Patrick O'Shaughnessy on the Next Big Thing in Passive Investing

feel like there's that much happening in the space. Well, I know I've said it before, and I don't remember the last thing we talked about it, but I know I've said it before that in the post Great Financial Crisis period, it felt like there was just this overwhelming message and there's like through the media and marketing and academic research, it's like just go passive, just go you know,

index whatever, forget about your investments. And it really feels like in the last couple of years, even before the pandemic, but now especially since the pandemic, it's like there's been the like revenge of active management and individual stock selection and robin hood and crypto and all that, and it's like this repressed desire to trade and invest in individual names. It just come like raging back. So I guess that sort of asked the question. It's like, okay, well then

like where does where does the passive fit in? Now? Yeah, totally. And the other thing I've been thinking about, just on that point, about the message about investing in passive like when you start to break it down, this idea of just pour all your money into an SMP E t

F like spy, you know, something like that. If you think about it, that's basically telling you to invest your money in a technology, like a fun technology that can trace its origins back to the early And it's kind of crazy with all the technological advances that we've seen since then, that the biggest um or the most prominent advice is to just dump everything in an E t F. Yeah. I like your characterizatione that as a technology, and this

is something that I think about a lot. Like, Okay, we call say index investing passive investing, and it's pretty passive. But prior to the advent of the index fund and especially like E t F, it was not like a trivial thing to do. So the academic research might say, by the SNP or by some big basket and forget about it. But prior to like some easy way to just sort of automatic that like that was not actually

like a strategy an individual could do. No individual is going to like buy all stocks in the SPI and re waste com early day and you know, so it's like there, it is kind of like a technological breakthrough that that happened that we sort of take for granted totally.

So on that note, today we're going to be talking about what a lot of people are saying, is the next technological breakthrough in fund management or the next big advancement um something that is definitely not boring but does count as passive investing sort of as we'll get into we're gonna be talking about custom indexing, and there's been a lot of action and deals in that space recently, right, And of course this gets to the question of like

you knows again, I think this is something you've pointed out a lot. You could buy the sp it's passive ish, but you're sort of outsourcing the indexing question or the management question to whoever you know in that case, the Committee of S and P or if you buy an MSc I index, the you're outsourcing investment decisions to mbs C I, so what is the future of like essentially designing the index exactly? So we have the best guests to talk about it, We're going to be speaking with

Patrick O'Shaughnessy. He's the CEO over at A Shaughnessy Asset Management, of course, also the chairman at Colossus and general partner or n CEO at Positive Some And in addition to that, he is also the host of the invest Like the Best podcast. So a fellow podcaster, Patrick, thank you so much for coming on. I'm really delighted to be here. I love love this show, so thank you for having me.

Thank you. So maybe just to begin with, we should start with the obvious question, uh, and I should mention here that your company, oh Sam, it has its own custom indexing platform called Canvas. What exactly is a custom index and what does your platform do? Sure? Thank you for having me. I love where you started the conversation around technology and innovation and that's how I think about this entire story. And custom indexing is just one point in in the timeline. And I think you raised the

right ones. Which are I think of as a code? I think of code mingled funds as a technology or innovation. I think of Vanguard's mutual structure that allowed for much lower cost for investors as a great innovation in this timeline. Ditto for E t F s. I think custom indexing is just the next natural uh stop in that journey. And when I say journey, I mean better, cheaper, more

convenient investing, more tailored investing for each individual investor. So in the past, it's E t f s in general and just index funds in general have been sort of like the model T You can have any color you want as long as it's black. And I think that is obviously going to change, and the reason it's going to change is because of technology. So I always like to look at what I call directional arrows of progress, the term I learned from my friend Josh Wolfe, and

see where the world's going. So we already know that trading is now free thanks to Robin Hood and all the other brokerages that have followed suit. We know that the cost of operating your own separate account in at a brokerage like a Schwab or wherever is falling in cost every single year for asset managers like us that that work with those firms, and we know that in

the future we're gonna have fully fractionalized shares. So the all three of those were huge impediments to owning your own basket of stocks directly, not through a fond or any t f but directly, and all those cost curves are either at zero or going towards zero, or going to be very possible. And in a world where it doesn't cost anything to trade, it costs very little to have a brokerage account and have an asset manager like us or a black Rock or a Vanguard whoever, trade

on your behalf, and you can own fractional shares. What seems really obvious to me in that world is this idea of custom indexing, a term that that I'm proud that we we coined a couple of years back. And this the idea is very simple, which is that why why should everybody own the same five stocks in the SMP five hundred. Why wouldn't it be easy to adjust for little things and big things such as I don't

