WSO Podcast | E235: VP in Quant Risk Asset Management
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WSO Podcast Episode 235 Transcript:
Patrick (CEO of WSO): [00:00:06] Hello and welcome. I'm Patrick Curtis, your host and chief Monkey. And this is the Wall Street Oasis podcast. Join me as I talk to some of the community's most successful and inspirational members to gain valuable insight into different career paths and life in general. Let's get to it. In this episode, Scott shares his winding path from starting a hedge fund right out of the University of Chicago to pivoting to a quantitative research position at Morningstar. Learn why he jumped to Schwab and eventually earned his title of VP of Risk and Quantitative analysis. We chat about his transitions about the fast-growing passive ETF trend in the asset management industry and much more. Enjoy. Scott, welcome to the Wall Street Oasis Podcast.
Scott: [00:00:57] Yeah, thanks for having me. Happy to join.
Patrick (CEO of WSO): [00:00:59] So it'd be awesome if you could just give the listeners a short summary of your bio.
Scott: [00:01:03] Yeah, sure. So, you know, I graduated from the University of Chicago, you know, quite a while ago, probably almost ten years ago. But I studied with a background in economics and statistics, you know, during that time actually was, you know, pretty heavy into fundamental investing, active research, and investing clubs, but also actually got into options trading and developed like, you know, volatility strategies through my time in college, probably a little bit too much. But, you know, did that for a little bit of time, was trying to go to the hedge fund route and hedge fund and then did that for, you know, half a year to a year after school, decided, you know, was going to go back to the workforce and then kind of worked at Morningstar for three years, worked kind of, you know, in the buy side, you know, investment management arm, focusing on tactical and strategic asset allocation. So doing a lot of, you know, top-down equity valuation work as well as bottoms up, you know, valuing asset classes and long-term expected returns and capital market expectations. So after, you know, roughly three years of doing that, Morningstar, you know, moved to Schwab. More on the quantitative research investment risk side.
Patrick (CEO of WSO): [00:02:11] Like internal corporate like you're doing you're doing running risk like on the is it more like an internal service for Schwab or was it just.
Scott: [00:02:19] Yeah, it's basically the investment risk team or the quantitative research team. So Schwab had they have a lot of quantitative they have actually eight quantitative active strategies, five of which are domestic, you know, large.
Patrick (CEO of WSO): [00:02:32] I interrupted your bio. Sorry, you can finish your bio, and we'll get there. We'll go back.
Scott: [00:02:38] Yeah, no worries. Um, but yeah, I mean, you know, it was quite a small team, and obviously, Schwab is more known for their brokerage, but they do have a lot of their own mutual funds and products. Right? They're also really well known in the retirement space. So, you know, I cover the quantitative strategies, kind of, you know, worked with portfolio managers, did a lot of quantitative research, market research, um, you know, also valuation work too, worked with a lot of risk models and really providing recommendations for portfolio managers and how to position their portfolios. So, you know, covered both, you know, active fundamental and active systematic strategies. And then at the same time, because, you know, Schwab was, you know, quite heavy in kind of their retirement business. They had a lot of target date funds, multi-asset portfolios where we would look to hire, you know, managers to essentially be sub-advised, you know, within like the active sleeves, right? So if we have like a target date fund, we want to hire, you know, large-cap growth manager. You know, my job would be to interview a lot of the top fund managers to see if want to hire them, fire them, put them on review. So really interacted with all the top buy side, you know. Funds and talk to their portfolio managers on a monthly and quarterly basis, like including BlackRock at the time. And, you know, AQR, Dimensional Fund Advisors Dodge, and Cox. You know…
Patrick (CEO of WSO): [00:03:53] They're trying to convince you to give them capital as an element, basically.
Scott: [00:03:58] Great! Exactly.
Patrick (CEO of WSO): Got it. Okay.
Scott: Cool.
Patrick (CEO of WSO): Okay.
Scott: [00:04:00] And then after that, for roughly three years, then kind of moved into moved to BlackRock in a very similar type of, you know, quantitative risk role, except now I'm moving more towards the ETF space. So now kind of, you know, manage a team covering the equity iShares book roughly worth $2 trillion. And it's also very, very different now, right? Blackrock obviously a much larger firm in equity iShares book there's like over a thousand funds, you know both institutional and on the retail side. And so the type of work is very different. You know, back at Schwab, I could spend a day on each fund diving deep, diving into the fund, looking at the portfolio, positioning, doing market research. But at BlackRock, it's gets very different because we're managing so many funds with kind of a smaller team relatively for how many funds you have to manage. We have to think about scale, right? How to develop a risk infrastructure, how to do quantitative research at scale to manage all of these products where I come in the morning, create this risk infrastructure that maybe flags like 10 to 15 funds like, Hey, you got to take a look at these because they're breaching our risk ranges. So what that comes with is decomposing the risk of every single fund into each individual components to come up with what is the expected risk level we would expect out of each fund and whether they're performing within that range.
Scott: [00:05:10] And also a lot of my work is goes into product development, too, right? You know, BlackRock is now developing a lot of more exotic products. For example, a lot of the Buywrite ETFs that recently launched earlier in the year. They're essentially, you know, covered call strategies on fixed income ETFs like high yield, you know, iShares. Now there's a, you know, a strategy where we write covered call options on those. Um, and a lot of that work goes into developing the benchmark and the benchmark methodology, right? Um, because after the product launches, all we do is we track the product. But a lot of the kind of alpha research that goes into developing these products starts really upstream. So I'm really working with like index providers, backtesting strategies, figuring out how is this product going to trade, you know, what is the strikes of the options, what are the expirations going to look like, When do we roll them? And obviously take into account liquidity of these options, Right? You may not always want to roll on the last day or the or two days before. So a lot of like alpha type of research goes into passive products. It's not just as simple as, oh, you just mash the benchmark focus on rebalancing. There's a lot of active type research that goes into these…
Patrick (CEO of WSO): [00:06:19] Like the mechanics. Setting up the mechanics and…
Scott: [00:06:20] Stuff like that. Developing new strategies.
Patrick (CEO of WSO): [00:06:22] Yeah, I'd love to dive into that a little bit more later, but let's go back all the way to your college days at Chicago U. Chicago. So you know your econ minor stats. Are you thinking finance all the way? You said something about a hedge fund. Do you try to start a hedge fund at a school? Was that is that what I heard?
Scott: [00:06:38] I did. So I was actually you know, I started I was really interested in finance, like pretty much on an early age. I was into fundamental investing stock picking, like your typical fundamental, like, you know, stock junky type of stuff, and doing investment clubs, and then had a couple friends.
Patrick (CEO of WSO): [00:06:54] That was your family in that. How did you, like come across it initially?
Scott: [00:06:56] That's a good question. Actually, my dad, he's an electrical engineer, but he's always had a passion for finance. And he just told me when I was young he just gave me a few thousand dollars. He's like, Hey, go buy some stocks, you know, let's talk about it. At this point, I was like maybe 10 or 11 years old. Had no idea was what I was getting myself into. I think during this time was around the financial crisis. So it was a terrible time to start. Yeah, but also kind of a good, a good way, right? Kind of great lessons learned. But, you know, he always told me he would have gone into finance, you know if he were to redo his career. And he just told me whether you choose to be in finance or not, it's always important to be financially literate, to understand how to invest your own money. It just happened to be I loved it. You know, something I always wanted to do. So that's that's why I wanted to major in Econ kind of as that foundational skill to go into the markets.
