- Well, now with ETFsand all of these other investment vehiclesthat we've unbundled index and factors,and the true alpha seeking componentsabove or in excess of index and factors,we can actually create our own playlist for our portfolios.(upbeat techno music)- Andrew, thank you so much for joining us today.It's great to have you here.- Well, thank you for having me.- Now, Andrew, we're here to talkprimarily around factor investing.But has it always been that factor investinghas been a very lucrative way of investinggoing back decades?- Well, this is what I think is the interesting thingis that they've always been with us.I think the great investorshave always wanted to look for bargains.They've wanted to identify and participate in trends.We call those value low momentum.We want high quality companies.We would prefer companies that are smallerand more nimble or low sized.And then, finally we wanna gravitate to safetywhich we can do in minimum volatility strategies.So, all of those things I think are new,but what the difference isis investors can allocate to them directly todayin a way that wasn't possible a few decades ago.When I was growing up,I remember these actual cassette tapes.- [Jamie] Me too. (chuckles)- And you know, we had these records and LPs.And you had to buy the entire LP, right?You might only listen to one or two tracks,but you had to get the whole thing.And what's really happened todayis that you can watch anything whenever you want toat whatever time.And you can watch videos, you can listen to music,you can engage how you want to.Before, we had to package all of these marketor index returns together with factors,and together with the pure alpha components.You had to buy the entire album.And what's happened today, I think,is that you don't need to buy the entire album.You can create the playlist that you want.Right for you.And if you're feeling a little downand you want a little song to cheer you up,or you want to celebrate something,you want a romantic mood.Well, now with ETFs and all these other investment vehiclesthat we've unbundled index and factorsand the true alpha seeking componentsabove or in excess of index and factors,we can actually create our own playlist for our portfolios.- Okay.So, we are the one making the album now.We don't have to buy the onethat somebody else made for us.- And I think it's really democratized accessto these sources of returns,these broad and persistent driversof value, momentum, quality,minimum volatility, and small size.And then, we can also better identifythe true alpha opportunitiesin excess of these broad and persistent factor returns.- So, walk us through the specific factorsand what exactly, or how exactly do you define them.- Intuitively, they have much more in commonacross industry than differences.But there are some implementation choicesthat each provider will have to make.But value at its heart is looking at low price stocks.- Price to book specificallyor just whatever price to earnings?- Yeah exactly.So, we can observe pricesbut you'd have to proxy fundamental value.So, sometimes you could take that as book value,but we could also take it as the amount of earningsthat a company would generate.Perhaps, I actually would like something more solidand actually look at cash flows themselves,particularly cash flow from operations.So, these are all metrics that originally date backto a book written in 1934 by two accounting professors,Graham and Dodd.They were actually professors of my institutionthat I taught at for many years, Columbia University.So, these have decades worth almost,you know, 100 years of history.But we can also take more proprietary definitionsif you're thinking about fundamental value.A lot of value in company today,it's not reflected on balance sheets or earnings statements.So, we might look at some intangible measures.We like in our proprietary formulations, patents.Patents are valuable.You can buy them, you can sell them, you can license them.But they don't usually appear on balance sheets.They're the result of a lot of culminationof research and development.And so, you can look at these unstructuredor alternative data sets as well.They range the gamut.- Andrew, you mentioned indices just nowand the fact that there's a sort of implicitactive decision made with indicesin terms of market cap weighting, liquidity and things.How efficient are indices at representingthe business economy that they do?And another part to that question is,to what extent is an indices just naturally a momentum play?I mean, right now we're in 2023,we're seeing these companies get so,some of these companies get so bigthat they make up such a big part of these indices.That, you know, the bigger they get,the more effect they have on the index itself,and it becomes a sort of self-fulfilling prophecy.So, if you could talk a little bit about those two things.- Yeah, so the first one which was basicallylooking at what's actually in the marketcompared to what's in the real economy.And there are some differences.But the bulk of market activity in the economy in the USand certainly absolutely in the world.Most of it is actually private rather than public.- Yeah. - And so,it's not surprising that the profileof the publicly traded securities,they actually look differentfrom the bulk of the mainstream economy.- [Jamie] Yeah, that's a good point.- And so there are sector biases.There's a lot more tech that we see in listed companiesthan we see in the real economy.And you actually might think about of an investment strategythat looks at the differences between those two.What's actually traded in the marketversus a proper reflectionof the underlying economic activity.- Yeah.- And some researchers have actually done that.- Yeah, I'd never thought about it before.But where I'm from in the UK, I mean,our entire health service is effectively nationalized,unlike the US where so much of it is, is not.So, yeah, I mean I'd never thought of it before,but it makes so much sense.- And I think you can go a little bit furtherthan that as well.So, it's not only the industriesor the sectors these companies have,but internationally there will be differences as well.I think companies, they tend to go public much earlierin the United States.Now, we actually have a lot more listings of IPOsespecially in China, and some of the other emerging markets.But you need to be a pretty established company, right?To actually be a publicly traded company.Even by definition, to actually being able to liston some of those exchanges.So, that also means that I thinka lot of private markets and public markets,you certainly can have public market equivalentsof these private industries, but they're gonna looka little different than a pure vanillamarket cap based index of public companies.