Episode 355 – Do Index Funds Incur Adverse Selection Costs?

22:45Wait six months, wait a year. Wait for the market to correct the mispricing that the firm is exploiting, and then rebalance. When you wait a year, you're taking more market tracking error. You're not holding a stock or you're not holding the composition of the market as it is. but you also may be increasing your returns by not getting adversely selected by firms. And so in the new version of the paper, we're going to have this idea of a market information ratio, which is going to trade off the additional return you get from, say, buying at a certain time with how much you deviate from the market.

23:20And the market information ratio will account for front running and trading costs. And we have a whole bottle of trying to estimate expected price impact. It should all go in there, but we're pushing for a different way to evaluate index funds. If index funds get really front run, given the rules they follow, that is forgiven in standard tracking error in the way it's calculated now, which we think maybe we want to push against. So Marco, can you give us an idea of how often index funds typically trade? I mean, obviously the answer is going to be different for different funds, but it does seem to me that traditional index funds trade very, very infrequently.

23:53If you look up their trading expense ratios, they're frequently rounded to zero. And so if there are these kind of frictional rebalancing costs, how can they be showing up to the extent of 20 to 80 basis points when there are really so few trades? I want to push back on the idea that there are so few trades. So first of all, an important thing is at the end of the quarter, when a fund like VTI rebalances, it actually has to trade all 3 ,500 stocks. Why? Because even if you didn't issue any equity or buy back any equity, everyone else did something and that money needs to be funded from somewhere.

24:28So even if you did nothing and Ben's company bought back a little bit, I'm going to have to now reinvest with the money I get from selling some of Ben's stock. So we found that on average, over the last 20 years, evaluated index fund on a gross basis. This is not the SEC's definition of turnover, which is like a net. On a gross basis, it's 8 % to 10 % a year of a portfolio like VTI is turning over. So that's the first part is that actually index funds trade a lot. That doesn't account for when they buy a big IPO, they have to scale everything down to fund the big IPO. that doesn't account for ad hoc events by S &P where they have a merger and they need to add a new stock to stay at 500.

25:04And so I actually think that they trade more than we think. The second thing is, and this is related to my paper with Alex Chinco that I talked about last time I was here, is that if you trade in the closing auction, it's kind of weird. Our traditional measures of trading costs and price impact and effective spread or bid-ask spread or realized spread, these things don't really apply in the closing auction. There's a price, you submit your market on close, buy, your market on closed sell, you get executed at a certain price. That's exactly the price the stock has added to the index. You could say, well, my trading costs were zero.

25:35I put in a market on closed order. I got the closed price. I have zero trading costs. That's one possibility. I don't want to say what index funds are doing, but that's one possibility. But my paper with Chris, we have a paper on IPOs. For the average IPO being added to the VTI, it increases 40 % from the IPO price to when Chris buys it. There are a lot of intermediaries who buy those stocks knowing they are going to flip it four days later. We believe that should be reflected as a trading cost. That is a execution cost. You can imagine, oh, well, one, maybe no one prepares the shares and Vanguard puts in a huge order and then we walk all the way up the book on the day of, or everyone buys the shares ahead of time.

26:15We walk up the book that way and then it happens and there's no price impact. But I'm going to push back against the idea that one, they don't trade that much. And two, I think we're mismeasuring the trading costs of index funds by just looking at the trades they make in the closing auction. If we did less frequent rebalancing, how significant do you think the effects would be? So John and I, again, find that the less frequently you rebalance in response to compositional changes, meaning adding IPOs, buying issuers, and selling buybacks, returns are pretty much monotonically increasing. They start to level out around two or three years.

26:46But we actually did a crazy exercise where we said, what if you run an index fund starting in 1980, and you never rebalanced. So you're not going to have Apple, you're not going to have Amazon, you're not going to have any of these big names, you're not going to account for anything. That thing's cumulative return is nearly the same as the fund that rebalances much more frequently. You mentioned Gene Fama before. Gene Fama used to always say, no stock is so important that you need to hold it. No individual stock is so important that you should have to immediately trade to rebalance your portfolio to hold that stock.

27:22John went to Booth and was Fama's student. So I think that was one of the guiding principles that like Gene has been saying for a long time, no individual stock is so special that you need to hold it right away. And so returns are increasing. It does level off around, say, a thousand days or a few years, but it does level off, but returns are increasing. And so like we said, you move, say, from quarterly to annual, you can improve your returns like 20 basis points. And if you go two years, three years, maybe you can go up to 80 basis points. Now, an important caveat is when do you earn higher than the market and when do you earn lower than the market?

