In this episode, we are joined by Jack Shannon, Senior Analyst at Morningstar, to discuss the dynamics of active equity management, portfolio construction, and the importance of downside protection in long-term investment success. Jack shares his insights on various topics, including:

Topics Discussed

• The asymmetry of returns and the importance of preserving capital on the

downside

•The role of active equity managers and the challenges they face in deviating

from benchmarks

•The impact of fund flows on portfolio management and the potential risks of

passive investing

•The role of risk management in active investing and the difficulty of

identifying winning strategies in advance

•The changing dynamics of growth and value investing, and the importance of

understanding market history

This episode is a must-listen for anyone interested in active equity management,

portfolio construction, and long-term investing. Jack's insights provide

valuable strategies to navigate the complexities of the financial markets and

better understand the nuances of active management.

A key contributor to long term success is being able to preserve

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that capital on the downside because, you

know, we all know that sort of returns

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are asymmetric and, you know, a loss

hurts a lot more than an equivalent gain.

4

So, then equivalent gain helps.

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So I think that's where investors can,

can really help themselves is looking

6

at the downside, even though most

people like to think about the upside,

7

you're buying an equity fund, you

want, you want to get those returns.

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you don't really care about, well, it only

lost 20 percent when the market lost 30.

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You're more focused.

10

Most people are more focused on sort

of the promise of the big gains.

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So I think people need to kind of

just shift their thinking in terms

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of, of what to really look for.

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Adam Butler: Welcome.

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We've got, Jack Shannon here

today from, uh, from Morningstar.

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Jack is Senior Analyst for

Morningstar Research Services and.

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Jack came to our attention through

our mutual acquaintance, Brian

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Moriarty, who shared one of your

more recent research pieces, I

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guess, on hit rates in large cap U.

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S.

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equity mutual funds and Mike and I both

read it and thought, wow, this would

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be a perfect guy to have on the show.

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So I'm glad we could

put the pieces together.

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Welcome.

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Jack Shannon: Yeah.

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Thank you.

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I hope I live up to being the perfect guy.

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Adam Butler: Well, there's

all kinds of perfect guys.

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So, um, you'll be a

perfect guy for the show.

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I have no

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Jack Shannon: Yeah, hopefully.

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Adam Butler: so maybe tell us

what you do at Morningstar.

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how do you occupy your time?

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What interesting projects

do you like to work on?

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What are you working on right now?

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Jack Shannon: Yeah.

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so I, um, I'm in the manager

research group at Morningstar.

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so what, what we do on a day to

day basis is we, we primarily

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cover, individual strategies

and individual investment firms.

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And so, you know, we meet with portfolio

managers, we Question them on a, you

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know, a wide range of topics related

to how they invest money, how they

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manage their team, how they manage

their time, and all these things.

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And ultimately, we sort of issue,

forward looking ratings on investment

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strategies and firms and whether we think

people should invest their hard earned

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money in these, in these strategies.

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So, so I focus on, active

equity for the most part.

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So, you know, I've, I've had an interest

in, in markets for a long time, but

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like markets in a very general sense

of just like, you know, how much

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information is, is, is embedded in, in

a single price is kind of amazing to me.

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And so in this day to day job, why

that's sort of relevant is, you

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know, you have portfolio managers and

analysts who, are fundamentally saying.

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I think I have better information

than the thousands and millions of

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participants out there, which is a very

interesting, and bold, uh, stance to take.

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And so a lot of my research is sort of

going down that, that road of exploring,

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You know, how good managers really

are at having an informational edge.

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So, so that's sort of the, the,

non core stuff I do on a day to

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day basis, but that, that occupies

a lot of the, the research time.

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Adam Butler: So let's start

at kind of a higher level.

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What is the goal of an

active equity manager?

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would be the success criteria

for an active equity manager?

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Jack Shannon: so an active equity manager

wants, wants to beat a, a benchmark,

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now they usually get to name their own

benchmark, which is sort of the, uhhh,

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you know I was reading a book from Mark,

Mark Spitznagel's Safe Haven where he

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described sort of the fund management

business as being sort of a, you know,

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a self fulfilling game where it's like

you get to set the rules and set your

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own performance standards and all that.

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And it's true to an extent, but active

managers ultimately want to beat a sort

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of a free passive benchmark, because

investors could take their money

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invested in a, you know, a passive

market ETF, for, 15 basis points, but

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instead you're going to say, well, if

you, if you give me 70 basis points, I

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will give you an index beating return.

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and obviously the sort of the

track record, over time is not

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very good for active managers.

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and so, you know, a big part of the

the hit rate piece that I, that I just

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published is sort of trying to get

into, other than fees, sort of why have

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active managers not been better than

just a passive, a passive alternative?

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Is it because they simply cannot

pick winners at the same frequency

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as you get in a passive portfolio?

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Or is it something else?

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Is it that they're just not good at

sizing and identifying their winners?

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in an appropriate manner.

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So, so yeah, so the goal is simply to, to

beat a passive benchmark, but oftentimes,

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especially in like the international

categories and whatnot, there really

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isn't even an investable passive option.

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You know, if you're a foreign large

growth manager, there's really,

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there's really not a, clean, um, You

know, actual investable benchmark

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for uhhh for everyday investors.

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So, so oftentimes it's a benchmark that

really an investor can't even access.

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So, a lot of different

angles there, I guess.

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But, um, yeah,

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Adam Butler: mean, I asked a very broad

question that was on purpose, right?

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But, what I, what I'm

trying to get at, too, is.

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Do managers typically act like that's

their objective to, I mean, and when

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we say beat the benchmark, do we

mean generate a positive information

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ratio relative to their benchmark,

generate higher absolute performance?

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How does risk factor in to that?

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Jack Shannon: I, uhh so it depends on

which shop you talk to and which managers.

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I think most, You know, I, a lot of, a lot

do want to beat on risk adjusted metrics.

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So they want to, you know, have a

sharp ratio, um, above the bench.

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but sharp ratio is, is,

you know, adjusting for the

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volatility of the returns.

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But I think that's kind

of a, I don't know.

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I think, I think claiming victory because

you had a lower return than the index, but

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lower volatility is, is sort of a low bar.

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so to me, you know, I, if I want

to pay an active manager, I want to

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pay them to, to beat the benchmark.

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I don't want to pay them to,

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give me a high five and say, Hey,

I didn't beat the benchmark, but at

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least I gave you more steady returns.

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because I could have

gotten the benchmark at.

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You know, a third of the cost, uh, so

you do have some managers who wanted to

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want to add, you know, add value on, on

pure, Um, sort of risk adjusted metrics.

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But, you know, when I'm evaluating

a manager, I like to look at

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just sort of pure excess return

potential because that's, you know,

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you can't eat alpha, you can eat.

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Excess return now.

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Adam Butler: We can debate that later.

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In terms of like a large cap manager,

it seems to me like if the goal is to,

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like, like, like, Beat the cap weighted

benchmark, for example, then they would

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cleave very closely to that benchmark

and only deviate from it on names

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where they felt that they had an edge.

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Is that typically what you observe or

is, you know, do we, do we mostly see?

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Large cap managers who have fairly

heterogeneous portfolios, they have,

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uh, you know, more concentrated basket

of stocks that they follow and that

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they, have conviction in it's probably

smaller than the S& P 500, for example.

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And they deviate quite substantially

from the cap weighted weights.

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Jack Shannon: you know, you're just

sort of hitting on sort of the closet

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indexers that are out there, and there

certainly are a lot of them who, you

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know, if you're a portfolio manager,

you're ultimately getting compensated.

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Um, well, it depends on the shop,

obviously, but a lot of it is, you know,

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deviation from, from the benchmark.

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So, There, there could be an incentive

there for a lot of managers to not

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want to take overly bold positioning

because if you do you're sort of

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risking your own personal comp, and

and I think that is a, certainly

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is a factor for, for some managers.

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And how they manage things.

