January 7, 2025 • 47 mins
The low volatility, momentum and quality factors are all up this year, with low volatility and momentum performing the best. In this episode of Inside Active, host David Cohne, Bloomberg Intelligence mutual fund and active management analyst, along with co-host and BI US quantitative strategist Christopher Cain, spoke with Andrew Slimmon, a managing director at Morgan Stanley Investment Management. They discussed factor exposures and why the investment process starts with a quantitative approach to determine what exposures each stock gives them. They also examined the importance of active share and tracking error, and why Slimmon is agnostic toward regional allocation and styles. He’s the lead senior portfolio manager on all long equity strategies for Applied Equity Advisors, including the Morgan Stanley Institutional Global Concentrated Portfolio (MLNIX).
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Speaker 1 (00:13):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
the processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active research at Bloomger Intelligence.
Today my co host is Christopher kine Us, quantitative strategist
at Bloomberg Intelligence. Chris, thank you for joining me today.
Speaker 2 (00:36):
Thank you for having me, David.
Speaker 1 (00:38):
So, you did a recent note about the traditional equity factors.
How have they performed so far this year? You know
which ones are performing the best?
Speaker 2 (00:46):
Sure, it's been certainly a strong gear for equity factors
so far. You know, we have our four main equity
factor families I would call them, which is low volatility, value, momentum,
and quality. Three of the four are this year. They're
all up double digits actually on a long short basis.
The only laggard is value, which is only down moderately.
(01:08):
We have our low volatility factor long short as actually
the best on the year. Now, one little wrinkle with
that is that you know we have a beta neutralized
long between the long and short legs. So what that
really means is a little bit more, you know, a
little bit more money in the low ball and a
little bit less money in the high ball. When you
do the long short factor that's the best performing on
(01:28):
the year momentum and quality. I've also performed very well.
Like I said, value is down. But the one thing
I'll say about value is when you do long short
on equal weight basis, it's just down moderately. It's just
that market cap weighted long short value is really getting harmed.
And that's because of the FASTAUP performance of the largest
most expensive stocks on the year. Interesting.
Speaker 1 (01:49):
So I think it'd be a great time to introduce
our guest, Andrew Slimon, managing director at Morgan Stanley Investment Manager,
where he's the lead senior portfolio manager on all long
equity strategies for applied equity Advisors. So, Andrew, welcome to
the podcast.
Speaker 3 (02:05):
Hey, thanks for having me on. Very exciting.
Speaker 1 (02:08):
So, you know, before we dig in, you know you're
no stranger to factor models. You know, I'd like to
kind of get your thoughts on what Chris just said.
And you know, are you seeing you know, higher returns
for momentum and quality? Is that kind of helping you
identify market drivers.
Speaker 3 (02:23):
Well, I think, you know, I would begin by saying
this year hasn't really been that different, to the extent
that if you look very very long term, what factors
work over time? The best performing factors are momentum and profitability,
which are is a form of quality. So you know,
I don't think this is very different. I do think,
(02:47):
you know a lot of people predicted that Value would
have a better year. It's done, as Chris said, it's
done okay, but it hasn't been spectacular. But overall, I
look at you know, what works long term, quality and
sticking with winners. Usually there's some fundamental backdrop behind it,
and this year hasn't been really different.
Speaker 1 (03:07):
No, it's great, So I'd like to stick I guess
step take the step back. You know, I think we'd
really love to hear how you got your start in
the investment business.
Speaker 3 (03:17):
Sure, I mean it's a great question because in many
ways it's a great way to frame the global concentrated
product that we run. And my experience in the business
really led up to really starting this strategy. So if
I could just wind the clock back for you a
little bit, I started my caravan in a very long time.
(03:39):
I think One of the things I love about this
business is, you know, I played college sports and competed
as a junior, and I love the investment business because
there's you know, there's a you know, there's score at
the end of the day, and you can't make up
you know, there's no room for commentary on the scoreboard.
And I think that's true of sports also. But I started,
you know, my career at a at a private bank
(04:02):
in New York out of college that had a you know,
an investment management arm and I never you know, they
had about thirty research analysts that cover all these different industries,
and you know, I was right out of college and
I was in the research department, and they all seemed
very very bright. And they had an investment committee that
met once a week and they would debate the investments
(04:26):
and then they put the investments into the fund based
on you know, what the research analysts would recommend. And
they all seem very very bright. Except I noticed after
being there a couple of years that the performance was, yeah,
it wasn't it wasn't terrible, but it was never really
really that good. And our outperformance and I think, now,
(04:49):
you know, what we've learned since the eighties. Is well,
when you have an investment committee that meets once a week. Uh,
you know, the market is more you know, kind of
reflexive than that. Uh, management by committee hasn't done as
well as managed by kind of uh lead or or
(05:10):
closely Philip Kim and I run the strategies. I think
that's That's another thing. And then most importantly, we've learned
that when you own you know, one hundred plus securities
in your benchmarks to the S and P, it's really
hard to perform over time. So that was the first
experiences that led me to believe huh, okay, uh, when
I start this, you know, I started the group. Those
(05:31):
experiences didn't work, you know very well. Maybe I won't,
I won't mimic that. Then I went to the Universe
Chicago Business School because I wanted to you know, kind
of hardcore finance experience, and I took Gene Foma's course
and Ken French's course, and I learned that, you know,
kind of there's a quantitative side to investing, and that
buying cheap stocks outformed buy expensive stocks. Uh. And uh,
(05:56):
you know, things like momentum actually work. And that had
nothing to do with fundamental research it had to do
for the quantitative side. And I think since that time
in business school and even morning Star has come out
and proven studies that you know, kind of two thirds
of it in manager's return comes from its factor exposure.
(06:18):
You know, Chris is loving what I'm saying now, But
the reality is is that think about the year twenty
twenty one. Growth in twenty twenty twenty one got so
expensive that going into twenty twenty two, it didn't really
matter what growth manager you chose. It really didn't matter
what growth stocked your own. You went down a lot.
(06:41):
So it really the decision was not which growth stock owner,
which growth manager invested in, is should I own growth stocks?
And so that led me to HM, before we get
to the fundamental research of analyzing a stock, maybe we
should understand what factor exposure we're getting when we buy
(07:05):
a sock. And look at the last month and a half,
did it really matter what financials you own? They've all
done great now, maybe some have done better than the other,
but they've done a hacker a lot better than they've
done recently. So it was a factor shift. And so
I think that's the second experience, and then third coming
out of business school, I wanted to stay in Chicago.
(07:27):
My wife got a very good job in Chicago, and
I wanted to really be start my career on as
a research you know, going back to the buyside. But
I couldn't really get a job. That was in nineteen
ninety one. We're in the depths of a bear market,
and I started my career at Morgan Stanley in their
prior wealth management office area. At the time, we didn't
(07:52):
have a you know, a broad distribution of wealth management
financial advisors, so we had this small group that kind
of cover family offices, smaller institutions and show them, you know,
investment ideas. And what I observed was a couple things
from that experience. Number one is clients generally don't care
(08:16):
whether they own growth, their value or large cap mid cap.
They want to make money and it doesn't really matter
where it comes. And the problem with that is that
their patients duration of investing in a style of investing
(08:37):
is not consistent with the duration which a style can
go out of favor. So inevitably, you know, after about
two years of your value manager underperforming the S and P,
the client starts to go with me. You know, maybe
we should get rid of them, and so eventually say
oh yeah, yeah, wah, we should definitely get rid of
(08:58):
that manager. And it always has happens right before that
style comes back into favor. So the point of this
was is that Okay, the style box driven managers, they
get all their money after they've done well because the
tear sheet, your tear sheet only tells you what they've
(09:19):
done in the past. It doesn't tell you what will
happen in the future. So the combination of the tear
sheet plus the emotional biases to buy things that are
working that are priced up in the equity market, which
is crazy. I don't know of any other market in
(09:41):
the world where when things go down prices are marked down,
people more willing to sell, and when we're marked up,
they're more willing to buy, except for this market. But
that's the reality. So when things have done poorly, clients
didn't want to buy, they wanted to sell it, and
(10:02):
so it led me to believe let's see, let's put
all those experiences together. We know we need a small team.
We know we need a portfolio that has a limited
number of socks. We know we need to focus on
a quantitative approach first, but quant doesn't explain everything, just
(10:24):
a portion. And thirdly, we can't be stylebox driven because
at the end of the day, clients really they're not
clientbox driven. Hey I did great, I lost you less
money than the growth index. Yeah, but you want to
perform the SMP, so let's move to something that's performed
the S and P. So by the very nature of
all these style boxing we're kind of setting people up
(10:47):
to fail. And so that was really, you know, kind
of the experiences led me to believe. In two thousand
and three, I raised my hands said I don't want
to cover these clients anymore. I want to start this
group that will be at the at the you know,
at the at the base of what we do is
factor analysis, quantitative analysis. But it won't be just that.
