July 25, 2024

Episode 315 - An Update from Avantis with Eduardo Repetto

July 25, 2024

During this episode, we welcome back Eduardo Repetto, Chief Investment Officer of Avantis Investors. In his leadership capacity, he directs research design and the implementation of strategies and oversees the investment team and marketing initiatives. Our conversation kicks off with Edoardo’s explanation of how Avantis systemizes active management before we dive into strategies for launching in Europe and beyond. He weighs in on the most significant capacity issues that people face today, offering solutions to tweak your approach. We touch on what makes Avantis strategies preferable for advisors and Eduardo shares his insights on the future of small-cap value strategies for emerging markets. We discuss short-term reversals, towing the line between growth and value and factors that should inform asset allocation before diving deeper into small-cap value in the US and Canada. Tune in today to hear more.

Key Points From This Episode:

(0:05:51) What sets Avantis Investors apart from other investment firms.

(0:09:26) Five strategies for launching in Europe starting with free and equity UCITS.

(0:14:00) Accessing UCITS and adapting strategies in accordance with currencies, geographical regulations and restrictions.

(0:22:49) The most significant capacity issue: an inability to invest cashflows.

(0:27:59) Feedback from the advisor community on why they are choosing Avantis strategies.

(0:32:43) Eduardo’s view on the future potential for the emerging markets small cap value strategy.

(0:35:58) Improvements and adaptations to portfolio implementation at Avantis since 2019.

(0:39:01) The controversial nature of short-term reversals and advice for investors thinking about growth and value.

(0:44:40) What should inform asset-allocation decision-making.

(0:45:46) The potential of expanding into a Canadian base.

(0:50:16) Mark’s thoughts on small-cap value in the US and Canada.

Read the Transcript

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Welcome to episode 315. Very exciting time. This is our first interview, where there’s three of us.

Ben Felix: That's right.

Mark McGrath: I was worried that it might be too much, but I think it's good.

Ben Felix: Yeah, I think it was fine.

Cameron Passmore: It was fine. It’s great, actually. We welcome back to the podcast, Eduardo Rapetto from Avantis, which people know Avantis. I'm sure many listeners are aware of Avantis, He came and joined us to give us an update on what's going on there. I guess, you've been talking to Eduardo lately, Ben?

Ben Felix: Yeah. They've been working on some stuff, which we talked about with them in the episode. I chatted to him and his team a little bit about what they were doing. Through those chats, we decided it would be cool to have them come on and talk about what they're working on.

Cameron Passmore: I think it was this week, they broke through 50 billion, right? I saw the announcement on Twitter. It's a pretty meaningful milestone.

Ben Felix: Big stuff happening. Pretty cool.

Cameron Passmore: Then we'll go to the after show, we're going to talk about this incredible small cap rally that happened in the past week. At most, it's been incredible. This gets back to, you got to be in your seat to capture the returns. It was wild. Just wild.

Ben Felix: Yeah, yeah. It has been wild. We'll talk a little bit about putting that in some historical context. It's not a huge segment on small cap value performance, but it's interesting. It fits with the theme of having Eduardo on to talk about their strategies, which largely focus on small cap value, or at least value.

Cameron Passmore: Before we get to the episode, I think Mark, you wanted to talk about stuff that's going on with the advisors lately.

Mark McGrath: Yeah. No, I just thought it was really interesting. The episode we did, episode 313, that we did on when someone should hire a financial advisor, we had a ton of great feedback on that. One investor in particular was really hesitant about hiring an advisor, who had considered us in the past, but was really hesitant about it. Listened to that episode and said that was, I think in their words, the tap that they needed on the shoulder to move forward. They were humming and hawing about whether they wanted to work with a firm like ours. After listening to that episode, and I think resonating with some of the discussion points that we covered, it was enough to push them over and say, “Okay. Yeah. Now is the time to hire an advisor.” Just found it really interesting.

Ben Felix: That wasn't the only story like that. I know the one you're talking about, but there were a few. I also found it really interesting. I'm always a little nervous. Listeners have heard me say this before, talking about why someone should hire an advisor, because it feels like a sales pitch. I feel like I'm making a sales pitch, because that's obviously what we do. Although, we've gotten the feedback that doesn't come across that way. Anyway, I'm always nervous about talking about that. Like, why should you hire us? It was interesting that a bunch of people reached out after that episode. I mean, the way we laid it out, I think it just makes sense, so it therefore makes sense that people would reach out after listening to it.

Mark McGrath: I think we also covered a lot about maybe just inversely, when it doesn't make sense to hire. It didn't feel really salesy to me. You did a ton of research, obviously, and went through a number of papers and some academic work on the topic. It was, I think, less of a sales pitch and more of a like, you don't need an advisor until, and that's the way that I saw it. Got really good feedback and was happy to hear it.

Cameron Passmore: I’ve gotten the same visceral reaction as you guys are on selling. I don't see that as a bad thing. Just helping people make good decisions is really what we're all about, right?

Ben Felix: That's true.

Mark McGrath: That's fair.

Cameron Passmore: I just don't think we have a product per se. But you going to a car dealership, you know they’re biased to sell you that brand of car. It's not the way we operate. Anything else in this intro?

Ben Felix: No, I think that's good. I think we can go into the main episode and introduce Eduardo.

***

Cameron Passmore: Okay, Ben. Eduardo is here today. Why don't you do this setup, since this was your idea?

Ben Felix: Okay, sure. Eduardo is the Chief Investment Officer of Avantis Investors. He directs the research design implementation of Avantis Investment Strategies and he provides oversight of the investment team and the firm's marketing initiatives and interacting with clients. He was previously the co-CEO and co-CIO at Dimensional Fund Advisors until 2017, and he departed and then eventually, kicked off Avantis.

Cameron Passmore: Man, time flies, doesn't it?

Ben Felix: It sure does.

Cameron Passmore: It's wild. It’s seven years ago.

Ben Felix: Yeah. They've been very successful, Avantis. We talk a little bit about this with Eduardo. But they were a startup in 2019 and they've just crossed 50 billion in assets under management, which is pretty incredible.

Mark McGrath: It's wild. Yeah.

