Episode #501: John Davi, Astoria Advisors – Macro+Quant, Inflation & Global Diversification
Guest: John Davi is the CEO and CIO of Astoria Portfolio Advisors, which provides ETF managed portfolios and sub-advisory services.
Date Recorded: 9/14/2023 | Run-Time: 55:34 
Summary: In today’s episode, John walks through his macro plus quant approach to the markets. We touch on his entrance into the ETF space with two tickers I love: PPI & ROE. We also talk about global diversification, opportunities in Europe and Japan, and why he focuses on after-tax after-inflation returns.
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Links from the Episode:
- 1:11 – Welcome John to the show
- 3:21 – The origin story of Astoria Portfolio Advisors
- 8:24 – Advisors at Future Proof are largely underweight on foreign investments, showing U.S. bias
- 10:19 – Astoria’s approach to using alternatives
- 17:01 – What led Astoria to launch ETFs?
- 20:26 – PPI ETF uses quant screens to target inflation-sensitive sectors
- 28:24 – ROE ETF combines quality, value, size factors; favors equally weighted S&P index
- 33:57 – Why John is bullish on India
- 35:06 – What belief John has that the majority of his peers disagree with
- 37:05 – Challenging the notion of U.S.’s valuation premium
- 39:38 – Importance of diversifying factors
- 42:45 – Diversification and active management can outperform single-factor, low-cost options
- 48:48 – Expensive stocks can underperform long-term, even if companies are strong; Research Affiliates post
- 50:37 – John’s most memorable investment
- Learn more about John: Astoria Portfolio Advisors
Transcript:
Welcome Message:
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Disclaimer:
Med Faber is the co-founder and chief investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb:
What’s up everybody? We got a fun episode today. Our guest is John Davi, CEO and CIO of Astoria Portfolio Advisors, which provides ETF managed portfolios and sub advisory services. Today’s episode, John walks through his macro plus quant approach to the markets. We touch on his entrance into the ETF space with two tickers I love, PPI and ROE. We also talk about global diversification, opportunities in Europe and Japan and why he focuses on after tax, after inflation returns. Please enjoy this episode with John Davi.
Meb:
John, welcome to the show.
John:
Hey, Matt, good to be here. Thanks for having me.
Meb:
I’m excited to have you. I’ve kind of known you as the ETF guy even before ETF guys were around, but you spent a lot of time on what many would consider to be sort in the plumbing of traditional Wall Street. Tell us a little bit about that time back then when people called ETFs EFTs, they weren’t quite sure what they were. Give us a little background on those are early 2000’s, mid 2000’s period in your world.
John:
Yeah, so it was a really interesting time to be starting to work. I mean, you had the big internet bubble ETFs were just starting to be launched. Back then the ticker for the NAV of an ETF wasn’t a Spy IB, let’s say it was some random ticker. So did a lot of work with institutional investors on how do you get exposure to emerging markets. Again, EEM wasn’t around that back then, so you’d have to put together an optimized swap basket of ADRs and local futures to try and get exposure to emerging markets to equitize cash. No one knew back then that ETFs would be as successful as they are today. I think originally it was launched for institutional clients, but then was quickly adopted on the wealth management side by financial advisors. So even at Merrill Lynch, we were the quant guys that would be a responsible put together like ETS that would track our strategist views.
So we had some pretty well-known strategists. Richard Bernstein was the head of strategy, Dave Rosenberg, we were the quant group that would take their views and put together ETFs for financial advisors. Those ETF model portfolios are huge and massive now 20 years later, obviously. But yeah, it was a great place to work and a lot of famous research analysts. As I mentioned, Rich Bernstein, Dave Rosenberg, Steve Kim, even Henry Blodget was very big at the time. Steve Milanovich the tech analyst. So it was a great place to work and start and definitely was one of the earlier guys in the ETF ecosystem for sure.
Meb:
So you spent your time, you did your time working for some of these big giant firms, and then you said, “Okay, I have the goal, the naive optimism to be an entrepreneur and start my own shop.” Give us a little bit of the inspiration and tell us a little bit about your company today.
John:
So the goal was always to manage money and to join the buy side. I think as I got older in my mid-thirties, it was like I knew that if I had joined the hedge fund that your risk capital was going to be watched very closely if you have a down quarter. That’s something that Steve Kim had taught me quite a bit on is just make sure when you join the buy side, all your ducks in a row, you can take that career risk because it’s not easy. So I thought that I had developed, I thought an edge in ETF. I knew the tickers, I knew how they worked. I knew from working with providers how they constructed these portfolios. I spent a lot of time doing the index research, learning portfolio, construction, macro quant. So I just thought, “All right, here’s a chance for me to start my own company, join the buy side, be an entrepreneur, kind of do it all at once.” So a story of portfolio advisors launched in 2017. I put together the business plan back in 2014.
Meb:
How similar does it look? I always love looking back on business plans because so many successful companies and ideas… I joke looking back on kind of what we began as is nothing resembling today. Was yours pretty close or is it strayed quite a bit?
John:
The costs have come down. There’s been firms issue model portfolios for free, “for free,” not really true. They have their own underlying ETF management fees that they’re accruing interest on and fees. But yeah, I mean there’s a lot more competition now than it was back then, but we’ve developed a niche. We serve as an outsource CIO to independent financial advisors, RAs, firms sub half a billion, let’s say that really need a macro quant kind of strategist to develop their solutions. And not only that, but also to do the physical trading on their behalf.
