WEBVTT - Fran Kinniry Discusses Diversified Portfolios 0:00:02.240 --> 0:00:06.800 This is Masters in Business with Barry Ridholts on Bloomberg Radio. 0:00:07.200 --> 0:00:09.799 This week on the podcast, I have an extra special guest. 0:00:10.000 --> 0:00:13.000 His name is fran Ken Irie and he is the 0:00:13.080 --> 0:00:18.360 head of portfolio Construction at Vanguard Group, managing a modest 0:00:18.840 --> 0:00:24.680 five point something trillion dollars. He has an absolutely fascinating 0:00:25.239 --> 0:00:29.920 career and the work he's done at Vanguard on a 0:00:30.040 --> 0:00:37.040 concept called Advisors Alpha is absolutely essential and part of 0:00:37.080 --> 0:00:41.920 the single largest trends UH in investment management today, which 0:00:42.360 --> 0:00:48.080 has to do with the shift from transactional brokerage type 0:00:48.479 --> 0:00:55.560 investments two more UM fee only long term asset allocation 0:00:56.360 --> 0:01:00.000 from advisors. This is one of the single biggest trends 0:01:00.240 --> 0:01:05.240 in investing and has seen literally trillions of dollars shift UH. 0:01:05.240 --> 0:01:07.280 This is a big part of the shift from active 0:01:07.280 --> 0:01:13.080 to passive, from transactional UM to long term. And if 0:01:13.120 --> 0:01:16.200 you are an advisor, if you work in the industry, 0:01:16.319 --> 0:01:19.319 or if you're just simply UM, if you're just simply 0:01:19.440 --> 0:01:23.080 an investor who is interested in learning what's going on 0:01:23.280 --> 0:01:26.399 in the world of investment management, you're going to find 0:01:26.400 --> 0:01:31.160 this conversation to be absolutely fascinating. So, with no further ado, 0:01:31.520 --> 0:01:37.960 my conversation with Vanguards Franken I Re. This is Master's 0:01:38.000 --> 0:01:42.880 in Business with Barry Ridholts on Boomberg Radio. My special 0:01:42.920 --> 0:01:46.360 guest this week is fran Kinnary. He is the global 0:01:46.400 --> 0:01:50.440 head of Portfolio Construction at the Vanguard Group, which manages 0:01:50.680 --> 0:01:56.040 over five trillion. That's trillion with a T five trillion dollars. 0:01:56.080 --> 0:01:59.600 He's a principal in the Investment Strategy Group, where as 0:01:59.600 --> 0:02:03.240 an m BE a slash chartered financial analyst, he helps 0:02:03.280 --> 0:02:09.720 to develop Vanguard's investment philosophy, methodology, and portfolio construction strategies. 0:02:10.240 --> 0:02:13.880 At Vanguard, he helped to create the firm's investment counseling 0:02:13.960 --> 0:02:18.600 and research departments, it's asset management services, and the Vanguard 0:02:18.919 --> 0:02:23.440 Advisory Services. But perhaps he is best known for creating 0:02:23.480 --> 0:02:28.640 the concept of advisor's Alpha. Fran Kinnary, Welcome to Bloomberg. 0:02:28.960 --> 0:02:30.680 Thank you so much, Barry. It's great to be here. 0:02:30.720 --> 0:02:32.560 I've been a big fan of your show and so 0:02:32.720 --> 0:02:35.120 just a pleasure to be here. I um I have 0:02:36.000 --> 0:02:38.400 had as a guest on the show just about all 0:02:38.440 --> 0:02:41.760 of your CEO s since the firm began. I have 0:02:41.840 --> 0:02:45.359 to track down the new guy. He's he's been elusive, 0:02:45.440 --> 0:02:48.680 but I will eventually. He's been busy, I can imagine. 0:02:49.800 --> 0:02:53.160 So so let's start a little bit with with some background. 0:02:54.120 --> 0:02:56.760 I hear that index funds are are a bubbler. Are 0:02:56.800 --> 0:02:59.919 you guys at Vanguard about to crash the economy? Yeah, 0:03:00.040 --> 0:03:03.800 that's an interesting one. The the author I guess of 0:03:03.840 --> 0:03:08.959 the or the creator of the big short came out recently, 0:03:08.960 --> 0:03:10.919 and I know your team covered at Josh covering it 0:03:10.960 --> 0:03:13.360 as well, and I think people, you know, I have 0:03:13.440 --> 0:03:15.440 to really take a step back when I see stories 0:03:15.480 --> 0:03:18.200 like this. There's a lot of confusion even on index 0:03:18.240 --> 0:03:21.040 and active and I think people don't even understand. As 0:03:21.080 --> 0:03:23.680 long as they've been