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The S&P 500 Concentration Trap and a Tax-Smart Way Out · Views from 6,230

• 0:10
  Ryan Nauman Host Views from 6,230: Hello, everyone, i'm Ryan Nauman today, we're going to challenge something that many investors probably take for granted.
• 0:18
  Ryan Nauman Host Views from 6,230: Just how diversified is the S&P 500?
• 0:22
  Ryan Nauman Host Views from 6,230: The S&P 500 index, it, it's designed to give investors broad exposure to the US stock market.
• 0:30
  Ryan Nauman Host Views from 6,230: But with a relatively small number of mega cap companies now representing such a significant portion of the index, are investors actually getting the diversification they think they are?
• 0:43
  Ryan Nauman Host Views from 6,230: And if you're a financial advisor with clients sitting on highly appreciated, concentrated stock positions, how do you address that risk without creating a potentially massive tax bill?
• 0:57
  Ryan Nauman Host Views from 6,230: And then we'll go ahead and shift gears, and then talk about the evolution of sustainable investing and where the industry is headed.
• 1:05
  Ryan Nauman Host Views from 6,230: All right.
• 1:05
  Ryan Nauman Host Views from 6,230: I've already talked enough, so let's go ahead and bring on the star of the show.
• 1:10
  Ryan Nauman Host Views from 6,230: To help us tackle all of this, I'm excited to welcome Bill Davis.
• 1:15
  Ryan Nauman Host Views from 6,230: Bill is a managing director at Stance Capital.
• 1:19
  Ryan Nauman Host Views from 6,230: Bill, thank you so much for coming on the show.
• 1:22
  Ryan Nauman Host Views from 6,230: We've been talking for a while.
• 1:23
  Ryan Nauman Host Views from 6,230: It seems like for a few months.
• 1:25
  Ryan Nauman Host Views from 6,230: We met at a conference.
• 1:27
  Ryan Nauman Host Views from 6,230: I've had great conversations with you, Bill.
• 1:28
  Ryan Nauman Host Views from 6,230: Really excited about this one.
• 1:30
  Ryan Nauman Host Views from 6,230: It's an honor to have you on.
• 1:32
  Ryan Nauman Host Views from 6,230: Can you please tell us a little bit more about yourself and Stance Capital?
• 1:36
  Bill Davis Managing Director Stance Capital: Sure.
• 1:36
  Bill Davis Managing Director Stance Capital: Well, Ryan, first off, thanks for having me.
• 1:38
  Bill Davis Managing Director Stance Capital: It's, um, it's my privilege to be here, and I'm looking forward to this conversation.
• 1:44
  Bill Davis Managing Director Stance Capital: So a bit about Stance Capital.
• 1:46
  Bill Davis Managing Director Stance Capital: I, uh, founded Stance back in twenty sixteen.
• 1:50
  Bill Davis Managing Director Stance Capital: there was actually a bunch of work done, uh, predating twenty sixteen, so really sort of the seeds of Stance Capital started back in twenty thirteen.
• 1:59
  Bill Davis Managing Director Stance Capital: And, we actually began building investment models in twenty thirteen, them at another shop that I was at at the time, then lifted out and launched Stance in, uh, twenty sixteen.
• 2:11
  Bill Davis Managing Director Stance Capital: And, you know, our initial...
• 2:14
  Bill Davis Managing Director Stance Capital: Uh, actually let me back up and say that we are a systematic Most everything that we do is quantitative.
• 2:23
  Bill Davis Managing Director Stance Capital: Uh, some of the things that we do is, and we'll get into this, you know, as we talk a bit, really are-- you know, fall a little bit short of the term quantitative, but I would describe, uh, everything
• 2:35
  Bill Davis Managing Director Stance Capital: that isn't quantitative as at least being rules-based and generally unemotional, uh, in terms of our thinking about the markets, individual securities, of that.
• 2:46
  Bill Davis Managing Director Stance Capital: Uh, we were around the idea that investors be able to align capital with values without, um, uh, necessarily suffering, uh, or, you know, ending up with concessionary, strategies or returns.
• 3:06
  Bill Davis Managing Director Stance Capital: I would say that that applies whatever the value set happens to be.
• 3:10
  Bill Davis Managing Director Stance Capital: I mean, you sort of teased the fact that, uh, we're gonna talk about sustainable investing, so a lot of what we do, I would say, fits within that overall framework.
• 3:20
  Bill Davis Managing Director Stance Capital: Uh, but importantly, w-we believe that even people who don't care about sustainable investing or who might in fact be on the opposite side of that trade, should also feel free to align capital with whatever values they happen to
• 3:34
  Bill Davis Managing Director Stance Capital: have.
• 3:34
  Bill Davis Managing Director Stance Capital: And so was sort of the, I think, the underlying A premise of Stance Capital.
• 3:41
  Bill Davis Managing Director Stance Capital: I would add to that, that, know, even going back to twenty thirteen or twenty sixteen, it was pretty obvious where th-the equity market was headed in terms of asset management, that we were sort of marching towards index, uh,
• 3:57
  Bill Davis Managing Director Stance Capital: solutions, really low cost solutions and in general, uh, cap-weighted solutions.
• 4:05
  Bill Davis Managing Director Stance Capital: And so from the very beginning, we made the decision that, look, we don't actually wanna be going in the same direction as everybody else.
• 4:12
  Bill Davis Managing Director Stance Capital: For one thing, we're not gonna compete with Invesco or BlackRock or, you know, like one of the really big guys.
• 4:17
  Bill Davis Managing Director Stance Capital: And so, you know, the first product that we built was actually focused on, um, I would say it's more of a midcap value strategy, and it's very focused on downside risk protection.
• 4:29
  Bill Davis Managing Director Stance Capital: That's Stance Sustainable.
• 4:31
  Bill Davis Managing Director Stance Capital: Uh, excuse me, um, it's actually, uh, Stance Equity.
• 4:34
  Bill Davis Managing Director Stance Capital: And the, um, there is an ETF version of it that we sub-advise for Hennessy Funds, uh, called Hennessy Sustainable Equity.
• 4:43
  Bill Davis Managing Director Stance Capital: Uh, and then we've gone on to do other things that are, I'd say, equally unique and differentiated and in many respects approximate the way, uh, any invest-- So most investors aren't looking just for one asset class.
• 4:59
  Bill Davis Managing Director Stance Capital: They want of different things.
• 5:01
  Bill Davis Managing Director Stance Capital: And so what we're trying to do is build out a suite products that represent those sub-asset classes that investors are looking for.
• 5:08
  Bill Davis Managing Director Stance Capital: A good example might be income, which y-you know, is just, is, is I think, uh, really ballooning, I think, in importance as more investors get older, um, are not quite ready to jump into the fixed income pool because
• 5:26
  Bill Davis Managing Director Stance Capital: it's, the water's kinda shallow and a little bit dirty.
• 5:30
  Bill Davis Managing Director Stance Capital: Uh, and so they sort of want the equity-like returns, but they wanna lighten up on the risk, and that's an example of one way to do it.
• 5:38
  Bill Davis Managing Director Stance Capital: And so that's sort of how we think about the market as a whole.
• 5:42
  Ryan: Bill, that's fantastic.
• 5:44
  Ryan: Lot of great information, and I completely agree with you about that last part about, you know, investors looking more for income, but limit that drawdown risk.
