Transcript: Fran Kinniry



The transcript from this week’s MIB: Vanguard’s Fran Kinniry, Global Head of Portfolio Construction at the Vanguard Group, is below.

You can stream/download the full conversation, including the podcast extras on Apple iTunesOvercastSpotifyGoogle PodcastsBloomberg, and Stitcher. All of our earlier podcasts on your favorite pod hosts can be found here.



VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: This week on the podcast, I know you guys bust my chops for saying I have an extra special guest. But I have an extra special. Michael Lewis sat with me for nine hours. We talked about everything he’s ever written since he was nine years old, and it is absolutely spectacular. So with no further buildup or ado, my conversation with Michael Lewis.

VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: This week on the podcast, I have an extra special guest. His name is Fran Kinniry, and he is the Head of Portfolio Construction at Vanguard Group, managing a modest five-point something trillion dollars. He has an absolutely fascinating career. And the work he’s done at Vanguard on a concept called “Advisors Alpha” is absolutely essential and part of the single largest trend in investment management today, which has to do with the shift from transactional brokerage-type investments to more fee-only long-term asset allocation from advisors. This is one of the single biggest trends in investing and has seen literally trillions of dollars shift. This is a big part of the shift from active to passive, from transactional to — to long-term. And if you are an advisor, if you work in the industry or if you’re just simply — if you’re just simply an investor who is interested in learning what’s going on in the world of investment management, you’re going to find this conversation to be absolutely fascinating.

So with no further ado, my conversation with Vanguard’s Fran Kinniry.

VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: My special guest this week is Fran Kinniry. He is the Global Head of Portfolio Construction at the Vanguard Group, which manages over $5 trillion — that’s trillion with a T — $5 trillion. He’s a Principal in the Investment Strategy Group where, as an MBA/Chartered Financial Analyst, he helps to develop Vanguard’s investment philosophy, methodology and portfolio construction strategies. At Vanguard, he helped to create the firm’s Investment Counseling and Research Departments, its Asset Management Services and the Vanguard Advisory Services. But perhaps he is best known for creating the concept of Advisors Alpha.

Fran Kinniry, welcome to Bloomberg.

KINNIRY: Thank you so much, Barry. It’s great to be here. I’ve been a big fan of your show and so just a pleasure to be here.

RITHOLTZ: I — I have had, as a guest on the show, just about all of your CEOs since the firm began. I have to track down the — the new guy. He’s — he’s been elusive, but I will eventually wield (inaudible).

KINNIRY: He’s been busy.

RITHOLTZ: I can imagine.


So — so let’s start a little bit with — with some background. I hear that index funds are — are a bubbler. Are you guys, at Vanguard, about to crash the economy?

KINNIRY: Yeah, that’s an interesting one. The — the author, I guess, of the — or the creator of the big short came out recently. I know your team covered and Josh covered it as well. I think people have to really take a step back when I see stories like this. There’s a lot of confusion even on index and active, and I think people don’t even understand. As long as they’ve been around, they’re still very confused.

RITHOLTZ: So — so let’s delve into the details. Explain the broad difference and why it matters.

KINNIRY: Yeah. First of, I think people confuse this idea of, you know, indexing maybe surpassing active management, right? So …

RITHOLTZ: In the U.S. …

KINNIRY: In the U.S. …

RITHOLTZ: … well, you really just did that this past quarter, right?

KINNIRY: We just — we just did that, exactly. But I think people forget that that’s ‘40 Act funds, ‘40 Act being mutual funds and ETFs. And that is a very small part of the capital market structure.

RITHOLTZ: So — so what is not included under the’40 Act?

KINNIRY: Separate accounts, institutional investors, sovereign wealth funds. So actually, the mutual fund and ETFs are somewhere between 30 and 35 percent, so if you do that math, index equities on the U.S. side is somewhere around 15 percent.

RITHOLTZ: So still relatively small indexing, passive investing much more than active investing.

KINNIRY: Exactly. And I think the other big confusion is that people think that indexing moves price. If there’s only two active managers, let’s say it’s you and I, Barry …

RITHOLTZ: Someone’s got to be a buyer, someone’s got to be a seller.

KINNIRY: … and — and you and I are playing golf and we’re not …


KINNIRY: … at our trading desk, the index doesn’t move.


KINNIRY: So the index is — is taking their direction. Their index will replicate active managers. So this idea that indexing is driving price or price discovery, if there are only two active managers and they decided to take the day off, the index wouldn’t move. There will be no index trading.

RITHOLTZ: Huh, that’s interesting. So as long as we’re — we’re talking about this bubble over the past couple of years, I’ve heard indexing is a threat to the economy, is un-American, it’s Marxist. It seems like a lot of people are flailing. And Jack Bogle very famously said when Vanguard first rolled out their initial index funds, they were accused of being un-American.

KINNIRY: Yeah, and I think some of the assaults that you’re hearing is aback to incentives, right? And — and, you know, Charlie Munger famously said that his whole life he believed that 95 percent of what people say or do is due to incentives and his whole life he underestimated incentives.


So I think there’s a large crowd that would love to talk about this indexing bubble or all the negatives of indexing. You have to look at the incentives there. The bottom line is indexing is broadly diversified, low-cost exposure and probably one of the greatest things that have happened to investors in the last 50 years.

RITHOLTZ: So — so are you suggesting that the people who are critics of indexing are the ones who are seeing outflows and losing market share? Is — is that how cynical you are?

KINNIRY: I think when you — your — your survival and, you know, depends on it, you’ll say whatever makes that right …


KINNIRY: … for you.

RITHOLTZ: The — the famous Upton Sinclair quote. So you’ve been at Vanguard since 1977. What path took you there? What — what was your first role at the Vanguard Group?

KINNIRY: I’m not that old, Barry. I joined in 1997.

RITHOLTZ: Is that what I say? I said ‘77. You — you were going into high school in ‘77.

KINNIRY: Yes, exactly, exactly. So I joined in …

RITHOLTZ: Ninety-seven.

KINNIRY: … I joined in 1997.

RITHOLTZ: By the way, Vanguard has only been around what – since ‘74?

KINNIRY: Right. I …

RITHOLTZ: So — so ‘97.

KINNIRY: Yes, so 1997 I joined Vanguard. The backstory is, like yourself, I was at a registered investment advisory firm. Back at that time, we had $1 billion, which was — was quite large. We were a multifamily office and institutional advisory firm.

RITHOLTZ: To — to be fair, in 1997, $1 billion was a lot of money. Now it’s walking around money …

KINNIRY: Exactly.

RITHOLTZ: … or so it seems with $6 trillion and $5 trillion and just crazy AUM numbers.

KINNIRY: Exactly. And so I was a big fan and studied Vanguard from a far from my prior firm, and I ended up at Vanguard because our RIA business got rolled up into a — you know, they were going through a roll-up stage and roll-up being other big advisory shops bringing other advisors together. I had about a year to figure out whether I was going to stay or move somewhere, and I just was a — I was a CFA and I happen to be at a CFA event, and Vanguard was entering the advise business.

And so a lot of people know about Vanguard’s advice today and they may think it’s new. But I was, you know, at the very, very early beginning of Vanguard’s starting advice and my role was to develop the investment methodology we used in our advise services.

RITHOLTZ: So — so let’s talk a little bit about that. Vanguard has been a giant advocate of the 60-40 portfolio — 60 percent equity, 40 percent bonds. Advisors embrace that in giant numbers. Is the 60-40 portfolio still a desired sort of mix?

KINNIRY: Yeah, I think some context there just like we — we started with the context on indexing. The context is, I think, Vanguard believes in broadly diversified portfolios, low-cost, whether it’s active or passive because we actually believe in active.

RITHOLTZ: You’re almost $2 trillion in active, right?

KINNIRY: That’s right. And so I think the 60-40 gets thrown out there, you know, as a starting point. But we — we believe that the asset allocation should reflect the client’s goals and objectives, so we have clients — for example, our target retirement funds, it’s a glide path …


KINNIRY: … where it starts out 90-10 and gets all the way down to 30-70.

RITHOLTZ: In other words, as you get older, you assume less risk with equities and more stability with bonds.

KINNIRY: Absolutely. So the 60-40, while — you know, that’s one spot on that front tier. I think the main part is having an asset allocation and investment policy, you know, that you’re navigating back to, so you’re rebalancing to that being broadly diversified and either having high talent and low cost. That would be our formula for success for an investor whether it’s 60-40 or 40-60 doesn’t really matter. But yeah, the 60-40 tends to be that starting point for many investors …


KINNIRY: … and — and a lot of the institutional funds, endowments, foundations were that for a very long time.

RITHOLTZ: Quite fascinating. So let’s talk a little bit about Advisors Alpha. Your team effectively created this concept in 2001. Let’s define it. What is Advisors Alpha?

KINNIRY: Yeah. So Advisors Alpha, as you mentioned, we created in 2001 and it really changed the value proposition or the framework of what it means to, you know, why hire an advisor. And my prior role, I was an advisor, and I think our value proposition was probably similar to most. And that was a myopic value proposition. Hire me and I’ll outperform a policy portfolio, whatever that policy is.

