This is the basic transcription on episode 9 by Otter.ai
Unknown Speaker 0:09
Welcome to Bogle heads on investing episode number nine and this episode I'll be speaking with Dr. Wesley gray, CEO of alpha architect where he and his colleagues are breaking new ground and the author of three books on quantitative investing.
Unknown Speaker 0:37
Hi everyone, my name is Rick ferry and this is Bogle heads on investing. This episode is sponsored by the john c Bogle Center for Financial Literacy, a 501 c three Corporation. Today we're speaking with Dr. Wesley gray. Have to serving in the United States Marine Corps dark degree earned an MBA and a PhD. in finance from the University of Chicago, where he studied under Nobel Prize winner, Eugene fama, He then took a job in academia before starting his investment management company, where he is on the cutting edge of new insights into factor investing. with no further ado, let's bring in Dr. Wesley gray. Welcome to the show. How are you today?
Unknown Speaker 1:25
I'm great, Rick, appreciate you bringing me on.
Unknown Speaker 1:28
Are you very much impressed me the very first time I I learned about you and I talked with you, the stuff
Unknown Speaker 1:33
you're working on is
Unknown Speaker 1:35
cutting edge. I really believe that you are the new Jedi out there in the quantum world. Before we get into what you're currently doing now, I want to start at the beginning. Where did you go to your undergraduate degree.
Unknown Speaker 1:49
I went to undergrad at University of Pennsylvania at the Wharton School. So I kind of started off with Uber finance geek undergrad and my car. My first one I parlayed my myself into academic researches, I walked into this gentleman's office named Chris gates, he to who now writes a lot of papers on the 200 year history and momentum or relative strength or value or what have you. And I just said, I love this stuff. Can you teach me how to be a professor? And he basically said, Hey, see that shelf right there, grab these 10 books and read them and come back in two weeks. And let's talk that was my initial starting to geek out and getting into academic research and moving along my initial path, which was to be a finance professor.
Unknown Speaker 2:35
But there was also another side to you.
Unknown Speaker 2:38
You had this idea that perhaps you could figure out ways of outperforming the market?
Unknown Speaker 2:43
Well, yeah, kinda simultaneous to decide. I want to be a finance professor. I was also trading my own money doing a lot of investing. I was there from 98 2002. And so that was obviously during the internet bubble. And so I had this exposure where I Come off, you know, reading every book everything I could get my hands on related to Ben Graham and Warren Buffett and the value investment philosophy. You know, pets, coms going up 1,000% a day, you know, my dad's telling me to go by the Janice global tech fund, and sit here, like, I'm a, I'm a value by nature person. And I'm watching these markets, they could they're crazy, obviously trading in value names getting destroyed, but then on the other side of my life, I'm like, Hey, I just, you know, actually liked this. And, you know, I was like, Hey, I should I want to stay this forever. So it was kind of a weird barbell in the sense that I was, you know, sitting there trading stocks. And then on the other hand, I was reading, you know, stochastic calculus books, just trying to get baselines, you know, essentially to be a research assistant for gates. And so what happened is, I kept doing all the investment stuff, kept doing my stock picking. And then, you know, I started essentially, I became For the Wharton finance department, the August I don't want to use the computer monkey, how does like the data monkey so if someone needed to have a, something coated up in MATLAB, that was my job. So like, I can't, it kind of became like a little mini, you know, workhorse for the parliament, you know, so like fast for a couple years. And you know, seeing all these guys are also by the way, Chicago PhDs because for whatever reason, Chicago tends to feed, you know, the Wharton faculty in Christian he is like, hey, you're going to apply to Chicago. And that's it. I was like, well, aren't there other schools like, should I consider other PhD programs and like not you got to go to Chicago. They're like, we'll get you in. And I'm like, Okay. How does that work? They're like a take all your tests and do all your stuff. And it will write your recommendations letters. And then So sure enough, you know, I applied to your Chicago PhD program, just straight out of undergrad which is also not Normal because typically you go get a masters or what have you. But I had a lot of kind of close holes in the department that were writing letters for me, in PhD programs, they only accept, you know, handful people every year. So it's a much more kind of one off deal. It's not like applying to an MBA program. Long story short, I got in, like, wow, I guess I'm going to actually do this essentially entered the program in 2002. The Chicago School at the time, and it still is, to a certain extent, it's just, we're going to take you in, and we're just going to beat you up, like you are going to get destroyed in problems. That's workload. And let's just see if you survive. And so the first two years are just literally I was studying like 15 hours a day, seven days a week just trying to stay above water, because I came in obviously, without having a lot of experience or grad school or what have you. So it's actually a pretty difficult And so after the first two years there, I, I don't say I was burned out, but I was 24 I'd been slaving away doing porn academic geek stuff forever. And I just thought, hey, I need to maybe take a break or do something else.
Unknown Speaker 6:17
So you, you really did do something else, I would say that what you did was quite radical. And of course, I'm proud of you for it.