27:52We've talked to a lot of index fund managers and they say, Marco, if I underperform by five basis points, I'm out of a job. In certain years, like 1999, where the, I hate this word, but like a growth episode where everyone gets really excited about tech stocks, tech stocks are issuing equity, IPO-ing at sky-high valuations, and then they continue to rise, our sleepy rebalancing strategy is going to miss that. We're going to underperform by 20 basis points, 25 basis points in 1999. It's going to look really bad for our strategy. But then in 2000, 2001, and 2002, we're going to outperform by 40 basis points, 60 basis points, 80 basis points, because we did not buy Pets.com, a company that has zero revenue, infinite multiple.

28:34And so you have to be careful that, yes, we can improve average returns, But this is a strategy for a very long run investor who on any year or two year basis, when there's a growth episode, whatever you want to call it, is not going to get skittish and sell out of the strategy. Because in the long run, we believe it does deliver higher returns. I didn't think about this paper when I was reading yours. And I don't think your paper mentions it. But Jeremy Siegel has a 2006 paper in the Financial Analyst Journal. Have you seen this one? No. What's it about? So they do what you just said. they compare the returns of the original S &P 500 firms from 1957 through 2003 to the actual index and find that the original firms outperform.

29:12I'll send it to you. You have to send it to me. That's awesome. But my guess is those last six years are really going to help his case because the stocks added from 98, 99 do really bad. Yeah, I think that's true. I think they have a chart in the paper showing. I haven't read it in a while. I'll send it to you. That's fascinating. We have to cite that paper and link to it more closely. But that's exactly consistent with everything I've been telling you so far. The answer to this question might be obvious because you kind of explained the mechanism earlier, but what is driving this excess return from delayed rebalancing?

29:41So you're asking, why do we believe that the delayed rebalancing does better than the instantaneous rebalancing? Right. There's actually two components of it. One, I think I explained that I'll revisit quickly. And then there's one that I haven't explained yet. So the one that I explained is the idea of you avoid getting adversely selected by firms. And maybe that's not the exact right word, Suppose for some reason, say GameStop's a good example. Some people who are not firms get really excited about GameStop and push up GameStop's price. Maybe GameStop's managers are not super privately informed, but they go, wow, our stock price went up a lot.

30:13Maybe now is a good time for us to issue equity. And then what do index funds do? They're going to buy GameStop. And so I hate to pick this as an example because again, you can miss Apple and our strategy still works. It's not just all Apple, but Apple has done pretty well. They've been buying back shares from whenever Einhorn started that campaign for iPrefs. They didn't do that, but they ended up doing a lot of buybacks and they've done really well. And you're reducing your holdings of Apple every quarter. And also, like we said, you're buying unprofitable firms. You're also taking factor risk, which also has negative returns.

30:42You're buying growthy firms. You're buying unprofitable firms. You're buying stocks that have went up a lot recently. You avoid these negative factor premium, if you want to call it that. And in addition, you avoid this mania's adverse selection problem. The second thing that we believe is important about rebalancing less frequently, and this is not in the version of the paper we have right now, is how we believe trading costs work. A lot of trading cost models, like ITG has a trading cost model like this. Eric Stafford, my colleague, has a paper called The Price of Immediacy. And in all these kinds of models, trading costs have some kind of curvature.

31:14There's some square root function usually as a percentage of ADV. Now, what does that mean? When you trade a little bit, you're walking up that square root function very fast. When you trade a lot, you start hitting that point where the curvature on a flatter point, the slope is relatively shallower. If you're an index fund and you have to trade all the time to make room for an IPO, you have to trade 3 ,500 stocks. You're going to be on that really steep point of the trading cost curve more frequently. By waiting and by putting in your trades at scale, you can take advantage of some of these benefits of being further up and on a flatter section of the marginal cost curve of trading and reduce your trading costs as we have measured them, which hopefully to some degree account a little bit for the front running and some of the other elements we've been talking about.

31:58You mentioned the tech run-up being pretty rough time for this lazy rebalancing because you're missing out on the gross stuff. This makes me think of Zahi Ben-David's paper on thematic ETFs. You're basically buying something that looks like the thematic ETF portfolio. Exactly. And so just to catch people who haven't seen Zahi's paper, the idea is people make indices on all types of things. And sometimes indices don't even have an ETF yet. They're just an index of Ben and Dan's favorite value stocks. When those indices have gone up a lot, people are like, oh, wow, now is the time I better launch an ETF on that index.

