The transcript from this week’s MIB: Chris Brightman, Research Affiliates’ CIO, is below.
You can stream/download the full conversation, including the podcast extras on Apple iTunes, Bloomberg, Spotify, Google Podcasts, Overcast, and Stitcher. All of our earlier podcasts on your favorite host sites can be found here.
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This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
ANNOUNCER: You’re listening to Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have a special guest, and his name is Chris Brightman he is the chief investment officer of Research Affiliates better known as RAFI, the farm which is one of the prime drivers behind the trend toward smart beta or fundamental indexing as it is more accurately called, we go off into the weeds about portfolio construction, what drives returns, what are the best ways to approach constructing a portfolio.
Research Affiliates, their models run about $200 billion worth of offerings, this is quite a fascinating conversation and I think you’ll find it very intriguing, so with no further ado, my conversation with Chris Brightman of Research Affiliates.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My special guest today is Chris Brightman, he is the chief investment officer of Research Affiliates whose investment strategies currently manage over $200 billion. He previously he was the board chair at the investment fund for Foundations, he was the CIO of the Strategic Investment Group and director of global equity strategy at UBS Asset Management, Chris Brightman, welcome to Bloomberg.
CHRIS BRIGHTMAN, CHIEF INVESTMENT OFFICER, RESEARCH AFFILIATES: Thank you for having me.
RITHOLTZ: So that’s a really interesting resume. You’ve worked at some very storied places, what first attracted you to the field of investment management?
BRIGHTMAN: I arrived at my University Virginia Tech having been accepted into the liberal arts school and after listening to the Dean of the liberal arts school address the auditorium of new students explaining why you’d made the right choice, I approached the podium and said I think I’m in the wrong place, I want to go to the school of business and without missing a beat or even seeming to notice the irony, the dean said, oh yes, well, you walk down three buildings over that way and I changed before I even began classes to the business program mostly because I figured you have to understand this is the 70s, I wanted a job when I graduated and I felt like majoring in business would be more likely to lead to a job then that liberal arts.
I don’t know if that was right but that so that’s what I did and then I chose …
RITHOLTZ: Well, it clearly worked right?
BRIGHTMAN: Yes, and finance because it was the more interesting than accounting.
RITHOLTZ: And for some of our younger listeners the 1970s was a period of stagflation, high inflation, and high unemployment, what was it like coming out of school into that environment?
BRIGHTMAN: I graduated in the early 80s and the early 80s were an awful time, there was a nasty recession and I was really lucky …
RITHOLTZ: Double dip recession actually right?
BRIGHTMAN: Yes.
RITHOLTZ: ’80 – ’82.
BRIGHTMAN: ’82 was horrible, ’83 was a little better and I was lucky to have graduated in ’83, ’84 and ’85 was boom times …
RITHOLTZ: Right.
BRIGHTMAN: It was great but I graduated in ’83 and the what I think really got me into the investment management industry was an internship that I had with for Chicago in 1982 over the summer, and my internship was with the institutional trust department at First Chicago which later became First Chicago Investment Advisers which later became Brinson Partners and Gary Brinson the founder of Brinson Partners was really my first mentor in the business beginning in 1982.
RITHOLTZ: So you were working on the endowment side of the street, how does the endowment side differ from working with retail investors and people whose money is with 401(k)s and IRIS, et cetera?
BRIGHTMAN: I had about a 3 1/2 decade career, 35 years in the business of which I took a rather brief five-year detour into the nonprofit area managing the University of Virginia endowment, and it differs in a number of ways probably the most interesting to an outsider is the access that one gains to elite investment managers.
RITHOLTZ: How big was the endowment at the time?
BRIGHTMAN: Over 5 billion.
RITHOLTZ: Okay so that’s real money.
BRIGHTMAN: I think it interestingly though it’s less challenging, it’s an easier job.
RITHOLTZ: I’m so surprised you say that and maybe this is me projecting but I would imagine that running an endowment and in my frame of reference is all the craziness we’ve seen with the Harvard endowment over the past 20 years and what recently happened with the Yale endowment and Swanson, I would imagine there are so many political constituencies to deal with.
You were the CIO at the Virginia University of Virginia endowment, and that covered what school or schools?
BRIGHTMAN: UVA.
RITHOLTZ: That is just one endowment, $5 billion.
