A

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011.

B

This is the White Coat Investor podcast and this episode is brought to you by KeyBank. For six years, white coat member benefit partner Laurel Road has been part of KeyBank. As of March, that partnership becomes even stronger as Laura Road is now officially under the KeyBank brand. With the transition to KeyBank, the same tools and services you rely on now come with enhanced resources and support and the same great experience you trust. WCI members can continue to enjoy the benefits and financial resources they always have with even more support from KeyBank. To learn more and for terms and conditions, please visit whitecoatinvestor.com KeyBank all right, it is a pleasure to make this podcast for you. We're grateful for you. We're grateful for what you do in your daily life. We're thankful for you taking care of your finances. I'm going to thank you on behalf of future you as well as your spouse, your kids, your grandkids, their spouses for taking care of this stuff now. It's going to make a difference in their lives. And so you should be proud of what you're doing, not just in your daily work, which matters. And you know, some of you are out there, you know, stamping out disease and saving lives. Or maybe you do estate planning or asset protection or I don't know what you do if you're an attorney, family law, real estate law, who knows? But thank you for doing that. If you're a pharmacist, thank you for making sure your patients are getting the best possible treatment they can and nobody's screwing anything up like we doctors like to do. Oftentimes based on the number of calls I get in the ER about prescriptions I have written or my partners have, whatever you do out there, know that we appreciate it. Okay, we should do a quote of the day here. Far more money has been lost by investors trying to anticipate corrections than lost in the corrections themselves. That was Peter lynch who said that, and there's a lot of truth to that. Stay the course, right? When things start feeling bubbly, know that the bubble might go for quite a while longer. Right? When you see irrational exuberance in the markets, you've got to ask yourself, is it 1996 or is it 1999? Alan Greenspan didn't necessarily get the timing right. And so I don't Know why you would expect you would be able to time the market perfectly. Just stay in the market and stay the course. Okay, we need some help from you. We run a scholarship, the White Coat Investors Scholarship. We run it all summer, and then this fall, the scholarships will be awarded. What are the scholarships? They are cash payments. We just literally give cash to students, professional students, medical students, dental students, et cetera. Lots of other types of professional students can also apply. You can find the details@whitecoatinvestor.com scholarship. You have until the end of August to submit your application. But we also need judges. Can't be a student or a resident and be a judge, but you don't have to be a doc or anything to be a judge. You just got to be someone in their career or retiree. And if you will, email scholarship. But whitecoatinvestor.com, you can just put volunteer judge in the headline. We will enlist you into our army of judges. And we need 40, 50, 60, 70 each time we run this scholarship. We won't ask you to do that much, but you will have to read something like 10 essays that people write to try to win the White Coat Investor Scholarship. And so if you're willing to do that, we would love to have you. You will be inspired by what you read. These people applying for this scholarship, they're incredible people. You will be inspired. It will renew your passion for medicine or whatever your career is. So please volunteer to judge. We'll contact you in September and outline the work you'll need to do as a judge. But if you're willing to volunteer for that again, email scholarshipcoatinvestor.com okay. I've been looking forward to doing this interview for months. I'm really excited about it. We're gonna be talking with somebody from the investment firm Avantis. Avantis Investments.

A

Okay.

B

And the reason why is I invest quite a bit of money with them, Right. A lot of, you know, my portfolio is 60% stocks and 20% bonds and 20% real estate. And in those stocks, I basically own four funds, right? A total stock market index, and that's either from Vanguard or from iShares. A total international stock market index, again from Vanguard or depending on how much tax loss harvesting I've had to do lately. But the other two funds are to tilt the portfolio toward small and value stocks. And I use Avantis funds now for that. They're ETFs. They're low cost, not very low cost. They're not free like a Fidelity index fund or nearly free like A Vanguard index fund, but they're still low cost funds. And until my portfolio towards small in value in hopes that those factors will actually give me better long term returns. Now obviously those haven't shown up while large and growth stocks have been outperforming the last few years. But for both risk and behavioral reasons, I do have hope that over my investing horizon, the remainder of my life, that they will outperform a total market approach. Now, I haven't bet the kitchen sink on it. I didn't put all my money into into those funds, but I do tilt my portfolio toward those sorts of stocks. And so it's interesting to me to talk to the people that are managing my money. And so a lot of times on this podcast we have people that are white code investor sponsors, right? And I've tried to be good about alerting you to when those people, you know, we have financial conflict of interest to them. We do not have a financial conflict of interest with Avantes. They have not bought any ads from us, they have not given us any money. In fact, I pay them, I guess through the expense ratio shows through the funds that they invest with us. So no conflict of interest today. But I think it's a really interesting interview and I hope you enjoy it. Let's get our interviewee on the line. Our guest today on the White Coat Investor podcast is Jeremy Thornton, cfa. He's a Vice president and a senior Investment director at the Vantis. He spent four years there. Prior to that spent eight years at DFA as an investment strategist and the head of product management. He's been at Deloitte Consulting and even did an internship at usaa. For all you USAA fans out there, Jeremy, welcome to the podcast.

A

Hey, thanks for having me, Jim.

B

Yeah, I'm excited to have you here. As I told you before we started recording, I'm a big Avantis fan. Long term readers of the White Coat Investor blog, long time listen to this podcast know I've got a significant amount of money invested in Avantis funds, but I've never really done a lot on Avantis. I think we've probably written one blog post over the years about the firm and so I'm excited just to kind of introduce it a little bit, talk about it and particularly about some of the things that are a little bit different, not only about Avantis but about DFA where you worked prior to Avantis. Different from, you know, kind of a hardcore rigid, you know, index fund strategy like you might see with Vanguard Fund. So we're going to get into a lot of that material. But why don't we start with just kind of the history of Avantis? I mean, Avantis was founded in 2019. It's a pretty fast growing investment unit of American Century Investments. And tell us a little bit about kind of the origin story of Avantis and maybe how that relates to Dimensional Fund Advisors or DFA.