(11:08):
We're going to have a fundamental group that focuses on
fundamental research so that we once we get the factors right,
we can overlay it with what's the best you know,
value socks oone, what's the best financialist to own? And that,
you know, that's what we started. Uh and I started
oh four Philip Kim, who had a much deeper quantitative
(11:29):
background than I did join me late oh four, and
you know we've been off to the running ever since.
Speaker 1 (11:35):
So I think that's a great segue into you know,
the strategy we're going to talk about today, the Global
Concentrated portfolio fund ticker mL and i X. Can you
go into just with the processes of how this all
works when you're making selections for the fund.
Speaker 3 (11:53):
Sarah, So, first and foremost, we try to limit the
number of sacks of twenty sacks. Occasionally it goes a
little over if we're kind of transitioning into out of
one sock into But the purpose of twenty stocks is
it is it's a global strategy. It's benchmark to the
(12:14):
MSCI world, which I don't know has fifteen hundred stocks
in it. So if we own twenty stocks and there
are fifteen hundred in the index, well that means our
active share is really high. And remember what I said before,
What studies have shown is that managers that have higher
active share ten not all. It was ten to outperform
(12:38):
managers that are benchmark huggers. Because at the end of
the day, if you have high active share, you differ
from the index, and therefore your people are going to
find out pretty quickly. You're either doing a good job
or you're not. You're not going to gradually underperform. So
we by having twenty stocks, it keeps our active very high. Now,
(13:00):
to be clear, you could have high active share because
you own lots and lots of socks, none of which
are in the index. But there's another measure that's very
very important to us, and it's called your tracking air,
and your tracking air measures how volatile your fund is
relative to the benchmark. Now it's not your beta because
(13:22):
that just measure is relative to the index. But so
in other words, if I had lots and lots of
stocks that weren't in the index, so I owned a
hundred socks none of which were in the index, well
then I wouldn't move with the index much, and so
my tracking air would be very very high. But if
(13:42):
I could own twenty stocks, all of which are in
the index, but they're not all you know, kind of
focused on one theme or one bet, then I could
keep my tracking air down and all Again, the academic
studies show high active share and only moderate tracking air,
(14:03):
you know, leads to success. So that's where we start.
We start with. Every time we look at a stock.
We say, well, if we add a stock, you know,
we got to take one away because we want to
keep it at twenty. But if we add that stock,
will that increase our tracking air which we don't want
(14:23):
to do, or lowers our tracking. So broadly speaking, if
we liked, say value, and we own only financials, well,
adding another financial would increase our value exposure, but it
would also increase our tracking. So we think in large
a lot about how to add or change stocks that
(14:47):
give us the factor exposures that we want but don't
necessarily they're not correlated to other stocks in the portfolio.
And that's how we you know, we start the the
process and then we begin with okay, well, what factors
are working? We want to stay in the game. We
(15:08):
don't want to be you know, all in value where
I'm sitting there and saying value work long term, and
you're you know, you're mister, mister or missus client, you're saying, yeah,
but value hasn't worked for three years. Right. We're looking
at what factors are working from a price performance basis
(15:29):
and then making an assessment and it continue to work
in the future. And that assessments based on is the
factor expensive or cheap. So we're looking at valuation and
momentum of the factor and assessing can it work in
the future. And if you look around the world, I've
(15:50):
heard a lot of people tell say, you got to
buy you know, especially in Europe, value is really cheap. Well,
it's really cheap, but it had to work for a
very very long time, so it hasn't pay just because
value is very very cheap, it hasn't worked. And so
again we're thinking about how to bias the portfolio from
(16:11):
a quantitative standpoint first in each part of the world US, Europe, Japan, Asia,
extrapan from a factor standpoint, and then and only then
picking stocks that give us that appropriate factor exposure that
we like for a fundamental, pure fundamental reasoning. So they
(16:33):
call us a quantinmental team quantinental philosophy. I just know
that pure quants try to diversify away the fundamental side,
and my roots started with a fundament. I know there's
value added good stock picking, but I'm also well aware
that at the end of the day, you got to
(16:55):
get your factors right first, and that's the most important.
That's the core of what we do.
Speaker 2 (17:01):
Man Andrew, I love so many things you said, I
don't know where to start, just two quick comments. You know,
I joked that the momentum windows one year, but investors
windows like three to five for hiring and firing managers,
which is more of a mean reversion window. So it
kind of goes to what you're saying. When they fire you,
you start out performing, and then you know, I think
(17:22):
a concentrated factor portfolio makes so much sense because you know,
what people don't really understand is, after so many assets,
so many alphas, however you want to say it, you
don't get very much diversification benefit.
Speaker 3 (17:32):
I mean, it's.
Speaker 2 (17:33):
Extremely marginal after let's say twenty stocks, extremely marginal. So
the difference in diversification between twenty and one hundred is
not nearly as dramatic as it kind of seems. So
I just love all of that. So my question is
maybe with value, you know, the much maligned value factor.
You know, without giving away your secret sauce, you mentioned
(17:53):
that you studied under the legend Professor Farma at Chicago.
When I think of Professor Fama, I think book to
market factor, you know, as a value factor. You know,
what do you how do you think about constructing value?
Is it a composite of a lot of different metrics.
You don't have to like get into them. But or
how do you broadly think about a constructing a value factor?
Speaker 3 (18:16):
Yeah, so so Chris, this is this is a very
interesting question because you know, don't forget I had worked
on Wall Street before gone to univer Chicago, and then
I had studied under Fama, and he's, you know, in
the classroom saying, look, price to book works great long term,
and then you start to really decompose deep what I
(18:37):
call price to book is a deep value metric, and
you realize it rarely works, but when it works, it
works huge. Right, So twenty twenty, in the midst of COVID,
if you had just bought stocks, had just gotten cream
because you know they were casinos or airlines or cruise ship.
(18:58):
If you just bought those, you did great. But you
know that's true of nine also two thousand and nine.
But most of the time price book doesn't work. So
on a calendar your basis. So it's great in academia
to talk about deep value as a factor, but in
(19:21):
the reality of what we're trying to apply, Oh, we
can't just look at deep value because most of the time,
it doesn't work, and I can't keep saying, hey, don't worry, well,
there will be a time when it'll work again. Clients
don't They're gone, They are gone. How many clients we're
buying into deep value strategies in you know, you know,
in twenty twenty into covid u, They how about it?
(19:45):
In eight? No way, but that's when they work. So
it's it doesn't it does, It's not practical to the
emotional biases of this business. So you move to earnings yield,
which doesn't do long term as well, but it has
a more consistent time frame. So we look at price
(20:07):
to book, but I think over time, we you know,
we look at things like earnings yel more closely. But
we so we have a deep value factor, we have
a stable value. We've looked at a gazillion different kind
of metrics quality, growth, value, but we've learned to try
to keep it simple and don't make it too complicated
(20:28):
because you're never going to kind of find only stocks
that fall into into one bucket. But I would say,
you know, practicality, it's it's very, very hard to run
a deep value book when clients can movement any in
and out of your fund or strategy on a you know,
on a daily basis. If I if I ran a
(20:50):
fund that was locked up for ten years, I just
go buy a lot of really really cheap stocks.
Speaker 2 (20:54):
But that's that's not realistic. Sure sure, so interesting. Yeah,
I have to ask you about combining multiple factors. I mean,
this is something that I get to question a lot.
So I guess kind of a two part question. Number one,
Like you know, you said your your global fund, your
your benchmark to the MSCI. So when you look at
(21:15):
these factors, I mean, do you normalize them for like
the country they're in or the geographic region they're in,
like like similar to like what we call sector neutralization
in the United States. And then the bigger question is
is around the kind of much maligned topic of factor timing.
You know, you mentioned factor timing. I think you did,
(21:37):
you know, I think you were hinting at that and
using momentum to time factors. You know, I'm informed by
the paper from aq R factor Momentum Everywhere, which basically
shows that factors themselves have momentum. So you know, I
would love to know is you know, is that your
main input in how much tactically, are we switching between
these factors or are you uh, you know, as Cliff says,
(21:58):
sitting a little.
Speaker 3 (22:00):
So first of all, in terms of geographic we have
a factor timing model for factor models for US Europe,
so we look at that one group at Japan and
Asia ex Japan, which captures most of MSCI world, and
(22:22):
different factor models send different clues about how much we
want to allocate to a country. For instance, when a
factor model is saying, hey, you should buy high dividend
yielding quality stocks, that's usually a sign of a risk
(22:44):
off market versus a mark versus word that says hey
buy growth or buy value, that's usually a risk on market.
So we will allocate and buyas the portfolio from a
regional standpoint where we see the factor models are setting
(23:05):
the strongest, strongest system signal. Now stay within the the
guidelines of you know, kind of requirements. We never can
go more than seventy percent in the US or seventy
percent outside of the US, so we will all there
are certain guidelines, but broadly speaking, it has paid to
(23:28):
have a higher allocation to the US within a global strategy,
and that's one of the reason why we started global
strategies was simply kind of my kind of picture advertisement,
which is, hey, international manager can only buy non US
A global manager can buy if it happens to be
the best the best era. But look, I'm you know,
(23:51):
like I like to say, I'm agnostic towards regional allocation.