Meb:
We’re going to get to some of you coming full circle, starting out really as ETF strategist, starting your own company and now launching two funds. But I want to hear a little bit about y’all’s framework because man, John, you put out a lot of content and coming from a content creator, I know how hard that is. Tell us a little bit about Astoria’s framework. So how do you approach the world? What are your main sort of levers when you’re building these model portfolios? Are you just doing a fancy 60/40 or is it a lot more involved in that?
John:
I think there’s kind of three buckets for how we determine our strategic asset allocation. So one is kind of the business cycle i.e., identify where we’re on the business cycle. Two, looking at earnings and valuations together. Valuations are a tool, not the only tool, but really kind of looking at those together. Is the stock cheap or is the country cheap, but are the earnings growing? So that’s a second input. And then third would be kind of sentiment. So those three things like where we in the business cycle, looking at earnings valuation and then third sentiment. That really dictates our strategic asset allocation. We have a dynamic overlay, so we’re going to use those three inputs, but then also use liquid alternatives as a way to kind of dampen our volatility. Essentially, Meb, what we’re looking to do is buy cheap assets where the earnings are growing, they’re cheaper than the market. There’s poor sentiment and there’s a clear catalyst for upside. We could talk about afterwards, but we kind of identify Europe and Japan as that strategic overlay let’s say.
Meb:
No, let’s hear about it now. I thought you were just going to say you have all your money [inaudible 00:07:56], but let’s hear about it. Where are some of the signals pointing and why? Let’s hear the thesis.
John:
So Europe is a country in a region where you’ve got strong earnings momentum, you’ve got positive estimate revisions, they’re cheap and you’ve got a catalyst for upside. The catalyst for upside is the fact that the three inputs I just mentioned, it’s very underweight in people’s portfolio. They’re much further behind the inflation cycle, the interest rate cycle. So that’s in overweight. Contrast that to us where all people want to do. And on your show, you’ve talked a lot about home country bias. All financial buyers want to do is own US, but if you look at the US story, you’re in an earnings recession. So earnings aren’t great. They’re very, very expensive. If you look at case Shiller P ratio, it’s 30, let’s say only people want to do is own the magnificent seven thinking that those are the only good stocks to own. So that’s an area where we, let’s say be underweight. So that’s kind of how we’re thinking about the US versus the rest of the world.
Meb:
Yeah, I mean looking at the sentiment, it is just down at this financial conference future-proof, and it feels like every advisor I talked to is either hugely underweight foreign and they just said, “Look, we haven’t owned any, we don’t want any for past decade.” And then the ones that do own it look pretty beat up and despondent and they’re almost looking for some comfort, but even then they’re almost looking for an excuse to get rid of it. They’re almost like the, “I can’t take it anymore.” Part of the sentiment, which it was pretty astonishing to me to feel how poor the sentiment is, but sentiment’s always a little squishy for me. It’s always hard to gauge exactly what it really feels like other than it was crazy extremes.
John:
There is a point in time in my career where emerging markets was the only kind of hot area where you wanted to invest in Dubai, Abu Dhabi, China, India, it was like-
Meb:
It feels like around ’06 in the timeline. To me that was a really ’05, ’06 was the bricks, was the SPAC. It’s not SPACs anymore. Now the AI of the day, if you were to do every year what the most popular topic was emerging markets, it’s hard to tell people to convey that today they’re just forgotten, but they were the AI of the day 15 years ago.
John:
Yeah, AI is interesting. If you look at the big banks on Wall Street, none of them were actually talking about AI in their year ahead outlooks. So it’s only September, so that was only nine months… Well, actually those sell side, and I worked on the sell side, I know they start putting those reports together in October of before year-end. But I would just say that investors have to look outside the US because I’ve seen periods in my career where it’s about other countries, Europe, Japan. So it’s not just a US home country bias in our portfolios for sure.
Meb:
All right, so you’re going against the grain a little bit owning some of those. What else? You mentioned the sort of alt or inflation basket. How do you approach that? Because that means a lot of different things, a lot of different people.
John:
So principally when we put together our pillars for investing, it’s like, okay, we believe in after tax, after inflation risk adjusted returns. So because we’re a physical sub-advisor and we manage money on behalf of other financial advisors, we’re always thinking about after tax. So tax loss harvesting is a big deal for our standpoint. What I tell people about inflation, obviously I’m very biased. We run an inflation strategy whether inflation’s two, whether it’s four, whether it’s nine, we tell people. Bogle, Vanguard world, invest for the long run, right? Siegel stocks for the long run. So 2% a year over 20, 30 years, I mean that can seriously compound. And then risk adjusted, that is a big thing. Having worked at a bank in ’08, Merrill Lynch was acquired in the very last minute. You learn about left tail risks on the sell side. I feel like the sell side, you focus on the left tail, the buy side, you focus on the right tail.
So just having that background working at a bank and then at a bank that was acquiring the last ninth in. So we do use alternatives and to your point, MAB alternatives that have very low correlations or ideally strongly negatively correlated. So there’s some strategies in ETFs where you get very negatively correlated longshore market neutral ETFs. Sometimes advisors come to me and say, ‘Oh, I own alternatives,” and it’s some mortgage read or something that’s positively correlated, high yield bonds. So those are the kind of three pillars for investing, and it’s about, I would say 10, 15% of a portfolio. So that’s kind of a little bit about investing.