Patrick (CEO of WSO): [00:07:40] Cool. So, okay, so you get there, you're like gung ho, You start you're still you've been trading now at this point for 4 or 5 years as a high school. You get to Chicago and what's going on in through your head?
Scott: [00:07:52] And then, I honestly just like, you know, at the time, you know, ten, 20 years ago, you know, equity research was really like the sexy thing to do, right? Stock picking, you know, fund investors. You'd have like an army of researchers. Each one falls 10 to 12 companies. And obviously, times have changed, you know, since then and even before then, and kind of got bored of equity research in a lot of ways because I've been in it for so long and I just want to try something new. I was young, nimble, and at the time had a couple friends, you know, one of my close friends from high school, he was a major at Berkeley and he worked at some trading firms internships. And he just approached me. He was like, Hey, you know, like, I want to work on something together, you know, in college, you know, was backtesting, trading strategy, volatility strategies. I think like there's a lot of potential arbitrage opportunities in this space. And that's what really got me into it. Started reading books on options trading really got, you know, into kind of derivatives trading, developing strategies, and yeah, I just loved it. I don't know. I loved it more than.
Patrick (CEO of WSO): [00:08:49] Do you feel like it was like there actually was arbitrage opportunities or was it something where, um, at that point, I mean, HFT high-frequency trading had already kind of started, I think, exploding by that point, right? So did you feel like there was money to be made or like obviously anytime there was an arbitrage, do people find it and it closes up, right? So was it something like a repeatable process? You guys felt like you could continue to innovate to find money or yeah. What was the thought process behind it? Because like I think as college students, it's pretty bold to think, Oh, we can go up against these multi-billion dollar hedge funds and find maybe it's because you thought there was smaller markets that just weren't being paying attention to, but what were your thoughts around that?
Scott: [00:09:31] So that's a good question. Like, obviously, you know, markets are highly efficient, right? You know, my thoughts around it was, hey, you know, within arbitrage, you know, if you study studying economic theory, there's always limits to arbitrage for various reasons. Right. For like. Trading out of the money. Selling put options like if you were to backtest it all the way back to the 80s, you notice that there's like a variant, a consistent variance premium from selling deep out-of-the-money options. You're almost getting compensated for almost being like an insurance company, right? Because you're like writing call options, writing put options, keep out of the money. And oftentimes those are the most mispriced options. And you're wondering, you know, why is this persistent profitable to be made over time? You would think that it would be arbitraged away. Well, there's a number of reasons. Number one is the human aspect of things. The average human is very risk-averse. They're willing to pay for that protection. Number two is just like limits to arbitrage regulation-wise, potentially, right? You have all these funds out there that are primarily long funds. All the largest asset managers like fundamental stock picking. They're all like long only and they have the most assets. And a lot of times they're not obviously allowed to short. Right? So a lot of times the best way that these managers can potentially protect against market downturns is by buying out of the money put options a lot of the times. So there's kind of this uneven, um, demand supply and demand. Exactly. That has been persisted from the early 80s. And actually, Warren Buffett has actually talked about it.
Patrick (CEO of WSO): [00:10:53] And even gotten worse probably as more and more money has flowed to these passive strategies. Maybe there's some passive strategies that employ this automatically. Who knows? Like in terms of just the trillions of dollars chasing like similar names and stuff. But yeah, okay.
Scott: [00:11:08] There's a lot of white papers on it. You know, like Warren Buffett has actually talked about it actually in his early days investing. He sold a lot of long-term out-of-the-money, put options across various expirations on top of his fundamental value investing. Right. He's actually talked about it, you know, in his early days. That's actually what he did to actually make some side money. So did a lot of research there, just like, you know, to understand the aspect of there being market efficiencies. But there's also limits to arbitrage. There are there are definitely opportunities. Like we weren't trying to compete with the high-frequency traders, right? We're not aiming to do the strategy. There's no way we're going to be able to beat those guys. Right. But if you can find your niche, find your market, think there is definitely money to be made.
Patrick (CEO of WSO): [00:11:44] For sure. So how did it go? So you launched this one with your friends in sophomore year.
Scott: [00:11:48] Launched? It was roughly. I started maybe like around 2013, reading a lot of books about it. Probably didn't really start actually trading with real. We did paper strategy first, didn't start trading real money until maybe like summer of 2014. Did it for a year, year, and a half. It was great. Like returns are great. You know, obviously, you know, at the time, just whatever money I had saved up as a college student, I just threw through it all into it. It's something I wanted to pursue. Um, and why did I stop? It's probably the next question…
Patrick (CEO of WSO): [00:12:21] Or not stop it. Were you doing any other internships during the time? I mean, that was kind of your junior year. Like, had you did you work at any hedge funds? Were you doing any internships during school or were you just focused on this?
Scott: [00:12:31] Actually, I didn't. I was going to junior summer internship and I decided, Hey, I've got something good going here. I'm going to spend my time in the summer to do this and…
Patrick (CEO of WSO): [00:12:40] You know, it was funny…you're doing paper strategy. How much money did you actually dump? $10,000?
Scott: [00:12:44] Like 15. $20,000? Like me and my friend, we both chipped in returns. Like, obviously we took a lot of risk because we had a huge risk appetite as young kids. You know, we made like four, five times our money in like probably a year, a year and a half. Obviously highly volatile sometimes like I'd lose like 30, 40% in one day. But that comes with the risk, right? You can adjust that risk level up and down.
Patrick (CEO of WSO): [00:13:06] Yeah, you had a big enough, roll to…you know how the poker players they talk about bankroll right? Like you never want to be more than like a 200th of your bankroll in any.
Scott: [00:13:14] Right. Exactly. It's like you're going to be collecting those premiums over time. The biggest thing is risk management. That's the biggest aspect of strategies. It's like…
Patrick (CEO of WSO): [00:13:21] You were able to lose 30% in a day and still survive, like…
Scott: [00:13:24] Yeah, within, like it depends, like sometimes black swan events, right? It's like, you know, you're going to lose money because we can't necessarily predict black swan events, but it's how you manage that risk after it happens. How do you minimize your losses? Yeah, because those events are going to happen no matter what. It's really after the fact after it happens. How are you going to manage your positions? How are you going to close them? How are you going to hedge it? That's where…
Patrick (CEO of WSO): [00:13:42] So you're having good returns year and a half. You've made 4 or 5 times your money or like when did when you pulled it out, you pulled out your money. What did that 15,000 turn into?
Scott: [00:13:50] Turn it to almost like 80, 90K or something like that. So I didn't put any more extra money.
Patrick (CEO of WSO): [00:13:55] Yeah. So what was the thought process of stopping and just going into the workforce? Why not just try to scale this?
Scott: [00:14:00] I didn't want to stop it. The biggest thing was I learned that in finance. The same with any other thing that is 10% executions, 90%, right? It becomes really, really difficult when you're a 21-year-old kid going around asking for money and have no credibility. All I have is like, Hey, I've been trading for two years. I have this performance. People can always say, Oh, even a broken clock is right twice, twice a day, right? So building that track record and building that reputation, you learn that there's a lot more to a hedge fund than just starting a hedge fund than just the returns in itself. You have to know people. You have to have because at the end of the day, someone's going to invest in me, invest in the fund. They're not investing in the strategy. They're investing in me. A 21-year-old kid, they believe that you have what it takes to do it, and in my mind, I can always go back to this at a later date. But, you know, I also felt like in order to scale something, I've also just never scaled something at that age in my life had no business experience.
Patrick (CEO of WSO): [00:14:54] Did you feel like in order to execute the strategy successfully, you did need to scale and like in terms of team, in terms of systems, you know…
Scott: [00:15:02] Right. I did feel like, you know, at some point I want to gain experience in the workforce, whether it's like managerial experience, understanding business operations, understanding business, politics, how to raise money, how to present.