Unknown Speaker 6:24
So what I did is I decided that I was going to join the Marine Corps, which you're alumnus of. And it certainly seems radical. But what was super interesting at the time, is I would say good 20 to 30% of the Chicago finance PhD program. Were actually former military officers a lot of them from Israel or, or Finland, or what have you. So they were all like, Oh, yeah, of course you should do that. Whereas many people outside are like, but you must be the first time anyone's ever done that. But it was super interesting is inside the program like my other fellow PhD Mater like hey, that's, that's pretty cool. And so yeah, I went down to Professor Fila and at the time Professor sailor who, which is crazy it has these two Nobel Prize winners were actually like the, you know, it wasn't my dissertation, but are my curriculum paper advisors? And I just had to ask them permission to get a four year sabbatical in Professor farmer was actually like, super cool about it. He's just like, Oh, that's awesome, like, proud of you. Yeah, happy to sign, you know, didn't even think twice about it. And then your professor Taylor, he was more curious. He was definitely like, you're going to what? But eventually, I got both those gentlemen to sign off and then submitted it to the PhD program coordinator and took a four year sabbatical.
Unknown Speaker 7:46
That's amazing that you could actually do that take four years off.
Unknown Speaker 7:49
Well, you so you can you can take technically one year off. And so that's the reason I had to go and have them sign off on this special kind of extended sabbatical. Because it was a unique circumstance where most people don't go on sabbatical to do service, the PC program director kind of agreed, like, Hey, this is unique circumstance, as long as you get your, you know, advisors to sign off on it. We're cool with it. And so I had to do a few extra hoops to jump through to actually make it happen.
Unknown Speaker 8:20
Well, that's great. And then you went down to Quantico and went through Officer Candidate School.
Unknown Speaker 8:24
Yep. So then I went OCS which is Officer Candidate School, then went to TBS, the basic school, and then my MLS was a ground intelligence officer. You go through your job corps, you kind of do everything that the officers do, and then they go pick up their platoons, whereas ground intelligence officers then go down to damn neck and do another six months of intelligence officer training, and then you go hit the fleet. So it's the longest pipeline Besides, you know, Hilo and 6 million people. But you know, it's about a year and a half, almost two years of trade. pipeline.
Unknown Speaker 9:01
And from there, they shipped to you off to
Unknown Speaker 9:03
open our I went right to Okinawa and then right when I was in Okinawa, they sent me down to one of the islands in Japan, and did a bunch of like joint training missions with them spent about a month there. And then I got sent directly down to the Philippines. And at the time, this was, I think, was at 2004 2005. That were there's a bunch of activity going on on this island called holo, which is a bunch of Muslim extremists and what have you, but then there was this thing called the late a mudslide disaster and a coup. So I, the Philippines, you know, going crazy for a couple of months there. And then right when I got back to Okinawa, which I was assigned there, but I rarely ever hung out there for like maybe a day or two. The colonel calls me and office and he's basically says, hey, you're going to Hawaii? And I was like, all right, what am I going to Hawaii like They're like, Oh, you're on a MIT team, a military transition training team, and you're going to get deployed to Iraq. So that, you know, then I went out to Hawaii did a big workout. And then yeah, then we deployed out, I was on one of the training teams read in bed with Iraqis and try to help them avoid shooting themselves in the foot.
Unknown Speaker 10:18
Back to you wrote an entire book, about your experience working with the Iraqis the name of the book was called embedded. And it was a fascinating insight into what was going on.
Unknown Speaker 10:29
Yeah, so I kind of went in to the service. I didn't join the service because I want to go to war, per se. I just, I just wanted to do my time. But I'm certainly under the belief when you probably remember but Colin Pollock showed that little powder of that white powder and said, Hey, we're all going to die. Kind of believe that. I was like, all right, we need to do some hair. Fast forward. Now. I'm actually deployed, living in an Iraqi battalion training of these Iraqi soldiers to You know, kind of take over their defense duties. And I really got opportunity to, you know, actually live with these people, either these people talk to these people and kind of get a better insight to the culture and kind of how they operate. In that experience, honestly just floored me and I took a whole 180 right, I said, I don't know what we're doing here. This is crazy. Like, I was not expecting this, these deeper tribal, they're totally different. Like, what we're trying to achieve here does does not jive at all with their society. I need to tell the story because there's probably a lot of guys like me that you know, rah, rah, let's go to war in you know, they don't realize it so so that I just got inspires like, I gotta share the story. So I had just read a whole book basically, about my time being embedded with the, you know, Iraqis and just trying to explain like their cultural nuance, and why what we were trying to do like, you know, bring freedom and democracy to their society, you seem like a, you know, maybe it wasn't a great idea. That's pretty much what that that book was about just sharing my experiences there, which were, you know, highly enlightening to me and I just wanted to make sure other people got to really experience it through at least my book, even if they can't be there themselves.
Unknown Speaker 12:20
I understand that you speak Arabic and that you taught yourself.
Unknown Speaker 12:25
I did. So I mean, I could probably conversion it as if I got warmed up. But yeah, so I was the intelligence officer in the more I read beforehand, it because I knew we were going to warn these areas that like, you know, speaking Arabic air, like the actual language there is it means a heck of a lot more because its associated with the religion, you know, because it's, you know, from a lot, so, you know, it's kind of a big deal. So the more you want to win in those sort of culture wars, you got to really, you know, establish bonds with the people you're working with. And so learning the language is thought was a main effort. So yeah, I just put a ton of time up front to train extremely hard, you know, both on learn how to kill people in everything, but also how to learn this language. And then when I got there, I just forced myself to literally in bed with the people and not use a term. And then, you know, if you sit there long enough and get tired of using hand signals and not understand each other, you know, eventually you can start maneuvering. So yeah, I got to a point where I actually serve as a Terp for our team, and we were convoys, and I would be the tariff, you know, to interface between our team and the Iraqis. Yes, and I definitely highly recommend, if anyone, you know, has to do that mission ever again to spend way more time learning the language and lot less on, you know, tactics per se, because it gives you a lot more, let's say, with what the Iraqis called wasps, like, you know, kind of Carmen and the ability to interact with them and have them actually listened to you. If you actually their language.
