SIP009: Jack Vogel on Quantitative Value & Momentum Investing - Sure Dividend Sure Dividend

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SIP009: Jack Vogel on Quantitative Value & Momentum Investing

Today’s conversation is with Jack Vogel, the CFO and CIO of Alpha Architect – a quantitative factor-based investing firm that invests client money using empirically-verified strategies like the value effect and the momentum effect.

Jack has a PhD from Drexel University and has an interesting mix of an academic’s knowledge and a practitioner’s experience. What really stands out about this conversation is his intellectual curiosity and his commitment to do the right thing for his customers – which means compounding capital at high rates on an after-tax basis over long periods of time.

Our conversation is wide-ranging and discusses everything from behavioral finance to security analysis to his firm’s research methodology. Please enjoy my conversation with Jack Vogel.

Full Transcript Below

Nick: so I guess first off I just want to give you a big warm welcome and thank you for taking time to be on the podcast. You guys are on a quantitative firm and when most people think of quantitative investing you know they’re going to picture a group of PhD’s running HFT algorithms until they turn blue in the face.

I know what you guys do is different than that so I thought we could start by just talking about what Alpha Architect does as a firm and how it’s different from most people’s perception of quant strategies.

Jack: yeah well first of all thanks for having me on the podcast happy to help with education efforts here. So what Alpha Architect does is we run mainly systematic strategies. We started out 2010 remaining a consulting firm or a big family up in New York City did a lot of research on a ton of strategies.

And then we went down the route of building systematic factor-based strategies that the three main factors we invest in our the value factor momentum factor and then the trend factor. It’s you had a good point there about quantitative investing in quantitative algorithms and that can mean a million things.

What do we do, well, I’ll give you the simplest example is value investing and most value investors who are trained in schools and whatnot they’re told to dig into the fundamentals where you want to dig in to the 10-K’s, statements from the CEO, try to figure out really what’s going on with the company.

And what we try to do quantitatively is basically say listen we are going to attempt to do some security analysis similar to how everyone gets trained in business schools. But we’re going to do it with a computer to kind of facilitate like a bottoms-up security analysis. And the reason there is we just at the outset know first off that there’s two reasons do that.

One is first of all there’s a ton of data that one can collect, then you can spend probably an entire week on one company. But where is that one week of company’s research fit into the whole macro of all the stocks of users.

So we use a computer to help build the screens to help us essentially take all that information and then filter to certain stocks that we like. The second area of reason that we do that is it also helps you to minimize your own behavioral bias that can become embedded in the process.

If you’re doing a bottoms-up analysis trying to figure out what’s the fair price for the security. At some level, you have to put in like a discounted cash flow number and that’s just some number based on weighted average cost of capital. But at some point that number is arbitrary I think everyone would agree with that and there’s only the research showing that behavioral biases can become embedded in there.

So we kind of take it out and that’s why we use a program – an algorithm to help us pick our value stocks.

Nick: that’s interesting, I really want to dig in and hear about how you measure quantitatively these different trends. So now everyone’s got their favorite metric of value could be market to book it could be shareholder yield, it could be even just something as simple as dividend yield.

Would you mind going through I guess each of the three factors you guys track and say what are the quantitative signals you guys use to capture that effect in the market?

Jack: so for value what we use is our main screen – the cheapest securities is we use enterprise multiples which is just EBIT over the total enterprise value. One of the reasons to use total enterprise value as opposed to market cap is you can embed what it would take to buy the entire company.

For those who don’t know what that means enterprise value is it’s the market cap of the company plus the debt of the company and then minus off cash. There are some other minor details, but those are the three main factors and the reason you subtract cash is if you buy the entire company, for all intents and purposes get the cash back.

We use enterprise multiples again there’s a lot of other measures that people use you mentioned a few like shareholder yield, P/E, price-to-book. You can also use a average of those measures. We’re just fans of the enterprise multiple, we think that’s kind of how on the outside like PE firm would think of firms.

That’s the one we use and then historically that one worked well our sample was 1972-2014 but now the sample actually that one didn’t work as well we’re so going to stick with and that data that’ll happen over short time periods.

And then for momentum we use an intermediate trend intermediate term momentum score. We look basically at the total return over the past twelve months and we ignore the last month and that basically so if you have a thousand stocks we would then sort all securities on their total return over the last 12 months ignoring last month and we would get down to the top 100.

