Quality and Low Volatility: The Factors That Get No Respect

[00:00:00] Welcome to Two Quants and a Financial Planner, where we bridge the Worlds of Investing and Financial Planning to help investors achieve the long-term goals.

[00:00:05] Join that Ziggler, Jack Forehand and me, Justin Carbonneau as we cover wide range of investing and planning topics that impact all of us and discuss how we can apply them in the real world to achieve the best outcomes in our financial life.

[00:00:15] So the two factors we're talking about today are very interesting to me because on one hand, like they don't get as much love in the academic community as the main factors.

[00:00:23] So value and momentum definitely in the academic community and the practitioner community like I am, they're at the top.

[00:00:28] And these other factors are lower, but they also like investors like them a lot more in many ways than the other factors.

[00:00:35] Because they tend to be lower in volatility, they tend to be to relate to what people want to do which is like grind buying great businesses.

[00:00:42] So it's interesting like that dichotomy between, and we're going to talk about quality and low volatility today,

[00:00:46] but it's interesting that dichotomy between like the way that people look at them in the academic community and the way that investors look at them in the real world.

[00:00:54] I'm fascinated by this topic, possibly as a highly volatile individual obviously.

[00:01:00] Am I talking to you on this and you're the high volatility in the podcast?

[00:01:03] Yeah, yeah, yeah.

[00:01:05] I'm high-vol high beta, you're pure alpha jack, you're pure alpha.

[00:01:09] Hopefully we're both solidity though.

[00:01:11] I like to think, you know, excess return is a quality endeavor.

[00:01:14] I think so.

[00:01:17] What I want to, I want to just talk about this for a second because I don't know where we're talking about quality.

[00:01:22] We're talking about the quality factor and how it works in security selection portfolio construction all sorts of fun things like that.

[00:01:29] But I think it's actually really interesting because quality is one of those terms that it sits there over to the side of quantitative.

[00:01:37] It sits there over the side of these other things.

[00:01:39] It kind of feels like ESG and GMOs and it's like the organic food of the investment industry or it's like, well, what really doesn't mean?

[00:01:51] As soon as you start, it's like, well, do I eat anything that's inorganic?

[00:01:56] Like, whatever buy something that is not quality at all and why he started to raise these questions.

[00:02:01] So I looked into the etymology the word very familiar with the etymology of quality jack.

[00:02:06] I know you're not going to stuff all the time.

[00:02:09] So the Latin QUI key, that's basically who and then quality type quality says who of what kind?

[00:02:17] So the modern definition is the standard of something as measured against other things of a similar kind,

[00:02:22] the degree of excellence of something or as the poet philosopher to LeBcwalee once explained his name is in the middle of equality.

[00:02:29] I think equality is actually useful here because that's the quality of state of two things being equal or the same.

[00:02:35] Which sets up inequality or quality as we're defining it as a way to explain a difference relative but in the in a different direction, in the direction or the orientation of excellence.

[00:02:48] So what we're talking about all these things we're actually saying who or what in the orientation of excellence, that's kind of the scale that we're measuring things on.

[00:02:59] Understanding the any time we say quality, we then also have to define the scale is kind of incredibly useful because it allows us to take all these various academic explanations, definitions and otherwise and start to go great quality.

[00:03:13] But now on what scale of excellence actually really helped me in understanding this literature better.

[00:03:18] Yeah, the scale's important in investing too because if you think about it like a lot of value portfolios will use quality but what you're getting there if you start with value and then you add quality.

[00:03:28] Like if you think about the overall scale of quality, you're not getting the highest quality companies in the world because once you put the value on there those companies aren't going to be cheap.

[00:03:36] So it's important to think about it too like from that perspective when you're an investor.

[00:03:41] You can invest in just the highest quality companies and you can not care about the valuation of them or you can buy trying to buy cheap companies basically the Warren Buffet approach.

[00:03:49] You know, trying to buy high quality companies cheaply in which case you're not going to get as much quality but you're going to get some quality relative to the cheapest bucket which is just a pure value stuff.

[00:03:58] Yeah, so remembering that there's always a ruler present whenever somebody tries out the word quality we have to ask what's the ruler because the ruler is kind of setting the parameters for how we're defining it.

[00:04:09] Because to your point if you put value first, you might slice off a bunch of the highest quality stuff and likewise it will talk about this. You could put the crappiest of crap but you could take the crappiest of crap ruler and say what's the highest quality of the crappiest of crap.

[00:04:24] Yeah, and it's interesting because the top of the ruler is not necessarily always the best.

[00:04:28] And in terms of the quality factor, it is and we'll talk about that later. Like the top desol of quality outperforms as you work your way down but if you start with value and you add quality you may end up with a better portfolio even though you're further down the quality ruler because you're adding something else that also adds value to your portfolio along with the quality.

[00:04:46] Yeah, it's a fascinating tool. It's fascinating framework for understanding things and this is I'll just put this up front.

[00:04:54] This is one of those things where understanding the lowest of low quality, the crappiest of crap. Many times this works is a really great exclusionary street and helps you take stuff for your like I just don't even want to fuss with this thing that either I can understand has a bunch of red flags in it or whatever else and allows you to kind of filter stuff out almost more valueably than what you keep in.

[00:05:18] Yeah, so let's go to the definition and this is interesting because this is kind of a unit when you see it factor to some degree.

[00:05:24] Like if you think about a high quality company like a lot of the things you think about is probably as we work our way down to the academic definition is probably what you're going to see but

[00:05:32] If I was just running my own business down the street like what would I want to see I'd want the business probably to be profitable.

[00:05:37] I'd probably want as low as less the least variability I could have in my results if my earnings were pretty consistent that would be better than if they're all over the place.

[00:05:46] I'd probably want to have a decent balance sheet, you know, I'd want to have some cash on there and want to have not too much debt.

[00:05:51] And if you think about as we carry down to the definition of quality, I mean that's what this is.

[00:05:55] This is trying to find companies that have those types of characteristics and as we work in the quality factor we're just doing it quantitatively to try to identify those things.

[00:06:03] This quantitative definition and again back like this ruler idea is I think of it a lot like it's a lot like like like food.

[00:06:12] You have junk food on one extreme and then you have really healthy food on the other extreme and you can start to kind of understand where it's just like all right I get why the potato chip is not as a value or relevant to me in nutritional value as I don't know the piece of broccoli or whatever.

[00:06:29] And there's there's sweet spots in how you balance this stuff and put it together in a portfolio where we can talk about the things one off as what the potato chip is or what the piece of broccoli is.

[00:06:38] But then we can also talk about what is a balanced diet looks like this language as much as it's I know what I see it is also really useful in examining the little pieces and in the construct of the whole.

[00:06:50] Yeah, so let's I just want to read the akr definition quick because I think it's good so a qr has a great paper on quality you can find on their website by cliff asnist and some other people there but.

[00:07:00] Their definition of quality was akr capital management is to find the factor qmj quality minus junk and it's a border remember with factors it's always long the best short the worst so that's what quality minus junk is you know junk is the worst companies.

[00:07:11] To be companies with the following traits lower in his volatility high margins high asset turnover indicating efficient use of assets low financial leverage low operating leverage indicating a strong balance sheet and low macro economic risk.

