I’m so glad you’re joining me for episode 449, where I have the privilege of interviewing Eduardo Repetto, Chief Investment Officer at Avantis. In today’s episode, we dive into recent market volatility, Warren Buffett’s growing cash reserves, and the investment philosophy behind Avantis Investors.
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Investing In Retirement – New eBook by Jason Parker
Transcript:
449 Expert Investing Insights with Eduardo Repetto, Ph.D. Avantis Investors
Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. And now, here is your host, Jason Parker.
Jason Parker: America, welcome back to another round of Sound Retirement Radio.
So glad to have you tuning in to episode number 449. I have the good fortune of interviewing Eduardo Repetto in the podcast today. He’s the chief investment officer at Avantis. And in today’s episode, we dive into recent market volatility, Warren Buffett’s growing cash reserves, and the investment philosophy behind Avantis investors, but before we get started, I always like to take a moment to renew our minds and today’s verse is from Romans 12: 10, be devoted to one another in love, honor one another above yourselves.
And then something fun for the grandkids. What do you call a boomerang that doesn’t come back? A stick. You know, I created the retirement budget calculator as a tool to help people build a solid retirement plan. And rather than making the tool exclusive to our clients, I decided to make it available to everyone because I believe all Americans deserve a well thought out retirement plan.
Once you have a retirement plan, the next step is developing an investment strategy that aligns with your goals. And that’s where Parker Financial comes in. We help clients implement an investment strategy. To help you understand our approach, I just finished creating a brand new ebook that explains our investment philosophy.
And you can download it for free by visiting retirementbudgetcalculator. com. Just look for the invest button in the upper right hand corner. And you’ll get access to my new ebook called Investing in Retirement. Now let me share a little bit more information about our guest. As Chief Investment Officer of Avantis Investors, Eduardo is responsible for directing the research, design, and implementation of our investment strategies, providing oversight of the investment team and the firm’s marketing initiatives, and interacting with clients.
Prior to Avantis Investors establishment in 2019, Eduardo was co chief executive officer, co chief investment officer, and director at Dimensional Fund Advisors until 2017. While at Dimensional Fund Advisors, Eduardo provided oversight across the investment client service, marketing, and operational functions of DFA and oversaw their day to day operations, directed the engineering and execution of investment portfolios, And was involved in the design, development, and delivery of research that informed the firm’s investment approach, as well as its application through portfolio management and trading.
Dr. Repetto earned a PhD degree in aeronautics from California Institute of Technology, a master’s in science degree in engineering from Brown University. and a Diploma de Honor in Civil Engineering from Universidad de Buenos Aires. Eduardo is a trustee of the California Institute of Technology. He is a recipient of the William F.Bauhaus Prize from the California Institute of Technology for Outstanding Doctoral Dissertation in Aeronautics and the Ernest E. Seckler Memorial Award for his teaching and research efforts. And so without any further ado, here’s my interview with Dr. Eduardo Repetto. Welcome to Sound Retirement Radio.
Eduardo Repetto: Thank you. Thank you. And remember, drop the doctor. My name is Eduardo.
Jason Parker: Eduardo. Okay. I appreciate you being here.
Eduardo Repetto: It’s difficult to say Eduardo. The right accent, but you know, I have an accent, so that’s okay. I live with that.
Jason Parker: Eduardo, though. Yeah. Yeah. I’m not gonna, I’m not going to get my R’s right.
I was hoping we could start off with this conversation, just sharing a little bit about your background. You have a master’s in engineering, a PhD in aeronautics, and now you’re in a finance, into finance and running as a chief investment officer for Avantis. Tell me about that background and how you ended up in finance.
Eduardo Repetto: I’m a geek. Let’s start with that. So I know that I’m a geek and and yeah. Cannot solve that. It’s in, in nature. So yes I study undergrad as a civil engineer, but in civil engineer you can do many different things. I study more structural engineer and hydraulics or river flows and sediment flow because that was more mathematical modeling on that.
So I like it. Then I work a couple of years in, in. Just designing systems to do structural processes and very weird processes from pipes to just how these drives, how they work, but basically simulation software. So what took me to do a master’s in mechanical engineering, but I’m not a mechanical engineer and I know how to fix an engine of a car.
I have not at all. I was developing. Systems modeling, mathematical modeling on how to solve structural problems, let’s call it. In reality, it was even nanostructural problems, so to at the material level. And what then just Took me to a PhD in aeronautics, but not because I know how to fly planes or anything about planes.
It was more about using mathematics to understand materials. You know, you create theoretical model, how a material works, but the theoretical models are so complicated that you can, you have to solve them through computers to simulations, to, to numerical system, to solve these complex theoretical models.
And so that’s what my PhD basically some weird thing, FTC, fatigue cracks in FCC metals. So forget about that. Wow. And it’s used in aeronautics in some sense, in very high in aeronautics but my PhD was really theoretical models that can be solved with computers to understand things.