And then from there we get down to 50 based on the quality of momentum score.

And then on our trend factor, we tend to use in our longer-term trends which are 12 month moving average of 12 month time series. So I’ll stop there and let you I see there any clarifying questions.

Nick: no that’s so that’s all very clear to me. I’m curious whether you guys do this exclusively in the United States or do you also take a global focus?

Jack: well so we do this both in US and in international stocks as well as indices. So we actually do both. We currently don’t do it in emerging markets but now that’s just a business decision at this point.

Nick: and in terms of how you when it comes to portfolio construction. Do you guys have a portfolio is it divided into three sections – there’s a value section and a momentum section and a trend following section? Or do you blend those three screens together for the selection of each stock?

Jack: yeah that’s a great question. So is the question mainly how do we combine value and momentum at a portfolio level or at a stock selection level?

Nick: I guess both mostly when it comes to portfolio construction though.

Jack: from a portfolio construction level again not security selection what we generally do is we say hey it’s like 50/50 value of no minimum one could arguably risk parity weight across some which we actually do and want one or more strategies. And what that does is it essentially will over weight value slightly relative to momentum because you know when you lose power you wait too long only equity strategies such as value of momentum.

What you’ll see is that your momentum just generally has a higher volatility than value but at the portfolio level we kind of will argue that you know 50/50 allocation to the two or risk parity based allocation is a good way to go. And then at the security selection level the details of if you wanted to lend the two together there the sequencing would matter.

Obviously you want to do value and then momentum generally is doing momentum and then value doesn’t add too much and I think at the margin a 50/50 screen or a 50/50 portfolio of separate value momentum ones we’ll probably end up around the same area and as a using value momentum in a blended security selection portfolio.

Nick: and then I guess just talk about how you guys offer these portfolios to investors I know you guys have some ETFs and I suspect you use separately manage accounts to.

So what are the different ways that an investor could capture these effects working with Alpha Architect?

Jack: what we currently have is we have we have five ETFs and basically the two of them are value ETFs ones US ones international. and then two of them of momentum ETFs one US one international and so each of those ETS they’re long only ETFs they hold you know 40 to 50 stocks and they’re equal weight either to the value or the momentum factor and either in the US or international markets right.

And so those are for people that are looking for you know basically value or momentum exposure we do it in a more concentrated fashion as I mentioned 40 to 50 stocks equal weighted.

Then I would say a lot of other options out there in the market and then the fifth ETF combines everything it’s our value momentum trend strategy and what that does is it holds the four underlying ETFs that are long only so those are Cuba ,iVal, Qmom, Himom.

It holds them as your baseline portfolio so basically you know if you’re looking at us and international stocks at the outset made large cap you have around 2,500 stocks it is pretty accurate number around that so if you hold those for ETFs basically of the 2500 we’re going to pick around the top hundred on a value and around the top funder on the mint so you’re going to have a 200 stock portfolio around 50 US fifty percent international.0

And then the third aspect which is the third fact that we like is a trend-following component and what we do there is every month we assess a trend rule on either the US market like S&P; or international develop markets such as the EZ index and if the trends are positive we stay long if the trend in either or both of the markets go negative we will actually hedge and will become either partially hedge or up to fully hedge.

So that’s I would say those are the ETF’s we have and then that’s the I would say the main way most people work with us we do have managed accounts but a lot of its derivatives of those products.

Nick: you know it seems like most your offerings are in value stocks and momentum stocks. How do you think about the diversification benefits of owning both value and momentum strategies?

Jack: yeah so obviously the you know when people talk about value momentum right one notices that for long short portfolios and this is what commonly gets touted and cited by many right. .

Is that for a long short value portfolio in a long short momentum portfolio what happens is if you return the run those two terms sequences right next to each other you see that they actually have a negative correlation right. Which is awesome from a portfolio diversification benefit because you know when you have a negative correlation that means when one’s doing well the other ones probably go to bed and vice-versa right.

And that’s commonly cited by many kind of in you know the marketplace. One thing I would say caveat people is most people when they try to access a value portfolio and a momentum portfolio they’re going to do it through a long only investment product right. And so it is important to understand that the the negative correlation is only on the long short.

