Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio news. This is Masters in
Business with Barry Ritholts on Bloomberg Radio.
Speaker 2 (00:16):
This week on the podcast, I have an extra special
guest returning for the first time in a few years,
John Montgomery. He is the founder of Bridgeway Capital, established
in nineteen ninety three, and the firm is really a
very interesting mix of quantitative, value based and factor based investing.
It's really none and all of the above. It's a
(00:38):
little more nuanced and sophisticated than that. The firm first
came to my attention because I was kind of intrigued
by the idea of donating half their profits to charity.
That's unusual in the world of finance. In addition, they've
put up some really impressed of numbers over the past
(01:01):
thirty years, which has given them the opportunity to donate
tens of millions of dollars to their favorite organizations. I
thought this conversation was fascinating and I think you will
also with no further ado Ridgeway Capitals.
Speaker 3 (01:16):
John Montgomery, Thanks Berry, it's great to be here.
Speaker 2 (01:19):
It's great to see you. Let's for people who may
not be familiar with the firm, and your background. Let's
start with how your interesting and unusual career BS and engineering,
BA in philosophy from Swarthmore. Then you get a graduate
degree from MIT and you go to Harvard Business School.
(01:40):
What was the career plan?
Speaker 3 (01:42):
Their career plan originally was urban development and transportation, So
that was my first career, was working with various bus
and transportation companies to improve the quality of life in
the cities. People ask how does that relate to investing,
and I say, well, they're both service industries. They're both
(02:02):
people intensive, and those are the elements that I love.
Speaker 2 (02:06):
And I got to imagine there's a ton of data
analytics and optimization thinking that goes into both.
Speaker 3 (02:14):
That's true. I like the intersection of people and analysis,
and both industries give a lot of opportunity that I
love serving people. They're both service industries, so I'm a
happy camper.
Speaker 2 (02:26):
That makes a lot of sense. You were pretty early
to computer modeling and statistical methods as a research engineer
at MCT. This is the late nineteen seventies. That sort
of data analytics wasn't really well understood back then. How
did that background help when it comes to modeling portfolios
(02:48):
or applying those methods of statistical analysis to invest in.
Speaker 3 (02:52):
Well, the statistical side definitely comes from my degree and
then work as a project manager at MIT, So you're right,
late seventies till nineteen eighty. The investment piece of that
didn't come tell business school about three four years later,
And that was kind of you could say, by chance
(03:14):
or on a lark. I thought, well, you know, there's
an opportunity cost of stepping out of your career where
you have a paycheck to go back to business school
full time, which I did, and thought, while I'm here,
I'll take a few investing courses and see if I
can use those to earn back the opportunity cost of
going to business school for two years.
Speaker 2 (03:32):
So from transportation to finance. That sounds almost but not
quite purposeful. Is that Is that a fair description?
Speaker 3 (03:40):
I think that's a very accurate description. So, and actually
didn't leave the transportation field immediately after business school. I
was in an investing course and we're doing a case study.
Professor ends the class and asks the question, who here
thinks that they'll be able to outperform post leaving Harvard
(04:01):
Business School this track record? And eighty percent of the
hands go up in the room. I'm not one of them,
by the way.
Speaker 2 (04:09):
So the whole class from Lake wobegone everybody's average.
Speaker 3 (04:13):
Yes, yes, exactly, I mean, and I immediately got the
eighty twenty rules. Wait a minute, this can't be And
if this is a microcosm and the methods that we
were using to think about the markets and valuation in
net present value kind of cfa classic kind of analysis.
If this is a microcosm of Wall Street in five years,
which probably it is, then quantitative methods should give you
(04:36):
a leg up on the competition for a lot lower costs.
Speaker 2 (04:40):
So you've previously discussed the epiphany you had at Harvard
Business School. Is that the epiphany or was it something.
Speaker 3 (04:47):
Else that was a major piece of it. I would
say the primary insights were behavioral finance ones we would
call like I didn't. I'd never heard the word behavioral
finance at the time.
Speaker 2 (04:58):
At that as a phrase didn't exist for another twenty
five years.
Speaker 3 (05:01):
Probably not you know, you see you watch. I've once
had a boss who said, this guy has enough sheep
skins to skin a sheep. But if I ever did
go back to school, the next degree I would love
to have is in psychology, because I really there's so
much there, and especially the intersection of psychology and money.
Speaker 2 (05:18):
When do you finish up at HBS. What year was that?
Speaker 3 (05:23):
Nineteen eighty five?
Speaker 2 (05:24):
All right, so what do you do between that and
nineteen ninety three when you launch Bridgeway?
Speaker 3 (05:29):
So the first thing I did was investing as a hobby.
So that was my advocation for the next six years,
and my personal track record in investing was about twice
the market for those periods, right in a good period.
Speaker 2 (05:44):
Scalable or kind of one off, little aberrational.
Speaker 3 (05:48):
No fine, reasonably scalable, reasonably scalable, I would say enough
that after six years, I had the thought of making
my avocation my next career and did something that was
modeled to me by the mayor of Houston, my hometown
at the time, and that is to take a year
off between careers. He'd actually had four careers in his
(06:09):
life in different fields, and every time he switched, he
took a year off just to study the heck out
of the next step. So that's when I really studied
deeply the research why what I'd been doing was working
more about when it might not and riding a business
plan for Bridgeway.
