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Chris Brightman Discusses the Investment Industry · Masters in Business

0:02
Speaker 1: You're listening to Mensters in Business with Barry Ridholts on
0:05
Speaker 1: Bloomberg Radio. This week on the podcast, I have a
0:09
Speaker 1: special guest and his name is Chris Brightman. He is
0:13
Speaker 1: the chief investment officer of Research Affiliates, better known as Raffie,
0:19
Speaker 1: the firm which is one of the prime drivers behind
0:22
Speaker 1: the trend towards smart beta or fundamental indexing as it
0:27
Speaker 1: is more accurately called. We go off into the weeds
0:31
Speaker 1: about portfolio construction, What drives returns? What are the best
0:36
Speaker 1: ways to approach constructing a portfolio? Research Affiliates their models
0:44
Speaker 1: run about two billion dollars worth of offerings. Uh. This
0:48
Speaker 1: is quite a fascinating conversation and I think you'll find
0:52
Speaker 1: it very intriguing. So, with no further ado, my conversation
0:57
Speaker 1: with Chris Brightman of Research Affiliates. This is Masters in
1:03
Speaker 1: Business with Barry Ridholts on Bloomberg Radio. My special guest
1:08
Speaker 1: today is Chris Brightman. He is the chief investment officer
1:12
Speaker 1: of Research Affiliates, whose investment strategies currently manage over two
1:17
Speaker 1: hundred billion dollars. He's previously he was the board chair
1:20
Speaker 1: at the Investment Fund for Foundations. UH. He was the
1:24
Speaker 1: CEO of the Strategic Investment Group and director of Global
1:28
Speaker 1: Equity Strategy at UBS Asset Management. Chris Brightman, Welcome to Bloomberg.
1:34
Speaker 1: Thank you for having me. So that's a really interesting
1:38
Speaker 1: um resume. You've worked at some very storied places. What
1:44
Speaker 1: first attracted you to the field of investment management. I
1:48
Speaker 1: arrived at my university, Virginia Tech, having been accepted into
1:54
Speaker 1: the Liberal Arts UH School, and after listening to the
2:00
Speaker 1: dean of the Liberal Arts School address the auditorium of
2:03
Speaker 1: new students explaining why you'd made the right choice, I
2:09
Speaker 1: approached the podium and said, I think I'm in the
2:12
Speaker 1: wrong place. I want to go to the School of Business.
2:15
Speaker 1: And without missing a beat or even seeming to notice
2:18
Speaker 1: the irony, the dean said, oh, yeah, well you walk
2:21
Speaker 1: down three you know buildings over that way, and and
2:24
Speaker 1: I changed before I even began classes to the business program,
2:30
Speaker 1: mostly because I figured, you have to understand, this is
2:33
Speaker 1: the seventies. I wanted a job when I graduated, and
2:38
Speaker 1: I felt like majoring in business would would be more
2:43
Speaker 1: likely to lead to a job than Liberal Arts. I
2:46
Speaker 1: don't know if that was right, but that's that's what
2:48
Speaker 1: I did, and then I chose, and I chose finance
2:52
Speaker 1: because it was more interesting than accounting. And for some
2:55
Speaker 1: of our younger listeners, the nineties seventies was a period
2:58
Speaker 1: of stagflation, high inflation, and high unemployment. Um, what was
3:04
Speaker 1: it like coming out of school into that environment. The
3:10
Speaker 1: I graduated in the early eighties, and the early eighties
3:14
Speaker 1: were an awful time. There was a nasty recession and
3:17
Speaker 1: I was really lucky. Actually right two was horrible. Eighty
3:24
Speaker 1: three was a little better, and I was lucky to
3:26
Speaker 1: graduate in eighty four and eighty five was boom times.
3:29
Speaker 1: It was great. But the but I graduated in eighty three.
3:33
Speaker 1: And what I think really got me into the investment
3:37
Speaker 1: management industry was an internship that I had with the
3:41
Speaker 1: First Chicago in nine over the summer. And uh, my
3:46
Speaker 1: internship was with the institutional trust department at First Chicago,
3:51
Speaker 1: which later became First Chicago Investment Advisors, which later became
3:54
Speaker 1: Brinson Partners. And Gary Brinson, the founder of Brinson Partners,
4:00
Speaker 1: was one of my was really my first mentor in
4:02
Speaker 1: the business, beginning in two So you were working on
4:06
Speaker 1: the endowment side of the street. How does the endowment
4:11
Speaker 1: side differ from working with retail investors and people whose
4:15
Speaker 1: money is with four O one ks and iras, etcetera.
4:19
Speaker 1: I've had about a three and a half decade career,
4:22
Speaker 1: thirty five years in the business of which I took
4:25
Speaker 1: a rather brief five year detour into the nonprofit area
4:30
Speaker 1: managing the University of Virginia Endowment, and it differs in
4:38
Speaker 1: a number of ways. Probably the m most interesting to
4:45
Speaker 1: an outsider is the access that one gains two elite
4:49
Speaker 1: investment managers. How big was the endowment at the time,
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Speaker 1: over five billion? Okay, so that's real money, I think, interestingly, though,
5:00
Speaker 1: it's less challenging. It's an easier job. I'm so surprised
5:05
Speaker 1: you say that. And maybe this is me projecting, but
5:08
Speaker 1: I would imagine that running an endowment, and and my
5:12
Speaker 1: frame of references all the craziness we've seen with the
5:15
Speaker 1: Harvard Endowment over the past twenty years and what recently
5:19
Speaker 1: happened with the Yale Endowment and Swanson, I would imagine
5:22
Speaker 1: there are so many political constituencies to deal with. You
5:26
Speaker 1: were the c i O at the Virginia University of
5:32
Speaker 1: Virginia Endowment, and that covered what school or schools? There's
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Speaker 1: just one endowment five billion dollars. Actually, fascinatingly enough, Uh,
5:43
Speaker 1: it's much more complicated than that. The University of Virginia
5:47
Speaker 1: has dozens of nonprofit organizations, all of whom have their
5:53
Speaker 1: own fundraising staff, their own endowments, and the University of
5:59
Speaker 1: Virginia Investment Management Company, a five oh one three c
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Speaker 1: nonprofit corporation with its own board and its own audit,
6:08
Speaker 1: its own charter, etcetera, serves as an investment advisor to
6:14
Speaker 1: those various uh pools of money. So in many ways,
6:18
Speaker 1: while I was there, I did have to address many
6:23
Speaker 1: different clients. Uh. And it is very political. You're quite
6:26
Speaker 1: correct about that. Do they all invest the same way?