want to own stocks with certain characteristics. For me, I work in capital markets, as you just mentioned my my CV, I don't really want to own more capital markets exposure. I've got plenty of that in my human capital in my day to day job. I don't want to own tobacco stocks. That's just a personal thing for me. It's a very small part of market cap, but I don't want them. Very easy to adjust for in something like

a custom index. Perhaps the most important thing that custom and also direct indexing unlocks is the ability to do better after taxes as well. What we've learned is that everybody has a very specific and personal tax situation. No one likes paying taxes. Everyone wants a better after tax return. That's the if you ask me. That's one of the key geniuses of the index fund is that it's low turnover, so you don't have a huge tax bill when you own SPY or own Vanguards Total Market d t F

or fund or something like this. What you can do when you own each of the underlying securities let's just stick with the SMP five, is you can sell positions that are at a loss and you can use that loss to offset gains elsewhere in your portfolio and actually come out ahead on an after tax basis. We call this tax loss harvesting. It's been around for a while, typically for just the very very wealthy because you need

very big accounts. But again, as the costs fall, this opportunity to create losses and create better after tax returns will to you know, more mass market uh individuals as well. So custom indexing is the prospect of why would I have the same strategy as everybody else when my circumstances,

my preferences are different, They're unique to me. And I think personalization is a big trend, not just in in investing, but in everywhere writing, whether it's in clothing or other areas of technology, and that that will come to investing. Two and and you know, we're proud to be at sort of the vanguard of pun intended of the custom indexing trend. So I sort of hinted at this in the beginning, and there's always this debate and you see

it on Twitter elsewhere. It's like this passive investing actually exist. And by that it's like, Okay, uh, is the S and P If you buy S P Y, is that truly passive? Because Okay, that's only five stocks and there

are thousands of stocks. Committee had to select them. And the way I think about this question is that it's sort of a false binary, and that there's like basically a spectrum, and that buying the SMP five or buying spy is you know, just like buying a little bit every month or never, say, more passive than some other strategy where you try to like pick twenty stocks or whatever. And it sounds like to me that with customer indexing, it's basically just adjusting where you are on the spectrum

a little bit. And so rather than going hole hog into some sort of like or trying to beat the market, it's okay, let's take the premise that for the most part we want to just sort of buy something general and stable and diversified, but it can be tweaked a little bit to get some sort of different returns while still maintaining the gist of the benefits of wide diversification and avoiding some market timing. Yeah. I think this. I think this whole committee thing whenever I hear the committee

at SMP brought up, I sort of laugh. It's just it's it's I think it's a very strange argument for people to spend any of their time on because if instead of uh, using the quote unquote committee, you just bought the top five stocks by market cap, it's the

exact same return. It's the exact same return, and and and so I think the key thing here is you want to own roughly the market in its market cap weights roughly to get the market return, and even if you deviate that from that, whether it's via committee or via a fancy term stratified sampling, which is what a lot of firms like us do, where you own most of the securities in the market, but you don't need

to own them all. You know, the the last ten stocks in the SMP make up a tiny miniscule weight even combined, and not owning them will not materially change your overall return. So I think the key here is you want to be broadly diversified. You want to roughly look like the market. But with customer indexing you can then also make these adjustments and and you'll, yeah, you'll perform a little bit differently, but that's sort of the trade you're willing to make to customize something to your

specific circumstances and preferences. Again, so in my view this all these arguments about like what is passive are just silly. I mean, technically passive would just be a market cap weighted total market every stock in the market um for equities globally, but most of the things that people argue about look very very close to that. So this feeds into something I wanted to ask you. But with custom indexing, what do people actually benchmark themselves against? Or does it

not really matter anymore? Like does your performance compared to a broader index or a specific index like just not come into the equation as much. So there's two ways to do it, and they're both very very simple. One is just to use a broad market index. It could be the Russell three thousand, and it could be you know, pick your pick your broad benchmark that's market cap weighted

and very simple to understand. The second would be sort of a custom benchmark, and this would be used by people who have a very clear deviation from something like the Russell three thousand. I'm gonna make up an example. Let's say someone's custom index is large cap sixty small cap, which that's not what the market looks like at all. The markets like large cap five percent small cap by

market cap. In that scenario, it really wouldn't make sense to compare your performance because in this case, you are making a very active allocation decision to be way overweight small cap. So in that case you might just blend a benchmark and say, my benchmark is going to you know, sp Russell two thousand or some other small cap benchmark. But in every case you're you're using simple, easy to understand, broad market benchmarks in some combination or or alone to

use as your reference for how you're performing. I'm really interested in what you said about, you know, if you work in capital markets, or if you work in a bank in some sort and you own bank stock to your kind of like you know, you're kind of doing the Texas hedge of betting on a sector that is already probably responsible for a lot of your annual income, and and so it maybe it may not make sense.

