Episode 194

full
Published on:

8th Mar 2024

Jack Shannon: Unveiling the Future of Active Management and ETFs

In this episode, we are joined by Jack Shannon, Senior Analyst at Morningstar, to discuss the dynamics of active equity management, portfolio construction, and the importance of downside protection in long-term investment success. Jack shares his insights on various topics, including:

Topics Discussed

• The asymmetry of returns and the importance of preserving capital on the

downside

•The role of active equity managers and the challenges they face in deviating

from benchmarks

•The impact of fund flows on portfolio management and the potential risks of

passive investing

•The role of risk management in active investing and the difficulty of

identifying winning strategies in advance

•The changing dynamics of growth and value investing, and the importance of

understanding market history


This episode is a must-listen for anyone interested in active equity management,

portfolio construction, and long-term investing. Jack's insights provide

valuable strategies to navigate the complexities of the financial markets and

better understand the nuances of active management.

Transcript
Jack Shannon:

A key contributor to long term success is being able to preserve

2

:

that capital on the downside because, you

know, we all know that sort of returns

3

:

are asymmetric and, you know, a loss

hurts a lot more than an equivalent gain.

4

:

So, then equivalent gain helps.

5

:

So I think that's where investors can,

can really help themselves is looking

6

:

at the downside, even though most

people like to think about the upside,

7

:

you're buying an equity fund, you

want, you want to get those returns.

8

:

you don't really care about, well, it only

lost 20 percent when the market lost 30.

9

:

You're more focused.

10

:

Most people are more focused on sort

of the promise of the big gains.

11

:

So I think people need to kind of

just shift their thinking in terms

12

:

of, of what to really look for.

13

:

Adam Butler: Welcome.

14

:

We've got, Jack Shannon here

today from, uh, from Morningstar.

15

:

Jack is Senior Analyst for

Morningstar Research Services and.

16

:

Jack came to our attention through

our mutual acquaintance, Brian

17

:

Moriarty, who shared one of your

more recent research pieces, I

18

:

guess, on hit rates in large cap U.

19

:

S.

20

:

equity mutual funds and Mike and I both

read it and thought, wow, this would

21

:

be a perfect guy to have on the show.

22

:

So I'm glad we could

put the pieces together.

23

:

Welcome.

24

:

Jack Shannon: Yeah.

25

:

Thank you.

26

:

I hope I live up to being the perfect guy.

27

:

Adam Butler: Well, there's

all kinds of perfect guys.

28

:

So, um, you'll be a

perfect guy for the show.

29

:

I have no

30

:

Jack Shannon: Yeah, hopefully.

31

:

Adam Butler: so maybe tell us

what you do at Morningstar.

32

:

how do you occupy your time?

33

:

What interesting projects

do you like to work on?

34

:

What are you working on right now?

35

:

Jack Shannon: Yeah.

36

:

so I, um, I'm in the manager

research group at Morningstar.

37

:

so what, what we do on a day to

day basis is we, we primarily

38

:

cover, individual strategies

and individual investment firms.

39

:

And so, you know, we meet with portfolio

managers, we Question them on a, you

40

:

know, a wide range of topics related

to how they invest money, how they

41

:

manage their team, how they manage

their time, and all these things.

42

:

And ultimately, we sort of issue,

forward looking ratings on investment

43

:

strategies and firms and whether we think

people should invest their hard earned

44

:

money in these, in these strategies.

45

:

So, so I focus on, active

equity for the most part.

46

:

So, you know, I've, I've had an interest

in, in markets for a long time, but

47

:

like markets in a very general sense

of just like, you know, how much

48

:

information is, is, is embedded in, in

a single price is kind of amazing to me.

49

:

And so in this day to day job, why

that's sort of relevant is, you

50

:

know, you have portfolio managers and

analysts who, are fundamentally saying.

51

:

I think I have better information

than the thousands and millions of

52

:

participants out there, which is a very

interesting, and bold, uh, stance to take.

53

:

And so a lot of my research is sort of

going down that, that road of exploring,

54

:

You know, how good managers really

are at having an informational edge.

55

:

So, so that's sort of the, the,

non core stuff I do on a day to

56

:

day basis, but that, that occupies

a lot of the, the research time.

57

:

Adam Butler: So let's start

at kind of a higher level.

58

:

What is the goal of an

active equity manager?

59

:

would be the success criteria

for an active equity manager?

60

:

Jack Shannon: so an active equity manager

wants, wants to beat a, a benchmark,

61

:

now they usually get to name their own

benchmark, which is sort of the, uhhh,

62

:

you know I was reading a book from Mark,

Mark Spitznagel's Safe Haven where he

63

:

described sort of the fund management

business as being sort of a, you know,

64

:

a self fulfilling game where it's like

you get to set the rules and set your

65

:

own performance standards and all that.

66

:

And it's true to an extent, but active

managers ultimately want to beat a sort

67

:

of a free passive benchmark, because

investors could take their money

68

:

invested in a, you know, a passive

market ETF, for, 15 basis points, but

69

:

instead you're going to say, well, if

you, if you give me 70 basis points, I

70

:

will give you an index beating return.

71

:

and obviously the sort of the

track record, over time is not

72

:

very good for active managers.

73

:

and so, you know, a big part of the

the hit rate piece that I, that I just

74

:

published is sort of trying to get

into, other than fees, sort of why have

75

:

active managers not been better than

just a passive, a passive alternative?

76

:

Is it because they simply cannot

pick winners at the same frequency

77

:

as you get in a passive portfolio?

78

:

Or is it something else?

79

:

Is it that they're just not good at

sizing and identifying their winners?

80

:

in an appropriate manner.

81

:

So, so yeah, so the goal is simply to, to

beat a passive benchmark, but oftentimes,

82

:

especially in like the international

categories and whatnot, there really

83

:

isn't even an investable passive option.

84

:

You know, if you're a foreign large

growth manager, there's really,

85

:

there's really not a, clean, um, You

know, actual investable benchmark

86

:

for uhhh for everyday investors.

87

:

So, so oftentimes it's a benchmark that

really an investor can't even access.

88

:

So, a lot of different

angles there, I guess.

89

:

But, um, yeah,

90

:

Adam Butler: mean, I asked a very broad

question that was on purpose, right?

91

:

But, what I, what I'm

trying to get at, too, is.

92

:

Do managers typically act like that's

their objective to, I mean, and when

93

:

we say beat the benchmark, do we

mean generate a positive information

94

:

ratio relative to their benchmark,

generate higher absolute performance?

95

:

How does risk factor in to that?

96

:

Jack Shannon: I, uhh so it depends on

which shop you talk to and which managers.

97

:

I think most, You know, I, a lot of, a lot

do want to beat on risk adjusted metrics.

98

:

So they want to, you know, have a

sharp ratio, um, above the bench.

99

:

but sharp ratio is, is,

you know, adjusting for the

100

:

volatility of the returns.

101

:

But I think that's kind

of a, I don't know.

102

:

I think, I think claiming victory because

you had a lower return than the index, but

103

:

lower volatility is, is sort of a low bar.

104

:

so to me, you know, I, if I want

to pay an active manager, I want to

105

:

pay them to, to beat the benchmark.

106

:

I don't want to pay them to,

107

:

give me a high five and say, Hey,

I didn't beat the benchmark, but at

108

:

least I gave you more steady returns.

109

:

because I could have

gotten the benchmark at.

110

:

You know, a third of the cost, uh, so

you do have some managers who wanted to

111

:

want to add, you know, add value on, on

pure, Um, sort of risk adjusted metrics.

112

:

But, you know, when I'm evaluating

a manager, I like to look at

113

:

just sort of pure excess return

potential because that's, you know,

114

:

you can't eat alpha, you can eat.

115

:

Excess return now.

116

:

Adam Butler: We can debate that later.

117

:

In terms of like a large cap manager,

it seems to me like if the goal is to,

118

:

like, like, like, Beat the cap weighted

benchmark, for example, then they would

119

:

cleave very closely to that benchmark

and only deviate from it on names

120

:

where they felt that they had an edge.

121

:

Is that typically what you observe or

is, you know, do we, do we mostly see?

122

:

Large cap managers who have fairly

heterogeneous portfolios, they have,

123

:

uh, you know, more concentrated basket

of stocks that they follow and that

124

:

they, have conviction in it's probably

smaller than the S& P 500, for example.

125

:

And they deviate quite substantially

from the cap weighted weights.

126

:

Jack Shannon: you know, you're just

sort of hitting on sort of the closet

127

:

indexers that are out there, and there

certainly are a lot of them who, you

128

:

know, if you're a portfolio manager,

you're ultimately getting compensated.

129

:

Um, well, it depends on the shop,

obviously, but a lot of it is, you know,

130

:

deviation from, from the benchmark.

131

:

So, There, there could be an incentive

there for a lot of managers to not

132

:

want to take overly bold positioning

because if you do you're sort of

133

:

risking your own personal comp, and

and I think that is a, certainly

134

:

is a factor for, for some managers.