A

Sure. Well, as you mentioned, Avantis was started in 2019 and it was started as a unit of American Century Investments. So if you think about American Century Investments, a long standing asset management company, historically offered active mutual funds. It's kind of been their history. They've been around for more than 60 years and today they manage over 300 billion in assets under management. And so we came in, as you know, I like to think of it almost like a startup inside of an existing company, you know, which is good for a lot of different operational reasons. It really meant that we got to focus at Avantis on what we think we do best and what we really love doing, which is designing strategies that we hope can help investors achieve their investment goals and service our clients. And so that's really where we focus our time. And then we work with American Century to really handle the other many things that come along with managing an asset management business. So someone's got to do the finances, someone's got to do hr, legal compliance, and all of these things. And so we really tap into that existing infrastructure, which was really helpful for us to be able to come out really day one with that backing and offer strategies at a price point that we thought could be really attractive to investors. So that, that kind of helps give you a little bit about that relationship. And I'll note that American Century, if you don't know American Century well, also has a really interesting and unique ownership structure. So they are. The largest owner of American Century is actually a medical research center called the Stowers Institute for Medical Research in Kansas city. And so 40 plus percent of the profits that come from our operations across the American Century and of funds that goes directly to the institute in the form of dividends and that supports research into trying to cure and provide ways to solve meaningful diseases and trying to really help, you know, in ways beyond the investment world in that sense. So that's something that we're really proud of. But to give you a little bit more beyond, okay, that's the structure, that's how we, we operate within American Century. You ask, you know, how do we, how are we, you know, what are some of the relationships to dfa? Well, you know our cio, Eduardo Repetto, he's the CIO of Avantis Investors and some listening may know his name. He previously was the co CEO and CIO at Dimensional Fund Advisors for many years. I think he was there about 20 years. He retired back in 2017, took a few years off to take the kids to school, be with the family and that sort of a thing. And then those kids went off to college. And after being retired for a few years, he was approached by the CIO at American Century who he formerly had worked with in different capacities in the industry. And they came to Eduardo with an idea of, well, American Century has a need to offer something that can be more competitive in this world where more and more dollars are moving towards the low cost, passive world. How can we compete more in that space? And the idea from that conversation came to be, let's create Avantis Investors as a separate brand and unit of American Century investors that can offer low cost funds that are broadly diversified and can compete in that world of low cost passive investments, but offer something a little bit more, which is that opportunity to do a little bit better than the market. And so that's sort of, that's how it started. And now we're, I guess, approaching seven years in. As of last Friday, we were at about 137 billion in total assets under management around the world, managing close to 50, I think now ETFs and mutual funds around the world. So as you mentioned, it has, it has grown fast. You know, I think the value proposition that we brought to the marketplace has been of interest and people have adopted it and we've been super proud of what we've built and thankful for the support from the many clients that we have today and folks like yourself. We're certainly thankful and appreciative of, you know, the, I guess the ride we've been on. It's been fun.

B

Yeah, it's, it's a pretty wild ride. I mean, if, if you think of, first of all, avantis apparently is how you pronounce it. That's the first time I've actually heard it pronounced.

A

Well, it comes from avant garde.

B

Okay.

A

So the Latin term avant garde is, you know, continuing to move forward is what that means. So avant. This comes from avant garde.

B

Very cool. But it's growing so fast. It's now it's a huge percentage of American Century. I mean, I think the numbers I saw a while ago, it was American century is about 300 billion and Avantis was about 100 billion at the time. It might Be more than a third of it now in just seven years. This company that's been around for decades and decades. So it's pretty impressive the amount of growth there.

A

Yeah, like I said, it's been a fun ride.

B

Yeah. Now, you know, I'm sure given how many, you know, a fairly sizable number of the staff of Avantas has worked at DFA in the past and I'm sure there's all kinds of, you know, non disparagement agreements and things like that. But I have this picture in my head and I don't know how accurate it is of how this ended up happening. And maybe you can disabuse me of this notion I have of how Avantis came to be. I picture some people sitting around a table at Dimensional Fund Advisors at DFA where the model has been to offer mostly traditional mutual funds and only through advisors. And I have this image in my head of people sitting around a table going, you know, maybe we can do this without going through an advisor network, especially now that ETFs are so popular. Why don't we just offer ETF share classes for these. And I have this vision of a disagreement and half the people wanting to do that and half the people not wanting to do it and the ones who wanted to do it, leaving and forming a new company. Accurate, not accurate. How much of that is similar to what actually happened with the origin of Avantis?

A

Well, I guess, full disclosure, Jim, I wasn't in the room that you're referring to, so I didn't hear the conversation. Do you know, I think, you know, Eduardo, I work with very closely. You know, he, and you know, I was intentional in laying out, he knows the retirement, you know, he took a few years off. If you think about, you know, Eduardo, his family was in la, he was, you know, being in Austin, Texas where DFA was located and you know, he worked there 20 years and you know, that's a long time, you know, doing a lot of work and traveling back and forth between Austin and his family. And I think it was, you know, you know, what I've heard from Eduardo, hey, it was just time to, you know, go spend that time with the family when he had that opportunity. So, you know, like I said, I wasn't in that room. Who knows what conversations were had. But you know, Eduardo retired, took a few years off. And then, I think, you know, what I do know more about is that, you know, at the point at which, you know, Eduardo started thinking about Avantis, you know, well, it was now he'd spent his career in this world that we know of, factor investing and mostly operating that in mutual funds. In 2019, he had a blank sheet of paper to think about, if I could build this new, what would I do different? And I can tell you part of the. One of his stipulations and launching Avantis was that we needed to be able to offer ETFs. At that time, that was something that the ETF world was predominantly just passive index options. But that world was changing quickly. And I think he, like many others have found that there's real value in the ETF structure. And I think the timing of Ontis was such that it started at the point at which you really saw that acceleration in ETF assets. So I think Eduardo saw that that's where things were going and that's continued to be the case since then. So clearly Eduardo felt compelled and conviction and we needed to offer ETFs and we needed to be able to offer our brand of investing in an ETF structure. And so I think that that was certainly an important part of it.