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But a lot of a lot of active managers

want or sort of now marketing marketing

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themselves as specifically, you

know, we're not like the benchmark,

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you know, if you want the, you know,

the big tech stake with, you know,

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NVIDIA and Apple and Microsoft,

you can get that in a passive fund.

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But we want to offer something different.

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And so if we're going to offer something

different, we kind of have to take these

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bolder, um, Bolder positions relative

to a market cap weighted portfolio.

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so you see, you know, especially

managers who have underperformed, uh,

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in the last five years because they

were already underweight, those names,

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sort of a repositioning of, well, you

know, we're, we're purposely underway.

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We want to be different and we want

to generate sort of a, a, a different

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return stream than you would get in

a, in a, in a market cap portfolio.

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Adam Butler: But, I mean, do you

think that, uh, Just how rational

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is it for an active manager with a

large cap equity benchmark to deviate

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materially from that benchmark?

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I mean, to me it seems like the Like

kind of the optimal approach is to

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have a portfolio where you hold, you

know, effectively all the stocks in

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the S& P 500, in S& P 500 weights,

and kind of proxy run a long short

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portfolio over top that effectively

what that's going to run is.

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You know, you're going to have some names.

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You've got conviction, more

conviction, long in other names.

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You've got more conviction, short in,

and a bunch of names that you probably

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don't have, you know, reason to have

a materially different view than what

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is expressed in the benchmark weights.

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And so, you know, it seems like it seems

reasonable to me as well, that if an

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investor actually has a preference to

not deviate too much from the benchmark,

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however you want to mention, um, measure

that, let's say in tracking error, then

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the managers should be accommodating

that objective in that way, rather

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than saying, well, you know, I want

to deliver the best return I can for

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the lowest amount of risk, which to me

seems like a reasonable objective for

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an equity manager, but you know, you

end up with that, with these potential

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misalignments between what a, an allocator

is allocating to you for versus what your

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true objective is as a manager, right?

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I just think this gets conflated a lot.

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How do you see managers reconciling that?

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Jack Shannon: I mean, I agree

that that's a, um, that's

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sort of a worthwhile approach.

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You just don't really see it.

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you might see it in, um, you know,

there are, quant funds or, or, you

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know, research funds where it's

like a bunch of analysts putting

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stocks in, into a portfolio.

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you might see the case where they're,

they'll have, you know, these structured

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rules in place where they'll say, you

know we'll, we have our sort of our, our,

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our risk budget, and we don't want any

given stock to add X percent of our risk.

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So maybe their fundamental

analysts hate Tesla.

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I think it's overvalued and think

NVIDIA is overvalued, but they're

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going to own it in the portfolio just

for pure risk management purposes.

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so you see that a lot with quants and

again, like these like broad research

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type portfolios, but there are some

managers who, I'm thinking of Um, I'm

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blanking on the man, the, manager at

Fidelity runs an international fund.

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but his approach is, to basically

use the, market weight as just

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the, sort of the, anchor point.

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And then, will go plus or minus, you know,

two, three percent one way or another.

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but it doesn't, it doesn't

hold like the whole, the whole,

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uh, universe in the portfolio.

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It's still a subset of stocks.

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but if it's like a, you know, if

it, if it was a large cap domestic

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portfolio, it'd be like, well, maybe

he's underweight Apple by three percent,

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but overweight Alphabet by Three, you

know, just, we do see managers who do

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anchor to that market weight, but it's

not while holding just the whole wide

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portfolio, the whole wide index that is.

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Adam Butler: Yeah, I'm just

trying to think about what what a

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rational manager should do given

a client who has an objective.

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I mean, if a client says, look, I'm

measuring you against the benchmark, then

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the client has said to the manager, Your

risk or I'm measuring you on risk, which

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is tracking error to the benchmark, right?

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So from the perspective of.

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A large cap manager who's been, you

know, told I'm allocating you because

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I want you to beat the benchmark.

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The implicit statement in that is,

the risk I'm measuring you on is

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your deviation for the benchmark.

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You're tracking your risk.

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And it could very well be that, that,

you know, a lot of managers say, look,

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I've got no edge in the mag seven.

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They're followed by every Every research

shop out there, they're massively liquid.

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They're as efficiently priced

as any stock, and I'm just not

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gonna take an active view on that.

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I'm gonna hold 'em all in equal

weight or, you know, in, in

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their respective cap weights.

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But there's, you know, a

hundred stocks near, closer to

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the bottom of the cap stack.

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that are less followed, where I

bring some expertise and where I can

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take, you know, be underweight and

overweight, 60 to 80 of those stocks.

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And that is how I'm going to try and

generate my long term alpha, right?

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That manager would presumably

have Very low active share, right?

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So on that benchmark, then because he's

only playing with, market, with, uh,

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stocks in the benchmark that have already

at very low weights, those deviations

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from those weights don't matter much

from an active share standpoint, but

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he could have a very large edge, right?

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So he might end up having a very high

information ratio as an example, right?

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But that's, that doesn't

seem to be the way that.

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That managers are evaluated

and, why do you think that is?

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Jack Shannon: yeah, I think it gets

down to sort of the question of the

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allocators and what they're looking for.

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I think a lot of times when we talk

with, with portfolio managers, the, the

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sense that we get is that especially

on, you know, the institutional

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side, you know, they're wanted

for sort of a more concentrated

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Uh, I guess more unique portfolio.

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so like, yeah, you know,

I feel like allocators can

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get beta plus pretty easily.

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And so when, when they're looking at

these more active managers, I, it,

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it seems to me that there's more of

an appetite for, more active share.

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I'm not sure that that necessarily

means higher expected return or, or

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anything like that, but I think that's

generally what, what managers are looking

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for or allocators are looking for.

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and so we can discuss whether that's a

good thing to look for or not, but I think

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that's part of the reason why you see it.

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Adam Butler: So, how would, uh, how would

most people get access to beta and alpha

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separation in the way that you're sort of

describing most allocators would look for?

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Jack Shannon: Um, what do you

mean in terms of, in terms

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of the institutional clients?

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Adam Butler: Well, no, I

mean, in terms of, I mean,

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institutional clients can, right.

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Because they can get their, their

betas and they can buy market

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neutral funds or, or what have you

and, and use leverage, et cetera.

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Right?

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But it, it was my understanding that most.

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Retail investors typically, they have

few options, but to kind of bundle their

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alpha and beta exposures together, right?

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Jack Shannon: Yeah.

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Yeah.

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That's generally, yeah.

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I think that's generally true.

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and you think about where all retirement

assets are, they're all, at least

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in the U S they're, you know, pretty

concentrated in, in just sort of,

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target date funds where you've got

your equity and your your fixed income

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and all that in, in one sort of fund.

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and, it's all usually passive.

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So it's all kind of,

it's all beta basically.

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and I think at least in the U.

266

S.

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part of that is, you know, with

the, with the history of, of

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active performance against, against

passive and that it has done poorly.

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If, if you have sort of a fiduciary

standard, it's, I think people are a

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bit gun shy, Of, of recommending or

putting active funds in, in a lot of

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sort of everyday people's portfolios,

simply because of sort of fear that, you

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know, maybe you're violating a fiduciary

standard by recommending something that

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in the aggregate has, has struggled

against a, a cheaper alternative.

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Adam Butler: How do you factor

regimes into your thinking?

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So, for example, regimes where, equal

weight portfolios outperform cap

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weighted portfolios tend to favor active

management versus, you know, obviously

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the last 10 years, with the possible

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favored, cap weighted, uh, portfolios.

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How do you try to factor that into

your analysis and, and recommendations?

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Jack Shannon: That's a big piece of it.

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So every time we have a ratings committee,

um, which is once a year, we update our

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ratings on, on every strategy we cover.

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and that's a big piece of the

discussion is, you know, how, how

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do we contextualize a performance?

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Based on sort of how the market has

behaved and whatever, given trailing

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five, trailing three, trailing 10 years.

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because that is, you know, it, it, there

are good managers who can look, who can

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look, who can look pretty bad for a while.

