:14:28,400 Speaker 1: normal for people nowadays to think about a manage has 244 00:14:28,400 --> 00:14:31,120 Speaker 1: been a good manager if they deliver a return that 245 00:14:31,520 --> 00:14:33,840 Speaker 1: exceeds that of the index. But of course, if one 246 00:14:33,920 --> 00:14:36,880 Speaker 1: goes to a manager, one's buying a whole bundle of 247 00:14:37,280 --> 00:14:39,760 Speaker 1: return streams all wrapped together in what their fund produced 248 00:14:39,800 --> 00:14:41,480 Speaker 1: is Some of that's a market beata. Some of it 249 00:14:41,560 --> 00:14:44,880 Speaker 1: will happen to be factors as you outlined just earlier 250 00:14:44,920 --> 00:14:47,960 Speaker 1: than to inform of smart beta. Some of it will 251 00:14:48,000 --> 00:14:51,000 Speaker 1: be very stock stetific decisions that the manager has made. 252 00:14:51,400 --> 00:14:53,880 Speaker 1: I think that one really important change is happening is 253 00:14:53,920 --> 00:14:58,280 Speaker 1: by smart beta or these sort of simple factors essentially 254 00:14:58,320 --> 00:15:01,640 Speaker 1: becoming free or something close to that. It really focused 255 00:15:01,640 --> 00:15:05,760 Speaker 1: attention on what one should get out of an active manager, 256 00:15:06,600 --> 00:15:10,720 Speaker 1: because it's always impossible for more sophisticate investors, say, to 257 00:15:11,400 --> 00:15:15,600 Speaker 1: disentangle the kinds of return streams that they've had from 258 00:15:15,640 --> 00:15:17,680 Speaker 1: the fund manager. But it's been much harder to do 259 00:15:17,720 --> 00:15:22,480 Speaker 1: that more broadly across the whole uh A space of 260 00:15:22,560 --> 00:15:25,600 Speaker 1: fund buyers UM. And now the one can buy these 261 00:15:25,640 --> 00:15:29,040 Speaker 1: factors essentially for free, A very important distinction gets made 262 00:15:29,040 --> 00:15:31,720 Speaker 1: and one can say, well, it is manager giving me 263 00:15:32,080 --> 00:15:36,040 Speaker 1: a return stream that is idiosyncratic, eye is different from 264 00:15:36,120 --> 00:15:39,200 Speaker 1: UM this set of factors that I can buy. I 265 00:15:39,240 --> 00:15:42,440 Speaker 1: think that's enormous important development because it allows us to 266 00:15:42,520 --> 00:15:46,840 Speaker 1: say which kind of return streams become genuinely valuable for 267 00:15:46,920 --> 00:15:50,200 Speaker 1: the asset owner. Return streams you cannot get from simply 268 00:15:50,240 --> 00:15:54,080 Speaker 1: holding a static combination of factors. So I'd argue that 269 00:15:54,120 --> 00:15:59,560 Speaker 1: actually with UM, with the cheapening of in the season, 270 00:15:59,760 --> 00:16:03,560 Speaker 1: the growth a more industries, maybe ironically, it's actually made 271 00:16:03,560 --> 00:16:07,440 Speaker 1: it much easier perhaps to now identify what one would 272 00:16:07,520 --> 00:16:12,920 Speaker 1: want from an active manager, and that is idiosyncratic returns. UM. 273 00:16:13,000 --> 00:16:16,680 Speaker 1: Why is that not more reflected in flows into active 274 00:16:16,760 --> 00:16:19,400 Speaker 1: management then? Because you know, this is the discussion that 275 00:16:19,440 --> 00:16:23,400 Speaker 1: comes up all the time with the explosion of passive investing. 276 00:16:24,080 --> 00:16:29,200 Speaker 1: Most people would say, well, eventually passive investment is going 277 00:16:29,240 --> 00:16:32,960 Speaker 1: to misdirect capital or misallocate capital, and there's going to 278 00:16:33,000 --> 00:16:36,840 Speaker 1: be big price discrepancies that active managers can come in 279 00:16:36,960 --> 00:16:40,320 Speaker 1: and exploit in some way, maybe by producing you know, 280 00:16:40,480 --> 00:16:44,320 Speaker 1: idiosyncratic or specialized returns as you put it. Why aren't 281 00:16:44,320 --> 00:16:47,840 Speaker 1: we actually seeing that play out in the market. Then? Yeah, 282 00:16:47,880 --> 00:16:49,400 Speaker 1: I think there a few reasons that. I mean, I 283 00:16:49,400 --> 00:16:53,280 Speaker 1: guess the initial answer is that the entire focus of 284 00:16:53,640 --> 00:16:57,040 Speaker 1: fund selection seems to be overly focused on headline fee. 285 00:16:57,080 --> 00:17:00,200 Speaker 1: I mean, it's obviously very easy to ident for a 286 00:17:00,240 --> 00:17:03,720 Speaker 1: headline fee up front ahead of time. UM, And I 287 00:17:03,760 --> 00:17:06,879 Speaker 1: said earlier, UM, that has meant there's been a huge 288 00:17:07,520 --> 00:17:10,639 Speaker 1: flow into the cheapest funds, both through an active and 289 00:17:10,760 --> 00:17:14,800 Speaker 1: with impassive. UM. I guess another reason is that different 290 00:17:14,840 --> 00:17:17,960 Speaker 1: goes back ten years. Then, yes, it's true there were 291 00:17:17,960 --> 00:17:21,440 Speaker 1: too many active investors who are charging an active fee 292 00:17:21,480 --> 00:17:24,440 Speaker 1: for delivering something that was very close to the index. 