In this episode, Jared visits with Phil McInnis, the chief investment strategist at the $100B+ asset manager Avantis Investors, to break down the science and art of building better investment portfolios. They explore the realities of passive vs. active investing, why fees and structure matter, and how to think about risk and uncertainty in today’s markets. Jared and Phil unpack what it even means to be an "evidence-based investor", exploring the key levers that matter most when constructing portfolios designed to optimize long-term returns.

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Welcome to Financial Planning for Oil and Gas Professionals, hosted by certified financial planners Justin Brownlee and Jared Machen of Brownlee Wealth Management, the only podcast dedicated to those of you in the oil and gas profession to help you optimize investments, lower future taxes, and grow your wealth. Learn more and subscribe today @brownlee wealth management.com.

Welcome back to another episode of FBOH G Financial Planning for Oil and Gas Professionals. This week I am excited to welcome Phil McInnis on the show.

He is going to talk to us about the science and, and I would argue the art, too, because nothing in this world is ever really one or the other, but he's going to kind of help us talk about the science of investing. Phil, welcome to the show. Excited to have you.

Thanks, Jared. Really, really excited to be here.

Awesome. Well, I would love to kind of give our audience a little bit of background about you and then for you to share a little bit of your story.

So, Phil, you are the chief investment strategist for Avantis investors. Right. And $100 billion. Right. Just recently crossed 100 billion. And then not pretty recently.

Yeah, pretty recently. Close to the end of last year. And it's, it's kept going. You know, markets are pretty volatile right now. We might talk about that.

But we, we, we eclipsed 125 at one point. So it's been, the traction's been good, the growth's been good. We're, we're really excited about it. Wow. Remarkable.

And it's a newer company, so, you know, kind of a, kind of a swift, a meteoric rise, if you will. And I'd love to talk about that as well as well. But so Avantes Investors is a company under the American Century Investments umbrella.

And, you know, Avantes, I'd love for you to share a little more about your background and then maybe talk about Avantis a little bit, you know, talk about you and your investment journey and kind of how Avantis fits into that and what Avantis does.

Sure. Yeah, absolutely.

So I got my, my introduction to buy side capital markets was probably, it was a little after leaving university and I had done some stuff on the structured asset finance side.

That work was kind of interesting, but wanted to have something that was a little bit more, I'll say, sort of bigger picture, kind of full picture, and happened to find an institutional investment consulting firm that was looking for analysts in Atlanta. So joined that, that would have been back in summer of like 07, so a while ago now.

But that for me is sort of the proper introduction to Buy side capital markets. And those were a couple of pretty formative years for me.

I mean number one, if you think about that summer of 07, there was a lot going on there and get into the fall then you had 08. And so I'm sort of very new in the industry.

And you got the global financial crisis, firms kind of collapsing or getting bailed out, all these things. So there was a lot to really take in right off the bat.

And as an institutional consultant, we represented a lot of large asset owners and so there were plenty of people who wanted to come and really kind of meet with us, right. And talk to us. Even though I didn't know anything about investing or even a little bit maybe I thought I knew, I probably didn't know enough about.

But we got to hear all these perspectives from these really large personalities and really in some cases famous investors. So it was a really good way in my mind because I, I saw every asset class, I saw really every style of investing, so many different styles.

So it allowed me a lot of perspective, A lot of perspective. At the same time, one thing that was really impactful for me is we were also sitting down with these pension plan investment committees, boards.

So you had teachers, you had firefighters, you had police officers, folks who had been appointed to help oversee their colleagues and beneficiaries retirements. And so there was a massive obligation there, a huge responsibility. And seeing, you know, folks that didn't have an investing background, right.

Didn't have a capital markets background, being faced with these complex decisions and we're there hopefully, you know, trying to help with those.

But you know, you have somebody who comes in and starts talking about zero cost collars and you know, forms of derivatives and hedge funds and things and you sort of see some people's faces as like, what is this? What's going on here? Right. Yet they're still tasked with a decision.

So that was really impactful for me in terms of the communication of how important it is to have that level of, of transparency and being able to break things down in a way that hopefully is really digestible and understandable and still remaining true to what the strategy is. Because I think it's a tough thing to ask somebody to invest in something that they have no idea how it actually works, right?

That is an immense amount of trust that you're going to be placing in somebody. And investing, financial services, a business, there's already a massive foundation of trust that's required.

And so that idea of really I grew a significant appreciation for that in those years if you follow my personal journey, there's a woman who's involved, who I follow a lot. So my wife, where I end up geographically, has a lot to do with what was going on with her as well.

So I tell this story a few years in, I got promoted from analyst to consultant at this firm. And the same day she got into grad school in Austin, Texas. And we were living in Atlanta at the time.

So we both came home with great news, at least or so we thought. And then we both had a little bit of a realization of, well, we're gonna have to figure something out here.

So it happened that over time I needed to find a way to be in Austin, Texas and ended up joining a firm there. Dimensional Fund Advisors spent better part of a decade there in a variety of roles.

Another kind of great introduction to a different way of investing. So spent a lot of time there, gained a lot of friends, gained a lot of knowledge.

But one person in particular who I spent a lot of time with was Eduardo Repetto. So he was, when I joined, he was CIO and co CEO there. And we happened to, I got staffed on a project kind of working with him a little bit.

So I got some good luck in that, I think. And turned out we liked the way each other worked. I tell people it's a lot more important he liked the way I worked than I liked the way he worked.

They've been a great partner for, for us. Their, their ownership structure is, is unique in the sense that the controlling shareholder is actually a medical research institute.

So happy to talk a little bit more about that. But 40% of our dividends each year go to funding that institute that's focused on gene based diseases. So something we're really, really proud of.