[00:07:22] And low stock specific risk volatility is unexplained by macro economic activity so so Matt give me this business like I love this business so I want the business that all these things you're describing the you know the access returns you to channel I think to the.

[00:07:36] You know the business behind the podcast is all those things.

[00:07:39] Hey, low financial.

[00:07:41] Actually, we will get that part of it.

[00:07:47] Well, but it's it's again like understanding as quality minus junk and if you think about it, it's also useful you have to play the ruler out over time.

[00:07:54] That's kind of this idea of being if I can repeatedly be short the worst and long the best.

[00:08:01] Back to diet terms this explains why if all you if you go full super size means you just eat McDonald's or if you only the potato chips and you never eat the broccoli you're going to run into a different type of health problem than if you only eat the broccoli and if you always avoid the McDonald's and the potato chips so.

[00:08:20] It's intuitive, but it's really important to I think see it framed up in that way as a QR did.

[00:08:25] Another thing to keep in mind here is that the these are not always the same companies over time like what is a quality company today may not be a quality company three years from now there's certainly some consistency and there's some companies that have just been quality companies for a really, really long time.

[00:08:37] But there's others that move in and out and so it's you know I think people when they have a picture of a quality company think about this idea of consistency and there is consistency in their metrics when they are a high quality company.

[00:08:47] But just because you're high quality company now doesn't mean you'll be a high quality company forever.

[00:08:51] Yeah, this is a snapshot in time every point along the way to snapshot on all those metrics on lower earnings volatility on high margins on high asset turnover.

[00:09:00] All those things like low earnings volatility can very quickly you run into a pandemic and things happen in interest rate environment shifts and things happen.

[00:09:09] But these are not static reports. These are all dynamic reports and therefore feed into how a company is is viewed over over any time period.

[00:09:21] So no, another thing you'll see sometimes in the places like AQR and us typically don't use this but you will see dividend growth use sometimes as a quality metric or consistency of dividends over time or something like that.

[00:09:32] I don't think it's the greatest factor and sometimes it can be a problem actually from a quality standpoint because a lot of times companies that get on these lists of like the consistent dividend payers for like 25 years will basically do anything to not stop.

[00:09:44] You know to keep paying the dividend and like in some sort of financial crisis they'll be like laying off their employees to pay the dividend or whatever so it could be a little bit dangerous.

[00:09:52] But you will see this you will see dividends used by some people too as a measure of quality.

[00:09:57] Yeah, and that's where and there's a bunch of people the bunch of great work on this dividend growth alone is a dangerous indicator because or even dividends stability alone.

[00:10:09] Because if you're not also incorporating the balance sheet against that cash flow statement one of the things we saw a lot of was in some of the oil companies and I'm specifically thinking of a certain overseas oil company where they just kept borrowing more and more money.

[00:10:22] So it'll low interest rate world is like well just keep supporting the dividend and raising it but they just kept on taking on more and more and more and more and more debt.

[00:10:29] And all of a sudden you start to have the question of well if the interest rates change and we have to roll over this 10.

[00:10:35] How are we going to cover the interest service and sustain the dividend?

[00:10:38] And we've seen that play out in telecoms and another a number of other places too.

[00:10:42] So back to that point you made earlier of these are just a snapshot of one point in time.

[00:10:48] You got to keep taking pictures and make a movie out of this fully understand it and avoid those single variables that can be really dangerous.

[00:10:56] So just one of the couple of things we should mention before we move on to the next thing is we should mention Joseph Pietroski's work and by the way I believe it is Joseph Pietroski and I missed pronounced it as piotroski for like 20 years.

[00:11:06] So someone here before we're on but I believe it is piotroski.

[00:11:09] So it should have been pronounced again off of the 20 years that I was missed pronouncing it as podcast so I apologize if Joseph listens which I doubt he does.

[00:11:16] I will apologize to him for my mispronunciation of his name.

[00:11:19] But anyway he did he did this work around F score which is a paper that's definitely 20 years old plus and it was an interesting paper because one of the problems with value investing is you get these crappy companies you get these value traps.

[00:11:30] And so he did a lot of research around what could be the criteria I could use to try to limit these value traps and he came up with this F score which is a bunch of different things.

[00:11:40] I'll read him.

[00:11:40] Return on assets change in return on assets cash flow from operations cash compared to net income change in long term debt assets change in current ratio change in shares outstanding changing gross margin and change in asset turnover.

[00:11:51] So he's he's looking at a lot of changes he's he's basically saying are things getting better for this company.

[00:11:56] And can I limit some of these value traps in the value universe by using what is a quality metric. I mean that's effectively what F score is it's a different thing but it's a metric of quality.

[00:12:05] The tries to eliminate these value traps from a value for failure.

[00:12:09] It's also really interesting in talking to people like Jim Oshanasi or Mike Green or anybody who helped.

[00:12:16] Take the the old company stat data and basically in the 90s and with the advent of computing start to like turn these metrics into things that you could actually use for markets for folios.

[00:12:27] And it starts off with a lot of these things where you're just trying to understand if I were to take.

[00:12:32] Avoid the value trap in particular if I'm trying to do a leverage buy out or if I'm going to step in and take a public company private or absorb it into another public company or something else when you're.

[00:12:44] Think about it if I'm buying a company out in full if I'm going full old school buff it on this thing.

[00:12:51] These are the types of things I really want to be aware of because it might look like a great value it might look like a great deal, but it's got all these red flags and the Piotrowski scores.

[00:13:01] Altman's the some of these other stuff that come into just ways we can cut off that left tail of the junkiest of junk.

[00:13:08] That can be really really valuable to just make sure those red flags get raised where it gets problematic is as you play that stuff forward and people start to treat it as an arbitrage and go like oh I have something trading at 10 times cash flow and something trading at two times cash flow and all I have to do is short the 10 times and get along the two times I close this gap for free and that's not really an arbitrage and that's kind of the bastardization of this problem.

[00:13:30] But understanding this at least in concept of ways to raise these flags and then how you apply it to not just your portfolio and your security selection approach, but like what's the end result you're trying to get out of this stuff.

[00:13:44] I raise this because for some of these they're really interesting academic details, but if you're not taking the company private or if you're not trying to understand in portfolio construction the pairing of these things.

[00:13:57] They're not always as useful as they are interesting.

[00:14:00] The other thing I was just saying before we move on for Piatrosky is a lot of times with academic research, you know you could look at papers as a whole or you can also take a component of the paper and you can really use it in a different way.

[00:14:10] So one of the problems with you know if you run a screen and we do want to run one of the Lydia based on Piatrosky and you look at it over the past whatever 1020 whatever period you want to look at it's a catastrophe.

[00:14:20] It's obviously a deep value for a portfolio it's been a period where deep value is not worked at all.

[00:14:25] But what's interesting about that is that doesn't necessarily mean there's not value, I mean again first them they come completely back and we may see a huge run in those types of stocks but one of the things we found is if you carve out the F score part of it because what he did in his paper is he used for his valuation metric with all the academics used for the valuation metric which is price to book.

[00:14:42] So he looked at the cheapest price to book stocks and then applied this F score.

[00:14:46] Well if you look at the cheapest value if you look at the cheapest stock using a value composite and you apply the F score you end up with a very different outcome.