For long only portfolios how most people invest the correlation is not negative and the reason is because boats have market veridic so they have a positive correlation but one thing that is nice is that the two portfolios basically have a lower correlation to each other compared to their individual correlations so market.

So basically what happens is you gain this portfolio diversification benefit holding the two value like a value portfolio and momentum side-by-side yeah it’s not the negative correlation unless you’re doing long shorts. But it still is better because the correlations are lower than what they are with the more.

Nick: I want to also talk for a moment about your research process. So it’s obvious you guys like value and momentum, I guess how do you guys think about adding new factors to the strategies you guys already have?

Jack: yeah that’s a great question and so what I would say is that you know we we’ve obviously looked a lot of the data you know initially did a lot of research and then you know when you when you’re investigating this for long times you kind of have to figure out well what factors do you want to invest in which ones do you want to stick with.

And what we’ve come to the conclusion is that you know from a long only perspective we kind of borrow the belief and I think it’s borne out in the data that the two biggest factors on long-only is valuing them right. So now some of the other factors that are both you know in academic literature as well as in practitioner portfolios.

We kind of use them within our portfolios so common ones are like quality and low volatility or like Looby right those are other ones that I think most people know about and so how do we use them.

So for our value portfolio what we do is you know let’s say we get down to around eighty to a hundred stocks on our enterprise multiple basis for value right. So we’re already in the cheap stocks what we do is we use a quality score to get down to the top what we call 40 or 50 stocks.

We still embed the quality factor into our portfolios but it’s just not that main driving factor and then from low volatility right we have what we call like a quality of momentum screen. Where we go from our top hundred momentum stocks down to our top 50 momentum stops and how we do that is we look for we try to look for I on the example I generally give it as you know imagine you have two momentum stocks one is boring big-box that’s up a hundred percent because it’s had a 50% return 200 days.

The other ones exciting biotech that you know was up 0% and then a month ago it went up 100% in one day on an FDA right. So those are like two vastly different momentum firms they got their momentum in different ways right and we use kind of ane we call it frog in the pan measure.

But it’s some level it’s similar to a low vol measure to pick like the boring big box type momentum firms so our value screen we use quality on our momentum on the screen we use low vol but those are the quality and low ball screens are kind of secondary they’re not like the driving factor.

And then if some level we use like the size factor just in our portfolio construction we equal weight across mid and large gap so you get a little more access to the the SMB or small cap exposure just do the fact that we equal weight across our 50 mid to large cap stocks.

Nick: can we dig in and learn more about your quality score. So there’s all kinds of different ways to measure this and a lot of them are empirically verified. I’m curious as to how you guys measure the quality of the companies you’re screening through?

Jack: for our US portfolio so we’ll actually I’ll go through I’ll go through let’s do the US won’t start. so for US we can I think of quality as a a table with no legs on each side right so on the left side what we do is we try to look for I’m like long term type of notes kind of like the Warren Buffett strategy of looking for firms that have notes right.

And so what we do there is we look at long term free cash flow over assets over like eight years that’s one of our measures. another thing we look at is long term return on assets and equity again over an eight year period right and the reason to do free cash flow our way are we over eight year period say okay maybe a firm is burning cash slightly for a year or has a negative ROA but over eight year cycle they should have positive terms on assets equity and then positive free cash flow.

And then a secondary long-term measures we will get margins right and so on margins we look for one of two things one is you have the Procter and Gambles (PG) of the firm. So we create like a Sharpe ratio your margin over the standard deviation. so Procter and Gamble’s a get great firm for like margin stability where they have a 50% margin like almost no volatility over eight year cycle and every single company in the world below they have 50% margin and no volatility on it.

But we also understand at the same time some firms can actually increase margins so we’ll look at like margin growth rates and kind of take like the max measure on it.

So that’s kind of our long-term eight year way of measuring quality and then on the other side of the table holding up so that was holding up the left-hand side and holding up the right-hand side we have what we call like our pre type pre-flight checklist. Which is we just want to make sure that these value firms was clearly or cheap or some reason that they’re going to be around in a year.

And so we look at like year-over-year measures there’s 10 it’s a 10 check point 10 point checklist going through certain factors like did you have positive cash flow last year. Did you issue new equity and we outline all these on our website. But it’s basically a 10-point checklist where you get a 1 or 0 and the reason we do that is to make sure that in the short run the company is still going to be around the farm here.