Ben Felix: For a startup, they're not a complete startup, because they built themselves on top of an existing fund provider. They became the quantitative arm of an existing fund provider. In any case, reaching 50 billion is absolutely incredible. I think it's a testament to the products they've created and the success that they've had in marketing and telling that story. People will remember from last time Eduardo was on, he's got a PhD in aeronautics from the California Institute of Technology, literally a rocket scientist, which we actually talked to him about last time he was on, but the parallels between aeronautics and finance, that was a really interesting part of that discussion.

The reason that this kicked off is that they're launching products in Europe. I've been chatting to them about that, and that's when we decided it would be interesting to talk about. We have a ton of European listeners to our podcast, and the Rational Reminder community has a large contingent of European contributors. This is interesting for all of them, Avantis launching there, will give them access to the strategies that we often talk about on the podcast in a way that they don't currently have. That's all very exciting. Then we also talked to Eduardo about a few other interesting topics related to their products. I thought it was a pretty good discussion.

Cameron Passmore: Okay. With that, let's go to our conversation with Eduardo Repetto.

***

Ben Felix: Eduardo Repetto, welcome back to the Rational Reminder Podcast

Eduardo Repetto: Thank you, Ben. It's always a pleasure. Cameron and Mark. It's amazing to be here.

Cameron Passmore: Great to see you again.

Ben Felix: It is always a pleasure. All right, so to kick it off, Eduardo, can you talk about what sets Avantis apart from other asset managers?

Eduardo Repetto: That's a tough question, because in my view, every manager is different from any other manager. Not two managers are the same. You say, “Well, Eduardo, what about index funds? How many managers manage the S&P 500?” You may have a point there, because in general, when you have index funds, they have not only the same strategy, but also, they have the same fee. Not always, but sometimes they have different services. Every manager is different from every other manager.

Now, the way I think about Avantis when we started and we spoke about this before, is that our goal is to systematize active management. What do I mean by that? You, Ben, are too young, but Cameron may remember something called typewriters. Remember typewriters?

Cameron Passmore: I took typing class in college, Eduardo.

Eduardo Repetto: Both of us. I took it in high school. I was quite bad. But I remember the typewriter that you have to move it, and not even the electric ones. You would know, Ben, about typewriting, because Word came to systematize typing. Typing was a terrible thing for the efficiency of workshops replacing.

We set up Avantis to systematize active management. Because active management is a very expensive proposition. You need a lot of people, analysts, portfolio managers to analyze a lot of security to try to come with a discount rate and then to come to the target price. That process is very, very inefficient from the point of view of cost, what basically prevents having the right level of diversification. If you are able to analyze more securities at a lower cost, you can provide value added and you can provide diversification and you can provide all that at low cost. That's what we were set up to do.

That's why we think about this valuation framework, just think about all the evaluation of the company and then you can decompose in peace, but putting it back together. That's what we set up to do. I'm sure there are so many managers, when we came to the world, the name Avantis, we are looking for names and they were – every name that you come to mind was already taken. There are so many managers around the world.

I haven't run any one that thinks the same as us and provides services the same as us. I cannot tell you that there are none. We try to think about the company holistically, try to think about trying to find what companies have been working with a higher discount rate, and why some companies have higher discount rates, because there is no axioma, law of physics, law of gold, a universal constant that says, every company will have the same discount rate. Companies will have different discount rates. The moment that you have different discount rates, some company will have higher returns than others, and that's what we're set up to capture. That's what's as different.

We, you know because we spoke before, we were set up to have a – if we were a restaurant, we would be a restaurant with great food, great service and good prices. We're an asset manager, we want great investment strategies, great service and good expense ratios. That's, I think, a decent recipe for successful restaurants and also for asset managers. That's how I think.

Ben Felix: Yeah, makes sense. That reminds me of your gas station sushi comment from last time, which became a bit of a meme within our podcast community.

Eduardo Repetto: Gas station sushi. I don't remember if I wasn't going to see and where. Someone told me, there is a gas station here that has excellent sushi. I haven't tried, but it has excellent sushi. I told you, I have to believe. I'm sure there is an exception on that, and some amazing sushi chef decided to have also gas station. That's a classic nowadays.

Ben Felix: Yeah. Yeah.

Mark McGrath: Eduardo, what strategies are you guys launching in Europe?

Eduardo Repetto: After our talk last time that we spoke, we started getting a lot of things from all around the world. People are asking us, not only from the US where we are made, but people are asking us from Canada, from Latin America, from Europe, from Asia. We keep track of how many things we get from people from around the world. Even more, we got business, some advice with business, someone that heard you guys in a conversation with us, and thank you.

When you get a lot of prospect, let's say, of possibilities in different parts of the world, at some point, you have to pay attention. You say, why you didn't do before? Well, we’re starting. We are, I think, at the today, yesterday, we are four years and 10 months since we launched the first product. We’re starting. The goal is to service as many clients all around the world as possible. What we plan to launch is free UCITS and equity UCITS to service people around the world. We have five with the Central Bank of Ireland, because these are going to be Irish-based UCITS, with more Irish-based ETFs in order to have the tax advantage that the Irish-based UCITS have relative to other UCITS offerings. We are in the quiet period, let's call it, but we have five. We have, hopefully, going to come to market soon when the Irish Central Bank approves us.

Ben Felix: Can you quickly, Eduardo, talk about what UCITS means? People in Europe will know what that means, but our non-European listeners might not.

Eduardo Repetto: Oh, yeah. In the United States, the funds are organized on the 40 Act. We have, when you speak about a mutual fund or an ETF in general, not always, but in general, are 40 Act vehicles. That's a regulation that under which a mutual fund, or an ETF is structured. UCITS is similar, but basically for Europe. It's an undertaking of collective – it has a long name, but basically, it's a regulation, under which the funds for ETF are organized in Europe. Europe is a whole set of countries, so you can't make them base in different countries. They can be used in the other countries if used, they have the right regulatory filings and papers.

One of the benefits that UCITS have is that they have become global funds. Many, many investors from around the world, say Asia, or Latin America offshore money, not only Europe, use UCITS, because some of the UCITS, depending where they’re based, have advantages related to double taxation. For example, if you are a foreign investor and you buy a US fund, when the fund makes an institution, the US keeps 30%, or whatever it is, in withholding taxes from the institutions. UCITS in certain jurisdictions and not to have these double taxation funds. That's why they have become a very popular global investment maker. That's what UCITS mean.

Ben Felix: Okay, got it. You mentioned that there are five strategies you guys are launching. What are the five strategies?