[00:14:54] And so that that's a way this F score may still very well be a quality, a good quality metric to use but you have to sort of switch ship the value part of it to get you know as much value out of it because a lot of us in the in the world them and are not big believers in the price to book it especially not is the one metric you're using.

[00:15:10] If we're using it we're using it and you know together with a bunch of other metrics so that's an example of the F score may still be valuable even though if you combine it with price to book you know your results in the past 10 20 years have been really bad and with any value strategy or results haven't been great in the past 10 20 years.

[00:15:25] But it's just an interesting thing to think you can sometimes take something like this and use it in a different way.

[00:15:30] It's part of why I was really excited when I read the etymology because that who of what kind this idea of saying like who and then how are we defining it how are we using it what's the ruler and what's the parameter what's the parameter of the rulers.

[00:15:43] It actually makes all the difference in something like this because something that worked 20 odd years ago in an academic regression a little bit of updating and tweaking for the way the world thinks about itself today can go a long way and saying oh those is actual merit here.

[00:15:59] I love that story.

[00:16:01] Let's move to low volatility low volatility is actually this will be a short one it's an easy thing to define and it obviously stocks that exhibit low levels of volatility.

[00:16:08] You'll see two standard metrics use a lot standard deviation which is just the volatility of the stock on its own.

[00:16:14] Beta was used things about it more in the context of the portfolio how it's related to other stocks and the market as a whole.

[00:16:20] So those are the two things you'll see and you'll see some people use one you'll see some people use the other you'll see some people which we do on our factor of one of the Lydia use a composite of both of them.

[00:16:29] But but the idea is I'm trying to get stocks that are less volatile than the market and we'll talk about why in a minute,

[00:16:34] but the great thing about low volatility stocks is you would expect if if theory is correct you would expect if I'm buying the stocks that are least volatile I should get a lower return because I'm taking lower risk.

[00:16:45] But that's not the way it works in the real world in the real world the cheapest though the lowest volatility stocks the bottom desk out.

[00:16:52] Give you something in the range of a similar return to the market with significantly less volatility than the market.

[00:16:57] So you are getting kind of a free lunch with these types of stocks and the stocks and the highest volatility bucket or a catastrophe on their way more volatile in the market they don't have better returns.

[00:17:07] You know this whole thing we saw in the beginning, you know this idea of like if you measure risk in this way that your you're just going to get better returns as the risk goes up is just been invalid it's not true it's not the way things work in the real world.

[00:17:18] It's a statistics puzzle it's a way to look at it just from the math side of it and that also makes it really interesting because it's if I'm really narrowing in on which specific rulers I'm going to use in a specific instance this is.

[00:17:32] You're just controlling for variants like that's what you're doing here you're picking which things and then you're going what's the variance around on this and give me the least amount of variance on this which hey it can make it can make a.

[00:17:43] A world of difference when you're rolling that snowball over and over and over and over again and you have a good consistent snow that's going to pack well you know what you don't want to do is have that one little tiny flaky snowball and.

[00:17:56] You know, it'd be chasing it down the middle of the road where they've already plowed and picking up salt in the bunch of other things high voss no ball rolling not not a good activity not a good idea for yeah I've tried.

[00:18:07] But going back to the academy thing I talked about at the beginning low balls interesting from that perspective because on one hand like investors it's like momentum to some degree investors don't understand why it works like if I'm buying stocks that are less involved in the market why should I get a better return it and even though professionals in the academics have.

[00:18:22] Some trouble explaining why low volatility works but investors love it in their portfolios like you you build a low valve portfolio, you know it's if you're getting the similar return with less volatility that's fantastic to experience on a regular basis so.

[00:18:35] In a lot of ways don't really care why it works is but if it is working you know that's great now that the one downside is like any factor it has its periods were it's out of favor and so just because it's less volatile in the market doesn't mean it doesn't diverge from the market a lot.

[00:18:48] So it doesn't mean you can have a period where certain other type of stock is really running in the market and you're underperforming a lot and your low volatility portfolio even though you miss maybe having less volatility in the market so.

[00:18:58] That second risk Jim O'Shawn is the always talks about which is the risk of underperformance that can be a big risk with this like all the other factors but it is better on the pure volatility from a pure volatility standpoint.

[00:19:08] My mind always goes to this expression that there's a difference between what the statistics say and what the statisticians do.

[00:19:16] And you kind of remember that in the case like this you got to be able to peel up peel apart the data and just go like okay the statistics actually say this.

[00:19:24] But now if we actually want to go implement on this if we want to actually do something about it let's try it's the you know.

[00:19:32] Cancer doctor enjoying a cigarette out behind the hospital people hear all these things.

[00:19:36] So let's just was brief we touched on the S. some of the academic research here and I think the first thing we should talk about is I love talking about Larry Swedjo and Andy Berkins criteria for what makes a good factor in applying this and these do apply it all you know that.

[00:19:48] These two factors both pass all these tests but the criteria is the factor should be persistent which means it should work over time.

[00:19:54] We're not going to use it because it's worked in the past five years or something like that.

[00:19:57] You know we should have a very long period of data that tells us this thing works it should be pervasive it should work assuming it applies across asset classes it should work across asset classes shouldn't just work in stocks like momentum's a good example of this momentum's improved across a bunch of different asset classes it doesn't just work in one.

[00:20:12] It should be robust so if you define it in different ways it still works so quality of quality only worked when it was like the variability of earnings but it didn't work with profitability or some of the other things like.

[00:20:24] Then then it's not as good of a factor you want to have a broad way to define it and it should hold up using different definitions and then intuitive which may or may not be true.

[00:20:31] Any more but the idea at the beginning was if these things should make there should be some logical reason it should make sense and you know we had Alejandro Loposliera and Andrew Chen on the podcast who are.

[00:20:40] Challenging that idea that maybe a lot of these factors that don't make sense or as good if not better than some of the ones that do and that's something more research in the future and because they have really strong evidence to support what they're doing.

[00:20:50] But in general if you go back to the original factor framework the idea that a factor should be intuitive is one that's always in there you feel better if there's some economic reason or some reason why this thing should work.

[00:21:00] And at least in the sense of quality again the directional orientation towards excellence compared to something else the who and then what ruler it's.

[00:21:11] The purely intuitive I know it when I see it thing that you talked about at the beginning is is that's there.

[00:21:17] It's going to be.

[00:21:19] Persistent is going to be pervasive and it's going to be robust because if all you do is just make sure something is a steady compounder over time where I'm reducing that downside of doing something that doesn't actually meet the purpose and potentially works against you.

[00:21:34] If you can persistently roll that snowball then it will pervasively grow and it's probably robust to tend different definitions to do it.

[00:21:42] That's intuitive enough to get this this general concept across.

[00:21:46] Did you work all the peas in the one sentence I think you might have not I definitely did I definitely did thank you Larry Swatter.

[00:21:53] That's very impressive.

[00:21:55] So let's talk a little bit about why these things work because they shouldn't in theory you know if we've talked a lot on the podcast about the reasons of factor works you've got your risk based explanation you've got your behavior.

[00:22:04] So let's start with the first one your risk based explanation you try to explain low volatility or quality like I could sit here all day you're going to have a hard time given that you can explain anything you may be able to do it.

