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Seth Cogswell on Fiduciary vs Asset Gathering Roles, Mid-Large Cap Stock Opportunities, and Rules-Based Investment Strategies

• Michael A. Gayed, CFA

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Discover the critical differences between fiduciary advisors and asset gatherers and how these roles impact investment management. Join us for an insightful conversation with Seth Cogswell, founder of Running Oak, who shares his unique perspective on financial stewardship, inspired by his father's groundbreaking work in the 1970s. Seth unveils the firm’s rules-based strategy and how it transforms his role from a mere portfolio manager to a dedicated steward of wealth. We'll explore how SMAs demand all-in commitment, the potential pitfalls of aligning with market performance, and the pivotal role relationships play in maintaining a disciplined investment strategy.

As we navigate the complexities of investment strategies and market conditions, we highlight the often-overlooked mid-large cap stocks and their promising opportunities. This episode sheds light on the limitations of traditional asset allocation and the importance of maintaining a disciplined sell strategy within a single, effective investment approach. Seth offers valuable insights into achieving sustainable growth, even amidst market pressure and economic fluctuations. Whether you're an advisor seeking sustainable portfolio management techniques or an investor looking to optimize your financial strategies, this episode equips you with the tools needed for long-term success.

DISCLAIMER – PLEASE READ: This is a sponsored episode for which Lead-Lag Publishing, LLC has been paid a fee. Lead-Lag Publishing, LLC does not guarantee the accuracy or completeness of the information provided in the episode or make any representation as to its quality. All statements and expressions provided in this episode are the sole opinion of Running Oak and Lead-Lag Publishing, LLC expressly disclaims any responsibility for action taken in connection with the information provided in the discussion. The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Speaker 1:

I think this is probably, if I were going to stress, the one thing that I would want to tell people today, or the one thing I really want to get out there is this there's a difference between being a fiduciary and being an asset gatherer.

Speaker 2:

Yes, they can overlap, but for the most part you know fiduciary, which is supposed to be about looking out for your client in the best interest of your client. For the most part, that's really not what, I would argue, a lot of advisors do.

Speaker 1:

I mean, investment management is a full-time job, and many investment managers aren't even that great at it when they're doing a full-time job. If you're not investing in your best ideas and you're not investing in the strategies that are situated to perform the best, you're going to end up basically performing in line with the market.

Speaker 2:

Typically, what do you find? Do people allocate 5%, 10%? Is it a larger portion? Do they want to do? They typically wait to see the large caps go down and then allocate Like, talk to me about sort of the things you're seeing in terms of the actions taken.

Speaker 1:

With the SMA. If somebody is going to invest in the SMA, it's kind of a it's. It requires a little more work, and so, because there's a little bit more work, people are either all in or they're not.

Speaker 2:

This is Michael Guyatt, publisher of the Lead Lag Report. Joining me for the hour, roughly, is Seth Cogswell. This conversation is sponsored by Seth's firm, running Oak. They've got a great ETF, runn, which we can touch on as well. But, seth, I know about you Plenty of new people listening for the first time. Who are you? What's your background? Have you done throughout your career?

Speaker 1:

what do you do now? Uh, you asked me the same thing I'm very real and I'm very basic.

Speaker 2:

You know, the trick is you got to say the same thing 500 different ways.

Speaker 1:

I love it well that, actually it messed me up last interview because, uh, I generally avoid talking about myself whenever possible and so I'm used to answering the question tell me about running Oak, or tell me about your strategy, or tell me whatever. Really threw me off when he said tell me about yourself. And, luckily, being the professional that you are, you were able to, you know, cover up my missteps and just move along.

Speaker 2:

I know you're intelligent, but to call me a professional is a little bit of a scratch. No, it's nothing.

Speaker 1:

I mean certainly better than I am.

Speaker 2:

Okay, that would be warm, I'll agree to that.

Speaker 1:

Yeah, yeah. So our strategy is rules-based, which means it's really designed to remove us from the process. It's designed to remove our discretion and our emotions, and so for me, I think that's one of the biggest positives. And because it removes us, it's definitely not about me, and so I generally avoid talking about myself. That doesn't mean I still talk too much, but I try to avoid talking about myself. That doesn't mean I still talk too much, but I try to avoid talking about myself, and so that, again, that question threw me off slightly, but as I thought about it more, it actually is about me.

