Why Active Investment Management Fails with Andrew Berkin, PhD

Andrew Berkin, PhD - head of research at Bridgeway Capital Mangement and author of The Incredible Shrinking Alpha - joins the podcast to discuss why active investment management fails, and why you're unlikely to get the outperformance you're looking for. 

Evon and Andrew dive into:

• Research behind why active management fails - both for individual investors and professional managers
• What an "efficient market" means, and why stock markets are efficient
• What is passive investing? 
• Why passive investing goes beyond index funds
• What investor SHOULD focus on, if not trying to actively pick investments.
• And so much more!

Andrew brings so much wisdom and expertise to the conversation. Hopefully this helps optometrists better understand their own investment approach and why it may or may not make sense.

And hopefully it encourages you to take an evidence-based, research-based approach to investing, just like you might take an evidence-based approach to optometry.

Have questions on anything discussed or want to have topics or questions featured on the show? Send Evon an email at podcast@optometrywealth.com.

Check out www.optometrywealth.com to get to know more about Evon, his financial planning firm Optometry Wealth Advisors, and how he helps optometrists nationwide. From there, you can schedule a short Intro call to share what's on your mind and learn how Evon helps ODs master their cash flow and debt, build their net worth, and plan purposefully around their money and their practices. 

Resources mentioned on this episode:

• Andrew Berkin, PhD - Bridgeway Capital Management
• Perspectives - Bridgeway Capital Management
• The Incredible Shrinking Alpha book
• Your Complete Guide to Factor-Based Investing book
• SPIVA Active vs. Passive Scorecard
• SPIVA US Persistency Scorecard

The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.

Transcript

Evon: 0:04

Hey everybody. Welcome back to The Optometry Money Podcast, where we're helping ODs all over the country make better and better decisions around your money, your careers and your practices. I am your host, Evon Mendrin, Certified Financial Planner(TM) practitioner, and owner of Optometry Wealth Advisors, an independent financial planning firm, just for optometrist nationwide. And thank you so much for listening. On today's episode, I have a fantastic guest. Dr. Andrew Berkin. Andrew is the head of research at Bridgeway Capital Management, which is a mutual fund and ETF management company. And the co-author of The Incredible Shrinking Alpha. Just a fantastic book along with other books as well. It's not often you get to have a literal rocket scientist on your podcast. So it was definitely a treat to have Andrew on. And we dive into the research backed reasons why active investment management fails, is unlikely to provide the outperformance that you're looking for. And reasons it should be expected to continue in that way. And we talk also about passive investment management, what that means. Which is the preferred investment approach for my firm, as well as many of my peers. As well as what investors should focus on, if not trying your hand at picking the best stocks or some other investment. And this is a little bit more in the weeds on the investment side than usual, but it's a really important topic. Ultimately, we all need to choose an investment approach and philosophy of investing your hard earned dollars. And you'd like to use an approach that is not only expected to work long-term and help you reach your investment goals. But also one that you can stick with. And with all of the temptations out there to try your hand at some form of active investing. I hope this conversation, as well as Andrew's book, sheds light on the reality and the challenge of, of what you're trying to do. And for passive investors, I hope this helps you get a better understanding of why index funds and other passive investment approaches work and make sense. I also hope it helps open your eyes to the fact that passive investing goes beyond just the S&P 500 index fund. And that you can invest passively and still work to improve your portfolio beyond the index. And at some point, Depending on your own approach. When comparing these passive strategies, these passive funds. The lowest cost isn't actually the best option. Implementation does matter. And as I mentioned towards the end of the episode, just as you hear about evidence-based Optometry. I invite you to take the same evidence-based, research based approach to investing. Or I hope your financial advisor is taking an evidence-based approach to his or her work for you as practitioner of your finances. So you can reach out with any questions at podcast@optometrywealth.com. You can check out all of the links and resources mentioned in the episode at the education hub on my website, www.OptometryWealth.Com. And of course, while you're there, feel free to schedule a no commitment introductory call. We can talk about what's on your mind financially, and I can share how I help optometrists solve investment decisions like this and, and so much more. So without further ado, here is my conversation with Andrew Berkin. And welcome back to The Optometry Money Podcast. And on today's episode, I am excited to have on Dr. Andrew Berkin. Dr. Berkin, thank you so much for coming on.

Dr. Berkin: 3:48

But Well thank you very much for having me.

Evon: 3:50

I, I am thrilled to, to have you on and have this conversation today. And you are the, the head of research at Bridgeway Capital Management. You're also the co-author of, a wonderful book, The Incredible Shrinking Alpha, along with others. To help our audience get to know you a little bit, tell us a little bit about how, what got you into, into your field of work and what you do as head of research.

Dr. Berkin: 4:13

Sure. My, my way here is a little bit roundabout. Actually my undergraduate degree is in physics. I have a PhD in physics, which is why I get to be called doctor, I guess, or why, why you call me doctor at least. And I actually did a postdoc in physics as well. And at that this point we learned the dangers of using extrapolation as a predictive technique because my next move was not in physics, but rather I went to work at a place called the Jet Propulsion Lab. It's a NASA research center run by Caltech in Pasadena, California. And what I did there was scientific data visualization. So I went from doing science to doing computer programming to enable scientists to analyze, visualize, and manipulate large amounts of scientific data on their own. I did that for five years and then I moved into investment management. I tell people, and this is actually something kind of important, that when I started off in investment management, I didn't know anything. I didn't know the value of a dollar, the proof of that being that I got a PhD in physics, which has gotta be about the least lucrative thing you can do for the most amount of effort. I set about learning what I could about investing. My transition was I started with a firm, a quantitative investment firm, doing programming that enabled financial researchers to analyze, visualize, and manipulate large amounts of financial data on their own. I thought that I was a decent programmer, but I wasn't like the greatest programmer. But what I brought to the programming, both in science and then in investments, was a knowledge of what the end user would want.

