 Welcome to Bogleheads On Investing episode number nine and this episode I'll be speaking with Dr. Wesley Ray CEO of Alpha Architect where he and his colleagues are breaking new ground and the author are three books on quantitative investing Hi everyone, my name is Rick Ferry and this is Bogleheads On Investing This episode is sponsored by the John C. Bogle Center for Financial Literacy a 501 C3 corporation today. We're speaking with Dr. Wesley Gray After serving in the United States Marine Corps, Dr. Gray earned an NBA and a PhD in Finance from the University of Chicago where he studied under Nobel Prize winner Eugene Fama He then took a job in academia before starting his investment management company where he is on the cutting edge of new insights into factor investing with no further ado, let's bring in Dr. Wesley Gray Welcome to the show. How are you today? I'm great Rick. Appreciate you bringing me on Are you very much impressed me the very first time? I I learned about you and I talked with you the stuff you're working on is Cutting edge. I really believe that you are the new Jedi out there in the quant world Before we get into what you're currently doing now. I want to start at the beginning Where did you go at your undergraduate degree? I went to undergrad at the University of Pennsylvania at the Wharton School So I kind of started off with you know the uber finance geek undergrad and my kind of my first way I parlayed my myself into academic research is I walked into this gentleman's office named Chris gatesy Who who now writes a lot of papers on the 200 year history of momentum or? Relative strength or value or what have you and I just said I love this stuff Can you teach me how to be a professor and you basically said hey see that shelf right there? Grab these 10 books and read them and come back in two weeks and let's talk That was my initial start into geeking out and getting into academic research and moving along my initial path Which was to be a finance professor, but there was also another side to you You had this idea that perhaps you could figure out ways of outperforming the market. Well, yeah kind of it Simultaneous to the sign. I want to be a finance professor. I was also trading my own money doing a lot of investing I was there from 19 2002 and so that was obviously during the internet bubble and so I had this exposure Where I'd come off, you know reading every book everything I could get my hands on related to Ben Graham and Warren Buffett and the value investment philosophy, you know pets comms going up a thousand percent a day you know my dad's telling me to go buy the Janice global tech fund and And Like I'm a I'm a value by nature person and I'm watching these markets They could they're crazy and I'm obviously trading in value names getting destroyed But then on the other side of my life I'm like, hey, I just you know actually like this and you know, I was like, hey I should I want to stay this forever So it was kind of a weird barbell in the sense that I was you know sitting there trading stocks And then on the other hand I was reading, you know stochastic calculus books Just trying to get baseline, you know essentially to be a research assistant for Gatesy And so what happened is I kept doing all the investment stuff kept doing my stockpicking and and you know I started essentially I became for the Wharton Finance Department the I guess I don't want to use the Computer monkey. I was like the data monkey. So if someone needed to have a something coded up in Matlab That was my job. So like I kind of kind of became like a little mini You know workhorse for the apartment, you know, so like fast for a couple years and you know saying all these guys are also By the way, Chicago PhDs because for where reason Chicago tends to feed, you know, the Wharton faculty and Chris Gates is like, hey, you're gonna apply to Chicago and that's it I was like, well aren't there other schools like should I consider other PhD programs like no, you got to go to Chicago. They're like, we'll get you in and I'm like, okay How does that work? They're like, hey take all your tests and do all your stuff and it will write your recommendations letters and then so sure enough, you know, I apply to your Chicago PhD program Just straight out of undergrad, which is also not normal because typically go get a master's or what have you but I had a lot of you know, kind of close-holds in the department that were writing letters for me and PhD programs they only accept, you know, a handful of people every year. So it's a much more Kind of one-off deal. It's not like applying to an MBA program Long story short, I got in I was like, wow, I guess I'm gonna actually do this Since you entered the program in 2002 The Chicago school at the time and it still is to a certain extent It's just we're gonna take you in and we're just gonna beat you up Like you are gonna get destroyed in problem sets, workload and let's just see if you survive And so, you know, first two years are just you know, literally I was studying like 15 hours a day Seven days a week just trying to stay above water because I came in obviously without having a lot of experience or Grad score would have you so it was actually say pretty difficult I made it and so after the first two years there I I don't say I was burned out, but I was 24 I'd been Slaven away doing corn academic geek stuff forever and I just thought hey I need to maybe take a break or do something else. So you you really did do something else I would say that what you did was quite radical and of course, I'm proud of you for it So what I did is I decided I was gonna join the Marine Corps, which you're an alumnus of and It certainly seems radical But what was super interesting at the time is I would say good 20 to 30 percent of the Chicago Financial PhD program were actually former military officers a lot of them from Israel or Finland and what have you so they were all like Oh, yeah, of course you should do that Whereas many people on outside are like you must be the first time anyone's ever done that But it was super interesting is inside the program like my other fellow PhD mates were like hey That's that's pretty cool. And so yeah I went down to Professor Fama and at the time Professor Thaler who which is crazy I had these two Nobel Prize winners were actually like at the you know it wasn't my dissertation but our my curriculum paper advisors and I just had to ask them permission to get a