[00:22:15] But you probably be digging pretty deep to figure it out I mean these are not low volatility by definition the stocks are less risky to the market and quality and who's going to argue like the highest quality companies with great balance sheet and consistent earnings and high profitability that those companies are going to somehow be riskier than the market it's it's very, very hard to do so most people do not buy into the risk based explanation.

[00:22:34] With this whereas like something like value we do think that's a that's a big part of it with with these two we don't so then how do we explain them?

[00:22:41] We've got to explain them with the behavior of explanation. So some sort of misprasing is going on that allow that we can take advantage of as an investor and profit over the long term. So how do we do that?

[00:22:52] There's a lot of different ones I won't go through all of them, but so for instance with low volatility there's this idea that a lot of investors don't have access to leverage and so if they want to juice up their portfolios they'll chase like the highest volatility stocks.

[00:23:03] And they'll over price those stocks and therefore by buying low volatility boring stocks I've got an opportunity to make a profit.

[00:23:11] The same idea like investors seek a lot of stocks sometimes and over price those so that could be part of it over confidence could be part of it.

[00:23:20] With quality you could be like investors focused too much in the short term sometimes so that they focus on these companies that are doing great things or whatever in the short term and they under price what long term quality means.

[00:23:29] So that this whole consistent is grinding up they under price that over time. So there's a lot of explanations for it, but they're not as strong as value momentum like when we were doing when I was doing this in the the value momentum podcast we did like I felt pretty strong about what I was saying like this is a really good strong explanation.

[00:23:44] There are a little weaker here and there's a little more disagreement about them.

[00:23:48] Do you feel like with quality in particular quality teams like one of those things that I know the statisticians would argue that it's predictable.

[00:23:59] But it's one of those things that this truly feels like it works the best over over long over like over time. It's like it's really easy to look back and go like oh there's quality working and it's really hard to say like McDonald's or whatever has this figured out forever and it's going to keep following these footsteps.

[00:24:19] Yeah, that's right. It's a slow grind up over time and you know one of the other interesting things about quality is the reason people think it works is not why it works.

[00:24:26] You know people think it works because I'm buying these great quality businesses and if you buy these great but quality businesses over time you're going to do well.

[00:24:33] The problem with that argument is the market knows that they're a great quality businesses. And so you've got to have if you're dealing at least in the academic world.

[00:24:39] You've got to have some reason the market would mispray these things not to it's great that they're great businesses, but the reality is a lot of great businesses are over price sometimes.

[00:24:48] So like in the academic world we think about it very differently than we think about it the way a person would think about it because you were eyes are buying apple or something we're thinking, wow that's a great quality business that's going to do really well over time.

[00:24:58] But the question I'd ask myself is why is the market not pricing that future growth properly or that quality properly and that's where the academic definition kind of differs from the way your average person would look at it.

[00:25:09] It's kind of like value investors inventing garp right say I won growth but I wanted at a reasonable price.

[00:25:15] Oh you mean value investing no I mean growth but at a reasonable price as opposed to an unreasonable price and yeah it's worth salad in the end.

[00:25:24] So one of the things I want to mention with both these factors because I mentioned at the beginning they're not considered like the A level factors.

[00:25:30] I'm going to forget I think it might have been broken in sweaters book where they kind of classify the factors based on where they are, but like value momentum are really considered your like A level factors.

[00:25:39] And these are for most people are considered compliments so like most of the guys I know building factor portfolios are using value momentum at a higher level than they're using these.

[00:25:48] These are these are comp they're certainly using these but they're complements to that.

[00:25:52] And that's that's the important point to make here is these are great secondary factors they're great when they work with other factors.

[00:25:58] So yes it's true that low volatility you know gives you a similar return at lower volatility over time, but what's also true about it is if you couple it with value.

[00:26:06] If you couple it with momentum you've got to even better portfolio and Tim Bond leads.

[00:26:10] Stunt a lot of work around this like the strategy we run on Valeria based on Tim Bond uses this low volatility along with other factors and you'll see a lot of people too that are kind of the buff it type people with value which is I want a cheap portfolio but I want some degree of quality and.

[00:26:25] And that works in a lot of different ways like some people are like our friend West Gray with Q Valera quantitative value fund they start with the value they add the quality.

[00:26:34] You know they see they don't want to just buy the cheapest stocks that they're seeing an improvement in what they're doing by adding quality.

[00:26:40] Then you've got the buffet type people that might say I'm going to start with the quality and I'm going to add the value I want the great businesses I want them cheap.

[00:26:47] You can do it in different orders, you know I would argue the value approach first is probably the better approach just because value I think is a better factor than quality over time and I'd rather have that be a bigger impact in my portfolio but.

[00:26:56] You see this in almost all it I don't see you do see it's an ETF you see no quality filters but most of the stuff you see out there these days that's like a quality ETF has.

[00:27:06] Some degree of you know, or sorry that's a value ETF has some degree of quality implemented in it.

[00:27:12] So these factors were really really well with other factors and that's how you'll see them use in the real world a lot.

[00:27:18] It's interesting to because there's that there's almost a reputational component for at least for professional money management of understanding quality whether or not you're formally screening for dinner.

[00:27:29] Because this is also one of those things where you're less likely to be touching the live wire or like doing something that feels irresponsible if you have something in there that's doing it less likely to have a fraud less likely to have something that's just like.

[00:27:45] I don't know what whatever deserves to get thrown out with the bath water itself.

[00:27:50] Quality is like the ultimate wingman in this scenario where you're like yeah of course, of course they're here with me because if you're out there doing this like solo with total ignorance of this and you miss some of this stuff.

[00:28:02] You can see how you could look really bad really fast especially if you're an active manager of some form.

[00:28:07] So you have there's two other benefits to these which is the perception benefit and the behavioral benefit.

[00:28:13] So the perception benefit is kind of what we've been talking about which is if almost value manager and I'm building a portfolio of value stocks like I'm that have a lot of stuff my investors looking at there are like these companies look horrific.

[00:28:23] Like these things are just purely awful.

[00:28:25] You add quality to that from a perception standpoint people are happier with the portfolio they see and it's interesting I don't know if you listen to this yet, but Gavin Baker was on Patrick O'Shawnisys podcast.

[00:28:33] I have a lot of good.

[00:28:35] I looked really good.

[00:28:36] I love Gavin Baker.

[00:28:36] Yeah, and it was a lot of it was about nothing to do with this a lot of it was about just like his his love his knowledge and AI and like how everything works behind the scenes and how we're going to figure out the winners are is like crazy.

[00:28:46] It's such a good podcast but at the end he mentioned something like in passing that I thought was really interesting and I'd like to get your take on it because I've been thinking about it since I heard it like he was saying one of the reasons that you know value has.

[00:28:57] One of the things that change a lot with value when you brought all these quantitative funds in is like this idea that I'm paying to hold this company kind of went away.

[00:29:09] So like if it would have an active manager or if I'm managing money myself and I put these stocks on my portfolio and I just look at this horrible company after horrible company after horrible company, I hate that.

[00:29:18] But you bury it in a value ETF and like now I'm okay with it now I don't really care anymore about it and like does that has that negatively impacted the performance of the value factor.