around, they're still very confused. So 0:03:23.680 --> 0:03:27.160 so let's delve into the details, explain the broad difference 0:03:27.639 --> 0:03:30.080 and why it matters. Yeah, first off, I think people 0:03:30.160 --> 0:03:34.920 confused this idea of you know, indexing maybe surpassing active management, right, 0:03:34.920 --> 0:03:37.320 so in the US, and you actually just did that, 0:03:38.240 --> 0:03:40.560 did that exactly, But I think people forget that that's 0:03:40.640 --> 0:03:43.440 forty ACT funds, forty ACT being mutual funds and e 0:03:43.560 --> 0:03:46.200 t f s, and that is a very small part 0:03:46.360 --> 0:03:49.240 of the capital market structure. So what is not included 0:03:49.320 --> 0:03:54.560 under the forty Act, separate accounts, institutional investors, sovereign wealth funds. 0:03:54.560 --> 0:03:58.600 So actually the mutual fund and ETFs are somewhere between 0:03:58.680 --> 0:04:01.240 thirty and thirty five percent. So if you do that math, 0:04:02.040 --> 0:04:06.080 index equities on the U S side is somewhere around 0:04:06.960 --> 0:04:12.440 so still relatively small. Indexing passive investing much more than 0:04:12.520 --> 0:04:15.520 active investing exactly. And I think the other big confusion 0:04:15.720 --> 0:04:19.040 is that people think that indexing moves price. If there's 0:04:19.040 --> 0:04:21.840 only two active managers. Let's say it's you and I Berry, 0:04:23.360 --> 0:04:25.160 and you and I are playing golf and we're not 0:04:25.320 --> 0:04:27.880 at our trading desk, the index doesn't move, so the 0:04:28.000 --> 0:04:33.480 index is taking their direction. They index will replicate active managers. 0:04:33.839 --> 0:04:37.400 So this idea that indexing is driving price or price discovery, 0:04:38.120 --> 0:04:40.160 if there were only two active managers and they decided 0:04:40.200 --> 0:04:41.920 to take the day off, the index wouldn't move. There 0:04:41.920 --> 0:04:45.360 would be no index trading. That's that's interesting. So as 0:04:45.440 --> 0:04:47.400 long as we're we're talking about this bubble. Over the 0:04:47.440 --> 0:04:51.760 past couple of years, i've heard indexing is a threat 0:04:51.800 --> 0:04:55.800 to the economy. Is an American, it's Marxist. It seems 0:04:55.839 --> 0:04:59.000 like a lot of people are flailing and Jack Bogel 0:04:59.200 --> 0:05:04.320 very famously said when Vanguard first rolled out their initial 0:05:04.400 --> 0:05:08.720 index funds, they were accused of being un American. Yeah, 0:05:08.720 --> 0:05:10.799 and I think some of the assaults that you're hearing 0:05:10.960 --> 0:05:14.040 is back to incentives, right, and and um, you know, 0:05:14.160 --> 0:05:17.320 Charlie Munger famously said that his whole life he believed 0:05:17.360 --> 0:05:21.040 that of what people say or do is due to incentives, 0:05:21.080 --> 0:05:24.480 and his whole life he underestimated incentives. Uh So, I 0:05:24.560 --> 0:05:27.120 think there's a large crowd that would love to talk 0:05:27.160 --> 0:05:30.320 about this indexing bubble or all the negatives of indexing. 0:05:30.720 --> 0:05:32.719 You have to look at the incentives there. The bottom 0:05:32.760 --> 0:05:37.480 line is indexing is broadly diversified, low cost exposure, and 0:05:37.600 --> 0:05:39.560 probably one of the greatest things that have happened to 0:05:39.640 --> 0:05:42.880 investors in the last fifty years. So so you suggesting 0:05:43.080 --> 0:05:46.000 that the people who are critics of indexing are the 0:05:46.080 --> 0:05:48.760 ones who are seeing outflows and losing market share? Is 0:05:48.960 --> 0:05:51.160 is that how cynical you are? Yeah? I think when 0:05:51.240 --> 0:05:54.760 you your your survival and uh, you know, depends on it, 0:05:54.920 --> 0:05:59.719 you'll say whatever makes that right. The famous Upton Sinclair quote. 0:06:00.440 --> 0:06:03.400 So you've been at Vanguard since nineteen seventy seven, what 0:06:03.640 --> 0:06:06.000 path took you there. What what was your first role 0:06:06.080 --> 0:06:08.160 at the Vanguard Group. Well, I'm not that old, Barry. 