four-year sabbatical and Professor Fama was actually like super cool about it. He's just like oh, that's awesome like proud of you Yeah, happy to sign, you know didn't even think twice about it. And then your professor Thaler he was more curious He was definitely like you're gonna do what? But eventually I got both those gentlemen to sign off and then submit it to the PhD program coordinator and took a four-year sabbatical That's amazing that you could actually do that take four years off Well, you so you can't you can take technically one year off And so that's the reason I had to go and have them sign off on this special kind of extend sabbatical Because it was a unique circumstance where most people don't go on sabbatical to do service The PhD program director kind of agreed like hey This is unique circumstance as long as you get your you know advisors to sign off on it We're cool with it. And so I had to do a few extra hoops to jump through to actually make it happen Well, that's great. And then you went down to Quantico and went through officer candidate school Yep, so then I went to OCS, which is officer candidate school Then went to TBS the basic school and then my MMS was a ground intelligence officer You go through the image officer course You kind of do everything that the image officers do and then they go pick up their platoons Whereas ground intelligence officers then go down the damn neck and do another six months of Intelligence officer training and then you go hit the fleet So it's the longest pipeline besides, you know, Hilo and in fixed wing people But you know, it's about a year and a half almost two years of training pipeline and from there they shipped you off to Okinawa I Went right to Okinawa and then right when I was Okinawa. They sent me down To one of the islands in in Japan and you know did a bunch of like joint training missions with them It's been about a month there and then I got sent directly down to the Philippines and at the time This was I think was that 2004 2005 that we were there's a bunch of activity going on on this island called Hilo Which is a bunch of Muslim extremists and what have you but then there was this thing called the leite mudside disaster and a coup So I You know going crazy for a couple months there and then then right when I got back to Okinawa Which I was assigned there, but I rarely ever hung out there for like maybe a day or two The colonel calls me in office and he basically says hey you're you're going to Hawaii and I was like all right what? Why am I going to Hawaii like they're like oh you're on a mitt team a military Transition training team and you're going to get deployed to Iraq so that you know Then I went out to Hawaii did a big work up and then yeah Then we deployed out I was on one of the training teams where you embed with Iraqis and try to help them avoid Shooting themselves in the foot fact you wrote an entire book about your experience working with the Iraqis The name of the book was called embedded and it was a fascinating insight into what was going on Yeah, so I kind of went in To the service. I didn't join the service because I want to go to war per se I just you know I just wanted to do my time But I was certainly under the belief when you're probably a member but Colin Powell like showed that little Powder of that white powder and said hey, we're all gonna die kind of believe that I was like alright We need to do something here fast forward now. I'm actually deployed Living in an Iraqi battalion training up these Iraqi soldiers to you know, kind of take over their defense duties And I really got an opportunity to you know, actually live with these people eat with these people talk with these people and kind of get a better insight to the culture and kind of how they operate and That experience honestly just floored me and I took a whole 180 Right. I said I don't know what we're doing here This is crazy. Like I was not expecting this these people are tribal. They're totally different like we're trying to achieve here It does just not jive it all with their society I need to tell the story because there's probably a lot of guys like me that you know, rah, rah Let's go to war in you know, they don't realize it. So so that I just got inspired like I got to share the story So I had just read a whole book basically about my time being embedded with the you know Iraqis and just trying to explain like their cultural nuance and why what we were trying to do like, you know bring freedom and democracy to their society just seem like a You know, maybe it wasn't a great idea That's pretty much what that that book was about just share my experiences there, which were you know Highly enlightening to me and I just I wanted to make sure other people got to at least experience it through at least my book Even if they can't be there themselves. I Understand that you speak Arabic and that you taught yourself I Did so I mean I could probably Converse in it if I got warmed up, but yeah so I was the intelligence officer and The more I read beforehand because I knew we were going to war in these areas Like you know speaking Arabic air like the actual language there is it means a heck of a lot more because it's associated with the religion You know because it's you know from a lot so you know kind of a big deal So the more if you want to win in those sort of culture wars You got a really you know Established bonds with the people you're working with and so learning the language is I thought was a main effort So yeah, I just put a ton of time up front to train extremely hard You know both on learn how to kill people and everything but also how to learn this language And then when I got there I just forced myself to literally embed with the people and not use a turp And then you know if you sit there long enough and get tired of using hand signals and not understand each other You know eventually you can start maneuvering so yeah I got to a point where I actually serve as a turp for our team And we would go on a convoys and I would be the turp, you know to the interface between our team and their rackies Yes, I Definitely highly recommend if anyone you know has to do that mission ever again to spend way more time Learn the language and lot less on you know tactics per se because it gives you a lot more Let's say with what the Iraqis called was to like, you know kind of karma and the ability to interact with them And have them actually listen to you if