Episode 346 - Hendrik Bessembinder: Why It's So Hard to Beat the Market

25:03So just take that into account. So I know you don't want to give investment advice, but maybe you can educate us instead. So between these two potential interpretations, diversification is very important, of course. And then you talked about it may be possible to hugely beat the market because of that skewness with a concentrated portfolio. Which view do you think investors should take? So I really do think it depends on the investor. And I can't read people's minds, but I really think for most people, the traditional advice, diversify broadly and be a long-term investor as opposed to trying to time the markets.

25:38I really think for most people, that's good advice. Who would want to deviate from that? If you have really strong taste for skewness or you're pretty confident you're skilled, or I should throw in the mix, or you're confident you can identify managers that are skilled. I will throw in there that I do think there are skilled portfolio managers out there. The challenge is identifying them in real time. Yep, that's exactly it. You reference in your paper, Burke and Ben Binsberg in 2015 and FAM in France 2010, that both look at different interpretations of why it's so hard to identify winning managers before the fact.

26:12Yeah, there's a lot of randomness in the market. From a statistical viewpoint, the problem is the signal-to-noise ratio is not high. Fama and French have done some calculations of how many years of data would you need to use statistics to identify a skilled manager. So there's some real challenges there. I'll just throw in that I don't rule out using more subjective measures to try to find skilled managers. It's going to be a challenge. But to put it in a different context, I believe Warren Buffett has said that when he invests in companies, to a certain extent, he's investing in the management team at those companies.

26:47I think there's a corollary in looking for investment managers. Yes, there's their track record, but the signal-to-noise ratio is not high. What do you think of these people? I think that matters too. Yeah. The Birkin Van Binsbergen paper and Birkin Green talked about how once the market knows a manager is skilled, they're going to flood them with capital up to the point that their skill doesn't benefit investors. But if you can find some characteristic that the market is undervaluing, I think, I don't know if it's Jules or Jonathan Andrews, but some combination of those guys had a paper on managers with foreign last names.

27:18Then they have better performance because people under allocate capital to them, even though they're skilled. I think that's right. And my colleague, Dennis Sassura, has a paper about fund managers from working class backgrounds. And if I remember the punchline, it was that there's also some outperformance there, perhaps because they're not members of the social network. These are interesting twists, but it just brings back the point that it's competitive out there. Trying to spot a misvalued security, well, there's a lot of other smart people trying to do it. Trying to spot the skilled manager, there's a lot of other smart people trying to do it.

27:50So we talked about this paper that blew everyone's mind based on U.S. stocks, a pretty long sample of U.S. stocks. We've also done a paper on global stocks. How do the results compare if we look at global data? After I did the first paper, this was just an obvious next question. So with the help of some co-authors, I was able to get a pretty broad global sample. It wasn't as long. It was only 30 years of data as opposed to the 90 that I originally had for US stocks. But it was enough to get the answer. The same phenomenon exists in global stocks, but even a little stronger. And maybe we shouldn't be surprised that global stocks are a little more volatile in the short run.

28:25And that translates to a little more skewness in the long run. It's a global phenomenon. And I can't forecast the future in the sense of telling you which stocks are going to be in the right tail. But at this point, I feel really confident saying skewness is an essential feature of investing in competitive markets. And you're going to see it everywhere you look. If it's a less volatile market, you'll see less of it. If it's a more volatile market, you'll see more of it, but you're going to see it everywhere you look for long run returns. And you just touched on this, but what do you think explains the stronger skewness in global stocks compared to US stocks?

29:01I think it's mainly that there's a little more volatility there. We can dig a little bit further into where the skewness comes from at a more mechanical level, if that's useful. Once you see where it comes from, I think it also follows intuitively that if there's more volatility, you get more skewness. As I said earlier, in principle, there's other things that can also contribute, like if you had long run momentum. But I think at a practical level, that's not really where it's coming from. It's just Volatility in the short run gives you skewness in the long run. What's the expansion on that? You said we could go deeper mechanically.