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and there are, there are, there

could be bad managers who look

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good for, for, uh, for a while.

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so as long as we can sort of try to

at least, uh, and that's why the The

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conversations with the portfolio managers

so are so crucial, cause you get to sort

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of figure out how they truly think about

portfolio construction and, and, and think

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about, um, risk management and all that.

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so through those conversations,

we can get a sense of like, you

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know, were they purposely making.

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You know, purposely positioning

this portfolio so that it could

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succeed in this environment.

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Or is this sort of just a lucky

byproduct of, of sort of a grab

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baggy philosophy type thing?

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so yeah, it's, it's, it's a big

piece of, of what we do on a

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day to day, day to day basis.

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Adam Butler: And where do you land?

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I mean, given that these regimes

can last for a really long time.

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Jack Shannon: it depends.

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So, um, you know, I was

actually just looking at a, um.

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We don't, we don't actually cover

the fund, but it's a, it's a super

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concentrated strategy that has, you

know, it's been around since like

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2015 and it's produced a great record,

over, over that timeframe, it beat the

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Russell 1000 growth, beat the S& P 500.

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And it did that without

owning any of the Mag 7.

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and so I was interested in like, okay,

how, how could this have happened?

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so I built a you know,

a simulator that would.

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Bundle together, you know, 500

random 20 stock portfolios since

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they're a, they own 20 stocks.

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They keep them pretty much equal weight.

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so let's put together 500 random

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see how they would have done.

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and then compare that to the actual

results of the, of the strategy

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and the strategy ends up still

being like the very top of the sort

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of the random distribution too.

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So that, that leads to sort of

multiple, more questions though.

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It's like, well, is it, is this

evidence of skill, uh, because they've

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sort of beaten the, even sort of

the most random of, of scenarios.

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Or is it the opposite that

this is possibly the luckiest?

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Portfolio, we could have created.

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So I think it's, I don't think we

ever sort of firmly land one way

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or another on, on a given regime.

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but I think we, we do a lot of

analysis like that to just sort of

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keep the conversation, you know,

interesting and making sure that

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we're, we're sort of looking at it

from all different sorts of angles.

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Mike Philbrick: In a, in a 20 stock

portfolio, yeah, that can get sort of.

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Very unlucky and very lucky, I suppose.

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And, and was there any indication

in that particular example

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of what the turnover was?

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Was It you know, the

idea of, of you've got

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Jack Shannon: was about

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0%.

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Mike Philbrick: you

beat those to death and,

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Adam Butler: Zero percent, you said?

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Jack Shannon: The, the annual

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Adam Butler: Wow.

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Jack Shannon: well, for 2023 was 0%.

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Yeah.

345

They, they didn't, yeah.

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Mike Philbrick: Interesting.

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Adam Butler: Yeah.

348

that's remarkable.

349

Jack Shannon: Yeah.

350

And, but then to your, to your

question though, it was, um, it was

351

very, it's, it Was remarkably even,

like contributions from the stocks.

352

It wasn't that they had, you know,

one huge winner that carried them.

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It was each stock like was, it wasn't,

you know, it wasn't a, you know, a

354

clean, you know, even just split, but

it was pretty close, which was, which

355

was, what was the sort of amazing part.

356

And so that's why I had to generate

this sort of random scenario to be like,

357

how, how sort of crazy, what is this?

358

and Yeah, that, that,

that's certainly an outlier.

359

, That

360

Adam Butler: how much do you

guys use random portfolios?

361

Always, I've been a huge fan of random

portfolios as a way to evaluate skill

362

in quantitative strategies, but also

in mutual fund performance, etc.

363

Ever since I read Patrick Burns

364

is that something you guys employ

quite prolifically at Morningstar?

365

I mean, it just seems like it makes

so much sense as, as a key dimension

366

to understanding manager skill.

367

Jack Shannon: I wouldn't say

it's, it's something we use

368

like super, super frequently.

369

I, I have like a I have, I have

some, coding skills and whatnot.

370

So I, I like to build a lot of these

sort of quantitative, Quantitative models

371

and whatnot to do some of this analysis.

372

you know, i, I find them extremely

useful because I, to your point, it's,

373

it's to me, that's the best, that's

the best way to sort of assess whether

374

or not this was a, true, true skill on

display or, or, or really, really lucky.

375

And.

376

You know, I think the more,

I think we should do it more.

377

I think the, you know, my goal is

eventually, again, that was like

378

the one we just talked about was

a pretty simple one of just taking

379

20 random stocks and the S& P 500

and just letting them sort of run.

380

but you could apply it to sort

of any sort of any manager.

381

So if there's a manager who is, you

know, You know, a quality growth

382

manager and, you know, I only like

companies with above median ROICs and

383

I want to see the valuation below the

median in the industry and I want to

384

have this target turnover percentage.

385

You know, you should be able to build

a pretty, Pretty robust sort of random

386

portfolio, um, simulation from that.

387

And just sort of see is if we know the

generally what the manager likes to

388

do, can we attribute the performance,

whether good or bad to, You know,

389

skill within that, that sort of narrow

niche, or just that, that narrow

390

niche ended up doing pretty well.

391

And that's maybe more of the

story than, you know, just sort

392

of, uh, a raw look at it might,

393

Adam Butler: Well, then actually

that raises a key question, right?

394

So you've got a manager who uses

a set of screens with, you know,

395

a set of constraints and a target

average number of stocks with

396

whatever, different weightings.

397

If that manager exhibits skill versus

an unconditional group of random

398

portfolios, but doesn't exhibit skill

is kind of right in the middle of

399

what you'd expect for any manager

that uses the same selected criteria.

400

How will you judge whether

that selection criteria itself

401

adds value over the longterm?

402

like how do you disentangle

that skill versus.

403

Jack Shannon: Yeah, that's

the That's the tricky part.

404

because yeah, you should get credit

for if, if you're investing in these

405

sort of higher quality companies

and lower valuations and it does

406

well, well, that's a good thing

that you, that you did that, right?

407

and that is an active decision.

408

so, I think that, yeah, I think, you

know, determining whether, you know, what

409

gets more credit, um, I think is hard,

I guess with the way, the way I would

410

think about it is every manager tells you

they invest in high quality companies.

411

Every manager tells you they, you

know, they're buying, you know,

412

companies that they think are

trading below intrinsic value.

413

Every manager, uh, you know, wants to

buy, companies with good sentiment.

414

Like, I think if we can, if we know the

exact sort of screens they run, that

415

makes it a bit easier, because then we

can tell within the, within their own

416

defined universe how they're doing.

417

But, um, because if you're not picking

stocks well in your own defined universe,

418

I'm not sure I have confidence in you

to, to continue to, and you outperformed.

419

I have confidence in you to continue

to do that unless I have confidence in

420

these factors continuing to, to do well.

421

Which we generally try not to, take

too, uh, too out of a stance on like

422

a given factor or, or given style.

423

But, Yeah, it's certainly tricky,

but I think, um, I said, I'm

424

a, I'm a, I'm a big fan of this

sort of the random simulations.

425

so yeah, hopefully we, we, we do it more

and hopefully people find it useful.

426

Adam Butler: well, how

do you think about this?

427

The style style box?

428

You guys still incorporate that

in your, in your recommendations?

429

Yeah.

430

Jack Shannon: We still do.

431

Adam Butler: is the thinking

evolved on that over time?

432

Jack Shannon: Yeah.

433

So all, all our ratings are

sort of category dependent.

434

So wherever the fund falls in its, in its

category, we sort of stack each, we stack

435

the, you know, we stack the deck depending

on where it falls in its own category.

436

So we don't take a stance on, you

know, large growth is a better

437

place to be than large value.

438

We just say within large

value, here's The good stuff.

439

And within large growth,

here's the good stuff.

440

are, there is a project underway now,

um, with the style box, just because

441

if you, if you looked at the style box

recently, a core, you know, S and P 500

442

fund looks like it's in growth water now.