BRIGHTMAN: Actually fascinatingly enough, it’s much more complicated than that. The University of Virginia has dozens of nonprofit organizations all of whom have their own fundraising staff their own endowments, and the University of Virginia investment management company, a 501(3C) nonprofit operation with its own board, and its own audit, its own charter etc. serves as an investment advisor to those various pools of money.
So in many ways while I was there, I did have to address many different clients and it is very political, you’re quite correct about that.
RITHOLTZ: Do they all invest the same way or does each of them have a different investment philosophy and a difference set of goals and therefore a different portfolio look?
BRIGHTMAN: UVIMCO, The University of Virginia Investment Management Company pools the money and invests it in one of fashion. That said, all of the different pools of money don’t have to invest with the University of Virginia Investment Management Company, they can if they choose or they cannot or they can invest part of the money.
F or many years, the law school wasn’t convinced that it wanted all of its money in the in the pool, so just a part of the law school endowment was invested in UVIMCO.
RITHOLTZ: So I would imagine that investing on behalf of endowment today is even more challenging and complex given everything we’ve seen with socially responsible investing, low carbon, pick your poison I can imagine that’s what I meant by the constituencies because when I what you are about the same age, when I was in college, I remember divestment from apartheid and people wanted to pull money away South Africa, I can’t imagine what it’s like today in the college atmosphere, it seems to be everybody is much more sensitive to specific causes than perhaps when you and I went to school.
BRIGHTMAN: It was – that was present when I was there, I don’t know that it — I really can’t say whether it’s gotten better or worse, you brought up the interesting example of the Harvard Management Company of Jack Meyer, truly a great the investor, was essentially chased out by the alumni who thought it was obscene that the investment managers were at the Harvard Management Company were compensated as they were the and that’s probably the highest profile political snafu, but it’s by no means limited, I recall UTIMCO, University of Texas Investment Management Company reneging on their incentive compensation plan that they had promised their staff.
RITHOLTZ: Really? That would beget litigation at least the…
BRIGHTMAN: No, the staff, they were very high integrity people, they just sucked it up and took the hit to their compensation…
RITHOLTZ: Really?
BRIGHTMAN: Continued on.
RITHOLTZ: See, I think you encourage bad behavior when you allow people to not honor the written contract, so I don’t want to be that moral hazard is a problem for me.
BRIGHTMAN: But when I said, getting back to what I said, I think it’s a little less challenging, the job is very straightforward, you understand who is the beneficiary of the assets being managed, you understand what the objective is and you have a very clear notion that I’m investing for the University to generate funds to pay scholarships, to advance research, to support the universities’ general mission, and you’re not competing every day for a fickle group of clients and investors.
The for-profit investment management industry where I spent 30 years as opposed to five years, you have all of the same complexities and difficulties and challenges of investing which makes the job so fun and interesting but the whole additional layer of complexity of competing in the business of the investment management industry.
RITHOLTZ: My special guest today is Chris Brightman, he is the chief investment officer of Research Affiliates whose strategies run about $170 billion in assets.
Let’s talk a little about smart beta which is really a phrase Research Affiliates founder Rob Arnott is credited with if not inventing, well certainly, publicizing, tell us what smart beta is and why investors should be thinking about it.
BRIGHTMAN: Well, smart beta is a fun and provocative label for a substantial and important evolution in the investment management industry. We are able today to take well researched and well understood principles of investment management and use that information to create simple, transparent, low-cost investment strategies that deliver more of the return to the end investor and consume less of the return in the fees and expenses charged to a typical active manager.
RITHOLTZ: So here’s the pushback that that the there’s a group of folks who look at smart beta and say well it’s going to be little more expensive than just straight up indexing up until the fourth quarter anyway, the S&P 500, a market cap-weighted index has been on all legendary streak from the lows in ’09 until let’s call it September 2018, that’s a solid decade, the market effectively triples, why should an investor go with a fundamental weighted index as opposed to a market cap-weighted index like the S&P 500?
BRIGHTMAN: That’s a great question and it depends, I believe, on what an investor is trying to achieve.
The advice given by many, for example one of my heroes, Jack Bogle from Vanguard that most investors would be better off investing in a very simple portfolio of mutual funds that track capitalization-weighted indices and do nothing else would be far better off if we look at what investors actually do when there’s considerable research on the subject.