RITHOLTZ: So that’s the traditional chasing alpha Wall Street, pursue the hot hands, we’ll beat the market.

KINNIRY: Right. And so whether you do that through security selection, market timing, fund selection the value proposition for a very long time in the advise invite community was outperform a policy portfolio.

RITHOLTZ: And — and none of the data supported anybody’s ability or at least the vast majority of investors and fund managers’ ability to do that consistently over time.

KINNIRY: Yeah, and think about what a high hurdle that is. If — if you’re charging, you know, let’s say one percent in a fee-based and arrangement, and then you now — so not only that you have to outperform by one percent plus any product fee …


KINNIRY: … so that’s a really tough hurdle, so it’s a value proposition that you’re setting up. You know, you own your value proposition as the advisor and you’re telling your client, you know, judge me on this and you’re — you know, you’re really handicapping yourself, and that’s what led to a lot of churn, a lot of turnover …


KINNIRY: … and unhappy clients.


KINNIRY: So we kind of broadened the value proposition. So Advisors Alpha, you know, is a much more holistic value proposition. It still has investment management if you believe that that is a, you know, skill you want to do, but what about financial planning, tax planning, wealth planning, saving planning, retirement income, how do I get a paycheck to me and then behavioral coaching?

Also, the service model. I work with a lot of investors that are very busy. You know, they could be a doctor, a lawyer, an entrepreneur. And they don’t want to, you know, come home at the end of the day and manage their assets so a..


KINNIRY: … a service model. You know, I came up with the acronym TWA. You know, client may not have the time, willingness or ability to do it on their own. And for most of those clients, it’s worth 100 basis points of advice.

RITHOLTZ: So you — you mentioned something that reminds me of the Vanguard concept of total return. You want to explain what that is because most people think total return. They think capital appreciation plus dividends, but Vanguard has a slightly different definition.

KINNIRY: Yeah. Our — our total return is I think a lot of people try to engineer a return. And what I mean by that is let’s take this low-yield environment, and they think that they — you know, they may need five or six percent for their spending …


KINNIRY: … so they kind of start with what is my liability stream, and we see this a lot in the institutional space …


KINNIRY: … too with endowments and foundations or …

RITHOLTZ: They have a five percent bogey if they want to stay completely — they must spend five percent, otherwise, they risk losing their taxes and status?

KINNIRY: Exactly, and who are a client who’s in retirement …


KINNIRY: … a client who’s in retirement. Let’s say they want to spend the four percent rule …


KINNIRY: … how do you — that works for — you know, if you look at a bond chart, the 60’s, 70’s, 80’s and 90’s, interest rates were above the spend rate.


KINNIRY: So you’re going to have …

RITHOLTZ: That was easy.

KINNIRY: … you’re going to have 100 percent fixed income portfolio and it was quite easy. But now you have dividend yields. They own the equity market and let’s say 1.8, 1.9, and the bond market it’s somewhere like two, so how do you get to a spending policy of four or five percent?

RITHOLTZ: You add them together.

KINNIRY: Yeah, well, you see people taking risk.


KINNIRY: They — they go out on the yield curve, the high-yield junk bonds …

RITHOLTZ: Durations.

KINNIRY: You see a lot of …

RITHOLTZ: Although duration doesn’t work and that you say it doesn’t.

KINNIRY: Duration doesn’t work.

RITHOLTZ: Inverted yield curve going out duration hurt you, doesn’t help you.

KINNIRY: Yeah. And you see a lot of these — let’s — and there’s nothing — this is not an anti-alternative investment or private investment conversation, but, you know, you — you see people going in reaching for, you know, alpha that may or may not be there.

RITHOLTZ: But — well, when you say may or may not be there, the — the data is pretty overwhelming that, for the most part, it’s not there and — and a lot of people who dabble on alternatives seem to — my joke is come for the high fees, stay for the underperformance. But that has not been the solution, it has not been the magic bullet especially for pension funds that have pushed in giant numbers into private equity, and hedge funds and venture capital. It’s like everything else, a winner take all.

There’s a handful of, you know, if you can’t get into Renaissance’s Medallion funds or D.E. Shaw, the odds are you’re not going to do as well as a simple 60-40.

KINNIRY: Yeah, and I think that goes even for liquid space, right? So I — and I still think that this gets back to the — the marketplace being very sophisticated but maybe not understanding the math. And the — and the math is — and most of your listeners will probably be familiar with zero-sum game …


KINNIRY: … which means that if you and I are counterparties, one of us is going to win on that trade and one is going to lose. So on average, active management, whether they be liquid or illiquid or alternatives or traditional, it’s going to be impossible at the 50th percentile in a zero-sum game …


KINNIRY: … to win.

That doesn’t — but — but I think what missed is that if someone is on the right side of that distribution …


KINNIRY: … someone is winning. And so, you know, if you can find talent, you mentioned a few Vanguard’s active funds have it actually done very well. So if you have good talent and you have your costs below your talent …

RITHOLTZ: Which is a key component of total return.

KINNIRY: … total return then that — you know, so we’re — we’re in the total return or outcomes. You know, we — we believe what’s the most important thing is what our client outcomes. And so what I mean by that, it doesn’t have to be all index or that alternatives are bad or, you know, private investments are bad. What you really want to end up with is — is my talent greater than my friction. And if that works, then there’s a real strong case for active and a strong case for privates and alternatives.

The question is do you have access to that, right? Not everyone is going to have access to world-class talent.


KINNIRY: And then …

RITHOLTZ: You just need a couple of billion dollars and you’re in.

KINNIRY: Yeah, or you work with — you work with a professional fiduciary so you could work …


KINNIRY: … with, you know, not — not to say Vanguard, you could work with someone like Vanguard that actually can, you know, find great managers, get access to great managers and deliver outcomes that are superior even though the cost structure is above an index cost structure.

RITHOLTZ: Let me give you a quote from one of your research papers that I found interesting. “Left alone, investors often make choices that impair their returns and jeopardize their ability to fund their long-term objectives. Many are influenced by capital market performance, and this is often evident in market cash flows mirroring what appears to be emotional responses — fear or greed — rather than rational ones.” Explain the idea of behavioral coaching and what that means.

KINNIRY: Yes. So behavioral coaching is one of the key pillars of Advisors Alpha. And what we mean by that is investing is emotional, right? And we know that, you know, you have to be, you know, in a decision state where your emotions are calm. And, you know, it’s hard to stay calm, let’s go back to the global financial crisis, ‘08, ‘09. It’s hard to stay calm when you have lost, you know, 45, 50 percent of your value of your equities. And what you’re asking the investor to do is let’s just take a $2 million portfolio, a million in stocks, a million in bonds.

Your million in stocks now is $500,000.


KINNIRY: And you’re asking — without an advisor, you’re — you’re saying, I’m going to sell $250,000 of bonds that are actually doing quite well in GFC and add to the stock portfolio, so now I have 750-750 …


KINNIRY: … right, to rebalance that. And when I — I’ve studied cash flow at Vanguard for my 20 plus years, and what we see is that, you know, investors, especially in the extreme. So you go back to that ‘08, ‘09 environment. There was huge outflows of equities in the money market, and so investors were not rebalancing on their own. And so working with a behavioral coach who’s going to help you through the emotions to stay committed to your policy, we think can add a tremendous amount of value.

RITHOLTZ: And — and I — I personally noticed the outflows going just — reaching their plateau that February, March ‘09, the worst possible time for it.

KINNIRY: Right at the bottom, you know, we studied that right. And — and equities went pre-GFC, so if you go back to, you know, ‘07 pre-GFC …


KINNIRY: … equities were about 68 percent on the household balance sheet, and that means that, you know, the 32 percent was in more risk-off assets. At the bottom, you mentioned February of ‘09, equities dropped to 36 percent.

RITHOLTZ: Amazing.

KINNIRY: So I call this the most hated bull market of all time because this bull market was very frontend-loaded, meaning a lot of the returns came out of March ‘09 …


KINNIRY: … in that very first — and investors only had 36 percent. And so if you look about the IRR, the compounded return that goes to an investor, the behavioral gap, you know, that — you know, we talk a lot about it in Advisors Alpha, it’s, you know, one to two percent. It’s episodic, but investors, you know, tend not to do the right thing at the right time.

RITHOLTZ: For sure. Let’s talk a little bit about Vanguard Group, which does things quite a bit differently than the rest of Wall Street. Here’s another quote of yours, “What Vanguard really believes in is high talent and low cost.” Aren’t those two things contradictory? Aren’t we taught, hey, if you want the best you’re going to have to pay up for it? How do you combine low cost with high talent?

KINNIRY: Yeah. Well, the asset management business is one of the, you know, more scalable businesses out there, right? And so what we behave …

RITHOLTZ: Meaning by scalable, meaning it doesn’t take a whole lot more to manage a billion dollars than it does to manage $25 billion.