[00:29:27] So I thought it was a really interesting thing in his conclusion by the way, was that he thinks that over time now like coupling AI with active discretionary value managers could lead to like a renaissance for those types of people because they're going to be able to like couple what they're doing with the benefits of AI.

[00:29:46] But I had just thought that idea was interesting I never thought about the idea that maybe some of these quantitative funds make it less painful to hold these values stocks.

[00:29:53] Yeah, that is a really interesting way to put it. It's also fascinating because this all to me a lot of this turns back into a into a flow conversation and I mean flow in the sense of somebody would have to come up with that.

[00:30:07] The comfort to hold the pain or put it in a way where the shareholders are excited about this or the opportunity that it creates.

[00:30:14] And then there has to be enough flows to move the needle on this thing.

[00:30:20] It's interesting when you think about the people who again like built up what we think of as it's worth saying it out loud 40 years ago, you were not doing this on a computer.

[00:30:33] You're at the library with a slide rule, you know ordering the annual reports from the SEC and doing all this stuff by hand.

[00:30:39] And there was a potential advantage the as West emitter on thing of you can't just take something off the table.

[00:30:47] You got to bring something to the table if you want to take something away 40 years ago you had to do a bunch of manual work and maybe you could see something via quality of AI of value via whatever else that somebody else couldn't understand.

[00:30:58] The computers kind of started to take that away where people were seeing the same things in the same way.

[00:31:06] That's accelerated accelerated accelerated to the point where does the stuff even work anymore because the computers all know it and therefore nobody's really looking at it anymore.

[00:31:16] If you could figure out a way to not just look at it but get enough other people looking at it that it's creating opportunities again.

[00:31:23] Yeah, it could be a little bit of a Renaissance.

[00:31:26] I think I'm skeptical on what would actually get people to care again in a meaningful way.

[00:31:35] Maybe that's where we need the we need like.

[00:31:39] I'll mark it cap weighted ETF portfolio or some individual stock situation or we need one of these like catastrophic events to go oh my god what did we build and now who got it right and how are they going to champion this mode of thinking for a whole new generation of investors.

[00:31:56] That's yeah, I think yeah I think about this line I don't I certainly don't have any conclusions to any of this but I always when I like Gavin's argument was one I hadn't heard enough heard so many different arguments about so many different things and and I was thinking about it and I'm like you know what it is very true that most quantum managers like me.

[00:32:11] Don't even know what's in our value portfolio's most investors who invest in our portfolios or invest in ETF let's a value portfolio don't even know what's in there so like maybe to some degree you have taken the pain and also where the academic research has led to a lot of people being believers in like this overall factor that's powering the portfolio and people are really thinking more about that than they're thinking about what they actually hold.

[00:32:34] So maybe some of the pain of holding now again the pain has still been horrific because these value portfolios have not been working like these ETFs that are out there have underperform so.

[00:32:44] It's not getting rid of the pain but it is interesting because it is getting a rid of a little bit of the like looking at this individual company and being like that things like catastrophe you know Amazon is destroying that company why do I own it in.

[00:32:57] That part is sort of gone away because there's this disconnect between the person and what's actually in the portfolio.

[00:33:03] Absolutely so another one of those questions where it comes back to what's the actual purpose of you know capital markets and make sure really start to question things all the way down to the most foundational and fundamental level.

[00:33:15] It's worth asking though it's worth thinking about is what worth asking what would trigger people who are comfortably bearing that pain either in the name of the company itself or the statistical reality that that company currently occupies.

[00:33:30] That would always unbring a bunch of attention back into this mode of thinking and.

[00:33:35] I like I don't think this mode of thinking is just left us and doesn't matter at all again ever I think it's just what's going to be the triggering event that makes people care about these things again if and when that occurs.

[00:33:47] Yeah, there's so many different moving parts this and we've talked to my green on the podcast like his work plays in here we've talked to Ben Hunt on narrative driving markets more than fundamentals.

[00:33:54] That plays in here there there's so many moving parts to all of this that it's it's impossible for any of us to figure it out, but you know one of the things we try to do with the podcast is present as many different cases on different sides of this as we can.

[00:34:05] So that we can sort of think this through to the future I guess we've got a little bit of tangent here from a quality and low volatility so I'll bring us back what it is an interesting discussion to have and the last point.

[00:34:15] The last point I'll make on quality and low volatility is they definitely are similar in many ways.

[00:34:21] So you would expect to some degree like a quality company to exhibit lower volatility than the market.

[00:34:27] It's it's not like value, I mean value has significantly higher volatility than the market you'd expect like these things are they're not the same they definitely have added value to each other but there are some similarities between the types of companies that would would have all these things we defined as quality but also might be lower in the volatility spectrum.

[00:34:44] It's interesting because it just goes back to just pick boring stuff like boring is wonderful in a story laden distracting all over the place thing like public markets in particular.

[00:35:01] Boring has a place and whether that's quality and low volatility however you define it however you parent if you figure out a way that boring in the right direction can work in your favor.

[00:35:12] It can be pretty friggin useful.

[00:35:16] So we're going to get into CTF here to kind of look how this works in the real world but one thing I forgot to mention earlier that I want to mention before we do that because we're going to look at two different types of ETFs.

[00:35:24] There is a difference between low volatility and minimum volatility and you'll typically see that in ETF's names and we're going to look at two of the bigger ones as we go through here but low volatility is really focusing on the individual assets so I refer before to standard deviation and beta.

[00:35:38] Like if I'm building a low volatility portfolio typically what I'm doing is finding low beta or low standard deviation stocks.

[00:35:43] I'm adding them to a portfolio.

[00:35:45] I'm not thinking in a portfolio context.

[00:35:48] I'm thinking add the assets that are lower volatility when I operate with minimum volatility what I'm really focusing on maximizing on is the volatility the overall portfolio.

[00:35:57] And what that might I might do in that case is I might add things that might score higher on individual volatility because they reduce the volatility of the overall portfolio.

[00:36:06] So for your average investor there's probably not such a huge difference that they have to be that worried about this but important to see this because you will see and they typically will say it in the name.

[00:36:15] You'll see low volatility ETFs, you'll see minimum volatility ETFs and they just are a little bit different in practice so I think it's important to acknowledge that.

[00:36:23] Understanding and I don't really look at some individual ETFs just for examples of this.

[00:36:29] This can impact all sorts of other constraints because this is where you start to have the questions of if it's low-volts and it's low volatility and therefore focused on security selection, having these low volatility tendencies.

[00:36:41] This is where you want to be aware of.

[00:36:46] sector exposure.

[00:36:47] This is where you want to be aware of sector constraints.

[00:36:50] This is where you want to ask questions about what the rebalancing cadence is because we've seen on more than one occasion these low-vol funds basically turn into.

[00:37:00] Giant sector bets are whatever else because a specific sector or part of the markets has become very low-vol and then it's become pervasive to this group of stocks that all exhibits similar characteristics and that can be an issue.

[00:37:12] Then conversely in when we get into like min-vol and we start to think about it in the portfolio context same thing sector constraints turn over the way this is constructed at the portfolio level because both can paint themselves into corners.

[00:37:28] And you just want to understand when that methodology starts to paint itself into a corner, especially in the context of an individual's broader portfolio.

[00:37:39] Great useful tools but you got to still look beyond just the title too, which is why we're going to dive into a few of these things now I think.

