The Risks of the Rise of Passive Investing | Mike Green

and there is no such thing as a passive investor. There can't be a passive investor. And what we did was we introduced a type of investor who operates off of a very simple algorithm. Did you give me cash if so then why? Did you ask for cash if so then so? And so as the asset value rises relative to the income potential for contribution, in other words, multiples expand, you eventually get to the point where the withdrawals exceed the contributions. And then it becomes a question of, does it correct quickly or does it correct slowly? We literally just lived through this, right? We went from zero to five, and we went from zero to five on the 30 year, taking 30 years from, or, you know, 55% of the index to 36% of the index. That's really what just happened. And so now that incremental dollar going in instead of buying 55 cents of the 30 year is buying 36 cents of the 30 year, that's not good. All right, Mike Green. Welcome back to excess returns. I'm Dave Nodick. We're going to dig into the active passive debate, something the UNI have talked about. Many times over the years, perhaps have not actually recorded a podcast on. I don't think we vigorously disagree on much, but could you maybe just have to sub today until we had some initial academic work, a number of years ago from Goethe and Coisin, talking about in the elasticity in markets, that is that when you put a dollar in, more than a dollar of reaction happens, there's been a lot of work since then. You've been involved in some of it and critiquing some other of it. What's the state of the art on our understanding of passive flows and how they're impacting markets? Yeah, so first of all, thank you very much. And it is shocking that you and I talk all the time in an offline world and there's even been podcasts in which you've been on reviewing my other podcast, the period of this. But I don't think we've actually been on a podcast together. So this is a first and I'm excited to do it. You're a good friend and the preparatory materials you sent me were awesome as we discussed. So I began doing work in this in 2016. The key thing for me that came out was a paper written by Losse Peterson. That was the same time, by the way, that a Nego Fraser Jenkins came out with his passive is worse than Mark has, Mark said, well, I think the idea of the voting component or the allocation of capital component is critical. It's somewhat secondary to what I actually think is the much more important issue, which is the functioning in markets. And so in 2016, Losse Peterson introduced what I think is the most important paper in terms of setting the new trajectory, which was a paper called sharpening the arithmetic of active management, went back and challenged the original Bill Sharp paper from 1991 called the arithmetic of active management, in which it was laid out the framework that really powered the growth of passive from that point, which is the idea that active managers and passive managers by definition in aggregate own the same portfolios, the only difference between the active managers and the passive managers is going to be the fees that are charged. Therefore, in aggregate passive will outperform active over time, this created the theoretical framework that is slowly allowed passive to grow from 2% of the market to about 50% of the market by its total market capitalization. And his done so under a framework that like, well, it's a smart thing to do, right? Now, Losse in 2016 identified that that could become an untrue condition under certain frameworks. And he was one of the first people to very, very carefully read Sharp's paper and challenge the underlying definition of what a passive investor is. And so I share this slide all the time. If it's OK with you, I'm going to share it in our discussion. The really critical point is what is the definition of passive management in that context? So this is going back to Bill Sharp's, the arithmetic of active management in 1991. What is passive investing? The definition of a passive investor is somebody who always holds every security from the market. And an active investor is one who's not passive. Now, the problem with that is, how does a passive investor get into the market? Or how do they get out? And the answer, unfortunately, is magic, right? Literally, there's a footnote that hypothesizes that any transactions from passive investors happen in the liminal hours in which the markets aren't open and after all of our analysis is done, right? That's just silly in terms of its construction. And always the market average prices. Right. And always the market average prices, et cetera, right? So Lossy Peterson's insight was very straightforward, which is occasionally the indexes of themselves rebalance. That means the portfolio that is held by the passive investor currently does not manage the portfolio that they have to hold in the next period. Therefore, they're forced to transact during market hours. This is index arbitrage, index inclusion. It's become the largest business for hedge funds in any single area dominated by the multi-straight, slight millennium, 0.72, et cetera, Citadel. And so there's a very oppression insight that came from Lossy Peterson, that when the index itself changes, the passive investors are forced to change. My contribution to this analysis was slightly different, but unfortunately, I think it's actually a much bigger deal, which is when the portfolio of the index investor changes by virtue of their end investor action. In other words, you make a contribution or you make a withdrawal. What you've actually done is change the composition of the portfolio, and it now needs to be traded again. Right. And the minute you recognize that, you recognize there is no such thing as a passive investor. There can't be a passive investor. And so all of Lossy's work and my work, and most of the academic work that has now followed, basically, is focused on this idea of what spends when you add cash or take cash away in the market or within a portfolio. Well, you clarify something. This looking at sort of endogenous flows, this is significant component of how pricing mechanisms work is a relatively new way of looking at markets, right? I mean, we've now got some demand asset pricing models that are sort of competing with more traditional KAPM versions of how you think about asset pricing that are remarkably explanatory for what we see in markets. So that move towards focus on supply and demand for security or portfolio assets has been, at least in my idiot head, one of the biggest shifts I've seen in academic finance in the last, say, 15, 20 years has been this movement towards understanding that flow really matters. Is that accurate or was there a long body of research just not in equities? So the quick answer is no, it is a brand new field of finance and a brand new avenue to tackle a field of finance. And it really was not introduced until, I believe the first papers around these flow characteristics were focused on the large demographic components. So this would be, I think, guys like Paturba or others who focused on the implications on the demographic front, blanking on his name right now, the search for the G, oh God, it'll come to me in a second. I'll shout it out to Red Style. But prior to Cabay, there was another G who focused very much on this idea of overlapping generation. So I want to say it's G and Occupy. G and Occupy. Yeah, G and Occupy, that's a Greek name. And so there was a recognition that the flows that were coming in in differential components associated with an aging population where demographics could impact this. And the San Francisco head released a paper in 2011 focused on this, et cetera. All of those predicted that we would actually see as the baby boomers hit retired, we would see praised valuations fall, right? Because there would be more net selling than there would be buying. And so there was this confusing and largely dismissal of that in the 2012 to give or take 2016 time period where markets didn't do what people expected. Valuations began to expand in defiance of the demographic framework. And the question became