6:30
Speaker 1: Or does each of them have a different investment philosophy
6:33
Speaker 1: and in a different set of goals and therefore a
6:35
Speaker 1: different portfolio. Look, you VIMCO, the University of Virginia Investment
6:39
Speaker 1: Management Company, pools the money and invested in one, uh fashion.
6:44
Speaker 1: That said, all of the different pools of money don't
6:48
Speaker 1: have to invest with the University of Virginia Investment Management Company.
6:51
Speaker 1: They can if they choose, or they cannot, or they
6:54
Speaker 1: can invest part of the money. For many years, the
6:57
Speaker 1: law school wasn't convinced that it wanted all of its
7:00
Speaker 1: money in the in the pool. So just part of
7:03
Speaker 1: the law school endowment was invested in yu Bimka. So
7:07
Speaker 1: I would imagine that investing on behalf an endowment today
7:12
Speaker 1: is even more challenging and complex, given everything we've seen
7:16
Speaker 1: with socially responsible investing low carbon pick pick your poison.
7:22
Speaker 1: I can imagine that's what I meant by the constituencies UM,
7:26
Speaker 1: because when I would you and I are about the
7:28
Speaker 1: same age. When I was in college, I remember um
7:31
Speaker 1: divestment from apartheid and people wanted to pull money away
7:35
Speaker 1: from South Africa. I can't imagine what it's like today
7:39
Speaker 1: in the college atmosphere. It seems to be everybody is
7:43
Speaker 1: much more sensitive to specific causes than perhaps when you
7:47
Speaker 1: and I went to school. It was that was present
7:50
Speaker 1: when I was there. I don't know that if I
7:52
Speaker 1: really can't say whether it's gotten better or worse. You
7:55
Speaker 1: brought up the interesting example of the Harvard Management Company.
8:00
Speaker 1: Uh Jack Meyer, truly a great investor, was essentially chased
8:08
Speaker 1: out by alumni who thought it was obscene that investment
8:14
Speaker 1: managers were at the Harvard Management Company were compensated as
8:17
Speaker 1: they were uh. And that's probably the highest profile political
8:24
Speaker 1: UH snaffoo, but it's by no means um limited. I
8:31
Speaker 1: recall UH you Timco University of Texas investment management company
8:35
Speaker 1: renegging on their incentive compensation plan that they had promised
8:39
Speaker 1: to their staff that would be get litigation at least
8:44
Speaker 1: not now. The staff they were very high integrity people.
8:48
Speaker 1: They just they just sucked it up and took the
8:52
Speaker 1: hit to their compensation and really continued on. Yeah. See,
8:55
Speaker 1: I think you encourage bad behavior when you allow people
8:58
Speaker 1: to not honor their it in contracts. So I don't
9:02
Speaker 1: want to be that moral hazard is a problem for me.
9:06
Speaker 1: I uh. But when I said, getting back to why,
9:09
Speaker 1: I said, I think it's a little less challenging. The
9:13
Speaker 1: job is very straightforward. You understand who is the beneficiary
9:19
Speaker 1: of the assets being managed, You understand what the objective is,
9:22
Speaker 1: and you have a very clear notion that I'm I'm
9:26
Speaker 1: investing for the university to generate funds to pay scholarships,
9:33
Speaker 1: to advance research, to support the university's general mission. And
9:38
Speaker 1: you're not uh competing uh every day for a fickle
9:45
Speaker 1: group of UH clients and investors. The for profit investment
9:50
Speaker 1: management industry where I've spent thirty years as opposed to
9:53
Speaker 1: UH five years. You have all of the same complexities
9:58
Speaker 1: and difficulties and challenges of investing, which makes the job
10:01
Speaker 1: so fun and interesting, but a whole additional layer of
10:06
Speaker 1: complexity of competing in the business of the investment management industry.
10:12
Speaker 1: My special guest today is Chris Brightman. He is the
10:15
Speaker 1: chief investment officer of Research Affiliates, whose strategies run about
10:20
Speaker 1: a hundred and seventy billion dollars in assets. Let's talk
10:25
Speaker 1: a little bit about smart beta, which is really a
10:28
Speaker 1: phrase Research Affiliates founder Rob are Not is credited with.
10:35
Speaker 1: If not inventing, will certainly um publicizing UH tell us
10:40
Speaker 1: what smart data is and why investors should be thinking
10:45
Speaker 1: about it well. Smart beta is a fun and provocative
10:50
Speaker 1: label for a substantial and important evolution in the investment
10:56
Speaker 1: management industry. We are able today to take well researched
11:02
Speaker 1: and well understood principles of investment management and use that
11:10
Speaker 1: information to create simple, transparent, low cost investment strategies that
11:17
Speaker 1: deliver more of the return to the end investor and
11:23
Speaker 1: consume less of the return in the fees and expenses
11:28
Speaker 1: charged to a typical active manager. So so here's the
11:32
Speaker 1: pushback that that the there's a group of folks who
11:36
Speaker 1: look at UM smart data and say, well, it's going
11:40
Speaker 1: to be a little more expensive than just straight up indexing.
11:44
Speaker 1: Up until the fourth quarter, anyway, the S and P
11:47
Speaker 1: five hundred, a market cap weighted index, has been on
11:51
Speaker 1: a legendary streak from the lows and oh nine until
11:55
Speaker 1: let's let's call it September. That's a solid decade, market
12:00
Speaker 1: effectively tripled. Why should an investor go with a fundamental
12:05
Speaker 1: weighted index as opposed to a market cap weight and
12:08
Speaker 1: index like the SMP. That's a great question, and it depends,
12:15
Speaker 1: I believe, on what an investor is trying to achieve.