I'm agnostic towards styles. I'm not here to convince you
to buy any sales. I just want to stay in
the game in terms of factor timing. Very interesting, Chris.
So when I started these strategies, especially on the institution side,
So I started going on and I you know, I'd
(24:11):
be taking around the world these very large institutions and
I'd say, well, you know, we're starting these you know
these we run these factor models and there's a factor
component to them. And I would get a lot of
pushback because at the time, it was kind of ten
years ago, people just started about factor modeling, and they
(24:35):
a lot of times I say, oh, well, we just
hired you know, ten PhDs that are going to build
these factor models, and you know, I thought, well, I've
been doing this a long time, and would you ever
hire someone, you know, right out of business school who's
going to run a a long you know, strategy that's
fundamentally based. But on the quantitative side, the belief was
(24:58):
that you could just hire a bunch of math whizzes
and you'd be really, really successful. So I remember walking
out of these meetings going, this is crazy. You know,
I have been watching factors for a very very over
twenty years. I've been watching factors. My knowledge is no
different than the knowledge you get from following company on
a fundamental side. And so I think what happened is
(25:20):
a lot of a lot of these big institutions. They
really fail at factor timing because you know, there is
you know, as we like to say it frames our viewpoint.
We are not a black box. And I know certain
things about what happens. For instance, I know that momentum
tends to fizzle out in the second half of December,
(25:43):
right because people are done tax loss harvesting and they
they they poured into the winners, and you know, momentum
kind of reverses in the late December. So you know,
that's just that's this knowledge of So we do run
factor timing models. I can tell you that, yes, we're
talking about the global concentratet, but we run a strategy
(26:06):
that just looks at our factor timing model, and it's
an enhanced index, and it's been running for a long time.
It's done very very well with a much lower tracking
error that's attracted kind of enhanced index product. So our
factor model models have added value from it, and therefore
timing has worked, but it hasn't done as well as
(26:30):
our more concentrated strategy like global contract simply because there
is value to fundamental research.
Speaker 2 (26:37):
Absolutely, you know, I totally agree with you. I mean,
I think there's more craftsmanship in art in this than
some people give credit for it, Like it's not just
crunch to numbers. So I completely you know, I love
what you said that.
Speaker 3 (26:50):
So can I just add one thing about that? At least, Chris,
you'll be interested. So what Philo Kim, who is the
co portfolio was on. He would tell say to right now, look,
so many quants have given up on factor timing, they've
thrown the towel, they are factor neutral. That this is
a big opportunity for us because the space is not
(27:13):
crowded anymore.
Speaker 2 (27:15):
I totally agree with that. So one kind of broad
question I wanted to ask you, and this is a
question I get a lot. I kind of disagree with it, So,
you know, I would love to know your answers. Like
some people that aren't nearly as sophisticated as you come
to me and say, well, isn't quality as a factor,
which is typically some culmination of like you said, profitability
(27:36):
and then things like low leverage, stability of earnings, et cetera.
Isn't that like growth? Isn't it the same thing?
Speaker 3 (27:42):
Right?
Speaker 2 (27:42):
Why do we need a quality factor? Why don't we
just do a growth factor? Isn't this exactly the same thing?
I don't think it is. What's your response to that question?
Speaker 3 (27:54):
The answer is, it depends what's in your quality factor,
because are if it's just Roe and r O I C.
We know that, you know, with you know, exception of two,
the mag seven have the highest Roe horst ir C.
So if that's your quality framework, yeah, then it is.
(28:18):
But we look at things beyond just that, like earning stability.
I think that's a wonderful factor. So earning stability measures
you know that the earning stream of companies and looks
at how stable their earnings are. Now that does not
(28:39):
necessarily mean they're you know, gross stocks. They could be
very defensive consumer staples type stocks. One of the reasons
why I still believe we're in the early stages or
you know, kind of you know, kind of not real early,
but we're we're not the tail end of this bull
market is yes, consumer state, peoples and healthcare stocks have underperformed,
(29:04):
but there are a lot of stocks that are perceived
as very earning stable that are still very very expensive
because they the investors perceived downside risk. So earning stability
is not necessarily just you know, tech growth. Another one
would be dividend yield, right, high dividend yield, It can
(29:24):
be a quality metric well, that tends to work in
bear markets. So you know, certainly tech is not our
gross stocks are not necessarily high dividend yields. So I
think there's different ways to dissect the quality factor. We
look at in terms of profitability as one, so that
(29:46):
does capture those gross stocks, but we look at bond
proxies as one, so those are higher dividend yields, And
we look at earning stability, which is in my opinion,
the ultimate risk off factor. That's what works into bear markets.
Speaker 1 (30:04):
So you mentioned in terms of exposure, you talked about
you know more us you know, and that's really a
factor that's driven by factors. I also, you know, the
last time I looked at the portfolio, it looked like
you were a bit underweight tech and overweight financials compared
to your benchmark. Is that also a result of factors
or is that driven more by the fundamentals?
Speaker 3 (30:24):
Uh? Yeah, I mean so, yes, we're underweight tech, but
not necessarily in the US. Okay, so you know you've
got to remember that we're looking around the world and financials. Yes,
but you know this is you know, Chris is going
(30:45):
to love when I say this, but you have to
be very careful on financials because on the surface, you say, oh, okay,
so financials they're all value stocks, right, and so therefore
you have a huge financial bet. But wait a minute,
insurance stocks traded very high multiples. They do not move
(31:07):
with money center banks, right, They've done much better than
money center bents. They're actually a much more defensive group
than money center banks. So yes, on the surface, you'd say, well,
we're making a financial bet because we're making a value bet,
but be careful that because some of those insurance type
(31:29):
stocks they actually fall into the You know that our defensive,
defensive bucket. So I guess when I boil it all down,
where we are and you know, obviously having a big
financial weight has helped in the last month. But what
we're achieving, at least in the US, is an overweight
(31:51):
to growth, an overweight to value, and an underweight to defensive.
So yes, we own insurance company, which fall into defensive bucket,
but we're underweight staples, healthcare and things like that that
also fall in to that as well. And so I
think if I think about performance here today, it's come
(32:15):
not it's you know, yes, we a great performance here today,
but and what And that's come from what we're overweight,
but it's also come from the factors that we've been underweight,
which are the defensive factors. And it's behavioral. I go
back to all this works. Quantitative investing works because of
(32:37):
behavioral investment. There is we know that people sell value
into recessions because during recessions people go, oh my god,
every bank's going to fail, well, every industrial it's going
down the tube, And so they sell value sucks and
they run into defensive because they're worried about risk mitigation. Downside.
(32:58):
I don't want to lose as much, right, so defensive
strategies get very expensive in bear markets, and value and
growth tends to get cheap. And as you come out
and people realize, huh, not every bank's going to fail,
you know, not every gross stocks going down. The two
growth and value outperform. And as a bear market proceeds,
(33:23):
people say, I don't want downside protection, I don't want
dividend yield, I don't want earning stability. I want to
make money, and they jettison defensive strategies and they move
more into growth and value. And this is what we
are just on the cusp of because early in bear market,
(33:45):
you know, bull market, you know, bull markets are born
on pessim. Let's buy a lot of defensive stocks. It
grows on skepticism, which is last year in matures on optism.
It's the optimism phase where people go, I don't care
about don doowntime protection anymore. And this is you know,
I started my career at Morgan Stali in ninety one,
and this is exactly what I saw, you know, in
(34:08):
ninety seven ninety eight, and I see it happening again.
Early in the early nineties. People wanted downside protection, they
wanted dividend yields in the late nineties, they had no
interest in dividend. So I just it's a quantitative investing
works because of the consistency of human behavior and the
(34:32):
you know what I would call, you know, kind of
the the the consistent fear to greed behaviors that I
see in this business.
Speaker 1 (34:41):
So actually, you know, that kind of brings up another
question I had. You know, you mentioned, you know the
factor analysis is quantitative. Is when you're actually applying the
fundamental analysis, is there a quantitative component there as well?
Speaker 3 (34:57):
So if we take you.
Speaker 1 (34:57):
Know, dividend yield, which you just mentioned, you know, if
you looking at the dibdend yield factor and you know
you think it's the right time to go into stocks,
do you have a quantitative filter to you know, look
at the stocks themselves, you know, based on yield.
Speaker 3 (35:11):
Yeah. I like to say it's a good question. I
like to tell people all the time, Look, no one's
going to walk in our door, and you know, obviously
we have a lot of people that are trying to
convince us to buy certain stocks. No one's going to
come into our office and say, hey, I got a
great investment idea for you. And then proceed to tell
us a fundamental store. All our investments begin with what
(35:33):
are the exposures? From a quantitative standpoint, each and every
stock gives us. So when we look at every stock,
we know what exposures are they do they do they
move with earnings yield or PE low P? Do they
move with growth? Do they move with earning stability? Quality? What?
