Andrew Slimmon on Quantitative Factors in Markets

This is Master's in Business with Barry Ridholds on Bloomberg Radio.

This week on the podcast, I have another extra special guest, ANDREWS.

Thank you. It's an ho to be here.

Well, it's a pleasure to have you. So let's start at the beginning with your background. You get a BA from the University of Pennsylvania and an NBA from University of Chicago. Was finance always the plan.

I think being in a competitive industry with all the plan. I played tennis competitively in juniors and went out and played in college, and I always liked the you know, you either won or loss. And what I always liked about this industry it was all about, you know, did you win or loose? There wasn't a lot of gray era and I think that's what I do love about the stock market and investing in general, because there's a scorecard and you can't there's no room in the scorecard for the editorials.

No points for style or form. It's just did you win or lose? So where did you begin? What was your first role within the industry?

Sure? So, well, my first role was opening the mail at a broker's firm in Hartford, Connecticut. But I started my career at Brown Brothers Harriman right here in New York in a training program, which was great because they had commercial banking, they had capital markets, and they had the investment management side of the business. And that's what getting exposure all those led me to believe, Gee, I really am interested in the stock market and how it works in investing in general.

So what led you to Morgan Stanley? How'd you find your way to write?

So? Yeah, I was a research analyst at Brown Brothers and I was covering, you know, in healthcare stocks. I realized that there must be something more to investing than just what was going on at the company level, because I noticed that the things that were moving my stocks on a day to day basis weren't just what was going on at the company level. And University's Chicago, where I got to my MBA, was obviously very focused on more the quantitative areas of investing, and I took FOMA

So ninety one kind of a mild recession, mild and really halfway through what was a rampaging bull market. What was it like in the nineteen nineties in New York and.

Finance, Well, I mean the thing that was amazing is we would have clients in the late nineties. It would come to us and they'd say, Andrew, I'm not greedy. I just want fifteen to twenty percent returns a year, right and no, with limited risks. And that is what was so fascinating about today is today people say to me, Andrew, why would I invest in equities when I can get five percent in the money market. And what a difference

Are identifying something that I'm so fascinated by. The problem we run into with surveys or even the risk tolerance questionnaires. Is all you find out is, hey, what has the market done for the past six months. If the market's been good, hey, I of course I want more risk. I'm more than comfortable with it. And if the market got shellacked, no, no, no, I can't so offer anymore draw downs. It's just pure psychology.

And I would go one step further. You know this, you're in the business, but when you first meet someone, you never know the ones that are going to be truly risk averse or truly can withstand the vault to the and ones that can. Some people say, don't worry, I'm not worried about the draw downs, and the minute happens on the phone to you, and some people I told you I wasn't worried and I didn't call you. And you can never know just the first time you meet people who that's going to be.

It's a challenge figuring out who people really are not easy. So you start at Morgan Stanley in nineteen ninety one, you're in. That's a long time ago. You start on the private wealth side. What led you to becoming a portfolio manager with Morgan Stanley Wealth Strategy.

So if you think about my career, I learned to be a fundamental analyst. I went to Universe Chicago and learned that, oh, there's quantitative factors that drive a stock price beyond kind of what's going on at the company level. The third part of my experience was being in prior wealth management. Clients want to believe they all buy low and sell high, but bear you know that doesn't isn't the case.

Somebody does accidentally, someone randomly top ticks and bottom ticks of market, but nobody does that conceive exactly.

And here's a great example of what I mean. If you think about the years twenty twenty. In twenty twenty one, growth stocks took off right, but in twenty twenty two they got crushed. Do you think more money went into growth managers and funds in twenty twenty one or the end of twenty twenty two after they got crushed.

The flows are always a year behind me exactly what people are backwards.

Like well, and that's because there's something called the tear sheet. If you were my client, I went to you and said, Barry, I think you should invest in emerging markets because look how terribly it's done. The last five years and I can. You're the tear sheet everybody. Hey, I hate it. So the problem with this business is a stock price does not care what happened in the past. It only cares about what's happened in the future. But as humans, we

That's unbelievable. I know folks who run short hedge funds and they say they could always tell when we're due for a major correction because that's when all of their redemptions and outflows hit a crescendo.