B

Now, not shortly after Avantis launched DFA, magically decided to come out with ETFs available to people without. Without an advisor. How much of that do you think was due to the. To the starting of Avantis?

A

Again? Hard to say. I think. I think it was inevitable. You know, DFA launched ETFs, but they're one of many other large, like historically large mutual fund managers that have made the same decision. Capital Group, another one, American Funds, another one that has, that took that path. You know, Fidelity, all these other historically large mutual fund providers have all come to the same conclusion. So I think, you know, trying to say that that Avantis was the reason, they'd have to answer that. But I think either way, it's clear that everyone was going that route. And I think that's to the benefit of investors because we think there's real benefit and value in the ETF structure. Everyone's coming to that same conclusion, it seems.

B

Now, the first thing I usually hear about from people who have kind of accepted the merits of passive investing when they hear about fund or an investment, etf, whatever, similar to what DFA has done for years and Avantis has been doing for the last seven years, the first thing they come out with is that's active. What they're doing is active. And you're always very careful to explain that. We have a passive philosophy, but active implementation. And can you explain what that means?

A

Sure. I think that there's a few pieces to this I'd say first off we should define, well, what is passive. And if we define it, or if we define passive or index investing as tracking an index, well then anything that's not exclusively tracking an index would not fall into that camp. Right. And so I think that when you think about the world today, it's a lot less black and white than I would say it probably was many years ago. There was at one point it seemed like there was traditional stock picking active approaches and then there was funds tracking and index and neither the two shall meet. There was just this, those are the options. And I think it's now more of a spectrum and we often talk about it in sort of three camps where you have traditional passive solutions or index based solutions, where you have your security selection is done by an index provider who determines what indexes are going to be, what companies are going to be in the index. And then it's also passively implemented every so often, whether it's once a year or it's quarterly, it will be reconstituted or the holdings will change at the point of. So that's really your passive implementation. It'll just be periodically rebalanced. Then I think you have what I would call sort of the strategic beta maybe factor world kind of in the middle where there is some deviation from market cap weights and selection. And so someone's making some determination on how we will select companies. That's different than just market cap weighting, which is what I would say that first camp is typically doing just market cap weighting selection. So there's some active decisions that go into that obviously. But then they may still do that in an index implementation. So they'll still rebalance that periodically, but just the weights of the companies won't be market cap weighted. And then you have your true just fundamental active where you're, you know, you're actively picking and implementing through time. Or you can trade any day you want, you can determine what you want to have in there. For us, the way I think about it is that, well, even if you are deviating from market cap weights, why should we have to only rebalance the portfolio one time a year or four times a year? Prices and fundamentals of companies, the characteristics of companies are changing every day. So why should we really have to wait, you know, till next June to be able to rebalance the portfolio? I may be running a small value portfolio and if I have to wait till next June, it's possible I'll have a company that's a large growth company. Do I really want to hold that until next June. And that can happen. We see that with some indexes. But that doesn't mean just because you look at the companies, the prices, the characteristics every day, that you necessarily have to be. You share all the same traits as the traditional active approaches. You don't have to necessarily be really concentrated. You can still be diversified. You don't necessarily have to have really high turnover. Just because you look every day doesn't mean you have to trade every day. And so I think that's really more of where we fall of. We want to build broadly diversified portfolios like you can get in passive solutions. But we want to be thoughtful about how we change it, how we change our. What holdings we have. And we want to have the opportunity, the flexibility to look on a daily basis because we think that can add value over just waiting once a year to trade the portfolio. So there's a couple of different things going on there, but certainly there's a difference between just based, I mean, passive implementation and also passive design or constant creation of the portfolio.

B

I think probably the best place for somebody to start when they start trying to wrap their mind around this concept of a passive philosophy and active implementation, is to remember why index funds work. The reason they beat all these stock picking actively managed funds is primarily low costs. Not only do they keep their expense ratio very low, which is very interesting. You know, investing, you know, beta essentially has become free in today's world. You know, Fidelity has these zero expense ratio index funds. Even at Vanguard, you know, for a total stock Market Index ETF, I think you're paying 3 basis points is essentially free. But it's not just that low expense ratio. It's also keeping turnover low. By keeping turnover low, it makes it very tax efficient and reduces costs as well. And once you get the costs low, the hurdle for any sort of active management to get over is much, much lower.

A

Right.

B

You only have to be able to add a little bit of value to overcome your costs. And so I think a lot of people, I don't understand why index funds trounce actively managed funds. And the main reason is costs. And one of the things I've loved about particularly Avantis and as it's moved into ETFs is it's managed to keep costs low. Now it's not three basis points. I think most of your funds are more like 25 or 30 or 35. But when I first started investing at Vanguard in index funds, that's what I was paying. For index funds, it cost 20 or 25 basis points to go invest in a total stock market index fund. We'd rejoice when the ER got got cut to 18 basis points or 15 basis points, you know, and I watched it trend down over a couple of decades. But once you get the cost down to a certain point, that's not the most important thing anymore, right? Going from 8 basis points to 7 or 6 or 5 basis points doesn't matter much at that point. You got to start looking at what else is the fund doing. And so I think that's created room for somebody to come in at 20 or 25 or 30 basis points and go, well, we think there's some things we can do that adds more value than the 20 basis points this is costing. And so far, at least, I mean, it's only been seven years, right? There's a lot of evidence you guys are doing pretty well. I looked at avus the other day. I was answering a question on one of the online forums, just comparing it to vti. Both kind of hold most of the stocks in the US and the Avantis advantage, despite charging, whatever it is, 20 more basis points or whatever was 20 or 30 basis points per year over the last five years they have added more value than the cost. So it's super exciting to see it working as people were arguing it would work in 20, 19, 20, 20, 2021. But there just wasn't this long track record of showing, hey, we can, by efficiently trading, by trading patiently, maybe adding a little bit of factor investing, we can make a difference and avoid index slippage and those sorts of things we talk about when we talk about the problems with index funds. While I'm on that subject, let me ask you a question that somebody asked me and I said, I'm not sure I know the answer, but I'm talking to the Evantus folks soon and maybe they'll be able to opine on this. But they asked, well, is that outperformance primarily due to the factor investing or is it due to this, these active implementation and daily implementation and patient trading, those sorts of techniques that they started doing at DFA and obviously you've continued doing at Avantis. Which one do you think you would chalk up that sort of outperformance more to?