But with Avantis, you know, the, the idea for us has really been trying to help help people build better portfolios. That's, that's really what it comes down to. So there's a way we go about doing that.

I know we're going to talk a lot more about that, but the idea for me is, you know, there is a, there is a science part to invest in, there's an art part to investing. There's that sort of balance.

And, and for us, we just want to help people build better portfolios, help have those, those better long term financial outcomes. And yeah, the 125 billion in six years, we're blessed. But we're just getting started too, so we're excited.

I love it, I love it. So much good in there that we're going to kind of unpack.

I think one of the things I love about what you said is you talked about, we use this word in our firm, we call it reference. Right.

The fact that people would accumulate their lifelong earnings and they would come to you and say, hey, there's all the acorns I've squirreled away. Help me, help me use this to get to the finish line. And like that astounds us and like we take that seriously.

Right.

And there's a gravity to that.

But it's also kind of interesting because part of like, you know, you got to explain it and teach them this, but also part of the reason they're paying you is because they know what they don't know. Right.

So there's this kind of duality of, hey, I want you to, at a high level understand what's going on and you need to have belief and conviction in your portfolio.

But also you don't need to know all the inner workings and whether or not this fund structure in, or how you're screening profitability or you know, whether it's a blended valuation metric or enterprise, the ebitda. Right. Like none of that should be there.

So it's kind of this interesting mandate that we have of teaching people, but also, you know, teaching them enough that's a productive amount. Not expecting them to know what us math nerds like is everything related to portfolio construction.

I think that's right. I think that's right.

I, I, I've always viewed it as if you're sitting across the table from somebody and they're a prospect for you, you're hoping to have them as a client.

I try to approach it from what is it that you need to be comfortable with what it is that we do to have a level of understanding that you're confident enough in it.

And in some cases if you ask sort of a couple of surface level questions and you're able to demonstrate some expertise, some capability, I think some folks that's, that's enough for them, they're like, okay, because they're going to do some of their own due diligence too and look at things. But you know, we have pretty low fees, we have pretty well, diversified portfolios, you know, they're pretty low turnover.

So there's a few things right off the bat where we can say, look, here's some things that you can expect from us that our strategies are always going to have. And I think that that can create a really strong foundation. But then the idea of, look, if you'd like to go deeper, that's why we're here.

You know, we want to make sure you're comfortable. And from that standpoint, I think the sort of, the managing, the setting and managing of those expectations is really critical.

We talk about the idea of it's okay to be disappointed by your investment results.

It is not okay to be surprised by your investment results because, and that may sound like similar things, but I, to me, those are very, very different things.

Because what, what I never want to have happen is that you have somebody, you know, who we're working with, having to sit in front of their client, you know, and, and say, yeah, I didn't, I didn't know this could happen. That's, that's not a place that you want to put anybody in.

So we want to be really clear of what we're setting out to achieve in a portfolio and how we're going to do that so that hopefully there's that alignment in expectations in those longer term outcomes.

Exactly right. And like, the best portfolio is one you can stick with. And all portfolios are going to have bad times.

So if you don't understand it, that's like a prerequisite for you abandoning ship at the worst possible time.

Absolutely. You have to know, you have to know what you're signing up for.

You have to know that there's uncertainty and markets throw a lot of uncertainty at you. You know, we're living that right now. There's heightened levels of, of uncertainty in the marketplace.

And I think people can sometimes come to very, very different conclusions about what to do about that uncertainty. Some, some people want to try to control absolutely all of it. Say I want to, I want to squeeze the uncertainty out of this equation.

Well, the uncertainty, the, the fact that the uncertainty is there is part of why you're able to earn a risk premium, right? Why there's some higher expected return that's in there over what you can get if you just put your money in t bills.

And so there's another sort of lens to that of like, well, we have to kind of embrace the level of uncertainty. Right. And that's what's able to generate some of these returns for us.

Then we have to Figure out a way to make sure we can deal with the uncertainty as people. There's things we can do in the investment side to limit that level of uncertainty, to have proper forms of risk management.

So we are taking unnecessary levels of concentration or unnecessary levels of risk in pursuit of this outcome. But, but risk is there. Risk is absolutely going to be there. That's, that's why we have that, that, that chance at a point.

Right. And I think everybody thinks about downside risk, but there's up, there's upside risk too. Right?

There's, there's a positive, there's a positive surprise and there's things you can do to compress the range of outcomes, but you might not actually like that because, you know, you can't one directionally compress outcome. So you have to, you know, you can limit upside and downside. Those are, those are kind of connected.

Phil, I'd love for you to kind of talk about, and I kind of disagree with the fundamental premise of this question.

Let me caveat with this, and we've talked about in past podcasts, there's not really anything as a, there's no such thing as an actually truly passive investor. But on this spectrum of passive, I'm just going to like low cost Vanguard, buy the market every two weeks, not think about it.

And then Active, where I'm kind of actively picking securities or overweighting, underweighting certain parts of the market or companies. Or I might, I might run all US Equity, which is only a small percentage of the global investment universe. Right. There might be a ton of reason.

It's a, it's a wide, wide spectrum, as you know. And so we're somewhere in the middle. I think the, it's in the eye of the beholder a bit as to where exactly on that spectrum we land.

Because in many cases, sometimes what you're dealing with in, in navigating this is perception. Sometimes you're dealing with biases. Labels have baggage. People have baggage from, from labels.

So the, the going back to, you know, sort of the formative experience I had as, as a consultant, we really try to break it down and, and say, well, look, here's, here's a definition of active, here's a definition of, of, of passive, and, and really try to define those terms that then start to connect to what it is that, that we do. So one way that I think is really simple about doing it is if, if you say passive. So passive is zero. Tracking error.

Now, tracking error is kind of a, a technical term, right? But the idea that you're going to perform differently than the, than the index, right? That's, that's really what tracking error is, is a measure of.