Unknown Speaker 14:01
That's fascinating. Well, you did that. Did you stay for four years?
Unknown Speaker 14:07
Yep, did my did the four year active duty?
Unknown Speaker 14:10
And then after that, you went back to the University of Chicago.
Unknown Speaker 14:13
Got out what it was, like, early 2008. And then I just I, my mind will, you know, being in services just obviously, way different than being in a PhD program at University Chicago, so I got out. Yeah, yeah, kind of like what at it and so literally, for the first three months, I just had to relearn everything because my curriculum paper had a bunch of math in it. And honestly, I can read my own paper. I was like, I don't even know what this person is talking about. But it was me so I just I just put the basics I'm like, hey, here, I gotta relearn calculus, all this stuff. And it is true that it is like, you know, riding a bike where you know how to do it. If you just get you know, back into it, you do quickly learn. So, so yeah, re enter the program. Move back Chicago. And you know, I was in much more like, it was in discipline mode versus a lot of my, you know, comrades there at the PhD program who were in students because I'd kind of come out with a new look on life. So I was like, I'm getting out of here in two years. And because usually you don't get out of the PC program and in a collective for years, usually it's five, six years, but I just didn't want to mess around. So I spent three months relearn everything, and then I nearly went to work on dissertation. So yeah, and that because I my goal was I need to get out of this by 2010 or my wife's GZ not going to be happy living on a ramen noodle salary for for longer than that.
Unknown Speaker 15:44
And who was your mentor on your dissertation?
Unknown Speaker 15:49
So I so I went back to my old curriculum paper visors, and it was sailor and pharma were the top two and then another gentleman, Andrea for z. Who's also famous now but he actually left and went to AQR so when I came back basically for Xenia already gone to go be a you know, millionaire over AQR sailor gotten to famous, so he was gonna mess with PhD students anymore. So really, what I was left with was fama because he was the only link in the chain that hadn't been broken. So, so essentially went to him. And he was kind of like, you know, my core, you know, advisor and then another gentleman Stavros panic. Yes, he helped me a lot because he had a theory paper as well as part of my dissertation. Pietro Viren, se was another one since I had a handful of them but I'd say the most influential in obviously the one had the most experience in political asset pricing work was obviously Professor farmer. So he was kind of a the one that haze me the most I would say in the dissertation writing stage.
Unknown Speaker 16:56
Your paper, if I'm not mistaken was about active management.
Unknown Speaker 17:00
Yeah, so you know, being a marine and probably a little hard headed, I came back and I'd always been like a standing before a stock picker, specifically a big believer in value investing in value investing, stock picking. And so what I decided was, I want to highlight to Professor pharma that, you know, active stock picking can add value, because this whole efficient market thing seems a little too crazy to me.
Unknown Speaker 17:26
So you're gonna tell Eugene fama, the future Nobel laureate that he was wrong,
Unknown Speaker 17:32
is at least out that was my going in. And so what I did is like, well, how am I going to highlight this? Well, it turns out that there's this organization called value investors club, where a bunch of super sophisticated stock pickers a lot of them associated with hedge funds, they would submit huge theses on Macy stock pitches, right so you know, Best Buy's undervalue. Here's my DCs. Here's the hundred reasons why. And so what I thought is like, hey, I've been following this club Since 2000, I'm a member of this club. You know, I think they add a lot of value, they seem to have really good ideas. I'm going to read every single one of these stock pitches, systematically interment a database and do the quantum analysis on it to then assess, hey, do these people actually add value or have clinical alpha? Long story short, they do at the margin? And so I submitted this, you know, as part of my dissertation, and somehow by the grace of God, you know, agreed with the dialysis he had some quibbles on, you know, takeaways, but at least at the margin, I highlighted that there is some segment of the market where, you know, active stock picking might work at the margin. So that was a small victory for me.
Unknown Speaker 18:49
How did you meet up with jack Bogle who you ultimately became partners with alpha architect?
Unknown Speaker 18:54
Sure. So what happened is, is when I graduated from the program, there Went on the academic Professor market. And they're also my wife was going on the academic market. She's a PhD in history, which is a way less, I'd say marketable profession than being a finance professor. So I went out to market and my wife's from Philly. And she needed a job as a history professor. And I ran into Drexel, who gave me what they call an exploding offer. So they gave me this offer I couldn't refuse. It gave me three days to decide on it. They say, hey, come to Philly, your wife's from here, we'll get her job. And we'll give you the best gig ever. And we'll assign you a PhD student who will do all your dirty work. So I was like, Okay, well Sign me up. You know, what are you gonna do how often you gotta twist my arm? So I interject sold and then part of my package was having a dedicated research assistant. And that happened to be jack Bogle. So just by circumstance and a lot of great luck, you know, I just Had a gentleman who was you know, insanely smart, extremely well and are extremely good at computer programming and doing all this data analysis and we just hit it off immediately so we've been working ever since you know 2010 when I took that job so the
Unknown Speaker 20:16
way I understood it was you know, jack had read your dissertation and he said yeah, all this is great these these people have alpha they've they're they're outperforming the market but I can replicate that using a computer. So are they really outperforming the market can you tell me about that?
