Wes Gray - Compound Your Face Off - [Invest Like the Best, EP.47]

I know firsthand how complex the tech stack is for asset managers, and seemingly every new tool and data source makes the problem even worse, adding more complexity, more headcount, and more risk. Ridgeline offers a better way forward, one unified platform that automates away all that complexity across portfolio accounting, reconciliation, reporting, trading, compliance, and more, all at scale. Ridgeline is revolutionizing investment management, helping ambitious firms scale faster, operate smarter, and stay ahead of the curve. See what Ridgeline can unlock for your firm. Schedule a demo at ridgelineapps.com. This podcast is sponsored by CFA Institute, the global association of investment professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals working to build an investment industry where investors' interests come first, financial markets function at their best and economies grow. The Chartered Financial Analyst Credential is the most respected and recognized investment management designation in the world. The views expressed in this podcast do not necessarily represent the views of CFA Institute. Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com. Patrick O'Shaughnessy is a principal and portfolio manager at O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast. My guest this week is a version of me, a funnier, cooler version, who also has a PhD and has served as an active duty Marine. Lots of you will already be familiar with Wes Gray, and those of you who are not are in for a treat. Wes is the founder of Alpha Architect, a firm which manages quantitative equity strategies for clients using factors like value and momentum. He also advocates a more concentrated, pure approach to factor investing, which listeners know is music to my ears.

While we share a lot of the same views on markets and investing, you will still find this refreshing. The conversation was easy to structure. I just took all the questions clients and prospective investors always ask of me and my firm and turned them on Wes. These range from very specific questions on quant investing to big existential ones. I listened to this on a long drive home and laughed out loud in the car at least five times. You're going to love it all. I close this introduction by offering you an opportunity which is not for the faint of heart. On September 16th, I will be joining Wes and his crew on a 28 mile trek called March for the Fallen, which is a small but important way of honoring those who have given their lives in service of our country. Wes and I invite you to join as well. If you're interested, check out the post on Wes's site with all the details. I will link to it in the show notes, which you can find at InvestorFieldGuide.com forward slash Wes. If you are still interested, then email me with the subject heading March for the Fallen. I told you Wes is a cooler version of me, and true to form, he will be doing the hike with a 40-pound rucksack. I will be doing the version without a rucksack. Either way, it will be a day of camaraderie and remembrance that we won't soon forget. Join us. Okay, now on to my awesome conversation with fellow quant fanatic, Wes Gray. Talk about the mindset that gets beat into you or maybe brainwashed into you as a Marine. I've read a lot about Bella Wood and Devil Dogs and sort of the mindset underneath it all. Compare that maybe to the rest of some other branches of the service and kind of how the mindset is or isn't an advantage. I don't want to assume you think it is. Yeah, Marine Corps, kind of their ethos is do more with less. You know, guys that always get the scraps, we've got to be ornery and mean and internal. And I don't know if that's a fair classification. But in general, Marines just, we like to think of ourselves as, you know, kind of survivalist and we can do more with less. So, I mean, I think that's, I don't know if that's true or not. Because when I was in, we had GWAT funds and they gave you as much money as you wanted. And if you want to go.

Shoot 10,000 rounds. As long as you were training, you got it. But still that mentality and that culture of doing more with less and winning at all costs, I think still permeates Marine Corps versus, you know, the bigger, more bureaucratic services for sure. Did that change your mindset? I always wonder how much of this is self-selection versus real transformation. Was your mindset like that before, or was it going to change? Yeah, I've always been like that, man. I grew up in the mountains in Colorado, and so I've always just been into adventure, survival. When I was a kid, we were pretty broke. I didn't really know it at the time, but I've always been in that mindset of don't spend money. Even if you have it, just always be kind of like a depression baby that was born in 1980. And so I think that kind of culture is just also in the Marine Corps, and at some level kind of attracted me to the Marine Corps. So I think the Marine Corps doesn't really change you a lot of times, at least in my scenarios. It just attracts. whack jobs uh like myself to come into it and so then you get a whole fraternity of people that were kind of already self-selected to be like this and then we all hang out together and it just makes it even worse you know so i and some people do come in the marines i think it does change them but but i was Like, I was already brainwashed coming in, basically. I didn't get transformed. I was already weird beforehand, I would say. What was your most memorable experience growing up in the mountains? It's funny, because you probably know this when you grew up, but there was this mountain behind where I lived there. At the time, it was called Adams Rib Ranch. The Coors family bought it. It's called Frost Creek, and the whole thing is like a development now. But there was this mountain behind us, and my brothers and I, we'd always... climb up this thing it was like an epic adventure take all day thought it was the best thing ever and then we went back probably about 10 years i brought my best friend out there and i was looking for this mountain and i'm like man henry you gotta hear about this thing it was so epic like this is where i did all my like toughest things and of course we go out there and it's like

A hill. Maybe a hill. And it was just amazing. When I was a kid, like, that was so great in my mind. It was, like, the most insane, awesome thing you could ever do. And we went back there. We're like, oh, that's pretty lame and doesn't even matter. Wouldn't even count. So, unfortunately, that was probably the best or the most memorable thing I did growing up there was just climbing mountains and doing crazy things. But it wasn't that cool after the fact. In the military, what experiences would you say are most related to kind of what you've done? gone on to see in public markets. So maybe the same sorts of mistakes that people make, arguably these mistakes are what strategies like yours and ours prey on. Sure. So what are some parallels that you saw? Yeah, I think, you know, Kahneman's book, Think Fast and Slow, the whole system one, system two, architecture to brain. I think that defines life in decision making. And in the military, it's just magnified because all your training, everything you do is set up. how do you minimize system one errors? And try our best to think in that system two mentality of like rational, calculated thinking. But obviously that gets more and more difficult at the margin when you got 100 pounds of shit you're carrying around. It's 125 degrees, you're tired, you're pissed off. And the military is just, it's all about how do we contain system one errors as best we can? And, you know, obviously in investing, that's... totally transferable where if you're not in that extreme as an environment, but clearly investing your money is pretty stressful and emotional. And I still think that the best investors are not really those that can make the best. stock pick, but more they're able to contain the damage from bad decision making and being overconfident doing stupid stuff, basically. What were your early forays? I realize I don't think you and I have ever actually talked about this despite a million investing conversations we've had. What were your earliest forays into stocks, into the stock market? Was it, how did you first, what was the first stock you bought or owned? Yeah, yeah. First story in the market. Yeah, I mean, I was on a path to total failure because the first stock I bought was Swisher Sweet Cigars. And I