If you think about finance is not much different. Instead of thinking about material, you can think about. Investing, you can think of markets and you can try to develop some theoretical or logical model that are complex, so you have to use numerical tools in order to solve them, in order to create, in the case of finance, better portfolios.
I think about this when you do a PhD and I was very lucky to have, to be in very good schools with very good advisors, you can abstract things quite a lot, so I can use, I can apply. And what I learned to marketing, I can apply to human resources. So you have human resources, you can develop a model of how that should work.
So people be better behaved, more productive, more client centric and then try to, to abstract that and try to create incentives or solutions. So people really work the best investment. So a PhD gives you a toolkit to apply to different settings and. I was lucky to be able to learn that.
Jason Parker: So you’ve taken these, this toolkit and these models and you’ve applied it to finance, tell me about the philosophy that you’ve adopted that you’ve, that you use at Avantis.
Eduardo Repetto: Oh, that’s a great question. So that’s a great question. Try to use as much market information as possible because look, there are tons of market participants, millions and millions of market participants buying and selling securities options, bonds, derivatives. So the market is full of people trying to bring information into prices.
So we like to use prices. As part of how we select securities or weight securities, but we think that prices alone is not enough. So what we do is we use prices together with fundamentals, balance sheet information, statement of cash flow information, income statement information, in order to buy securities.
So if you say what kind of securities you like? So in simple words, the kind of securities that we like are securities that have good balance sheet, good cash flows, and low price. And you say you don’t need a PhD to tell me that. Of course. I don’t need a PhD to tell you that. Who doesn’t like securities?
A good balance sheet, good cash flows and low price. We like them. The problem is that you start ha have to have approximations and models in order to have what is a good balance sheet, how can I represent that? What is a good set of cash flow, how I represented? And then once I do that for one security, how can I do that across all the securities?
in order to put together a portfolio. And so it’s data intensive computational intensive and you have to have models in order to make this trade off. So Avantis is a company that is using market information together with fundamentals in order to find securities that are price attractive in the market in order to create portfolios that have higher than market expected returns.
Jason Parker: Avantis is often categorized as an active manager. Yet, much of the advice regarding investing today emphasizes the benefits of low cost passive index investing. Given this, how does Avantis differentiate itself, and why should investors consider your approach over a traditional index fund?
Eduardo Repetto: I love that question.
So low cost is important. And I completely agree with that. When we came to market. So we started Avantis around five and a half years ago. With no money. Before this market downturn we were around 65 billion. So in five years we grew quite a lot. And why? Because we care about One of the reasons is because we care about low cost.
Yeah. The other one is we care also about good strategies. Because you Paying low cost for a bad strategy no one likes, but you want to have low, good strategy, low cost, and good service. If you have a restaurant that has good food, good service, and low cost People will want to go, it will be full.
Here the idea is the same. I want to have low expense ratios, good strategies and good service. And so about the low cost of index funds, I think that is a great idea. We embrace that. We try to have low cost. About index funds being solution, I’m not so into that. And why is that? If you buy a market index fund, yeah?
There is no security selection. If security is in the market. It’s in the index fund, it’s in the portfolio. Yeah. The moment that you have an index fund that is not the market index fund, someone is making a security selection. It’s not the portfolio manager, it’s the index house. So if you tell me I have the Russell 1000 value what securities are in the Russell 1000 value?
And you’re telling me large value securities. I tell you, Russell 1000 value has different securities than the Morningstar large value.
Than the S& P 500 value that is social. So all the different indices have different securities. So someone is making security selection. So is it active or passive?
I say in the market portfolio where no one makes security selection, it’s passive, no doubt. In any asset class portfolio, where someone is making a security selection, that’s active. That is an active decision. It’s not done by a portfolio manager, but it’s done by the index house. We are also making active decisions because we don’t buy a market portfolio.
We do security selections, but we do based on some theoretical framework based on valuations that, in our opinion, is better than what index houses do, and also that other managers do. For me passive, we embrace the concept of passive because we take market information, we take market prices. We never tell you the market price is wrong.
We tell you that’s the price. We take it and we mix the fundamentals to identify better security. So we empower the power of the market in our security selection and deliver that. at low cost with broad diversification.
Jason Parker: You had worked at Dimensional before starting Avantis. Can you take a minute and describe the differences between the two firms methodology?
Eduardo Repetto: Yeah. I can try a little bit. Dimensional is a great company. I have a great fan. I learn a lot, great people. At some point I didn’t want to work there anymore. I worked there for more than 17 years. So at some point I said, Time to go. I was lucky enough to be there at the right time.
We grew from 25 billion, more or less, to 550 billion. We have great things with it. And we’re great people. And I have a great appreciation for all of them. But At some point, you say, look, I want to do things a little bit better. And so we decided, I decided I don’t want to be here anymore.
Resigned. I did nothing for a couple of years. And then, since when you work too long in the industry, you start knowing a lot of people. And so some people from another company called American Century reach out, Hey, we want to do something with you. I say, if you are going to have it at a low cost, I’m more than happy to do it
Jason Parker: together.