Evon: 6:06

Hmm.

Dr. Berkin: 6:07

And that's something that I felt was really crucial and I think still is crucial and really guides a lot of what we do in investing now, where it's not just running all the numbers and statistics and all that, but having a good intuitive understanding as well about why things work, why things happen, why things behave as they do in investments.

Evon: 6:32

Yeah. You took that natural career path from physics to investing, right? As all physicists do, right.

Dr. Berkin: 6:38

Yeah, there's, you know, you ask what can a physicist do? And the answer is either nothing or everything. And, you gotta find the ones that think it can be everything. Anything

Evon: 6:48

And is it accurate to say you are the first and maybe only ever rocket scientist on the podcast?

Dr. Berkin: 6:55

on this podcast. Probably, but within the world of investments, there's a very large number actually, you know, who've made the transition from physics. I don't know how many came out of, you know, Jet Propulsion Lab, but, you know, it's, it's not unheard of. Let's, let's just put it that way.

Evon: 7:12

Okay. So, fascinating background. Obviously well educated and trained. You bring a ton of expertise to this conversation and the book that you had co-authored, The Incredible Shrinking Alpha is, is such a wonderful resource for me, for investors, for the optometrists listening on, really explaining in, in really great detail, but easily understandable ways why active investment management I is not likely to succeed, why it's probably a bad idea. And you do such a great job of bringing out the research behind why that is and explaining it all in ways that are easily understood. And when we talk about alpha, what, what does that mean? How do we define alpha?

Dr. Berkin: 8:02

So alpha basically can be defined as returns above an appropriate risk-adjusted benchmark. Alpha's often used as simply being beating the benchmark. In other words, having returns that are better than the benchmark. But it's really important to take that risk-adjusted into account as well, because the fundamentals of investments say that risk and return should be related. The more risk you take, the higher the return. We see that, for example, in the stock market, it's a lot riskier than simply holding cash. But on time, over time, the returns have been much, much better. Doesn't mean that's true. You know, every single day, month or year, there have been extended periods where the stock market has underperformed. That's the risk. But on average, and over time, the stock market has done quite well. Within segments of the stock market as well. There are aspects of the market that are riskier than others, and it's appropriate and important to account for that risk when looking at the returns of a strategy of a fund of a stock relative to that benchmark.

Evon: 9:26

Got it. And I think, perhaps optometrists listening are, are trying to get alpha on their own. They may not be calling it that, but they're trying to make their own investment decisions, trying to pick certain companies they feel will give them that outperformance. Maybe they're looking at mutual funds and trying to find these active managers who will provide that alpha, that outperformance or, maybe I, I, and I think often inappropriately expecting financial advisors that they're hiring to be the ones that will provide that, that alpha or that outperformance. And you bring such a good point then that it's not just performance. It's not just outperformance, it's performance relative to the appropriate risk-adjusted benchmark. And so many times you see comparisons of either, portfolio managers or individual's investments to the S&P 500. I feel like it's always the S&P 500, but the S&P 500 may be irrelevant relative to the investments that you're looking at. You know, you may be comparing apples to oranges or maybe if anything, you know, granny smith apples to gala apples. You really need to look at what you are comparing to the appropriate risk-adjusted benchmark. That's the only way you can make a, a clear, accurate comparison between the two.

Dr. Berkin: 10:42

A hundred percent. Agreed. I mean, a classic example is that over time smaller stocks and value stocks and especially small value stocks have outperformed the market. And one could simply hold small value stocks and, you know, on average have done better than say the S&P 500, which reflects a certain segment of large cap stocks. But is that alpha? Well, we'd say no. It's simply holding stocks that have a greater amount of risk because smaller stocks and value stocks, you know, have tended to be riskier, and that's reflected as well. If one looks, for example, at the volatility of returns. but it doesn't mean that one has engaged in, you know, a tremendous amount of skill, shall we say, In beating, in beating the market, or that one has got e excellent stock picking abilities.

Evon: 11:42

Right, right. It's almost, you know, potentially says little about the skill or ability of that, that individual. in your book you talk a whole lot about the, the difficulty and how unlikely it is for either an individual investor like myself or optometrists listening or an active professional manager to, to get this alpha, to get this consistent outperformance relative to that appropriate benchmark. And a, a big underpinning reason or explanation for that, a foundational, understanding of why that might happen is that we tend to see that these public markets are efficient markets. Their, there's market efficiency. And when we say that, what is an efficient market? How would you describe that?

