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This conversation going now with Rob are Not. He is chairman and founder at Research Affiliates, joining us on set. Great to see you in person, Rob, Yeah, thank.
You both very very much for wearing green to celebrate the launch of our new ETF in the crowded space of cap weighted indexing.
Well, you made my transition for me, so I thank you for that. Let's talk about this ETF that you launched last week, the Research Affiliates cap Weighted US ETF. This tracks the Research Affiliates cap Weighted index and Rob, you made the bold claim that this could represent a new future for passive investing. Tell us about this product.
It's actually very straightforward. Cap Weighted indexing has an enormous achilles heel. People think active versus passive. Cap weighted indexes are passive. Yeah they are, but no they're not. There's four or five percent turnover per anum on average, So ninety five percent of the portfolio is blissfully uncaring about whether the stocks are going up or down, whether the businesses are flourishing or floundering, and four to five percent is traded. That four five percent is active and boy
is it wild active. It would make Kathy Wood blush. It buys stocks at an average of twice the market multiple. It sells stocks that are deeply out of favor, unloved, and typically half the market multiple. It chases a frothy emerging growth strategy. All we're doing is saying, wait a minute.
This leads to flip flops. For every new tesla and video that gets found and added to the index, there's a dozen companies that come along that look super promising, that turn out to fall short of lofty expectations and crash right back out of the index in five to ten years. We call these flip flops. They do enormous damage. What if you just add a little bit of patience. You add stocks to the index when the business is
big enough to matter. Not that the five hundred largest market cap stocks the five hundred largest businesses, and you sell stocks when their business is no longer large enough to matter. Now, if you do that, you slow down the trading, you have lower turnover. It's more passive than conventional cap weighted indexes. And when you go back over the last thirty four years, you find this really simple change boost returns by sixty nine basis points per annum with about one percent tracking error.
Yeah no, so okay, this is our aus at ETF that tracks the index that would do this correct. And it is actively managed, so you're basically having a person time the market.
Is that right? It is not actively managed. It is every bit as passive as the Russell one thousand. It's more passive than the S and P, which is managed by committee. It has turnover that's lower than the Russell one thousand. It has turnover that's almost identical to the S and P five hundred, and the turnover doesn't chase fads and bubbles and doesn't bail out of a stock when it's wildly out of favor. That's where the value added comes. It is a passive strategy.
Looking at the holdings here, it looks a lot like the S and P. I mean, you've gotten a video Microsoft, Apple, They're all there. Let's talk about strategy, right, This is a case for the S and P. We qualified, but the committee who knows who they are, decided no, we don't like it. It's also not in yours. So it's interesting there talk a little bit about what really is passive and what determines whether a thock gets in here, and maybe strategy is a good example. Why isn't in here?
Well, I love your framing this. In terms of active versus passive, there is no such thing as a passive portfolio. Portfolio has turnover. That turnover can be based on rules as at Russell, it can be based on committee decisions as at SMP. Better to define passive as sitting placidly and going with the flow. Well, the sitting placidly and going with the flow applies to ninety five percent of
the portfolio. It's also interesting that our strategy has ninety five percent overlap with the S and P. Five hundred percent of the holdings are identical. The difference is at the margins. There are companies that are not yet big businesses that don't make it onto our index. Pallanteer is the largest market cap stock that we don't own, but it's not a big business. Trades at one hundred times
it's annual sales. And at the other end of the spectrum, there are companies that are big businesses that aren't in the S and P because they've never been popular or frothy enough to make it into there there's a wonderful example of flip flops a Dillard's department store. It's been a member of the S and P five hundred and five times in the last thirty years. It's been kicked out four times, it's come back in four times. Every time it's by high sell low. Now here's an astonishing fact.
If you owned Dillards during the thirteen years in the last thirty five that it wasn't in the Russell one thousand, you would have made sixty seven times your money. If you owned it during the twenty three years that it was in the Russell one thousand, you would have made ninety nine percent negative loss. You would have a penny
left of every dollar you started with. So a six thousand to one ratio of wealth owning it when it's not in the index versus owning it when it's not just absolutely mind blowing.
Well, Rob, you bring a Dillards, which is an incredible example of this. But bringing it back to I mean this ETF you said it has ninety five percent overlap with the S and P five hundred. So we're talking about large cap names here. How does this effect look when you think about midcaps? When you think about small caps. Do you have the same sort of flip flopping that you might see when it comes to the S and P five hundred.
You do, but it's more powerful at the large cap end of the spectrum. Think of it this way. When Dillard's is not in the Russell one thousand, it is in the Russell two thousand and So what we find is is that every time Dillard's is added, it's added after an average of a fifty percent outperformance year five thousand basis points. Then it underperforms by an average of
six thousand basis points and gets kicked back out. Then it snaps back by an average of two hundred and ten percentage points of outperformance, fifty percent of that in the last year before it's added, and then it's kicked out. Leather rids repeat. It's wild rob.
Before we let you go, we got to ask you about the president's proposal. It's not official, but this idea that companies report earnings every six months, then every three months. As an investor, what do you think of something like that.
I'm a libertarian. I prefer to let people and businesses do what they want. I think a requirement of every three months fine. Lift the requirement. If a company wants to report every six months, every twelve months, that's fine. Publicly traded it out a report at least once in a while, but a requirement for quarterly reporting increases short termism. I've often said that I will never ever work for
a publicly traded company. Again, I've been saying that for a quarter century, and the reason is regulatory distraction and short termism. I can think about business rouse the new ETFRUS. We're pricing it at zero for the first year. The beauty in that is scale. If we get in one hundred billion dollars, multiply that by a zero fee, and that's a lot more money than one hundred million dollars time zero, Right, I'm joking. We're able to do that because we look past the coming quarter. We want to
create a revolution in indexing. And if we create a revolution in indexing and it succeeds, it'll be a big money maker in ten years. I don't care if it's a big money maker in five years. I certainly don't care about the first year.
Yeah, and certainly not the first three months. Rob. Fantastic to get some time with you, as always, that is Rob or Not of Research Affiliates, talking about, of course, his new ETF ticker rus