Patrick (CEO of WSO): [00:15:14] And what did your friends say to get your co-founder? Did he want…
Scott: [00:15:16] They agreed! I mean, we tried. It's just we did a lot. We still did a lot of it on the side. While during our full-time jobs, we decided to like, you know, we don't have to go that quickly. You know, we could we could take our time really, you know, focus on developing other intangible skills right into starting a business, raising a business. It's not as simple as in tech, where if you develop a product, and there's nothing out there and the product gains traction, it's very different because, at the end of the day, finance is much more homogeneous. You know, business. You know, there's so many things and products that are doing very similar types of things, right? It's not like tech where you can come up like a great idea. There's no one out there. Once you have traction and you've like developed this, you know, software or this app people are using, it's entirely different. You know, it's like it's much easier to start in tech software engineer at a young age than it is to start a hedge fund when you're 21 or 22.
Patrick (CEO of WSO): [00:16:10] That sounds entirely different. Well, you need capital, right? And more capital. And like it's hard to and people won't give you capital until you have like ten years of track record. That's like, Yeah, exactly. Whereas it's almost the opposite. Like if you're super sharp young tech engineer, some genius and you're like, Hey, look, and we have traction, then people will be throwing…
Scott: [00:16:28] Exactly. You know, like experts always say, like you can't teach market experience. You know, all the best investors have 20, 25, 30 years. They've been through multiple market cycles. It's tough to give your money to someone when they haven't even lived through a full business cycle yet. That's just like the general mentality in finance.
Patrick (CEO of WSO): [00:16:41] So walk me through kind of as you're approaching this realization that you're not able to raise any money, that you're not going be able to scale this, and then talk to me about how you started the interview process, who you were reaching out to, because at this point you had already graduated, right? And so, like you're kind of like a CEO semi-like of your own thing, which to a lot of people says, oh, you're just unemployed. So tell me a little bit about like how you had those conversations because this might be really relevant to people who also break out on their own and then decide, well, actually, no, maybe I should get some experience. So how did you kind of have this conversation around networking and how did you even get the interview at Morningstar?
Scott: [00:17:19] Yeah. Quite honestly, like, you know, at that point, like I told you, I'd spent so much time doing stuff on my own that I kind of like lost focus on my own schoolwork. You know, my grades weren't as good as they were going to be, and obviously, University of Chicago is also, really crazy great deflation, right? It's like the average for a lot of the majors are like below 3.0. And if you don't spend three hours studying a week, you're not going to be able to get on the radar of the top buy-side firms because you won't meet the filter, which is exactly what happened to me. It turned into like a numbers game. You know, luckily you know, Morningstar think you know, obviously was started by a University of Chicago grad, um, so think even though my GPA is a little bit lower they gave me an opportunity to interview and you know at this point I'd sent out 50, you know, to 100, you know, resumes just like shooting down a black hole. Um, you know, see whatever I can get. It didn't really get that much back because of that. You know, obviously the issue and obviously seeming like I didn't have a junior internship, it definitely was a risk that I took. Now, looking back, I honestly don't regret it.
Patrick (CEO of WSO): [00:18:18] Yeah,
Scott: But…
Patrick (CEO of WSO): [00:18:19] On your resume, did you have like your returns and your strategy that you had been doing and on?
Scott: [00:18:22] Yeah, I put it in there. I put it in my cover letter. That was the most important part, right? I think the cover letter mattered more for me. Than any other person because of my unique situation. And actually, my interview process through Morningstar was really interesting. They just grilled me on the strategy and the option strategy that every single interview they're like, actually, this is like really, interesting. Um, they're like, you know, we want you because like, we can see you're really passionate about the markets. And that's actually, to us, more important than any sort of that you can get because they know like this kid wants to be in it for the long haul, right? Yeah. And I think that's, it's unfortunate that there's kind of this filter that a lot of top buyside firms have, but it doesn't mean that you can't make an extra step or two to get to that spot. Right? You can still get there. You just have to be very, you know, um, cognizant of your story, your narrative,
Patrick (CEO of WSO): Deliberate and...
Scott: very deliberate, you know, and really plan out your path. So, you know, start at Morningstar. Obviously, they weren't well known Buyside firm, but, Still a big name nonetheless. So that's where I kind of, Got my first chance essentially.
Patrick (CEO of WSO): [00:19:24] In Data Analyst, So, you know, did you have any sort of engineering background? You had a little bit of stats, but you know, tell me about the learning curve, the skills you needed when you first started there, what they expected of you because there was like some portfolio analytics and acquisition. So you were buying portfolios for them, Or…
Scott: [00:19:41] So, You know, The Morningstar's biggest product was Morningstar Direct at the time. You know, I joined Morningstar's, you know, development program, which was kind of a rotational program, and that was my first role they put me in and the reason why they put me in there was because at the time they were trying to improve their derivatives analytics and they knew that I had experience with options and derivatives. So this is like the first group they put me in and they kind of rotational program where I worked there for like, you know, probably for a year or maybe less than a year or so before I rotated into the more asset management side. But we were essentially acquiring data and client portfolios to put onto our Morningstar Direct platform. It's not that we were actually getting their money. We wanted to get analytics and kind of build that database for derivatives, obviously for future use and for more for obviously like developing algorithms and stuff like that. So I was really part of their data business doing a lot of ticketing, you know, answering client questions on analytics, you know, developing the advanced portfolio template with which was at the time, You know, was trying to, you know, create through the court ruling how what type of, you know, derivative analytics they had to start collecting from asset managers to gain transparency. Right? So it did a lot of work on the analytics side.
Portfolio analytics, like anything that you saw. Kind of, Like on the sell side, research on Morningstar, Morningstar style boxes, all the analytics they have, I was like in charge of all of that, Essentially.
Patrick (CEO of WSO): [00:21:06] That's awesome. That's pretty good for your first job out of school.
Scott: [00:21:09] Yes, it's pretty good. You know, I got lucky. They gave me a chance for sure.
Patrick (CEO of WSO): [00:21:13] And then it was pay kind of like more obviously like a top hedge fund pay. Was it like mostly base salary? I assume.
Scott: [00:21:20] It's pretty much all base, Pay wasn't good at all. I mean, Morningstar, Generally, I think the pay was you know, a little bit lower…
Patrick (CEO of WSO): [00:21:27] Like 70-ish? 60 ish? Like what are we talking here?
Scott: [00:21:30] At the time it was like 60 back like ten years ago. But also remember, this is Chicago. Chicago pays to be a little bit lower just because, like, the cost of living is like cut in half. Like…
Patrick (CEO of WSO): [00:21:39] At this point, What are you thinking to yourself? I'm sure there's people at Chicago that's like at the top hedge funds. They're like, Oh, I got this bonus and you're sitting here, you're like, Well, I'm you know, I started my own hedge like I have I have the chops to, you know, are you thinking like, Hey, I'm going to get there? Are you thinking, hey, let's map out this data kind of more data asset management career or what? Or are you?
Scott: [00:21:58] I didn't really worry about that. I wanted to get into asset management. You know, I had trust in my own skills, My own market knowledge. I understand markets really well at that age. I think relatively to most people, I had confidence that at that point, I actually took my level one my senior year of college and that's also why I potentially got some Interviews, was like, Oh, this Guy's kind of ahead of the curve. He started early, so actually did that, you know, my last year of college. And honestly, I think at a very young age, yes, I think it's easy for you to look.