why, right? And when you talk about the diagnostics that are now being applied, right, what's called the demand side analysis, it's a super complex problem, right? Like if you just mechanically think about it, right? There's 3,500 public stocks in the United States. My decision to buy one of the 3,500 is contingent on the behavior of all the other 3,499, right? If it is the worst performing stock, if it becomes the cheapest stock, then that becomes very interesting to me. But what if it just slightly cheapens while everything else cheapens? Does that affect my demand curve as it relates to that individual security? And so you can figure out very quickly that this is a dimensional problem that is really, really hard to solve. And it's one of the reasons why we adopted the efficient market hypothesis, not because we thought it was true in its totality. You know, Cliff Aziz, we'll regularly talk about Eugene Falma challenging it and saying it's not totally true. But it was like a map of the territory. It was useful and it allowed us to build models that allowed us to apply a degree of rationality to risk-reward trade-offs. That's what the CAPM framework was really about, okay? But it was purely theoretical and it hypothesized the idea that given the information that you were able to derive the information and that each individual basically had one vote that the wisdom of the crowds would guide us to something that approximated an efficient market. And that by and large accurately described the market that we lived in through most of our lives. Now, two things happened. One is just like Newtonian physics are perfectly adequate for circumnavigating the globe. But they are completely inappropriate for semiconductor design. Once you move from a small portion of the market that is investing as if this hypothesized framework, the efficient market hypothesis was right to the majority of market behaving in this way. It's very much like that difference between Newtonian physics which is a very close approximation and quantum physics which operates at an entirely different scale. Well, I would argue it's, it's significantly worse than that because the efficient market hypothesis has foundationally removed the human being from the decision, right? It is a mechanical explanation of precedence and behavior. What I think we have discovered in the intervening years as we've developed now, I think like the inefficient and elastic market hypothesis, is that human behavior has all of these components that are not necessarily easily described by these mathematical preferences and patterns of returns. Like for instance, the tax treatment advantages of investing a certain way versus another way. The free money from a 401k matches, all of these very human reaction functions that are very, very difficult to model, which is why I think to me as an investor, focusing on flows seems much more intuitive because at least there, I have some very explain that like I'm five foundations to understand which is that if I want something and Mike doesn't want to sell it to me, I'm going to raise my demand until you eventually capitulate and save five. If you want to pay me a billion dollars for my bicycle, I will sell you my bicycle. That feels much more human and intuitive in terms of how we actually get to pricing behavior. And it seems to me that the intervening work has really done a good job of identifying that. It's really advanced appeal to an extraordinary degree but with very uncomfortable conclusions. Imagine we used to joke about this. We used to experience this on a fairly regular basis where we'd read the news story about somebody following their GPS so closely that they drove right off the road into a swamp. Because it wasn't there on the map. Now that's very similar to how I would describe this phenomenon. And it's really interesting when we talk about things operating at scale, this reintroduces the global financial crisis. Like the insight on RNBS is 100% correct. Any individual mortgage behaves in a somewhat unpredictable fashion. I can lose my job before it's to sell my house and relocate. That is largely unpredictable. But what is predictable is the behavior of thousands of mortgages or tens of thousands of mortgages because that idiosyncratic risk is reduced. The problem in the GFC was the assumption about how those mortgages would behave. So we assumed, as we increasingly were assigning mortgages, risk characteristic associated with the aggregate behavior. And therefore, we were much more willing to take risks than we otherwise might have in areas like subprime, et cetera, which we had a historical representation that said, guess what, these things are fine. They don't really have an impact. Right. But once we got to scale, and actually ironically, the system began manufacturing mortgages to fill demand for investment product as compared to mortgages to fill demand for housing, right? We created the global financial crisis. This is the same underlying phenomenon. We have effectively driven to the end of the road. And the road, you know, we're supposed to stop. But the GPS is statistically, and road that is continued is going to continue, right? And so like that's where we are at this point. And I agree with you. The new systems are doing a much better job of explaining behavior. The old system basically involved. I collect a whole bunch of information. And if my information is deviant enough from what the overall market position is, then I have an incentive to transact. And that transaction will in a very, very minor way slowly start bringing the market back towards fair value. Right. So the state we're in now, I would describe as, and I'm going to fast forward a bunch of the mechanics here. People can go get all the links at the bottom of the episode. But the model that we have now is the way to think about it is that for any given dollar showing up in the market impassive. So you can think of that as just retirement allocation of another $1,000 going into the S&P 500, where the portion that goes through their target date fund and ends up in the S&P 500, that dollar burns into an increase in market cap in that index of stocks of depending on who's Matthew wants to use somewhere between five and 20, right? Meaning there is a multiplier effect because of the elasticity of demand there, which means that for every dollar that comes in, there isn't a dollar waiting in the way that this exact price to immediately fill that demand. It's passed to move a certain amount before other market participants are going to vomit those shares back out in so that the passive investor can get access to that flow. Now, there's been a lot of discussion about what's the actual multiplier rate is at five, which was the Bay and Coison sort of initial take. There's now been some refinement to that, which could be anywhere from 11 to 20 to 25. I mean, very large multiples. And obviously this is going to be idiosyncratically differently, different, depending on how you measure it. It's different that you're looking at a dollar in the S&P 500 versus a dollar into the mag seven versus a dollar into the Russell, right? They're all going to have their own unique components, but they all have this general quality of more money comes in and it has this accelerated effect on actual prices. The reason that that's uncomfortable for investors is it implies that we're living in this sort of volatility of volatility down the world. How do we, how do we mesh that observation? And it's not a theory. That's just an observation, right? We can look at stock charts and everybody can see that. How do we mesh that with what I would argue is the equally obvious efficiencies that have been created through things like ETFs and passive investing vehicles? I mean, it's inarguable that my access to beta as an investor has collapsed in price in my lifetime from multiple percentages to single digit basis points. So, and for the most part, you look, most measures of market efficiency are way, way, way up versus the 80s, the 90s, the early 2000s. How do we, how do we square that circle? How do we have both a highly efficient, highly effective high volume market, but one that is subject