135

:

And how they manage things.

136

:

But a lot of a lot of active managers

want or sort of now marketing marketing

137

:

themselves as specifically, you

know, we're not like the benchmark,

138

:

you know, if you want the, you know,

the big tech stake with, you know,

139

:

NVIDIA and Apple and Microsoft,

you can get that in a passive fund.

140

:

But we want to offer something different.

141

:

And so if we're going to offer something

different, we kind of have to take these

142

:

bolder, um, Bolder positions relative

to a market cap weighted portfolio.

143

:

so you see, you know, especially

managers who have underperformed, uh,

144

:

in the last five years because they

were already underweight, those names,

145

:

sort of a repositioning of, well, you

know, we're, we're purposely underway.

146

:

We want to be different and we want

to generate sort of a, a, a different

147

:

return stream than you would get in

a, in a, in a market cap portfolio.

148

:

Adam Butler: But, I mean, do you

think that, uh, Just how rational

149

:

is it for an active manager with a

large cap equity benchmark to deviate

150

:

materially from that benchmark?

151

:

I mean, to me it seems like the Like

kind of the optimal approach is to

152

:

have a portfolio where you hold, you

know, effectively all the stocks in

153

:

the S& P 500, in S& P 500 weights,

and kind of proxy run a long short

154

:

portfolio over top that effectively

what that's going to run is.

155

:

You know, you're going to have some names.

156

:

You've got conviction, more

conviction, long in other names.

157

:

You've got more conviction, short in,

and a bunch of names that you probably

158

:

don't have, you know, reason to have

a materially different view than what

159

:

is expressed in the benchmark weights.

160

:

And so, you know, it seems like it seems

reasonable to me as well, that if an

161

:

investor actually has a preference to

not deviate too much from the benchmark,

162

:

however you want to mention, um, measure

that, let's say in tracking error, then

163

:

the managers should be accommodating

that objective in that way, rather

164

:

than saying, well, you know, I want

to deliver the best return I can for

165

:

the lowest amount of risk, which to me

seems like a reasonable objective for

166

:

an equity manager, but you know, you

end up with that, with these potential

167

:

misalignments between what a, an allocator

is allocating to you for versus what your

168

:

true objective is as a manager, right?

169

:

I just think this gets conflated a lot.

170

:

How do you see managers reconciling that?

171

:

Jack Shannon: I mean, I agree

that that's a, um, that's

172

:

sort of a worthwhile approach.

173

:

You just don't really see it.

174

:

you might see it in, um, you know,

there are, quant funds or, or, you

175

:

know, research funds where it's

like a bunch of analysts putting

176

:

stocks in, into a portfolio.

177

:

you might see the case where they're,

they'll have, you know, these structured

178

:

rules in place where they'll say, you

know we'll, we have our sort of our, our,

179

:

our risk budget, and we don't want any

given stock to add X percent of our risk.

180

:

So maybe their fundamental

analysts hate Tesla.

181

:

I think it's overvalued and think

NVIDIA is overvalued, but they're

182

:

going to own it in the portfolio just

for pure risk management purposes.

183

:

so you see that a lot with quants and

again, like these like broad research

184

:

type portfolios, but there are some

managers who, I'm thinking of Um, I'm

185

:

blanking on the man, the, manager at

Fidelity runs an international fund.

186

:

but his approach is, to basically

use the, market weight as just

187

:

the, sort of the, anchor point.

188

:

And then, will go plus or minus, you know,

two, three percent one way or another.

189

:

but it doesn't, it doesn't

hold like the whole, the whole,

190

:

uh, universe in the portfolio.

191

:

It's still a subset of stocks.

192

:

but if it's like a, you know, if

it, if it was a large cap domestic

193

:

portfolio, it'd be like, well, maybe

he's underweight Apple by three percent,

194

:

but overweight Alphabet by Three, you

know, just, we do see managers who do

195

:

anchor to that market weight, but it's

not while holding just the whole wide

196

:

portfolio, the whole wide index that is.

197

:

Adam Butler: Yeah, I'm just

trying to think about what what a

198

:

rational manager should do given

a client who has an objective.

199

:

I mean, if a client says, look, I'm

measuring you against the benchmark, then

200

:

the client has said to the manager, Your

risk or I'm measuring you on risk, which

201

:

is tracking error to the benchmark, right?

202

:

So from the perspective of.

203

:

A large cap manager who's been, you

know, told I'm allocating you because

204

:

I want you to beat the benchmark.

205

:

The implicit statement in that is,

the risk I'm measuring you on is

206

:

your deviation for the benchmark.

207

:

You're tracking your risk.

208

:

And it could very well be that, that,

you know, a lot of managers say, look,

209

:

I've got no edge in the mag seven.

210

:

They're followed by every Every research

shop out there, they're massively liquid.

211

:

They're as efficiently priced

as any stock, and I'm just not

212

:

gonna take an active view on that.

213

:

I'm gonna hold 'em all in equal

weight or, you know, in, in

214

:

their respective cap weights.

215

:

But there's, you know, a

hundred stocks near, closer to

216

:

the bottom of the cap stack.

217

:

that are less followed, where I

bring some expertise and where I can

218

:

take, you know, be underweight and

overweight, 60 to 80 of those stocks.

219

:

And that is how I'm going to try and

generate my long term alpha, right?

220

:

That manager would presumably

have Very low active share, right?

221

:

So on that benchmark, then because he's

only playing with, market, with, uh,

222

:

stocks in the benchmark that have already

at very low weights, those deviations

223

:

from those weights don't matter much

from an active share standpoint, but

224

:

he could have a very large edge, right?

225

:

So he might end up having a very high

information ratio as an example, right?

226

:

But that's, that doesn't

seem to be the way that.

227

:

That managers are evaluated

and, why do you think that is?

228

:

Jack Shannon: yeah, I think it gets

down to sort of the question of the

229

:

allocators and what they're looking for.

230

:

I think a lot of times when we talk

with, with portfolio managers, the, the

231

:

sense that we get is that especially

on, you know, the institutional

232

:

side, you know, they're wanted

for sort of a more concentrated

233

:

Uh, I guess more unique portfolio.

234

:

so like, yeah, you know,

I feel like allocators can

235

:

get beta plus pretty easily.

236

:

And so when, when they're looking at

these more active managers, I, it,

237

:

it seems to me that there's more of

an appetite for, more active share.

238

:

I'm not sure that that necessarily

means higher expected return or, or

239

:

anything like that, but I think that's

generally what, what managers are looking

240

:

for or allocators are looking for.

241

:

and so we can discuss whether that's a

good thing to look for or not, but I think

242

:

that's part of the reason why you see it.

243

:

Adam Butler: So, how would, uh, how would

most people get access to beta and alpha

244

:

separation in the way that you're sort of

describing most allocators would look for?

245

:

Jack Shannon: Um, what do you

mean in terms of, in terms

246

:

of the institutional clients?

247

:

Adam Butler: Well, no, I

mean, in terms of, I mean,

248

:

institutional clients can, right.

249

:

Because they can get their, their

betas and they can buy market

250

:

neutral funds or, or what have you

and, and use leverage, et cetera.

251

:

Right?

252

:

But it, it was my understanding that most.

253

:

Retail investors typically, they have

few options, but to kind of bundle their

254

:

alpha and beta exposures together, right?

255

:

Jack Shannon: Yeah.

256

:

Yeah.

257

:

That's generally, yeah.

258

:

I think that's generally true.

259

:

and you think about where all retirement

assets are, they're all, at least

260

:

in the U S they're, you know, pretty

concentrated in, in just sort of,

261

:

target date funds where you've got

your equity and your your fixed income

262

:

and all that in, in one sort of fund.

263

:

and, it's all usually passive.

264

:

So it's all kind of,

it's all beta basically.

265

:

and I think at least in the U.

266

:

S.

267

:

part of that is, you know, with

the, with the history of, of

268

:

active performance against, against

passive and that it has done poorly.

269

:

If, if you have sort of a fiduciary

standard, it's, I think people are a

270

:

bit gun shy, Of, of recommending or

putting active funds in, in a lot of

271

:

sort of everyday people's portfolios,

simply because of sort of fear that, you

272

:

know, maybe you're violating a fiduciary

standard by recommending something that

273

:

in the aggregate has, has struggled

against a, a cheaper alternative.

274

:

Adam Butler: How do you factor

regimes into your thinking?

275

:

So, for example, regimes where, equal

weight portfolios outperform cap

276

:

weighted portfolios tend to favor active

management versus, you know, obviously

277

:

the last 10 years, with the possible

exception of:

278

:

favored, cap weighted, uh, portfolios.

279

:

How do you try to factor that into

your analysis and, and recommendations?

280

:

Jack Shannon: That's a big piece of it.