A

I think that when we think about outperformance, there's many things that can go into that. But when I think about what is the driver, what do we expect from our strategies that would drive the most meaningful component of outperformance over time? And it's really going to be about the exposure that you're getting relative to the benchmark. And so for any of the strategies that, any of the equity strategies that we run, different approaches and objectives and asset classes here, but really across the board, they're all designed to provide consistently higher exposure relative to their benchmarks and companies that are at the same time attractively priced with strong balance sheets and strong profits. And so when you have consistently higher exposure to those companies, and I would view these, I would talk about these as companies that are, their prices are highly discounted relative to their fundamentals. These are the companies that we expect to produce a premium over time. So if we are consistently providing greater weight to those companies, that's what we expect to drive the performance relative to just pure market cap weighted benchmarks. And if you look at the performance of our strategy since we launched back in 2019, that's going to be the significant driver. You mentioned trading and implementation. You know, I would argue that implementation always matters. You know, I think you have an ability to add some value by simply not being led to an index and being forced to track that and you know, rebalance on some periodic frequency. But when we think about the ideas of patient trading and these sorts of things, I think that is more meaningful in the mutual fund structure than it would be in the ETF structure. Because in reality with the ETF structure a lot of the rebalancing occurs in kind. So it's really when you have new shares being created and redeemed of an etf, securities are being brought into the portfolio or passed out of the portfolio in kind, which doesn't require the manager to go out onto the market and trade them. So I think that that's really a concept that had greater importance historically when mutual funds were more dominant than I think in today's world where we're talking about ETFs.

B

So it sounds like you attribute it more to the factor issues, the profitability factor, the value factor, the small factor, size factor, whatever you want to call it, producing that outperformance. Because if you look at it, if you pull it up, you pull a VUS up against VTI on Morningstar, you'll see on their nine box thing, you'll see it's a little smaller, a little more valuey and obviously the performance has been quite good. It's not that easy to beat an index fund. If you look at the long term data over 20 years and of course this is pre tax data, but that data over 20 years, is it only something like 5% of actively managed Funds beat an index fund. So it's no small feat to have done this over over five years, even if it's only by 20 or 30 basis points. It's impressive to me, having looked at a lot of this over the decades. It is impressive outperformance to me and makes me start going, maybe I ought to think about that. But where I've actually implemented used Avantis funds in my portfolio is in I tilt my portfolio toward primarily small and value factors. And so I've used avuv, which is the US Small Value Index etf, and avdv, which is the International Small Value etf. And I've used those as significant components of my portfolio. So what I'd like to talk to you a little bit about is about this concept of factor investing and this decision that an investor, whether they're a do it yourself investor or whether they're working with an advisor, has to make a decision, am I going to tilt my portfolio toward these factors? Whether it's small or value or profitability or momentum or whatever the factor is, am I going to. And what do you think somebody should think about when they're deciding whether or not to tilt their portfolio?

A

I think there's a few questions that I would ask. I think first is how comfortable are you with deviating from the market portfolio itself? So as you mentioned, you got BTI out there. If you think about the US Stock market, whether you take the S and P or what VTI is tracking, crisp US market Russell 3000. Those indexes will ballpark it at around 10% per year over time. That's not a bad outcome for investors. It's a pretty good starting point. You're getting a broadly diversified portfolio of stocks that has performed and provided pretty good growth for investors over time. And so I think you have to ask yourself, how comfortable am I with deviating from that and accepting that my performance will not match what I read on the Wall Street Journal every morning.

B

The classic tracking error.

A

Exactly. And I was intentionally dancing around the term tracking. Eric, I know not everyone, and maybe your audience is more familiar, but some don't know what that means. But in simple terms, we're just saying the tracking error is just a fancy way of measuring how different does your portfolio perform through time, how much does it track away from a benchmark or an index through time. So higher tracking error just means you're getting away from it more through time. You should expect more volatility in your return relative to the market return. I think that's an important concept that people have to be, you know, thinking about, you know, if I say, well, if I'm going to deviate from the market and I find out one year I underperform, underperform the S&P by 4, 4 or 5% in one year, am I comfortable with that? You know, and, and I think, I think that first and foremost we have to understand that question. Am I comfortable? The second question I would ask is, well, what am I going to overweight or what am I going to tilt towards? And do I have a good belief system around why I should expect that to continue to provide outperformance or some value in the future? Because I think that when we think about, I think we should get more into the idea of more talk more into the concept of factors and kind of how we think about it. But I think what you're then getting to is if you can, if you have an area of the market or some exposure that you want to put more weight into, then it's a question of, okay, am I comfortable with how different that's going to make my returns through time? Obviously, I mean, most people are going to do that with the goal of about value over time, but also recognizing that there will be periods anytime you deviate from the market, there will be periods that you do better and there'll be periods that you do worse. And so you have to have a strong belief system in what you are pursuing so that you can stick with it through the periods where it doesn't do as well as you want with the hope that it will be there more often than not to provide value over the long term. And so then that starts to get into the question of, okay, well, how much do I do it? And just recognize that the more you tilt away from the market, the more tracking error you will get. It's a trade off. You know, you can pursue greater and greater levels of outperformance on expectation relative to the market, but that will result in more and more tracking error relative to the market. So I often get asked, you know, what's the right amount of tilt? And there's the answer is it all comes down to you and what is your goal? What's your time horizon? You know, how much do you need the money over a certain period of time? Are we working with excess cash that, you know, you can manage more tracking error? All those things have to kind of weigh into how you come to those decisions. But that's kind of the framework I would start with. If you're going to deviate from the market, have a good belief system so that you can stick with it through time. Understand your tolerance for tracking errors so you can get a better sense of how much tilting you can be comfortable with over the long term.