to what appears to be these distortions? Well, I think that there's a couple of things that are really interesting that, right? So among other things, like, think about what you just described. You have been given low cost access to beta. I'm sorry, what is beta? The market reserve, right? What is the market? Is the market the S&P 500? Is the market the total market? Is the market inclusive of private stocks? Is the market inclusive of small companies in your local community? I would argue that in all of those cases, my access has gotten cheaper and more efficient. I would actually, every one of your definitions and I think the answer is yes. Yeah, so I would actually argue that is very much untrue. And so what has actually happened is we have given a preferential access at low cost to the existing publicly traded equities. The existing, that's important, right? And so one of the reasons why we're getting a paucity of IPOs because by definition, the new IPO is not in the index. And it requires active managers to subscribe and support that through the process of a traditional IPO, right? And those active managers are losing the ability to do so. And so one is your gaining access to beta defined as existing publicly traded equities in a certain proportion, right? The second issue is when you describe that as efficient, again, I've gained efficiency in a particular type of investment, right, that disadvantage is small business. It disadvantages local communities. It disadvantages alternative forms of investment that I might have made historic like starting my own business because I've now provided a differentially low cost of capital to their competitors, right? So all of these factors are actually now playing through what you're describing as efficiency is largely an academic demonstration of how much do the prices actually react to information. Previously, the larger that multiplier gets, the more efficient the market becomes in a macro framework, which is what the evidence actually suggests, right? So if prices move, if a company gets a lower and lower effective flow because it is more and more held by passive and therefore when information comes out like an earnings report and that earnings report engenders a giant move because now the stock is basically low float in its characteristic and the active managers who would trade other information are treating in a smaller pond and therefore causing larger disturbance, perversely, that's called more efficient. Well, well, it is in some way, it's right, I mean, I guess it's not. I agree in the academic sense. It is more efficient if meta falls 50% on an earnings report and then reacts exactly like the market from then on, right? That gins what's called post-earning announcement drift. That is viewed as a measure of efficiency. Is it at all efficient that meta falls 50% on one earnings report and then rises 50% on the next earnings report? No, that's actually not efficient from any reasonable assessment of it. But it is from an allocation of value and capital perspective. Sure, I understand that. Like, you wouldn't want to do the same. That's actually part of the point, right? You use your GPS, not because you're trying to get an accurate representation of the map of GPS. Yes, it gives you lower cost access to maps. You use GPS because it facilitates your transition from one destination to another. Well, by that definition, targeted funds have been the best invention in market history because they have been an enormous vehicle for helping people transition from one set of investments to another. Again, a particular set of investments, right? And we have created all sorts of incentives around it. The issue is, is it differentially biasing behavior in our economy towards certain outputs? And I think the question to the answer to that is unequivocally yes. Sure, yes. I don't think we're disagreeing on that, right? The impact of this effect, right? So first of all, there's the does this effect exist? You and I both think it does. I think the majority of the academic research, now the preponderance at least suggests that yes, these effects are very real. Even one year. Yeah, and we're seeing more and more defections from people who have historically defended it. It's not very sweet row or somebody like that. Yes. And I think, look, I think there's real value in people who are very loathed to change their long held and well-researched opinions. And so I think they're very valuable to see how those folks react to new information. And my observation has been a lot of those folks who have been very resistant to this line of inquiry or to at least the conclusions of this line of inquiry are starting to recognize, okay, these effects do seem to be here in the market. Now, if we just take all that for granted and we can play through what that implies and implies more dominance at the top of the cap table and implies lower IPOs, right? I mean, it implies mega corporations and there's been good research around that, the rise of the megacorp as a result of this. There's been a great news and paper on that. So let's just accept all of those as truisms. There's then two avenues that I think for our audience are helpful to think about. One is the, what would it take for this to no longer be true, either because of market reaction, investor behavior changes, policy distinctions, changing in market structure. So I need those are interesting to understand because then we can observe as those things happen, we should expect different market reactions. And then the flip side of that is assuming nothing changes and the market just continues along its merry way. What is this imply for our portfolios and what should we do about it? Because the initial conclusion would be, I guess just keep investing at the top of the cap table because those are the ones that are gonna go up most and most of us as individual investors care much more about whether our personal bag is secure than whether or not capitalism is working. So like interest in those two angles. Well, like the pick one, either the policy response and what should we look at to know it has changed or the investor part. I wanna hit both, which one do you wanna hit first? - Oh, let's hit the investor part because that's actually the easier one, all right? I mean, the quick answer is you're 100% correct, right? The answer is you as an individual should be working to exploit this effect as much as you possibly can to maximize your individual outcomes, right? And so that means that it is almost impossible to beat the S and P500 or an even more large count passive skewed index that really benefits, right? A mag seven type framework where that multiplier is even higher and just to give some perspective on that, we wouldn't actually walk through how those multipliers are derived or they work out too, et cetera. My work suggests that those aggregate numbers that we're talking about are correct, but even if we look within Hadad's paper in 2022, which is really the one that isolates this intro market dynamic of the multiplier effects and then was built on by Zhang in the paper that you were referring to about passive dominance. Well, you know, Hadad will acknowledge that the data that he presents is intentionally actually underflade because the actual output is so offensive to efficient market models that he was very worried that he would basically be slid, right? And even within his data sets, as the data is presented, I shared with you one of his co-authors pieces in which it's broken down on the basis of desiles or the 90th percentile, the 25th percentile type framework. When we talk about the MAG7, we're talking about the 0.1 percentile, right? We're talking about seven stocks out of 3,500, so technically 0.2, you know, in terms of the 0.02 percent on by number, right? And for those, the multipliers are now crossing into triple digits, right? It's like it's becoming a huge issue. But in that world also, I think they're, so yes, I understand that's what came out of the data. Those stocks also strike me as the ones where it could probably poke the most holes in terms of valuation methodologies because we have seen sort of at least at a gross