WEBVTT - How Passive Investing Could Change Capitalism 0:00:09.760 --> 0:00:13.200 Hello, and welcome to another episode of the Odd Thoughts podcast. 0:00:13.280 --> 0:00:17.599 I'm Tracy Allowitt and I'm Joe. So, Joe, we've talked 0:00:17.680 --> 0:00:21.600 before on this podcast about passive investing, right, I seem 0:00:21.640 --> 0:00:24.640 to remember that. I'm sure we must have. In fact, 0:00:24.680 --> 0:00:27.200 I didn't. Are there any other types of investing anymore? 0:00:29.480 --> 0:00:31.760 If we talked about investing, I'm sure we talked about 0:00:31.760 --> 0:00:36.159 passive investing. No, you're absolutely right, But I'm trying to 0:00:36.200 --> 0:00:38.920 think now, I guess that means we haven't talked about 0:00:39.080 --> 0:00:44.440 the sort of basis of passive investing, which is index construction. Right. 0:00:44.520 --> 0:00:47.520 If you're going to invest passively, you need to be 0:00:47.640 --> 0:00:51.880 investing essentially in some sort of index or benchmark exactly, right. 0:00:51.960 --> 0:00:54.000 So you could say, oh, I'm not going to make 0:00:54.040 --> 0:00:57.960 any choices in my investment, I'm just going to invest 0:00:58.000 --> 0:01:00.640 in the market. But even that has to have some definition. 0:01:01.200 --> 0:01:04.600 If it's the SNP five hundred, then whoever designed the 0:01:04.720 --> 0:01:09.120 SMP five hundred is ultimately the one constructing your portfolio. 0:01:09.720 --> 0:01:13.520 So ultimately someone is making a decision, even if you 0:01:13.560 --> 0:01:16.200 think you're sort of trying to take human discretion out 0:01:16.240 --> 0:01:19.440 of the process. Right, And there's really been an explosion 0:01:19.600 --> 0:01:23.679 in all types of indices recently, sort of growing in 0:01:23.760 --> 0:01:26.480 tandem with the big growth that we've seen in passive 0:01:26.480 --> 0:01:30.039 investing in general. One thing that gets bandied around quite 0:01:30.080 --> 0:01:32.920 a lot is that there are now more indices in 0:01:33.000 --> 0:01:36.399 the world than there are individual stocks, which, you know, 0:01:36.520 --> 0:01:38.680 stop and think about that for a moment. It's it's 0:01:38.680 --> 0:01:41.679 pretty amazing, although I guess, you know, you could say, 0:01:42.280 --> 0:01:44.600 given the amount of stocks available in the world, there's 0:01:44.600 --> 0:01:47.880 sort of an infinite number of combinations that you could 0:01:47.880 --> 0:01:51.080 get at that point. But it does suggest that something 0:01:51.120 --> 0:01:54.160 that was supposed to be a simple reflection of a 0:01:54.200 --> 0:01:58.600 particular market has sort of morphed into something else, right. 0:01:58.640 --> 0:02:02.520 I think Bloomberg uh Eric Belcoon has had a really 0:02:02.560 --> 0:02:06.480 interesting column this week, you know, pointing out that, you know, 0:02:06.520 --> 0:02:10.000 there's only really twelve notes on an octave, but there's 0:02:10.120 --> 0:02:12.960 hundreds of millions of songs, and I think that's a 0:02:13.000 --> 0:02:20.240 pretty good analogy for the relationship between individual components and indexes. 0:02:20.639 --> 0:02:23.960 And of course there's essentially an infinite number of ways 0:02:24.040 --> 0:02:28.080 that you can arrange them and wait the components and 0:02:28.200 --> 0:02:31.919 wait them by size or factor or whatever. So it's 0:02:31.960 --> 0:02:35.600 not surprising that there is an incredible amount of interest 0:02:35.760 --> 0:02:40.200 and important place on a index construction these days, right, 0:02:40.240 --> 0:02:44.359 and people thinking about this indexation kind of issue or 0:02:44.440 --> 0:02:48.240 explosion and indices, it tends to either be of of 0:02:48.280 --> 0:02:51.200 that sort of ilk where people think, oh, well, it's 0:02:51.240 --> 0:02:53.880 it's natural that this is happening because we have these 0:02:54.000 --> 0:02:57.280 different varieties of indexes that you can build using different 0:02:57.280 --> 0:03:01.359 types of stocks. But there's another extreme dream end of this, 0:03:01.639 --> 0:03:04.240 and you know people who actually find it quite worrying 0:03:04.320 --> 0:03:07.200 and quite dangerous for one reason or another. End. Today 0:03:07.639 --> 0:03:10.320 we're going to be speaking with someone who is firmly 0:03:10.680 --> 0:03:14.080 at that end of the discussion. I can't wait. This 0:03:14.160 --> 0:03:17.720 is a really important topic. I joked in the beginning 0:03:17.880 --> 0:03:21.200 that is there any other type of investing besides passive 0:03:21.280 --> 0:03:26.440 because it really does feel like that is swallowing everything. 