Dr. Berkin: 12:26

Yeah, that's, that's really an excellent question and, and in, in some ways a very tough one to, to explain.'cause it gets into a lot of nuances and, you know, issues of definitions. But roughly speaking, an efficient market means one where everything is appropriately priced and priced pretty quickly. By appropriately priced meaning that that investors as a whole are taking into account all the available information that's out there and using that to make adjustments in the price of securities. And when new information comes out, that new information is incorporated very, very quickly into the price of securities. So a stock announces that its earnings are, you know, better than expected. People react to that very, very quickly. And the price of a stock will. You know, shoot up appropriately. Similarly, if a company warns that its earnings or cash flow or revenue is expected to be weak in the future, that's going to be incorporated into the price of that stock very, very quickly. And indeed, this is in general what we see. Information is indeed incorporated quickly. And not only that, that the collective wisdom of the market is reflected in that price. So that it is in becomes very difficult to so quote unquote beat the market. That there aren't what are called anomalies out there. There's not, you know, free dollars floating about where anyone can go and say, oh, this stock is obviously mispriced. I'm going to buy it. And, you know, make a lot of money. And that is reflected, really in, you know, in what we've seen in the market, which is that alpha, that risk-adjusted excess performance and by the way, one can use various, mathematical models based upon finance theory to, to measure that performance. And we discussed that in the book that that alpha, you know, has been shrinking. And that's really the, I mean, that, that indeed is, you know, the, the title and, and the topic, you know, of the book that we've written.

Evon: 15:05

Yeah, and, and I think we can forget sometimes that it's, it is a market and there are market participants and there are thousands of, of investors by volume, most of which are professional or, or, institutional investors all looking at these different investments, all taking in all of the information that is publicly known. Looking at how that information might impact these investments in the future. And making, buying decisions based on their own interpretation, based on their own experience, based on their own motivations for buying and selling and all of those purchases. And sale, buying and selling are, are what sets fair prices. I mean, it sets as accurate prices as we possibly can see for all of these different investments. And as you mentioned, as soon as news is available, as soon as new information is available, it's reflected in these investment prices. You know, as soon as it hits Apple News, like it's, it's too late. I mean, we, we, don't really have an informational advantage. And, and talk about more, how do we know what is the proof that markets are efficient? What, what's really the proof behind that?

Dr. Berkin: 16:16

Yeah. So, how do we see it? I mean, you, you, you, you mentioned something, interesting, which is that, you know, the news is reflected, very, very, quickly. Indeed, there was a time where, investors, and these are, you know, very well off, professional investors. Some of them were investing in, you know, access to very high speed networks so they could get a fraction. Of a second. I mean, truly a fraction of a fraction of a second, you know, advantage in terms of trading off of that information. People have been, you know, investing in high frequency trading, and for a while that was a hot topic, and after a while, you know, so many people had been doing it that, it, it's not mentioned as much. There's still folks that are, that are doing it, but it, it seems, and we see this with all sorts of different quote unquote anomalies that are out there. Once something becomes known, it tends to vanish. So I gave the example of, of stocks reporting good earnings. There was a time, and you go back, you know, something like 30 years now when a stock reported good earnings, yeah, it's price would go up. But over the next, you know, quarter until it announced earnings again, the price would increase more gradually, but still go up. As time went on, that jump got higher and the subsequent rise got less and that jump got quicker. It went from being, you know, so that it, instead of seeing, you know, the, the quick rise and then the, the gradual, it was that it, it jumped up, climbed a little bit more, and then was flat for say the next two months instead of a quarter. Then it was, the, the, it jumped and it rose for the next week and then it jumped and, and that was that. So it's something called the earnings surprise effect.

Evon: 18:13

Hmm.

Dr. Berkin: 18:13

And it's something where over time we've seen, that initial jump get higher, the subsequent rise get lower and lower and pretty much vanish at the same time that, you know, the subsequent time went from being a quarter to a month, to a week to a day, to, to nothing as well. I should point out as well a couple things. One is that there's some academics who believe, you know, very, very much in the efficient market theory. There's a lot of practitioners who believe it to a certain extent. I'd have to say that I'm in that camp. I believe that it markets are pretty efficient. They're not necessarily a hundred percent efficient. And a counter argument that's been given is what's been called behavioral investing. That we are people, we have behavioral biases, and that can cause. People, investors on occasion to do irrational things. In fact, the Nobel Prize in economics went some years back to Eugene Fama, who was a main proponent of the efficient market theory, but they also gave it to Robert Schiller, who was a big, proponent of behavioral investing. One way or the other though we do see that markets, are pretty darn efficient and that they're become incredibly hard to beat, much harder than before.

Evon: 19:45

And I, I guess it's so interesting, you can sort of observe this and you can see that continuing to be more and more the case. And if it weren't efficient, I, I guess you would see evidence of the ability to persistently outperform, take advantage of these anomalies, which as you mentioned, you don't see, not only has, and we'll, we'll talk about this a little bit more, but not only has the percentage of professional active managers been small that have been able to get that alpha persistently, but the the, the amount of them has continued to decline. And, I think it, it's easy to look at weird stuff happening in specific companies or specific stocks like the GameStop events of, of during the Covid times the last couple years, the.com or, or a tech, burst, I guess you would say, into early two thousands, and just other anomalies like that. Like I isn't that proof that markets aren't efficient? How, how would we look at that?

Dr. Berkin: 20:42

Yeah, great philosophical question as well, and, and one that's not just philosophical though, but you know, very practical and pragmatic, you know, for, for what we can do. So these actually are parts of the arguments for whether markets are or are not, efficient. I guess where I come down is, yeah, weird things can happen. In fact, I would say that sometimes markets can be perhaps the opposite of rational, efficient, but you can have totally crazy things happen, but it also makes it very difficult to exploit.

Evon: 21:27

Hmm.