443

so there's sort of the issue of like,

Do we want the style box to be totally

444

relative to, you know, if you want the

445

uh, benchmark, do we want the Russell

446

Or do you want to take maybe a more

absolute approach and say, well,

447

valuations have gone up across the

448

growth going in, Russell 1000 going

into the side of the, you know, fence?

449

Maybe that is a signal to somebody

that, that, Hey, if you want pure

450

core exposure, maybe you look a

little further left on the style box.

451

So, I don't think we've, I don't

think we've landed anywhere on sort

452

of, on any changes in that respect,

but that is something we've, we've

453

seen recently is just sort of growth

inflation, pulling everything to

454

the, to the right of the style box,

455

Adam Butler: Yeah, it's just a question

of whether a manager, you know, should

456

get credit for choosing growthy stocks

when growth, the prospects for growthy

457

stocks is, is better and choosing

value stocks from the prospects.

458

It's just, you know, I remember my early

days working in an asset management

459

shop and you go through a 3 year period

where, you The value guys would hide

460

in their offices and all the growth

guys would congregate at the water

461

cooler, high five in one another.

462

And then you'd go through the next three

years where, it would be, you know, the

463

reverse, The value guys would be out

of the water cooler and the growth guys

464

would be hiding in the back office.

465

And neither group had any influence

or, you know, did, they weren't

466

able to dictate at all the

conditions of their own success.

467

It's just, is their style in favor or not?

468

Right.

469

It just seems.

470

It just seems so absurd.

471

Jack Shannon: Yeah.

472

Yeah.

473

It's funny you mentioned that.

474

Cause, uh, you know, when I first

started here, value, value was, was

475

beaten down for, for a decade plus.

476

And every time I talked to a

value manager, you know, they're,

477

it's almost, it was almost like

an apologetic tone from them.

478

And they're, you know, they're

trying to say, look, you know, just,

479

just give us a little more time,

you know, things are going to turn

480

around, blah, blah, blah, blah, blah.

481

And the growth managers are always, you

know, they're beaming with confidence

482

and, you know, so sure of themselves.

483

And then, you know, 2022 comes around

and, you know, growth managers Get

484

um, Get hammered and value looks

relatively good, even though they still

485

didn't do well on an absolute basis.

486

But, but then you see the role is

reversed where it's, you know, the

487

growth managers are sort of apologizing

and saying, yeah, you know, we got, we

488

got a little ahead of ourselves on, on

these and, and, you know, we learned

489

our lesson and then the value managers

finally get to say, see, we told you so.

490

You know, we, we told you that the

value would, would bounce back.

491

so yeah, we, we, it's, it's

interesting from my seat, just sort

492

of seeing the, the psychology of, of.

493

Portfolio managers and having to

deal with those, those ups and downs.

494

Cause I think that is, that is a big

sort of behavioral piece that they have

495

to manage is that you can look, again,

like I said before, you can look dumb

496

for a while, and yet, you know, I have to

have the fortitude to, to stick it out.

497

And on the flip side, you know, you

can look very smart and very bright and

498

make a lot of money in a short period of

time, but you kind of have to understand

499

that, you know, success can be fleeting

and, that can, that can turn on a dime.

500

Adam Butler: Yes it's just a

strange, there's a bunch of strange

501

dimensions too, but one of them

is that growth environments tend

502

to be highly concentrated in a

few stocks and value environments

503

tend to be, have much broader.

504

Participation in the markets.

505

And so for a kind of multidisciplinary

manager, so someone say, who doesn't

506

particularly favor growth or value as

say a core manager, part of his job

507

is going to be, you know, emphasizing

growth or value, I guess, over time, but

508

in those growthy markets, the amount of

conviction you have to have in those.

509

Few names that completely dominate the,

the cap stack in the index and also often

510

end up also dominating the return profile.

511

Like you sort of saw, in the recent

period and in this sort of pre 21

512

period for five years, obviously

513

the amount of conviction you've got

to have, like as a fundamental, equity

514

core manager in your allocations.

515

Is so out of proportion with

what anyone could reasonably

516

expect to have as their edge.

517

For, for you, for a bottom up analyst.

518

To want to give 7 percent each to,

to Apple and Microsoft and, you know,

519

4 percent to Nvidia, et cetera, like

the amount of excess return that

520

you need to assume for those, for

those stocks to give those stocks,

521

those weights in the portfolio.

522

Like there's just no responsible

way that you could, from a bottom up

523

standpoint, be that confident, right?

524

So.

525

How do you, how do you think managers

should navigate that paradox?

526

Jack Shannon: It's also, uh, in the

U S it's tricky because they, um,

527

oftentimes can't even hold it at

market weight if they want it to.

528

So there's the, diversification

rules in a 40 act fund that, you

529

know, the 25 5 rule, you can't have

more than 25 percent of your assets

530

in positions of 5 percent or more.

531

And you literally can't own, if you're

a large growth manager, you can't own,

532

the top five stocks at market weight.

533

So you If you're a diversified manager,

so you either have to change the

534

diversification status of your fund,

which I haven't got a great answer on

535

why that's so difficult, but, a lot of

managers don't seem to want to do it.

536

I guess it has to go through a, you

know, a shareholder vote and all that.

537

And maybe there's a, some

operational headaches and

538

Adam Butler: Massive platform

539

Jack Shannon: Non diversified funds,

but yeah, so regardless, you know,

540

they run into that, that, that

problem, and like I said, I think

541

a lot of them now are just like,

542

There's a tendency of managers to you

know, explain themselves as being unique

543

when they're, when they have to be unique.

544

Like, it's not necessarily a, I'm not

sure it's an active choice they're making.

545

It's, it is a regulatory constraint

that they have to be, And so, yeah, it

546

would be, it would be interesting if,

if you've removed that 25 5 rule, where

547

their portfolio weights would go, and

I suspect they would go up in those,

548

in those seven names in the aggregate.

549

there certainly are some managers

who I think are legitimately,

550

you know, have legitimate bearish

views on a lot of those names.

551

but to our earlier discussion on, sort

of tracking error and managers sort of

552

being incentivized to stay positive.

553

Somewhat close to the index.

554

I think that that is a huge

amount of risks they're taking

555

on that they, that again, they

don't really have a decision on.

556

and so I think if they could close that

risk gap, they certainly would like to.

557

Adam Butler: It's an interesting, point

you make though, Mike, I hadn't thought

558

of this about the fact that a lot of

these active funds are actually not able

559

to hold the MAG 7 and the, weights that

the cap weighted index holds them in.

560

so there's actually a, a structural

compliance or regulatory disadvantage

561

that these funds are facing at the moment.

562

Is that a fair characteristic

or characterization?

563

Jack Shannon: Yeah, they, yeah.

564

So the 40 acts diversification rule

is a 25 five rule, and I don't have

565

the The exact stats on like the

percentage of non diversified versus

566

diversified funds in like the U.

567

S.

568

large cap universe, but it's

very few are non diversified.

569

Um, and the ones that are, have been

non diversified for a long time,

570

because they were sort of coming out

of the nineties as these concentrated

571

portfolios that were popular at the time.

572

And then saw their popularity wane and,

now they've kind of come back in vogue.

573

You have seen some, some shops, I think

Fidelity and TRO have, have recently

574

changed some funds from non diversified

to diversified, or I'm sorry, from

575

diversified to non diversified to sort

of address this issue, but it hasn't

576

been as widespread as, as, we thought.

577

you know, cause on our side, it's

like, again, we're not, you know,

578

we're not on, you know, we're

not overseeing any platform.

579

We're, we're just issuing

our own opinions on things.

580

And so we were always wondering,

you know, it sort of seems

581

like a free option, right?

582

To.

583

To just label yourself non diversified.

584

And if you want to hold a

diversified portfolio, great.

585

There's no, there's nothing

stopping you from, from doing that.

586

but you are constrained on the

other side where if you, if you

587

are diversified, but you want to

be non diversified, you, you can't.