32:32They do exactly that. And of course, they're buying high, then the performance reverts, and then these newly launched ETFs are disastrous. It's exactly had that flavor, but the important thing here in going back to Sharpe's arithmetic, because I think that's a good null hypothesis for the whole thing. it comes from the investment universe changing. When companies issue equity or companies get IPO'd, it changes the universe of stocks. And that's one place that the margin sharps with tick and break down. Zahi's paper is about something a little bit different that's within the existing set of universes.

33:03This is a new ETF. And ours point is just a little bit different on changing the composition of the market. How much tracking error are we introducing by delaying rebalancing? I wish I had my slides in front of me. Maybe next time I'm on, I'll have a little slides. As you're going to delay rebalancing, you're going to have more and more tracking error. But because no stock is super special, like with everything else we talked about, it is going to level out at some point. There's some point where the tracking error is not going to increase that much more. And so if you rebalance, say, once a year, you might have 80 to 100 basis points of tracking error at a daily level annualized relative to our ideal version of the market.

33:39Now, I think that a lot of people are going to say, wow, Marco, my tracking error budget is five basis points a year. This is something I can't stomach. We can't do that. But John and I believe, what if we just define a new index? What if we define Marco and John's Sleepy Rebalancing Index? You could run an index fund with zero tracking error with respect to the index as we have defined it. And I think it's a good question. Yes, we're going to incur more and more market tracking error by delaying more slowly. But if that's the goal of what the fund is doing, we think it's okay. And then I want to ask you guys here, because this is something that John and I were really wondering, why do you think the index fund world has become so obsessed with tracking error?

34:14This is the way we compensate managers. This is how people get and lose their jobs. I've talked to a lot of people who say, all I care about is minimizing tracking error. Is there a huge agency problem? Are people really worried that people are going to run the index fund badly, and we need to really tie their hands just giving them a tracking error budget? Why is this the equilibrium we're in? That's a really interesting question. I would say that certainly most individual investors are not going to be sensitive to it. But as advisors who work with clients and expound on the virtues of index funds, we do want to hold the funds accountable and look for those low tracking errors.

34:49I can think of a specific example that happened a few years ago with an iShares fund that was supposed to be a total market US equity fund. They tried to get a little creative. And I honestly don't know what they were thinking, but they could have simply bought all the stocks in the index like everybody else does. whatever they did caused a very significant tracking. It was something like 50, 60 basis points, or it might've even been more than that. And as advisors who were using that fund, we actually went to the fund provider and said, what are you guys doing? You have a responsibility to deliver the index return.

35:22And it's not your job to get creative and try to improve on it. And by doing so have it backfire. So I do think there is some accountability and there is some expectation. That's why I find it so interesting that you're saying it becomes self-referential at some point. We build the index and then we implement the index and we pat ourselves on the back for tracking the index perfectly. But you've pointed out the very important distinction between tracking the index and tracking the market that the index is supposed to be a proxy for. And those are not the same thing. But it matters. In the example Dan just talked about, we do annual fund due diligence for all the ETFs and mutual funds that we use in our business.

36:01And we put a big warning on that fund that we are watching this very carefully and we may not continue to use it if they don't solve these problems. It's a real issue. And I would also think about some of the investment committee work that I do. Indexes are just reference point. And so even if an investment committee decide that we're going to do this lazy rebalancing thing, if you have a year of negative tracking error to the index, which you're still going to benchmark to, even if that's not what your fund is benchmarked to, it's a problem. It's a real problem. Should we keep doing this? I don't know.

36:27It underperformed this year. So I think what you're saying is if I'm going to use this as a building block in my broader strategy, I want to know that this is the building block I think I'm getting, especially if you're hedging some risk. I'm going to buy Facebook and short the tech ETF. I want to isolate my Facebook risk. And if all of a sudden my hedge isn't hedging what I thought it was, I would be really mad. I would tell those people, okay, this is not right. But then I guess this gets now to the second question, which I wanted to talk to you about is this idea of this spectrum of whether this is active or passive.

36:58And I'm curious, when I say the word passive or someone says the word index, how do you think about that with your business? And then I'll tell you what I think about that. It's something that we've struggled with the language on for a long time. Dan and I have slightly different approaches to portfolio management. Dan is generally using total market index funds. I'm generally using funds from dimensional fund devices, which tilt toward small cap and value stocks a little bit, but are pretty close to an index fund. So we just say it's spectrum and that dimensional is closer to index funds, but it's not an index fund.