Can you talk a little bit more. I've always wondered about this whether financial advisors think about this question and when you and it's because i'd something I just like popped into my head before, and that's the first time I've heard someone talk about this and tailoring a portfolio around someone's um, you know, normal income. Can you talk a little bit more about how that's being used in

some of the ways you see that uh, potentially being used. Sure, so, so what is the market but a collection of discounted cash flows? You know, theoretically, and maybe there's some problems with that conception, but if you look at the SMP five, the value of each of those stocks and therefore of your portfolio is the market's estimation of how all those companies will do in the future, discounted at some rate back to today, and that's that's the value of your portfolio.

Well why why should my human capital be any different than that I've got, you know, fifty years or hopefully more left to live and work, and there's going to be cash flows that I generate from that. And when I dig into where those cash flows are going to come from, I couldn't be talking about what's one step beyond the Texas hedge, like, wouldn't be more all in on on capital markets, like the equity market specifically is going to be a large determinant of how I do

in my human capital. So if I think of my human capital as discounting my future cash flows into some value today, often that is worth a lot more to people than they're they're brokerage portfolio is if you actually did the math and I certainly think it is in my case, So why would I have more exposure to the same risk profile that determines you know, a large chunk of my human capital portfolio, let's call it. And I think simple adjustments like that are just intuitive. It

just makes sense to me. Um. And you can certainly demonstrate it, you know, if you if you do some napkin math, you can say, yeah, like, I don't really like, let's go back to oh eight, if I if I'm working at Lehman. Uh, And it's a ridiculous example, of course in hindsight. But if I'm working at Lehman, like, it's pretty obvious where my risk is bundled up and

I don't want more of that same risk. So if if indexing in part is great because of diversification, I think this is just one way to add another asset to the mix, which is your own, your own learnings. Yeah, so Joe and I are going to have to steal steer clear of financial data stocks. And actually that reminds me no facts set for you. I should just mention um that Bloomberg does have its own indexing business. In the interests of transparency. Um. So now that I've got

that disclaimer out of the way. Um, one thing I wanted to ask was, can you give us an example of like the most interesting or unusual custom index that you've seen in your time in the space. Sure, so, well, I guess the first thing I would say, at an even higher level is how popular customization is. So we built this platform. It's a web it's software. It's a web based platform. So you think about it like building a car. So go to like Tesla dot com and

go through the experience of building a car. There's an interior next year, you can you know, tune all these old dials or choose options. It feels like that to build a customer index with with a bit more options. So we don't we don't anyone to do anything, you know, the default, Our default would be that you buy the broad market, right, that you don't do any customization, that you just do low cost indexing, maybe with some tax loss harvesting. And we went into this not knowing what

people would do with this platform. That's the beauty of platforms, I think, is to be surprised by how they're used. And now we're you know, a year and a half click getting in on two years in, we're about two billion in assets or approaching that number today on the platform, and fully eight or so of the of the indexes that are designed are completely unique, meaning they're not they have they have different settings than any other custom index

that's been built to date on the platform. And I would definitely I would have taken the under on that. Had you set the line at will be fully customed, I definitely would have said it's going to be way less than that. There's going to be more you know, clumpiness around what people do. So I guess the first big point is like people really use the customization features, and we we've been blown away by some of the stuff that people ask us if they can adjust for UM.

So some thing's are in taxes, So they might say, I want to pay zero dollars in capital gains gross. I want you to generate a single gain for me. I refused to pay taxes. Others might. Others have said, look, we're willing to We're willing to spend a hundred thousand dollars on capital gains taxes, so do everything you can

inside that absolute dollar budget. UM. One person came to us and said, we don't want to own companies that produce sugary drinks because one of our key focuses as a family is to avoid or help ameliorate the obesity epidemic, and we think sugary drinks are the prime culprit. So we had to build a custom quantitative screen for that. We've had people say, look, I've got all these and this is a more advanced feature that wouldn't be broadly

available right now, but what we can do. We we've got this huge private equity portfolio and clearly kind of like the human capital example, I gave like, we've got a lot of risk in these fifty portfolio companies, but we don't really know how to map them onto public equities. Can you do that? And that's where you know, the fancier like machine learning modeling type stuff can come in and create something really cool so that we can avoid public equities that look very very similar when we model