B

And I think this is a big deal because we talk about personal finance, right? And it's 90% personal and 10% finance, you know, 90% behavior and 10% math. Tracking error is when you're at that cocktail party and somebody talks about how well their portfolio did because so much of it is invested in the mag 7. And you realize that your small and value stocks have been underperforming the market for the last 15 years.

A

Right.

B

I mean, my tilt that I've had in my portfolio for the last 15 years toward the small and value factors has resulted in me having less money, you know, because large growth stocks have had this, you know, historically incredible run the last, you know, 10 or 15 years. So I've always told people, when they ask how much should I tilt? I tell them, do not tilt more than you believe. You know, if you don't believe that these, you know, that these factors are real and that they will pay off in the long term, you don't want to have a very big tilt because the long term can be an awfully long time. This is a bit of a lifelong commitment to a portfolio because it might be 40 years for this sort of a tilt to pay off. And of course, we have limited data in the past. There's no guarantee the future will resemble the past. So I think you really do have to be a believer, for lack of a better term, to have a significant tilt in your portfolio and be able to stick with it through periods of underperformance that can be at least as long as 15 years. Right now, I think small in value is outperforming large in growth this year, but that hasn't been the case for most of the last 15 years.

A

Yeah, and I think the belief part that we're talking about right now is really important because I think when you think about factors, the reality is there's. I mean, there's a paper that documented more than 400 different factors with some statistical significant pattern in the historical data. I mean, there's tons of tons. I mean, there's just tons of patterns in the data that have existed historically. I mean, some of them are, you know, kind of just correlated to other ones. You know, some of them are maybe more for hedging, aren't really there to produce outperformance. And there's a lot of noise that's out there. So we have to have some reason that we should believe and expect it to provide outperformance in the future. You can even take small cap, as you mentioned, as a good example. I guess the small cap factor was really first, I guess formalized in a paper in 81 by Ralph Bonds. But then if you look at how small cap has performed since then, there's really not a statistically significant outcome for small cap outperforming large cap since that period of time. And so you have to ask yourself, well, what's the rationale? What's the logic? Why should we expect small cap stocks to outperform large caps? Why should I expect that in the future? And this is an area where we differ from what I would call the traditional fact world. When I think about small cap, all it's looking at is just market capitalization, just looking at the price. And if all you know about a company is its price and its market cap, why should you expect it to outperform some other company just because that other company is larger? And this is where we, I think, deviate or we provide some a different point of view of that. Well, even with small caps, we probably want to look at the company, we probably want to understand its fundamentals. You know, is it making money? You know, is it not making money? Does it have significant liabilities or does it have a strong balance sheet? We think those things probably matter even in the small cap space if we want to find companies that should provide a premium over the market over time. So that theory matters. And we think it should all link back to valuation evaluation framework so that we not just have a pattern historically, we have a good reason for why we expect it should occur in the future.

B

Now I've often heard, and probably repeated a fair amount of times that there's really two kind of cases for small and value outperformance, one of which is a risk story. They're riskier companies, they're smaller companies, they have fewer products, their moat is not as wide, et cetera. And the other story is a behavioral story because people want to own the nvidias of the world and so they tend to shy away from stocks that nobody's heard of because it's not cool to own them. If you had to decide how much weight to put on both of those stories for why you would expect outperformance of these sorts of factor investing type companies, which one would you put more weight on? Do you think it's more of a behavioral aspect or do you think it's more of a risk story that's hard

A

to answer on its own because I think it also, we have to come back to, well, where do we think that the premiums actually exist? Like, when I think about small caps, I struggle to find a great story for small caps on its own because I think that that factor just doesn't give you enough information in our view. We do think you can find out performance in the small cap space. We just think you have to also look at the companies. I mean, you mentioned a strategy that you use of ours, which is a small cap strategy that specifically focuses on companies with attractive prices, good balance sheets, and good profits in the small cap space. And we've seen those companies in the small cap space provide strong outperformance. Now, that's a premium that I believe in. I believe that if we find good quality companies at good prices, that's a good thing. The market's discounting those companies. So we would say that those are companies with high discount rates and those are companies that are highly discounted and that we should expect a premium for that. Now, exactly why the performance, why that premium is there? I'm in the camp of we may never really know. We can make these stories. And I think that there's a reality here that investors often want to have. They need a story. They need to know why. They need to know why. And I can't really tell you. So the way that I think about it is that, well, if I can find companies whose price is highly discounted to their fundamentals, to their balance sheet, to their earnings, then the market is telling me that that company is highly discounted and has a high discount rate and it should have strong outperformance. We can link that back to evaluation, equation, evaluation framework. I can't tell you why that company is highly discounted. It could be for any number of reasons. Maybe people have, you know, someone, maybe some people have more uncertainty or feel more risk about something. You know, it could be any number of things. It could be other tastes and preferences. You know, maybe, you know, people are buying something else because they prefer something else or they're buying something else because they need that to hedge. There can be all these different reasons that's really hard to nail down. And so where we gain our confidence is that, well, if we have a good theoretical framework that makes sense logically. But then we also see that in the historical data those patterns have shown up in the returns, that gives us a lot more confidence that we expect to be going forward. And I know, I didn't answer your question directly, Jim, because I just don't frankly know why it would be a risk story, a behavioral story. It could be some combination of all of it. Who really knows for sure? But I give you the way we think about it, which is a little bit different.