Speaker 1:

This has been a learning process and it's led to me actually realizing that you know I need to be able to answer this question because Running Oak is me. I took a 99% pay cut to launch it. I basically mortgaged my family's future to get to where we are today, which has led to a lot of stress. I've worked my butt off for 11 plus years to grow it, however I can, and it's also a result of the experiences, my life experiences, leading up to the launch of Running Oak, and you know also the last 11 years. So it very much is me. So I decided I need to actually embrace that question.

Speaker 2:

Well, can I say something Because I think it is actually interesting for the audience A little bit about sort of the fund world, right? So you're a portfolio manager and I often make this point that in the fund world, whether it's a mutual fund or an ETF, if it's rules-based, you're really more of a product developer rather than a portfolio manager, which is important because it does separate out the let's call it the the person from either the problem or the success, but the person still has to communicate what those rules are.

Speaker 1:

Correct. Yeah, and not only that. It'd be one thing if I had created the strategy and the process, but I didn't even do that, right, I mean, my father created the strategy in the process in the seventies and has been running it since it was basically given to me. I look at it as though I was handed a golden ticket and it's really up to me to help it reach its potential. I see myself as more of the steward of the strategy, or the firm, which is not especially sexy, you, or the firm, uh, which is not especially sexy, I'm certainly. I don't look at myself as this portfolio manager um, you know, badass, or anything like that. And so, again, you know, there's the three p's of anytime somebody's doing due diligence or talking strategies, there's the three p's. Right, it's like I'm gonna actually mess up the third b, but it's because I'm never in those in that position, but it's one of the p's is people, and it's always awkward because I don't want to talk about myself. I'm actually going to still not talk about myself for the most part, but I am going to tell a story because I think it does provide a really good sense of running oak of myself and hopefully inform investors or future clients.

Speaker 1:

So I again, my father, created the strategy in the 70s. I grew up kind of looking over his shoulder. That was pre-80s, early 90s. That was pre-computer. So my father would receive these stock chart books there was one that was blue and orange and I would steal them and then like comb through them and imagine how easy it would have been to buy low and sell high, and that got me very interested in stocks. So the moment I had a few hundred dollars in college I set up a brokerage account and bought a very hot stock tip from a kid who it turned out had no business giving anyone hot stock tips. It declared bankruptcy within a week. It was literally the worst stock tip ever.

Speaker 2:

Oh, okay. So on that stock tip, uh, did you like what was the conversation like after that, like were you still friendly with that person?

Speaker 1:

We weren't even really friends, I don't even know. I literally it was. I don't think I put much thought into it and it's funny this. Actually we could take this later on into a discussion about passive. But you know, I didn't think about what I was investing in. And so here's I didn't have much money, I worked hard for this money and then I invested it without thinking, which is crazy, but that's what I did.

Speaker 1:

And but I learned a very valuable lesson. I learned first of all, I should probably bet my sources. Clearly, I didn't bet that one, but two. I should probably actually learn what I'm doing. And so I went on to read every single book I could find on markets and stocks, went on to read every single book I could find on markets and stocks. I was right, I just lived in the library and look through newspapers and did whatever and continue to trade. And so I'd run. You know, as soon as math class was over, I'd run to the computer lab and put in some trades or something.

Speaker 1:

I was definitely trading, not investing, and and I did well. So at some point these numbers are going to be a little. They're inaccurate, but you get the trend. I started with $500. And at some point I think, let's say, senior year I was managing or not managing, but I had like $12,000. And so I had done well. And I had some friends. I was actually just texting with two of them. I had some friends who had some money saved up and they had invested in almost every decision they made, destroyed value, and so they were like they asked me to manage their money for them, and the deal was that they would give me 20% of what I made and I would pay them 20% of what I lost, which was my rule because I knew I'd feel guilty if they lost money.

Speaker 2:

Oh, hold on. So this is like literally, it's like a prop shop.