So it's sort of like a relative standard deviation kind of a deal.

And so the idea that if we're, if we're not wed to an index where we're going to match every single company that's in that index at the index weight, then we are taking active risk, we are taking tracking error. So from that perspective, right off the bat, you are an active strategy.

But then there's the idea, well, how are you deciding which companies you're going to hold and how you're going to weight them? That gets into. There's many different types of active management, right?

There are folks who are trying to look at, well, which sector do I think is the best opportunity right now? And they're rotating across sectors in the market.

There's others who are going company by company and saying, as you said, I want to find the 50 best opportunities in my mind that are going to form a good portfolio and I'm going to start there and then I'm going to see is there anything I need to do to diversify or is there too much concentration in a single name? Those types of things.

So there's those types of strategies at Avantis, what we're really trying to do, I think any strategy, what's important to recognize is any strategy has to, at the end of the day, they have to decide. There's a portfolio manager who has to decide what companies am I going to hold and how am I going to weight them and then how do I rebalance.

So if you're evaluating an investment strategy, be it index based, be it active of any different sort, some are referred to as more quantitative, some fundamental. Whatever it is, you want to make sure you understand the answer to those three questions.

Which companies get into the portfolio, how do they get in, how are they weighted and then how is it rebalanced and what's the logic behind that approach?

If you can really have a strong foundational understanding of what that is and it makes sense, do you understand the role it's going to play in the portfolio? I think you are setting yourself up for a much higher level of success in terms of being able to use that strategy effectively.

Then if it's just, well, what are the returns that it generated over the last three years? Oh, that looks like a really nice return relative to these other things.

Why don't we assume that they're going to keep generating that return and, and start allocating? Right. So, so I, I come back to that. We're, we're avantis bits.

When you think about, you know, how do we select which companies, how do we weight those companies and then how do we think about rebalancing?

For us, the, the main idea is if we start with a style neutral universe, meaning I'm not going to constrain my universe to only low price stocks or high price stocks. I'm going to say let's just look at the whole picture, the whole universe and start with market cap weights of those securities.

Then the ones that I'm more interested in have a good price multiple relative to their equity position. So we're looking for a lower price relative to the level of equity in the company. And equity is just assets minus the liabilities of the company.

So we're looking at that. But at the same time we want to make sure that the company has decent profits, right, decent profitability.

So we're looking to try to get the best combination of those two things as we assess across the whole range of companies. And then we have strategies that do this in slightly different ways.

Meaning in some cases we build what we call value portfolios where we're just focusing in on maybe the top quarter of companies in that universe that look more attractive.

Or we have strategies that are buying most of the companies in the universe and then overweighting or underweighting, that's how we're improving the expected return profile in the portfolio. But in both cases we're going to do it in a really diversified way.

But you know, it's good businesses with strong enough balance sheets, good enough cash flows, those are the ones that are going to end up in our portfolios and at higher weight. And then it's about keeping that exposure through time.

I would love for you to talk about, I love the three, the three pronged approach of like how you think about investment selection, investment universe creation, Portfolio Management 101. As an, as a portfolio manager, I'd love for you to talk about some of the cons of passive, right? Like pure passive.

Because I feel like, you know, early on investment manager value was active selection. Then a ton of research came out and basically said, hey no, no, that's a cost friction. Plus these people can't manage their behavior.

So they're, you know, they're selling at the worst possible time, buying at the worst possible time, right? So like it's, it's, it's pretty easy, especially with like a lot of our audience. Like everyone comes in with like, hey, I'm vanguard, I'm all in.

I like low cost and like, which I believe is really a net benefit compared to, you know, the option of picking an active portfolio manager and paying 120 basis points for that. But I'd love for you to kind of talk about some of the cons as to why you might even start to deviate from the passive in the first place.

The growth in indexing has been pretty phenomenal, right?

If you look over the last 10, 15, 20 years and you look at the share that quote, unquote passive makes up in the universe, it's far greater than it was and probably for some of the reasons that you mentioned. And there's, there's a lot of studies that are out there, right?

There's the SPIVA results that look at what, what is the percentage in any of these asset classes that active managers that have outperformed the benchmarks and those, those long term numbers, they don't look so good for, for many of the categories in terms of how, how the average active manager, most of the active managers have performed.

Bill, you're putting that nicely. It's, it is brutal out there. It is abysmal, right? Like the, yeah, the data is not on your side.

I tend to try to be diplomatic in those, in those things, not be too extreme in how I describe things. But yeah, your comments, fair, it doesn't look good.

But with that said, one of the things that I think is left out of even something of a study like that, so you have to think about the impact, the fees right off the bat. And you said it right.

So let's just assume that I have two strategies and they buy, you know, the exact same stocks and hold them at the exact same weights and one manager charges 1% to do it and the other manager charges a quarter of a percent to do it. Well, the one who charges a quarter of a percent relative to the one who charges a percent is going to compound at 75 basis points more a year.

75 Basis points more a year over a full investing timeline. A 15 year, 20 year, 25 year, 30 year horizon. That's real money. That's real money.

So the concept of fees and how much fees matter in this equation, if you got a bunch of really, really high cost strategies that are in those universes.

What all a really, really high cost strategy is guaranteeing is that they have a really high hurdle rate they have to overcome each and every year to be able to beat the benchmark. Right. They're already starting sort of, you know, the, the, the index has a head start, the passive option has a head start.

That's one of the reasons why we have low fees as a pillar of what we do. We, we want to have really as we think as fair cost as possible. We're, we're not trying to match the returns of indexes.

We were absolutely trying to exceed the returns of indexes. And if you look at our results on balance so far, we've done a pretty good job of that.