Speaker 2 (06:28):
That's pretty fascinating. I took a year off between college
and grad school, but I had no idea I was
actually doing what you advocate, or with the Mayor of
Houston advocates. I just was kind of lost and not
sure what to do next, and spent a year thinking
about it before pulling the trigger on law school. But
(06:50):
your hometown is Houston. The firm is still locating in
Yuston right since nineteen ninety three, that's when you launched.
Where you launched. From the very beginning, you said something
kind of unusual about the firm. We want to donate
half of our profits to nonprofit organizations. Tell us where
(07:12):
that idea came from. It's fairly unusual either in finance,
and I've been to Houston. That's a kind of unusual
idea in Houston as well.
Speaker 3 (07:23):
That's true. If I gather around, you know, just random
business people in Houston and say that we donate half
our profits, I have to say I get some very
puzzled looks around the room. Not so much from other
purpose driven people in different fields, though, But yes, it's different.
Where did that come from? You know, we think things
(07:45):
come from one place, but usually there are a lot
of forces at Bay. So I would look back to
my father, who was a businessman and CEO of an
oil exploration firm, and believe that business was a way
to change the world and engage. My mother was what
I would think of as almost a professional volunteer, so
giving back to the community. And this was in a
(08:07):
time when the War on Poverty, you know, was the
slogan at the time. So I was hugely influenced by
both of my parents. But I would say also a
conversation with my wife on the very first conversation of
starting Bridgeway, and it went something like this, let me
get this straight, John, You're thinking of leaving the transportation
(08:29):
industry where you have a lot of experience and a
w two to start a company in an industry you've
never worked with, no initial guarantees, no guarantees on the
money side. And I said, yes, we talked that through.
I have to say, I'm married to an extraordinary woman.
(08:50):
I didn't realize at that age of thirty seven how
extraordinary she was. But she believes in supporting people who
have a dream and she did that for me in
for Bridgeway, So she was all in. She had two questions.
Speaker 2 (09:04):
Yeah.
Speaker 3 (09:04):
Question one, can we still send our daughters to college?
That was like, I should have paid more attention to
that question because my budget, my business plan was fifty
percent of our net worth. Before it was all said
and done, it was one hundred and fifty percent of
our net worth. Right, so it took three years to
(09:24):
break even when my business plan had it at one.
The second question was do I have to go to
cocktail parties? Why would she not her cup of tea?
Speaker 2 (09:35):
No? But I mean, why would she imagine? Launching of
funds is going to require your spat Just like.
Speaker 3 (09:42):
She grew up in Washington, DC around academicians and government people,
and her view of business was you have to go
to cocktail parties and schmooz with people. Right, that makes sense,
And having taken a course of negotiation at Harvard Business School,
I immediately recognized the opportunity and said, dear not if
you don't want to. So she only comes when she
(10:03):
when she desires to come wherever I am. But she's
an amazing soulmate and supporter of everything Bridgeway.
Speaker 2 (10:10):
That's fantastic. So you've been donating half your profits to
these different organizations over thirty years? Is that right?
Speaker 3 (10:19):
Thirty one years?
Speaker 2 (10:20):
So how much have you guys donated? What are the
organizations you support? What's been the response in the community
over the decades.
Speaker 3 (10:28):
We don't give exact numbers. We're privately held firms. Since
we donate half, we don't report our profits specifically either,
but I'll just say it's tens of millions. Okay, over
you know what substantial amount of substantial amount of capital.
The bullseye of our giving is our own affiliated Bridgeway Foundation.
This is an extraordinary organization led by a powerhouse of
(10:53):
a woman, Shannon Davis. Our mission statement focuses on ending
genocide and prevent any war atrocities, of which there are
too many opportunities in the world today. So that's the
crosshairs of our Let me.
Speaker 2 (11:08):
Interrupt you right here. So, so I know you have
very quantitative leanings. How do you measure how successful you
are in stopping genocides? Just generally speaking, it's hard to
measure something that doesn't happen, so you're always engaging in
counter factuals. But how do you know if you've moved
(11:30):
the needle?
Speaker 3 (11:31):
It's probably no easier, no more difficult than things that
we do on the investment side and in the stock market,
there's time series analysis. We actually hired an outside firm
to come in and review the record of what we
had done in our first engagement with an organization called
the Lord's Resistance Army. And if you want more details,
(11:51):
there's a book called to Stop a Warlord that Shannon
Davis wrote. I never thought we'd be able to tell
the story at that level because you don't want to
put at risk the people that are on the ground
doing the real work. However, she found a way to
do that and protect them, and so there's a book
that goes into a lot of detail on that. But
(12:12):
people think there's not a way to measure there is,
and you're right, being a quantitative statistical guy, you can
bet that that comes up on the table frequently.
Speaker 2 (12:22):
Huh. Really really fascinating. What's been the response from the community.