Meb:
I was laughing as you’re talking about this because if future-proof Bill Gross was on stage and they’re talking about what’s your trades, what’s your portfolio? And he said, “40% of my portfolio today is in MLPs.” And I heard that and my jaw just kind of dropped because MLPs were also, there was a big cycle. Everyone was marketing MLPs was that like five years ago, and they’ve long since been forgotten because they struggled. But to hear someone like Bill who’s a billionaire, come and say darn near half his portfolios, MLPs was pretty funny. You mentioned after tax. I mean that’s a topic that certainly people I feel like talk about, but it doesn’t get enough appreciation really after tax, after expenses, risk adjusted. Really I feel like we live in a nominal world that everyone is really just looking at the nominal returns and underappreciated. I mean, I guess the serious crowd, I think it gets there, but I feel like that’s pretty underappreciated to hear on all those measures.
John:
I think the beauty of ETFs is that when you deal in those large Morningstar buckets, you’ve got so many different ETFs that can develop Europe, your emerging markets. If you’re in large cap, small cap in the US. So the beauty of ETFs is you just punting the basis down the road. So you swap out of one emerging market ETF into another that’s 90% correlated. So it’s great from that standpoint. It’s very rare to do. I think some of my peers, Meb, they’re just on different platforms and they put their asset allocation models on platforms, but those platforms, they’re not going to tax us harvest. How could they possibly know what the replacement ticker is? So when you use a sub-advisor like us and we’re bolted underneath you at the custodian like a Schwab for ATD, we’re going to do that systematically. So we’ve got full trading team, we’ve got back office, operations. I think that’s hugely important to do that for sure.
Meb:
Yeah, this is a little bit of a nerd alert, but one of the advantages of using ETFs too, usually across the board is the short lending revenue, which isn’t crazy on the numbers. In some cases it is crazy high, but usually it is a material amount, maybe five basis points, 10, 20. But when people spend so much time focused only on things like expense ratio, but this is an extra benefit that almost no one talks about or understands. So you guys got a lot going on this framework. Why don’t we spend just a little more time here and then we’re going to hop over to two particular ideas that are super interesting as you look around the world and as the strategic, here we are in almost Q4 of 2023, almost hard to say. So we’re mid-September right now recording this, what does the world look like as far as these allocations? You mentioned a little Europe and Japan. Japan has certainly seen a renewed interest. Anytime Uncle Warren Buffett is taking his jet somewhere at this age, it’s going to hit the media cycle. But what else are you guys thinking about?
John:
I think going into this year, basically everyone predicted that we were going to have an economic recession. There was going to be a DEF five moment for US equities. We were going to have a profits recession. So we told our investors, “Look, consensus trades rarely pan out, maybe one of those three things would happen, but not all three.” So we’re still in an earnings recession here in the US. We don’t have an economic recession and certainly we didn’t have a DEF com five 20% pullback in the S&P. I would say right now, if anything, this year’s market reaction didn’t necessarily make us overly bullish on the US when you’ve got investors crowded into just seven stocks. So we had no choice but to look overseas. When I look at the US, because it does make up 50% of the world. I would say that yeah, GDP is a lot stronger than what most people anticipated.
I think that the tight labor market and the consumer is kind of keeping things together. What we tell people is like, “Look, watch consumer’s health.” It’s now two years where they’re paying elevated prices for rent and for food grocery shop. The minute people lose their job, I think you start to get things a little bit more trickier. But what I think everyone missed and truly we missed, and I’m not afraid to say it, is there was about a trillion dollars of stimulus put into the economy, all these extension of student loan memorandum, Medicare, and you just can’t put a trillion dollars into the economy without having a positive reaction. And this is why we don’t just invest in macro because yes, there’s some macro stuff that’s pretty bad, PMIs, you’ve got the fiscal stimulus that supportive asset prices, but you really got to kind of marry the macro with the earnings. And there’s a good earnings story in Europe, Japan that you just don’t have in the US. So I think that’s crucial.
Meb:
All right, listeners, you heard it here first. All right, so we mentioned earlier coming full circle, you’ve been at this game for a long time. You said, “You know what? We got to do our own ETFs.” Tell us a little bit about the inspiration. Tell us a little bit about the experience. Was it nerve wracking? Was it piece of cake? Was it exciting? You now have two and then we’ll talk a little bit about the strategies behind both.
John:
Sure. And we’re the sub-advisor for both ETFs. So access investments, we partnered with them to launch the inflation strategy and then technically our other ETF is with Wes Gray’s firm and he’s technically the advisor, we’re the sub-advisor. So we just thought we’d keep that clean. It’s clear in the asset management industry you’ve got to have a strategy for ETFs. And when I worked on the sell side at Morgan Stanley, these big asset managers were even back in 2010, 2011, like, “Okay, are we going to get into this space? Are we not getting…” And you saw some of these guys came in just in the last few years, Capital Group launching only in the last year or two and having a lot of success for us it’s like, “Okay, could we bring assets to the table? We’re not going to launch ETF where we can’t put our clients assets behind it.”
So for us, the first ETF, the inflation strategy was very clear. We had to in March June 2020, it was very clear to us inflation was going to be a problem in my economics one-on-one class they taught me, “Okay, if you restrict supply, you increase demand, prices go up.” So you didn’t have to be like a quant or PhD to understand that we would have an inflation problem. I couldn’t believe what I was seeing. This is different from ’08 when the banks were bailed out, but all the money was given to the banks. It didn’t actually go in the real economy. Here, it was literally helicopter money in the streets and housing. So we told our investors, okay, let’s put 10% of your 60/40 or your 50/50 and let’s put together 10 different inflation linked ETFs that would help hedge your inflation risk if inflation would be your problem.