I remember exactly. It was $6.50, the stock price. And I'd been brainwashing Warren Buffett stuff and Ben Graham. So it was all about return on capital, low P.E. This was probably like 98. And at the time, like, I think I even read the value line back in the days of the paper one. It was amazing. Like, huge return on capital, huge return on assets for multiple years. You know, the earnings kept growing. It was super cheap on P.E. Bought it at $6.50. Like, literally a month later, a buyout for like, it was like $9.00 or $9.50. And I was like, oh, this is so easy, man. No wonder Buffett's a billionaire. This is all you got to do. And so that's unfortunately how I started with like a ton of. success, which was kind of lucky because then I started getting huge in like stock picking, special situations, did that for years and kind of also got lucky in the sense that I wasn't lucky starting around like the late 90s because, you know, my dad would call me up telling me to buy the Janus Global 20 fund every day. You know, this is when internet go-go was going on. So I kind of, I felt confident because I had my Swisher Suite success. But then, you know, I kept not doing as good as the general market, but just by nature being a small cap value player. And as we all know, the story's now been told. Minus the internet crash, like small cap value, you could have thrown a dart at a wall. and made 30 keggers for 10 years. But that all ended poorly because towards the end of it, I kept doing more of the stock picking stuff. And even to this day, I still sit on about a half a million dollar capital loss carry forward. And that's kind of what moved me into, I'm not Warren Buffett and I need to focus on systems and not basically fucking everything up. Yeah, I went from the super overconfident and then all the way down to the bottom of the depths. And then luckily, I wasn't that rich. I kind of ate my humble pie pretty early. And thank God, because now I haven't looked back now. I don't do stock picking at all. So what was the transition into the quantitative investing space? So how did you kind of discover it? What was the early research process like? How did you build conviction that this was the way to do things? Well, it's another bad story. So I actually launched a hedge fund that was going to be basically like kind of what

where quantitative value does, but long short in September 08. So I literally launched a hedge fund right when the whole thing was like blowing up. And of course, just by dumb luck, I go in hedged. So, you know, in those months I'm looking good relatively, but at the time I wasn't doing short and individual security names. I was just using Russell 2000. And of course, because all the naked shorting rules got blown up, even IWN got like called in so I couldn't short anymore so now I'm long and strong these quant value names which I was like oh this is great but of course this is it now in December I start going back to the old Ben Graham ways where there's all these like biotechs that are selling for less than cash like all the traditional things that I've been doing for like 10 years and I'm like oh guys We got to switch. This is the best opportunity ever. All we got to do is go buy these stubs. We'll make all this money. And so literally, we talked to LPs, which it was like $3 million, just our internal money and a few rich guys we knew. And we changed the whole system. Said, screw this quant thing. This is a once in a lifetime. And of course, long story short, we ended up basically getting R2K with like... twice the vol and then end up liquidating and transition to business because I had some bigger rich guys call me. And when we back-tested what we would have done if we just followed the damn model, we obviously would have outperformed our own stupid ideas. So that was my last straw where I'm like, you know what? I'm done. I'm pure quant now. Just build a system and a process that you think makes sense when you're in a System 2 frame of mind. And then when you're in the battle and the fight, just Follow the model. And you almost got to take a religious bent towards your own kind of scientifically minded system. So, yeah, I don't do stock pick anymore. If you had to sort of describe the, we'll call it quantitative investor, like landscape or map.

How would you do that? What would you say are the major camps or applications of the basic idea, which is get some things. There's a group of stuff you can buy or sell. There's data on those things, and there's future returns, and you build models. ton of ways to apply that basic kind of scientific method idea. So if you were describing to, let's say, a sophisticated investor out there that came forward in a time machine from the 70s when no one was doing quant or very few, no one except Ed Thorpe was doing quant, how would you describe what it looks like today? Like what are the major camps? Who are the pockets? Who are at the leading edge? Yeah. So just like anything, it's good to define the term. And I'm sure you guys get the issue all the time. Quant can mean anything from what I consider ourselves, and I imagine you guys as well, where we are just long-term investors that like to use quantitative tools to help us make good decisions for the long term and minimize the baggage of being a human. And then there's a whole other spectrum of quant, which is the Caltech physics PhD building like AI machine learning algorithms on... basically making markets. And I think it's really important for people to just know when you say quant, What do you mean and what are you trying to achieve? And so I think the applications in the much higher frequency land, because we know a lot of them like the prop trading world or market making, that's where I think a lot of like the biggest brains in the world are super useful because that's a game of super high frequency information acquisition, trying to be smarter than the next guy. I got to build good computers. Uncertainty gets resolved immediately and I keep making thousands and thousands of bets. That's extreme quant. We don't play in that game. We don't got any edge. We don't want to. And then on the other extreme is you got people that say, hey, Warren Buffett has a pretty cool idea. Buy cheap stuff that's high quality and has low beta, it turns out, too. But his real edge is just patience and ability to sit back and not worry about what everyone else is saying about the world. And I'm not sore enough to be Warren Buffett, tried and failed. But I.

I don't know if I'm smart enough, but I think I can capture the essence of what he's trying to achieve using quantitative tools. And that works for me. And is this meant to say that my model is better than your model? It's better than AQR's model or better than Joe Schmoe's model? No, we all know the same data. We all know the same facts. I've determined the edge is not in building a better mouse chap. The edge is in coupling. educated capital that understands why your mousetrap works and pairing the two together, which was why our firm's mission and impact is we empower investors through education. Our mission is not we're going to build cooler models than Patrick O'Shaughnessy or Cliff Azenis because there's no edge in that. We can all run CompuStat tapes until we're blue in the face, as you mentioned. We've both done it, yeah. Yeah, we've all done it. And I was even listening to actually Cliff. I was watching a little YouTube video of him because he's a guy I really respect. Yeah, I just love their firm and what have you. And someone asked him about like machine learning. They're like, hey, Cliff, what do you think about machine learning? And he almost said the same thing that I wanted to say. Super interesting. You know, haven't really seen anything in its application of what I do, which is kind of this lower turnover kind of quantitative investing to capture these premiums over the long haul. He's like, we do value. We do momentum. And that's what we do. And we're probably not changing it. And I'm the same way. Like I literally get people with PhDs in every physics, math thing you could ever mention saying, hey, you guys are really cool. You're awesome. I got this new machine learning algorithm and I'm an equal opportunity employer. So I'll just send them a bunch of data because I already know what we've done on it. And I'll say, here's a bunch of data. You go crazy. And here's all the robustness requirements you got to show me. Prove to me. that it works any better than just predictive regression approach. And to date, I have not seen it. It's one of those things where it's on one end of quant, super hardcore is great.

Like an HFT. On the other end, you could give me 50 guys with 200 IQ Caltech math PhDs, and they're not going to convince me that their value algorithm is better than mine or yours or whoever's. That's not what matters. We're going to spend most of the rest of the time parsing our world, which is, I'll say, like the more just automated fundamental type investing, more or less. Killing system one error, simple, basic, long-term stuff. So we're going to return there and spend time there. But it'd be fun. to get your perspective because you have straddled all the worlds. You've been in the Chicago PhD program. I think FOMO was literally your thesis advisor. So we could get into that story a little bit. But you have sort of a window into all types of quant, including that crazy, you know, megamind, thousand PhD, informational advantage market making thing. I don't want to assume it's easy to throw around terms. It would be great if you could explain in a little more detail what that means. So what do you mean high frequency, market making? What is the nature of these strategies? What exactly is it that they're trying to do? And how are the good ones or the best ones better than the second and third tier ones? Yeah. So a perfect example is one of the guys that seeded our business came out of a firm called Gecko. And we have a lot of clients that kind of come through that channel through him. you know gecko was like the original gangster in in pixie market making right crush the world they they came into that kcg acquisition kind of mesh with a different culture and then all the original get guy gecko guys for most part left and they're they're now all running their own little shops and one of our clients who's a guy in chicago that does this and it just These are a system that's probably got 100 mil capital max it can take, but they can leverage it to infinity. And he's got 40 people that are all math, physics, PhDs, and they're literally all working on one central machine learning algorithm. And their whole thing is they're literally making microsecond transactions just...