0:06:08.200 --> 0:06:10.120 I joined in nineteen nineties seven, is that? What did 0:06:10.120 --> 0:06:12.480 I say? I said seventy seven you you were going 0:06:12.520 --> 0:06:15.680 into high school? Yes, exactly, exactly, So I joined in 0:06:15.800 --> 0:06:18.400 nineteen ninety seven. By the way, Vanguard's only been around 0:06:18.400 --> 0:06:21.640 with what's in seventy four? So so ninety seven, Yes, 0:06:21.720 --> 0:06:25.560 so nineteen ninety seven I joined Vanguard. UM. The backstory 0:06:25.760 --> 0:06:30.000 is like yourself, I was at a registered investment advisory firm. 0:06:30.800 --> 0:06:32.880 Back at that time. We had a billion dollars, which 0:06:32.960 --> 0:06:35.839 was was quite large. We were a multi family office 0:06:36.320 --> 0:06:41.680 and institutional advisory firm. To be fair, in nineteen ninety seven, 0:06:41.720 --> 0:06:43.960 a billion dollars was a lot of money. Now it's 0:06:44.160 --> 0:06:47.720 walking around money exactly. So it seems with six trillion 0:06:47.760 --> 0:06:51.640 and five trillion and just crazy a UM numbers exactly 0:06:51.760 --> 0:06:54.320 and so UM. I was a big fan and studied 0:06:54.520 --> 0:06:58.000 Vanguard from AFAR, from my prior firm, and I ended 0:06:58.080 --> 0:07:00.600 up at Vanguard because our r I a business, got 0:07:00.720 --> 0:07:02.760 rolled up into a you know, they were going through 0:07:02.760 --> 0:07:05.280 a roll up stage and roll up being other big 0:07:05.360 --> 0:07:08.840 advisory shops bringing other advisors together. I had about a 0:07:08.960 --> 0:07:11.520 year to figure out whether I was gonna stay or 0:07:11.800 --> 0:07:14.360 move somewhere, and I just was. I was a c 0:07:14.560 --> 0:07:16.080 f A and I happened to be at a CFA 0:07:16.160 --> 0:07:19.200 event and Vanguard was entering the advice business. And so 0:07:19.280 --> 0:07:21.720 a lot of people know about Vanguard's advice today and 0:07:21.800 --> 0:07:23.720 they may think it's new, but I was, you know, 0:07:23.800 --> 0:07:27.000 at the very very early beginning of Vanguard's starting advice, 0:07:27.120 --> 0:07:29.760 and my role was to develop the investment methodology we 0:07:29.880 --> 0:07:32.440 used in our advice services. So so let's talk a 0:07:32.520 --> 0:07:36.200 little bit about that. Vanguard has been a giant advocate 0:07:36.280 --> 0:07:42.880 of the sixty forty portfolio. Equity bonds advisors embrace that, 0:07:43.560 --> 0:07:48.480 uh in giant numbers. Uh. Is the sixty forty portfolio 0:07:48.680 --> 0:07:53.040 still a desired sort of miss Yeah. I think some context, 0:07:53.120 --> 0:07:56.160 they're just like we we started with the context on indexing. 0:07:56.800 --> 0:07:59.840 The context is, I think Vanguard believes in broadly diverse 0:08:00.040 --> 0:08:04.240 fight portfolios, low cost, whether it's active or passive, because 0:08:04.280 --> 0:08:07.240 we actually believe in active. You're almost two trillion and active, 0:08:07.440 --> 0:08:10.080 that's right, And so I think the sixty forty gets 0:08:10.120 --> 0:08:13.240 thrown out there, you know, um as a starting point. 0:08:13.320 --> 0:08:16.720 But we we believe that the asset allocation should reflect 0:08:16.800 --> 0:08:19.600 the client's goals and objectives. So we have clients, uh, 0:08:19.960 --> 0:08:22.920 for example, our target retirement funds, it's a glide pass. 0:08:23.200 --> 0:08:25.520 It starts out nine ten and gets all the way 0:08:25.560 --> 0:08:28.160 down to thirty seventy and otherwise, as you get older, 0:08:28.360 --> 0:08:32.600 you assume less risk with equities and more stability with bonds. Absolutely, 0:08:32.679 --> 0:08:35.440 So the sixty forty, while you know, that's one spot 0:08:35.600 --> 0:08:39.000 on that frontier, I think the main part is having 0:08:39.040 --> 0:08:42.439 an asset allocation and investment policy. You know that you're 0:08:42.520 --> 0:08:46.680 navigating back to, so you're rebalancing to that, being broadly 0:08:46.720 --> 0:08:50.360 diversified and either having high talent and low costs. That 0:08:50.400 --> 0:08:53.240 would be our formula for success for an investor. Whether 0:08:53.280 --> 0:08:57.760 it's sixty forty or forty sixty UM doesn't really matter. Um, 0:08:57.960 --> 0:09:00.720 But yeah, the sixty tends to be that starting point 0:09:00.800 --> 0:09:05.119 for many investors, and a lot of the institutional funds, endowments, 0:09:05.160 --> 0:09:09.040 foundations were that for a very long time. Quite fascinating. 