Eduardo Repetto: They were on the same page. That’s why we came to very low cost strategies. For example, when we came to market to our US small value, we came at 25 basis points. Dimensional was at 52. There you have it. We are embracing the concept of low cost. Very seriously. Dimensional lowered the cost. But I think they’re at 31 for example now in that.
So we have low cost. But if you look at the strategies that we manage, they are different. For example, what is a value security for the mentioner? It’s a security that has a low price to book. There is some other things, but, you know, it’s basically a low price to book security. Think about company earnings.
If a company makes no money, what do you think the price in general will be low, yeah? So if you buy a security that is low price to book, you’re going to have a lot of money, companies that make no money. Because in general, companies that make no money have low price. So you have a bias toward companies that make no money, or little money, yeah?
We wanted to solve that problem. So for us, when I told you, I look company have good balance sheet, good cash flows and low price, I didn’t say low price relative to the balance sheet or the book value. I thought I also including cash flows because cash flows are very important in company valuations.
Yeah. And so that’s a difference, for example, between us and Dimensional. I can go into more details, but and write formulas and whatnot. But look, we care about. The holistic set of company valuation, as much as possible holistic, instead of factors or different ratios. Now, there has been a humongous amount of work in factor models or in characteristics or ratios that have information about the specter returns.
What we like to do is grab that information and see how can we fit that into a valuation model in order to have a better valuation model so we can identify securities based on what the market price and fundamentals is and identify securities that have greater opportunity to produce higher specter returns.
Jason Parker: Interesting.
Eduardo Repetto: It’s a different process it’s not so much I want a factor portfolio, a multi factor portfolio, I want to collapse all that factor information into a valuation process. Now what I really try to do is to systematize active management. And what the heck does that mean? The active manager guy is trying to say, is the value of this security attractive in the market?
If it’s attractive, I should buy because it’s going to go up. But that process is very hands on, very expensive. So you finish with a portfolio that has a high expense ratio and not a lot of diversification because analyzing more securities Costs you more and more because you need more and more people.
If I can get this labor intensive process into a model, into a system, into computers, I can analyze more securities faster at a lower cost. So I can deliver new portfolios with value added broad diversification and lower expense ratios.
Jason Parker: Actually, that brings me to my next question, actually, with this AI boom, how do you see artificial intelligence impacting these strategies, these models you’ve built and finance in general?
Eduardo Repetto: That, that’s an open question to the truth. It’s, you know, who knows there, there are certain things where AI is certainly helpful. Like for example, analyzing data and cleaning data. You know, you get a lot of data. Let’s suppose, and we have seen that. I’m pretty sure you got a call from your credit card company saying, Are you today in, I don’t know, South America, buying computers and paying restaurants?
And no, I’m here in L. A. Okay, someone is using your card. So they found something weird in the pattern of data that is not what it should be. They identified it. And they call you. The same you probably can do with financial statements. You know, you have a lot of financial statements. A lot of data.
Can you apply some kind of AI process to analyze that data? In order to say, there is something weird in that data. You know, the jury’s out. You know, we are, we’re in the early days. But certainly that’s something that is is very promising.
Jason Parker: There
Eduardo Repetto: are people that have applied AI. To just read the transcripts or analyze the transcript of earnings calls and trying to see if there is information on how those earnings call go and what is said.
And so That is potentially using AI to analyze data, to come to detect issues with data, or to capture more data, for example, from earnings calls, that, you know, it’s not someone speaking, you get the transcript and try to see is there information beyond the financial statement. That’s very promising, to be fair.
If you tell me, can you use AI to pick stocks, because which ones are wrong price? I think that the market is a big AI machine at the end of the day. What we are trying to do with computers and AI, basically, is what the market is trying to do in itself. You have all this, yeah, mess of information and news coming into prices through some process.
And the market is can I use AI to find better prices? I say I’m not so sure about that. But can I use AI? to just analyze data and come with better data or more complete data sets, that’s extremely promising. So we’ll see. That’s interesting.
Jason Parker: Yeah. You know, I thought that too, that the market was the original AI.
It’s the collective intelligence of all the people coming together to determine prices. I guess the difference is now that we have large language models that can take information they can take data and they can talk to us rather than just determining prices. That is interesting. You know, as I was preparing for our interview, one of the strategies you guys manage is a U.
S. large cap value. But as I was looking at some of the top holdings some of the companies that were the top holdings of that value fund were companies that I think most people would identify as growth companies. And I think this comes back to this previous conversation we’re having about cash flows and how you go about deciding values.
Would you take a minute and talk about how you differentiate between value and growth and how these companies that would typically, most people would probably say we’re growth oriented are in a value strategy.
Eduardo Repetto: Yeah, that’s a great question. And so I want to try to simplify with just as much as possible and anyone wants more information, you can always reach out to us hopefully, or go to our website.