Nick: and how often would you say you guys find new ways to measure these quality scores or low vol scores or even the value in momentum effects that you guys are capturing?

Jack: I mean we haven’t changed our main screening algorithms now for some time and what I’d say is that we could change it and there’s reasons to change. We kind of believe like the models are built in our opinion to be good going forward. Obviously, we always keep up on the research to make sure that we’re not in the same thing but a lot of times embedded in data what you see is you kind of end up in the same general area anyway.

A good example would be like the value fad right so on the value factor if you just look at all those different multiples we went through so like priced above PE Enterprise multiples we can argue back and forth which one’s the best which ones optimal and depending on your sample you could you can basically get different results.

But I would say over like longer time cycles like I’m talking like 20 30 years I think they’re all going to be in the general area so since that historically has kind of been true that you generally are in the same area you could be off one or two percent but which does amount to a lot over a long time.

But I don’t know what one’s going to do the best but since we know you’re in the scene area we try to just try to not mess with the model. Unless there’s something super compelling that would require us to do so.

Nick: so it sounds like you guys are actively doing research but not very often you guys find something that changes your approach to investing. And that makes me wonder you guys are obviously very research focus.

What’s your approach to winning the human capital arms race that kind of naturally occurs in the field of quant finance and finance in general. Actually, how do you find the best talent?

Jack: yeah that’s a great question and but let me sort this I think it’s kind of important to actually distinguish and differentiate between trading and investing right so with trading I would agree a hundred percent with you that there’s a massive arms race we’re by these HFT firms are just by or attracting PhDs mainly in math stats and sometimes engineering and they that like they actually need to do that to win right because they need to always be building a better model it’s trying to get data faster to win fractions of pennies every nano set.

And we know some people in that space and we stay way away from that because that’s just not that’s not our expertise. We don’t want to compete there. So that’s I would say that’s probably the arms race most people think about I would say our arms race is like slightly different right because we’re talking about investing and trying to attract investors to potentially invest in our strategy.

We’re looking for individuals and advisors which is same thing DFA AQR what those guys are doing that want to invest somewhat differently than the passive Vanguard, ishare portfolio right so some use our products for small portions of the portfolio while others use it for larger so for us the arms race and really the key is just we’re trying to find the right investors who understand our process and know why it can and also why it can’t work.

So you’re we’re competing by trying to help educate on different factors portfolio construction and one thing we’ve done there we’ll build now a new tool on our website which you may have seen that the visual active share tool trying to help advisors individuals and what’s actually going on within ETFs and different funds out there and so our firm mission is they can empower investors through education. Which I know you’re trying to do through this podcast which is great and but we know at the outset that and this has happened millions of times.

Sometimes we spend a ton of time helping someone out and they may just go to Vanguard or another competitor firm but we think in the long run just being transparent honest which can even be our expense from time is one way to compete in the arms race. I kind of feel like an honest integrity type way of putting out a message our message.

Nick: yeah you definitely can’t argue against that. Having good clients sounds like it’s a really important part of your business I’m curious what your what does your ideal client look like?

Jack: yes so our ideal client is mainly taxable high net worth individual and just to give you a background like I mentioned at the outset of the pod here. We started out as a consultant to a large family office and the whole idea there what we were doing is we were investigating tons of hedge fund strategies and besides just valuable momentum simple strategies we were investigating a lot of hedge fund strategies.

And what happens is you start to understand that for a lot of these strategies if you’re a taxable individual you’re like well hmm that may be great but if I have to put pay 50% to the government every year why don’t I just buy like the index right. And so what I would tell you is at the outset we kind of started young with taxable investors and building all of our strategies all of our philosophies mainly torts a taxable high net worth individual.

That’s probably our ideal client because that’s where we think we have the largest value proposition relative to other firms in marketplace.

Nick: now you mentioned the taxable component seems really important to that what makes Alpha Architects stand out for investors who are specifically looking to invest their money at an after tax rate or a return that’s very appealing?

Jack: yeah that’s a great question one of the one of the reasons we went down the ETF route as opposed to the mutual fund route it literally goes back to taxes so we were rear solve a problem for a client a long time ago and long story short we couldn’t do it but it was a great problem guy had yet stopped with very low basis and it was about to be bought out with a cash merger and fortunately had to pay taxes.