• 5:56
  Ryan: I have more and more conversations about whether it's more on the asset management side or financial advisors building portfolios around that, because I think investors now, they're realizing what the real risk of investing, and it's losing money.
• 6:11
  Ryan: It's not so much volatility, standard deviation, right?
• 6:14
  Ryan: It's like, if I'm investing, I want my money back at least.
• 6:18
  Ryan: I don't wanna lose it.
• 6:20
  Bill Davis: Well,
• 6:20
  Ryan: So I'm really glad-
• 6:21
  Bill Davis: right?
• 6:22
  Bill Davis: I would argue that the best alpha of all is tax alpha, and I don't think historically most investors spend a lot of time thinking about the after-tax return is.
• 6:33
  Bill Davis: And I think today this is, uh, it is very much the next wave of, of, um, you know, fiduciary, n-not duty because that's sort of a defined term, but I'd, I'd say oversight is really thinking about how to
• 6:51
  Bill Davis: create advantage strategies for clients.
• 6:55
  Ryan: Yeah, you're spot on.
• 6:56
  Ryan: That's another conversation I have a lot about is the importance of tax alpha.
• 7:01
  Ryan: Bill, three, four, five years ago, tax alpha, nobody really pro- it wasn't a term.
• 7:08
  Ryan: Now it's very popular, and you're exactly right.
• 7:11
  Ryan: It's a huge risk, and I'm glad it's getting more press, more headlines, because it is important.
• 7:18
  Ryan: I think that is one way financial advisors can really improve the outcomes of their clients is focusing on tax alpha
• 7:27
  Bill Davis: Yeah, and that's-- Ryan, that actually gets back to something you said at the very beginning, which is about w- you know, whether the S&P is overly concentrated.
• 7:36
  Bill Davis: Because one of the reasons why tax alpha is so important now is in fact the run-up in all of these, um, securities over the last you know, five years, 10 years.
• 7:47
  Bill Davis: I mean, if you go back 10 years, I don't think either of us thought that we would be looking at the kinds of years that we've been having, especially lately in the S&P.
• 7:56
  Bill Davis: I mean, it's really quite extraordinary.
• 8:00
  Ryan: Yeah, you're exactly correct.
• 8:01
  Ryan: We've had, what, three consecutive years of double-digit returns.
• 8:06
  Ryan: Not sure if that's ever happened.
• 8:07
  Ryan: It's been a while since it has, if it has.
• 8:10
  Ryan: So fantastic.
• 8:10
  Ryan: So let's talk about the S&P.
• 8:13
  Ryan: Perfect segue, Bill, and let's talk about that market concentration.
• 8:19
  Ryan: You know, has that S&P 500 become a concentration risk trap for investors, do you think?
• 8:26
  Ryan: Y- we all-- we've heard the re- headlines, we've read about it, we've seen it, that the S&P is, you know, there's a dominance of the S&P 500 in a handful of mega cap companies.
• 8:39
  Ryan: Is that concentration risk trap for investors?
• 8:43
  Bill Davis: Yeah, I mean, I think, I think it definitely is.
• 8:47
  Bill Davis: I think that originally-- And we have actually, and it's on our website somewhere, but we wrote a piece about this about e- I think it was at the beginning of, uh, this year.
• 8:58
  Bill Davis: but I've been thinking about it for a few years.
• 9:00
  Bill Davis: And, um, I guess what I would say is originally my concern was the Mag Seven, because at one point, the Mag Seven was nearly forty percent of the S&P.
• 9:14
  Bill Davis: So this is, actually it was the Mag Seven plus three other names, uh, accounted for forty percent of the, weighting of the S&P five hundred, which obviously means four hundred and ninety-three positions that are competing, for the remaining
• 9:31
  Bill Davis: sixty percent.
• 9:33
  Bill Davis: And it's-- And, and, and that number one, I think that's the highest concentration that it's ever been in the history of the S&P.
• 9:42
  Bill Davis: importantly, uh, those names were mostly highly, very highly correlated with one another.
• 9:49
  Bill Davis: So to the extent that one of them stumbled, a bunch of them are gonna, they were, they were all gonna kind of get in line and follow suit.
• 9:57
  Bill Davis: And we've seen that, like, I think at the beginning of, uh, Q2, I think it was, or maybe at the very beginning of this year, where Mag Seven sort of fell out of favor and people were like, these
• 10:08
  Bill Davis: guys really deliver on these lofty, um, valuation expectations?"
• 10:13
  Bill Davis: Uh, and then all of a sudden, you know, there was a ten or a fifteen percent decline from the top.
• 10:21
  Bill Davis: and I would say that certainly tech-heavy portfolios suffered.
• 10:27
  Bill Davis: what I think most investors?
• 10:28
  Bill Davis: don't appreciate is that they are tech-heavy.
• 10:31
  Bill Davis: Like they s- they think that, "Okay, I own a S&P index fund.
• 10:35
  Bill Davis: I'm broadly diversified."
• 10:36
  Bill Davis: Well, well, you're not if like forty percent of it is like so highly correlated.
• 10:40
  Bill Davis: And I would go on to say that it's more like fifty percent if you, if you get out of the Mag Seven and you just start counting smaller tech companies.
• 10:51
  Bill Davis: I think it's really a big issue.
• 10:52
  Bill Davis: Um, and I, I, I'll, I'll pause there, actually.
• 10:57
  Ryan: Yeah, Bill, you're spot on.
• 10:59
  Ryan: I did some research earlier this year about different time periods.
• 11:05
  Ryan: You're exactly correct.
• 11:06
  Ryan: The concentration in the top 10 holdings right now is, I believe, the highest ever.
• 11:11
  Ryan: The second was the, the Nifty 50s, and then there's been some times in between Nifty 50s and now.
• 11:19
  Ryan: But it's really interesting.
• 11:20
  Ryan: Not saying...
• 11:21
  Ryan: You know, history doesn't repeat itself, but it rhymes.
• 11:24
  Ryan: Each one of those time periods, there's usually a steep correction bear market that follows.
• 11:31
  Ryan: Who knows if it...
• 11:32
  Ryan: Not saying it's gonna happen again, but history shows that during periods of high concentration, it does happen.
• 11:37
  Ryan: So there is some risk there.
• 11:39
  Ryan: But do you think the problem is with concentration itself or the fact that investors may not realize exactly how concentrated they actually are?
• 11:50
  Ryan: You just said it, that most investors are highly concentrated, most likely in tech names.
• 11:56
  Ryan: What's the biggest risk, concentration itself or just the unknown?
• 12:02
  Bill Davis: I think, well, I think that the...
• 12:04
  Bill Davis: Look, I think that everything is becoming kind of technology in a weird way, and actually I'll come back to that in a second.
• 12:12
  Bill Davis: But I think investors are kinda clueless.
• 12:16
  Bill Davis: that they, I think in general, they think they're diversified when they're not.
• 12:24
  Bill Davis: I don't think...
• 12:25
  Bill Davis: And, and also I would a- also add to this, that the problem gets worse every day because the way an index fund works, most assets, es- especially in, say, US large cap or S&P strategies, are passive, you know,
• 12:41
  Bill Davis: index funds, low cost.
• 12:43
  Bill Davis: Uh, and the way an index fund works is that more, as more and more money plows into the index funds, they get disproportionately allocated to the, um, largest names, right?