0:03:26.520 --> 0:03:29.280 And I think there's a real existential question about the 0:03:29.400 --> 0:03:33.600 role of what used to be called discretionary investing. And 0:03:33.720 --> 0:03:37.800 so I think there's it's a great it's a great 0:03:38.040 --> 0:03:43.080 timely and timeless topic for us. Yes, indeed, all right, 0:03:43.160 --> 0:03:46.440 So without further ado, our guest for this episode is 0:03:46.480 --> 0:03:50.920 Intego Fraser Jenkins. He is a quantitative strategist over at 0:03:50.960 --> 0:03:55.800 Bernstein you may remember him listeners as the guy who 0:03:55.840 --> 0:03:59.560 wrote The Silent Road to Serfdom why passive investing is 0:03:59.600 --> 0:04:02.800 worse than Marxism. So, I promise this is going to 0:04:02.880 --> 0:04:05.880 be an interesting discussion. And Ago, thank you so much 0:04:05.880 --> 0:04:07.840 for coming on, but thank you for having me on. 0:04:08.200 --> 0:04:12.360 So and I guess my my first question is you've 0:04:12.400 --> 0:04:15.800 written quite a few notes about indexing at this point 0:04:15.840 --> 0:04:18.920 in time. Your latest one is sort of unusual in 0:04:18.960 --> 0:04:21.880 the field of analyst research. You know, it was called 0:04:21.920 --> 0:04:25.520 fund Management Strategy the man who created the last index, 0:04:25.560 --> 0:04:29.440 and it's sort of a fictional slash historical look at 0:04:29.520 --> 0:04:35.800 index creation. How did you focus on this particular topic. Yes, so, 0:04:35.880 --> 0:04:40.200 when we think about the way investment works at the moment, 0:04:40.240 --> 0:04:43.560 I think this five trillion switch from active a passive 0:04:43.600 --> 0:04:45.840 has taken place in last decade is one of the 0:04:45.880 --> 0:04:48.880 biggest changes that we've seen, and I think that passive 0:04:48.920 --> 0:04:51.240 as a lot of further to grow. I think that 0:04:51.320 --> 0:04:53.560 some people have interpreted some of our previous work, because 0:04:53.600 --> 0:04:55.960 that's the one you just mentioned earlier, as us being 0:04:56.000 --> 0:04:58.880 anti passive in some way. I wouldn't describe myself anti 0:04:58.880 --> 0:05:03.240 passive because passive is and more to democratize access to 0:05:03.279 --> 0:05:06.360 capital markets than any other invention in investing in the 0:05:06.440 --> 0:05:10.159 last couple of decades. But it does change the calculus 0:05:10.200 --> 0:05:12.919 for investors, both at the micro level, for an individual 0:05:12.920 --> 0:05:16.800 investor and for society overall. And so if an individual investor, 0:05:17.240 --> 0:05:20.640 there's a question of how active and passive interact with 0:05:20.680 --> 0:05:23.920 each other in their overall holdings. For society of all 0:05:23.960 --> 0:05:27.640 are big implications for capital allocation and for stewardship. And 0:05:27.720 --> 0:05:29.279 I think that what it all comes down to is 0:05:29.400 --> 0:05:34.039 the relationship between a fund buyer and an asset manager 0:05:34.600 --> 0:05:37.400 is changing and as further to change, and that's been 0:05:37.480 --> 0:05:41.520 driven to something sent by the increase in passive options 0:05:42.080 --> 0:05:44.240 that are out there. Now you mentioned we've written about 0:05:44.279 --> 0:05:46.040 this in research notes in the past. We want to 0:05:46.080 --> 0:05:48.839 say a bit bit different here by writing a work 0:05:48.839 --> 0:05:51.640 of fiction, um, I mean, firstly hopefully a bit more fun. 0:05:51.640 --> 0:05:53.840 It allows us to use kind of language is not 0:05:53.920 --> 0:05:56.920 possible in a normal style side research note, but also 0:05:56.960 --> 