B

Yeah. Obviously I don't know the answer either. Right. So. And they're probably. Nobody knows the answer, but it's interesting to think about and talk about. Okay, let's talk a little bit. I mean, I think people understand size as a factor, right. It's market capitalization. It's very easy to understand. For the most part, I think people understand value as a factor, whether you're measuring it with a price to earnings ratio or price to book ratio or dividend yield or whatever. I think people understand value. I think it's harder for people to wrap their mind around the concept of quality as a factor, around the concept of profitability as a factor. Can you explain a little more about those factors and how they're incorporated into funds like AVUV and avdv?

A

So the way I think it, what we think about this is that we really don't think about the factors themselves. You know, I think that there's a. There's a large community. You know, I spent a lot of my career as well, you know, in what I call really factor focused approaches and mindset. But I think that there are shortcomings to the factor being too wed to the factors themselves. And I'll give you some examples, and then I'll get into how we think about it. Specifically, if we think about the value factor, the most common way of thinking about it comes from the Fama French research. And that factor is really focused on companies with low prices to their book equity. So you've got a price and you've got some information about their assets and liabilities that come from the balance sheet. In that scenario, we've said nothing about profitability. We're only looking at the price and the book equity. We've ignored profits. And what we find is that, well, when we do that, we find companies that are cheap, they have low prices, but many of them actually are probably cheap, not because they necessarily are discounted and should have a high expected return. It's because they don't make any money. They might have net operating losses, but we didn't look at profits so far. In the value factor, we've only looked at the price, and we've looked at the balance sheet data. They might have really high liabilities. They might have a low price and be viewed as a value stock to the factor world for reasons that aren't really linked to what we would say is they shouldn't have expected outperformance. They don't have a high discount rate. But that's what the value factor in

B

the traditional sense of maybe they're a value stock because they're on their way to bankruptcy is what you're saying.

A

That's right. They sometimes I call it as well, they're cheap, but they're cheap for a reason. They're not cheap. And it's not that I should expect them to provide a premium to me as an investor. Now, profitability, that factor is, you know, also from the fama French definition of it, is really just looking for companies with high operating profits. There's companies that have outperformed companies with low operating profits, and that factor runs into similar challenges. You know, now I'm looking at profitability, so I'm looking at a relative measure of profits, but it's profits to book equity. So now what have we left out? Well, now we've left out price. We don't know anything about the price at that point. So now we might just be buying companies that are great businesses, really high quality earnings and profits, but we might just be paying extraordinarily high prices for them. So now we're missing information as well. And that's actually the reality. We tend to see companies that are low price to book in the traditional value sense tend to have lower levels of profits. Companies that have really high profits tend to have higher price levels. Now, what we would contend is that if we get too focused on the factor itself and I say, just give me a value factor portfolio, well, now I'm going to get a lot of low profitability companies. If I say give me a high profitability or quality portfolio, I'm going to end up with a lot of expensive, highly valued companies. And so what we say is that, well, why do we have to keep these things separated? We really shouldn't. In our view, we need to look at this more comprehensively if we want to find companies that are highly discounted and that should provide a strong premium. And these are going to be the types of companies I'm going to talk about are being the types of companies that are overweight in our strategies are going to be companies that at the same time have attractive prices, strong balance sheets, and also strong profits. So in simple terms, if I can get companies that have attractive valuations and at the same time strong profits, now I'M finding companies that have a discounted price relative to a more comprehensive view of their fundamentals. So I can avoid overweighting these companies that are cheap but aren't making any money. What we see in our data is those companies historically perform a lot like the market and don't provide a premium to the market. So we don't expect them to provide outperformance. But you get a lot of that in the traditional value factor approaches. And we can avoid the companies that are highly profitable but really expensive. Again, those companies have historically returned kind of like the market, not a premium on expectation. And so really what I think what we have done is said we learned a lot from the factor world, but we're evolving that and saying we need to look at companies more comprehensively. And so I'm less worried about factors and I'm more focused on premiums. What are the companies that give me higher expected returns? I don't care about the factor. We learned from the factors. But what I really care about are what are the companies that are prices highly discounted to those fundamental characteristics linked to the valuation framework that can give me higher expected returns. So I think that's an important concept and that gets into a lot Jim around what we do would just differ from a value factor approach or a profitability factor approach.

B

It's interesting. It makes a lot of sense to blend those together and hopefully getting the best of both worlds by doing so. Okay, so there's a listener out there that's been kind of a total market investor up until this point and they've become convinced that, okay, maybe there's something to this factor investing thing. I'm going to go ahead and tilt my portfolio, overweight some of these factors and I think I'm going to do it with such and such percentage of the portfolio. Now how do they choose? Right, they can go to Vanguard and buy a small value fund. They can go to Avantis, they can go to dfa, they can go to I shares. You know what, how do they choose which fund to use to get this tilt?