29:32Let's do it. Sure. So the first thing is just take things at the really big picture level. As long as we have limited liability, the downside, we can't do worse than negative 100%. But on the upside, there's no hard cap. In terms of the symmetry, we certainly can do more than plus 100%. And many stocks do more than plus 100 % in the long run. So just limited liability alone gives you some indication of where the skewness is coming from. But you can also get it from the mechanics of compounding. So if you're very with me for a numerical example, but it really drives it home. So I think it's the simplest possible numerical example.

30:10Let's just say there's two possibilities. Your stock will go up 10 % or it'll drop 10%. And then we're going to consider running that two times in a row. So let's think about what the possibilities are. You could get lucky and draw 10 % twice in a row. But with compounding, that's not 20%. That's 21%. So anyway, that's one possibility. You could get 21%. All right, you could get unlucky and you could draw the negative 10 % twice in a row. But with compounding, that's not negative 20%. It's negative 19%. So you can already see some asymmetry. Two good draws in a row gives you a bigger outcome than two bad draws in a row.

30:51And now to finish out the whole thing, the other possibility is you get one good draw and one bad draw. So you're up 10 % one year, down 10 % the next year. And that can be in either order. But again, with compounding, 10 % up, 10 % down doesn't give you zero. 10 % up, 10 % down gives you negative 1%. So that's a simple example, but it already captured every feature. The upside is bigger than the downside. And if you don't get momentum, that is, you don't get a good followed by a good or a bad followed by a bad. If you get reversals, you actually slightly lose money. That simple example gives all the essential features.

31:32The upside is bigger than the downside. And there's going to be a lot of outcomes that are a little bit below the average or somewhat below the average. Awesome. I'm glad we dug into that. If you want to see the effect of volatility, just take that example. Instead of doing it with 10 % up or 10 % down, do it again with 20 % up or 20 % down. That's more volatile. You'll see the effects get bigger. So anyway, that's it in a nutshell. So a lot of financial planners listen to this podcast. Mark and I are ourselves financial planners. What do you think the practical implications of this research are for financial planning?

32:04The biggest single thing is don't focus just on the mean. The mean is really important. And there's a lot of debate for financial planning purposes. Should we assume a mean risk premium of 6 % or should we assume 7 % or should we assume 5 %? I mean, that's really important. People debate it. They should debate it. But if the expected return is 6%, and this is a little bit of a techie point, but hate to say it wrong. If you know that number, you can compound it out and say, here's the mean of my wealth distribution. Just assume buy and hold here. You can compound that out and say, here's the mean of my wealth distribution.

32:40Okay, fine. But the thing is, there's a lot of skewness, both uncertainty and skewness. Probably you won't end up at the mean. You might end up higher, you might end up lower. But with skewness, it's not 50-50. It's much more likely that you'll end up lower than higher as compared to your mean. So the biggest thing is don't just focus on the mean. A lot of financial planners will have already done this even without any prodding for me. But to me, the simplest thing is think about the whole distribution. Think about the whole range of outcomes. But the simplest way to do it is with some simulations.

33:13And I'm sure lots of financial planners have already done simulations. But if you do the simulations or you've already done the simulations, you're going to see that most of your outcomes are below the mean. You can see where the median is. You can see the whole distribution if you just run some simulations. Is that just a simple Monte Carlo simulation? How would you approach that? Simulations could be simple or complicated. The simplest thing would be what you refer to a Monte Carlo simulation. And assuming that each draw is statistically independent of prior draws, that would be the simplest thing.

33:42And that would be enough to see the main points. If you just said, look, I think I'm going to have a risk premium of 6 % per year, have volatility of 20 % per year, whatever you think is the right number. Just simulate it out for 30 years and see what the distribution looks like. That would make the point. But then, of course, you might say, well, can't we be more realistic than that in our simulations? And of course, there's room to run with that for a long time. But as soon as you do the simulations, you'll see the essential point that focusing on the mean is missing a lot. Yeah, I'm laughing because I've played with adding mean reversion to simulations and stuff like that.