0:09:09.679 --> 0:09:13.320 So let's talk a little bit about Advisor's alpha. Um, 0:09:13.480 --> 0:09:17.400 your team effectively created this concept in two thousand and one. 0:09:18.160 --> 0:09:23.240 Let's define it. What is Advisor's alpha? Yeah, so advisor's alpha, 0:09:23.320 --> 0:09:25.439 as you mentioned, we created in two thousand and one, 0:09:25.520 --> 0:09:29.199 and it really changed the value proposition or the framework 0:09:29.760 --> 0:09:33.080 of what it means to you know, why hire an advisor? 0:09:33.640 --> 0:09:36.640 And um my prior role, I was an advisor, and 0:09:36.720 --> 0:09:39.280 I think our value proposition was probably similar to most 0:09:39.960 --> 0:09:43.599 and that was a myopic value proposition. Hire me and 0:09:43.720 --> 0:09:48.760 I'll outperform a policy portfolio whatever. That's the traditional chasing 0:09:48.800 --> 0:09:53.240 alpha wool Street pursue the hot hands will beat the market, right, 0:09:53.320 --> 0:09:57.240 and so whether you do that through security selection, market timing, 0:09:57.600 --> 0:10:00.679 fund selection, the value proposition for a long time and 0:10:00.720 --> 0:10:04.880 the advice community was outperform a policy portfolio, and and 0:10:05.120 --> 0:10:08.680 none of the data supported anybody's ability or at least 0:10:09.080 --> 0:10:13.839 the vast majority of investors and fund manager's ability to 0:10:13.920 --> 0:10:17.000 do that consistently over time. Yeah, and think about what 0:10:17.080 --> 0:10:19.480 a high hurdle that is if if you're charging you know, 0:10:19.600 --> 0:10:23.040 let's say one percent in a fee based uh an arrangement, 0:10:23.679 --> 0:10:25.199 and then you now so not only that, you have 0:10:25.240 --> 0:10:28.040 to outperform by one percent plus any product fee. So 0:10:28.160 --> 0:10:31.320 that's a really tough hurdle. So it's a value proposition 0:10:31.800 --> 0:10:34.079 that you're setting up. You know, you own your value 0:10:34.080 --> 0:10:37.520 proposition as the advisor, and you're telling your client, you know, 0:10:37.679 --> 0:10:40.040 judge me on this, and you're you know, you're really 0:10:40.080 --> 0:10:42.280 handicapping yourself. And that's what led to a lot of churn, 0:10:42.400 --> 0:10:45.000 a lot of churn over and unhappy clients. So we 0:10:45.160 --> 0:10:49.280 kind of broadened the value proposition. So Advisor's alpha, you know, 0:10:49.720 --> 0:10:53.319 is a much more holistic value proposition. It still has 0:10:53.440 --> 0:10:56.800 investment management if you believe that that is a you know, 0:10:57.080 --> 0:10:59.880 skill you want to do. But what about financial planning, 0:11:00.320 --> 0:11:03.839 tax planning, wealth planning, saving planning, retirement income? How do 0:11:03.920 --> 0:11:06.880 I get a paycheck to me? And then behavioral coaching 0:11:07.280 --> 0:11:09.360 also the service model. I work with a lot of 0:11:09.480 --> 0:11:11.880 investors that are very busy, you know, they could be 0:11:11.880 --> 0:11:14.719 a doctor, a lawyer, an entrepreneur, and they don't want 0:11:14.760 --> 0:11:16.160 to you know, come home at the end of the 0:11:16.240 --> 0:11:19.079 day and manage their assets. So a service model, you know, 0:11:19.200 --> 0:11:21.760 I came up with the acronym t W A you know, 0:11:21.840 --> 0:11:24.480 client may not have the time, willingness or ability to 0:11:24.559 --> 0:11:27.000 do it on their own. And for most of those clients, 0:11:27.040 --> 0:11:29.200 it's worth you know, the hundred basis points of advice. 0:11:29.520 --> 0:11:33.880 So you you mentioned, um, something that reminds me of 0:11:34.040 --> 0:11:37.720 the Vanguard concept of total return. I want to explain 0:11:37.800 --> 0:11:40.280 what that is because most people think total return, they 0:11:40.320 --> 0:11:43.920 think capital appreciation plus diven ends. But Vanguard has a 0:11:44.000 --> 0:11:47.120 slightly different definition. Yeah, our our turtle return is um. 0:11:47.240 --> 0:11:49.880 I think a lot of people try to engineer a return. 