KINNIRY: Well, it depends on the strategy, but yes, that’s exactly right. So, you know, if I’m managing a billion dollars versus a million dollars, my cost should not be — my marginal costs …

RITHOLTZ: Shouldn’t be 10X.

KINNIRY: … my marginal cost should shrink, right, if — if we …


KINNIRY: And so what we’ve been able to do at Vanguard, I think the most important thing is to take a giant step back is, you know, when Jack Bogle started the Vanguard Group, it was a mutual — mutual fund. And what that means is that we are owned by our investors, and so there’s different ways that you can set-up an organization. You can be public, you know, public equity where the public shareholders, you know, get the — the P&L. You can be a private partnership where the partners get the excess P&L.

What Vanguard does and sometimes people think of Vanguard is — is a non-profit, but we are actually fiercely for-profit. Everything we do is try to maximize our profit. It’s what we do with the profit. We end up giving it back to our shareholders, our owners, so the owners of our funds through lower costs in the future. And so we pass along the — you know, the P&L excess back to our investors either in the form of lower cost coming out of that or higher service levels. And that — so that gives us that advantage relative to some of our competitors.

RITHOLTZ: I — I think people confuse unfair advantage and it is an unfair advantage with an illegal advantage. It’s a perfectly legal advantage any other mutual fund could have set-up this way. They chose not to.

KINNIRY: That’s exactly right. I mean, so — and — and again, everyone has to pick their ownership structure. We’re not here to say the public is wrong or private is right. They’re just different, right?


KINNIRY: And so we are owned by our investors and you kind of think about one master as opposed to multiple masters. And so that allows us, you know, to kind of pass back through where you can actually — your original question of how can you have high talent and low cost? Well, A, we have our ownership structure, and B, we pass along scale back to our investors.

We also think our brand is very attractive, so what I mean by that is we’re able to attract world-class active managers who want to work with us because they know just the brand to be, you know, working with Vanguard but they also know we’re very patient with our active managers. And so if you actually want to be a pure asset manager and let, you know, Vanguard take the client servicing and the distribution, it’s a — it’s an arrangement that works very well and it’s probably one of the reasons why we’re so successful in active management.

RITHOLTZ: So — so let’s — let’s focus a little more on the active management. You rolled out — you, Vanguard rolled out a group of quantitative funds not too long ago. I don’t want to call them smart beta, but a fundamental factor-based set of funds. The one thing there’s really hasn’t been a big push into yet, but I’ve heard rumors of is an ESG-type of fund. I know you have the FTSE in the U.K., the FTSE ESG fund. Where else is Vanguard going to go with some of these active funds? And — and what are the areas that have done very well under active at — at Vanguard?

KINNIRY: Yes. So the areas have very well for us is — is, you know, the full suite first off, so a lot of people (inaudible), but we are one of the largest managers in tax-exempt, you know, so municipal bond funds, so high net worth clients that might be at your practice. You know, we are like world-class in tax-exempt fixed income and also taxable fixed income on the active side.

RITHOLTZ: So you — on the munis, let’s talk about that because it’s so attractive in a low-yield environment because post-tax makes a big difference or — or — or tax equivalent yield makes a huge difference. Is this on a national basis? Is it a state by state basis? How do you put these together?

KINNIRY: Yeah. So we have a full suite of — of tax-exempt bond funds. You know, we have — as you mentioned, we have multistate so you would own the U. S. in a multistate way, but we also have single state where there’s actually a higher state tax like New York is quite high. So we offer both. We offer a lot of things in active and passive because we have an ETF on the tax-exempt as well. But our active funds on the fixed income side, both tax-exempt and taxable, have done quite well.

You also talked about some of our factor funds. You know, I’ve — I’ve been an author of a lot of papers on smart beta, and so we were really just critical of the term. We didn’t think it was smart or it was beta.


KINNIRY: And — and we were kind of, you know, early and kind of being critical of the narrative, you know, because it — you know, but we believe that there’s factors. You know, if you think about a factor, a value factor, momentum factor that actually have a different risk and return stream, and they have some premiums to them. And you can even kind of think about why those premiums would exist. Some of them could be behavioral, some of them could be just back to misunderstanding the risk …


KINNIRY: … so we do have a series of quant factor funds out there, and — and — and a whole list of traditional bottom-up funds that — that you’re probably familiar with that Vanguard has offered for many, many years.

RITHOLTZ: You mentioned earlier target date funds, which used to get kind of a bad rap, but they have, for the most part, become the default setting for 401k plans. If you don’t pick something, you tend to go right into a target date funds. These have done pretty well over the past decade. Tell us a little bit about the Vanguard target date funds because I think these are attracting a whole lot more money every month.

KINNIRY: Yeah, I mean, outside of the invention of index funds, I think target retirement funds, you know, will go down as one of the more helpful innovations for the average person trying to save for retirement. And if you go back before target retirement funds, the 401k space, which is where most of these are used. Let’s say I’m starting day one at Vanguard, I would get a brochure about all the Vanguard funds and I had to make these decisions for myself.

RITHOLTZ: As — as an employee, you start, you fill out. Here’s my health care choice, here’s my 1099 or — or W-2 tax choice, and now I got to deploy money in my 401k.

KINNIRY: Exactly. And so here’s 100 funds, you know, that you have to select from. And — and we call that unbundled, meaning that think about going into a restaurant and you’re at the buffet and you now have to pick — you know …

RITHOLTZ: Everything.

KINNIRY: … there’s — overwhelmed with choice.


KINNIRY: And we talked earlier about investor behavior. What you probably saw most often is investors buying the things that had great five and 10-year returns, and so investors …

RITHOLTZ: Five and 10 years, month or quarter was …


RITHOLTZ: … whatever the flavor of the month was everybody plows in.

KINNIRY: And so that’s a hard thing for the average investor to be successful. Target retirement funds now are the default option, as you mentioned, where you — it’s a basket of multi-asset class funds. So you …

RITHOLTZ: Stocks, bonds, et cetera, TIPS.

KINNIRY: Yeah. So in our — to talk about Vanguard target retirement funds, you virtually own the world. You own, you know, over 10,000 U.S. — you know, non-U.S. stocks, 3,000 U.S. stocks. You own the global equity and fixed income, and it stays rebalanced.

RITHOLTZ: Automatically throughout your life up until your retirement.

KINNIRY: Automatically, and it glides down in risk. And so you think about it’s starting out if — if — I’ll use my son …

RITHOLTZ: 90-10 as an example.

KINNIRY: Yeah. So my son just graduated from Bucknell. He joins the workforce. He starts out 90-10 and he glides gradually down through time. And on his last day of work, it’ll be 30-70.

RITHOLTZ: So here’s a question about that I’m — I’m intrigued by. People are living much longer. They need to have, I suspect, additional risk assets in order to carry them through their entire life span so they don’t run out of money. How our target date funds dealing with the rise in longevity stats amongst — forget your son, someone who’s 68 next week probably is going to live 25 plus years assuming they’re healthy at retirement?

It used to be that, all right, the average lifespan was 72, 74, we need just five years. Now you need 25 years. How do target dates adjust to that?

KINNIRY: Yeah. So we do a lot of modeling on, you know, sufficiency, well, this meet sufficiency savings on a life horizon of 100, you know, if not more in years. And so at 30-70, you think about 30 percent stocks, 70 percent bonds, in most environments, is going to, you know, give you a real return over inflation that’s going to last you, number one.

And number two, this is not meant to be 100 percent. Most clients or people that use them …


KINNIRY: … will have social security …


KINNIRY: … or at least they have it today, and we hope that they’ll have it tomorrow. That’s a different topic for a different day, but …

RITHOLTZ: Yeah, I think that’s career suicide for any competition who wants to vote against that because — because the retired, they vote.

KINNIRY: Exactly.

RITHOLTZ: The young kids today, they’re voting more than they used to but they’re still far below their numbers, so I can’t imagine anyone is foolish enough to, yeah, let’s give it a social security. That is just political career suicide.

KINNIRY: Yes, I totally agree. And so I think the 30-70, we — we will continue to challenge that, so to your point, maybe if investors start living to 110 or 120, we’re not — we’re not fixed to that final …


KINNIRY: … allocation. We tested every year and we tested very thoroughly. But if we were — hypothetically, let’s say you wanted to take more risk, you know, you — risk is kind of a — a tradeoff of longevity risk …


KINNIRY: … versus capital, you know, depreciation. So if you get ’08, ’09 and you’re 40 percent versus 30 percent, you know, value at risk is going to be much. So you’re trading one risk for the other.

RITHOLTZ: Makes perfect sense. Let’s talk a little bit about bonds. We were discussing target date funds earlier. What does an investor, who’s looking for yield, do in the current environment? Interest rates are relatively low, inflation is relatively low, valuations on the equity side are relatively high. What’s an investor to do?