So we started doing that in September of 2020. And then we had known the guys that access investments and I had known them from prior life. So we said, “Look, we can scale this thing and it’s much more tax efficient when we’re making changes within the ETF as opposed to we’re balancing an SMA.” So we launched an inflation strategy in December of 2021, a very good experience, and we still think there’s a place where… Our mantra Meb, is that higher rates higher for longer. It’s now consensus. But we had this view two years ago that we’d be living in a higher interest rate world.
And then our second ETF, which is just more of a plain Jane kind of quality invest in ETF hundred stocks, equally weighted. That was more because of the concentration risk we’re seeing in the US marketplace. I’ve seen periods in my career where a few stocks dominate the indices in the late nineties, early 2000’s, and we were just uncomfortable with some of the own ETFs we were using just to super mega concentration risk and tech stocks and semiconductors. So that was the impetus we’d really have to get our backs behind it. That’s our unique position as a sub-advisor and we’re just going to put our client’s assets behind it and if we can do that, then we would launch more ETFs.
Meb:
All right. Well, let’s hear about it. The PPIs, the ticker, great ticker. You guys know I love my tickers. Tell us a little bit about what goes into the strategy. You guys just going YOLO long into cold calls or what’s the strategy entail?
John:
All right, so we run a quant screen and say, “Okay, what are the sectors that have the most sensitivity to higher and inflation going back decades and decades?” So those sectors tend to be historically energy materials and industrial stocks, financials as well. But you’ve got a stronger cohort with the energy and material stocks. So basically the strategy and it’s a global problem, inflation. So globally we’re going to own 40, 50 stocks, 10 in those four sectors, five US, five non-US generally speaking kind of equally weight. So it’s a multi-asset ETF because different asset classes will perform differently depending on where you are in the inflation cycle. So sometimes it’s just actual commodity equity, sometimes it’s just those energy stocks, material stocks, sometimes it’s physical commodities. There’s been periods of time even since we launched our strategy where there’s a positive carry for owning commodities.
Now there’s a cost, so it’s an active asset allocation, kind of like let’s say 70-80’s are pure equities, 10, 15% physical commodities, 10, 15% tips. The commodities and the tips tend to be other ETFs because just a lot easier as opposed to us rolling futures and buying individual CUSIPs. In the case of tips, inflation being such a highly nuanced strategy, we just thought that you need to be active and to have a great partner like Access that has deep experience in liquid alts and being an advisor and helping with the sales and market.
Meb:
We often say on the buy and hold side, the two areas that are lacking in most investor portfolios we see are one, obviously a global focus and two, is the real asset bucket. And almost every investor we see has really nothing in real assets. They typically may own a home personally, but as far as their actual portfolio, usually they have almost zero. And those two to me are kind of glaringly obvious. This cycle I think is starting to wake people up to that. But certainly the older cohort that remembers… My father-in-law if we’re moaning about our high mortgage, he was like, “Are you kidding me?” He’s like, “Mortgages back in the day could easily be double digits.” So I feel like the memory of inflation and certainly if you go around the rest of the world, inflation is something that is much more front of mind than it is in the US. And we’ll see, we’re kind of hanging out around that not too comfortable 4% range, which I think if that sticks around for a longer period of time, certainly will be a regime shift from the old days of zero to two.
John:
Yeah, well I think the last 15, 20 years has been about globalization, which is deflationary as you think about these complex issues like US-China relations and what’s going on with Taiwan onshore and reshoring. If you were a CEO of a large Fortune 500 company and your supply chains were stopped because of this China-COVID issue a couple years ago, you really got to have a strategy, “Okay, are you going to build your supply chain back in the US? And oh by the way, how long is that going to take? And oh, by the way, we have labor laws here in this country.” These are very complicated issues. We told investors that, look, I think all this stuff is going to be very inflationary. It’s going to be higher ticket for longer. If you just look at CPI in the seventies, CPI was above 5% for 10-15 years.
It was between five to 15, it fluctuated. And there’s some charts right now that people overlay the 70 CPI with now and they argued that inflation is going to be a little bit hotter. And we had two inflation prints this week as we filmed this podcast and they’ve both been hotter than expected, but yes, definitely it’s come down quite a bit from nine back to four let’s say or three. But the key is to get it back down to two, what does the fed do? Do they really catch and sink the economy and put everything into recession or they let it run at 3%? And my gut says… And you’re right in overseas they deal with inflation all the time. Think about Turkey, Russia, Brazil, they constantly have inflation problems, whereas we as a US country just not used to it, but I think the tide may shift in years to come.
Meb:
You get an added benefit right now, listeners of the sectors that John mentioned being pretty strong value contenders to materials, industrials, energy, financials, on and on, particularly in the United States. We’ve talked a lot about this and I’m still pretty firm in the camp of this being one of the best times ever to having a value tilt. You get kind of a double whammy here. You get value tilt and you also get this potential inflation exposure tilt. So we’ll see how it plays out, but I certainly like it. You got any crypto in here? The modern precious metals. I don’t really know what to think about that world. Is that a potential entrant current portfolio holding?