Eduardo Repetto: I say three. The plan, we have filed for approval from the Central Bank of Ireland. Hopefully, we’ll get it soon. We hope soon. We plan to launch three strategies. But the other plan is to over time, enhance our family. In the US, if you remember, we start our first year was emerging markets, and one week later, we launched four other ETFs. Today, we have 28 and two more to come. You have to start somewhere.

The strategies that we are planning to have are basically strategies similar to strategies that we have in the US. We are trying to have emerging market strategy. We’re planning to have an equities, global equities strategy. We're planning to have a small value strategy, global small value strategy. We're planning to have all these things in all the different markets that we go.

Let's suppose, we start in Canada tomorrow, probably that's a good idea of what we plan to do in Canada, or if we do it, I'm not promising it, but we're also having a local equities strategy. That's basically, if you put yourself in our shoes, that's probably how you will start, because those are basically why we are known.

Cameron Passmore: Eduardo, can you talk about how aggressive are the factor tilts in the UCITS global equity strategy?

Eduardo Repetto: If you're speaking about the strategy, our global equities strategies, you know our US strategy, so let's speak about the US strategy, because it's easier. If you look at our US strategy, what we are always trying to do is emphasize in security strategy, and our opinion and trade at the higher risk number. It would be how low prior for that to the equity and the cash flows of the company in banks, who are safe. Now, security with high profitability and high modifier of book to practice. In particular, in small caps and mid-caps, where the premiums are higher because the dispersion of valuation is higher.

Our idea, when we launched these global strategies, is to follow what we have done in the US. In the US, you have AVUS, AVDE. You know these two tickers, our US equities, our international equities, that give you more or less an idea what we will do in any market that we launch a global equity strategy. It's global, so you have to be waiting US and international, but you know that when we select securities, we do country by country. Putting a strategy that our multi-country is just basically using the security selection and waiting that we do in a country, another country and then a restriction then to whether using what we do in general is marketplace.

Ben Felix: Okay. That's one of the questions that I had, or it's related to it. For the global small caps value strategy that you mentioned, what does the geographic exposure look like?

Eduardo Repetto: That's what we're speaking about. This is a good question. Let's divert a little bit. If you speak about the global market, the global market is around 60. I'm speaking about X emerging markets. When we say global, we are not including emerging market, emerging market who put apart. You can tell me why is that, because many investors really don't want to have emerging markets. If you allow that having emerging market apart, you basically can have someone best in the developed market, they want emerging market economy. Subtract it, it's impossible.

If you think about the developed markets, let's say, or what we call lower market, the US is around 70% international developed is non-US developed, it’s 30%. When you look at the small caps, this is very interesting fact, because if you look at the small caps, FTSE, Morningstar, S&P, they are basically 70-30. But when you look at MSCI, MSCI is 60-40. That's because MSCI methodology puts a cap in the maximum market compensation that you can buy in any country. The US has an artificially small representation in MSCI small caps here relative to their benchmark. That's why MSCI has six instead of seven.

Our view for global markets, no matter if it's a large cap, or small caps, it's probably we follow in the 70-30. The centre cases, we have not done that, but we like to follow this in general. Unless, you have one country specific that the people really, really are attached to MSCI, we follow that 70-30.

Mark McGrath: Beyond some of those differences and beyond it being a UCITS, is there any major difference between the strategies that you're going to be using in Europe, versus the ETFs that you launched in the US market?

Eduardo Repetto: Well, the answer is we have our strategies and we need to accommodate our strategies to the different regulatory environments. If we have to apply UCITS, then maybe a slightly different regulation from the US, so we will have to adapt to the European regulatory framework. Like the same if we do in Australia, we do in Ghana, or whatever, we launch a strategy, we have to adapt to the regulatory framework. But the strategies are the same. We manage the strategies in the same way, with the same people, with the same philosophy, with very, very similar process, however this regulatory difference that you make up here and there.

You know our strikes. We don't change our strikes, because we're in a different market. We only will change things when there is a particular need in a particular market. Let’s assume, for example, in certain markets, for example, if you go to Australia, they have franking credit. There, you make out to accommodate franking credit for Australia, different than if you are running a typical global strategy investment in Australia. In this case, now we're speaking about, I think, you can't think about these as the same as what we are doing in the U.S.

Mark McGrath: Great. Thanks.

Eduardo Repetto: Now, one more thing. One thing that happens in Europe that is interesting, and this is different than the US, in particular for the US, and funds are different. When you have a UCITS fund and people want to access that UCITS fund in different currencies, you have to have different share classes in different currencies. When you have a UCITS ETF, that's not the case, because you look at UCITS ETF, there may be listing, you may have for the same fund, listings in different countries, in different currencies. You see UCITS fund that they may be in USD, but listing in Europe, in Germany, for example, or in Netherlands is in Euro in the list, or in Italy is in Euro on the list. In the UK, maybe in GBP and USD on the list. In Switzerland, maybe in Swiss Francs. That's different from the US. People can access in whatever currency is more convenient for them, depending on the listings. UCITS, in general, you have several listings to provide easier access.

Ben Felix: That is interesting. One of the things that people worry about with new ETF launches is that they won't survive and that they'll have to close down and maybe there'll be a taxable disposition. Do you have a sense of how much AUM these new strategies will have to reach for them to remain open in the long run?

Eduardo Repetto: I’ll tell you how we think about this in general. You can imagine how many times we have to answer that question. We're not answering that question anymore, but we are answering that question day in, day out. You have to plan that before going to market. You are not going to market. Actually, going to market in any market is a big expense for anyone. You have to have some level of confidence that things are going to be okay. Remember the restaurant. You have a good restaurant, it has great food, you have a great chef, great stuff. You have good food, good price, good service. Things will work okay. It may take a little bit longer, or a little bit shorter.

I don't think about one fund and an installation. I think the whole offering when you go to any particular place together. Sometimes maybe have a little bit more, sometimes make a little bit less, but you think about the whole offering. Once you commit to go there and you have the right strategy, you have the right price, you have the right service, you have to go and just fight the battles. If you have the right price, things will happen. You will be able to survive. You will be able to thrive. If you charge too much, the answer is, only you're going to suffer. If you have bad strategy, probably you're going to suffer. You have bad service and people don't know about you, probably you will suffer. Whenever you just put an offering in the market, you have to take into account all these different aspects.