level if you look at the most actively held stocks, they're also the MAG7, right? So there is this sort of oxymoron where if you look at stocks 20,500, they're massively passively held. If you look at the top 20 stocks, it actually falls off because those are also the names that individual investors and active managers are day trading like MAG. So I'm weary of waiting too deeply in there because that strikes me as a place that's right for more sophisticated analysis. So I understand why they might not want to just say the multiplier effect on NVIDIA's 50, right? Because that seems insane, right? If people put $100 into it, they don't expect it to go up 5,000. And I think that there's some reason for that mass to be wiggled and to be wrongs. But back to the point for the individual investor, the implication is the top of the food chain keeps growing. But it also is that when something reverses and the when something reverses in this case is just more aggregate selling shows up for whatever relays it can just be sentiment, you would expect the same kind of reaction on the downside. That often gets put out in the presses, well, that's why you should hedge everything. And that's always the wrong answer too because it's never post-efficient to do that. You've talked in the past about things like doing big out of the money straddles to try to take advantage of big small moves without having to spend all that money to hedge the inside. Does any of that actually work? Do you feel like we're in a market where a sophisticated auction strategy can surely outperform here? - I think it's very, very hard because of the path dependency and options. The technically right approach is that long straddle. It's simplified, we do have a portfolio that is built in that way. It effectively buys calls and to a lesser extent buys puts. That has delivered modest outperformance although not as smoothly as we would like it to. And so the answer is effectively like if you're gonna capture the upside, a call option will work. If you're trying to capture the downside, a put option tends to be a little bit less effective because of the underlying drift, right? And so you've seen these slides, they'll just share them very quickly so people can see the actual kind of math behind what's occurring here. I just wanna help people understand this so that we can make sure we're all talking from the same playbook. So part of the demand side analysis, I did it in my own way back in 2016 in a far less sophisticated manner than Cabet and Coygian or in particular Ralph Coygian and as far as Hugo and Blakey his first name. Have built in terms of the demand side analysis, right? But I asked a very simple question. I simply tried to establish what a marginal propensity curves, marginal propensity to buy and marginal propensity to sell. So I went on and they asked portfolio managers a very simple question is in your portfolio manager, you have 5% cash in your portfolio, so cash is not a constraint in either direction, right? You receive an inflow or an outflow. What is your propensity to buy or sell based on that inflow or outflow given valuation? And the totally own surprising outcomes is that your marginal propensity to buy falls as valuations arise, your marginal propensity to sell rises as valuation rises. That makes perfect sense in the context of a discounted cash flow type analysis where a higher price all else being equal represents lower return going forward, right? That should be totally unsurprising. What was really surprising coming out of it though is the intersection of these two curves at exactly, almost exactly 50/50, and remember, this is just a survey of 450 investors, right? But they intersected almost exactly 50/50 at exactly the market's historical valuation average. And the reason why that's so important is if I then build an agent-based model and I give them the responses from these surveys and they then somewhat randomly give them cash and take cash away, the market behaves in a meaner, verding framework, right? As prices' valuations rise, people become more willing to sell less willing to buy, as valuations fall, they become more willing to buy less willing to sell. The reality is, as prices fall and valuations fall, people become less willing to give them money because they think that stocks are suddenly a terrible asset to invest in, we see this over time. And so this tends to get more extended because it's not truly random in the acquisition or distribution of cash. But at least we now kind of understand what caused the mean-reverting feature of the market. It's that the participants themselves discounted and behaved in a mean-reverting way. And if we go back to the mid-1990s, about 80% of investors acted in this way. This is what drove the marginal transaction. Today, only about 10% of investors are being driven or investment decisions are being driven into this framework. And so the propensity for mean-reversion has been dramatically reduced. Instead, what we did was we introduced a type of investor who operates off of a very simple algorithm. Did you give me cash if so then why? Did you ask for cash if so then sell? In other words, a 100% marginal propensity to buy or sell regardless of valuation. And so as those investors gave share, the market moves from mean-reversion to mean-exponge. And this, unfortunately, matches exactly what we see in the market. The largest stocks become ridiculously overvalued. While the median stock is just becoming overvalued. Right now, because of capital structure components, there's actually some perverse consequences of this as well. These companies tend to have leverage. And so then being overvalued lowers their cost of capital in the debt market, because the debt market's treat the equity as collateral. That says, hey, we don't really know what the right valuation of this thing is, but we're going to rely on the equity market. But that just leads to sort of runaway oligarchy scenario, which seems like from a political policy perspective seems like what's going on, obviously. So that certainly has explanatory power there. But again, from the investor's perspective, the putting risk aside answer is, well, tech just stay long. The thinking about risk perspective is, well, when this train stops, that looks like a scary thing, what would it actually take for the train to stop? Given, let's put policy changes aside, right? We could get rid of the 401k market. All sorts of crazy things could happen there. But is there a world that you can see in the size to 10-year time horizon, where the marginal investor is so disenamored of the market that propensity to sell overwhelms the structural flows we see from the retirement markets, from this sort of consistent allocations, from everybody around the world getting their slug of American exceptionalism. Like that is not going to go away completely. So something would have to overwhelm it on the sell side. You know, we sent the market down 9% over three days in April. Nobody seemed to care, keen back a week and a half later. - Do we actually have... - Let's be clear, keen back in one day. There's a 10 and a half person again, and it's a single day, right? So why should an investor be concerned at all? I mean, is this not games entirely rigged? There's really no reason to think of the music would stop. So the quick answer is, the music inevitably stops for the same reason the trees can't grow to the sky, right? Eventually, the thing to remember is that contributions are always going to be a function of income or borrowing a city. Withdrawals are always going to be a function of asset levels. And so as the asset value rises relative to the income potential for contribution, in other words, multiples expand, you eventually get to the point where the withdrawals exceed the contributions. And then it becomes a question of, does it correct quickly or does it correct slowly? And the math behind, unfortunately, what passive suggests is that it would be a very quick, very sharp and nearly continuous correction that is heavily influenced by where you start in the process. So I don't share this slide all that often, but I will for this podcast, I want to be very, very