Unknown Speaker 20:35
Well, yeah, so so that was that was an insight that that that actually I had before I met jack and kind of the takeaway from will the interesting takeaway from the dissertation was we cannot all this data on these individual stock pickers and it's sure enough they had alpha your relative to you know, fama, French miles, what have you, but essentially what they were Doing for all intents and purposes was small cap value investing in certain element of concentration because there's only so many ideas that they would produce. It's not like you go by 500 names at a time. So there used to be like five or six ideas a month, sometimes 10. So on a rolling basis, this portfolio would have anywhere from 50 to 100 stocks. So but for essentially what they were doing from a quantum perspective is buying smaller stocks that were super cheap, generally higher quality and doing it in somewhat concentrated fashion. And sure enough, you could also just have a computer essentially do the same idea, right, concentrated, small, cheap quality. And lo and behold, it basically replicates what all these stock pickers were doing, which was certainly the road was kind of disheartening because at the time I was still kind of believing in stock picking because I was thinking stock picker. But that kind of analysis there proved to me, why am I saying in my head against the wall so hard to you know, do these dissertations on these stocks when you can essentially replicate a lot of the you know, the core ideas with just use an algorithm. And so that that was really kind of the the straw that broke the camel's back as they say, they moved me much more heavy into just pure quadrant and less into, you know, thing I was going to be Warren Buffett, I think the proof was in the numbers.
Unknown Speaker 22:34
And jack Bogle, your research assistant was doing a dissertation similar to that.
Unknown Speaker 22:40
So Jack's dissertation was a little bit different. So what he looked at is there's a huge argument over whether value investing which in define an academic term just means buying cheap stocks right on book the market or price earnings or what have you. He was looking into argument is this is a risk based phenomenon? Or is this a behavioral based phenomenon? Where just to explain the two ideas simply, the risk based hypothesis essentially says that the reason cheap stocks earn higher returns is because cheapness is a proxy for fundamental risk. So the reason you're getting paid more on average is because these stocks are just fundamentally riskier. The behavioral argument, which is on the other side of the coin, is like, no, it's not because the stocks are riskier. It's because the market generally throws the baby out with the bathwater. And that's more related to a mispricing story that, you know, sentiment, you know, throws these names out and beats him up too bad. And so his dissertation was about how do we empirically identify whether value is risk, or mispricing. And the short story is that it seems like if anything, it's more likely mispricing versus risk that explains the value premium. In obviously, this is highly debatable, but that's what his dissertation was all about.
Unknown Speaker 24:07
And after all of that, you decided you were going to go out and create a company together.
Unknown Speaker 24:12
Well, kinda it actually all this happens simultaneously. And it's one of the probably the craziest stories in our industry. So right when I actually got my job, it actually was during the time I was on the professor markets, at the time was writing a blog. And obviously, my dissertation is out there. I got cold call by a very large real estate family in New York and the sun had been put in charge of essentially managing it was around $4 billion. It's like their liquid wealth. And they were in the middle of just living through 2008. And they were big and hedge funds, big and active management, and they got smoked and they're like, we're firing every one of these people. We're going to take control of our wealth. We're going Do this in house. We're going to do croissant. We need someone to help us and he had just been out there googling around some sounds me, and he calls me up. He's like, Hey, can you help me manage them is $4 billion? We were to use computers. I really like your dissertation. How do we do this? So went up there, madam. Again, this is all at the same time I'm sitting here like thinking I'm going to be a professor. It gives I wasn't 100% sure if this would actually lead to anything, but initially kind of led to like a basic consulting gig, where the gentleman said, help me for a couple years. If you guys do a great job, you know, we'll we'll see your business on the asset management side because because they just got out of the whole Asset Management hedge fund world, they're like, we're never going to see it or do that ever again. And then I was putting ask on the table, so but they said, Hey, give me two years. And so since I kind of helped them initially, and then I got jack involved Amelie, because it kept scaling up bigger and bigger and in After two years, in 2012, they essentially seated $20 million in, in the quantitative value strategy, which we have a book about. And then very quickly, they ramped it up to 50. And they put the other part in the international quantitative value. And this was all going on simultaneous to when I was being a professor as my day job. It just things kept happening in the background. So it was very hectic time in my life, I would say,
Unknown Speaker 26:29
and you were having children at the same time.