0:11:50.040 --> 0:11:51.839 And what I mean by that is, let's take this 0:11:52.000 --> 0:11:54.719 low yield environment and they think that they you know, 0:11:54.800 --> 0:11:57.840 they may need five or six percent for their spending, 0:11:58.360 --> 0:12:01.120 so they kind of start with widow is my liability stream? 0:12:01.160 --> 0:12:03.079 And we see this a lot in the institutional space 0:12:03.440 --> 0:12:06.360 with endowments and foundations. Um or they have a five 0:12:06.400 --> 0:12:09.439 percent bogy. If they want to stay completely, they must 0:12:09.480 --> 0:12:12.319 spend five percent otherwise they're risk losing their texas and 0:12:12.440 --> 0:12:15.560 status exactly. And we're a client who's in retirement. Had 0:12:15.679 --> 0:12:17.439 earth client who's in retirement, Let's say they want to 0:12:17.440 --> 0:12:19.760 spend the four percent rule. How do you know that 0:12:19.920 --> 0:12:22.720 works for you know, if you look at a bond chart. 0:12:22.920 --> 0:12:26.040 The sixties, seventies, eighties, and nineties, interest rates were above 0:12:26.120 --> 0:12:28.640 the spend rate, so you could have you canna have 0:12:28.640 --> 0:12:31.079 a fixed income portfolio and it was quite easy. But 0:12:31.400 --> 0:12:33.800 now you have dividend yields it on the equity market 0:12:33.800 --> 0:12:36.040 of let's say one eight, one nine, and the bond 0:12:36.160 --> 0:12:38.439 marketed somewhere like two. So how do you get to 0:12:38.960 --> 0:12:42.079 a spending policy of four or five percent? Uh and 0:12:42.200 --> 0:12:45.199 them together? Well, you see people taking risks. They go 0:12:45.280 --> 0:12:47.800 out on the yield carve, they high yield junk bonds. 0:12:48.920 --> 0:12:51.640 You see a lot of duration doesn't work, doesn't work 0:12:51.880 --> 0:12:54.719 inverted yield care of going out duration art. Yeah, and 0:12:54.840 --> 0:12:57.240 you see a lot of these that's there's nothing. This 0:12:57.360 --> 0:13:01.679 is not an anti alternative investment or private investment conversation, 0:13:01.800 --> 0:13:04.360 but you know, you you see people going in reaching 0:13:04.559 --> 0:13:07.680 for you know, alpha that may or may not be there. 0:13:07.960 --> 0:13:09.920 But well, when you say may or may not be there, 0:13:10.280 --> 0:13:14.040 the data is pretty overwhelming that for the most part, 0:13:14.640 --> 0:13:17.000 it's not there. And and a lot of people who 0:13:17.120 --> 0:13:21.040 dabble alternatives seem to my joke has come for the 0:13:21.120 --> 0:13:24.880 high fees, stay for the under performance. But that has 0:13:25.000 --> 0:13:27.680 not been the solution. That has not been the magic bullet, 0:13:28.440 --> 0:13:32.760 especially for pension funds that have pushed in giant numbers 0:13:33.120 --> 0:13:37.040 into private equity and hedge funds and venture capital. It's 0:13:37.120 --> 0:13:39.840 like everything else, a winner take all. There's a handful 0:13:39.920 --> 0:13:43.079 of You know, if you can't get into renaissances, medallion 0:13:43.160 --> 0:13:46.559 funds or d E shaw, the odds are you're not 0:13:46.640 --> 0:13:49.280 going to do as well as a simple sixty. Yeah, 0:13:49.320 --> 0:13:51.760 and I think that goes even for liquid space, right, So, 0:13:52.160 --> 0:13:54.439 and I still think that this gets back to the 0:13:54.800 --> 0:13:59.040 marketplace being very sophisticated but maybe not understanding the math. 0:13:59.200 --> 0:14:01.360 And then and then math is and most of your 0:14:01.400 --> 0:14:04.560 listeners will probably be familiar with zero sum game, which 0:14:04.640 --> 0:14:07.079 means that if you and I are counterparties, one of 0:14:07.160 --> 0:14:08.679 us is going to win on that trade and one 0:14:08.760 --> 0:14:12.720 is gonna lose. So on average active management, whether they 0:14:12.800 --> 0:14:16.800 be liquid or ill liquid or alternatives or traditional, it's 0:14:16.800 --> 