John:
It hasn’t been only because we try and stick to the research and we’re trying to be very quantitative and systematic and it’s a new phenomenon, cryptos. Conceptually it makes sense. Bitcoin is whatever 19 million has been mined, they only have 21 million coins in total. There’s going to be a reach. We would not be surprised if we see Bitcoin do better in years to come, but not because of its inflation just because it operates to its own beat. But I like what you said before about value stocks, because it is. The P ratio of our strategy is 10. You think about the US it’s like 20 times forward earnings. So if advisors bucket our strategy in the alternatives bucket, and it’s a compliment because if you’re going to run a 60/40 and have a lot of concentration in large cap index beta strategies, our fund, it’s underweight.
There’s a chart that’s floating around Twitter, it’s got Michael Kantrowitz… Actually we worked in Merrill Lynch quant research back in the late ’90’s and he shows you the sector weights of basically cyclicals, which is the four sectors we just talked about versus growth plus defensive. So that would be tech stocks, utility staples, and it’s at 100 year wides in terms of how much the S&P is dominated by growth plus defensive sectors versus cyclical. So we just tell people… And I’ll give credit to Nassim Taleb, he was on TV one time, he was like, “Look, you don’t time your car insurance or your home insurance.” And his argument was like, “Don’t time your disaster insurance.” I’d say.
We just take that to the next level and say, “Look, you should always have inflation insurance because A, they’re cheap right now.” I’ve seen periods in my career where these energy stocks are literally the biggest in the world. ExxonMobil was the biggest stock in the world for many, many years when I was starting my career and it doesn’t cost you a lot. It’s like a 10 P ratio. And there was some inverse correlation that we saw in our strategy last year where our strategy was up, but the S&P was down significantly. So it kind of works well and it carries well in the portfolio.
Meb:
All right, let’s hop over to ROE, another killer ticker man, two for two. What’s the thesis behind this strategy? What are you guys doing here?
John:
We’re multi asset investors and on the equity side we do believe in combining factors in your portfolio because the research shows that when you combine factors, you’ve historically been able to get higher up on the fish and frontier. So kind of owning a basket of quality, value, size, we do subscribe to that notion and there’s a lot of research and you’ve had Swedroe on your podcast and talking about this and other Rob Arnott. I would say that right now most people would be surprised if we said that the equally weighted S&P index has actually outperformed the S&P 500 index since 1999, which is when data goes back. And I’m not even sure why S&P doesn’t go back until the start of their index. They should and they’ve got the constituents.
Meb:
Well you can ask your buddy Wes to do it, those quants can certainly tease that out.
John:
The S&P equally weighted index, the index has actually outperformed the S&P 500 index since 1999. You’ve had some mega cap rallies.
Meb:
I think you can definitely go back on that. Looking at equal weight. Rob Arnott, who you mentioned has done a lot here in his book Fundamental index and the first step of anything where you just break that market cap link and the problem with market cap, it’s totally fine most of the time, but particularly when you get these boom environments. ’99, I’d argue today or even more so a couple years ago, but obviously Japan in the eighties is like the granddaddy, but it happens in sectors and countries as well. When you have these boom times, the market cap because there’s no tether to fundamentals goes nuts. So equal weighting severs that a little bit, but factor weighting, which is what you’re digging into, severs that even more because it gives you a tilt towards a certain characteristics, which historically have been very favorable. Okay, keep going.
John:
Yeah, so just the point here is the historical CAGR and all the past performance on dig a future results, but the historical CAGR of the equally weighted index is almost 9%, whereas the actual S&P historical CAGR since 1999 is about 5%. So you get almost like 400 basis points pick up based on history and that’s pretty substantial. So we just thought, okay, our current ETFs that we use, smart beta ETFs, index beta, depending on the demand that we have a range of strategies. Range of solutions. There’s just way too much concentration risk in just these seven stocks. So we thought, okay, we always want to be tilting towards quality, we like that, that’s our true north, but let’s just equally wait and we’re still using some other smart beta ETFs in our strategies and SMAs. So what we tell people is use it as a compliment, don’t replace your S&P 500 index ETF, use this as a compliment to augment and help diversify.
Meb:
You’re never going to get to 5 billion without telling them to replace all of the S&P, but I appreciate your candor. Talk to us a little bit about both these funds have been successful. Talk to us a little bit how you did it. How have these both been a success and what’s the plan on growing them going forward?
John:
Well, I would say content is important. So we produce quite a bit of content, we’re out loud and we do a lot of media, we write a lot of blogs, do videos and whatnot.
Meb:
Where does most of that sit, by the way, for the listeners who are new to you, where can they find most of that?
John:
It’s astoriaadvisors.com, that’s where most of our content is. I think for us as a sub-advisor, we’re always like, “Okay, what are we lacking in our portfolios? Where could there be a better solution? And then let’s look if we can improve the solution by launching a strategy.” So that’s really… We use ourselves as the litmus test. So you won’t see us go ahead and launch in some crypto ETF just because we’re just not set up that way. If we can use in our own models, we think that that is the first step in the decision tree. The second and future steps would be is there viability? We would hate to launch something and have to close it because then we miss forecasted, let’s say try and think about very long-term themes, things like inflation. We think that you should have an inflation strategy in perpetuity, whether it’s this year or next year, CPI goes back down to two, you should have it.