37:27But yeah, it's not an easy thing to communicate. Yeah, I was just going to say that we were chatting, Ben and I, a little bit before about this idea that I think somewhere along the line, those of us who advocate index funds can sometimes slip into this notion that indexing is an ideology. In other words, cap-weighted indexes are perfect. They are the natural order. We must follow them exactly. And any deviation from that is not passive. It's a silly idea. And that's why I like the ideas in your paper so much. It's look, the index is supposed to be a reflection of the market, but it's always going to be imperfect.

38:04So if we add a few extra rules that actually counterintuitively reflect better what the market is rather than just simply reflect this man-made index, then there's a lot of potential for improvement here. I think the challenge, and this goes back to the question about tracking areas, how do you benchmark it? If my S &P 500 index fund, I can compare it to the S &P 500 index, but your sort of sleepily rebalanced fund, what do we benchmark it against? And if we can't benchmark it, how can we be accountable? So first of all, I like to give as a fun example is you're right, there's a spectrum of fully passive, meaning we hold the market every second there is and fully active.

38:44Bill Ackman holds six stocks and he's really convinced about those six stocks. Vanguard total market is really close to that ideal of the totally passive fund. Now, we're saying we should rebalance less. Russell has until next year, I think, annual rebalancing. Does anyone go, oh my God, Russell is so active. They rebalance once a year. This is a huge deviation from the market. Of course, actually, among all the major index families, this is not a critique of Russell because Russell actually also does better. In line with our findings, the Russell 3000 does better because it waits. But Russell deviates in the market by delaying rebalancing.

39:19Also, they trade all at once. So they walk up the trading cost curve in a smarter way. I've never heard anyone in the world ever say that Russell is really active for making that decision. And they're like, your thing is really active. You're delaying rebalancing. I'm like, well, other people are doing it and no one says it. So the first thing I want to say is that we hold all the same stocks as VTI. We just rebalance them with a little bit of a delay, excepting for IPOs. The second thing is, you know, there's been a huge growth and we haven't talked about this yet. This is related to Zahi's paper of these thematic ETFs.

39:43My favorite example is COWS, C-O-W-Z. It's the 100 most profitable stocks in the Russell 1000, and it's weighted by cash flow yield. So not only is it not the whole market, it's not value weighted. Ended up putting a weight cap on it that I think you can't have more than a weight of 5 % in the index because there were certain stocks that had a huge free cash flow yield. Dividend ETFs have the same problem where you weight by dividend yield. And so I think that in recent years, there's been an explosion of index products, meaning they follow a set of publicly available rules that do not look at all like the market.

40:13And I guess what John and I are saying is we have a set of publicly available rules. We could say you rebalance after a buyback by weight off 252 trading days. It is a set of public rules, but it looks kind of like the market. I want to push back. And, you know, now I've gotten so into this, I forgot my third point. I'm sure it'll come back later when you guys ask me a few more questions. The cows point makes me think of Adriana Robertson's paper on passive in name only. Are you familiar with that one? I don't know it, but I think from the title, I understand the flavor. She talks about indexes that are created by the fund managers themselves.

40:44And so it's really just an actively managed fund, but they call it an index fund because they're tracking an index, even though they've made the index. Yeah. If you think about like DFA or whatever, they try to do smart things when small stocks, they can get them at a discount. Where do we draw the line between a public rule, taking a little bit of tracking error to trade a little smarter? It's really hard. How do you think investors should decide? I mentioned the investment committee example, or that's a hard thing because you've got a bunch of people with varying levels of knowledge and you've got to benchmark against something to Dan's point about accountability, how do you think investors should decide on their optimal excess return from lazy rebalancing to tracking or trade-off?

41:18That's a great question. There's some introspection, which is how long am I going to have this investment? I actually think that for retail investors, when they underperform their buddies by 20 % or 30 % and are going to go, wow, what's going on? This is a very different value proposition than I'm running a pension fund that needs to provide cash flows 50 years in the future and one bad year this year for three amazing years next year is a trade-off I'm willing to make. So this first step is, how long are you willing to stay in this? Now, John and I's strategy outperforms almost every year for the past 40 years, except for the 99, 98.

41:54And I think after COVID, a bunch of companies issued equity. And then when the rebound happened, it underperformed a little bit. Of course, that equity ended up not being amazing. So can you stomach one or two years of underperformance? And then we kind of have somewhere around two years. If you use our concept of market tracking or a market information ratio, our market information ratio is, this is not in the paper yet, it's gonna go up very soon, I hope. Around two years is where you maximize the market information ratio. Now, of course, the last thing we haven't talked about is how big is this strategy?

