#4 – Ben Reeves: Institutional vs. Retail Investors, Alternatives

0:06Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry investment and market insights. We define insights as concepts that are counterintuitive, widely misunderstood, or underappreciated. In other words, unique ideas that you probably won't hear elsewhere. I'm Alex Shahidi, the host of the podcast and co-CIO of Evoke Advisors, one of the nation's leading investment advisory firms. Learn more about our show at insightfulinvestor.org.

0:43Today, we're joined by Ben Reeves, the CIO of Wealthsimple, one of the largest managed investing platforms in Canada, and I guess one of the fastest growing as well, with over 20 billion in assets in about 10 years, and over 3 million Canadian clients. Thanks for joining us today, Ben. Thanks, Alex. Really happy to be here. Why don't we kick it off with just a summary of your background and what led you to this industry. And if you could highlight any interesting or unique segments of the path that you've traveled, I think that would be most interesting. Sure. Yeah. I had a bit of a unique, unique path in the industry where I started really in asset management at Bridgewater about 10 years into my career.

1:29I'd always been interested in investing, but had done a tech startup and consulting prior. But then I went to, after going to grad school for a policy and And business degree was sort of always interested in asset management and wanted to try my hand at it. And so Bridgewater took a chance on me and I was able to work there in asset allocation and the client service group, kind of working with institutional investors on asset allocation issues. And also like over in the group that oversaw the portfolios on a daily basis. So, you know, I was at Bridgewater about five years and got to see like a really tremendous education and had a lot of great mentors.

2:06One of the nice things about that place is people really take the time to teach it in a first principles way. But when I was at Bridgewater, I also discovered towards the end of my tenure that my kidneys were failing, which made it, as you can imagine, very difficult to work or really do anything. So I had to take some time off and get a transplant. I tried to go back, but it didn't really work. As you can imagine, it's a pretty intense environment and I couldn't really make it through a day. Bridgewater was really wonderful and helped me through that, but it ultimately wasn't the right fit for me.

2:43And then so as I was starting to get back in the workforce, starting to figure out how can I start reengaging with the world again, I knew someone early from WellSimple and they were looking for part-time investing help. I joined probably three or four years into the journey for Wealthsimple, and they had had a lot of growth, but then were thinking, okay, we're getting to a certain scale. Let's professionalize certain functions and let's build out a real investing practice and investing team. So I was lucky enough to be able to start from scratch at Wealthsimple, which has been a really fun journey since then.

3:22So when you started, do you recall how big they were and how many clients they had? We were about under$2 billion in assets. I don't remember the number of clients, but significantly, significantly smaller. We'll do a couple of months now of our total AUM back five years ago or so. That's pretty amazing. And is your health better and you're in a better place now? And obviously, I mean, I know people who worked at Bridgewater, the largest hedge fund in the world. and being fully healthy is hard to work there, let alone having health challenges that you have to overcome. So hopefully that's been improving.

4:02Yeah, the transplant community and how it all works is really, it's really an incredible gift to get. You sort of lose everything and you're able to come back through that and you have a lot of people to help you, but I'm doing great so far. Good, good. Really glad to hear that. You know, so Bridgewater and Wealthsimple are almost like two ends of the spectrum in terms of, you know, one end you have, you know, really large, super sophisticated institutional investors, maybe the most sophisticated in the world. And on the other end, you have the average retail investor. What are some of the similarities and differences that you've observed spending time deeply involved in asset allocation at Bridgewater and as CIO with the retail investors?

4:56I think in a lot of ways, it's very structurally similar. I think in two important ways. One way is both are trying to accomplish something in the real world. You have inflows, you have some spending goal in the future or in the case of pensions or endowments currently. And you're trying to take risk in a way that manages inflows to sort of what are the outcomes in the world you want to have. And that that structures a lot of the asset allocation problems. So in that way, it's very similar. It's also very similar in some of the governance and agency challenges that you face. And I think that creates a lot of different asset allocation decisions in the industry.