Think about buying a company that has a low price related to The equity that the company has, the balance sheet, the book value, yeah? Now, that’s a typical definition of value, you know. They have factor models that says low price to book companies are value companies. You have indices that select securities based on low price to book, and define them as value companies, yeah?
That’s not the full valuation of a company. You will never buy a company by just looking at the balance sheet and ignoring cash flows. So imagine that you have a company, imagine that you have two companies, they have the same book value, yeah? But one of them has humongously high cash flows and the other one has no cash flows or is losing money.
And let’s suppose that the price of the one making a lot of money is a little bit higher than the other one. Which one do you think is better as an investment?
Jason Parker: I personally love cash flow.
Eduardo Repetto: I told you, it’s a little bit higher the price. It has the same balance sheet and one makes a humongous amount of money and the other doesn’t make money.
Jason Parker: Yeah. Yeah.
Eduardo Repetto: You will say the one that makes a lot of money seems to be a better deal. So cash flows matter. So when you think about companies that they are in our value portfolio. in our value strategies, but they are not in some other value strategies or some other indices, the difference seems, tends to be that those companies produce very large cash flows.
So if you produce very large cash flows, you deserve to have a higher price and a company that doesn’t produce those cash flows. Now, if the price is too much higher, we will agree that’s not the company that should be in our value portfolio. But if the price is a little bit higher, That company should be considering the portfolio.
So what we’re thinking, what we’re looking for, is not for low price companies. We’re looking for companies that, that given the cash flows, given the equity, the balance sheet, the price is relatively low where it should be. The price is heavily discounted. The market is applying a very high discount rate to those cash flows because a lot, a very large discount rate It’s high
Jason Parker: spectrograms.
Eduardo Repetto: Think about that. Let’s go and eat sushi. Will you go with me to eat cheap sushi at the gas station? You say I like to eat cheap, but quality matters. Will you go to me to eat sushi, to a very high quality sushi shop, but the price is astronomical? You say the quality is great, but the price is too high.
Okay, let’s find an intermediate situation. Will you like to have good quality, but at a discounted price? Yes, that’s what I want. Good quality at discounted price is basically what we’re looking for. Good balance sheet, good cash flows, and low price. You have to consider cash flows.
Jason Parker: That’s interesting, okay.
Yeah, I don’t think I’d feel very comfortable eating sushi at a gas station, but
Eduardo Repetto: I was told in an interview that there is a gas station in the southeast that has amazing sushi. And one day I will go. I don’t know, I guess. But the price will be high probably, so we’ll see.
Jason Parker: You know, I should probably ask, because we’re experiencing so much volatility in the market right now, and the headlines are about tariffs, artificial intelligence, war between Russia and Ukraine, and then a lot of these layoffs with the federal employees.
And we’ve got a lot of people that listen to this show that are within five years of retirement. Some of them have recently retired. For people that are in that type of a situation, what do you say about this market volatility? What should they be thinking about?
Eduardo Repetto: I hope that they had the right balance portfolio before all this crisis started because just fixing portfolios in the middle of a very volatile market is probably not the best time unless if you really have to.
So I always think you have to have. You know, the portfolio that fits your risk tolerance and your needs. You know, not being scared of having fixed income when you need to have fixed income. In particular now, fixed income rates are way more attractive than what they were a couple of years ago. It’s not a bad idea to have some fixed income, you know, it’s not bad.
Acting, just flying to quality and just bailing from the market because of the high volatility. I’m not a big believer in that.
Jason Parker: . Why
Eduardo Repetto: prices go down. Prices go down because the market is demanding a higher discount rate. Why is the market is demanding a higher discount rate? Because there is more uncertainty.
And prices can go down because earnings, the expectations are bad, or because the market sees demand at a higher discount rate that, in other words, higher rewards for being invested, for the risk being taken. And bailing down now and going to safety may be selling at prices that are depressed. You never know, but it may be selling at prices that are depressed.
That’s it. It’s better to adjust your portfolio to the right restaurant when things are calm than in the middle of a storm. But sometimes you have no choice. And if you have no choice You do what you have to do. The most important things at the end of the day is what you say at the very beginning.
Let’s say, be sure that you have low cost strategies that are extremely well diversified, that they care about turnover and they have low turnover. Diversified, broadly diversified is important. You don’t want to have something that has extreme exposure to any particular company. Because you never know what would happen.
You mentioned tariff. Tariff may affect some companies more than others. You want to have a broadly diversified portfolio. There is no need to take extreme bets one way or the other. And so my advice is be sure you have good strategies that are broadly diversified, that have low fees, and If you can, it’s taxable money.
Be sure that they’re tax efficient because you don’t want to pay taxes when you shouldn’t. And have the right amount of fixed income. And hopefully you have the right amount of fixed income and the right type of fixed income before all this volatility spike. But if now. You’re in the middle of storm, be careful adjusting but in some cases you have to.