you actually know their language That's fascinating. Well you did that. Did you stay for four years? Yep did my did the four-year active duty and then after that you went back to the University of Chicago Got out was like early 2008 and then I just my mind. Well, you know being in the service It's just obviously way different than being in a PhD program at University of Chicago. So just like got out Yeah, yeah, it's kind of like 180 and so literally for the first three months I just had to relearn everything because my curriculum paper had a bunch of math in it and honestly I couldn't even read my own paper. I was like, well, I don't even know what this person's talking about But it was me. So I just I just put the basics on like hey here I got to relearn calculus and all this stuff and it is true that it is like You know riding a bike where if you know how to do it if you just get you know back into it You do quickly learn so so yeah re-enter the program move back to Chicago and You know, I was in much more like in I was in discipline mode versus a lot of my You know comrades there at the PhD program who are students because I kind of come out with a new look on life So I was like I'm getting out of here in two years And you know because usually you don't get out of the PhD program in a collective four years usually It's five six years, but I just didn't want to surround so I spent three months relearn everything and then I immediately went to work on dissertation so Yeah, and that because I my goal was I need to get out of this place by 2010 or my wife She's not going to be happy living on a ramen noodle salary for for longer than that And who was your mentor on your dissertation? So I so I went back to my old curriculum Papervisors and it was Thaler and Fama were the top two and then another gentleman Andrea Frazzini who's also famous now, but he actually left and went to a qr So when I came back basically Frazzini had already gone to go be a you know millionaire over at a qr Failure gotten too famous. So he obviously was gonna mess with PhD students anymore So really who I was left with was Fama because he was the only link in the chain that hadn't been broken So so I since you went to him and and he was kind of like, you know my core, you know advisor and then Another gentleman Stavros Panagias He helped me a lot because I had a theory paper as well as part of my dissertation Pietro Virenasi Was another one so it's I had a handful of them But I'd say the most influential and obviously the one that had the most experience in empirical Asset pricing work was obviously Professor Fama So so he was kind of the the one that hazed me the most I would say in the Dissertation writing stage your paper if I'm not mistaken was about active management Yeah, so you know being a marine and probably a little hard headed I yeah, I came back and I'd always been like a standing before a stock picker specifically a big believer in value investing in value investing stock picking and so what I decided was I Want to highlight to Professor Fama that you know active stock picking can add value because this whole efficient market Paying seems a little too crazy to me. So you're gonna tell Eugene Fama the future Nobel laureate that he was wrong It's at least out. That was my going in and so what I did is like, well, how am I gonna highlight this? Well, it turns out that there's you know, this organization called value investors club where a bunch of Superfiscated stock pickers a lot of them associated with hedge funds They would submit huge theses on basically stock pitches, right? So, you know best buys under value Here's my DCF. Here's the hunter reasons why and so what I thought is like hey, I've been following this club since 2000 I'm a member of this club, you know, I think they add a lot of value. They seem to have really good ideas I'm gonna read every single one of these stock pitches Systemically intermitted database and do the quant analysis on it to then assess Hey, do these people actually add value or have quote-unquote alpha? Long story short, they do at the margin and so I submitted this you know as part of my dissertation and Somehow by the you know grace a god, you know Fama agreed with the Dallas's he had some quibbles on You know takeaways, but at least at the margin I highlighted that there is some segment of the market where you know active stock picking might work at the margin So that was a small victory for me How did you meet up with Jack Vogel who you ultimately became partners with at alpha architect sure So what happened is is when I graduated from the program there? I went on the academic professor market and They're also my wife was going on the academic market. She's a peachy in history Which is a way less I'd say marketable profession and being a finance professor So I went out to a market and my wife's from Philly and she needed a job as a history professor And I ran into Drexel who gave me what they call an exploding offer So they gave me this offer. I couldn't refuse they gave me three days to decide on it They say hey come to Philly your wife's from here We'll get her a job and we'll give you the best gig ever and we'll assign you a PhD student Who will do all your dirty work? So I was like, okay, well sign me up What are you gonna do? How often you got a twist my arm? And so I entered Drexel and then part of my package was having a dedicated Research assistant and that happened to be Jack Vogel. So just by Circumstance and a lot of great luck, you know, I I just had a gentleman who is you know, insanely smart Extremely well and extremely good at computer programming and doing all those data analysis and we just hit it off immediately So we've been working ever since you know, 2010 when I took that job the way I understood it was you know, Jack had read your dissertation and He said yeah, all this is great. These these people have Alpha they they're they're outperforming the market, but I can replicate that. Yeah using a computer So are they really outperforming the market? Can you tell me about that? Well? Yeah So so that was that was an insight that that that actually I had before I met Jack and kind of the takeaway from Well the interesting takeaway from the dissertation was we I catalog all this data on these individual stock pickers And it's sure enough. They had alpha you're relative to you know farm of French models What have you but essentially what they were doing for all intents