281

:

So every time we have a ratings committee,

um, which is once a year, we update our

282

:

ratings on, on every strategy we cover.

283

:

and that's a big piece of the

discussion is, you know, how, how

284

:

do we contextualize a performance?

285

:

Based on sort of how the market has

behaved and whatever, given trailing

286

:

five, trailing three, trailing 10 years.

287

:

because that is, you know, it, it, there

are good managers who can look, who can

288

:

look, who can look pretty bad for a while.

289

:

and there are, there are, there

could be bad managers who look

290

:

good for, for, uh, for a while.

291

:

so as long as we can sort of try to

at least, uh, and that's why the The

292

:

conversations with the portfolio managers

so are so crucial, cause you get to sort

293

:

of figure out how they truly think about

portfolio construction and, and, and think

294

:

about, um, risk management and all that.

295

:

so through those conversations,

we can get a sense of like, you

296

:

know, were they purposely making.

297

:

You know, purposely positioning

this portfolio so that it could

298

:

succeed in this environment.

299

:

Or is this sort of just a lucky

byproduct of, of sort of a grab

300

:

baggy philosophy type thing?

301

:

so yeah, it's, it's, it's a big

piece of, of what we do on a

302

:

day to day, day to day basis.

303

:

Adam Butler: And where do you land?

304

:

I mean, given that these regimes

can last for a really long time.

305

:

Jack Shannon: it depends.

306

:

So, um, you know, I was

actually just looking at a, um.

307

:

We don't, we don't actually cover

the fund, but it's a, it's a super

308

:

concentrated strategy that has, you

know, it's been around since like

309

:

2015 and it's produced a great record,

over, over that timeframe, it beat the

310

:

Russell 1000 growth, beat the S& P 500.

311

:

And it did that without

owning any of the Mag 7.

312

:

and so I was interested in like, okay,

how, how could this have happened?

313

:

so I built a you know,

a simulator that would.

314

:

Bundle together, you know, 500

random 20 stock portfolios since

315

:

they're a, they own 20 stocks.

316

:

They keep them pretty much equal weight.

317

:

so let's put together 500 random

portfolios back in:

318

:

see how they would have done.

319

:

and then compare that to the actual

results of the, of the strategy

320

:

and the strategy ends up still

being like the very top of the sort

321

:

of the random distribution too.

322

:

So that, that leads to sort of

multiple, more questions though.

323

:

It's like, well, is it, is this

evidence of skill, uh, because they've

324

:

sort of beaten the, even sort of

the most random of, of scenarios.

325

:

Or is it the opposite that

this is possibly the luckiest?

326

:

Portfolio, we could have created.

327

:

So I think it's, I don't think we

ever sort of firmly land one way

328

:

or another on, on a given regime.

329

:

but I think we, we do a lot of

analysis like that to just sort of

330

:

keep the conversation, you know,

interesting and making sure that

331

:

we're, we're sort of looking at it

from all different sorts of angles.

332

:

Mike Philbrick: In a, in a 20 stock

portfolio, yeah, that can get sort of.

333

:

Very unlucky and very lucky, I suppose.

334

:

And, and was there any indication

in that particular example

335

:

of what the turnover was?

336

:

Was It you know, the

idea of, of you've got

337

:

Jack Shannon: was about

338

:

0%.

339

:

Mike Philbrick: you

beat those to death and,

340

:

Adam Butler: Zero percent, you said?

341

:

Jack Shannon: The, the annual

342

:

Adam Butler: Wow.

343

:

Jack Shannon: well, for 2023 was 0%.

344

:

Yeah.

345

:

They, they didn't, yeah.

346

:

Mike Philbrick: Interesting.

347

:

Adam Butler: Yeah.

348

:

that's remarkable.

349

:

Jack Shannon: Yeah.

350

:

And, but then to your, to your

question though, it was, um, it was

351

:

very, it's, it Was remarkably even,

like contributions from the stocks.

352

:

It wasn't that they had, you know,

one huge winner that carried them.

353

:

It was each stock like was, it wasn't,

you know, it wasn't a, you know, a

354

:

clean, you know, even just split, but

it was pretty close, which was, which

355

:

was, what was the sort of amazing part.

356

:

And so that's why I had to generate

this sort of random scenario to be like,

357

:

how, how sort of crazy, what is this?

358

:

and Yeah, that, that,

that's certainly an outlier.

359

:

, That

360

:

Adam Butler: how much do you

guys use random portfolios?

361

:

Always, I've been a huge fan of random

portfolios as a way to evaluate skill

362

:

in quantitative strategies, but also

in mutual fund performance, etc.

363

:

Ever since I read Patrick Burns

papers back in, like, The mid:

364

:

is that something you guys employ

quite prolifically at Morningstar?

365

:

I mean, it just seems like it makes

so much sense as, as a key dimension

366

:

to understanding manager skill.

367

:

Jack Shannon: I wouldn't say

it's, it's something we use

368

:

like super, super frequently.

369

:

I, I have like a I have, I have

some, coding skills and whatnot.

370

:

So I, I like to build a lot of these

sort of quantitative, Quantitative models

371

:

and whatnot to do some of this analysis.

372

:

you know, i, I find them extremely

useful because I, to your point, it's,

373

:

it's to me, that's the best, that's

the best way to sort of assess whether

374

:

or not this was a, true, true skill on

display or, or, or really, really lucky.

375

:

And.

376

:

You know, I think the more,

I think we should do it more.

377

:

I think the, you know, my goal is

eventually, again, that was like

378

:

the one we just talked about was

a pretty simple one of just taking

379

:

20 random stocks and the S& P 500

and just letting them sort of run.

380

:

but you could apply it to sort

of any sort of any manager.

381

:

So if there's a manager who is, you

know, You know, a quality growth

382

:

manager and, you know, I only like

companies with above median ROICs and

383

:

I want to see the valuation below the

median in the industry and I want to

384

:

have this target turnover percentage.

385

:

You know, you should be able to build

a pretty, Pretty robust sort of random

386

:

portfolio, um, simulation from that.

387

:

And just sort of see is if we know the

generally what the manager likes to

388

:

do, can we attribute the performance,

whether good or bad to, You know,

389

:

skill within that, that sort of narrow

niche, or just that, that narrow

390

:

niche ended up doing pretty well.

391

:

And that's maybe more of the

story than, you know, just sort

392

:

of, uh, a raw look at it might,

393

:

Adam Butler: Well, then actually

that raises a key question, right?

394

:

So you've got a manager who uses

a set of screens with, you know,

395

:

a set of constraints and a target

average number of stocks with

396

:

whatever, different weightings.

397

:

If that manager exhibits skill versus

an unconditional group of random

398

:

portfolios, but doesn't exhibit skill

is kind of right in the middle of

399

:

what you'd expect for any manager

that uses the same selected criteria.

400

:

How will you judge whether

that selection criteria itself

401

:

adds value over the longterm?

402

:

like how do you disentangle

that skill versus.

403

:

Jack Shannon: Yeah, that's

the That's the tricky part.

404

:

because yeah, you should get credit

for if, if you're investing in these

405

:

sort of higher quality companies

and lower valuations and it does

406

:

well, well, that's a good thing

that you, that you did that, right?

407

:

and that is an active decision.

408

:

so, I think that, yeah, I think, you

know, determining whether, you know, what

409

:

gets more credit, um, I think is hard,

I guess with the way, the way I would

410

:

think about it is every manager tells you

they invest in high quality companies.

411

:

Every manager tells you they, you

know, they're buying, you know,

412

:

companies that they think are

trading below intrinsic value.

413

:

Every manager, uh, you know, wants to

buy, companies with good sentiment.

414

:

Like, I think if we can, if we know the

exact sort of screens they run, that

415

:

makes it a bit easier, because then we

can tell within the, within their own

416

:

defined universe how they're doing.

417

:

But, um, because if you're not picking

stocks well in your own defined universe,

418

:

I'm not sure I have confidence in you

to, to continue to, and you outperformed.

419

:

I have confidence in you to continue

to do that unless I have confidence in

420

:

these factors continuing to, to do well.

421

:

Which we generally try not to, take

too, uh, too out of a stance on like

422

:

a given factor or, or given style.

423

:

But, Yeah, it's certainly tricky,

but I think, um, I said, I'm

424

:

a, I'm a, I'm a big fan of this

sort of the random simulations.

425

:

so yeah, hopefully we, we, we do it more

and hopefully people find it useful.

426

:

Adam Butler: well, how

do you think about this?

427

:

The style style box?

428

:

You guys still incorporate that

in your, in your recommendations?

429

:

Yeah.

430

:

Jack Shannon: We still do.

431

:

Adam Butler: is the thinking

evolved on that over time?

432

:

Jack Shannon: Yeah.

433

:

So all, all our ratings are

sort of category dependent.

434

:

So wherever the fund falls in its, in its

category, we sort of stack each, we stack

435

:

the, you know, we stack the deck depending

on where it falls in its own category.