Speaker 1:

Like my own little thing when I was 22. And so I agreed to give them, or I didn't agree. I insisted that I would pay them 20% of what I lost and I wasn't worried about it because they didn't agree. I insisted that I would pay them 20% of what I lost and I wasn't worried about it because they didn't have that much money. I continued to do really well and at some point the father of a friend found out and asked me to manage his money. He had a lot more money than my 22 year old friends. It wasn't so much that I was concerned about my ability to kind of backstop it, uh, but so I agreed to do it and so I continued to do well.

Speaker 1:

At some point, I think, my $500 investment grew to again. These numbers aren't perfect, but let's say $35,000 to $40,000. And I did well with this my friend's father's account as well, as well as my friends. He got excited and doubled or tripled the amount that he had invested and I called him.

Speaker 1:

I was like I can't, that's too much money, I can't backstop this. And he was like well, I'm putting it in there and you can decide whether you want to invest or not. It's not my choice. I'm just putting the money in there. It's up to you. And uh, you know, I was 22 dumb, felt like I was invincible because at that point, I had just been killing it for a few years, and so, of course, I felt the need to uh invest it and, unfortunately, soon after I ran into uh, one of the worst more, I guess, one of the most challenging periods of my life One of the most difficult and one of the kind of series of books that I loved when I was learning about the markets was called Market Wizards by Jack Schwager, and it's interviewing.

Speaker 2:

By the way, not to interrupt, but I've interviewed Schwager in the past. Won't tell him how to say his name, yeah, and I will say that, yeah, those are always like go-to books for me personally as well. Right, just the interviews and sort of the… they're awesome, the strange quirkiness of some of these supposedly legendary traders. I only say supposedly because I had asked Jack this question before. He actually never really verified the performance that's a whole different argument.

Speaker 1:

That's really funny. We even heard on the podcast, but anyway, we even heard on the podcast. So one of the major trends or kind of prevailing themes in his books was do not trade. When you're emotional, it's hard enough to make high stakes, objective decisions. It's another thing when you're a mess. And I was a complete wreck. And so I ended up in, I think, a matter of a month or maybe, a little wreck, and so I ended up in, I think a matter of a month or maybe a little more.

Speaker 1:

I turned my $40,000, which took me years to build up into zero. I went from 40,000 to zero and my friend's dad luckily I was taking a lot less risk, but I was taking a lot of risk to get those kinds of returns and you know, he lost a good amount. I guess he, uh, he maybe had too much confidence in me, so he didn't pull the plug, which would have been nice. So eventually it came down to me to pull the plug, which I did at some point, and when I did I owed him a lot of money. So what I did is I uh, there was a, a bank or a credit card company that made the foolhardy decision to lend me $25,000 at a 0% APR, and so I got this credit card, I maxed it out and I sent this guy a check and that was it. That was the end of my self-made kind of prop shop. But why this really matters is I see this as one of the most defining moments in my life, where it was a nightmare. It's hard to imagine more going wrong. I had zero dollars and, you know, I was able to find the kind of strength to do what was right, despite how much it scared me. And again, I think Running Oak is me and this is one of the most formative experiences of my life. It's one of the things that I'm proudest of and I think it's an aspect of Running Oak.

Speaker 1:

We will do whatever we can to benefit the client. That doesn't mean that we're perfect. Market's going to go up and go down to fit the client. That doesn't mean that we're perfect. Market's going to go up and go down, but we will always put the client, our clients and their well-being first, which I think differentiates us. There's a lot of very large companies in the investment management industry which are dominating flows simply because they are big there. There's not much to them other than they're like a vacuum cleaner. Uh there, I don't think that they're really putting the client first, whereas we are. The other takeaway I would say is uh, the rules-based nature of our strategy really appeals to me following that experience, because that's the purpose of it. The purpose of the rules-based process is to ensure that that doesn't happen, to ensure that our emotions are not negatively impacting how we manage the portfolio and our clients, and so, again, you know, there's nothing better than learning from other people's mistakes. I've had some hard knocks and ideally, running out can help clients avoid those.