and purposes was Small cap value investing in a certain element of concentration because there's only so many ideas That they would produce. It's not like you go buy 500 names at a time So so there'd usually be like five or six ideas a month sometimes 10 So on a rolling basis this portfolio would have anywhere from 50 to 100 stocks So but for essentially what they were doing from a quaint perspective is buying smaller stocks There were super cheap generally higher quality and doing it in somewhat concentrated fashion and Sure enough. You could also just have a computer Essentially do the same idea right concentrated small cheap quality and lo and behold It basically replicates what all these stock pickers were doing which it was certainly Well, it was kind of disheartening because at the time I was still kind of believing in stock picking because I was Stuck picker, but that kind of analysis there proved to me Why am I banging my head against the wall so hard to you know do these dissertations on these stocks? When you can essentially replicate a lot of the you know the core ideas with just use an algorithm And so that that was really kind of the the straw that broke the camel's back as they say they move me Much more heavy into just pure quaint and less into you know, I think I was gonna be Warren Buffett I think the the proof was in the numbers and Jack Bogle your research assistant was doing a dissertation similar to that So Jack's dissertation was a little bit different so what he looked at is there's a huge argument over whether Value investing which in defined in academic terms just means buying cheap stocks right on book to market or price stirrings Or what have you he was looking into argument Is this a risk-based phenomenon or is this a behavioral based phenomenon? Where just to explain the two ideas simply the risk-based Hypothesis essentially says that the reason cheap stocks earn higher returns Is because cheapness is a proxy for fundamental risk So the reason you're getting paid more on average is because these stocks are just fundamentally riskier the Behavioral argument which is on the other side of the coin is like no It's not because these stocks are riskier It's because the market generally throws the baby out with the bathwater and that's more related to a mispricing story That you know sentiment, you know throws these names out and beats them up too bad And so his dissertation was about how do we empirically? identify whether value is risk or mispricing and The short story is that it seems like if anything it's more likely mispricing Versus risk that explains the value premium, you know offices is highly debatable But that's what his dissertation was all about and after all of that you decided you were going to go out and create a company together Well kind of it actually all this happens simultaneously And it's one of the part of the crazier stories in in our industry So right when I actually got my job it actually was during the time I was on the professor markets At the time I was writing a blog and obviously my dissertation was out there I got cold call by a very large real estate family in New York and the son had been put in charge Of essentially managing it was around four billion dollars of like their liquid wealth and they were in the middle of just living through 2008 and they were big in hedge funds big in active management and they've got smoked and they're like we're firing Every one of these people we're gonna take control of our wealth. We're gonna do this in-house We're gonna do a quant we need someone to help us and he had just been out there googling around and some Sounded to me and he calls me up. He's like hey, could you help me imagine this four billion dollars? We were to use computers. I really like your dissertation. How do we do this? So went up there madam Again, this is all at the same time. I'm sitting here like thinking I'm going to be a professor It gives I wasn't a hundred percent sure if this would actually lead to anything But it initially kind of led to like a basic consulting gig where the gentleman said help me for a couple years If you guys do a great job, you know, we'll seed your business on asset management side because they just got out of the whole Asset management hedge from world and they're like we're never going to see it or do that ever again And then I was putting the ask on the table So but they said hey give me two years and so essentially I kind of helped them initially and then I got Jack Involved immediately because it kept scaling up bigger and bigger and then so after two years in 2012 they essentially seeded $20 million in in the quantitative value strategy, which we have a book about and then very quickly They they ramped it up to 50 and they put the other part in the international quantitative value and this was all going on Simultaneous to when I was being a professor as my day job. It just things kept happening in the background So it was very hectic Time in my life I would say and you're having children at the same time. Yeah, I was I was up to two and we were working on three and Yeah, it was getting crazy and then essentially what what happened is after I think it was around three years into it You're like this was clearly becoming a real business because we were your manager $50 million managed account We've got like a huge consulting contract. I'm also date You know moonlight now at this point basically as a finance professor and I just think and hey I need to go one way or the other here and so I've talked to my boss directs the head of the parliament I just told him I was like listen I I think I need to resign But I don't want to screw you over here You know because recruiting for professors is like a total nightmare like at least like a one-year cycle So he's like hey put in one more year So we can at least recruit for your position and then you can you know go out into the sunset So that's essentially what happened I after my third year being a prof for all intents and purposes. I was all in on the business, but I was still technically professing Until they could recruit for my position and then then you know basically kicked me out the door Another interesting thing along the way is through this whole time period It wasn't just there's large family office for whatever reason people like what we were putting out there We were just being super transparent about putting a research putting our ideas So a bunch of random