Jason Parker: Okay. With historical valuation metrics, U. S. equities are expensive, and that’s whether you’re looking at price to book, price to earnings, or the CAPE ratio. And the U. S. market weighting and global market cap has been rising from under 50 percent to over 65 percent over the past 20 years. How should investors, especially those nearing retirement, approach asset allocation?
And given these trends, what role should global diversification play in their strategy?
Eduardo Repetto: That that’s a magnificent question. So if you look at CAPE, CAPE is basically PE ratios, an earnings price ratio. Yeah. So it’s true. The U. S. is trading at that higher PE ratios, price to earnings ratio.
So you’re paying more per unit of earnings in the U. S. than international markets. Absolutely true. That has been the truth historically. So the U. S. Tend to have higher peak ratios than other markets. Yeah. And it may be because of different reasons. It may be more expected growth, more efficiencies, for whatever reasons, you know.
But still, the U. S. now, if you look at the international markets, the peak ratio is more or less what it has been in the last 20 years. It’s a little bit higher, but it’s basically the average. If you look at the U. S. We are above average, no doubt about that. But if you get the U. S. market and you split it in pieces, yeah, the part that is really way above average is large growth.
If you look at U. S. large growth, and think about some of the tech companies, you know, The price is really high related to earnings. If you compare with historical standards, we have seen this before. You saw that in 19 99, 19 20, and that’s what sheer you think, thinks about the peer ratio the cape in the, in his case, as an indication of.
Future expected returns, very high price to earnings, really should have some effect on what the future expected returns of those securities is. If you pay too much for some unit of earnings, probably you are going to have low returns going forward. So with that, all that said, it’s a, what do you do with all this?
If you think, be sure that you don’t have overexposure to U. S. large growth, that’s one thing. If we’re saying that the U. S. large growth is the one that has the highest speed ratios maybe don’t have overexposure to U. S. large growth. Be sure that your portfolio is not full of U. S. large growth and nothing else.
Having international diversification is interesting, but being diversified inside the U. S. market is also important. If you look at small caps or value securities, The PE ratios are not unreasonable. They are attractive. If you look at U. S. companies, U. S. large companies over the last 10 years, their earnings have been amazing.
Earnings of U. S. large growth companies went up 140 percent over the last 10 years. Amazing, no? 14 percent earnings growth a year? It’s a big number. The problem is that Price went up
Jason Parker: 300%.
Eduardo Repetto: So that’s why you say price went up way more than earnings. Oh, maybe they are a little bit rich. But if you look at the other part of the market in the U.
S. They are not in the same situation. The prices are way more reasonable related to earnings. So you still can have a U. S. allocation that is reasonable. You still can have international allocation. You don’t have to build the U. S. and go all international, but it’s good to have some international probably.
But be sure that you are not overly focused or concentrating in U. S. large growth. You know, if you look at the rear view mirror and you see large growth going up 20 percent in the last 10 years. I want more of that. You should have want more of that 10 years ago. Now, be sure not to have too much.
Be diversified across everything.
Jason Parker: And I guess that’s the question. So global market capitalization is the foundation for the asset allocation models, but with the U S increasing from maybe 60 percent last year to 65 percent this year, it feels like it’s backward looking. So we’d be allocating more to us, which is already expensive.
And wouldn’t we want to instead be counterintuitive and say geez international developed looks like it’s a lot better price. So we would want to maybe be contrarian and add more of the asset allocation to the global or the international developed market instead of chasing the U S. What are your thoughts about global market capitalization as a tool for determining the initial asset allocation?
Eduardo Repetto: I’m a believer in starting with global market capitalizations, because the market, you know, the market is the AI. Remember, it’s this piece that is incorporating information. If US investors or global investors that can move capital, you know, you can move capital from here to Europe, you can move capital from here to Africa, South America, Asia, you can move capital everywhere.
And the other way around. So if the conglomerate of investors are analyzing risk and opportunities, and they’re coming to U. S. prices. I said there is some information there that the U. S. is probably not you know, not the worst place to be because, you know, people will be running to the other direction.
Now, sometimes you say people get overexcited and buy too much and things depart from for a more reasonable allocation. But you have to be careful to say it’s wrong. Let’s move the other way. You know, starting with global market capitalization is not a bad idea. Deviating a lot from global market capitalization is really saying, I know way more than the rest.
And there are millions of the rest, so you have to be careful about that.
Jason Parker: I see, yeah.
Eduardo Repetto: You know, having most people that I know have a very strong biases. So if you look at portfolios, look at any portfolio, you know, most people don’t start with global market capitalization. They start with something that is, if it’s not 100 percent US, it’s 80 percent US.
So what is, what I will say is. Be a little bit more close to the market instead of start betting and go below the market. Become more global diversified instead of being so US centric because that’s where the market is.
Jason Parker: And we’re seeing that happen. We’re seeing that global diversification during this recent market meltdown be a ballast to that volatility in the US.