Unknown Speaker 26:31
Yeah, I was I was up to two and we're working on three. And yeah, it was getting crazy. And then essentially what what happened is after I think was around three years into it, like this was clearly becoming a real business because we were managing $50 million managed account, we've got like a huge consulting contract. I'm also date, you know, moonlight now at this point, basically, as a finance professor, and I was just thinking, hey, I need to One way or the other hair. And so I talked to my boss address the head of the department, I just told him I was like, Listen, I, I think I need to resign. But I don't want to screw you over here. But you know, because recruiting for professors is like a total nightmare like at least like a one year cycle. So he's like, hey, put in one more year, so we can least recruit for your position, and then you can, you know, go out into the sunset. So that's essentially what happened. I after my third year, being a prof for all intensive purposes, I was all in on the business, but I was still technically professing until they can recruit for my position. And then then, you know, basically kicked me out the door. Another interesting thing along the way, is through this whole time period, it wasn't just this large family office. For whatever reason, people like what we were putting out there. We were just being super transparent about putting our research putting our ideas. So a bunch of random rich people would call us up and say how do I do this? And we'd say, well, we have a managed account. That's how you could do it. And so we can't build the business up. We do tax loss harvesting to try to minimize tax impact, because everyone we're dealing with was is taxable money, and not our thing happen along this way. Another couple hundred million gentlemen out in the Midwest, we're working for them as well. And he had a tax problem. And it was wearing situations where he had a low basis stock that was going to get bought out by a large conglomerate for cash. And he was very afraid that he was going to have to incur like a huge capital gain event. So he says, Go figure this out. And you know, this is like one of these impossible things were like, hey, go figure out how to not pay tax but you know, the rich guy says jump, you know, I say how high and so that's what I did. I went on this mission how much this problem in a rarity into a gala at a bacon structure product in this is not Sunday. could really do any more but but it was all related to the ETFs structure. And I started learning about how the ETFs structure essentially allows assets to come in at mark to market basis, the ETFs can then don't you know, any asset out even if it has low basis onto a market maker with no tax liability, and it's essentially kind of a laundry mat for capital gains, liabilities, and just, you know, a light went off in my head, like, holy cow, if I'm doing strategies that involve trading and turning over in taxes, or, you know, essentially Uncle Sam's 50% performance fee. You know, this seemed like a good idea. So, long story short, we doubt in around 2014 we say we're going to get into this ETF business, because we thought it was a better structure to deliver these, you know, concentrated factor portfolios than doing them an estimate with tax loss harvesting.
Unknown Speaker 29:55
Just out of curiosity, all that works, it did on the ETFs Structure of how it yep. But the creation and the redemption, how you can push out any unrealized gains on to the authorized participants. You had that one client in the Midwest who had this big capital gain problem. And then you had this ETFs here. I've always wondered, is there any kind of a structured product? Or can they be a structured product where you could take people who have the stocks out there and put them all together, and bring it in and just issue them shares of an ETF and then take the stock, then that they put in kind into the ETF, and then give it to an authorized participant to get rid of and now their cost basis? is in the ETF? Yeah, it's diversified is is
Unknown Speaker 30:40
that possible? Yes. Yes. And no, the long story short is, in the old days, yes. But what happened is, all the big banks got smoked out on a bunch of tax things a few years ago, and they just caught off anything that could even be perceived. As you know, being on the edge because they didn't want to make Treasury angry. So my understanding from the inside baseball of talking to people that that deal in this world is in the old days, they would actually do stuff like that for for like super ultra high net worth clients and you know, where they control like the the cussing and clearing pipes. But my understanding is nowadays, that doesn't go on. But I certainly feel like an enterprising entrepreneur that had the time and energy to try to figure that out. It could be possible. We've looked into it from like 50 different angles and have mil figure it out. But yeah, there's certainly there's something there. I just haven't solved it.
Unknown Speaker 31:45
I believe there's something there too. I believe that, you know, this thing called direct indexing where you can, you know, you buy 250 or 300 stocks and then you individually sell off the ones that that are at a loss and do a tech swap in at the end when that's all played out. For Five years down the road, when there is no really longer any ability to do a lot of tech swapping, you've got this portfolio of 200 300 stocks that have low cost basis, but that looks an awful lot like an index. So yeah, if you could just take that and just turn that into an ETF provider, and get shares of a more diversified ETF with a cost basis of the ETFs is the cost basis of all your stocks in aggregate, but it's a lot more easy to manage one security than 400
Unknown Speaker 32:30
Yeah, so Yeah, I agree. 100% and I get insights all the time with people arguing over you do you do you do the ETF structure Do you do the tax loss harvesting structures? in you know, it's, it's kind of I still believe there's a marginal benefit, like even if you're doing pure passes, like say for example, like the parametric solution like s&p with tax loss harvesting, or just go by the vanguard fund. I still believe that the veins It's fun is better, because a lot of people also forget into your point that eventually you get basis and everything. But the index changes like firms get bought out for cash, guess what you can deal with that prominent ETFs structure. You can't if you have security, right, like if you have low basis and you know, Joe Blow wants to buy the company out for cash, you're going to eat tax liability that's easy to cleanse in an ETF. So I think and then there's the fee differential, like those tax loss harvesting solutions are, you know, 20 3040 pips, you know, an s&p 500 ETF is basically zero. So if you're new at times that cost differential over, you know, the life of investment, you know, the lump sum of that's maybe two 3% of your wealth like that makes sense? Probably not. You know that the value of the tax loss shield you're going to get? I don't think so. So, I think tax loss harvesting direct indexing is total hype. overblown versus just buying the passive index or an ETF structure for zero, that that seems like a better long term solution to me. But I agree, people can disagree.
Unknown Speaker 34:12
Let's move on a little bit. So all of a sudden you decide you're going to launch alpha architect and you open the world headquarters, which I've been to several times now.