293 00:17:24,480 --> 00:17:27,520 Speaker 1: And it's right that someone has created a series of 294 00:17:27,560 --> 00:17:31,560 Speaker 1: passive indices and taken capital from those managers. I think 295 00:17:31,600 --> 00:17:35,199 Speaker 1: where it gets more complicated, UM is that again, as 296 00:17:35,200 --> 00:17:38,840 Speaker 1: I mentioned earlier, this has been an environment for thirty 297 00:17:39,000 --> 00:17:43,840 Speaker 1: thirty five years when with hindsight, having a passive long 298 00:17:43,920 --> 00:17:46,680 Speaker 1: only exposure to equities and a passive longer exposure to 299 00:17:46,760 --> 00:17:50,600 Speaker 1: bonds has been not only good from a return perspective, 300 00:17:50,720 --> 00:17:54,000 Speaker 1: is beaten CPI, but they've offered a diversification between them 301 00:17:54,080 --> 00:17:56,680 Speaker 1: to go back of a longer horizon. That diversification is 302 00:17:56,720 --> 00:18:00,399 Speaker 1: actually quite unusual. UM. So I think that some of 303 00:18:00,400 --> 00:18:04,680 Speaker 1: the support that passive has had has been a matter 304 00:18:04,680 --> 00:18:06,720 Speaker 1: of circumstance and where we happen to have been from 305 00:18:06,760 --> 00:18:09,000 Speaker 1: macro respective the last in a few decades, and that's 306 00:18:09,000 --> 00:18:12,159 Speaker 1: going to evolve now negative but now inevitably it will 307 00:18:12,200 --> 00:18:14,480 Speaker 1: take time for people to realize that we're in a 308 00:18:14,600 --> 00:18:19,320 Speaker 1: new lower return world where bonds and equities aren't diversifying. 309 00:18:20,400 --> 00:18:23,320 Speaker 1: That will take some time to be more broadly recognized, 310 00:18:23,720 --> 00:18:27,160 Speaker 1: but when it does, it does change the calculus between 311 00:18:27,680 --> 00:18:31,240 Speaker 1: active and passion investing um. Also, the other thing I 312 00:18:31,320 --> 00:18:33,680 Speaker 1: would just pick up on is your point about this 313 00:18:33,800 --> 00:18:37,240 Speaker 1: discussion around does the market become inefficient in some way 314 00:18:37,320 --> 00:18:41,560 Speaker 1: when there's so much passive that it creates perhaps unusually 315 00:18:41,560 --> 00:18:44,919 Speaker 1: good opportunities for active managers. Well, I mean, in theory 316 00:18:45,520 --> 00:18:47,560 Speaker 1: we can say that that's the case. I think in 317 00:18:47,640 --> 00:18:52,280 Speaker 1: practice it's very hard to identify. To my knowledge, no 318 00:18:52,320 --> 00:18:56,160 Speaker 1: one has managed to theoretically identify where such a limit 319 00:18:56,400 --> 00:18:59,960 Speaker 1: might apply. We don't even know if the relationship between 320 00:19:00,000 --> 00:19:03,040 Speaker 1: amount of past investing um that exists in the market 321 00:19:03,359 --> 00:19:06,240 Speaker 1: and the efficiency of the market is something that is 322 00:19:06,320 --> 00:19:11,760 Speaker 1: a linear thing that simply gets a worse and worse 323 00:19:11,880 --> 00:19:14,359 Speaker 1: over time as passive gets larger, whether there's some the 324 00:19:14,400 --> 00:19:16,480 Speaker 1: tipping point. But we can say is the case of 325 00:19:16,560 --> 00:19:20,080 Speaker 1: Japan where the penetration of past investing has gone away 326 00:19:20,119 --> 00:19:23,760 Speaker 1: beyond the level that the US has got to, and 327 00:19:23,760 --> 00:19:27,000 Speaker 1: the Japanese market is still functioning. So I think we 328 00:19:27,040 --> 00:19:30,760 Speaker 1: can say that we should expect more growth impassive to 329 00:19:30,800 --> 00:19:36,280 Speaker 1: come um and that to identify a point at which 330 00:19:36,320 --> 00:19:40,760 Speaker 1: there is where we should expect a mean version back 331 00:19:40,840 --> 00:19:44,440 Speaker 1: into active, I think