essentially trying to understand supply and demand better than the next guy to make little, small, little return. And when I asked him, I was like, well, what's your returns you make? He's like, well, we make 30%, 40% returns just like Rentech does. But what people don't understand is we're not investors. We are traders. And if I were to capitalize all the brain damage, all my computer systems, the servers, my ROA, return on assets, is probably like buy an S&P, but I have a hell of a lot more fun because this is my passion, what I like doing. And, you know, so I think their game is they're in the true edge of outsmarting the next really smart guy and just being able to understand supply demand better than the next. And, you know, buying low and selling high is what they do. It's just that's, you know, if you're competing with supercomputers at the margin, if you're one millionth of a second better than the next PhD guy, that's everything. It's kind of a winner-take-all, essentially. And it's also always changing, too. Their markets, unlike what we do, like value, okay, there's some element of risk, obviously. There's some element that people just hate like retail stocks right now because Amazon's going to kill them. The edge of the bet is they always throw the baby out with the bathwater. No amount of technology or brain damage or 500 IQ people is going to change my mind about that. Whereas in their world, It is the case that a smart, like I do think machine learning, mainly because you can learn much faster with much more frequency, I think that those technologies can make that better at the margin. But it's always going to be a limited scale opportunity where, yeah, you're always going to have to be innovating, always going to have to be smarter than the next guy. It's not Warren Buffett, you know, frequency of change. People are always curious about who populates these firms, right? given that you came through the Chicago PhD program, you know, a lot of, a lot of the alumni from that go to firms like this. So can you talk a little bit about like the human capital arms race in this space? Like how, how, how is rent tech, you know, outpitching to Sigma outpitching whomever to get the top talent? Like what, what, what is the, what are the kind of the, the, the,

elements or variables that matter there from a recruiting standpoint yes so i so i know a few of the teams like millennium and some of these big shops like that one of the things is they just have great infrastructure and to be honest a lot of them aren't chicago phds a lot of them are just more like hard science types. But you can go to a shop like that, like Millennium, and say, hey, here's all the data pipes in the world. Here's all the legal infrastructure in the world. And oh, by the way, we charge whatever, $3.50. And because our fee structure is so high, we can pay you internally like $0.20 or $0.30, and everyone's still winning. And the ability to be able to offer someone who's maybe a PhD geek that's got really cool ideas and say, hey, you're almost like a postdoc coming into a science lab. You don't have to go raise – you don't have to go fight for grant money. You can just come in here and do cool stuff. And oh, by the way, because our fee structure is so big and deep, we can also pay you a ton of money. And so I think that's the initial attraction on all these guys. And then I think it boils down to culture because most of the folks – We all know guys that work at all these best shops. The decision usually comes down to what's the cultural fit. And there's people that will be like, honestly, I'd rather work for you guys and make 150th because this is so much pressure. I'm losing my hair. I hate my life. And I really think the culture element is what within those firms is probably what decides who goes where. Because in the end, it's kind of commodity what they're going to provide for you. It's more like what's your fit with. Like, you know, probably Bridgewater, you get people that love it or people that are like, yeah, I'd like to go hang myself from the rafters now from hanging out at that place for longer than two months. So I think culture is like a big kind of soft element of recruiting that most people. You just can't quantify it that well. But it matters. So obviously, we've both chosen a very different poker table to play at. So let's go to our world, which I'll let you start by describing at a high level the basics of our findings. So you already mentioned that a lot of us, we're all looking at copy stat data, world scope data, MSCI data, whatever. And obviously, if you do fairly simple work, you're going to reach.

fairly similar conclusions. That's not to say that you can't differentiate yourself in how you calculate things. I want to get into portfolio construction because I think you and I agree that can be a huge differentiator. But maybe describe for the 10 people listening that don't already know who you are, given that we're kind of operating in similar circles here. Maybe describe at a high level what the approach is and the characteristics that you mentioned Buffett before. So that's one kind of mental model. But the characteristics that you found in your research to be most predictive or usefully predictive. of future returns in stocks. Yeah, I mean, it's going to sound like a beating drum and your dad wrote a whole freaking book about it. But we have a saying, buy them cheap, buy them strong and hold them long. What does that mean? Buy cheap is basically encapsulating an idea of value. Buy stuff that the market at that time, basically everyone hates and just hold your nose. and have a long horizon and then buy strong refers to momentum is you just we know that winners we get winning so do that but the last part is arguably the most important buy them cheap buy them strong dot dot dot and hold them long Because everyone in this factor rat race, and you know, we know, and anyone who's studied the data knows that if you're going to capture those factor premiums, it's going to be insanely painful. Especially if you do it how you and I do it, where I think it's the more intellectually honest way to do it, which is much more concentrated and focused in the actual factor. It's just, that's the nature of it. It's going to be painful. So it isn't a free lunch. for having to endure that pain, you get some gain. And I think those are the buy them cheap, buy them strong, and hold them long is about my summary of all the research out there for the last 200 years on this thing. So one of the most interesting debates going on now is around portfolio construction. And when you say pain, there's kind of only one type of portfolio that can deliver real intense pain, which is a...

high active share, highly differentiated one. Because by nature, the more different you are, the more potential there is to do really badly, which always hurts much more than doing really well feels great. So we've got this goofy, you know, fear, greed imbalance. So talk about your research on portfolio construction, because the standard party line for quants is you got to be really broadly diversified and take basically no individual name exposure, neutralize every risk. to everything. So you've got these platonic, pure factor exposures and nothing else. And this kind of coalesces around the idea of smart beta, which everyone's familiar with. So you and I have very different takes on this. So talk about portfolio construction. Yeah. So again, we use quantitative tools to capture what we think are... important good insights from qualitative investors. Munger has that whole thing about diversification and if you have an edge, why would you dilute it out? And again, to your other point, being different is the way you're going to add value or potentially subtract a ton of value. So I understand the merits and doing like the super sector constrained control for every little thing. And that's cool for a certain buyer. We build products for our own money. I'm in the business of trying to compound my face off for 20, 30 year horizon after fee, after taxes. And I don't frankly care that much about sector risk or volatility or what have you. And I feel like that's. the only way I can capture my edge, which is being crazy and having a lot of patience. Because if everyone in the world has to sector neutralize to placate this institutional mandate, just if you think about it, are you going to have more or less edge when you have to look more and more like the Vanguard fund? Almost mechanically, if you think of this as the poker game, if more and more I have to play poker like all the other poker players,

Almost mechanically, it destroys any edge or ability to take paint. So we just build portfolios. I'm not saying they're right or wrong. I'm saying for a particular mission, they make a lot of sense. But they're also the worst idea on the planet Earth for probably a vast majority of investors. And it's much more appropriate to kind of manage the risk. Again, our portfolios, we don't say you should put everything in one of these things that has 50% retailers right now. Because that's a real risk. What if the whole damn thing blows up and Amazon takes over the world? I'm not discounting that as a real risk. If you're paying me to deliver you the value premium and presumably that's being wrapped in a broader portfolio set where, you know, you're doing some element of efficient frontier portfolio versification, you want me to have as much active risk as possible because that's what you're paying me to do. And, you know, I know as this retort, I'd be like, oh, yeah, well, a lot of that's not active risk. That's just sector risk. Well, I'd say, yeah. You show me how to easily and with low brain damage and low cost separate out the value premium from sectors. I don't think you could do it that well. And a perfect example is like the Internet bubble. So in 1999, you're going to force me to own some tech stocks that are quote unquote cheap at like 500 times earnings. You know, that's not the value premium. The value premium is buying pain and hate and discontent. i.e. right now buying everything that amazon is going to destroy quote unquote best buy best buy all this crap that we own i'm sure you guys own a lot of it a lot of best buy yeah you got you got to own the pain you got to own the risk and it is risk there's some misprice in there too but it's a lot of risk but that's fine if you got horizon you you can bear risk and so We just build super risky portfolios, and that's just what we do for them. We're a boutique. We're not saying it's for everyone, but that's what we do. And I think you guys do it as well at some level. Maybe this is something where you and I may have slight disagreements. So let's see if we can explore this a little bit more. So what we found is that a lot of quantitative managers are sort of risk-free.