Speaker 3 (12:26):
The smallest in community is the Bridgeway community. So that's
the twenty eight people at Bridgeway we call partners. Right
they sign on for this work because it's in the
mission statement. You don't not know about it coming in
and you don't come if this isn't from day one
and that's that's everything. The community of Houston, I would
say less so, but it's kind of it's specific to individuals.
(12:50):
So every once in a while you get somebody's like unbelievable,
that's amazing and cannot come huh that level. We have
partnered with other organizations, one of those being Howard Buffett,
Warren Buffett's son that does substantial philanthropic work.
Speaker 2 (13:07):
Is he in Texas?
Speaker 3 (13:08):
No, No, he's in Nebraska, But we have partnered with
him and work in the Ukraine. Worked in the first
year of getting generators in for obvious reasons and getting
the grain out for obvious reasons. I tell people at Bridgeway,
we don't know squat about farming, but Howard Buffett does.
And the third thing is documenting war crimes, and that's
(13:30):
actually something that Bridgeway Foundation knows a lot.
Speaker 2 (13:32):
About documenting war crimes. Documenting and what do you do?
Does this then go to the Hague to the UN
What do you do with once you've documented and it
should be fairly substantial in Ukraine, considering the Russians have
been bombing civilian hospital, schools, infrastructure, apartment buildings, it looks horrific.
(13:55):
What do you do with all of that information once
you've documented a warp rhyme in Ukraine.
Speaker 3 (14:01):
So it depends on what national or international jurisdiction engages.
So optimally you like to keep it at the country
level if possible. The International Criminal Court is the other
place that you can take a case that's in the Hague.
Speaker 2 (14:17):
That is in the Okay. So that's what I was
really thinking about. Do they take these on as individual
cases or are they kind of you know, it seems
like the UN is sort of paralyzed because of you
just have one voting member say no and that that's
that at the end.
Speaker 3 (14:33):
One of the indicities of the International Criminal Court was
Dominique Angwin, who was a general in the Lord's Resistance
Army the first conflict that I mentioned earlier, and we
played a major role in getting him to the Hague
to stand trial for justice. So win for justice and
then and as a deterrent by the way to kind
(14:54):
of thugs of the world that think they can get
away with war atrocities.
Speaker 2 (14:57):
What one would hope what happens when you have somebody
like Putin who's kind of hard to reach and is Wisconsin, Moscow,
and you know, how many hundreds of thousands of people
have been killed, civilians, non combatants killed in the Ukraine.
How do you reach someone?
Speaker 3 (15:16):
I would say one step at a time, and then
you know, it's a lot of hard work slugging through
and then occasionally you just need a stroke of good
luck for something going the right way. Typically it takes
more time. You know. They say the arc of justice
gets there, but it's slow. That's not an exact quote,
but that's my Martin Luther King summary of it.
Speaker 2 (15:37):
Yes, sure, so we'll come back to this because this
is really fascinating. I had no idea you were so
international in the philanthropic sphere. But we'll definitely circle back
to that. Let's start talking a little bit about that
track record. You have a couple of mutual funds, a
couple of ETFs. I'm assuming you're running other stuff as
(16:00):
a either separately managed accounts or a separate what have you.
I know, one of your funds since inception has outperformed
the market by about one hundred basis points, and the
other I don't know if it's still a mutual fund.
I know it started as a mutual fund is now
about three hundred basis points over market returns. Tell us
(16:21):
about the mutual funds and ETFs you run on behalf
of Bridgeways clients.
Speaker 3 (16:26):
Yes, so let me talk about the strategies. One you
referred to as aggressive investors, and as the name would indicate,
it has high beta, very well high beta, but very
high exposure to the factors that we want that we
believe in, so.
Speaker 2 (16:43):
High active share. And when you say factors, very high active.
So you know I should have mentioned this earlier. What
a lot of people call smart beta, You guys were
doing long before anyone had a name on it. You've
been doing smart beta, You've been doing factor investing a
long time. Tell us a little bit about the sort
of factor investing that drives Bridgeways returns.
Speaker 3 (17:04):
Well, these are factors that we believe in. First of all,
some of my co portfolio managers will bristle if you
refer to us as a factor based firm. I owned
that a little bit more. But it's a fair point
in the sense of being systematic, statistically driven over long
periods of time. But there are human elements, Like if
(17:26):
there were no human element, everybody would be operating the
identical strategy out there. So yes, we believe in value.
We have our own proprietary mix of metrics and we
can show statistically based on data over decades why we
do that.
Speaker 2 (17:41):
So let me stop you before you go on to
the next one. When most people hear value, they immediately think,
you know, low PE, low price to book ratio. Your
approach to value, I know, is a little more sophisticated
than that. Put some flesh on the bones. Tell us
about Bridgeways value approach.
Speaker 3 (18:02):
So we believe in value, quality, and sentiment, or the
three primary legs of the stool. Within that, one of
the things that we've done for a long period of
time is mix different measures. So and why do we
do that. It's because it gives you a more stable
return stream over time. So if it's academically, you know,
(18:23):
paper when I was in business school came out FAMA
French and.
Speaker 2 (18:28):
The value factory model factor.