42:25How many people are doing this strategy? One good thing about our strategy is it's kind of immune in many ways to gaming by firms by introducing a fixed delay. So if you rebalance quarterly, if a company issues equity on the second to last day of the quarter, they might buy it two days later. Even if you rebalance once every five years, if you have a fixed period of rebalancing, firms could just wait and then issue right before when they know they're going to have an elastic buyer. Our methodology imposes a fixed delay on all compositional changes. So that type of gaming, I think we're pretty immune from.

42:58The type of gaming we're less immune from is the front running. And so even if you're going to wait two years to rebalance, people who are sophisticated and can predict that, remember, this is all public rules, they could still front run you and that would show up as trading costs. And the bigger you got, the bigger your trading costs would be. And that might not even be linear. And so I don't have a great answer for yet. But I do think right now we have a partial equilibrium view of your one person running this strategy for something that is not systematically important in the passive industry ecosystem.

43:28As that changes, the rules we need might change. And so I can't speak to that yet, but somewhere around with our partial equilibrium calculations, two years is close to optimal. This probably isn't proper equilibrium thinking, but not everyone's going to do this because of the tracking error. I don't know how you do an equilibrium model of that, but it's just not going to happen. A lot of people are still going to prefer index funds because they can't stomach any tracking error. They can't stomach any tracking error relative to the really famous benchmarks like the S &P 500 or the Vanguard total market.

43:54I totally agree. And so I think that I'm just trying to hedge a little bit and say there are some products that have become very huge, you know, VTI now buying 7 % of the float of every IPO. That is a massive demand shock that is coming. You've had Val on here and Ralph on here and many people. We are having massive inelastic demand shock. And so I'm just saying that I want to be careful that if people move towards not even our model, but any model of rebalancing differently, whether it's sleepy rebalancing or instantaneously rebalancing, or here's one other thing, a weird feature, and I wanted to stick this in here because I think this is so cool.

44:29I forgot what movie it's from. You don't skate where the puck is. You skate where the puck is going, right? This is like an old adage in hockey. So when an index fund gets inflows, they scale everything up. So think about VTI. They scale everything up. And then at the end of the quarter, they end up selling Apple, which bought back. So now they're trading Apple twice. They're scaling up Apple when they get the inflows. And then they're scaling it down at the end of the quarter for rebalancing. Why not, if you're getting inflows, just put those into the things you know you're going to have to buy in the next regular rebalance, as opposed to putting them in things you literally already know you are going to have to sell in the next rebalance.

45:03Trading twice doesn't make sense. We could really go very far on the scope for enhanced indexing in this sense. I've just got one more question, and I think Dan has one last one too. What effect do you think the increasing share of index fund ownership of stocks has on the implicit cost of indexing as it's currently implemented? This is actually a perfect segue from our last discussion, which is, do you think indexing is getting bigger and bigger in those inelastic demand shocks, which given the way many index funds are run now happen all at once on one day and are predictable in many senses? You can imagine that this could increase the front running.

45:40But there is one interesting data point that I want to push back on here. So many of you might have seen that there was a Bloomberg article a few months ago saying Millennium lost$900 million in their contraindex liquidity group. This goes back to Jeremy Stein has a paper from the late 80s, I think, about the idea of an unanchored strategy. And I think this is one reason answering your question is so hard. What do I mean by unanchored strategy? Suppose you, Dan, and I all know that some fund is going to buy a million shares from Tesla a month from now. All of us start accumulating shares ahead of time with the idea of selling it to the fund.

46:13I tell you guys, you shouldn't accumulate any shares. I've already got all the shares. We're going to tank the price. We can't commit to this. This is like Cournot competition. Now, if everyone bought too many shares because we cannot coordinate, we cannot commit. We all buy too many shares. We all sell them in the closing auction. The price goes way down and then all of our trades get blown out of the water. So in this sense, it is an unanchored strategy because none of us can commit ahead of time to limiting the quantity that we front run indices. I think that even though these groups have had many good years, there was an article in Bloomberg like two years ago saying groups at major banks were making hundreds of millions printing money.

46:48And then you have a year like this year where they're losing hundreds of millions. So I think that this coordination problem and this unanchored strategy problem makes this really almost impossible to predict. Mark, I'm just wondering if there's any kind of genuinely practical application here, at least in the medium term. One of the trends we've seen in the index fund world is more and more funds are looking to alternative index providers, mainly to avoid the high licensing fees of the big guys like S &P and MSCI and so on. So these secondary index providers are looking to provide an alternative that has some advantages and not just, hey, I'm going to pick 500 large cap US companies and make this kind of faux S &P 500.