KINNIRY: Yeah, I think what an investor should do is, you know, really think about — then you asked me earlier on total return is don’t think about the individual components of your portfolio, so don’t look at bonds in isolation of stocks or stocks in isolation of bonds because what you see is some bonds. If you’re reaching for yield, it could have equity like beta to it. For example, if you’re going into high yield bonds or emerging market bonds and the equity market were to have a sell off, they’re going to have equity correlation to it. So …


KINNIRY: … you know, you really want to be careful if you were to do that because, you know, for most investors, bonds are to diversify to your equity risk. And we see that time and time again and we saw it in ’08, ’09. We saw it in the Internet tech bubble. We saw it in December of ’18 where we had that little mini sell-off where bonds have very nice correlation properties, meaning that they — they serve really well when equities are doing poorly. And so — but if you …

RITHOLTZ: It’s a ballast during a downturn.

KINNIRY: It’s a ballast during a downturn in most environments. I don’t want to say all environments. But certainly, in all environments, if you increase the risk of your bond portfolio, it’s going to look more and more like equities.

RITHOLTZ: So let’s talk a little bit about — all right, so that’s credit risk. What about duration and what about other bonds like TIPS that are indexed to inflation?

KINNIRY: Yeah. Duration is kind of a — it’s another one of those tricky areas because I think what most people don’t feel to understand is these risks are tradeoff risks. So if you wanted to increase duration, let’s just say increase duration, you’re taking on interest rate risk, right? So if I went from a five duration to a 10 and interest rates go up, I’m going to lose twice the amount of money because I went from a five duration to a 10.

But if you’re using duration in hope that if the equities go down and bonds are the ballast, you would double your returns in equity contagion in that environment.


KINNIRY: So it’s really what is the role of a bond portfolio. So, you know, there are some institutional investors, some pretty sophisticated investors that have lengthened duration because they really want the bonds to have that high, you know, negative correlation and positive offset to equities, but we are taking on is interest rate risk. So it is hard, you know, to kind of think about these risks and and — and make sure you’re talking about tradeoffs.

RITHOLTZ: So — so let’s talk about another tradeoff. We — we, in the United States, pretty much have the highest yields in the developed world, but we look at Japan, negative interest rates. We look at Germany, negative interest rates. We look at a lot of Europe, negative interest rates. First, is that possibly going to come here? And second, what can an — an investor do if they don’t want to pay for the privilege of — of owning bonds?

KINNIRY: Yeah. I mean, you know, what you mentioned is true. It is hard to believe that, you know, the U.S. market being, you know, actually offering some pretty good yields relative to some of the other high quality developed sovereigns that are out there. So I would — just would caution everyone, you know, regardless of how low rates go even if they go to zero or negative, what is the role of bonds in a portfolio?

If it is the ballast of the portfolio then trying not to stretch for yield, you know, kind of take what the market gives you, anytime we see people trying to engineer returns that the market isn’t giving you, that’s usually when they get themselves in trouble.

RITHOLTZ: Well, it worked out so well in ’08, ’09 reaching for yields.


KINNIRY: That’s …

RITHOLTZ: What — what — what could possibly — I remember hearing sales people pitch me on safest treasuries but paying 250 to 300 basis point more. Well, someone is either going to win a Nobel Prize or go to jail. There’s nothing in between.


RITHOLTZ: It’s — you’ve just changed the fundamental rules of economics. The only problem is no one went to jail, so I was not fully correct about that. So taking what the market gives you as opposed to reaching for yields, what does that do to that four percent drawdown calculus we talked about for people in retirement who need to take money out of their portfolio to live on?

KINNIRY: Yeah. And — and I think education and I think also the role of the advisor, the advisor is doing a great job educating their clients. The way I’ve always looked at total return is it’s a partnership between the capital markets and the investor themselves. And what I mean by that is, for a lot of periods, the capital markets did all the heavy lifting. The individual didn’t need necessarily to save as much.

And so if you’re thinking about this partnership of how much the capital markets is going to contribute to your total return versus how much you personally are going to contribute, if we are in a muted return environment, which I think is pretty much consensus, it’s certainly Vanguard’s outlook to have a muted return, then the partnership is going to have to come more from saving more, spending less and — and making sure that you’re doing your end of the bargain as the saver, work longer or, if not, just expect a lower retirement income stream in retirement.

RITHOLTZ: So I think investors may not have realized how lucky they were in the second half of the 20th century. That was a fantastic period of time if you were fortunate enough to be born, pick a decade, the 30’s , 40’s, 50’s, the next 50 years of your investing returns have been spectacular. We’re not likely to see that over the next 20 plus years or so, are we?

KINNIRY: Absolutely not. I mean, from 1982 to 1999 the stock market was up 18 compounded annually, and the bond market was up about 10.

RITHOLTZ: Eighteen percent a year?

KINNIRY: Eighteen percent a year.

RITHOLTZ: I know that Dow went up about 1,000-point …


RITHOLTZ: … 1,000 percent over that time.

KINNIRY: So you then got a balanced investor over that time and you used the demographic of being born in the 30’s. If you were at your peak earning or near — near retirement and you were able to get 14 percent from a balanced portfolio …

RITHOLTZ: I’ll take it.

KINNIRY: … I’ll take it right now.

RITHOLTZ: Right, for sure.

KINNIRY: And — but I think one other thing is people have to understand is if you are saving to eventually spend it or gift it, you have to think about real returns.

RITHOLTZ: Meaning after-tax returns.

KINNIRY: After — after-tax and after inflation.


KINNIRY: So in that environment with I — my — my mom is always saying, oh, I want to go back to those days where CDs were 18 percent …


KINNIRY: … and I — and I say, Mom …

RITHOLTZ: Twelve percent inflation.

KINNIRY: … but — but — but interest — you know, inflation was 15 percent so you got …


KINNIRY: … three net. So I think, you know, in this environment you also have to understand that inflation is quite low.

RITHOLTZ: So it’s a little misleading.

KINNIRY: It is a little bit misleading.

RITHOLTZ: It — it was better than — but once you back out inflation it wasn’t as — it — it looks much better than it was. It was still better , but not as overwhelmingly better than today. Is that the implication?

KINNIRY: Yeah, that’s right. Let’s say that the stock market gets you five to seven percent hypothetically in the bond.

RITHOLTZ: Don’t go by the first half of this year. We’re up 22 percent.

KINNIRY: Exactly.

RITHOLTZ: That’s an — but you look — the — the — that’s year-to-date, you look the previous 12 to 18 months, it’s essentially flat.


RITHOLTZ: So — so five to seven percent going forward, is that a reasonable expected return?

KINNIRY: Yeah, I think if you think about a 10-year horizon and — and then if you say you’re 60-40 or, you know, we can pick whatever ratio you want …


KINNIRY: … in stock bonds, two to three on bonds, you know, all of a sudden a balanced portfolio is probably closer to four percent, right?

RITHOLTZ: Net of inflation you mean.

KINNIRY: Well, it’s probably nominal. And then if you add in …

RITHOLTZ: Oh, really?

KINNIRY: … 1.5 to 2 inflation, your — your real returns …

RITHOLTZ: Two to three percent?

KINNIRY: Two to three percent …

RITHOLTZ: That seems light.

KINNIRY: … where the periods we were talking about before for someone born in the 30’s and the 40’s was probably close to …


KINNIRY: … five to seven percent.

RITHOLTZ: OK. Wow, that’s a big difference.

KINNIRY: So — and that’s going to really — then what is the education coming out of that? You can’t choose when you are born.


KINNIRY: Right? So this idea of taking what the market will give you the person today who’s going to look at the future with reality that it is, they’re going to have to save a little bit more.

Back to our — you know, talk about our retirement funds, we do think with auto enroll, auto save, auto escalate, and companies matching, they’re in a much better position to maybe generate those kind of returns on their own behavior.

RITHOLTZ: And — and so it takes the behavior component and bring it back to Advisors Alpha, we seem to be much smarter these days about understanding our own emotions, our own biases and why investors are typically their own worst enemies. And this is anecdotal, but my observations are people seem to be doing a better job of not blowing themselves up the way they did so much in the 90’s and 2000’s. They still messed up in ’09, and we — we saw a lot of people dragging their feet in 2010, 2011, 2012 to get back into the market. But on average, is it fair to say people seem to be a little smarter about their own behavior and how it impacts investing?

KINNIRY: Yeah. You’re exactly right. So we — I mean, the Advisors Alpha worked that my team and I work on and created, we created the Vanguard Risk Speedometer. And the Vanguard Risk Speedometer looks at cash flow through time. And so what we actually have seen is that throughout most of history, investors would be known as momentum investors, meaning whatever risk category or sector was doing well, that’s where all the flows went.

RITHOLTZ: The hot hand. You’re talking about fund flows to different mutual funds.

KINNIRY: Fund flows to not only the funds, but the categories.


KINNIRY: Let’s say growth, value, U.S., non-U.S., emerging stocks and bonds. And that was a theme that was pretty much is, you know, the sun coming up, you know, tomorrow. That was a …

RITHOLTZ: The — the church of what’s working now.

KINNIRY: The church of what’s working now, and so investors — you know, whether you want to use procyclical or momentum-based wherever they — wherever the hot hand was or the asset class, that’s where the flows have gone.