Speaker 3 (18:30):
Yeah, and the three factor then was price to book
And it's a metric, but we could show statistically that
if you match it with things like PE, with things
like price to sales, which has its own part. Think
through the balance sheet and the income statement, different ways
to measure value. That putting them together in a efficient
(18:54):
way gives you a steadier stream of returns into the future.
So that's why we do that. There's a very interesting
output of that though, that comes. So I was at
a conference I don't know, I'm going to say, maybe
twelve years ago or so, paper presented by NOV marks
on quality, and he's presently like everybody's excited. I'm excited.
(19:16):
We go back in. The first thing we all always
try and to is replicate the work if it's new.
So we replicated the work we put it into see
could it help our models, and the answer was no.
Do you know why the reason was no?
Speaker 2 (19:29):
Because you already had quality.
Speaker 3 (19:31):
And inadvertently we had already included quality in the process.
Because that doesn't ultimately.
Speaker 2 (19:37):
That doesn't surprise me because you're you're talking about different metrics,
and when I think about value, and I also think
about value traps, and I know you cannot generate the
numbers you have if you're constantly buying stuff that's cheap
but low quality, high debt, all these other issues that
come up. Eventually, those things have to underperform. So I
(20:01):
kind of had the sense that you guys have quality
exposure just by your long term track record. So you
reproduce Novi's work. Where do you go from there?
Speaker 3 (20:12):
There's always a next step, Barry. If I take a
look at just three of our strategies currently, it gives
you a feel for the breadth of what we do.
So one would be our small value strategy and you
might think small value. That seems pretty plain. Vanilla mentioned
the research on value that we've done. We try and
incorporate some things and how you incorporate them into the
(20:34):
portfolio construction where you constrain and where you don't like
how much are you willing to take on of sector risk?
But our OMNI small value strategy is a strategy that
we designed specifically for the purposes of an organization called
Buckingham or BAM. Then now it's now called Focus Partner's Wealth,
(20:56):
great friends of ours and our small value OMNIE small
value fits into their allocation in a way that's efficient
for their portfolio construction. Now, what's Bridgeways advantage. It's our
size and this is something that's true across all of
our strategies currently. We have a huge leg up being
a smaller organization. Several reasons think of the OMNI small
(21:20):
value because we're smaller and we don't have hundreds of
billions under management, we can go deeper on small deeper
to a degree. Our benchmark is still the Rustle two
thousand value index, but our strategy is x real estate
and utilities because our partners focus Wealth Partners has separate
(21:43):
strategies for that, so we don't duplicate that. And so
that's an example of the kind of research that we do.
How does that affect the reterms? Is that a good
idea to do? But Bridgeway's own small size means that
we don't have well, it means several things. Really. Number one,
it means our transaction costs are less, which, based on
(22:05):
your career, you know exactly the importance of that. So
if you're a trader and I give you an order
on a particular stock ticker symbol and say go buy
me a thousand shares of that, and your job is
to get this completed at the best price possible. However
you want to measure it, and I give you one
ticket for one thousand shares and another ticket for fifty
(22:27):
thousand shares, but I'm going to hold you accountable to
the same price. Which one do you want?
Speaker 2 (22:33):
Well? From back in the day, when it was five
cents a share, you wanted the fifty thousand share order,
but that's not how you're getting paid. Well, the thousand
share orders much easier to get done at a good price. Yes,
fifty thousand shares, especially a small cap, you may move
the price up. You're certainly not just absolutely lifting the
offer and walking away with fifty absolute shares.
Speaker 3 (22:54):
So for the investor, you want the smaller one that
gets done more quickly. If you can get it done
more quickly, it's more favorable price. You're less likely to
move the price of the security in an unfavorable way.
And that same thousand shares will make a more meaningful
contribution to a smaller shop than to a larger shop.
(23:15):
Same number of shares is just going to be you know,
point zero zero one in the portfolio. Why even waste
your time at Bridgeway. It's more meaningful. That's a big deal.
And the last part is something that very few people
I hear talking about, and that's that our effective universe
is a larger universe. So that gets into our next
strategy that I'd like to highlight, which is our global opportunities.
(23:38):
This is a long short strategy. It's glows.
Speaker 2 (23:40):
This is the one that's one hundred percent long one
hundred percent short. Yes, so less correlation to the market.
Volatility doesn't matter. If anything, volatility could actually help return
can So no guarantees, but it could.
Speaker 3 (23:55):
Jacob Pejorni, who who led the research for a two
year period, resulted in three peer reviewed articles, which for
firm our size is an astonishing achievement. He likes to say,
market agnostic. This is long short. The success for us
is defined as if you know the direction of the
(24:17):
market tells you nothing about the direction of the returns
of this strategy.
Speaker 2 (24:21):
Well, if you long short, you should have half the
volatility of long only.
Speaker 3 (24:25):
Right, that's pretty much right in line with our target. Okay,
so volatility.
Speaker 2 (24:30):
Is this an absolute return strategy? It is. The assumption
is you're picking stocks that you think you're going to
do well, and you're also looking for stocks to short
that you think you're going to do poorly, and we'll
do especially poorly. In a draw down, how's that working out?