Unknown Speaker 34:23
Yeah, for sure. So, so the original world headquarters was in a little house I had in New Jersey. But that was five minutes from my mother in law. So both my wife and I agree that hey, was probably move a little bit further away. So we moved over here to the Pennsylvania side. And at that I'd spent a year doing a commute from Baltimore to Philly when I was first year as a professor there because we still had a place down there. And it you know, I came out as service i'd swore off commuting, because I actually wanted to hang out my kids. I like exercising. So I said, You know what, I'm going to set up a business in my head. house and if people don't like it, like that's fine but it's good for my mental physical health it's going to make me operate more efficiently. Why not? And so we bought this place out in Pennsylvania it's kind of a compound of sorts. And now it's your alpha architect global headquarters. But yeah, since we just built an office inside this residence you know God zone and everything and you know, start off with obviously no AUM hardly at all and you know, now we're have almost a billion but you know, it functionally achieves the goal, we keep our costs down low and it keeps commuting time down, so we're stuck with it. So it's a bit awkward, but in the, in the world of, you know, zero percent management fees, you got to do weird things sometimes. And understand some interesting artifacts went along with that house. Yeah, so so we got this place from a big game hunter, who was basically Had a tragic situation he had pancreatic cancer. And he was basically going to die in three months. So it was kind of a liquidation opportunity of some sort both the House and our friends we have, he was a, like I said, a big game hunter. So we acquired a grizzly bear leopard and much other really cool taxidermy mounts, and one of which we keep in the office, the grizzly bear, because we like to say that, you know, we try to kill bear markets, and we have evidence of it by having our grizzly bear here. So it's definitely a unique experience, visiting alpha architect headquarters.
Unknown Speaker 36:38
It was for me because when I first time I went to visit you I'm driving down this residential street and I'm saying this can't be it.
Unknown Speaker 36:44
Yeah, we've had many of very, very wealthy people and a lot of famous folks roll through here with that exact same expression, but it's the world this guy talked me into Why am I hanging out in a residence in the suburbs of Philadelphia? Is this person crazy or what?
Unknown Speaker 37:07
So things have gone? Well, you've launched several ETFs. And the way in which you do ETFs and factor investing, I find it to be kind of the right way of doing it. It's almost like the next generation factor investing because it's so deep and so concentrated, that if you want to do factor investing, that it seems to me, you should be paying for as much exposure to these factors in a in a concentrated form as you can get. So it appealed to me right away when I found out, you know how you were doing it?
Unknown Speaker 37:47
Yeah. So essentially, the the genesis of this idea is, when we're working for the family office, they were going to do the typical thing where they're like, let's go buy our cheap beta. They we need to figure out how to replicate a lot of these different exposures that we used to get from these hedge fund people. And hedge funds obviously aren't doing like cheap beta stuff. They're usually doing concentrated bets in, you know, with stock picking. But what's essentially is factors like small value quality, but they're doing in a much more focused way. So we naturally thought, Well, if we want to replicate these more unique exposures out there, we need to replicate them how they need to be replicated, and that means we're going to do maybe factors but we're not going to hold 500 securities and focus so much on how how close this tracks the index, we're going to do 50 stock portfolios, and just tell people up front that this is not a closet index, with a little tilt to like the value factor. This is pure value, where we're literally buying the cheapest, you know, 40 or 50 These securities on you know, are, you know, a different metric we use enterprise multiples, but keep it simple, like PE ratio. So yeah, and that's just what we did. And we just told people up front of the downside, which is, of course, the tracking error and the relative performance, that this stuff can bounce around both good and bad, you know, over long time periods, and should just be prepared for that. It's not the vanguard fund, and we just wanted to deliver it, you know, transparently, affordably, and be very upfront about the potential pain associated with the style of investing.
Unknown Speaker 39:37
And I think that's all very interesting. Let's say that you want to have a slice of your portfolio to additional risk factors. And the reason is additional risk factors is because I actually interviewed Jean fama one time, and I said, yo, you know, if beta beta is a factor, so what do you call these other things? You call them Smart beta, do you call them? What do you call them a nice his answer was they are additional risk factors. So there are additional betas. I said, Okay, yeah. So let's say you wanted to expose you to something other than beta. I guess you could do it by going long. Short. You're right. But that would be expensive. In many ways. Yeah. So long, only what you're doing is very concentrated and you keeping the cost down.
Unknown Speaker 40:26
Yes, that's right. So you got it. So So the concept, Professor farmers point in our portfolios are constructed in a way that is much more akin to how can academics form portfolios, and that's what all the evidence shows like, look how great they are. The idea is, we're not going to go long, short to your point, because it's much more expensive to run operate in just access those exposures. And so it's a we're going to stick on the long side, but it's not going to be broad mark. Beta exposure, it's going to be some beta, obviously because it's long only, but we're going to focus as much as we can on capturing. You know the value risk premia, or the momentum risk premia. And again, it's very important for us to communicate this element that this is a risk premia. And this is very different, because frankly, the biggest issue with doing different risk is that they're different than what a lot of people see on the news channel, like on the sp 500. And if they're not mentally prepared for that, you know, they're oftentimes going to be in at the wrong time out at the wrong time, and kind of ruin the whole reason for holding additional risk for me, which is to help your long long term performance and to kind of diversify away from just owning, generic beta.
Unknown Speaker 41:50
The UU and I went back and forth on Twitter a little bit about what What does the word long term holding mean? You know, how long How long is long and I think I said it A lifetime and you said no, it's only 20 years. And I said, Okay, we will compromise at 25 years. But, you know, this idea of holding these factors for a long, long time is really critical to the success of an investor.