The last five to six years we’ve seen behavior, believe it or not, contrary into that, which is — which is hard to think about. So right now you think about, you know, the — the — the top performing category in the U.S. is large cap growth, it’s actually one of the bottom cash flow categories.

RITHOLTZ: Really? So if it’s not going into large cap growth, it’s going to value and small cap?

KINNIRY: Well, it’s actually going into fixed — like so who would have ever — I would have never thought in my career that we’d be in one of the largest and longest bull markets in equities, 20 percent trail in six months and you have negative equity flow year-to-date, you know, in equities year-to-date in August and all the money going into fixed income. So …

RITHOLTZ: That’s a big contrarian play.

KINNIRY: And — and to me, that’s a compliment to the education, to the advisor community to back to target retirement funds. I think what has really changed is it went from the fund picker world where people were picking stocks and building a portfolio bottom-up to a top-down way, meaning …

RITHOLTZ: An asset allocation model.

KINNIRY: Yeah, you know, so whether it’s — whether it’s, you know, target retirement funds, advisors such as your — your firm and the firms out there, the amount of money that are in these systematic auto rebalance programs …


KINNIRY: … ETF models that, by definition, if stocks are up, they’re going to sell stocks and put them in bonds.

RITHOLTZ: Isn’t — isn’t there a ton of research and data — and I’m trying remember if it was you or your firm or another from that basically had reached the conclusion that stock picking as much fund and interest as it can be, the asset allocation decision is far more impactful to the portfolio returns over time.

KINNIRY: Yeah. And so going all the way back to Brinson, you know, so Brinson has covered this work. Jahnke has covered this work. Me and my team actually covered the — the Brinson-Jahnke debate, which is really about how much of the return is coming from policy and asset allocation versus security selection and timing. And — and so both — both of the arguments are right, right? So and this is where our context is important.

If you’re 60-40, Barry, but you only have two stocks and I’m 60-40, and I have two stocks but those stocks are different, then security selection drive, the policy doesn’t quite matter.

RITHOLTZ: But when we’re 60-40, your 60 percent broad index isn’t 40 percent, you know …

KINNIRY: Correct, but I just want to think of a context.


KINNIRY: When — when you’re talking about broadly diversified …


KINNIRY: … portfolios that what you …

RITHOLTZ: The asset allocation decision …

KINNIRY: … the asset allocation drives everything.


KINNIRY: Timing decisions and which mutual funds or securities you selected get almost to be, you know, decimal places relative to the policy portfolio.

RITHOLTZ: Can you stick around a little bit? I have a ton more questions for you.

KINNIRY: I’d love to, I love this.

RITHOLTZ: We have been speaking with Fran Kinniry. He is the Head of Global Portfolio Construction at the Vanguard Group. If you enjoyed this conversation, well, be sure and come back for the podcast extras where we keep the tape rolling and continue discussing all things asset allocation. You can find that at Apple iTunes, Google Podcast, Stitcher, Spotify, wherever your finer podcasts are sold.

We love your comments, feedback and suggestions. You can write to us at Give us a lovely review at Apple iTunes. You can check out my weekly column at or sign up for my daily reads at Follow me on Twitter @ritholtz. You might guess.

I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio.


RITHOLTZ: Welcome to the podcast. Fran, thank you so much for doing this. You and I have net on — on several occasions previously, and I’ve been a fan of your work and obviously, I am a fan of Vanguard for a long time, but I’ve been meaning to sit down with you for forever and I’m glad we finally got you into New York from — from Pennsylvania.

I have a ton of questions I didn’t get to during the — during the broadcast portion, but the first one is a little funny and I have to ask you about this because it’s such a ridiculous statistic. I either heard or read somewhere it’s one of these like urban legends, Vanguard has 97 percent of the certified financial planners in the state of Pennsylvania. Is that remotely possible? Is that true?

KINNIRY: It’s — it’s probably. I can’t confirm the exact number, but I would imagine we have a high percentage. So, you know, I think context is in order. We’re probably one of the largest employers in — in that area and in …

RITHOLTZ: In finance in Pennsylvania …

KINNIRY: … in financial services …


KINNIRY: … so we’re likely to have maybe 97 percent of the CFAs in the community.


KINNIRY: I mean, even 97 percent of the phone representatives in financial services. I think it’s our size and it’s also our dedication to advice and why we think advice really matters, and our commitment to, you know, having professional advice.

RITHOLTZ: Let’s talk a little bit about that advice because there’s some really interesting debates back and forth with that. Who needs a financial advisor? So I — I get this question all the time and my answer is, well, if you could do it yourself, do it yourself. But you have to be disciplined, you have to know yourself, you have to manage your own behavior and you have to put a little time and elbow grease in, but it’s not hard, it’s doable. But not everybody seems to be able to manage yourself.

So the question is who should have an advisor out of — out of people who have been self-directed and are not happy with — with what it’s taking? How do you decide who should really be working with an advisor and who should be doing this themselves?

KINNIRY: Yeah, I mean, and not to be too curt with it, but I do think if you’re human …


KINNIRY: … because of emotion, you probably most — the vast majority of clients — will be well-served working with an advisor.

RITHOLTZ: Really? That’s a big — when you say vast majority, that’s a bigger number than I was expecting from you. And I …


RITHOLTZ: … I don’t mean to tee up softballs.


RITHOLTZ: But you’re — you’re answering this in a way that was different than — than I expected.

KINNIRY: Yeah. I mean, I’ll give you a great, great little story of my brother, and I — and hopefully he doesn’t listen to the show, but I’ll throw one of the smartest individuals I know. He’s Head of Medicine at Penn so, you know, Columbia Med School, Penn Med School …

RITHOLTZ: Just skating through school.

KINNIRY: … very, very smart.


KINNIRY: Ten years ago he calls me up and, you know …

RITHOLTZ: Ten years ago like middle of the crisis.

KINNIRY: And he calls me and says, “Hey, look, I’m — I’m like literally the worst investor ever. I studied this. I put so much time into it. Vanguard has the — you know, his 401(k), so he’s in the right place.


KINNIRY: So he’s in the right funds, right place, but he himself who studies it is — is shooting himself in the foot …


KINNIRY: … because he studies this analytically like he would study anything else he would study in school.


KINNIRY: And what we know — I wrote a paper several years ago about decision-making, right? And so decision-making, there’s a lot of credibility on persistence, meaning that what — you know, if your top doctors, top hotels, top restaurants tend to stay top.


KINNIRY: The investment market, you know, asset classes, strategies, there is not that same persistence, right?


KINNIRY: You see almost some …

RITHOLTZ: It shifts regularly.

KINNIRY: … some reversion and no patterns to it. And so most investors, well, you know, it is a rare person that — who in 2008, 2009 — you know, back to my analogy earlier, you have a million in stocks, a million in bonds, 50-50 investor, you just lost $500,000 in stocks and you’re going …

RITHOLTZ: Buy more.

KINNIRY: … you’re going to sell bonds that are actually doing well and buy $250,000 in February of ’09.

RITHOLTZ: Not easy, not easy to do.

KINNIRY: Yeah. There — there are obviously some investors who can do that or maybe some investors who will use a single fund solution. We talked about target retirement funds or balanced funds that do it for you. But a lot of investors would be, you know, benefit from working with an advisor to not only help them with emotions but, you know, retirement income, tax planning, you know, generational planning, so I think it’s more than most people would think.

RITHOLTZ: So your brother — doctor, you’re saying?

KINNIRY: Doctor and he’s with an advisor.

RITHOLTZ: So — so my experience with doctors — and I’m going to say this very specifically so you can send your angry emails to me.


I have found that doctors are exceedingly bright. They’ve been very studious their whole life and they are genuinely surprised when all that intelligence and all that studying does not rarely translate to investing, and they find it to be very frustrating. And I’ve actually said to doctors, “Listen, I — I have to cut the conversation short, I’m going to Wikipedia to learn how to take out a gallbladder and I have surgery this afternoon.”

And haha, it’s funny, but the reality is, OK, this isn’t brain surgery, but it’s not the sort of thing that you could do casually. And very often because doctors are so successful and they’re so smart and they’ve done so well educationally, there is a lack of, hey, maybe this is harder than I think. Am I overstating this or …

KINNIRY: Yeah. No, absolutely. And I — and I follow all the behavioral literature and all the behavioral finance stuff and sometimes I think it’s quite critical on investors, but I actually reframe that. I actually think how would you — how would any other intellectual person decide to put their money in the worst performing asset class. And that’s what rebalancing is, right?

RITHOLTZ: Well, mathematicians maybe but — who understand mean reversion, but everybody else are horrified by that.

KINNIRY: Yeah. And so I think, you know, outside of your own personal health, Barry, think about what’s most important. You have health, you know, your family and then your wealth, right? And so …


KINNIRY: … you know, wealth destruction or wealth in the moment is not just on the downside. Look at all the mistakes people made in ’98, ’99 in the Internet tech (inaudible).

RITHOLTZ: Piled in.