Speaker 3 (24:48):
It's working out well. This is a big deal in
terms of the design. A paper that caught my attention
was following two thousand and eight, and this paper took
a look at all hedge funds that reported to be
market neutral, and the bottom line was, most of the
time they did a pretty good job, but when you
really needed it, in a downturn of two thousand and eight,
(25:09):
the beta was zero point four, so about forty percent
of the downside. Well, it's like, okay, that's cushion, but
it's not zero. It's not zero, it's not a it's
neither an anti gravity fund, nor do you expect not
to be hurt. We've done research on the competition as well,
and this is fascinating and also just over the last week,
(25:30):
so we're now, you know, on two days that get
us close to twenty percent. That's enough to you know,
run your numbers and see how did they do. Our
closest competitors to global opportunities have done a much better
job than quote market neutral funds did back in two
thousand and eight. All of them within a percent of zero. Well,
(25:53):
one of them was two percent negative. But out of
seven strategies that I looked at just earlier today, I
would say doing a better job.
Speaker 2 (26:03):
I think it was Cliff Astness at AQR had a
paper out our hedge funds really hedged and Unfortunately, the
conclusion for a lot of them were not very much.
And that sounds like it's very consistent with the research
you guys.
Speaker 3 (26:18):
Well, we specifically designed this not to have the two
thousand and eight problem identified. But there are a couple
more areas that we have a huge leg up on
the competition with a strategy number one. Again, getting back
to our small size, our universe of stocks is so
much larger.
Speaker 2 (26:35):
That's both domestic and international.
Speaker 3 (26:37):
Yes, and especially internationally. That's because out of the nine
thousand or so stocks, significant majority, probably our bigger competitors
simply can establish a meaningful.
Speaker 2 (26:50):
Position in a competitive advantage.
Speaker 3 (26:53):
Oh it's and it's big.
Speaker 2 (26:54):
Well.
Speaker 3 (26:54):
And by the way, those are the ones that are
less liquid, less efficient that you are likely to win
with active management. Huh.
Speaker 2 (27:03):
Really interesting. So we talked earlier about donating tens of
millions of dollars half of the profits of the firm
to charity. How does that affect how you recruit employees,
how you develop a compensation structure. Tell us a little
bit about the impact of that on running an asset
(27:24):
management business.
Speaker 3 (27:25):
Sometimes I get into conversation with a prospective client and
you might hear something like, you know, it sounds like
you're good guys. You know, you're philanthropically geared and you
get awards. Is a great place to work. But all
of that, like, put that aside. I just want to
talk about the investments. And what I would say is
culture is everything. It's the housing within which we do
(27:47):
what we do. So it's very important, and you can
measure that in some statistical ways like turnover. I would say,
there are proxies for commitment at Bridgeway and then returns
of the strategies. Why would you think that's independent of
the culture that you've built up.
Speaker 2 (28:03):
You also have an internal rule the highest paid employee
earns no more than seven times the lowest paid employee.
Is that right?
Speaker 3 (28:12):
So statistically that's probably true. We don't measure it that way.
There's a new statistic that came out from the sec
required of public companies and those are some of the
metrics that we look at currently. Some people think it's like, oh,
so you underpay. That is absolutely not the intent. It's
just not to pay outrageous salaries on the top. And
so you know, if you want to make azill the
(28:33):
most money that you can make in our industry, you
probably wouldn't come to Bridgeway if you want to make
an absolute livable wage and if you invest, save and invest,
you should do very well over a full career. Then
then we're purpose driven firm and we ascribe to Daniel
Pink's what really motivates people is not money, but it's purpose,
(28:58):
which we have in strong Suit. It's autonomy and it's mastery.
So we really invest in our people by way of mastery,
give them opportunities for learning and growth, invest by way
of mentoring as well, and then the autonomy piece we're
trying to continually up our game with in a system
(29:19):
of structure called traction or entrepreneurial operating system.
Speaker 2 (29:23):
And the firm's culture also emphasizes accountability. Tell us about
the Firewood Group. What does that do?
Speaker 3 (29:33):
Okay? So the Firewood Group is a personal accountability group
that's not inside Bridgeway. And what happened is in nineteen
ninety eight a friend of mine came to me and
he said, so, I want you to be on the
board of directors. And he worked for a publicly held firm.
But he was like, Charlie, I like, you're not in
a position to ask me on that board, and I
don't know squad about that industry And he said, no, no,
(29:54):
not the company board, the board of directors of my life.
And he said, well, what does that look like? You
never heard of that. Out of that came the following observation.
We were each members of groups that were great at
support but lousy it accountability, and we both knew we
needed accountability. So we formed this group specifically around the
(30:16):
concept of accountability. And just to give you a very
specific example, I had a life goal of ending genocide.
This group starts, and you know, I'm sharing life goals like, well,
you've made great progress on this one and this one,
but we don't. We think it's time for you to
actually turn the ignition on on this one. Out of
that conversation, we turned the ignition on on our foundation
(30:37):
and everything that you see that Shannon Davis is doing
along with our partners.
Speaker 2 (30:44):
That's really fascinating. And I would assume if the founder
and CEO has that degree of accountability in his personal life,
how does that then affect the culture of the organization.
How do you bring your work ethic and your sense
of accountability into the office.