Speaker 2:

I will say that point is underappreciated because a lot of people in our industry, as you know, throw the term around fiduciary and there's a difference between being a fiduciary and being an asset gatherer. Yes, they can overlap, but for the most part fiduciary, which is supposed to be about looking out for your client in the best interest of your client. For the most part that's really not what, I would argue, a lot of advisors do. They're just asset gathering. They're doing standard, traditional asset allocation. They're not really caring about markets. They never read Schwager's books, they never had the intellectual curiosity. They are not rules-based. It's hard to get that message across when I think the vast majority of the industry is exactly like that.

Speaker 1:

I don't know. I think in the end it's a people business, right, I think, particularly for advisors. I think a lot of it just comes down to we can't be the best at everything. We can try to be our best at a handful of things. I think advisors the true benefit that advisors provide their clients is that relationship. It's helping them kind of think through things. It's helping them hopefully hold their hand, because it's not.

Speaker 1:

Life can be challenging. The market doesn't always go straight up. I realize it's basically gone straight up for the last 15 years. That just means that it's highly unlikely to not do so in the not too distant future. But investing's hard and you know if you're working hard and you're putting money in the market, that's investing. It's difficult and I think advisors it's that relationship. That's the value they have. Now. Whether advisors um can best serve their clients in you know investment management ways. I don't know like some might be really good. It's just really hard to like get it. I mean, investment management is a full-time job and many investment managers aren't even that great at it when they're doing those full-time. So I think for an advisor to focus all their attention to provide the best possible service for their clients, let alone try to grow and actually prospect and manage portfolios, particularly picking out individual slots. I just think that's very difficult to do.

Speaker 2:

All right. So I get the rules-based. I'm a huge fan of rules-based as well. I share a similar dynamic to you. In that sense, the strategy is probably different than the product developer who's named as the PM let's talk about. So you built out the firm You're doing separately managed accounts. Talk to me about the types of strategies that you've used firm-wide, presumably more than just what you're doing with Run. And then what got you to even launch the fund to begin with?

Speaker 1:

Well, firm-wide and actually I think this is an interesting differentiator versus a lot of other firms is we do one strategy. We've only ever done this one strategy. I spoke with someone a little while ago who I really like and he made the comment that he kind of wished he had launched some other strategies, just because you never know what's going to be in favor at that moment. Our strategy has been out of favor for basically the last decade. Fortunately, it's still performed really well.

Speaker 1:

I generally think that no good data point should be left unsaid, and so our strategy, despite being out of favor, still top one percentile in our space, which is mid-cap core, and it's performed relatively. It's basically performed in line with the S&P over the last decade, despite minimal exposure to the Magnificent Seven. It's been a hard road, but we have continued to only run one strategy, and it's because I have running Oak again is me, and I have absolute conviction that the way that we manage money is one of the best possible ways to achieve long-term compound growth for clients. I just. Anything else that we would provide I don't think it would be as good, and that's largely driven by we have real-time data going back to 89. And over that period it was in the top half of a percentile of all US managers as far as risk and downside return, and I just don't have to beat top half of a percentile.

Speaker 2:

Like everything else, there are going to be times when a rules-based approach works and times when it looks like it's not. There's always cycles to everything. So you're going to have periods of outperformance, periods of underperformance over time. Cumulatively, obviously, you hope the outperformance swells, the underperformance. Were you ever tempted, in those times when it looks like it's not really synced up or working for whatever reason, were you ever tempted to kind of rethink the rules or change things up? I say that because I've seen that and I think it's a mistake when quant managers are bending the knee to clients who are saying you have to change up the way you're investing because it's not performing right now.

Speaker 1:

I have had very little negative feedback over the last 11 years. There's only one client that's kind of a little challenging and it was largely with regard to realizing gains. Uh, they just really didn't want to tell their clients that they had taxes. But if our strategy I mean again, it's performed in line with the sp. The sp is up huge over the last decade, so that means we're up huge and but over the long term I would expect our strategy outperform the sp by three to three and a half percent or so. The sp is fees up on average. We're up more, there's going to be gains and I think one of the biggest.