First, risk mitigation is a key, key part of their process. And you can define risk a lot of ways, but tracking error is a very common one. So the sort of great pitch from some enormous asset managers that do factors is factor exposure, but low tracking error, which to us is kind of like you, a little bit oxymoronic. It can be right for the right investors for sure. Obviously, these asset managers are multiples the size of both yours and mine. There's an appetite for it. But I'm curious how you think about risk within this category of highly active. So one of the things we've found is step one needs to be get really concentrated in your key factors. But then within, let's say that's the... cheapest decile of stocks or something like that in large cap stocks. But then within that group, then you can do some stuff around risk management. So then let's say that today, you know, the cheapest is 50% retailers. Well, maybe it's 40%. And that as long as you're within the kind of best of category by value momentum, you know, kick out the worst crappy companies, it's kind of step one, then you can kind of shape. and not take as much active sector risk. So how do you think about that? So like, is there any risk management that you do or? So here's the problem. I'm leaving out some context here because the other way we're always, when we think about like value, for example, it's always in the broader context that we know we're going to do this in a global value and momentum portfolio. So when I want to go get my value risk, I'm going to go get the most whoop it on. crazy highest expectation thing I can get. And obviously it's going to have a lot of vault and quote unquote risk, you know, risk that may be associated with sector bets, what have you. However, if those 40 stocks are part of a 200 stock portfolio, especially pulled with momentum, where a lot of times it's doing kind of like the convex bet that's opposite of the best buy pain trade, I think as a global portfolio there, which is really the in-state equity book.

it's not that big a deal. But to the extent that you were just buying our little value exposure, and that was your all-in with your entire life's net worth, you're going to be probably overexposing yourself at the margin to the best buy bet. And you can obviously hedge against that and maybe put some sensible rules in there, which I also agree with. Let's not do 100%. We have 25% rules or whatever. So you don't want to go totally insane. But the thing that kills me is when people are like, It's almost like getting too scientific where like every sector is going to have the exact exposure and we're going to have these 10 longs, these 10 shorts. We're going to rip out the every factor element of it. And that's what I just call like overengineering. And it seems like the benefit versus brain damage is just it's not a good quotient there. So in general, if you can go simple and robust with reasonable constraints is. Good. So I think we would agree, actually. I'm more talking to the hyper-quant types, that it's like... seems over-engineered to me. So QVAL, at least last time I checked, which is the standalone value ETF, I think it's 40 holdings, right? Something in that ballpark. So how do you think about that number versus 100 versus 10? What is the portfolio construction logic just behind the number of names and the sizing of the positions in the portfolio? Yeah, sure. So we all have to operate in some constraints for like 40 act and what have you. But in general, we kind of look at it as... You always have that tradeoff between expected return and volatility or some measure of volatility. And we all know the chart. How many positions do you really need to hold to get the benefit of diversification, especially if you consider that these investors are probably going to hold other things? And we just feel that if you're... Going to try to bottom ticket and give people as much active risk exposure as possible without being insane or running afoul of these different rules we have to operate within the regulated space. We think like kind of that 30 to 50 seems reasonable. And could you do 100? Sure. That's not bad. That's at the margin better than 500 where you got sector neutral everything and you're not really buying the factor. So I think it's more of the art and the science of it. We're just.

trying to get it as focused as absolutely humanly possible, where the results back 40 versus 55 versus 23.2 positions? No, but 30 to 50 seems like a good ballpark to maximize active risk without getting stupid about it by holding a five-stock value factor portfolio. We feel like we can get the versification we need, but still deliver the high-octane kind of... pure blue meth drug that we're trying to deliver out there. And then, you know, people can chop that up and add their baby powder on their own terms. But, you know, we're going to personally, you know, smoke our own blue meth because we like it. It's kind of how I'd say I think about portfolio construction. Gun to your head. You got 20 year horizon. You get to pick one factor. You're picking value or momentum. OK, so the evidence would say momentum. But because I'm a human and because I was raised on Ben Graham, value is just intuitive for me. So when I incorporate the system one risk that when that gun's to my head and momentum stops working, I'm just going to give up on it. Value something that you could put 50 guns to my head and I will never. Even if it goes negative 99% return, I'll still be holding my value stocks. Whereas momentum is something where I know the evidence is compelling. I know all the rationale for it, blah, blah, blah. But it's not as intuitive. It just doesn't sit with my system one as well. So I would be more inclined to blow that trade out when I'm in worse pain than value. So I'd stick with value because behaviorally. I could ride that to zero. When you say that momentum, if you just went with the data, it would be momentum. Describe what that means. So what that means is when you look across all the robustness studies, all the asset classes, all the time periods, this idea of momentum, buying relative strength.

is more compelling from just a straight-up empirical-based standpoint than value ever thought of being, especially when you control for, like, the risk and kind of how it fits in, like, a broader portfolio. I don't think anyone denies that. Even, you know, Fahm and French in the dissected anomalies paper, they say, this is the premier anomaly. Like, we can actually look at book-to-market. which, you know, classic value factor. And, of course, they picked that one because it sucks. But, you know, you can kind of make all kinds of story why it's risk-based, blah, blah, blah. But they say momentum. And, oh, by the way, our prior is we've got to make the world efficient market hypothesis here. We even can't explain this. This is absurd. And so I think the evidence is there. And because it is so counterintuitive in how it works and why it works, I just feel like it is a better long-term bet. If you were like a scientist, like computer robot guy, which I'm not. That's why I said value. But if I was a robot, that's what I would do. I feel like I spend like a tenth of my career explaining to people why I don't like price to book. So maybe I'll let you do it for me. So when you say price to book sucks, why? Why relative to other value factors? Well, I mean, before we get into the weeds, though, because you guys have like tons of great research on like the mechanical reasons why, I'll give you the simplest reason why. There's this little shop. called DFA that has now, I don't know, $600 billion of hardcore capital that won't sell book-to-market stocks unless you put 50 guns to their head. So anytime you get a factor... You know, there is the thing, you know, the market does matter. Supply and demand does matter. So if you have a factor that is the sole focus of a firm that has actually created insanely disciplined investors and done a great thing for their investors and essentially arbitraged their factor away, it happens. So, and same thing, if someone took, you know, our favor, which is enterprise multiple, and you said, hey, we're going to get a bunch of, we're going to get $500 million of brainwashed capital that's permanent that will never leave.

Risk premium slash mispricing premium will erode because it's not leaving. It's not timing, factor timing, just like if we did your guys' stuff, shareholder yield. Blow out of the water. But guess what? If you grew to $500 billion and you arbitraged away your shareholder yield factor, you over that time period have done an incredible service to your investors because they've gained that whole benefit of arbitraging that mispricing because they presumably were the permanent capital initially. And they were like the $1 billion, not the $500 billion, which at the margin is now just buying risk premium, pure. So I just think it's probably... been arbed out. Not to mention that, you know, there's mechanical reasons you guys talk about with how book the market works with share repurchases, all these other things. So it's not a bad factor. It's going to capture just what DFA tells their people are going to capture a risk premium pure. Great. But if you want to try to maximize your value premium exploitation, you obviously going to eat the risk component of it. But if we can add a little bit of mispricing sizzle in there, why wouldn't we do that as opposed to the book to market version. It raises an interesting question, which is one of the key questions, I guess, any manager that seems to have an edge has to answer, which is how do you know when this is going to stop working? And flows affect factors, right? Obviously, if there's $500 billion in something and a million dollars in the other thing, you probably want to be in the million dollar thing. So what are the sorts of things that worry you about the strategies that we've spent our careers on? 10 years ago, honestly, even five years ago, it feels like, were much lesser known, much less popular. There wasn't a Wall Street Journal week-long series written about these strategies. So what kind of things worry you, and what would be the circumstances? So we sit here in System 2 right now, being very rational. If you had to set a set of criteria at which you would say, okay, I actually need to get out of this strategy, what would that look like? So I would say...