is very hard and something that's 332 00:19:44,520 --> 00:20:01,840 Speaker 1: very far off in the future. I thought it was 333 00:20:01,960 --> 00:20:06,520 Speaker 1: very interesting what you said about our faith in passive 334 00:20:06,560 --> 00:20:10,679 Speaker 1: strategies as being somewhat dictated by the backdrop of markets 335 00:20:10,680 --> 00:20:14,560 Speaker 1: over the last few decades and the inverse relationship between 336 00:20:15,000 --> 00:20:18,280 Speaker 1: stocks and treasuries. I think it is the same point 337 00:20:18,520 --> 00:20:22,080 Speaker 1: made in our recent discussion with Chris Cole of Artemis 338 00:20:22,119 --> 00:20:26,040 Speaker 1: Capital about expectations of volatility. I think it's been a 339 00:20:26,119 --> 00:20:30,960 Speaker 1: consistent theme on this UH podcast. I mean Tracy said 340 00:20:30,960 --> 00:20:34,119 Speaker 1: at the beginning, have we talked about passive and we 341 00:20:34,160 --> 00:20:38,880 Speaker 1: definitely have. But I do think that a consistent idea 342 00:20:39,119 --> 00:20:41,439 Speaker 1: that we've heard a lot of people discussed from a 343 00:20:41,480 --> 00:20:46,000 Speaker 1: lot of different angles has been this question of whether 344 00:20:46,160 --> 00:20:50,840 Speaker 1: investors have been lulled into thinking that there's some strategy 345 00:20:50,960 --> 00:20:53,919 Speaker 1: that's clearly the best strategy, but that it's only the 346 00:20:53,920 --> 00:20:57,240 Speaker 1: best strategy in fact, because of the certain behavior of 347 00:20:57,680 --> 00:21:00,280 Speaker 1: markets over the last few decades, particularly the relations ship 348 00:21:00,359 --> 00:21:05,160 Speaker 1: between stocks and bonds, that has made that the best strategy. 349 00:21:05,200 --> 00:21:08,160 Speaker 1: So I'm curious if you could expand more on that 350 00:21:08,280 --> 00:21:11,480 Speaker 1: and talk about why the way a lot of uh, 351 00:21:11,520 --> 00:21:15,080 Speaker 1: you know, maybe individual investors or more sophisticated investors have 352 00:21:15,200 --> 00:21:22,359 Speaker 1: their portfolios constructed. Why passive strategies may not thrive if 353 00:21:22,400 --> 00:21:25,560 Speaker 1: there is a regime shift or if there is a 354 00:21:25,600 --> 00:21:29,280 Speaker 1: relationship shift between asset classes. Yes, I think there's a 355 00:21:29,320 --> 00:21:32,399 Speaker 1: lot of recency bias, which is hard to avoid for 356 00:21:32,480 --> 00:21:36,320 Speaker 1: good reasons, um in lots of financial research takes place. 357 00:21:36,359 --> 00:21:39,720 Speaker 1: I mean, I guess we could point to the last 358 00:21:40,480 --> 00:21:44,840 Speaker 1: decade of a que dominating environment as giving rise to 359 00:21:44,920 --> 00:21:47,000 Speaker 1: a series of interactions in the market that might not 360 00:21:47,040 --> 00:21:49,720 Speaker 1: be normal, and as that comes to an end, uh, 361 00:21:49,760 --> 00:21:53,000 Speaker 1: they may change. I think there's also recently bus in 362 00:21:53,040 --> 00:21:55,199 Speaker 1: the longer run which the peers since the early eighties 363 00:21:55,280 --> 00:21:59,720 Speaker 1: has been one of declining yields across after classes or 364 00:22:00,040 --> 00:22:02,560 Speaker 1: deals have come down, bond deals have come down, there's 365 00:22:02,600 --> 00:22:07,240 Speaker 1: been asset price inflation at the same time inflation has 366 00:22:07,240 --> 00:22:13,840 Speaker 1: come down as well. UM that's contributed to returns from 367 00:22:14,160 --> 00:22:20,680 Speaker 1: stocks and bonds being much higher than returns are required 368 00:22:20,720 --> 00:22:25,080 Speaker 1: to beat inflation. And this negative stock bond correlation as well, 369 00:22:25,080 --> 00:22:26,800 Speaker 1: which is Unusually, if you go back over a couple 370 00:22:26,880 --> 00:22:30,400 Speaker 1: of centuries, you don't normally see negative stock bond correlation, 371 00:22:30,800 --> 00:22:34,440 Speaker 1: and only that's a positive number. And so I guess 372 00:22:34,440 --> 00:22:37,199 Speaker 1: to try and put in perspective how important that is. 373 00:22:37,240 --> 00:22:40,160 Speaker 1: One again comes back the question of why people trying 374 00:22:40,200 --> 00:22:43,320 Speaker 1: to to invest, and I think they're trying to invest 375 00:22:43,359 --> 00:22:46,040 Speaker 1: to fund needs that they have with