And so that's the problem with the dedicated style is you're always fighting human behavior just at the juncture with which you should be investing. They're selling, they're selling their stocks.

So let me ask you the flip side of the question. If you can't get people or if it's really challenging to make people comfortable with buying out of favor styles or companies, can you get them to sell the companies that are in favor and have had, you know, an exorbitant run up and are really pricey or is that just the other side of the same coin.

It's the other side of the same coin. But I think what complicates is is taxes, sure, because people don't want to sell for taxes and general Electric was a very important experience in my life in a you know back in the nineties, which was it became the number one stock. Everyone loved it, and then you know, it

So you've been with Morgan Stanley since nineteen ninety one, three decades with the same firm, pretty rare these days. What makes the firm so special? What's kept you there for all this time?

Well, you have to remember that when I started in nineteen ninety one, wealth management was a relatively small part of of the firm, and I give James Gorman tremendous credit. He really grew that area because of the stability of the cash flow. You know, I'm a pretty stable cash flow. And then when I progressed to Morgan Stanley Investment Management, it was the same concept, which was we value the multiple on stable cash flows is higher than on capital

Sure, I had John mac on about a year ago and he described that exact same thing, the appeal of wealth management, and part of the reason what was a Dean winner. The big acquisition that was done was, hey, this allows us to suffer the ups and downs in the other side of the business, which has potential for great rewards but no stability versus ready steady, moderate gains from the funeral wealth management.

We bought Smith Barney another thing. So then over the acid management side, there's eating Vance each trade wealth management, and with eat Advance came Parametric and Calvert. So the firm has grown in the areas that I've grown personally. So it's been a great, great marriage for a long time.

So your experience with General Electric, I had a similar experience with EMC and with Cisco late nineties, trying to get people to recognize, hey, this has been a fantastic run, but the growth engine isn't there, the trend has been broken. Don't be afraid to ring the bell. And I'm not an active trader. I'm a long term holder. Getting people to sell their winners not easy to.

Do, very hard. But also when stocks get very very big, companies get very very big, it just gets tougher to grow. In my experience, and this has nothing to ge just in general, is when companies get big, usually the government starts looking into their business because they might dominate too much.

Well, it hasn't been twenty five years since the Microsoft any trust. Uh boy, that's that's that's amazing. How often are equal weight SMP outperforming?

It outperforms about half the time. It's certainly had. I mean, think about last year and through October, the cap weighted to perform the equated by eleven hundred base ports. Wow. That's But the thing that's fascinating about this verier and again you know this is that it's always the first year off of bear market low investors sell. So tail flows were negative from the low of October twenty two until for a year in that November twenty three exactly.

A February twenty. That's amazing because from the lows in March it was a huge set of game.

Net flows from muta funds ets. They're always negative the first year because of that rear view mirror recency bias. The reason why that's relevant, Barry, is because when investors finally said I shouldn't sell anymore, I should buy. They're not going to buy what's already worked. They're looking for other things and that's when the equated really started out before. Huh. Really interesting.

So let's talk a little bit about your concept of applied investing. What does that mean? What is applied investing involved?

Okay, so there's the theoretical story about it, and then there's a practical story. I'm sure you'll get a kick out of the practical, But the theoretical is that I don't believe that a stock price return comes purely from what's going on. Fundamentally, you have to decide should I own growth, value, large cap, mid cap US versus non US any stocks return? About two thirds of return in any one year can be defined by those, So we have to get that right first, and that's the quantitative size.

So let me just make sure I understand this geography, size, sector, and style, all the four metrics. If you're looking at and trying to tilt into what you expect to be working away from.

Exactly, and the goal of that is to keep people in the game. Flip side is you know things are out of favor, they can stay out of favor. The problem in this business is styles and investing can stay out of favor longer than the client's patients duration.

Just look at value in the twenty tens. I mean, if you were not leaning into growth, you were left way behind exactly.