436

:

So we don't take a stance on, you

know, large growth is a better

437

:

place to be than large value.

438

:

We just say within large

value, here's The good stuff.

439

:

And within large growth,

here's the good stuff.

440

:

are, there is a project underway now,

um, with the style box, just because

441

:

if you, if you looked at the style box

recently, a core, you know, S and P 500

442

:

fund looks like it's in growth water now.

443

:

so there's sort of the issue of like,

Do we want the style box to be totally

444

:

relative to, you know, if you want the

Russell:

445

:

uh, benchmark, do we want the Russell

:

446

:

Or do you want to take maybe a more

absolute approach and say, well,

447

:

valuations have gone up across the

market and maybe the Russell:

448

:

growth going in, Russell 1000 going

into the side of the, you know, fence?

449

:

Maybe that is a signal to somebody

that, that, Hey, if you want pure

450

:

core exposure, maybe you look a

little further left on the style box.

451

:

So, I don't think we've, I don't

think we've landed anywhere on sort

452

:

of, on any changes in that respect,

but that is something we've, we've

453

:

seen recently is just sort of growth

inflation, pulling everything to

454

:

the, to the right of the style box,

455

:

Adam Butler: Yeah, it's just a question

of whether a manager, you know, should

456

:

get credit for choosing growthy stocks

when growth, the prospects for growthy

457

:

stocks is, is better and choosing

value stocks from the prospects.

458

:

It's just, you know, I remember my early

days working in an asset management

459

:

shop and you go through a 3 year period

where, you The value guys would hide

460

:

in their offices and all the growth

guys would congregate at the water

461

:

cooler, high five in one another.

462

:

And then you'd go through the next three

years where, it would be, you know, the

463

:

reverse, The value guys would be out

of the water cooler and the growth guys

464

:

would be hiding in the back office.

465

:

And neither group had any influence

or, you know, did, they weren't

466

:

able to dictate at all the

conditions of their own success.

467

:

It's just, is their style in favor or not?

468

:

Right.

469

:

It just seems.

470

:

It just seems so absurd.

471

:

Jack Shannon: Yeah.

472

:

Yeah.

473

:

It's funny you mentioned that.

474

:

Cause, uh, you know, when I first

started here, value, value was, was

475

:

beaten down for, for a decade plus.

476

:

And every time I talked to a

value manager, you know, they're,

477

:

it's almost, it was almost like

an apologetic tone from them.

478

:

And they're, you know, they're

trying to say, look, you know, just,

479

:

just give us a little more time,

you know, things are going to turn

480

:

around, blah, blah, blah, blah, blah.

481

:

And the growth managers are always, you

know, they're beaming with confidence

482

:

and, you know, so sure of themselves.

483

:

And then, you know, 2022 comes around

and, you know, growth managers Get

484

:

um, Get hammered and value looks

relatively good, even though they still

485

:

didn't do well on an absolute basis.

486

:

But, but then you see the role is

reversed where it's, you know, the

487

:

growth managers are sort of apologizing

and saying, yeah, you know, we got, we

488

:

got a little ahead of ourselves on, on

these and, and, you know, we learned

489

:

our lesson and then the value managers

finally get to say, see, we told you so.

490

:

You know, we, we told you that the

value would, would bounce back.

491

:

so yeah, we, we, it's, it's

interesting from my seat, just sort

492

:

of seeing the, the psychology of, of.

493

:

Portfolio managers and having to

deal with those, those ups and downs.

494

:

Cause I think that is, that is a big

sort of behavioral piece that they have

495

:

to manage is that you can look, again,

like I said before, you can look dumb

496

:

for a while, and yet, you know, I have to

have the fortitude to, to stick it out.

497

:

And on the flip side, you know, you

can look very smart and very bright and

498

:

make a lot of money in a short period of

time, but you kind of have to understand

499

:

that, you know, success can be fleeting

and, that can, that can turn on a dime.

500

:

Adam Butler: Yes it's just a

strange, there's a bunch of strange

501

:

dimensions too, but one of them

is that growth environments tend

502

:

to be highly concentrated in a

few stocks and value environments

503

:

tend to be, have much broader.

504

:

Participation in the markets.

505

:

And so for a kind of multidisciplinary

manager, so someone say, who doesn't

506

:

particularly favor growth or value as

say a core manager, part of his job

507

:

is going to be, you know, emphasizing

growth or value, I guess, over time, but

508

:

in those growthy markets, the amount of

conviction you have to have in those.

509

:

Few names that completely dominate the,

the cap stack in the index and also often

510

:

end up also dominating the return profile.

511

:

Like you sort of saw, in the recent

period and in this sort of pre 21

512

:

period for five years, obviously

leading up to:

513

:

the amount of conviction you've got

to have, like as a fundamental, equity

514

:

core manager in your allocations.

515

:

Is so out of proportion with

what anyone could reasonably

516

:

expect to have as their edge.

517

:

For, for you, for a bottom up analyst.

518

:

To want to give 7 percent each to,

to Apple and Microsoft and, you know,

519

:

4 percent to Nvidia, et cetera, like

the amount of excess return that

520

:

you need to assume for those, for

those stocks to give those stocks,

521

:

those weights in the portfolio.

522

:

Like there's just no responsible

way that you could, from a bottom up

523

:

standpoint, be that confident, right?

524

:

So.

525

:

How do you, how do you think managers

should navigate that paradox?

526

:

Jack Shannon: It's also, uh, in the

U S it's tricky because they, um,

527

:

oftentimes can't even hold it at

market weight if they want it to.

528

:

So there's the, diversification

rules in a 40 act fund that, you

529

:

know, the 25 5 rule, you can't have

more than 25 percent of your assets

530

:

in positions of 5 percent or more.

531

:

And you literally can't own, if you're

a large growth manager, you can't own,

532

:

the top five stocks at market weight.

533

:

So you If you're a diversified manager,

so you either have to change the

534

:

diversification status of your fund,

which I haven't got a great answer on

535

:

why that's so difficult, but, a lot of

managers don't seem to want to do it.

536

:

I guess it has to go through a, you

know, a shareholder vote and all that.

537

:

And maybe there's a, some

operational headaches and

538

:

Adam Butler: Massive platform

539

:

Jack Shannon: Non diversified funds,

but yeah, so regardless, you know,

540

:

they run into that, that, that

problem, and like I said, I think

541

:

a lot of them now are just like,

542

:

There's a tendency of managers to you

know, explain themselves as being unique

543

:

when they're, when they have to be unique.

544

:

Like, it's not necessarily a, I'm not

sure it's an active choice they're making.

545

:

It's, it is a regulatory constraint

that they have to be, And so, yeah, it

546

:

would be, it would be interesting if,

if you've removed that 25 5 rule, where

547

:

their portfolio weights would go, and

I suspect they would go up in those,

548

:

in those seven names in the aggregate.

549

:

there certainly are some managers

who I think are legitimately,

550

:

you know, have legitimate bearish

views on a lot of those names.

551

:

but to our earlier discussion on, sort

of tracking error and managers sort of

552

:

being incentivized to stay positive.

553

:

Somewhat close to the index.

554

:

I think that that is a huge

amount of risks they're taking

555

:

on that they, that again, they

don't really have a decision on.

556

:

and so I think if they could close that

risk gap, they certainly would like to.

557

:

Adam Butler: It's an interesting, point

you make though, Mike, I hadn't thought

558

:

of this about the fact that a lot of

these active funds are actually not able

559

:

to hold the MAG 7 and the, weights that

the cap weighted index holds them in.

560

:

so there's actually a, a structural

compliance or regulatory disadvantage

561

:

that these funds are facing at the moment.

562

:

Is that a fair characteristic

or characterization?

563

:

Jack Shannon: Yeah, they, yeah.

564

:

So the 40 acts diversification rule

is a 25 five rule, and I don't have

565

:

the The exact stats on like the

percentage of non diversified versus

566

:

diversified funds in like the U.

567

:

S.

568

:

large cap universe, but it's

very few are non diversified.

569

:

Um, and the ones that are, have been

non diversified for a long time,

570

:

because they were sort of coming out

of the nineties as these concentrated

571

:

portfolios that were popular at the time.

572

:

And then saw their popularity wane and,

now they've kind of come back in vogue.

573

:

You have seen some, some shops, I think

Fidelity and TRO have, have recently

574

:

changed some funds from non diversified

to diversified, or I'm sorry, from

575

:

diversified to non diversified to sort

of address this issue, but it hasn't

576

:

been as widespread as, as, we thought.

577

:

you know, cause on our side, it's

like, again, we're not, you know,

578

:

we're not on, you know, we're

not overseeing any platform.

579

:

We're, we're just issuing

our own opinions on things.

580

:

And so we were always wondering,

you know, it sort of seems

581

:

like a free option, right?

582

:

To.

583

:

To just label yourself non diversified.