the set in 376 00:22:46,040 --> 00:22:48,320 Speaker 1: the real economy. If the set in the real economy, 377 00:22:48,359 --> 00:22:51,080 Speaker 1: it's more likely that inflation is a better benchmark for 378 00:22:51,080 --> 00:22:55,560 Speaker 1: people UM. And so when people want to assess to 379 00:22:55,600 --> 00:22:58,120 Speaker 1: return from a strategy going forward, I think it's more 380 00:22:58,200 --> 00:23:03,840 Speaker 1: likely that people are focused on inflation plus as a benchmark, 381 00:23:04,720 --> 00:23:09,480 Speaker 1: or thinking of absolute outcomes UM, so guaranteed outcome or 382 00:23:10,000 --> 00:23:14,639 Speaker 1: a hard outcome target UM such as five percent or 383 00:23:14,640 --> 00:23:18,399 Speaker 1: six percent, as being a return that people should expect UM. 384 00:23:18,440 --> 00:23:20,720 Speaker 1: Now that's not to say that I'm barish on the 385 00:23:20,720 --> 00:23:24,320 Speaker 1: stock market. UM. The bid does not require UM start 386 00:23:24,359 --> 00:23:28,919 Speaker 1: to go down to focus people's minds on the market 387 00:23:28,960 --> 00:23:32,280 Speaker 1: in this way, but from a shillipe in the low 388 00:23:32,359 --> 00:23:37,399 Speaker 1: thirties it does strongly imply subpar returns many years in 389 00:23:37,440 --> 00:23:40,760 Speaker 1: the future. I briefly mentioned this in your intro. But 390 00:23:40,800 --> 00:23:43,760 Speaker 1: I'd be curious. You know, the note that you wrote, 391 00:23:44,280 --> 00:23:48,080 Speaker 1: why passive investing is worse than Marxism that got a 392 00:23:48,119 --> 00:23:51,399 Speaker 1: lot of attention at the time and certainly cropped up 393 00:23:51,440 --> 00:23:55,040 Speaker 1: in a bunch of different financial media. What was that 394 00:23:55,119 --> 00:23:57,760 Speaker 1: like for you? Like, what sort of feedback did you 395 00:23:57,800 --> 00:24:02,480 Speaker 1: get from from clients or or readers. Uh, and maybe 396 00:24:02,600 --> 00:24:05,600 Speaker 1: even you got some backlash from index providers. I don't 397 00:24:05,600 --> 00:24:09,120 Speaker 1: know what was what was the reaction? Yes, certainly surprised 398 00:24:09,119 --> 00:24:11,680 Speaker 1: by the scale the reaction, I have to say. Um. 399 00:24:11,720 --> 00:24:14,240 Speaker 1: I think the feedback I got if many people was 400 00:24:14,320 --> 00:24:17,800 Speaker 1: that this is a topic that people were concerned about 401 00:24:17,960 --> 00:24:21,720 Speaker 1: and it and it often falls been the planks of 402 00:24:21,760 --> 00:24:24,760 Speaker 1: the way the research is conducted. UM. Certainly in terms 403 00:24:24,800 --> 00:24:28,240 Speaker 1: of reach on the south side. People don't normally write 404 00:24:28,280 --> 00:24:32,680 Speaker 1: about business strategies U on the buy side, UM. And 405 00:24:32,840 --> 00:24:36,160 Speaker 1: so it certainly spoke to a lot of the concerns 406 00:24:36,600 --> 00:24:41,280 Speaker 1: that people had. I think. UM. Also it finds some 407 00:24:42,280 --> 00:24:45,919 Speaker 1: agreement from people in NASA management companies who have been 408 00:24:45,920 --> 00:24:48,680 Speaker 1: trying to engage with policymakers and trying to make the case. 409 00:24:48,720 --> 00:24:52,920 Speaker 1: So there are some strategic issues at stake here Aside 410 00:24:53,040 --> 00:24:59,040 Speaker 1: from them the more specific issues around an individual fund 411 00:24:59,480 --> 00:25:03,520 Speaker 1: um and whether an individual asset owner should buy an 412 00:25:03,560 --> 00:25:06,840 Speaker 1: active or passive fund in that particular case. Maybe you 413 00:25:06,880 --> 00:25:09,800 Speaker 1: can just sort of quickly summarize your argument because in 414 00:25:09,920 --> 00:25:12,800 Speaker 1: talking to you so far as you said, you're not 415 00:25:12,880 --> 00:25:15,760 Speaker 1: really anti passive per se and you point out that 416 00:25:15,840 --> 00:25:18,840 Speaker 1: we don't know where the tipping point would be, that 417 00:25:19,040 --> 00:25:21,800 Speaker 1: in Japan the share that goes to passive is much 418 00:25:21,840 --> 00:25:24,280 Speaker 1: higher than it is here in the Japanese market still 419 00:25:24,600 --> 00:25:27,600 Speaker 1: more or less function fine. So for those who haven't 420 00:25:27,640 --> 00:25:31,080 Speaker 1: read your note, which is most people, what does that 421 00:25:31,240 --> 