And what I observe from my time being advisor is at the end of the day, clients don't really care where they own growth or value. They don't care where they own European US. They want to make money and they don't want to go backwards. And if all you keep saying is yes, but you know, my value manager has outperformed the value index and they're like, yeah, but the S and P is going through the roof, right, So you have to have some flexibility in your approach.

SMA is separately managed account. Let's talk about active share. Because your portfolios are fairly concentrated. The US core portfolio is thirty to sixty companies. That's considered a modest holding, a concentrated holding. Tell us about the thinking behind that concentration.

So it's funny going back to that first job at Brown Brothers, you know, and the time in the eighties, no one knew about passive investing. But I observed that, you know, they'd have these portfolios and they'd have kind of two or three stocks in every sector, so you'd end up with you know, one hundred, one hundred and fifty stocks, and you know, they not that they did poorly, but they never really you know, it's really hard to drive a lot of active you know.

Performance everything is one to two percent.

And at the time it wasn't really there wasn't really passive investing. But then as as time progressed, all these studies came out and said, well, actually the most excess return in active management comes from managers that are very, very active. And if you own one hundred and fifty stocks and you're the benchmark is the S and P, you're not active. So it was clear to me that we needed very concentrated portfolios but control the risk. And

That's very that's triple a exterminator. So let's talk about two things you just mentioned. One is active share. But really what you're implying are that a lot of these other funds with two hundred and three hundred or more holdings, they're all high fee closet indexers. What's the value there?

Right? And that's why as an active manager, I have nothing against ETFs. I think it's done great for the industry because shame on funds that own lots and lots of securities. You're not doing a service to your investing. But at the end of the day, if I marginally underperform, not me, but in general, you know, it will take time to lose your assets. You know, what's right for the money management firm is not always what's right for the investors. So the right thing is choose passive strategies.

Core and satellite. You have a core of a passive index, but you're surrounding it, which something that gives you a little opportunity for more upside exactly. Huh really really interesting. So if the US holdings are thirty to sixty companies, the global portfolio is even more concentrated about twenty companies.

Yeah, I mean, so taking a step back again, one of the you know, remember I run mutual funds, but I started in the separate managed account business. So what it what means is they would wealth manage would implement our portfolio for individuals by buying socks. And one of the things that I observed is that clients pull from the market faster than they pull from stocks. So in other words, when you're worried about the market, if it's about the market some macro story, Well do you want

There's a brand name, there's a brand.

Exactly, so people are more likely to pull from the market. So I believe in owning stocks. But the problem is again it goes back to but if you own two hundred sucks, then they don't have any wedded So did we start a strategy? We started this so eight where all the securities would be on one page. That's amazing.

So your global portfolio also has some international US companies. So in addition to things like LVMH and some other international stocks, you have Microsoft, you have Costco. Correct, what's the thinking of putting those because giant US companies in a global portfolio.

It goes back to Barry that concept, which is clients don't care really where they make their money. And the problem with the benefit of global global strategies. I can own some US stocks and international only I can't own and what happens If the US just so happens to do better than the rest of the world, then international doesn't work as well. So it just gives us more flex It's that flexible flexibility to go where the opportunity set up.

And to that point, your fund. The Morgan Stanley Institutional Global Concentrated Funds, which does have US stock trounce the MSCI X US because the US has been out performing international. That's another style for fifty since the financial crisis. The US has been crushing everyone else.

But think about this way also, if I can own twenty stocks, okay, but they're not all correlated to each other, so they have a lot of different themes. Like I really like this the infrastructure stocks right now, but I also think they're a place as you said Microsoft, but luxury brands only a few stocks but have a different theme. Then I can control the risk in the portfolio. You act to share, good concentrate high act to share, but lower kind of risk.

So when I look at the Morgan Stanley Institutional US Core, the description is we seek to outperform the benchmark, regardless of which investment style, value or growth, is currently in favor. So your style agnostic. You want to just stay with what's working exactly.

And Philip Kim is the other portfolio manager. We've worked together fourteen years. I started these quantitative models and then he really took it to the next level, and this was what has the likelihood of outperforming for the next twelve to eighteen months. From a style standpoint, that's how we buy us the portfolio. Things could get just too expensive, things get too cheaps, but we need to see some migration in the opposite direction, and then we buy us accordingly.