Speaker 1:

I think, actually I would say that the main value that we offer is our sell discipline. That's where many managers and individuals struggle. You get attached to something. That sell discipline means that we are going to sell things when they become of value. Again, that's our big value add. But it means there's going to be gains and it means there's going to be taxes. Now, that is one of the huge benefits to the ETF. That at least enables our clients to kick the gains down the road until they decide to sell the ETF which ideally they never do and just donate it, but yeah, that's just gonna. That's one of the areas where I've ever gotten feedback. I've otherwise, and maybe it's maybe I've been sort of lucky I would.

Speaker 1:

The last decade was, I think, it could always be worse Maybe our worst nightmare. Our sell discipline which again I'd say is our most valuable value, that's our main value add is effectively anti-momentum. We sell companies when they become overvalued, when they go up a lot. We also. One of the ways in which we look to protect to the downside is to avoid companies with too much debt. Over the last decade, companies have taken on more debt than any time in history and largely for no other reason than to buy back stock. They didn't add more value, they just simply bought back stock. That is also or avoiding debt and kind of fighting that trend is also anti-momentum. And then, lastly, our portfolio is equally weighted, which puts mean reversion in your favor, but is also anti-momentum.

Speaker 1:

Meanwhile, a few months ago, momentum hit the 99.8th percentile in history. The only time that it was even close to the last you know, to the last few years was the tech bubble. To the last you know, to the last few years was the tech bubble. So in the hottest period in history for momentum. We've been sitting here anti-momentum and we've still performed in line with the S&P. Now, if we had struggled quite a bit more and we had maybe people were becoming impatient. That would have been a different story, right, and then you're watching. Then you're watching this business that you've worked to build kind of start to dwindle, and being disciplined is very hard. There's going to be times where, over the long run, there's no arguing that it's not good to be disciplined, but there's going to be times in the short run where you're sitting there watching everybody party and you're feeling a little lonely.

Speaker 2:

Yeah, I think that's very well said. I wonder, since you mentioned the tech bubble and 99.3% whatever the number was, you yourself do you think that we're in some what of a maybe not bubble, but some sort of a mania phase that could be due to reverse pretty aggressively?

Speaker 1:

I would have said that a while ago.

Speaker 2:

Oh, that's the problem, I know.

Speaker 1:

So that we were definitely in an everything bubble, particularly in 2020, 2021, or right before COVID 2021 or right before covid. Tech had been absolutely insane leading up to that and then, all of a sudden, it just kept going up more and more, and it was doing so while china word was coming out that china was closing down and still stocks are going straight up. It was also when debt was had negative yields, I think there was there was no arguing that we weren't in some massive bubble. And you also look at real estate it's extremely difficult to afford at this point. I mean, I'd say it's basically just completely unaffordable for many. Uh, so whether I'd say it's a bubble or not, I don't know, cause there's going to be a lot of people to argue with me, but I I do think that things are out of control and it'll be interesting because there's a lot of similarities to the tech bubble and today One of the big differences is in the tech bubble, the stocks that kind of led the charge were largely unprofitable.

Speaker 1:

That was definitely a little bit of a more of a mania, whereas today, the stocks that I would say are the most crowded trade, the trades where you have the most indiscriminate money going into. It is the big tech stocks Now. Those are very profitable and they generate a lot of cash. So it's very different from the tech bubble, but it'll be interesting to see how it plays out, because the popularity of passive over the last decade or two means a lot of people have indiscriminately just been investing a massive percentage of their net worth in a small number of companies.

Speaker 1:

And again, I think the most important part of that is indiscriminate. There's no major decision that you make in life where it makes sense to not think, but that's what's been going on for quite a while and and that's usually when you experience a bear market it's when that poor behavior, the bull market and people getting ahead of themselves, the bear market is where that is rung out. And again, the big tech companies that's been the biggest. They've been the biggest recipient of that behavior. So I would expect the bear market to punish them more than almost.

Speaker 2:

You know like about equal weighting, you alluded to the mean reversion point, but it's the purest form of factor investing right, because it's not based on idiosyncratic aspects market cap weighting on momentum, it's. You know, every one of these thoughts fits that criteria for whatever factor that you're tracking and on average you know it's a good representation of that dynamic. You've mentioned the mid cap, core-ish side of things. Talk to me about the construction of RUN. How many positions, what type of sector allocations are there, and can it conceivably be more of a core allocation as opposed to mid-cap satellite?