00:25:34,359 Speaker 1: mean worse than Marxism? How would you describe it? And 422 00:25:34,440 --> 00:25:37,760 Speaker 1: I would not be surprised if the media distorted your 423 00:25:37,840 --> 00:25:41,680 Speaker 1: argument in someone um. Well, the argument is quite a 424 00:25:41,680 --> 00:25:44,840 Speaker 1: simple one, which is simply to think about how capitals 425 00:25:44,840 --> 00:25:48,879 Speaker 1: allocate in society. So it's the worst of Marksism is 426 00:25:48,880 --> 00:25:50,879 Speaker 1: definitely not from the point of an investor. It's from 427 00:25:50,920 --> 00:25:53,840 Speaker 1: the point of view of society, of rule and the 428 00:25:53,960 --> 00:25:57,080 Speaker 1: role of capital allocation in society. So I thought about 429 00:25:57,119 --> 00:25:59,960 Speaker 1: investment outcomes, per se Um, and I can think about 430 00:26:00,600 --> 00:26:04,720 Speaker 1: three different possible types of society. One a fully capital 431 00:26:04,840 --> 00:26:08,840 Speaker 1: society where people make very active as allocation decisions. Another 432 00:26:09,040 --> 00:26:13,360 Speaker 1: marks of society where someone is given the job centrally 433 00:26:13,400 --> 00:26:16,960 Speaker 1: to plan how capital is allocated. Uh. And then a 434 00:26:17,000 --> 00:26:19,800 Speaker 1: third possibility, which should be a sort of fake capitalis 435 00:26:19,840 --> 00:26:23,960 Speaker 1: society if you like, in which the capital allocation is 436 00:26:24,000 --> 00:26:28,040 Speaker 1: done on a sort of passive trailing basis. So companies 437 00:26:28,040 --> 00:26:31,159 Speaker 1: that have done well simply are accorded bigger weights and 438 00:26:31,160 --> 00:26:34,320 Speaker 1: equity indusseries. And I guess the pushback on it um 439 00:26:34,600 --> 00:26:36,680 Speaker 1: and there's been various forms of it, but one of 440 00:26:36,800 --> 00:26:39,080 Speaker 1: the main forms of pushback was the idea that do 441 00:26:39,200 --> 00:26:42,679 Speaker 1: companies actually need to raise equity? If we're in a 442 00:26:42,720 --> 00:26:47,520 Speaker 1: capitalite economy where the growth, especially coming from more service 443 00:26:47,560 --> 00:26:52,920 Speaker 1: based industries, how important is the capital allocation process from 444 00:26:52,960 --> 00:26:55,960 Speaker 1: active investors? And I'd argue that it is still important. 445 00:26:55,960 --> 00:26:58,240 Speaker 1: I mean a because there is still a range of 446 00:26:58,280 --> 00:27:00,480 Speaker 1: the of corporates in the market it that do need 447 00:27:00,520 --> 00:27:03,720 Speaker 1: to raise capital. Secondly, even if the company is not 448 00:27:03,800 --> 00:27:07,679 Speaker 1: raising equity capital, often they want credit or bank loans, 449 00:27:07,760 --> 00:27:11,200 Speaker 1: and that becomes cheaper if they have a share price 450 00:27:11,200 --> 00:27:14,040 Speaker 1: that reflects all the information. And Thirdly, they want to 451 00:27:14,040 --> 00:27:18,159 Speaker 1: pay employees, often through stock if that's possible, So is 452 00:27:18,200 --> 00:27:23,119 Speaker 1: the argument that basically capital is being allocated in a 453 00:27:23,200 --> 00:27:28,679 Speaker 1: way dictated by index providers UM well merely to make 454 00:27:28,720 --> 00:27:31,600 Speaker 1: the point that as new kind of capital um and 455 00:27:31,760 --> 00:27:37,000 Speaker 1: is invested, UH, there are reverse ways of thinking about 456 00:27:37,040 --> 00:27:41,199 Speaker 1: how that is directed to corporate um and one can 457 00:27:41,240 --> 00:27:44,879 Speaker 1: either take a very active decision to say, well, a 458 00:27:44,920 --> 00:27:49,800 Speaker 1: certain company has certain growth prospects determined by its fundamental 459 00:27:49,840 --> 00:27:54,600 Speaker 1: outlook or its role in society overall, and accorded to 460 00:27:54,720 --> 00:28:00,359 Speaker 1: certain evaluation and allocation of capital accordingly, or else it 461 00:28:00,440 --> 00:28:04,480 Speaker 1: is simply grown to be a certain size of a market, 462 00:28:04,560 --> 00:28:08,040 Speaker 1: and therefore, as new the capital comes in to an 463 00:28:08,080 --> 00:28:13,240 Speaker 1: index that that company is simply accorded extra value purely 464 00:28:13,280 --> 00:28:17,160 Speaker 1: because of the size it's reached in the index. Already, 465 00:28:17,920 --> 00:28:21,199 Speaker 