Then, just go and do your homework. Just go and knock at the doors, go and speak with people and think what happens. I would not be too worried if I were someone thinking about this question, about, will they come into the end? They will, and they go out tomorrow. The best example is what we have done in the US. We have been able to start from scratch, grow it from nothing to, now it's around 50 billion dollars. Just expand the offering. Anywhere we go, we do the same, because that's the right thing to do. That's the right thing to help people that trust you on day one.

Cameron Passmore: Related to that 50-billion-dollar milestone and Ben's question, with AVUV, for example, at 12 billion or so of AUM, at what point do you start to worry about strategy capacity, or do you even worry about that?

Eduardo Repetto: That's an amazing question, because that's where you started thinking about ETF versus funds, versus estimates, or separate institutional and separate accounts. Capacity is basically, your inability to invest, and there are two parts of capacity. One is how much you want a good accompany. You need to own 80% of the company to invest money, while [inaudible 0:22:37]. You are owning the company in that font. You're not an investor. You are the owner. You're a controlling shareholder. Forget about that part of capacity. That's a big number.

The more common capacity part is your inability to invest cash flows. You are giving me so much money, my fund is so hard that I'm getting buckets and buckets of cash. When I go to trade, I'm having problems investing that cash in a reasonable time at a reasonable cost. Then I have to equitize the cash, and if I have a small cap strategy, I have to equitize with S&P futures, that are not really the strategy, but have a lot of other issues. It becomes the typical capacity issue. What people do, then the portfolio starts to be more less focused, so the portfolio changes the strategy, or you just incur higher trading costs, which is a problem in another day for the initial investor to have to deal with that.

Here, are a little bit different. Why? Because in India, we don't get cash. We have securities. Whenever we manage ETF, and you buy our ETF, if the market maker needs to create ETF shares to settle the transaction with you, they have to do it by speaking with us, and say, “Hey, I want to create ETF shares.” I say, “Okay. Give me these securities, and I give you ETF shares.” That's an in-kind creation process. We are not having cash drag because of cash loss, because we get the securities that we want.

When we manage ETF, we have two baskets, a creation basket and a redemption basket. Each time the market maker want to create ETF shares, because there are purchases that they have to settle, they have to give us securities in our creation basket. You can imagine that a creation basket is a securities that we want today. What we say, what is the new securities that we need to increase weight and we need to add to the portfolio? When there is some redemption, what do we deliver? We deliver the redemption basket. You can imagine that that redemption basket is a security switch. We already don't want so much in the portfolio anymore, but they have already served the purpose and it's time to let them go.

This dual basket process, where you have in-kind creation, some redemptions, basically help you rebalance the portfolio. It's like this in outsourcing the trading, because you receive the security. You don't have to pay for commission. You don't have marketing back, because you're not trading. You're receiving the securities. Capacity gets extremely alleviated when you're managing ETF with this in-kind redemption purchase process, creation and redemption baskets.

Our strategies have a lot of securities, small values, because 750 names. That spreads the allocation and the amount of trade that you need in a particular name. Our strategies are low turnover, so that minimizes the amount of trading that you have. Our strategy I view in particular, is an ETF. A lot of the trading doesn't happen by us trading. Most of the trading happen by in-kind processes. That gives you a humongous amount of capacity.

Cameron Passmore: That's interesting.

Eduardo Repetto: It's amazing. You start thinking about ETF versus funds, or separate accounts. You see the benefit of ETF. If there is a reason why ETF are growing so much, it's the benefit that this structure brings to an investor is quite impressive.

Mark McGrath: Even here, there's some big fund companies that are rolling out ETF versions of their mutual funds to trend here as well.

Eduardo Repetto: What is interesting, a lot of people are speaking of all creative share classes. You have a fund and you create a share class of the fund that is an ETF. I'm not a big believer in that. Why? Because if I have an ETF, whenever I buy and sell, I want to be sure that no one else comes in cash and impost costs on me. If you give me the ability to have a fund, I'm an investor now, and I come by an ETF that is standalone, or an ETF that is a share class of a fund, everything equal, I always speak with the ETF at the standalone. Why? Because if I'm buying the ETF that is a share class of a fund, I'm exposed to cash flows in and out from people coming in the fund share class, that are coming in cash and they're going in cash.

In the ETF, I don't have that. I'm completely isolated. Yes, a lot of people are bringing and trying, at least in the US. I don't know a thing. Trying to bring this share class is not fully approved yet. But they're trying to bring share class, ETF share classes attached to their existing funds, basically, to save their funds. I prefer to have ETF alone. That's why you know, we have the same strategies standalone, fund and ETF. You want the fund for whatever reason you want the fund. Maybe you are a 401k. You have no choice by having a fund. Okay, we have a fund. You want an ETF? You fund an ETF. We're trying not to give you the cocktail and the dessert mix. We try to give them both of them up, so you can decide which one is best for you.

Mark McGrath: What are you hearing from the advisor community, or the investment community at large about why they're allocating to your strategies?

Eduardo Repetto: You can imagine, this is such a diverse group of people. There are many, many different stories why. Some people do it, because they love our strategies, and I imagine that's a lot, and also the pricing. Some people do it because they want manager diversification. They want to have one more management that is really good, that allows me to diversify my managers. That's another reason. There are different people that do it for different reasons.

Performance has been quite good. You know the numbers. Our fees are low. Our service is good. You know that we produce this thing called the field guide that comes in the third business day of the month, that is broadly years by the advisor community. I think that we provide good products and good service at a very attractive fee. I always think about the rest. I mean, it's the same.

If you have these three things together, people, sooner or later will realize, “Ah, it's worth doing business with these guys.” Early on, people can say, “Well, I don't know if they will survive, or let's see what happens, or let's get more track record.” But the more that the time passes and the strategies prove themselves and the service prove themselves and people realize, “Oh, this is good for my clients.” Advisors are extremely good fiduciaries. They love to find that solution that will improve their client's portfolio, that will improve the outcomes for the clients. I think we came to market, basically, with an idea that we could provide a state of their solution with the state of their client service in a very attractive price. People have embraced that. We strive to keep on doing that and even better every day. You tell me, you're an advisor. You have a lot of experiences as an advisor. You tell me, why will you use someone like us?