them to the private equity portfolio. You know, that's just four examples, but it's kind of constant, like every everyone that we meet, every new client that we bring on, has some new question in the form of you know, can it also do X? And so I just think what we're what we're seeing live is a huge latent demand for customization that has gone unfulfilled for a long time, so no one talks about it. But I think you'll see an explosion of these platforms in the next couple

of years. Can you talk a little bit more about the sort of I don't know, maybe it's trading tech or the sort of like other platforms necessary to make this work, because, as I mentioned in the introduction, you know, even if you go back long enough, by even buying just the straight up S ANDP five would would not have been a trivial exercise at all for an individual. No one can sort of like buys and rebalance them, etcetera. And of course that got productized and now it's easy.

But like, okay, let's say I want to buy I don't know how many financials are in the SMP five hundred, but let's say I want to buy you know, four hundred and sixty of the spire excluding all the financials. Could you talk a little bit about the text act that makes it possible for someone to set that index using your software or any software, and then how that how it can after that decision has made get the sort of like you know, cheap trading and replication of

that part of the index. Sure, and it brings to mind a really cool idea from a gentleman named Eric Bistria, who's an early stage technology investator from called Benchmark. He uses this term competitive frontier, which is the sort of the battlegrounds if you will, that an industry will fight on and where things will be lost or one. So you have to be good in these competitive frontiers to

to compete in a changing era. I think those two competitive frontiers for for this segment of the market for indexing and and of course custom indexing are quantitative research and software development, and those are very different probably than what has won or determined the winners in indexing at large for a very long time. And it's the answer to your question, which is that it requires a lot

of technology. We honestly sort of fell backwards into this opportunity because we just by luck, had built so much trading software for our our core firm, which is a quantitative, quantitative investing firm over the last you know, ten plus years. So we were a quant firm that was managing active strategies that managed thousands and thousands of separate accounts. To be able to do that at scale across brokerages and across custodians, etcetera, you have to build software that you

can't do it manually with a database. So we had built we had built an entirely custom piece of trading software, an entirely custom piece of something called workbenches is like account management and settings management software for all of our separate account strategies. Um, so it requires the technolo alogy that I talked about, like building a Tesla, that's just the front end that sits on top of these other systems. And so so I think that the answer is a lot.

It requires a lot. It's it's effectively pure software and technology that's required. And the twist on this is that to be really good at this, you have to be good at quantitative research, which is just different than software development. Bring the best software development people in the world, they're not going to be able to do some of the stuff that's required for custom indexing. That's a data science function. And that's the second function that I think is will

be critically important. So just on the competitive frontier idea, I mean, there has been a lot of activity in the direct indexing space um which we mentioned intro. But you know, I think JP Morgan bought open invest and black Rock and Morgan Stanley have also been buying indux platforms. How intense is the competition at the moment. What are the sort of variations in strategies being pursued by different players? Uh?

And and what can make you sort of stand out from the crowd, like what makes a custom index platform better than another one? So so direct indexing to define that, since we've used the term a few times, I think of as picking a reference index supplied by somebody else, S and P Russell and S C I whatever, and then running a tax loss harvesting strategy on top of it.

And sometimes that's just you know, simple market cap index is probably most of the assets indirect indexing firms like a Parametric or Imperio which were bought as you mentioned by some of the big players. That it's it's very simple. You just try to generate after tax returns. You sell positions at a loss. It's a complicated optimization and algorithm to be clear, so it requires a lot of work on their part, but it's it's sort of one thing

that you can do. Uh. In a portfolio, I think of customer indexing is the natural next uh progression in that. So if if if we're painting on a blank canvas, so to speak, as a reason we call our system canvas. If you're planning on a blank canvas, direct indect seeing a sort of like one tube of paint. It's it's one of the things that you can do in your portfolio. I think for us, staying competitive and being competitive first was arriving at the party first or getting the party started.