The biggest one – and this is, again, the art and the science of it because as yourself, you probably know, when you look and you're trying to be scientific-minded, we're going to have the scientific – or we're going to use the scientific method here where we have competing hypotheses. We're going to look at all this data, look at out of sample, in sample, different time periods, different markets. And we've done that for hundreds of years now on value and momentum. I'm in. So now if I'm a Bayesian updater, like we need so much time. to go out of sample for me to change my prior at this point, I'm basically not changing. I can't even live a long, long enough time for me to change that core ethos on the science. But then it gets back to the art. And the way I look at it is it's still in the end, it's all about supply demand. And just going back to this DFA example, the art of this is if you see massive amounts of insanely patient disciplined capital that's not exposed to principal agent issues with like recycling, short-term chasing, DFA type money, where we put billions upon hundreds of billions of dollars of super hardcore factor premium exploitation capital to play on something, you will arbitrage the thing away. Period. But I just don't see that. What do I see? I see more intermediation, more stupidity, more data access, more transparency, which you would think would make better decision makers at the margin. But what do you think happens when someone has the Robinhood app on their phone when they can click a button and buy or sell something? But also when they have all the data in the world at their fingertips, this is not going to make people more rational, patient capital, 20-year hold investors. It's going to actually create availability bias and force decision-making, which is the decision-making you don't want, which is short-term minded. And so I think we're entering a world where ironically –

All the information access, more data, more technology that, quote, unquote, helps people make better investment decisions is end up going to make people just make more decisions, which we all know if there's a chance that a decision maker has a flaw of making a decision because we're all humans. There's a lot of system one in there. The more times you take that bet, the higher probability you're going to screw it up. So the art of it is I'm not changing my mind. Buy them cheap. Buy them strong, hold them long is going to be in my ethos till the day I die. There may be new things like trend or other things I'll explore, interesting, but those core concepts ain't changing. And it's just because there's not enough time for me to be alive to make enough out of sample to convince me otherwise. But what would change me is, again, going back to the dynamic of the market and understanding what Creightsey is saying in the first place, usually delegated asset management, principal agent problems. And then just look for basically little mini Warren Buffetts starting to pop up that stick to these factors. There's ETF strategists. What do they do? Factor time mechanically. It's not permanent capital. They're literally going to be blowing out of value because now they're going to low vol. That's the exact kind of capital that actually permanent capital exploits in the value premium. And you just see more of that. Not less of that. So, I mean, I think it would be insane to think, at least based on a short-term forecast and knowing psychology of the marketplace and how institutions are framing and pitching themselves right now, to think that that's creating more patient factor capital. I mean, that's the way I look at it. How do you think about new research? So most of these, we'll call it like fundamental quant. strategies. Really, it's data coming from its price plus the financial statements, more or less. There's other stuff too, but that's the basis of most of what people like you and I do. How do you think about new ideas to explore, new research? You guys write a ton. You mentioned the idea of education being a central mission of yours. How do you think about

What to explore next? Maybe give some examples today. Like what are the sorts of things that have you interested and engaged with the data and, you know, tinkering around? Yes. So, you know, every morning, I mean, all I do, like I know you read like tons of books, which is awesome. I just read. Unfortunately, because I'm just a finance geek, I just read source journal literature. It's kind of like my books. So I don't practice the Munger mental model thing. My mental model is finance crap all day, every day, just because I like it personally. I love reading research, love and desire like no other to find new ideas and hope that they change my mind. I'm passionate about that, and that excites me anytime I get something new. And I'm always reading because I always want to hunt for that new Easter egg. But that said, having been doing this for a while now, there hasn't been... Ever since we've kind of like summed up everything we knew about value and everything we knew about momentum, we always test stuff all the time. But the problem is the bar to entry is so much higher now because we always have to, you know, kind of consider, again, this is more art and science of the chance of overfitting, overoptimization, data mining, where anytime you already have kind of the baseline idea, buy them cheap. Am I going to argue that our model is better than your model? They're all about the same. Buy cheap. Who cares? Just have discipline. You'll probably win. We think ours is better than your stuff. And that's great. I think, honestly, the stuff that comes out on the new models is marketing. Because every time we look at every idea, re-engineer, test it, and we say, hey, does this add value at the margin of what we already have? Unfortunately, and you guys probably know it too, inevitably it doesn't. So then you got to sit back and ask the incentives of the marketplace, usually sales guys, well, why are you keep adding all this new crap onto this model? And it's because there's a thing called complexity and it sells, right? So people quickly move from being an evidence-based investor to a story-based investor.

And you've probably seen it. You know, all our friends or my friends, like, all run these things. But you go to, like, a big shop, and they got, like, 90 PhDs over there. And their model hasn't changed in 50 years. And you got to say, well, why do you got these 90 PhDs over there? And on the outside view, they'll be like, oh, yeah, they're always doing research, finding new ideas to make our model awesome. And then you, like, give them a few beers. They're like, dude. When the consultants come here, we can't just tell them we're doing this model, man. We got to tell them we're doing something. And so I got to point to these 90 PhDs over here with all their Chicago PhDs because it's got to look like we're doing something here. But the reality, that's just more like the marketing part of the business. And I totally understand it. I don't think they're actually adding value anymore because we've already – like that's why Warren Buffett has like him and he reads his like 10Ks in his underwear in Omaha. He doesn't need 500 staff and he does perfectly fine. I mean we see family offices all the time where they have a staff of like two because that's all you really need to get the job done. And, yeah, so I don't – we're always doing research. I love it, passionate about it. But – The cold honest truth is I'm not sure it adds much more value to what we already got. But I just do it because I intellectually like it, frankly. We always say that it can be an incredibly frustrating exercise because you'll often find things that work in isolation, but the second you go and add them into what you're already doing, there's, there's nothing there. And that's probably 95% of, of research. So it's a big cutting room floor. And what, so what we used to do, which I'll probably do cause I need to contain my own system. One issues is, you know, cause it's way more exciting to do like prop strategies and cool guys stuff is right now we're in the investment. We're trying to build systems to allow you to compound after tax what we think is the best way we can do that. But then there's this whole fun game of the fun research where you're trying to be smarter than the next 200 IQ guy. And we've done that in the past. But the issue is those things take a ton of resources, a ton of brain damage. And they're really cool and really exciting because you're trading them all day. But it's just not our business focus. So if I ever got...

rich enough where I just didn't really care, I would do that more just for the fun of it. Knowing full well, I'd have been better off just buying my ETFs probably, but it's just a lot more fun to do the action-packed things. And so I'll probably create a little unit down the road where we just do prop trading things just to placate my own need to be engaged in cool guy stuff. If you had to give your money to some other active manager, so you can't choose Vanguard, which is what... the boring answer that everyone gives these days. I wouldn't give it to them, honestly. To Vanguard. I think they're going to have mean reversion at some point. I love the idea and the concept, you know, tax efficient, cheap investing, but... There is no firm that still exists 100 years ago. And if you get too damn big and too damn powerful, governments get involved, other people get involved, cultures change, and you just can't keep something going on forever, in my opinion. I do love Vanguard. So how would that play out, though? So what would be the seeds of their demise? I've spent a decent amount of time with... Some really great people there. Oh, it's amazing people. It's an amazing culture. And Tone was set early on by Jack, and it's been continued by some really great leadership. They're about to get another CEO. So think through that thought exercise. What might that mean reversion look like? This is a question everyone has, which is this massive one-directional trade from everything else into Vanguard. You see some people saying, usually it's high-fee active managers, so consider it the grain of salt. But usually it's saying this is creating. creating distortions and perversions and fundamentals matter less today. And the internals of the market are weird as a result. So how do you think about that? Like, how do you think about, I don't really agree with that, but yeah, I don't really think about it. Yes. So, so here's what I'd say. I don't think they're really screwing anything up in the market, but I'll tell you what I think about Vanguard and the same argument would be applied to like an Amazon. If you get too good.