rich people would call us up and say how do I do this and we'd say well We have a managed account. That's how you could do it and so we kept building the business up We would do tax laws harvesting to try to minimize tax impact because everyone we're dealing with was it was taxable money and Another thing happened along this way another couple hundred million gentlemen out in the Midwest we were working for them as well and he had a tax problem and It was one of these situations where he had a low basis stock That was going to get bought out by a large conglomerate for cash And he was very afraid that he was gonna have to incur like a huge capital gain event So he says go figure this out and you know This is like one of these impossible things or like hey go figure out how to not pay tax But you know if the rich guy says jump, you know, I say how high and so that's what I did I went on this mission how am I going to deal with this problem and Arranging to a Gallaudet at a bank and structured product And this is not something you could really do anymore but but it was all related to the ETF structure and I started learn about how the ETF structure essentially allows Assets to come in at mark-to-market basis the ETF can then Don't you know any asset out even if it has low basis on to a market maker with no tax liability And it's essentially kind of a laundry mat for capital gains liabilities and This you know a light went off on my head like holy cow If I'm doing strategies that involve trading and turning over in taxes or you know Essentially Uncle Sam's 50% performance fee, you know, this seems like a good idea. So long story short We now in around 2014 we decided we're going to get into this ETF business because we thought it was a better structure to deliver These you know concentrated factor portfolios then doing them an SMA with tax loss harvesting Just out of curiosity yet all that work you did on the ETF Mm-hmm structure of how it yeah, but the creation of the redemption how you can push out Any unrealized gains onto the authorized participants? You had that one client in the Midwest who had this big capital gain problem and then you had this ETF over here I've always wondered is there any kind of a structured product or can there be a structured product where you could take people who have These stocks out there and put them all together and bring it in and just issue them shares of an ETF And then take the stock then that they put in kind into the ETF and then give it to an author rights participant to get rid of And now the cost basis is in the ETF Yeah, it's diversified is is so that possible. Yes. Yes and no the long story short is in the old days Yes, but what happened is all the big banks got smoked out on a bunch of tax things a few years ago and they just cut off anything that could even be perceived as You know being on the edge because they didn't want to make Treasury angry So my understanding from the inside baseball of talking to people that the deal in this world is In the old days they would actually do stuff like that for for like super ultra high net worth clients and You know where they control like the the custody and clearing pipes, but my understanding is nowadays That doesn't go on, but I certainly feel like an Enterprising entrepreneur that had the time and energy to try to figure that out. It could be possible We've looked into it from like 50 different angles and have middle figured out, but yeah, there's certainly There's something there. I just haven't solved it. I believe there's something there, too I believe that you know this thing called direct indexing where you can yeah You buy 250 or 300 stocks and then you individually sell off the ones that that are at a loss and do a tax swap And at the end when that's all played out four or five years down the road when there is no really longer any ability to Do a lot of tax swapping. You've got this portfolio of 200 300 stocks that have a low cost basis, but that looks an awful lot like an index So yeah, if you could just take that and just turn that into an ETF provider and get shares of a more diversified ETF with a cost basis of the ETF is the cost basis of all your stocks and aggregate But it's a lot more easy to manage one security than 400. Yeah. Yeah, I agree 100% And and I get in fights all the time with people arguing over you do you do the ETF structure do you do the tax loss harvesting structures and You know, it's kind of I still believe there's a marginal benefit like even if you're doing pure passive Like say for example like the parametric solution like S&P with tax loss harvesting or just go by the vanguard fund I still believe that the vanguard fund is better Because a lot of people also forget into your point that eventually you get basis and everything But the index changes like firms get bought out for cash Guess what you can deal with that problem in an ETF structure You can't if you are so security right like if you have low basis and you know Joe Blow wants to buy the company out for cash. You're gonna eat tax liability. That's easy to cleanse in an ETF So I think and then there's the fee differential like those tax loss harvesting solutions are you know 2030 40 bits You know an S&P 500 ETF is basically zero So if you annuitize that cost differential over, you know, the life of the investment You know the lump sum of that's maybe two three percent of your wealth like does that make sense? Probably not You know, is that the value of the tax law shield you're gonna get I don't think so So I I think tax laws harvesting and direct indexing is total hype overblown versus just buying the passive index through an ETF structure for Zero that that seems like a better long-term solution to me, but yeah, I agree reasonable people can disagree Let's move on a little bit. So all of a sudden you decide you're gonna launch alpha architect and you open up Yeah, the world headquarters, which I've been to several times now Yeah, for sure. So the original world headquarters was in a little house. I had in New Jersey But that was five minutes from my mother-in-law. So both my wife and I agreed that hey we should probably move a little bit further away so we moved over here to the Pennsylvania side and I at the tide spent a year Doing a commute from Baltimore to Philly when I was first year as a professor there because we still had a place down there and And you know, I came out of service I'd swore off commuting because