1: I want to ask about what it will take for 466 00:28:21,359 --> 00:28:25,960 Speaker 1: active management to make a comeback, essentially, and to for 467 00:28:26,280 --> 00:28:30,440 Speaker 1: managers to convince investors that there's more to life than 468 00:28:30,640 --> 00:28:34,040 Speaker 1: just the upfront fee. And something I've been thinking about 469 00:28:34,040 --> 00:28:36,879 Speaker 1: this year is that we have had these periods of 470 00:28:36,960 --> 00:28:41,400 Speaker 1: volatility in which the relationship between stocks and bonds that 471 00:28:41,440 --> 00:28:44,560 Speaker 1: we've been talking about has not in fact held up 472 00:28:44,640 --> 00:28:47,400 Speaker 1: the way people might have expected. Whether it's the February 473 00:28:47,480 --> 00:28:52,160 Speaker 1: volatility or volatility this fall, and yet when I look 474 00:28:52,200 --> 00:28:57,840 Speaker 1: across the landscape, I don't exactly see active management appearing 475 00:28:57,880 --> 00:29:00,480 Speaker 1: to have done all that well. To be honest, and 476 00:29:00,560 --> 00:29:03,080 Speaker 1: I know that you know, it was a pretty brutal 477 00:29:03,160 --> 00:29:06,920 Speaker 1: month for many hedge funds. I think November was pretty 478 00:29:06,960 --> 00:29:10,800 Speaker 1: awful for them. So I'm curious why haven't we seen 479 00:29:11,320 --> 00:29:15,440 Speaker 1: this year more examples of active managers saying, ah ha, 480 00:29:16,040 --> 00:29:18,000 Speaker 1: this is what you pay us for because we can 481 00:29:18,040 --> 00:29:21,120 Speaker 1: deliver in times like this and then be just what 482 00:29:21,280 --> 00:29:24,520 Speaker 1: the general strategy will be for the industry to not 483 00:29:24,840 --> 00:29:30,720 Speaker 1: keep bleeding A m yeah. Um. So I think that's 484 00:29:30,720 --> 00:29:34,239 Speaker 1: certainly apparent from conversations have had with active managers over 485 00:29:34,240 --> 00:29:36,960 Speaker 1: the last few years that a few people have taken 486 00:29:36,960 --> 00:29:39,320 Speaker 1: a view what we really need is a big draw 487 00:29:39,360 --> 00:29:42,440 Speaker 1: down in the market and that will separate active and passive. 488 00:29:42,680 --> 00:29:44,800 Speaker 1: And my response always been, will be really careful what 489 00:29:44,840 --> 00:29:47,080 Speaker 1: you wish for, because the two thousand and eight period 490 00:29:47,160 --> 00:29:49,200 Speaker 1: was not a happy one for many active managers, So 491 00:29:49,480 --> 00:29:52,400 Speaker 1: I'm not sure if that is something that active managers 492 00:29:52,680 --> 00:29:54,760 Speaker 1: should wish for. It's not in a short term anyway. 493 00:29:55,200 --> 00:29:58,800 Speaker 1: I think there is something that can be said about 494 00:29:58,920 --> 00:30:02,320 Speaker 1: the potential for active out performance and the structure of 495 00:30:02,360 --> 00:30:05,520 Speaker 1: the market, And by that what I mean is the 496 00:30:05,600 --> 00:30:09,080 Speaker 1: performance of active managers tends to depend on how many 497 00:30:09,720 --> 00:30:13,040 Speaker 1: independent bets they can put on in their portfolios. That 498 00:30:13,120 --> 00:30:15,680 Speaker 1: in turn is a function of how correlated stocks are. 499 00:30:15,920 --> 00:30:17,400 Speaker 1: And we happen to have gone through a period in 500 00:30:17,440 --> 00:30:19,800 Speaker 1: recent years where stocks have been other stocks been very 501 00:30:19,840 --> 00:30:23,520 Speaker 1: correlated amongst themselves, and that's an environment where it's generally 502 00:30:23,560 --> 00:30:27,840 Speaker 1: harder for active managers to perform. So if correlation came 503 00:30:27,880 --> 00:30:30,680 Speaker 1: down between stocks, they we at some point arrived in 504 00:30:30,720 --> 00:30:33,840 Speaker 1: a more benign macro environment and that would help. The 505 00:30:33,880 --> 00:30:36,920 Speaker 1: other thing is the dispersion between stocks and how different 506 00:30:36,960 --> 00:30:40,640 Speaker 1: stocks are in terms of their valuation or their profitability. Again, 507 00:30:40,880 --> 00:30:45,040 Speaker 1: if stocks are very dispersed in terms of their valuations, 508 00:30:45,080 --> 00:30:48,960 Speaker 1: that then tends to help active manage performance. But all 509 00:30:49,000 --> 00:30:50,719 Speaker 1: that really is just tactical and I think