The Rational Reminder Podcast

You don't need to be a rocket scientist to work at Dimensional Fund Advisors, but Gerard O'Reilly sees it as an asset, particularly when it comes to problem-solving. Now the Co-CEO and Chief Investment Officer of one of the fastest-growing US investment businesses, Gerard received a Ph.D. in aeronautics before entering fund management, attracted to Dimensional because of the opportunity it afforded him to learn from the world-leading economists at the company; including Eugene Fama, Myron Scholes, Merton Miller, Robert Merton, and Ken French. We recently sat down with Gerard to discuss the firm's research-based culture and rules-based approach to investing. In this episode, we get into the nitty-gritty regarding Dimensional's distinctive portfolio management decisions and the data sources they draw from and Gerard answers some technical questions regarding risk assessment, factor tilted portfolios, operating profitability, goodwill, and more. We also touch on the value of combining multiple metrics, why small-cap stocks deserve a place in your portfolio, and some of the biggest changes that Gerard has witnessed in Dimensional portfolios over the past decade, as well as how he applies his scientific learnings to make unique portfolio adjustments and some of the various benefits of Dimensional's integrated approach. Make sure not to miss this informative, insightful, and in-depth conversation with Dimensional CIO and Co-CEO, Gerard O'Reilly!

Key Points From This Episode:

• Market-cap-weighted passive strategies versus Dimensional's rules-based higher expected return strategy. [0:03:45]
• Assessing risk based on the Intertemporal Capital Asset Pricing Model (ICAPM). [0:07:07]
• Diversification in a factor tilted portfolio versus a cap-weighted market portfolio. [0:10:57]
• What criteria the variables that Dimensional uses need to meet before they're considered dimensions of expected returns. [0:13:00]
• Sources Dimensional draws from regarding portfolio decisions and implementation. [0:16:09]
• How Gerard decides between underweighting or excluding securities in portfolios. [0:19:59]
• Why Dimensional uses operating profitability rather than cash-based profitability. [0:22:38]
• Gerard's view on intangible assets, goodwill, and Dimensional's investment strategy. [0:29:31]
• The value of including internally developed intangibles in value and profitability metrics. [0:37:49]
• Gerard reflects on the opinion that Fama and French's findings are no longer valid. [0:42:58]
• Whether or not it's better to combine multiple metrics to measure relative price. [0:46:41]
• How Dimensional targets value and profitability together (for large and small caps). [0:50:39]
• How Gerard thinks about capacity for investment strategies in small and micro-cap stocks as Dimensional continues to grow. [0:54:03]
• Understanding how entering into the ETF market has impacted his thinking. [0:57:24]
• Expected premiums for owning smaller stocks over larger ones. [0:58:50]
• The importance of security lending revenue for expected returns on Dimensional funds; improving the investor experience. [1:00:12]
• How Dimensional deals with sector weights and the role that diversification plays. [1:04:12]
• Why they decided to implement credit, despite research to suggest that it doesn't add an independent source of expected returns. [1:06:08]
• Some of the biggest changes in Dimensional portfolios over the past 10 years. [1:10:23]
• How Gerard applies his scientific learnings to make unique portfolio adjustments. [1:12:52]
• Comparing Dimensional's core and vector strategies with a combined cap-weighted portfolio; from fees to the benefits of hindsight and more. [1:15:15]
• Papers that seemed compelling but were deemed ineffective by their research team. [1:19:11]
• Insight into Dimensional's decision to make their internal research public. [1:21:42]
• Why their rules-based approach is the hardest part of Dimensional to replicate. [1:25:55]
• What to be aware of when comparing backtests: how data can be manipulated. [1:30:06]
• Valuable lessons and perspectives Gerard has learned from their competitors. [1:32:22]
• Commonalities between aeronautics and asset management, like problem-solving. [1:35:20]
• Why Gerard believes that having his own financial advisor is invaluable. [1:36:55]
• Gerard explains why we might expect factor premiums to persist in equilibrium. [1:38:28]

Many people have been contemplating the death of bonds, which is why for the main topic of today's episode we're going to be talking about their immortality. After a vicarious trip to The Masters, an overview of The Art of Insubordination, and an explanation of why we're concerned about the changes that WealthSimple has made to their business model, we get into the world of bonds. Bond returns have not been good this year, and bond index funds are down all round, but that doesn't mean that bonds are necessarily the riskier choice of investment in the long term, or that you should be feeling disheartened about them. Tune into our conversation today to hear why!