I actually wanted to hang out with my kids. I like exercising So I said, you know what I'm gonna set up a business in my house And if people don't like it like that's fine, but it's good for my mental physical health It's gonna make me operate more efficiently Why not and so we bought this place out in Pennsylvania. It's kind of a compound of sorts And now it's you know alpha architect global headquarters But yeah, since you we just built an office inside this residence, you know got it zoned and everything and You know we start off with obviously no aum Harley at all and you know now we're have almost a billion but You know it functionally achieves the goal we keep our costs down low and it keeps commuting time down So we're stuck with it So it's a bit awkward but in the in the world of you know, zero percent management fees You got to do weird things sometimes and understand some interesting artifacts went along with that house Yeah, so so we got this place from a big game hunter who was basically had a as a tragic situation He had pancreatic cancer and he was basically going to die in three months so it was kind of a liquidation opportunity of some sort both the house and our Friends we have he was a like I said a big game hunter So we acquired a grizzly bear a leopard and such other really cool taxidermy mounts And one of which we keep in the office the grizzly bear because we like to say that You know, we try to kill bear markets and we have evidence of it by having our grizzly bear here So we it's definitely a unique experience Visiting alpharctic headquarters It was for me because when I first time I went to visit you I'm driving down this residential street, and I'm saying this can't be it. Yeah, we've had many of Very very wealthy people and a lot of famous folks roll through here with that exact same expression In the world that this guy talked me into why am I hanging out in a residence in the suburbs of Philadelphia? Is this person crazy or what? So things have gone. Well, you've launched several ETFs and The way in which you do ETF and factor investing I find it to be kind of the right way of doing it's almost like the next generation of factor investing because it's so Deep and so concentrated that if you want to do factor investing that it seems to me You should be paying for as much exposure to these factors in a and a concentrated form as you can get So it appealed to me right away when I found out, you know, how you were doing it Yeah, so essentially the the genesis of this idea is When we're working for the family office, they were going to do the typical thing where they're like Let's go buy our cheap beta But then we need to figure out how to replicate a lot of these different exposures that we used to get from these hedge fund people and Hedge funds obviously aren't doing like cheap beta stuff. They're usually doing concentrated bets in you know with stock picking but what's essentially is factors like small value quality But they're doing it a much more focused way So we naturally thought well if we want to replicate these more unique exposures out there We need to replicate them how they need to be replicated That means we're going to do maybe factors But we're not going to hold 500 securities and focus so much on how how close this tracks the index We're going to do 50 stock portfolios and just tell people up front that this is not a closet index With a little tilt to like the value factor. This is pure Value where we're literally buying the cheapest, you know, 40 or 50 securities on you know Are you know a different metric we use enterprise multiples, but to keep it simple like PE ratio? So yeah, and that's just what we did and we just told people up front of the downside Which is of course the tracking error and the relative performance that this stuff can bounce around both good and bad You know over long time periods and you just be prepared for that. It's not the Vanguard fund And we just wanted to deliver it, you know, transparently affordably and be very upfront about the potential pain associated with this style of investing And I think that's all very interesting Let's say that you want to have a slice of your portfolio to additional risk factors And the reason yeah additional risk factors is because I actually interviewed Gene Fama one time and I said, you know, if beta beta is a factor. So what do you call these other things you call them? Smart beta do you call them? What do you call them and he's his answer was they are additional risk factors. So they are additional betas I said, okay. Yeah, so let's say you wanted to expose you to something other than beta I guess you could do it by going long short. Yeah, but that would be expensive. Yeah in many ways Yeah, so you're you going long only, but you're doing it very concentrated and you're keeping the cost down Yes, that's right. So you got it So so the concept to Professor Farmer's point in our our portfolios are Constructed in a way that is much more akin to how Kind of academics form portfolios and that's what all the evidence shows like look how great they are The idea is we're not going to go long short to your point because it's much more expensive to run operate and just access those exposures and so and so we're going to stick on the long side, but it's not going to be Broad market beta exposure. It's going to be some beta obviously because it's long only But we're going to focus as much as we can on capturing You know the value risk premia or the momentum risk premia and again It's very important for us to communicate this element that this is a risk premia And this is very different because frankly the biggest issue with doing Different risk is that they're different than what a lot of people see on the news channel like on that speed 500 And if they're not mentally prepared for that, you know They're oftentimes going to be in at the wrong time out at the wrong time and kind of ruin the whole Reason for holding additional risk for me, which is to help your long long-term Performance and to kind of diversify your way from just owning generic beta That you and I went back and forth on Twitter a little bit about what what does the word long term holding mean You know how long yeah, how long is long and I think I said a lifetime and you said no, it's only 20 years And I said okay, we'll compromise at 25 years But you know this idea of holding these factors for a long Long time is really critical to the success