A

So I think this is a really interesting question because there's some things here that I think a lot of folks fail to recognize about some of the index options that are out there. So let's think about if we were to say just buy the total market. You can buy a total market US market index fund from Vanguard or from iShares and they're going to look pretty similar. They're each market cap weighted portfolio is buying really every stock there's not really any selection that's happening, right? Just give me all the companies. Once we go into say small value now there's an active element of even the index world in my view. Someone has to decide what companies are going to go into that val, that small value index. So if it's Vanguard or iShares, it's going to be decided by whichever index the index provider for whatever index they're tracking, whether it's Russell or Crisp or what have you, they are all going to have to make decisions on well, what is small cap and what is value. And as it turns out, they're all making some different decisions on that. And so interestingly, if you look at the exposure that you get between these different small value index funds from different providers that can vary, the rebalancing frequency of those can vary, and critically and importantly, the performance that you get from those will vary in some cases more than you might think. Even in large value, we've seen return differences in a single calendar year between different large value indexes of 13% in a single year. In the small value space we've seen almost 20% difference in a single year. And so I also want to urge people to not just assume that the option is give me the style passive index fund option or someone who frames it more as a factor option, who's maybe not implementing so passively and you know, not not linked to an index or so I mean there's, there's different options but even the truly index tracking options can be more different than you might think. And so what I would urge anyone to do is to not just look for the name, look beyond the label, not just look at well, is it passive or is it active? We need to look under the hood and really understand, okay, what exposure am I getting? Is it giving me the exposure that I'm really interested in having an overweight too? Now when I think about small value, while there are differences in how these different indexes are constructed, what we tend to observe from most of the value index options is they run into that shortcoming that I talked about earlier where you will get a lot of low price to book companies, but many of them will be low profit. So you will also get a tilt to low profit when you buy a small value index type solution. I would argue that that is also true of much of the factor approaches or the strategic beta approaches because even the factor itself in the research is just low price to book and so it tends to bias you towards low profits. And so I think where we will be different in that world and the small value world or any of the value worlds is what you will find from us are portfolios that are similarly attractively priced in terms of their price to book or book to market ratios, but on average at much higher levels of profitability. So you're buying similar, on average similarly priced companies, but that on average have higher levels of profits. And so I think if you believe like I do, that that approach can add value over time relative to the value index options that are out there, well then I think that that can be attractive. Beyond that, if you're, you know, if you're just looking at the passive approaches, well, versus the factor approaches that I would still argue don't just look at cost, also look at what is the actual exposure I'm getting because it can vary widely even when they're all the same name and label.

B

Yeah, it's. So I think your argument to sum it up is, you know, if you're choosing a small value fund, whether and trying to choose it from, you know, various companies that offer these sorts of funds and that are, well run low cost funds, you would say look for one that not only incorporates, you know, a value, you know, a value factor in there, but also a profitability factor. I think is, is your argument, is that, is that fair to sum that up?

A

I think that's fair. My basic argument is that, you know, if you want to have a lot of cheap companies that exposure to a lot of cheap companies that don't make a lot, don't make much money, well, there are ways to do that. That's what a lot of the options that are out there today. But if your goal is to provide, to get higher returns over time and pursue higher expected returns, a premium that's supported good theoretically and empirically, well then I would argue you want to look for that combination of exposure to attractive prices but also strong profits.

B

Now I think as people dive into this and they'll probably come to a similar conclusion like I have. If you're looking for companies that do this at relatively low cost, not the very low cost, but low cost, and you want somebody that looks at both a value type variable there as well as a profitability type variable, they're going to end up looking at Avantis and they're going to end up looking at dfa. And I confess, I use both funds, right? I need a tax loss harvesting partner because I'm investing in these in a taxable account. So I need two funds for each of these asset classes and I actually use them Both. What differences do you see between Avantis and dfa?

A

I mean, I think we've been circling around it for a lot of the conversation, Jim. I mean I think we don't hold ourselves out to have the same factor focus. You know, we're really focused on finding companies that are, that are highly discounted and so we think about value specifically differently. You know, I think over time it's felt like value driven through the factor world has been, you know, it kind of synonymous with just finding cheap companies. And when we think about value, you know, it really should be getting the most you can for what you pay is value. Right. So you know, analogy that we often use is that you know, if you want some sushi, you want cheap sushi and I take you to 7 11. You know, you might not be that thrilled with it. You know, it's, you're, you're probably going to get what you pay for, it's cheap, probably not going to be very good. And so I asked, you know, you know, would you, would you think you're getting value from that versus our team at Avantis is in la, kind of near an area where there's a lot of good Japanese food and there's a lot of good sushi there. I mean there's a guy who runs a little sushi shop there, 10 seats, he's got great prices and it's good, authentic quality Japanese food. For me that's value relative to going to 7:11. Again, sushi. If I can get something that's just a little bit higher price but I get a much better quality to it, well now I'm getting a better value. And so what we're arguing is largely just thinking about value differently, that it can't just be looking for low price to book cheap companies. We have to look more holistically and that's going to, that concept of thinking about value differently, you'll see that really play out across any of our funds. I'd say relative to dfa, as you mentioned, or relative to even or the value type index, asset class indexes that are out there, that's going to be relatively consistent of we're thinking about value differently, which is going to mean we're not just looking for the cheap companies, we're looking for companies that are highly discounted are going to give us the most for the price that we pay. So I think you'll see that play out. If you look at the characteristics of an Avanta's value strategy versus any of these other value type approaches, you're talking about, you'll find similar levels of similar valuation metrics like price to book, but on average higher levels of profitability. Which just means, hey, we're getting more of the companies that we think provide good value versus just the ones that are cheap. I think that's the easiest way to think about it. So it's an evolution of it. Let's look at these things more comprehensively, be less wed to these factors in isolation and think about companies more holistically to get to the ones that we think are really discounted and should add value.

B

Do I understand that you now have traditional mutual funds as well, not just ETFs?

A

We do. So we've had mutual funds from day one, actually. So when we launched our original, we launched five strategies initially back in 2019 and each of those were offered in both an ETF and a mutual fund.

B

Were they different share classes of the same fund? You know, Allah, the Vanguard patent that's now expired?