0:14:19.680 going to be impossible at the fiftie percentile and zero 0:14:19.760 --> 0:14:22.640 some game to win that doesn't. But but I think 0:14:22.680 --> 0:14:24.920 what misses that is someone is on the right side 0:14:24.960 --> 0:14:28.440 of that distribution. Someone is winning. And so you know, 0:14:28.600 --> 0:14:32.560 if you can find talent, you mentioned a few vanguards, 0:14:32.600 --> 0:14:35.000 active funds have actually done very well. So if you 0:14:35.120 --> 0:14:39.440 have good talent and you have your costs below your talent, 0:14:39.960 --> 0:14:42.560 which is a key component of total return total return, 0:14:42.640 --> 0:14:44.680 then you know, so we're we're in the total return 0:14:44.760 --> 0:14:47.080 or outcomes. You know, we we believe that what's the 0:14:47.160 --> 0:14:50.520 most important thing is what our client outcomes. And so 0:14:50.640 --> 0:14:52.120 what I mean by that it doesn't have to be 0:14:52.280 --> 0:14:55.840 all index or that alternatives are bad or you know, 0:14:56.120 --> 0:14:58.600 private investments are bad. What you really want to end 0:14:58.680 --> 0:15:02.960 up with is is my talent greater than my friction? 0:15:03.360 --> 0:15:05.640 And if that works, then there's a real strong case 0:15:05.760 --> 0:15:09.560 for active and a strong case for privates and alternatives. Um, 0:15:09.600 --> 0:15:11.560 the question is do you have access to that? Right? 0:15:11.640 --> 0:15:13.880 Not everyone is going to have access to world class 0:15:13.960 --> 0:15:16.440 talent and they just need a couple of billion dollars 0:15:16.480 --> 0:15:18.640 and you're in yeah, or you work with you work 0:15:18.720 --> 0:15:22.120 with a professional fiduciary, so you could work with you know, 0:15:22.240 --> 0:15:24.280 not not to say you could work with someone like 0:15:24.480 --> 0:15:29.200 Vanguard that actually can you know, find great managers, get 0:15:29.320 --> 0:15:33.040 access to great managers and deliver outcomes that are superior 0:15:33.560 --> 0:15:36.360 even though the cost structure is above an index cost structure. 0:15:36.520 --> 0:15:38.440 Let me give you a quote from one of your 0:15:38.640 --> 0:15:43.320 research papers that I found interesting. Left alone investors often 0:15:43.400 --> 0:15:46.480 make choices that impair the returns jeopardize their ability to 0:15:46.560 --> 0:15:50.560 fund their long term objectives. Many are influenced by capital 0:15:50.640 --> 0:15:54.560 market performance and This is often evident in market cash flows, 0:15:55.080 --> 0:15:59.800 mirroring what appears to be emotional responses fear or agreed 0:16:00.560 --> 0:16:04.920 rather than rational ones. Explain the idea of behavioral coaching 0:16:05.000 --> 0:16:07.840 and what that means. Yeah, so behavioral coaching is one 0:16:07.920 --> 0:16:11.080 of the key pillars of Advisor's alpha. And what we 0:16:11.160 --> 0:16:14.280 mean by that is investing is emotional right, and we 0:16:14.400 --> 0:16:16.360 know that, you know, you have to be, you know, 0:16:16.520 --> 0:16:21.000 in a decision state where your emotions are calm, and 0:16:21.320 --> 0:16:23.240 you know it's hard to stay calm. Let's go back 0:16:23.280 --> 0:16:26.240 to the global financial crisis, oh eight oh nine. It's 0:16:26.280 --> 0:16:28.960 hard to stay calm when you've lost you know, forty 0:16:30.240 --> 0:16:33.360 of your value of your equities. And what you're asking 0:16:33.400 --> 0:16:34.960 the investor to do is it, let's just take a 0:16:35.040 --> 0:16:37.960 two million dollar portfolio, a million in stocks, a million 0:16:38.000 --> 0:16:41.200 in bonds. Your million in stocks now is five hundred thousand, 0:16:42.320 --> 0:16:46.400 and you're asking without an advisor, You're you're saying, I'm 0:16:46.440 --> 0:16:50.160 going to sell two and fifty thousand of bonds that 0:16:50.240 --> 0:16:53.440 are actually doing quite well in GFC and add to 0:16:53.560 --> 0:16:56.560 this stock portfolio. So now I have seven fifty seven 0:16:56.640 --> 0:17:00.280 fifty right to rebalance that. And when I've studied cash 0:17:00.320 --> 0:17:03.200 flow at Vanguard for my twenty plus years. And what 0:17:03.320 --> 0:17:06.320 we see is that you know, investors especially in the extreme. 