of an investor. Yeah, it's just the advice from Bogals is actually timeless and it applies everywhere like when he talks about holding, you know equity He doesn't suggest you should go buy the S&P 500 fun or VT or VTI and just you know trade it every year He's like no This is like basically your permanent holding because you want to capture The equity risk premia well same thing here We're trying to capture, you know some specific factor risk premia and the same advice applies You're not going to capture it by trying to time it day-trade it Around all over the place. You've got to hold the thing and actually earn the associated risk premia with it which means you need to look at it more as a long-term strategic holding and not as a You know kind of a short-term Trading vehicle because that's not what it's really designed for So let's get down to the nitty gritty then the bottom line on all this It's gonna cost me more money to go after those additional betas because they have to pay a fee every year That's higher than the basically beta is free now. Yeah, so anything other than beta, which is now free out there I'm gonna decide to add additional betas or additional factors to my portfolio Using yeah using your funds, but your funds are not free your funds have cost So number one I have to get over that hurdle rate of the cost. Yeah, and there's a thing out there called a where we talk about it as a alpha decay or a Premium decay that's going on is more and more people are doing what you're doing There yeah seems to be a decay going on as to the expected return from these additional factors can you yeah, can you see that have you measured it to Are are your funds going to produce? Because I have to take money out of beta to put it into the additional factors Yeah, literally It's long only so I'm taking a slice of my total market index fund and I'm gonna allocate it to your fund And I'm going to pay you a higher fee and yeah, I need to at least get beta Which I know I'm going to get in the market. Yeah, I got to get above and beyond that. Is it worth it? So Yes, that that there's a lot of questions in there and it's all about cost and benefits so in general when you look at Any of these sort of factors like the cheaper you can get them the better right and a lot of times The price is going to be associated with the scarcity of said factor if if something has massive insane Capacity well at the margin that's something that vanguard can deliver at scale an example of a factor like that might be Market beta right that's obviously something that has trillions of dollars of capacity You can jam tons of money into it not not infinite amount of money by the way But you know in general that would make sense But then there's other sort of Strategies where if you're actually going to do the actual factor like for example like what we do 40 stocks You know mid cap a lot of times small cap weight like you just can't jam a trillion dollars into that strategy right so there's going to be a natural limit on Capacity which means you can't just scale it to infinity which means the cost can't be free Because got to pay the fixed costs and the bills and operational things for running this damn thing, right? so so that's just kind of economics of General capturing any exposure that doesn't have infinite scale the second question relates to well. What do these premiums? Actually deliver so for example value Let's say and and you could do value investing just generic Let's just call it low PE investing you could do it one of two ways We'll just make up one way is you could go buy a portfolio of say 40 stocks that have low PE Another way is you could go and wait you could go take the SP 500 stocks and kind of tilt more weight towards the low PE less weight to the high PE But on net you're basically not really doing much. You're kind of tilting one way or the other so clearly The potential value add from the so-called value factor is gonna be a lot higher in the Concentrated one then in the diluted one So that's one element like how's the thing constructed? But then the other important element is is this premium gonna pay off in the first place because if let's just say value Just doesn't work at all Well, then if I have it in a concentrated format or have it in a diluted format It's not gonna do anything for me and that gets back to the question of well why does a factor pay off in the first place and Because it's an open secret and because a lot of people know about it and because a lot of people are Proceed to be doing it. Will that make it decay? Well, why that that's we got to step back and say why do these things get why did they pay off in? historical sense well value generally paid off because to Fama's point it's risk here So unless you were to believe that risk preferences have changed Then one would probably want to believe that exposure to the value factor Will probably pay off at some point in the future clearly it hasn't paid off very well in the last five or ten years But just like generic market beta doesn't pay off all the time, you know, it's had 10 20-year droughts as well There's a reason to believe from economic perspective that value will pay off Just because a lot of times it's fundamentally riskier and then the second point is that if someone is going to do Value and you believe even in the mispricing Component of value like they people throw the baby out the bathwater. There's this aspect of what they call career risk So just because everyone knows about something doesn't mean they may go and do it because if you go out and buy Concentrated portfolios of value stocks like right now It's very likely that you have a high probability of getting fired because these things can bounce all over the place You know, you're gonna get destroyed by the S&P 500 Sometimes and people think you're an idiot and you get booted out of the you know the job So this creates its own what we call career risk premium So to the extent that you know a lot of people are quote-unquote doing these things But these strategies earn premiums for a reason i.e. they're risky and they stink to do One would expect that over the long haul. They're probably gonna earn Some premium. I don't know what that will be You know historically like a concentrated value portfolio like like what we're doing, you know, maybe I don't know Maybe three to four percent over like a generic index which is going to be being sourced from being smaller being cheaper