Rob Arnott – People Need To Ratchet Down Their Return Expectations by Meb Faber
Guest: Rob Arnott. Rob is the founder and chairman of Research Affiliates. In 2002, he established Research Affiliates as a research-intensive asset management firm that focuses on innovative asset allocation and alternative indexation products. He previously served as chairman of First Quadrant, as president of TSA Capital Management (now part of Analytic Investors), and as vice president at The Boston Company. He also was global equity strategist at Salomon Brothers. He has published more than 100 articles in journals such as the Journal of Portfolio Management, the Harvard Business Review and the Financial Analysts Journal.
Rob Arnott
Date: 8/31/16
Run-Time: 1:05:30
Topics: Episode 18 is packed with value. It starts with Meb asking Rob Arnott to talk about market cap weighting and its drawbacks. Rob tells us that with market cap weighting, investors are choosing “popularity” as an investment criterion more so than some factor that’s actually tied to the company’s financial health. What’s a better way? Rob suggests evaluating companies based on how big they are instead (if you’re scratching your head, thinking “size” is the same as “market cap,” this is the episode for you). Is this method really better? Well, Rob tells us it beats market cap weighting by 1-2% compounded. Then Rob gives us an example of just how destructive market cap weighting can be: Look at the #1 company in any sector, industry, or country – you name it – by market cap. Ostensibly, these are the best, most dominant companies in the market. What if you invest only in these market leaders, these #1 market cappers, rotating your dollars into whatever company is #1? How would that strategy perform? You would do 5% per year compounded worse than the stock market. Now slightly tweak that strategy. What if you invest only in the #1 market cap company in the world, rebalancing each year into the then-#1 stock? You’d underperform by 11% per annum. Meb then moves the discussion to “smart beta.” Why is Rob a fan? Simple – it breaks the link with stock price (market cap), enabling investors to weight their portfolios by something other than “what’s popular.” But as Rob tells us, there are lots of questionable ideas out there masquerading as smart beta. The guys then dive into valuing smart beta factors. Just because something might qualify as smart beta, it doesn’t mean it’s a good strategy if it’s an expensive factor. Next, Rob and Meb turn their attention to the return environment, with Rob Arnott telling us “People need to ratchet down their return expectations.” All of these investors and institutions expecting 8-10% a year? Forget about it. So what’s an investor to do? Rob has some suggestions, one of which is looking global. He’s not the perma-bear people often accuse him of being. In fact, he sees some attractive opportunities overseas. Next, Meb asks Rob about the idea of “over-rebalancing.” You’ll want to listen to this discussion as Rob tells us this is a way to amp up your returns to the tune of about 2% per year. Next up? Correlation, starting with the quote “The only thing that goes up in a market crash is correlation.” While it may seem this way, Rob tells us that we should be looking at “correlation over time” instead. Through this lens, if an asset class that normally marches to its own drummer crashes along with everything else in a major drawdown, you could interpret it more as a “sympathy” crash – selling off when it shouldn’t; and that makes it a bargain. Does this work? It did for Rob back around ’08/’09. He gives us the details. There’s way more, including viewing your portfolio in terms of long-term spending power rather than NAV, the #1 role of a client advisor, and even several questions for Rob written in by podcast listeners. What are they? Listen to Episode #18 to find out.
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Links from the Episode:
- Research Affiliates
- RA Twitter
- The Fundamental Index: A Better Way to Invest – Arnott
- CommonFund
- A few Arnott papers on SSRN
- Rob Keynote at UCLA
- Meeting of the Minds
- Too Big to Succeed – Arnott
- The Biggest Urban Legend in Finance – com
- Selection Bias – Arnott
- Why You Should Invest Based on Sustainable Spending – Arnott
- Sustainable Investing in a Low Return World – Arnott
- Why You Have Way Too Much Invested in US Stocks – Faber
- Lots of RA publications can be found here, and a short list is below:
- Mind the (Expectations) Gap: Demographic Trends and GDP¹ – Arnott
- Research Affiliates Asset Allocation Module – RA
- To Win with “Smart Beta” Ask If the Price Is Right – Arnott
- Beware of Rising Valuations in Smart Beta – RA
- How Can “Smart Beta” Go Horribly Wrong? – Arnott
- Rip Van Winkle Indexing – Arnott
- Are Stocks Overvalued? A Survey of Equity Valuation Models – Brightman
- Woe Betide the Value Investor – Hsu
Running Segment: “Things I find beautiful, useful or downright magical”:
- Rob – Next year’s eclipse
- Meb – Board games for kids
Read the transcript here.