So we have a lot of conviction, our ability to do that over the long term. But we want to make sure that the fee level is one that people can stomach and feel good about and feel like it's good value for that money.

So that's a really important kind of component.

But when you think about passive, to get more directly into your question, when you think about some of the passive strategies that growth in index based investing that I was referring to, and you talked about all these different types of investors and things, there's a lot of growth in index based investing. That is not people saying, I am not going to make any active decisions here. I'm just going to put my money in the market and let it work.

So a lot of the growth in indexing has been people putting together different components, different index funds. So you have index funds that just cover large cap stocks. You have index funds that just cover mid cap or small cap stocks.

You have index funds that just cover a specific sector or a specific country. In some cases you have index funds that cover a style within a universe or a country. So think about large cap value indexes as an example.

Well, there isn't just one large cap value index that's out there. There's many, many, many different large cap value indexes that are out there. And somebody has to define what those indexes are.

They have to have a definition for, well, how do I decide if you're a value stock or if you're a growth stock? How do I decide where I draw the line of are you mega cap, are you large cap, are you mid cap, are you small cap?

Those, those have to be defined as rules. And so they're active decisions that somebody is making. In these cases it's somebody who works at an index house as opposed to a portfolio manager.

Right. So Sort of, they're, they're creating the recipe, and then the funds that track those indexes are in charge with the implementation. Okay.

I know what stocks I have to go buy on a given day or sell on a given day to try to match the returns of that index. And the issue that comes into that is it's, it's quite mechanical. Right. So the idea of, I won't mention anybody by name, right.

But there are some index providers that they only rebalance once a year. So the way that they control turnover is constraining how often they trade. So we're going to trade once per year in terms of the rebalancing.

Now, I don't know about you, right. We're, I know you're in Fort Worth, I'm in Dallas. We're both here in Texas in, in March.

It's kind of a mild day outside, so maybe we'd be okay in this instance.

But imagine, you know, we're somewhere where it's a 100 degrees today, or we're somewhere where it's 5 degrees today and we're deciding what we're going to wear for the rest of the year based on the weather today. I think about an index fund that is going to rebalance once a year and looking at stocks and assessing. Where should I put you?

Where should I, where should I group you based on how you look today? It's like trying to pick your outfit based on the weather on one day a year and then you're signing up for. That's my outfit for the year.

That's what I'm wearing. And there's going to be a lot of days where you're hot, a lot of days where you're cold. And that's not a great outcome. Right?

That's not a great outcome. There's many, many other ways that we can control turnover in a strategy and have it be, be a way where we're not spending a lot of money to trade.

Right. We're really controlling how much we're spending in terms of, of going and affecting turnover than just only trading once per year.

So that's one example. There's, there's a lot more I can give of how some of the mechanical natures of it, we think you can improve upon it.

And there's more technology now to be able to improve upon.

You know, passive investing has been kind of positioned as like the poster child of scientific investing.

But if you deconstruct the formulas for index constitutions, you realize getting back to this art versus science tension it's actually way more artistic and almost sometimes even arbitrary. So the turnover and kicking a position out, adding a new position wasn't a quantitative or mathematical decision.

It was purely just based on how this index has decided to constitute itself. People have decided this one is in and this one is out.

We try to do is, you know, there's, there are, I think about it as there are principles, there are aspects of more of an index based approach or index like approach that are good characteristics for an investment strategy.

So that's going back to the idea of transparency, of low turnover, of low fees, that those things are, are all things that I say, look, I, I think they should be a hallmark of, of any investment strategy that, that we build.

But then when you think about there, if you think about more that traditional active kind of approach of well, how much do I want to consider valuations as I'm deploying capital across companies? We would argue you absolutely want to consider valuations as you're deploying capital across companies.

And then well, how should I think about maintaining that exposure and keeping an eye on the portfolio? We would absolutely agree that you want to use the most up to date information you have as you do that.

So you want to have oversight each day in the portfolio.

So I think about it as borrowing concepts from multiple disciplines and then trying to combine those in an effective way that gives you hopefully the best of all worlds. Gives you something that's comprehensive and thoughtful and good value for money.

I love that. I'd love for you to kind of just riff on that idea a little bit more.

Like we're talking about this idea of one of the ways you talked about pulling from, hey, we like know broad diversification, low turnover, low cost, all great things, but kind of blindly following an index. Like, right, like what, what are the, one of the reasons you might deviate from the index? Right?

Like, like you said, the hey, the price you pay matters also the profitability matters. You know, how, how did you kind of come to decide that?

You know a ton of people could develop different reasons as to why they might deviate from a, from an index.

Why fundamentally for, for Avantis is, is, is that kind of the, the two things of hey, I really want to focus on these as the, what I would call the active share, the reasons we're deviating.

You can get to this conclusion from a couple of different starting points or, or paths. The way, the way that I, I find I talk about what we do a lot. Obviously that's a, that's a big part of of my job.

So making sure that it resonates and, and people can, can get a good grasp of is something that's really important to me. So I a shot. And if I do poorly, I'm probably gonna get some really negative feedback from my colleagues. I'm gonna try not to do that.

But, but if, if I'm not measuring up to your standard of communication, then, then challenge me on. So here's the way that I think about it.

If you've got, if, if I were sitting in a room and trying to come up with sort of the, the best stock idea or just I was told to evaluate an individual company, right? So somebody gives you an individual company, go ahead and see if this is a good investment.

Well, you think about that process as an investor, what you're going to do, you're going to have access to financial statements and those kinds of things.

But when I think about fundamental investing, because there's a lot of different approaches that are out there, people will look at different things, they will weight different considerations.

There are some things like the quality of the CEO, some people will really be honing in on that and their vision, what they think they're going to be able to do with the company.