Speaker 3 (31:04):
Well, I like to think that I modeled it. Number one.
Number two, we attract people for whom that's an exciting concept.
And number three, then you've got to actually live it out.
And that's where aspects of this structure that I call
traction or some people call entrepreneurial operating system come into play.
There's an annual goal setting process and most companies have that,
(31:26):
the ninety day goals that they refer to as rocks.
There's a very high level of commitment toward It's like
when you take on that I'm going to do this
in the next ninety days, everybody is looking at its
very high profile. It's online. We have to report to
all of the partners the leadership team's experience, and then
every partner at Bridgeway, that's every person that has a
(31:48):
long term commitment to and front Bridgeway, has to do
the same thing.
Speaker 2 (31:52):
So when I talk about accountability, one of the things
I was thinking about is the company's annual report where
you guys kind of own your biggest mistakes, tell us
about that.
Speaker 3 (32:06):
That's something we started, I don't know, maybe a year
four or five, and it comes around accountability. The normal
thing is this in business or in government or academy
or journalism anywhere. You know you want to learn from
your mistakes, but you don't want to own them too publicly,
right it doesn't feel good. People might ask the wrong question.
(32:27):
We had a lawyer member of our board of directors
at the time that said, you do realize you're like
putting on a silver platter something that people could sue
you over. And my answer to that is like, yeah,
I get that, that's true, but you can't cut it
both ways. You either have to own your mistakes, get
them out in the open, learn from them and make
sure you don't repeat them, or you sweep them in
(32:49):
under a rug. And you just can't do both, and
I choose the former. Our shareholders are investors, our clients
are our boss. We have a fiduciary duty to them.
And I had one an early client say, you do realize,
like I'm your boss and there's accountability there. I should
know what's really going on. And I'm like, I can't
(33:10):
argue with that. That is a brilliant statement. This woman,
by the way, didn't have a high school degree, and
I learned so much from her.
Speaker 2 (33:18):
Huh, really really fascinating. So let's talk a little bit
about what's going on in the marketplace. There has been
a shift over the past twenty thirty years too passive
from active, especially from expensive underperforming active. I don't put
you guys in that category. You've done well, your fees
(33:39):
are are kind of middle of the road. How you
navigating what's going on in the marketplace?
Speaker 3 (33:46):
A few things that I can point to. Number one
is you always have to keep working to stay ahead
of the game and adding value, and that's the research part.
So we like to say small incremental improvements, but it
never stops. Number two, we were an early adapter of
moving some mutual funds converting them into ETFs, so we've
(34:09):
done that. That was painful because it's costly. Out the
other side, it's been helpful for the after tax return
of the shareholders, so big plus there. And those strategies
are both in positive flows, so good for the advisor
as well. And the last one is, you know, don't
make indexing and passive the enemy. What can you learn
from them? So Bridgeway actually came to market with our
(34:33):
blue chip strategy. To really be an index fund, you
have to have somebody else calculating it, and there are
all rules, and we decided we weren't willing to do that.
We just wouldn't call it an index fund anymore. But
it's a megacap strategy that gets off of what I
think of as the inefficient market cap waiting portfolio construction
(34:56):
of almost every index fund, not absolutely all of them,
but we have more than a quarter century real time
data like this has been a mutual fund. Now it's
an ETF converted. You can look at that track record
and draw your own conclusions. But I like to say
market cap weighting is like a momentum strategy that you
never rebalance, so you ride the wave up and then
(35:17):
you write it down, and that's just not very efficient.
That leads to more volatility. This strategy, on average, has
different ways to measure it. Beta standard deviation draw down
of very roughly five percent less than a market cap
weighted index of a broad index like the S and
(35:38):
P five hundred, So a little bit less risk, we believe,
not in every market environment. But you can measure it
over the long term in last decade for example, and
then a little bit more return. And why is that
it's roughly equal weighted, which means you're always investing a
little bit more in what's done poorly and harvesting a
(35:58):
little bit from what's done really well. That's bilos sell high.
Isn't that a basic investing principle?
Speaker 1 (36:05):
That's just.
Speaker 2 (36:07):
That sort of rebalancing is one of the few free
launches in finance. So if you're not doing market cap waiting,
and you're talking about blue chip companies, how you're waiting
the portfolio.
Speaker 3 (36:19):
So we look at the top thirty five thirty six companies,
We make sure that we've got industry representation at the
time of recomposition, and then we're rebalancing quarterly and reinvesting
dividends along the way, and I'll say roughly equal weighting,
so there's some cushion on harvesting from the top. It
(36:40):
can go up. Our rule of thumb is about four
percent is the maximum weight and a strategy. So if
Apple or Microsoft or somebody else is eight percent of
an underlying market cap weighted US index, we're going to
be half of that. But it gives you a more
diversified fund in me a cap stocks, which gives you
(37:02):
some of the downside protection and some of the risk characteristic.
Speaker 2 (37:06):
Well, as we've seen in year to date in twenty
twenty five, the mag seven have become the lag seven. Yes,
so not being full market cap weight certainly had to
have a positive impact on returns. What happens when those
stocks are doing great? How comfortable do you feel if
you're not full market weight of in Nvidia, Apple, Amazon, Microsoft,
(37:29):
as as they're going higher and higher.