I think equally weighted and is very interested and certainly we’re not the first firm that equally weights. There’s been many other peers that launched WisdomTree. They made a lot of success by tilting away from mark cap, obviously Rob Arnott with what he does with his partners. So I think we try and look at a few different buckets and that’s essential. And content is huge for us. We have to be educating and advisors how to use it. So think about this, we get inbounds because we have existing advisors that we manage. So they’re constantly coming to us. “How does this fit in? How do I size it? How should I asset allocate?” So we don’t have any plans for additional strategies as of yet, but that’s been a good experience so far.
Meb:
So no more imminent ideas on the horizon it sounds like. I don’t know if I believe you. Well, let’s go back to markets a little bit. We’ve covered a little bit. You were on a podcast recently where you said you’re going to ask the next person on the podcast, if you had to pick one country to invest in the next 10 years, what would it be? So I’m turning it back around to you. What’s your one country if you got to close your eyes, hold your nose for the next decade?
John:
That’s a tough question, man.
Meb:
You asked it, not me. So you’re the author.
John:
It would probably be for me, and we’re thinking about sector size, style. We’re thinking about all these different asset allocation, but I pick one of the large emerging markets, something like India. I do think that there’s a ways to monetize a billion people in a country. I think China is very, very controversial. I have some peers of mines that are all about China. It’s good contrarian trade, everyone hates it, they’re cutting rates. But I think India is a way to kind of play that same concept but just it’s a little cleaner. I see a lot of value in that region of the world.
Meb:
We just did a podcast talking about India and tech, which went pretty deep on the topic. I still haven’t been, I need to get over there, but certainly fascinating country and opportunity. When you look at just the scale, it’s hard to fathom I think for most people in terms of just how many folks you have in that part of the world and certainly the potential is staggering. Another fun question we’d like to do for people, and I’m guessing as a New Yorker you’re going to have plenty of opinions, but what belief do you have that the vast majority of your peers, so call it two thirds, three quarters disagree with?
John:
It would definitely be the home country bias for sure. I spent a lot of my time traveling internationally when I worked on the sell side, I would go to meet with the Central Bank of Denmark and Japanese pension funds, Taiwanese life insurers. There’s such a home country bias here in the US and the rest of the world just doesn’t think that they’re much more global.
So I would say that along with the fact that everyone doesn’t want to own alternatives and they do serve a valuable place in your portfolios if you can pick the right strategy and if they’re cheap and if they’re implementable, there’s alternatives that are complicated, all sorts of tax issues and whatnot. But if you can find it in ETF wrapper and if it’s inversely correlated, it can really help. Because what I find for managing money is that in bull markets, clients are annoyed. They’re like, “Oh, the NASDAQ’s up 30, why is your 80/20 portfolio only up 10%?” Let’s say, but they really value when that NASDAQ index, which was only last year was down 30, 35 when you’re 60/40, 80/20 is down fraction of that. So having alternatives certainly helps in those bad years. And there’s a stat people feel the loss two times greater than they feel the gain when it comes to investing.
Meb:
What do you say to people and give us a little bit of feedback on the vibe on… You mentioned this home country bias, but so many other people I talked to, it’s like you brought up something that’s just so unpalatable. I was having a conversation with an advisor this week and they were talking about how the US deserves this current valuation premium to the rest of the world. And I said, “Yeah, maybe they do. It’s certainly at a huge premium right now.” And I said, “Well, just historically curious,” I said to this person, I said, “What do you think the historical valuation premium of the US over the rest of the world has been?” Because it’s a lot now. And they were trying to guess 20, 30% or something.
And I said, “Well, the answer is zero. The actual valuation premium is zero.” It just happens to be since 2009 you’ve had this era or regime where the US valuations have gone straight up and the rest of the world is kind of sideways and muddled along. It’s just most people think that a decade or 13 years is an infinite amount of time an investor’s lifetime, but in a timeline of markets it’s not that much. I was going to say, so give us a little like what do you say to people and how do you deal with these advisors and investors who are saying, “John, you’re kind of a moron. I’m all in US and I’m stomping everything. So what do you know?”
John:
Well, I would say that there’s periods of time where Japan, Europe, emerging markets can do significantly better than the US. The US should deserve a premium. We’ve got much better companies in general, I would say better technology, better healthcare companies. You just don’t have that in Europe, Japan, let’s say on a relative basis, US should deserve a premium. We have better companies, maybe better regulatory, better tax structure, but it shouldn’t deserve the premium that it has now. To play devil’s advocate, what I would say is that some of these other non-US markets, they do trend and they can exhibit some fair amount of momentum, which then you get into a timing issue. So we would just tell people, “Look, you should just own all of it, maybe tilt one way or another depending on your views. But definitely don’t try and time it or try and be tactical with it.” I think US should deserve a little bit of a premium, but I think if you’re looking to be fully invested, you should own both.
Meb:
So we’ve kind of danced around the world, talked about a lot of things. As we look out to 2024, anything we haven’t talked about that you think is particularly interesting that’s on your brain? Anything you’re excited about, you’re working on? I know you write so much that you look forward to the notes that you’re getting ready to put into production. What else are you thinking about that we haven’t really dug into today?