• 12:56
  Bill Davis: And so think about the ERISA market.
• 12:59
  Bill Davis: Every two weeks, you know, out of y- your paycheck or my paycheck, money goes into a 401plan or a 403or something.
• 13:10
  Bill Davis: the reality is those are largely set and forget, um, uh, y- y- you know, um, allocations.
• 13:20
  Bill Davis: And so if you just consider a normal, you know, 35-year-old, probably 70 or 80% is going into S&P index funds, and that's just adding to the, um, I think to the problem.
• 13:34
  Bill Davis: So- Interestingly, there-- you know, unless investors are willing to get active, there aren't a lot of ways to combat it.
• 13:44
  Bill Davis: I mean, I think a great way to combat it, I mean, just as a quick aside for a US large cap investor, the, um, RSP, which is the-- it's an Invesco ETF which, uh, tracks the Invesco Equal Weight
• 13:58
  Bill Davis: index.
• 13:59
  Bill Davis: I think it's been around since like 1980 something.
• 14:02
  Bill Davis: so it's gonna own all f-five hundred and three or four names in the S&P 500, but they're all equally weighted, right?
• 14:10
  Bill Davis: So Nvidia is gonna be like a quarter of a percent instead of being, um, you know, seven percent or whatever it happens to be today.
• 14:19
  Bill Davis: So it's another way to about kind of investing in all of this, or at a minimum, I think for investors who, who own a bunch of S&P products, probably never think about the cap weighting scheme and the, and
• 14:35
  Bill Davis: the risk that it poses.
• 14:38
  Bill Davis: an equal weight to that and, and having a bit of a counterbalance to it not only great downside risk protection, but importantly, in most markets, actually equal weight outperforms the S&P 500.
• 14:53
  Bill Davis: I mean, you, you mentioned, um, you know, there's been times where there's a huge blowup, uh, and a great example of that is the dot-com era, which was up, up, up and then like down, down, down.
• 15:06
  Bill Davis: And for the ten years after the dot-com bubble burst, the equal weight outperformed the market cap weight by seventy-eight percent.
• 15:18
  Bill Davis: So that's pr- that's pretty massive outperformance, and that's true in other as well.
• 15:24
  Bill Davis: I think that the hard thing, like for us, and like, I-I'm really interested in your view on this as well, is that though we have worse concentration now, uh, than we did in the dot-com era, the reality is,
• 15:39
  Bill Davis: is that the underlying fundamentals of the companies are very different.
• 15:42
  Bill Davis: Like in the dot-com era, there, there were no underlying fundamentals, right?
• 15:46
  Bill Davis: But now it's like the biggest, most cash flow positive companies on earth are the ones that are playing in this.
• 15:55
  Bill Davis: And so it's a very different dynamic, and I don't think it's gonna kinda end the way the dot-com experienced it.
• 16:02
  Ryan: Yeah, Bill, I completely agree.
• 16:05
  Ryan: We always-- Seems like we always wanna compare market cycles and market periods, and a lot of comparisons are made to the dot-com.
• 16:14
  Ryan: Yes, maybe because it's all been tech-driven, AI-driven, but you are completely correct.
• 16:21
  Ryan: It's a different environment now.
• 16:24
  Ryan: The names that are really driving the market, they actually have earnings.
• 16:28
  Ryan: They actually have cash flow.
• 16:29
  Ryan: Back in the dot-com, there was, you know, sandcastles in the skies, right?
• 16:35
  Ryan: There, there just wasn't...
• 16:37
  Ryan: They didn't have earnings.
• 16:38
  Ryan: They didn't have cash flow.
• 16:40
  Ryan: Yet they had dot-com attached, and they, you know, shot to the moon.
• 16:44
  Ryan: So you're exactly right.
• 16:45
  Ryan: Different time period.
• 16:47
  Ryan: So I do think, you know, we're gonna have a different ending than what we had in the dot-com period.
• 16:54
  Ryan: Very good point there.
• 16:55
  Ryan: Do you think this concentration, uh, what will cause it to unwind?
• 17:01
  Ryan: You mentioned a little bit earlier, do you think it'll be high valuations or maybe earnings disappointments?
• 17:06
  Ryan: You just said it.
• 17:07
  Ryan: They're all kinda highly correlated, and the s- kinda s- play in the same sandbox.
• 17:12
  Ryan: If one has bad earnings, will it all bring them, bring them all down?
• 17:16
  Ryan: Regulation, disruption.
• 17:18
  Ryan: What do you think could make it unwind?
• 17:21
  Bill Davis: Well I think two things.
• 17:24
  Bill Davis: One is of breadth in the market, coupled with a shock within, like one of those big companies could be enough to undo it.
• 17:33
  Bill Davis: I mean, there's always macro issues that can unwind a market, whether it's wars or inflation or whatever.
• 17:40
  Bill Davis: But the obvious Death Star Death Star here is You know, 50% of all earnings, uh, this year are linked to AI CapEx.
• 17:53
  Bill Davis: Uh, 50% of the growth of the GDP is linked to AI CapEx.
• 17:59
  Bill Davis: And, you know, we've seen...
• 18:01
  Bill Davis: And, and I think that there's gonna be a series of stages that we're gonna go through.
• 18:06
  Bill Davis: We're already through at least the first stage where all of the action was with the hyperscalers, and they went straight up and straight up, and then people started looking at Nvidia and going, "Okay, this thing is already like
• 18:20
  Bill Davis: priced almost beyond perfection."
• 18:23
  Bill Davis: If, if Nvidia doesn't meet its numbers for the next two or three years, um, you know, a lot could go wrong there.
• 18:31
  Bill Davis: And so I think that the, the game has now moved from the hyperscalers to the chip manufacturers, now they're doing really well.
• 18:40
  Bill Davis: But now there's also questions to whether or not their dependence on the AI companies for their own revenue growth is potentially a trap.
• 18:50
  Bill Davis: There's this kind of weird thing out there w- which speaks to the circular nature of all of the relationships between the chip makers the hyperscalers, like using AMD as an example.
• 19:04
  Bill Davis: I think, um, 20% of AMD's common stock has been pledged to four or five hyperscalers who get to exercise penny warrants, uh, if they achieve their revenue targets with AMD or their sales orders, whatever it is.
• 19:21
  Bill Davis: Um, which is probably good because it means AMD is gonna get a lot of business.
• 19:26
  Bill Davis: But the point is, is that if, if, you know, the, the hip bone is connected to the leg, leg bone, right?
• 19:32
  Bill Davis: And so if, um, again, if AI falters, it's gonna now take the chip companies down with it.
• 19:39
  Bill Davis: And we still haven't gotten to the point where, where this has made its way into a kind of like a normal business, right?
• 19:48
  Bill Davis: I think only 13% of US large cap companies have indicated that they have seen bottom line improvements to their business as a result of AI expenditures.
• 19:59
  Bill Davis: Uh, I think that's gonna change.
• 20:01
  Bill Davis: I also think that, um, I think that companies, especially large enterprises, are gonna not be reliant on-- They're gonna lose a willingness to be reliant on and a lot of these LMMs, and they're gonna start, um, uh, essentially
• 20:20
  Bill Davis: building their own out of open source Uh, data, and I think that that is good for the chip makers, right?
• 20:26
  Bill Davis: Because that means that there's gonna be a lot of CPUs that are built, and that's sort of different from kind of the AI thing in and of itself.
• 20:34
  Bill Davis: Um, think, I think that's sort of the Death Star that's out there.
• 20:39
  Bill Davis: So much of the economy...
• 20:40
  Bill Davis: I mean, technology is in everything, right?
• 20:42
  Bill Davis: It's in your car, it's in, uh, things that you buy that are now smart where they didn't used to be, IoT.
• 20:50
  Bill Davis: It's moving into, um, and quantum computing and, uh, healthcare and really kind of every part of our lives.
• 21:00
  Bill Davis: And so to some extent, the techn- the technologification, if that's a word, I know it isn't, um of everything kind of gets back to the point we were talking about earlier, which is like, is it dangerous to have
• 21:15
  Bill Davis: stuff be tech?
• 21:15
  Bill Davis: I don't think it really is.
• 21:16
  Bill Davis: I think it's dangerous the highly correlated stuff that all hinges on sort of the data center build-out.
• 21:24
  Bill Davis: That's the, that's the Death Star here.
• 21:27
  Bill Davis: Now, under-- like counterbalancing that is the fact that the market, unlike two years ago, where, uh, and, and don't quote me precisely on this 'cause this is an approximation, but I think something like 90% of the performance of
• 21:44
  Bill Davis: the S&P 500 was like in, I think, 10 names.
• 21:48
  Bill Davis: Um, what's unusual right now, or not unusual, it's actually more normal it has been for the past few years, is that there is a widening of the breadth of the market as a whole, and there are strong earnings
• 22:00
  Bill Davis: in everything from to utilities and of course, yes, technology.
• 22:06
  Bill Davis: But the point is, as that market broadens out, it has the capacity to kind of take out its own garbage, if you will.
• 22:14
  Bill Davis: So as problems emerge, the market can absorb them because there's strength throughout the market, and I think that's a very positive sign.
• 22:23
  Ryan: Mm-hmm.
• 22:24
  Ryan: Yeah, I, I agree, Bill.
• 22:25
  Ryan: And to back, going back to the AI and just kind of the trickle down effect here, you're exactly right.
• 22:33
  Ryan: Hyperscalers, at some point they're gonna build their data centers, their infrastructure, everything, then that spending's gonna probably slow down.
• 22:40
  Ryan: What impact does that have on the, you know, downriver, downstream companies?
• 22:46
  Ryan: What I feel the best long-term play, no recommendations here, but the more optimistic, better opportunity long-term plays are the companies that are gonna leverage AI.
• 22:57
  Ryan: You said it.
• 22:58
  Ryan: They might not use Anthropic, they might do open source something, but I feel it's, you know, what is it?
• 23:04
  Ryan: Healthcare, financials, maybe utility.
• 23:07
  Ryan: Those companies that really are able to harness the power of AI, help their bottom line, make processes more efficient.
• 23:15
  Ryan: Those are the companies I think will have a long...
• 23:19
  Ryan: better longer term play than maybe just a hyperscaler.
• 23:23
  Bill Davis: Yeah, and actually between now and then, I think the companies that are more relevant than the hyperscalers are the semis.
• 23:32
  Bill Davis: Because the semis are actually, you know, building out the inference tools which require actually more silicon and more compute and, more servers.
• 23:46
  Bill Davis: Uh, and so I think while those companies are massively dependent on for orders, ha- they themselves have sort of a, a broadening breadth of customers that are just in demand for, like, chips, right?
• 24:01
  Bill Davis: And, so to me, they're the sort of new hyperscalers.
• 24:04
  Bill Davis: They're the kind of the hot dot market these days.
• 24:08
  Bill Davis: But I do think ultimately where this is really-- where this we're really gonna find out is when we get down to the, your typical enterprise, and I think we're probably a year or two away from fully understanding how
• 24:20
  Bill Davis: that plays out.
• 24:22
  Ryan: Yep.
• 24:22
  Ryan: Yep.
• 24:23
  Ryan: So continue on this theme.
• 24:25
  Ryan: Do you think the S&P 500 is becoming less of a representation of the US economy and more of a representation of the, the winners of the technology and AI investment cycle?
• 24:41
  Bill Davis: Yeah, I do.
• 24:42
  Bill Davis: I think, I think that that's-- I think that that is the case.
• 24:47
  Bill Davis: I, I don't think it is representative.
• 24:50
  Bill Davis: I would also add that a lot of these sectors in the S&P 500 are kinda bullshit.
• 24:55
  Bill Davis: Like, you've got, um, you've got companies like...
• 25:00
  Bill Davis: Well, I'll just take Uber.
• 25:01
  Bill Davis: Like, Uber is listed as a, as, in the, as a technology company, but it's basically like a taxi dispatcher, right?
• 25:09
  Bill Davis: Isn't that all it is?
• 25:11
  Bill Davis: I mean, with a little bit of logistics technology.
• 25:14
  Bill Davis: And so you have some misclassification of companies, which I think, I, I think, I don't know that it should be concerning to investors, but investors, you know, there's this old adage, "It's less important what company you invest in,
• 25:28
  Bill Davis: and more important what sector you invest in," because things in a sector tend to move together.
• 25:33
  Bill Davis: But where that starts to get confusing now is that you've got technology companies that used to be sort of GICS-coded as a tech company, but since they support mostly, let's say, healthcare, they're now listed as a healthcare company.
• 25:49
  Bill Davis: Uh, and then you've got companies like Amazon, which in my mind is mostly a retailer, but because of AWS, they're like, I don't know whether they're comm services or tech, I forget which.
• 26:01
  Ryan: Угу
• 26:01
  Bill Davis: Uh, so there's just a lot of, um, there's a lot of mismatching, and I think it's, it can be a little bit confusing.
• 26:10
  Bill Davis: Um, and I think that also contributes to why everything sort of looks like it's a technology company.
• 26:17
  Bill Davis: Not all of it really is, it's just kind of labeled that way.
• 26:21
  Ryan: It also makes it more difficult.
• 26:24
  Ryan: Years ago, we used to just be like, you know, do the nine style box, large growth, large value.
• 26:30
  Ryan: But it feels if those lines are blurred now.
• 26:34
  Ryan: A lot of companies that years ago that you wouldn't think producing a dividend, now they're producing dividends, some of these tech names.
• 26:42
  Ryan: It might not be very big, but they're producing dividends.
• 26:45
  Ryan: Like you said, some of these tech names might be more in the, you know, value sectors, the traditional value sectors.
• 26:53
  Ryan: So I am a firm believer, kinda get outside that nine style box that was so 1990s
• 27:00
  Bill Davis: Yeah.
• 27:01
  Ryan: and expand.
• 27:02
  Ryan: But, um, and I also think...
• 27:04
  Bill Davis: a good example, right?
• 27:05
  Bill Davis: So Tesla trades like a growth stock.
• 27:07
  Bill Davis: I forget what its multiple it is these days.
• 27:11
  Bill Davis: But it has- but it doesn't grow, it, it's actually shrinking.
• 27:15
  Bill Davis: you know, so you've got just...
• 27:17
  Bill Davis: I think you've got a lot of anomalies kind of working their way the system, and I think that also creates some confusion
• 27:26
  Ryan: You're exactly right.