47:31I'm wondering if you have heard of any index providers who are looking at this kind of research and saying, hey, we're going to start with these traditional cap-weighted indexes, but we're going to add this sleepy rebalancing strategy or some form of it. And we're actually going to suggest to you that this can improve performance benchmarked against the traditional indexes. So it's interesting without sharing too much information, because we've talked to a lot of people about this. When we got covered in Matt Levine's article, a lot of people reached out to us, talked about this last time in the podcast, whenever you have a good idea, everyone says, oh, I knew it already.

48:06Actually, this is my idea. So what's interesting is some very large institutional managers, these are not fund providers. These are people who think sovereign wealth funds, think pension funds. They reached out to us, the people from their enhanced indexing groups and said, yeah, we knew this. We never do this. And they actually, the other people, they try to participate a little bit in the front running. They buy a little bit ahead of the ad. They hold onto the drops for a little bit and get some of the bounce back. I think that enhanced indexing groups at very large institutional managers who have the trading expertise and who have a long-term focus in consummate tracking error, they are already doing this, even if it's not a retail-oriented product yet.

48:43But I do think that you're making a good point. CRISP is a great example of this. Having a five-day rebalance, letting the rebalance be spread out a little bit, having a little bit of uncertainty so you can't be perfectly front-run. I do think that in many ways, these index providers that we follow, like Dow Jones or S &P or Russell, these are things that date back 50-plus years. And so a lot of modern indexing may be a historical accident. These index providers who were started a long time ago with a price-weighted index, because that's easy to compute back in the 1920s, that somehow has carried over 100 years.

49:18And we think that if a lot of indexing is historical accidents, why don't we just start from first principles? We want to follow the advice of the CAPM. We want to track the market, but we don't want to expose ourselves to well-known risk factors. So why don't we just design a set of rules that does that? I don't think there's any question that Dow Jones is a historical relic. If somebody were to create such a benchmark today, it would be laughable. And the only reason it still exists and so popular is because, well, it doesn't help that Dow Jones is a large media company as well. But what are all of the ideas?

49:47What are the core principles that make indexing so powerful? Just stick to those and recognize that there are some other factors in constructing and managing an index fund that don't really add any value. and probably subtract it. So if we can reduce those frictions and just stick to the big ideas, the question is how successful can it be implemented? And I guess that remains to be seen. I think I couldn't say it better than you. That's exactly right, that we should stick to the principles. These are indices that have been around for 30 years, more. We can revisit these ideas and rebuild them given what we know.

50:21I think it's important always to remember that those original indexes were not designed to be investment strategies. They were designed to be benchmarks for active investment strategies. The S &P 500 predates S &P 500 index funds by at least 20 years. That's a great point that these were originally designed to evaluate active managers. Not to pile on to the other people thought of this before you, but - But you thought of it first. I didn't, but DFA, like you said earlier, they do think about a lot of this stuff, but most of their strategies are factor strategies that are tilted towards certain types of stocks, but they do have one ETF that they converted from a mutual fund.

50:57I can't remember one. It's fairly new, but it's total market ETF. It doesn't have any factor tilts. It just tries to replicate or capture the returns of the market, but it follows DFA's trading strategies, which includes delaying buying IPOs by, I think it's a year, other stuff like that. And they don't follow a fixed rebalancing strategy. It's all flexible trading to try and minimize transaction costs. When I read your paper, I went and looked at how that fund has performed relative to VTI. And when I looked at it, I don't know if it's changed since then, when I looked at it, it outperformed by about 50 basis points, which is kind of like right in line with what your model suggests.

51:30I did not know that. I got to look this up after. We got to talk about this afterwards. Everyone says, oh, what if you actually, this is kind of like Dan's question, what if you actually run this strategy? What does it look like? How does it do? That's a nice first step towards, okay, someone tried to run this and they can do better to the tune of our exact estimates. Yeah, I thought that was pretty interesting. This has been a great conversation, Marco. I think this paper is super interesting. Like I said, as soon as I saw it, I knew we had to have you back on to talk about it. But I think you're getting at some stuff that, like Dan said earlier, indexing has become in a lot of ways ideological.