Ben Felix: I think you talked on a lot of the right points. You guys aren't in Canada, obviously. It's not something that we've had to seriously consider.

Eduardo Repetto: I'm not selling in Canada.

Mark McGrath: Yet.

Ben Felix: Yet. But from other advisors that I've talked to, I mean, manage your diversification for sure. You guys did come in with a nice product at a lower fee than some of your direct competition. Those have all been meaningful. Then, like you said, you launched at a time when performance ended up being pretty good after the launch. I think that always helps.

Eduardo Repetto: That helps. If you look at long term, it's more than just a timing luck. It's a long term. But anyway, well positioned.

Ben Felix: I agree.

Eduardo Repetto: Sorry, I interrupted you.

Cameron Passmore: Do you have any sense, Eduardo, of your client breakdown, like advisors versus individual investors, or DIYers? Can you tell?

Eduardo Repetto: Most of the money is advisors, or wealth management money. We also have institutional money. We also have some advisory business with a lot of insurance companies. You're asking me, basically, how much you are in retail clients. The answer is I cannot be completely sure. It's quite difficult for a retail client to find us, unless if it's someone that is very knowledgeable. I'm sure that a lot of people listen to your podcast, or reading some particular technique. Because we don't have technical publication, but we don't do advertising. You're not going to go and see the Dodgers Avantis, or whatever. We don't have any force, or what is the genre on the page with a look at all my Morningstars, or anything.

We are not targeting retail clients. It's not our business. We like to speak with people that are knowledgeable. There is a lot of retail clients that are knowledgeable, but it's very difficult for us to know who. By working with intermediaries, like constitutional consultants on offices of institutions, or professionals in insurance companies, or other asset managers that we also advice, or advisors of wealth management in general, while speaking with people that are knowledgeable, we can explain what we do and they learn what we do and then they learn how to use their asset allocation. We feel we're more comfortable with that.

Ben Felix: Yeah, that's interesting. That'll make people listening to the podcast feel very special. Because like you said, many of our listeners are retail investors who are using Avantis products. They'll feel like they've got a secret.

Eduardo Repetto: All of us are geeks. If we listen to a Rational Reminder, even the name, the Rational Reminder, all of us are geeks in this field, and that's okay. It's very nice to create a community, like the community that you guys have created, where people that have a common interest can listen, participate, learn, debate. It's impressive when you guys have that.

Ben Felix: Thanks, Eduardo. Since the last time you were on Rational Reminder, you guys have actually launched an emerging market small cap strategy, which is something you didn't have last time. One of the questions we got from the rational reminder community is, is there potential for an emerging markets small cap value strategy in the future?

Eduardo Repetto: We thought about that. What we did is something that looks different. We have a strategy that we call the emerging markets value. That emerging market value strategy is not a market-wide strategy. It's not get all the value stock from mega caps to small caps. What we do is we exclude mega caps. The largest mega caps are not part of the strategy. You can think about that strategy as a small meal. Maybe it's a little bit larger than a small meal, depending how you define mega caps, but it doesn't have the largest mega caps. That was our solution for a small value strategy.

Let me give you an idea. Let me give you an idea. If you look at the market-wide strategy value, the allocation to mega, to large caps, to the largest cap is around 40%. Call it large and mega caps. Then you have mid-caps and then you have more comments, like 40% is a big number. Our allocation is much smaller to those comments. Our way to average, actually, our geometric market capitalization are not in emerging markets, value is around 6.5 billion. Visit Morningstar. Anyone can check it. If you look at MSCI, emerging markets, geometric market capitalization is 28 billion. We are way smaller if you think about market capitalization.

Now, the other smaller market cap solutions than us in emerging markets, others provide smaller than 6.5 billion geometric market capitalization. But our view is that once you get out of mega caps, and you get into mid-caps and smaller caps, and if you consider the whole valuation framework, trying to buy companies that despite the high profitability they train at the pricing, you have a nice universe of companies with nice valuation spreads, and you can provide good value at it. I think we do something for people that are asking about emerging market to small value. I think what we have may satisfy the need is not as a small I understand, but I think that we may satisfy the need.

Mark McGrath: Since you guys launched in 2019, have there been any enhancements, or improvements to the way you guys implement portfolios at Avantis?

Eduardo Repetto: The luckiest thing is we didn't have to make any big changes. We were having many big changes and maybe because of a screw up and something. There have not been any big changes. But there has been a small improvement here and there. Some of the improvements are on processes. I remember that I told you dual baskets. At the beginning, we were not working with dual basket creation. We were working with one basket. Soon later, we could start working with dual basket. They start moving to a whole basket. That's it. Operation, that's the big improvements. It's cumbersome, but it's a big improvement, because it allows you to much better balance your portfolio at lower cost.

Then, they have another changes imposed on us, because of changing reporting. Reporting in whatever country, financial report is changing in whatever country, so now we have to adapt and find the new variables that are going to work in the way we want. There have been a small changes here and there. We have looked at a lot of things. For example, instead of using the cash profitability at some point, we were looking at free cash flows. We found out that it didn't work as well as cash profitability; at least our version of cash profitability. The difference between free cash flows, the main difference, not the only difference, but the main difference between free cash flows and cash profitability is capex, capital expenses. You start thinking why it doesn't work as well is because in capital expenses, the managers of the company has quite a lot of discretion when they make it, how they make it, and can make all the capex for this year, for the next three years, or they spread it out. The numbers become less comparable.

One of the things that we learned from Robert, Robert Novy-Marx’s paper, is going up in income statement, you make numbers more comparable. Being able to compare apples and apples is better than compare apples and oranges, or pears, or whatever is as close. Free cash flows didn't work as well. Imagine that you have two companies. Ben and Cameron's company. Ben's company and Cameron's company, they are great businesses, but Ben doesn't make any money, so he doesn't produce any cash flow, so he doesn't make any capital expense. His free cash flow is low.

Cameron makes a humongous amount of money. He's bullish in his business. He makes a big capital expense, so his free cash flow is low. The two business are very, very different, but they have similar free cash flows. While the cash flow operations is very, very different. That gives you an idea why we find that it didn't work very well. We play with a lot of things, trying to improve our metrics. Beautifully or luckily, depending how you think, we come and find yet something that is a big enough change to publicize. But they're having small changes here and there.

Cameron Passmore: What's the most exciting research you guys are looking at implementing now?