588

but Adam, to your point on, on sort

of the platform, issues, I, we've

589

long suspected that's the case, but

we haven't really, we just haven't

590

really gotten enough, you know, firm

information on, on that and sort of

591

how big of a constraint it truly is.

592

Adam Butler: Yeah, fair.

593

So, with all your data wrangling,

do you have any, uh, suggestions

594

on what investors might look for?

595

You know, how first of all, what is

the, what is the sort of future of Of

596

active management in your, in your view

and, and, um, how should investors think

597

about the role of active management

and portfolios versus other options?

598

and, if they were going to choose

to pursue active management, what

599

are some good rules of thumb?

600

Jack Shannon: Yeah.

601

So the, the future of active management

I was, um, as I was reading a story in a

602

Wall Street Journal today about a manager

complaining about the passive flows, um,

603

warping the market and, you know, creating

all sorts of issues and contributing

604

it to it being top heavy and all this.

605

and to me, I see that and I say,

wouldn't an active manager love that?

606

Wouldn't an active manager love

uninformed, participants adding into,

607

you know, coming into the market because

if you're the, the informed investor

608

with, You know, an informational edge,

you should, you should like that.

609

You should, you should be able to then see

where the market's overheated and where

610

it's not, and be able to act accordingly.

611

so if you talk to managers that, you

know, they feel threatened by, by

612

passives and not just from a, from

a flow standpoint and from an asset

613

standpoint, but they, a lot of them

sort of characterize it as sort of,

614

you know, changing the market overall.

615

But I'm not sure I, I buy that argument.

616

we've seen, um, Uh, at our Morningstar

conference, I'm hosting a panel on, um,

617

On active ETFs, which is sort of the,

I guess that the vehicle of the future

618

for active management where, instead

of in a mutual fund wrapper, you're

619

getting it in an, in an ETF wrapper.

620

There are obviously some

tax advantages to that.

621

you know, the, the portfolio managers, you

know, there, there was always a question

622

of sort of transparency with an ETF.

623

You have to disclose your

portfolios every day.

624

some portfolio managers didn't like

the idea of that and thought that,

625

hey, maybe people could get out in

front and front run me and sort of

626

hurt my hurt my performance that way.

627

but I think a lot of that sort of

fallen by the wayside and we, we see

628

a lot of shops launching back ETFs.

629

and I think there's, there's certainly

gonna be more to, more to come.

630

they're sort of specifically trying to

keep them as distinct strategies for

631

the most part, which is interesting.

632

So, you know, if you're a, if you have

a large cap growth strategy, in a mutual

633

fund, a lot of times we're seeing.

634

firms launch a large cap growth ETF.

635

That's slightly different

than the mutual fund version.

636

And I, again, getting back to that sort

of fiduciary point we hit on earlier.

637

I think a lot of that has is the

reason behind that is if you have

638

an ETF version, that's cheaper than.

639

a mutual fund version, then

you're probably just going to

640

cannibalize the flows between them.

641

so, so that's where we're seeing managers

go right now, just in terms of vehicles.

642

And then in terms of just

everyday investors and sort of

643

how they can, sort of better

their odds with active management.

644

to me, it's all about, it's all about

quality and it's all about downside.

645

I think if, if you can find a manager

who is consistently, investing in

646

high quality businesses, and I know

quality is a very nebulous term,

647

we can, Talk about the different

definitions for that or whatever.

648

But, generally I think, I

think you, you can do well.

649

There are, there are certain

shops that lend themselves to

650

being high quality firms that

invest in high quality businesses.

651

They do it for the long term.

652

You know, they're not churning

portfolios 200 percent in a year.

653

and you see that in the

downside protection.

654

So if you, if you go on morningstar.

655

com or I don't know what other, sort

of outlets out there that, that publish

656

sort of downside metrics, but I think

that's a key, A key contributor to long

657

term success is being able to preserve

that capital on the downside because, you

658

know, we all know that sort of returns

are asymmetric and, uh, you know, a loss

659

hurts a lot more than an equivalent gain.

660

So, then equivalent gain helps, So

I think that's where investors can,

661

can really help themselves is looking

at the downside, even though most

662

people like to think about the upside,

you're buying an equity fund, you

663

want, you want to get those returns.

664

you don't really care about, well, it only

lost 20 percent when the market lost 30.

665

You're more focused.

666

Most people are more focused on sort

of the promise of the big gains.

667

So I think people need to kind of

just shift their thinking in terms

668

of, of what to really look for.

669

Adam Butler: Right.

670

In terms of the flows, sorry, Mike,

you look like you had a question.

671

Um,

672

Mike Philbrick: No, I was just, I

was just thinking through, you know,

673

win rate doesn't really matter or

isn't that effective in certain ways.

674

Um, big bets aren't really

that effective in ways.

675

So is it, is it really the,

it's the risk management?

676

Is there, so there's a risk

management, a downside.

677

Is there any of the picking on the upside

that adds value or like, how, how do you,

678

how have you, can you elaborate more on

679

Jack Shannon: Yeah.

680

So, so I did the research on the,

on the hit rates and the big bets to

681

see if, how can active managers win?

682

Can they, can they win via a higher

percentage of, of stocks being right?

683

Answers?

684

Eh, not really.

685

Can't really say that's the case.

686

you see a, you know, a loose

linear relationship, but, um, in

687

some categories it's, it's, you

know, not really linear at all.

688

It's just like a random scatterplot.

689

Yeah.

690

Same on the bets.

691

You'd think, well, I want an

active manager to make these

692

concentrated bets, you know, where

they have the informational edge.

693

And you're like, ah, you see that,

and you're like, yeah, it doesn't

694

necessarily help out too much either.

695

so on the, so yeah, so it's, it comes

down to just sort of consistency and,

696

you know, I, I, think, I think, on the,

on the upside, you do see funds, um,

697

where over their whole track record,

you look at 25, 30 year horizon.

698

where they're not good on the downside,

but they're, they're good enough.

699

They're so good on the upside that,

that, that it, that it makes up for it.

700

so there are some cases of that

happening, but it's, it's, it's

701

just sort of rare to find them.

702

and I think because if, if you are, if

you are worse on the downside, while

703

people don't pay attention to it, when

maybe they're buying their fund at first,

704

and those moments of pain and you're

losing a lot more than, passive index,

705

You know, people are going to start

pulling money from your, from your fund.

706

And I think it's, it's harder to survive

when you have the, worst downside

707

profile, but the higher upside profile.

708

Mike Philbrick: Right, the, the fund

flows beat you up a little bit, but if

709

you're, if you're an investor, that's

I'm going to dollar cost average.

710

And I love it.

711

I love being down

712

Adam Butler: Uh, Uh,

713

Mike Philbrick: I

714

love all I have all, and I

love being down and I'm good.

715

A dollar cost average is probably a better

716

Jack Shannon: Yeah.

717

I mean, there are, there certainly are

some, some, some growth funds that have,

718

yeah, you look at their profile, like.

719

Damn, how did this, how has this

survived and how, but, but it's, you

720

know, they have sticky client base

who are willing to stick through those

721

sort of turbulent times and, and,

they do get the payoff eventually.

722

they're just, yeah, they're,

they're, they're rare.

723

Mike Philbrick: Yeah it's super

hard to obviously identify

724

those in advance as the one.

725

I mean, this really sticks out in my

mind too, is it's not a five year game.

726

Like the people talk about

your time horizon and investing

727

being three to five years.

728

There's all, it's, it's just

randomness in three to five years,

729

like literally 20 years, you can

reliably count on stocks beating most

730

other asset classes historically.

731

And that's what you got to think.

732

I'm making a 20 year decision here.

733

And if you can make it 30 years,

boy, boy, it gets even better.

734

but wow, what a, what a decision to

try and make with a certain, call it

735

dogma or religion or market cap value

736

Jack Shannon: Yeah.

737

I've looked at, Um, so that's something

I've, I've, nothing's been published on

738

it, but it's something I've been really

interested in is like, Looking at any sort

739

of trailing risk metric, beta, standard

deviation, down, you know, maximum

740

drawdown, blah, blah, blah, blah, blah.