Speaker 1:

let's say, yeah, so our universe is companies with market capitalizations of $5 billion and above, which is mid-large. We then sort out companies that are expected to grow at the highest rate we can possibly find, but then we're very disciplined. We then call that down based on valuations and some other risk metrics. It's always going to be mid-large Again, we've got data going back to 89, and the portfolio will always be always going to be mid-large Again, we've got data going back to 89 and the portfolio will always be walking the line between mid-large.

Speaker 1:

I wouldn't describe it as a mid strategy, it's probably more of a. I don't really love using the word all cap, but anytime you constrain your decisions, you want to make sure you're doing so for the right reasons. We constrain our market cap at $5 billion because, as you go lower, I don't think you can argue against the fact that you take on more risk because there's less liquidity there, the companies are smaller, and so we do have that constraint there for a reason. Otherwise it's it's largely unconstrained, other than the process is there to guide our investment, to consistently invest in companies that have the qualities that we seek, which is, uh, as high earnings growth as possible, but avoiding overvalued companies at all costs and then, uh, invest, then investing away from qualities that lead to greater downside risk, such as, I mentioned earlier, debt. Now, as far as sector exposures, the portfolio is equally weighted. We're completely indifferent towards sectors, but ValueLine breaks the market up into 99 different industries and we do invest. We make some kind of allocation decisions based around those. We want to make sure that we have significant diversification, so we generally have more than 30 industries represented. We'll cap any one industry 13 to 15% and so the end result is you get an equally weighted portfolio that's diversified across companies and industries, really with the goal of minimizing that idiosyncratic risk, I would say.

Speaker 1:

Since we're talking about mid-cap, there was something I wanted to show you. I think this is probably, if I were going to stress, the one thing that I would want to tell people today, or the one thing I really want to get out. There is this I have been as the firm's grown with the launch of the ETF. We've had more and more conversations with the largest firms, which is enabling me to get a much better sense of how the largest firms are allocating clients, or maybe even just the biggest trends. In the past, we worked more with independent investment managers or investment advisors, so it was a little more nuanced. We would see, you know, kind of smaller windows into what people were doing. As I've gotten a broader, something really interesting has become obvious and it excites me because I think we work perfectly with it.

Speaker 1:

But as much as I hate investing around the style boxes, I think the style boxes can be really helpful for getting a sense of where your exposure lies. If you start out with the traditional style blocks, every allocator whether it's investment advisor, the big platforms where they approve strategies they all have large cap and because of what has happened, because of the dynamic over the last 10 years, a large percentage of most large cap strategies are mega cap and big tech. Now that could be a result of just complete performance or it could be a result of the only way for most managers to keep up was to go overweight those big tech companies and many, many have. But if you use SCHG, which is the Schwab growth portfolio, as an example and that's something that I see a lot of clients invested in so I think that's a good representative of this large cap growth portfolio 51% of SCAG is in eight companies. Over 50% is in eight companies that are highly correlated. So this little mega slice that you see is probably actually a lot smaller. It's I mean, it's highly concentrated at the very top end now. So people think they're getting large cap, but they're not. They're. They're. Most of their exposure is up at the very top end. That large cap exposure is then balanced with smit.

Speaker 1:

So the the issue with doing there aren't many pure mid-cap strategies. When I last time I spoke with goldman sachs, they didn't have a single mid-cap strategy that was approved on the platform. Uh, most of the platforms I talked to have smid and if you're walking the line between small and mid, you're probably going to end up and you, you know, kind of concentrating around your midpoint, which is going to be the larger part of small, the smaller part of mid, and that leaves that upper mid part largely uninvested. That Megan Smith exposure is then complemented with value. So these are kind of like the three very obvious ways in which many of these platforms and advisors allocate clients. You've got growth value, smid, large, and value might overlap a little bit with SMID on the mid-large side, but what you see is this leaves a huge gap in a client portfolio. You can see it, it's this massive gap and we not that creatively, but there's a lot of ways to play on it so I like it. We've called it Marge, which is just mid-large. I'm sure plenty of other people call it Marge. It's not all that creative but regardless it's this sweet spot that is wildly underinvested. When I look at other, when I look at the large platforms, when I look at advisor portfolios, people think they're getting large cap exposure. They're largely getting mega. People think they're getting mid cap exposure through SMID. They're largely getting the smaller side of mid. And this part, this large area, is exactly where you want to be right now. So you mentioned we would discuss maybe year end. So this touches on that.