So there's, there's a, that's one example of hundreds or thousands, but it, to me, it really doesn't matter when you think about all those different kind of characteristics or things that folks are, are looking at, maybe what they believe, their specific edges. The, the, the tenets of a fundamental investing process are what? I have to do a discounted cash flow analysis on that business.

I'm going to take the projected future cash flows of that business, right. So, and I can use today's as a, as a proxy. I might have growth rates that I'm making into it, whatever it is.

But I'm going to project those cash flows out into the future. They are subject to some uncertainty. So I'm going to assign a discount rate to those cash flows to bring them back to today.

I am also going to look at the assets and the liabilities of the company, right. I have to look at the balance sheet and I have to look at the cash flows and I'm using all that information to arrive at a price target.

So I'm going to come up with my price that I think the company is worth and then I'm going to go and compare it to the market price. If my price is lower than the market price, I'm not interested in that company. If my price is higher than the market price.

Oh, that sounds like it could be a good deal. That is the, the fundamental foundation of, of active management at Avantis. What we think about is, that's a really strong foundation to think about.

That's really what valuation theory is about. And a lot of this factor research and things is about.

What we're really interested in is the concept of those discount rates, because the discount rate in our mind is a really good proxy for your expected return as an investor. So what I'm looking to do is say, well, which characteristics do I need?

What are most important in helping me discern which companies have more attractive or less attractive discount rates, AKA expected returns today? And the ones that have more attractive expected returns are the ones I'm going to want to either focus on or overweight in the portfolio.

And so in that sort of ecosystem, I was laying out, the price that the company's trading at is one thing that's pretty important. The equity that's in the company, those assets minus the liabilities, and then those future expected profits.

Those are three things that research shows you.

And whether that's empirical evidence, whether that's theory, it all shows you that those three things matter a lot in terms of the expected return of those companies. So what we're doing is we're, we're distilling down across many, many, many, many companies, right?

We're doing this across thousands of companies, across more than 50 countries every day, but discerning and distilling down into, well, how attractive does this company look relative to a measure of equity and this measure of profits? And then, and then starting to orient the portfolio towards the ones that are more attractively priced to those underlying fundamentals.

And then there's other things. We're looking at things like momentum and those things and paying attention to trading costs.

But that idea, it's the concept of being more valuation aware. So that's the fundamental tenet for us as far as how do these companies get into the portfolio?

And then the process of rebalancing is making sure that each day we're going back and looking at the universe again and saying, is something significant changed here that might make me want to change the portfolio?

And the idea is really small adjustments each day, as opposed to wholesale changes that we would make in a portfolio, but keeping it there, keeping it there over time.

And then the aim is that having that more valuation aware approach means you're going to compound at a higher rate than the index over long time frames.

Yeah, yeah. How do you think about that as it Relates to, right. People talk about market efficiency, right?

And one of the ways, and I'm this, I'm curious what you have to say about this. Like, the way I think about it is the markets are efficient, but the markets aren't always rational. Right?

And then the other thing is like, like people are investing on different time horizons. Like, like if these, like, why is it, why aren't more people doing this? And right, like how, how is collect.

Like, why, how has collective wisdom led us astray? If people say, hey, you know, because basically the price we see today is a function of a buyer and a seller, right? And hopefully based on flows.

And I mean, if they're passive, probably less educated, but there are still like active share, right? A bunch of buyers and sellers in the market coming to what they think is a fair price.

How do you reconcile that idea with, you know, the markets being efficient, if you will, and kind of reflecting all the information that's available?

When you think about market efficiency or the efficient markets hypothesis, I think, you know, one thing that's really important to at least my interpretation of it. Right. All this is open to some level of interpretation because we, we can each read the exact same paper and draw very, very different conclusions.

But so I'll, I'll speak about my interpretation.

If you think about the efficient markets hypothesis, it doesn't tell you about whether companies have differences in expected returns or expected discount rates. It doesn't really say anything about that. What it says is that prices are reflective of all aggregate available information. Right?

That's, that's really what it's saying. And so I don't think that just because markets are, you know, we can argue, are they, are they efficient? Are they perfectly efficient?

Are, you know, strong, semi strong forms? Right. We can get into, into a little bit of that debate. But are prices perfectly right 100% of the time?

I think, I think it's a, it's a really hard thing to say that all prices of all companies are 100 right, 100% of the time. Right? That's kind of reminds me of a Voltaire quote that I'll probably butcher if I try to remember.

But it's like, you know, something about uncertainty being in an unpleasant condition, but certainty being an absurd one. Right. So the idea for me is our markets, how much information do prices have?

I'm a big believer that market prices have a ton of information in them that we absolutely want to put to use and we can put to use in building a portfolio. But that doesn't say anything about My ability to. Or our ability to try to deliver a return that's above and beyond that market rate of return.

That doesn't tell, that doesn't tell you that the market is efficient or inefficient. There are structural things we can do right there.

I think about coming back to just algebra fundamentals of companies that if I give you two companies, they have the exact same price, they have the exact same level of equity, and they have the exact same profits. Well, I should say one has more profits than the other. The one with more profits. The market has decided to discount those at a higher rate.

I might not be able to tell you exactly why, but I know that that company has a more attractive expected return. So that's how I kind of put them in juxtaposition together. And I'm okay with the way that that foots that they can both exist together.

They can both be true.

Yeah, I love that I kind of tried to trap you there with like a false dichotomy. It's like, yeah, information is available, but also participants are like, everyone's playing different games, right. And humans are going to human.

And that's over optimistic, overly pessimistic, and reality is probably generally somewhere in between.

But I love, I love kind of that idea of, hey, both of these things can be true by, by declaring, hey, I'm going to take advantage of this widening discount rate. Doesn't mean that I think this, these prices are just incorrect.