0:06:01.760 allows us to approach the active assive split from a 0:06:01.800 --> 0:06:06.400 few different perspectives. Where do you see this showing up? 0:06:06.480 --> 0:06:09.720 So it's one thing to talk about changes in governance, 0:06:09.839 --> 0:06:13.880 it's another thing to talk about changes in capital allocation 0:06:14.040 --> 0:06:16.440 and how that goes about. But when you look at 0:06:16.480 --> 0:06:19.200 the market, you still see some stocks doing well. You 0:06:19.279 --> 0:06:23.400 still see some stocks doing badly, some companies thriving. Can 0:06:23.440 --> 0:06:27.360 you point to something happening in the market that's sort 0:06:27.360 --> 0:06:31.440 of independently observable and say, okay, here is a change 0:06:31.760 --> 0:06:35.719 in the way markets behave that we can associate with 0:06:36.320 --> 0:06:39.680 all the money leaving active and flowing into passive. I 0:06:39.720 --> 0:06:43.640 think the biggest issue here is just it's a question 0:06:43.640 --> 0:06:46.320 of what an investor expects to get out of an 0:06:46.360 --> 0:06:50.160 active manager, and I think we've seen some miss beans 0:06:50.200 --> 0:06:52.800 have blown up about that in the last decade or so. 0:06:52.800 --> 0:06:56.600 So the idea the one could charge for beta as 0:06:56.880 --> 0:07:00.320 as an active manager UM has been obviously deep anked 0:07:00.360 --> 0:07:03.440 some time ago with the role of passive broad index funds. 0:07:03.760 --> 0:07:06.640 I think the next stage really is the idea of 0:07:06.720 --> 0:07:11.160 charging for factor beta in sense active managers who are 0:07:11.280 --> 0:07:14.400 actually just consistently hugging some factors in the market, well, 0:07:14.760 --> 0:07:17.120 and now you can buy those factors the current going 0:07:17.200 --> 0:07:19.760 rates four basis points. I think smart beta will be 0:07:19.800 --> 0:07:22.200 free within a year or so, based in terms of 0:07:22.200 --> 0:07:24.960 headline fee if nothing else UM, And so that really 0:07:25.000 --> 0:07:27.240 kind of focused attention on on what the point of 0:07:27.240 --> 0:07:29.880 an active manager is, and so I think that's where 0:07:29.880 --> 0:07:34.480 the biggest change comes here. I think there's been perhaps 0:07:34.560 --> 0:07:38.200 a mistaken belief that because it's very easy to measure 0:07:38.600 --> 0:07:42.360 headline fee, that has become the key determinant in so 0:07:42.440 --> 0:07:44.600 many fund allocation decisions. And when you look at the 0:07:44.640 --> 0:07:48.480 allocations both with an active and with impassive in the 0:07:48.520 --> 0:07:51.440 last few years, more than a hundred percent the net 0:07:51.480 --> 0:07:54.800 flow has gone the cheapest of active funds and the 0:07:54.880 --> 0:07:58.800 cheapest of passive funds. Now, on one hand, that's great, 0:07:58.840 --> 0:08:03.160 and it's allowed asset owners to lower their overall cost 0:08:03.400 --> 0:08:08.640 of employing asset managers, But headline fee only really matters 0:08:08.640 --> 0:08:11.640 to extent that it influences the quality of the net 0:08:11.640 --> 0:08:14.480 of fee outcome, and I think that there needs to 0:08:14.520 --> 0:08:17.720 be a focusing on the minds about what kind of 0:08:17.800 --> 0:08:21.440 outcome people want from investment decisions. Um and this sort 0:08:21.480 --> 0:08:24.600 of just fit into a much bigger picture, which is 0:08:25.120 --> 0:08:27.920 last thirty five years, Exus and got Up bonds have 0:08:27.960 --> 0:08:29.720 gone up, and they've managed to do so in a 0:08:29.720 --> 0:08:33.319 way that's given a negative correlation between them. So an 0:08:33.320 --> 0:08:38.319 extraordinarily benign set of circumstances, and that's as least been 0:08:38.480 --> 0:08:41.199 part of the reason why at least of the hindspee 0:08:41.240 --> 0:08:44.079 made sense for people to allocate from acts of the passive. 