5:39Just given the randomness, it's really hard to assess the quality of an investment manager. If I like a shirt or if I buy another shirt, it's probably going to be pretty good if it's from the same company. Whereas if an asset or asset class is doing well, it's actually maybe more likely that that asset class isn't going to do as well in the future. And similarly with active managers. It's really hard to sort of make prospective judgments about how things will go in the future. And I think both institutional investors or many institutional investors and many retail investors, they deal with that by having pretty tight benchmarks to a conventional portfolio.

6:24And that's, I think, huge pressure of individual investors to be conventional and also with institutional investors, right? Because you ultimately do have boards of directors that are kind of implicitly benchmarking you to the local equity index and so on. So a lot of that feels very, very similar. And then even behind the scenes at Wealthsimple, we've constructed a sort of a representative institutional investor. And we kind of track deviations and track mirror and so on for that investor. So it feels very, very similar in that structural sense and sort of how do you approach investing as a professional manager.

7:08But then I think in terms of what are the range of things you can invest in, it gets pretty different. I think for a couple of reasons. And one reason is it's just it's way harder for individual investors to assess strategies, pick managers, you know, figure out. And even once you see performance, as you're talking about, like figure out, you know, is the thing actually performing in a way that's helpful for me? Or is it a risk that I'm running that I don't really want to run? whereas institutional investors can do that more and make sure that their managers are operating with a mandate and they have a portfolio construction philosophy.

7:50So I think that's where it really deviates is what sort of risks can you take on and what's the legibility of those risks to the investor versus just a single return stream. But I think in both cases, It puts a premium on sort of high return to risk active strategies, you know, like sort of high information ratio in jargon, as opposed to your highest return to risk ratio of the overall portfolio. And then so I think as you communicate better, or if you can really work on these governance or trust or agency problems, there is a lot of room to improve outcomes relative to what's conventional, just because of these sort of structural things that are part of the industry.

8:37You know, I mean, an institution is a committee or a board, and those are made up of individuals, right, who are themselves, you know, retail investors in many cases. so i guess the the big difference in terms of structure is in one case you have one person dealing with their own money in the other case you have a group of people dealing with with somebody else's money and then also like the the board will it's like the same problem that the board will be able to take a little bit more time and understanding a process and a strategy you know as opposed to an individual investor where you're sort of seeing something on your phone when you're taking care of your kids or you know that there's a lot more a lot less focus and process.

9:16But yeah, I think that that's right. And that creates a lot of the governance issues. Right. And then is your sense of the sophistication level, I think the assumption is institutional clients are more sophisticated than retail investors. And that may be true. So first off, do you think generally that's accurate? And then second, what is it about the sophistication level that you think it differentiates the two? I think that it is accurate simply because you've had, you know, you have people who are doing it professionally. It's, it's your discipline. Uh, and, and, you know, you of course learn things when you, when you apply yourself to something and try to compound over time.

9:58So, uh, it is very, uh, it is different. Um, and I think for, uh, but the one thing that's very similar is that the things that ultimately made you successful probably both as an institutional and as a individual investor is just following your governance process, following the thing that you set out in advance that you're going to do, following your plan. The thing that individual investors get stuck on is, do I really want to keep depositing if the market's gone down? And institutional investors, they have their funding plan that's probably already established. But then it's, do I believe the asset allocation after, say three, five years, and then the pension funds, there's a lot of evidence that they do sort of act like individual investors in some of that performance chasing.

10:49But then I think for more interesting or sophisticated strategies, it's easier for individual investors to invest in things where there's a story or something that's very intuitive that you can understand, which means I think alternative asset classes where you're investing in a company either through debt or equity or real estate is a lot easier to understand and believe in and buy. As opposed to, say, a quantitative strategy that might help your return to risk ratio more. But then every strategy, even if you're at a 2.0 return to risk ratio, is going to underperform sometimes. And that's very, very hard for individual investors to deal with if you don't really understand what's happening.