clear. This is a theoretical model of what ends up happening. - Do not blame Mike. - Do not blame Mike at home, right? But this is effectively what the model plays to look like, which is very much like what I just showed in a chart. We had higher and higher and higher. If at any point the passive flows turn negative, and that is simply a function of more and more passive holders getting into that baby boomer or retirement stage, at which they are now actually holding assets that need to be sold in a passive framework, then the valuations retreat sharp. - Let me just challenge you on that fundamental premise, 'cause this is one of the biggest complaints I've had about a lot of the target they've fund researched. Pick the number, 30 trillion, roughly captured by the baby boomer generation, being handed down to millennials, been hearing this for 15 years. We know the demographics. The problem with this analysis that everyone that I've read is that either they're making the assumption that Mr. wealthy retiree has stuck in their passive equity portfolio until the day they die on age 80, and then all of that has to be sold, which is ridiculous, because we know that that's not how people at the age of 80 are invested, or as they have aged from say 62 their 80's deathbed, they have been consistently selling their equity and buying bonds, which is we know fundamentally what's happening, because that's target date funds. And we are now living in the current window, where the first target date funds I was selling in the 90's are all coming to. We were selling 2020's back in the day. So we know that that is what has actually happened. We also know that when we're talking about investable wealth, most of these boomers are not sitting here on a portfolio that is barely covering their income needs. The bulk of the actual wealth is in people who have vastly more invested than they need to survive the rest of their lives. So when they get to end of life, one of two things has to be true. Either they're handing a bunch of effectively cash to millennials who we know are going to do two things with it, buy equities and buy houses, because that's what they do. Or they're dying and they have a bunch of equity and you now have to make some strange assumption that their ears are going to sell all of these now free from tax basis problems, equities, and buy something that is not indexed, that is somehow either just buying a house or selling it all in cash. Those are both counter to all the evidence we have about what's actually happening. So why do we believe that there would be this wall of baby boomers selling equities when everything suggests the opposite's happening? - Well, there's two separate components to that, right? So first of all, when you talk about target date funds, first target date funds really aren't used by those who are wealthy enough to meet the description that you described. The second is that target date funds are actually a relatively new category. So as you point out, you started selling them in the 1990s, the life cycle funds were first introduced in the 1990s, the first retirees that are hitting those are in that 2020 wealth area, right? And then we actually see this. There has been, perversely, a continuous bid for most bond structures. In fact, passive allocations to bonds is faster growing than passive allocations to equities at this point, right? So one is, I agree with you that if your argument is eventually we will end up with wealth so concentrated that it'll all be held effectively in the hands of those who don't really need the wealth and don't need to spend it, then sure, we can sustain very high valuations, right? And that is a potential outcome. I'm not sure if that's the outcome any of us had in mind would be started saving for 401K in 401Ks as a retirement system for the broader American public. Along the second thing is, is remember that much of the wealth that you're describing in that way is actually not held in publicly traded equities. A large portion of that wealth is held by the 1% is held in their private businesses or the real estate that they own, et cetera, right? So there is a mismatch when we talk about public equities and private equities. Even look to it, look at Bill Gates' holdings, which have now been diversified into something that looks an awful lot like the S&P with a slight bias towards real estate, right? He doesn't show up as a sizable holder of anything. - Right, but the point, the chart that you put up here is about people selling public equities, right? - Yeah, this implies that - Passive owners of public equities have to all of the sudden either become active owners of public equities, or they're selling to replace public equities with cash, with bonds, with real estate, with consumption, with something. - Yeah, though, my question is, what is it we believe will be that? Because it's certainly not the 30 trillion millennial hand down, because if anything, I can make a very strong case that will increase public equities participation. - Oh, I, again, I wanna be actually very, very clear. One, if the baby boomers were to hand it off right now, right, they would probably skew slightly towards equities. Right, if that handoff happens in another 10 years, it's gonna be less of a skew, because the actual millennials themselves are now starting to hit the point at which the, the glide paths start to reduce their equity allocations. The second point though that I'm emphasizing is that that is in and of itself ignoring that a sizable fraction of the investment public that is 70 or 80 years old, they're actually not in target date funds. The penetration of target date funds amongst the 70 plus set is actually remarkably low. And perversely, the penetration of passive within that group is actually remarkably low relative to the overall average. And so like, I'm actually agreeing with you. The part of what is happening is the baby boomers who were allocated to value managers, for example, or active managers are firing those individuals and replacing them with S&P exposure. 'Cause they're like, well, I might as well just go with the low cost. - Right, so what causes this chart? - Yep, what actually causes this chart is eventually you get to the point where any type of withdrawal overwhelms the income levels, right? And so that is just very straightforward, Matt. Eventually you get to the point. Imagine instead of $30 trillion, it goes to $400 trillion, right? Now, am I gonna spend any of that wealth? Well, I am. I am gonna spend some portion of it. And in the process, I will bid up the prices for all the goods and services, right? In a manner that you had expected, biases towards those retirees, right? And so what do we gonna end up doing? End up allocating our economy to cater to old people. Gosh, that sounds an awful lot like what we have. And so again, the point is there is nothing that you as an individual investor need to do, but as a regulator and as a government official, you should be very much thinking about, is this actually what we're trying to accomplish? Okay, great, perfect transition. So we've covered, I think that's the first, at least at a very high level, what could investors do? There are these convex tails that are worth thinking about extraordinarily difficult to get that timing and pricing correct. For most people, the answer is going to be, ride to this horse as far as it will take you. So now let's put our pundits, policy makers, walks and idiots hats on and talk about, what should somebody do? You and I have talked for years and out of potential policy responses, like getting rid of the tax advantages that they are baked in the system all over the place, for passive investing. In other words, versions of make active management great again by reducing some of its barriers to being successful. That's a set of conversations we could have. However, it seems pointless because this administration and the previous administration seem to be going very much in the opposite direction. The strongest example by far are the so-called Trump accounts, which I think fairly uniquely in investment management history, not only mandates specifically the S&P 500 or similar