[00:37:46] Yeah, that's that's a really important point. Again, we're going to look at this in one second, but that's the idea is you've got to think about alright I'm getting a I'm investing in a low-volatility ETF.

[00:37:55] Alright, what are all the other things going on beneath the surface that I need to understand as to what it's doing because to your point and sectors I mean low-volatility tends to focus in certain sectors.

[00:38:05] So if I'm investing in a low-volatility portfolio, I may be overweight a bunch of sectors relative to other sectors and that may have implications on the rest of my portfolio.

[00:38:15] And how I'm thinking about it because I may not want to be having significant weight in those sectors in the other part of my portfolio because I may be concerned about the overall the overweighting on the low-volatility one.

[00:38:25] But then there's other of these funds and we'll look at this in a second that will say like if I'm a quality fund, I could say I'm going to be sector neutral.

[00:38:32] And I could say alright I'm not going to deviate too much from the sector allocation of the S&P 500 so in that case the natural tendency of the fact the fact that a concentrated certain sectors doesn't really matter to me because the ETF is handling that the ETF level.

[00:38:45] So we'll think of it now but that's the type of stuff you want to look at and we have a tool in the video which we're going to look at right now, but there's a lot of tools out there, artistry.

[00:38:53] But you can just use these tools to figure out when I'm buying, alright I want quality is part of my portfolio.

[00:38:59] I want to invest in quality. Well how do I get there? I mean I can use like we mentioned QVAL before I could buy a value ETF that has some quality exposure in it.

[00:39:07] I could invest directly in quality and not care about valuation. I could invest in something that has you know 200 holdings. I could invest in a focus portfolio of 30 stocks.

[00:39:17] I could invest in something that's sector neutral, it's not sector neutral. There's so many different ways this can be done and it's hard for an investor like if you go read the perspective a lot of times you still have no idea what they're doing.

[00:39:28] So what these tools do for you is that they allow you to say alright what am I actually getting here under the hood in this portfolio.

[00:39:34] And the way we do it is we actually look at the current holdings of the portfolio. So we're looking at what they hold right now and we're telling you how does that portfolio rank using a variety of metrics here.

[00:39:46] This is an example of what I was talking about. This is the I shares US quality factory ETF which is a very big $46 billion is a amount of money I'd love to manage sometime in my career, but obviously a very big low cost quality ETF.

[00:40:01] And going down here this is this is the kind of stuff we were talking about before is so this is what you'd expect it to be.

[00:40:07] Their exposure to quality is very very high now like we said before there's different ways to define quality like in our validity of composite for quality we have ROE return on capital gross margin net margin EPS consistency and sales consistency and it looks like you know they be using some of these more than others they probably are not that concern with gross margin

[00:40:25] because that's that's worth pretty low but they definitely seem concerned on the return on equity return on capital and the consistency type metrics.

[00:40:31] But you're getting what you'd expect to be getting here which is you're getting a high quality portfolio so that's kind of question one when I'm looking at any ETF it's a quality ETF I'm actually getting a quality portfolio.

[00:40:40] And here I am.

[00:40:42] And then it's it's always interesting to look at like what the other exposures are. So for instance I mentioned before that quality and move volatility of a lot of similarities so you'd expect like above average low volatility scores.

[00:40:51] That's what you're getting it turns out right now there's a lot of momentum that probably that's probably not a function of their using momentum in their criteria.

[00:40:58] It's probably a function that these quality companies have been doing very well relative to the market right now so they happen to have a lot of momentum in their portfolio although they're trying to have the momentum in their portfolio.

[00:41:07] And right now these companies are not particularly cheap so right now you have lower exposure to value but it's important to keep in mind I mean quality low volatility these factors can fluctuate with respect to their exposure to the other factors.

[00:41:19] So there's times where quality stocks can be cheaper I mean you never expect them to be you never expect to see 99 on value in 99 on quality because why would the most quality stocks in the in the you know in the university the cheapest stocks in the universe that would never happen.

[00:41:33] But you can have different within that you can have different exposures to value so right now what you'd expect is here which is these companies should not be particularly cheap if they're the actually highest quality companies in the market.

[00:41:42] So you're seeing here in this ETF what you would expect to see on an ETF like this and the other thing I just want to before we switch to another one.

[00:41:49] And I get your take on it is like looking at this sector exposure you mentioned before is is always interesting and what you're seeing here is very very little deviation from the S&P 500 and so what that tells me is what I said before is probably true here I mean I haven't read the perspective but they have some sort of system in here where they're not deviating too much from the market.

[00:42:08] And in terms of how they're constructing this because none of these exposures are all that different and what the exposure the S&P 500 is.

[00:42:15] So it's really useful about something like this and just some some real world kind of use cases for a strategy like this I have definitely sat on investment committees or in pension meetings or other things where we're looking at stuff.

[00:42:27] And if there's an overall concern with valuations in the broader markets people might start to say well we don't just want to be out of the market for valuation concerns but we are concerned about what's coming next.

[00:42:42] Let's increase the exposure to quality because of where we fill we are in some macroeconomic cycle something like this might be useful in that situation because you go I'm still getting my sector based exposure right I'm not filtering out.

[00:42:57] Because of value so aggressively that I've turned into a value fund but I've kept that sector exposure I still have my large cap stock exposure and now what I'm doing is if I'm worried about economic sensitivities I'm kind of minimizing some of the stuff that might be more sensitive to whatever bad happens next.

[00:43:16] Spoiler the risk of that is these measurements are looking in the rear view mirror and you know what what else loves to happen then a good curveball to the teeth of some of these companies so you got to be aware on both angles.

[00:43:29] But that's one good argument for saying if I want to control for sectors if I don't want to be overly concerned with valuation but I really want to boost the quality.

[00:43:38] A fun like this can help meet all that criteria effectively.

[00:43:43] Let's just look I want to just look at we were going to look at a value ETF and I just want to just to describe what we were talking about so this is another example so this is Q Val this is the off architect quantitative value ETF and if I was correcting what I said earlier like this is going to be a value ETF with significant exposure to quality.

[00:43:56] And then that's what you're seeing I mean you know typically your tip and you could tell which metrics they're probably using or similar metrics they're using but.

[00:44:03] Typically with a value ETF with you know 97 exposure to value you're going to see very very low quality if you just do it by default in your for your only criteria are the value criteria you're going to see very very low exposure to quality.

[00:44:15] But what they've been able to do here is they found a pretty like an above average quality portfolio while still getting in the 97% how in terms of cheapness so that's really really interesting like that that's very very hard to do and there's sometimes you can do that in the market and there's sometimes you can't.

[00:44:29] But this is an example of a value ETF that's using quality and so using this tool or a tool like it this would tell me.

[00:44:35] All right they're starting with value here clearly because that's the highest thing you know that's their highest rankings but they clearly are focused on quality and I could pull up some other value ETFs.

[00:44:44] Where these quality scores would just be at the bottom where you could say right clearly here they're just focused on value they don't care about quality so that that's how these kind of tools can help you as as you analyze different things.

[00:44:53] And back to say you're sitting on an investment committee your argument is you think the markets and the economies about to go into some type of savage downturn.