11:39Whereas with institutional investors, there will be a governance process. They will have expectations for managers and a certain range of outcomes they expect. And that's really pretty well understood, I find. One of my experiences over a couple of decades is, in many cases, emotions drive decision-making for investors. Oh, in life, everybody. Yeah, exactly. All decisions, yeah. That's right. And I feel like the emotional investor generally is not a great investor. And it's because of what you said earlier, which is markets are cyclical, managers are cyclical. We're taught early on buy low, sell high.

12:19and most people will buy high and sell low. And it's because emotions drive you to do that because in all other parts of your life, you sell the underperformers and you buy the outperformers. And so is your sense that on the institutional side, because there's more process, that they're less prone to making emotionally driven decisions that may be a mistake than individual investors? or how do you think about kind of that difference? So what I see and what we see now in our client data and individual investors who are asking us to manage money for them is that if there's market stress, they don't withdraw.

13:00They just don't put new money into the market. And that's a very emotional thing. And then they wait for a rally to put money into the market. So I think that there's some belief. There's a lot of folk belief in the risk premium, right, for kind of the vocal heads of Vanguard school of investing. And I think to some extent people know the right answer is to stick with it. They just don't want to put their new savings into the market. Where, you know, if people are trading on their own, they're much more likely to totally do a risk after you see. And that's also what our data suggests. Totally do a risk after you see a drawdown.

13:40On the institutional investor side, yes, there's a process. But I think it also just takes longer for that emotional process to play out as an institutional investor. And I'm more basing this on academic research as opposed to my firsthand observations. I kind of wasn't in it long enough to do that. But you do see the same things of, but it's more like a five-year time horizon where you start to see the performance chasing. And that's ironically like really the mean reverting time horizon that you get, right? It's five years. But it's also very understandable that this thing hasn't worked for five years.

14:16Why do I think it's going to work now? And then there are probably matters of degree that will depend on type of investor and what your emotional makeup is and so on. To me, that's one of the more fascinating parts about investing is the behavioral side of it. Because if you think about it, what you earn isn't what the returns you see on paper are for each strategy. It's what we call the dollar way to return. It's the return you earn for the dollars you put in and dollars you take out and the timing of doing that. And just in my experience, most people end up buying things after they've gone up, whether it's a manager or an asset class, and they sell them after they go down.

14:58And over time, they do worse than if they just stayed the course the whole way. And so one of the challenges that I always face is fighting that emotional pull to do the wrong thing at the wrong time. even though it's extremely counterintuitive. Because basically everywhere else in life, if something is done poorly for five years, that's very predictive of its future results. And despite all the warnings of past performance is not indicative of future results, I think just about everybody ignores that. And what I found is more sophisticated investors make more educated excuses for why past performance is predictive of future results.

15:40uh, you know, so it is, uh, I don't know if you've experienced something like that as well between the two. I think that also even expensive, expensive, like the social psych research about partisanship, right. And then the, it's not like smarter people are less partisan. They just come up with better reasons for, you know, for like wide support gun control or don't or whatever, really interesting studies about that. One of the things I learned at, at Bridgewater is, uh, when you're constructing a portfolio, you want to take those thoughts and emotions you have and turn them into math, which then I think really helps structure the problem, right?

16:15I have this view, okay, you know, what's the ratio of that view? What's the probability of being right? I have a strategic asset allocation, okay? If I do like this view, how much do I weight it? And it's a long and a short position. And I think going through that process, even if you think you're wrong that you have an edge, that does manage the risk somewhat in a way that if you're an individual investor, you're not quite this kind of rigor and process where you're not thinking in those terms and it's a little harder to manage. Right. So when you're designing asset allocation for a sophisticated institution versus the average retail investor, obviously neither one are computers.