Speaker 3 (37:31):
That's the discipline of any investment process in the design.
So know the design of what you're investing in, know
when it's likely to outperform and when it's not, and
then you need to be comfortable with those numbers. But
in that strategy you pointed out exactly when it would
you know, underperform when the top seven you know, and
you know there're the nifty fifty back in the well.
Speaker 2 (37:53):
You and I remember the nifty to fifty in the sixties.
Half our listeners are unfamiliar with them. But people talk
about out the Magnificent seven like it's something new. Yes,
it's fifty sixty years old. We have the same sort
of top heavy market happen when everybody clamoring into the
same sort of blue chips. Yes, being weighted on a
(38:16):
non capitalization basis, having other elements drive the waiting, how
do you manage around that?
Speaker 3 (38:23):
As a disciplined investment shop. We have everything documented in detail.
So there are four portfolio managers on every strategy at Bridgeway.
In theory, any one of the four can step in
and do that job, one because they're trained to do so,
but two because they have documentation of how to do it.
In this case blue Chip, I mentioned there's a quarterly
(38:44):
rebalancing process. There's instructions exactly how you rebalance, how you
take care of unusual situations, which might be a merger,
an acquisition, a spin off. Now a company and you
in the portfolio is no longer one of the top
thirty five, thirty six by size, so what do you
do about that? So those are the kinds of exceptions
(39:05):
that you document, and otherwise it's fairly straightforward.
Speaker 2 (39:09):
What you're describing sounds like a very systematic process to
evaluate securities and build a portfolio. Tell us a little
bit about the things that go into that system.
Speaker 3 (39:21):
Let me shift gears back to global opportunities, which is
which gives you more the full breadth of how we
do what we do with respect to stock selection and
portfolio construction. The stock selection side, as I mentioned, you're
combining factors of value, quality, and sentiment. However, that's within
a framework of intangible capital intensity. And what that's intangible
(39:44):
capital intensity? Yes, so are these things like intellectual property,
patents excesses exactly? Okay, So high intangible capital would be
exactly the things you mentioned research and development. If you
rank them by industry, things that flow to the top
would be the pharmaceuticals, AI software things at the other
(40:05):
end of the spectrum would be things like manufacturing, transportation utilities.
So you think of old economy stocks and new economy
stocks as another way to think about them. But we're
measuring literally ranking these according to intangible capital intensity. The
high in tangible capital intensity ones don't work real well
(40:25):
with the classic measures of value. For example, what we
found is that sentiment is a stronger predictor of future
returns for those so we don't only use centiment. We're
always using the combination, but we're going to overweight the
sentiment part of that. So we have these three categories
of factors underneath, which, as I mentioned before, multiple ones
(40:48):
in the framework of intangible capital intensity, which is original
research that Bridgeway did over a couple of year period
and published papers on. That's the overall framework. Then you've
got in this particular strategy, it's global, and we like
to be neutral exposure on things that we don't care
about or aren't in the design, and positive on the
(41:09):
ones that we do. So what do we not care
about sectors? So we're always trying to move back to
it to be sector neutral, which means the same dollars
on the long side as you have on the short side.
Similarly with sectors, sectors, countries, certain factors. Book value, for example,
as a classic one. Don't like that one as much.
(41:30):
It's problematic for reasons that we relate well.
Speaker 2 (41:33):
Book value doesn't really it tends to measure physical plants exactly,
and so it much more heavily and IP kind of
gets the short shrift there.
Speaker 3 (41:41):
Yes, exactly. So what that means is the industries that
are on the low capital intensative part of the spectrum
tend to do fine with the classical measures of value.
So you can see you put all that together, you
constrain the portfolio according to certain things that you don't
want it to be exposed to. People come and say, oh,
(42:02):
global opportunities, that's got China. I don't want any China.
Well at any one point in time, we might be
a percent or possibly even too positive exposure to China
or negative exposure to China. On average, we're targeting that
zero percent, so you're not going to get any value
add over the long term. Shouldn't be coming from the
actual country or the sector. It should be the specific
(42:24):
factors that we're trying to give exposures to, and that
leads to a much steadier stream of returns.
Speaker 2 (42:33):
That's really intriguing. So I've always kind of thought of
you as sort of a factor shop, sort of a
value shop, sort of a quand shop, a little bit
of everything. Is that a fair Is that a fair description?
I don't want to overgeneralize, but you guys do a
little bit of a lot of things.
Speaker 3 (42:53):
Yes, I would say that that's true. The one thing
that you left out, which is the hard piece and
a significant part of our time, is qualifying the data.
Cleaning the data, especially on the global side. Data is
cleaner in the large caps on the US side, for sure.
And also the model assumptions. There's certain assumptions built into
the model. You get a strong pick. Are the reasons
(43:16):
that those picks of a model come to the surface,
ones that really hold true in the marketplace. Is there
something that you don't know, for example, regulations that have
just come out in a country that are going to
change the earnings and financial characteristics that you care about
with a particular model. So that's part of the work
(43:38):
and the scrubbing, and you know, that's why we chafe
a little bit when people say, oh, you're just a
smart beta shop.