What about the Russell three thousand strategy that's not It's obviously more concentrated than the Russell, but it's still a few hundred stocks. Tell us what goes into that thing.

Well, we noticed that our just our quantitative factor model alone was doing well right beyond just adding the stock to buy. So we wanted to start a strategy that would add a little bit of excess return versus just buying an ETF that was just focused on that factor models, but we would diverse five away. The stock risk really intriguing.

So let's talk a little bit about Slimmon's take, which is not only widely read at Morgan Stanley, it's also pretty widely distributed on the street itself. Towards the end of twenty twenty three, you put out a piece a few lessons from the year, and I thought some of these were really fascinating, Starting with the S and B five hundred has produced a positive return in sixty seven of the past ninety three years, the market produced two consecutive down years only eleven times. That's amazing.

I had no idea. Well, I mean, think about it, the likelihood over time in any one year the market's going to go up, and if it doesn't go up, that's irregular, but then to have another year in a row is very very irregular. So that's why being in twenty twenty three saying hey, it's it's highly likely it's going to be a good year, just purely based on the odds, and then you layer in that whole recency by rear view mirror, and people were way too negative.

Yeah, At the end of twenty twenty two, the SMP peak to troth was down about twenty five percent. You point out there were only eight instances since nineteen sixty where you had that level of draw down and the average one year return was twenty two percent following that.

So I put out a piece in September of twenty twenty two saying market's down twenty percent, you should add money down twenty percent, And of course I felt like an idiot, you know, a month later, because and then the mark was down twenty five percent, and I produce a piece saying the average return is just over twenty percent if you buy into down twenty five percent, which doesn't necessarily mean it stops going down, right, But what's amazing about that is, you know what the return off

Human nature is what it is, no doubt about it.

And that's what gave me confident that the fun flows would turn positive at some point in the fourth quarter, because it was a year off below.

I really liked that be dubious when a stock is declared expensive or cheap based on a singular evaluation methodology like pe, this is a pet peeve of mine. The E is an estimate, it's someone's opinion. How can you rely on something, especially from someone who doesn't have a great track record of.

Making it's the I think that's the biggest air investors make over time is well, this stock is you know, as you said, this stock is cheap or this market. Think about Europe mark. Europe has looked cheaper than the US for a number of years. The flaw on that is the E is a forward estimate, and it's turned out that the E for Europe hasn't been as good as what's expected, and the E for the US, especially the NASTAC has been a lot higher than was expected.

So that's always amazing is if the estimates are wrong to the downside, well then expensive stocks aren't that expensive, and vice versa. If the estimates are too high, cheap stocks really ain't cheap right.

I watched that, but we also watch revisions, and I've learned also from being, you know, cynically in this business. Companies don't always come clean right away and say, oh, business really bad. It's that they drip out the news. Usually one bad quote as follows another bad quote. I mean, it's very rare, so be careful that. And analysts are slow to adjust their numbers. Anytime someone says, I'm cutting my estimates, cutting my price target, but I think it's bottomed. Yeah, be careful.

That's always amusing. I thought this was really very perceptive. Over thirty seven years in the investment business, I have become convinced that the most money is made when perceptions move from very bad to less bad. I love that because if you've lived through the dot com implosion, or the financial crisis, or even the first quarter of twenty twenty, you know how true that is.

Think about last year. You know it's the old saying by Sir John Templeton. Bull markets are born on pessimism, they grow in skepticism, they mature on optimism, and they die on you for it. Well, we had a bear market bottom in October of twenty twenty two. And so we came into last year twenty twenty three, with it's going to be a hard landing, it's going to be bad,

We saw that in eight oh nine, and we saw that in twenty twenty twenty. It was really, it was really quite amazing. The flip side of this is also true, which is most money is lost when things moved from great to just good.

