Trey Lockerbie (00:02:52):
Good clarification.

Jim O’Shaughnessy (00:02:53):
… greed, hope, and ignorance.” Fear, greed, and hope are all emotions. Ignorance is the only non emotion. And I believe that fear, greed and hope are responsible for greater losses in investing than any bear market, because they access an ancient part of our brain that we think we’ve got control over, but we really don’t. So by way of example, my friend, Jason Zweig gives a great example of this. When you have a client come in and say, “Here’s the portfolio, here’s how it’s done. Here’s what we would suggest you invest in. But we want to make sure that this is right for your risk profile.” And oftentimes that’s done in a variety of methods, and a simple one is often asking the client, “How do you think you could handle say a 20 or 30% decline in your portfolio?”

Jim O’Shaughnessy (00:03:50):
Well, interestingly, men specifically, women are better at this, actually, in fact, there’s a lot of studies showing women are better at investing. We’ll come back to why that is in a minute. But if you ask them that in a public space and there are other people in the meetings, there’s a bunch of behavioral things going on right there, but they’ll say, “Yeah, sure.” And Jason’s analogy, which I think is quite wonderful is, it’s like showing somebody a picture of a snake and saying, “Does this scare you?” And they say, “No,” And then actually throwing a live snake in their lap. What happens between the two scenarios is massively different. Our brains, and this is evolutionary psychology, deep in our human operating system is the fight or flee. And that kept us alive so that we could ultimately become the dominant species on the planet. However, it’s still active. And when you intellectually know something it’s very different than emotionally knowing something.

Jim O’Shaughnessy (00:04:55):
Our emotions, specifically fight or plea are hardwired. In other words, for the most part, they don’t let the prefrontal cortex take them over and say, “Calm down now, I’ve got this, I’m the planning aspect of the brain. You just settle down,” no dice, because honestly they have to be. And so are they here in the room with us? I’m not afraid, I’m filled with hope so, maybe that one’s here, but the other ones are simply the main reason that I have found being in this business for 35 plus years, that time and time and time again, something bad happens in the market, people freak out, they’re convinced that it’s going to zero and they sell usually at or near a market bottom. And then vice versa, when a bubble is being inflated, that too motivates the greed aspect and the FOMO, fear of missing out, and gets people to, as a friend of mine, quite humorously put it, price what they’re investing in at the price to magic ratio.

Trey Lockerbie (00:06:01):
That’s perfect. Obviously the reason I’m asking is because the market is seemingly correcting. Obviously it has corrected, it might just be going into full on bear market now. And so a lot of people, now their rationality is being challenged. And so this is where investing really gets hard. And even though it can be simple, it’s very hard. And I’m curious about quant style investing, because I wonder if some of those strategies might start to look like they’re broken. So how have you built such a successful company based on keeping investors calm and reserved during times like these?

Jim O’Shaughnessy (00:06:36):
So we do our very best to qualify. We work with advisors and brokers. We don’t work with the end client. And when we’re interviewing a new candidate that wants to work with us, we pay very special attention to things like, how quickly did they sell out of an investment that they had maybe only made a year or two before? Listen to what they’re saying, very, very careful. You can make a lot of inferences about somebody’s ability to actually hold on through downturns. Now you’re not always going to get it right. We had a client that had been a client of my absolutely first company, which was O’Shaughnessy Capital Management, and he stayed with us through all of the iterations of… I was at Bear Stearns for a while, and then OSAM. And quite literally, when I went down with my head of private client services, I thought of him as a good friend and still do. But literally when he saw me, he goes like this, and he says, “Jim, I know the briefcase you’re carrying is filled with all sorts of tables and charts and graphs that explain to me why this is a massive buying opportunity.” And he said, “I just don’t care.” And that was during the great financial crisis. And in the scope and scheme of things, a very understandable attitude.

Jim O’Shaughnessy (00:07:56):
There were people who believed that the entire banking system was going to collapse. I didn’t believe that, because I had studied the Fed. And I knew that one of the reasons that the Fed is there, despite its many haters, is to act as the buyer of last resort. And that’s in fact what they did in the great financial crisis. So that all sounds very calm and measured as we’re talking here in 2022. If we were having this conversation in January of 2009, and I’m not saying you, Trey, specifically, but many, many would look at me and say, “You are out of your mind. Cannot you see Lehman Brothers, which has been around more than 100 years, failed. Bear Stearns, which had never had a quarter since the 1920s where they lost money, were a forced sale to JP Morgan. Jim, you don’t understand the facts on the ground, man. This is it. This is the cataclysmic bear market to end all bear markets.”

Jim O’Shaughnessy (00:08:58):
And my response was, as it always is, that’s certainly a possibility, but there is a huge difference between possibilities and probabilities. We bank everything we do on probabilities. If you think about it, if I was going to take every possible thing, scenario into account, I’d never leave my house, because literally the possibility I get into a car accident, and die, the possibility that somebody intentionally kills me or randomly kills me or whatever, there is an infinitesimal possibility, some bigger than others, but it would basically freeze you in place cowering in the fetal position, because when we’re talking possible, almost anything’s possible. Is it probable? I think not. So to answer your question specifically, all of our work has some, what I would call foundational principles.

Jim O’Shaughnessy (00:09:58):
For example, in general, over time, directionally, these strategies work with a pretty high base rate. In other words, the base rate is how often over a one, five, 10 year rolling periods did that strategy do better than its benchmark? And we look at things like valuation. We look at things like momentum. We look at financial strength. There’s a whole host of things that we look at to determine whether a stock can get in or not. But on the point, as in terms of, “Your strategy’s broken,” well, one of the things that I’m very proud of is right now, I think that we have the finest research team that OSAM has ever been lucky enough to have. Some major, major brain power in there. And one of the things that we do, it’s like the old joke back in the nineties, when quant was new, everyone would go, “Well, what do you do all day, golf? I mean, you’re not interviewing companies, you’re not doing any of that.” And I responded then as now, “No, but we are continually trying to refine and improve our research.”

Jim O’Shaughnessy (00:11:02):
And if you look through just any one of our strategies, for example, the biggest one is called shareholder value, or market leaders value, is the technical name, but if you look at what that strategy started at and what it is today in terms of the underlying factors and all of the various things, we improved it continuously, not massive improvements, but improvements nevertheless. And then simple things like that will just improve our results. For the most part, I was very hated by my research team about 12, 14 years ago, when I set them out on a data cleansing operation, very few people understand how actually dirty, or incorrect if you will, the data is from a variety of sources. And so we had to source it. Very unhappy work. I did a little just so that I felt like I was contributing, but the fact is, I think that’s how we managed to continue to improve and hold the clients.

Trey Lockerbie (00:12:01):
Well, going back to your 2009 reference, you had this great paper in 2009 about a great buying opportunity. And at the top of that paper, there’s this amazing quote by John F. Kennedy that says “The Chinese use two brush strokes to write the word crisis. One brush stroke stands for danger, the other for opportunity. In a crisis, be aware of the danger, but recognize the opportunity.” I think that was just such a great pull for that exact purpose of that reason. But to your other point about these factors, I mean, one in particular that everyone is aware of nowadays is the idea of price to book. Since retail investors may not have the research that you do, how are we to maintain conviction over some of these factors, knowing that they can evolve and change over time?

Jim O’Shaughnessy (00:12:43):
Specifically to that factor, I wouldn’t advocate investors don’t really look at it anymore. And that is based not on my opinion, but on very deep research that we did. We published several papers about it, we had a podcast about it, and it has to do with the changing nature of valuing businesses. Price to book was great for industrial type companies, and typically price to book, a low price to book, was very good going forward. A high price to book meant probably over priced. The other thing about price to book even back then is if you do get a horrible bear market, like they got in the crash of 1929 and the ensuing depression, price to book is also a pretty good proxy for bankruptcy risk. So if you actually look at the behavior of low price to book stocks in the thirties, you will see that there was an inversion, with the stocks that had the highest price to book doing much, much better than the stocks with the lowest price to book, because in fact, they did go bankrupt because of the economic situation of the depression.

Jim O’Shaughnessy (00:13:48):
But flash forward to today, the idea of brands as intangible assets is self-evident. I mean, why is Apple valued at what it’s valued at? A big part of that is its brand. Same with Nike, same with virtually any kind of company you’re thinking about, Amazon. So the intangible aspects that valuing brand brings to the table sort of negate the whole raison d’etra of price to book in the first place. So we actually removed it from our composites. We use composites of factors for all of our algorithmic selection of securities. And the challenge there is that often people are really, really reluctant to change their mind about something that’s been working well for them. I know there are some other asset managers who still claim price to book is quite good.

Jim O’Shaughnessy (00:14:45):
Again, I’m basing this just on, you’re too young, but there was a show called Dragnet and Joe Friday was this cop who never smiled. And whenever he interrogated somebody, it was, “Just the facts now, just the facts.” And so that’s what we’re looking at, just the facts. And since there are a huge number of other valuation metrics that we can and do use, we saw this is a pretty easy choice to make. I mean, something that had worked very well, a lot of academic studies on… I mean, French Fama, which got the ball rolling, used price to book, many, many other academic studies did as well. I have it in my book, of course. In this edition of the book I hedge a bit, because we hadn’t gotten all of the other deeper research, but even when we included the 30s, because we got the CRSP data, which is the data from the University of Chicago Center for Research and Security Pricing, thus the acronym and we’re able to run it, we’re like, “This is something that is material. This is something that we didn’t know at the time. Now we have this new data,” and so we were removed it.

Jim O’Shaughnessy (00:15:53):
So the way that our strategies work, I think, to be fair, this is probably true of all quant investors, is that they refine them as they do additional research. I think the bigger question for a quant specifically is not, how much did you change your model over time, and was it all based on evidence? For example, a generational buying opportunity that I published in March of 2009, that wasn’t me, it wasn’t Jim striding into the office and saying, “I am going to say this is a generational opportunity.” That was the data. That’s why you very, very seldomly see papers from us making that kind of call. The data was screaming at us. “Wow. This really, really is presenting a huge opportunity.”

Jim O’Shaughnessy (00:16:41):
But the better question around quants in my opinion is, did they override their models? And we learned after the great financial crisis, when a consultant who called specifically for a large brokerage on quants came out and told us, and honestly it floored me then and still floors me as I think about it now, that over 60% of the quantitative managers that he followed had overridden their models because of the financial crisis. To me, I tend to be a purist on this. If you’re a quant and you override your model without it being based on research, but is based on you panicking, you’ve negated your entire past record, because that was contingent and built upon the idea that you do not override your model.

Jim O’Shaughnessy (00:17:32):
I’m retiring actually from OSAM at the end of this year, I think you might have seen that, and I’m doing that because I think the team there is just incredible and everyone’s in great hands. And frankly, I have some other adventures that I think would be fun to work on. I wouldn’t have done it, of course, if the team wasn’t like, as I said, the best team I’ve ever had. But the idea of when I got asked the question, “What are you proudest of?” And I said, “I’m actually proudest of the fact that I never overrode one of our models.” And you know, here in the relative calm, well, it’s not relative calm, in the markets, but let’s say it was last year in the relative calm of a market where everything’s going stratospheric. That doesn’t sound like much, but when times are like the great financial crisis, listen, those are scary times. And I run human OS too. And so I was lucky that at least my Vulcan infusion saved me from overriding the bottle.

Trey Lockerbie (00:18:27):
So from what I’ve studied about you, and actually we recently had Dan Rasmussen on the show, and through that research, I was listening to your conversation with him, and as I understand, both of you know, you’re both data driven, which means you’re more focused on the rear view mirror than going ahead and forecasting where we’re going. So, it sounded like you were in agreement with this idea that discounted cash flows, for example, or those kind of models should be thrown out the window as well, as far as just our inability to forecast. And that kind of goes against a lot of what we’ve learned as traditional investors. So I’m curious what your stance is on that in particular.

Jim O’Shaughnessy (00:19:01):
So I wouldn’t advocate throwing something like price to cash flow out the window. Dan, I love him to death and he looks like a boy scout, and then he manages to throw Molotov cocktails. And one of the reasons I love him is his research is incredibly thorough. And he, like me, is sort of a, “Here’s what the numbers say. You can argue with it. You can say you don’t like it. But this is the empirical evidence.” From our point of view, we still believe that many of the metrics, as you say, looking in the rear view mirror, that’s set. There’s no speculation as to what those numbers were. And our point of agreement with Dan would come more on the forward looking estimates. I am not doctrinaire on this, however, I am absolutely open to models that in fact, I used a couple in my early days that looked at consensus estimates, because if you take the wisdom of crowds as actual, and it works pretty well, the aggregate of all of the analyst estimates was pretty darn good.

Jim O’Shaughnessy (00:20:03):
As a matter of fact, one of the things that I did in a strategy that did use forward looking numbers was simply study historically what the aggregate guess was, and then compared it to the actual. And I just said, “Isn’t it interesting that it’s almost always about 10% wrong.” Usually they say a dollar and it comes in as 90 cents. So what I did was simply build that discount right into the consensus estimate, and it was pretty darn good. So I’m very open to like, if I was looking at either financing a new quant or anything like that, and they were going to use the idea of forward, I’m not going to dismiss them out of hand. I’m going to ask, “What’s your methodology? How are you deriving those estimates? How large is the sample of the estimates?” One of the things that I love and I wish the United States would allow more of are these prediction markets. So I would want to see all of that.

Jim O’Shaughnessy (00:21:01):
And one of the things that I advocate, especially in markets like this, is if you’re young, “I call you a time billionaire.” And so you have a lot of time. And unless you believe that the world is in fact ending, then I would recommend that you find a farm in a very underpopulated state, and put antibiotics and guns and everything. But if you’re not that extreme, the better bet is to just keep putting money into the market as a young person. I believe that. Well, for example, if you look at all rolling 20 year periods, real returns, so inflation taken out, there’s never been a 20 year rolling period where the market in the US at least was negative. Now it has been negative in other markets, but in the United States, given the size of our economy, given the size of our stock market, it’s never been negative over a 20 year period. Now, does that mean it will never will be? No, of course not. Some horrific horrible thing could happen and it could lead to a 20 year negative number. In fact, it got close for the 20 years ending oh eight.

Jim O’Shaughnessy (00:22:09):
But again, probabilities, if you can think probabilistically and tone down and control your emotions, what’s going to happen is that over time, directionally these models are going to continue to work. And to try to be very specific and say, “It will compound at 13.23%.” That’s nonsense.

Trey Lockerbie (00:22:32):
I’m glad to hear you say that. I mean, the tool we have on our website is an IRR calculator that actually has a probability feature, so you can plug in your own different predictions in there. So I want to pull a couple of other quotes I’ve heard you say, and I want to get some clarity around this as well. So I know that, for example, you’re not much of a Buffet guys, I’ve heard you say, but I’ve also heard you say that GDP is useless. So I’m not trying to pull these out of context, but I want to definitely put this together in my mind, because I know that Buffet is well known, for example, to have this market cap to GDP indicator, as far as whether the market is cheap or not. And a lot of value investors, I think, rely on this kind of indicator in particular. So if GDP is now useless and we should talk about why I think it plays into that sort of price to book discussion, we were just having, but we should talk about why that is. And if so, does the market cap to GDP ratio work anymore in your opinion?

Jim O’Shaughnessy (00:23:23):
So, when you bring a person who has been sainted while he is still alive into the conversation, that’s another great example of human operating system. The odds are heavily stacked against me to say that Warren Buffet is wrong on any particular thing. Listen, the guy is the most successful investor, at least that I’ve been able to find, in history. So he is doing something right. And I think that the idea of GDP, however, is a separate issue. I don’t know. He might still say that. I don’t know how much he still uses that, but like the price to book, the challenge with GDP is if you look at the way it’s calculated, it is calculated for a country that only has industrial style concerns. It does not take into account any of the things where America is the world leader. For example, technology.

Jim O’Shaughnessy (00:24:17):
An example, this might be a little old, so if somebody listens and looks it up and says, “Jim was wrong, Jim was wrong,” this is an old example, but I’d love to hear that if I was wrong. I’m wrong often. But you look at Intel as a company, and they make all the chips. And why are they interesting? Well, they’re interesting because the way GDP is calculated is the sale of the chip, and what did it cost to make that chip. What people fail to consider is, what Intel really did was retain all of the intellectual property, where they would design the chips right here in the good old US of A, but then they would ship them to a variety of wafer manufacturing, chip manufacturing companies, usually in emerging markets, that had to complete cutthroat competition. In terms of the quality, as you rate their ability, they were all at the top. And so all they really had to compete on was price.

Jim O’Shaughnessy (00:25:20):
And so they would get a razor thin margin in the emerging market, send it back to the United States. Intel marks it up considerably more and has essentially captured all the profit of that transaction. Apple does it with iPhones, for example. If you look at the percentage of market by distribution of phones, Apple is not number one. The various Android phones put together are much bigger, much, much bigger. And yet when you look at the share of profits from the sale of smartphones, Apple is the clear winner. And so none of that gets captured in GDP. So for the same reason that I think that price to book needs to be put back on the shelf, I think it would be great if some group of economists came up… I mean, that’d be a great book almost, if a group of the younger economists out there systematically examined, “Why is price to book no longer good? What should we put in its place? Why is GDP no longer good? What should we put in its place?” That would be a real contribution, I think, to the economic literature, as well as investors using that particular literature.

Jim O’Shaughnessy (00:26:38):
So to sum up, I remember reading, and I can’t remember the exact formula, but if you read a lot of history on investing, what you see is some people, like in the 1950s, were swearing on this, it was some differential between the earnings yield on stocks and bond yields. And it was really simple. So if the earning yield on stocks was below bonds, get out of stocks, go into bonds, and vice versa. Well, that changed, something in the early 60s, I think, late 50s. And it never went back to the other way until you got the super high rates in the first half of the 1980s, the second half of the 1970s. So it was wrong for most of the biggest bull market in history.

Jim O’Shaughnessy (00:27:24):
So I think that you always have to just look, “What are these numbers that I’m using? How are they derived? Does that derivation still make sense? And does the concept, if you will, of a GDP to ratio or to replacement cost or…” There’s a lot of interesting ones, it’s just, we haven’t found any efficacy. And believe me, we’ve tried. We haven’t found any efficacy in using these as filters either in the going long, we’re a traditional long only manager, but we’ve experimented with tons of timing models too, and have found basically a few of them actually do work, but the fortitude, the emotional fortitude that you would have to have is pretty extraordinary. My friend Wes Gray has a really interesting model that works, but it’s hard for him to keep clients in it, because there’s a lot of false positives. And when it really works, it really, really works. But, again, because of the way we look at things is signal, fail, signal, fail, signal, fail. Then, “This doesn’t work.” And usually, as I like to joke, that happens after the fourth one, signal, succeed.

Trey Lockerbie (00:28:36):
Well, I bring that up actually, this is so fascinating, I know that there’s something misleading about GDP and being a quant, garbage and garbage out, there’s a lot of people out there with this narrative that, for example, the Fed can’t raise interest rates because of our debt to GDP ratio, or as far as just a simple amount of debt. And it’s a different story than where we were even in the 70s and 80. So with that in mind, I’m curious what your take on the debt level is, and how much further you think the fed could go.

Jim O’Shaughnessy (00:29:06):
So I normally don’t comment on this, primarily because I’m probably just as ignorant about these types of things as anyone else. And so let me caveat it with that ahead of time. Even though I have a degree in economics, I am not an economist. I am a practitioner, and practitioners look at the world very differently than economists do. The points that I would make about the current discussion, if you will, being had around the debt to GDP, et cetera, is, it is true that we have seen the Fed take unprecedented action in the market if we just look at the Fed’s history back to 1913, when it was created. And then you had a lot of theorists saying, “Modern monetary theory,” et cetera, that would be just a completely different discussion in and of itself. So yes, the Fed has taken unusual steps, primarily as a reaction, in my opinion, to the very, very dangerous situation that evolved during the great financial crisis.

Jim O’Shaughnessy (00:30:10):
Now can the Fed just do whatever it wants? I don’t think so, really. I think that ultimately markets step in, and it’s fine if the Fed is keeping interest rates artificially low. Because if you’re a rational actor, and you can borrow money at 1%, why on earth would you not? And if you look at what happened, that’s exactly what happened. You got things like the Bored Apes, and crypto and a variety of NFTs and everything. And let me hasten to say that doesn’t mean that those might not emerge, or a version of them, as successful down the line. It does mean that some of the prices you were seeing, like Beeple and these astronomic prices being paid for NFTs was in my opinion, a result of these artificially low rates that even a rational human would say, “If the bank’s going to be willing to loan me a bunch of money for nothing, I’m going to take a huge loan.”

Jim O’Shaughnessy (00:31:15):
Now, what’s happened currently is, and usually happens afterwards, when you flood the system with money, inflation seems inevitable. The only time it isn’t inevitable that many people point to is when it doesn’t get put officially into circulation. So for example, when the Fed started on the easing strategy, most of that money wasn’t getting out into the economy, it was actually on a ledger between all these various banks. So if you looked at M1, and got very alarmed, like, “Good Lord, look at the chart on M1,” you’d have to keep in mind that a lot of that, or in the early days, was ledgers on a bank transaction. And so that doesn’t get into the economy. People can’t actually spend that. When they can actually spend it, hello, inflation. And I think that there’s many, many things happening here, but one of them is inflation’s probably higher than the official rate that’s being stated. I know a lot of people put a lot of work into showing actual price changes for the average American, and those price changes are a lot bigger than the so-called stated rate of inflation.

Jim O’Shaughnessy (00:32:26):
And so the question as you put it to me though, is the Fed’s hands tied in their ability to raise rates? The answer is no. And you want to look at a fantastic example of it, look at Paul Volcker breaking inflation by raising rates to historic heights, with the tacit buy-in of Ronald Reagan, who was president at the time, because when you do that, you cause a very severe and deep recession. So if we’re thinking “They would never do that,” well, yes, they would. They have in the past. And if you get a similar reaction from the Fed today, that’s what’ll happen. And markets are a future discounting, aggregate, best guess estimates of what’s going to happen. So I think if you’re looking at the market’s behavior since basically the first of the year, the market’s sort of saying, “Thank you for that wonderful bucket of ice water you just put over my head. Now I got to start worrying about the Fed’s going to really, really jack up rates.”

Jim O’Shaughnessy (00:33:28):
And remember too, that the Fed is not the ultimate decider of interest rates. They affect them obviously through where they set the discount rate at, but many banks are going to charge what the market will bear. And then you have the additional concern of demographics coming into play. So I’m the tail end of the baby boomer. I would argue that I’m not a baby boomer. I was born in 1960 and the analytical work on people in my cohort finds that we have almost nothing in common with the real baby boomers, but the point is, so the real baby boomers are probably in their 70s now. A lot of them have hung on with their stock portfolios, because again, it’s what they knew. They got into stocks when everyone hated, or at the end of everyone hating them, stocks treated them very, very well. And they look at bonds and they’re like, “But it doesn’t pay me anything.”

Jim O’Shaughnessy (00:34:20):
So if we see a situation where rates on bonds became very attractive to people, you might see baby boomers doing a bigger shift of asset class from stocks to bonds, which of course would be a lot of pressure on the price of stocks. All of that being said, do I believe in the prospects of the United States of America? Absolutely. I mean, despite all of the problems and everyone at each other’s throats, we still have the rule of law here. We still have the bill of rights. We still have a government designed to not be able to do anything too radical because of the various branches.

Jim O’Shaughnessy (00:35:02):
Our founders did not trust the average human being very much. And so they designed our government to make it really hard for the government to become very tyrannical, which I think is a great thing. And so I am still wildly bullish on the prospects of this country. Does that mean that I might have to grin and bear it through a horrible recession? Yeah, I might have to. But again, I come back to the notion, if you just look at odds, the odds are really, really high that this country in particular, because of all of its advantages, is going to do very, very well.

Jim O’Shaughnessy (00:35:36):
Finally, circling back to the question about the debt ratio in the United States. We are also the only country in the world, as the world’s reserve currency, that has the privilege of pricing its debt in its own currency, which its central bank controls. What better way to essentially default on massive debt than having great inflation, take it away. And so you can speculate, “Well, maybe foreign lenders will not allow us debt to be priced in dollars.” I would say don’t hold your breath on that one.

Trey Lockerbie (00:36:12):
Very interesting. I was bringing it up, I mean, you mentioned the 70s, where Paul Volcker jacked up interest rates, and I think our debt to GDP around that time was in the 30s. So it was a different scenario than where we are now, but to your point about GDP, it seems like that number is underselling the US. And I’ve heard this argument a lot, and I don’t know how the Fed is looking at this, but they could be saying, “Yeah, we might have a lot of debt, but look at all these assets we have too. Not only the world reserve currency, but how amazing are these assets that we hold? They’re the best in the world.” I’m just curious if what we just saw just now speaks to your experience being in markets a long time, knowing that things can change.

Jim O’Shaughnessy (00:36:47):
So I really believe in this idea of imbued or saturated intuition. If somebody who spends 35 years looking at markets, studying markets, sees these patterns happening and immediately… You know the famous story of George Soros getting a backache, and the saturated wisdom, if you will, kicks in. And so perhaps their take is going to be a little bit different than others. Things got crazy and people bid things to unsustainable levels, but they always do. And as long as we have history of markets, now we’re back to fear, greed, and hope. And we’re back to arbitraging human nature, because I don’t know what the market’s going to close today. I have no idea, zero, what, at the end of this year, the market, how much it will be down or up. As we extend our timeframes, my ideas get stronger and stronger. And when you start asking me about 10 years, 15 years, I go from being pretty bearish to being very bullish.

Jim O’Shaughnessy (00:37:50):
But the default I think is, if you could successfully time markets, you would be the richest person on this planet. And Elon Musk, I don’t think, tries to time markets. Now, people who don’t like him might say he did that with Dogecoins. But the fact is those are temporary dislocations, if you will. I am much more interested in the directional movement of various asset classes. And in the case of US stocks, I think directionally they’re heading up. That does not mean that we might not have a wicked, wicked bear market. And if the Fed decides to raise interest rates, that means that we could have a significant recession.

Jim O’Shaughnessy (00:38:29):
The challenge with all of this is, let’s say somebody’s listening to our podcast, and they’ve read my book or whatever, and they think that I know a lot about the market. And so they say to their significant other, “I just heard Jim O’Shaughnessy, who’s totally always bullish on the market. He said he was worried about the market here. Let’s wait.” The problem is waiting until the water clears, the water never clears. And so the default assumption that I urge all investors to do is consistently put money into the market. It’s really, really simple.

Jim O’Shaughnessy (00:39:03):
Let’s say you have a dog, and you buy a week’s worth of his food every week at the supermarket, and let’s say it costs you $10, and you have enough cans to feed your dog for the next week. If you walked into the supermarket and you saw that they were having a special on the dog food, it was only $5 to buy all the cans, do you run home and return those cans of dog food? Of course not. You bulk up on it. You might even buy four weeks or five weeks. Only in the stock market, it seems to me, do people rush to sell when there’s a bargain. So if you’re listening and you’re interested in the stock market and trying to learn new things about it, just remember it’s not easy, but it’s simple. Consistent investment in a diversified portfolio. Just keep doing it, keep doing it. And time’s on your side.

Trey Lockerbie (00:39:55):
Yeah, if Sir Isaac Newton can’t time the market, certainly, we probably can’t either. I love this quote. I wrote it down. I’m going to remember this. “The water never clears.” I just think that’s so accurate, and what a cool picture of what you’re talking about there.

Trey Lockerbie (00:40:07):
I posed this question to a couple of people, but I have a feeling you’ll give an answer that’s backed a little bit more by data. I’ve basically heard, Buffet and Munger say, “With investing, those who are seeking excess alpha, and they’re not indexing,” let’s say, they basically say these investors, they have it or they don’t. I think what they’re referring to is the fortitude maybe to manage down markets and a couple of other things. But what does the data that you’ve researched… Because I know you’ve spent a lot of time studying psychology and the human brain, is there data to back this up?

Jim O’Shaughnessy (00:40:37):
Yeah, there is. And the data specifically is around the ability to delay gratification. And there’s a study, which is under some scrutiny because it apparently has not replicated, but everyone’s familiar with it. And it’s the one where the little kid’s put in the room with two marshmallows. And I can’t remember the exact way they do the study, but if he or she only eats one, they’ll give him several more. But if he or she eats two, they don’t give him anymore. And it’s basically a proxy for that individual’s ability to delay gratification. And that is a really interesting marker for human beings. Those who can delay gratification, those who have patience and those who persist, all of the studies that I’ve seen or we’ve conducted actually show that raw intelligence, it’s great to have, but if you took somebody who had an IQ of 100, or whatever gifted is, 140 or thereabouts, and then contrasted them with somebody who has a 120 IQ, which is typically the IQ you need to get into legal or medical school. You can’t make any prediction based on those two numbers.

Jim O’Shaughnessy (00:41:54):
This guy could be a nervous Nelly and just flip out, because he’s so smart he can think of all the really out-there scenarios about what could go wrong. And this guy’s just persistent. So, if you said, “Jim, you’ve got to invest in the careers of these 10 young people who have distinguished themselves in investing.” What I would look for is persistence, patience and the ability to follow a process. PPP. Patient, process, persistence. If you persistently use a well supported by empirical evidence process, you will be rewarded. Will it work for you always? Of course not. During the times that it’s not working for you, you will be ridiculed. You will be called names. People will make fun of you. And that’s just part of the drill here, unless you decide you want to be Bogle, and be the king of indexing, which is by the way, a totally acceptable choice for many investors. In fact, I would say the preferable choice, if you are just not, like us, a stock market junkie, but you just know you want to save and send your kids to good schools and have some money in retirement. That’s a perfectly acceptable way to invest money.

Jim O’Shaughnessy (00:43:09):
But the idea of those three Ps, persistence, process, patience, those are going to be the winners. And by the way, the Warren Buffet of 2039 or 2040, is going to get there in a much, much different way than our Warren buffet got there. He took advantage of the conditions, if you will, on the ground. This gets back to this idea of saturated intuition. But then he grew, he used to invest like his idol and teacher Ben Graham, who wrote the Security Analysis and the Intelligent Investor. And that was called the margin of safety and buy cigar butts, and et cetera, et cetera. Buying super cheap companies and then selling them when they reach what you think they’re worth.

Jim O’Shaughnessy (00:43:53):
And that’s one way to do it. None of our value stuff does that particular methodology. If you do get a serendipitous amount of those companies, I’d say scoop them up. But what Buffet did was decide, “No. I’m going to evolve myself.” And he did. And so don’t sanctify any belief. Because the sacred is unquestionable, and it becomes doctrine. And every time if you study history and you look at ideas, you look at institutions, you look at all of these things, when you make something sacred. And if you question it you’re a heretic or an apostate, very bad things happen. Learn from everyone. Study Buffet, study Graham, study the momentum guides, study everything that you think there is a reasonable hypothesis underneath for that particular school of investing. You’ll probably end up with a hybrid, but that’s fine. I was much more of a proselytizer when I was young, in terms of, “You’ve got to do it this way. This is the only way.” and then I realized I was young and foolish, and there’s a lot of different ways.

Jim O’Shaughnessy (00:45:01):
The key thing is you’ve got to find something that’s right for Trey. And that could be very different than what’s right for Jim. One of the biggest mistakes I ever made was designing my own strategies, the round one, iteration one, for me. I have a really high risk tolerance, and it was pointed out to me that, “Jim, these are really crazy good, but when they’re not working, they’re crazy bad.” And so we evolved that as well, but the point is, you’ve got to find what’s right for you. And then just let it happen. Let it work. It is boring. I mean, successful investing, honestly, should be about as exciting as watching paint dry.

Trey Lockerbie (00:45:44):
So from there, I’ve got a few ideas. First of all, I want to double click on saturated intuition again, because you brought it up a couple of times. And then there’s a genetic question in my mind for what you’re speaking to and how much of a factor that might be. And then there’s also this third point that I did want to circle back to from what you said earlier about women being much better investors in than men. Do any of those three go together? Is there a through line through the three of them?

Jim O’Shaughnessy (00:46:07):
I think that there might be a bit of a evolutionary reason for why women are better investors than men. Women are far more patient. Women are also far more likely to admit what they don’t know. Men are very unlikely to admit what they don’t know, because of the way we evolved as a species. And so Terry Odean, a professor who, at the time he did the study, was at Berkeley, he might still be at Berkeley, I lectured to his class once, he was a very nice guy. He’s also a super smart guy. And he has a interesting study, I don’t know if it’s been updated, because I haven’t looked at it in a while, but basically empirically showed that women were in fact better investors than men. And you know, I joke testosterone is your answer there. Testosterone is a very useful thing to have, but it comes with a lot of downsides and some of the downsides are abrupt action, being hypervigilant, and mistaking your hypervigilance for, “Market’s going down. That means it’s going to end. I have to act now to save my life.” And so the man will get out. And then of course men are also much more overconfident than women. Can you tell I have nothing but older sisters?

Jim O’Shaughnessy (00:47:19):
But the fact is, women are more patient, women do not try to pretend that they know something that they don’t for the most part. Again, I can just hear that somebody’s saying right now, “Actually Jim, there is this group of women who do not fit this profile.” Yes. I understand that, I’m talking broadly, and the empirical evidence is on their side. The saturated intuition. Well, I don’t know that breaks down by sex, men versus women. I do know that women in many, many psychological tests demonstrate a, probably, higher what I would call practical intuition. And again, how much of this we’d have to really disambiguate, how much of this was because of our evolution, how much is because of the societal game rules that we’re playing under, et cetera. But I think obviously both sexes, if they are at something long enough, can get this imbued or saturated intuition and make use of it.

Jim O’Shaughnessy (00:48:19):
And again, with genetics, that’s such a hot button issue. And I mean, I understand I’m more of a, “Let’s just look at the data and show us what the data shows us.” And you know, there are many twin studies, identical twins. I’m originally from Saint Paul, Minnesota, which was the twin cities, and these studies were actually done at the University of Minnesota, the original ones that I’m referring to, where they found identical twins, so in other words, clones, you share 100% of your genes with that individual who were separated at birth. There’s a brilliant book on it I have, it was written in, I think, the late 70s, early 1980s, by the professor who did most of the research. And very, very decisive, if you will, that our genes do determine quite a bit of our predilections, our attitudes, things like that.

Jim O’Shaughnessy (00:49:07):
There was another study done by some Swedish, I think Swedish, researchers, actually included, if you go to my profile on Twitter, it’s me giving a talk at Google, Talks at Google, about why this stuff is really hard. And one of the slides includes that from this study, looking again at identical twins, not separated, but looking at how they invested. The researchers, academics, determined that approximately 35 to 40% of our investment behavior is genetic and cannot be educated against. That’s the real killer line in their report. It’s like, no matter how hard you try, you can’t. Blood will out, so to speak.

Jim O’Shaughnessy (00:49:50):
And so that’s where I think the genetic thing comes in. Much less so on the intelligence side, much more so on the persistence, patient and ability to follow process. And I would add just from my own personal experience, your ability to admit you were wrong. Because when you’re wrong, a lot of people take that as some sort of loss of base. I’m just the opposite. I love when I’m wrong because I can learn from, why was I wrong? What was I thinking that led to the decision I made? And that’s one of the reasons why I recommend that everyone keep journals. I didn’t start these journals at age 18 because I knew that human memory was very unreliable, but they taught me that human memory is very unreliable and consistently updates itself to what we believe today, which is why you can have this hindsight bias, “Well, everybody knew.” And they don’t even know they’re doing it. And again, they, me, anyone who’s a human being, can do it.

Jim O’Shaughnessy (00:50:45):
It’s really cool though, when you’re going through an old journal and you just have made a comment that you would swear to in court, that was how you felt back then, and then you, in your own handwriting, see, “I didn’t feel like that at all back then. It’s quite jarring, but it’s also quite liberating, because it allows you to understand your own foibles and then intuit, “This happens with everyone. Let’s use this as a learning opportunity to make our process better, continually.”

Trey Lockerbie (00:51:17):
So fascinating. For those wondering, I think that study is called, “Why do individuals exhibit investing biases?”

Jim O’Shaughnessy (00:51:24):
Thank you.

Trey Lockerbie (00:51:25):
And I won’t embarrass myself by trying to pronounce the names, because I’m terrible with names to begin with, and it’ll be in the show notes as well.

Trey Lockerbie (00:51:30):
So shifting gears slightly here, Jim, I have a couple more questions for you. And one is around your entrepreneurial nature. I’m an entrepreneur myself, so I’m selfishly interested in this. But you’ve built numerous companies and most notably, OSAM, which actually recently sold to Franklin Templeton. I’m curious what the impetus to sell the company was. I know it was tied to this Canvas product that you guys had built. So I’m curious what your experience was like selling something that you spent decades building.

Jim O’Shaughnessy (00:51:59):
Bittersweet to be sure. So funny, I was just having this conversation with my wife last night, and sometimes entrepreneurs treat their companies like their children, and you never want to sell your children, obviously. But also, I think the right thing to do given these circumstances. And if we take a step back, the ability to customize people’s portfolios to their particular needs and tax situation and employment situation, I think is going to be the next massive category in asset management. I think it’s going to be as big, if not bigger, than ETFs. And I thought that a long time. I started a company called Netfolio, which was essentially the same thing. The tech back then wasn’t up to the snuff that we have today. And then of course my own prediction came true and the internet collapsed, but it never stopped me from wanting to continue to support that. It was actually my son, Patrick, who came into my office and was like, “You do know that we built a killer Death Star here, that we could just flip it around and let our clients use, kind of like your idea for Netfolio.” And I’m like, “Do tell.” And thus what we call strategy indexing was born.

Jim O’Shaughnessy (00:53:11):
The benefits of this evolution in asset management, simply it’s difficult to overstate how good they are for people, from our ability to tax manage your portfolio, so that situations which would normally make a person frightened, like the current market activity that’s going on, actually get reframed in that individual’s mind and like, “I’m not going to pay as much taxes because they are actually tax managing my portfolio for me at OSAM.” The ability to immunize you, let’s say you’re a entrepreneur and you own a significant portion of your wealth is in your private company shares, and your private company is tech or whatever.” We can immunize that position for you so that your portfolio with OSAM, through your advisor, does not have any exposure, because you have way too much there.

Jim O’Shaughnessy (00:54:05):
We can also give you a real ESG portfolio. ESG’s been coming under a great deal of scrutiny recently, and a lot of very well known and respected people are saying some pretty negative things about ESG. And my view on ESG was always, I would never package a product in a mutual fund or whatever, where I presumed that I was the font of wisdom which would know what you were going to find socially relevant. However, when we had Canvas coming online, we were able to put 50 different levers in there that you and your advisor get to pick. So you literally, let’s say you’re a huge believer in our need to have fewer carbon emissions, you can specifically click that particular lever, and that’s what happens in your portfolio.

Jim O’Shaughnessy (00:54:58):
Let’s say we had a client who wrote a great book about women investing in starting businesses, and she wanted her portfolio to have a tilt to companies where women were 20% or more of the C-suites or on the board. We can do it, but equally important. Let’s say you come from a red state, and you like the idea that hunting is fun and guns should be around and, I might not share your opinion, but what I wanted for our offering to be was something where the individual on the other end got to reflect their actual desires, cares, what they want to see win, what they want to see lose. I can’t dictate that to people.

Jim O’Shaughnessy (00:55:46):
Now, if they do some kind of crazy thing, we’re trying to build in a situation where we can quickly back test that type of strategy and say, “You might not want to do that.” But the point is we are not picking, the client is picking, and they truly will get a portfolio that does reflect their social concerns or organizational concerns, or any of those things. And then finally, you just might, for no real rational reason at all, hate five companies in the S&P 500. When we launched this, my friend Howard Lindzon was nice enough to give us the Howie 495, which got rid of the five companies in the S&P 500 that Howard hated. And of course it was a joke and whatnot, but we wanted to show the flexibility of it. The technology scales, and so the way I put it is, this is the way it was back in the 1930s, when every rich person had a bank that invested just for them.

Jim O’Shaughnessy (00:56:46):
It’s always been a little rule of thumb of mine is try to see to the end of something. So if you look in our field, so how did rich people get treated back then? Well, they all had chauffeured cars. Hello, Uber. They all had multiple vacation homes, hello, Airbnb, or whatever the more luxurious one. They all had individual portfolios. Hello, Canvas. And so what we’re able to do with the leverage technology allows for us to do is to treat everyone like they were the king and queen of Sheba. And I don’t know necessarily whether this will ever get down to an app on your phone. I would love that. But you also have to be careful because you don’t want to ever gamify it, in my opinion.

Jim O’Shaughnessy (00:57:33):
But back to, why would we sell? So I have seen two really significant innovations in asset management over my career. Well, three. The first, indexing. Back when I started in the 80s, Bogle and his team were still being made fun of by Wall Street for the most part. When he launched that index fund, by the way, the number of headlines in American papers calling him a communist, saying an American who wants to settle for average, it was unAmerican. Absolutely he took so much flack for that I just chuckle every time when I see the dominance of indexing today. So indexing, major innovation, low costs, big, very important. The next innovation was ETFs, exchange traded funds. They wrapped up a mutual fund in a more efficient manner. I missed the vote. I have a piece called, Mistakes Were Made, and Yes, By Me. I was asked to launch by the American stock exchange, a series of exchange traded funds when they were just coming out. And I was like, “Nah.” And obviously they very, very innovative and got better.

Jim O’Shaughnessy (00:58:40):
Onto the stage walks, custom indexing or custom portfolio creation. Once you see the benefits of this as an affluent investor using an advisor, you not only will never buy another packet, now, again, this is my opinion, and I’m giving you a bit of a sales job here too, because we believe in Canvas obviously, but that’s important to keep in mind, I personally think that once you see these benefits, you’ll never buy a package product again. Thus, the sales to Franklin Templeton. Quite frankly, I wanted OSAM to be the company that dominates custom indexing. And when you looked at little old OSAM, we were punching above our weight in terms of people’s awareness about us. But when it comes to actually being the leader in a massive new category in asset management, you need a lot of tools. You need wide distribution, you need the kind of heft that a trillion and a half dollars money manager can exert on your behalf. And so I simply looked at it and you know, Patrick and I talked about it, it was like, “At the end of the day, we want this to win, because we think investors are going to do much, much better by it.” And so that was what drove our decision.

Trey Lockerbie (00:59:54):
Amazing. Well, that just goes to the integrity you have, and it ties into all the research you’ve made public along the way throughout your career. I mean, very philanthropic of you. And I wanted to lead that actually into my last question for you, which is around your grandfather, Ignatius Aloysius O’Shaughnessy, my goodness, what a name. What an amazing name. But at one point he must have been the most successful people live. I mean, he was widely successful, I believe from oil, but he proceeded to give 95% of his wealth away before he died, which is just mind boggling. So you got to spend a lot of time with your grandfather, especially later, it seems, and were a witness to some of these givings. What kind of impact do you think that may have had on you and possibly your career?

Jim O’Shaughnessy (01:00:40):
So I think it had a very deep impact on me. I just hold my grandfather in the highest esteem, that he not only was probably one of the richest people in the country, in fact, I saw an old magazine from the 30s that said everyone thinks Joe Kennedy is the richest Irish Catholic in America, there’s a guy in Saint Paul called I.A. O’Shaughnessy who could buy him and sell him 10 times over. But what really impressed me about my grandfather was exactly that, that he gave so much of his own money away during his own lifetime. And that’s now just getting hinted at with the Gates and Buffets of the world. My grandfather always said that money was a lot like manure. It stunk to high heaven when it was piled up in one place. And it acted as a beautiful fertilizer when you spread it around. And so I believe that, and I believe that there’s just so much that you can do to help.

Jim O’Shaughnessy (01:01:38):
And look, let’s not say we’re looking for sainthood here. It’s in my genes, and it’s in my examples and everything, and so I believe strongly in it, but at the end of the day, I think we all do things because they give us pleasure. And rather than, “I’m so good and noble about how I’m going to help my fellow, man,” I really don’t believe that. I think you really don’t do things unless they make you feel good. And that makes me feel good. I love giving money to things I care about. And I love participating with my time about things that I care about. And as far as my grandfather, I mean what an incredible example. And I just think it’s in our genes, that’s how you do things.

Jim O’Shaughnessy (01:02:19):
I’m going to be starting some new ventures after I retire from OSAM because I want to. That’s another thing I learned from my grandfather, never retire. Because my grandfather was one who always said to me… And you mentioned that I managed to be able to spend a lot of time with him because my grandmother had died on my dad’s side before I was even born. I was the Martini baby. I was six years younger, six and a half years younger than my next sibling. My grandad came to our house twice a week for dinner. He had like incredible stories, incredible stories. And he was really funny, but he was also very open about why he thought you should do things a certain way. And so I learned so much from him, not only the philanthropic aspect, but how to run a business, how to take care of people.

Jim O’Shaughnessy (01:03:09):
One of my big beliefs is you should push all the decisions down. People at the top of the organization have no right deciding on what trading system you’re going to use. And yet it’s the instinct of a lot of people who are higher up that, “We should use this one.” And my answer always is, “No, we’re going to go talk to Lenny and find out what he wants, because he’s the one who’s doing it.” And my grandfather taught me that. And the thing I think that he taught me that I’ve made the most use of, that really was the reason I started the journals, was what he called premeditating. Just basically running a Monte Carlo simulation, but on paper.

Jim O’Shaughnessy (01:03:44):
And the reason I think it helped me so much is that when you premeditate, you have to document, and it’s hard to explain why this is true, but once a thought gets moved from your head to paper, it becomes a real thing, and you start thinking about it very differently, then it’s just, “I’m going to write that novel someday.” No, you’re not. But if you have it written out, the other thing that premeditating is really good at is, A, do you understand the thing you say you want, sometimes you don’t and then you got to go, “Step back. Maybe I don’t want that.” Other times, there’s something you really do want, but as you run the various decision trees, you see that the number of potential bad outcomes for you, or your family, or for whomever, outweigh the good outcomes. And so you don’t do it because of that. And most of all, though, it just gives you a sense for how much do you really want this thing? Number one, number two, do you have the means to make this thing happen?

Jim O’Shaughnessy (01:04:45):
And so that was another great lesson for my grandfather. I have huge respect for his memory and for everything he did. And I think that carries on, so does my son, and he was his great grandfather whom he never met. The generations were big in our family. The reason he was Ignatius Aloysius was because he was the 13th child. These were some serious Irish Catholics. They never took with me. But at one time I had a funny priest looking at me and I was an altar boy, and he was like, “We’re never going to get you, are we?” I’m like, “No, Father, you’re not.” But back then, very, very serious Irish Catholic. A lot of his charity went to… He put Notre Dame on the map, for example, by making one of the first big donations there, and many, many others.

Jim O’Shaughnessy (01:05:25):
But I think honestly for me, the thing that moved me the most emotionally was at his funeral, at the wake, which was held at a university, University of St. Thomas, which he basically built. The wake part was held there, and a very scruffy looking man clearly probably homeless, and this is 73, so not too much homelessness back then, came in, I was 13, I’m watching everyone’s reaction, and you see people recoiling a little bit. He walks over, looks at my grandfather and his casket, leans in, kisses him on the forehead, does a cross and walks out. And I just saw it like, what did my grandfather do for him? Obviously something huge.

Jim O’Shaughnessy (01:06:09):
And to me, I mean, I’m not a very emotional person, but just thinking of that, that really was what got me. And so life is short and I’m not a Hindu, I don’t think that this is a dress rehearsal. I don’t think we get reincarnated. As my daughter, Kate, once said when she was just a little girl, when we were talking about reincarnation on a family car ride, my son, Patrick, who everyone knows, and Kate were there, and Patrick was hemming and hawing about, “There’s this and there’s this, and there’s this.” And Kate must have been three and a half. And I said, “What do you think Kate?” She thought for a minute, and she goes, “Daddy, I don’t think that you can relight a match once it’s been blown out.” And I’m like, “Whoa.”

Trey Lockerbie (01:06:50):
Wow.

Jim O’Shaughnessy (01:06:51):
So, life’s short, enjoy it, have fun, help other people. It makes you feel better.

Trey Lockerbie (01:06:57):
Life is short, Jim, and that just makes it all the more profound that you spent some of your very valuable time with us today. I really, genuinely appreciate it. And not only that, all the wisdom and research and information and everything else, experience, that you’re sharing with us in our audience is just so highly valuable. And I really appreciate it. So thank you for taking the time.

Jim O’Shaughnessy (01:07:16):
My pleasure. Thanks.

Trey Lockerbie (01:07:18):
All right, everybody. That’s all we have for you this week. If you’re loving the show, don’t forget to follow us on your favorite podcast app. And please leave us a review if you’d be so kind, it really helps the show.

Trey Lockerbie (01:07:26):
Feel free to reach out to me directly @TreyLockerbie on Twitter. And if you’re really looking to up your investment game, go to theinvestorspodcast.com, or simply Google TIP Finance to find all the resources we’ve built for you there. And with that, we’ll see you again next time.

Outro (01:07:40):
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