34:14But most, you can do that in Excel. Most financial planning softwares, though, are not built to handle that kind of thing. So a little tricky. I didn't know that the software is mostly not built to handle it. What that says to me is people need to be thinking more about these things. I agree with that. We've talked about this already. I'm going to ask one more time just to make sure it's really driven home for listeners. What are the main practical implications of this research for investors? Well, I think we touched on it, but again, to drive it home, don't focus entirely on the means. Give thought to the fact that there will be skewness in long run outcomes and that most likely you'll be below the mean.

34:50and for financial planning purposes. If you're going to focus on a single number, maybe the median is more informative than the mean, but try to think about the range of possible outcomes. That's the single biggest thing that comes out of it, I believe. I said range. That's a statistical term that's more limited than I meant. Try to think about the distribution or all the possible outcomes. Yeah, it makes sense. I appreciate the precision on language. Okay, I'm going to move on to another paper that was also super interesting. It's which U.S. stocks generated the highest long-term returns. The first question is the title, which stocks in the US market have delivered the highest returns to investors?

35:25I do want to actually say that you answer this question multiple different ways in the paper, because there are a lot of different ways to look at it. I'll leave it open to interpretation, how you want to answer the question. Yeah, sure. Part of it is, what do you mean by long-term returns? I have at this point, I think, 96 years, 97 years of data to work with from the CRISPR database. So one way is to say over the whole 96 or 97 years, who delivered the highest return? The answer there is Altria Group. And it is a mind-boggling number when you actually compound the returns. So I don't have the exact number in front of me here, but it's in the vicinity of 250 million percent.

36:03It's just a crazy high compound number. But on the other hand, somebody might say, well, that's odd. I thought it was an NVIDIA. Well, NVIDIA actually is at the top of the list if you don't measure things over the whole 95 years. So NVIDIA has been there, I don't remember the exact number, 25 years or so. NVIDIA has the highest compound return of any stock over at least a 20-year period. But since they only have about 25 years or so, it's not as big as the ones that have been there the whole 95 years. So, you know, answering the question does require saying, well, how long does a stock have to be in the market to be eligible to be included on the list?

36:43And it makes a difference. I think I read once, I don't remember when or what the time period was, but there was a point where Domino's Pizza was actually the highest compounding stock in history, more so than all of these tech giants and stuff. Totally anecdotal. And I saw a chart of it somewhere and I don't remember again what the timeframe was, but it was just one of those things where it's like, yeah, it's not always the stocks immediately come to mind that are the biggest winners. Yeah. And another point of perspective is, do we want to focus on the compound return, the buy and hold return?

37:09Or do we want to focus on the annualized return, which again, if we want to be precise in our language, would be the geometric mean, annual return. And if you don't say, well, let's look at stocks that were there for at least 20 years, if you look at shorter periods, you can find some stocks with crazy high returns. And so I don't remember Domino's in particular, but you can find stocks with returns a thousand percent per year for a year or two. One of the lessons of the paper is that those crazy high returns never persist over long periods. As a matter of fact, among the stocks that were at the top of the all-time leaderboard, that is their buy and hold returns over the 90 some odd years were the highest.

37:47Those were mostly stocks that were actually there for 70, 80, 90 years. But if you look at their annualized returns, they were good, but they weren't crazy good. They were more like 13, 14, 15%. And do you see any relationship between the type of company or industry and earning high returns? In the particular paper we're talking about, I didn't dig very deeply. I do have another paper that can be found on SSRN that goes to the question of which industries end up in the right tail. In that paper, I basically did things decade by decade. And I said, okay, what hundred stocks ended up in the right tail for this decade?

38:23and there might be a tendency to think it's consistently technology stocks that are over there because if you look at the actual lists I've put together, you'll often see a lot of tech stocks near the top of the list. But I did not find that tech stocks were disproportionately likely to end up in the right tail. Another way to put that is there's a heck of a lot of tech stocks that ended up in the left tail that we've all forgotten their names. So it's not as simple as tech stocks are the stocks that are there. I'll even go further and say it's not necessarily even what you'd call a sexy stock.