And too powerful. It's not the market that screws things up. It's the government. What do you think happens when a senator knows that a one-stop shop owns 20 percent? of all of corporate America. And I don't have to go haggle with everyone now. I can just go talk over here. Things get corrupted. It's just like Amazon. That's why I love the Amazon trade. Everyone just assumes Amazon's going to take over the world because they are and they should. But here's the problem. When they take over the world, do you think government's going to put less regulation on them or more regulation? And what do you think happens when... bureaucrats start interfering with marketplaces. The margins, everything that was great about that wonderful business model gets totally destroyed. And so I think if you just assume that these things are going to go forever exponential, they can't eat the whole world because eventually it starts running into other forces that are outside the marketplace that mechanically suck. And I think all these things come to an end at some point. So it's not that... Vanguard in particular is an amazing firm. They're probably the most respected firm that I like. I like everything about them, their culture, and I hope they keep... But just knowing the culture of the world and how power seems to attract corrupt people, they end up screwing up. That I imagine with 100% probability will happen in the next 200 years. Just like Amazon, I guarantee will not be around in its current amazing form in 100 years from now. Someone will screw it up. It's just inevitable. It's an interesting example of the inside-outside view from Thinking Fast and Slow where the inside view on both these firms. Amazon's actually a good parallel for Vanguard, is that they're invincible and can do no harm, and it's so easy to project a perfect future. Whereas the outside view is, to your point, go look at the biggest companies from 100 years ago. It's just not around. There's all sorts of interesting arguments, like the government regulation thing.

That makes you think of like Standard Oil or something where they're cornering markets and gouging customers. Whereas Amazon's very different, right? Like their model has been, no, let's actually deliver lower and lower prices. So it'll be interesting to see like how the hell is the regulator going to explain that? And here's what's interesting. Yeah. So the government will screw that up or in those sort of models. And this is like – so Google's a firm I probably most respect. I actually really like those guys. Like what they do, their culture of like do no evil. I think they're amazing. When you become a brand that's known for doing that, and like Amazon is a good example. So my business model is I'm going to get insane, massive scale, basically burning money. till the cats come home. And then I guess investors just assume at some point they're going to magically have all this economic moat because people don't want to leave. And I guess they'll get to raise prices a little bit or something. But here's the problem. They don't understand that that demand curve is highly elastic because the minute they're no longer the low cost producer and their prime's pretty cool, but guess what? Everyone else is starting to get that too now. The minute they say, oh crap, now we own the market. Let's leverage your economic moat to like do a standard oil. monopoly play well guess what's going to happen everyone's going to be like oh wait a second like oh let's go back to walmart man it's right down the road and it's a lot cheaper than you guys so there it's like a phantom economic moat it's there in theory but then the same question is can you exploit the moat you built and maybe they're so good and then get so many magnitudes better that even if they keep their cost structure they can somehow create like massive p and l on it but i'm just I'm not really sure. And that's without even considering that, I imagine, well, government already has. Remember they used to have like the no state tax thing? They had to manage that. Like all these firms, if you get too big and too successful, you end up having to fight non-market forces. So we got way far away from my question, which was if you had to give money to another active manager, who would it be? Who else out there does work?

And it doesn't have to be quant. Actually, I'd be very curious if you give a non-quant answer. Maybe I should change the question. But if you had to give your money to any number of outside managers, active managers, who do you really respect out there? What would I be trying to achieve? The same thing I'm trying to achieve now? Yes. I mean, honestly. I like, this sounds totally pathetic, but I actually do like what you guys do. And like your dad said, the only way you guys tax problem would cause me some angst there. But I mean, I don't even know who else does like super concentrated, highly disciplined, transparent quant. Not many. That's what I want. So whoever does that is who I'd give all my money to. And if they could help me like build tax deferral even better in it. I just don't know. Yeah, I don't know. I mean, I like what you guys do. Whoever would fit that, if you can just give me a transparent, super focus, well-established, like an AQR thing, but if they concentrate it way down and they can figure out how to get tax fraud, use them too. I like those guys. It's tough, man. Tough, man. Yeah. I mean, that's why we built our own firm. It's good news that not too many people are doing this. That's how we want it, right? Yeah, yeah, exactly. Talk about the business then. So talk about Alpha Architect. how the firm has evolved, how it started, what the client base is like, the marketing versus sales mindset. I love hearing about the businesses behind this because you said earlier that the real edge is pairing the right investors with the strategy more than just like having some super secret sauce. The secret sauce is often the clients, the right clients. So talk about... the business behind it, sort of the organizational alpha, as our friend Ben likes to call it. I like that term. Tell me about Alpha Architect. So there's this famous paper, Cipher Vishny 97, it's called Limbs Arbitrage. And you probably know LSV, those guys, the two of the names in there, you know, went off to create this like $100 billion monster. And that paper, in my opinion, is the theory of how the asset management market works. And what does it basically say? It says,

Delegated asset management creates a problem because there's a situation where there's really smart people that manage money and come up with whiz-bang cool ideas that are going to work over the long haul. But what happens is they couple those strategies with capital that doesn't understand that. And inevitably, when they say, wow, in 10 years from now, this strategy is going to be amazing. But oh, by the way, in the short run, it's... could be the stupidest idea on the planet. Well, ex-Annie, all these really smart people are like, well, I could just do that and collect fees for a while until it blows up. So I'll just run 200 funds and I'll just have, always have turnover, do spaghetti against the wall. So that'd be like the BlackRock model. We'll do 200 funds a year. You know, inevitably some are going to work. We'll market those track records. We'll blow the other ones out and you just do that model. The other model is you say, okay, if this is the problem, if I'm not going to be a Caltech, 500 IQ PhD doing HFT or information acquisition edge, where we're just trying to win in that game, which I don't want to play. I want to do an investing game. What I noticed is there's a structural problem where everyone knows about what works, but the problem is it's a long duration. and it always gets coupled with short duration capital, which always leads to a lose-lose situation. The manager wins for a while, then he has bad performance, he gets fired, the clients hate him, and no one ever wins. So instead of focusing so much on trying to be the smartest guy to figure out how to do value or momentum, whatever the hell it is, let's stop competing on that. Let's focus on the investor education and building or creating or identifying the long-duration capital that we can then pair with the long-duration strategy, which is why, again, our mission is not we're going to be smart and build cool models. Our mission is we're going to empower investors to education in order to build sustainable investors.