Yeah, yeah, that's right.

Awesome. Well, I'd love to kind of talk about, you know, this idea like the tracking error, right.

Because you talked about like, hey, we're, we're going to deviate from a given benchmark. Right. And when you deviate to, to, to be, to win long term, which we'll call, we'll define as beating a benchmark, you have to be different.

Right.

If you own the benchmark inherently, you can't beat it because you own it. Right. So you have to be different. And being different is hard. And there is inevitably times you will underperform.

Right.

Like, I love this, I love the, the fact that these two things.

Berkshire Hathaway is just such a great example of this because everybody knows Warren Buffett, he's like objectively one of the greatest investors of all time, right? Of course I'd throw Jim Simons up there and Jim Simon up there and a couple other people. But like ma investor, he is the, he's the goat, right?

And over like a, you know, over a 60 year period, a third of the time he underperformed, right. And so when, when an investor inevitably underperforms for being different, they come to one of two conclusions.

One is I am in a bad investing strategy and then the other one is I am in a good investing strategy that is out of favor, right? Like, you know, at any given point you could have watched Warren, you know, lose a year and be like, man, he's lost it. He's gone and gotten out.

So, so those, so those single years where he underperformed were kind of just noise for, But I'm curious for someone as they, as they start to go on this journey of maybe deviating from a benchmark for whatever reason they deem.

Important,.

What solace do you have or advice do they have? As they inevitably have years when they underperform, because they will.

It can be, I'll start by saying it can be challenging.

And any investor who is out there, who is nervous or what have you of you have a strategy that is, that is underperformed and that, that doesn't feel good like a strategy underperforming. I guarantee you it doesn't feel good for the manager. It certainly doesn't feel good for, for the investor. It doesn't matter the, the period of time.

It could be over a month, it could be over a year, you know, it could be over, you know, three years. What, whatever it is, it's, it's not going to feel good. But I think you have to come back to what did I hire this strategy to do?

You know, what, what was sort of the thesis and the, the goal and the objective when, when I hired it. And that gets back to that setting and managing of, of expectations that I believe is just so critical.

Because if you, if you hired a specific tool, you know, for a specific job, then what you really want to make sure you're doing is evaluating it in terms of its job. And some, and there, there can be really good benchmarks that can help you do that. There's also a lot of really bad benchmarks that are out there.

One thing I don't think that is spoken about enough is, you know, in, in the industry there's, there's a lot of funds that have benchmarks that make absolutely no sense for the actual strategy that they're putting out there and putting to work. It's not a great comparison.

So you have to kind of come up with your own benchmark in my mind of how, of what you're, what you believe the strategy is trying to achieve. What's, what's a good way of being able to inspect whether or not they did their job well.

What we try to come back to is make it very, very clear of what we believe our job is, what we're trying to achieve in a strategy and then show you how did those characteristics do.

So they're baking in massive growth expectations into these companies. Those companies are not going to come through our screens as attractive ever. Right? It's about more what are you accomplishing right now?

That's something that we care a little bit more about. And so in that case, if I'm sitting down with somebody using our strategy, I want to be very transparent about that.

I'm going to show them the numbers. Look, these are the companies that did well that are not really of interest to us. But you didn't hire us to buy those companies.

You hired us to find good companies with good underlying prices and good profitability. And that's what we're going to keep doing. So there's a, there's a really important piece of what did you hire us to do and are we delivering on that?

Because look, anybody out there that promises you a return, I turn around and run the other way in my mind, because there's way too much uncertainty that is out there, especially talking about equity markets, right. When we get into fixed income.

And if you're able to completely duration match your liabilities, whatever you can get, you can start to have a little bit more certainty around, around something like that. But if we're thinking about equity markets, so in those instances, it's the idea of, here's what, here's what we're setting out to do.

Here's the conviction level, level that we have and, you know, test us, right? Ask us for the updates and everything else, and we'll show you, we'll show the attributions, we'll be clear.

But long term, we expect, we expect to win. And so far, that's worked out for our clients, that's worked out in our strategies. But the underperforming. It's going to happen. You said it.

It is absolutely going to happen. What we want to avoid, because I think the worst thing that can happen in this ecosystem chain is that people bail out at the exact wrong time.

And that can be in a strategy, that can be in an asset allocation or an asset class, that can be in an asset allocation. There's many, many levels. And I'm sure, Jerry, you all deal with this all the time.

If you're putting together a total asset allocation for a client, you have to really be thinking about that. Of is this an asset allocation that we feel like they can stick with longer term? Because.

Because if not, you know, if they're going to bail out at the wrong time, then we really have to kind of rethink that in the context of their goals. Because people jumping ship at the wrong time is the absolute worst thing that can happen.

Yeah, totally agree. Yeah. Suboptimal allocation you could stick with is better than an optimal allocation that, that you can't. Right.

I think one of the things you're touching on is just it's so important, right? Like, it's, it is going to happen. So getting back to why is it happening? And then kind of like, okay, how is it happening relative to what?

Like the rules of engagement in which I'm playing, right? Because like, if you're, if you're actually building a diversified portfolio, each piece has a respective job, right?

And again, you're not gonna, you're not gonna come at the end of the halftime to the point guard and be like, man, you need 500 more boards than you had, right? Yeah, you should be getting some rebounds, but that is also not your job.

So Just like I think I love that point thinking about like the attribution and hey, what role did I define for this? And I think that that's part of investing too.

If I actually have a diversified portfolio, you know, if, if I knew how the world was going to unfold, I wouldn't have a diversified portfolio.

Any of our strategies that invest across like multiple countries, like if we have a non US developed market strategy or an emerging market strategy, what we do is we set them up so that you're kind of getting the country weights that are in line with the index, right. And then we're looking for the more attractive opportunities within each country.