• 27:28
  Ryan: And, and one last thing on this too, as you're talking during the first, you know, 15 minutes of this conversat- it sounds a lot like the S&P 500 index, you know, SPDR, the cap-weighted index, is really almost a
• 27:44
  Ryan: momentum play,
• 27:45
  Bill Davis: Mm-hmm.
• 27:46
  Ryan: uh, than, than any...
• 27:48
  Ryan: You know, you mentioned the equal weight, which obviously gives you more diversification, stability.
• 27:54
  Ryan: But to me, the, the cap weight is, is a momentum play
• 27:58
  Bill Davis: I agree.
• 27:59
  Bill Davis: I agree completely.
• 28:01
  Bill Davis: And index funds exacerbate that
• 28:04
  Ryan: Yeah.
• 28:04
  Ryan: E- exactly what you're talking about, the ERISA pro- you
• 28:07
  Bill Davis: yeah, it forces buying at the top of the market, uh, which seems a little sort of like backwards to me, but
• 28:16
  Ryan: Yeah.
• 28:16
  Ryan: Yeah, exactly.
• 28:18
  Ryan: So let's talk about potentially a solution here.
• 28:21
  Ryan: We talked about at the opening, you talked about tax alpha.
• 28:24
  Ryan: Let's get into that a little bit more because it is so important, and it is one way where I think you can control alpha, you can find alpha, you have a better control of producing a better outcome for
• 28:37
  Ryan: your clients.
• 28:38
  Ryan: A lot of advisors have clients sitting on highly appreciated individual stocks, and the obvious problem here is that selling will create an enormous tax bill.
• 28:50
  Ryan: How can a Section 351 exchange help advisors solve that problem?
• 28:55
  Bill Davis: Yeah.
• 28:55
  Bill Davis: So actually, let me just preface it by saying there are a few different tools out there that are being deployed, and every situation is different.
• 29:06
  Bill Davis: You may recall something called an exchange fund, which was popularized by, I think, Eaton Vance and Goldman Sachs a while ago.
• 29:13
  Bill Davis: That's one solution, and that's kind of the solution that's tailor-made an executive who's retiring from a big company where they-- he's got a lot of in that company, and he's looking to diversify out of it.
• 29:26
  Bill Davis: So you can go to an exchange fund and you can say, "Look, I wanna contribute my American Express or whatever."
• 29:34
  Bill Davis: To the exchange fund.
• 29:35
  Bill Davis: But the problem is, those funds are is a collection of things people don't want.
• 29:41
  Bill Davis: And so it becomes kind of a bit of a Mr.
• 29:43
  Bill Davis: Potato Head portfolio, and they themselves can end up being a little bit over-concentrated.
• 29:49
  Bill Davis: furthermore, since today most of the stuff people are, are, are too long on the Mag Seven, and they will limit the amount that you can contribute simply because everybody else is looking to contribute the same stuff.
• 30:06
  Bill Davis: funds tend to have high fees, startup fees, high fees annually, and it's a seven-year lockup.
• 30:13
  Bill Davis: So that's one solution.
• 30:15
  Bill Davis: I think it's-- I think it works for a certain profile investor who doesn't need liquidity and, who doesn't mind paying those fees and who has kind of a single stock I think that the idea of a Section 351
• 30:32
  Bill Davis: is really tailored for, I would say, a more typical investor who just simply, as a result of the run-up of certain sectors of the market, just has way too much, an un- an uncomfortably large amount highly volatile, highly
• 30:48
  Bill Davis: correlated with one another positions.
• 30:51
  Bill Davis: And so specifically, Ryan, Section 351 is IRS tax code, what it allows for is investors to u- to make in-kind contributions to the launch of an ETF in exchange for shares of the ETF without, uh, creating a gain
• 31:14
  Bill Davis: in the process.
• 31:15
  Bill Davis: And of course, you know, this isn't-- we're not really here to talk about kind of the mechanics of how ETFs work, 'cause you've probably already done that.
• 31:24
  Bill Davis: the...
• 31:24
  Bill Davis: I will simply highlight that the benefit of an ETF is that it can use custom baskets inside of a create redeem process to exchange positions that it doesn't want positions that it does want as a part of a
• 31:42
  Bill Davis: normal rebalancing without creating taxable events.
• 31:45
  Bill Davis: So it is that specific mechanical and technical u- uniquely, you know, belonging to ETF's capability that allows for investors to unload things that they have too much of.
• 32:02
  Bill Davis: And it doesn't matter how many investors are unloading the same stuff like 10 people can contribute to the seeding of an ETF, let's just say that every one of 'em is giving the ETF 10 million of, know, Nvidia
• 32:17
  Bill Davis: or whatever.
• 32:17
  Bill Davis: I'm just making up numbers here.
• 32:19
  Bill Davis: Um, over the course of rebalancing, that ETF can wash out or rebalance away from that to Nvidia and get on mandate in terms of what the ETF is intended to hold.
• 32:35
  Bill Davis: So a very neat vehicle for investors who qualify because they can basically, um, they can basically deconcentrate their portfolios into a broadly diversified ETF without creating a capital gain.
• 32:53
  Bill Davis: Now, you might say, "Well, what happens to the that's owed to the government?"
• 32:57
  Bill Davis: It doesn't actually go away.
• 32:59
  Bill Davis: It simply carries over in the cost basis of their shares in the ETF.
• 33:04
  Bill Davis: So, but, you know, importantly, it solves an immediate problem.
• 33:10
  Bill Davis: Now they've got a diversified portfolio, and of course, the problem?
• 33:14
  Bill Davis: doesn't get worse because as ETFs rebalance over, you know, like whether it's on an ad hoc basis or monthly or quarterly, they're not creating additional capital gains for their clients just because th- the nature of how ETFs operate.
• 33:31
  Bill Davis: it's a very elegant solution.
• 33:33
  Bill Davis: Uh, when I mentioned that in-- for investors who qualify, not everybody qualifies.
• 33:38
  Bill Davis: So, uh, the IRS has a defined, uh, or has a definition who qualifies and that is a diversified...
• 33:49
  Bill Davis: Well, a diversified portfolio that's submitted qualifies and they have a defined term for what a diversified portfolio means which specifically says that the largest position that's contributed can't be more than 25% of that client's contribution.
• 34:05
  Bill Davis: The top five positions can't be more than 50%.
• 34:08
  Bill Davis: effectively they're saying if you do the math, that it needs to be a minimum o- of 11 positions and that therefore qualifies under the IRS definition of a diversified portfolio.
• 34:21
  Bill Davis: Um Interestingly, ETFs can be contributed as a part of a three fifty-one contribution.
• 34:31
  Bill Davis: Individual securities can be contributed.
• 34:35
  Bill Davis: Uh, cash cannot be contributed, government securities cannot be contributed, uh, and, um, mutual funds cannot be contributed.
• 34:46
  Bill Davis: But I think it's perfect for advisors who have clients who have...
• 34:51
  Bill Davis: And by the way, it doesn't have to be Mag seven.
• 34:53
  Bill Davis: I mean, we have, uh, we have now done two Section three fifty-ones and, we will be doing additional ones.
• 35:03
  Bill Davis: The first one was, um, when we launched, um, is now the Hennessy Sustainable ETF.
• 35:11
  Bill Davis: And when we launched that, I had never heard of a three fifty-one.
• 35:14
  Bill Davis: I sort of learned about it like three weeks before the, before we launched.
• 35:20
  Bill Davis: we scrambled, and we introduced it to, I think, three outside wealth management firms.
• 35:25
  Bill Davis: And collectively, with certain of their clients, um, they seeded the launch of our ETF with twenty-seven million dollars on day one.
• 35:34
  Bill Davis: And so that was not only our introduction to three fifty-ones, but I think we might have been the first firm ever, and again, it was all like quite accidental, to actually syndicate a three fifty-one out to other, uh,
• 35:46
  Bill Davis: wealth management firms and other investment firms.
• 35:49
  Bill Davis: Fast forward, that was five years ago.
• 35:51
  Bill Davis: Fast-forward to today, estimated that this year alone, ten billion in assets in in-kind contributions will see the launch of about sixty or seventy ETFs this year, alone.
• 36:08
  Bill Davis: And so this has become a very popular, way to deconcentrate portfolios
• 36:15
  Ryan: Yeah.
• 36:16
  Ryan: it.
• 36:16
  Ryan: is, And another great way of, for building tax alpha and a, and an opportunity for financial advisors.
• 36:23
  Ryan: Do you think right now that people think it's more complicated than, than it is?
• 36:29
  Ryan: You know, there's some red tape, paperwork, or is that just a misconception?
• 36:36
  Bill Davis: I'd say it's mostly a misconception.
• 36:37
  Bill Davis: I think that, m- you know, look, five years ago when we were kind of like out in the wilderness doing this thing, nobody knew what it was.
• 36:46
  Bill Davis: Uh, we barely knew what it was.
• 36:48
  Bill Davis: We kind of learned.
• 36:49
  Bill Davis: And obviously, all of these transactions are done under the supervision of, uh, outside tax attorneys who are signing off on each and every one of these transactions, and they ultimately come back to the client with a legal opinion
• 37:04
  Bill Davis: letter.
• 37:06
  Bill Davis: so but I would say that now it is becoming more mainstream.
• 37:14
  Bill Davis: the paperwork has...
• 37:16
  Bill Davis: you know, look, it's a lot of work for us as the issuer do one of these things because it's kind of-- it's, it's herding a bunch of cats and trying to get them all into the same pen, 48
• 37:27
  Bill Davis: hours before the launch of an ETF, and that's just challenging, especially if you're working with 20 different firms at the same time.
• 37:36
  Bill Davis: And I would say some custodians have geared up and view it as an opportunity to grow their, their custodial business.
• 37:43
  Bill Davis: And s- I'm s- talking specifically about Schwab.
• 37:46
  Bill Davis: Schwab has literally hired people to help streamlining the three fifty-one and for them it's as simple as a letter that accompanies...
• 37:58
  Bill Davis: It's, it's essentially a DTC authorization letter, which they require that the client sign.
• 38:03
  Bill Davis: And from our perspective, we ask the RIA to sign a very simple that basically is a know your client letter.
• 38:12
  Bill Davis: Um, uh, I would also point out that we don't generally, when we do them, we don't take in retail clients in the process.
• 38:20
  Bill Davis: There are firms that will take in retail assets off the street into a three fifty-one transaction.
• 38:27
  Bill Davis: We would prefer that that client have an advisor, between us and them.
• 38:33
  Bill Davis: Um, but I think it's getting pretty streamlined.
• 38:36
  Bill Davis: I mean, look, there's, there's firms out there that are literally launching an S&P clone fund once a quarter, uh, simply to attract, uh, three fifty-one contributions.
• 38:48
  Bill Davis: And generally speaking, they're launching each of these clone funds with three or, three or four hundred million of assets every quarter.
• 38:56
  Bill Davis: And that speaks to just the nature of the, the magnitude of the problem, which is, by the way, getting worse, not better, right?
• 39:02
  Bill Davis: The S&P continues to go up.
• 39:05
  Bill Davis: more and more positions that are kind of a little bit too big.
• 39:09
  Bill Davis: Um, I would also say that there is one other popular way of dealing with concentration risk, is, um, well, the original is doing like a direct index.
• 39:21
  Bill Davis: But of course, I think people are finding five years into a direct index, and especially if participant is no longer, uh, contributing adding capital to the account, is that those direct indexes can get ossified and tax-locked.
• 39:37
  Bill Davis: And then you have the same problem within the direct index that you had before you went into it, which is that you've got a misshapen portfolio that, you know, is maybe off of, uh, off of an investor's risk
• 39:49
  Bill Davis: profile.
• 39:50
  Bill Davis: But the third w- the third way is to do a long-short, uh, extension, which is another way of doing it, which can take two or three years.
• 39:58
  Bill Davis: So there's a lot of ways of doing all of these things.
• 40:01
  Bill Davis: The nice thing about a three fifty-one exchange is it's, it's basically free to the participant.
• 40:07
  Bill Davis: The only thing that costs them money is whatever ETFs that they're going into as an expense ratio, so they're gonna be paying that expense ratio, but there's no upfront cost.
• 40:16
  Bill Davis: They don't pay for legal opinion letters.
• 40:19
  Bill Davis: Um, you know, they get tax, they get diversification, and they get back, by the way, also If, um, let's say you were contributing Ryan, and you gave me a combination of ETFs and individual positions, between all of those
• 40:38
  Bill Davis: things, there was like a hundred tax lots.
• 40:41
  Bill Davis: When we give you back shares of that ETF, you're gonna have a hundred tax lots of that ETF, which gives you a lot of flexibility you're gonna, you know, gift money to, you know, gift to a charity versus
• 40:56
  Bill Davis: taking a taxable distribution.
• 40:58
  Bill Davis: It gives you flexibility to kind of tax manage around that as well
• 41:04
  Ryan: Great insights there, Bill.
• 41:05
  Ryan: And, and to all of our listeners out there, financial advisors, you know, do some research.
• 41:12
  Ryan: Nice thing is, is that we're a couple years into this.
• 41:15
  Ryan: There is a lot of research out there on 351 exchanges, a lot of information, a lot of, uh, great people doing them.
• 41:22
  Ryan: So Bill, you're one of them.
• 41:25
  Ryan: So great stuff out there if you're looking for help.
• 41:29
  Ryan: Let's, uh, shift real quickly, um, finish up this conversation.
• 41:34
  Ryan: It's been fantastic so far.
• 41:36
  Ryan: Just talk about sustainable investing.
• 41:39
  Ryan: It's evolved a lot over the years.
• 41:41
  Ryan: Aging myself here, you know, it used to be responsible investing and just all these...
• 41:47
  Ryan: ESG, now sustainable.
• 41:51
  Ryan: Do you think just all the different names just adds kind of some clutter to it?
• 41:55
  Ryan: 'Cause at the end of the day, you said it earlier, it's just investing in your values, investing in your beliefs.
• 42:02
  Ryan: Do you think...
• 42:03
  Ryan: What, what's your stance on the landscape today of sustainable investing?
• 42:09
  Bill Davis: I think it's important to remember that it goes back hundreds and hundreds of years, right?
• 42:16
  Bill Davis: Um, and I'm spec-specifically talking about faith-based investing, which is in values and avoiding things that are antithetical to one's faith.