But in our research we came across the taxation of ETFs and basically what we learned is that through the in-kind creation and redemption mechanism that is available to ETFs but not available to mutual funds. one can tax efficiently there are say more tax efficiently than a mutual fund potentially rebalance your ETF to defer taxes out into the future.

For our value and our momentum strategies we knew at the outset that we were going to have turnover right. So you know Vanguard it doesn’t really matter to buy the S&P; 500 raisers basically buying the biggest stock. so mutual fund ETF with no turnover it doesn’t really matter right the minute you start saying hey I want to do value investing great right how am I going to do it?

Typically its its own managed account and we started that a long time ago and when we were doing managed account strategy what do we have to do we had to do the similar problem that I would say most advisors that are doing value valuing soft pick and do they have to say okay. I want to rebalance my portfolio here but I need to wait a year and a day to get this stock out because I don’t want to have a short-term gain to my client right.

With the ETF if done properly through the creation and redemption mechanism you can actually do rebalances slightly more often and defer those taxes out into the future. So I would say the main way that we have a slight edge on some people not everyone is just through the ETF wrapper itself.

Nick: that is super interesting I had no idea what tax implications of ETF offerings. Another important consideration for your clients is how can you find clients that are knowledgeable enough to want to invest in a factor based quant strategy. But also trusting enough that they are willing to keep their hands off when your model goes through a period of underperforms which is inevitable for even the best strategies right so I guess how do you go about finding clients that meet those characteristics?

Jack: that’s hard and we kind of taken the longer view on things is what I would say. So how we do that is you know a lot of times people will you know just happen to stumble across our site because they read something and they may reach out to us. And you know what we generally do now is we tend to say hey you know here’s guy investing this is this is what value investing is from 50,000 foot yeah right.

Then if you want dig in the details we can go into the very nuanced painstaking details of why we do what we do but then at the flipside and most people if they’re interested the 50,000 foot view they stay like digging in and then a lot of times people will be like oh this is great totally understand right.

What we try to do is we also try to highlight at the outset to people that when you do a 40 50 sock value investing strategy you’re going to have large tract yard from an index. 10% plus tracking out which means from a year to here you can lose or win by a lot so one way we try to get what you’re kind of describing when we call like sustainable clients.

One way you can get that as you can at the outset tell people why your strategy’s going to suck right like why it’s going to from time not work and I think people understand and appreciate that honesty and integrity because most of time when someone’s trying to sell you something they’re not going to tell you that there’s times it’s not going to work right.

So to be telling that the outset and then the secondary thing is to be honest with you like we’ve had a lot of people that I’ve talked to going back to the arms race question where I was telling you that sometimes people just go to Vanguard. And you know there are a lot of times I personally send people they may reach out ask a lot of questions and then be like hey I noticed your value strategy last month lost by like 2% what happened like is the system broken.

And when someone asks that question I would say 99% of time that they’re probably going to always be tracking it to an index in which case for them the best strategy is to just go buy a cheap index fund.

I would say it’s again hard to find those clients and we potentially give up some but we’re trying to achieve or look for like what we call sustainable clients that understand our strategies may not work all the time

Nick: it’s interesting to interview different people in the financial world and hear their thoughts on this one-sided Vanguard trade we’re just billions and billions of dollars are going into Vanguard every month.

Do you think that that’s had a noticeable effect on the way that the markets function?

Jack: what I would say is I’m not sure to be honest with you on that question. Here’s an interesting factoid though that I think is kind of related right.

So a lot of times people will be like oh yeah everyone’s going yes right like that’s kind of that’s like a story that you hear in the news right like look at the flows in the bank or looking at the flows into the iShares cheap S&P – or total market fund right and I think this is kind of getting back to your question like is this changing how the markets work correct.

Into one thing that’s interesting is there’s people like David it’s honor we wrote a short sorry on the paper but he said hey let’s look at every single active ETF or like factor base EPS so basically non non market cap weighted you know SP or also 1000 index.

And let’s look at them all of these funds and say hey what do they in aggregate come up to because a lot of times people and get back to: what’s the capacity on these strategies etc and they forget to say okay well let’s just look at in aggregate what does everyone do right.