there's too 510 00:30:50,800 --> 00:30:55,160 Speaker 1: much bigger things that would really help to drive the 511 00:30:55,200 --> 00:30:59,800 Speaker 1: performance of active managers. And I'm not gonna try their performance, 512 00:30:59,840 --> 00:31:02,840 Speaker 1: but but be the core focused their business models and 513 00:31:02,920 --> 00:31:06,440 Speaker 1: restore faith in the industry. One is this idea of 514 00:31:06,920 --> 00:31:08,880 Speaker 1: if we really are in a low return world, and 515 00:31:08,920 --> 00:31:11,000 Speaker 1: if the next five to ten years is one where 516 00:31:11,640 --> 00:31:16,320 Speaker 1: capital markets can only slightly beat inflation, then asset owners 517 00:31:16,360 --> 00:31:19,120 Speaker 1: are gonna have to come into active managers or managers 518 00:31:19,120 --> 00:31:22,640 Speaker 1: in general, and ask for return streams that can fund 519 00:31:22,680 --> 00:31:25,400 Speaker 1: their liabilities. I don't think there is any such thing 520 00:31:25,440 --> 00:31:30,000 Speaker 1: as passive asset allocations, so I'm almost definitionally that generation 521 00:31:30,080 --> 00:31:31,960 Speaker 1: return stream has to be an active decision. Now, of 522 00:31:32,040 --> 00:31:34,560 Speaker 1: course it can involve a passive instruments as part of that, 523 00:31:34,840 --> 00:31:37,200 Speaker 1: but overall it has to be active, I think. And 524 00:31:37,280 --> 00:31:41,360 Speaker 1: the second thing is this idea that by the creation 525 00:31:41,680 --> 00:31:45,520 Speaker 1: of so many indices, and by the cheapening of broad 526 00:31:45,600 --> 00:31:50,720 Speaker 1: market um exposure and the cheapening of factor exposure in particular, 527 00:31:51,440 --> 00:31:53,800 Speaker 1: it finally gives a new tool for asset owners to 528 00:31:54,360 --> 00:31:57,120 Speaker 1: decide which kind of returns streams they should pay for 529 00:31:57,240 --> 00:32:00,800 Speaker 1: and mass the owner who has scarce has to spend 530 00:32:00,920 --> 00:32:04,720 Speaker 1: on ASID management services logically should spend them on a 531 00:32:04,760 --> 00:32:07,320 Speaker 1: manager who can give a return stream which you cannot 532 00:32:07,400 --> 00:32:10,960 Speaker 1: get from holding a combination of simple factor strategies. Hence 533 00:32:11,000 --> 00:32:15,440 Speaker 1: the idea that it's not the active share or the 534 00:32:15,560 --> 00:32:19,160 Speaker 1: overall out performance of manager that becomes important, but it 535 00:32:19,240 --> 00:32:22,479 Speaker 1: is how much idiosyncratic returns are they can generate. Him 536 00:32:22,520 --> 00:32:25,440 Speaker 1: by that, I mean the returns that idiostyncratic to a 537 00:32:25,520 --> 00:32:28,400 Speaker 1: set of factors that they could buy cheaply, alright Innego 538 00:32:28,440 --> 00:32:31,360 Speaker 1: Fraser Jenkins of Bernstein Research, thank you so much for that. 539 00:32:32,320 --> 00:32:46,000 Speaker 1: That was great. Thank you for your time. So Joe, 540 00:32:46,040 --> 00:32:50,240 Speaker 1: I found that discussion really fascinating and much more nuanced, 541 00:32:50,400 --> 00:32:54,320 Speaker 1: perhaps than I would have thought based on the titles 542 00:32:54,480 --> 00:32:58,120 Speaker 1: of his research. Yeah, I mean, I can't. He said 543 00:32:58,160 --> 00:33:00,960 Speaker 1: he wasn't at the very beginning, that he wasn't act 544 00:33:01,080 --> 00:33:05,960 Speaker 1: anti passive per se. But I'm sure it's understandable why 545 00:33:06,000 --> 00:33:09,000 Speaker 1: people interpreted that he was if you're going to say 546 00:33:09,080 --> 00:33:12,560 Speaker 1: it's worse than Marxism. But I get his point that 547 00:33:12,680 --> 00:33:19,280 Speaker 1: from a strict capital allocation standpoint, that the essential truth 548 00:33:19,560 --> 00:33:22,960 Speaker 1: of based going based on the indices, which is that 549 00:33:23,120 --> 00:33:26,960 Speaker 1: the indusicries are weighted towards size, and passive investing inherently 550 00:33:27,320 --> 00:33:31,680 Speaker 1: will just reward yesterday's biggest companies. That that may be 551 00:33:32,400 --> 00:33:36,760 Speaker 1: one of the worst ways to allocate capital imaginable. Yeah, 552 00:33:36,800 --> 00:33:40,680 Speaker 1: and there are some big picture questions embedded in that idea, 553 00:33:40,800 --> 00:33:43,200 Speaker 1: one of which has to be you know, what is 554 00:33:43,200 --> 00:33:46,400 Speaker 1: the stock market actually telling us if the price signal 555 00:33:46,520 --> 00:33:52,000 Speaker 1: embedded in it is being so distorted by indexes and um, 556 00:33:52,040 --> 00:33:56,719 Speaker 1: you know, these massive allocations of capital to the biggest companies. 