38:54So let me take a particular example. On that list of stocks that deliver the highest lifetime compound returns, Saltreya Group's number one. Many of your readers will understand that's a tobacco stock. Don't blame me. I'm just the messenger. But number two on the list is a company called Vulcan Materials. I didn't know what Vulcan Materials was. I had to look it up. Vulcan Materials is a company that has products like sand, gravel, and asphalt. I don't want to be pejorative to our friends at Wilco Materials, but most people would not call that a sexy business. But I think it's a really interesting lesson.

39:29I mean, Warren Buffett, among others, have pointed out the importance or desirability for an investor of competitive moats. Competitive moats can arise in a lot of different ways. If you think about sand, gravel, and asphalt, those things are really heavy. You don't move them a long ways. Having those resources in the right locations is a competitive moat. and i think that's relevant to understanding why this non-sexy company ended up performing so well so if there's any lesson it's that performance can show up anywhere maybe you got to look beyond the obvious things like this is a tech firm or this is a firm that's engaged in disruptive technologies okay makes sense to look there but let's take one of my favorite examples i personally think that passenger carrying drones are going to change the world that's my view so if you run with that, you might say, well, let's start investing in the companies that are working in that area.

40:24Maybe so. But again, it's competitive. We're not the first ones to think about this. Also, there's going to be a shakeup. Today's companies, some of them aren't going to make it. And there's the possibility that even if I'm right, 20 years from now, passenger carrying drones have changed the world. It could be a company that we haven't heard of or doesn't exist yet that ends up at the top of the leaderboard. So I don't think it's as simple as go for the glamour companies. It's do your homework. Yeah, we've seen that in lots of industries like, I don't know, electric vehicles recently, where prices shot up for all of them and a lot of them ended up being either actual frauds or there just wasn't much there.

41:00I have a couple of follow-on papers that we haven't touched on, but I created some lists of biggest wealth-destroying companies. You can find a couple of electric car companies on that list. I missed that paper. What was the name of the industry paper? So the industry paper, the name was just something like, do technology stocks dominate? Something like that. You can find it on SSRN. The other one that I referred to was just one of the updates. So I've been updating the papers on a three-year cycle. So there's one that says wealth creation to 2019. Then there's another one that says wealth creation to 2022.

41:32In a while, there'll be one that says wealth creation to 2025. Slight variations on the titles. Okay, got it. But I think you can find what I just referred to was the one that went through 2022. I just found the new technology stocks dominant. I wish I'd found that one. I didn't find it when I was preparing for our conversation. I'm going to read that one though, right after this. I appreciate that. I guess that means I've turned out enough papers that not everybody knows about all of them. There's still room if you're interested. On this, which stocks have generated the highest long-term returns paper, what do you think the practical insights are for investors?

42:06I really think it comes back to this question of, do you want skewness or not? If skewness doesn't get you excited, the arguments are stronger than ever for just diversify broadly. But if skewness gets you excited, two reasons for that. You either think you're skilled or you just like the possibility of the dream. You want to keep the dream alive. If you like skewness, then my paper says, well, diversification reuses skewness. So I think those are the practical implications. All right. One more paper I want to talk about on mutual fund returns, which was super cool to see this paper because it takes the predictions, I guess, from the unison stock returns paper and puts it into what happens in live portfolios when people are actually building relatively concentrated portfolios in an attempt to beat the market.

42:50It's like an empirical investigation of the heat and pulse and a wet paper that says, yeah, this will probably happen. And then you show that, yes, it in fact does. Yep, exactly. This was take the ideas from the first paper to portfolios and not to random bootstrap portfolios, but to actual portfolios that actual fund managers compiled and managed. Yeah. And some of the results are crazy. I'm not going to get ahead of myself, though. I'll ask you the first question I have here. What proportion of U.S. equity mutual funds in your sample outperform SPY? And by the way, I love that you used a live fund as a comparison.