Scott: [00:22:26] At your peers and go, I'm making less money, blah, blah, blah. But that doesn't matter in the long run early on in your career, you just. To learn, Gain, get the skill sets. The pay will come. As long as you're passionate about something and you work at it, people will notice it. And then if you combine that with good networking. Your, you know, your network will also work for you, right? And what I mean by that is.
Scott: [00:22:53] Um, Really like be giving of your time with people at work, Right? You know, you want to get noticed, you know, treat the people below you as you would above, you know, a lot of people, they just suck up to their directors. They're above you. Don't, don't, don't do that. You got to treat people you the same way. It shows a level of maturity, shows a level level of leadership that you're giving about your time, and people will notice that that's how you get promoted. That's how you get people to speak positively about you. Right?
Patrick (CEO of WSO): [00:23:21] So speaking of internal or networking in general, you did make a transition within Morningstar, looks like from more like the data side to more the an investment analyst side. Can you talk to me about like what the skill sets were different, how you made that transition specifically? Like was it because you were, you know, making building a good reputation on the data side that you were able to make that internal transfer? And then how did you even I know it can be tricky when you're in a certain group to kind of lateral to another one? How did you do that?
Scott: [00:23:51] Yes. Absolutely. I mean, it was part of the rotational program. So they did expect to rotate.
Patrick (CEO of WSO): [00:23:55] That's good.
Scott: [00:23:56] But, you know, there was obviously huge competition. Right? Like everyone wants to rotate from data into like the equity research portion or rotate from data into like. The asset management portion, the asset management arm of Morningstar. So there is that competitive aspect. So this is where like the networking comes in.
Scott: [00:24:10] Building a good reputation for yourself, you know, giving just be giving of your time, like your impact in your role is beyond what you do day to day. Help your employees have an indirect impact on the company, right? If someone asks you for help, you should be giving to help. At the end of the day, you're all working for the same firm… Manager.
Patrick (CEO of WSO): [00:24:26] Is there a specific example like of a time when you did that?
Scott: [00:24:29] Yeah, absolutely. If someone you know needs help with like a SQL query or something. You should be giving it your time. You know, help them. Like, you know, don't be stingy with your work. At the end of the day, you're working for the same company. People will notice that.
Scott: [00:24:39] Hey, you know this person, not only does he make a direct impact in his role. But he makes an indirect impact. On the firm and on the department. And that indirectly affects the bottom line. You know, I think. Just when you're younger, you have to think bigger picture. Everyone gets stuck in the weeds.
Scott: [00:24:52] And that reputation builds. My manager saw that. You know, the people in asset management saw that on the investment side. So when I interviewed, you know, people are already kind of know your name, right? It's like guys that you already kind of build reputation for himself. You know, he's been a huge value add to the company and this is really how you kind of stand out. You know, it's a huge part of his networking. Right? You know. Painting yourself in the right light…
Patrick (CEO of WSO): [00:25:13] For sure. And this is a rotational program, but it was competitive to get into that specific…
Scott: Exactly
Patrick (CEO of WSO): Rotation. So you ended up in the it was called Capital Markets and Asset Allocation Group.
Scott: [00:25:23] Yeah. So…this was how your work.
Patrick (CEO of WSO): [00:25:25] This was how your work changed day to day, and like it sounds like it went from very data heavy to more like what to more obviously investment analysis and stuff like that and how like so what does that mean day to day?
Scott: [00:25:36] Yeah. Um, so yeah, obviously a lot less on the SQL, a lot less on the coding side, and more glossy with Excel market research. So Morningstar had a subsidiary called Morningstar Investment Management, and that was their business. They had a lot of target risk portfolios that they would, you know, sell. And they also had an advisory business as well, where, you know, other firms like, let's say TD Ameritrade at the time when they weren't bought out yet, would hire us to give them asset allocation views and tell them how to position their portfolios. So both had, you know, worked in advisory as well as kind of managing Morningstar's asset allocation portfolios entirely, entirely different. You know, work did a lot of market research, a lot of asset class level research. So at the time, you know, I was in charge of, you know.
Scott: [00:26:24] My sector is like global consumer discretionary and global technology and I would essentially model 200 to 300 different asset classes and come up with expected returns over 10 to 20-year period using a very fundamental contrarian valuation-driven approach. So it did a lot of economic research, pretty data intensive. Obviously, you know.
Patrick (CEO of WSO): [00:26:47] Collecting primary sources. Yeah. Where are your primary sources for that data? Like to be able to do that.
Scott: [00:26:51] Bloomberg and FactSet, you know FactSet was huge. You know FactSet, they had a lot of really good index-level data. So let's say I wanted to model the Japanese tech sector and see whether we wanted to gain exposure to Japanese tech sector. Obviously, at the time, you know, Japan we wanted underweight. Yeah, still probably want to underweight but you know you would look at you know the topics for example TOPIx is the kind of like the S&P TOPIx was kind of the Japan overall index but they also have the S&P TOPIx.You know. Japanese Tech Sector Index. And so we would look at the history of that index and the fundamentals of that index relative.
Scott: [00:27:32] You know, to its median levels of valuation and seeing is it overvalued, undervalued, based off of a bunch of these different fundamental factors like, you know, price to book price to earnings, price to adjusted earnings, price to sales and really trying to understand what is essentially the medium level of valuation over time and seeing it's essentially a mean reversion model, right?
Patrick (CEO of WSO): [00:27:56] You're basically trying to say what's a relatively out of favor potentially a deal and what's overly hyped and what you want to potentially underweight.
Scott: [00:28:05] Right. Exactly. If we felt like something was, you know, undervalued a particular index or particular asset class is undervalued. You know, we may want to invest it. We would do more in-depth research. Right. Because you still need some sort of a catalyst that's going to bring it back to fair valuation. Right. So just... Because something's undervalued doesn't mean you should buy by it, obviously.
Patrick (CEO of WSO): [00:28:24] Yeah, It’s an interesting Yeah, I mean, there's probably some cyclicality around, you know, oil and gas and all this stuff and like, you know, what's the play long term like? Are there are there industry trends that are going to be making, you know, oil and gas long run, like looking at long run when there's such like massive changes happening in the market and battery technology? It kind of makes it like scary just to be like, oh, it's undervalued. Go.
Scott: [00:28:49] Yeah. And at the time, you know, energy was performing very poorly, you know, and how we modeled the energy sector, you know, at the top down level was very, very different. We wouldn't use price to earnings. Obviously, the earnings were negative. You wouldn't even touch price to cash flow. It was more like you look at price to book price to sales relative to, you know, the last 20 to 30 years and really trying to understand, you know. When is it going to revert back? And so like energy, for example, Tom was one of those things where we really underweight for quite a long time. Yeah.
Patrick (CEO of WSO): [00:29:19] So, okay, so then you're kind of there for almost two years in that new role. And what's your thought process as you're kind of there, your skills are growing, Why start looking around? You had said to me in another call like you made a few moves and you kind of knew what firms you wanted to go do and you didn't talk to that many people. It wasn't like you were just sending your resume everywhere. You kind of had mapped your career. So talk to me about. Like, why go to Schwab next in that investment risk-specific role? And then kind of first off, how did you even know what that path was at such a young age, kind of a couple years out of school?
Scott: [00:29:56] Yeah. I'll kind of provide some context in terms of time, right? I think I graduated in a time where. You know, the industry and financial industry was really changing, you know, like becoming more, you know, less focused on Excel and moving more towards Python. I think Python really took off over the last 3 to 5 years. And at the time, you know, fundamental investing, stock picking was becoming less and less of a thing is becoming more of like kind of the like the dinosaur age, right?