557 00:33:57,160 --> 00:33:59,080 Speaker 1: By the way, there are other people out there who 558 00:33:59,160 --> 00:34:01,800 Speaker 1: have had a similar idea to this. You know, Matt 559 00:34:01,880 --> 00:34:05,400 Speaker 1: king over at City has talked before about how markets 560 00:34:05,520 --> 00:34:07,680 Speaker 1: used to be self limiting in the sense that you'd 561 00:34:07,720 --> 00:34:09,960 Speaker 1: get a bunch of money moving into one asset and 562 00:34:10,000 --> 00:34:12,920 Speaker 1: eventually it would become overvalued and then money would leave 563 00:34:12,960 --> 00:34:16,719 Speaker 1: that asset. But he argues that because we have so 564 00:34:16,800 --> 00:34:20,400 Speaker 1: much passive investing, basically the market never self limits anymore, 565 00:34:20,480 --> 00:34:24,480 Speaker 1: and you have inflows essentially following inflows. So you know, 566 00:34:24,520 --> 00:34:28,040 Speaker 1: this isn't necessarily a unique idea. Yeah, it's interesting to 567 00:34:28,120 --> 00:34:32,200 Speaker 1: think about that. So obviously, anyone who's sort of maybe 568 00:34:32,239 --> 00:34:36,480 Speaker 1: through a retirement plan just sort of throws money every 569 00:34:36,520 --> 00:34:41,880 Speaker 1: month at a index fund that tracks the SPI is 570 00:34:41,920 --> 00:34:44,160 Speaker 1: buying a lot of Amazon every month, and they're buying 571 00:34:44,200 --> 00:34:45,960 Speaker 1: a lot of Microsoft every month, and they're buying a 572 00:34:46,000 --> 00:34:49,520 Speaker 1: lot of Apple. It raises the question would they do 573 00:34:49,560 --> 00:34:52,800 Speaker 1: that if they weren't just buying the index, or would 574 00:34:52,800 --> 00:34:57,480 Speaker 1: they not keep throwing money and in fact the lion's 575 00:34:57,520 --> 00:35:00,319 Speaker 1: share of their money at the biggest company. So really 576 00:35:00,360 --> 00:35:02,320 Speaker 1: like that idea we should get Have we tried to 577 00:35:02,360 --> 00:35:05,600 Speaker 1: get mad on the show? We probably he's been on 578 00:35:05,680 --> 00:35:12,120 Speaker 1: the show, we weren't. Yeah, well let's get him back 579 00:35:12,120 --> 00:35:15,799 Speaker 1: on and talk about that time specifically. Yeah, yeah, we 580 00:35:15,840 --> 00:35:18,440 Speaker 1: totally should. Um And I just want to say, you know, 581 00:35:18,480 --> 00:35:20,360 Speaker 1: I talked about a little bit, but I am fascinated 582 00:35:20,400 --> 00:35:24,560 Speaker 1: by this how the relationship between stocks and bonds just 583 00:35:24,680 --> 00:35:29,080 Speaker 1: keeps creeping up in our conversation, and how many different 584 00:35:29,640 --> 00:35:34,800 Speaker 1: things going on in investing could change dramatically if intra 585 00:35:35,160 --> 00:35:39,279 Speaker 1: asset class correlations were to change, and how many strategies 586 00:35:39,320 --> 00:35:42,560 Speaker 1: that we think our sound inherently might end up being 587 00:35:42,560 --> 00:35:46,960 Speaker 1: totally busted in a different environment one that could come about, say, 588 00:35:47,040 --> 00:35:50,160 Speaker 1: if inflation were to pick up. Yeah, it's definitely a 589 00:35:50,200 --> 00:35:53,800 Speaker 1: recurring theme on this podcast. We should start an index 590 00:35:53,840 --> 00:35:58,920 Speaker 1: called risk disparity disparity. Let's do it. We have a 591 00:35:58,920 --> 00:36:03,600 Speaker 1: lot of projects. Okay, this has been another edition of 592 00:36:03,640 --> 00:36:06,880 Speaker 1: the Odd Thoughts podcast. I'm Tracy Alloway. You can follow 593 00:36:06,880 --> 00:36:09,399 Speaker 1: me on Twitter at Tracy Alloway, and I'm Joe Why 594 00:36:09,440 --> 00:36:12,440 Speaker 1: isn't all. You can follow me on Twitter at the Stalwart, 595 00:36:12,880 --> 00:36:16,759 Speaker 1: and you should follow our producer on Twitter tover Foreheads. 596 00:36:16,760 --> 00:36:20,120 Speaker 1: He's at foreheads t as well as the Bloomberg head 597 00:36:20,120 --> 00:36:25,080 Speaker 1: of podcast Francesca leading at Francesca Today. Thanks for listening.