So if everyone was loading up on value if you took all the active funds you should see like a high HML or value similarly if everyone was loading up on momentum you should see like a high momentum right. What the crazy part is when you look at all these assets in total you’ve literally get just a loading of around one on the market and nothing significant on any of the factors.

So what does that mean that means literally all of the active funds in aggregate or just giving you the mark so yeah while people are going to Vanguard going iShares for cheap beta.

All that’s probably doing I don’t know if it’s changing the way the markets are working but it’s probably just changing the overall economics cash flow to more active based strategies.

Nick: I just want to make sure I’m thinking about what you said right so you said all the active managers in aggregate are basically a passive fund if you lump them all together so with that in mind this shift to Vanguard is really not changing how stocks are owned it is just kind of changing their fee structure?

Jack: through the potentiate yeah and to be clear I’m not 100% certain if I I don’t even know if I have a great answer to that I don’t know if new flows are flows to passive strategies are necessarily changing the way markets are working. But I will say that it is true that there was a cool studies showing that yes all the aggregate and this was just for ETFs not from mutual funds but all that I reviewed ETFs essentially just give you back no more which is kind of crazy.

Nick: that is really interesting. You mentioned in your previous answer about capacity constraints. How do you think about capacity and constraints with the strategies you guys implement at Alpha Architect?

Jack: obviously that’s a question we think about all the time. so capacity constraints and the question comes in with factor investing and maybe the question you’re asking or derivative of that question is the kind of like do factor investing portfolio survive transaction costs and you know there’s a lot of debate about the answer with people on both sides of the argument.

We kind of believe that they do but there definitely is a capacity constraint and you know for as we think of it and like how do we think about right. Well we can see in real time like the trading costs for our funds including both commissions base spreads market impacts. So we are always saying hey we need to weigh the pros of portfolio rebalancing.

For momentum everyone knows that you know the more often you were balanced in general ex-ante in the past on paper portfolios those better but there’s also cons which are tradable so we always have to wait pros vs. cons. and and for now the way we build our portfolios that will work sometimes.

But if you’re saying tomorrow we have 10 billion dollars in our momentum fund you know just one fun we’re definitely going to need to change the construction. so I would say we think about all the time and I don’t have a direct answer because it’s going to vary across strategy like value and momentum you know if we ever made a change would have there’s different ways you could do that.

So value may be your rebalance less often momentum maybe we have to stagger and do bucketing across mid large caps where you know we do a little bit more too large relative to mid its then same again across the US and international. so there’s no perfect answer there and I think any fund manager would tell you that there’s no there’s no it’s not like a mathematical you can optimize on what’s the best. But he would vary across the strategy type as well as US international.

Nick: yes I mean I’ve never had a the privilege of managing such a big sum of money but if I were to hypothetically think about it I would say you know there’s kind of four things that a portfolio manager can do when they get huge inflows.

They can either cap the fund which is an option or and then there’s three kind of continuing options where they actually do continue to accept new money and you can move up the market cap spectrum which you mentioned, you could have more diversification so instead of owning the 40 50 you guys own now you can own you know say 200, or you can just accept that you’re going to be trading with higher trading cost you can just kind of eat it in your fund.

The one that you really didn’t mention in there is is owning more stocks and I’m guess I’m curious about how you think about diversification and why you guys have deliberately chosen to own it seems like 40 or 50 is your magic number for all your funds.

Jack: yeah and so on that question you know for as you mentioned we held 40 50 stocks on the long so you know what are the benefits that are versification so you know for those going back know. One thing is when you hold a bucket of stocks all together if you put together a diversified portfolio you can eliminate what’s called like idiosyncratic risk or like single stalkers right.

And so all of the research and people have shown this is you know if you hold around 30 stocks or more you gain around 90 98 to 99% of the diversification benefit holding a 1000 stock portfolio right. So from about 30 stocks and on in general you’re going to have similar diversification benefits to analysis on portfolio from an idiosyncratic or just volatility based measure.

Obviously at 30 stocks relative to a thousand you may have different sector allocations etc which are different risks but from just a way people think about it from like a standard deviation perspective gain almost all the benefits.

Why we do 40 50 stocks is you know we kind of think we want to be more concentrated I think that then those funds out there generally it’s around you know 200 plus stocks for factor based funds. There’s some that are around 100 which are good as well but we want to be give people more access to a more concentrated value or momentum security selection method and then you know we equal weight across those positions.