12:24
Speaker 1: The advice given by many, For example, one of my heroes,
12:29
Speaker 1: Jack Bogel from Vanguard, that most investors would be better
12:34
Speaker 1: off investing in a very simple portfolio of mutual funds
12:43
Speaker 1: that track capitalization weighted indices and do nothing else. Would
12:51
Speaker 1: be far better off. If we look at what investors
12:54
Speaker 1: actually do, and there's considerable research on this subject, they
12:58
Speaker 1: tend to chase ads, chase performance, and generate returns that
13:05
Speaker 1: are approximately two per year below simple cap weighted indices
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Speaker 1: Before high fees and expenses. They do that bad. That's
13:17
Speaker 1: what the typical individual investor does, and Jack vocals quite
13:24
Speaker 1: right that they would be far better off simply having
13:27
Speaker 1: a completely passive investment in low UH low cost capitalization
13:34
Speaker 1: weighted index funds. However, there are people on the other
13:38
Speaker 1: side of that trade. Where does that two percent go
13:41
Speaker 1: That that that some investors are underperforming the market, somebody
13:45
Speaker 1: else has to be outperforming the market zero some gain
13:48
Speaker 1: for every loser that's a winner, and vice versa correct
13:51
Speaker 1: and we know where it goes. It goes to the
13:54
Speaker 1: re balancers, the people that are selling the market what
13:58
Speaker 1: the market wants to buy when market wants to buy it,
14:01
Speaker 1: and buying from the market what the market wants to
14:04
Speaker 1: sell when the market wants to sell it. And the
14:07
Speaker 1: fundamental index is a simple, elegant way of automatically pursuing
14:17
Speaker 1: that contrarian trading approach of rebalancing against the market. So
14:23
Speaker 1: that's very much a value driven strategy. You're you're selling
14:26
Speaker 1: what everybody wants, which probably means it's pricey and it's
14:30
Speaker 1: had a good run, and you're buying what everybody hates,
14:33
Speaker 1: which means it's probably cheap because it's so disliked fit
14:37
Speaker 1: fair statement, it's exactly correct, and the market has to
14:41
Speaker 1: pay a premium for that rebalancing, thinking of it as
14:45
Speaker 1: market making or being the house providing insurance. In order
14:50
Speaker 1: for the market to clear, there has to be that premium. Now,
14:53
Speaker 1: it's easy to say, and it's straightforward to do, but
14:58
Speaker 1: it's not easy to do. It's not easily, it's not
15:01
Speaker 1: easy emotionally to do. And that's why having simple, transparent
15:06
Speaker 1: rules based process aids in that kind of rebalancing and
15:11
Speaker 1: and those investors earn a return over the market. But
15:16
Speaker 1: unless you understand and unless you can stick with the approach,
15:20
Speaker 1: it's probably not right for you. So so let let
15:23
Speaker 1: me let me jump in here, because um I want
15:25
Speaker 1: to address that unless you can withstand, unless you can
15:29
Speaker 1: stay with it. Value goes through these periodic cycles where
15:34
Speaker 1: it's underperforming the broad indices UH and up until September,
15:41
Speaker 1: what was it a decade of underperformance by value over
15:44
Speaker 1: growth that seemed to have begun to reverse in the
15:47
Speaker 1: fourth quarter. So first question is, is the under performance
15:52
Speaker 1: period of value always seeing that regression to the mean
15:55
Speaker 1: where value is going to catch up and pass growth.
15:59
Speaker 1: How do you see the an environment um for value
16:03
Speaker 1: given the long term under performance. And by the way,
16:06
Speaker 1: on a regular basis, valuable lag growth and then catch
16:10
Speaker 1: up and pass it. We've seen it in every bear market.
16:13
Speaker 1: What all the hot stocks get crushed? Value blows right
16:17
Speaker 1: by it. How many times have we heard Warren Buffett
16:19
Speaker 1: is washed up and it never turns out to be true.
16:24
Speaker 1: I think you said it well. Over the long run,
16:26
Speaker 1: history teaches that a value investment strategy outperforms growth. That's
16:33
Speaker 1: been confirmed in every long term study of every market
16:38
Speaker 1: around the world. However, the market will test your patients.
16:44
Speaker 1: There there will be long and difficult periods of underperformance
16:48
Speaker 1: for a value strategy, and only by sticking with it
16:50
Speaker 1: over the long run will you actually succeed. If you
16:54
Speaker 1: throw in the towel in and and I you know
17:01
Speaker 1: A O. L and Cisco, as lots of folks did
17:04
Speaker 1: right um to their great regret. What I can say
17:10
Speaker 1: is that the dispersion between the pricing of value and
17:15
Speaker 1: growth stocks reached in the last year or two extremes
17:22
Speaker 1: that we almost never see, not quite to the extreme
17:26
Speaker 1: of the tech bubble, but about as significant as we see.
17:31
Speaker 1: That's perhaps an indicator that the cycle is about to turn,
17:35
Speaker 1: and then, of course we've seen a lot of market turmoil, uh,
17:40
Speaker 1: suggestive of an inflection point. So I I wouldn't confidently
17:47
Speaker 1: predict that the cycle has turned and value is going
17:51
Speaker 1: to go on a a long terror of out performance,
17:55
Speaker 1: but the environment does seem to suggest that that's a
17:59
Speaker 1: distinct post ability and and less smart beta question. Some
18:04
Speaker 1: folks have said the advantage of smart data and fundamental
18:08
Speaker 1: indexing is that the outperformance comes from taking additional risk.
18:13
Speaker 1: Burton Malkiel other folks like that have said that what
18:16
Speaker 1: what are your thoughts on that? I find the debate
18:22
Speaker 1: about whether factor returns and of course the most uh,
18:30
Speaker 1: the largest, most persistent and longest discovered factor is value
18:37
Speaker 1: are generated by risk or generated by behavior and inefficiency.
18:45
Speaker 1: The truth of the matter is it's both. They're intertwined.