index, but also tap the potential fee at 10 basis points in the legislation, which I've found still often, because I've not that I'm against passive, I've had my whole life in it, but I am a big believer in like market competition. So the idea that we're going to mandate this fee and this target investment is wild and very much counter to, I think, anything you and I have ever talked about in terms of how we would fix things to avoid this. What's your thought there? And is there some counter? Does the move towards putting crypto and private markets more in the public hands change your opinion about that? How do you balance these out? - Yeah, I know. So first of all, I actually think interestingly enough, what you just highlighted is one of the reasons I ultimately do think that this administration may be the administration that takes action. And so part of what you're actually doing there is you're saying we think the passive, low cost passive plays a role and we want to use it to advantage younger people. That, by the way, is actually something I completely agree with, right? And I want to be very, very clear on this. Part of, you know, it's regularly put out that my green hates passive investing. I don't hate passive investing. I just want to make sure that it is declared to be correctly what it is, which is a systematic algorithmic strategy that simply says, did you give me cash if so then buy and buy in proportion to the public market caps, right? Float adjusted to be more accurate, right? That actually interestingly enough has value in the marketplace. When you initially introduce a new model for why you buy something, it's introducing heterogeneity into the investor universe and previously it actually lowers valuations and low or sorry, lowers volatility and raises valuations. So that's in that positive, right? I get that, but you can make that argument about just the existence of 401(k)s. I can make that existence again. Is it a good thing to encourage people to save for retirement? Absolutely, yeah, right? Is it a great thing to provide them with an incentive and to employ, to provide employers with an incentive to encourage people to save for retirement? Absolutely, these are wonderful, wonderful things. Within that, exactly as you're describing on the Trump administration's Trump accounts, is it a good idea to designate that you will only buy stocks in the companies that are owned by friends of Donald Trump? We would all look at them and be like, wow, that's a really terrible policy. Well, why is it good then to say it has to be the S&P 500? Because that's, while they may not all be friends of Donald Trump and we can't directly point to the grift associated with that. What we can say is, wait a second, now the government is very firmly putting its thumb on the scale and providing differential capital costs for this selected group of companies, right? It's the antithesis. But we do that, I mean, let's just be clear. We do that in every single piece of economic policy in this country, we make, we pick winners and losers from oil to solar power. I mean, in every single political decision has that component to it. And I am absolutely in agreement with that. And therefore, find the fact that we think that we aren't doing the same thing when we direct flows towards multinational corporations, impassively traded indices in a liability protected and a tax advantage manner that we aren't changing the outcomes in our society in a very meaningful way. Okay, but back to your point, you think this administration might do something about it. You haven't convinced me yet, why do you think that? Well, I will tell you exactly why. Because what we're actually talking is making the largest companies more and more powerful. And therefore, they become a threat from a policy standpoint to the actual regulators in government itself. And that is what I would argue as the primary tension that you're actually seeing at this point. You're seeing a system of democracy in which theoretically, people are represented by having a single vote that empowers the individual. And at the same time, we're introducing an economic system and a capital markets assumption that biases us towards the largest and most powerful, effectively the nobility having differential access. But why do you say, I agree, I'm nodding along with everything you've just said there. Why in the world would you think that this administration is pushing against that when almost literally every single action we've seen has been in the opposite direction towards more deregulation towards skewing the playing field more towards key large players, whether it's whether it's contracting where we've given up all pretense of competitive bidding and everything's going to the largest player in the space, whether it's from space acts or Palantir or anybody else, like everything I see in reading the paper suggests that this administration is deepening the oligarchy, deepening the power of the most powerful corporations in the country at the expense of the individual investor at the expense of the individual voter. So why do you think that there's going to be some sort of come to Jesus moment where all of the sudden we're going to become capital socialists where we say, we got it all the barriers out of here so all companies are on an even playing field. Yeah, I actually am doing the opposite. Instead of it come to Jesus moment, it's a come to Satan moment, right? It is effectively saying, look, when these companies actually become large enough or there are ways that you can influence these outcomes in public markets, and I would just point to Tesla, right? When Elon Musk was perceived as being tied in with the administration, he managed to alienate both parties in the past six months, right? So you know, like now all of a sudden Tesla is reporting terrible quarters and Elon Musk is hiding X and saw, you know, it's his Twitter takeover inside his new AI start as compared to Tesla, right? There couldn't be a clear signal that says, you know, you could be a trillion dollar company, and the reality is that the stroke of a pen, the government can wipe you out. So I like that's actually the point that I would emphasize is as the administration is waking up to the power base that is created by the differential inflation of the equities of the largest companies, they are going to wake up to the threat that that represents and act out against it. That's the point that I'm going to say. It's not a come at Jesus moment, it's a come to Satan moment. But you say act against it the way I see this administration thing against anything is largely by fits a peak in executive orders, not engaging market structures. So like the kinds of things we've talked about before that we changed this are things like rewriting tax code and rewriting or RISA regulations. You actually think there's those are on the table in the next five years? I think that the odds that are higher under this administration than they were under the prior administration on. Interesting. I couldn't disagree more. I think Elizabeth Hars was much more likely to do something about this than anybody existing in the Trump administration. I think that Elizabeth Warren was far more likely to talk about it and formally complain about as opposed to get it out. Far less capability to actually affect you. Fair enough, fair enough. As we've seen. You know, you know, a toothless dog can only bite so hard. Okay, that's the kind of thing we can gloriously disagree about because it's a giant unknown that either of us have. I want to be very, very clear. I'm not projecting certainty in terms of my knowledge on this. But you know, part of what I'm part of and you know this. You've experienced this firsthand in our conversations offline. Part of the challenge for me at this point is that I'm moving from trying to convince people that, look, this is happening. This is a big deal to now actually trying to guide people to what do we do about it? What do we do about it? We mean involved in this. Let me ask you about the other inputs here, right? Because we've got tax code. We've got the retirement system, which I think in general is one of the