Speaker 1:

The most important dynamic in the market right now is interest rates. I would imagine most people would argue that After the Fed cut rates, the did a jumbo cut in September. Interest rates went straight up. The whole point of cutting rates is for them to go down and so they went up. They cut again and they didn't go up much, but they've come down a little bit recently. But the main thing is who knows what's going to happen with interest rates? Because the Fed's cutting rates, they're going up. There's no telling. It's an uncertain time.

Speaker 1:

If rates continue to go higher, that hurts Smith because those companies are smaller. They're more interest rate sensitive. They had less leverage when they negotiated terms. You know I think 50% of the Russell 2000 is actually zombie companies, maybe certainly unprofitable. So if interest rates go up that's going to hurt Smith. It won't impact mega very much because they generate a ton of cash. They did have a lot of leverage and they got great rates. But it also won't impact Marge very much because Marge is're again larger companies. They're not quite mega but they're close and particularly as far as run or efficient growth goes, we intentionally avoid companies with a whole lot of debt. So higher interest rates will impact Marge less and will impact efficient growth or run quite a bit less.

Speaker 1:

Now if interest rates go down, interest rates generally go down for one reason and that's because we are in a recession. Usually the Fed's famous for being late. If they're cutting rates they're probably a little concerned we're headed into a recession. If there's a recession, smid while lower interest rates will benefit SMID, a recession definitely won't. They're much more economically sensitive. That'll be difficult for smaller companies generally coincides with a recession.

Speaker 1:

A bear market is where the excesses of the bull market get wrung out. Many would argue that the excesses are most concentrated in the big tech companies. That's where an insane amount of money has been indiscriminately invested constantly. That is where the most pain probably lies if we do end up in a recession, because again, that's where the excesses are wrung out. That means that companies go back to fair value, but the problem is they don't stop at fair value, they usually go flying right through. So again, if interest rates go down, big tech's probably going to really struggle Metal struggle Margin.

Speaker 1:

On the other hand, there's a reason why we're invested there. It's because of that gap. Nobody's investing there, which means there's less dollars chasing these companies. It means that the valuations are more attractive. And so if these companies did not participate in the excesses, why? There's nothing to be wrung out. So you could see a scenario.

Speaker 1:

Now this is I wouldn't say it'd be this extreme, but in 2000, you had a handful of companies that got wildly overvalued and when the market went down, those companies went down, but there were a lot of companies that didn't participate in the excesses of 2000. So you had value and quality in our portfolio. We're actually up in 2000. I'm not saying if we see a recession, we'll be up or those will, but again, that's a. That's a good example where, if things did not participate to the upside, why should they participate to the downside? Certainly not, certainly they shouldn't to much extent. So, again, I think this gap, if I just go back, I would just recommend that many clients, many advisors, take a look at the actual holdings and where they lie. From what I have seen, this space is completely under invested and for and for those reasons, as far as interest rates, whether interest rates go up, whether they go down, whether we have a recession, whether we don't, this is the place to be.

Speaker 2:

Yeah, you got to be curious. I was going to say show me the next slide, because that is yeah. Let's go back and by the way I agree and it makes sense. The underinvestment because, to your point about the passive side right, all this money has been flowing into large cap market cap weighting and left a lot of things largely for dead. So there should, almost by definition, be much more opportunity because there's fewer players betting on that payout right on a relative basis.

Speaker 1:

So this actually perfectly supports all that I just said. A client of ours sent this to me last week and what it illustrates. So the top is large cap. As far as, like the Shiller kind of CAPE index, what you see is that P's currently are way beyond the median for large cap. In small cap they're actually marginally overvalued or marginally above the median, which kind of surprised me. Mid cap, on the other hand, is actually undervalued or below its median, which is crazy.