So we're comparing companies within a country as opposed to across countries.

And that's an example where it's, if we're talking a year from now, whatever else, and over the next year you look at attribution or strategies and we have it a five times weight in one country and a half weight in another country. Like that's where you would have every right to raise your hand, be like, what, what are you guys doing?

This isn't, you know, this isn't what you, how you said you added value, right?

Those types of things like be able to get back to how is a manager saying that they're going to add value and then hold them accountable to that, right? Like what is it that, that you're doing in, in the strategy that, that alignment, I think is, is it incredibly fair.

But if, if there isn't that understanding, then I think you're really coming off of a more of a, you're leaving a lot of things to chance, which I don't. There's, there's enough uncertainty out there. We already talked about that. I'd rather not leave that to chance.

Yeah, exactly.

So like, you know, we talked about kind of like, you know, there will be periodic underperformance and I know Warren Buffett had three year stretches where he underperformed. How might somebody like begin to think about like the long term?

Right.

Because these things can go on for a while. Right. Like I love Mev Faber talks about this. There's been a bare market in diversification, right. The last 10 years it has just been US large growth.

Right. And so, but also investors are quick to forget that was preceded by a decade where US large growth had no, you know, no real return.

So I'm curious how, how might somebody begin to think about like long term when they think about being a long term investor. What does that mean to you, the.

Tongue in cheek as long as you're willing to give it and probably longer. So I, I think, I think about the concept of as much as, as much as we'd all like to think we're, we're special in the eyes of the market, we're not.

So, so, you know, Jared, I think you're special. Hopefully you think I'm special, but the market doesn't think either of us are special. Right?

So from that standpoint, the ability to, and this is one of the reasons why we think it's so important for investors to work with advisors like yourself is because the context of everything really matters. I used to not really tell people what I did.

If I was getting at like a friend's wedding or whatever else, I wouldn't tell people what I did because inevitably, you know, as the reception's going on, we were saying, so, oh, well, what, what stocks should I buy? Right? What do. What, what stock should I, should I, should I add to my portfolio?

And not that I'm, I'm not happy to have that conversation, but it's just, I don't want to have that conversation over and over and over again at a, at a wedding. But the idea, when somebody says, where should I put my money if I don't know anything else about them? That's a really hard question to answer.

Maybe an impossible question to answer.

You can maybe take some shortcuts, but the engagement interaction that you all have with your clients and really sitting down and getting a sense of what, what do you want to do with your mind, right? What are the goals? What are the objectives? What's going to fulfill you?

Those types of things are so, so critical because the money is really just a vehicle and hopefully helping you to be able to do some of those things more easily, better, faster, whatever it is.

So all of that has to really come back to the context of what it is you're trying to achieve, the horizon, you're trying to achieve it on, what you're able to put to work in terms of savings, you know, all these different things. The, all of that's just, just so critical in being able to, to actually come up with what's the right allocation.

Where should we start to put these things to. To work? If you don't have that, then I think it's, I think long term doesn't matter, right? Like, I, I just.

Because then you're, you're still just sort of guessing of like, well, maybe I should have more. Maybe I should have more. I mean, at some point you've got enough, right? So it's more about breaking it down into what is it we're trying to achieve.

Is this the right allocation to help us achieve that? Are we tilting the odds in our favor and then kind of revisiting that over time as there's any big changes in life events or whatever else?

That's where I'm not trying to skirt the question on long term, but without that context, I think the duration of the investment horizon is, is much less relevant.

That also answer long term might vary by asset class. Right. Or season of life you're in. So I think saying, hey, this, this is, and is it long term is just, it's, I wouldn't say it's unimportant.

I'd say it's, it's secondary to having a portfolio that matches whatever your long term is.

Yeah, I agree.

So we've kind of skirted around this and we'll, we'll end the plane here. We talk about this idea of like following kind of like evidence, right?

Because, you know, you talked about it earlier and there's a buzzword in our industry like evidence based investing, evidence based medicine. Right. Everybody's following the evidence and inevitably coming to different conclusions about the evidence.

Which shows you, you know, how quickly we, we data mine things as people or form fit them to suit our own preferences.

But assuming, you know, you're like a student of the markets and a lot of our listeners are, and they kind of want to go on this journey and they've, they're maybe at the vanguard spot where like, okay, I believe all those tenants, but is there anything we could do to improve upon what evidence or research or like, where might somebody who's kind of in that part of the journey? Hey, I've, I've gone from the active spectrum to the passive.

But also some of the things you're saying about passive, like, you know, arbitrary rebalance, constitution, tax inefficiency, the indexes themselves being arbitrary. Right. Like, oh, I wonder if there is a better way.

Where might you point somebody who's, who's, who might be kind of asking those, asking those second level questions from now.

On, at least for the, the, for the intermediate term here, I'm going to point them to you, Jared. Right. We've had a good conversation if, if I come across anybody in Dallas, Fort Worth area be putting them to you? Love it.

I didn't pay, I didn't pay him to say that, by the way, folks.

No, I, I think it's, there's a lot of information that's out there.

Now, like, and, and obviously that's maybe doesn't even need to be set, but I, I think you got to be careful about where you're sort of curating it from as well. I think that the idea of costs really matter, right? I mean, Vanguard has, was, was really at the forefront of, of that.

Bogle was really at the forefront of that.

And, and among others, that it's, it wasn't just jackbook, but those types of things, I think they're just a lot more prevalent today than they were 20, 25 years ago.

And I think that's a good thing because I think if the average person, and I don't want to put the question back to you immediately, but I would be interested in like, your experience today versus even five or ten years ago, if a prospect walks into your office, the concept of do they know what an index fund is?