0:08:44.520 --> 0:08:46.920 I think that if one projects forward from here and says, well, 0:08:47.320 --> 0:08:49.319 there are a number of reasons to suspect that what 0:08:49.480 --> 0:08:52.800 might be in a lower return world across asset classes 0:08:53.320 --> 0:08:55.640 um and it raised the question of well, what is 0:08:55.640 --> 0:08:58.160 the outcome people want? What is the real benchmark that 0:08:58.320 --> 0:09:02.000 investors care about? That real benchmark probably ultimately comes down 0:09:02.000 --> 0:09:06.200 to trying to fund retirement, healthcare cost, school fees, etcetera. 0:09:06.559 --> 0:09:10.720 All those things trade more like CPI than like a 0:09:10.800 --> 0:09:16.360 capital market return. The question is, can um asset owners 0:09:16.400 --> 0:09:20.240 come to active managers and buy a return stream the 0:09:20.280 --> 0:09:23.000 net of fees will beat that UM. That in my 0:09:23.040 --> 0:09:26.120 mind's an active decision, but it's been somewhat subsumed by 0:09:26.120 --> 0:09:28.800 everyone assuming that the right thing to go and do 0:09:28.920 --> 0:09:32.160 is to hire a series of active managers who can 0:09:32.160 --> 0:09:35.440 perform a relative to a very specific benchmark in a 0:09:35.480 --> 0:09:39.440 series of pigeonholes across the market. Mhm, So could you 0:09:39.480 --> 0:09:43.040 maybe step back for a second and describe how we 0:09:43.200 --> 0:09:47.400 got from you know, a sort of a relatively simple 0:09:47.600 --> 0:09:50.600 or simpler place where we had the Dow Jones index. 0:09:50.640 --> 0:09:52.960 I mean, when the Dow Jones index was invented, it 0:09:53.040 --> 0:09:56.120 had I think something like a dozen stocks in it. 0:09:56.600 --> 0:09:59.800 And now we're at this place where we have hundreds, 0:09:59.840 --> 0:10:03.079 if not thousands, of different industries and benchmarks of all 0:10:03.080 --> 0:10:06.640 different types of flavors, smart, beata, factor investing, whatever you 0:10:06.720 --> 0:10:11.640 want to call it. How did we actually get here? Yeah? So, um. 0:10:11.679 --> 0:10:15.280 In the background to doing this note, was spent some 0:10:15.360 --> 0:10:17.680 times reading the early work of Dow and Paul and 0:10:17.679 --> 0:10:21.920 it's kind of fascinating to see the motivation behind the 0:10:21.960 --> 0:10:24.560 work that they did. Um. The work of down Poor 0:10:24.720 --> 0:10:27.800 was firmly in the camp of financial journalism, not in 0:10:27.840 --> 0:10:31.720 the camp of investing. UM. So people may complain about 0:10:32.080 --> 0:10:35.360 price witted industries, but it was perfectly sensible decision for 0:10:35.440 --> 0:10:38.880 Dow if he wanted to report on the movement of 0:10:38.920 --> 0:10:41.120 the market the day before, seeming to add up prices 0:10:41.120 --> 0:10:43.480 and divide them by the number of stocks that he 0:10:43.600 --> 0:10:48.840 was using apartment anything else. Without modern calculating machines, it 0:10:48.960 --> 0:10:51.960 was hard to do that work any other way. UM. 0:10:51.960 --> 0:10:54.199 And that was a fair way to give a sense 0:10:54.240 --> 0:10:58.200 of broad market movements. You can go back before that, 0:10:58.360 --> 0:11:02.080 the work of Poor and his work on the history 0:11:02.120 --> 0:11:06.040 of railroads in the US. It doesn't seem like ones 0:11:06.600 --> 0:11:09.520 reading a work of an index constructor when one picks 0:11:09.600 --> 0:11:11.120 up that book. But I would argue that one is 0:11:11.200 --> 0:11:14.800 because he has this massive enumeration of facts, which in 0:11:14.800 --> 0:11:17.480 this case miles of new track laid each year and 0:11:17.559 --> 0:11:21.400 dividends paid by railroad companies. And it's basically a prose 0:11:21.600 --> 0:11:25.240 version of an index, I would argue, I guess as 0:11:25.240 --> 0:11:29.320 one roller clocks forward, the question of indexing became kind 0:11:29.360 --> 0:11:32.760 of critical for solving the agency problem, which is always inherent. 