So most of those direct indexing firms can't do anything remotely close to the kind of customization driven by our quant research capabilities that that I've described so far. So you can you basically get to pick your index and and that's that's your pick. But it's typically supplied by a third party. Our viue is it should be first party, Like we should design these things, not not SMP. We can move a lot faster, we can be a lot more specific to the individual. We can we can use

our quant research muscle to do so. So those two competitive frontiers are what we're focused on. Like, if you look at who are hiring our last you know five hires are three software developers to quantitative research experts, and if we can keep pushing the envelope on what we can do at low cost. We haven't talked about costs, but these things are are very low cost. What we can do at low costs, then we should stay at

the at the forefront of this trend. Can you actually just explain a little bit further the quant researching component. I mean, you mentioned the two component trading software and quand I kind of I think I intuitively get the trading software. Look, talk a little bit more about um what the quant research aspect is and why that's so pivotal to make this work. Yeah, you know, I think

this is something way beyond just investing too. You're you're seeing data science pop up as something that used to be no one talked about or knew what it was. Now it's a central function in like every company, and it's not complicated, it's very simple. There there's some quantitative outcome, some measurable outcome that matters to people, and I'm talking big picture here, not just investing, and you you build a model that that does a good job of predicting

that outcome. And this happened in sports with the moneyball trend. You know, we figured out that obviously you want runs, you want to score points, and you don't want to give up you don't want to give up runs in any sport, and certain things relate to that. On base percentage was the example in in moneyball. In in public market invest you want good returns, but there's other things you want to So anything that you can target, that could be companies that sell sugary drinks, well that's a

that's a measurable outcome. It's hard. You have to get data sets, you have to build data sets um but you can build predictive models for outcomes that matter or information that matters to the individual. And every time you do that, you're adding an arrow to your quiver. So once we did that, Once the next family that comes to us and says we don't want to own sugary drinks, we don't have to rebuild that thing from scratch. We have the model already. Same thing for the tax loss optimization.

Every time you build a new model, you sort of expand what your platform can do. And quantitative researchers that's all they do all day. So they say it's very simple terms. There's three things that matter. There's the outcome that's called the label in in the data science parlance. There's the inputs, the features, what what things are going to predict the outcome that we care about and how?

And what is the model itself. It's you know, people listening probably are familiar with something very simple like living your aggression or a linear model. These are just much fancier models. That's that's all you have to really know about it. So there's inputs, there's the model, there's outputs. You have to be expert at building those things and those three parts of a model and then offering those

effectively as services or products. To build a custom index in this case, or you know, predict what clothes you're gonna like in the case of something like stitch fix or whatever. It's a function that we just think will

be embedded everywhere. What does this mean for e t f s and mutual funds and the sort of traditional players of fund management, because I imagine, as you just mentioned, you know this idea that if you build one custom index, basically you've created a new product that you can then

roll out to additional clients. So it seems like a pretty efficient way to create you know, almost an infinite number of indexes which on the surface would would seem to um potentially threaten or at least compete with ETFs

and mutual funds. I think if you narrow two taxable investors where the the underlying strategy that's being designed or implemented has has an annual turnover of twenty or less, which is sort of the crossover point for taxes, that this is a huge threat to e t f s. There in my mind, there's really no reason, especially as costs continue to fall, and it's not like they're that

far apart anyway. You know, our lowest prices twenty basis points today, um so that additional let's call it ten basis points that we might get down to over the next ten years. I mean, you comp on ten basis points over time, it's not a huge difference. And so we're pretty close on cost already. And if you think about that whole segment of UH turnover would qualify for that and taxable investors that own e t f s,

that is a huge segment of the market. Now above turnover, ETFs remain and I think will remain thanks to the sort of law of tax law that governs them the ultimate app right, there's just there's there's no beating. Let's say you want to invest in a pure momentum strategy or something that has a PC annual turnover. There's just no better rapper than the e t F because you don't have to pay the ongoing taxes as a taxable investor.

So high turnover strategies I think will always and should always live in an e t F S for the most part, unless you know, deep customization is really important to the investor, in which case they may go custom index but below that threshold. And this applies to mutual funds too, you know, more of which are converting to e t f s or will in the future. I think this is a huge This is a huge and

important uh move and shift, And obviously it's counterpositioned. E t F providers other than going into the custom indexing business cannot compete against this. I mean, it's the rapper itself by definition does not allow for customization. So Patrick, I want to uh, you know, I think of you as someone who's just sort of like the ultimate markets

and business omnivore. And even like when Tracy did the intro, I mean well, would you have like four titles I think you mentioned, including host of a podcast that's a competitor to ours, you know, not all partners here but uh but no, but in all series is you have like an extraordinary like broad ray of interest. And it's evident to anyone who follows you. And I'm kind of like jealous, I would say, of how open minded you are, and whether it's like VC investing or crypto or n

f T S or anything. I think you just like exhibit this sort of like first to learn more. And you know, I said in the intro, and I really felt this like my career, like as a journalist, really started in the wake of a great, great financial crisis. You know, like we're just like hammered home this idea of like passive passive passive by the index. Forget about it. Don't buy individual stocks, don't try to time the market,