John:
I would just make a point about, we talked a little bit about Swedroe and he’s got this one book that we tend to give to advisors and we say, “Look, whatever we say about macro…” And we have a 50 slide deck cover of our website, story at advisors.com where we literally show people what our tilts are. A lot of the indicators that we look at, we’re very transparent. We will tilt towards a factor depending on where we’re on the cycle. But Swedroe’s book I think is for people that are really curious why you want to own something besides beta? Because the masses, the big Vanguard, State Street, they giveaway beta for free. So should you just build a portfolio of just zero cost beta equity and fixed income ETFs? And there is a lot of value in owning other factors. And Swedroe’s book I think is really seminal to how we invest, which in his book and he’s got data that goes back 75 years where he says, “Okay, a 25% allocation to the beta factor, the size factor value momentum gets you a sharp ratio of about 0.7.”
And momentum has similar sharp ratio but lower, it’s like about 0.6 let’s say. But momentum is very, very volatile, could have a good year and then a terrible year. So if you equal weight beta size value momentum, you get a 0.7 sharp ratio. Then his book and there’s a table says, “Okay, if you take those four factors and you add profitability, you get a 0.9 sharp ratio then if you substitute quality for profitability, and I don’t want to get into the weeds about the difference between those two, you get a sharp ratio of 1.1. Basically in the last two data points I mentioned, you’re getting almost triple the sharp ratio if you just own any one factor. So I know beta is great, it’s zero, but you really, for the efficient frontier standpoint, it’s good to own a lot of factors because there’s years when value will do better.
There’s years where small caps do better. Again, here we are Meb, right? Nobody wants to own small caps, nobody wants to own value. It’s just about large cap… Not even about beta, it’s about mega cap beta in the US only. So he’s got all these great stats, the odds of underperforming a strategy over a 1, 3, 5 year period and all the odds greatly are in your favor over long periods of time when you harvest a portfolio of factors. And I would just encourage listeners to just look away from just mega cap beta because I think in the next 1, 3, 5, 10, you’re going to find there’s other strategies, other stocks that do better.
Meb:
Yeah, I think well said. It seems to be thoughtful advice. So many people, they want to find the perfect factor, but this concept of combining an ensemble as some people call it or a group of factors, multifactor certainly I think can be a really thoughtful way to go about it because so many people get caught up in a binary world where all their decisions are in or out, this one, that one. When in reality the blend can still be much better and the composite can be much better than the individual alternative, which is this market cap entry price, but not something that necessarily, I think it’s cheap, but doesn’t mean it’s going to be a great thing.
John:
Yeah, just because it’s cheap doesn’t mean it’s good. You got to have more of a reason to own something. And honestly, I think the RA world, the ETF world, maybe firms like yours and mine, it’s just exacerbated this problem because now anyone can build a portfolio, you can build a portfolio from your laptop on the beach and think you’re getting a good solution because you’re not paying any commissions, you’re not paying any management fees. So we look at this not like, “Hey, this is not a fair type thing.” We say, “Look, we think there’s a great opportunity for active management.” And frankly, I think active management has a little bit of a tailwind from this standpoint. But the problem that we have or we see with active managers is a lot of them don’t take enough risk. So if you read Barron’s, the portfolio management section every week there are top stocks for whatever reason they like it.
They’re basically owing a lot of the stocks that are in the S&P in a similar weight. So you really got to do something different and think outside the box. And then of course you need to time it, you need to size it and then do take some risks. So we don’t have problems like with the zero management fee world and zero cost world, all the big guys giving models away for free. We think that’s exacerbating the problem and it’s given us an opportunity and our clients like it, we’ve had some success over the years by doing these three tenants, the restaurant across factors, using alternatives, investing for the long run, keeping our own costs low.
Meb:
Yeah, well said. One of the biggest problems I think in our world is the seduction or laziness of many investors to not really read past the headline. And what I mean by that is so many people like Twitter, it’s like, “Are you sure you want to comment on this? Have you actually read the article now?” But the headline of something, what I’m alluding to is the name of a fund and so many funds people, what’s the percentage that never read the prospectus? I don’t know, 99%. So thinking in terms of a lot of these funds that say there’s something, but in reality give you a closet index is where I’m going with this.
If you’re going to do a closet index, you definitely shouldn’t be paying more than five basis points because the index you can get for free, which you just mentioned. But so many of these funds, if you look at their history, either because they have raised a ton of assets, some of these funds that are 50 billion, it’s hard to concentrate at 50 billion certainly if you say you’re a small cap fund or something. So challenging investors to look past just the name of something when they buy it, I think is pretty great advice because so many times we talk to people who end up buying something that is not what they thought they were getting.
John:
So our two strategies, one, our inflation strategy, we have I think 52 positions, and then our other quality strategy has a hundred and I think a hundred’s a lot, but it is meant to be part of the core, whereas inflation is more kind of the alternatives satellite. What I would say is that we do run these quantitative stock portfolios, and we’ve been doing it since the firm started in 2017. We’ve always just owned in those quantitative stock portfolios, 40 stocks.
Meb:
Yeah, I think the flip side is that so many investors, they say they want to be concentrated, they say they want active, they say they want to look different, they say they want to put on these exposures as long as it goes up, as long as they’re right. And the concentration, as we know, works both ways. But to me, and drilling down really kind of nerdy is there’s a handful of tools, and I think our buddy Wes has one, but other sites that let you look into how much of the fund is really active share and what you’re paying for it. Meaning it may sound great that something is only 10 basis points, but if it’s giving you the closet index, well that’s pretty expensive, 10 basis points. But if something is 75 basis points, but it’s given you something that’s a pretty unique and differentiated and concentrated exposure, then it could be totally reasonable.