They tend to chase fads, chase performance, and generate returns that are approximately 2 percent per year below simple cap-weighted indices, before high fees and expenses, they do that bad, that’s what the typical individual investor does and Jack Bogle is quite right that they would be far better off simply having a completely passive investment in low-cost capitalization-weighted index funds.
However there are people on the other side of that trade where does that 2 percent go to the did some investors are underperforming the market, somebody else has to be outperforming the market.
RITHOLTZ: Zero-sum game, for every loser that is a winner and vice versa.
BRIGHTMAN: Correct and we know where it goes it goes to the rebalancers, the people that are selling the market what the market wants to buy when the market wants to buy it and buying from the market what the market wants to sell when the market wants to sell it in the fundamental index is a simple elegant way of automatically pursuing that contrarian trading approach of rebalancing against the market.
RITHOLTZ: So that’s very much a value driven strategy, you’re selling what everybody wants which probably means it’s pricey and it’s had a good run and you’re buying what everybody hates which means it’s probably cheap because it’s so disliked, fair statement?
It’s exactly correct and the market has to pay a premium for that rebalancing thinking of it as market-making or being the house providing insurance in order for the market to clear, there has to be that premium.
Now it’s easy to say and it’s straightforward to do but it’s not easy to do, it’s not easy emotionally to do and that’s why having simple transparent rules-based process aids in that kind of rebalancing, and those investors to earn a return over the market but unless you understand and unless you can stick with the approach, it’s probably not right for you.
RITHOLTZ: So let me let me jump in here because I want to address that unless you can withstand, unless you can stay with it, value goes through these periodic cycles where it’s underperforming the broad indices and up until September of 2018, what was it, a decade of underperformance by value overgrowth, that seem to have begun to reverse in the fourth quarter. So first question is the underperformance period of value always seeing that regression to the mean where value is to catch up and pass growth, how do you see the current environment for value given the long-term underperformance?
And by the way, on a regular basis value will lag growth and then catch up and pass it, we’ve seen it in every bear market what all the hot stocks get crushed, value blows right by it how, may times have we heard Warren Buffett is washed up and it all but never turns out to be through.
BRIGHTMAN: I think you said it well, over the long run, history teaches that a value investment strategy outperforms growth that’s been confirmed in every long-term study of every market around the world. However the market will test your patience, there will be long and difficult periods of underperformance for a value strategy and only by sticking with it over the long run out will you actually succeed. If you throw in the towel in 1998 to 1999 and buy AOL and Cisco…
RITHOLTZ: As a lot of folks did.
BRIGHTMAN: Right.
RITHOLTZ: To their great regret.
BRIGHTMAN: What I can say is that the dispersion between the pricing of value and growth stocks reached in the last year or two extremes that we almost never see, not quite to the extreme of the tech bubble but about as significant as we see, that’s perhaps an indicator that the cycles about to turn and of course we’ve seen a lot of market turmoil suggestive of an inflection point.
So I wouldn’t confidently predict that the cycle has turned and value is going to go on a long tear of outperformance, but the environment does seem to suggest that that’s a distinct possibility.
RITHOLTZ: And last smart beta question, some folks have said the advantage of smart beta and fundamental indexing is that the outperformance comes from taking additional risk.
Burton Malkiel, other folks like that have said that, what were your thoughts on that. I find the debate about whether factor returns and of course the most, the largest most persistent and the longest discovered factor is value, are generated by risk or generated by behavior and in efficiency. The truth of the matter is it’s both, they are intertwined, there is feedback, the real world is much more interesting than these dry theories and models and I guess I would say there is a risk component and we should be thankful that there is a risk component to the value factor return because it means that it can’t to be and won’t be arbitraged away.
RITHOLTZ: So let’s talk a little about institutional and retail investors, you’ve worked with both, you’ve alluded that there are some differences previously, what is the most consequential difference between how institutional investors operate and how mom-and-pop retail investors think?
BRIGHTMAN: Institutional investors operate in a governance structure and an environment that prevents the worst investment mistakes. Retail investors don’t. There are many advisers that try to bring this sort the discipline and structure to the practice of retail investing and I think some, many have great success but not as much in as the institutional context.