So that's why we have that mission. Because the only way we're going to exploit that long-term edge is not us being smart. It's us finding the capital, getting them mentally prepared, and telling how crappy this idea is going to be in the short run so they have the ability to stick to it. That's stage one. The other thing is we have a segment on individuals who are taxable. So one of the things, if you look... real estate investors and why the hell are they so rich all the time is because a lot of times my small little anecdote view on them is they hate taxes more than they like making money which makes them incredible investors because they never want to transact so if you get a real estate investor And the real estate goes up, down, or they're feeling a lot of pain. If they didn't have that tax burden, you'd see way more transactions. But good real estate investors, the reason they get so damn rich is not because they're that smart. It's because they're stuck in this low basis asset and forced to hold it for like 20 years when other people are going in and out. So the great thing about taxable investors is to the extent that... You can get a deferral mechanism in place where you create like this tax liability for them to be able to move out of a – basically make a bad decision. You can also – and kind of what we've structured is to mechanically get people in a position where, one, they've got to come in with all guns blazing. I am in. I am holding this for 20 years. But then also build structures where even if at a certain point five years from now, they're like, God. This is stupid. I got to pay the taxes to get out of it. I got to stick to it. If we can mechanically just keep you being successful, either through education or structures or whatever, we're going to win. And so we just want to get people to be better, long-duration factor investors, which is why that's our mission, and that's why we're super segmented, we're super focused, and we don't have armies of sales guys because we almost need the inbound.

flow because you've got to understand what we're trying to help you with. And if you don't, we can't really talk to you. It's not going to work long term. Go get marketed to. And we're marketing, but we're trying to solve the cipher vision problem, basically. And that was our best attempt at it. Talk about the profile of that investor. So you do a great job with the education, obviously. I think you and I... Both have probably written 170 white papers or whatever. So you can write and educate until you're blue in the face. But at the end of the day, you still need the right person or family or whatever. So what does that investor tend to look like? Are there common traits? There are common traits, at least for the folks we deal with. So we have this acronym called EDUCATED, which stands for a bunch of stuff. But the best way to think about it is... engineer types that are very like process driven don't trust anybody like these wall street clowns i'm smarter than them because i went to electrical engineering where they were like marketing guys chasing the girls i know i can figure out what they're figuring out i want to understand this process and yeah i understand i can't actually do it in the end because i don't or i don't want to but i want to understand what's going on and why this works what is this system Those type of people are perfect because they actually care about the process and they want to know the weeds. And one of our core beliefs is in transparency. So we're willing to facilitate. So we just need people like that. We also like. business owner types because if you think about like the private versus public owner mentality public ceos or public ownership you just inevitably you get in the quarterly mentality and it's just the world if you talk to private business owners they're always thinking 10, 20 years. It's just their culture. They're cheap bastards because they usually start this company. They understand do more with less, understand what's the value proposition before I buy it, what's the process. They're just very methodical on wanting to control, wanting to understand, and want to be cognizant of the fees and who they're dealing with. So we just attract people like that, which means we're not in a hot money game. We're in like...

The two, three years of figuring all this out, how are you guys working? But that's fine. We don't want hot money because it'll come in and be out the next day. We want people to understand what they're doing, why we're doing it. And if you want to ask 500 questions, we're not going to complain. We're going to be like double thumbs up. This is the right person. And then also structurally able to play the game. Because if you're an intermediary that totally gets us, but you have clients that totally don't get it, you also break the chain. Which is what we were talking about beforehand. As we're starting to get more and more in an intermediary channel, it's a segment. But there is a segment of advisors out there, like we're talking about the DFA advisors, who are super hyper-focused on process. client education, and they were in the small value trade. Talk about a hair raiser, and they did it. There's a segment of advisors out there who work on behalf of clients where they've figured out a mojo and a symbiotic relationship there where the intermediary is really smart, and their clients, through that intermediary and that relationship they've built over the years, are able to... basically be sustainable capital, you think. And we're building fintech tools to help them be successful in that. But the intermediary world's hard because of the shy provisioning problem. Whereas we've always been direct consumer because you can go to a rich guy who owns that capital and he's like, well, Yeah, I get it. I don't have a principal agent problem because I am the principal and an agent, man. I get it. Good. This is my money. I want to compound. I'm not worried about my career here. You mentioned earlier that all this information, data, technology, et cetera, is just forcing more decisions. And the other way to think about that is the more layers of people and processes and checklists and whatever else are between you and the end money, the more...

decisions there can be to screw the whole thing up for everyone involved there's more conflicts interest coming in that's right and there's yeah as you know there's a lot of pat actually our cco had a great analogy on the on the poker game whereas if you go to a poker table you know buffett's always like hey if you don't know who the patsy is Well, it's screwed because you're the patsy. But that's not enough. You also got to know who the best poker players are. Because if you go in, you're like, all right, that's the idiot over there. We're going to exploit him. But you don't recognize there's someone 50 times smarter than you. You're also going to lose to him, and you're still a loser. And so the issue is you got to go in these games. You got to go, okay, who's the patsy? Roger that. Who's the biggest brain in the world? Roger that. I have no edge at this game. However, that biggest brain over there. has 50 people that have given him money, and they've saddled him with, like, 50 constraints. Like, hey, you can only bet on spade cards. You can only bet when you have double aces. Like, they start constraining that best poker player. Now, me, as, you know, smarter than average but not a genius, and I know who the idiot is, I can be like, oh, wow, now's my opportunity. Because I see that smart guy who I'll never be, his constraints. I can find some edge in that middle ground, which is things where he can't exploit because of some structural problem. And to your point, the more hands are in the pot, i.e. the more careers that get involved, the more principal agent conflicts that are created. And we're no longer in a game of after fee, after tax, compounding our faces off for 20 years. We've got other incentives. Let's go a little bit farther on this analogy. We talked earlier about all this money going passive, and I've talked to Michael Movison about this paradox of skill, where one argument is that in this transition to Vanguard, basically, a lot of those losers you just talked about, where we were previously in our backtest effectively exploiting those losers and their dumb decisions, that a lot of those have gone to Vanguard and are no longer...

ponying up their money into the pot. Do you think that that's right? Or do you think that there still is enough, there are enough weak hands in the collective market for these strategies to work for the next 10 or 20 years? So here's what I'd say. So everyone knows the whole sharp math, right? So to the extent that money goes into the market portfolio and essentially takes that supply out because it doesn't trade it and it's permanent, all these arguments go through. The minute you have people investing in passive stuff and then actively day trading it, all that math is totally out the window. And if you could tell me with a straight face that this whole movement to passive is. this is permanent capital that's going to hold this trade for 50 years, and this really isn't essentially another short-term performance chasing thing, I'd say you're probably crazy. Because if you look at a lot of the way this is couched, passive investing, the way it should be couched is don't buy the bullshit, get low cost beta that's tax efficient. This is your permanent allocation. Let all these fancy smart guys compete with each other. That's not how it's couched. It's look at this study of active managers. Passive beats 95% of them. And most of the frame that I've heard is you'd use passive to beat. the active guys. It's not you use passive as a portfolio tool to capture the average very efficiently. It's you use passive to beat these active guys. So it's being couched again as a performance chasing vehicle and the best way to invest because it gives you the best returns or whatever the thing is. But I just think that if you have tons of money chasing what seems to be always winning with infinite supply. And if you don't do it, you're an idiot and we're going to stop paying attention to anything else. I don't know of any macro equilibrium in the history of the world where that's ever ended well. And I honestly don't know how it's going to end, but I know it's not going to end well.