16:59They have biases. And I think a lot of that is predictable and understandable. So how do you conceptually, before we get into the details, how do you conceptually think about constructing an optimal portfolio for one versus the other? For the individual investor, you start with a goal of wealth building, right? And so for the of investors, it's mostly about saving, right? And saving means growing your top line, not as much as your expenses with your time doing something that's more valuable for the world or something that's paid is more valuable for the world. And that's sort of by far the most important thing that you can do.

17:40So we spend a lot of time on that. And then we sort of model that into the asset allocation. And you do that by just educating them about, this is the thing that really moves the needle. This is something you actually have control over, whereas markets you have less control over. So it's just education. Exactly. And then the thing that they're interested in at the time, you always have the same punchline, right? That there's a risk premium for risky assets over cash. But you take that thing that's really interesting at the time that they're thinking about and package whatever they're interested in learning about, but keep that message going.

18:15So recently, we've been talking a lot about cash, right? What is it? What's the role in the portfolio? How does it work as an active strategy? How does it fit into an asset allocation, if at all? But then the punchline is still there's a risk premium for risky assets over cash. 2021, we're more talking about don't get too excited. Keep rebalancing. You don't need to chase tech stocks. But keep putting your money into the market. but it kind of seemed, and you get, say, 4 % to 5 % over cash for your equity portfolio. But in terms of how we then set up the portfolio, it's money in, money out, right?

18:54That's the most important thing. And then it's really putting your money at risk in, I think, any reasonable portfolio, right? Like that's important. Even if you're just getting an equity risk premium, that's much better usually than putting your money in cash over most time periods of matter to investors. And then finally, you think about, okay, how can I manage this range of outcomes for investors? And so we think about the timeline that they have and then the kinds of ways that it can go wrong. So you think you're with risk premium, you're probably gonna do fairly well, but then if you're overly concentrated in anything, that can really, that gives you a bad tail of outcomes, right?

19:36Right. So for most part, and we're trying to balance those two things. Right. So trying to balance making sure you stay believing, making sure you keep putting your money at risk, but also trying to manage those 10, 15 year periods or even 20 year periods where the, say, a domestic stock market can can underperform. And so what we the way we do that is we just have a few different ways of diversifying. We use asset class diversification. We use geographic diversification and some style diversification. kind of describe them as each and then put together a portfolio that we think has a kind of better chance of consistent 10-year return, say, for our investors with a long time horizon, which is a lot of our client base, right?

20:20A lot of our client base is in your 30s saving for retirement. So do you find that challenging to do? Because conceptually, it sounds pretty obvious, which is if you want to get reasonably attractive returns over time with less risk. You just own a bunch of different return streams that are different from one another, but individually attractive. So conceptually, that makes sense. And the math is bulletproof. But in practice, when you ask somebody how the market is doing, they talk about the stock market. And so the reference point is the stock market. So if you have a portfolio that's more diversified than the stock market, even if it gets the same returns over a long period of time, you're going to zig and zag at different times.

21:01And when the reference point is something that is more volatile than your portfolio, you're going to be disappointed maybe half the time or so. So how do you think about all of that? Well, I think the other thing is when you're managing our managed platform, we have hundreds of thousands of clients on our managed platform, right? And that's a huge mix, right? A lot of people just aren't paying attention, have no idea. They hear from me once a month, look at their balance occasionally, and just trust us to manage their money for them. And that's where you feel the real responsibility to generate the best risk to return portfolio that you can, right?

21:39Because they're just giving, here's the money, I'm going to keep investing. But then you have this other group of investors who are doing the thing that you said. And if you have one model, you're trying to balance between those two extremes. And so we do it in a couple of ways. One, we just use a sort of a standard reference and tracking error model, and we allocate risks to different ways of deviating from a reference portfolio. And I think the other thing we do is just spend a lot of time on communication. And all of that communication is focused on just being useful to investors to help them do the right things at the right times.