43:23So what percent proportion of U.S. equity mutual funds beat SPY in your sample at the decade horizon specifically? Actually, I think I've got here the lifetime number. It's a 30-year sample, and it's not going to be greatly different. So it's 30%. 30 % of funds beat the SPY. And I'm glad you mentioned that, but I think it's important to compare to a benchmark that in principle somebody could have earned. Anyway, that's why we chose the SPY as the benchmark. By the way, I'll mention here that there's another widely recognized study that goes after the same question, and that's the SPIVA scorecard.

43:57And I'll just refer people to the paper for the details, but 30 % is actually a higher number than what SPIVA reports. If you're curious why that is, I'll refer interested people to the paper. I assume fees? Yeah, I read that part of the paper with interest because your number is quite a bit higher than SPIVA. But SPIVA also benchmarks to the Index Not Too Alive fund. Is that right? I believe that's true, but it's not the main thing driving it. Should we talk about it? Because people might be interested. Can we please? I guess we could. I mean, I think in some sense, the SPIVA people are transparent about it.

44:29They focus on funds that outperform and survive. So they take, say, a 20-year period and they say, okay, during the 20 years, they take the funds that were there at the start of the 20 years. And then they say, did you outperform? Yes or no? Were you there for the whole 20 years? Yes or no? And to be in their number, you have to both outperform and be there for the 20 years. You might not see this coming, but there's quite a lot of funds that outperformed, but were not there for the whole 20 years. That's the difference. Yeah, that's interesting. I'm not sure how the U.S. study is done, but in Canada, I know they also mix in commission-based funds into their sample, which have much higher fees to pay for the cost of advice.

45:10And that drives down the performance just because the fees are so much higher. I don't know how they do it in the U.S. report, though. Yeah, I'm not sure either. They have footnotes that detail their methods, but I can't recall all of them. Yeah, that one's not in a footnote. That one I had to email years ago to ask about their methodology. I don't know if that contributes, but it could make a difference, obviously, if the fees are a lot higher than your sample. Yeah, good. Okay, so back to this paper. How does the average mutual fund perform? If we focus on means, averages, in some sense, I've got the same result that the prior papers have, which is basically that on average, mutual funds turn in slightly negative performance.

45:47They slightly trail their benchmarks. This is something that other people have found too. There is some evidence of skill among fund managers, but not quite enough to overcome their fees on average. When I compound the returns, I've still got essentially the same punchline about what happens on average. But I've been trying to emphasize one of the messages is we need to look beyond averages. And there is skewness in the distribution of compound fund returns. It's for the same reasons that there is in individual stocks. It's not nearly as dramatic as it is in individual stocks for the reasons we've been talking about it, but there is skewness in the distribution and it's enough to matter.

46:25Yeah, that's one of the things that I found so interesting about this paper is that the majority of funds underperform before fees, like gross of fees. That's crazy. It's expected based on what we've been talking about, but it's just crazy to think about. Exactly right. On average, they outperform before fees. But again, the average is not the typical fund. The typical fund underperforms even before deducting fees. That's wild. Now, the other side of that, as we've been talking about, so most funds underperform by number of funds, but are there also some big winners like we see in stock returns?

47:01Yep, exactly. It's not as dramatic as in the stock returns. I'm not going to tell you about anybody getting 250 million percent. We had almost 8 ,000 funds in the study. So among those, there were about 450 that doubled the SPY over their lifetimes, and there were about 160 that tripled the SPY over their lifetimes. And the SPY is a pretty high hurdle during the 30 years we studied, 1990 to 2020, roughly. So tripling the SPY is really impressive. There were some fund managers that really delivered. Of course, we still have the question of, can you identify them in real time, as opposed to looking back?

47:39Yeah, the persistence question. It's a tough one. Yep. And can you hold throughout that whole period too? Yeah. You have to capture the entire period returns yourself and you have to behave well. Oh yeah, that's an interesting point. Maybe we're getting a little ahead of ourselves here because I'm pretty sure you're going to ask me about the$1 trillion number in a minute. So we can maybe jump to that. In the abstract of the paper, we say mutual fund investors underperformed by a trillion compared to the SPY benchmark. which is a big number, striking number, but it's got a few pieces built into it.