Key Points From This Episode:

• The incredible experience of attending The Masters, and how you can win a ticket. [0:02:21]
• Three business-focused TV series that we highly recommend. [0:02:27]
• Upcoming guests, and some very positive listener reviews. [0:03:34]
• An overview of The Art of Insubordination. [0:09:16]
• Why change is challenging for most people, and the value of creating environments that encourage dissent. [0:11:12]
• How dissenters can make their actions more impactful, and what leaders can do to encourage dissent. [0:13:16]
• Key takeaways from The Art of Insubordination. [0:16:39]
• Why we are disappointed with the changes that Wealthsimple has made to their business. [0:18:47]
• Nuances that Wealthsimple has left out of their venture capital analysis. [0:23:51]
• Today's main topic: the immortality of bonds. [0:33:38]
• Statistics which highlight the fact that bond returns have not been good this year. [0:33:51]
• Why volatility is not the only risk that matters. [0:35:06]
• How Ken French defines risk. [0:37:51]
• Some of the pros and cons of bonds and stocks. [0:38:56]
• Calculations which show that stocks are not necessarily less volatile than bonds in the long run. [0:40:48]
• The five components of long-run predictive variance. [0:43:23]
• An explanation of a model we created for the dispersion of outcomes. [0:45:10]
• Why now is the time to get excited about bonds. [0:49:27]
• Today's first misconception: high growth sectors/regions/companies are good investments. [0:53:52]
• Today's second misconception: you can lose all of your money in stocks. [0:55:57]

Welcome back to the show all about sensible investing in Canada! Today we have yet another masterclass with a wonderful guest, Sebastien Betermier. Sebastian is an Associate Professor of Finance at Desautels Faculty of Management at McGill University, where he teaches investment management, applied investments, and pension funds retirement systems. We have a deep, thoughtful, and precise conversation with him about his recent research and papers, much of which stands in contrast to our usual fare on the show. In our chat, we dive into the nuts and bolts of asset allocation, hedging risk, and his research into what demographics can teach us about investment behaviours and returns. We also hear from our guest about interesting topics of expected persistence and tilting towards value stocks, before shifting the conversation towards homeownership and property investment. Sebastien provides some sound advice around when it might be a good idea to purchase property over other asset classes, and we evaluate this position from a number of different investing perspectives. Lastly, we spend some time looking at pension plans, and what we can learn from those available in Canada right now.

Key Points From This Episode:

• Sebastien explains the theoretical relationship between labor income and financial asset allocation. [0:04:30]
• Findings on hedging labour income risks and the paper that Sebastien published on the subject. [0:06:47]
• The relationships between risk and age, gender, wealth, and heterogeneity across households. [0:10:05]
• Unpacking Sebastien's investigation into value and growth investors. [0:12:07]
• The effect that the characteristics of labor income have on the rate of progression on the value ladder. [0:18:43]
• What we can learn about expected persistence in the value premium. [0:22:39]
• Weighing the possibility of predictive demographics for future value premiums. [0:24:29]
• Advice for young investors looking to tilt towards value stocks. [0:27:50]
• Explaining differing returns according to the characteristics of people. [0:29:41]
• Sebastien explains the factors of markets, wealth, and age, in the pricing model. [0:31:24]
• Understanding how investors tilt to age and wealth factors, and what these portfolios look like. [0:38:19]
• The impact of age and wealth factors on wealth inequality, and how younger investors can combat this. [0:42:19]
• Possible rationales for homeownership and the storage of wealth in housing. [0:44:26]
• The household characteristics that are predictive of larger allocations to housing. [0:48:49]
• Economic importance of risk-free benefits of homeownership. [0:52:15]
• The decade-long rule of thumb for purchasing property; Sebastien weighs in. [0:55:31]
• Why asset-only performance is not the only correct way to measure the success of the Canadian pension fund model. [0:58:50]
• Differentiating asset-only performance and liability-hedging performance measurement. [1:02:29]
• A list and explanation of the assets that Canadian pension funds use for hedging real liabilities. [1:04:03]
• Lessons from the Canadian Pension Plan for individual investors and firms. [1:12:54]
• Sebastien's personal definition of success: making the most of opportunities and a balanced life. [1:16:07]