A

No, they are not. They are independent funds, totally separate. So they're the same strategy, same price point. But we, you have the option to, to invest in that, in an ETF or invest that in a mutual fund. I would say in, in practice, what we've seen is I've looked at the numbers really recently, but the last time I looked at it it was probably, you know, about nine out of, you know, nine out of every $10 that have come through the door would have gone into the ETFs versus the mutual funds. But we still think there's a role for the mutual funds, particularly in the retirement space where many plans, the record keepers, don't have the ability to keep ETFs. And so we think that there's a place for those mutual funds. But there are far more dollars going into the ETFs across the industry than the mutual funds. And we've seen that sort of reflected back in our own offering.

B

Yeah, it's pretty impressive. I mean the company's seven years old, it's the fourth largest ETF company by the amount of dollars invested, which is pretty darn impressive, I think. Okay, well, our time is getting short. It's probably going to be listened to 25 or 30 or 35,000 high income professionals, most of them doctors. What have we not talked about today that you feel like they ought to know about investing?

A

Oh man, that's a great question. What I often talk to folks about and I speak with a lot of advisors and I think there are many people that spend a lot of time tinkering with portfolios and trying to find the perfect mix of all these different funds that they like. And I urge people to really just focus in on the core investment principles that matter to them. When I think about it, ideally, I want to build lower cost portfolios. I want to embrace diversification, I want to embrace a long term view. And if you can then tailor that portfolio to bring in the tilts that we talked about earlier, that where you have that belief in, like we do, building that portfolio that really suits your goals in terms of the level of tilt you're comfortable with, the level of tracking error you're looking to get. Building that in a simple way and holding that and sticking with something like that, something that you can stick with for the long term. I think that sets up people for good long term outcomes in my view. And so I think just, I always try to reinforce kind of those basic principles and I think they're important to keep in mind for anyone. There's no perfect portfolio, but we can build pretty darn good ones. And then if we manage our own behavior and give ourselves an opportunity for success, there's a good chance folks can have good outcomes over the long term.

B

Yeah, that's great advice. At the end of the day, we love to talk about the intricacies and get into the weeds on the differences between one fund and another. But at the end of the day, it's how much money you put in the account and whether you can stick with your plan long term matters far more than the exact details of the plan. Well said. We've been talking with Jeremy Thornton, cfa. He is a Vice president and the Senior Investment Director at Avantis. And we thank you so much, Jeremy, for your time.

A

That is great to be here. Really appreciate the opportunity.

B

All right. I hope you enjoyed that interview. That was a lot of fun for me. You know, a lot of those are questions I've wanted to ask him for a while. And you know, in a public setting like this podcast, I don't know that I get all the dirty details. I wanted to hear about, you know, how DFA and Avantis are related. And, you know, there's so many people that work at Avantis now that used to work at dfa. I figured there's probably a lot of stories there, but I think unless you work at one of the first, you're probably not going to ever hear all of the details of what appears to be a little bit of a breakup in the industry. Maybe it's just two totally separate companies, but they certainly work similarly when it comes to managing the investments, but fascinating conversation for me to have, so I hope you enjoyed coming along for the ride. One of the fun things about having a popular podcast is that I can get guests on here that I want to talk to and it's a large enough audience thanks to you and we appreciate you being here that they're willing to come on and talk to me. So I thank you for that and hope that makes for more interesting content for you to listen to as well. This episode was brought to you by KeyBank, one of the nation's largest full service banks offering banking, lending and financial solutions for healthcare professionals at every stage of their career. Key's suite of services includes student loan guidance and financial education tools to help clients find and financial peace of mind. To learn more for terms and conditions, please visit whitecoatinvestor.com KeyBank all right, don't forget about the scholarship. If you want to apply for the scholarship that includes first years that are starting school this fall, go to whitecoatinvestor.com scholarship. You got to be in good standing. You got to be enrolled full time. It has to be a brick and mortar institution. If your school is all online, you don't qualify. But we'd love to give you a chance to win. Cash directly reduces your indebtedness. That's the whole point of the White Coat Investor Scholarship is to help reduce your debt to go through school, your cost to go through school, while also promoting financial literacy among your peers and giving us a chance to pay back a community that has given us so much. If you're willing to judge, please email scholarshipinvestor.com and you can choose the winners. None of the staff here at White Coat Investor choose the winners for this scholarship. Scholarship. It's all our community, our audience that does the selection of the winners. So we need you to volunteer to help out. It's not that hard. You'll just have to read a few essays in September. But email scholarshiphicoatinvestor.com to volunteer today. Thanks for leaving a five star review. It helps spread the word about the podcast. Trustworthy Advice Good to see trustworthy advice exists. Been following for a while now. Any conflicts of interest are clearly disclosed. You can get this advice elsewhere via books, blogs, et cetera. But it's compiled in an easy to digest format so no need to scour the Internet, et cetera. Keep up the good work. Five stars. Appreciate that review. You know, the longer I do this, the more inspired I am by what you're doing in your lives. I love hearing about your financial successes, but most importantly, I love hearing about what that financial success allows you to do. I got an email back from somebody that's actually one of my partners, although it's like 450 people in the partnership. I don't actually know the doc personally, but he told me about what what learning about WCI early in his career meant for him, what it had allowed him to do. At this point, he was in his mid, late 40s and was able to leave medicine if he needed to, but he's been able to cut back, he's been able to coach his kids teams, he's been able to get into the music scene, he's been able to do all this stuff. And it's really cool to see not just the people can be financially successful, but what that success allows them to do not only in their own lives and boosting their own wellness, but also in the lives of other people. So I congratulate each and every one of you for the steps you've taken so far to make yourselves a little bit more financially stable, a little more financially successful and promises you, as you continue to pay some attention to this aspect of your life, that it will pay great dividends and be very worthwhile future you. Thanks you for what you're doing. Keep your head up, your shoulders back. You've got this. The whole White Coat Investor community is here to help you. See you next time on the podcast.

A

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