Speaker 1:

If you think about how the market has gone up a lot, both recently but for the last decade, it's easy to think that everything is overvalued. But according to this chart, that space, that large space, is not overvalued right now. Large cap, at least relative to its long-term median, is wildly overvalued. Small cap is marginally overvalued, but mid cap is the place to be as far as valuations go. So again, just another. You know this. This really supports that um, that kind of marge discussion in the fact that this, this space, is the place to be. Um, you, in the long run, you want to be buying assets at attractive prices.

Speaker 2:

David Pérez, I love that you're all in right, meaning it's on the SMA side, it's on the ETF side. I'm always reminded of a great line that diversification is a luxury for the rich and if you want to get rich, you've got to be all in, right on on your business, on whatever it is that you're doing, um for advisors or individuals that are looking at run, are you in and your fund? Um, typically, what do you find? Do people allocate five percent, ten percent? Is it a larger portion? Do they want to? Do they typically wait to see the large caps go down and then allocate like, talk to me about sort of the things you're seeing in terms of the actions taken uh, that timely question.

Speaker 1:

That's actually gonna be the topic on my next newsletter. Uh, because it's something I've thought a lot about. I we found that with the sma, if somebody's going to invest in the sma, it's kind of a it's it requires a little more work. Right, you've got to create accounts, um, and so, because there's a little more work, right, you've got to create accounts. And so, because there's a little bit more work, people are either all in or they're not, and so our largest SMA clients actually use our strategy as 15 to 20% of their equity portfolio, which is how I would argue to use it, because it walks the line between growth and value mid and large. So it really is that I would use as that sliver in mid and large in blender core. I think that's the sweet spot for it, and the fact that it's performed so well just means that you know you've got a little extra invested in your best idea. I'm saying that my strategy is your best idea, but, again, I didn't create it, so I can say whatever I want and not be bragging. That is how our largest clients use it. That's how I would recommend using it. That's how I would use it if I'm building portfolios.

Speaker 1:

What we found with the ETF, though, is it's so easy to invest in that people are not necessarily all in or not invest in that people are not necessarily all in or not. There's, I think probably from what I know, there's 60 teams or advisors with an aggregate of, let's say, 100 million invested in RUN, but their aggregate AUM is probably $100 billion, and so they've got less than 1% right now invested in, which is very different from that 15 to 20%. Even if you use it as a mid cap strategy, that would be, let's say, 5%, so it's below that, and that's something that I've been struggling with and trying to figure out. I think part of it is it's so easy to invest in that you don't have to be all in or not. You can dip your toe in and see how it plays out, which and I understand that mentality, although it doesn't fit my mentality If I see something that I think is the best I'm in, that's definitely something I'm struggling with, so if anybody would like to provide feedback on how to best communicate, how to use our strategy, please let me know, because that's again that is going to be my topic of the next letter is, really, if you're not investing in your best ideas and you're not investing in the strategies that are situated to perform the best, you're going to end up basically performing in line with the market.

Speaker 1:

I mean, if you invest in, you're effectively sort of closet benchmarking. If you've got there's a lot of firms I see where they've got like 30 strategies that are, you know, make up their overall portfolio, and that does reduce risk to a certain extent, but it also means that you almost have, maybe, market risk. So that actually, I mean if you're there's a, if you're really disciplined and invest in strategies that really guard to the downside, but then you dilute those, then you might actually be taking on more risk by investing in more managers.

Speaker 2:

Very well said, Seth. For those who want to learn more about run and maybe learn more about the RIA, what would you point that to?

Speaker 1:

want to learn more about run and maybe learn more about the ria. Where would you point that to? So, uh, running oakcom, running oak, etfscom. Also, feel free to email me at seth s-e-t-h, at running oakcom.

Speaker 2:

uh, we would love to talk to you and now, like I said, seth's got a killer camera so, as you can tell, you'll see him in full hd. Appreciate those that watch this live. Uh, this will be an edited podcast under Lead Lag Live. Again, this is a sponsored conversation by Running Oak. I'm a big fan of Seth's and hopefully I'll see you all in the next episode. Appreciate it, everybody. Cheers.

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Michael A. Gayed, CFA

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