48:13So again, we do find, consistent with others, that there's evidence that on average fund managers are skilled, but their fees are bigger than the skill on average. So that's one contributor, fees. There's also, we consider opportunity costs. So essentially, if you paid a 1 % fee back in 1990, That's 1 % less that you had invested as the market had a great three decades. So I'm measuring things at the end of the sample. So we're also picking up opportunity costs on fees. But the third thing that you touched on there, it's partly investors' own fault. Return chasing behavior has not helped. It's actually hurt investors.

48:55And we touched on this earlier. You can compute buy and hold returns. They're hypothetical if somebody had done buy and hold. and the SPY is a buy and hold benchmark. So if this is what you mentioned, Mark, the benchmark is the hypothetical person who bought and held the SPY. In actual funds, people are not buy and hold investors. So you can measure the buy and hold returns, which is the geometric mean, or you can measure this dollar weighted return, which takes into account money going in and out, the effects of return chasing. And a significant part, we couldn't find a way to cleanly break it into pieces, but return chasing also contributes to that negative$1 trillion number.

49:34So it's a combination of fees, compounding on fees, and investors' own return chasing behavior. Crazy. Yeah, it's cool that you're able to get that piece in there. I did not realize that when I read through the paper. It's kind of subtle. All three of them are going on in there. Yeah, makes sense though. I might throw in here an editorial comment because if you see that$1 trillion number, It'd be easy to conclude from that, well, I'll just stay away from actively managed mutual funds. But again, part of the problem is investors' own behavior. Control this tendency to chase returns. It's not helping you.

50:08But the other thing is, in the past, there's this question, how big is active versus passive? What I take away from this is, in the past, we had some combination of too much active money and too high of fees. But active has gotten smaller and fees have gotten lower. we got to make decisions based on the future, not the past. So with a smaller active segment and lower fees, those past numbers don't have to dominate our thinking about the future. That is really interesting because the index share is getting pretty significant, especially in the US market. And just doing thought experiments, if that index share got up to say 95%, then I have really strong intuition that there would be money to be made in active funds.

50:56Because if everybody's indexing, why should the prices be efficient? And if the prices aren't efficient, you know the reasoning. Yeah, the Grossman-Stiglitz paradox. Exactly. We had Marco Salmon at Harvard on the podcast a while ago, and he has a paper estimating the total active share, not just of funds, but he uses transaction volume around reconstitution dates, I think. And his number was, geez, 34 % or something like that of the US market. still got a ways to go maybe i don't know from 95 i don't know what the limit is though i don't know either marco's got a series of interesting papers we're hosting a conference here my academic department's hosting a conference here and one of his papers is on the program i'm looking forward to seeing it okay nice yeah he was great on the podcast here we talked about mutual fund underperformance we talked about fees we talked about skewness do you know roughly even how much of mutual fund underperformance is explained by fees and how much by skewness Yes.

51:50So the way we sunk our teeth into that, we've got the finding that the majority of funds underperform the SPY. So we asked ourselves, well, if you artificially added performance to every fund, how much would you have to add to get to the point where half the funds outperform the SPY? And our answer was you have to add 12 basis points per month. That's the effect of skewness. The net effect is about 12 basis points per month. Now, fees in our sample average is about nine basis points per month. What I take away from that is that the skewness effect is actually a little bigger than the fee effect in terms of what a typical fund does.

52:32And so what are the lessons from this research for investors? It's parallel to the individual stock stuff. The central question again, maybe the single biggest question is, should I be a passive diversified investor or should I be an active investor? It's the same question here. I think many investors, it makes sense for a lot of investors to be indexers or be broadly diversified. There's actually a distinction there that we maybe should spend a little time on. You don't have to be in an index to be diversified. The debate about the Magnificent Seven and their effect on the evaluated indices is relevant in the background there.