I'd say, you know, if, if, if I'm guessing, it is way more prevalent and there's way more knowledge today than there was 10 years ago because it's just so much more pervasive. So that type of knowledge, I think, is a good thing.

The idea that there's many, many different options out there versus I go to whoever my, my neighbor's guy or, or girl is, right? Let me set you up with Thyro, my guy.

They've got a lot of good ideas and, and then you walk in and you, you don't know anything about investing, so you're just kind of having to trust their word because it's an awkward thing to talk about. Nobody, nobody likes to get in that conversation where they feel like they don't know anything about the subject. Right?

That's a really uncomfortable position to be in as humans. If somebody starts talking to me about cars, I just start to smile and nod because I'm not a car person.

I like, I, that's not what gets me excited or anything else. But for some people, I'm like, man, you know a lot about cars.

And the, you know, I sometimes tell a story about when I go to get my oil changed, if they, if they take out the filter and they put it up on the hood of the car and they say to me, you know, there's your air filter. And I look, I said, yep. And they said, you think you need a new one? I say, I have no idea. Right? I have no idea how dirty that is or clean that is.

Like, I could give you a guess, but why don't you tell me if I need a new filter and if I come back in six months to get my oil change again, and you do the same thing. I'm going to be like, look, guy, I know I don't need a filter every six months now. I'm sort of losing trust with you.

There's a component of what can we be actually experts in? Where can we develop that specialized knowledge versus where should we hire coaches?

Where should we hire people who have that expertise and outsource that to them and have a foundation of trust and then get better fulfillment? Right? That's. I think it's the blend of those things that's really important.

So if somebody's interested in all this, I would not say to them, like, go get your master's in finance, you know, and go get your CFA and all those things.

Like, I would say, look, look for an advisor whose values sort of match up with things that you think are important to you, and then go have a conversation and maybe go have a conversation with a couple of them and see what's consistent and see what maybe is. Is a little bit different.

And from there, I think you can form a much quicker picture into what's going to be impactful for you and your financial journey than like, oh, let me make sure I get this Sharpe ratio as high as I can get it in my portfolio. I think that's what's probably more critical in my.

Yeah, yeah.

And for the three of you who are DIY investors listening, who are never going to hire an advisor, what I would say to you is, I think, like, I would focus on robustness, right? Like, I would develop, hey, what are my core convictions about investing?

Try to find as many people that disagree with you as possible and see why you do or don't disagree with them. But also people, a bunch of people who agree and do they agree differently.

Like, one example of this is like, one of the things that makes me most optimistic about value and valuation mattering and fundamental based investing is, is everybody debates, is it price to book? Is it price to sales? Is it enterprise value to ebitda? Is it a blended? Right.

The fact that it works in all of these different ways, just to varying degrees, almost support the fact that the intuitive reason as to why it works is there, right? So, like, I think, like, there's also something to be said of, like, how many people agree in different ways.

Probably because, like, that's, you know, Phil, that's what we're talking about is like finding good companies, right? I liken it to, like, hey, my goal is finding good companies and I'm not As good at that as I think I am, it's like finding Olympic swimmers.

But if I, but if I overweight a pool to people with wingspans in excess of 6 foot 5 and people with shoe size greater than 12, my probability of finding that swimmer goes up. Doesn't guarantee it, but it just shifts, shifts that shift the odds in my favor knowing kind of what I know about being a good swimmer. Right.

And like, investing is much of the same, but I think that's, that's such a good idea of like, hey, play, play your game. And also figure out what do you want to know and what don't you want to know?

But also, like, define what you believe about how investing should work and then find people that agree in as many different ways as possible or even disagree to see if it confirms your. Denies your intuition.

Absolutely. Well, Jared, I'm just glad you said six five, because I'm over six foot and I've got shoe size that's 12.

But you put me in that pool, I'm not going to.

There you go. The factor screening would have you in there.

So when you, when you're representing our country with a career pivot, I, I want some of, I want to, I want to cut off of that carve out of that gold medal, maybe a couple shavings. Phil, I appreciate you. You've been so generous with your time. I'm sure our audience has loved it.

All of our, all of our people who love to, you know, live in the spreadsheets. If people want to follow you or the work they're doing or you, the work you or Avantis are doing, where might they do that?

And then I'll just open the floor up to you. Any thoughts or ideas that you didn't get to share?

Yeah, well, so our website there, avantes investor.com, they can learn more there. We've got all the, all the socials. Well, most of the socials. There's way more socials now than there used to be.

But we, we've got a, you know, a couple of those handles. So we're trying to put out good content there.

We've got, we've got a podcast that we do with Professor Hal Hfield from UCLA called the Behavioral Divide, where we're trying to take, you know, some of these concepts around. How do I make better decisions?

How do I deal with something like fomo, whatever it is, and bring some, some academics in, bring some advisors in together and really have that conversation. So if you're a student of, of that type of research, I'd encourage you to listen there, but, you know, otherwise.

It's been a, it's been an absolute pleasure, Jared. I mean, we've covered a lot of ground. I, I've really enjoyed the conversation.

And the, the only thing I'll say, we exist to try to help people have those better kind of financial outcomes. We're obviously not alone in that existence, but we're quite passionate about it and we think we do a pretty good job at it.

So, yeah, we're, we're very fortunate to count you all as clients and your clients as clients, and we appreciate that trust. And if there's anything ever I can ever do to help personally or we can do to help, we'll. We'll do our best.

Awesome. Well, we appreciate you sharing your wisdom with our audience.

The innovation you're bringing to the world, and you know how much of those profits are being directed at medical research. It's a, it's a win, win, win. Thank you again for listening, everybody.

Like, subscribe, share future ideas, or if we want to have Phil back on for a 2.0 because we've really just covered a ton of ground. Podcast@brownleewealthmanagement.com thanks. We'll see you next time.

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