The world of personal finance is full of axioms, and new investors can get caught up in investing myths and 'rules of thumb' that are limiting at best and lead to underperformance and unnecessary losses at worst. In this week's episode, we outline some of the common misconceptions that new investors have, the evidence (or lack thereof) surrounding them, and how to think more like a seasoned investor. Is value investing really a safer strategy with lower expected returns? Do you need to employ a Buffett-Lynch stock picking approach when value investing? Are all index funds good investments? Tune in to find out the answers to these questions and gain some insight into the relationship between risk and return, dividend investing versus total risk investing, and whether or not exclusively investing in US stocks is a good idea, plus so much more!

Key Points From This Episode:

• Upcoming guests, including Professor Eugene Fama in Episode 200. [0:01:27]
• An update on our 22 in 22 Reading Challenge, with over 1,000 books read. [0:05:30]
• A review of The Great Depression: A Diary by Benjamin Roth and lessons learned. [0:07:18]
• A quick overview of The Bond King, the story of Bill Gross by Mary Childs. [0:17:10]
• This week's news stories: 24/7 investing from Robinhood, stock splits, Wealthsimple portfolio changes, and more. [0:20:02]
• Our main topic: some of the common misconceptions that new investors have. [0:28:50]
• Whether or not value investing is a safer strategy with lower expected returns. [0:30:42]
• Some examples of where the myth that value stocks are safer comes from. [0:33:25]
• The fallacy that value investing requires discounted cash flow (DCF) analysis. [0:40:52]
• Why Warren Buffett's outcome could be a challenge to systematic value investing. [0:43:41]
• Debunking the misconception at all index funds are good investments. [0:46:48]
• Conversely, Ben shares why not all actively managed funds are bad investments. [0:47:34]
• Why all exchange-traded funds (ETFs) tracking an asset class are not the same. [0:48:12]
• The myth that risk and return are always related and the cases when this isn't true. [0:51:02]
• Ben shares his reflections on the misconception that dividend investing is less risky than total return investing. [0:53:14]
• Analysis that demonstrates whether or not dividends are actually safer. [0:56:09]
• Our last misconception for today: you should only invest in US stocks because they perform best. [0:59:40]

When it comes to the uncertain future of financial markets and technological innovation, a deep understanding of history and the roots of the systems at play in our contemporary climate is often overlooked. This is the argument made by Bill Janeway, our guest on the show today and the author of Doing Capitalism in the Innovation Economy. We have a fascinating conversation with Bill who has vast experience in both the academic and venture capital spheres, having spent years working in both sectors. Bill does an amazing job of sharing his expertise, talking about the role of the state in innovation, how venture capital actually operates, and what the innovation economy means for those who are not on the vanguard of technological progress. We discuss how investors can think about allocating their assets in relation to innovative companies, Bill's reflections and advice regarding financial bubbles, and how Bill applies his understanding to current questions about cryptocurrencies and decentralization. Bill's lifelong passion and commitment to learning about the history of economics and the financial markets makes him a deeply valuable resource and having him on the show was so illuminating, we hope you enjoy the conversation as much as we did.