53:07Let me rephrase it a little bit. Be broadly diversified versus being active. for many people, it makes sense to be broadly diversified. But if you either value skewness, or you think you can find the right fund manager, you'd deviate from that. I just made a video on this that by the time this episode is out, I think my video will have been released. My conclusions were way more extreme than that. I said most people should be indexing. But I did think about my YouTube videos are shorter than this podcast, they're like 10 or 15 minute videos. And it's harder to keep people's attention, I think in those shorter videos.

53:38I don't have as much nuance, but my case for index funds was something like low costs, broad diversification, tax efficient, simple, and theoretically consistent. But you can get all of those things in an actively managed fund. But telling that to random person with relatively low financial literacy is not going to help them, I don't think. Yeah. I'm not sure your punchline and mine are that much different. If people did say, what do you advise for me? Not that I'm giving advice. Most of the time, I think my answer would be broadly diversified and a low cost index fund can deliver that for you.

54:12But some people are skilled. Some managers are skilled and some people like skewness. And should I tell them they shouldn't like skewness? I mean, that's their decision. That's very true. I just want them to be educated about it. We had, I think Vanguard's former CIO on this podcast a while ago, and he talked about how there was some evidence, I can't remember if this was academic published papers or not, or if it was Vanguard evidence, but they had evidence that fund companies were able to identify skilled managers before the fact. I'm at least open-minded to the idea. In economics speak, it's comparative advantage.

54:44So some people have comparative advantage at running funds, and some people have comparative advantage at identifying those with comparative advantage. The question we all have to ask ourselves, though, is, is that me? Do I have the comparative advantage? The other interesting question on the size of the active management industry is even if we decided at some point, okay, the passive is too big. It makes sense to go active. You still have to make the decision at some point to go back to passive, which is not an easy decision. Yeah. And the best answer might differ at different points in time.

55:16On the risk of being wrong is really high too, right? Yeah. Years ago, we had Lubos Pastor on this podcast and he talked about his research on that. We had the same conversation. I left thinking, I still don't know when I would switch back to passive. We've got a couple more questions here. Mark, I'll leave the last one for you. I'll ask the second to last one. We've talked a lot, Hank, about your research on skewness, broadly speaking, and just how it affects long-term returns. You've got a ton of other research though. What other areas of your research do you think investors should know about?

55:47Well, you're right. I've been doing finance research for almost 40 years, and I did a wide array of other things before I stumbled into this idea of looking at long-run market outcomes. So it's obvious that the world has been less interested in the other things I did as compared to the long-run stuff. It probably doesn't make sense to try and go through the whole list, but if anybody is curious, you can find almost everything on SSRN. But I've pivoted a few times in my career. I just follow what seems interesting to me, What's interesting and also gives an opportunity to ask interesting questions.

56:22So I worked for a few years on commodities or futures, and it was mostly from a risk return perspective and how commodities can alter risk return. That was fun. Then I pivoted to what we call market microstructure, which is basically trading strategies, trading rules and such. I actually think some of the things that I've done in market microstructure might be of interest to a somewhat broader set of people if they came across them. For example, I've got some papers about bond market trading and what determines liquidity and trading costs in the bond markets that some people might find interesting.

56:53I've also done some papers on the various rules for trading. Take one example. It might seem almost irrelevant if you haven't really thought about it. The tick size in financial markets, the minimum price increment. You might think, who cares about that penny? But it turns out to be actually quite important for people's order submission strategy and order management strategies, the tick size. So I studied the tick size and have some things to say about whether a big or small tick size is good for the markets. I took a very unusual pivot. This definitely has a specialized audience, but I just think the industry is so fascinating, and that's electricity.

57:31There's been a ton written about commodity trading and about hedging. But what makes electricity uniquely interesting is it's so hard to store it. And of course, people are working hard at strategies for being able to store electricity. You know, think batteries, pump storage and such. But we're a long ways away from it being storable like other commodities are. So that means its prices are really volatile. And it also means that the instruments for risk management, options, futures, swaps and such, the theory about how to value or how to price those derivatives is all based on storing. It's all based on arbitrage strategies between being in the spot or being in the derivative, and it's all based on storage.