- So, I wanted to ask about market environment.When it comes to factor investing,is the idea that you have allocationto each one of the factors,and you should be pulling those levers as you see fit?Or is it that you are sort of more recommendingthat you should follow, use factor investingto invest in one theme?- So, I think you're better off investing in a balancedportfolio- - Right. Okay.- Over all factors.And have that really as the core part of your portfolio.I think over the long run, we do want value momentum,high quality companies.Those should form the basis of a core portfolio holding.But around that, one might think about tacticallyor dynamically shifting those factor exposures.And here I think single factor types of strategiesare quite useful.So generally, if we're in a downturn,or late economic environment or a recession,then you prefer the more defensive factors,particularly quality minimum volatility.So, they give you this payoff that tends to perform wellduring these relatively poor economic conditions.In the very early part of the economic cycle,pro-cyclical factors like small stocks and value strategies,those tend to do better.If we're in late cycle, then the trendshave been established in the economy.And so, momentum strategies tend to fare well.So, if you're looking at around your core,then potentially these factor rotationor factor tilting strategies, they may be important too.- What do you think is the biggest driverof the stock market over the next 6 to 12 months?I see people talk about the fact that you just needto look at the size of the Fed's balance sheetand basically as it expandsthat will just take asset prices with it.Others say, well if the Fed keeps tighteningtowards the end of the year,then that's gonna bring markets down.What are the things that people need to be focused onwhen deciding where to, how to allocate them their money?- Well, I think over, and not only over the next year,but I think over the next 5 to 10 years,this is now the era of the return.It's like the "Empire Strikes Back."- [Jamie] Yeah.- It's the return of macro risk.- [Jamie] Right.- And factors, these are long-term rewarded sources of,or drivers of return.And macro risk is, well,you get compensated for bearing that risk.Some examples.So, inflation is now back.You know, the great moderation is over.Okay, inflation, we might have reached peak inflation,but I think we still have some ways to gobefore we go back to-- It's not going to- - 2% or below.- It's not going to low single digit.We're gonna hang around- I think so.And that's a change.It really is a change from the periodfrom the 1980s to 2020.I also think that there are three thingsthat have also changed today compared to previous decadesthat will lead to a higher inflation environment.We see extreme weather, right?All of the build back for destructive effectsof extreme weather.- That's interesting. - All of that is inflationary.- Yeah. - Right.I don't think we're gonna go to a de-globalized world,but I think the gains for further globalizationprobably muted or very close to zero.And so, building robustness into supply chains,the reshoring elements that are now happening,those are inflationary tendencies as well.And then finally, there is some debate on this,but researchers like Charles Goodhartwould say that aging populations,those tend to be inflationary.In his summary, basically you would have larger proportionsof retired people.Retired people, they consume but they don't produce.- Right. - And so,therefore those tend to be the higher proportionsof this inflationary effect.So inflation, I think it's gonna be with us.Real rates, I think this was the big unsung event for 2022.Yes, we had markets come down by 15 to 20%in equities and bonds,but one of the other big developmentswas that we saw the real interest rateschange from minus 1, minus 1 1/2to now plus 1 1/2-- Yeah. - You know, plus 2.Those were massive changes.- Yeah. - And so,we have positive real rates now.Discount rates are back.You know, associated with all of those.There's much more uncertainty.We're going away from quantitative easing, right?The Fed will shrink its balance sheets.There are very large government deficits now worldwide,but certainly we have the highest GDP to,our debt to GDP ratios since World War 2.- Yeah. - In the United States.Macro risk is back.- Right. - And all of that,I think sets the stage for a lot of these factoror style factor risk premiums.- Final question, Andrew.I just feel looming over all of this is the topic of AIand how deflationary it could be.Do you have a particular viewon the impact that AI could have?'Cause typically innovative tech is quite disinflationary.Where do you sit on that?- Well, I think it's not so much,at least this is my opinionfor being an effect for deflation.But I think we will see large productivity gainsin fact. - Okay.- We'll all be better off.There will be the flip side of that,there'll be some unfortunate increases in inequalityand we do need to address those.But I wanna say that factor investinghas always been at the forefront of incorporatingthe latest data and the latest quantitative techniques.So we started off, I mentioned in 1934with Graham and Dodd, right?No one actually looked systematically at these companies.Even for something as simple as a book to market ratio.They were the first ones.Factor investing were at the forefrontof using financial reports.All these balance sheets and earnings statementsin the 1970s and 1980s.That was the big data of its time, right?And then, we looked at all the development of indexingwith all the data that's used there in the 1990sthat kind of really became widespread.I think AI or machine learning,this is just the latest incarnation.But we've been using these techniques for quite some timein our proprietary definitions of factors.And I'll just give one example, corporate culture.So, this was one of the best performing signalsfor our proprietary factors.And we treat it as a form of quality.It's a non-financial measure of quality.It was one of the best performersduring our COVID years of 2020 and 2021.And we use an algorithm called embedding, word embedding,to develop a dictionary over a training sampleof words related to corporate culture.- Wow.- And then with that dictionary,we can then analyze a conference call information.And after the machine has done that,we've now got a quantitative score for a conceptthat tends to be much more qualitative.- Amazing. - In nature.You know, we're pushing now with large language modelslike ChatGPT for versions of sentiment.But we've always wanted to get the best dataand the best quantitative techniquesto bring all of these sources of returnsto people's portfolios.- Pioneering stuff, Andrew.Listen, Andrew, this has been suchan insightful and interesting conversation.I wanna say thanks for your time.- Thank you.(soft piano music)