Key Points From This Episode:

• Bill explains his concept of the 'three-player game' and how it brings together two important histories. [0:03:13]
• The role of venture capital in technological innovation in the last 50 years. [0:05:16]
• Findings on the returns experienced by entrepreneurs in light of VC structures. [0:10:22]
• Thinking about venture capital as a private investor; best approaches for asset allocation. [0:15:05]
• Investing in innovation and assessing secondary market public equity benefits. [0:20:02]
• Bill explores the relationship between innovation and financial bubbles. [0:31:43]
• Waste and innovation; what we should expect as we progress. [0:35:43]
• The people left behind by innovation; who has taken the role of trade unions? [0:41:09]
• Bill weighs in on the question of cryptocurrencies and their place in the conversation about innovation. [0:45:38]
• Investment in crypto from big firms; separating the 'adults' from the crooks. [0:51:36]
• Why a deep understanding of history is paramount to sustainable innovation. [0:53:10]
• Bill's personal definition of success; staying motivated for work! [0:55:15]

Today on Rational Reminder we take a deep dive into the evolution of modern portfolio theory. We kick the show off with some updates and reviews on some of the brilliant shows and books we are watching right now. A key item from this selection is Stolen Focus: Why You Can't Pay Attention and the points it makes about the value of flow state for learning and creativity. After this week's news stories, we get into the main topic, and Ben starts with a breakdown of portfolio theory as it was laid out by Harry Markowitz in 1952. From there we talk about research that shaped the current understanding of portfolio theory, exploring the distinction between the mean-variance efficient portfolio and the multi-factor efficient portfolio, and how they theoretically combine to make the market portfolio. One of the biggest takeaways here is that your financial asset portfolios can look the same in terms of asset allocation but the person with more macroeconomic risk in the remainder of their financial situation is taking on more risk. Additionally, even if somebody is the perfect candidate to be the mean-variance investor and they could theoretically tilt toward value, it doesn't necessarily mean they have to. We wrap up our conversation by inviting our good friend Larry Swedroe onto the show to speak about his love of reading and share his methods for incorporating what he learns from books into his work and thinking.

Key Points From This Episode:

• Updates: Shows, books, upcoming guests, reviews, and our reading challenge. [0:00:22]
• A review on Stolen Focus: Why You Can't Pay Attention. [0:11:00]
• News stories for the week: Wealthfront offers thematic ETFs and more. [0:18:47]
• Moving onto the main topic for today: How modern portfolio theory has changed since 1952. [0:23:00]
• Lessons to be taken away from Markowitz's 1952 portfolio theory. [0:25:09]
• How the math changes when you have a risk-free asset in your portfolio problem. [0:26:59]
• The capital asset pricing model: the other foundational portfolio theory principle that comes from the mean-variance model. [0:29:08]
• Portfolio advice that stems from mean-variance optimization. [0:32:46]
• Building a tangency by expressing information beliefs. [0:36:06]
• Findings from Michael Jensen's 1967 application of the CAPM. [0:37:04]
• Why diversification is important according to Markowitz's portfolio theory. [0:38:02]
• Why the CAPM does not accurately reflect the relationship between risk and expected return. [0:39:49]
• The origins of multi-factor thinking and examples of multi-factor models. [0:41:10]
• How the allocation of the multi-factor efficient portfolio creates a third dimension. [0:49:29]
• How the theory predicts how people behave in aggregate. [0:52:44]
• Takeaways from today's discussion to keep in mind when building your portfolio. [1:00:00]
• Larry Swedroe joins us to talk about the importance of reading. [1:03:32]
• The many subjects that Larry reads about. [1:04:12]
• How Larry's reading habit works. [1:05:12]
• How to capture ideas you read for later use. [1:05:57]
• Larry's storage system for all the books that he reads. [1:08:38]
• The effectiveness of making a public commitment to read more. [1:12:13]