0:11:33.240 --> 0:11:35.800 If one goes out and hires an asset manager to 0:11:35.880 --> 0:11:38.280 run assets for you, how do I know I'm getting 0:11:38.280 --> 0:11:41.200 good value for money from this asset manager. How do 0:11:41.240 --> 0:11:44.000 I know they're doing something for me that I couldn't 0:11:44.040 --> 0:11:47.520 get more cheaply somewhere else. And of course that's become 0:11:48.080 --> 0:11:52.480 a very broadly embedded as the as the idea of 0:11:52.559 --> 0:11:55.559 needing to perform a board market index, and that's driven 0:11:55.600 --> 0:12:00.600 the initial role of passive um. But once one accepts 0:12:00.600 --> 0:12:04.520 that idea that an index could be a rules driven 0:12:04.559 --> 0:12:07.040 approach to selecting kind of companies, as you said in 0:12:07.080 --> 0:12:11.560 your introduction to this piece, then suddenly the possibilities are endless. 0:12:11.559 --> 0:12:14.520 And who's to say that a given definition of broad 0:12:14.559 --> 0:12:18.400 index is the benchmarks people have and there are a 0:12:18.440 --> 0:12:23.320 massive number of other ways of doing that. The question, 0:12:23.360 --> 0:12:27.800 I think, then becomes confused about whether one is right 0:12:27.880 --> 0:12:31.520 in a given circumstance to get rid of an active 0:12:31.559 --> 0:12:34.520 manager and replace them with a passive manager, which you 0:12:34.559 --> 0:12:35.880 know that would be the right thing to go and 0:12:35.920 --> 0:12:39.559 do if that active manager was doing nothing other than 0:12:39.720 --> 0:12:42.760 hugging a passive index. But that gets confused with a 0:12:42.800 --> 0:12:45.599 broader question of well, what is the end outcome that 0:12:45.760 --> 0:12:47.640 people want to have? And I think there's been almost 0:12:47.720 --> 0:12:51.720 a inversion in the direction of causation, if I can 0:12:52.080 --> 0:12:54.880 say that, in the way people think about industries. The 0:12:54.920 --> 0:12:58.640 initial industries were there to report on what had happened 0:12:58.679 --> 0:13:01.360 in the market the day before. Now the construction of 0:13:01.400 --> 0:13:04.400 new induseries, particularly on the smart beta induseries, are actually 0:13:04.400 --> 0:13:09.400 directing capital allocation um and become a the essentially a 0:13:09.400 --> 0:13:14.400 forward looking a guide to where equity capital goes. Right. 0:13:14.480 --> 0:13:17.160 I think about this a lot. So you know, we're 0:13:17.160 --> 0:13:20.120 talking about smart beta, So for people who aren't necessarily 0:13:20.160 --> 0:13:24.319 familiar with it. This idea that there are factors within 0:13:24.480 --> 0:13:29.720 stocks that by some sort of researchers have you know, 0:13:29.800 --> 0:13:33.000 characterized out performance, whether it's stocks that are cheap on 0:13:33.040 --> 0:13:38.160 a pe basis, or stocks that exhibit high levels of momentum, 0:13:38.600 --> 0:13:42.760 things like that. And so this idea is that, well, 0:13:43.080 --> 0:13:45.199 why not just invest in a E T F for 0:13:45.280 --> 0:13:48.120 an index that capture all those things, and don't you 0:13:48.160 --> 0:13:50.679 don't have to do the work. One thing I wonder 0:13:50.720 --> 0:13:54.240 about is like, Okay, you make a interesting and important 0:13:54.280 --> 0:13:57.160 point that the issue for investors shouldn't be fees per se, 0:13:57.200 --> 0:14:02.200 but that return negative fees. That still raises the question 0:14:02.280 --> 0:14:04.760 of that even if there are active managers who can 0:14:04.840 --> 0:14:10.680 deliver superior performance negative fees, does the individual investor have 0:14:10.800 --> 0:14:16.720 any way to identify them? Um. I think the investor 0:14:16.800 --> 0:14:20.080 needs to be clear about what kind of return stream 0:14:20.120 --> 0:14:23.680 they want from their active manager. So I think it's 0:14:23.720 --> 0:14:28.400 normal for people nowadays to think about a manage has 0:14:28.400 --> 0:14:31.120 been a good manager if they deliver a return that 0:14:31.520 --> 0:14:33.840 exceeds that of the index. But of course, if one 0:14:33.920 --> 0:14:36.880 goes to a manager, one's buying a whole bundle of 0:14:37.280 --> 0:14:39.760 return streams all wrapped together in what their fund produced 0:14:39.800 --> 0:14:41.480 is Some of that's a market beata. Some of it 0:14:41.560 --> 0:14:44.880 will happen to be factors as you outlined just earlier 0:14:44.920 --> 0:14:47.960 than to inform of smart beta. Some of it will 0:14:48.000 --> 0:14:51.000 be very