don't try to beat the market. Put some of your paycheck at an index fund every two weeks or whatever and just said it and forget it and look at your four one K maybe twice a year or whatever. Okay, so we all know that obviously we live now in this world of people buying all kinds of stuff, and you've like really dived head first into that. How do you think about this question of like, Okay, all the academic research says do X and don't try to time the market, but we have a lot of people who

are interested in all this other stuff. How do you think about this sort of like tension and how people should think about incorporating sort of more concentrated, riskier, far out of the risk curve ideas and bets into their portfolio. It's a great question, obviously an animating one for me when I spend all my time thinking about, you know, at my own portfolio. I you know, I'm involved in

a lot of people's portfolios. It's it's so interesting and important, I think, honestly, I think the answer is there's a lot of room for all this stuff in in our lives and our careers and our portfolios, and that some large component of low cost broad market exposure is appropriate advice for just about anybody. And I have to say, like when I was at when I was thinking learning about all this stuff in the early days, the passive thing makes complete sense to me. But it's also remark

comply boring from a career standpoint. I mean like, Okay, you can say that and become convinced of it, but then go work and you know, manufacturing or something like. There's nothing left to do, right. You just described the whole, the whole strategy in thirty seconds. And look, I think that strategy for like literally for everybody or for the vast majority of people is incredibly smart and will produce

good outcomes. Um, but it's fundamentally ignoring things that are changing rapidly where you can access them via an index fund. You know, you cannot buy some crypto in these kind of cool index like structures, but you certainly can't access let's say, early stage technology companies. That's something I'm very interested in. I spend most of my time in investing

in building thinking about software. And I can buy a software e t F I suppose, But to me, it's far more interesting to build a variety of software companies like Canvas. It's far more interesting to form a VC, which I did, to invest in early stage companies and help them along the way. I I guess I'm just defined by change and understanding how systems work, and when those two things come together, there's just an unlimited amount

of cool stuff to learn about. And so you know, in I spent a huge amount of time trying to understand crypto, and I still do. I just think it's fascinating. Um, I don't, I don't. I don't have a huge amount of personal exposure to it. I do have some a lot more than I used to, just because of market appreciation. And and I'm just I just like new stuff that is changing, that enables new behavior or new good outcomes for for humans, and like to have, like to be

at the frontiers of these things. And yeah, I've got a lot of titles, and you know, it seems like I'm doing a lot, but I'm kind of just doing one thing, which is trying to understand what's new, what's changing, is it interesting or not? What people can help us learn about this, you know, can can we expose their ideas to the world. Can we share as broadly as we can as we learn? And and that's that's very fun. It's a lot more fun than you know. By Vanguard, uh,

and by Vanguard is very very good advice. Still, this is something that I think Joe and I both wanted to ask you. But what do you see as the role of crypto in a portfolio, because you just described having a little bit of it more than you used to. And I think one way that a lot of investors think about it is as a sort of like lottery ticket, where you know, you put a little bit of money in a particular token or coin or whatever, and you kind of hold your breath and hope that it's going

to be the right one to go up. So how are you thinking about it? One of my favorite investing quotes I Cammeramer who said it. But but the quote is diversification is the only rational deployment of ignorance. And I have to claim some like a lot of knowledge but but also a lot of ignorance on the topic of crypto and what the few sure of it might be in a as you said, traditional portfolio. I think traditional there is is the operative word. I don't I

don't know the answer. I can tell you what I've done, which is that you know, when I learned about this stuff, the exciting core, you know, base level protocols that I spent the most time with seemed really interesting to me, and I could I could understand a future where they are critical components of how the world works. Much like http is or or smt P for email. These are other protocols that just didn't have any value associated with them that have totally changed the world. And in this case,

the protocols have a value. They have a they have a they have a token or a coin or whatever you want to call it, a cryptocurrency which quote unquote powers the protocol and those things can can have and retain value or grow value. And is bitcoin gonna be a thing in ten years? You know, I'm not smart enough to know, Sure seems like it will be to me? Um is ethereum gonna be a thing? It sure seems like it to me. Uh as as something that I

know countless people are using on a daily basis. How many products can you say that about with a very clever, you know, economic design behind of it, behind it and evolving design. So for me, it was it was no more complicated than Look like, these are incredibly interesting technologies. Many of the smartest people that I've encountered, and I encounter a lot of smart people in in the course

of my life, are are gravitating towards this field. And you could see how philosophically these are good ideas that could could have and retained values. So I put a small position and and have have added a little bit and and never really sold anything. And and that's been my personal stance. It's not advice, it's just what worked for me. But I think of it as diversification, and I think everyone agrees to versification is good at some level.