Well again, if I go back to kind of growth investing, it got expensive and the growth rates of companies were quite as good. And you know, in twenty twenty two and the Fed started raising rates and that was problematic. It was no different. It reminded me a little bit of the dot com bubble. What brought down the dot com bubble is that companies just couldn't report the earnings that were expected, and you had plenty of time to

It's amazing that muscle memory. When you're rewarded for buying the dip for a decade, it's a tough habit to break, exactly. So here's another really interesting observation of yours. Whatever the hot product is rarely works the next twelve months.

It's because a hot product invariably pushes oftentimes valuations to extreme And one of the things that we got very right in twenty twenty three was in twenty twenty two bear market, what did people buy into the lows of bear market they bought defense stocks. Dividend oriented, low volatility type strategies became very popular in twenty twenty two during a bear market, and so we could see that the

Historically, once the FED stops hiking rates, equity rallies last longer and go higher than anyone expects.

Explain the thinking though, So I think it's good news for this year, but also worries me about this year is if you look at the history of the period of time when the FED said we're done hiking till we're going to cut, that period does very very well for equities, and we're kind of at a juncture where we've done pretty well. But if they're not going to cut rates until the summer, I think there's more room

See, I'm a student of Federal Reserve history, and I could say with a high degree of confidence, they don't know anything that you don't know. They look at the same data. They're populated by humans. None of them have demonstrated any particular sort of prescience. And if we watched the past decade, they were late to get off their

But I just think the stock market is an emotional beast. Sure, And you know, and I looked last year and the bears people were too pessimistic. Every time they popped their head out of the den, they got stampeded. And so they'll have a better year this year. And I think it will scare investors, and cynically, I can't help but think, well, people missed. A lot of people missed last year, and

I love this data point. Since nineteen forty, markets have always gone up in the year when an incumbent president runs for reelection seventeen for seventeen. Now, if we break that down, what you're really saying is, hey, if an incumbent isn't running, the economy really has to be in the stinkaroo when the stock market is following. But anytime an incumbent is running typically means we're doing pretty okay well.

And remember I said, didn't get reelected, just ran for reelection, right, And so what happens, and I see it this year, is when presidents run for reelection, they want to juice the economy. They want the economy going well. And we have Joe Biden has in his pocket the Infrastructure Act, the Chips Act, in the Inflation Reduction Act, we own.

And the really interesting thing about all this, you know, it's funny. The twenty twenties is the decade of fiscal stimulus, whereas the twenty tens were monetary stimulus. The first three Cares Acts, that was just a boatload of money that hit the market, hits the economy all at once. Each of the legislation packages you mentioned that's spending over a decade, that could be a pretty decent tail wind for a while.

Very interesting between listening to Wall Street and what you listen to companies. And so I'm a company guy. I listen to companies, and I'll give you a great example. Right now, people think the consumer is getting tapped out, but on the costco call the other day, they say they see big ticket purchase items reaccelerating. Well, wait a minute, I thought, the considering which is it? Which is it? Right?

And we've seen some uptick in credit card use, but nothing problematic with the ability to service that debt still seems to be very much intact.

Correct, And that goes back to last year. One of the reasons. The other reason I was optimistic is I kept hearing our companies say to me, I'm being told the recessions around the corner, but our business seems to be doing with it. We don't see it.

That's really amazing. So let's talk a little bit about who your clients are. You obviously are working with all the advisors at Morgan Stanley, but you're managing mutual funds. Who are the buyers of those funds? Are they in house? Are they the rest of the investing community? Who are your clients?

Yeah? I mean so that's when I left being advisor in two thousand and four, I started this group within more coan Stailing Wealth Management with the products were only available to financial advisors at Morgan Stailing. But when I left to go into more Cogan Saliing Investment Management in twenty fourteen, the purpose of that was to make my products available beyond more con Stailing Wealth Management because I was getting calls from consultants and institutional investors saying, how

Yeah, one of the reasons I like Slimmon's take is you really boil things down to brass tacks. You're not afraid to use third parties in some of your competitors research. You cite other people on the street when they have an interesting data point or and I very much appreciate that because a lot of people sort of take the if it wasn't invented here, it doesn't exist to us.