[00:45:03] And if you just scroll back down to the go down to the sector exposure on this one if you want a value to take your priority then well what's going to happen you're going to be way underweight technology stocks right now.

[00:45:15] And that's that's going to really impact your exposure going forward that dramatic overweight that you see here at two energy is going to show up in lots of places.

[00:45:24] So great way to take over valuation risk down an portfolio and I'm thinking about as like a sub component of a portfolio here but it comes with the added risk that you're very deliberately now making a value bet not just the quality bet.

[00:45:38] Yeah, that this plays in the we've had West Gray a bunch of times on the podcast and you know, Wes is a big believer that on a long only basis you don't want to do sector neutral value.

[00:45:46] You want to let value go wherever it finds it and that's what you're seeing in his actual portfolios he's doing that.

[00:45:51] He's heavily underweight technology which by the way is very very expensive relative to all the sectors so that this shows you can see when you see somebody talking about their portfolio or you see what it says in the perspective.

[00:46:01] And in this you can use these types of tools to really figure out what's in the actual portfolio.

[00:46:05] What are they actually doing and in the case of this that they're doing exactly what they're saying they said they're doing on an ETF we talked about before too so that's good.

[00:46:12] I mean, you're seeing what they're doing and then you're seeing kind of what the side effects are well how does you know if I have a completely high quality portfolio what are the side effects with respect to the other factors it's just interesting to see all that.

[00:46:23] Yeah, so we'll do go ahead it gives you context so the nice thing about seeing this is you can start to go from what are we actually talking about what are we trying to accomplish and then does this fund help accomplish this again not in isolation.

[00:46:38] In the context of the broader portfolio this is still one piece of the pie it's not necessarily the whole pie tools like this or how we start to understand.

[00:46:47] How this one piece might fit in influence the rest of the pie you don't want to take your pizza pie and jam it into your blueberry pie without thinking about what those consequences are.

[00:46:55] That way we just be disgusting with the consequences that I was in value you know I did say orange juice and pizza.

[00:47:01] So let's look at this one through this so this is SP HQ this is just another quality ETF and again we can get.

[00:47:07] It looks like a very very similar definition of quality I would guess again I haven't read the perspectives but like the scores end up very very similar to what we're seeing before we still end up with a low level of value.

[00:47:17] We're still in a little above average exposure to low volatility so you're seeing very very similar things here.

[00:47:23] One of the differences here is clearly there's a little bit more of an ability in terms of how they're constructing the portfolio I don't know the other one might have been market capweight it on that really sure.

[00:47:31] But like you're seeing more willingness to deviate from the benchmark in terms of you're not seeing what you saw with QVAL which is significant.

[00:47:38] Expo changes in the exposure to the sectors but you are seeing changes here so.

[00:47:42] That that's something again you'd want to know like I well this one is a little bit more in terms of its willingness to deviate from the benchmark with respect to the sectors so I just have to understand that as I'm building the portfolio and and I understand that these sector exposures you'll be over and under weights may change over time.

[00:47:56] If certain sectors end up being higher or lower quality although again they're they're pretty consistent and you're not going to see utilities and energy you're typically not going to see in the high quality bucket.

[00:48:05] These days you're seeing technology more and more in the high quality bucket because those big technology needs are actually very high quality companies whereas back in today you wouldn't see that.

[00:48:14] And way back in today you actually would see energy in the high quality bucket sometimes and you would see it in the low volatility bucket sometimes as well but that's that's not the case anymore so it's just interesting it gives you an overall look at what all this stuff is.

[00:48:28] So yeah I think and let's look at let's just look quick at low volatility as well just a couple of these almost look at SPLV so we're going to look at low volatility the F and then we're looking at a min volatility ETF.

[00:48:41] Let's look at that SPLV.

[00:48:44] Yeah, so this is this is SPLV which is low volatility ETF and we can see are they doing what they're supposed to be doing yes they are you know low volatility using you I don't know what metric they use but maybe it's standard deviation I don't know but what I do know is that they're pretty correlated.

[00:48:58] with each other in that overall you've got a very low volatility portfolio again as I mentioned before you know typically if you have a low volatility portfolio.

[00:49:07] You're going to have above average quality so we see the same thing we saw with the quality if you have just in reverse now we're seeing the highest scores on low volatility but still above average scores on quality whereas before we saw the highest scores on quality and the above average scores on low volatility.

[00:49:20] And again this is you know with value low volatility is kind of like momentum and that it's a chameleon.

[00:49:26] Depending on how these stocks are being priced by the market it can be they can be very cheap they can be expensive you just don't know they can't have momentum they cannot have momentum so that can change a lot over time that's more a function of like.

[00:49:39] How much the market is appreciating these types of companies at any given time and then also you'll see here what you would expect you know people typically low volatility think about.

[00:49:49] So with those of your staples utilities typically fall on this bucket technology you might see more of that in the future but right now you know in general below average exposure to technology so I'm kind of seeing.

[00:50:01] What I think I wouldn't want to see in a low volatility ETF.

[00:50:05] You map it back to how much additional active share do I want to take on how much additional tracking error do I want to take on and that can be as simple as because I'm trying to make a very deliberate or specific.

[00:50:19] Market call or positioning overweight or underweight and it can be a specific as just you know I believe in this thing I think it's going to work over time and here are all the reasons why.

[00:50:31] This is one of the ones in particular where it's really interesting to watch.

[00:50:35] The community definition put the highlighter on that all day long because you'll see that utilities and consumer non cyclical.

[00:50:42] Overweight and that tech underweight you'll see that shift over time.

[00:50:46] It'd be really interesting to go back to the last read balance date on this one and just see where those things were because it feels like tech was probably a lot more stable maybe six or nine months ago.

[00:50:56] Then it's been in the last few months and I wonder how that's impacted the way these.

[00:51:01] That sector exposure for example looks today.

[00:51:04] Yeah, the sector exposure is could be we will usually be pretty consistent with low volatility but to your point they certainly can fluctuate.

[00:51:10] You know you're typically those sectors that are at the absolute top are usually there but over time you will see them fluctuate and also over very long periods of time as I mentioned before you'll definitely see them fluctuate like we had somebody.

[00:51:21] I forget who it was when we were interviewing somebody about low volatility in the podcast and they were talking about what I said before how like way back in the day.

[00:51:28] Like energy could actually be a big part of these low volatility portfolios and like now it's basically not ever part of these low or big part of these low volatility portfolio so it does fluctuate over time and it's interesting to keep track of it and just before we wrap up here.

[00:51:41] I just want to do one more and we'll do actually have at the wrong box there.

[00:51:44] Yeah, so before we wrap up I just do one more I want to do US.

[00:51:47] I don't do minimum volatility just to show that is a different construction technique so you US and be minimum volatility ETF.

[00:51:54] You'll see we'll go down the low volatility you'll see high high scores because like we said before these are very similar to each other there's similar approaches you know you wouldn't expect to be running.

[00:52:03] A min volatility strategy and then have like all the stocks not be low volatility that's in there that makes no sense.

[00:52:09] So you're seeing something very similar here you're seeing very high scores on low volatility maybe a little bit lower scores because again I'm not my primary thing here is not the scores of the individual stocks my primary thing is the overall portfolio.

[00:52:21] You're seeing high quality you're seeing a little bit below average exposure to value you're seeing the same types of stuff you saw on the other thing.