Eduardo Repetto: We are working on the other side of the spectrum, we're on the value side, we're working on the growth side. With you, we make up something interesting on the growth side. We’ll see. We make some noise at some point. We think we can have something interesting on the growth side. That's interesting. In general, we're always looking at how to improve our proxies for the equity of the companies, our proxies for the cash flows of the company, or how they can improve efficiencies in our process, like I told you the dual bucket, or other things that we have been applying in order to minimize costs of every kind.

ETF allows you to do a lot of improvements in the operations that yeah, it's saving pennies, or sub-pennies here and there, but everything adds up. We are also working on that. We will make more noise when we find something. We're working on the growth side of the market. We think that there is room there to some interesting things.

Ben Felix: Yeah. We noticed the perspectives you thought. I want to come back to that in a minute. We had Wei Dai from Dimensional on recently. She talked about the cool thing that they're looking at right now is short-term reversals in their investment processes. Is that something that you guys are looking at, or will look at?

Eduardo Repetto: Well, we look at short-term reversals even when I was there. Yeah. It's a bit controversial, depending for you, as I'm sure you asked some of the efficient market guy and maybe they will tell you, “Ah, it's bid ask spread, or bounce back.” Wei is great. Look, let me be clear. I cannot say more great things about Wei. Wei is great. It's a pleasure as a person, but it's also a very knowledgeable person.

Now, what is reversals? Reversals is basically, it's a very high turnover strategy, because it's the performance of a company over a short period of time. It can be a week, it can be three weeks, it can be a month. A company has the best performance over the last very short period of time. The expectation, they have a reverse, they have bad performance in the next short period of time. That's short-term reversals. It's extremely high turnover strategy. You know our strategies. Our strategy is extremely low turnover. If you look at our market-wide strategy, you are speaking a lot single digits, or low, very, very low double digits, in 10% to 15% are low. It's not expected to come up.

Even if you look at our value strategy, turnover is around 20%, 25% on expectation. We have low turnover. When you have, let's call it a signal, that gives you information on a very high frequency basis and you're trying to apply it to something that really doesn't move, you really don't have a lot of value added. It's just statistical noise when it comes to value added at a strategy level. We know reversal. We have looked at reversal. We knew it. I knew it. Before this Avantis experience, we knew that before. For our strategy that are so diversified and so low turnover, really, they don't make any sense. No, it's just statistical noise, let's put it that way, at best.

Mark McGrath: You mentioned earlier that there's some interesting things that can be done in the growth investing space. Avantis recently filed a prospectus for a US growth equity ETF. I'm curious, what is it that you think that's interesting that can be done in the growth space? Then also, how do you think investors should think about allocating between growth and value?

Eduardo Repetto: Still, we haven't settled on the name. Maybe we'd change the name. On the growth space, one of the big things, so if you think about our valuation, we are using today's profits as a proxy for future profits. Can you improve that proxy? Can you improve the proxy? Can you have something better to say, about not level, but changes in level? The answer is maybe. That's basically the angle that we are playing with. You can call growth, or you can call quality, or there's many ways to name these things, and we haven't – some people may say this is more quality than that growth, but it's all related. That's basically the angle that we're playing with. When we come to market, we've heard it tell more about this.

The second part of your question is interesting. What do you think about how much an investor should buy value, or versus growth? Or should they even buy growth? The answer, I think, was given by Markowitz, not by me, so I cannot take credit. Markowitz said, “Hey, when you're forming a portfolio, expected returns are low is not the answer. You shouldn't say that expected returns and risk.” There is a trade-off there. Because if you just care about the expected returns, you finish with one security in your portfolio, the one that you think has the highest expected return ever.

I think there is a role for growth, for value, for large, for small, for diversification in your portfolio. That doesn't mean that we cannot deviate from the market overweighting some securities, because we think of the opportunity that those securities provide us is better than others. We can deviate from the market overweighting value securities, and underweighting growth securities, if you think of value security have higher expected returns than growth securities. You know when we manage a portfolio like a US, we have growth security, we have value security, we have large cap security, we have mid cap security, we have a small cap securities, but we deviate from market weight.

Growth, or equality, or a strategy plays a role in someone’s portfolio. It may not be a market weight, it may be below market weight, but it plays a role in someone’s portfolio. If we can create a strategy that is growth quality with high expected returns, it certainly would play a better role than a security that has lower expected returns, that certainly would be more than that weighted. All these plays a role when you're thinking about the trade-off between expected returns and diversification.

Ben Felix: Yeah, really interesting. I think Novy-Marx has – he talks about it as good growth in one of his papers.

Eduardo Repetto: Robert is declaring that. I saw Robert one month ago, or two months after so many years I’m not seeing him. We were in an event and we have dinner together with other people in the day. It was such a pleasure. Yeah, yeah. I always remember that Robert used to like old-fashioned spirit. Very little or not sure. Then he changed his drink. I said, “Robert, what happened? You changed your drink.” It was fun. It was great to catch up.

Ben Felix: That's great. For funds like AVGE, which is a single-ticket asset allocation fund, how are decisions made about asset allocation? Just for example, one of the questions that we got from listeners is if they like the current factor tilt in that portfolio, should they be concerned at all that they will change over time, maybe get more aggressive, or less aggressive with the tilt?

Eduardo Repetto: That's a good concern, because you are outsourcing the asset allocation to us. It's a good concern, but I don't think that they should be concerned, because our strategies are not hyper note. I would not expect any dramatic change in our built-in, or allocations in our strategy. People that have use about their abilities to predict the future to do changes, we don't do these changes. Our, what we call tilts should be quite stable. It should be quite stable. Unless, there is a new discovery, it should be very, very stable.

We tend to have low turnover strategies and whatnot. It may change. For example, it's counterweights. You know that the US now is a bigger fraction of the world. When I started, the US was a smaller fraction of the world. It can. But the same as. Australia may be a bigger fraction of the world, and Italy, maybe a lower. You don't see, but those things are happening. These allocations across countries, they are low turnover allocation, but they're moving slightly here and there. The tilts towards the premiums that we're trying to deliver to the higher discount rates that we're having, I would not expect that any dramatic change, and since there is some discovery that it will be worth speaking broadly.

Ben Felix: Makes sense.

Mark McGrath: Eduardo, is there any hope for us, Canadians, that you guys are going to launch some ETFs for us here?