584

:

And if you want to hold a

diversified portfolio, great.

585

:

There's no, there's nothing

stopping you from, from doing that.

586

:

but you are constrained on the

other side where if you, if you

587

:

are diversified, but you want to

be non diversified, you, you can't.

588

:

but Adam, to your point on, on sort

of the platform, issues, I, we've

589

:

long suspected that's the case, but

we haven't really, we just haven't

590

:

really gotten enough, you know, firm

information on, on that and sort of

591

:

how big of a constraint it truly is.

592

:

Adam Butler: Yeah, fair.

593

:

So, with all your data wrangling,

do you have any, uh, suggestions

594

:

on what investors might look for?

595

:

You know, how first of all, what is

the, what is the sort of future of Of

596

:

active management in your, in your view

and, and, um, how should investors think

597

:

about the role of active management

and portfolios versus other options?

598

:

and, if they were going to choose

to pursue active management, what

599

:

are some good rules of thumb?

600

:

Jack Shannon: Yeah.

601

:

So the, the future of active management

I was, um, as I was reading a story in a

602

:

Wall Street Journal today about a manager

complaining about the passive flows, um,

603

:

warping the market and, you know, creating

all sorts of issues and contributing

604

:

it to it being top heavy and all this.

605

:

and to me, I see that and I say,

wouldn't an active manager love that?

606

:

Wouldn't an active manager love

uninformed, participants adding into,

607

:

you know, coming into the market because

if you're the, the informed investor

608

:

with, You know, an informational edge,

you should, you should like that.

609

:

You should, you should be able to then see

where the market's overheated and where

610

:

it's not, and be able to act accordingly.

611

:

so if you talk to managers that, you

know, they feel threatened by, by

612

:

passives and not just from a, from

a flow standpoint and from an asset

613

:

standpoint, but they, a lot of them

sort of characterize it as sort of,

614

:

you know, changing the market overall.

615

:

But I'm not sure I, I buy that argument.

616

:

we've seen, um, Uh, at our Morningstar

conference, I'm hosting a panel on, um,

617

:

On active ETFs, which is sort of the,

I guess that the vehicle of the future

618

:

for active management where, instead

of in a mutual fund wrapper, you're

619

:

getting it in an, in an ETF wrapper.

620

:

There are obviously some

tax advantages to that.

621

:

you know, the, the portfolio managers, you

know, there, there was always a question

622

:

of sort of transparency with an ETF.

623

:

You have to disclose your

portfolios every day.

624

:

some portfolio managers didn't like

the idea of that and thought that,

625

:

hey, maybe people could get out in

front and front run me and sort of

626

:

hurt my hurt my performance that way.

627

:

but I think a lot of that sort of

fallen by the wayside and we, we see

628

:

a lot of shops launching back ETFs.

629

:

and I think there's, there's certainly

gonna be more to, more to come.

630

:

they're sort of specifically trying to

keep them as distinct strategies for

631

:

the most part, which is interesting.

632

:

So, you know, if you're a, if you have

a large cap growth strategy, in a mutual

633

:

fund, a lot of times we're seeing.

634

:

firms launch a large cap growth ETF.

635

:

That's slightly different

than the mutual fund version.

636

:

And I, again, getting back to that sort

of fiduciary point we hit on earlier.

637

:

I think a lot of that has is the

reason behind that is if you have

638

:

an ETF version, that's cheaper than.

639

:

a mutual fund version, then

you're probably just going to

640

:

cannibalize the flows between them.

641

:

so, so that's where we're seeing managers

go right now, just in terms of vehicles.

642

:

And then in terms of just

everyday investors and sort of

643

:

how they can, sort of better

their odds with active management.

644

:

to me, it's all about, it's all about

quality and it's all about downside.

645

:

I think if, if you can find a manager

who is consistently, investing in

646

:

high quality businesses, and I know

quality is a very nebulous term,

647

:

we can, Talk about the different

definitions for that or whatever.

648

:

But, generally I think, I

think you, you can do well.

649

:

There are, there are certain

shops that lend themselves to

650

:

being high quality firms that

invest in high quality businesses.

651

:

They do it for the long term.

652

:

You know, they're not churning

portfolios 200 percent in a year.

653

:

and you see that in the

downside protection.

654

:

So if you, if you go on morningstar.

655

:

com or I don't know what other, sort

of outlets out there that, that publish

656

:

sort of downside metrics, but I think

that's a key, A key contributor to long

657

:

term success is being able to preserve

that capital on the downside because, you

658

:

know, we all know that sort of returns

are asymmetric and, uh, you know, a loss

659

:

hurts a lot more than an equivalent gain.

660

:

So, then equivalent gain helps, So

I think that's where investors can,

661

:

can really help themselves is looking

at the downside, even though most

662

:

people like to think about the upside,

you're buying an equity fund, you

663

:

want, you want to get those returns.

664

:

you don't really care about, well, it only

lost 20 percent when the market lost 30.

665

:

You're more focused.

666

:

Most people are more focused on sort

of the promise of the big gains.

667

:

So I think people need to kind of

just shift their thinking in terms

668

:

of, of what to really look for.

669

:

Adam Butler: Right.

670

:

In terms of the flows, sorry, Mike,

you look like you had a question.

671

:

Um,

672

:

Mike Philbrick: No, I was just, I

was just thinking through, you know,

673

:

win rate doesn't really matter or

isn't that effective in certain ways.

674

:

Um, big bets aren't really

that effective in ways.

675

:

So is it, is it really the,

it's the risk management?

676

:

Is there, so there's a risk

management, a downside.

677

:

Is there any of the picking on the upside

that adds value or like, how, how do you,

678

:

how have you, can you elaborate more on

679

:

Jack Shannon: Yeah.

680

:

So, so I did the research on the,

on the hit rates and the big bets to

681

:

see if, how can active managers win?

682

:

Can they, can they win via a higher

percentage of, of stocks being right?

683

:

Answers?

684

:

Eh, not really.

685

:

Can't really say that's the case.

686

:

you see a, you know, a loose

linear relationship, but, um, in

687

:

some categories it's, it's, you

know, not really linear at all.

688

:

It's just like a random scatterplot.

689

:

Yeah.

690

:

Same on the bets.

691

:

You'd think, well, I want an

active manager to make these

692

:

concentrated bets, you know, where

they have the informational edge.

693

:

And you're like, ah, you see that,

and you're like, yeah, it doesn't

694

:

necessarily help out too much either.

695

:

so on the, so yeah, so it's, it comes

down to just sort of consistency and,

696

:

you know, I, I, think, I think, on the,

on the upside, you do see funds, um,

697

:

where over their whole track record,

you look at 25, 30 year horizon.

698

:

where they're not good on the downside,

but they're, they're good enough.

699

:

They're so good on the upside that,

that, that it, that it makes up for it.

700

:

so there are some cases of that

happening, but it's, it's, it's

701

:

just sort of rare to find them.

702

:

and I think because if, if you are, if

you are worse on the downside, while

703

:

people don't pay attention to it, when

maybe they're buying their fund at first,

704

:

and those moments of pain and you're

losing a lot more than, passive index,

705

:

You know, people are going to start

pulling money from your, from your fund.

706

:

And I think it's, it's harder to survive

when you have the, worst downside

707

:

profile, but the higher upside profile.

708

:

Mike Philbrick: Right, the, the fund

flows beat you up a little bit, but if

709

:

you're, if you're an investor, that's

I'm going to dollar cost average.

710

:

And I love it.

711

:

I love being down

712

:

Adam Butler: Uh, Uh,

713

:

Mike Philbrick: I

714

:

love all I have all, and I

love being down and I'm good.

715

:

A dollar cost average is probably a better

716

:

Jack Shannon: Yeah.

717

:

I mean, there are, there certainly are

some, some, some growth funds that have,

718

:

yeah, you look at their profile, like.

719

:

Damn, how did this, how has this

survived and how, but, but it's, you

720

:

know, they have sticky client base

who are willing to stick through those

721

:

sort of turbulent times and, and,

they do get the payoff eventually.

722

:

they're just, yeah, they're,

they're, they're rare.

723

:

Mike Philbrick: Yeah it's super

hard to obviously identify

724

:

those in advance as the one.

725

:

I mean, this really sticks out in my

mind too, is it's not a five year game.

726

:

Like the people talk about

your time horizon and investing

727

:

being three to five years.

728

:

There's all, it's, it's just

randomness in three to five years,

729

:

like literally 20 years, you can

reliably count on stocks beating most

730

:

other asset classes historically.

731

:

And that's what you got to think.

732

:

I'm making a 20 year decision here.

733

:

And if you can make it 30 years,

boy, boy, it gets even better.

734

:

but wow, what a, what a decision to

try and make with a certain, call it

735

:

dogma or religion or market cap value

736

:

Jack Shannon: Yeah.