Dr. Berkin: 21:28

Let's picture the hypothetical case where, you know, market prices aren't determined by fundamentals at all. They're, let's say they're set randomly every night. Someone randomly draws a bunch of stocks. Draws prices, you know, from a lottery machine for, for all the stocks? How are you gonna beat that? Well, the answer is you're not. That's by no means, a rational, sane market if you're just setting prices randomly, but it makes it impossible to predict. Now, what happens then is in some of these cases that we see where markets seem to be acting crazy, that also can make it very, very difficult to outperform. So take the case of GameStop, for example. People thought that yeah, the price was priced to fall. Instead, what happened is, and, and they did what's called shorting the stock. It's kind of betting against it. Well enough people piled into the stock to make the price shoot up like crazy, as you noted, for a period of time, it eventually fell back to earth, but not before those who had bet against the stock. I'm trying to figure out how to say this politely, but, got hammered, shall we say. And this comes back to, a statement of, John Maynard Keynes, another Nobel Prize winner who said"Markets can remain irrational longer than you can remain solvent". There sometimes there are things that happen out there that seem crazy that may, in retrospect end up being crazy, but that craziness can persist for a bit and it can be very difficult to profit from it. Indeed, you can end up getting hammered because of it. So the answers, you know, in part, are that we are people, we have behavioral biases. Things can occur in the markets, which may seem wrong, but you need them to correct in a nice, orderly fashion as well, to be able to take advantage of it. And again, that's, that can be a, a, a big, big challenge. So personally, I'm, I believe that markets tend in general to be pretty darn efficient. When they're not, it can be, quite tough sometimes to exploit.

Evon: 24:02

It sounds like even when they're not, it's not something that you can predict ahead of time or know when and how to take advantage of. And so whether their markets tend to be, on average, fairly efficient at setting reasonably good prices, or whether these, there's these strange anomalies, weird stuff that happens either way, we really shouldn't have the expectation of profiting. And you, you've used in the book and, and is commonly used as a metaphor is that you might find, you might find$20 on the floor. And if you find it, pick it up. But that doesn't mean you should spend the rest of your life trying to make a living on finding$20 bills on the floor. Because if, if someone sees it, they're going to be picked up quickly. you should be happy you found one and then move on with your life. And, and similar to investing, markets are over time fairly efficient. And if there are, there are opportunities potentially to profit and, and to be actively managing and profit, but those opportunities come and go quickly and are nearly impossible to predict ahead of time. And if, if they're there, they're gone quickly, you shouldn't spend your whole life trying to take advantage and profit from those opportunities. And, as we've talked about already, you know, the, when you look at professional managers where people might expect them to have the, the ability to do all this. And you've, we've seen over history that a, actually, a small percentage of them do. There's no persistency with those that do, and that percentage has been dwindling over time. Less and less of these active professional managers have actually been achieving this outperformance. And you give four themes for, for why that is, but just talk us through why, why has that happened and why should we expect that to continue to happen? This difficulty of achieving this alpha, even with these professional managers?

Dr. Berkin: 25:55

Yeah. So as you point out, we give four reasons. Let's, kind of go through them one at a time. The, the very first reason is what we call in the book, the conversion of what once was alpha into beta. And what does that mean? We've defined alpha as appropriate risk-adjusted return above a certain benchmark. And the issue boils down to then what do we mean by risk? And when we're talking about risk. What we refer to here, what academics talk about is what's often called beta and beta are factors or characteristics of securities such as stocks that end up driving returns. It's something we discuss in greater detail in my other book with Larry, Your Complete Guide to Factor-Based Investing. But it's important as well to discuss here and I'll, I'll try to simplify it. The simplest form of beta is what many people simply refer to as beta, but we call market beta, which is how much, a stock moves with respect to the stock market. So there's some stocks that when the market goes up, they go up by about the same. When the market goes down, they go down by about the same. But there are other stocks that when the market goes up. They tend to jump even more than the market does. And when the market goes down, they tend to fall more than the market does. Those are stocks that have beta greater than one. They have greater exposure to the movement of the market. And by the way, if you picked stocks that had greater beta, if you had a portfolio that had greater beta, you could over time do better than the market because the market tended to go up. Now, over time, academics, and for that matter I should say, not just academics, but practitioners had found this before as well, that stocks with certain characteristics tended to do better than the market as well. Over time, I've mentioned a couple of them. Stocks that are smaller in size have tended to do better over time. Similarly, value stocks. Have tended to do better than the market over time. And so those betas or characteristics of small size of value, if one invested in stocks that had those characteristics in general, one would've tended to outperform. There was a time where you had a lot of managers, they were running value funds and they were beating the market.

Evon: 28:49

Hmm.

Dr. Berkin: 28:49

And what's happened over time is that people said, well, you know, yeah, they're picking value stocks. Is it that they're picking such wonderful stocks? Overall, what ends up happening is they've picked stocks that have tended to have these value characteristics, and those are stocks that overall have tended to beat the market. And so rather than comparing. A value portfolio to a broad market based portfolio, it should be compared to, to an appropriate benchmark that takes that value into account,

Evon: 29:24

Interesting.

Dr. Berkin: 29:25

those value characteristics into account.

Evon: 29:28

yeah, so the research of academics and other practitioners trying to figure out, basically tried to figure out what, what were the characteristics of these? Quote unquote experts or star managers, what were the characteristics they were investing in that that explains their returns? And so you look at Graham and Dodd and, you know, Warren Buffett and all, all of the, whoever, experts, star manager you can think of in the past, academic research has pulled these characteristics and converted them into something that you can invest in passively. And so you then have to decide, well, why would I pay the more expensive manager who's unlikely to outperform anyways when you can just invest in this passively at a much, much less expensive cost and still have investment in these characteristics. So it's, it's interesting how that has happened. And, and, and what are some of the other things you, you also talk about, the shrinking pool of, of victims and,

Dr. Berkin: 30:29

Right,

Evon: 30:30

in professional competition. Talk to us about that.