Let me give you a general concept of what the results look like, the results look like retail investors on average through being too emotional, trading too much, generally lose on the order of 2 percent a year of their returns are relative to the broad markets, institutional investors after fees and expenses generally get about market returns, if you look at the returns before their fees, expenses and costs, they beat the market but most of that is absorbed by the fees, expenses, and costs, the staff, the investment management fees, that absorbs most if not all of the outperformance, but that’s 2 percent better than the retail investor, and I think that’s from superior governance structures that prevent the worst mistakes.
RITHOLTZ: So now there been a number of studies that have come out about both retail and institutional. I recently saw something out of NYU Stern school of business about the underperformance of foundations and endowments versus a simple 60/40 portfolio and according to that research, the institutions are barely doing a whole lot better than individuals, at least at these nonprofit foundations, endowments, et cetera.
So cost is clearly a factor, what else is the driving factor, you brought up it’s a zero-sum so for every winner, there is a loser, are the institutions winning at the expense of the retail investors or is there a winning and loss component between different endowments some do well, some do poorly, but on average they get as you said, market-based returns.
BRIGHTMAN: Well there is a cyclical and a secular time horizon, on the secular time horizon, I think we find nonprofits particularly large university endowments tend to get the best results. Pension funds public pension funds get as I said just a moment ago, about the market return after their fees and expenses and retail investors, lose about two percent a year of that two percent a year is mostly paid to professional investors and value investors.
Now that gets to the cyclical component, if we evaluated the performance of the endowments up until the global financial crisis, there were many books written about their remarkable decades of outperformance.
RITHOLTZ: Right.
BRIGHTMAN: We’ve been in a cycle a 10 year horizon where growth has outperformed value, and to oversimplify, most endowments are going to be value investors.
So I think you’ve seen a period where value investors have struggled and it’s been a difficult time for the value oriented endowment model.
But I think 25 years from now, looking back, you’ll still see the success of that model.
RITHOLTZ: So I’m going to ask you to go a little outside of your comfort zone, using that same secular versus cyclical time period, the pre-crisis era, we saw a lot of investments in venture capital and private equity and hedge funds, that actually had done pretty well and since the mid-2000s, you know, venture capital has lost a little bit of its, shine none of the big well-known names are performing as well as they did previously same with a lot of the hedge fund guys that used to shoot the lights out, they seem to be struggling, what is it about this past decade that’s been so difficult for so many different styles of investment – investing?
BRIGHTMAN: Well, there’s a couple of things, one we’ve had just a stupendous roaring bull market and so it just is easy to comprehend from first logical principles that a strategy that is 100 percent long stocks is going to outperform a strategy that is both long and short stocks during a monumental bull market, so that basically explains the difficult performance environment for hedge funds. What has worked, what kind of alternative investment to if you want to use that label has worked over the last 10 years, well private equity, and why? Well because they don’t just go 100 percent long, they go hundred percent long with some leverage so that works pretty well in a roaring bull market.
I would guess if I had do I put my money on who outperforms over the next 10 years, it would be on the hedge funds rather than the private equity funds because markets don’t always go in straight lines up.
RITHOLTZ: A lot of your research and commentary that I find quite fascinating, you’re very good at crafting a headline that is intriguing and I want to just throw a few of them at you and see what you what you have to say about that.
One of them was are we at peak profits and I have to ask the question because people have been saying we are at peak profits for I don’t know, four or five, six years, this whole run up, we been hearing people say that, are we at peak profits? We discussed all of the monopoly rents and the other issues with crony capitalism earlier. Organically speaking, have we hit the point where profitability can go higher or can this trend continue for the foreseeable future?
BRIGHTMAN: Until policy changes, the trend will continue, and I see no evidence of policy change coming out of the divided government we presently have in Washington.
However, markets are forward discounting, the amount of the value of the S&P 500 or any given stock in the S&P 500 that is the dividends that are going to be paid over the next two or three years is trivial, most of the value is discounting future cash flows over the decades and I believe that we are seeing an increasing likelihood of a very significant change in policy, perhaps as soon as the 2021 new administration.
I would expect and this is an interesting forecast, I — if you want to you want to handicap who’s going to be our next president take a look at who seems like a 21st century Teddy Roosevelt.
RITHOLTZ: Meaning the Trust Buster?