18:50
Speaker 1: There's feedback. The real world is much more interesting than
18:54
Speaker 1: these dry theories and models. UM, and I guess I
19:01
Speaker 1: would say there is a risk component, and we should
19:05
Speaker 1: be thankful that there's a risk component to the value
19:09
Speaker 1: factor returned because it means that it can't be and
19:12
Speaker 1: won't be arbitraged away. So let's talk a little bit
19:15
Speaker 1: about institutional and retail investors. You've worked with both. You've
19:20
Speaker 1: alluded that there are some differences previously. What is the
19:25
Speaker 1: most consequential difference between how institutional investors operate and how
19:31
Speaker 1: mom and pop retail investors. I think institutional investors operate
19:37
Speaker 1: in a governance structure and an environment that prevents the
19:42
Speaker 1: worst investment mistakes UH. Retail investors don't. UM. There are
19:52
Speaker 1: many advisors that try to bring UH this sort of
19:58
Speaker 1: discipline and structure to the practice of retail investing, and
20:06
Speaker 1: I think some many have great success, but not as
20:12
Speaker 1: much as the institutional context. Let me give you a
20:18
Speaker 1: general concept of what the results look like. The results
20:22
Speaker 1: look like. Retail investors, on average, through being too emotional
20:27
Speaker 1: trading too much UH, generally lose on the order of
20:32
Speaker 1: two percent a year of their returns relative to the
20:36
Speaker 1: broad markets. Institutional investors, after fees and expenses, generally get
20:44
Speaker 1: about market returns. If you look at the returns before
20:47
Speaker 1: their fees, expensive and costs, they beat the market, but
20:52
Speaker 1: most of that is absorbed by the fees, expenses and costs,
20:57
Speaker 1: the staff, the investment management fee these UH that absorbs most,
21:04
Speaker 1: if not all, of the outperformance UM, but that's two
21:09
Speaker 1: percent better than the retail investor, and I think that's
21:12
Speaker 1: from superior government structures that prevent the worst mistakes. So now,
21:18
Speaker 1: there have been a number of studies that have come
21:20
Speaker 1: out about both retail and institutional UM. I recently saw
21:25
Speaker 1: something out of n y U Stern School of Business
21:29
Speaker 1: about the underperformance of foundations and endowments versus a simple
21:36
Speaker 1: sixty forty portfolio. And according to to that research, the
21:41
Speaker 1: institutions are barely doing a whole lot better than individuals,
21:46
Speaker 1: at least at these nonprofit foundations, endowments, etcetera. So cost
21:53
Speaker 1: is clearly a factor. What else is the driving factor?
21:57
Speaker 1: You you brought up? It's a zero sum. So for
22:00
Speaker 1: every win or there's a loser. Are the institutions winning
22:04
Speaker 1: at the expense of the retail investors? Or is there
22:07
Speaker 1: a um a win and lost component between different endowments.
22:12
Speaker 1: Some do well, some do poorly, but on average they
22:15
Speaker 1: get as you said, market based returns. Well, there's a
22:20
Speaker 1: cyclical and a secular UH time horizon. On the secular
22:26
Speaker 1: time horizon, I think we find nonprofits, particularly large university endowments,
22:34
Speaker 1: tend to get the best results. Pension funds, UH, public
22:39
Speaker 1: pension funds get as I said just a moment ago,
22:43
Speaker 1: about the market return after their fees and expenses, and
22:46
Speaker 1: retail investors lose about two percent a year. That two
22:51
Speaker 1: percent a year is mostly paid to UH professional UH
22:56
Speaker 1: investors and value investors. Now that gets to the cyclical component. UH.
23:01
Speaker 1: If we evaluated the performance of the endowments up until
23:08
Speaker 1: the global financial crisis, UH, there were many books written
23:13
Speaker 1: about their remarkable decades of outperformance. We've been in a
23:20
Speaker 1: cycle a ten year horizon where growth is outperformed value,
23:24
Speaker 1: and to oversimplify, most endowments are going to be value investors.
23:29
Speaker 1: So I think you've seen a period where value investors
23:34
Speaker 1: have struggled, and it's been a difficult time for the
23:39
Speaker 1: value oriented endowment model. But I think it twenty five
23:44
Speaker 1: years from now, looking back, you'll still see the success
23:48
Speaker 1: of that model. So I'm gonna ask you to go
23:49
Speaker 1: a little outside of your comfort zone using that same
23:53
Speaker 1: secular versus cyclical time period. The pre crisis era, we
24:00
Speaker 1: are a lot of investments in venture capital and private
24:02
Speaker 1: equity and hedge funds that actually had done pretty well.
24:06
Speaker 1: And since the mid two thousand's, you know, the venture
24:10
Speaker 1: capital has lost a little bit of its shine. None
24:12
Speaker 1: of the big, well known names are performing as well
24:15
Speaker 1: as they did previously. Same with a lot of the
24:18
Speaker 1: hedge fund guys that used to shoot the lights out,
24:20
Speaker 1: they seem to be struggling. What is it about this
24:24
Speaker 1: past decade that's been so difficult for so many different
24:28
Speaker 1: styles of investment invest Well, there's a couple of things. One,
24:32
Speaker 1: we've had just a stupendous roaring bull market. Uh, And
24:38
Speaker 1: so it just is easy to comprehend from first logical
24:43
Speaker 1: principles that a strategy that is a long stocks is
24:47
Speaker 1: going to outperform a strategy that is both long and
24:51
Speaker 1: short stocks during a monumental bull market. So that basically
24:58
Speaker 1: explains the difficult perform it's environment for hedge funds. Uh.
25:04
Speaker 1: What has worked? What kind of alternative investment if you
25:08
Speaker 1: want to use that label, has worked over the last
25:12
Speaker 1: ten years? Well, private equity, Why, Well, because they don't
25:17
Speaker 1: just go a hundred percent long, They go hundred percent
25:19
Speaker 1: long with some leverage. So that works pretty well in
25:23
Speaker 1: a roaring bull market. I would guess if I had
25:29
Speaker 1: to uh put my money on who outperforms over the
25:32
Speaker 1: next ten years, it would be on the hedge funds
25:35
Speaker 1: rather than the private equity UH funds because markets don't
25:40
Speaker 1: always go in straight lines. Up. A lot of your
25:44
Speaker 1: research and commentary um that I find quite fascinating. You're
25:48
Speaker 1: very good at crafting a headline that is intriguing, and
25:54
Speaker 1: I want to just throw a few of them at
25:55
Speaker 1: you and see what you, uh, what you have to
25:58
Speaker 1: say about that. One of them was are we at
26:01
Speaker 1: peak profits? And I have to ask the question because
26:03
Speaker 1: people have been saying we're a peak profits for I
26:06
Speaker 1: don't know, four or five six years. This whole run up,
26:10
Speaker 1: we've been hearing people say that are we at peak profits?