Dr. Berkin: 30:33

Right. So, a couple more themes. Maybe I'll even make it three themes if I ramble on long enough to, to cover all of them. But, the second theme that you know, is that the pool of victims has been shrinking. And in order for someone to profit, so to speak, to to buy a stock that's like a, a winner stock, you know, someone else has gotta be selling that. And the what we've, you know, seen is that, for example, the amount of stocks that have been owned by shall we say not professional money managers, for example, by individuals. That's been shrinking over time as the investment management industry has grown, as the number of mutual funds have grown, as retirement accounts have grown, and people have moved from pension funds with professional managers to 401k's and, IRAs for example, investors are holding much, much fewer individual stocks on their own. They're going to see their brokerage with their brokers, giving'em the, so-called Latest Hot Stock Tips, far less than they used to. So there's far, for that matter, if we look at financial advisors, I would say that's an industry that's undergone a lot of professionalization. People, such as you with, a number of qualifications such as, I, I see in back of you and on, you know, on your shelf. But some of the things that, that many advisors are not doing these days are picking, individual stocks. It used to be that people would go to their brokerage house and, they would, give, they thought of their broker as being an advisor and they'd say, oh, buy this stock in that stock. That's something that's, that's, gone down quite a bit as well. So, so many stocks now, so many securities, so many assets as a whole,'cause this applies well beyond the stock market are these days being managed by, professional managers. There are far fewer naive or less sophisticated investors out there. waiting the, to be fleeced, so to speak. Our book goes into greater evidence on that. At the same time though, we've had a dramatic increase in the amount of professional managers, and not only that, but in the skill of professional managers, and both of those have tended actually to decrease the amount of alpha out there. Why is that? Let's take the skill of professional managers first. If, if you're okay with that, and it may sound strange that as managers get more and more skilled, it becomes harder to beat the market. But in fact, what it means is that the competition has got so much tougher. One of the things we do in the book is we give some analogies such as baseball. Hitting 400 in baseball is a tremendous accomplishment, but it's something that hasn't been done since, I believe the 1950s now. it was not common before, but it, it certainly happened, but it's shrunk. And does that mean that baseball players are not as good as they used to be? The answer to that is no. By any arguable metric, baseball players are better.

Evon: 34:07

Hmm.

Dr. Berkin: 34:08

They train all year round. They're bigger, stronger, faster. They've got all sorts of, coaches and techniques and analysis to help them. But what that ends up doing is it ends up shrinking the spread. Between those who are, you know, really, really good and those who are, are so-so. Everyone's got those same advantages. And that makes it much, much tougher to excel as a hitter trying to hit 400 against pitchers that are stronger, that throw faster, that, have got all sorts of techniques and post-game video analysis and scouting on all the players, bringing in relief pitchers, tailored, against the specific batter. So all of this excess skill makes it really harder to stand out. And when you're an investment manager competing against other managers who all have the same techniques, it makes it that much more difficult to excel.

Evon: 35:14

It. This is such a, those two points are so important, I think to just think about as individual investors. And the fact that the, that less and less individual and non-professional, non-expert investors are trying their hand at actively managing their investments. At trying to select the very best stocks or whatever it is. And let's face it, listeners like we are in the pool of victims. All right. I. There's no reason to sort of beat around the bush there. Like we are, we would've been in that pool of, of non-professional, victims to be exploited. And less and less rightly so are, are trying their, their hand at that game. At the same time, more and more I. The, the most highly educated, the most, the, the best trained, and professional investors with the best technology and tools to use in implementing their investment strategies. And there are more and more of those professional investors competing not only against this shrinking pool of victims, but against each other. And all of these things really fit together to make this market more and more efficient. They're doing better, analysis on these investments. They're implementing better, incorporating better information, better interpreted into these prices. I mean, all of these things work together to make a more efficient market and I, I would say, and, and harder to beat. And you, you mentioned baseball as a great example of that. You also mentioned a really fantastic metaphor that I'm gonna, start using now from now on in terms of tennis. And, imagine, Roger Federer, who was one of the, the best tennis players in the world when he was playing, as an individual. And he's competing one-on-one against other professionals. He had an advantage in some way. He was extremely successful. But imagine Roger Federer, as you'd put it, was not competing against some individual, but against this sort of pieced together, Frankenstein tennis player that had the very best, serve the very best back and forehand the very best athleticism and speed, had all of the best characteristics of every best player. And how successful would Roger Federer be against that pieced together tennis player? Well, probably not very, you know, who knows whether he would win a tournament And that's sort of the. That's really what we are competing against as individual investors. It, it's not really this one-on-one individual sport. If it was, I would say we're probably still at a disadvantage. It's more likely the other person on the other side of our trades are some professional manager with, you know, better information or, or better interpretation or tools. but but we're really going against this market as a whole, as this collective wisdom of the market as a whole, much of which are the most highly trained and educated professional investors there ever were. And more and more of them. And we really, I mean that's sort of like a humbling realization. The more you think about that, like you really start to ask these questions. Do I as an individual with a laptop and an internet connection really have more information than this collection of, of, investors? No. Do we have better information? No. Do we have, can we interpret information better? No. Do we have better tools and can we implement better? No, I mean, we start to go through all these questions and all the advantages we would need as individuals to outperform this broad collection of investors. We just don't have. And and I think the more you really start to think about that and realize that, it's sort of a humbling realization and it should help us to come to investing with more humility, I think.