741

So just to think if I was, if I was

an investor at any point in time, and

742

I looked at all these risk metrics

that are commonly, pumped out for in

743

financial, websites and whatnot, would

that tell me anything about the long

744

run potential of the of the strategy?

745

you know, would those high beta funds,

746

Adam Butler: Well,

747

Jack Shannon: know, end

748

Adam Butler: I mean, we

749

Jack Shannon: better or worse, whatever.

750

And so, it's something I've done a lot

of work on and it ends up, depends what

751

time period you look at, but like those

trailing risk metrics are not very great

752

for when you, when you go over those long

horizons, you know, 20 years, they're

753

not going to tell you much in terms

of either the downside or the upside.

754

It's, it is just sort of, but to your

point on the sort of the three and five

755

years, you know, you go on Morningstar.

756

com or you go on Fidelity or wherever.

757

The beta it's going to show you is

going to be like a trailing three year

758

beta, which is going to be on based on

monthly, most likely monthly returns.

759

So that's 36 data points that you're

going to base your, your decision on.

760

it's just, sometimes it's hard for

me to think that those are super,

761

super useful for an investor thinking

of, you know, truly long term risk.

762

Mike Philbrick: Well,

it's interesting though.

763

If you, if you're in accumulation

and you're doing that dollar cost

764

averaging, you're, probably going

to have some tailwind to that.

765

although decumulation, you know,

works in the exact opposite

766

Adam Butler: And I think you need to, it

needs to be relatively evenly spaced out.

767

You know, having a, having something

where it kind of goes up for eight

768

years and then gives you a 60 percent

decline for two years, it doesn't really

769

help the dollar cost average, right?

770

Mike Philbrick: of course.

771

There's going to be, there's going

to be this certain, the fingerprint

772

of it that would be advantageous

or disadvantageous over time.

773

And I'm being, I'm doing

a thought experiment.

774

Let's be honest.

775

The fact is that the mental capital

that's required for someone to continue

776

to invest in something that is, you

777

and continue to just she money in.

778

I mean, I guess you have seen a little

bit of that in the, in the space of

779

cryptocurrencies where there is a group of

people who are just in it no matter what.

780

They're, they're yolo-ing no matter what.

781

And, and maybe there was a few

people in the tech world like that.

782

but boy, oh boy, that's, that's a hard

road to follow behaviorally from, uh,

783

from an investor's perspective, going

through some 90 percent declines.

784

Adam Butler: definitely.

785

I was just saying, Jack, that, you

know, there's good evidence that

786

that lower volatility stocks and

lower volatility portfolios provide

787

a tailwind, over time, but obviously

that's far from a sure thing.

788

And there's, there's going to be,

good, long stretches where lower

789

volatility portfolios underperform.

790

So,

791

Jack Shannon: I think, um, so

betting against beta, there is, I

792

think AQR wrote a, wrote a, paper.

793

on it.

794

actually that was my, uh, so when we

interview for Morningstar, we have

795

to, we have to pitch a fund and do

that as part of the interview process.

796

And mine was AQR defensive style,

which is based on the, uh, betting

797

against beta paper, which is about

low vol stocks over the long run.

798

Adam Butler: And quality.

799

Yeah, awesome.

800

Yeah, that's a, that's a good paper.

801

And then the guys at Robico have done

some fabulous work on that as well.

802

We've published some on it.

803

There's definitely something there,

but, you know, again, you're going

804

to go through 3, 5 year periods where

those are going to look pretty silly

805

too, relative to cap weighted indices.

806

We're in the middle of

807

Mike Philbrick: we're

five value investors.

808

anyone?

809

Adam Butler: Oh, yeah, not value,

value 10 to 15 to 30 years, but

810

depending on the metric, but

811

Mike Philbrick: It's a great

time to be accumulating.

812

Adam Butler: that's right.

813

That's

814

Mike Philbrick: this, this is not, if

you're a value investor, this is the,

815

this is the, the heaven, the nirvana

that you look for in order to be

816

able to just accumulating these value

stocks over and over again at these

817

Adam Butler: That's right.

818

20, 20 years of

accumulation with no payoff.

819

Jack Shannon: Lower that cost basis.

820

Mike Philbrick: it's a rough game, man.

821

It is a rough game.

822

Adam Butler: But that's, you

know, to your point about the

823

flows, the passive flows, right?

824

And I, you know, I, we've had

discussions on this before, but, you

825

know, others have raised this idea

that, well, if there's all these.

826

passive flows that are kind of no edge

flows, then why wouldn't active managers

827

be all over this and trying to orbit?

828

And I think the reality is that you're,

you may be right at some point, right?

829

Like you're sort of betting that

you're going to be right at some point.

830

That the passive flows are going to stop.

831

And, but as long as passive flows

continue into stocks with disregard for,

832

you know, any anchoring to fundamental,

metrics, then you're going to remain

833

offside and your degree of offsidedness

is going to grow over time, right?

834

So it's one of these, the market can

stay irrational for many, many, many

835

more years, and you can stay solvent or

stay in business as an active manager.

836

I think that's the.

837

I

838

think that's a fair point.

839

Mike Philbrick: and

840

potentially, you know, when you're

fighting the dumb crowd, sometimes

841

the dumb crowd's pretty smart.

842

Jack Shannon: Yeah.

843

Mike Philbrick: know, I mean, I've

never seen a company like Meta grow at

844

the size it is at 25 percent last year.

845

That's astounding.

846

Adam Butler: Yeah.

847

Mike Philbrick: I just don't know you.

848

I'm, I'm gobsmacked.

849

I mean, this is the, this,

this set of companies is not

850

the 2000 set of companies.

851

it's a very different set of companies.

852

So it is, and the, you know, the

whole software eats the world

853

and, and the change in the way

you can lever these businesses.

854

I think you're right.

855

There's a lot of people fading that

trade until they're all out of business.

856

They've sold everything.

857

They're underweight as

late as they can be.

858

and just didn't make it to the end

859

Jack Shannon: I actually did a,

860

Mike Philbrick: and maybe they are right.

861

I don't know

862

Jack Shannon: I did a study comparing

those two periods just in terms of

863

how, managers were trading during

this sort of tech bubble and the,

864

what I call the COVID bubble.

865

the idea of the, the the idea in

my head was that, oh, managers

866

must have learned from that.

867

Like, you know, there's, there must

be enough institutional knowledge at

868

a firm where they don't get sucked

into buying, you know, ridiculously

869

valued companies that had never earned

a single dollar in their history.

870

And of course it ended up being

slightly worse than the tech bubble,

871

just in terms of buying activity.

872

Like I'll have to look at the numbers,

but something like four and a half,

873

percent of all large growth assets

at one point were in companies

874

that had never earned a profit.

875

and that's with historically well

below like one percent, like a tenth

876

of a percent is a usual amount.

877

and so you see this big spike in 2000,

878

nothing, nothing, nothing, big spike

879

Um, that's, that's an interesting,

angle that I, again, I want to explore.

880

I don't know how, how exactly to

do it, but just, um, sort of market

881

memory and, and sort of how much, you

know, managers, managers or, or, any

882

participant in the market really has,

you know, actually internalized history.

883

Yeah.

884

Mike Philbrick: the collective memory.

885

Cause we, we had the nifty 50 as

well, prior to the tech bubble.

886

Then we had the reason reason tech bubble

followed right along the resource boom.

887

You know, we had the bricks and

all, all the rush into Canada

888

and Australia and South Africa.

889

I mean, I don't know.

890

I don't know.

891

I think it's, it's a feature.

892

Adam Butler: think it's that the man, the

managers who have those long memories.

893

Will not participate in those

markets and get left behind.

894

And so it's, you know, they just

get run out of the business, right?

895

Like too much experience in this business

actually ends up being detrimental

896

because you just, you know, you keep

looking at this crazy market saying.

897

You know, it's, this is ridiculous.