KINNIRY: Piled in.

RITHOLTZ: At the top, absolutely.

KINNIRY: You know, we — you know, we — we talked about how changing cash flow, never in the history of the markets that we have five years in a row with 20 percent return.

RITHOLTZ: It was — it was just insane.

KINNIRY: And we had negative bond flows in ’98, ’99. All the money was going into stocks. So, you know, I think …

RITHOLTZ: Which, by the way, you were about halfway through a multi-decade bond bull market that, for big periods of time, significantly outperformed equities.

KINNIRY: Yeah. And so — and so I do believe that the vast majority of clients would benefit from advice. The good news is, you know, the — the access to advice, you know, 10 years ago, 15 years ago, access to high-quality advice was pretty limited, right? You needed maybe a million or two to get access to world-class advisors such as yourself. But, you know, as technology has come around, I know your firm is, you know, offering different solutions. It doesn’t have to be …


KINNIRY: … high-touch, it could be more tech automated advice. So advice is now becoming much more tech-enabled and so …

RITHOLTZ: For sure.

KINNIRY: … the ability to get advice for a $50,000 or a $10,000 investor is here and the cost have come down on that, so I think, you know, given that change, you know, a huge opportunity for self-directed investors to use advice.

RITHOLTZ: So one of the things that you mentioned earlier I want to just address, when we talk about things like generational wealth transfer or state planning or more complicated tax planning or — or even a sale of a business, you’re paying for that when you’re paying an advisor. I’ll use the one percent fee because that’s pretty standard these days. But if you’re a — a $100,000 or even a $500,0000 portfolio and you don’t need all those extra services, why pay the one percent or more? You’re better off in — if you can work with the CFP we’ll help you do the planning, but automate is much of that technology and the fee is half or less. Why wouldn’t you do that? Why should you pay for, you know, advice on setting up a philanthropic trust if you’re not going to do that? People sort of forget that — that this can be a little ala carte and you don’t need to pay for everything if you’re not going to use it.

KINNIRY: Totally agree. And that’s why I think, you know, this is really the golden opportunity for investors because, you know, we talked about access. In the past, it was really a reserved space …


KINNIRY: … for clients of the ultra high net worth in the institutional marketplace, and they had a very high touch, and — and they — the advisors added a lot of value from some of the things you mentioned of succession planning, making sure your will and your state is in good order, all of those things. But now for the average individual that doesn’t have all those needs, you know, advice is here for the masses, and — and I think it’s a very good value for those who want to, you know, employee an advisor, whether it be tech-enabled or a hybrid.

RITHOLTZ: So one of the questions speaking of technology I didn’t ask you about, one of the new technologies that have been rising is direct indexing where instead of owning an ETF or a mutual fund, you own the entire index but in individual stocks, and this seems to come up when someone has a concentrated risk in a given space or a given — so hypothetically, you’re an employee of Apple and 20 percent of your net worth is an Apple stock. Do you really need more Apple in — in your index?

With a direct index, you could tune down Apple or any of the other tech names similar to that. Have you — has Vanguard looked at this and — and what are the thoughts about this?

KINNIRY: Yeah. I mean, we looked at it a lot. There’s other reasons, too. You mentioned the single stock risk like Apple. There’s been some — people believe that it’s more tax-efficient. Other people that may, you know, want to think about excluding certain sectors of the market.

RITHOLTZ: Well, the ESG side, the social responsible side, you can be a little more granular …


RITHOLTZ: … than you can with broad indexes.

KINNIRY: Right. Yeah, a couple things I would say. One is what is the cost? You know, if — if you can get an index, a broadly based, so let’s take the Apple example. I’m an employee of Apple. Apple is 20 percent of my portfolio. Do I really want more Apple?

Well, if I were to just buy the total Vanguard U.S. stock market, my position in Apple is only adding another 2.5, 3, 3.5 percent. And do I want more of it? No, but that’s like a pretty small amount. And I guess, it would really be what is the cost differential to do self-directed indexing? And then how do I keep that rebalanced through time, right, because the great news about an — an open index fund is we can use other investors cash flow in and out to keep that portfolio rebalanced the minute you’re now creating a separately managed direct index.

The market is moving all over. You may have cash coming and going. It’s — it becomes much more complicated, and that’s where you lose some of the — you know, this idea that it’s more tax-efficient. We’ve done some work on that. Actually, it is — it would actually be a little less tax-efficient because you get locked up in your basis …


KINNIRY: … and the market moves away from you, so indexing has been extremely tax-efficient.

RITHOLTZ: For sure.

KINNIRY: ETFs have been extremely tax-efficient. So a lot of the direct indexing things we hear out there are very niche or actually they’re actually not correct.

RITHOLTZ: And since you’re talking about tax-efficiency, I have to talk about one of my favorite stories of this year because it’s just so wild and unexpected, and that’s the Vanguard patent on making mutual funds almost as tax-efficient as ETFs.

And a little background for people who may not follow this sort of arcane tax stuff, the huge advantage of ETFs is that they’re incredibly tax-efficient. If other people buy or sell holdings with an ETF, it doesn’t matter. It’s only when the investor sells that ETF that there’s a potential tax event. But you can own a ’40 Act fund, you can own a mutual fund. And if within that fun there are takeovers or sales or whatever else happens where there’s a capital gain, that passes straight through to the investor.

Vanguard — I want to say this was early 2000’s; we just heard about it recently or mid 2000’s — came up with an idea that allowed ETFs to effectively be a different share class of mutual funds and are able to share that tax-efficiency between ETFs and mutual funds. Am I — am I doing that justice or have I mangled that completely?

KINNIRY: No, no, I mean, no, you know, a couple things on that is so why indexing, in general, is very tax-efficient doesn’t really necessarily have to do with its structure or our patent because others, you know …

RITHOLTZ: An ETF wherever you go.

KINNIRY: And so — and so what the — you know, what happens with an index fund is that, you know, adds into — first of all, it’s broad indexing, right, because there’s not a lot …


KINNIRY: … of adds and deletes. And when you are getting deleted, you’re almost getting delisted.

RITHOLTZ: Unless there’s a merger or a takeover, right?

KINNIRY: And that’s a merger or takeover.

RITHOLTZ: And that’s usually where you see some capital gains.

KINNIRY: And that’s where you see some capital gains, but — so those are more of the rare instances. You know, where you see more inefficiencies would be the — the niche sector ETFs or …


KINNIRY: … you know, so there you have graduations. And that’s why active sometimes …

RITHOLTZ: Meaning they go from small cap to mid cap or mid capital or to large cap.

KINNIRY: Or growth to value …


KINNIRY: … you know, stuff like that. And that’s where even active has some tax inefficiencies relative index because …


KINNIRY: … if I no longer like Stock A, I don’t necessarily care what my cap gain is because I have also have tax-exempt — I have tax-exempt clients, I’m really just trying to add excess returns …


KINNIRY: … not necessarily thinking about a taxable entity.

RITHOLTZ: They don’t — most active funds are not really focused on tax-efficiency.

KINNIRY: Exactly. And so why indexing is so tax-efficient in general is because they own a market.


KINNIRY: And the adds and deletes are quite small, only due to this merger.


KINNIRY: So that’s where indexing and ETFs, whether they’re a mutual fund form or in ETFs have been very tax-efficient over the last 20, 25 years.

RITHOLTZ: But your patents specifically — so where — no matter what company you buy an ETF fund, you’re — an ETF from, you’re not going to generate an unintentional tax consequence merely by owning it.

KINNIRY: Correct.

RITHOLTZ: It’s only when you sell it. But mutual funds have that. Your unique patent allows mutual fund holders in taxable accounts to effectively reduce their tax bases dramatically.

KINNIRY: Right, it’s a share class of their fund. So they — you know, they would end up sharing in — you know, in that because it’s — the ETF is a share class off of the mutual fund.

RITHOLTZ: So — so because of that somehow the tax savings from within the ETF managed to work backwards to the mutual fund. Is that fair?

KINNIRY: Yeah, and vice — and vice-versa, right? So the mutual fund with an ETF starts with no assets, the mutual fund — you know, so it’s — it’s a …

RITHOLTZ: So you immediately get a track record, you immediately get some real assets so you’re not launching an ETF, which seems to be a problem with ETFs. You’re not launching it with no track record and …

KINNIRY: Correct.

RITHOLTZ: … no assets. So right away, Vanguard ETFs — and this is a fairly unique structure making ETFs not a standalone but a share class of a core portfolio or a model portfolio.

KINNIRY: That’s correct.

RITHOLTZ: Is that a fair way to say it?

KINNIRY: That’s correct.

RITHOLTZ: But it’s the tax-efficiency that reverts back to the mutual fund that’s really somewhat unique also.


RITHOLTZ: And that patent expires this year, next year, soon?

KINNIRY: Yeah, soon, yeah.

RITHOLTZ: So should we expect to see more tax-efficiencies at other mutual funds or other companies either looking to do this themselves or license it from you?