BRIGHTMAN: Correct.
RITHOLTZ: Someone who is going to come in and say hey you know 93 percent of the search being with Google who I’m okay welcoming Google as our new overlords, but I understand the antitrust argument against it or half of all online retail transactions being with Amazon, that’s an immense concentration of power in a very small number of hands, there’s been almost no appetite for antitrust enforcement, there has been no appetite for preventing these giant mergers, when was the last time somebody other than CNN and I have a forgot who was even though the merger was with, that the president was unhappy with was he doesn’t like the CNN coverage.
But that whole Time Warner CNN whatever the last broadband merger, other than that one political example, has there really been much in the way of stopping big companies from becoming giant companies in order to preserve a fair and competitive landscape?
BRIGHTMAN: No, there has not been and we have a strange economy as a result. One that is not working for the average worker. We are known and Research Affiliates for being leaders in factor investing, let me talk to you about the most recently discovered factor and how it relates to this issue of monopoly profits and stagnating wages.
Among academic researchers, we all understand this new factor called investment, not many retail investors I think are aware of this the this new factor that was researched by many and popularized by Fama, and French Fama, and French Now (ph), the famous inventors of the three factor model the market value and size, now have a five factor model, they have added two factors, profitability and investment, and investment is the one I want to talk about.
Investment refers to a very strong empirical relationship, a scientific finding that the more company invests the lower the returns are.
RITHOLTZ: Meaning capital expenditure actually works against ..
BRIGHTMAN: The returns, right. As Warren buffet’s been telling you for a long time you don’t want companies that have to invest to create their profits, you want companies that have a moat and generate monopoly profits.
RITHOLTZ: Right.
BRIGHTMAN: And the less a company invests the more they are rewarded in the stock market and so we have — don’t have much investment, we don’t have much capital investment you get some cash what you do, you buy back your shares or you buy your competitor, maybe do a little about a but you don’t invest for the future.
And that’s the this is a scientific finding that comes out of the Academy that comes out of finance professors, it’s the new factor in the Fama French five factor model is go find companies that don’t do any investing.
That’s responding to the environment that’s been created, the environment the rules of the game that we have is not competitive capitalism where innovating and investing for the future creates wealth, it’s manipulating the system to create monopoly rents, that’s how you create wealth, and until we change that system, we are not going to change the results.
RITHOLTZ: How do we change that system, is it simply just a matter of saying hey your cap X expenditure is a separate line that doesn’t affect your profitability? But you share buybacks, does how can the rules, how can the regulatory and tax environment I’m assuming you’re saying we want more capital expenditure, we want more investment in the future, how can we encourage companies to think long term when the market is rewarding companies that don’t? I don’t know if I’m overstating it there.
BRIGHTMAN: Sure I think the biggest the simplest way to describe the problem is regulatory capture, the …
(Crosstalk)
RITHOLTZ: Pharmaceutical, oil and energy, go down the list, finance for sure.
BRIGHTMAN: Yes.
RITHOLTZ: Finance and banking for sure.
BRIGHTMAN: And I will loop back to the longer version, if you want to — if you want to understand the economics, I think you can do find no better discussion then Edmund Phelps’ “Mass Flourishing” and if you want to understand the legal tools to address the issue, read Tim Wu.
That – there are tools, we can do this, I mean that the robber barons were running the economy before Teddy Roosevelt showed up …
RITHOLTZ: Right, railroad, electricity, go down the list. Telegraph, quite fascinating, I have to tell you that’s an intriguing thesis you’ve laid out, I don’t disagree with it, I’m a little surprised at how forceful you articulated it. I certainly think you’re right and I’ve heard this from both the left and the right Scott Galloway at NYU Stern wrote before and his recommendation was that Apple, Amazon, Google, and Facebook get broken up, they are too powerful.
BRIGHTMAN: That’s correct.
RITHOLTZ: It’s quite amazing.
So let’s jump to our favorite questions while we still have you, tell us the most important thing most people don’t know about your background.
BRIGHTMAN: Boy.
RITHOLTZ: I was going to go with you’re from West Germany originally.
BRIGHTMAN: I was born in West Germany but I was the a born to my — a dad and mom who my dad was serving in the military of the so that’s really much less interesting than it sounds. How about I have never lived in one house for as long as I lived in Newport Beach, California where I’ve lived for eight years, this is the longest I’ve ever lived in a house in my entire life.
RITHOLTZ: Well, every army brat tells the story of getting moved around from our you know assignment to assignment and I guess that stays with you. So you met — let’s talk about your mentors you mentioned one of your early mentors who helped shape and guide your career over time.
BRIGHTMAN: Yes, I have had the privilege of learning from a number of charismatic leaders one and the first was Gary Brinson, I don’t think I would do it be nearly as successful in investment management industry today without that — without Gary’s example.
Second was a fascinating woman named Hilda Ochoa. Hilda was a refugee from Venezuela who ended up in the PhD program at Harvard University, ran the pension fund of the World Bank, spun that out into Strategic Investment group and when I left Brinson Partners I ended up at Strategic Investment Group as the eventually the CIO there, Hilda is a fascinating innovator and entrepreneur.
And while I was the chair at TIFF, I had the privilege of working with a fascinating individual named David Salem, probably less known than some of these others but nonetheless a fascinating figure in the nonprofit investment world.
And now finally Rob Arnott who is a quite well known, so I really had the privilege of getting to know a lot of the fantastic investors.
RITHOLTZ: Welcome to the podcast. Chris, thank you so much for a doing this, we met some time ago and I’ve been looking forward to having this conversation, I know Rob Arnott the founder of RAFI for a long time, he’s a fascinating guy, must be fun to work with.
Are you here or are you Newport Beach located?
BRIGHTMAN: Newport Beach.
RITHOLTZ: Yes that’s quite — that might be one of the most beautiful places in America to go to work every day.
BRIGHTMAN: I joke with people, I ask them do you know why we’re headquartered in Newport Beach?
RITHOLTZ: Because you can.
BRIGHTMAN: That’s right.
RITHOLTZ: For those listeners who may not have ever been to that part about an hour south of LA maybe a little less depending on traffic, it’s just is t Balboa Island, right over there, it’s just a gorgeous part of Southern California, everything you imagine Southern California is but nicer, I mean it really is kind of ridiculous.
BRIGHTMAN: Everything is wonderful except for …
RITHOLTZ: The traffic.
BRIGHTMAN: No traffic is almost nonexistent in Newport you live and work in Newport Beach, it’s wonderful, the problems are the price of real estate and the taxes.
RITHOLTZ: Price of real estate so funny say that a friend who I won’t mention was having conversation with Rob about you know if you moved to Nevada you live in Las Vegas you won’t have to pay state taxes and his answer was, yes, but then I have to live in Nevada and he goes I’m in what might be the most beautiful place in the world, I’m going to have to pay the VIG for staying there.
BRIGHTMAN: You know, I spent a decade in Chicago and have a lot of friends in the business in Chicago and I was there not too long ago saying boy higher taxes are in your future, I’ve been paying attention to what’s going on with the pension problems …
RITHOLTZ: In Illinois for sure.
BRIGHTMAN: And the only way.
RITHOLTZ: And New Jersey and a few other places.
BRIGHTMAN: So you are going to get California like taxes in your future to fill this hole in the pension fund, and they say, you know, we can’t do that Chris, they said, we have a 13 percent state income tax in California.
RITHOLTZ: It’s that high?
BRIGHTMAN: It is that high.
RITHOLTZ: 13 percent, wow, that is a lot.
BRIGHTMAN: And he says you don’t understand, you can raise the taxes studio 10 percent 15 percent in California and nobody, they’re not going to move to Nevada right some people course do move to Nevada.
RITHOLTZ: Very few.
BRIGHTMAN: But there is a magnet to the West Coast and to California.
RITHOLTZ: Sure.
BRIGHTMAN: He said Illinois doesn’t have that, people will moved to …
RITHOLTZ: Anywhere.
BRIGHTMAN: Wisconsin, they will move to Indiana, we can’t take taxes up to that level.
RITHOLTZ: Chicago happens to be a very reasonable city it’s a reasonable — it it’s big enough that it has whatever you want but it’s not as big as New York’s where it’s completely overwhelming and their prices are much more reasonable than the coast, the problem is your weather is much nicer, when you have Southern California weather, you could charge 13 percent and in Chicago if they in Illinois to raise it to a certain point, people will say all right, I am going to Arizona this high taxes plus terrible winters equals I’m out and that’s been the shift southward across the whole country people of been making the argument it’s political, but I really think it’s weather based.
BRIGHTMAN: I think it’s both, I think it is the taxes, it think it’s regulatory environment and I think it’s the weather.
RITHOLTZ: So let’s talk a little about you mentioned some books, you mentioned Tim Wu and Edmund Phelps’ books, what other books do you think are essential reading or what you just like to read if you want to relax?
By the way, this is everybody’s favorite question, people want reading suggestions more than anything they don’t know which of the 300,000 books that come out each year to read so they take these very seriously.
BRIGHTMAN: Yes sure if you want to understand the future markets and the intersection of public policy in markets, the three books that I just mentioned are the ones of the dozens that I’ve read over the last few years that I think are most important.
RITHOLTZ: Phelps, Wu, and what’s the third one?
BRIGHTMAN: Jonathan Tepper.
RITHOLTZ: Okay.
BRIGHTMAN: It’s “The Myth of Capitalism” when I want to escape, I don’t read about economics and policy, I read science fiction but it’s not escapist.
RITHOLTZ: So what do you like? So nothing wrong with that, what do you like under sci-fi?
BRIGHTMAN: I guess under fantasy instead of sci-fi, I love to the game of thrones and I love you so much that after watching the series I then read all of the books and I went back and rewatched all of the series.
I also read the one of one of my favorites although you’re seeing less get published is in a sort of sub genre called cyberpunk.
RITHOLTZ: Are you a Neil Stephenson fan?
BRIGHTMAN: Absolutely.
RITHOLTZ: I’ve just got — I haven’t read it yet but I have sitting on my desktop “Seveneves” that’s what is literally sitting on my night table.
BRIGHTMAN: I read it, it’s fabulous.
RITHOLTZ: Really and also on my list, I’m going to throw you books that people have recommended to me that I haven’t gotten to yet “The Three Body Problem” people have raved about that trilogy from the author out of China, I’m really fascinated by your list.
So what are you most excited about right now? What is the part of the industry that has you really enthusiastic?
BRIGHTMAN: I am very enthusiastic about the opportunity to use 21st-century technology and part of it is financial technology, part of it is financial modeling and predicting what’s going to happen but importantly a lot of it is communication technology, what we’re doing right now to help educate investors to achieve a better outcomes and I am very pleased to see the costs being reduced in the industry, the provision of investment strategies at couple of basis points, right?
It used to be 100 basis points, 150 basis points was the cost of investment strategy, now it’s 20 basis points or 10 basis points of five basis points and providing the average investor the ability to compound wealth for their retirement without intermediaries gobbling up so much of the returns.
RITHOLTZ: Tell us about a time you failed and what you learned from the experience?
BRIGHTMAN: I left UBS, so Brinson Partners where I kind of got my start what we sold ourselves I was a partner at the firm, I made a little money on that sale to UBS and I’ve learned after a time there that that was not the place for me, I’m better off in smaller employee owned investment management firms than large institution. God love the people that thrive in large institutions as the world appears to need them but it’s not a good fit for me.
And I tried to start a quantitative equity market neutral hedge fund in 1999 to 2000 with some backing from a firm called Greenwich Capital.
RITHOLTZ: Sure.
BRIGHTMAN: Greenwich Capital isn’t around anymore but that I had some friends at the top of that organization that were interested in exploring getting into the asset management industry and …
RITHOLTZ: Market neutral and ’99 2000 should’ve done not too bad, right?
BRIGHTMAN: It would’ve been a wonderful time but as the environment turned less conducive to risk-taking or perhaps I was just not as persuasive as I had been the year before, they decided to pull the plug on that endeavor, but I’ve learned a lot in that period of time, I’ll give you a lesson about the marriage and the area of a lesson about to the structure of the quantitative investment management industry.
After I determined I was good to be unsuccessful in starting that business I just hung around the house for a while, I helped coach my son’s soccer team and I got a lot of cycling in and I just spent a lot of time around the house and my wife explained to me you know Chris, for better or worse, but not for lunch, you need to go back and get a job.
RITHOLTZ: Better or worse but not for lunch, that is great.