898

I'm not going to participate this time.

899

I learned my lesson last time

and it goes on and on and on.

900

And eventually you just get

hopped and someone with that will

901

participate, um, replaces you and has

a good run for two or three years.

902

And then they learned the hard

lessons and it all just repeats.

903

Jack Shannon: Yeah,

904

Mike Philbrick: Yeah, there's got to

be a collective memory though that, you

905

know, sort of the, the collective memory

of the participants of the marketplace,

906

um, with interest rates, even, I mean,

I was in the transitionary period of

907

that going from a period where, when

908

interest rates and nothing built.

909

And I bought a Canada

savings bond that paid 19.

910

5%.

911

That was a pretty good deal.

912

And then watched it go

from 19 and a half to zero.

913

And, uh, you know, I remember an

old, an old sod of a broker who

914

would get his old paper out from

915

here, here's the newspaper from 20

years ago, what do you want to buy?

916

And he kept it, they'd

always be like stocks.

917

And he's like, no, it's just

long duration bond over here.

918

You see this 30 year bond

yields, 18 percent or yields.

919

It wasn't 18%.

920

It was about 15%.

921

You know, 30 year bond for 15 percent

and rates went, you know, straight

922

down, but totally outperformed stocks,

both risk adjusted and absolute.

923

So even if you're given all

the information, investors

924

will make the wrong decision.

925

Adam Butler: Yeah, I don't think

there's any institutional memory

926

lasting longer than a couple of years

at all, just because the people that for

927

Mike Philbrick: a couple of years, but

there's definitely, you know, there,

928

there's, there's certainly a youngening,

I think, going on at the moment.

929

You know, there was, uh, in the advisor

space anyway, there's, and even in the

930

institutional space, you're seeing.

931

More and more of a, you know, the,

um, the boomer crowd being sort

932

of moved on for the most part.

933

and, uh, millennials moving into that

Gen X is, is in there a bit, but, um,

934

you know, the youngening is a real thing.

935

So that, that collective

936

Jack Shannon: I've asked

firms about how, um,

937

Mike Philbrick: I mean, the

number of times I heard.

938

Jack Shannon: Yeah.

939

I've asked some, I've asked some mutual

fund companies how they handle that

940

because, you know, they're, a lot of their

analysts with 10 years of experience,

941

they graduated college in 2012 and

they didn't see anything but growth,

942

growth, growth, growth, growth, and it

worked, worked, worked, worked, worked.

943

Um, And then again, 2022 was a disaster.

944

And, you know, a lot of them acknowledge

that we, yeah, we actually have to spend

945

time to, you know, educate the analysts

on sort of market history overall, and

946

that, you know, the more enterprising, I

guess, analysts are naturally interested

947

in, in market history, I think.

948

like I, I like to just

read it on my own anyway.

949

But if, if you, if you, if you do

treat it just simply as a day job

950

and not something you're naturally

curious about, it is something you can

951

overlook and get burned by, I feel like.

952

Adam Butler: I hear.

953

Yeah.

954

But too much knowledge of history

can also be detrimental for for

955

very, very long stretches of time.

956

so it's,

957

Mike Philbrick: I also think there's

nothing, there's nothing like living it.

958

I could read it.

959

I could read it.

960

I could read it.

961

And until you've got rubber

under the road and chinks in your

962

armor and stab wounds and scars.

963

Adam Butler: I don't even think

there's any motivation to read it.

964

If you read it, but you kind of

just skip over the parts where,

965

you know, they were rough.

966

You know, value oriented grinds

because you're having so much fun

967

in the current growth environment.

968

I mean, I remember, I

remember those times.

969

I remember feeling exactly the same way

and you know, you read the histories

970

if you're forced to, but really you're

not paying attention because it just

971

is not salient to you at the moment.

972

Mike Philbrick: even, even, I mean,

I think I've seen the same game

973

run written about extensively in

reminiscence of a stock operator

974

in the stove, whatever it was.

975

I've seen that fricking gamut run

through four different marketplaces.

976

I've seen the whole thing done.

977

Like I, I just, I, I see

it over and over again.

978

I'm like, wow.

979

We, they just, they, they, you know,

doll it up a little bit, but anyway,

980

I, you know, there's, there's, uh,

there's basic, boring investing.

981

Uh, I think, I think you were, you were

talking about that, Jack, you know,

982

just kind of basic, boring stuff kind

of wins in the longterm trotting along.

983

And, uh, and, and maybe, maybe

984

Jack Shannon: it's it's no fun

at a cookout when, you know,

985

Mike Philbrick: we've been

chatting for about an hour, but,

986

but I wonder what is boring.

987

Yeah.

988

Adam Butler: He was - Mike

wasn't being, dismissive of

989

Mike Philbrick: no.

990

I mean, but what, what are the key,

what are the key features of boring of

991

sort of boring that, that you would,

that I know you alluded to that in

992

the papers, you know, this is boring.

993

It's just boring.

994

It's kind of this, but what maybe,

maybe as a final parting gift, what

995

are the key features of boring that

tend to work and just are, you know,

996

things that people can look for?

997

Jack Shannon: It's the low turnover

sort of buy and hold approach.

998

Um, you know, we, we talked about

sort of those portfolio simulations

999

that you can, you can run.

00:53:09,742 --> 00:53:12,062

And if, again, if you look at five

years or three years, it's not going

00:53:12,062 --> 00:53:13,422

to tell you much because of market cap.

00:53:13,707 --> 00:53:17,977

Weighted portfolio would have beaten

00:53:17,977 --> 00:53:20,917

and pick any random selection of, of

companies and just sort of let the

00:53:20,917 --> 00:53:24,507

market take them and it's, it's the

most boring thing you could possibly do.

00:53:24,507 --> 00:53:24,787

Right.

00:53:24,787 --> 00:53:25,847

Set it and forget it for?

00:53:25,917 --> 00:53:26,747

30 years.

00:53:27,077 --> 00:53:29,039

but it Turns out that doesn't do that bad.

00:53:29,039 --> 00:53:32,935

And, in fact can do better than

most of the active stuff that you,

00:53:32,955 --> 00:53:34,445

that you, you end up paying for.

00:53:34,822 --> 00:53:38,972

so yeah, I, I think just the low

turnover buy and hold, you know, don't

00:53:38,972 --> 00:53:42,582

look at your, your, your, your balances

every week, don't look at them every

00:53:42,592 --> 00:53:44,462

month, maybe check in once a year.

00:53:44,942 --> 00:53:47,752

Uh, make sure that your portfolio

manager didn't commit fraud or

00:53:47,752 --> 00:53:51,869

something, but, Other than that,

it's, it's, it's a really long game.

00:53:51,959 --> 00:53:53,569

and, and I'm saying this

and I'm not that old.

00:53:53,579 --> 00:53:57,489

Um, so I, I kinda, I, I kinda

recognize the, uh, the inherent sort

00:53:57,489 --> 00:54:00,405

of contradiction and, you know, a

young person telling somebody that,

00:54:00,405 --> 00:54:02,032

but, that's how I sort of view things.

00:54:02,032 --> 00:54:05,485

I don't, I don't check any of

my, any of my balances, any, any.

00:54:06,170 --> 00:54:07,360

Real frequency at all.

00:54:07,697 --> 00:54:10,097

and who knows, I'll check it in a

couple of years, make sure nothing,

00:54:10,197 --> 00:54:11,387

nothing's too off the rails.

00:54:11,387 --> 00:54:12,957

But,, yeah, that's

00:54:13,253 --> 00:54:14,413

Mike Philbrick: Benign neglect.

00:54:14,767 --> 00:54:15,057

Jack Shannon: right.

00:54:15,097 --> 00:54:15,397

Yeah.

00:54:15,467 --> 00:54:15,777

Yeah.

00:54:16,863 --> 00:54:21,143

Mike Philbrick: The key to investment

success in a world that's overhyped

00:54:21,473 --> 00:54:25,680

and over, marketed is benign neglect.