26:13
Speaker 1: We we discussed all of the monopoly rents and the
26:17
Speaker 1: other issues with chrony capitalism earlier. Organically speaking, Have we
26:23
Speaker 1: hit the point where profitability can't go higher? Or can
26:26
Speaker 1: this trend continue for the foreseeable future Until policy changes,
26:32
Speaker 1: the trend will continue, and I see no evidence of
26:37
Speaker 1: policy change coming out of the divided government we presently
26:41
Speaker 1: have in Washington. However, UH markets are forward discounting the
26:48
Speaker 1: amount of the value of the SMP five hundred or
26:52
Speaker 1: any given stock in the SMP five hundred, that is,
26:57
Speaker 1: the dividends that are going to be paid over the
26:59
Speaker 1: next two or three years is trivial. Most of the
27:02
Speaker 1: value is discounting future cash flows over the decades. And
27:10
Speaker 1: I believe that we are seeing an increasing likelihood of
27:16
Speaker 1: a very significant change in policy, perhaps as soon as
27:22
Speaker 1: the UH one new administration, I would expect, And this
27:31
Speaker 1: is an interesting forecast. I if you want to, if
27:33
Speaker 1: you want a handicap, who's going to be our next president?
27:37
Speaker 1: Take a look at who seems like a twenty one
27:41
Speaker 1: century Teddy Roosevelt, meaning a trust buster? Correct, someone who's
27:46
Speaker 1: gonna come in and say, hey, you know of the
27:49
Speaker 1: search being with Google? Who I'm okay welcoming Google as
27:54
Speaker 1: our new overlords, but I understand the antitrust argument against it.
27:58
Speaker 1: Or half of all on line retail transactions being with Amazon,
28:02
Speaker 1: that's an immense concentration of power in a in a
28:06
Speaker 1: very small number of hands. Uh There's been almost no
28:11
Speaker 1: appetite for antitrust enforcement. There's been no appetite for preventing
28:17
Speaker 1: these giant mergers. The f When was the last time
28:21
Speaker 1: somebody other than CNN and I forgot who it was
28:25
Speaker 1: even the merger was with that UM the president was
28:28
Speaker 1: unhappy with because he doesn't like the CNN coverage, but
28:32
Speaker 1: that whole time Warner CNN, whatever, the last broadband merger. Um.
28:36
Speaker 1: Other than that one political example, has there really been
28:40
Speaker 1: much in the way of stopping big companies from becoming
28:43
Speaker 1: giant companies in order to preserve a fair and competitive landscape. No,
28:49
Speaker 1: there has not been, and and we have a strange
28:58
Speaker 1: economy as a result, one that is not working for
29:01
Speaker 1: the average worker. Let's we're known at research affiliates for
29:10
Speaker 1: being leaders and factor investing. Let me talk to you
29:13
Speaker 1: about the most recently discovered factor and how it relates
29:19
Speaker 1: to this issue of monopoly profits and stagnating wages. Among
29:29
Speaker 1: academic researchers, we all understand this new factor called investment.
29:36
Speaker 1: Not not many retail investors, I think are aware of this.
29:42
Speaker 1: The this new factor that was uh researched by many
29:47
Speaker 1: and popularized by Fama and French. Fama and French now
29:51
Speaker 1: the famous inventors of the three factor model the market
29:56
Speaker 1: value and size, now have a five factor model. They've
29:59
Speaker 1: had to two factors, profitability and investment. And investments the
30:03
Speaker 1: one I want to talk about, Investment, refers to a
30:07
Speaker 1: very strong empirical relationship but scientific finding that the more
30:12
Speaker 1: a company invests, the lower the returns are meeting. Capital
30:17
Speaker 1: expenditure actually works against the returns. Right as Warren Buffett
30:22
Speaker 1: has been telling you for a long time, you don't
30:24
Speaker 1: want companies that have to invest to create their profits.
30:27
Speaker 1: You want companies that have a moat and generate monopoly profits.
30:31
Speaker 1: And the less a company invests, the more that rewarded
30:35
Speaker 1: in the stock market. And so we have don't have
30:38
Speaker 1: much investment. We don't have much capital investment. You get
30:41
Speaker 1: some cash, what do you do. You buy back your
30:42
Speaker 1: shares or you buy your competitor, maybe you do a
30:45
Speaker 1: little both, but you don't invest for the future. That's
30:50
Speaker 1: this is a scientific finding that comes out of the academy,
30:53
Speaker 1: that comes out of finance professors. It's the new factor
30:56
Speaker 1: in the FAMA French five factor model is go find
31:00
Speaker 1: companies that don't do any investing. Uh. That's responding to
31:05
Speaker 1: the environment that's been created. The the the environment, the
31:09
Speaker 1: rules of the game that we have is not competitive capitalism,
31:12
Speaker 1: where innovating and investing for the future creates wealth. It's
31:18
Speaker 1: manipulating the system to create monopoly rents. That's how you
31:22
Speaker 1: create wealth. And until we change that system, uh, we're
31:26
Speaker 1: not going to change the results? How do we change
31:31
Speaker 1: that system? Is it simply just a matter of saying, hey,
31:35
Speaker 1: your capex expenditure UM is a separate line that doesn't
31:39
Speaker 1: affect your profitability, but your shared by backs does. How
31:43
Speaker 1: can the rules? How can the regulatory and tax environment.
31:48
Speaker 1: I'm assuming you're saying, we want more capital expendatory, we
31:51
Speaker 1: want more investment in the future. How can we encourage
31:55
Speaker 1: companies to think long term when the market is rewarding
31:59
Speaker 1: companies that don't. I don't know if I'm overstating it's sure.
32:02
Speaker 1: I think the biggest, the simplest way to describe the
32:05
Speaker 1: problem is regulatory capture. Uh the indo, pharmaceutical, oil and energy.
32:12
Speaker 1: Go down the list finance for sure, finance and banking
32:15
Speaker 1: for sure, And I'll loop back to the longer version
32:19
Speaker 1: if you want to. If you want to understand the economics,
32:22
Speaker 1: I think you can do find no better uh discussion
32:27
Speaker 1: than Edmund Phelps mass flourishing. And if you want to
32:30
Speaker 1: understand the legal tools to address the issue, UH read
32:34
Speaker 1: Tim Woo Uh that there there are tools we can
32:39
Speaker 1: do this. I mean the robber barons were running the
32:44
Speaker 1: economy before Teddy Roosevelt showed up. There is going road
32:48
Speaker 1: electricity going on the list. Yeah, Telegraph quite fascinating. I
32:52
Speaker 1: have to tell you, that's an intriguing um thesis you've
32:56
Speaker 1: laid out. I don't disagree with it. I'm I'm a
32:59
Speaker 1: little prized at how forcefully you articulated. I certainly think
33:04
Speaker 1: you're You're right. And I've heard this from both the
33:08
Speaker 1: left and the right. Scott Galloway at at and while
33:11
Speaker 1: you Stern wrote the Foreign and his recommendation was that Apple, Amazon,
33:17
Speaker 1: Google and Facebook get broken up they're too powerful. That's correct.
33:21
Speaker 1: It's quite quite amazing. So let's jump to our favorite
33:24
Speaker 1: questions while while we still have you, um tell us
33:27
Speaker 1: the most important thing most people don't know about your background?
33:32
Speaker 1: Um boy, I was gonna go with you from West
33:36
Speaker 1: Germany Originally I was. I was born in West Germany,
33:41
Speaker 1: but I was born to uh my dad and mom
33:45
Speaker 1: who my dad was serving in the military at the time,
33:48
Speaker 1: So that's really much less interesting than it sounds. How
33:51
Speaker 1: about I have never lived uh in one house for
33:58
Speaker 1: as long as I've lived in Newport Beach, California, where
34:01
Speaker 1: I've lived for eight years. This is the longest I've
34:03
Speaker 1: ever lived in a house in my entire life. Well,
34:05
Speaker 1: every Army brat tells the story of getting moved around
34:08
Speaker 1: from uh, you know, assignment to assignment, and I guess
34:11
Speaker 1: that that stays with you. So you met. Let's talk
34:13
Speaker 1: about your mentors. You mentioned one of your early mentors
34:17
Speaker 1: who helped shape and guard your career over time. Yeah,
34:20
Speaker 1: i'd said. I have had the privilege of learning from
34:26
Speaker 1: a number of charismatic leaders. One and the first was
34:30
Speaker 1: Gary Brinson. I don't think I would be nearly as
34:33
Speaker 1: successful in the investment management industry today without without Gary's example. Uh.
34:39
Speaker 1: Second was a fascinating woman named Hilda o Chewa. Hilda
34:45
Speaker 1: was a refugee from Venezuela who ended up at in
34:50
Speaker 1: the PhD program at Harvard University, ran the pension fund
34:54
Speaker 1: of the World Bank, spun that out into Strategic Investment Group,
34:58
Speaker 1: and when I left Brinson Partners, I ended up at
35:01
Speaker 1: Strategic Investment Group as the as the eventually the c
35:04
Speaker 1: I oh they are held us in fascinating innovator and entrepreneur. Uh.
35:11
Speaker 1: And while I was the chair at TIFF, I had
35:14
Speaker 1: the privilege of working with a fascinating individual named David Salem,
35:20
Speaker 1: probably less known than some of these others, but nonetheless
35:24
Speaker 1: a fascinating figure in the nonprofit investment world. And now
35:30
Speaker 1: finally Rob are Not who uh quite well known, So
35:34
Speaker 1: I've really had the privilege of getting to know a
35:36
Speaker 1: lot of fantastic investors. Welcome to the podcast, Chris, Thank
35:41
Speaker 1: you so much for doing this. We met some time
35:44
Speaker 1: ago and I've been looking forward to having this conversation.
35:47
Speaker 1: I know Rob are Not the founder of raffie UM
35:51
Speaker 1: for a long time. He's a fascinating guy. Must be
35:54
Speaker 1: fun to work with. Um you're in Are you here?
35:57
Speaker 1: Are you Newport Beach? Located Newport Beach? Yeah, that's quite that.
36:00
Speaker 1: That might be one of the most beautiful places in
36:03
Speaker 1: America to uh to go to work every day. I
36:07
Speaker 1: joke with people, I asked them, do you know why
36:09
Speaker 1: we're headquartered in Newport Beach? Because you can? That's right.
36:14
Speaker 1: For For those listeners who may not have ever been
36:17
Speaker 1: to that part about an hour south of l A,
36:20
Speaker 1: maybe the little less depending on traffic. It's just this
36:24
Speaker 1: Balbo Island right over there. It's just this gorgeous part
36:27
Speaker 1: of southern everything you imagine southern California is, but nicer.
36:32
Speaker 1: I mean, it really is kind of ridiculous. Everything is
36:35
Speaker 1: wonderful except for the traffic. No, they traffic is almost
36:40
Speaker 1: non existent in Newport. If you live in Newport Beach
36:42
Speaker 1: and work in Newport Beach, it's wonderful. The problems are
36:45
Speaker 1: the price of real estate and the Texas price of
36:48
Speaker 1: real estate. So funny you say that a friend who
36:52
Speaker 1: I won't mention, was having a conversation with Rob about
36:56
Speaker 1: you know, if you move to uh Nevada, you live
36:59
Speaker 1: in Vegas, you won't have to pay state taxes. And
37:03
Speaker 1: his answer was yeah, but then I have to live
37:05
Speaker 1: in Nevada, and he goes, I'm in what might be
37:08
Speaker 1: the most beautiful place in the world. I'm gonna have
37:11
Speaker 1: to pay the the viig first thing there. You know,
37:14
Speaker 1: I spent a decade in Chicago, and I have a
37:16
Speaker 1: lot of friends in the business in Chicago, and I
37:19
Speaker 1: was there not too long ago, saying, boy, higher taxes
37:25
Speaker 1: are in your future. I I've been paying attention to
37:28
Speaker 1: what's going on with the pension problems in Illinois, sure,
37:33
Speaker 1: and the only Jersey and a few other places. So
37:37
Speaker 1: you're gonna get California like taxes in your future. To
37:40
Speaker 1: fill this hole in the pension fun and he says,
37:42
Speaker 1: you know, we can't do that. Chris I said, whatnot.
37:44
Speaker 1: We've got we have the thirteen percent state income tax
37:47
Speaker 1: UH in in California. It's that high. Wow, that's a lot.
37:52
Speaker 1: And he says, you don't understand. You can raise the
37:54
Speaker 1: taxes to you know, ten fifteen percent in California and nobody.
37:59
Speaker 1: They're not going to move to Vada. Some people, of course,
38:01
Speaker 1: do move to Nevada. But but but there's a magnet
38:06
Speaker 1: to the west coast in California. He said, Illinois doesn't
38:11
Speaker 1: have that. People will move to anyway, Wisconsin, they'll move
38:15
Speaker 1: to Indiana. We can't take taxes up to UH to
38:18
Speaker 1: that level. Chicago happens to be a very reasonable city.