KINNIRY: Yeah, I think back to our early conversation, I think the reason why indexing in ETFs are so tax-efficient is back to the original structure of owning everything without …


KINNIRY: … a lot of adds and deletes. What you’re talking about is — is very, very, very small advantage so I don’t — I don’t see it changing much the landscape of helping or hurting either complex, you know, the industry (inaudible) …

RITHOLTZ: I just thought it was so fast and …


RITHOLTZ: … such a — and that came from your now retired CIO …

KINNIRY: Gus Sauter.

RITHOLTZ: Right. And — and that was really — I thought it was very clever idea. What about alternatives to assets under management fees, AUM fees? Things like flat fees or hourly fees, how do you guys look at that trend within the advisor space/

KINNIRY: Yeah. I mean, we he always hear a lot of talk about flat fee or hourly fee. We haven’t seen it grow much. I mean …

RITHOLTZ: It’s hard to scale, isn’t it?

KINNIRY: It’s hard to scale. And I also think that advisors earn their, you know, money episodically. And what I mean …


KINNIRY: … here’s what I — here — here’s an example I’ll use.

RITHOLTZ: Like — like ’09.

KINNIRY: ’09, right. Let’s — I — I — I show this in the Advisors Alpha paper that if you were, you know, 60-40 and you were unable to keep your investor, I called you up, I was a client of Ritholtz hypothetically and I’m 60-40 and I call you up and I’m like, “You know, Barry, I just can’t take it anymore, I just lost 50 percent.” And you weren’t able to you influenced and convinced me to stay, and I went to money market. I went all out.


KINNIRY: And a lot of clients did that. We saw — you know, money markets reach about 50 percent on household balance sheets in February of ’09.

RITHOLTZ: That’s across the entire investment world.

KINNIRY: Across the — all investors in ’40 Act funds. So — and then if I just had stayed in that position, that was a hypothetical situation but if it did happen, you know, the returns differential between doing that, you keeping me 60-40 …

RITHOLTZ: Oh, God, it’s giant.

KINNIRY: … versus — it’s — it’s — it’s — it’s about 100 — you would have earned 100 years versus your one percent fee …


KINNIRY: … in one phone call.

RITHOLTZ: Amazing.

KINNIRY: So I — I do believe that the fee — you know, are — is — let’s say you have a million dollars with one percent, that’s $10,000 a year, you’re earning $10,000 every single year, you know, maybe, maybe not depends on what you do.

RITHOLTZ: It’s episodic.

KINNIRY: It’s episodic and it comes in huge waves.

RITHOLTZ: You know, it’s funny, I — I was getting emails in 2010, ’11. But by 2013 they started to trickle down, but it was — I’ve been reading you forever. I follow you out of the market in ’08, but when you jumped back in in ’09, I thought you were crazy and now I’m paralyzed, I don’t know what to do. And I’ve missed 50, 60, 70 percent of gains, what do I do?

And you can’t — even though the math is just put the whole thing in as a lump sum, people can’t do that emotionally. Hey, break it up into four quarters. Scale your way in over a year and then just continue making contributions after that.

The only advice I found that works for people because they’re still suffering from PTSD post financial crisis, what did you guys see after the crisis from people?

KINNIRY: Yeah. I mean, the good news is that Vanguard, you know, a lot of investors read our education and — and back to the role of an educator, the role of advice, so our behavior at — at — at Vanguard was — certainly not, we weren’t — we weren’t seeing huge flows into equities and now the bonds, but it was much more balanced, much more muted relative that we saw in the industry.

RITHOLTZ: Let — let me interrupt you right here because I have to share a story from your former CEO and Chairman Bill McNabb who word got back to him that employees were nervous about getting fired and that nervousness was being communicated to clients and sent out a missive, “Nobody is getting fired. Everybody’s job is safe. Your job is now is when you earn your money. Your job is to keep clients informed and happy and let them know this too will pass.” And that turned out to be a key turning point in Vanguard attracting a ton of assets.

KINNIRY: Yeah. I think we’ve always kind of had that, you know — you know, stewardship, you know, is the word of — you know, we’ve been through many cycles at Vanguard. You know, and so I think, you know, every cycle is different. But again if — if you like stocks in ’07, it was hard not to like stocks in ’09, and so, you know, the theme of staying the course and rebalance, I think, was a very, very good advice for investors who follow that.

RITHOLTZ: And — and before we get to my speed round questions, the last question I have to ask you, you mentioned technology sort of implying about robo advisors. What is it that human advisors can do that computers can’t?

KINNIRY: Yet I still think this debate on robo versus hybrid versus high-end service gets again maybe out of context. I’m a big believer of, you know, what does the client want, right? And I used my son and — and my brother already in — in — in this story. My son has a cell phone, but he never talks on it.


KINNIRY: He’s — he’s on the apps. And he might, you know, be more comfortable in a robo automated digital advice than actually coming in and sitting down with you or Josh, right?


KINNIRY: My brother who’s, you know, our age, you know, he’s used to probably wanting to sit face-to-face and have a coach help him through things in — on a couch or in a conference room and talk through that. So, you know, I think it really gets back to what is the investors’ experience, what do they want. Do they want a digital offer? Meaning, all robo. Do they want to work with a CFP or a CFA, or do they want to have a very high-touch engagement?

And so I think the great news is is now investors have choice …


KINNIRY: … and — and there’s not that one is better or — or it’s really what does the client want and how do they want to engage in your services is the key point.

RITHOLTZ: Do you think it’s segmented? You’re implying it’s segmented almost generationally. If you’re over 60, you want one experience. If you’re 40 to 60, it’s something else, and then there’s a very different group of investors under 40. Is that a fair way to — to break that up? And do they really want very different things ultimately?

KINNIRY: Yeah, it’s probably a stereotype, but it probably does, you know — you know, hold to some extent. If you didn’t grow up with technology or you didn’t grow up with, you know, taking advice from, you know, an app that maybe you’re less inclined that if you actually grew up in that environment …


KINNIRY: … so I think it’s a — it’s an overgeneralization. So will there be a — a demographic that is in retirement in their 70’s and 80’s that are very comfortable using digital? Absolutely. And are there millennials who would, you know, more than we want to sit down face-to-face and work with a human? Absolutely. But on average, I think it’s kind of what you’re used to and what you grew up with that will probably have a big pull on who will select what.

RITHOLTZ: Quite, quite fascinating. I know I don’t have you forever, so let me get to some of my favorite questions that I ask all of my guests. Tell us the first car you ever owned, year, make and model.

KINNIRY: My first car — and it wasn’t a classic yet, it was a — so it was a 1967 Mustang. But, you know, at the time, that was, you know — I bought it for under $1,000 with my landscaping money and …

RITHOLTZ: (inaudible).

KINNIRY: Yeah, it was — you know, had I known what would eventually come to be …

RITHOLTZ: Right. It wasn’t a GT350 or a 500, it was just a standard …

KINNIRY: Just a straight …

RITHOLTZ: … Fastback.

KINNIRY: … you know, Fastback.

RITHOLTZ: Yeah, those are still handsome cars.


RITHOLTZ: And you can now get them with 700 horsepower …


RITHOLTZ: … if you want, and a live rear axle as opposed to those old truck. Your car had effectively a — a solid truck axle in the back.

KINNIRY: Yes, it did.

RITHOLTZ: So that was a — but it was a very handsome car. I — I know you’ve seen the movie Bullet, right?

KINNIRY: Absolutely.

RITHOLTZ: Repeatedly. That was — that was effectively your car, right?


RITHOLTZ: What’s the most important thing that people at Vanguard don’t know about you.

KINNIRY: I think the most important thing that people may not know is being at Vanguard and — and — and really working very — I’ve been — I think I’m the luckiest person at Vanguard because I got to work …


KINNIRY: … really closely with all four CEOs, so I — I got to …

RITHOLTZ: You started with Bogle.

KINNIRY: I started with Bogle and we had a French (ph) up until his passing away. We would have lunch. Jack Brennan and I worked …

RITHOLTZ: (inaudible).

KINNIRY: … together very, very closely. A lot of people don’t really understand that, you know, Jack Bogle started Vanguard, but Jack Brennan, a lot of the things that are driving Vanguard …


KINNIRY: … and outcomes for clients today, Jack Brennan …


KINNIRY: … started target retirement funds, ETFs.


KINNIRY: … advice. So Jack Brennan, you know, and I were, you know, extremely close, you know — you know, a mentor in some respects. Bill and Tim, I worked very close with Tim long before he was CEO, so I’ve worked — you know, so I feel I’m more than lucky to these things. And being close with Vanguard, I think a lot of people think that, you know, Fran is an index guy, of which I am, but I actually started out in active and a big believer in active.

We already talked about zero-sum game, so I think it gets back to talent and costs, and so I started out as, you know, a bottom-up stock picker at a deep value firm, and so that’s kind of my roots and my training is, you know, how do you tear a company apart and find out what its intrinsic value is. So coming from Vanguard who’s known for indexing, I think most people don’t know that my training — my formal training was in active management.