And, again, I'm not smart enough to figure out. I don't think anybody is. And we don't know where the bubble is going to pop out. But, again, you can't have some people perceiving something that works all the time, that has zero cost, and comes in infinite supply, and that's just all we're going to do because that's the best thing, and tell me that that sort of mentality is a mentality that leads to good macroeconomic outcomes. It doesn't. That's not to say passive is not bad. All the theories are not correct. But they always hinge on the assumption that this is permanently deployed capital that essentially took all that stock off the market. So now it's just me and you like dicking around over the active scraps. I find it very interesting that the performance chase that always happens right now, it just happens to be the S&P 500, right? Like it is outperformed. everything in the world and I don't think anyone that's buying it is really thinking about that. It's an incredibly easy trade because it's cheap and it seems like the thing all the smart, responsible people are doing. But at the end of the day, you're buying the thing that's done the best. And of course, fees matter. And we never want to downplay that. But costs are real and they compound. And I think that was Jack's fundamental insight. It wasn't so much be passive, it was be low cost. Yeah, be affordable and know what you're buying. You got to make one other point to give a shout out to the actual investors. guys, they make a good point about, okay, the stock selection thing is one element, but when everyone's buying these passive Vanguard funds, the theory of all this is the global market portfolio. And active asset allocation decisions a lot of times have way bigger... portfolio effects than whether I pick Best Buy or whatever. And people can buy S&P, but that is so divergent from the passive global market portfolio. So you are taking an insanely active bet through what feels passive and what you're being told is, oh, they're all the smart guys competing away, but not really because you're not the global market portfolio. You actually have massive...

epically huge active bets in that portfolio. They're really cheap, but they're super active and they don't even know about it. And we'll realize this in hindsight only. Yeah, exactly. We'll all figure it out that 60-40 was stupid over the next 30 years and 30 years from now, but we'll see what they cook up next. What is the most memorable individual day of your career? Which one? In finance? How about one of each? Okay. So in military, I mean, this is because I still remember this. It sounds kind of cheesy, but the infantry officer course, which is like basically a Hazex, I got put in charge of the platoon commander. We had to do an exercise at Bridgeport, and it was literally I didn't sleep for five days straight, and we did this administrative march out of there, and I literally couldn't. I never not slept for like four or five days straight and never ate, and I remember getting on that seven-ton at the end of that and thinking, I just thank God for water. Like just being alive and not having to deal with that bullshit anymore. And I'll just never forget that. This is like the best day of my life. Can I just sit down and close my eyes and like have some water? And I just remember that like versus combat things like training, that one little training episode and being able to finally have that done was like my happiest, best moment of my life in the Marine Corps. So it's kind of a weird one, but it's just in my mind. Now, as far as in... investing well i'll tell you that one too has nothing to do with quant it has to do when part of my freaking capital loss i still got to write on my books is you know i used to be totally crazy like put like like buffett style 50 in some penny stock where you know i thought i had some sort of inside edge or something and and i'm not going to even name the names it's so embarrassing but so it was just penny stock i own like 4.99 so i didn't have to file on it but that doesn't mean i was rich it means it was like a

$10 million company. And I did everything you're supposed to do. Met the CEO, went down to visit, channel, everything that every old school value guy does to get your edge in such a way that you're not doing anything illegal. But you obviously have some edge because you know this thing better than anyone, and you do everything legally to be on the scoop, right? I was all in on this damn thing, and I became friends with the CEO. Again, you got to know him, blah, blah, blah. You know, he's a quote-unquote, turns out this was false, West Point grad, so we had the military connection going on. Whole ball of wax, totally ate this thing, hook, line, sinker. It was over the summer, and I knew they were in a situation where they were renegotiating their debt, right? And it was a situation where my inside baseball was like, oh, that is because it's a cloud-based business. They're free cash flowing. The debt's totally going to get negotiated, and it's done, right? So I get this 8K. And I'm looking at this saying and I'm reading it. It sounds really great. Like, oh, they've negotiated the debt and everything. But the stock is down like 90%. And I'm like, wait a second. And of course, again, I've done everything. It turns out this guy, the CEO guy, he was overconfident. His own information set, which was then being conveyed to us. And it turns out that basically the debt holders smoked him out and all of us along the path. So it was a total like permanent loss of capital. And then one of the other guys, we had a little syndicate of like penny stock traders. All these rich guys that were bored basically. He actually hired a private investigator. It turns out the CEO guy was like a total fraud. never even went to west point like it was it was just a scam basically and we had all just bought in hook line sinker like believe in this guy and that was just my moment when i i went from at the time having like a pretty good amount of money for like whatever i was like 25 or 26 to basically being basically bust for many many purpose for all expected uh purposes here and i was just like i am just

Done. So I just always remember that. I just don't trust any humans anymore. Yeah, it's just I don't do it anymore. Only computers. It'll be a good transition from that to this one. So what is the kindest thing that anyone's ever done for you? I would be remiss. If I didn't mention the standards, right? My mom and my parents, obviously, they did good there. But that's cheesy because everyone says that even though it's true, you know, my wife for dealing with me and having my three kids. So those are all the standards. But I'm going to have to do another military one. But again, it's going to sound weird. And unfortunately, again, it's going to go back to IOC, infantry officer corps. But we had this guy there, I'll never forget him, Captain Redinger. And he was the captain in charge of running IOC. And at the time, this was kind of serious because people were getting pulled out of IOC to go in country combat. So it was a pretty hardcore time. And this guy was the hardest, meanest, biggest. asshole like on the planet you're like like just a straight up not i want to call it hazex everything in the end i realized after the fact was there for a reason but it was he was totally insane as far as like his warrior monk like just we're gonna dement you it's almost like you guys are like vikings like that was his mentality and but we're all still kind of like living the 21st century but but his harshness which which at the time because i was a total buyer on that like i personally was like into it and I hate it at the same time and and the reason I say it was the kindest thing is because I really felt he made us so freaking hard and so intense that like when you actually did the real thing you never had to even breach in the system one like I was always in system two even in like combat zones like IED whatever dude we're just doing SOPs and I say it's the kindest thing because

I just feel like that's a good reason why not just me, but I think a lot of Marines that went through that platoon training with that guy are alive today because he actually kicked our ass so hard that it was actually ironically like a really kind thing because he wasn't trying to be your friend. He was trying to, what we learned after the fact, basically make you really good at your job. And I just thought that was really nice of the guy, to be honest. for kicking my ass, which is kind of a weird, nice thing. I always love that idea that you don't rise to the occasion, you sink to the level of your preparation. And it basically seems that that's what that was, right? It's overdoing it, but preparing you for hard situations. And I think your mission in educating investors, we share the same mission, is kind of like a light. Obviously, I don't think you can harden. prospective investors to nearly the same degree, obviously you can't. But the best thing you can do is just grind away at education. I think transparency is a big part of that. And highlight the warts. Always post about how many you could have this 10-year underperformance. It happens all the time. Yeah, just almost Captain Redinger style. Be nice by being mean. Explain why this sucks so bad, why this is so terrible, why you shouldn't do this, and why this is an inevitably terrible idea. And if you still come through my traps and all my hazexes and you're still willing to be standing at this door, now you at least got a small chance of being successful. But a small chance is better than zero. And I haven't figured it out, but I think if all of us could figure this out. In a small scale, because if we get too good at it, we end up screwing up our own trade, and then we've got to go be like everyone else. But in the short run here, if we could do that, we'd probably have a huge win on our hands. I love it. Well, I think this hour and a half is a good step in that direction, so I appreciate the time. This was a blast. Thank you for having me, Pat. Hey, everyone. Patrick here again.

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