Patrick (CEO of WSO): [00:30:22] Yeah.
Scott: [00:30:23] And….
Patrick (CEO of WSO): [00:30:24] Active managers.
Scott: [00:30:25] Right, and active managers at the time. Obviously, you know. Active managers are doing a lot better now given, you know, sector dispersion. You know, there's recession. People are looking for active managers but passive was a huge at that time and also quantitative investing was building. Obviously, there's a ton a ton more data.
Scott: [00:30:40] Better technology, you know, machine learning able to handle large data sets. The way people were investing was very, very different. You know, didn't in my mind I wanted. To change with the industry. You know, for the longest time wanted to go into portfolio management, go into equity research.
Scott: [00:30:54] So at this time I was kind of thinking about maybe want to like move more towards the quantitative space. Um, you know, hadn't really, you know, taken action. I had worked at, you know, kind of the investment management arm for roughly two years now. And then one day, um, my actually, my first manager from my data role. Uh…
Scott: [00:31:10] You know, reached out to me and he said, you know, he was actually moving over to Schwab. He was taking a huge, you know, managing director position at Schwab and told me that, you know, he would like me to apply to potentially join him. And he knew that you know, I worked with him for like a year in my first role. He's actually my first manager ever. Um, you know, great dude.
Scott: [00:31:31] He always looked after me. He always tried to, you know, he always had me in mind, right? He knew that I wanted to stay in a market role. And he was moving into a market role at Schwab. And he's just like, hey, you know, like, give it a shot. I know that you know, you always wanted to kind of stay in markets, and I think this would be a good role for you. And it was kind of more of a quantitative role and had already kind of started thinking about it.
Scott: [00:31:50] It just happened to work out. And so, yeah, I interviewed and that's how I essentially moved, is just a combination of me already thinking about going more to the quantitative space, given where the industry is moving and really learning more about factor models.
Patrick (CEO of WSO): [00:32:02] And that was a move to West Coast.
Scott: [00:32:04] Right? Actually, I was staying in Chicago, Actually Schwab at the time, uh, they were opening their first branch in Chicago, and I was one of the first employees in the Chicago office for Schwab.
Patrick (CEO of WSO): [00:32:15] Was your boss there too?
Scott: [00:32:16] Yeah, he's based in Chicago. His family's there. He's still there. Um, and, yeah, I hadn't moved into San Francisco until maybe around the pandemic. Yeah. And then moved to the San Francisco office for Schwab.
Patrick (CEO of WSO): [00:32:28] So tell me about, like, what is even a senior manager of investment risk? What does that even mean? Like, what's the day-to-day like? How is it different from what you were doing before? Um, at Morningstar?
Scott: [00:32:38] Yeah, absolutely. Um. The way I started looking at strategy is very, very different. You start looking at cross-sectional bets in the portfolios, like for ologists, look at individual stocks, you know, aggregate them, bottoms up out to the index level, see what the fundamental valuation is, what are the catalysts working in Excel? Really, really little work on risk factors, right, once you move to investment risk. When you start evaluating fundamental managers through the risk lens, it becomes an entire different beast, right? Because a lot of these fundamental managers, they're not very familiar with risk models. Sometimes, A lot of these managers may not even be really familiar with the style of bets they're making. They don't pay that close of attention to it.
Scott: [00:33:22] Like sometimes they manage the risk at the individual stock level, but when it gets aggregated up to the portfolio level, they may realize, oh, they're actually very overweight. You know, volatility or very overweight, you know, reversal or underweight profitability.
Scott: [00:33:39] And they didn't necessarily intend that and that can have outsized impacts on your attribution and on the performance of your fund.
Scott: [00:33:47] If a certain factor moves significantly in one direction from like a market regime change or something
Patrick (CEO of WSO): Like it did in 2020?
Scott: Yeah, Exactly.
Patrick (CEO of WSO): [00:33:57] 2021 If people were underweight growth, They were in trouble.
Scott: [00:34:00] So the way I start to look at the markets and managing assets, it went through like a completely change, completely through a different lens and it became really, really useful to really have, you know that knowledge of both the fundamental aspect but also the quantitative aspect of how factors actually, I mean.
Scott: [00:34:20] Factors explain the vast majority of returns. Everyone knows that generating alpha is extremely tough. Generating alpha more than the fees they charge. And so really understanding factor moves and under the hood.
Patrick (CEO of WSO): [00:34:33] For people who don't know what factor moves, can you explain to the listeners what that means?
Scott: [00:34:36] Yeah, absolutely. So, you know, factors is essentially, you know. High-level characteristics that you can describe a stock, right? You know, some stocks are going to have more value exposure. They can have more growth exposure. They have more profitability exposure. Right. So let's say, for example, a profitability factor.
Scott: [00:34:54] Uh, there's many different ways you can measure profitability. You know, obviously, you can look at margins like a way that people model profitability might be profit margins. So you look at, you know, which companies have the highest.
Scott: [00:35:10] Profit margins, you would rank them, you know, from top to bottom, all the different stocks. And you could almost like. Create a factor index weighted by profit margins. Right? And that is essentially almost your profitability factor where you can see, oh, if profitability is now very in favor because we're entering a Recession.
Scott: [00:35:28] You know, people want strong balance sheets, you'll see the profitability essentially the factor index outperform the S&P 500.
Patrick (CEO of WSO): [00:35:35] Get over, or get too overweight or get too hyped.
Scott: [00:35:38] Right. Exactly.
Patrick (CEO of WSO): So growth.
Scott: [00:35:41] Yeah. So you're essentially you're slicing and dicing the market into these different risk factors that you think explain the returns of a particular stock.
Patrick (CEO of WSO): [00:35:53] It's interesting. Yeah. I think. Um. Yeah, Just how everything has shifted so crazy from 2019 to today, 2020…2023. These are the last three, three-ish years since the pandemic. Really from like crazy bull to suddenly a dramatic drop to an explosion. Really explosion up with liquidity to suddenly everything coming out of favor and interest rates exploding with inflation. Did everything, just literally being just flipped on its head and reversed and super fascinating. So yeah, I mean, I'm sure factors were. I mean, I'd be curious to hear like what you guys were saying in 2021 when growth was super, you know, before things started falling apart and stocks with no profitability. I'd be curious if you guys were begging the table like might want to rotate into some more value at this stage or…
Scott: [00:36:48] Yeah. It's funny because at Morningstar, you know, the longest time, like we tried to underweight growth, we thought that there's going to be a reversal, or reversal at the time there was this was 2016, 2017, and it really hurt the performance. You know, it's really hard to time the market at some point. Obviously, growth did reverse. You know, now we're in 2023, but… and it really hurt the performance. You know, it's really hard to time the market at some point. Obviously, growth did reverse. You know, now we're in 2023, but man, you're underperforming for like 5 or 6 years, right? Continuously, you know, underweighting that aspect. I think it's just the aspect of like playing both sides. You should definitely start trimming. You may not have to be super aggressive and try to time the market, but like a lot of the managers, like we were taught, we were talking to Schwab during the time.
Scott: [00:37:27] They were so growth heavy like everyone was overweight growth and that and overweight momentum too. Um, and eventually, obviously it broke down with the whole pandemic.
Patrick (CEO of WSO): [00:37:37] I was overweight…I was overweight.