38:22
Speaker 1: It's a reasonable it's big enough that it has whatever
38:25
Speaker 1: you want UM, but it's not as big as New York's,
38:28
Speaker 1: where it's completely overwhelming, and their prices are much more
38:32
Speaker 1: reasonable than the coasts. The problem is your weather is
38:36
Speaker 1: much nicer. When you have southern California weather, you could
38:40
Speaker 1: charge and in Chicago. If they in Illinois they raised it.
38:44
Speaker 1: At a certain point, people will say, all right, I'm
38:46
Speaker 1: going to Arizona. This is UH, this high taxes plus
38:50
Speaker 1: terrible winter's equals I'm out. And and that's been the
38:53
Speaker 1: shift southward across the whole country. People have been making
38:58
Speaker 1: the argument it's political. I really think it's weather based.
39:03
Speaker 1: I think it's both. I think it's taxes. I think
39:05
Speaker 1: it's a regulatory environment, and I think it's uh, the weather. Um,
39:11
Speaker 1: so let's talk a little about you mentioned some books. Um,
39:14
Speaker 1: you mentioned Tim Woo and Edmund Phelps books. What other
39:17
Speaker 1: books do you think are essential reading or what do
39:20
Speaker 1: you just like to read if you want to relax.
39:25
Speaker 1: By the way, this is everybody's favorite question. People want
39:28
Speaker 1: reading suggestions more than anything. They don't know which of
39:32
Speaker 1: the three hundred thousand books that come out each year
39:34
Speaker 1: to read, so they take these very seriously. Yeah. Sure,
39:39
Speaker 1: if you want to understand the future of markets and
39:42
Speaker 1: the intersection of public policy and markets. The three books
39:45
Speaker 1: that I just mentioned are the ones of the dozens
39:48
Speaker 1: that I've read over the last few years that I
39:50
Speaker 1: think are most important Phelps, Woo And what's the third one?
39:53
Speaker 1: Jonathan Tepper? Okay, it's the myth of capitalism. Uh. When
40:00
Speaker 1: I want to escape, I don't read about economics and policy.
40:08
Speaker 1: I read science fiction, but so nothing wrong with that.
40:14
Speaker 1: What do you like under sci fi? I guess under
40:16
Speaker 1: fantasy instead of sci fi. I loved the Game of
40:20
Speaker 1: Thrones and I loved to do it it so much that
40:23
Speaker 1: after watching the series, I then read all of the books,
40:28
Speaker 1: and then I went back and rewatched all of the series. Um.
40:34
Speaker 1: I also read uh, one of one of my favorites.
40:38
Speaker 1: Although you're seeing less get published as in a sort
40:41
Speaker 1: of sub genre called cyberpunk. Are you a Neil Stevenson fan? Absolutely,
40:47
Speaker 1: I just got I haven't read it yet, but I
40:50
Speaker 1: have sitting on my desktop seven eaves, that's what is
40:55
Speaker 1: literally sitting on my night table. I read it. It's fabulous, really.
40:59
Speaker 1: And then also on my list that I'm going to
41:01
Speaker 1: throw you books that people have recommended to me that
41:04
Speaker 1: I haven't gotten to yet, The Three Body Problem. People
41:07
Speaker 1: have raved about that trilogy from the author out of China.
41:11
Speaker 1: I'm really fascinated by by your list. So what are
41:15
Speaker 1: you most excited about right now? What? What is the
41:18
Speaker 1: part of the industry that has you really enthusiastic. I
41:22
Speaker 1: am very enthusiastic about the opportunity to use twenty one
41:27
Speaker 1: century technology, and part of it is financial technology. Part
41:32
Speaker 1: of it is financial modeling and predicting what's going to happen,
41:35
Speaker 1: but importantly a lot of it is communication technology. What
41:39
Speaker 1: we're doing right now to help educate investors to achieve
41:44
Speaker 1: better outcomes, and I am very pleased to see the
41:50
Speaker 1: costs being reduced in the industry. The provision of investment
41:57
Speaker 1: strategies at a couple of basis points right. It used
42:00
Speaker 1: to be a hundred basis points. A hundred and fifty
42:03
Speaker 1: basis points was the cost of investment strategy. Now it's
42:07
Speaker 1: twenty basis points or ten basis points are five basis
42:10
Speaker 1: points and providing the average investor the ability to compound
42:17
Speaker 1: wealth for their retirement without intermediaries gobbling up so much
42:24
Speaker 1: of the UH. The returns tell us about a time
42:28
Speaker 1: you failed and what you learned from the experience. I
42:32
Speaker 1: left UBS so Brents and Partners, where I kind of
42:35
Speaker 1: got my start what we sold ourselves. I was a
42:38
Speaker 1: partner of the firm. I made a little money on
42:40
Speaker 1: that sale to ubs UH, and I learned after a
42:44
Speaker 1: time there that that was not the place for me.
42:47
Speaker 1: I'm I'm better off and smaller employee owned investment management
42:51
Speaker 1: firms than large UH institutions. God God loved the people
42:57
Speaker 1: that thrive in large institutions because the world appears to
43:00
Speaker 1: need them. But it's not a good fit for me.