Like the SP five hunter that we talked about earlier, you should own that instead of one stock, one stock would be dune. I think there's an argument to be made that that idea of diversification needs to extend further into things that maybe we don't quite understand yet or or we're not sure where they're going to go. But

seemed to have that kind of promise. You know. I was talking to someone a few months ago, I think he worked, he did he worked at a macro hedge fund, and he was talking about how like they had this very tiny crypto allocation in the fund a while back, but then over like the course of the last year, it became a fairly substantial crypto allocation because of the rapid appreciation, and it got to the point quickly where not only did it becomes substantial, but on a day

to day basis, or a week to week basis, the funds returns were almost always determined by whether that crypto portion, and so I feel like there's a kind of like this like weird like I get, you know, mind virus aspect where maybe it feels like people dip their toe in the water and they're like, oh, I'm just you know, gonna have a little bit because I'm curious, and then suddenly it like dominates the daily swings in their portfolio, and then they can't stop thinking about it and can't

stop talking about it, And I'm curious, Like mean, you talk to people all the time, both on your podcast and then professionally and through the VC. I'm curious if you see that phenomenon where it's like somehow it's sort of they have this like little interest or buy some on a lark, and then it next thing, you know, it's sort of like dominates their every waking second like

thinking about it and watching the return. Yeah, it's like it's like surpassed you know, being from Texas or going to Harvard, Right, is like the first thing you mentioned, right, I mean, there's a joke that one of my friends who's one of the largest bitcoin owners in the world said it was very early in the ecosystem. It's like,

look like, don't worry. Everyone wishes they had more bitcoin, like myself and myself included, and when something especially bit Bitcoin is my favorite because ultimately it's tethered to nothing, right like the the the use case. The use case is the value, and the value is based on perception. And unlike ether, which is actually used in a lot of you know, like like a utility in a lot of ways, for for for functions or for things that happen in in on the web, bitcoin is just this

kind of like it's like a philosophy argument. It's so cool and and I think for something like that, if you own a lot of it, it's hard not to become obsessed with it. And uh, for for wealthy people, I have this idea called balance sheet syndrome, which is like you get too rich and then you all you do is like think about and talk about and worried about your balance sheet, which I think is awful by the way. Um, and you see that like crazy with with holders of a lot of crypto, and it's very

very religious esque. You know, if you study mass movements or religions or history, like there's a lot shared in common here, and uh, that's not interesting to me at all, Like you know when someone like it's just not it's just it's just It's one of those things that if someone wants to talk about endlessly, like I lose interest very quickly. But I do see it kind of constantly.

I want to ask about one other thing and another project that you're associated with then that sort of joint colossus and you do these like deep dive into like mechanical understandings of businesses. So it's like we we think we understand like how to Polar works or Lululemon works or GM works, And this is something you see, um that you are clearly very interesting. Is like let's really like drill down and like get to know their business models and so forth, that how they became, what they did,

How has that helped you as an investor? And what do you think is the importance of that, because I don't see a lot of people doing that the way you do, like really like getting to know a business. Well, talk to us a little bit about what value you've gotten from that exercise. Yeah, one one of my one of my frustrations with a lot of investors, even the great ones. Is that as they get better and better known, like they tend towards being philosophers versus you know, on

the ground thinkers like that. And I just like getting on the ground. Like there's that amazing quote. It's like one of the painters that says, like, you know, our critics are always talking about theory and and and aesthetics and whatever, and like painters are talking about like where to buy cheap turpentine and and I just like that idea. So I personally have learned a lot more. I didn't want to. I did we call these business breakdowns? And I did one yesterday on on Wyndham Hotels with my

friend Lauren Taylor Wolf. And you know, we spent an hour and a half talking about Windham Hotels, right like

who cares? But when when when you dive into windhom you just learn all this cool stuff about the world, like how all their brands like Super eight to this kind of lower segment of the market evolved along with the interstate highway system in the fifties and sixties, and and what the franchise economics look like for someone that starts and buys a Windham hotel versus buying a dominoes or you know whatever, like these very real on the ground things that if you pay seventy bucks for a hotel,

like now I know where that seventy bucks goes, and like what the underlying economics are. And when I'm looking at another business to invest in or or to build in the future, it feels like I'm just collecting all these individual models and I can say, oh, like this looks like this piece of software somehow looks like windhom you know, doubt that one will happen, But all these points of learning in comparison, you know, Harvard is famous for its business case studies, which I think are very good.