That is happening this time around. Yeah.
Eduardo Repetto: You see a strong flows in, I’m only speak about that, you know, but you see very strong flows in international and also in, in other parts of the US market that are priced attractively. But yes, global, look, over the last Let’s say 10, 12 years, the US have done much better than international.
. And it’s a long period of time, 12 years, you know, it’s a long period of time for people to say, I believe in global diversification. And when the SAP 500 is going like that, yeah. Emerging markets is going the other way or flat and the international market is barely going up. So a lot of people have mobile locations more and more towards the us.
So that’s why I was telling you what performance that you see out there and to be very home centric, very U. S. centric and maybe diversifying a little bit more. I’m not saying underweight in the U. S. related to the global market, but diversifying a little bit more probably is not a bad idea.
Jason Parker: This next question has to do with really, I think price discovery, but with index funds now making up roughly 50 percent of the market.
Some argue that it creates a flywheel or a momentum loop where new investments automatically flow into the largest companies that re and that reinforces momentum regardless of fundamentals. Do you see this as a risk to market efficiency and how should investors navigate an environment increasingly dominated by passive investing?
Additionally, are there opportunities to capitalize on? in inefficiencies that are created by the rise of index funds.
Eduardo Repetto: Okay, that’s a good question. Let’s separate the first from the second. The first one, do we have a problem because indexes being index investors having so much money in the market?
So you mentioned 50 is probably true if you look at funds and ETFs. But if you look at securities, the number is probably lower. It’s somewhere between 16 and 33 percent. Because if you look at funds and ETFs, it’s true that it’s around 50 50 between active and passive. Or active and indecent.
But there is a lot of people that has Individual stocks, you know, whatever, separate accounts. And there is a lot of other assets that are not in commingled vehicles, funds or ETFs. So the number is a little bit lower than that. But, you know, there is some paper there that estimates to be about 33%, others around 16%, somewhere around there, less than 50, yeah.
But then I go back to my initial discussion with you. So there are two kind of indices. The one is a market portfolio. No one makes investment decisions. So in those ones, if there is a lot of money coming into a market portfolio, yeah, it’s coming from fixed income into a market portfolio. The money is distributed across all the companies basically equally.
Everyone is pushed up in the same way. Equally, I mean, market cap weighted. So it’s not a disproportionate amount to some company to the other. Everyone, if you bring a hundred billion into the market, you know, you are buying the same slice of every company. So for every company, you’re buying 0. 1 percent of the shares of the standard of every company.
So you’re buying the same slice of the shares of standard of every company. So everyone is pushed the same when you’re buying a market portfolio. So it’s not that one is pushed more than the other. Everyone is pushed the same in that sense. So that’s market portfolios. And that’s the truly passive strategy where there is no security selection.
Now, if you look at other indices, like asset class indices, small cap value, small value, large growth, those are not pushing everything the same. If you sell your value strategy to buy a growth strategy, you are pushing value down, pushing growth up. You like it or not, that’s, those are different animals, no?
It’s the same as if someone sells a value active manager and buys a gross active manager. You are producing the same effect when you’re selling this index or this active manager, than when you’re buying Another active management grows or an index grows a fund. So I make the case that I don’t think that there is much to worry.
There are so many indices that make so many decisions. And it’s like buying baskets of securities. And there is a lot of money that is not attached to indices. So I think we have no issue to worry. And market portfolios. Are still not a big part of the market. Most of the money in index funds is not in market portfolios.
I think Vanguard has a beautiful chart that shows the growth of assets in indexing versus active and the growth of assets in market portfolios. You see market portfolios when there is no security selection, it’s much, much later. So what we’re saying is there is A lot of money going to index funds, but in those index funds, there is a security selection process, and that security selection process is done by an index house instead of being done by the portfolio manager.
That is security selection. In some cases, The index has rules to select securities. In some other cases, the index has committees. You know that S& P 500 has a committee making security selections. So I don’t think I would have to worry too much. One part of the question. The other part of the question is about inefficiencies on indexing.
And that’s real. That’s real. So indexing has a lot of. Inefficiencies, but one of them is implementation. What happened if I tell you, I want to buy your house right here, right now, what should be your answer?
Jason Parker: You’re going to have to give me a lot of money cause I don’t want
Eduardo Repetto: to sell it.
Exactly. So basically I say, I want 20 million from my house. That should be your answer. And if I sell you, I’m buying yes or yes, you will get 20 million. Yeah. So what does an index do? An index strategy, an index fun, has to match an index. And an index changes securities on one particular day of the year.
And you are hiring that index manager to match the index. So that index manager has to trade on that day, yes or yes. It’s buying your house on that day. Yes or yes. So the market knows that, no? At the end of the day, the market knows, we’re not speaking about dumb people out there. And what the market is going to do?
If there is a big demand for some stock that is going to be added to an index on that particular day, what do you think it is going to do? What happens with that stock? The price is going to go up because the index is going to be buying. And what happens when the index is going to drop some name?