We always appreciate research-based arguments here at the Rational Reminder and when those arguments might rattle some assumptions we get particularly excited. Today we have an eye-opening conversation with finance professor Alex Edmans, in which he discusses his idea of growing the pie and how social change and value relate to investor decisions. Alex's work is deeply rooted in skepticism and a critical method of assessing evidence, an approach that has resulted in surprising and sometimes paradoxical findings. We get into a fascinating conversation dealing with employee satisfaction and ESG, with Alex challenging some commonly held beliefs around socially responsible investing, with the data to back it up. A strong theme that emerged during our chat is the need for these conversations to be grounded in research, instead of empty rhetoric, and Alex's data-rich perspective is a great inspiration. Towards the end of the episode, Alex talks about the practical, individual application of his ideas, and how an empowered employee can add value on any level. So, to hear all this and a whole lot more unmissable insight, join us on the show.

Key Points From This Episode:

• Unpacking what Alex means by 'growing the pie' and differentiating this from other similar-sounding goals. [0:02:38]
• How to go about measuring the growth of the pie, and the pieces that cannot be measured. [0:05:14]
• Alex addresses Milton Friedman's famous quote about responsibility and profits. [0:06:48]
• The role of big asset managers in directing investment towards more socially responsible causes. [0:08:56]
• Thoughts on the value of divestment as a means to effect social change. [0:11:34]
• How much impact are typical ESG funds having currently? [0:15:05]
• The subjective discussion around sustainability and Alex's definition of what makes a company sustainable. [0:17:06]
• The inconvenient truth about sustainable funds' performance against the market. [0:20:56]
• Alex's research into the relationship between stock returns and employee satisfaction. [0:22:23]
• How to take a quantitative approach to employee satisfaction as an investor. [0:29:16]
• The practical application of information about happy workplaces for investors. [0:32:51]
• Alex's input on the problems associated with executive pay. [0:35:18]
• Counter-arguments to some of Alex's unpopular opinions and positions. [0:39:52]
• Tackling the tricky subject of board diversity at organizations. [0:41:27]
• Finding trustworthy evidence in the contemporary climate and combatting the post-truth era. [0:46:22]
• Using Alex's idea of growing the pie in everyday life; making the world better on an individual level. [0:48:46]
• The left-field study that Alex conducted linking Spotify playlists to stock performance. [0:52:16]
• Alex's perspective on his role as a finance professor and his purpose with regard to knowledge. [0:56:38]
• How Alex looks at success in his life and his goal of positively impacting people. [1:00:12]

There seem to be many differing opinions out there about investing in emerging markets, and unfortunately, many of these are inaccurate. This is mostly due to the fact that emerging markets and your involvement in them, perform in ways that are somewhat counterintuitive. In today's episode, we tackle this tricky subject from a number of angles and try to give all of our listeners a better understanding of the strengths and weaknesses of using emerging markets within your portfolio, without falling prey to some common traps. To kick off the episode we talk about some financial news and the interesting recent book Making Numbers Count, before diving into the main course of the show. Listeners can expect to come away with some new insight into the history of emerging markets theory, realistic emerging markets returns, the appropriate amount of caution to exercise when investing in them, and more. Towards the tail end of the show, we are joined by our friend Morgan Housel, author of the prominent new book, The Psychology of Money, and we briefly discuss reading habits and how implementing a few small practices for learning can have an extraordinary impact on ones' life. Don't miss out on this great show.

Key Points From This Episode:

• Rounding up some interesting recent content; TV shows, articles, and more. [0:01:16]
• This week's book review of about the powerful, Making Numbers Count. [0:07:23]
• Standout data points; Twitter's valuation, Deere Corp, and more. [0:13:14]
• A few pieces of the most interesting financial news from the last week. [0:16:18]
• The roots of the idea of emerging markets and its appearance in the 1980s. [0:20:05]
• Unpacking the findings on emerging markets and the best examples of the thesis. [0:21:20]
• What to expect with regards to returns from emerging markets. [0:26:37]
• Reasons for the benefits of diversifying a portfolio using emerging markets. [0:29:26]
• The importance of market integration segmentation and how this relates to emerging markets. [0:33:46]
• Portfolio skewness and how assets contribute to this. [0:35:18]
• Reasons for surprising yields with emerging markets for Canadian investors. [0:41:26]
• The cautious place that emerging markets deserve in a balanced portfolio. [0:47:20]
• The dangers of mixing and matching products relating to emerging markets. [0:49:45]
• Morgan's opinion on how reading can take us beyond our mundane bubble. [0:51:38]
• The approach that Morgan uses to gain and learn the most from what he reads. [0:52:47]
• Decisions on what to start reading and exploring a variety of your interests. [0:54:03]
• Weighing the value of conversations and discussions about the books we have read. [0:57:32]
• Morgan's process for capturing and retaining useful information from books. [0:58:35]
• Parting advice from Morgan about finding the time for a healthy reading habit. [1:00:11]

It is commonly believed that rational thought is threatened by emotion, but contemporary understandings of the brain paint a more complicated picture. Today's guest is Leonard Mlodinow and he joins us to talk about why. As a mathematician and theoretical physicist, Leonard might seem like an odd fit for this topic at first glance. However, when Leonard's desire to discover the secrets of the universe spilled over into a curiosity about the brain, he started publishing books on the subject, his most recent being Emotional: How Feelings Shape Our Thinking. In today's show, Leonard argues that the brain is essentially an information processing organ and that emotions play an integral role in feeding it data. As such, there is no way to separate emotions from thinking, and in fact, they often aid the decision-making process, as well as play a vital role in motivating us. However, our emotions evolved in a different world to the one we live in today, meaning that there are situations where a certain emotion might be influencing a decision in a way we don't want, and this is where the cultivation of emotional intelligence becomes a beneficial practice. So for all of this, as well as perspectives on its ramifications for sensible investing, be sure to tune in today!

Key Points From This Episode:

• Introducing Leonard Mlodinow and his book, Emotional: How Feelings Shape Our Thinking. [0:00:19]
• The role of emotions in rational decision-making. [0:01:04]
• How the brain processes data and the role of emotions in this process. [0:04:09]
• Whether emotions are detrimental to decision making. [0:06:50]
• The situations our emotions evolved in and how our world has changed. [0:09:05]
• Whether it is wise or possible to separate emotions from rational thinking. [0:11:50]
• New findings from affective neuroscience about emotion. [0:13:36]
• Why simplistic categorizations of emotions and beliefs that they are associated with certain organs are wrong. [0:14:51]
• What 'core affect' is, its relationship to emotion, and how it affects decision making. [0:18:36]
• How to gauge when to make certain kinds of decisions. [0:22:12]
• What Leonard's findings on emotion mean for evaluating risk tolerance in investment. [0:24:00]
• What role emotions play in theoretical physics and mathematics. [0:26:28]
• Wanting, liking, and determination: Where the feeling of motivation comes from. [0:30:45]
• How to develop emotional intelligence by cultivating awareness of how emotions affect decision-making. [0:34:21]
• Whether some emotions are more influential than others. [0:37:57]
• What causes people to have different emotional profiles. [0:39:41]
• How other people's emotions affect us. [0:42:14]
• Considerations about the impact of a financial advisor's emotional profile on their clients.[0:44:24]
• When and how to control emotions versus embrace them. [0:45:43]
• Why Leonard wrote Emotional when he is a theoretical physicist and mathematician. [0:50:24]
• How Leonard defines success in his life. [0:52:14]

In this special episode, we review the relationship between war and financial markets. War is a tragedy. We are not minimizing the humanitarian tragedy of what is happening in Ukraine by focusing on the potential impact on financial markets. But we are offering a Rational Reminder for investors in a stressful time. Wars and financial markets have coexisted, and often been intertwined, for hundreds of years. Countries that have lost major wars have had their financial markets decimated, while global markets have been relatively resilient, even to major conflicts. In addition to the historical perspective, we offer some timeless lessons for investors to remember in times of stress.