51:58There will be people in the Bogleheads community who are going to be absolutely furious about this episode. But I think it's really important. And I think what you've done here is really sensible. Well, thank you. And I hope they can reach out to me and we can have a discussion. I hope no one's too mad about this. But thank you so much. This is awesome. I actually learned a lot from you guys, a lot of ideas that John and I hadn't thought of and that we're going to have to incorporate into the next draft because this is super cool. Awesome. Thanks, Marco. It's a pleasure. That was awesome, man.

52:23Thank you.

52:29That was a great conversation with Marco Dant. I know we both found it super interesting. Hopefully the listeners did too. Yeah. And he's such a compelling speaker too. I mean, academics certainly vary in their ability to communicate their research in layperson's terms and articulately, but he's really high energy, very articulate and really a pleasure to talk to. Yeah, he's a great guest. I'm sure that this won't be his last time on the podcast. All right, we got one review, and then I want to talk a little bit about Cameron appearing on another podcast. Do you want to do the review and I'll do the Cameron thing?

52:58Yeah, sure. We'll just read the review here from iTunes. So it says, I found the podcast because I moved to Canada in 2020, and I did not understand all of the tax nuances. So I remember I searched with the keyword TFSA, and I found a bunch of podcasts, and I listened to one of the podcasts, and I immediately loved it because of the depth and the complexity. At times, it's challenging to understand and follow, but you know you're learning by pushing the boundaries of your knowledge. I also got into the habit of reading with the reading challenge and got some good book recommendations from the podcast.

53:30I think the podcast changed my life in a positive way by adding this high-intensity research, not only from finances, but also other areas that were related. They have a nice forum that I like to check when I have questions. I don't post, but I read, And maybe one day I encourage you to make an episode about someone who just moved to Canada, how to understand the financial differences from non-North American countries such as FHSA, RSP, etc. Thanks for all the hard work. You guys are awesome. Very nice review. That's a nice review there. Interesting episode idea too. Yeah, it would be. I imagine that we have a lot of listeners who have come to Canada just in the last few years.

54:09And I've certainly dealt with clients like this who are very smart financially, but they just are from another country and they don't understand all of the specific account types and tax implications. And yeah, it might not be a bad introductory. And I guess that a lot of Canadians too would learn a lot from that discussion as well. Totally. I will give a shout out to MoneyScope where Mark Soth and I do have an episode specifically on Canadian account types and how to think about each one and what each one's meant for and how to use them. Yeah. And Dave Chilton on the Wealthy Barber podcast has planned to do a series like that as well.

54:45And the one that he did on TFSA is, of course, featured Mark McGrath. So you guys can go back and check that out if you want to learn more about TFSAs. Good call. I will also shout out the forum that he's talking about, of course, is the Rational Reminder Community. It lives at community.rationalreminder.ca. It's ridiculously active. I think we're just under right now 500 ,000 page views per month in the community, which is an insane amount of page views for any website, but it's very active, very good discussions always happening in there if people want to go and talk about things they heard in the podcast or talk about anything usually related to finance and investing.

55:23but some other stuff too, with people that are like-minded-ish. The type of person that listens to this podcast, there's lots of them in that community. Okay. I wanted to mention Cameron, who of course is our longtime original co-host, is going to be making some more frequent appearances back on the podcast now that Mark has stepped away. He was recently a guest on Michael Kitts' podcast. Michael was a guest in episode in the 100s. I want to say 122, but I'm not 100 % sure on that, but you can just search Michael Kitz's Rational Reminder if you want to hear him. We had a great episode with him.

55:56Michael Kitz also has his own podcast, the Financial Advisor Success Podcast that's been running for a very long time. It's kind of a go-to podcast for really nerdy financial advisors, nerdy in the sense of wanting to have a really, really good financial advisory practice. It's less so about specific stuff on investing or financial planning and more so about how to build a great financial advisor practice and how to serve your clients in the best way possible. His podcast is focused on and he talks to advisors who have built great practices. Cameron was a guest on there recently. He talks through PWL's growth story, PWL's story more generally, and also about the decision to join One Digital and what our vision is for the future.

56:38I thought it was a great conversation. I know that Cameron's gotten great feedback from it, from other people about that podcast appearance overall. And someone in the Rash Reminder community, I thought they had a really good comment that summarized why someone might want to listen to it. So they said, I was shocked that in 350 episodes, we never got this much insight into PWL. This podcast episode gave a family member confidence to reach out to PWL and me more confidence to one day apply to a job. Really happy we got this inside look into the company itself, I assume RR, Russian reminder, doesn't want to come across like you're there to sell PWL, but man, if you've got it, flaunt it.