737

:

I've looked at, Um, so that's something

I've, I've, nothing's been published on

738

:

it, but it's something I've been really

interested in is like, Looking at any sort

739

:

of trailing risk metric, beta, standard

deviation, down, you know, maximum

740

:

drawdown, blah, blah, blah, blah, blah.

741

:

So just to think if I was, if I was

an investor at any point in time, and

742

:

I looked at all these risk metrics

that are commonly, pumped out for in

743

:

financial, websites and whatnot, would

that tell me anything about the long

744

:

run potential of the of the strategy?

745

:

you know, would those high beta funds,

746

:

Adam Butler: Well,

747

:

Jack Shannon: know, end

748

:

Adam Butler: I mean, we

749

:

Jack Shannon: better or worse, whatever.

750

:

And so, it's something I've done a lot

of work on and it ends up, depends what

751

:

time period you look at, but like those

trailing risk metrics are not very great

752

:

for when you, when you go over those long

horizons, you know, 20 years, they're

753

:

not going to tell you much in terms

of either the downside or the upside.

754

:

It's, it is just sort of, but to your

point on the sort of the three and five

755

:

years, you know, you go on Morningstar.

756

:

com or you go on Fidelity or wherever.

757

:

The beta it's going to show you is

going to be like a trailing three year

758

:

beta, which is going to be on based on

monthly, most likely monthly returns.

759

:

So that's 36 data points that you're

going to base your, your decision on.

760

:

it's just, sometimes it's hard for

me to think that those are super,

761

:

super useful for an investor thinking

of, you know, truly long term risk.

762

:

Mike Philbrick: Well,

it's interesting though.

763

:

If you, if you're in accumulation

and you're doing that dollar cost

764

:

averaging, you're, probably going

to have some tailwind to that.

765

:

although decumulation, you know,

works in the exact opposite

766

:

Adam Butler: And I think you need to, it

needs to be relatively evenly spaced out.

767

:

You know, having a, having something

where it kind of goes up for eight

768

:

years and then gives you a 60 percent

decline for two years, it doesn't really

769

:

help the dollar cost average, right?

770

:

Mike Philbrick: of course.

771

:

There's going to be, there's going

to be this certain, the fingerprint

772

:

of it that would be advantageous

or disadvantageous over time.

773

:

And I'm being, I'm doing

a thought experiment.

774

:

Let's be honest.

775

:

The fact is that the mental capital

that's required for someone to continue

776

:

to invest in something that is, you

know, the Nasdaq in:

777

:

and continue to just she money in.

778

:

I mean, I guess you have seen a little

bit of that in the, in the space of

779

:

cryptocurrencies where there is a group of

people who are just in it no matter what.

780

:

They're, they're yolo-ing no matter what.

781

:

And, and maybe there was a few

people in the tech world like that.

782

:

but boy, oh boy, that's, that's a hard

road to follow behaviorally from, uh,

783

:

from an investor's perspective, going

through some 90 percent declines.

784

:

Adam Butler: definitely.

785

:

I was just saying, Jack, that, you

know, there's good evidence that

786

:

that lower volatility stocks and

lower volatility portfolios provide

787

:

a tailwind, over time, but obviously

that's far from a sure thing.

788

:

And there's, there's going to be,

good, long stretches where lower

789

:

volatility portfolios underperform.

790

:

So,

791

:

Jack Shannon: I think, um, so

betting against beta, there is, I

792

:

think AQR wrote a, wrote a, paper.

793

:

on it.

794

:

actually that was my, uh, so when we

interview for Morningstar, we have

795

:

to, we have to pitch a fund and do

that as part of the interview process.

796

:

And mine was AQR defensive style,

which is based on the, uh, betting

797

:

against beta paper, which is about

low vol stocks over the long run.

798

:

Adam Butler: And quality.

799

:

Yeah, awesome.

800

:

Yeah, that's a, that's a good paper.

801

:

And then the guys at Robico have done

some fabulous work on that as well.

802

:

We've published some on it.

803

:

There's definitely something there,

but, you know, again, you're going

804

:

to go through 3, 5 year periods where

those are going to look pretty silly

805

:

too, relative to cap weighted indices.

806

:

We're in the middle of

807

:

Mike Philbrick: we're

five value investors.

808

:

anyone?

809

:

Adam Butler: Oh, yeah, not value,

value 10 to 15 to 30 years, but

810

:

depending on the metric, but

811

:

Mike Philbrick: It's a great

time to be accumulating.

812

:

Adam Butler: that's right.

813

:

That's

814

:

Mike Philbrick: this, this is not, if

you're a value investor, this is the,

815

:

this is the, the heaven, the nirvana

that you look for in order to be

816

:

able to just accumulating these value

stocks over and over again at these

817

:

Adam Butler: That's right.

818

:

20, 20 years of

accumulation with no payoff.

819

:

Jack Shannon: Lower that cost basis.

820

:

Mike Philbrick: it's a rough game, man.

821

:

It is a rough game.

822

:

Adam Butler: But that's, you

know, to your point about the

823

:

flows, the passive flows, right?

824

:

And I, you know, I, we've had

discussions on this before, but, you

825

:

know, others have raised this idea

that, well, if there's all these.

826

:

passive flows that are kind of no edge

flows, then why wouldn't active managers

827

:

be all over this and trying to orbit?

828

:

And I think the reality is that you're,

you may be right at some point, right?

829

:

Like you're sort of betting that

you're going to be right at some point.

830

:

That the passive flows are going to stop.

831

:

And, but as long as passive flows

continue into stocks with disregard for,

832

:

you know, any anchoring to fundamental,

metrics, then you're going to remain

833

:

offside and your degree of offsidedness

is going to grow over time, right?

834

:

So it's one of these, the market can

stay irrational for many, many, many

835

:

more years, and you can stay solvent or

stay in business as an active manager.

836

:

I think that's the.

837

:

I

838

:

think that's a fair point.

839

:

Mike Philbrick: and

840

:

potentially, you know, when you're

fighting the dumb crowd, sometimes

841

:

the dumb crowd's pretty smart.

842

:

Jack Shannon: Yeah.

843

:

Mike Philbrick: know, I mean, I've

never seen a company like Meta grow at

844

:

the size it is at 25 percent last year.

845

:

That's astounding.

846

:

Adam Butler: Yeah.

847

:

Mike Philbrick: I just don't know you.

848

:

I'm, I'm gobsmacked.

849

:

I mean, this is the, this,

this set of companies is not

850

:

the 2000 set of companies.

851

:

it's a very different set of companies.

852

:

So it is, and the, you know, the

whole software eats the world

853

:

and, and the change in the way

you can lever these businesses.

854

:

I think you're right.

855

:

There's a lot of people fading that

trade until they're all out of business.

856

:

They've sold everything.

857

:

They're underweight as

late as they can be.

858

:

and just didn't make it to the end

859

:

Jack Shannon: I actually did a,

860

:

Mike Philbrick: and maybe they are right.

861

:

I don't know

862

:

Jack Shannon: I did a study comparing

those two periods just in terms of

863

:

how, managers were trading during

this sort of tech bubble and the,

864

:

what I call the COVID bubble.

865

:

the idea of the, the the idea in

my head was that, oh, managers

866

:

must have learned from that.

867

:

Like, you know, there's, there must

be enough institutional knowledge at

868

:

a firm where they don't get sucked

into buying, you know, ridiculously

869

:

valued companies that had never earned

a single dollar in their history.

870

:

And of course it ended up being

slightly worse than the tech bubble,

871

:

just in terms of buying activity.

872

:

Like I'll have to look at the numbers,

but something like four and a half,

873

:

percent of all large growth assets

at one point were in companies

874

:

that had never earned a profit.

875

:

and that's with historically well

below like one percent, like a tenth

876

:

of a percent is a usual amount.

877

:

and so you see this big spike in 2000,

s,:

878

:

nothing, nothing, nothing, big spike

in:

879

:

Um, that's, that's an interesting,

angle that I, again, I want to explore.

880

:

I don't know how, how exactly to

do it, but just, um, sort of market

881

:

memory and, and sort of how much, you

know, managers, managers or, or, any

882

:

participant in the market really has,

you know, actually internalized history.

883

:

Yeah.

884

:

Mike Philbrick: the collective memory.

885

:

Cause we, we had the nifty 50 as

well, prior to the tech bubble.

886

:

Then we had the reason reason tech bubble

followed right along the resource boom.

887

:

You know, we had the bricks and

all, all the rush into Canada

888

:

and Australia and South Africa.

889

:

I mean, I don't know.

890

:

I don't know.

891

:

I think it's, it's a feature.

892

:

Adam Butler: think it's that the man, the

managers who have those long memories.

893

:

Will not participate in those

markets and get left behind.

894

:

And so it's, you know, they just

get run out of the business, right?

895

:

Like too much experience in this business

actually ends up being detrimental

896

:

because you just, you know, you keep

looking at this crazy market saying.