Eduardo Repetto: I hope so. We are expanding. I hope so. I love going to Canada, because Canadians think that I have an accent. They also think that Americans have an accent. A level playing field for me. I remember being in a conference and say, “Oh, you have an accent the same as the other guys.” I love that. I love going to Canada. Yeah. No, no, we're seriously considering.

We know that we have Canadian investors now. We know that now, because we are selling in Canada if we can, but we know that because we look at customer records and given, we infer from the customer records that this money coming from Canadian investors, though, we don't know who.

I think that in for retirement money, you guys would know more than me. For retirement money in Canada, US basic years provide a very, very competitive product. In particular, the US basic year that invest in US securities, because you don't suffer withholding taxes. I think that that's where the money is coming, the advisors that are very, very clever. Or retail investors that are very knowledgeable, that listens to you guys, or someone like that. They say, “Oh, I am not suffering withholding taxes by buying the US ETF, versus buying the Canadian version of the ETF.” There you go. I buy these guys in the US.

Yes, we have been looking into Canada. It's a new market. You need not only the ETF, or the price, but you also need all the infrastructure to support from the marketing point of view, the servicing point of view. You cannot say, “I have a great chef, and the proof good meal, but the service sucks. I don't have dishes, not napkins, and not forks and knives.” You have to have the whole offering. We have been looking into that. I really hope we can get into Canada, because there are so many places that are worth visiting in Canada. I love coming there.

Ben Felix: Love it. Love to hear it. All right, Eduardo, this has been great. We really appreciate you coming back on. It's great to see you.

Eduardo Repetto: It's always a pleasure. Thank you very much. Thank you for all what you do, for all the investors all around the world. Yeah.

Cameron Passmore: Thanks Eduardo. Great to see you again.

Mark McGrath: Thanks, Eduardo.

Eduardo Repetto: Bye.

***

Cameron Passmore: That was fun. Now to the after show for the three of us. I must laugh, there's so many people. I know it's now more than three. It’s probably up to what? Five people that listen, and they're pretty active on Twitter about, “I'm pretty proud to be here.” It's a private little club.

Mark McGrath: There's always a joke on Twitter about it afterwards.

Cameron Passmore: There’s always a joke.

Eduardo Repetto: Yeah. John Stalking, I think, is our biggest after show fan. He talks about it quite a bit. A little bit too much. It's weird, John. Lay off.

Cameron Passmore: Well, it's basically based on some reviews, Ben in the mids, right Mark?

Mark McGrath: That's right.

Cameron Passmore: Ben in the mids.

Mark McGrath: It's so funny, because I've been playing a lot of it. My wife's away right now. She took the kids to Mexico for an extended vacation. She's having a good time, right? Kids off school at summertime. My wife's not working right now. Just thought it'd be a great time for her to go and take the kids. I've been playing a lot of guitar. These guitars on my wall are not just for show, people. I actually play. Or I have been at least this week. I was driving home the other day. I was like, “I should start a band.” Then I was thinking about names for it. The first name that popped into my head was Mark in the mids.

Cameron Passmore: We didn't even talk about that.

Mark McGrath: No, no, no.

Ben Felix: It came to me, too.

Mark McGrath: Yeah. I just think it's a pretty catchy name. It also means, I'm not mid. I'm Mark. The other guys are mid. It works in my favour as well.

Cameron Passmore: Yeah, exactly.

Mark McGrath: Album coming soon.

Cameron Passmore: Before we talk small cap, it just ties in with the mids. Let's read the recent reviews. Is that okay with you guys?

Ben Felix: Yeah. Who's going to read it?

Cameron Passmore: I'll read it. It came from Three-Year-Long from the United States. Ben Felix, you heard it here first. “Ben Felix is a global treasure mark.”

Mark McGrath: Can we get Ben to read this?

Cameron Passmore: Actually, that's a better idea. Ben, you read it. How's that?

Ben Felix: Come on.

Mark McGrath: I just want to see him squirm.

Ben Felix: “Ben Felix is a global treasure.”

Cameron Passmore: Let that sink in. Just appreciate it, Ben.

Ben Felix: “This is the only podcast that gives honest, real, analyzed financial information with a gentle dazzle of subtle dad humour. It truly is gold. Ben Felix is at the top of my and my husband's top hottest celebrity list. No one else has the courage to be this detailed and boring.”

Cameron Passmore: It’s so good.

Ben Felix: Very unique review.

Mark McGrath: That was great. Those are great.

Ben Felix: Lots of layers.

Mark McGrath: Had a good laugh when I read that.

Cameron Passmore: Yeah. Ben in the mids.

Ben Felix: Yeah. Anyway, small cap value.

Cameron Passmore: Let's get back to your happy place.

Ben Felix: It's done really well recently. It was a record five-day run, a historical record.

Cameron Passmore: Really?

Ben Felix: At least for the Russell 2000. I just looked at the month to date return as of July 17th for AVUV, the event is US small cap value ETF, it's up month to date, July 17th, 8.85%. Which is pretty incredible.

Cameron Passmore: Isn't small growth also doing well? Not just the value side, right? I saw someone posted that.

Mark McGrath: Small growth is doing pretty well also. Yeah. I just looked at the Morningstar style boxes yesterday for the past month. Both US small value and US small growth were up about 10% over the month.

Cameron Passmore: Sorry, Ben.

Ben Felix: Not too bad. Over that same period, so month to date, July 17th, VTI just with the Vanguard US total market ETF is up 2.82%. Very significant month-to-date premium. Now, it's still trailing year to date. US large growth has been insane this year. Small value still has some catching up to do. That short burst of positive returns from small value in an excessive large growth is always a reminder about the importance of staying in your seat, if you want to capture risk premiums, and maybe think of – actually, Mark, you reminded me of this with the chart. Back in episode 147, we have Paul Merriman on. He talked about his, I don't know if it's his actually. Might have been Bogle's chart originally. Anyway, he talked with the tell-tale chart comparing US small cap value returns to S&P 500 returns. It's a neat chart that shows a relative performance of small cap value relative to the S&P 500.

What it basically shows visually is that small cap value going back to 1930, which when the chart starts, has tended to have really long periods, where it underperforms the S&P 500, and then relatively short bursts about performance. On average, in the long run, small value outperforms, but it tends to happen in these short bursts. Then in these long periods, we've got to stay in your seat if you want to capture this. As a long-term investor, you end up being better off in small cap value eventually, but getting there requires enduring those periods of relative underperformance compared to something like the S&P 500.