Dr. Berkin: 39:07

Yeah. No. Look, you, you, you've said it very, very well. You are. competing against the market as a whole, against everybody. The collective wisdom of every single participant in the market. And the collective wisdom tends to be, you know, pretty darn good. The one other thing I'd say as well, and this is the, the fourth point that we make, is that the amount of dollars out there chasing alpha has become so much greater because we've seen such an increase in professional management that when you go out to compete, you're competing not just against the best, but against a huge amount of money. And what that means is if there are some anomalies out there that's getting spread out, not over a smaller pool, but over a much, much bigger pool and a bigger pool that's jumping on it. That much faster. The evidence that we, some of the evidence that we give in the book and discuss is that with regard to hedge funds, where the hedge fund industry has seen tremendous growth over the last 25, 30 years, and with that growth in assets, the excess returns, the alpha, I should say, the, the returns not accounted for by by factors, that's come way down as well with this dramatic increase in money, the chasing after it.

Evon: 40:46

And, some interesting points you bring up in the book is that for those that are successful, their own success leads to, sows the seeds of their demise. The, the, the inability to, as more dollars flow into the fund, the inability for them to, effectively use the extra funds towards their investment approach or certain size or expenses that come out of these increased, funds. It, it's interesting that even for those that are successful, it, it's so difficult for them to continue to be. There, there's really little persistence and a lot of it is their own success sort of breeds their own demise, which is, is fascinating to think about. It's no wonder Charlie Ellis, the, you know, a common quote, Charlie Ellis calls this The Loser's Game. A active management, the losers game in that, like gambling, it's possible to win, but the odds of succeeding are so bad that the, the best way to win is simply not to play. And I, I think there's a lot of wisdom in that. And let's talk about what it means not to play the game. The, the other approach.'cause there is another approach. And the other approach that we as Advisors often talk about is, and subscribe to and use with our clients is, is a passive style of investing or systematic or rules based. And, what, what does that mean? Passive investment management, what exactly does that mean to you?

Dr. Berkin: 42:13

Yeah. It's actually, it's a commonly used term. It's one that we don't necessarily Mm, love here, and I'll get to that in a moment. So we prefer terms like systematic, evidence-based investing. But, what passive investing has, you know, has often meant is, investing in index funds. And that is something that, as you mentioned, because index funds tend to be, tend to have lower fees, they, you know, they're lower cost, they tend to do better. It's found that active management, it's not that it's so horrible, but it's that you tend to pay higher fees for it and after fees, which of course is what you get to keep, the investor is worse off. So index funds is, is what many people often think of when they talk about passive investing. When with, with Larry and I in our book, and, you know, others as well, when we talk about passive investing, we think of indexing as being only one aspect of it, but rather passive investing can be expanded to include this evidence rules-based investing. Go back to the very first point about why Alpha has been shrinking. It's that the conversion of what once was considered alpha, what was once considered excess return has been converted into beta, returns attributed reflect characteristics of of stocks that have tended to outperform in large part because they, would have good risk-based, exp was for those higher returns. The classic example being value stocks, the price has been beaten down to make them, relatively inexpensive relative to their fundamentals. And historically that's something that's paid off in that risk and investment has done well. So simply buying value stocks has over time, at least historically, tended to do quite well. And so what investors can do are, is invest in stocks, in securities. Groups of securities really, that share those common characteristics such as small and value stocks, stocks that have got higher quality or higher profitability to them, stocks with higher momentum. These are the types of, of stocks, for example, that have tended to outperform and that's something that investors can do about it. That while still engaging in what some would call passive investing, what we prefer, evidence rules-based investing, and part of the reason we don't like the term passive, but nonetheless we live with it. It's, it's kind of unfair to our poor portfolio managers and our por for our poor traders when we're talking about these stocks. I mean, execution is really important. Again, it's not just, it's not what you make, it's what you keep. And when we're talking about smaller stocks, those tend to be less liquid. That's part of the risk, but it also means that one needs to trade them very carefully. And that's what our traders are out there doing. We hold very well diversified portfolios of stocks with these, appropriate characteristics, these factors that have paid off over time. And with that diversification, it's something that our portfolio managers are, are looking at again on a constant basis to ensure that the stocks that we buy are adequately reflecting those characteristics, selling stocks, when they no longer reflect those characteristics and keeping track of the portfolio as a whole to make sure that it keeps those characteristics, those that data that has tended to outperform over time. It can be greater risk, but again, with greater risk over time, should come greater reward.

Evon: 46:34

I, I appreciate you describing it that way because I think there is sort of this misconception that passive investing equals only index funds. And I would say, and I may perhaps you would agree, index funds are a substantial, or were a substantial innovation in investing and are a huge benefit to investors. Maybe a dramatic, improvement on the sort of whatever active strategy you were trying to chase before using index funds. But index funds are one example of what, what you would certainly call systematic or rules based investing. When I say passive to clients, that is how I describe it, is the systematic rules-based investing. And in your book, you even put some criteria on it. You say it should be, it, the, the fund, whether it's a mutual fund or ETF, should have rules that are systematic, that are able to be replicated in, are transparent. And importantly, there's no individual investment selection or market timing. There's no reliance on the skill of some manager to, to outperform. So, passive investing, as we would call it, definitely goes beyond index funds. And as you mentioned, there are potential ways to. Improve a portfolio beyond simple using index funds by, adding in or incorporating some of these other characteristics like, like you had mentioned earlier. And, for, for listeners, please go through the book and I'll throw a, a link to the, in the show notes to, the other book you'd mentioned on factor investing. You talk about the, the criteria needed to make sure that these characteristics are legitimate or they are, they're at least something that should legitimately be considered and added to our portfolio. And, I, I definitely think this is a, a, an approach to, to take in investing because. Well, a saying that's commonly used among my advisor peers is that you, you should be passive in your investments and active in your lifestyle. And, take a passive investment approach, but be very active in your career and in increasing your income, in your, your relationships and in your health and in your business. If you own a private practice or another business, be very active in those.'cause that's where the activity, the efforts are going to give you a, a positive return. There's actually gonna be a return on the hassle. And thinking about all of this, why, why do investors continue to try to get this alpha, this outperformance?