Yeah, I mean, look, I want to grow the assets, I want to perform well, but I value the response is from those who sit on the front lines dealing with clients every day, because they're the ones that feel kind of the emotional side of the business. If you sit back in my office and all I'm looking at a company and just evaluating whether it's pe is appropriate and earnings, you're missing a huge part of this business.

So you serve on Morgan Stanley's Wealth Management's Global Investment Committee, what is that experience? Like, I would imagine that's a huge amount of capital and a tremendous responsibility.

It is a huge amount of capital and it drives kind of suggested asset allocation for advisors. They don't necessarily have to pursue it that way. My input is obviously on the equity side, but they have people in the the fixed income, high yield alternatives and they all provide

So in the old days, you used to speak with retail investors all the time as a PM. Do you miss that back and forth because there is some signal in all of that noise, whether it's fear or greed or emotion. How do you operate being arm's length away from that.

That is a big concern I have is losing that access. So I still I'm going to I'm speaking an event tonight with you know, a room full of advisors, so and then you know, we'll get together afterwards and I'll listen to what they have to say. So I'm always interested in feedback that I get from advised. Obviously, I can't spend all day talking on the phone. That's the big reason why I left being an advisor was I recognize, hey,

You can't control what country is invading what other country, but.

You can manage your own behavior. And people a hard time with that exactly.

It's really interesting. I know only have you for another five minutes, so let me jump to my favorite questions. I ask all of my guests starting with what have you been screaming these days? Tell us what's been either audio or video? What's been keeping you entertained?

Yeah, so, if I think about my career, no one took me aside and said this is how you manage money, right, Like, think about it. I learned about fundamental research, I learned about quantitative I learn about the practicality of being in wealth management. And so I've always researched and watched. And what does that do to do with your question is I've learned my way to being successful portfolio managers. So I'm obsessed with kind of always learning along the way.

Really really interesting to tell us about your mentors who helped to.

Shape your career. So I mean, again, I look at points along the way we're in their valuable. When I got to Morgan Stanley Byron Ween, who you know, I barely knew, but he was the first person that I recognized had this very good touch of fundamentals. But also the psychology, and so he was a great mentor, even though he never really knew me, but listening and reading

What are some of your favorite books? And what are you reading right now?

I just finished Same as Ever by Morgan House. Again, this concept of behavioral I will eat up at you put a behavioral anything about behaviors in front of me. I read it so like you know, Richard Thalor or misbehaving or you know, think fast and slow, all those boasts of books. Daniel Crosby is another one all those books. I just but I just finished that and I just love it because again, all he spends the whole book is about these things. They just don't change over to

My favorite version of that story was are you familiar with Cuba? So Obama announces we're going to normalize or start the process of normalizing relationships with Cuba. There's a stock that trades under the symbol Cuba, having nothing whatsoever, and it runs up twenty percent just on the announcement because some algorithm picked up Cuba and bought it and

Yeah, so it's interested to have for kids that are, you know, in the process of or have just come out of college, or in the process of it. And one of the dangers I see today is kids come out of school and they think they know exactly what they want to do, you know, and then and I'll say, you don't know what your capabilities are when you're twenty two years old. I mean I was an introvert where I was twenty two. I've I've realized in their early thirties,

I think that's great advice. People. Most of the folks I work with who are very successful, they're not doing what they did right out of school. And to imagine that that's going to be your career very much misleading. And our final question, what do you know about the world of investing today that you wish you knew thirty plus years ago when you were first getting started.

Well, I think, you know, thirty years ago, I thought it was all about just what's going at the company level, and then I realized, oh wait, that doesn't really you know, drive most of a stocks return, So you have to understand more about the broader implications of companies. I think thirty years ago there was less dissemination of fundamental news broadly. Today it's much you know, it's much broader, so having

Really fascinating stuff. Thank you Andrew for being so generous with your time. We have been speaking with Andrew Slimon. He's Managing director at Morgan Stanley Investment Management, where he is also lead portfolio manager for the long equity Strategies for the Applied Equity Advisors team. If you enjoy this conversation, be sure and check out any of the five hundred previous discussions we've done over the past nine and a half years. You can find those at iTunes, Spotify, YouTube,