(35:54):
What are we getting if we buy the stock? So
even before our fundamental re search, guys and gals start,
they always start. They have to show us that because
we're making if we add a stock to the portfolio,
we're making a factor adjustment. So first and foremost we
(36:14):
start with that, and then we drill down into the stocks.
But even before we do that, we look at the Okay,
so we're thinking of adding a stock, let's say in
the value are well, okay, we start with it has
exposure to earning yield? Check the box. Okay, we like that. Well,
(36:36):
what's the correlation to the other stocks in the earnings
yield low pe bucket? Because we want to have companies
that will not increase What I remember why I said
in isually our tracking error. I want to have exposure
earnings yield, but I don't want to make a what
I call a big bet on something that's outside our
(37:00):
you know, quantitative models. So in other words, if I
just keep adding banks, I'm making a bank exposure, right,
So that then and only then do we call down
the list to Okay, now, let's let's look at the
following stocks. And so a great example, we added a
real estate company recently to the portfolio because we wanted
(37:22):
to increase our value exposure. And we have quite a
bit of financials as you mentioned, we have industrials, and
we didn't have a uh, you know, a real state
a stock that moves with the value exposure, at least
in the States.
Speaker 2 (37:38):
Interesting, you know, I would love to ask you about
position sizing generally, you know, without getting into into specifics.
I mean, how do you think about that? I mean,
all the major industries are market cap weighted. You know,
you could kind of naively do it equal weighted, which
gets you a lot of the way there, or you
could do some kind of optimization or I've seen a
(37:58):
lot of people do things like have their position size
be congruent with you know, how good do they think
the investment is, or what their estimation of the alpha
of this certain investment is. So, how do you think
about position sizing within your portfolio?
Speaker 3 (38:12):
Sure, well, so, first of all, I don't think about
it in terms of an absolute basis. I think about
it in terms of relative because at the end of
the day, you could go and buy the NSCI world
ETF right. And I to be clear, I'm an active manager.
I got nothing against passive investing. I really don't. I
think people should have passive exposure to these to these markets.
(38:36):
What I you know, I roundly against is managers that
have you know, they're broadly diversified, and then they're scratching ahead.
Why you know, why they haven't outperformed, why they're losing
au M and so I think I think passive strategies
are bring are doing what's right for the the industry,
(39:00):
which is forcing manages to be truly active twenty stock
people say, oh my god, that's really concerted. Yeah, it's
really concentrated. We try to control the risk by not
having all stocks correlated to a theme. But that's what
we're Brian and chieve and certainly the performance over time
has proven so. So I think in terms of relative exposure.
(39:21):
You know, if you go to our fact sheet it's
to shows I'm required to show our top ten. It
looks like you look at top ten. Oh it looks
like you got big positions in some tech names, but
actually on a relative basis, we have much bigger relative
position to value names. So that's you know, that's the
first place we saw start in terms of position side size.
(39:42):
You know, again, I've been in this business a long time.
I've got a lot of tattoos on my back figuratively
that of you know, kind of bad decisions. And I've
learned that. You know, we're making educated bets, but we
don't know everything, and so therefore I don't I want
to make sure if something ha happens, it's not going
to take them, you know, kind of the fun And
(40:04):
so how does that happen is I got to make
sure we don't let the relative weight and anyone stock
get too big. So when the relative weight gets to
kind of ten percent of the portfolio, I start to
switch a little. But the other way we look at
it is in terms of we look at each stock's
(40:27):
contribution to risk. And we know that if you know,
stocks that are very very big in the index, if
we bring those down, that will lower our overall risks
of our portfolio. So we it's not a you know,
there's not any one kind of magical line we do.
(40:50):
Tram Wind stocks have done extremely well, and we think
there's you know, there's a risk of underperformance on a
short term basis regardless of what our factor modeling says.
And certainly we've been forced to trim some big winners
this year, but it's really in terms of relative weights.
And again, when it gets over ten percent, I start
(41:13):
to get nervous that one stock's going to determine the
outcome of the portfolio.
Speaker 2 (41:17):
Gotcha.
Speaker 3 (41:18):
Yeah.
Speaker 2 (41:18):
My last question is really kind of going along with
that theme, I mean, just risk management as a theme.
I mean, it seems like most of the risk management
is based on position sizing, you know, making sure your
correlations are relatively not negative, but you're not adding just
the same risk to the portfolio over and over again.
Is that where most of the risk management comes from
from your from your side or is there any kind
(41:40):
of like I mean, I know you're tactical with the
factors and such, but is there any kind of like,
you know, tactical overlay. Maybe the market's going down and
we sell some futures or go to some cash or
something like that. Is there anything like that in the portfolio?
Speaker 3 (41:56):
Yeah, So let me start with the last question, which
is you know again. And I used to sit and
listen to people come and pitch their strategies and and
to me when I was first startup more insali and
I hated when people would say things like, well, I'm
a long acquity manager, but if I don't like the market,
I'll go to cash, Because at the end of the day,
(42:16):
I think that's a bunch of I mean, I just
don't think that's being honest. Like, are you a manager
that's in the business of competing on a relative basis
and an active manager or you a you know, a
long short you know, kind of neutral where your return
is your relative returns cash. You can't be both, right,
(42:37):
And so someone says I don't like you know, I'll
go to cash. What they're suggesting to you is I'm
going to give you a good relative performance on the upside.
I'm not going to lose your money on the downside.
I think that is that's just being that's just not honest.
I hope in all the data shows that our downside
capture is less than the market and our upside is
(42:58):
more you know, since we started the strategy, so it
has worked in terms of how we shift. Now how
we do that Again, what I told you before is
when I look at say in Europe, right, you know,
over the last a decade, it really it's it's screened
own safe stocks, own quality stocks, and that means focus
(43:23):
on the amount of beta risks you have, right, and
so we've been very cautious on stepping into deep value
or very low value stocks because they tend to have
higher valuation. So the factor model very much guide how
we think in terms of how you know, that's the
(43:45):
first you know kind of risk management, uh that we do.
And then the other thing that we watch is the
correlation of a stock to the factor. Okay, so what
there's something called residual volatility. I'm really getting quantity here,
but volatility. Residual volatility is kind of the unexplained volatility,
(44:10):
which is basically the uh, the volatility that comes from
at the company level. So a biotech company has a
lot of residual volatility because you know, they you know,
it's not it's not correlated to growth, it's correlated to
drug success. Stock goes up, drug failure stock goes down,
so that has high residual voltilay. I don't want high
(44:32):
residual volatility. I want stocks that are correlated to their factors,
because what I desperately don't want to have happened is
where I get the factor right, but something happens fundamentally
that I didn't know about, and then stock goes down
even though I'm you know, in my quantitative side, guys
are dancing say yeah, we got the we got the
factors right, oh oh yeah, but this company didn't move
(44:55):
in the fact So we watched the changes in the
correlation to the fact there's and that can set off
what we call a warning bell that oh my gosh,
there's a problem here, because you know, for instance, if
and our financials did very well, but we know that
value in financials did have done very well last month.
(45:15):
If we have a stock in financials that hasn't done well,
then we're all over fundamental guys going okay, there's a
problem there. There's a problem here, and we need it.
So that's that's a big part of the risk management.
And then the other the last part is and we
kid we have something called correlation Thursday, where we look
at the portfolio and address each relationship of the stocks
(45:37):
as the correlations come together, and that will cause turnover
if you know position as you mentioned position sizing, if
boil boy, you know, we've got a couple of AI
stocks and gone through the roof and they are moving
one for one. You know, that's going to cause us
from a risk management standpoint, to take down the exposures
(45:58):
as well.
Speaker 2 (46:00):
Yeah, it's great us as an industry. Just just one
quick comment, David, I just think US as an industry,
like you know. I that's one of my big things
is to measure the volatility of or portfolio from the
factors as well as from your videosyncratic or residual volatilities
as well, because you want to know where that's coming from.
I think a lot of people don't do that, and
it's a very important step in the process. And I'm
(46:21):
really glad that you mentioned that.
Speaker 1 (46:23):
Well, Andrew wanted to thank you for your time. I
definitely learned a lot.
Speaker 3 (46:26):
This is great, Well, thank you, it's great. It's it's
fun to be able look at in the weeds, and
I really appreciate David, especially Chris and understanding what we do.
It's a it's a complicate in some ways. It's complicated,
but what we like to tell people, look, we're just
we just want to stay in the game. We just
want to stay in the game and not convince you
(46:47):
to buy some style it's you know, out of favor
if it could last for you know, multiple multiple years. Now,
how we do that is is is a little bit
more complicated, so it's fun to actually talk about it.
Speaker 1 (46:59):
Thank you, Thank you, Chris, thank you again for serving
as my co host.
Speaker 2 (47:03):
Thank you.
Speaker 1 (47:05):
Until our next episode, this is David Cone with Inside Act.
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
the processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active research at Bloomger Intelligence.
Today my co host is Christopher kine Us, quantitative strategist
at Bloomberg Intelligence. Chris, thank you for joining me today.