Dr. Berkin: 49:06

Yeah, that, that's a great question. And, one for where you kind of gotta put on both your, your investor hat and your, you know, your, your shrink or psychiatrist, you know, had as well. You know, there's a number of reasons, but, and a lot of them revolve around behavioral considerations.'cause, after all, we're people, and as people, we're only human, we're subject to so many different biases. And there's, long, long lists of them. But some of them are, what we call, what many have called the lake woe-be-done effect. Where, everyone thinks they're better than average. Well, I can pick, you know, I can pick great stocks. I can pick, a great manager. There's extrapolation of past results where people think that what's happened in the past is gonna continue into the future. That can be true about some things, but not about others. And certainly in investment management, you know, those that have done well in the past, it tends not to be very indicative at all of how of, how that fund or that manager is going to do in the future.

Evon: 50:19

Yeah.

Dr. Berkin: 50:19

again, this comes down to the paradox of skill. You've got so many people putting in this effort, trying to beat the market. It makes it that much more difficult to do. So. I think some of it as well is that people want to be in control.

Evon: 50:36

Hmm.

Dr. Berkin: 50:36

They feel like, okay, you know, passive, that just sounds so, wimpy. I'm doing nothing. I want to be in control. I want to be in charge. That's, that's got to be better. I mean, this is why people think they're better off, they're, driving a car than flying in a plane because, well, I'm not in control of a plane. Yeah, of course. Well, who is in control of the plane? It's a professionally trained pilot. We've had a dramatic, dramatic decrease in, in aviation deaths over the years as well with better training, with, you know, better equipment, et cetera. At the same time that, unfortunately, car accidents tend to be one of the leading causes of, of death. And gets back as well to the lake woe-be-gone effect. Everyone thinks that they're better drivers than everybody else. Something like, I think 90% of everybody, of all drivers think they're above average. Well, you know, sorry that doesn't square with the math. And probably a heck of a lot of people think that they're, you know, better investing, better at choosing managers, what have you than than everyone else. A couple other things. It's, it's hard to admit that you're wrong

Evon: 51:47

Yeah.

Dr. Berkin: 51:48

and that leads to hope always springing eternal. And finally, there's, I mean, there's a good amount of money out there dedicated to trying to get people to, to, to chase those, you know, so those elusive returns.

Evon: 52:01

It. It's, it's hard. I don't think anyone wants to, wants to say that they are overconfident. You know, I don't think anybody wants to admit that they're overconfident in their abilities to do anything, let alone investing, to earn money to do, to do something like that. And, it takes a lot of self-reflection and self-awareness to say, okay, I am overconfident in my abilities. Maybe I'm not as good of an investor as I am. What's difficult is that many investors, especially younger investors, over the last, let's say decade, have invested and simply because markets have increased, for much of it. That has fed their overconfidence, and that really doesn't say anything about their skill. It's simply maybe simply based on the fact that they're invested at all. So that, that's certainly that randomness, that that, luck certainly plays a part in feeding that overconfidence. But it takes, again, I keep saying like humility, it takes, takes a lot of humility to sort of look at yourself and just realize, listening and reading through a lot of what we talked about today. Maybe I'm not, or maybe I am a skilled investor, but I, I am not as skilled relative to all of the others and to the market as a whole. And I've seen as an advisor, I've seen clients realize that unfortunately after mistakes, I mean after big mistakes, is finally where they real take, come to that realization. So the earlier you can figure that out, the better off you're gonna be long term. On some of your other points in terms of the, the hard work and effort, which is a fascinating, discussion. Daniel Crosby, who is an author. He writes a lot about investor psychology and does a lot of work around that. Calls investing in these public markets, Wall Street Bizarro World, where in almost all the other parts of your life, hard work and effort go a long way. They improve outcomes. You go to school, you work harder, you learn more, you get better grades. You, you go into practice, you learn more, you improve your work with patients. You, you open a, a, you cold start a practice. Your hard work and efforts grow the business, contribute to your, your return in a growing business. In investing in these public markets, it's almost like the upside down world of Stranger Things. It's, the, the more time you put into it, the less return you should expect and the more effort you put into it, the more you tinker and play with your portfolio, the more likely you are to make mistakes and to see a, a negative outcome. So it's sort of this upside down world where that hard work and effort, you, you're shouldn't expect a return on it. And you know, the earlier you can start to see these, these internal biases in the early, the earlier you can start to come to these realizations, I think that the better off you'll be long term. And, on control. We saw a lot of that psychology come out during Covid. There was the, the, everyone running to grab toilet paper, right? Because as the world was seeming to end, like that was the thing people controlled was this, I'm gonna go buy up all the toilet paper in every store. And just as an advisor talking clients into not making dramatic changes in their investments during, during COVID was an experience because that's something that people felt like they had control over. If I only take action right now, this is the thing that can improve my life right now, as all the scary events are going on. And, it's, it's something to just sort of step back on and, and to sort of really think through a little bit more before you take that action. Because all of your impulses are telling you you should take action. And, and on control. In your book, you talk about a few things that investors can do and and should do. So knowing all that we've talked about above, what are some things that investors should focus on doing?