There’s a lot of deep sort of analytics you could do there. But that’s again, going down the list of things investors will do, that’s probably 10th on the list. But an easy way to do it often is just to pull up a chart and see how close to the S&P or whatever the index may be.
John:
Part of the reason for us, the impetus to launch a quality is that the S&P is being so concentrated by those seven stocks. Fine, we all get it. We all know it, but just remember, all these smart beta ETFs are all optimized against the S&P. So they may be smart beta in their name or their title, but they’re still going to give you an outsized position and exposure to Microsoft Apple. So we were just… I think it’s a unique period. I don’t think it stays that way if there’s all these charts on Twitter circulating about the top stocks in the index and how it’s evolved over time. And yeah, NVIDIA’s a great company. Apple’s a great company, but a great company doesn’t always make a good stock investment. So it’s a very unique period we’re in right now for sure.
Meb:
Well, certainly that example can be well documented from the late 1990s to today. There’s so many charts where you look at a lot of these stocks and there’s a lot of misconceptions too. People always say, “Well, no, those are stocks. They didn’t have earnings.” And actually they did. It was a lot of great companies and not only that, continue to increase their earnings for the better part of five, 10 years, but the stocks were so expensive relative to the underlying business that we had a Tweet the other day.
It was a research affiliates article, and we’ll put it in the show notes listeners, and this is a quote said, “How many of the 10 most valuable tech stocks in the world at the peak of the .com bubble beat the market by the time the next bull market peak in 2007? None. How many were ahead at the end of 2022, fully 23 years after the .com bubble crested, and the answer is only one, which was Microsoft.” So it can go a really long period buying these super expensive companies over time and 23 years is I think a lot longer than… And many of these still exist and are fantastic businesses, they’re just expensive stocks.
John:
And remember, Microsoft wasn’t in the original FANG index, just kind of crept up in there in the last few years. And I remember being on the sell side on trading floor, and Microsoft was like a value stock and everyone was trying to buy it because why is this down so much? Hasn’t gone up. It was for 10 years, I think before Satya came, the CEO, he revitalized that company, but it was just left for dead for 10 years. So that’s the cycle from a quant standpoint. You go from a value stock to growth, then momentum and then could go back down. So single stocks a very, very difficult to time for sure.
Meb:
John, what is your most memorable investment over your career?
John:
Memorable, good or bad?
Meb:
It can be either. It can be just whatever’s burned into the frontal lobe or your brain could be painful, could be wonderful, could be meaningless in terms of profit,
John:
I’ll give you a few. So probably the worst was in 1998, ’97, I was in a mutual fund company and I was in a call center processing trades and basically-
Meb:
Sounds exciting.
John:
Yeah, mutual funds. Basically there was a tech 100 mutual fund, or maybe it was like 40 stock mutual fund. And my little brother graduated from the eighth grade and he wanted me to invest his money and I bought the tech mutual fund and then it went down 40% because the NASDAQ index fell 80%. So I made them whole, but that was a very difficult kind of experience. So that’s on the bad side. On the good side-
Meb:
Yeah, I mean losing money for your family. I think probably all of us in our twenties, I imagine my crypto buddies that are younger can relate to this, but I don’t know what the attraction is to try to wrangle our friends and family into terrible investments. I certainly went through that in the late 90’s bubble and probably even a few times since then. But there’s a certain lure, and the hard part is on the downside, as you mentioned, mixing money with family is always such a painful and volatile combination. And this is one of the reasons when we talk about, we keep saying we’re going to write a book on this topic, but so many ways that parents as well as schools teach children to invest is really problematic.
These stock picking contests or parents say, “Hey, I’m going to give you child a thousand bucks. Let’s go pick a stock and we’ll talk about it.” And as the stock goes up, it gives them a bonding thing, they’re excited, the child’s proud looking for parental recognition, and then it goes down or they lose money and there’s this real emotion of shame and embarrassment. They don’t want to talk about it. And there’s probably better ways to organize that sort of concept and make it educational where it’s not something that just kind of teaches the wrong lesson, AKA that Robinhood app.
John:
Maybe they should read the quantitative approach to asset allocation.
Meb:
Your brother learned from it. You made him whole, very generous older brother, by the way. All right, give me the other one.
John:
On the good side, and this is a specific company just bought WisdomTree stock in, I forgot what year, but it was around 2, $3, somewhere around there. And this was before HDJ, DXJ and then sort the stock up to twenties. Still a shareholder of it, but just this concept of the average stock doesn’t actually go up in perpetuity. Maybe a basket of US larger, higher quality stock over time like an ETF. But to see a stock go from four to 20, I thought I was the smartest guy in the room, but it really taught me that when you invest in single names, you got to time it, you got to size it, and you got to have two decisions.
Two smart decisions and correct, you got the entry and the exit, and I think the exit is the most difficult part of it. It’s kind of not easy, but it’s a little bit easier to identify a good stock. But then the exit point is really, really difficult. So thought I was the smartest guy in the room, and it was a lesson to me like, okay, I find that I personally make more money when I do strategic asset allocation as opposed to just individual names. Individual names are much tougher.
Meb:
John, this has been a whirlwind tour. We talked about a lot. Definitely have you back on as the world turns. I think you mentioned it one more time, best place to find you guys.
John:
Astoriaadvisors.com.
Meb:
Perfect. Thanks so much for joining us today.
John:
Thank you, Meb. It’s been a blast.
Meb:
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