Patrick (CEO of WSO): [00:37:38] I mean, especially I was, you know, and I was probably throughout the… I was pretty, pretty balanced throughout the whole bull run. But then what happened was in the crash, tech. It made a lot of sense to just pile into tech where that's the one, you know, slack, all these other ones, you know, Peloton, all these things, they made a lot of sense, right? So you could go into there pretty confident. These are good businesses. They're growing. They're exploding actually in growth. So it made a lot of sense. But then I think it was the it was the non-rotate. A lot of people got caught with too much of that factor of growth-oriented factors, myself included. So the like the last two years, you know, luckily I never I never go too heavy. I always have a pretty balanced portfolio. So I'm okay like, but I know some people who got really aggressive or trade on leverage and it's… it got ugly in the last year or two, So…
Scott: [00:38:29] And now you mentioned it's actually really interesting because you could still invest in growth but in like a safer way. Right? There's dividend growth strategies like dividend is also one of the really big risk factors in models. And there's a period of time, I think, you know, 2017 to 2020 ish where dividend factor really outperformed, and, you know, think a lot of recommendations to manager was like actually, you know, you could invest in the dividend factor. Stocks that have pretty good dividend growth, and get exposure to that growth but also be protected on the downside. The reason why, if you think about, you know, at the time, why did dividend perform so well? So its interest rates were so low, right? Any sort of investor that was looking to, looking for yield, looking for stable cash flows, they wouldn't put it in like the ten-year yield. At one point, the ten-year yield was 2500 yield. Yeah. It's like you're… you might as well you know, you get better yield from investing in the S&P 500 than you did from putting in a ten-year Treasury.
Patrick (CEO of WSO): [00:39:26] Yeah.
Scott: [00:39:27] So that's why, you know, for investors that are looking at yield, they moved away from fixed income. They started coming into equities because interest rates are so low for so long.
Patrick (CEO of WSO): Yeah.
Scott: [00:39:36] And it caught a lot of investors off guard. So a lot of them that were underweight dividend because they were just buying growth, and companies that obviously, like didn't have any dividends, they just reinvest their cash into their businesses, they got screwed. They were underweight dividend and the dividend yield factor, you know, really outperformed for a couple years, three years because of the substitution effect with fixed income, and now you look at now actually, if you had put your money into dividend growth strategy like one example is DGRO, which is, you know, the iShares dividend growth, Since the drop in last year, it's been pretty much flat. The total return, including dividends, has been positive. Actually, if you had put your money into dividend growth, you know, mid, last year, early last year, you'd be totally fine. So there's ways to get a balance of both flavors to really like manage your, you know, assets from a diversified standpoint.
Patrick (CEO of WSO): [00:40:22] For sure. Yeah. It's really fascinating. So, okay, so you're kind of start this job at it was, Schwab.Right? So you're saying you're there and kind of doing some more of these models and trying to, you know, identify factors, and but like your day-to-day, you're working with your boss. But is it it's an internal role or is it something where you're actually talking to clients and helping them, you know, helping them?
Scott: [00:40:47] With a lot of different hats? It was internal and external. The internal aspect of…because Schwab also had their own active quant strategies. So I would have day-to-day communications with portfolio managers, do a lot of quantitative research for them, um, and really provide like recommendations on where they may be taking too much risk, maybe where they're taking too little risk, um, and like…
Patrick (CEO of WSO): [00:41:09] What's the most important skill you had? Python?
Scott: [00:41:13] Market knowledge, I think there are too many people that are in the quant space now that lack that market sense, that lack that market knowledge, and think that is why a lot of portfolio managers don't really like taking advice from.
Patrick (CEO of WSO): [00:41:27] And so when you say market knowledge, you think obviously your economics degree helped knowing macro really well, being able to talk about broad general macro… macroeconomic trends. Do you agree? Is that like probably where helped you the most? Because you could speak intelligently on that.
Scott: [00:41:42] Right. I think that's where it helps you be able to connect with the portfolio managers because all these portfolio managers are not necessarily the most quantitative. They're not doing the quantitative research. So if you can put a narrative behind the words, it makes it a lot easier for them to understand. So I'll give you an example, right? I was looking at the time, you know, health care. Um. I was looking at kind of the macro risk models and one of the factors was essentially the sensitivity of the healthcare relative to economic growth and this factor is proxied using the industrial production index, and you notice if you looked at the factor in the exposure of the healthcare sector relative to the economic factor of industrial production. The exposure had essentially doubled.
Scott: [00:42:31] Over the last 15 years, so essentially what that means is healthcare is becoming less and less defensive, large, large-cap healthcare. That's what came through the numbers and came through the risk models. But what the managers want to know is why is that happening. From a qualitative aspect, right? You know, the risk models are not always right. You can't just take the numbers for what it is. You need to put some sort of narrative or a story behind it to make it more of a convincing argument. Now, the reason why that is.
Patrick (CEO of WSO): [00:42:57] Retail, they're all becoming consumer-like…
Scott: [00:43:00] Yeah, yeah.
Patrick (CEO of WSO): And Walgreens. Yeah.
Scott: At the time and I'm sure you've heard about it, right? The industry has changed significantly back then. You know…
Scott: [00:43:12] All the large pharma companies, biotech companies did a lot of their own R&D nowadays in the late 20 tens. They don't do R&D anymore. They let the small caps in the new companies do it and they just acquire them. What this means is they're much less insulated now, these larger. They're much less insulated to changes in the economy because now they're much more focused on commercialization of drugs, much more focused on manufacturing of drugs. So the revenue mix completely changed and it made the whole large cap health care less defensive. Now, this was a story.
Patrick (CEO of WSO): [00:43:46] I understand that. So like you're saying that the because they became more acquisitive of small, they weren't doing the R&D. Why would that make them more susceptible to less defensive? They're still selling drugs. They're still manufacturing drugs. Drugs still seem to be a pretty inelastic good, right? Or like pretty elastic. So, like what what part of that, I guess, makes it less defensive because they're. It's become more like commercialized in the sense of like it's more of a…More like almost like non drugs that are non that makes became drugs that are not like needed for like critical illness but more like cosmetics and other stuff or.
Scott: [00:44:28] It's just like tied to like industrial production. It's tied to like, you know, a lot of, like…
Patrick (CEO of WSO): [00:44:34] It was more of a manufacturing got it became more of a manufacture.
Scott: [00:44:37] Increase costs.
Patrick (CEO of WSO): [00:44:38] Rather than…
Scott: [00:44:40] Right. Exactly. So like if you're more at the whim of increased input costs, like, yes, it's still defensive. People are still going to be purchasing drugs, but your cost of producing those drugs are going to start increasing and you're going to be more susceptible to that because now a large of your revenue mix is going to be in manufacturing and even like advertising to, now they spend a lot of money on advertising, advertising. These drugs and advertising is also also very cyclical. The cost advertising is also very cyclical. They're more exposed to these areas, whereas back then in R&D, you know, R&D is like.
Scott: [00:45:09] It's much more defensive in the sense that. You know, you're…You can like license out drugs that you're doing research on, and also like acquisition aspect is also very cyclical. If you're focusing more on M&A, your ability to acquire smaller companies puts you in a much more cyclical business. Right? Because if there's lack of funding and we're about to hit a recession, your cost of financing is going to increase and your acquisition costs of smaller companies are also going to increase, which is going to hit your bottom line, which also makes large caps less defensive. So that's also another aspect of it is the M&A aspect is cyclical in itself. That's interesting.
Patrick (CEO of WSO): [00:45:45] Yeah, it's interesting to think of that. And so Okay, cool. Good example. So yeah, you're there for two and a half years. What then what? and why the move?
