This Tuesday, I was fortunate enough not just to attend, but to be invited to speak, at the Ritholtz Wealth Evidence-Based Investing conference in New York City.
The team at Ritholtz (Barry, Josh, Mike, Ben, Bill, and Joey) put on a fantastic conference. True to their evidence-based mantra, the conference did not have a single market prognostication or discussion of economic outlook. Rather, panels were filled with engaging discussions with real, actionable takeaways.
Here are the 4 big lessons I walked away with…
Behavior is everything
If there was a single theme of the conference, it would be behavior.
Some panels discussed how behavior was the source of alpha. Others discussed how behavior ultimately dictated client performance. Some panels even discussed how we can control our own behavioral biases to protect client interests. To quote Ben Carlson, “part of the beauty of a 60/40 is that there are fewer knobs to fiddle with.”
The takeaway: the theoretical optimal portfolio and the ideal behavioral portfolio are different beasts. For a client to have long term success, they have to be able to stick with their plan first. (We agree.)
You don’t have to play the game
In his keynote, Charley Ellis espoused on the difference between playing to win and playing to lose.
Using a tennis analogy, Mr. Ellis explained how the Williams sisters play to win by creating points against their opponents. Mr. Ellis claimed, on the other hand, that he plays to lose: he gives points to his opponent by hitting the ball into the net, hitting the ball out of bounds, and double faulting. Knowing whether you are in a game that you can play to win or play to lose is a key difference in deciding whether you want to play at all.
To paraphrase Ben Carlson, “you have to hold the mirror up and ask, ‘do I actually need to create alpha?'”
This is an important question to ask, given that almost every panelist agreed that actually achieving alpha was a painful process. To quote Wes Gray, “Everything that works has to suck.” Strategies that work well over time require periods of pain. (We agree.)
The takeaway: client goals and the pursuit of alpha are not necessarily the same thing. Sometimes the best choice is simply to not play the game.
It isn’t passive vs. active: it’s cheap vs. expensive
Meb Faber was the first to say it at the conference, but it was a consistent theme: active and passive is a meaningless distinction. What investors should focus on is how much they are paying and what they are getting.
Wes Gray agreed with Meb, claiming that price has to be viewed relative to value. A 20bp closet indexer may actually be more expensive than a 100bp highly concentrated, non-scalable portfolio. This echoed Charley Ellis’s earlier quote that investors should ask first, “what am I buying?” and then ask “what am I paying?”
Even, Bill McNabb III, CEO of Vanguard, echoed these sentiments in his fireside chat. He claimed that Vanguard’s distinction had never been active vs. passive, but always that cheaper would be better for investors in the long run. After all, 1/3rd of Vanguard’s assets are in active strategies.
(Side note: When asked about how Vanguard chooses active managers, Bill said they take a long-term outlook and are willing to overlook short-term underperformance. He then mentioned that he enjoyed our recent commentary on the topic, Outperforming by Underperforming.)
The takeaway: Active versus passive is a fallacy, and investors should focus not just on what they are paying, but what they are paying for.
Information can influence behavior
Dan Egan relayed a story about how portfolio visualization can dramatically influenced the behavior of their clients.
Originally, Betterment displayed portfolios at the holding level. Using ETFs to build portfolios, they utilized several ETFs to represent different cross-sections of the U.S. equity market, but only a single ETF to represent foreign developed equities. This led many clients to question why they held such a heavy allocation to foreign equities.
So instead of showing the ETF level, Betterment decided to perform a look-through and show the effective country weights. Now instead of seeing a single ETF for foreign developed equities, clients saw that they were diversified across many countries. However, now all the U.S. equities were aggregated, causing the U.S. equity position to look outsized, causing clients to ask why they were so heavily allocated to U.S. equities.
Same portfolio, different visualization, different behavioral result.
Dan also explained how they moved away from showing security-level performance and now only show portfolio-level performance. Their argument is that the portfolio is designed to be a whole, and that a security-level performance gets clients focused on the wrong result, ignoring the first-order effects between securities that make the whole greater than the sum of the parts.
The takeaway: Rethink about how you look at your portfolio and its performance. Avoiding itemized performance may help investors stick with holistically designed portfolios.