0:17:06.840 --> 0:17:09.240 So you go back to that O eight oh nine environment, 0:17:09.640 --> 0:17:13.359 there was huge outflows of equities in the money market, 0:17:14.040 --> 0:17:16.960 and so investors were not rebalancing on their own. And 0:17:17.080 --> 0:17:19.720 so working with a behavioral coach who's going to help 0:17:19.800 --> 0:17:23.080 you through the emotions to stay committed to your policy, 0:17:23.160 --> 0:17:25.320 we think and had a tremendous amount of out and 0:17:25.480 --> 0:17:30.040 I I personally noticed the outflows going just reaching their 0:17:30.080 --> 0:17:34.440 plateau that February March oh nine the worst possible time 0:17:34.520 --> 0:17:37.280 for it, right at the bottom. You know, we study 0:17:37.359 --> 0:17:41.000 that right and and and equities went pre GFC. So 0:17:41.080 --> 0:17:44.040 if you go back to you know O seven, pre GFC, 0:17:44.640 --> 0:17:47.480 equities were at about sixty eight percent on the household 0:17:47.520 --> 0:17:49.880 balance sheet, and that means that you know, the thirty 0:17:49.960 --> 0:17:53.520 two was in more risk off assets. At the bottom 0:17:53.560 --> 0:17:56.679 you mentioned February of oh nine, equities dropped the thirty 0:17:56.760 --> 0:18:00.320 six percent. So I call this the most hated bull 0:18:00.400 --> 0:18:03.280 market of all time because this bull market was very 0:18:03.359 --> 0:18:05.800 front end loaded, meaning a lot of the returns came 0:18:05.880 --> 0:18:08.800 out of March O nine. In that very first and 0:18:08.880 --> 0:18:12.280 investors only had thirty And so if you look about 0:18:12.320 --> 0:18:14.439 the I R R, the compound that returned that goes 0:18:14.520 --> 0:18:17.840 to an investor, the behavioral gap, you know that. You know, 0:18:17.920 --> 0:18:20.520 we we talk a lot about Advisor's outfit. It's you know, 0:18:20.640 --> 0:18:24.240 one to two percent, it's episodic. But investors, you know, 0:18:24.359 --> 0:18:26.000 tend not to do the right thing at the right 0:18:26.080 --> 0:18:30.359 time for sure. Let's talk a little bit about UM 0:18:31.119 --> 0:18:34.199 Vanguard Group, which does things quite a bit differently than 0:18:34.280 --> 0:18:37.720 the rest of Wall Street. Here's another quote of yours. 0:18:38.280 --> 0:18:41.960 What Vanguard really believes in is high talent and low cost. 0:18:42.520 --> 0:18:45.760 Aren't those two things contradictory? Aren't we taught? Hey, if 0:18:45.800 --> 0:18:47.240 you want the best, you're gonna have to pay up 0:18:47.280 --> 0:18:52.239 for it. How do you combine low costs with high talent? Yeah, well, 0:18:52.320 --> 0:18:56.240 the asset management business is one of the more scalable 0:18:56.280 --> 0:18:59.840 businesses out there, right, and so UM, what we've been 0:19:00.080 --> 0:19:02.760 meaning by scalable meaning it doesn't take a whole lot 0:19:02.880 --> 0:19:05.119 more to manage a billion dollars than it does to 0:19:05.200 --> 0:19:08.959 manage it depends on the strategy. But yes, that's exactly right. 0:19:09.040 --> 0:19:11.040 So you know, if if I'm managing a billion dollars, 0:19:11.160 --> 0:19:14.040 versus a million dollars. My cost should not be my 0:19:14.240 --> 0:19:18.200 marginal contents. My marginal costs should shrink, right if we 0:19:18.880 --> 0:19:20.840 and so what we've been able to do at Vanguard, 0:19:21.000 --> 0:19:22.960 I think the most important thing is to take a 0:19:23.119 --> 0:19:25.879 giant step back is you know, when Jack Bogel started 0:19:25.920 --> 0:19:29.320 the Vanguard Group, it was a mutual mutual fund. And 0:19:29.400 --> 0:19:32.359 what that means is that we are owned by our investors. 0:19:32.840 --> 0:19:35.000 And so there's different ways that you can set up 0:19:35.080 --> 0:19:38.040 an organization. You can be public public equity, where the 0:19:38.080 --> 0:19:41.200 public shareholders you know, get the the p and L. 0:19:41.800 --> 0:19:44.440 You could be a private partnership where the partners get 0:19:44.520 --> 0:19:47.280 the excess P n L. What Vanguard does and sometimes 0:19:47.320 --> 0:19:50.280 people think at Vanguard is a nonprofit, but we are 0:19:50.280 --> 0:19:54.159 actually fiercely for profit. Everything we do is try to 0:19:54.320 --> 0:19:57.840 maximize our profit. It's what we do with the profit. 