Speaker 2 (00:36):
Thank you for having me, David.
Speaker 1 (00:38):
So, you did a recent note about the traditional equity factors.
How have they performed so far this year? You know
which ones are performing the best?
Speaker 2 (00:46):
Sure, it's been certainly a strong gear for equity factors
so far. You know, we have our four main equity
factor families I would call them, which is low volatility, value, momentum,
and quality. Three of the four are this year. They're
all up double digits actually on a long short basis.
The only laggard is value, which is only down moderately.
(01:08):
We have our low volatility factor long short as actually
the best on the year. Now, one little wrinkle with
that is that you know we have a beta neutralized
long between the long and short legs. So what that
really means is a little bit more, you know, a
little bit more money in the low ball and a
little bit less money in the high ball. When you
do the long short factor that's the best performing on
(01:28):
the year momentum and quality. I've also performed very well.
Like I said, value is down. But the one thing
I'll say about value is when you do long short
on equal weight basis, it's just down moderately. It's just
that market cap weighted long short value is really getting harmed.
And that's because of the FASTAUP performance of the largest
most expensive stocks on the year. Interesting.
Speaker 1 (01:49):
So I think it'd be a great time to introduce
our guest, Andrew Slimon, managing director at Morgan Stanley Investment Manager,
where he's the lead senior portfolio manager on all long
equity strategies for applied equity Advisors. So, Andrew, welcome to
the podcast.
Speaker 3 (02:05):
Hey, thanks for having me on. Very exciting.
Speaker 1 (02:08):
So, you know, before we dig in, you know you're
no stranger to factor models. You know, I'd like to
kind of get your thoughts on what Chris just said.
And you know, are you seeing you know, higher returns
for momentum and quality? Is that kind of helping you
identify market drivers.
Speaker 3 (02:23):
Well, I think, you know, I would begin by saying
this year hasn't really been that different, to the extent
that if you look very very long term, what factors
work over time? The best performing factors are momentum and profitability,
which are is a form of quality. So you know,
I don't think this is very different. I do think,
(02:47):
you know a lot of people predicted that Value would
have a better year. It's done, as Chris said, it's
done okay, but it hasn't been spectacular. But overall, I
look at you know, what works long term, quality and
sticking with winners. Usually there's some fundamental backdrop behind it,
and this year hasn't been really different.
Speaker 1 (03:07):
No, it's great, So I'd like to stick I guess
step take the step back. You know, I think we'd
really love to hear how you got your start in
the investment business.
Speaker 3 (03:17):
Sure, I mean it's a great question because in many
ways it's a great way to frame the global concentrated
product that we run. And my experience in the business
really led up to really starting this strategy. So if
I could just wind the clock back for you a
little bit, I started my caravan in a very long time.
(03:39):
I think One of the things I love about this
business is, you know, I played college sports and competed
as a junior, and I love the investment business because
there's you know, there's a you know, there's score at
the end of the day, and you can't make up
you know, there's no room for commentary on the scoreboard.
And I think that's true of sports also. But I started,
you know, my career at a at a private bank
(04:02):
in New York out of college that had a you know,
an investment management arm and I never you know, they
had about thirty research analysts that cover all these different industries,
and you know, I was right out of college and
I was in the research department, and they all seemed
very very bright. And they had an investment committee that
met once a week and they would debate the investments
(04:26):
and then they put the investments into the fund based
on you know, what the research analysts would recommend. And
they all seem very very bright. Except I noticed after
being there a couple of years that the performance was, yeah,
it wasn't it wasn't terrible, but it was never really
really that good. And our outperformance and I think, now,
(04:49):
you know, what we've learned since the eighties. Is well,
when you have an investment committee that meets once a week. Uh,
you know, the market is more you know, kind of
reflexive than that. Uh, management by committee hasn't done as
well as managed by kind of uh lead or or
(05:10):
closely Philip Kim and I run the strategies. I think
that's That's another thing. And then most importantly, we've learned
that when you own you know, one hundred plus securities
in your benchmarks to the S and P, it's really
hard to perform over time. So that was the first
experiences that led me to believe huh, okay, uh, when
I start this, you know, I started the group. Those
(05:31):
experiences didn't work, you know very well. Maybe I won't,
I won't mimic that. Then I went to the Universe
Chicago Business School because I wanted to you know, kind
of hardcore finance experience, and I took Gene Foma's course
and Ken French's course, and I learned that, you know,
kind of there's a quantitative side to investing, and that
buying cheap stocks outformed buy expensive stocks. Uh. And uh,
(05:56):
you know, things like momentum actually work. And that had
nothing to do with fundamental research it had to do
for the quantitative side. And I think since that time
in business school and even morning Star has come out
and proven studies that you know, kind of two thirds
of it in manager's return comes from its factor exposure.
(06:18):
You know, Chris is loving what I'm saying now, But
the reality is is that think about the year twenty
twenty one. Growth in twenty twenty twenty one got so
expensive that going into twenty twenty two, it didn't really
matter what growth manager you chose. It really didn't matter
what growth stocked your own. You went down a lot.
(06:41):
So it really the decision was not which growth stock owner,
which growth manager invested in, is should I own growth stocks?
And so that led me to HM, before we get
to the fundamental research of analyzing a stock, maybe we
should understand what factor exposure we're getting when we buy
(07:05):
a sock. And look at the last month and a half,
did it really matter what financials you own? They've all
done great now, maybe some have done better than the other,
but they've done a hacker a lot better than they've
done recently. So it was a factor shift. And so
I think that's the second experience, and then third coming
out of business school, I wanted to stay in Chicago.
(07:27):
My wife got a very good job in Chicago, and
I wanted to really be start my career on as
a research you know, going back to the buyside. But
I couldn't really get a job. That was in nineteen
ninety one. We're in the depths of a bear market,
and I started my career at Morgan Stanley in their
prior wealth management office area. At the time, we didn't
(07:52):
have a you know, a broad distribution of wealth management
financial advisors, so we had this small group that kind
of cover family offices, smaller institutions and show them, you know,
investment ideas. And what I observed was a couple things
from that experience. Number one is clients generally don't care
(08:16):
whether they own growth, their value or large cap mid cap.
They want to make money and it doesn't really matter
where it comes. And the problem with that is that
their patients duration of investing in a style of investing
(08:37):
is not consistent with the duration which a style can
go out of favor. So inevitably, you know, after about
two years of your value manager underperforming the S and P,
the client starts to go with me. You know, maybe
we should get rid of them, and so eventually say
oh yeah, yeah, wah, we should definitely get rid of
(08:58):
that manager. And it always has happens right before that
style comes back into favor. So the point of this
was is that Okay, the style box driven managers, they
get all their money after they've done well because the
tear sheet, your tear sheet only tells you what they've
(09:19):
done in the past. It doesn't tell you what will
happen in the future. So the combination of the tear
sheet plus the emotional biases to buy things that are
working that are priced up in the equity market, which
is crazy. I don't know of any other market in
(09:41):
the world where when things go down prices are marked down,
people more willing to sell, and when we're marked up,
they're more willing to buy, except for this market. But
that's the reality. So when things have done poorly, clients
didn't want to buy, they wanted to sell it, and
(10:02):
so it led me to believe let's see, let's put
all those experiences together. We know we need a small team.
We know we need a portfolio that has a limited
number of socks. We know we need to focus on
a quantitative approach first, but quant doesn't explain everything, just
(10:24):
a portion. And thirdly, we can't be stylebox driven because
at the end of the day, clients really they're not
clientbox driven. Hey I did great, I lost you less
money than the growth index. Yeah, but you want to
perform the SMP, so let's move to something that's performed
the S and P. So by the very nature of
all these style boxing we're kind of setting people up
(10:47):
to fail. And so that was really, you know, kind
of the experiences led me to believe. In two thousand
and three, I raised my hands said I don't want
to cover these clients anymore. I want to start this
group that will be at the at the you know,
at the at the base of what we do is
factor analysis, quantitative analysis. But it won't be just that.
(11:08):
We're going to have a fundamental group that focuses on
fundamental research so that we once we get the factors right,
we can overlay it with what's the best you know,
value socks oone, what's the best financialist to own? And that,
you know, that's what we started. Uh and I started
oh four Philip Kim, who had a much deeper quantitative
(11:29):
background than I did join me late oh four, and
you know we've been off to the running ever since.
Speaker 1 (11:35):
So I think that's a great segue into you know,
the strategy we're going to talk about today, the Global
Concentrated portfolio fund ticker mL and i X. Can you
go into just with the processes of how this all
works when you're making selections for the fund.