00:54:26,260 --> 00:54:28,430

Is to just ignore all of it.

00:54:28,695 --> 00:54:31,305

Adam Butler: as long as the initial

portfolio wasn't informed by

00:54:31,305 --> 00:54:32,885

whatever mania was in place at that

00:54:33,094 --> 00:54:33,724

Jack Shannon: 100%.

00:54:33,804 --> 00:54:34,134

Yeah.

00:54:34,724 --> 00:54:35,144

Yeah.

00:54:35,294 --> 00:54:38,312

cause there's a fund in, uh, in

America, it's called like, Voya

00:54:38,382 --> 00:54:44,482

Corporate Leaders Trust, um, was put

00:54:44,802 --> 00:54:46,372

Hasn't traded a thing since.

00:54:46,782 --> 00:54:50,102

not be the right date, but over its

00:54:50,102 --> 00:54:53,795

entire history, it's beaten the S&

P 500 and hasn't traded a share.

00:54:54,781 --> 00:54:57,181

Adam Butler: It's amazing that

all the companies are still in

00:54:57,415 --> 00:54:58,915

Jack Shannon: Well, not all of them are.

00:54:59,071 --> 00:54:59,711

Adam Butler: Maybe they all

00:54:59,880 --> 00:55:04,050

Jack Shannon: So it's, it's a big big

Union Pacific stake in it right now.

00:55:04,167 --> 00:55:07,187

because, you know, some companies

have, you know, been, you know,

00:55:07,187 --> 00:55:08,837

bought out, some have, some have died.

00:55:08,837 --> 00:55:11,797

And so You end up then getting,

you know, market weightings

00:55:11,817 --> 00:55:13,167

within this small portfolio.

00:55:13,467 --> 00:55:15,087

and so, yeah, it's, it's

become a very concentrated

00:55:15,137 --> 00:55:17,237

portfolio, but it's still beaten.

00:55:17,555 --> 00:55:20,109

The broader market over, you

know, almost a hundred years.

00:55:20,119 --> 00:55:21,659

So there's something to it.

00:55:21,948 --> 00:55:22,638

Adam Butler: yeah, sure.

00:55:22,785 --> 00:55:26,925

Well, um, are you working, working

on any particular project right now?

00:55:26,925 --> 00:55:28,215

You wanna give a teaser for.

00:55:28,329 --> 00:55:32,399

Jack Shannon: Um, nothing, nothing that's,

you know, going to get published anytime.

00:55:32,719 --> 00:55:33,719

Immediately soon.

00:55:33,759 --> 00:55:37,509

Um, I, I mentioned sort of the risk stuff

I've been, I've been looking at of just,

00:55:37,509 --> 00:55:42,429

um, how informative are sort of trailing

risk metrics in terms of forward risk.

00:55:42,795 --> 00:55:47,105

you know, the classic betas and standard

deviations and, and, all that jazz

00:55:47,115 --> 00:55:50,769

that, That we all see when you pull

up a fund on a, you know, on a screen.

00:55:50,769 --> 00:55:54,585

But, yeah, that's a, that's a, that's a

more, you know, this hit rate stuff and

00:55:54,585 --> 00:55:57,055

the big bet stuff is very straightforward

when you're getting into the world of

00:55:57,055 --> 00:56:01,082

risk, there's so many sort of other angles

that people, people want to explore that

00:56:01,082 --> 00:56:04,770

makes it a bit bigger of a project, but,

Hopefully that one sees the light of day.

00:56:05,014 --> 00:56:08,227

but if not, you know, everything

sort of comes to me through, uh, you.

00:56:08,227 --> 00:56:10,617

know, like talking with portfolio

managers and that they'll say something

00:56:10,617 --> 00:56:15,457

and I'll say, like this hit rate stuff

that came up because a manager said he

00:56:15,457 --> 00:56:17,567

had hit on 70 percent of his stock picks.

00:56:18,187 --> 00:56:20,657

And I thought that was

a ridiculous number.

00:56:21,147 --> 00:56:24,167

And so I said, I want to

see how rare that, that is.

00:56:24,617 --> 00:56:27,787

And I, and I did The study and there

was one manager who had 70 percent

00:56:27,787 --> 00:56:29,420

or more and it wasn't, this guy.

00:56:30,470 --> 00:56:35,147

Um, so it's, uh, yeah, it's, I just,

I, I like being here and having, having

00:56:35,147 --> 00:56:39,297

sort of a unlimited, uh, access to

our database to just sort of explore

00:56:39,297 --> 00:56:41,097

what's ever top of mind at The time.

00:56:41,097 --> 00:56:43,460

So something will pop in my

head and you'll, you'll see

00:56:43,460 --> 00:56:44,650

it at some point, I suppose,

00:56:45,311 --> 00:56:45,901

Adam Butler: I hear you.

00:56:45,931 --> 00:56:52,751

The best articles are motivated by someone

who says something that you think is

00:56:52,751 --> 00:56:54,951

silly or that you strongly disagree with.

00:56:55,040 --> 00:56:55,410

Jack Shannon: right.

00:56:55,620 --> 00:56:56,790

I got to prove that guy wrong.

00:56:57,728 --> 00:56:58,088

Adam Butler: Yeah.

00:56:58,191 --> 00:56:59,831

100 percent yes.

00:57:00,691 --> 00:57:01,571

Completely concur.

00:57:01,571 --> 00:57:01,931

Okay.

00:57:01,931 --> 00:57:02,965

Well, this is great.

00:57:02,975 --> 00:57:05,815

A little over an hour, um,

covered a lot of ground.

00:57:05,991 --> 00:57:09,051

Jack, uh, where can people find

you other than at Morningstar?

00:57:09,626 --> 00:57:11,096

In addition to Morningstar.

00:57:11,586 --> 00:57:13,036

Mike Philbrick: On the streets of Chicago.

00:57:13,170 --> 00:57:15,190

Jack Shannon: you can bump into

me on the South side of Chicago.

00:57:15,200 --> 00:57:15,870

That's where I live.

00:57:15,880 --> 00:57:19,160

But, uh, no, other than that, um, I

don't really have a social media presence

00:57:19,160 --> 00:57:22,452

or anything, but, um, yeah, you can

just Google me with Morningstar and

00:57:22,452 --> 00:57:25,512

you'll see a list of all my articles

pop up if you're, if you're interested.

00:57:25,602 --> 00:57:27,309

Um, I, I have a LinkedIn page.

00:57:27,309 --> 00:57:30,189

I don't really look at it, but,

people can find me there, I suppose.

00:57:30,599 --> 00:57:33,172

but yeah, and I do, you know, I

like to hop on these podcasts too,

00:57:33,172 --> 00:57:35,815

so maybe they'll see me across,

you know, some other ones or, or

00:57:35,815 --> 00:57:36,965

on this one again at some point.

00:57:37,430 --> 00:57:37,980

Mike Philbrick: Sounds good.

00:57:38,046 --> 00:57:38,506

Adam Butler: Awesome.

00:57:38,756 --> 00:57:39,176

All right.

00:57:39,176 --> 00:57:42,463

Well, thanks so much for sharing

and for the, for the great chat.

00:57:42,563 --> 00:57:44,763

And, maybe we'll catch up

with you in a year or, so.

00:57:44,763 --> 00:57:46,633

See what you've, what you've touched on.

00:57:47,342 --> 00:57:47,922

Jack Shannon: Yeah, I,

00:57:47,933 --> 00:57:48,323

Mike Philbrick: cooking?

00:57:48,812 --> 00:57:49,332

Jack Shannon: that's right.

00:57:49,332 --> 00:57:50,002

I appreciate it.

00:57:50,032 --> 00:57:51,832

Uh, again, thoughtful discussion.

00:57:51,832 --> 00:57:53,165

Um, I enjoyed it as well.

00:57:53,330 --> 00:57:53,810

Adam Butler: Perfect.

00:57:53,980 --> 00:57:54,330

All right.

00:57:54,340 --> 00:57:54,940

That's a wrap.