897

:

You know, it's, this is ridiculous.

898

:

I'm not going to participate this time.

899

:

I learned my lesson last time

and it goes on and on and on.

900

:

And eventually you just get

hopped and someone with that will

901

:

participate, um, replaces you and has

a good run for two or three years.

902

:

And then they learned the hard

lessons and it all just repeats.

903

:

Jack Shannon: Yeah,

904

:

Mike Philbrick: Yeah, there's got to

be a collective memory though that, you

905

:

know, sort of the, the collective memory

of the participants of the marketplace,

906

:

um, with interest rates, even, I mean,

I was in the transitionary period of

907

:

that going from a period where, when

I grew up into:

908

:

interest rates and nothing built.

909

:

And I bought a Canada

savings bond that paid 19.

910

:

5%.

911

:

That was a pretty good deal.

912

:

And then watched it go

from 19 and a half to zero.

913

:

And, uh, you know, I remember an

old, an old sod of a broker who

914

:

would get his old paper out from

:

915

:

here, here's the newspaper from 20

years ago, what do you want to buy?

916

:

And he kept it, they'd

always be like stocks.

917

:

And he's like, no, it's just

long duration bond over here.

918

:

You see this 30 year bond

yields, 18 percent or yields.

919

:

It wasn't 18%.

920

:

It was about 15%.

921

:

You know, 30 year bond for 15 percent

and rates went, you know, straight

922

:

down, but totally outperformed stocks,

both risk adjusted and absolute.

923

:

So even if you're given all

the information, investors

924

:

will make the wrong decision.

925

:

Adam Butler: Yeah, I don't think

there's any institutional memory

926

:

lasting longer than a couple of years

at all, just because the people that for

927

:

Mike Philbrick: a couple of years, but

there's definitely, you know, there,

928

:

there's, there's certainly a youngening,

I think, going on at the moment.

929

:

You know, there was, uh, in the advisor

space anyway, there's, and even in the

930

:

institutional space, you're seeing.

931

:

More and more of a, you know, the,

um, the boomer crowd being sort

932

:

of moved on for the most part.

933

:

and, uh, millennials moving into that

Gen X is, is in there a bit, but, um,

934

:

you know, the youngening is a real thing.

935

:

So that, that collective

936

:

Jack Shannon: I've asked

firms about how, um,

937

:

Mike Philbrick: I mean, the

number of times I heard.

938

:

Jack Shannon: Yeah.

939

:

I've asked some, I've asked some mutual

fund companies how they handle that

940

:

because, you know, they're, a lot of their

analysts with 10 years of experience,

941

:

they graduated college in 2012 and

they didn't see anything but growth,

942

:

growth, growth, growth, growth, and it

worked, worked, worked, worked, worked.

943

:

Um, And then again, 2022 was a disaster.

944

:

And, you know, a lot of them acknowledge

that we, yeah, we actually have to spend

945

:

time to, you know, educate the analysts

on sort of market history overall, and

946

:

that, you know, the more enterprising, I

guess, analysts are naturally interested

947

:

in, in market history, I think.

948

:

like I, I like to just

read it on my own anyway.

949

:

But if, if you, if you, if you do

treat it just simply as a day job

950

:

and not something you're naturally

curious about, it is something you can

951

:

overlook and get burned by, I feel like.

952

:

Adam Butler: I hear.

953

:

Yeah.

954

:

But too much knowledge of history

can also be detrimental for for

955

:

very, very long stretches of time.

956

:

so it's,

957

:

Mike Philbrick: I also think there's

nothing, there's nothing like living it.

958

:

I could read it.

959

:

I could read it.

960

:

I could read it.

961

:

And until you've got rubber

under the road and chinks in your

962

:

armor and stab wounds and scars.

963

:

Adam Butler: I don't even think

there's any motivation to read it.

964

:

If you read it, but you kind of

just skip over the parts where,

965

:

you know, they were rough.

966

:

You know, value oriented grinds

because you're having so much fun

967

:

in the current growth environment.

968

:

I mean, I remember, I

remember those times.

969

:

I remember feeling exactly the same way

and you know, you read the histories

970

:

if you're forced to, but really you're

not paying attention because it just

971

:

is not salient to you at the moment.

972

:

Mike Philbrick: even, even, I mean,

I think I've seen the same game

973

:

run written about extensively in

reminiscence of a stock operator

974

:

in the stove, whatever it was.

975

:

I've seen that fricking gamut run

through four different marketplaces.

976

:

I've seen the whole thing done.

977

:

Like I, I just, I, I see

it over and over again.

978

:

I'm like, wow.

979

:

We, they just, they, they, you know,

doll it up a little bit, but anyway,

980

:

I, you know, there's, there's, uh,

there's basic, boring investing.

981

:

Uh, I think, I think you were, you were

talking about that, Jack, you know,

982

:

just kind of basic, boring stuff kind

of wins in the longterm trotting along.

983

:

And, uh, and, and maybe, maybe

984

:

Jack Shannon: it's it's no fun

at a cookout when, you know,

985

:

Mike Philbrick: we've been

chatting for about an hour, but,

986

:

but I wonder what is boring.

987

:

Yeah.

988

:

Adam Butler: He was - Mike

wasn't being, dismissive of

989

:

Mike Philbrick: no.

990

:

I mean, but what, what are the key,

what are the key features of boring of

991

:

sort of boring that, that you would,

that I know you alluded to that in

992

:

the papers, you know, this is boring.

993

:

It's just boring.

994

:

It's kind of this, but what maybe,

maybe as a final parting gift, what

995

:

are the key features of boring that

tend to work and just are, you know,

996

:

things that people can look for?

997

:

Jack Shannon: It's the low turnover

sort of buy and hold approach.

998

:

Um, you know, we, we talked about

sort of those portfolio simulations

999

:

that you can, you can run.

:

00:53:09,742 --> 00:53:12,062

And if, again, if you look at five

years or three years, it's not going

:

00:53:12,062 --> 00:53:13,422

to tell you much because of market cap.

:

00:53:13,707 --> 00:53:17,977

Weighted portfolio would have beaten

way, but go back and start in:

:

00:53:17,977 --> 00:53:20,917

and pick any random selection of, of

companies and just sort of let the

:

00:53:20,917 --> 00:53:24,507

market take them and it's, it's the

most boring thing you could possibly do.

:

00:53:24,507 --> 00:53:24,787

Right.

:

00:53:24,787 --> 00:53:25,847

Set it and forget it for?

:

00:53:25,917 --> 00:53:26,747

30 years.

:

00:53:27,077 --> 00:53:29,039

but it Turns out that doesn't do that bad.

:

00:53:29,039 --> 00:53:32,935

And, in fact can do better than

most of the active stuff that you,

:

00:53:32,955 --> 00:53:34,445

that you, you end up paying for.

:

00:53:34,822 --> 00:53:38,972

so yeah, I, I think just the low

turnover buy and hold, you know, don't

:

00:53:38,972 --> 00:53:42,582

look at your, your, your, your balances

every week, don't look at them every

:

00:53:42,592 --> 00:53:44,462

month, maybe check in once a year.

:

00:53:44,942 --> 00:53:47,752

Uh, make sure that your portfolio

manager didn't commit fraud or

:

00:53:47,752 --> 00:53:51,869

something, but, Other than that,

it's, it's, it's a really long game.

:

00:53:51,959 --> 00:53:53,569

and, and I'm saying this

and I'm not that old.

:

00:53:53,579 --> 00:53:57,489

Um, so I, I kinda, I, I kinda

recognize the, uh, the inherent sort

:

00:53:57,489 --> 00:54:00,405

of contradiction and, you know, a

young person telling somebody that,

:

00:54:00,405 --> 00:54:02,032

but, that's how I sort of view things.

:

00:54:02,032 --> 00:54:05,485

I don't, I don't check any of

my, any of my balances, any, any.

:

00:54:06,170 --> 00:54:07,360

Real frequency at all.

:

00:54:07,697 --> 00:54:10,097

and who knows, I'll check it in a

couple of years, make sure nothing,

:

00:54:10,197 --> 00:54:11,387

nothing's too off the rails.

:

00:54:11,387 --> 00:54:12,957

But,, yeah, that's

:

00:54:13,253 --> 00:54:14,413

Mike Philbrick: Benign neglect.

:

00:54:14,767 --> 00:54:15,057

Jack Shannon: right.

:

00:54:15,097 --> 00:54:15,397

Yeah.

:

00:54:15,467 --> 00:54:15,777

Yeah.

:

00:54:16,863 --> 00:54:21,143

Mike Philbrick: The key to investment

success in a world that's overhyped

:

00:54:21,473 --> 00:54:25,680

and over, marketed is benign neglect.

:

00:54:26,260 --> 00:54:28,430

Is to just ignore all of it.