[00:52:28] So I'm seeing what I would expect from a min involved portfolio and I'm seeing some willingness to deviate from the benchmark here again.

[00:52:35] I think a little bit less than maybe what we saw on the other one but again similar.

[00:52:39] But overweight here to healthcare more so than the other ones but beyond that the staples again the utilities again the underweight to technology the underweight to energy I'm seeing a lot of the same things I saw with the other one.

[00:52:51] Again think about this in portfolio construction language where if this is the piece of the pie that you're looking at either adding or amending or whatever else.

[00:53:01] You're asking these questions about how does this act in complement to other things that I'm doing.

[00:53:08] It's kind of simple to see, depending on what your current exposure is, how layering this on top of another piece of your public market exposure especially your large cap exposure.

[00:53:18] How this would sort of like influence who you're exposed to.

[00:53:21] It's also really interesting not to keep up bringing up the sector thing but I just think it's one of the most interesting places this plays out.

[00:53:27] This gives you a little bit more utilities but not a ton more utilities and this gives you more of like your healthcare your consumer non-cyclicals.

[00:53:34] Some of the other things you have the tech underweight, but it's not quite as dramatic here so for somebody who was concerned about valuation and a downturn in the economy for example.

[00:53:44] This might be an interesting way to pair back on maybe like a US large cap passive equity portfolio.

[00:53:52] And what you're seeing here which is interesting is when you're not just focusing on the low volatility assets but to back to your point about the sectors, you can end up with a little bit more of a diversified sector exposure.

[00:54:01] Because if you think about it portfolio of all utility is my primary goal then I'm probably going to have a little bit more I'm going to in my strategy or however I calculate it is probably going to end up with a little more diversification across the sectors because.

[00:54:13] Bringing in that sector diversification is going to reduce the overall portfolio of all utility.

[00:54:18] Whereas when I'm thinking about it on an individual asset level, I'm just bringing in the asset that a low volatility and I can tend to have maybe a little bit more overweight in certain sectors because that's where those assets reside.

[00:54:29] And that's going to show up in a lower active share that's going to show up in a lower contribution to your tracking error and hey at you know.

[00:54:37] 15 basis points if you're trying to express a view like this and almost 24 billion dollar fund.

[00:54:43] There are ways in there are ways to use these tools that are very effective for an investment committee or somebody else who's thinking about this stuff.

[00:54:52] You have an extra view you want to express it.

[00:54:54] There's tools to help think through like okay stocks have had a great run we want to take a little off the top without taking away the exposure.

[00:55:02] Maybe a quality tilt or something like that can help you in feeling good they've made some.

[00:55:08] Step towards achieving that result and encouragement to go out and do those things but these are there are ways to send a little to borrow that term with tools like this.

[00:55:18] And what you said plays into the last point I want to make and I would like to highlight the work of pneumatic Samuel we can.

[00:55:23] Because his site picture for for folias that come is excellent you know he does a lot of great work there and what he's really trying to do on that site is he's trying to build multi asset portfolios that have great like volatility drawdown risk and return characteristics.

[00:55:38] So he's looking a lot about how can I build these really low volatility portfolio is the combined assets together and have very minimal drawdowns relative to say like what a stock and bond portfolio would do in.

[00:55:49] And the reason I bring that up is both of these factors and particularly min volatility are are really good in that from that perspective because if you think about it if I'm building if I'm building a portfolio that has stocks and as a bunch of other assets.

[00:56:01] And I want to have the minimum volatility possible well I can deal with volatility by having all those other asset classes in there but I also can deal with volatility within the stocks bucket.

[00:56:10] And that's what he's doing when he builds these portfolios he'll use a lot of these I think he uses us mv a lot on the min volatility ETF.

[00:56:16] That's a great use of that because not only are you reducing the drawdowns by bringing in the other asset classes, but you're reducing the drawdowns with the lower volatility and to our point at the beginning like there's a lot of data to suggest that I'm not reducing my return.

[00:56:29] When I'm investing in these low volatility types stocks so if I can get a similar return for my stocks portfolio with less volatility it's perfect for these types of multi asset drawdown managed types portfolios.

[00:56:42] One of the great things about just all these products existing in the world now is that different people and we see this with clients like we have like some point has our firm models that we run.

[00:56:53] And then the sub variations of those models, but when you're trying to build that portfolio to meet goals objectives and the behaviors of the clients across the table.

[00:57:03] Being aware of tools like this being aware of the research and the work of people like nomadic Samuel and putting all this together it can be really effective to say we have the tools to build the investment part to overlay with the plan that you're on to make you feel better about this.

[00:57:19] Minimum ball low-vol can be very effective in distributing portfolios for example and we've done a lot of work on this.

[00:57:28] It can be very effective to pair with income generating portfolios again when somebody is in a distribution phase for all over a trunch of their assets they can be very effective because in those cases like we've talked about with the 4% rule and other things you're just trying to avoid the big drawdowns where you're taking out a fixed percentage or a fixed dollar amount of that pie.

[00:57:46] And so if I can reduce the amount of the size of that drawdown the sustainability of things like withdrawal rate actually goes like a really really really long way.

[00:57:55] So these products existing out in the world as tools, huge value add I love that you guys have the tool to where we can quickly skate through some of the high level details to just tighten up the conversation.

[00:58:06] And just to wrap up with a final point like behavior is everything is investing and that's something we've talked about a million times in this podcast and that's where these factors are really really good.

[00:58:14] Because anything that's reducing the volatility of your portfolio, anything that's making you feel more comfortable about your holdings because they're higher quality companies.

[00:58:21] It makes you more likely to stick with your investment strategy.

[00:58:24] These can be more valuable factors than even say value and momentum because although I might say value and momentum or your A level factors and these are your B level factors for some investors these are your A level factors because they a lot they believe in them they allow they reduce the volatility of portfolio they allow you to stick with your strategy like that's everything investing.

[00:58:42] So I think that's probably to me the biggest takeaway from these types of from these factors is that they can be a great addition to a lot of people's portfolios because of those characteristics they have.

[00:58:51] They give us a language to describe them and my name is in Matt Minval Ziggler and you're not Jack High quality forehand.

[00:59:00] I wish I wish it was so it would be a great name for me, but it's probably not it's probably not what I am.

[00:59:03] It would really have to sign off for this episode if we had those names but unfortunately we don't would but we do have these tools.

[00:59:10] If we start signing off on based on that some people got to check our ego somewhere.

[00:59:14] We'd be probably need to get off the camera and do you go do something else but for anyway on that note thank you everybody for joining us and we'll see you next time.

[00:59:20] Hi guys this is Justin again.

[00:59:22] Thanks so much for tuning into this episode.

[00:59:25] You can follow Jack on Twitter at at practical quant you can follow me on Twitter at JJ Carbono and follow Matt on Twitter at at Coltish Creative.

[00:59:34] If you found this discussion interesting and valuable please subscribe and either iTunes or on YouTube or leave a review or a comment.

[00:59:41] Also if you have any ideas for topics you'd like us to cover in the future please email us at Access ReturnsPod at gmail.com

[00:59:48] We would like this to be a listener driven podcast and would appreciate any suggestions.

[00:59:52] Thank you.