stock stetific decisions that the manager has made. 0:14:51.400 --> 0:14:53.880 I think that one really important change is happening is 0:14:53.920 --> 0:14:58.280 by smart beta or these sort of simple factors essentially 0:14:58.320 --> 0:15:01.640 becoming free or something close to that. It really focused 0:15:01.640 --> 0:15:05.760 attention on what one should get out of an active manager, 0:15:06.600 --> 0:15:10.720 because it's always impossible for more sophisticate investors, say, to 0:15:11.400 --> 0:15:15.600 disentangle the kinds of return streams that they've had from 0:15:15.640 --> 0:15:17.680 the fund manager. But it's been much harder to do 0:15:17.720 --> 0:15:22.480 that more broadly across the whole uh A space of 0:15:22.560 --> 0:15:25.600 fund buyers UM. And now the one can buy these 0:15:25.640 --> 0:15:29.040 factors essentially for free, A very important distinction gets made 0:15:29.040 --> 0:15:31.720 and one can say, well, it is manager giving me 0:15:32.080 --> 0:15:36.040 a return stream that is idiosyncratic, eye is different from 0:15:36.120 --> 0:15:39.200 UM this set of factors that I can buy. I 0:15:39.240 --> 0:15:42.440 think that's enormous important development because it allows us to 0:15:42.520 --> 0:15:46.840 say which kind of return streams become genuinely valuable for 0:15:46.920 --> 0:15:50.200 the asset owner. Return streams you cannot get from simply 0:15:50.240 --> 0:15:54.080 holding a static combination of factors. So I'd argue that 0:15:54.120 --> 0:15:59.560 actually with UM, with the cheapening of in the season, 0:15:59.760 --> 0:16:03.560 the growth a more industries, maybe ironically, it's actually made 0:16:03.560 --> 0:16:07.440 it much easier perhaps to now identify what one would 0:16:07.520 --> 0:16:12.920 want from an active manager, and that is idiosyncratic returns. UM. 0:16:13.000 --> 0:16:16.680 Why is that not more reflected in flows into active 0:16:16.760 --> 0:16:19.400 management then? Because you know, this is the discussion that 0:16:19.440 --> 0:16:23.400 comes up all the time with the explosion of passive investing. 0:16:24.080 --> 0:16:29.200 Most people would say, well, eventually passive investment is going 0:16:29.240 --> 0:16:32.960 to misdirect capital or misallocate capital, and there's going to 0:16:33.000 --> 0:16:36.840 be big price discrepancies that active managers can come in 0:16:36.960 --> 0:16:40.320 and exploit in some way, maybe by producing you know, 0:16:40.480 --> 0:16:44.320 idiosyncratic or specialized returns as you put it. Why aren't 0:16:44.320 --> 0:16:47.840 we actually seeing that play out in the market. Then? Yeah, 0:16:47.880 --> 0:16:49.400 I think there a few reasons that. I mean, I 0:16:49.400 --> 0:16:53.280 guess the initial answer is that the entire focus of 0:16:53.640 --> 0:16:57.040 fund selection seems to be overly focused on headline fee. 0:16:57.080 --> 0:17:00.200 I mean, it's obviously very easy to ident for a 0:17:00.240 --> 0:17:03.720 headline fee up front ahead of time. UM, And I 0:17:03.760 --> 0:17:06.879 said earlier, UM, that has meant there's been a huge 0:17:07.520 --> 0:17:10.639 flow into the cheapest funds, both through an active and 0:17:10.760 --> 0:17:14.800 with impassive. UM. I guess another reason is that different 0:17:14.840 --> 0:17:17.960 goes back ten years. Then, yes, it's true there were 0:17:17.960 --> 0:17:21.440 too many active investors who are charging an active fee 0:17:21.480 --> 0:17:24.440 for delivering something that was very close to the index. 0:17:24.480 --> 0:17:27.520 And it's right that someone has created a series of 0:17:27.560 --> 0:17:31.560 passive indices and taken capital from those managers. I think 0:17:31.600 --> 0:17:35.199 where it gets more complicated, UM is that again, as 0:17:35.200 --> 0:17:38.840 I mentioned earlier, this has been an environment for thirty 0:17:39.000 --> 0:17:43.840 thirty five years when with hindsight, having a passive long 0:17:43.920 --> 0:17:46.680 only exposure to equities and a passive longer exposure to 0:17:46.760 --> 0:17:50.600 bonds has been not only good from a return perspective, 0:17:50.720 --> 0:17:54.000 is