Speaker 3 (11:53):
Sarah, So, first and foremost, we try to limit the
number of sacks of twenty sacks. Occasionally it goes a
little over if we're kind of transitioning into out of
one sock into But the purpose of twenty stocks is
it is it's a global strategy. It's benchmark to the
(12:14):
MSCI world, which I don't know has fifteen hundred stocks
in it. So if we own twenty stocks and there
are fifteen hundred in the index, well that means our
active share is really high. And remember what I said before,
What studies have shown is that managers that have higher
active share ten not all. It was ten to outperform
(12:38):
managers that are benchmark huggers. Because at the end of
the day, if you have high active share, you differ
from the index, and therefore your people are going to
find out pretty quickly. You're either doing a good job
or you're not. You're not going to gradually underperform. So
we by having twenty stocks, it keeps our active very high. Now,
(13:00):
to be clear, you could have high active share because
you own lots and lots of socks, none of which
are in the index. But there's another measure that's very
very important to us, and it's called your tracking air,
and your tracking air measures how volatile your fund is
relative to the benchmark. Now it's not your beta because
(13:22):
that just measure is relative to the index. But so
in other words, if I had lots and lots of
stocks that weren't in the index, so I owned a
hundred socks none of which were in the index, well
then I wouldn't move with the index much, and so
my tracking air would be very very high. But if
(13:42):
I could own twenty stocks, all of which are in
the index, but they're not all you know, kind of
focused on one theme or one bet, then I could
keep my tracking air down and all Again, the academic
studies show high active share and only moderate tracking air,
(14:03):
you know, leads to success. So that's where we start.
We start with. Every time we look at a stock.
We say, well, if we add a stock, you know,
we got to take one away because we want to
keep it at twenty. But if we add that stock,
will that increase our tracking air which we don't want
(14:23):
to do, or lowers our tracking. So broadly speaking, if
we liked, say value, and we own only financials, well,
adding another financial would increase our value exposure, but it
would also increase our tracking. So we think in large
a lot about how to add or change stocks that
(14:47):
give us the factor exposures that we want but don't
necessarily they're not correlated to other stocks in the portfolio.
And that's how we you know, we start the the
process and then we begin with okay, well, what factors
are working? We want to stay in the game. We
(15:08):
don't want to be you know, all in value where
I'm sitting there and saying value work long term, and
you're you know, you're mister, mister or missus client, you're saying, yeah,
but value hasn't worked for three years. Right. We're looking
at what factors are working from a price performance basis
(15:29):
and then making an assessment and it continue to work
in the future. And that assessments based on is the
factor expensive or cheap. So we're looking at valuation and
momentum of the factor and assessing can it work in
the future. And if you look around the world, I've
(15:50):
heard a lot of people tell say, you got to
buy you know, especially in Europe, value is really cheap. Well,
it's really cheap, but it had to work for a
very very long time, so it hasn't pay just because
value is very very cheap, it hasn't worked. And so
again we're thinking about how to bias the portfolio from
(16:11):
a quantitative standpoint first in each part of the world US, Europe, Japan, Asia,
extrapan from a factor standpoint, and then and only then
picking stocks that give us that appropriate factor exposure that
we like for a fundamental, pure fundamental reasoning. So they
(16:33):
call us a quantinmental team quantinental philosophy. I just know
that pure quants try to diversify away the fundamental side,
and my roots started with a fundament. I know there's
value added good stock picking, but I'm also well aware
that at the end of the day, you got to
(16:55):
get your factors right first, and that's the most important.
That's the core of what we do.
Speaker 2 (17:01):
Man Andrew, I love so many things you said, I
don't know where to start, just two quick comments. You know,
I joked that the momentum windows one year, but investors
windows like three to five for hiring and firing managers,
which is more of a mean reversion window. So it
kind of goes to what you're saying. When they fire you,
you start out performing, and then you know, I think
(17:22):
a concentrated factor portfolio makes so much sense because you know,
what people don't really understand is, after so many assets,
so many alphas, however you want to say it, you
don't get very much diversification benefit.
Speaker 3 (17:32):
I mean, it's.
Speaker 2 (17:33):
Extremely marginal after let's say twenty stocks, extremely marginal. So
the difference in diversification between twenty and one hundred is
not nearly as dramatic as it kind of seems. So
I just love all of that. So my question is
maybe with value, you know, the much maligned value factor.
You know, without giving away your secret sauce, you mentioned
(17:53):
that you studied under the legend Professor Farma at Chicago.
When I think of Professor Fama, I think book to
market factor, you know, as a value factor. You know,
what do you how do you think about constructing value?
Is it a composite of a lot of different metrics.
You don't have to like get into them. But or
how do you broadly think about a constructing a value factor?
Speaker 3 (18:16):
Yeah, so so Chris, this is this is a very
interesting question because you know, don't forget I had worked
on Wall Street before gone to univer Chicago, and then
I had studied under Fama, and he's, you know, in
the classroom saying, look, price to book works great long term,
and then you start to really decompose deep what I
(18:37):
call price to book is a deep value metric, and
you realize it rarely works, but when it works, it
works huge. Right, So twenty twenty, in the midst of COVID,
if you had just bought stocks, had just gotten cream
because you know they were casinos or airlines or cruise ship.
(18:58):
If you just bought those, you did great. But you
know that's true of nine also two thousand and nine.
But most of the time price book doesn't work. So
on a calendar your basis. So it's great in academia
to talk about deep value as a factor, but in
(19:21):
the reality of what we're trying to apply, Oh, we
can't just look at deep value because most of the time,
it doesn't work, and I can't keep saying, hey, don't worry, well,
there will be a time when it'll work again. Clients
don't They're gone, They are gone. How many clients we're
buying into deep value strategies in you know, you know,
in twenty twenty into covid u, They how about it?
(19:45):
In eight? No way, but that's when they work. So
it's it doesn't it does, It's not practical to the
emotional biases of this business. So you move to earnings yield,
which doesn't do long term as well, but it has
a more consistent time frame. So we look at price
(20:07):
to book, but I think over time, we you know,
we look at things like earnings yel more closely. But
we so we have a deep value factor, we have
a stable value. We've looked at a gazillion different kind
of metrics quality, growth, value, but we've learned to try
to keep it simple and don't make it too complicated
(20:28):
because you're never going to kind of find only stocks
that fall into into one bucket. But I would say,
you know, practicality, it's it's very, very hard to run
a deep value book when clients can movement any in
and out of your fund or strategy on a you know,
on a daily basis. If I if I ran a
(20:50):
fund that was locked up for ten years, I just
go buy a lot of really really cheap stocks.
Speaker 2 (20:54):
But that's that's not realistic. Sure sure, so interesting. Yeah,
I have to ask you about combining multiple factors. I mean,
this is something that I get to question a lot.
So I guess kind of a two part question. Number one,
Like you know, you said your your global fund, your
your benchmark to the MSCI. So when you look at
(21:15):
these factors, I mean, do you normalize them for like
the country they're in or the geographic region they're in,
like like similar to like what we call sector neutralization
in the United States. And then the bigger question is
is around the kind of much maligned topic of factor timing.
You know, you mentioned factor timing. I think you did,
(21:37):
you know, I think you were hinting at that and
using momentum to time factors. You know, I'm informed by
the paper from aq R factor Momentum Everywhere, which basically
shows that factors themselves have momentum. So you know, I
would love to know is you know, is that your
main input in how much tactically, are we switching between
these factors or are you uh, you know, as Cliff says,
(21:58):
sitting a little.
Speaker 3 (22:00):
So first of all, in terms of geographic we have
a factor timing model for factor models for US Europe,
so we look at that one group at Japan and
Asia ex Japan, which captures most of MSCI world, and
(22:22):
different factor models send different clues about how much we
want to allocate to a country. For instance, when a
factor model is saying, hey, you should buy high dividend
yielding quality stocks, that's usually a sign of a risk
(22:44):
off market versus a mark versus word that says hey
buy growth or buy value, that's usually a risk on market.
So we will allocate and buyas the portfolio from a
regional standpoint where we see the factor models are setting
(23:05):
the strongest, strongest system signal. Now stay within the the
guidelines of you know, kind of requirements. We never can
go more than seventy percent in the US or seventy
percent outside of the US, so we will all there
are certain guidelines, but broadly speaking, it has paid to
(23:28):
have a higher allocation to the US within a global strategy,
and that's one of the reason why we started global
strategies was simply kind of my kind of picture advertisement,
which is, hey, international manager can only buy non US
A global manager can buy if it happens to be
the best the best era. But look, I'm you know,
(23:51):
like I like to say, I'm agnostic towards regional allocation.
I'm agnostic towards styles. I'm not here to convince you
to buy any sales. I just want to stay in
the game in terms of factor timing. Very interesting, Chris.
So when I started these strategies, especially on the institution side,
So I started going on and I you know, I'd
(24:11):
be taking around the world these very large institutions and
I'd say, well, you know, we're starting these you know
these we run these factor models and there's a factor
component to them. And I would get a lot of
pushback because at the time, it was kind of ten
years ago, people just started about factor modeling, and they
(24:35):
a lot of times I say, oh, well, we just
hired you know, ten PhDs that are going to build
these factor models, and you know, I thought, well, I've
been doing this a long time, and would you ever
hire someone, you know, right out of business school who's
going to run a a long you know, strategy that's
fundamentally based. But on the quantitative side, the belief was
(24:58):
that you could just hire a bunch of math whizzes
and you'd be really, really successful. So I remember walking
out of these meetings going, this is crazy. You know,
I have been watching factors for a very very over
twenty years. I've been watching factors. My knowledge is no
different than the knowledge you get from following company on
a fundamental side. And so I think what happened is
(25:20):
a lot of a lot of these big institutions. They
really fail at factor timing because you know, there is
you know, as we like to say it frames our viewpoint.