Which I as I mentioned earlier it gives you a little bit more access to mid-caps relative to just large caps.

Nick: you guys equally what’s your approach to rebalancing you guys rebalance monthly or quarterly or what’s your rebalancing schedule?

Jack: yeah so within the funds for value we rebalance queerly in the US and every six months international and you know. Why it different there international trading is just there’s a cost right so us as the manager that are we have to say okay we probably would want to do quarterly in both but we know value at the outset is a more longer-term strategy that you could rebalance it out to a year right and or even further.

But so we do three months for us six months for International on the value on the momentum of funds we do them every quarter and the reason we do momentum rebalancing internationally for momentum whereas for valuable you six months is momentum is a more faster moving strategy that one needs to rebalance more frequent.

And then on our trend rules we apply them so the trend rule is applied in the 1-1 fund reboot that gets applied in a system.

Nick: I want to switch gears here and talk about I guess why choose factor investing versus you know say kind of a Warren Buffett pick individual stock selections and hold them for a couple decades that that approach.

So you know the obvious benefit is that it takes away the human aspect of investing we’re our own worst enemies when it comes to managing our money you know we tend to sell low and buy high which is obviously the worst thing you can.

Do for you personally and from the perspective of your firm how do you guys think about minimizing this the behavioral biases and the psychological areas that that tend to happen for investors who are even following a factor based strategy?

Jack: I’ll answer that two ways one is that at the within the security selection process you know they’re one of the reasons we use a computer or quantitative an investment strategy to come up with the stock means is we don’t want to necessarily be looking at the names and being like oh we should have put that in it.

Because it’s true sometimes when we run our value screens I’m like ah yeah really I don’t even know why this stocks going in but no we just follow the model.

So clearly and that’s probably good right because in general for value investing you know it could be that stocks are inherently risky which that’s at some level that is right like you know we’re a little bit overweight consumer discretionary and there’s probably a legit risk that Amazon you know eats all those companies and destroys them. but you know there’s also potential who knows that Amazon needs that it does so but then it also needs you know properties to make more shipping centers which those retailers may have so who knows I don’t know.

But we try to limit our behavioral bias on the security selection by by doing it with a computer and then as far as for someone to be successful in our strategy right that’s a secondary behavioral bias question and I think what have we tried to help people succeed in our strategies is and I mentioned this earlier but also but by telling them why and how our strategies can underperform that time.

And so what we then tell people is hey by the way you know this is a good stretch we think it’s a good strategy but it may it may lose the market for a five-year period ten-year period what are you going to do and if someone’s like yeah I don’t care I’m fine I can I can live with it I’m going to hold this for 30 years then then maybe for that person they have a larger portion of the portfolio.

For someone who’s like they’re on the fence and that they still want to invest in that strategy we used to tell them they make it a smaller portion in your portfolio. so that’s kind of how we try to help investors at the outset make sure that they win to the to the extent they’re investing in our strategy.

Nick: what’s your take on the unique individual investors like a Buffett or a Charlie Munger or a Seth Klarman who have shown an ability to beat the market over time.

Do you think that and I guess more broadly under what circumstances do you think that individuals have the ability to perform a factor based investing model?

Jack: obviously it’s probably the rule that you know a models problem we’re big fans of there’s a lot of research out there kind of showing that you have models generally beat experts. But as you mentioned there are these outliers right like there is the Buffett’s of the world right and if some level you know one who knows water makes given this great climber than his head that he hasn’t told anyone about which is probably what he’s doing at some level.

But I think in general people are probably good especially from an investment standpoint not from like a human capital like putting in their time trying to run a business obviously that’s a different thing right. But from an investment standpoint I think most people are pretty we’re going to be better off just doing some sort of either factor based model or you know even just invest in S&P; which is some level factor based model that loads up on the market factor I do think there’s chances that people can you know potentially be you know the S&P; it but maybe that comes with an additional risk.

An example I like to give is kind of realistic because a lot of times you know a lot of people we’ve met that have made a lot of money it’s being in real estate right and you can make money in real estate because y-you can they use leverage to basically defer taxes for a very long period of time right. And if you do those two things and do well you’re going to end up with a lot of them right.