beaten CPI, but they've offered a diversification between them 0:17:54.080 --> 0:17:56.680 to go back of a longer horizon. That diversification is 0:17:56.720 --> 0:18:00.399 actually quite unusual. UM. So I think that some of 0:18:00.400 --> 0:18:04.680 the support that passive has had has been a matter 0:18:04.680 --> 0:18:06.720 of circumstance and where we happen to have been from 0:18:06.760 --> 0:18:09.000 macro respective the last in a few decades, and that's 0:18:09.000 --> 0:18:12.159 going to evolve now negative but now inevitably it will 0:18:12.200 --> 0:18:14.480 take time for people to realize that we're in a 0:18:14.600 --> 0:18:19.320 new lower return world where bonds and equities aren't diversifying. 0:18:20.400 --> 0:18:23.320 That will take some time to be more broadly recognized, 0:18:23.720 --> 0:18:27.160 but when it does, it does change the calculus between 0:18:27.680 --> 0:18:31.240 active and passion investing um. Also, the other thing I 0:18:31.320 --> 0:18:33.680 would just pick up on is your point about this 0:18:33.800 --> 0:18:37.240 discussion around does the market become inefficient in some way 0:18:37.320 --> 0:18:41.560 when there's so much passive that it creates perhaps unusually 0:18:41.560 --> 0:18:44.919 good opportunities for active managers. Well, I mean, in theory 0:18:45.520 --> 0:18:47.560 we can say that that's the case. I think in 0:18:47.640 --> 0:18:52.280 practice it's very hard to identify. To my knowledge, no 0:18:52.320 --> 0:18:56.160 one has managed to theoretically identify where such a limit 0:18:56.400 --> 0:18:59.960 might apply. We don't even know if the relationship between 0:19:00.000 --> 0:19:03.040 amount of past investing um that exists in the market 0:19:03.359 --> 0:19:06.240 and the efficiency of the market is something that is 0:19:06.320 --> 0:19:11.760 a linear thing that simply gets a worse and worse 0:19:11.880 --> 0:19:14.359 over time as passive gets larger, whether there's some the 0:19:14.400 --> 0:19:16.480 tipping point. But we can say is the case of 0:19:16.560 --> 0:19:20.080 Japan where the penetration of past investing has gone away 0:19:20.119 --> 0:19:23.760 beyond the level that the US has got to, and 0:19:23.760 --> 0:19:27.000 the Japanese market is still functioning. So I think we 0:19:27.040 --> 0:19:30.760 can say that we should expect more growth impassive to 0:19:30.800 --> 0:19:36.280 come um and that to identify a point at which 0:19:36.320 --> 0:19:40.760 there is where we should expect a mean version back 0:19:40.840 --> 0:19:44.440 into active, I think is very hard and something that's 0:19:44.520 --> 0:20:01.840 very far off in the future. I thought it was 0:20:01.960 --> 0:20:06.520 very interesting what you said about our faith in passive 0:20:06.560 --> 0:20:10.679 strategies as being somewhat dictated by the backdrop of markets 0:20:10.680 --> 0:20:14.560 over the last few decades and the inverse relationship between 0:20:15.000 --> 0:20:18.280 stocks and treasuries. I think it is the same point 0:20:18.520 --> 0:20:22.080 made in our recent discussion with Chris Cole of Artemis 0:20:22.119 --> 0:20:26.040 Capital about expectations of volatility. I think it's been a 0:20:26.119 --> 0:20:30.960 consistent theme on this UH podcast. I mean Tracy said 0:20:30.960 --> 0:20:34.119 at the beginning, have we talked about passive and we 0:20:34.160 --> 0:20:38.880 definitely have. But I do think that a consistent idea 0:20:39.119 --> 0:20:41.439 that we've heard a lot of people discussed from a 0:20:41.480 --> 0:20:46.000 lot of different angles has been this question of whether 0:20:46.160 --> 0:20:50.840 investors have been lulled into thinking that there's some strategy 0:20:50.960 --> 0:20:53.919 that's clearly the best strategy, but that it's only the 0:20:53.920 --> 0:20:57.240 best strategy in fact, because of the certain behavior of 0:20:57.680 --> 0:21:00.280 markets over the last few decades, particularly the relations ship 0:21:00.359 --> 0:21:05.160 between stocks and bonds, that has made that the best strategy. 