We are not a black box. And I know certain
things about what happens. For instance, I know that momentum
tends to fizzle out in the second half of December,
(25:43):
right because people are done tax loss harvesting and they
they they poured into the winners, and you know, momentum
kind of reverses in the late December. So you know,
that's just that's this knowledge of So we do run
factor timing models. I can tell you that, yes, we're
talking about the global concentratet, but we run a strategy
(26:06):
that just looks at our factor timing model, and it's
an enhanced index, and it's been running for a long time.
It's done very very well with a much lower tracking
error that's attracted kind of enhanced index product. So our
factor model models have added value from it, and therefore
timing has worked, but it hasn't done as well as
(26:30):
our more concentrated strategy like global contract simply because there
is value to fundamental research.
Speaker 2 (26:37):
Absolutely, you know, I totally agree with you. I mean,
I think there's more craftsmanship in art in this than
some people give credit for it, Like it's not just
crunch to numbers. So I completely you know, I love
what you said that.
Speaker 3 (26:50):
So can I just add one thing about that? At least, Chris,
you'll be interested. So what Philo Kim, who is the
co portfolio was on. He would tell say to right now, look,
so many quants have given up on factor timing, they've
thrown the towel, they are factor neutral. That this is
a big opportunity for us because the space is not
(27:13):
crowded anymore.
Speaker 2 (27:15):
I totally agree with that. So one kind of broad
question I wanted to ask you, and this is a
question I get a lot. I kind of disagree with it, So,
you know, I would love to know your answers. Like
some people that aren't nearly as sophisticated as you come
to me and say, well, isn't quality as a factor,
which is typically some culmination of like you said, profitability
(27:36):
and then things like low leverage, stability of earnings, et cetera.
Isn't that like growth? Isn't it the same thing?
Speaker 3 (27:42):
Right?
Speaker 2 (27:42):
Why do we need a quality factor? Why don't we
just do a growth factor? Isn't this exactly the same thing?
I don't think it is. What's your response to that question?
Speaker 3 (27:54):
The answer is, it depends what's in your quality factor,
because are if it's just Roe and r O I C.
We know that, you know, with you know, exception of two,
the mag seven have the highest Roe horst ir C.
So if that's your quality framework, yeah, then it is.
(28:18):
But we look at things beyond just that, like earning stability.
I think that's a wonderful factor. So earning stability measures
you know that the earning stream of companies and looks
at how stable their earnings are. Now that does not
(28:39):
necessarily mean they're you know, gross stocks. They could be
very defensive consumer staples type stocks. One of the reasons
why I still believe we're in the early stages or
you know, kind of you know, kind of not real early,
but we're we're not the tail end of this bull
market is yes, consumer state, peoples and healthcare stocks have underperformed,
(29:04):
but there are a lot of stocks that are perceived
as very earning stable that are still very very expensive
because they the investors perceived downside risk. So earning stability
is not necessarily just you know, tech growth. Another one
would be dividend yield, right, high dividend yield, It can
(29:24):
be a quality metric well, that tends to work in
bear markets. So you know, certainly tech is not our
gross stocks are not necessarily high dividend yields. So I
think there's different ways to dissect the quality factor. We
look at in terms of profitability as one, so that
(29:46):
does capture those gross stocks, but we look at bond
proxies as one, so those are higher dividend yields, And
we look at earning stability, which is in my opinion,
the ultimate risk off factor. That's what works into bear markets.
Speaker 1 (30:04):
So you mentioned in terms of exposure, you talked about
you know more us you know, and that's really a
factor that's driven by factors. I also, you know, the
last time I looked at the portfolio, it looked like
you were a bit underweight tech and overweight financials compared
to your benchmark. Is that also a result of factors
or is that driven more by the fundamentals?
Speaker 3 (30:24):
Uh? Yeah, I mean so, yes, we're underweight tech, but
not necessarily in the US. Okay, so you know you've
got to remember that we're looking around the world and financials. Yes,
but you know this is you know, Chris is going
(30:45):
to love when I say this, but you have to
be very careful on financials because on the surface, you say, oh, okay,
so financials they're all value stocks, right, and so therefore
you have a huge financial bet. But wait a minute,
insurance stocks traded very high multiples. They do not move
(31:07):
with money center banks, right, They've done much better than
money center bents. They're actually a much more defensive group
than money center banks. So yes, on the surface, you'd say, well,
we're making a financial bet because we're making a value bet,
but be careful that because some of those insurance type
(31:29):
stocks they actually fall into the You know that our defensive,
defensive bucket. So I guess when I boil it all down,
where we are and you know, obviously having a big
financial weight has helped in the last month. But what
we're achieving, at least in the US, is an overweight
(31:51):
to growth, an overweight to value, and an underweight to defensive.
So yes, we own insurance company, which fall into defensive bucket,
but we're underweight staples, healthcare and things like that that
also fall in to that as well. And so I
think if I think about performance here today, it's come
(32:15):
not it's you know, yes, we a great performance here today,
but and what And that's come from what we're overweight,
but it's also come from the factors that we've been underweight,
which are the defensive factors. And it's behavioral. I go
back to all this works. Quantitative investing works because of
(32:37):
behavioral investment. There is we know that people sell value
into recessions because during recessions people go, oh my god,
every bank's going to fail, well, every industrial it's going
down the tube, And so they sell value sucks and
they run into defensive because they're worried about risk mitigation. Downside.
(32:58):
I don't want to lose as much, right, so defensive
strategies get very expensive in bear markets, and value and
growth tends to get cheap. And as you come out
and people realize, huh, not every bank's going to fail,
you know, not every gross stocks going down. The two
growth and value outperform. And as a bear market proceeds,
(33:23):
people say, I don't want downside protection, I don't want
dividend yield, I don't want earning stability. I want to
make money, and they jettison defensive strategies and they move
more into growth and value. And this is what we
are just on the cusp of because early in bear market,
(33:45):
you know, bull market, you know, bull markets are born
on pessim. Let's buy a lot of defensive stocks. It
grows on skepticism, which is last year in matures on optism.
It's the optimism phase where people go, I don't care
about don doowntime protection anymore. And this is you know,
I started my career at Morgan Stali in ninety one,
and this is exactly what I saw, you know, in
(34:08):
ninety seven ninety eight, and I see it happening again.
Early in the early nineties. People wanted downside protection, they
wanted dividend yields in the late nineties, they had no
interest in dividend. So I just it's a quantitative investing
works because of the consistency of human behavior and the
(34:32):
you know what I would call, you know, kind of
the the the consistent fear to greed behaviors that I
see in this business.
Speaker 1 (34:41):
So actually, you know, that kind of brings up another
question I had. You know, you mentioned, you know the
factor analysis is quantitative. Is when you're actually applying the
fundamental analysis, is there a quantitative component there as well?
Speaker 3 (34:57):
So if we take you.
Speaker 1 (34:57):
Know, dividend yield, which you just mentioned, you know, if
you looking at the dibdend yield factor and you know
you think it's the right time to go into stocks,
do you have a quantitative filter to you know, look
at the stocks themselves, you know, based on yield.
Speaker 3 (35:11):
Yeah. I like to say it's a good question. I
like to tell people all the time, Look, no one's
going to walk in our door, and you know, obviously
we have a lot of people that are trying to
convince us to buy certain stocks. No one's going to
come into our office and say, hey, I got a
great investment idea for you. And then proceed to tell
us a fundamental store. All our investments begin with what
(35:33):
are the exposures? From a quantitative standpoint, each and every
stock gives us. So when we look at every stock,
we know what exposures are they do they do they
move with earnings yield or PE low P? Do they
move with growth? Do they move with earning stability? Quality? What?
(35:54):
What are we getting if we buy the stock? So
even before our fundamental re search, guys and gals start,
they always start. They have to show us that because
we're making if we add a stock to the portfolio,
we're making a factor adjustment. So first and foremost we
(36:14):
start with that, and then we drill down into the stocks.
But even before we do that, we look at the Okay,
so we're thinking of adding a stock, let's say in
the value are well, okay, we start with it has
exposure to earning yield? Check the box. Okay, we like that. Well,
(36:36):
what's the correlation to the other stocks in the earnings
yield low pe bucket? Because we want to have companies
that will not increase What I remember why I said
in isually our tracking error. I want to have exposure
earnings yield, but I don't want to make a what
I call a big bet on something that's outside our
(37:00):
you know, quantitative models. So in other words, if I
just keep adding banks, I'm making a bank exposure, right,
So that then and only then do we call down
the list to Okay, now, let's let's look at the
following stocks. And so a great example, we added a
real estate company recently to the portfolio because we wanted
(37:22):
to increase our value exposure. And we have quite a
bit of financials as you mentioned, we have industrials, and
we didn't have a uh, you know, a real state
a stock that moves with the value exposure, at least
in the States.