And this is just that, you know, for for and in the open and in conversation. So I like the turpentine approach to learning about business versus the very like haughty, philosophical, you know, principled approach. And I was a philosophy major, so you know, I know this takes one to know one,

I guess, and that's why we do it. We we just I just like how stuff works, and I find all of the detail to be far more interesting in a Chipotle than you know, like the source of its Moat, Like, I like learning about how the guacamole has made and how you can get the cost of guacamole down by owning a guacamole farm, and this kind of stuff like just more interesting to me. You know, I think for Tracy and I that probably that speaks to us because we I think some of both of our favorite episodes

have been like let's talk about how trucking works. It reminds me of like uh Bob Dylan's actually his Nobel Prize speech where it's like people always talk about Shakespeare, you know, something like great literary of playwright, but Shakespeare was thinking about the quote is like where am I going to get a human skull? Because that needed to me and like to put on to put on a

performance of Hamlet that yorick. So like I feel like you know that actually, like understanding what matters for the person doing the thing is often way more interesting than

like the deep theory. I mean we we both talked to Ryan Peterson at flex Sport, and you know, you talk to someone like that and you're talking, you're talking about maritime law and how it came to be, and what you realize is, like God, everything's just messy, like nothing's neat and tidy, like like Aristotle was right, not

not Plato. You know, if you know your philosophy, and the details matter and path dependence matters, and you just like everything is a compromise and you gotta keep pushing, like all these great stories like Ryan will tell about their business, like he ran headfirst into it, not a brick wall of steel, wall of just inertia, and like weird paper and pen processes, and he learned about how stuff moves around on the ocean and it's way more

interesting and complicated than you could possibly imagine. And and my friend zachs Zack Cantra has an amazing article he always sends around called reality has a surprising amount of detail, And I just loved I love that idea, like learning about maritime law and shipping invoices and why it matters to the world. And it's just so much more interesting to me than than some you know, broadly applicable concept detail. It's more fun. I love that saying, Um, that's really good.

We're going to have to take that to heart in some future Logistics and supply episodes. I think, Okay, well, Patrick, we're going to leave it there, but thank you so much for coming on. That was really great. Thank you guys so much for having me. That was great, Patrick, thank you so much. Okay, so that was really enjoyable. And obviously, um, Patrick is a pro at podcasting and a competitor. UM, so we shouldn't hype his podcast too much,

although it is very good. Um. But one thing I was thinking about is you know that, um, you know that last point he was making about, you know, reality is sort of full of details, are all about the details, And I was sort of thinking about that in the

context of the custom indexing business itself. So this idea that if you want an index that actually reflects the world as you see it, or you know, as you want it to be reflected, like, you are going to have to drill down into specific companies and maybe it makes more sense to make your own judgment call on what those should be versus actually buying you know, the

top five hundred firms by market cap. Yeah, I thought, I mean, I thought that whole conversation is interesting and he was definitely sort of speaking our language at the end. I thought you were going to go the other way with the point about like, you know, again that buying the S and P five hundred seems like the easiest

like strategy in the world. But as he points out, like even that is like and you pointed out in the intros, like even that as an doble like feet of technology, even though like the technology has been abstracted away to the point where we like I don't think most people think of like buying spy as a technology thing, but even that, like just think about like how messy that must have been, like to create a piece of software that can like rebalance five stocks every minute or

every day, Like, given that, it is like sort of an extraordinary feet of like detail and attention, you know, attention to detail. Yeah, But also it sort of ties into his point about diversification as well, which is like passive investing isn't necessarily very good at identifying the next

up and coming thing for obvious reasons. So like there's not going to be some sort of crypto play in the SMP five hundred um, so you're not going to make a lot of money from that, and so you kind of have to go out and seek those outside of the realms of traditional fund management. I think, well, Visa Blood and n f T recently, so they're now now they could be okay, but no, no, no, you're

absolutely right. Yeah, everyone's um buying bitcoin for they're like cash reserve, so everything will be a crypto play soon enough. But you know, if you wanted to get in early, you would have struggled without some sort of absolutely yeah, okay, um, shall we leave it there? Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wisn't Thal. You can follow

me on Twitter at The Stalwart. Follow our guest on Twitter, Patrick O'Shaughnessy. He's at Patrick Underscore Oshang. Follow our producer Laura Carlson. She's at Laura M. Carlson. Followed the Bloomberg head of podcast were incessca Levie at Francesco Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening to