Rob Arnott is something of a pioneer in the investment space, the founder and chairman of the board of Research Affiliates, he is also portfolio manager on various funds at PIMCO.
His work to date has involved pioneering a number of unconventional portfolio strategies that are now widely applied in investing; these include the fundamental (smart beta) index approach. He is also one of the most respected financial analysts globally.
We ask him about his journey so far.
Where and what did you study?
Rob Arnott: I graduated from University of California at Santa Barbara with a triple-major in Applied Mathematics, Computer Science and Economics. I chose those majors because they all dovetail with quantitative finance (a term that hadn’t been invented yet … I thought of it, at the time, as using scientific method and computer science in investing).
How did you get into the ETF industry?
RA: ETFs are – legally – merely another form of mutual fund. I’ve been involved in asset management for quite a while. ETFs were a natural next-step, especially for someone who has done a ton of work on tax-advantaged investing.
What has been the defining/proudest moment of your ETF career?
RA: That would be the launch of the first-ever RAFI® (Fundamental Index®) strategy, which launched in the form of the Invesco FTSE-RAFI® 1000 fund (PRF) in December 2005. That fund sowed seeds for assets of over $160 billion in licensed and sub-advised strategies that are either RAFI® funds or are related to RAFI® in some direct way (RAFI® Multi-Factor, or PIMCO’s RAE active equity strategies).
What has been the proudest moment outside of your career?
RA: This is a difficult question, rather like asking my favourite child! I was very proud of our work on Tactical Asset Allocation and Global TAA in the 1980s, on Tax-Advantaged investing in the 1990s, on RAFI® in the 2000s, on the linkage between demographics and capital markets in the 2000s and 2010s, and on the pitfalls of backtesting in the factor investing arena in the last 3-5 years.
What are your goals over the next five years?
RA: We’re just about the only business in the global macro-economy where customers love high prices and hate a discount. I’d love to see us transform the industry from a fixation on past returns, and performance-chasing, to a focus on forward-looking returns, and a willingness to buy whatever is newly cheap. Our AAI (Asset Allocation Interactive) and SBI (Smart Beta Interactive) websites are (1) free, (2) intent on exactly this focus, and (3) give people an interactive way to explore their investment options. I expect that – after 12 years in which value investing has been savaged – we’re going to see some remarkable results for value-oriented strategies in the coming 5-10 years. Sadly, too few investors will be positioned to benefit.
What do you do in your spare time?
RA: I collect vintage motorcycles, typically fastest-of-their-era street bikes. But my reflexes aren’t what they once were, so I ride far less than I used to. I also love to go see total solar eclipses, wherever in the world they happen. In 2019 and 2020, there is a total eclipse in Chile, and in 2021 in Antarctica. I’ll be there!
How do you anticipate the ETF industry will evolve in the next ten years? OR Do you think the ETF industry is missing anything?
RA: Product innovation will continue. There will be some truly awful ideas and some truly brilliant ideas that come to market. The so-called “smart beta” revolution will continue and will (ironically) become more scattered and more focused in the years ahead. More scattered in the sense of product proliferation. More focused in the sense that investors will develop a feeling for the best ideas in the marketplace; these ideas will get most of the asset growth. I’m expecting that we’ll see a surge in back-to-basics Fundamental Index ETFs, once the value cycle turns. If we’ve been able to beat the market during a dozen years of headwinds, with value managers and strategies getting savaged, imagine how we’ll do when value begins to outperform.
What challenges does the ETF industry currently face?
RA: Ironically, we’re victims of our own success. The price war in ETFs is interesting. On the one hand, investors benefit directly from lower fees. Our research suggests that every basis point lower fees delivers two basis points in higher net-of-fee returns, on average, because many high-fee players are actually pretty sloppy. BUT, the difference between a good investment idea and a bad one – or between good and careless execution – can be scores of basis points a year. If we’re willing to sacrifice scores of basis points in performance, to save five basis points in fees, that’s a bit dumb. So, we should hope that the current fee war doesn’t shut down the innovations in the industry, or the best ideas that require more than a few basis points to manage them properly.
How does your company differentiate itself from its competitors?
RA: We’re singularly focused on research and product innovation. We’re $180 billion asset managers, who manage no assets! We license our ideas to others – distribution powerhouses like PIMCO, FTSE, SSgA, BlackRock, Legal and General, Invesco and Nomura, to name a few – who bring our ideas to their end clients. Our distribution partners don’t need us – they have their own R&D and product innovation teams – so, we can succeed only if we bring them very good ideas that are complementary to their own product innovation efforts, and can help them make the case for these ideas in the marketplace.
What is your favourite ETF and why?
RA: This will vary over time. Right now, emerging market stocks are cheap – less than half the valuation multiples of US stocks. And value in emerging markets have never traded at a deeper discount to the EM broad market than today. As a result, deep value in EM is priced very cheap – about one-fourth the valuation multiples of the S&P 500 – but I’m a believer that deep value stocks in the emerging markets represent the best bargains in the world today. Of course, bargains get that way by inflicting pain and losses on the way to bargain basement prices. Anyway, RAFI® in emerging markets is a great way to get access to Emerging Markets at a CAPE ratio well under 10x. So, I personally like the Emerging Markets RAFI® strategies offered by Schwab, Invesco and PIMCO. From my perspective, Invesco’s offering provides deep value, while PIMCO moderates that value tilt, by using a multi-factor strategy that relies on additional factors other than value.
What job would you have if you weren’t working in the ETF industry?
RA: When I was eighteen, I was trying to decide between quantitative finance and astrophysics; I quickly settled on finance. So, I’d probably be a mediocre astrophysicist. Why mediocre? Because astrophysics is all math, and there are people who are way better at math than I am. But, when I started in investing, most of the industry didn’t use serious math or scientific method. For what it’s worth, most of the industry – including the quant community – still doesn’t use scientific method. I find the continuing prevalence of pseudo-science (and the finance equivalent of alchemy) pretty surprising.