0:19:57.920 --> 0:20:00.160 We end up giving it back to our sharehold it's 0:20:00.200 --> 0:20:03.800 our owners, So the owners of our funds through lower 0:20:03.880 --> 0:20:07.800 costs in the future, and so we pass along the 0:20:08.000 --> 0:20:11.320 you know, the P and L access back to our investors, 0:20:11.960 --> 0:20:14.359 either in the form of lower costs coming out of 0:20:14.400 --> 0:20:17.440 that or higher service levels. Uh and that so that 0:20:17.560 --> 0:20:20.840 gives us that advantage relatives to some of our competitors. 0:20:21.040 --> 0:20:24.719 I think people confuse unfair advantage, and it is an 0:20:24.800 --> 0:20:29.840 unfair advantage with an illegal advantage. It's a perfectly legal advantage. 0:20:30.000 --> 0:20:32.840 Any other mutual fund could have set up this way, 0:20:33.560 --> 0:20:36.159 they chose not to. That's exactly right, I mean. So, 0:20:36.359 --> 0:20:38.960 and and again everyone has to pick their ownership structure. 0:20:39.480 --> 0:20:41.320 We're not here to say that public is wrong or 0:20:41.359 --> 0:20:44.000 private right. They're just different, right. And so we are 0:20:44.080 --> 0:20:46.120 owned by our investors, and you kind of think about 0:20:46.160 --> 0:20:49.440 one master as opposed to multiple masters, and so that 0:20:49.600 --> 0:20:52.600 allows us, UM, you know, to kind of pass back 0:20:52.720 --> 0:20:55.719 through where you can actually your original question of how 0:20:55.840 --> 0:20:58.680 can you have high towent and low cost, Well A, 0:20:58.920 --> 0:21:02.119 we have our ownership ructure and be we pass along 0:21:02.280 --> 0:21:05.520 scale back to our investors. We also think our brand 0:21:05.640 --> 0:21:08.520 is very attractive. So what I mean by that is 0:21:08.600 --> 0:21:12.239 we're able to attract world class active managers who want 0:21:12.280 --> 0:21:15.679 to work with us because they know just the brand 0:21:15.800 --> 0:21:17.920 to be, you know, working with Vanguard. But they also 0:21:18.000 --> 0:21:21.520 know we're very patient with our active managers. UM. And 0:21:21.640 --> 0:21:24.160 so if you actually want to be a pure asset 0:21:24.280 --> 0:21:27.880 manager and let you know, Vanguard take the client servicing 0:21:27.920 --> 0:21:30.840 and the distribution. It's a it's an arrangement that works 0:21:30.960 --> 0:21:32.880 very well and it's probably one of the reasons why 0:21:32.920 --> 0:21:35.880 we're so successful and active managers. So so let's let's 0:21:35.960 --> 0:21:40.160 focus a little more on the active management you rolled out. 0:21:40.400 --> 0:21:44.200 You Vanguard rolled out a group of quantitative funds not 0:21:44.320 --> 0:21:47.320 too long ago. I don't want to call them smart data, 0:21:47.480 --> 0:21:51.920 but a fundamental factor based set of funds. UM. The 0:21:52.040 --> 0:21:55.320 one thing there's really hasn't been a big push into yet, 0:21:55.520 --> 0:21:58.359 but I've heard rumors of is an E s G 0:21:58.960 --> 0:22:01.399 type of fund. I know, you the foot see in 0:22:01.480 --> 0:22:04.520 the UK the Footsie E s G funds. Where else 0:22:04.640 --> 0:22:09.360 is Vanguard gonna go with some of these active UM funds? 0:22:09.560 --> 0:22:11.840 And and what are the areas that have done very 0:22:11.920 --> 0:22:15.600 well under active at Vanguard? Yeah, so the areas have 0:22:15.720 --> 0:22:18.040 done very well for us is is UM you know, 0:22:18.119 --> 0:22:20.080 the full suite first off, So a lot of people 0:22:20.160 --> 0:22:22.399 don't know, but we are one of the largest managers 0:22:22.480 --> 0:22:25.920 in tax exempt so municipal bond funds, so high net 0:22:25.960 --> 0:22:29.119 worth clients that might be at your practice. UM. You know, 0:22:29.200 --> 0:22:33.040 we're like world class in tax exempt fixed income and 0:22:33.160 --> 0:22:35.840