0:21:05.200 --> 0:21:08.160 So I'm curious if you could expand more on that 0:21:08.280 --> 0:21:11.480 and talk about why the way a lot of uh, 0:21:11.520 --> 0:21:15.080 you know, maybe individual investors or more sophisticated investors have 0:21:15.200 --> 0:21:22.359 their portfolios constructed. Why passive strategies may not thrive if 0:21:22.400 --> 0:21:25.560 there is a regime shift or if there is a 0:21:25.600 --> 0:21:29.280 relationship shift between asset classes. Yes, I think there's a 0:21:29.320 --> 0:21:32.399 lot of recency bias, which is hard to avoid for 0:21:32.480 --> 0:21:36.320 good reasons, um in lots of financial research takes place. 0:21:36.359 --> 0:21:39.720 I mean, I guess we could point to the last 0:21:40.480 --> 0:21:44.840 decade of a que dominating environment as giving rise to 0:21:44.920 --> 0:21:47.000 a series of interactions in the market that might not 0:21:47.040 --> 0:21:49.720 be normal, and as that comes to an end, uh, 0:21:49.760 --> 0:21:53.000 they may change. I think there's also recently bus in 0:21:53.040 --> 0:21:55.199 the longer run which the peers since the early eighties 0:21:55.280 --> 0:21:59.720 has been one of declining yields across after classes or 0:22:00.040 --> 0:22:02.560 deals have come down, bond deals have come down, there's 0:22:02.600 --> 0:22:07.240 been asset price inflation at the same time inflation has 0:22:07.240 --> 0:22:13.840 come down as well. UM that's contributed to returns from 0:22:14.160 --> 0:22:20.680 stocks and bonds being much higher than returns are required 0:22:20.720 --> 0:22:25.080 to beat inflation. And this negative stock bond correlation as well, 0:22:25.080 --> 0:22:26.800 which is Unusually, if you go back over a couple 0:22:26.880 --> 0:22:30.400 of centuries, you don't normally see negative stock bond correlation, 0:22:30.800 --> 0:22:34.440 and only that's a positive number. And so I guess 0:22:34.440 --> 0:22:37.199 to try and put in perspective how important that is. 0:22:37.240 --> 0:22:40.160 One again comes back the question of why people trying 0:22:40.200 --> 0:22:43.320 to to invest, and I think they're trying to invest 0:22:43.359 --> 0:22:46.040 to fund needs that they have with the set in 0:22:46.040 --> 0:22:48.320 the real economy. If the set in the real economy, 0:22:48.359 --> 0:22:51.080 it's more likely that inflation is a better benchmark for 0:22:51.080 --> 0:22:55.560 people UM. And so when people want to assess to 0:22:55.600 --> 0:22:58.120 return from a strategy going forward, I think it's more 0:22:58.200 --> 0:23:03.840 likely that people are focused on inflation plus as a benchmark, 0:23:04.720 --> 0:23:09.480 or thinking of absolute outcomes UM, so guaranteed outcome or 0:23:10.000 --> 0:23:14.639 a hard outcome target UM such as five percent or 0:23:14.640 --> 0:23:18.399 six percent, as being a return that people should expect UM. 0:23:18.440 --> 0:23:20.720 Now that's not to say that I'm barish on the 0:23:20.720 --> 0:23:24.320 stock market. UM. The bid does not require UM start 0:23:24.359 --> 0:23:28.919 to go down to focus people's minds on the market 0:23:28.960 --> 0:23:32.280 in this way, but from a shillipe in the low 0:23:32.359 --> 0:23:37.399 thirties it does strongly imply subpar returns many years in 0:23:37.440 --> 0:23:40.760 the future. I briefly mentioned this in your intro. But 0:23:40.800 --> 0:23:43.760 I'd be curious. You know, the note that you wrote, 0:23:44.280 --> 0:23:48.080 why passive investing is worse than Marxism that got a 0:23:48.119 --> 0:23:51.399 lot of attention at the time and certainly cropped up 0:23:51.440 --> 0:23:55.040 in a bunch of different financial media. What was that 0:23:55.119 --> 0:23:57.760 like for you? Like, what sort of feedback did you 0:23:57.800 --> 0:24:02.480 get from from clients or or readers. Uh, and maybe 0:24:02.600 --> 0:24:05.600 even you got some backlash from index providers. I don't 0:24:05.600 --> 0:24:09.120 know what was what was the reaction? Yes, certainly surprised 0:24:09.119 --> 0:24:11.680 by the scale the reaction, I have to say. Um. 0:24:11.720 --> 0:24:14.240 I think the feedback I got if many people was 0:24:14.320 --> 0:24:17.800 that this is a topic that people were concerned about 0:24:17.960 --> 0:24:21.720