22:20And I think that's sort of how we're trying to balance that tension. Yeah. In my experience, the clients and the investors who are the least involved tend to do the best. And the ones who are more involved tend to buy high and sell low more often than the ones who are less involved. And I think it's because the more involved you are, the more prone you are to the emotions driving your decision making process. And as we talked about earlier, oftentimes that's like the wrong thing to do at the wrong time. And so it sounds like you almost have to communicate to ward off the ones who are more involved from doing the wrong thing at the wrong time.

23:04Is that generally how you think about it? Yeah. And even the ones who aren't involved, they'll still see their portfolio go down and maybe they're more absolute return motivated as opposed to relative. And that's another thing you have to manage, right? And actually, and then the third dimension that's hard to manage is if you are doing a portfolio that's managing skew or downside, you're trying to make, in some ways, your arithmetic return be sort of close to your compounded return or above. But if the implicit reference is like a highly volatile portfolio with a high arithmetic return, you're going to have more years where you're going to sort of struggle with that relative performance.

23:41So I think that's the third dimension is the relative, particularly if you're trying for more consistent returns. But I think we're basically trying to manage that balance, trying to manage the drawdown issues as well as the performance chasing issues. And it's sort of a mixture of portfolio construction and the communications. And then we have a team of advisors, so we also just offer different portfolio options. So if you are truly a benchmark-driven an investor, we will give you a very conventional portfolio, back to that hierarchy of ways we can add value, right? A lot of it is just putting your money to work in a reasonable way.

24:26It's a totally reasonable portfolio and go from there. And so communication is a big part of your responsibility and the value add to your investors. How do you think about effectively communicating? Because people are different. They absorb information differently. They're different experiences, different levels of sophistication. So how do you think about effectively communicating to 3 million plus people? Yeah, and they mostly take in information differently than I do, right? And so I've had to learn that. And we actually have a great team of people who specialize in it. So I have an editor who used to work at a men's magazine.

25:09He's sort of really good at shaping things. So what we think of is you're probably not paying that much attention. We have you maybe once a month to pay attention to us, and we want to give you a message that you're going to get and is something that's useful to you in a way that you'll sort of immediately understand and you can read on your phone. And so what that means is we'll do a message with one message, something that is just focused on being helpful and improving your outcomes. and we're trying to get it down to like you can get the whole point in a picture or a graph and that that's sort of a bar that we that we hold it for doing our job really well that's the bar so like at the end of third quarter our graph was a cone chart or a range of outcomes chart and then we sort of showed how things have been going over well simple as inception you could see the drawdown the recovery and then the third quarter wasn't a big deal That's the thing that you saw on your phone.

26:08This last month for end of year, we didn't do a market outlook. We pulled flows data into stock ETFs and overlaid it with stock market performance, cut it up by the major segments of the market. And you get this gap two smile for the flows, but really no flows from the point of the rebound in the market in June of 2022 until the fourth quarter this year. Uh, and, but you see that in the kind of viscerally in the chart. And then we're asking, okay, like reflect on your risk tolerance and what you've been doing. Um, but really focus on that. If I see that chart, I'm going to get basically the message.

26:49So obviously simple, right? Wealth simple, keep it simple, but sophisticated. And it's kind of that, that marriage that is really hard to do, right? To take, to take a complicated concept and put it into one picture or one page is a lot harder to do than to write a whole paper about it. But it's a lot more effective when it's shorter because you have limited attention span. Is that generally how you think about it? Yeah. And it's just respectful to people about how they want to receive information, how much they're willing to put in. And then you're just trying to really, really laser focus on trying to be useful and get a lot of feedback and make sure that you're useful, which isn't that different from writing a white paper for an investor that really wants a white paper.

27:31right and and it's institutional you're thinking about that as well right how does this person want to receive information what is the portal like what are the dynamics sort of very similar in um in investing um the other thing we do in communicating is beyond that for the for the clients that do want to go deep we show up once a month on a webinar uh present on a topic start at a high level go deep uh and then we'll just sit there and answer all their questions so like for the clients who do really want that engagement then there's not many of them so it actually it still scales over hundreds of thousands.