Scott: [00:45:56] I just felt like I wanted to move on and I personally mean think at the time like I wanted to work for. I Want to learn more, feel like was my growth. After the three-year mark, I wasn't learning as much anymore. I feel like I was kind of like doing the same thing over and over again, and my team was pretty small. I wanted to like learn from someone new, learn from a different firm. I wanted to get obviously more reputable firm with, you know, better talent, and so I started applying for, like you said, like top biocide firms, right? I was very, you know, specific in who I wanted to target and what I was looking for, and at the time, BlackRock was, you know, at the top of my list for a number of reasons. One, they're almost like the Google of finance. They have the best technology of any financial firm in the industry. You know, that's what separates them.
Scott: [00:46:43] Like at the time.When I was, you know, covering products at Schwab.I was also kind of covering a little bit of the passive products at Schwab too.
Scott: [00:46:49] And when we did Competitor analysis, I'd always noticed iShares always track tighter to the benchmarks and they almost always slightly beat the benchmarks, even in the past. This space always. I never really understood why, um, for so many years and I want to know, like just knew BlackRock was number one. And after interviewing with the people.
Scott: [00:47:12] I think just the level of talent there, the caliber of people on average. So much more. And you know, that's one of the best ways to grow your career is your network and also the people you learn from. It's not just about the role itself. I want to surround myself with, you know, people that had the same level of motivation that the same level of. You know, passion for markets and felt that the culture at BlackRock had that.
Scott: [00:47:36] And it was something that a lot of firms feel like misses and the technology aspect. Um, and yeah, obviously just the wide range of products. There's just so many more products that can learn about and learn from. And so…
Patrick (CEO of WSO): [00:47:49] You were looking to do something similar to what you were doing just at a different firm. So tell me how it's, how has it been?
Scott: [00:47:58] It's been very different. It's not exactly what I expected…
Patrick (CEO of WSO): [00:48:03] Tell me why. I think that's always hard. Because, like, before you make the jump, you think something, but then, you know, you're used to your manager. How they work, the way that firm works. And, you know, you've been that you were there for almost three years, and then suddenly you're in a new role, which is supposed to be similar. But tell me how it was different and why it was surprising.
Scott: [00:48:24] I think the most surprising part was. How much research and quantitative research goes into managing a passive product in the ETF space? At the time considered actually had interviewed with, You know, The active systematic team and the active fundamental team at BlackRock and also interviewed with kind of…
Scott: [00:48:45] You know, the beta team, which Is that's what they called there for the ETFs Beta, essentially you're looking at the market level risk because you're not necessarily making active bets and it was interesting too because I wanted to try something new and like I told you, I always knew, like Ishares is a huge growing business, you know, huge money going to passive. A lot of it is because multi-asset a lot of these multi-asset products have Ishares as underlying, you know, funds in their Portfolios and…
Scott: [00:49:12] I always wanted to be on the bright side of the changes in the industry and that's what kind of drew me to it. And then what was so fascinating about it was. The product development in the passive space. Developing these new strategies. It's almost like there's so much product innovation in this space. And the reason why there's so much growth Is because, you know, we're doing all this kind of like developing these new strategies, Generating…You know, alpha on an absolute return basis while also continuously lowering the fees and lowering the costs for investors. Right? You know, so many investors are talking about, oh, you know, fees of active funds are too high, blah, blah, blah, blah, which is entirely true because, you know, a lot of most managers, obviously, as people know, you know, don't beat the benchmarks after fees.
Scott: [00:49:58] They're not, you know, whatever they charge the costs, they're not able to generate alpha over the long term to meet those costs. And so the value proposition for active just wasn't really there and could obviously see that's why there was such a huge growth in the ETF space, not only that, you know, as you know, ETFs also are highly tax efficient vehicles. You know, they actually exist. In two places in the secondary market and the primary market. Think a lot of people don't know this. Where if you buy an ETF, you're actually just buying the shares, the ETF.
Scott: [00:50:27] You know, You're not actually necessarily buying the underlying stocks within that ETF, and the reason why ETFs have such great liquidity and it trades like a stock is because there's a second layer called the primary market where there's these apps or authorized participants that almost act as liquidity providers and they hold inventory of stocks, right? If they're if, let's say, you know, a retail investor wants to buy a block of retail investors wants to buy a particular ETF. The ETF order goes to authorized participant, The ET holds obviously a bunch of stocks inventory, almost kind of like market makers, and then we create an ETF share. Blackrock does, right.
Scott: [00:51:08] We give the ETF shares and they give us the basket of stocks, if you notice this exchange, we're never selling or buying the stocks. They're all just exchanging of baskets of stocks, which is why there's no taxable event. And that's why are so tax efficient and that's why they pay less way less taxes than mutual funds and be.
Patrick (CEO of WSO): [00:51:28] Able to rebalance without having to go in and out. Right. You're getting…
Scott: [00:51:31] Exactly
Patrick (CEO of WSO): [00:51:32] You're getting about. So the question I have for you that I think, you know, I think I've heard it a few times. So like as trillions and trillions and trillions of more dollars flow into these passive funds, do you see there being risk around specific concentration? Like if there's too many in in the standard S&P 500 shares? Right. So like being in the S&P 500 or not, isn't that single-handedly like driving the value of the business or the market cap of that business way up just because there's so much passive that has to has to track that index? Like so like just that decision of being whoever decides, you know, whatever companies are in the S&P 500 or the Dow or whatever it is, whatever index you're tracking too, doesn't that have like an outsized or couldn't that eventually have a really outsized impact on the valuation of the actual company? Because there's… and are you aren't we already seeing that?
Patrick (CEO of WSO): [00:52:29] Like is that something where, like as a factor, like another factor of being part of an index could almost you could almost say it's overweighting. That's probably why there's so many other additional strategies you guys are coming out with in more breadth to these baskets because you shouldn't be putting it all in the one basket. But like know, what's your thought on that? Because there is just so much flowing to the passives. It's like to me like, is there systemic risk around, you know, some of these larger baskets that are just now accumulating? And it's not just it's not just BlackRock, it's all the others that are also have the same 500 or the same 30 stocks. What's your thoughts? Any thoughts on that?
Scott: [00:53:10] It definitely generates more volatility in the market, especially because so many of these let's say there's like Vanguard State Street, right? Yeah, BlackRock, all these index providers. They all have like your typical Sp500 index, right? So that's why like now, more so than ever, all these companies are trying to get into the index because they know that it's if you get your name, your company into the S&P index, it's automatically going to pump up your stock. There's more eyes on it. There's more demand for it.
Scott: [00:53:35] So now more…
Patrick (CEO of WSO): [00:53:36] So by how much do you think it's like a 20% premium, like from being the 500 1st company to being the 500th company? Like, does your stock like get a 20% market cap boost? Is it like worth billions of dollars just to be in that index? Probably, right?
Scott: [00:53:49] I think it does. But also…
Patrick (CEO of WSO): [00:53:51] Like remember, Tesla got added or something and it was like this big deal or was it Tesla?
Scott: [00:53:57] Yeah, I think. Tesla's added, but I think for the longest time it wasn't added because S&P had certain rules around how many years of profitability, like profitability, you needed in order to get in there.
Scott: [00:54:08] So depending on the index methodology and what you need to meet in order to get into those indexes. But mean, like you said, that's $1 million question. You think there's been a lot of talk on CNBC, you know, just the headlines talking about, oh, are we in like a passive investing bubble? Right?
Patrick (CEO of WSO): [00:54:21] Right.
Scott: [00:54:22] Now, that's entirely true. That's $1 million question. I'm not going to put my opinion out of saying that we are in a bubble or we're not. You know, it's obviously a very difficult question to answer, but the vast majority of money that's actually in passive is going to be in public pension funds. It's going to be in retirement space. Right. In order for a bubble to pop.