Speaker 2 (37:38):
Interesting, you know, I would love to ask you about
position sizing generally, you know, without getting into into specifics.
I mean, how do you think about that? I mean,
all the major industries are market cap weighted. You know,
you could kind of naively do it equal weighted, which
gets you a lot of the way there, or you
could do some kind of optimization or I've seen a
(37:58):
lot of people do things like have their position size
be congruent with you know, how good do they think
the investment is, or what their estimation of the alpha
of this certain investment is. So, how do you think
about position sizing within your portfolio?
Speaker 3 (38:12):
Sure, well, so, first of all, I don't think about
it in terms of an absolute basis. I think about
it in terms of relative because at the end of
the day, you could go and buy the NSCI world
ETF right. And I to be clear, I'm an active manager.
I got nothing against passive investing. I really don't. I
think people should have passive exposure to these to these markets.
(38:36):
What I you know, I roundly against is managers that
have you know, they're broadly diversified, and then they're scratching ahead.
Why you know, why they haven't outperformed, why they're losing
au M and so I think I think passive strategies
are bring are doing what's right for the the industry,
(39:00):
which is forcing manages to be truly active twenty stock
people say, oh my god, that's really concerted. Yeah, it's
really concentrated. We try to control the risk by not
having all stocks correlated to a theme. But that's what
we're Brian and chieve and certainly the performance over time
has proven so. So I think in terms of relative exposure.
(39:21):
You know, if you go to our fact sheet it's
to shows I'm required to show our top ten. It
looks like you look at top ten. Oh it looks
like you got big positions in some tech names, but
actually on a relative basis, we have much bigger relative
position to value names. So that's you know, that's the
first place we saw start in terms of position side size.
(39:42):
You know, again, I've been in this business a long time.
I've got a lot of tattoos on my back figuratively
that of you know, kind of bad decisions. And I've
learned that. You know, we're making educated bets, but we
don't know everything, and so therefore I don't I want
to make sure if something ha happens, it's not going
to take them, you know, kind of the fun And
(40:04):
so how does that happen is I got to make
sure we don't let the relative weight and anyone stock
get too big. So when the relative weight gets to
kind of ten percent of the portfolio, I start to
switch a little. But the other way we look at
it is in terms of we look at each stock's
(40:27):
contribution to risk. And we know that if you know,
stocks that are very very big in the index, if
we bring those down, that will lower our overall risks
of our portfolio. So we it's not a you know,
there's not any one kind of magical line we do.
(40:50):
Tram Wind stocks have done extremely well, and we think
there's you know, there's a risk of underperformance on a
short term basis regardless of what our factor modeling says.
And certainly we've been forced to trim some big winners
this year, but it's really in terms of relative weights.
And again, when it gets over ten percent, I start
(41:13):
to get nervous that one stock's going to determine the
outcome of the portfolio.
Speaker 2 (41:17):
Gotcha.
Speaker 3 (41:18):
Yeah.
Speaker 2 (41:18):
My last question is really kind of going along with
that theme, I mean, just risk management as a theme.
I mean, it seems like most of the risk management
is based on position sizing, you know, making sure your
correlations are relatively not negative, but you're not adding just
the same risk to the portfolio over and over again.
Is that where most of the risk management comes from
from your from your side or is there any kind
(41:40):
of like I mean, I know you're tactical with the
factors and such, but is there any kind of like,
you know, tactical overlay. Maybe the market's going down and
we sell some futures or go to some cash or
something like that. Is there anything like that in the portfolio?
Speaker 3 (41:56):
Yeah, So let me start with the last question, which
is you know again. And I used to sit and
listen to people come and pitch their strategies and and
to me when I was first startup more insali and
I hated when people would say things like, well, I'm
a long acquity manager, but if I don't like the market,
I'll go to cash, Because at the end of the day,
(42:16):
I think that's a bunch of I mean, I just
don't think that's being honest. Like, are you a manager
that's in the business of competing on a relative basis
and an active manager or you a you know, a
long short you know, kind of neutral where your return
is your relative returns cash. You can't be both, right,
(42:37):
And so someone says I don't like you know, I'll
go to cash. What they're suggesting to you is I'm
going to give you a good relative performance on the upside.
I'm not going to lose your money on the downside.
I think that is that's just being that's just not honest.
I hope in all the data shows that our downside
capture is less than the market and our upside is
(42:58):
more you know, since we started the strategy, so it
has worked in terms of how we shift. Now how
we do that Again, what I told you before is
when I look at say in Europe, right, you know,
over the last a decade, it really it's it's screened
own safe stocks, own quality stocks, and that means focus
(43:23):
on the amount of beta risks you have, right, and
so we've been very cautious on stepping into deep value
or very low value stocks because they tend to have
higher valuation. So the factor model very much guide how
we think in terms of how you know, that's the
(43:45):
first you know kind of risk management, uh that we do.
And then the other thing that we watch is the
correlation of a stock to the factor. Okay, so what
there's something called residual volatility. I'm really getting quantity here,
but volatility. Residual volatility is kind of the unexplained volatility,
(44:10):
which is basically the uh, the volatility that comes from
at the company level. So a biotech company has a
lot of residual volatility because you know, they you know,
it's not it's not correlated to growth, it's correlated to
drug success. Stock goes up, drug failure stock goes down,
so that has high residual voltilay. I don't want high
(44:32):
residual volatility. I want stocks that are correlated to their factors,
because what I desperately don't want to have happened is
where I get the factor right, but something happens fundamentally
that I didn't know about, and then stock goes down
even though I'm you know, in my quantitative side, guys
are dancing say yeah, we got the we got the
factors right, oh oh yeah, but this company didn't move
(44:55):
in the fact So we watched the changes in the
correlation to the fact there's and that can set off
what we call a warning bell that oh my gosh,
there's a problem here, because you know, for instance, if
and our financials did very well, but we know that
value in financials did have done very well last month.
(45:15):
If we have a stock in financials that hasn't done well,
then we're all over fundamental guys going okay, there's a
problem there. There's a problem here, and we need it.
So that's that's a big part of the risk management.
And then the other the last part is and we
kid we have something called correlation Thursday, where we look
at the portfolio and address each relationship of the stocks
(45:37):
as the correlations come together, and that will cause turnover
if you know position as you mentioned position sizing, if
boil boy, you know, we've got a couple of AI
stocks and gone through the roof and they are moving
one for one. You know, that's going to cause us
from a risk management standpoint, to take down the exposures
(45:58):
as well.
Speaker 2 (46:00):
Yeah, it's great us as an industry. Just just one
quick comment, David, I just think US as an industry,
like you know. I that's one of my big things
is to measure the volatility of or portfolio from the
factors as well as from your videosyncratic or residual volatilities
as well, because you want to know where that's coming from.
I think a lot of people don't do that, and
it's a very important step in the process. And I'm
(46:21):
really glad that you mentioned that.
Speaker 1 (46:23):
Well, Andrew wanted to thank you for your time. I
definitely learned a lot.
Speaker 3 (46:26):
This is great, Well, thank you, it's great. It's it's
fun to be able look at in the weeds, and
I really appreciate David, especially Chris and understanding what we do.
It's a it's a complicate in some ways. It's complicated,
but what we like to tell people, look, we're just
we just want to stay in the game. We just
want to stay in the game and not convince you
(46:47):
to buy some style it's you know, out of favor
if it could last for you know, multiple multiple years. Now,
how we do that is is is a little bit
more complicated, so it's fun to actually talk about it.
Speaker 1 (46:59):
Thank you, Thank you, Chris, thank you again for serving
as my co host.
Speaker 2 (47:03):
Thank you.
Speaker 1 (47:05):
Until our next episode, this is David Cone with Inside Act.
Host
Gina Martin Adams
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Current and classic episodes, featuring compelling true-crime mysteries, powerful documentaries and in-depth investigations. Follow now to get the latest episodes of Dateline NBC completely free, or subscribe to Dateline Premium for ad-free listening and exclusive bonus content: DatelinePremium.com
On Purpose with Jay Shetty
I’m Jay Shetty host of On Purpose the worlds #1 Mental Health podcast and I’m so grateful you found us. I started this podcast 5 years ago to invite you into conversations and workshops that are designed to help make you happier, healthier and more healed. I believe that when you (yes you) feel seen, heard and understood you’re able to deal with relationship struggles, work challenges and life’s ups and downs with more ease and grace. I interview experts, celebrities, thought leaders and athletes so that we can grow our mindset, build better habits and uncover a side of them we’ve never seen before. New episodes every Monday and Friday. Your support means the world to me and I don’t take it for granted — click the follow button and leave a review to help us spread the love with On Purpose. I can’t wait for you to listen to your first or 500th episode!