RITHOLTZ: And I don’t want to digress too much to Tim Buckley, but he’s got a fascinating career path at Vanguard, started as Jack Bogle’s intern. Is that a fair way to describe?

KINNIRY: Yeah, Jack Bogle’s assistant.

RITHOLTZ: Right, and then worked his way through both technology and CIO. That’s a really interesting career path to CEO.

KINNIRY: Well, yeah. So, you know, so Tim and I worked together very closely so Jack Bogle’s assistant. Then he was in the I.T. and then became the Chief — CIO, Chief Investment Officer.


KINNIRY: Then actually ran our whole retail and has — really has a big hand in our advice. You know, you know, Tim’s hand in — in our advice offer his hands are all over that and his vision to see advice then became the CIO, and now he’s the CEO, one of the smartest. You know, Jack Brennan and Tim are probably two of the smartest people I’ve ever been blessed to be around.

RITHOLTZ: You — you mentioned Brennan, you mentioned Buckley. Any other mentors you want to bring up?

KINNIRY: So my — my career — well, first, my parents. You know, my parents, I think, you know, really gave my brother and I an unbelievable head start and — and that we came from pretty modest means, but they really stressed education. And so I would, you know, be remised without talking about them.

My kids, I’ve learned as much from my five kids as probably pretty much anybody, just the good nature and humility of them. And then maybe my first boss, my first boss coming out of a business school was Terry Gabrielle (ph). He’s the individual who ran the billion dollar RIA firm that was Executive Investment Advisors was the name of our firm.

RITHOLTZ: What about investors who influenced your approach to analyzing companies and thinking about portfolio construction?

KINNIRY: Yes, so on the valuation side, certainly Graham-Dodd, you know, read all the work on Graham and Dodd. Mario Gabelli, you know, is — is the name …

RITHOLTZ: Oh, really?

KINNIRY: … you know, so again being, you know, deep value, Munger, Buffett, so I think of them really on the valuation side of the house. But then on the behavioral side, you know, Kahneman and Tversky, Thaler, there’s huge readers and consumers of all the work that they have done.

RITHOLTZ: Quite, quite interesting. Let’s talk about books. What are some of the books you enjoy reading, finance, non-finance, fiction, non-fiction? What — what do you like to read?

KINNIRY: Yeah. I would say “Fooled by Randomness” by Taleb.

RITHOLTZ: Sure, and seemed to love for sure.

KINNIRY: Probably my most favorite — but then back to, you know, Tversky so, you know, “Judgment Under uncertainty.” That’s one of the very earliest books, so 1982 is when they wrote that book. Annie Duke …

RITHOLTZ: “Thinking in Bets.”

KINNIRY: … “Thinking in Bets,” you know, just an incredible way to think about resulting. You know, because I’m a big believer, you know, before she actually framed it in that way of thinking think about what is your process …


KINNIRY: … and does your process seems sound and then, you know, not necessarily resulting or always thinking about, you know, was your decision right in changing your progress? If your process is right, you’re going to get your results that it’s not 100 percent probability.

RITHOLTZ: It’s a probabilistic approach, and that means sometimes you’re going to do the right thing and — and lose.

KINNIRY: Exactly. So those will be — you know, what I’ve read, you know, consistently. You know, I’m a consumer of reading books over and over again so …

RITHOLTZ: Oh, really?

KINNIRY: … those are books I probably have read, you know, multiple, multiple times.

RITHOLTZ: Quite interesting. Tell us about a time you failed and what you learned from the experience.

KINNIRY: Yes. So I’m a huge music buff. I love going to live events. And as a teenager, I — I so wanted to have a career in music.


KINNIRY: And so I took guitar lessons. I was one who didn’t fail, you know, easily. I failed a lot, but not easily, and so I kept trying and kept trying for years. I just did not have the music gene.


KINNIRY: I think I have the music ear, so I — I — I — I — I can identify maybe talent early, but I just — as hard as I tried. So the idea of grit and persistence, you know, I — I really tried my hardest but I just missed the musical gene.

RITHOLTZ: The — you mentioned you and I have something in common. You go to a lot of shows. What have you seen recently? I go to a ton of live music events.

KINNIRY: I have a very eclectic so …


KINNIRY: … most you may not even know of.


KINNIRY: So Kamp (ph).


KINNIRY: Hop Along.

RITHOLTZ: So now you’re way out there.

KINNIRY: Yeah. So I — I mean, I’m …

RITHOLTZ: Is that country or is that …

KINNIRY: No, it’s progressive.


KINNIRY: So I’m a mix of indie, rock, progressive. But I — I see — you know, I’ve been to 50 Cent, Eminem to seeing Adele’s opening act.

RITHOLTZ: Oh, really?

KINNIRY: So I saw — I was lucky enough to see Adele before anyone knew who she was in a small arena of 2,000 people. So I probably go to 20 live concert events, and I’m also a big live sporting event person, you know, mostly Philadelphia fan but — so I love live events.

RITHOLTZ: The — I just — the Sunday before we recorded this I just saw The Who …


RITHOLTZ: … as part of their –their farewell tour. But it’s nice being in or near a big city because everybody eventually passes through Philadelphia, everybody eventually passes through New York. You could go to a different show every single night and not see the same band twice.

KINNIRY: Absolutely. And I’m more close to New York, too. I’m only an hour train ride so I get into New York quite often as well.

RITHOLTZ: What do — what do you do for fun? You mentioned you go to live shows. What else do you do?

KINNIRY: Yes, the live shows and then five kids. My — my — my five kids …

RITHOLTZ: So you’re busy.

KINNIRY: … are — you know, and to me, it is a hobby, you know, going to all their sporting events and their extracurricular events. I’m also a big workout person, so I have always been into, you know, weight training and running and anything outdoors. To me, that’s my hobbies.

RITHOLTZ: What are you most optimistic and pessimistic about within our industry?

KINNIRY: I’m very optimistic about the continued democratization for investors. And what I mean by that is, you know, 10, 20 years ago we talked a lot about access. You really needed to be a large institution or a very high net worth to get world-class investments and world-class advice, and so I’m very optimistic for — and investors to get world-class outcomes. And so whether it’s you’ve seen, you know, pricing go from bid-ask the spreads of halves and quarters to decimals, commissions go down, product go down, advice minimums go down, so to me, it’s all about the end investor. I always wanted to do investments and I also wanted to be helping my clients, and so I am very optimistic about the continued democratization of giving investors a fair and fair shake to get world-class outcomes.

RITHOLTZ: So if a recent college graduate came to you and said they were interested in a career in asset management, what sort of advice would you give them?

KINNIRY: Yeah. I — I would say, you know, it’s hard not to see what technology and machine learning and A.I. are doing to asset management, and so maybe getting a little bit out or less in the STEM or I.Q. and more into the E.Q. side because I think, you know, what is going to be left standing is behavioral coaching and relating the clients and working with clients, which is a different skillset …


KINNIRY: … than sitting in a terminal and trying to figure out should I buy stock X or Y or Z. So I think there’s going to be, you know, somewhat of a shift from I.Q. to E.Q. in this space. So if I were a millennial or — or talking to my son who’s trying to enter the space, I’ll talk about making sure these world-class and relationship management on the E.Q. persuasion and influence side as much as he is on the math and analytical and technology side.

RITHOLTZ: Quite, quite interesting. And our final question, what do you know about the world of investing today that you wish you knew 30 years ago when you were first getting started?

KINNIRY: Yeah. I — I would say that the market does not know or care what my valuation of a fair value is. You know, I remember my first job, we’d say the fair value of this company, it’s selling blue book value, it’s only below cash value and it’s kind of canes (ph) this quote that, you know, the — the market can stay irrational longer than you can stay solvent, and there’s never a truer quote than that, right?

So, you know, the market doesn’t know/care what my valuation or my assumption is. The market is going to do what it’s going to do. And I think, you know, having that sense of humility, I — I think it would — you know, I probably wasn’t as humble and — you know, have as much humility in my earlier days than I have today.

RITHOLTZ: You know, it’s funny you say that. I — I used to hear early in my career a variation on that, which is the market doesn’t care what you paid for that stock. It really — so valuation or even what you paid, it’s not relevant. It’s going to do what it’s going to do. Your little purchase is not relevant.

KINNIRY: Right. Yeah, the market doesn’t know your cost bases.

RITHOLTZ: Right, exactly. Hey, Fran, this has been absolutely fascinating. Thank you for being so generous with your time. We have been speaking with Fran Kinniry, Head of Global Portfolio Construction for Vanguard Group in Malvern, Pennsylvania, which manages a small $5 trillion.

If you enjoyed this conversation, well, well, be sure and look up an inch or down an inch on Apple iTunes and you could see any of the other 258 or so previous conversations we’ve had.

We love your comments, feedback and suggestions. Write to us at Give us a review on Apple iTunes.

I would be remiss if I did not thank the crack staff that helps put these conversations together each week. Michael Batnick is my Head of Research. Atika Valbrun is our Project Manager. Michael Boyle is my Producer.

I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.



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