Scott: [00:54:41] It has to be panicked. People have to pull money out. But you think about it, retirement. It's all locked. People can't really pull it out. So people are saying that even though there is a premium to these names are in the passive space, it may. The premium might actually stay there for decades. So people are kind of talking about the you know, there's thoughts.
Scott: [00:55:02] Experts are saying that potentially, you know when the baby boomers start pulling money out at retirement age. Right. It may lead to a large decline in a lot of these large-cap names because of, you know, the selling of these large-cap names and these indexes in the retirement funds.
Patrick (CEO of WSO): [00:55:20] I'd just be curious to hear like or just to think about that like that whole factor, like the demographic factor moves like the because I think that's super interesting, right? Like in terms of these passive strategies, you know, they're exploding and I mean, maybe the explosion of growth and the money moving in would offset those big boomers pulling it out so that it's kind of, you know, a wash. Who knows? But like, maybe not. Maybe, they're going to continue. Maybe the premium is going to continue over the next 20, 30 years where it gets to a point where there maybe it's a bubble that just gradually very slowly builds, and then it becomes really scary.
Scott: [00:55:58] I don't know. I mean, I think the passive space, I think there's obviously in my mind there's still more positives than negatives. It's definitely worth investing.
Patrick (CEO of WSO): [00:56:09] Yeah, I agree 100%. I think there is some solace in the sense of. Not everyone just puts it in S&P 500 index. So like, there are there's a lot of money going elsewhere.
Scott: [00:56:21] I think the space is evolving pretty quickly. I think there are, you know, mitigating factors, right? In the sense that like all the vanilla, you know, ETFs have already come out already. Now there's a lot more bespoke products. Like you have like an iShares like Saudi Arabia ETF, iShares Poland ETF. Like we're offering so many products now…
Patrick (CEO of WSO): [00:56:42] With even short, Short based ones, Right? There's there's like vol, there's all these other ones that, you know, allow people to get different, you know…
Scott: [00:56:51] Exposures.Yeah. I think that has a lot of mitigating effects for sure. And right now, like BlackRock, for example, the primary focus is to come up with a lot of these more exotic products. And I think a lot more firms are following that footstep because there's a lot of market share to be grabbed and as more of these products come out, there's absolutely a shift, you know, from kind of the larger index funds and just say like the S&P 500.
Scott: [00:57:14] And really, if you think about it, the active investing in the onus is really put on the retail investor right now. You're not buying like an active manager who's actively managing an S&P 500 benchmark. Now it's up to the retail investor to decide, oh, you know, I want to allocate my portfolio to like a European ETF or like a Chinese technology ETF. So the onus is gonna, I think put more on the retail investor. I don't know how that's really gonna, you know, shape the long-term investing landscape.
Scott: [00:57:45] Because at the end of the day, like it comes down to financial literacy. Right? And I think there's so I mean, I think retail investors. It's everyone's, You know, investing is like so heterogeneous. Everyone has different views of the world. There's going to be just a lot of demands for all these different bespoke products. And I think that in general, the products in the passive space will become more and more diversified over time. So I don't necessarily think, you know, I don't know how big that bubble is going to be.
Scott: [00:58:11] Or how worried I'd necessarily be because I do see a lot of innovation in the space, Where there's a lot of. You know…
Patrick (CEO of WSO): [00:58:16] There's money flowing not just to the same names everywhere.
Scott: [00:58:19] Exactly. Yeah, and it's another example is like the ESG space. You know, we have a lot of these ESG passive products now where. You know, a lot of. We develop these ESG indexes where we have to develop a methodology for what stocks can make it into this ESG index. Right? They have to maybe meet some sort of an ESG score, like they may meet some sort of a baseline screen like, oh, they cannot be involved in like, you know, fossil fuel production or manufacturing cannot be involved in…
Scott: [00:58:50] Like tobacco. Or like, you know, or stuff like, you know. Child labor or, you know, like sex trafficking. There's a lot of these like, you know, factors that are putting more focus on like companies that are much more like conscious of like obviously society and like. They're much more conscious of like know making a positive impact in society. So like this is, you know, putting more money inflows into ESG names, which I think is great. It's not just all about profits, you know, it's about, you know, putting money in and creating a more sustainable future for us to live in.
Patrick (CEO of WSO): [00:59:27] That's great. Well, Scott, out of all your moves and all your things, what would you kind of leave listeners, Our listeners with in terms of words of, Final words of wisdom?
Scott: [00:59:37] I mean, I'll just say like. I mean, I think a lot of times people in finance, they really go after money or whatever it is like follow your passion for foremost. Like, you know, I didn't know I would be…
Patrick (CEO of WSO): [00:59:48] Has the money arrived? Are you making three 400-ish?
Scott: [00:59:52] Yeah, it's good. Uh…
Patrick (CEO of WSO): $3 million a year? No.
Scott: [00:59:58] Definitely not trailing my peers, as I did my first role. but, you know, definitely chase your passions. Focus on Skills, Skills, Skills. Because if you develop the right skills, It'll show up in interviews, It'll show up through your resume and people will want to hire you. You know, don't be discouraged just because like, you sent out a hundred resumes and you got, like, one interview. I totally understand it is discouraging and I think. I've been through that. A lot of people have been through that. But it doesn't mean that you can't get to where you want to get and you can still have a very, very fulfilling career. So just like, you know, think long term, like your career, is 20, 30 years.
Scott: [01:00:34] Just because you aren't where you are right now. Like put your head down and just, you know, work harder. It'll definitely come and, you know, network properly. You know, as I said, you know Like think meeting. It's, you know, meeting people is the easy part. The harder part is, you know, portraying yourself in the right way to the right people.
Scott: [01:00:56] Otherwise, you're going to be finding yourself, introducing yourself to people one at a time. You want to make your network work for you. Right? That's how you build reputation over time and that's how you grow your career. And that's the same thing with developing skills. You know, think very long term. Think. I mean, career is going to be long. Like, I feel like I've been in finance for a long time, but man…
Patrick (CEO of WSO): [01:01:18] Your network working for you is kind of like as you're kind of approaching the end of a call or an end of a coffee chat, it's just like, Well, is there anyone else you think I could talk with? That kind of thing. And then obviously keeping in touch with them and so that they feel a connection with you. They want to help you because they mentored you and they want to see you succeed. So I think that's people underestimate that power of that because why are they going to want to help me? I can't do anything for them. Well, they probably maybe see themselves in you. They want to help. They feel good about themselves giving back. That's value. So…
Scott: [01:01:51] Not only that, it's just also like, you know, be personable. I think a lot of people say that. But what is that exactly mean? Like when you work, People don't want to just talk about work. They want to know that you're a fun person outside of work. You have a lot of energy. You're interesting person. At the end of day, you're going to be spending 40-plus hours with this person, you know, day in and day out.
Patrick (CEO of WSO): [01:02:09] Hilarious because we had a top trending content on the forums this past week, which was like, how do you how can you be interesting? I'm so boring because all I do is work.
Patrick (CEO of WSO): [01:02:20] But there were some good times there. Yeah, I try to be at least outside of work. But listen, Scott, we'll end it there. Thanks so much for joining and sharing your story, Really appreciate it.
Scott: [01:02:31] Yeah, no problem. Thanks for having me. It was a great time.
Patrick (CEO of WSO): [01:02:33] And thanks to you, my listeners at Wall Street Oasis. If you have any suggestions whatsoever, please don't hesitate to send them my way. [email protected] and till next time.
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