• 42:27
  Bill Davis: Um, if you look at, you know, everything from Catholic values to Jewish values, to values, to, you know, Protestant, um, investment portfolios, they all like are kind of like almost exactly the same.
• 42:47
  Bill Davis: I mean, there's, there's always something that somebody doesn't want, whether it's pork or whether it's contraception or like whatever, right?
• 42:55
  Bill Davis: There's all these like little variations, but basically it's ESG.
• 43:01
  Bill Davis: Like if you get at the underlying tenets of faith-based investing, they are about supporting people and communities, about making money and giving money back.
• 43:13
  Bill Davis: about preserving resources, which is sort of the envi-- and treating the environment responsibly.
• 43:20
  Bill Davis: It's all just like the same as what sort of a, a typical ESG investor does.
• 43:26
  Bill Davis: I think that the, uh...
• 43:28
  Bill Davis: And, and so I think that the disservice, you wanna call it that, is that when the term ESG came out, it means so many things to so many different people that it's almost absolutely like useless.
• 43:40
  Bill Davis: And then if you add to that, that the, that the firm that really kind of made the industry what it is, at least in the US, was BlackRock.
• 43:51
  Bill Davis: Um, and yet they were building kind of the least authentic ESG products in the market, somewhat cynically, right?
• 43:58
  Bill Davis: Because they were basically taking an S&P 500 portfolio, eliminating four names, branding it as ESG, and adding twenty bips to the expense ratio.
• 44:11
  Bill Davis: so there's sort of good and bad with it.
• 44:13
  Bill Davis: Number one, they kind of created the category in the US, or at least they were the marketing muscle behind it with Larry Fink's letters and all that.
• 44:21
  Bill Davis: Um, but at the same time, I think that they've, many ways, they devalued it through their lack of authenticity and, you know, just to kind of make a very small point, you take the largest three, you take the
• 44:37
  Bill Davis: three big firms, right?
• 44:38
  Bill Davis: BlackRock, Vanguard, State Street in that order.
• 44:42
  Bill Davis: They have the largest amount of assets in their ESG ETFs And yet they're the three largest investors in fuels in the US collectively, institutional investors in fossil fuels, to the point where I think that their ESG investments total
• 45:01
  Bill Davis: about $100 billion.
• 45:02
  Bill Davis: Their fossil fuel investors investments total one point one trillion, including into coal facilities.
• 45:10
  Bill Davis: so it's kinda like, well, I give these guys money if, like, in fact, they're just...
• 45:17
  Bill Davis: 'Cause I care, you know, I care about climate risk.
• 45:20
  Bill Davis: would I give BlackRock money if they're just marching me closer and closer to a climate cliff, right?
• 45:26
  Bill Davis: And so I think that that's kind of part of this, like, confusing issue for investors who care about this stuff.
• 45:34
  Bill Davis: But then the other side of it is the whole culture war side of it, which somehow or other took this obscure, like undefined, like nebulous term called ESG and it as woke capitalism, whatever that means.
• 45:49
  Bill Davis: in fact, like the underlying tenets of ESG investing have been going on for li-like a millennial, like, or at least in the US the last couple hundred years, and nobody had any problem with it and still doesn't, by
• 46:04
  Bill Davis: the way, faith-based investing.
• 46:06
  Bill Davis: So I think, I think the landscape is today, it's confusing.
• 46:12
  Bill Davis: I think a lot of the momentum that was established in 2020 and 2021 been chilled.
• 46:19
  Bill Davis: However, it's not going away.
• 46:21
  Bill Davis: Uh, assets in Europe, which is, by the way, has always been years ahead of us in this, are growing.
• 46:28
  Bill Davis: I would say also they're, they're growing toward...
• 46:31
  Bill Davis: They're leaning into authenticity, and they are leaning into some ar- some sort of thematic areas like nature-based investing.
• 46:41
  Bill Davis: you know, people think of nature-based investing as protecting the environment.
• 46:44
  Bill Davis: I would say that it's a bit of a ticking time bomb, and investors really everybody needs to understand that there are a lot of macroeconomic drivers related to the importance of protecting the environment because you can either protect
• 47:00
  Bill Davis: it in advance, or you can deal with all of the sovereign defaults that are gonna come, uh, as land becomes, you know, like unarable and the oceans become unfishable timber, uh, resources are depleted and, um, and global warming,
• 47:20
  Bill Davis: you know, kinda continues to march down its path.
• 47:23
  Bill Davis: So I think So I think strategies related to water, to energy, to timber, to carbon, um, to agriculture, I think are gonna become more prevalent, and it's gonna be less about buying, you know, some plain vanilla ten basis
• 47:42
  Bill Davis: point ETF and checking the box.
• 47:47
  Bill Davis: So I think it's not only not going anywhere, I think it's, it's gonna become more important because the reality is, know, climate risk, as one example, really doesn't care about politics.
• 47:59
  Bill Davis: and the reality is, is if businesses don't decarbonize, they are going to...
• 48:04
  Bill Davis: It's gonna create not only there's systemic risk around but there's gonna be very specific risk around companies who are exposed to climate risk and who aren't, aren't doing everything they can to become more resilient.
• 48:19
  Bill Davis: I would also just as-- add as a kind of a final point on that, um, companies are paying attention to this.
• 48:27
  Bill Davis: You know, there's two sides of this.
• 48:28
  Bill Davis: There's like, what are, you know, asset management firms like Stance Capital doing in terms of building product and, and bringing them to market?
• 48:37
  Bill Davis: But the other side, the more important side is how is all of this affecting the companies that we are investing in and are engaging with?
• 48:45
  Bill Davis: And the answer is moving more slowly than they were five years ago and more-- and definitely they're being more, um, thoughtful around their footing.
• 49:01
  Bill Davis: and they've definitely kind of gone underground and not talking about it as much.
• 49:05
  Bill Davis: But most big businesses have financially operationalized, um, sustainability into their business units, so it's no longer simply like compliance-driven ESG reporting sort of, you know, some small department over on the side.
• 49:25
  Bill Davis: I think businesses understand the actual benefit of decarbonizing, capturing market share, attracting and retaining the best employees, commanding premium prices from more loyal customers as a result of their, you know, off-balance sheet behavior around decarbonizing.
• 49:45
  Bill Davis: And so I think, I think that the business world gets it, and that's probably the most important thing.
• 49:49
  Bill Davis: That's the most important point to make.
• 49:51
  Ryan: Yeah.
• 49:52
  Ryan: No, that's an important point, Bill, and I love that you brought up these huge asset managers who have, you know, one side of their business.
• 50:02
  Ryan: It, they just don't coordinate, right?
• 50:04
  Ryan: And I think that's the biggest issue with this industry.
• 50:08
  Ryan: They're just all trying to chase the dollar, build AUM, chasing trends, and you see that with what you just said.
• 50:15
  Ryan: They have all these ESG products, that's one message.
• 50:20
  Ryan: Under the same brand, they have a different message that doesn't really correspond with sustainable investing or ESG.
• 50:27
  Ryan: So, it's a problem I have.
• 50:30
  Ryan: That's my soapbox.
• 50:32
  Ryan: But also too, I think, and you said it too, like just ESG, it's so hard to be environmental, social, and governance, but at the same time, like to find companies that fit all three.
• 50:46
  Ryan: At the same time, I don't know one asset manager who doesn't think about governance when they're making an investment.