Speaker 2 (43:47):
Clearly there's a lot more going on than just smart beta.
All right, I only have you for a limited amount
of time, so let's jump to our favorite questions we
ask all of our guests, starting with what's been keeping
you entertained these days? What are you watching or listening to?
Speaker 3 (44:02):
One of my favorite recent ones was actually a South
Korean series called The Extraordinary Attorney Wu, and it's a
fascinating study about a woman who's an adult autistic, brilliant
person in a law firm in South Korea and her
(44:23):
experiences navigating a non autistic world and the adjustments that
people do and don't try and make assumptions that people make.
You know, you might think that has nothing to do
with investing, But the assumptions side and the statistic side,
and then the human interaction side, and the behavioral side
is all right there. That's one of my top recently.
Speaker 2 (44:46):
Really really interesting. Let's talk about mentors who helped to
shape your career.
Speaker 3 (44:51):
Several had a mentor that passed away last year, Henry
GROPPI SoundBite from him was respect all people, all the time,
no exceptions. And it's that last piece that's really challenging.
So I'm going to put him as a top mentor.
Had some at MIT advisors there who taught me never
(45:14):
come to my office just bringing problems. Always try and
bring solutions when you can. People that have engaged on
a human level within these that didn't have to. Some
of the better things that I've learned Jack Bogel, certainly
on the cost and structure side, a little gritty, which
is I like, I think that's fun.
Speaker 2 (45:35):
Those are some of momentors really interesting. Let's talk books.
What are some of your favorites? What are you reading
right now?
Speaker 3 (45:41):
Right now, I'm reading two books. One is called People
Dare to Build an Intentional Culture. So you can imagine
why that would be attracted to me. Chapter two of
that book is about love. We don't tend to use
the word love. And workplace they say, well, and more
accepted word might be genuine caring, and so we think
(46:06):
a lot about that. We play the Simon Senek game
of why is why is that important? And underneath that,
why is that important? If you play that game at
Bridgeway of why you're doing what you're doing and get
to a core value, caring frequently comes out among different people,
board members, partners at Bridgeway. The other book is Jason
Swig's recent update on The Intelligent Investor. I'm halfway through
(46:30):
that one. It's it's a thick read because it's really
two books. It's in Benjamin Graham's book and it's Jason
Swigg's commentary on it. It's great and not too long ago.
Speaker 2 (46:39):
I saw you mentioned, was it Dan Arawle's The Truth
About Dishonesty? Yes?
Speaker 3 (46:45):
Right, that's one of my favorite. It might be it
might be a decade old now, but wonderful book on
humility in statistics and in non statistics.
Speaker 2 (46:56):
And our final two questions, what sort of advice would
you give to a recent college grad interested in a
career in either investing or finance.
Speaker 3 (47:06):
I actually had this opportunity just yesterday. It was somebody.
I'm going to guess he was about twenty five years
old and early stage in his career. And my advice is,
people scare you away when it's a declining industry or
not declining, but where feet pressure is increasing. So the
feed pressure has been very strong, different ways to measure it.
(47:29):
But you know, fees are less than half of what
they were a dozen years back, and that scares a
lot of people away. Within that, there's a lot of change,
and within the change there are strategic opportunities. And because
it doesn't attract as many people think supply and demand,
there are great they're kind of even bigger than normal
mature company opportunities and not as many people coming in.
(47:51):
You can make a big difference in that environment. I
think it's fun and fascinating. I would definitely choose this
as a career if I were doing it all over again.
Speaker 2 (47:59):
And our final question, what do you know about the
world of investing today that would have been useful back
in nineteen ninety three when you were first launching the firm.
Speaker 3 (48:09):
Wow, I was a contrarian by nature, but I didn't
understand the dynamics of chasing hot returns and panicking and downturns.
Understanding that dynamic better would have helped, not because not
personally but professionally. It would have given some good insights
(48:30):
for the individual investor. I would say, build your portfolio
and learn how to not pay attention in the downturns.
If it's long term money. And by the way, if
it's not long term money, you shouldn't have it in
the stock market. So it's assuming it is long term money.
The only price you really care about is the last
price when you want to take the money out, and
(48:51):
that wasn't last week or this week. Ever, whether it's
up or down, there's volatility in between. All those numbers
are irrelevant. All you need to know is the last
one the first day. You're going to know that number
his years in the future when you're actually gonna need it.
Speaker 2 (49:04):
Huh, Absolutely fascinating. We have been speaking with John Montgomery,
founder of Bridgeway Capital. If you enjoy this conversation, well,
be sure and check out any of the previous five
hundred or so we've done over the past ten years.
You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever
(49:24):
you find your favorite podcast. Check out my new book
How Not to Invest. The Ideas, numbers and behavior that
destroys wealth and how to avoid them, how not to
invest wherever you get your favorite books. I would be
remiss if I did not thank the correct team that
helps put these conversations together each week. My audio engineer
(49:47):
is Sam Danziger. Sean Russo is my researcher. Ana Luke
is my producer. I'm Barry Ritolfs. You've been listening to
Masters in Business on Bloomberg Radio