Unknown Speaker 42:16
Yeah, it's just the advice from a Vogel's is actually timeless and it applies everywhere. Like when he talks about holding, you know, equity, he doesn't suggest you should go buy the s&p 505 or VT or VTI and just you know, traded every year he's like, no, this is like basically your permanent holding, because you want to capture the equity risk premia will same thing here. We're trying to capture, you know, some specific factor risk premia. And the same advice applies, you're not going to capture it by trying to time it, day traded, bounce around all over the place. You've got to hold the thing and actually earn the associated risk premia with it. Which means you need to look at it more as a long term strategic holding, and not as a, you know, kind of a short term trading vehicle, because that's not what it's really designed for.
Unknown Speaker 43:12
So let's get down to the nitty gritty than the bottom line on all this, it's going to cost me more money to go after those additional betas because they have to pay a fee every year. That's higher than the basically beta is free now. Yeah, so anything other than beta, which is now free out there. I'm going to use it to add additional betas or additional factors to my portfolio. Using Yeah, using your funds, but your funds are not free. Your funds have cost. So number one have to get over that hurdle rate of the cost. Yeah. And the thing out there called a where we talk about it as an alpha decay or a premium decay that's going on as more and more people are doing what you're doing. There. Yeah, seems to Be a decay going on as to the expected return from these additional factors, can you? Yeah. Can you see that? Have you measured it to? What are your funds going to produce? Because I have to take money out of beta to put it into the additional factors they have. Yeah, literally, oh, it's a long only. So I'm taking a slice of my total market index fund. And I'm going to add to your fund, and I'm going to pay you a higher fee. And yeah, I need to at least get beta, which I know I'm going to get in the market. Yeah, I gotta get above and beyond that. Is it worth it?
Unknown Speaker 44:40
So yeah, so that, that there's a lot of questions in there. And it's all about costs and benefits. So in general, when you look at any of these sort of factors, like the cheaper you can get them, the better, right? And a lot of times the price is going to be associated with the scarcity. Have Said factor if if something has massive, insane capacity? Well, at the margin, that's something that Vanguard can deliver at scale. An example of a factor like that might be market beta, right? That's obviously something that has trillions of dollars a capacity, you can jam tons of money into it not not infinite amount of money, by the way, but you know, in general, that would make sense. But then there's other sort of strategies where if you're actually going to do the actual factor, like, for example, like what we do 40 stocks, you know, mid cap, lot of times small cap weight, like you just can't jam a trillion dollars into that strategy, right? So there's going to be a natural limit on capacity, which means you can't just scale it to infinity, which means the cost can't be free, because gotta pay the fixed costs and the bills and operational things for running this damn thing, right. So that's just kind of the economics of Generally capturing any exposure that doesn't have infinite scale. The second question relates to, well, what do these premiums actually deliver. So for example, value, let's say, and you could do value investing just generic, let's just call it low p investing, you could do it one of two ways we'll just make up one way is you could go buy a portfolio of, say, 40 stocks that have low PE. Another way is you could go and wait, you could go take the s&p 500 stocks and kind of tilt more weight towards the low p less way to the high P. But our net, you're basically not really doing much you're kind of tilt in one way or the other. So clearly, the potential value add from the so called value factor is going to be a lot higher in the concentrated one than in the diluted one. So that's one element like how's the thing constructed, but then the other important element is is this premium Going to pay off in the first place. Because if let's just say value just doesn't work at all, well, then if I have it in a concentrated format or having a diluted format, it's not going to do anything for me. And that gets back to the question of, well, why does a factor pay off in the first place? In because it's an open secret? And because a lot of people know about it, and because a lot of people are perceived to be doing it, will that make it decay? Will why that's we got to step back and say, Why did these things get why did they pay off? in historical sense? Well, value generally paid off, because the farmers point it's riskier. So unless you were to believe that risk preferences have changed, then one would probably want to believe that exposure to the value factor will probably pay off at some point in the future. Currently, it hasn't paid off very well in the last five or 10 years. But just like generic market beta doesn't pay off all the time, you know, it's had 1020 year jobs as well. There's a reason to believe from economic perspective, that value will pay off. Just because a lot of times it's fundamentally riskier. And then the second point is that if someone is going to do value, and you believe even in the mispricing component of value, like they people throw the baby out with the bathwater. There's this aspect of what they call career risk. So just because everyone knows about something, doesn't mean they may go and do it. Because if you go out and buy concentrated portfolios of value stocks, like right now, it's very likely that you have a high probability of getting fired. Because these things can bounce all over the place. You know, you're going to get destroyed by the s&p 500 sometimes and people think you're an idiot, and you get booted out of the you know the job. So this is its own where we call career risk. premium. So to the extent that, you know, a lot of people are, quote unquote, doing these things, but these strategies earn premium for a reason, ie, they're risky, and they stink to do, one would expect that over the long haul, they're probably going to earn some premium. I don't know what that will be, you know, historically, like a concentrated value portfolio like, like what we're doing, you know, maybe, I don't know, maybe three to 4% over like a generic index, which is going to be being sourced from being smaller being cheaper. You know, for the most part, let's say that cuts in half to 2%. Right, because