• 50:54
  Ryan: All right?
• 50:55
  Ryan: I
• 50:56
  Bill Davis: except everybody who invests in, uh, s- um,
• 51:01
  Ryan: Yeah, there you go.
• 51:02
  Ryan: Exactly
• 51:02
  Bill Davis: the worst governed company ever to, like, um, do an IPO.
• 51:08
  Bill Davis: I mean, there is no governance there.
• 51:09
  Bill Davis: You...
• 51:10
  Bill Davis: shareholders have zero rights in that company.
• 51:13
  Bill Davis: It's, it's, it's effectively like a publicly traded venture capital firm where nobody has any rights
• 51:20
  Ryan: Yeah, exactly.
• 51:21
  Ryan: So you're exactly right there.
• 51:24
  Ryan: But, uh, you know, most...
• 51:26
  Ryan: If, if financial, if a asset manager, money manager is doing what's best for their, you know, investors, you know, they're probably gonna consider the G part
• 51:38
  Bill Davis: Yeah,
• 51:38
  Ryan: of ESG.
• 51:39
  Ryan: So
• 51:40
  Bill Davis: Look, despite all of the sort of performative theater around ESG in the last couple of years, the politicis- politicization of it, the, you know, the McCarthy-style hearings in Washington for practitioners of it, reality is, is that all it
• 52:01
  Bill Davis: is is a proxy for finding a well-managed company.
• 52:04
  Bill Davis: Like, you and I both would agree that if we wanna invest in a company, we want it to have strong governance, we want a good management team, we want a company that's responsible to its employees and the communities
• 52:17
  Bill Davis: in which it operates, want a company that amplifies its returns to shareholders specifically by good at those things and also protecting, like, underlying resources like the environment.
• 52:34
  Bill Davis: So
• 52:35
  Ryan: You're
• 52:35
  Bill Davis: It's really not any more complicated than that
• 52:38
  Ryan: Yeah, you're exactly correct.
• 52:39
  Ryan: But we had to put an acronym to it and then make it all political.
• 52:44
  Ryan: Last thing, let's tie this all together, Bill.
• 52:47
  Ryan: Fantastic information.
• 52:49
  Ryan: I learned a ton.
• 52:50
  Ryan: It's been a lot of fun.
• 52:51
  Ryan: Let's bring AI and sustainable investing together.
• 52:56
  Ryan: You know, there's a huge amount of energy required to power AI.
• 53:00
  Ryan: So how do you reconcile that explosive growth in AI infrastructure with sustainable investing?
• 53:07
  Bill Davis: So I think sustainable investing needs to exist in the world in which it-- we live in, the, the real world.
• 53:14
  Bill Davis: reality is, um, AI is happening.
• 53:19
  Bill Davis: Uh, n-nobody...
• 53:21
  Bill Davis: I mean, we can d- a se- a separate conversation is sort of the, you know, the ethics of, of like uncontrolled AI and, um, and all of that, and social media and everything.
• 53:35
  Bill Davis: So leaving all of that stuff aside for a moment, think what s- what investors can be thinking about is investing in those companies who are doing it as responsibly as possible.
• 53:48
  Bill Davis: So, you know, you can power AI through a variety of ways.
• 53:54
  Bill Davis: I think that those in the industry that are advocating for sustainable approaches I think that those messages are very, very well received, um, by the hyperscalers.
• 54:07
  Bill Davis: But I think if you think about their priority, it's like speed, sustainability, and then cost.
• 54:15
  Bill Davis: They don't really care what it costs to solve the problem.
• 54:17
  Bill Davis: They wanna get it done quickly.
• 54:20
  Bill Davis: interestingly, in some cases, renewables are the fast path to doing it.
• 54:24
  Bill Davis: I would say one of the big worries that I have actually relates to water.
• 54:29
  Bill Davis: I think water is like a hidden risk that everybody should be thinking about and not taking for granted.
• 54:36
  Bill Davis: and it's gonna become more and more precious.
• 54:38
  Bill Davis: And I think these data centers have the capacity to do closed-loop water systems.
• 54:45
  Bill Davis: They have the capacity to not do it, but we're starting to see pushback from communities and NGOs and other parties around irresponsible center build-out.
• 54:59
  Bill Davis: And I think...
• 55:00
  Bill Davis: You know, look, I mentioned at the beginning, um, our flagship product is the Hennessey Sustainable Fund.
• 55:08
  Bill Davis: Our approach to selecting companies in that fund is, number one, we look at the underlying fundamentals.
• 55:15
  Bill Davis: We use machine learning to identify companies who we think are statistically likely to generate positive total return and alpha over the next quarter.
• 55:26
  Bill Davis: Then we also look at how, um, we sort of grade them quantitatively or on a rules-based framework, um, on up to twenty-five different ESG criteria, and then its relative strength, right?
• 55:41
  Bill Davis: So we're not trying to exclude certain-- I mean, we, we tend not to invest in fossil fuel companies, but for everything else, you know, like mining, for example, we're one of the few ESG companies that will invest in
• 55:54
  Bill Davis: a mining company, but we're only gonna invest in those mining companies who are more responsible relative to their peers.
• 56:00
  Bill Davis: And so I think the same is true with AI, and that's how investors should think.
• 56:04
  Bill Davis: They should think about supporting companies who are actually making an effort to do it responsibly.
• 56:10
  Ryan: Yeah.
• 56:11
  Ryan: Bill, great way of ending this conversation.
• 56:14
  Ryan: Really fun.
• 56:15
  Ryan: I enjoyed it.
• 56:17
  Ryan: I learned a lot.
• 56:18
  Ryan: Really insightful.
• 56:20
  Ryan: Thank you so much for coming on.
• 56:21
  Ryan: It's been an honor, uh, to have you on.
• 56:24
  Ryan: Where can our audience get more information about Stance Capital?
• 56:29
  Bill Davis: Yeah.
• 56:29
  Bill Davis: Um, so Ryan, first off, thanks very much for having me.
• 56:33
  Bill Davis: Um, love to do it again.
• 56:35
  Bill Davis: Uh, are at www.stancecap.com, and if you navigate through our website and you want-- anybody wants more information on Section 351 exchanges, we've got a great primer there, which is to understand and very comprehensive.
• 56:52
  Bill Davis: It explains what they are, who can participate, how to go about it.
• 56:57
  Bill Davis: and ultimately, as we launch ETFs in advance of launch of ETFs, we'll find ways to let people know that we've got an upcoming opportunity in that regard.
• 57:09
  Ryan: Awesome, Bill.
• 57:10
  Ryan: You're, you do have a lot of great insight, especially on 351 exchanges.
• 57:14
  Ryan: People need the information, so thank you.
• 57:17
  Ryan: Thank you for coming on, and yeah, let's do it again.
• 57:20
  Ryan: Let's do it again.
• 57:21
  Ryan: And thank you, everyone.
• 57:22
  Ryan: You know, thank you everyone for listening to this episode of Adjusted for Risk podcast.
• 57:27
  Ryan: You can watch all of our other episodes on YouTube and Spotify and wherever else you catch your podcasts.
• 57:33
  Ryan: Also, be sure to like and subscribe to those channels and give us a follow on LinkedIn.
• 57:38
  Ryan: Thank you very much and have a great rest of your week