I pulled up quote from Paul back in that episode. He said, how many people are going to be able to stay the course when for 13 years, and there have been longer periods of underperformance, when for 13 years, their neighbour is bragging about how much money they're making in the S&P 500. That's what they're going to have to put up with. That's like –

Cameron Passmore: Now.

Ben Felix: - now hasn't changed. It's just as true as it was when Paul said that to us back in 2021. Anyway, this recent historic small value, or small cap in general performance is just a good reminder that those returns tend to show up in short bursts, and you've got to be there if you want to capture them. I did also want to mention, though, that, so year-to-date, US small cap value is underperforming market. In Canada, though, small value is doing quite well, year-to-date. I looked at just year to date as of July 17th, again, DFA Canadian Vector, which is a small cap value tilted Canadian equity strategies from Dimensional, it's up 13.91%, and then the Vanguard FTSE Canada all cap ETF, just a market cap weighted Canadian ETF is up 10.99%. Pretty meaningful.

The Vector is not even a small cap value fund. It's just a more aggressively tilted toward small cap in value, but it's still more like a total market with aggressive tilts than it is a small cap value strategy. Anyway, it's done quite well year-to-date. Even over the last three years, it's outperformed. Yup, so there it is, small cap value. It's back, sort of.

Mark McGrath: Patience is rewarded. There's somebody I follow on Twitter. He goes by Jake and his handle is @econompick. Instead of economic, it's an econom pick. Good follow, by the way. He puts out a lot of really interesting information. But he posted a chart this morning. It's the 30-day correlation between the S&P market cap weighted benchmark versus the S&P equal weighted benchmark. It's a rolling 30-day correlation matrix. It's the lowest it's been since 2006. The correlation between an equal weighted portfolio and a market cap weighted portfolio is in the neighbourhood of 0.25 over the past 30 days.

The two is hilarious. He's like, you could have essentially diversified your S&P 500 market cap weighted risk with S&P 500 equal weight risk, because they haven't been moving at all in tandem. It's a corollary to the small cap under performance, had you weighted differently to small value, or even small caps in general. The performance has been incredibly different from large cap over the past 30 days.

Ben Felix: Yeah, that is interesting.

Cameron Passmore: Do you want to talk about one of your new friends on Twitter, Mark?

Mark McGrath: Yeah.

Cameron Passmore: One of your many friends.

Mark McGrath: Yes.

Cameron Passmore: You've got energy for that stuff that is beyond me.

Mark McGrath: It fires me up. I don't know. I think social media, we know from looking at studies on this, that people turn to social media for advice. There are a lot of finfluencers, if you want to call them that, putting out advice. There's lots of good ones that have reasonable advice, but there's a lot of really, really bad ones. I saw a post from somebody saying, why would you ever leave $100,000 in cash? Didn't you know you can generate 1% per week selling stock options on that? It's 1% per – come on. Okay, so if you compound your money.

Cameron Passmore: It’s compelling.

Mark McGrath: Yeah. well, of course, it's compelling. Because it works out to a 68% annualized compound return. I just quickly pull up a compound interest calculator. I think I worked it out. It would take you 43 years, starting at $100,000 to own all of the wealth on the planet. If you had that compounding return for 43 years, starting with a $100,000, you'd end up with 420 trillion dollars in your back pocket. You would completely consume all of the capital in the world after 43 years of these types of returns.

Anyways, he was talking about option selling. I happen to know a decent amount about option selling. What I realize is a lot of these people talking about selling options for income are only considering half of their trade. I won't get too deep into what I wrote about it. I think Ben, you and I decided, we might just do this in a separate episode coming up. I wrote a big rebuttal, basically, to why that is absolute nonsense. You shouldn't expect those types of returns. It's funny, I had a couple small hedge fund managers that run option strategies, reach out to me by a direct message saying, “Yeah. No, I've been doing this systematically in a quantitative way for 18 years. If we can get 20% consistently per year over a long period of time, we are absolutely thrilled with that.” Any amateur trader promising 1% weekly return selling options, you can just ignore them with prejudice.

Cameron Passmore: That's a Rentech type returns.

Ben Felix: I think that is.

Mark McGrath: Let's just say, and of course, that's the comparison they're going to make. If you say, nobody can do it, they'll be like, “Well, somebody did.” It's like, okay, but I don't think you're the next.

Cameron Passmore: Rentech.

Mark McGrath: The next Rentech. Maybe you are. I don't know.

Ben Felix: They didn't do that selling options either.

Mark McGrath: No. They did no 40 million trades a year, but I don't think they were selling options.

Cameron Passmore: Cool.

Ben Felix: Yeah. We did an episode on covered calls a while ago, same idea. I think we talked about a lot of the issues you cover in your thread.

Mark McGrath: Yeah. Yeah, the other strategy that people love is selling cash secured puts, which we'll get into in the episode, because it can get fairly complex. Anyways, the tweet was just a breakdown of how this works and why it's absurd to think that selling options can generate that type of return over the long run. It's not sustainable. I tagged this individual saying, “Hey, like, here you go.” When I commented on his post, he first said, “Sounds like you don't know how to sell options.” I was like, “Well, okay, now I have to write a whole thing.” I wrote the whole thing. Then I tagged them. Then he wrote back saying, “Sounds like you don't know how to sell options.” I was like, “Dude, I just wrote 2,000 words on selling options. What have you contributed here?” Anyways, in these Twitter spots. I do it just because I think it's good for people to read that information to counter the misinformation that's out there. Not because I –

Cameron Passmore: Oh, I agree. I’m just saying, your energy, I don't have for that.

Ben Felix: Yeah. Your energy is impressive on that stuff.

Mark McGrath: Yeah, it's exhausting, though.

Cameron Passmore: Anything else on your minds this week?

Mark McGrath: It's like the small cap value premium. It comes in fits and spurts, this type of energy.

Cameron Passmore: All right, anything else on your minds? Mid-summer here. Nice weather.

Ben Felix: Yeah. I think we're good.

Cameron Passmore: Okay. All good, Mark?

Mark McGrath: All good.

Cameron Passmore: All right. Thanks, everybody, for listening once again.

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