at the margin, it gets more efficient, that you may earn this 2% premium, but this is not like an arbitrage. This means you're going to deal with probably more risk, probably more evolved, probably will definitely way more pain and anguish in a relative This sense to like common benchmarks, so you're probably going to earn this return. But then the question is, well, how much does it cost me to access this 2% Premium? Well, if it cost me 200 pips, that's probably a bad idea. Is it cost me, you know, zero? That'd be a great idea. Right? And then and then there's somewhere in between. So what we do is like, on our stuff, we, you know, for the domestics, we charge 49 basis points. So just under 50 bets, which is obviously, way more expensive than zero. I wouldn't call it outrageous. But the idea is, we're the bet on our stuff would be Hey, over the next 20 years, do I believe that the excess return associated with the factor exposures that I'm getting here are in excess of 49 basis points? If not, then why would I do this? If so, okay. I might want to do this. But then the second question would be will Can someone else deliver it even cheaper? Because maybe Vanguards got some concentrated value factor fun for 30 minutes. Right. And the process is very similar. I like it. Well, okay, I think I project it's worth 1%, you know, over the long haul or 2%. You know, it cost me 30 minutes here, I'll go to that one. Right. So so it's just it comes down to the trade off between, what do you expect this premium to pay off or the long haul? What do I gotta pay for it? And obviously, you want to pay less and earn more as best you can. Which is what I argue a lot of these people that do factor investing are doing today are not buying and holding, you know, our fund for 20 years, they're like day trading, you know, the shares, factor funds that that's not that's not arbitrage, extra premiums, that's, that's in the end, probably contributing to make them even higher in the future. But that's a baby speed dating factor funds rather than
Unknown Speaker 52:01
Unknown Speaker 52:03
Yeah, yeah, exactly that the only way you can pull premium out of the market is you need to have massive amounts of permanent capital sticking in something because it's kind of taking supply off the market. But if all you got is more day traders, you know, throwing money around sloshing around and factors, that's not arbitrage going away the factor that's just money sloshing around and it's adding volatility to the factor but unless that money is like all many Warren Buffett's, you know, holding for 20 years, through thick and thin, it's not going to depress the risk premium associated with them, or it'd be very unlikely to do so. And I frankly don't see that sort of mentality amongst factor investors in the in the marketplace. Nor do I see that as an incentive for product manufacturers because they're, they're in the business of of activity. So the more I can get you like day trade Do this and the other thing that's, that's good for the business out there. So I think people have an incentive to promote activity in factors. And you've written a lot about this. You've got three books
Unknown Speaker 53:13
out there, numerous papers, the books are quantitative value, quantitative momentum, and then DIY Do It Yourself financial advisor. I've read the book and
Unknown Speaker 53:26
it's not as easy as I think you make it out to be in that book how you can do all of this as a do it yourself investor, but
Unknown Speaker 53:33
Well, yeah, I would say just like a Bogo heads, you can go review to start here, here's how it's done. And yeah, you can read it and there's the cookbook, but at the right price, sometimes people will still like, you know what, thanks. I really appreciate the transparency. I understand what you're going to do, but I have better uses for my time, and rather pay you to do this for me. So but there are people that definitely are DIY, but there's certainly a lot People, you know, like my grandma, for example, where she's probably, she's probably not well suited to DIY, even if she read the book and thought it was cool because her grandson wrote it with a bit of a misnomer on the title.
Unknown Speaker 54:14
We're coming up on the end of our time. Just like to switch gears here for one last second. Could you talk about your march for the fall and, and what that's all about?
Unknown Speaker 54:24
Yeah, so March, the following is a 20 mile March held at the Pennsylvania National Guard Training Unit. And the the idea here is, you're out there representing for on behalf of those who lost loved ones in the military, so we're supporting Gold Star families and people who have lost people in war. It's not a charity in the sense that you give money. It's a charity in the sense that people that have lost their loved ones like to know that other people are remembering and honoring the fallen. So that's what you're doing. there and your charities, kind of your blood, sweat and tears to represent and, you know, let them know that we still appreciate, you know, sacrifices they gave as a family, and to go out there and hang out. And it's a great cause and you meet a lot of great people. And I really enjoy, you know, promoting it and trying to encourage as many folks as possible to come out.
Unknown Speaker 55:21
And if somebody was interested in joining your group, you you've got a pretty large group that you've put together.
Unknown Speaker 55:27
Yep, so you got so last year we had around 150. This year, I imagine will have probably 200 Plus, all you got to do is you want to be on notifications, obviously, reach out direct or just go to alpha architect comm slash MFPS. There's a whole website about training plans, nutrition, how to sign up and all these sort of other things. And all you gotta do is just show up, we take care of lodging and Chow and I think it's like 35 bucks. You got to pay to the National Guard. So very low cost. super efficient, great cause you mean a bunch of great people. And I think everyone should at least do one time in their life.
Unknown Speaker 56:10
Thank you Wes. It's been a great conversation. I really appreciate you joining us here on Bogle heads on investing
Unknown Speaker 56:15
you got it's been an honor and keep doing what you guys do over Bogo had the love education and and love the effort for DIY investors out there.
Unknown Speaker 56:24
This concludes the ninth episode of Bogle heads on
Unknown Speaker 56:28
investing. I'm your host, Rick ferry. Join us each month to hear a new special guest. In the meantime, visit Bogle heads.org and the Bogle heads wiki, participate in the forum and help others find the forum. Thanks for listening
Transcribed by https://otter.ai