bigger components of the flow issue. And now we've got in both of those cases, crypto and private assets have entered the chat, right? And both of them are now being considered for broader inclusion in the retirement system. Both of them are now being considered for differential tax treatment. Certainly crypto is certainly on the two page for being different tax treatments. I would not be surprised to see something similar on how we deal with taxation and marketing of privates. So all those things push in that direction. Does that change the math here? I mean, crypto, we know it's the greatest, you know, it's the greatest lab we have were in elasticity because ain't nobody making them no more Bitcoin. And private markets are sort of amorphous and difficult to measure from millions of reasons in terms of their actual impact on pricing and flows and capital. So how do you think about those two big movements, which I would say feel like where are the gas pedals being pushed by this administration in terms of security regulation? Yeah, again, so part of the, you know, not to go back and relitigate the conversation we just had, but everything you just were changing tax policy. We're changing acts. We're changing why, right? And why are we doing it? We're doing it in response to money, right? And so, you know, the idea that it is going to be extended in a different direction. Once we recognize that one of the ways of gaining more power is by reducing the power of your enemies or those who are not necessarily aligned with you on, I think that's an easier ask than you do. But, um, and you've also brought a Bitcoin. And I think Bitcoin is one of these fantastic tools. Like it, it's so fantastic from a theoretical standpoint. And I'll just share very quickly one slide on that that I put this on Twitter all the time. So this, this is literally just looking at Bitcoin and trying to explain the movement in the price in Bitcoin over the last 30 days relative to the change in the Bitcoin that is held inside ETFs. And I mean, it's, it's tough to explain to people how important a chart like this is because what it's literally telling you is the only thing you need to know is what's happening to the change in Bitcoin, called in funds, right? Well corporate treasury activity, everything else that's going on, et cetera, is largely meaningless in terms of its overall exposure. What is happening here is the exact same phenomenon that we're describing inequities in which the price of Bitcoin is being driven higher by an increase in the quantity of Bitcoin that is held in funds. Is there utility to it? None that we've currently discovered. Other than I'm rich. Right. And this, this chart isn't even really capturing, I would imagine the recent effects of sort of the Bitcoin treasury movement, which is frankly just another way of Bitcoin held in funds. Certainly when we start looking at proxy companies that are just Bitcoin treasury companies. Yeah, and to me, that's actually one of the interesting features that comes out of it is it doesn't attempt to capture those Bitcoin proxies. But perversely, those Bitcoin proxies in some ways could be sapping demand from Bitcoin itself, right? Instead of deciding to buy the Bitcoin ETF, I'd buy the current narrative of the owning micro strategy or some other Bitcoin treasury fund is a way of getting a multiplier on it, right? It's absurd, but there is an element of narratives to it, right? And so it is actually really interesting that despite the fact that you've seen this rise in treasury holdings of Bitcoin, it's pretty incredible when you actually stop and think about that component. And so, you know, again, this is just further evidence that this is really what's happening, and now the question becomes, what are the implications associated? What comes up? And again, the perverse aspects of it are some, it feels really good, right? Like, if I own Microsoft, then Microsoft goes to 100 times earnings. Am I unhappy? Not up, it's because the valuation rose and not because earnings fell. I mean, I'm happy, right? That's good. I've tripled the value of my Microsoft shares. That makes me feel good, right? Is it wealth in the sense that it can be spent? Well, not if I want to avoid the risk that prices ever come down and so it's worth, right? You end up, you know, with a society that feels very much like, you know, late 19th century England where there's tons of wealth tied up in land ownership and very little in terms of actual industrial spending. Right? That's going on everywhere else is if you're hollowing out the empire. This is the experience that we're having in the United States. And so this is actually one of the really perverse aspects of this is like, it feels good to see valuations go up. We want to see the market higher, but that also then creates its own problems. And so we've forgotten this, but in 2003, there was a paper written by Jensen who unfortunately, I'll pass the way, it was a true lion in financial research. He wrote a paper called the unanticipated cost of overvalued equities for the Asian based costs of overvalued equity. And he basically points out that, look, everyone takes that seriously. Microsoft is trading in a hundred times earnings. We treat that as a signal about how wealth can be created in our society. And so if the answer to it is, hey, let's give all of our wealth to cash rich companies that don't need it. Well, then guess what? You know, you're going to get adverse outcomes with lower investment and everything else. And so again, like, you know, what are the implications to this? Well, the implications are very straightforward. Markets go up. What are the secondary implications to it? Investments that should be made or not being made. Right. Well, and that's a that's a that's a broader policy issue, right? Which is the I think micro strategy is a fantastic case of point here, which is a, you know, now enormously large company that it's absorbed enormous amounts of capital that I would argue is really not doing anything productive in terms of capital allocation as we would describe it in terms of capitalism, the way it's designed in the textbooks. And that is foundationally kind of the point of ego Frazier Jenkins points about it being worse than Marxism, right? In this case, the every dollar going into micro strategy is a dollar that is not going to some guy who's building a better widget to do a thing that's actually going to add value to the economy long term. So in the Bitcoin example here, clearly these passive effects will have hacked Bitcoin even more than they will. Otherwise, if target date funds start throwing a percent a half into Bitcoin every monthly contribution, you're going to see these effects even more in Bitcoin than you do in the S&P 500. What about private markets? Because that's a really interesting question. To me, if we saw a regime where, say, the average 401k plan could alongside its target date funds be offering a target date fund sleeve that's, you know, 30 percent of its bond exposure is in private credit and 15 percent of its equity exposure is in private equity. Does that, how does that change the math? Because the signaling on pricing in private markets is so garbage. How could we even know? I mean, the quick answer is that the immediate effect, of course, would be to inflate valuations further in private markets. You're introducing an additional buyer. It's no different than creating a Bitcoin ETF. There are very few sellers of these at least until the institutions are able to dump their holdings into the 401k's, which by the way, I would actually anticipate is the path that a lot of this ends up taking, right? That effectively this turns into a monetization framework for institutions like Harvard that are currently very cash poor because they pursue the David Swenson model of, hey, we never need carbon. And then all of the policy changes and they need cash, right? So I'm cautious on this one, but I want to actually say to me, the really interesting thing that's happening with this threat of a move to private equity or to private assets is actually the loss of bid that that creates for the public equities. And so previously, like