But if you really think about it like the real estate investor let’s say that compounds that you know 12% when the S&P; compounds that let’s say 10% or 9% historically right. If you think about it the real estate investor that did that and they spent a lot of time you know worrying about these properties let’s say they have only five six properties. They probably ended up really just taken in addition they’ve really ended up taking more risk than the market right.

So the real estate investor is just investing in individual properties that who knows like they may look like great properties now but in 20 years you don’t know what’s going to happen with demographics you know of that individual location that you hold a block.

So you know you potentially can be beat a model beat the market you know in like real estate but it’s probably because your end up really just taking additional risk that you may not be accounting for and at the end of it you know gets back to the riskier the investment the higher the rewards.

I don’t I think that I hope that answers your question.

Nick: yeah it definitely does. I want to continue on this trend of talking about kind of the big hotshot investors and just ask you would you say that there’s a particular investor who you know through reading books or annual reports or this could even be someone on a company management team.

Would you say that there’s anyone who’s influenced your investment approach in a big way that you kind of feel like has acted as a mentor maybe you’ve never even met but someone that you’ve learned a lot from?

Jack: one thing and this is just now we’ve even had the luxury of meeting a lot of people have been very successful only and one thing I say that is common among those that did it is they generally found out a way to look kind of like compound their wealth at some level and tax-deferred.

I would say that that is probably the most common attribute that all have had whether it’s someone making manufacturing labels that did it through net operating losses or someone who did it through real estate where you know you 1031 rollovers for sixty years.

In general those people wanted one of their common attributes is they figured out a way to kind of minimize taxes and you can even argue Warren Buffett some level you pay out dividends you minimize taxes over you know a 50-year period.

I would say that’s a very common attribute something that I always keep in the back of my mind when making like any investment decisions is and how can i is there a way or is it possible at all to do this in a tax efficient manner.

Nick: that’s interesting. When I think about the stereotypical real estate investor someone who’s actually buying real properties. One of the things that stands out to me is that they seem to hate paying taxes more than they like making money and you mentioned that earlier too but that’s what that comment reminds me of.

Jack: yeah and you know if you it sounds like you had get a real estate person on before. but you know this very it is true and there are those people that literally sometimes well they’ll figure they’d rather does not pay taxes as opposed to paying money sometimes yeah I disagree there I’d rather make money on an after-tax basis.

But yes that that is common amongst the real estate investors.

Nick: I want to close up with a few more questions that are kind of in the fun bucket the first is you know you’ve talked about how you the three most dominant factors in the market or value momentum and trend-following.

Let’s say you know there’s a gun to your head you have to pick one factor to follow for say the next ten or twenty years which would you pick and why would you pick it?

Jack: yeah I think I it’s obviously that’s a tough one. I probably would end up having to pick momentum if I had a guess and you know one of the reasons there is just the fact that it’s some level it’s you’re just following the trend and you know across everything in life like you know the more experiences you have you understand like trends exist you know like in sports teams do well for some time you know in politics a party wins for some time you know investing some stock wins for some time’s.

I kind of I kind of I’ve become I was you know a huge value fan to L set but I’ve become I’d say more of a momentum believer just the fact that doing it systematically you know you’re always going to be in stocks that just for some reason you’re doing well and your brain may not be able to figure out exactly why.

But the whole idea is just kind of following up following the momentum factor which it’s similar to the trend but following the momentum of individual stocks as well.

Nick: that’s a great answer. My next question is about investment management and I guess you know we talked about Vanguard we’ve talked about AQR and DFA a little bit.

If you had to give your money to one outside active investment manager for the same time rising as my last question so say 10 or 20 years who would it be?

Jack: AQR is great, DFA does good things on the value front I think AQR or you know I like who they does momentum as well. But I would say I probably prefer a firm that’s like similar to like large-size and just kind of similar culture and just personally cuz I know them which would kind of be like the Cambria guys like Meb or the other ones like the Resolve guys up in Canada.

They both kind of have different strategies but similar at the same time and I and I like what they’re doing so I’d probably pick one of those two probably just split it amongst the two funds there.

Nick: that’s all I have for to talk about today thanks a bunch for taking some time to tell with me it was a great conversation and I’m sure our listeners learned a lot.

Jack: yeah well thanks for having me on and everyone learned something as well.