If there is a big price pressure to sell on that particular day, the price is going to be down. And those price changes will not be driven by fundamentals, by changing earnings, it will be driven by liquidity. I hold this security, you want to buy, yes or yes price is going to go up. And so that’s an inefficiency inherited in an index that costs.
Money, and there are papers on this and yes, there are inefficiencies in indices, and the more money attached to asset class indices that have to change securities, the bigger that liquidity issue becomes.
Jason Parker: And is there an opportunity for small investors to try to front run that and take advantage of it?
Eduardo Repetto: But that’s a complicated issue. Because I imagine that a small investors, we have one company or another company. Yeah. But if we’re thinking about basket of securities you can provide liquidity on index. So when an index is adding a security, if you see that there is positive net price pressure.
So a lot of people, a lot of indices, because it’s not one index manager, every index manager in ETS. Funds, separate accounts, collective investment trust is buying at the same time. You see there’s a lot of price pressure there. You can say I sell it now and then maybe I buy it later, or I sell it now and I buy something else that is similar.
So you can do things like that. But when you are speaking about one, one company or another, it’s better to do always in baskets, because there may be always news that push the price the other way around. So You have to be careful with these things. You are a bigger manager. This is across many securities.
You have more opportunity than an individual investor with just a few shares or a few names in their portfolio.
Jason Parker: Most retirees don’t have a 100 percent stock portfolio, at least most of the people that we talk to when you think about the market, the stock market, a hundred percent equities, the number that gets thrown around a lot is over a long period of time, stocks have averaged about 10 percent per year.
But if you’re retired and you have something like a 60 percent stock, 40 percent bond portfolio, your expected return shouldn’t be 10 percent if a 100 percent stock portfolio has delivered that. So if the expected return is lower, And treasury market let’s just say 6 to 8 percent for 60%, 60 percent stock, 40 percent bond portfolio, treasury money market accounts.
Let’s say they are relatively risk free and they’re paying 4%. Investors face a choice between. taking risk for potentially higher returns versus opting for a safe return that they could get in a money market account. What kind of time horizon do you think is necessary to justify taking on market risk and how should investors think about the trade off between risk and time as they prepare for retirement?
Eduardo Repetto: Okay, that’s a complicated question and can be very theoretical because risk never goes away. Let’s say I’m invested for a hundred years. Will I be sure that I will not lose money? No, there is no certainty. You can say that the probabilities of losing money go down over time, but they’re always there.
There is always there. No matter how high you think the expected returns are, the probability of losing money is always there. So what we’re doing is we’re taking risk because we think we’re going to have higher returns, but there is always some tale that we are not going to make money and we may have to work longer or live with less money.
So the risk is always there. It’s no free lunch, no matter how long you wait. But it’s true. You know, you have a long time horizon, the probabilities of losing money probably go down. The way, the best way to think about this is to say, let’s suppose that we agree that equities has higher returns than bots.
Yeah, let’s suppose. I agree. You agree. All of us agree. What do you think that is going to be the market in the next 10 seconds? Equities or bonds? You have no idea. No idea. Because the volatility is so high relative to the expected returns over 10 seconds, that is 50 50 basically, yeah? So the longer you wait, the better the odds for you are.
But the odds are no, don’t think that this is a done deal. If you are going to invest for a long, short period of time, remember the 10 seconds 50 50. You save one year, it’s not going to be 50 50, but it’s going to be. You know, not much better, maybe 60, 40. I don’t know what’s the number here. So think about investing for long periods of time.
Let’s look at five years, 10 years and whatnot. When you retire, you’re close to retiring. You are not investing for, I’m retiring in three years. You’re not investing for the next three years. You’re investing if you’re retiring at 60 and you know, you will live until 90. You’re investing for a long period of time.
So let’s remember that. So having a balanced strategy is not. It’s never a bad idea. You have some time allocation to safe, safer assets, in some sense, fixed income, so you can consume and deal with the market volatility, and, you know, when markets go up you can put more money in fixed income and just rebalance in order to maintain your risk profile, and Over time, you know, just just increase your fixed income allocation because you don’t need so much growth in assets if you are using this money for consumption.
Yeah. So that’s not a bad idea.
Jason Parker: And so this brings us to Warren Buffett. You probably saw that he increased cash in his portfolio. He currently has over 330 billion of cash. And what are your thoughts about maintaining such a large cash position? And. What does it signal about the market? Does Warren Buffett know something that the rest of us don’t know?
And more importantly, how should everyday investors think about their own cash allocation as they approach retirement?
Eduardo Repetto: I’m, I never would put myself as the same as Warren Buffett, you know, so that’s kind of eminent. So does he know things that I don’t know? I’m pretty sure he knows hundred million things that I don’t know.
When it comes to his business, he runs a different business at the end of the day, you know. So his business is trying to buy companies and bring his way of thinking to those companies so the companies improve and get more assets. So he’s having 300 billion or whatnot there because I think as you’re saying, he’s not finding opportunities for him to buy, you know.