43:03
Speaker 1: And I tried to start a UM quantitative equity market
43:08
Speaker 1: neutral hedge fund in UH thousand with some backing from
43:15
Speaker 1: a firm called Greenwich Capital. Grantwich Capital isn't around anymore,
43:18
Speaker 1: but I had some friends at the top of that
43:21
Speaker 1: organization that we're interested in exploring getting into the asset
43:25
Speaker 1: management industry, and market neutral should have done not too bad, right,
43:31
Speaker 1: it would have been a wonderful time. But as the
43:35
Speaker 1: environment turned less conducive to risk taking UH or perhaps
43:41
Speaker 1: I was just not as persuasive as I had been
43:44
Speaker 1: the year before, they decided to pull the plug on
43:47
Speaker 1: that endeavor. But I learned a lot in that period
43:53
Speaker 1: of time. UM, I'll give you a lesson about marriage
43:58
Speaker 1: and a a lesson about the structure of the quantitative
44:05
Speaker 1: investment management industry. After I determined I was going to
44:10
Speaker 1: be unsuccessful in starting that business, I just hung around
44:12
Speaker 1: the house for a while. I helped coach my son's
44:16
Speaker 1: soccer team, and I got a lot of cycling in
44:18
Speaker 1: and I just spent a lot of time around the house,
44:21
Speaker 1: and my wife explained to me, you know, Chris, for
44:23
Speaker 1: better or worse, but not for lunch. You need to
44:25
Speaker 1: go back and get a job better or worse, but
44:29
Speaker 1: not for lunch. UH. One of the fascinating discoveries as
44:34
Speaker 1: I was recruiting people to join my UH never to
44:38
Speaker 1: be quantitative equity market neutral global hedge fund was how
44:44
Speaker 1: many of the best staff I was recruiting, how many
44:48
Speaker 1: people I was interviewing didn't work at what you and
44:53
Speaker 1: I think of as an investment management organization, but worked
44:56
Speaker 1: at family offices right here in Manhattan, and family offices
45:02
Speaker 1: of former prop traders, people that would leave Goldman Sachs
45:07
Speaker 1: Prop Desk or Lehman Brothers or Morgan Stanley with enough
45:13
Speaker 1: money that they didn't need to manage money for anybody else,
45:17
Speaker 1: and they would hire these incredibly gifted quants from India
45:22
Speaker 1: or from China. And I think people don't realize that
45:28
Speaker 1: most of the money that is made by arbitraging inefficiencies
45:36
Speaker 1: in the capital markets these days is not in funds
45:41
Speaker 1: that are invested. UH investing the money of Harvard University
45:48
Speaker 1: or the UH State of California's pension fund it's mostly
45:53
Speaker 1: private money. Uh and and that's where those uh, those
45:58
Speaker 1: profits go. There's a new ormous amount of professional investment
46:03
Speaker 1: expertise applied to the management of individual family money, not
46:11
Speaker 1: investable to the public, not investable to the public. They're
46:14
Speaker 1: not even they're not even registered investment management companies. They're
46:17
Speaker 1: just the office. Uh and and they don't want to
46:22
Speaker 1: tract attention. My favorite part of the Renaissance technology story
46:27
Speaker 1: with Jim Simons was at a certain point they realized
46:31
Speaker 1: their ability to generate alpha was limited and only scaled
46:35
Speaker 1: up so large. And when their own investments hit that point,
46:39
Speaker 1: they told their outside investors, hey, thanks so much for
46:42
Speaker 1: coming by, but we we don't want your capital anymore.
46:45
Speaker 1: We're going to take this ourselves. And that's a well
46:47
Speaker 1: known example. What I found is that there are dozens,
46:51
Speaker 1: perhaps hundreds of similar outfits here in New York City
46:55
Speaker 1: that never took private money ever, uh, never took outside money.
47:00
Speaker 1: And these aren't giant, multi billion, necessarily giant multi billion
47:04
Speaker 1: family offices. These are fifty a hundred, two hundred fifty
47:07
Speaker 1: million dollars. And I on my bullpark, I don't think
47:10
Speaker 1: we know. They don't have to tell us Huh that
47:13
Speaker 1: that's quite fascinating. You mentioned cycling. What do you what
47:16
Speaker 1: do you do for fun? What do you do to relax?
47:19
Speaker 1: What do you do to to stay trim and fit?
47:22
Speaker 1: I one of the benefits of living in Newport Beach
47:25
Speaker 1: in southern California is that I can cycle all year round.
47:29
Speaker 1: So I both get out on my road bike and
47:33
Speaker 1: I spend time on my mountain bike. Uh. And then
47:38
Speaker 1: I go to the gym a few times each week
47:40
Speaker 1: because I have to keep fit so that I can
47:44
Speaker 1: I can cycle, and I can ski and I can hike.
47:47
Speaker 1: That southern California lifestyle sounds increasingly um attractive. So a
47:54
Speaker 1: millennial or recent college grad comes up to you and says,
47:57
Speaker 1: I'm thinking about going into finance as a career. What
48:00
Speaker 1: sort of advice would you give them. Here's some advice.
48:05
Speaker 1: My daughter Amy, when she was growing up, she wanted
48:10
Speaker 1: to be in fetching, merchandizing. But then she went to
48:14
Speaker 1: college and decided, you know, maybe I should be a
48:17
Speaker 1: little more practical, and she started her major in economics.
48:24
Speaker 1: After a few years in economics, she decided that that
48:26
Speaker 1: wasn't really where she wanted to go. She wanted to
48:28
Speaker 1: and she switched to psychology, and one of the things
48:31
Speaker 1: that Amy found is that she had taken a full
48:34
Speaker 1: raft of stats classes for economics, and then when she
48:38
Speaker 1: switched to psychology, they said, oh no, no, those are
48:41
Speaker 1: econ stats classes. You need psychic stats classes. So she
48:45
Speaker 1: had to take a double load of statistics. Amy started
48:50
Speaker 1: a digital advertising agency here in New York and when
48:53
Speaker 1: she was talking to her younger UH sibling, my son
48:57
Speaker 1: John Uh, when he was entering college, she said, you
49:02
Speaker 1: know what, you really need to take stats. That's been
49:06
Speaker 1: the most helpful thing for me in my career in
49:10
Speaker 1: digital advertising. And it's equally true. I think in the
49:14
Speaker 1: investment management industry become numerous uh take statistics. The world
49:25
Speaker 1: has become the professional world puts a premium on numeracy.
49:31
Speaker 1: I think that's great advice. And our final question, what
49:34
Speaker 1: is it that you know about the world of investing
49:37
Speaker 1: today that you wish you knew thirty five years ago
49:41
Speaker 1: when you were first starting. Humility is enormously important to
49:47
Speaker 1: professional development. Can't say I disagree with that any particular
49:52
Speaker 1: reason that led you to that, And you're not the
49:54
Speaker 1: first person who has mentioned it, but as I've a
50:00
Speaker 1: antst in my career, it has become more and more
50:05
Speaker 1: important to inspire other people, to build a team, to
50:13
Speaker 1: nurture and help other people grow. And one can't do
50:19
Speaker 1: that effectively without a humility. I for me to succeed,
50:24
Speaker 1: I have to lead a group of people, all of
50:28
Speaker 1: whom more at least many of whom are smarter, better educated,
50:35
Speaker 1: and more productive than I am. And and one can't
50:38
Speaker 1: do that without a considerable a degree of humility. Quite
50:42
Speaker 1: quite fascinating. We have been speaking with Chris Brightman. He
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