Dr. Berkin: 55:44

Yeah, thank you for the question. Because I mean, we talk about, you know, being a good investor or not, I mean, being a good investor doesn't just mean being able to pick, you know, a small set of great stocks or great bonds or what have you. It really relates to the overall picture. So what can you do? It starts with a consideration of risk. How much risk are you willing and able and need to take? And you know, how much you know will you take? And you should only take as much as you can stand when times get tough. you know, the, the well-known financial advisor, Mike Tyson as well as heavyweight, former heavyweight boxing champion, you know, used to say, well, everyone's got a plan until they get punched in the face. And, there are events out there that really can be a huge punch in the face. Like you mentioned Covid, when the market drops precipitously. People who've once thought that they could tolerate a lot of risk, often learn otherwise. And it's a place where I know from experience, from talking with financial Advisors such as yourselves, where they've made a huge difference by keeping their clients invested according to plan, so that when the market rebounds, as it inevitably does, they are there. That they're not, buying high and selling low, which is not a recipe for success. What else? You know, how much risk you wanna take. You then wanna diversify those risks. It's been said that diversification is the only free luncheon investing. So diversification throughout asset classes, stocks, bonds, others perhaps. And within those, for example, domestic stocks, large cap, small cap, international, emerging markets, all those that diversification can matter and diversification within those portfolios as well. So not buying a portfolio of a fund that's composed of only a few stocks. We, of course recommend investing in, in systematic rules-based evidence-based funds, such as, as we've discussed. Another thing is to keep costs low and remember that costs are not just expense ratios, but a huge cost, for example, for inve, for investors is taxes. So, you know, you talked about investors wanting to dance in and out of, you know, this fund to that fund. If that's in a taxable account, you're running up your account, your, your taxes, every time that, that you sell something. similarly look at the taxes that are incurred from a fund in taxable accounts manager accounts. Accordingly, keep your, your, your co your overall costs low. It, it's okay to pay up some, at least for the potential for those higher returns that can come by investing in, in in systematic funds. They tend not to be quite as cheap, for example, as the S&P 500, which is offered out there for very, very low amounts. But, the prospect of improved returns can certainly pay off as well. stay disciplined. That's crucial. It goes back to knowing how much risk you truly can take. And finally, as you mentioned, you know, enjoy your life. It's been said that you can, eat well or you can sleep well. But, you know, I think you can do both to a certain extent. And this is why people go with Financial Advisors to help guide them through all those steps. It's something that an individual can really do on their own, but it sure helps to have an advisor, to have a paid professional who does this for a living out there to, to help manage it. And to put into focus as well, the the various priorities that our life. I mean, why are you saving, why are you investing? It's ultimately so you can have a good life. So make sure you get to enjoy it some.

Evon: 59:53

I love that. And all of those things are things that are actually within our control. The types and amounts of risk we're willing to take on, the diversification that we are implementing in our investments. The type of funds and, and managers we use, whether it's active or, or passive or systematic, the costs and, and taxes that we might potentially be taking on our own behavior. I mean, those are things that are actually, within our control and, and focusing on enjoying your life as we, as, again, as I mentioned, you know, be passive in your investments, be very active in the other parts of your life. And I, I think that's, that's fantastic and I, I really appreciate you, you coming on and, and sharing your wisdom and expertise here because, optometrists and investors as a whole are surrounded by temptation, the financial media constantly, pushing information around, encouraging people to actively manage and, and to take action on their investments where it probably isn't in their best interests or all of the ads and books and courses around, different investment strategies or day trading, or even if you just look at, online social groups and communities, just the opinions that are, are, easily shared about investing. I, I appreciate you bringing in, in, in this conversation and in your books as well, a very thoroughly researched, approach to making investment decisions. And also, for those that think that index funds are the be all, end all of investing passively. Hopefully this opens your eyes a little bit to the fact that it goes beyond that and there is more than just the S&P 500 on planet Earth. I hope this conversation helps optometrists to make more evidence-based investment decisions. You, you hear listeners, you hear about evidence-based, Optometry focused on academic research and data-driven approaches to, to patient care. And, and I, I'd invite you to take that same evidence-based, research based approach to investing or, or if you're working with an advisor, hopefully your advisor or your practitioner for your finances is taking that same approach for your finances as well. And, where can people find and follow and, and learn more about what you're doing?

Dr. Berkin: 1:02:04

Sure. I guess there's a few ways. So, at. At Bridgeway Capital Management. We, among other things have, you know, papers, thoughts, white papers that we put out, thought leadership. So that's available, you know, to the general public. You can go to bridgeway.com and there's an appropriate section there. So you can follow me and the rest of the folks at Bridgeway there. On LinkedIn. I also have started becoming more active and, you know, posting there as well. You know, try not to do it every day, but, you know, off and on. And if you really want to, let's see if you really wanna get down into the weeds. If one goes on, Google Scholar scholar.google.com, you can find everything that I've written and including physics. If you, I don't know, really have a, a, a weird streak about you, I suppose, and, see the articles that I've written referenced there, as well as who's, cited them.

Evon: 1:03:04

Well, I'll put links to all of that and more in the show notes, and of course your books as well. Dr. Berkin I, I really appreciate your time. This was fantastic. For the listeners really appreciate your time and attention. We will catch you all on the next episode. In the meantime, take care.