57:16And it's true. We've become a little bit more overt. We didn't do it today, although I guess I'm kind of doing it now. We've become a little bit more overt about talking about PWL and the fact that we're taking clients and the fact that we're hiring and that kind of thing. But we were intentional about that a year ago, maybe. Prior to that, we were super, super sensitive about coming across as promotional in any way. Since we've started doing it, I've found that there's really no negative reaction. And overall, it's actually probably a positive reaction when we do talk about the business. So this person's comment kind of affirms that.

57:46Yeah, I think when you've got a long track record of creating good content and educating investors, people have come to trust that this is not a marketing exercise here. And I think in a lot of ways, the vast majority of our audience are people who will never be clients of PWL because they're enthusiastic DIY investors. And that's fine. That's great. That's what we're here to help. But I found the Kitsis episode amazing as well. I mean, I've been here a dozen years, around the same time, I think, as you've been. And I learned so much about PWL that I had not known about. Things that happened before I got there, things that have happened after as well.

58:27So yeah, if you're looking for an introduction about PWL's culture. Cameron doesn't spend a lot of time in the podcast talking about investment strategy and that that's less, I think, unique, but about the company's culture and its approach, it's a really remarkable summary. So a great episode. Yeah. So hopefully people will check that out. My suspicion is that it's the recent market volatility. We have noticed a big uptick in people who are DIY investors reaching out to inquire about becoming a client of PWL. And really the only variable that I can see, and it could just be noise, but it seems to have coincided with market volatility, which is an interesting thing that we've noticed.

59:05I wonder if people become a little more sensitive to their behavioral biases during a downturn. It's easy to be a buy and hold investor during a long bull market. It's a little harder when you're tempted to make changes. We get more client emails as well and calls about, should we be doing something different when there's market volatility than we do when markets will go basically in a straight line up for six months? Those are the quietest times. So it does make sense. I think advisors can add a lot of value during periods of downturns like this just by keeping people on track. Yeah, totally.

59:44You and I worked on it together, Dan, an email that went out to clients, which listeners heard a version of because we've summarized some of those notes in our last AMA podcast episode at the beginning. But we got a ton of really good feedback from clients saying that they're glad that we're thinking about it. They're glad to have some clarity on what's happening and what we're doing. Communication in times like this is super important. Yeah, it's really important, I think, for clients to know that we're not, quote unquote, doing nothing because we're staying the course. There are lots of things we can do behind the scenes.

1:00:14There's opportunities for tax loss selling. there's opportunities for proactive rebalancing and do during market downturns but sometimes the most important thing is just to let clients know we didn't know when this was going to happen but we knew there was going to be market volatility along the way it's baked into the plan it's not a surprise so often the financial media makes every downturn seem like it's some sort of first time it's ever happened and we have this fundamentally changes everything and it's like No, it's stressful. It's difficult, but it's nothing that we haven't endured countless times before.

1:00:49So if it weren't so stressful for people, it would be comical. How it would be so easily perceived if you just looked at the media and even talk to certain people, it would be so easy to assume that this is the first time that we've ever had any uncertainty in the world. That's right. There was an AMA that I'd seen on another media outlet at some point. And people ask questions like, I've had my portfolio for X number of years, and now it's down 7%. What should I do? Really? I don't mean to make fun of people's concerns. I'm just really surprised that your portfolio for sure has been down more than 7 % lots of times.

1:01:25Have you forgotten all of them? And if you have, I suppose that's a good thing because it didn't burn it into your brain as some terrible experience. But it is really interesting why the response isn't just, this is awful. It was much more volatile, I think, over the last couple of weeks than it is in a typical correction. And it was a bit scary for sure. But again, it's not a unique occurrence in the markets to fall 10%. It really is something that I think no one ever gets used to. I think that's what it comes down to. Yeah. And we talked about this when we covered this idea in the AMA episode recently, but it's because the cause is always different.

1:02:01And that's why it affects the market because it's, oh, this is a new thing that the market has to price. And that's why we see major volatility. this time is always different, but it's really always the same. And people act as if it's really different. I will mention, I don't know when it comes out, but I did an interview with Amy Arnott and Christine Benz for Morningstar's The Longview Podcast. They sent me a bunch of questions. We covered a lot of ground in about an hour. I'm assuming that comes out soon. I'll just mention it now in case it's out by the time this is out. But if it's not, then presumably it'll be out pretty soon.

1:02:34All right. Anything else, Dan? I think we're good. All right. Thanks everyone for listening see you soon