:

00:54:28,695 --> 00:54:31,305

Adam Butler: as long as the initial

portfolio wasn't informed by

:

00:54:31,305 --> 00:54:32,885

whatever mania was in place at that

:

00:54:33,094 --> 00:54:33,724

Jack Shannon: 100%.

:

00:54:33,804 --> 00:54:34,134

Yeah.

:

00:54:34,724 --> 00:54:35,144

Yeah.

:

00:54:35,294 --> 00:54:38,312

cause there's a fund in, uh, in

America, it's called like, Voya

:

00:54:38,382 --> 00:54:44,482

Corporate Leaders Trust, um, was put

together in:

:

00:54:44,802 --> 00:54:46,372

Hasn't traded a thing since.

:

00:54:46,782 --> 00:54:50,102

And over that,:

not be the right date, but over its

:

00:54:50,102 --> 00:54:53,795

entire history, it's beaten the S&

P 500 and hasn't traded a share.

:

00:54:54,781 --> 00:54:57,181

Adam Butler: It's amazing that

all the companies are still in

:

00:54:57,415 --> 00:54:58,915

Jack Shannon: Well, not all of them are.

:

00:54:59,071 --> 00:54:59,711

Adam Butler: Maybe they all

:

00:54:59,880 --> 00:55:04,050

Jack Shannon: So it's, it's a big big

Union Pacific stake in it right now.

:

00:55:04,167 --> 00:55:07,187

because, you know, some companies

have, you know, been, you know,

:

00:55:07,187 --> 00:55:08,837

bought out, some have, some have died.

:

00:55:08,837 --> 00:55:11,797

And so You end up then getting,

you know, market weightings

:

00:55:11,817 --> 00:55:13,167

within this small portfolio.

:

00:55:13,467 --> 00:55:15,087

and so, yeah, it's, it's

become a very concentrated

:

00:55:15,137 --> 00:55:17,237

portfolio, but it's still beaten.

:

00:55:17,555 --> 00:55:20,109

The broader market over, you

know, almost a hundred years.

:

00:55:20,119 --> 00:55:21,659

So there's something to it.

:

00:55:21,948 --> 00:55:22,638

Adam Butler: yeah, sure.

:

00:55:22,785 --> 00:55:26,925

Well, um, are you working, working

on any particular project right now?

:

00:55:26,925 --> 00:55:28,215

You wanna give a teaser for.

:

00:55:28,329 --> 00:55:32,399

Jack Shannon: Um, nothing, nothing that's,

you know, going to get published anytime.

:

00:55:32,719 --> 00:55:33,719

Immediately soon.

:

00:55:33,759 --> 00:55:37,509

Um, I, I mentioned sort of the risk stuff

I've been, I've been looking at of just,

:

00:55:37,509 --> 00:55:42,429

um, how informative are sort of trailing

risk metrics in terms of forward risk.

:

00:55:42,795 --> 00:55:47,105

you know, the classic betas and standard

deviations and, and, all that jazz

:

00:55:47,115 --> 00:55:50,769

that, That we all see when you pull

up a fund on a, you know, on a screen.

:

00:55:50,769 --> 00:55:54,585

But, yeah, that's a, that's a, that's a

more, you know, this hit rate stuff and

:

00:55:54,585 --> 00:55:57,055

the big bet stuff is very straightforward

when you're getting into the world of

:

00:55:57,055 --> 00:56:01,082

risk, there's so many sort of other angles

that people, people want to explore that

:

00:56:01,082 --> 00:56:04,770

makes it a bit bigger of a project, but,

Hopefully that one sees the light of day.

:

00:56:05,014 --> 00:56:08,227

but if not, you know, everything

sort of comes to me through, uh, you.

:

00:56:08,227 --> 00:56:10,617

know, like talking with portfolio

managers and that they'll say something

:

00:56:10,617 --> 00:56:15,457

and I'll say, like this hit rate stuff

that came up because a manager said he

:

00:56:15,457 --> 00:56:17,567

had hit on 70 percent of his stock picks.

:

00:56:18,187 --> 00:56:20,657

And I thought that was

a ridiculous number.

:

00:56:21,147 --> 00:56:24,167

And so I said, I want to

see how rare that, that is.

:

00:56:24,617 --> 00:56:27,787

And I, and I did The study and there

was one manager who had 70 percent

:

00:56:27,787 --> 00:56:29,420

or more and it wasn't, this guy.

:

00:56:30,470 --> 00:56:35,147

Um, so it's, uh, yeah, it's, I just,

I, I like being here and having, having

:

00:56:35,147 --> 00:56:39,297

sort of a unlimited, uh, access to

our database to just sort of explore

:

00:56:39,297 --> 00:56:41,097

what's ever top of mind at The time.

:

00:56:41,097 --> 00:56:43,460

So something will pop in my

head and you'll, you'll see

:

00:56:43,460 --> 00:56:44,650

it at some point, I suppose,

:

00:56:45,311 --> 00:56:45,901

Adam Butler: I hear you.

:

00:56:45,931 --> 00:56:52,751

The best articles are motivated by someone

who says something that you think is

:

00:56:52,751 --> 00:56:54,951

silly or that you strongly disagree with.

:

00:56:55,040 --> 00:56:55,410

Jack Shannon: right.

:

00:56:55,620 --> 00:56:56,790

I got to prove that guy wrong.

:

00:56:57,728 --> 00:56:58,088

Adam Butler: Yeah.

:

00:56:58,191 --> 00:56:59,831

100 percent yes.

:

00:57:00,691 --> 00:57:01,571

Completely concur.

:

00:57:01,571 --> 00:57:01,931

Okay.

:

00:57:01,931 --> 00:57:02,965

Well, this is great.

:

00:57:02,975 --> 00:57:05,815

A little over an hour, um,

covered a lot of ground.

:

00:57:05,991 --> 00:57:09,051

Jack, uh, where can people find

you other than at Morningstar?

:

00:57:09,626 --> 00:57:11,096

In addition to Morningstar.

:

00:57:11,586 --> 00:57:13,036

Mike Philbrick: On the streets of Chicago.

:

00:57:13,170 --> 00:57:15,190

Jack Shannon: you can bump into

me on the South side of Chicago.

:

00:57:15,200 --> 00:57:15,870

That's where I live.

:

00:57:15,880 --> 00:57:19,160

But, uh, no, other than that, um, I

don't really have a social media presence

:

00:57:19,160 --> 00:57:22,452

or anything, but, um, yeah, you can

just Google me with Morningstar and

:

00:57:22,452 --> 00:57:25,512

you'll see a list of all my articles

pop up if you're, if you're interested.

:

00:57:25,602 --> 00:57:27,309

Um, I, I have a LinkedIn page.

:

00:57:27,309 --> 00:57:30,189

I don't really look at it, but,

people can find me there, I suppose.

:

00:57:30,599 --> 00:57:33,172

but yeah, and I do, you know, I

like to hop on these podcasts too,

:

00:57:33,172 --> 00:57:35,815

so maybe they'll see me across,

you know, some other ones or, or

:

00:57:35,815 --> 00:57:36,965

on this one again at some point.

:

00:57:37,430 --> 00:57:37,980

Mike Philbrick: Sounds good.

:

00:57:38,046 --> 00:57:38,506

Adam Butler: Awesome.

:

00:57:38,756 --> 00:57:39,176

All right.

:

00:57:39,176 --> 00:57:42,463

Well, thanks so much for sharing

and for the, for the great chat.

:

00:57:42,563 --> 00:57:44,763

And, maybe we'll catch up

with you in a year or, so.

:

00:57:44,763 --> 00:57:46,633

See what you've, what you've touched on.

:

00:57:47,342 --> 00:57:47,922

Jack Shannon: Yeah, I,

:

00:57:47,933 --> 00:57:48,323

Mike Philbrick: cooking?

:

00:57:48,812 --> 00:57:49,332

Jack Shannon: that's right.

:

00:57:49,332 --> 00:57:50,002

I appreciate it.

:

00:57:50,032 --> 00:57:51,832

Uh, again, thoughtful discussion.

:

00:57:51,832 --> 00:57:53,165

Um, I enjoyed it as well.

:

00:57:53,330 --> 00:57:53,810

Adam Butler: Perfect.

:

00:57:53,980 --> 00:57:54,330

All right.

:

00:57:54,340 --> 00:57:54,940

That's a wrap.

Next Episode All Episodes Previous Episode

Listen for free

Show artwork for Resolve Riffs Investment Podcast

About the Podcast

Resolve Riffs Investment Podcast
Welcome to ReSolve Riffs Investment Podcast, hosted by the team at ReSolve Global*, where evidence inspires confidence.
These podcasts will dig deep to uncover investment truths and life hacks you won’t find in the mainstream media, covering topics that appeal to left-brained robots, right-brained poets and everyone in between. In this show we interview deep thinkers in the world of quantitative finance such as Larry Swedroe, Meb Faber and many more, all with the goal of helping you reach excellence. Welcome to the journey.

*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.