But he also says loud and clear that if he is going to invest for the long term or Most people should invest for the long term, just buy some low cost strategy. He used the S& P 500 as an example. So kind of a market portfolio, that’s what he’s telling you. That’s a business of investment. His business is a little bit different than the business that we’re doing when we’re saving for retirement.
So I wouldn’t compare that, but by no means I’m putting myself at the same level of Warren Buffett now.
Jason Parker: But what about individual investors and cash allocation when they first retire? So those, they’re going to be consuming some of those resources, how much. Cash, do you think the average investor that’s just retired should be holding on to, to help offset the short term volatility that we know is inherent in the market?
Eduardo Repetto: So again, it depends on a lot of things, but if your only asset is your savings, You should be conservative. Now, I know that you have social security, so your only asset is never your savings, if you have social security or some pension asset and whatnot. And social security, let’s assume that it’s safe, works like an annuity, you know, you get the payment, so you can think about Pilot fixing and that is paying you some money every year.
But I still think you should be conservative. That’s your only asset and you have no ability to go back to the workforce if things go bad. Yeah it’s certainly not pleasant if you lose. That’s your only asset and you live for a long period of time. So being conservative in your allocation, I think that is a need more than a desire.
All of us, we want to have more equity allocation because we want the growth of that equity, that an expectation should happen. But, you know, markets do whatever they do. They are volatile and sometimes you have long periods where that doesn’t happen and you have crashes once in a while and whatnot. I think.
I think that this, that’s your only asset being conservative is the right thing. Some people, for some people, conservative means different than others. So that is studies. We work with a lot of behavioral finance professors, and some people are willing to give up 10 percent of their standard of living in order to gain another 30 percent or 40%.
So that’s telling you the trade offs that you’re going to make if that’s your only asset. If I invest more money in fixing inequities can lose, you know, let’s say 20 percent over some, let’s say, longer period of time, your standard of living will go down. Are you willing to do that? So you have to think about that.
Jason Parker: I know our listeners are really going to love this interview. Thank you for taking the time. I’ve got one more question I wanted to ask you related to a book that I recently finished. The book is called The Man Who Solved the Market. It tells the story of Jim Simmons, who passed away recently. And the book describes him as the most successful investor of all time.
What are your thoughts on his methodology as an active manager? How does his quantitative data driven approach compare to the investment philosophy of Avantis?
Eduardo Repetto: Okay, that’s a great question and it’s a question that I probably cannot answer because no one knows exactly what Jim Simonson, his medallion fund was doing.
There is speculation of what those fund is doing, but there is no certainty. So some, the speculation that fund was basically doing something like a market making. So very short investment, very short term investments, trying to find Price pressures, dislocations, inefficiencies. So when a lot of people are buying, the price is moving up because of liquidity, for example, that we spoke.
And maybe they step in at that time and provide liquidity. And then when the price is, they just cover the position. So that’s a speculation of what they were doing. But the truth is that the details are not there. So supposedly there were a lot of doing a pattern recognitions in order to this, to find these kind of diversions in prices in order to step in and before they converge.
So it’s a very different strategy than what we do. Does Avantis use any pattern?
Jason Parker: Does Avantis use any pattern recognition?
Eduardo Repetto: No, we don’t. We are long term investors in general. Our portfolio have very low turnover whereby, as I mentioned, we like companies have low price with good balance sheet, good cash flows, and we think about them long term investors.
So our typical turnovers are, you know, 25 percent for, you know, on equities products, that’s on the higher end of our turnover. So we tend to hold securities like for four years, five years, sometimes long. So in that sense, we are closer to I mean, a more buffet approach. We hold company for a long period of time instead of, oh, Jim Simmons and branch that, that higher turnover, more market making strategy, but again, the details of what he was doing, at least as far as I know, they are not known.
Jason Parker: Very secretive. This has been a lot of fun. Thank you for the work that you’re doing at Avantis. Any final thoughts for our listeners before we finish up today?
Eduardo Repetto: No, I think that the, your podcast is amazing. I think that the you know, you’re providing a service to a lot of people and retirement is a very important transition in life going from working to not working, going from getting a paycheck to having to create your own paycheck is a big transition.
And so help the one that you provide, I’m sure it is extremely appreciated.
Jason Parker: Very appreciated. A lot of responsibility, you know, you only get one shot at retirement. Like you said, most people don’t want to go back to work. And so you don’t want to be guessing. You don’t want to be figuring it out just as you’re trying to make this transition into retirement.
And there’s a lot of fear. There’s a lot of uncertainty, you know, people. They look out into the world and they’re not quite sure what the future looks like. And so being able to help people achieve clarity, confidence, and freedom as they’re heading for retirement. So it’s wonderful work. I’m blessed that we get to do it.
Thank you. Thanks for your input and thanks for your contribution to that.
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