BRIGHTMAN: One of the fascinating discoveries as I was recruiting people to join my never to be quantitative equity market neutral global hedge fund was how many of the best staff I was recruiting, how many people I was interviewing didn’t work at what you and I think of as an investment management organization, but worked at family offices right here in Manhattan, and family offices of former prop traders, people that would leave Goldman Sachs prop desk or Lehman Brothers or Morgan Stanley with enough money that they didn’t need to manage money for anybody else, and they would hire these incredibly gifted quants from India or from China and that I think people don’t realize that most of the money that is made by arbitrage inefficiencies in the capital markets these days is not in funds that are invested investing the money of Harvard University or the State of California’s pension fund, it’s mostly private money and that’s where those said those profits go.
There is an enormous amount of professional investment expertise supplied to the management of individual family money.
RITHOLTZ: Not investable to the public.
BRIGHTMAN: Not investable to the public, they’re not even they’re not even registered investment management companies that are just trying office and they don’t want to attract attention.
RITHOLTZ: My favorite part of the Renaissance technology story with Jim Simons was at a certain point they realize their ability to generate alpha was limited and only scaled up so large and when their own investments at that point, they told their outside investors “Hey thanks so much for coming by but we don’t want your capital anymore, we are going to take this ourselves.”
BRIGHTMAN: And that’s a well-known example what I found is that there are dozens perhaps hundreds of similar outfits here in New York City that never took private money ever, never took outside money.
RITHOLTZ: And these aren’t giant multibillion — necessarily giant multibillion family offices, these are 50, 100, $250 million, am I ballpark?
BRIGHTMAN: I don’t think we know, they don’t have to tell us.
RITHOLTZ: That’s quite fascinating. You mentioned cycling, what you what you do for fun, what do you do to relax, what do you do to stay trim and fit?
BRIGHTMAN: I one of the benefits of living in Newport Beach in Southern California is that I can cycle all year round so I both get out on my road bike and I spend time on my mountain bike and then I go to the gym a few times each week because I have to keep fit so that I can the cycle and I can ski and I can hike.
RITHOLTZ: That Southern California lifestyle sounds of increasingly attractive.
So a millennial or recent college grad comes up to you and says I’m thinking about going into finance as a career, what sort of advice would you give them?
BRIGHTMAN: Here’s some advice my daughter Amy when she was growing up, she wanted to be in fashion merchandising but then she went to college and decided you know maybe I should be a little more practical and she started her major in economics, after a few years in economics she decided that that wasn’t really where she wanted to go she wanted to, she want to do and she switched to psychology and one of the things that Amy found is that she had taken a full raft of stats classes for economics and then when she switched to psychology, they said oh no those are Econ stats classes, you need psych stats classes so she had to take a double load of statistics.
Amy started a digital advertising agency here in New York and when she was talking to her younger sibling, my son John when he was a entering college she said, “You know what? You really need to take stats, that’s been the most helpful thing for me in my career in digital advertising and it’s equally true I think in the investment management industry become numerate, take statistics, the world the it has become, that the professional world puts a premium on numeracy.”
RITHOLTZ: I think that’s great advice, and our final question what is it that you know about the world of investing today that you wish you knew 35 years ago when you were first starting?
BRIGHTMAN: Humility is enormously important to professional development.
RITHOLTZ: Can’t say I disagree with that. Any particular reason that led you to that and you’re not the first person who has mentioned it but …
BRIGHTMAN: As I advanced in my career, it has become more and more important to inspire other people to build the team to nurture and help other people grow, and one can’t do that effectively without humility. I – for me to succeed I have to lead a group of people all of whom or at least many of whom are smarter and better educated and more productive than I am and one can’t do that without do a considerable degree of humility.
RITHOLTZ: Quite fascinating. We have been speaking with Chris Brightman, he is the chief investment officer of Research Affiliates. If you enjoy this conversation well look up an inch or down an inch on Apple iTunes or Stitcher, overcast, wherever your finer podcasts are sold and you can see any of the other 250 such conversations we’ve had over the previous five or so years.
We love your comments feedback and suggestions, write to us at MIBPodcast@ Bloomberg.net, I would be remiss if I did not thank the crack staff who helps put together this conversation each week. Karoline O’Brien is our audio engineer, Taylor Riggs is our Booker/Producer, Atika Valbrun is our project manager, and Michael Batnick is our head of research.
I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.
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