58:16So none of the standard stuff applies to electricity. So that's what made it so interesting for me. So I've done a couple of papers about electricity markets that I think they're interesting, but others are only going to find it interesting if they think the lead-in here was a good motivator. I'd like to throw in one other thing, and it's actually really recent, but I'm excited about it. the studies that I started with and we've been talking about got me to thinking more about long-run outcomes in investments. So this is still under the umbrella of long-run outcomes, but it's not about skewness in particular.

58:48But I think it's a big issue to be thinking about. So most of the ways that we measure returns implicitly have built into them, and this applies to what I've done also, they implicitly have built in that it's all about wealth accumulation. It's all about getting a big portfolio, buy and hold returns, what the wealth creation measures. But I think that misses the point of why we invest. Maybe you do want to have a big portfolio at some target date, but I don't think the idea is to have the biggest possible portfolio in the last month of your life. So we think about why do we actually invest? We invest because you can pull money out of your investments for other stuff.

59:29The narrow version of that is I pull money out so I can consume. your retiree and you pull money out to live off of. Okay, but you pull money out for real purposes, whatever those are. You're pulling them out to give money to charity. You want to fund cancer research or you're running an endowment. You're talking about pulling money out to fund research or operate your university. I think we actually invest to be able to pull money out for other purposes. Anyway, with that lead in, I and my co-authors develop, in some sense, it's just a new measure of returns, but we call it the sustainable return.

1:00:02And yes, we are cashing in a little bit on the popularity of that term sustainable. But what it is, is instead of measuring what your portfolio accumulates to, we measure how much could you have pulled out each period such that your final value was equal to your initial value. That's the sustainable part. You haven't eaten the seed corn. It's written up in a paper that was just published in the Financial Analyst Journal last month, or you can find it on SSRN. But the reason I think this is powerful and the reason I'm excited about it is I think we should be thinking more about measures of investment performance that focus on what can you pull out of the investment for other purposes, as opposed to these ones that implicitly assume it's all about how big a portfolio can you build.

1:00:47Yeah, I did see that paper. I didn't include it in the questions because I had a lot to read with the students papers already. That one did look really interesting. I like the concept a lot. Yeah, I'm excited about it. And to the extent I can use this to go into a marketing role, I recommend that paper to other people. I think it's an avenue worth thinking more about. Cool. I'll have to go back and reread it carefully. It's obviously very relevant to us as planners because that's a lot of what we're trying to solve for clients. How much can you spend from your portfolio over certain timeframes?

1:01:14And when can you stop working and rely on the portfolio more and that type of thing? So yeah, we'll have to go take a look at it. Anything related to pension planning or endowment management, in my mind, this is the natural way to think about it. Awesome. This has been great. I think we've got one more question for you, which we like to ask all of our guests. And that's, how do you define success in your life? So, philosophical question. I'm a finance professor, so I'll answer it partly in finance terminology. To some extent, it ties into what I was talking about in this most recent paper. if you have enough money and wealth that you don't have to worry about money and wealth.

1:01:50It's not the whole story, but I think it's a measure of financial success. Circling back, I don't think it's about trying to always make your portfolio bigger. You've got a lot of things to balance in your life, including what are you going to pull money out for other purposes. But if you've managed your finances so that you don't have to worry about your finances, that sounds like success in the finance domain to me. And then, of course, I'd throw in other things like if you've got a job that you enjoy, which I'm fortunate enough to have, that would be a measure of success. If you've got a balance between your job you enjoy and the other things that are important to you, like your family and your hobbies and your interests, that's a measure of success.

1:02:30But anyway, those are the things that come to mind for me. Great answers. Great. All right. That's our last question, Hank. This has been a fantastic conversation. I know our listeners are going to love it. We really appreciate you coming on the podcast. All right. Well, it's my pleasure. We covered a lot of ground. I hope it's useful to people. I like to do research, but part of the reason I like to do it is the hope that it'll actually be useful to people. This will be useful, I'm sure. All right. Well, thanks, gentlemen.