You know for the most part let's say that cuts in half to two percent right because at the margin it gets More efficient that so you may earn this two percent premium, but this is not like an arbitrage This means you're going to deal with probably more risk probably more ball Probably will definitely way more pain and anguish in a relative sense to like common benchmarks So you're probably going to earn this return But then the question is well, how much does it cost me to access this two percent premium? Well, if it costs me 200 bits that's probably a bad idea if it costs me, you know Zero that'd be a great idea right and then there's somewhere in between so what we do is like on our stuff We you know for the domestics we charge 49 basis points. So just under 50 bets, which is obviously Way more expensive than zero. I wouldn't call it outrageous But the idea is we're the bet on our stuff would be hey over the next 20 years Do I believe that the excess return associated with The factor exposures that I'm getting here are in excess of 49 basis points if not Then why would I do this? If so, okay, I might want to do this But then the second question would be well can someone else deliver it even cheaper because maybe vanguards got some Concentrated value factor fund for 30 bits right and the process is very similar. I like it Well, okay, I think I project. It's worth one percent, you know over a long haul or two percent It only cost me 30 bits here. I'll go do that one right so so it just it comes down to the trade-off between What do you expect this premium to pay off or the long haul? What do I got to pay for it and obviously you'd you want to pay less and earn more as best you can Which is what I argue a lot of these people that do factor investing are doing today They're not buying and holding, you know our funds for 20 years They're like day trading, you know, the ice shares factor funds that that's not that's not arbitraging Factor premiums. That's that's in the end Probably contributing to make them even higher in the future, but that's a Dating speed-dating factor funds rather than marrying one Yeah, yeah, exactly the only way you can pull premium out of the market is you need to have massive amounts of Permanent capital Sticking in something because it's kind of taking supply off the market But if all you've got is more day traders, you know throwing money around Sloshing around in factors, that's not arbitraging away the factor That's just money sloshing around and it's adding volatility to the factor But unless that money is like all mini warren buffets, you know holding for 20 years through thick and thin It's not going to depress the risk premium associated with them or it'd be very unlikely to do so And I frankly don't see that sort of mentality Amongst factor investors in the in the marketplace Nor do I see that as an incentive for product manufacturers because they're they're in the business of Activity so the more I can get you to like day trade on do this than the other thing That's that's good for the business out there So I think people have an incentive to promote activity in factors And you've written a lot about this you've got three books out there numerous papers The books are quantitative value quantitative Momentum and then DIY do-it-yourself financial advisor Did I read the book and Thought it's easy is I think you make it out to be in that book How you can do all of this as a do-it-yourself investor, but Well, yeah, I Would say it's just like on Bogo head you can go review to start here Here's how it's done, and yeah, you can read it and there's the cookbook But at the right price sometimes people will still be like, you know what thanks I really appreciate the transparency understand what you're gonna do But I have better uses for my time and rather pay you to do this for me So but there are people that definitely are DIY, but there's certainly a lot of people You know like my grandma for example, where she's probably she's probably not Well-suited to DIY even if she read the book and thought it was cool because her grandson wrote it Oh, it's a bit of a misnomer on the title We're coming up on the end of our time. I'd just like to switch gears here for one last second Could you talk about your March for the Fallen and what that's all about? Yeah, so March for the Fallen is a 28-mile March held at the Pennsylvania National Guard training unit and the the idea here is You're out there representing Full on behalf of those who lost loved ones in the military So we're supporting Gold Star families and people who have lost people in war It's not a charity in the sense that you give money It's a charity in the sense that people that have lost their loved ones Like to know that other people are remembering and honoring the Fallen So that's what you do you're out there in your charities kind of your blood sweat and tears to represent and You know let them know that that we still appreciate You know sacrifices they gave as a family and so you go out there and hang out and it's a great cause And you meet a lot of great people and I really enjoy, you know Promoting it and trying to encourage as many folks as possible to come out And if somebody was interested in joining your group you you've got a pretty large group that you've put together Yep, so you got so last year we had around a hundred and fifty This year I imagine we'll have probably 200 plus All you got to do if you want to be on notifications I'll just reach out direct or just you go to alpharquetech.com Slash MFTF there's a whole website about training plans nutrition How to sign up and all these sort of other things and all you got to do is just show up We take care of lodging and chow and I think it's like 35 bucks. You got to pay to the National Guard So it's very low-cost Superficient great cause you meet a bunch of great people and I think everyone should at least do it one time in their life Thank you, Wes. It's been a great conversation. I really appreciate you joining us here on bogelaheads on investing You got it's been an honor and keep doing what you guys do over bogelheads I love the education and and and love the effort for DIY investors out there This concludes the ninth episode of bogelheads on investing. I'm your host Rick Ferry Join us each month to hear a new special guest in the meantime Visit bogelheads.org and the bogelheads wiki Participate in the forum and help others find the forum. Thanks for listening