we actually saw this happen. I've demonstrated this before I can show it on screen if you want. Like if we go back to August of 2015, you remember August of 2015 because of a very short correction that happened in the S&P 500 that was assigned to a Chinese devout. So this is going back to August of 2015. On August 10th through August 12th, the Chinese devalued their currency by about 2% in an unexpected fashion, right? A week later, starting on the 18th and then through the 24th, U.S. equity work is corrected rapidly, right? Now the question is this ended on the 12th. This started on the 18th on the 19th. Did the news like not come over the wires? Did they send it to us by dropship? Was it a slowboat from China that brought the news over? Right. The actual reality is that equity markets were unaffected by that devaluation. What actually happened on August 24th 2015 was a Vanguard rebalance their target date funds. This is the last time they used to use a rolling five-year period in which allocations remained fixed for five years and then they would change the allocations in a step-down framework, right? And so on August 24th 2015, Vanguard rebalance target date funds, which then were about one and a half to two trillion dollars in assets. Today, they're about four trillion sets, right? And with that rebalance, we literally walked in that morning, Johnson and Johnson priced at a penny down from 85 bucks a share. ETFs couldn't trade. The entire market was basically shut down for an hour, so we tried to figure out the chaos of what was actually going on. And the reality is it was this type of rebalancing, right? Now what you're describing in private equity, imagine we take a scenario and which we reduce public equity exposure to reflect the problem. Right? Yeah, that's a three-year change that we had here by a large magnitude. Yeah, so the only mitigating factor would be that it probably wouldn't all happen in two days. It would happen over a long period of time and people would have rampends, et cetera. But the net effect is going to be largely the same. And I think it's reasonable to question whether it's better to take a shop all at once and get the reaction function or just to have the slowest steady decline. I think reasonable people could disagree. Yeah, and well, in so part of it is a question of like, does that actually sell the process? Because think about what then happens. Each dollar that comes in, imagine it's currently a 50/50 bonds equities. We now suddenly switch it to its 30 equities, 20 private equities. That means the next dollar in is buying less of those richly valued stocks as well. That pulls forward that point at which passive could turn negative in public markets. Right? This is why I put out a chart that are a tweet on this with that sitting forward image as they decided to pass this because this is actually going to meaningfully affect flows if they follow through with it. The other question that we just don't know yet is where is it going to take form? Is that money going to be allocated to private equities? It's going to be allocated to venture. Is it going to be allocated to private credits? Well, and how do we value that? To me, the much bigger question is, how will we value those investments? Both at the point of sale and ongoing, right? Well, you know how we're going to value it. We're going to value it at whatever the private equity companies tell us their values. No, but this is my point. We've seen this example at XOVR, the fund that owns it to giants. Like a SpaceX, which may have claimed it's been worth $185 since December and has never moved and priced. So, yeah, maybe we end up with things like that where now you've got a sluggish SpaceX in your 401k, but at some point things do have to be revalued. 401k's have to be sold so people can take their minimum distributions at some point. So they're going to sell, but that's no, but that's a reasonable point that private equity would probably be the last thing sold out of a retiree's account on his steps. That's actually the objective, right? The objective is not to get into the portfolio of the 65-year-olds. The objective is to get into the portfolios of 22-year-olds. Right. And then every question is right. And they're like they are by definition holders from an account. They will haunt forever, right? Or at least until we come to a decision, this is wholly crap. This idea of investing in 401k's was a terrible idea. We'll never do this again, right? Or we should be adding bonds. I actually put out a tweet the other day that shared allocators responses in 2015. And in 2015, it was all about get out of equities and buy bonds. Equities were trading at 18 times bonds were trading at 2%. We got an LDI match, right? We can see this ahead of us, right? Now nobody wants the buy bonds. And in fact, the thing that frightens me more about the discussions of private equity and private credit is the idea is increasingly being floated is we replaced the 60/40 portfolio of the 60/20, which is 60-pregnant equities, 20% private assets, and 20% debt. Yeah. And obviously those things would have huge impacts if they happened at scale. I guess I'm a bit skeptical that this administration or even the next one or two will have enough putspa and mandates to actually pull that off. I think we'll have a conversation about it, but I think it's a bit of a fantasy to think that side years from now, the average 40&K is going to be 5% in private anything. I think this is going to be a much longer slower burden. And I think to your point is the kind of thing that people who are currently 20 and 25 years old are going to be sold as they start hitting their peak earning years. And that's when this really starts becoming an issue. Again, part of the point is education. The simple reality is one of the problems with government action is that there is no real feedback mechanism. Once the change has been made, there's not much we can do about it. And you can't really do the counterfactual because life is complicated. So if Vanguard decides that they want to include private assets in target data phones, they're going in target data phones. In the same way that when BlackRock went from Larry Fig, two years ago, telling us that Bitcoin was rat poison to launching a very profitable ETF, to now wanting to drive adoption of that ETF by pushing it into model portfolios, like there's no fiduciary in that process. Right. Well, as you usually have teared me up, Mike. I'll wait for your hair, Paul. Yeah, that happened a long time ago. All right, before we wrap up, anything that you're either working on or is on the brink of being published that you're excited about that's informing the debate? Well, on the brink of being published, obviously, my book, which I'm working desperately on, and I have to be honest with you, writing a book is a labor of love for which I have none. But the stuff that I'm really working on right now and is one of the reasons why I actually think the administration is increasingly going to care is actually the distortion that's happening in the fixed income space by virtue of passive. And that is a much bigger issue. And so I can share a few pictures on that, but I think you're actually really important to do influence what I'm advising people to do in their portfolios. And I want to be very, very clear that this advice is actually very anti to what at least the current mantra is of what's going on. And so maybe I'll take two seconds and try to share this. Okay, so for those who have followed this debate, one of the really important components has actually been on a discussion that was introduced by David Einhorn on Barry Reynolds's podcast and which he introduced the idea that markets are broken right now. He credited me with the insights that brought him to that conclusion. But much more importantly, he actually addressed what was he doing about it. And it did help him a lot to understand this and change the behavior. So he effectively recognized that what was happening is his peers who would traditionally recognize value and buy stuff after he had identified it were being redeemed and reduced. And therefore, he could no longer rely on then them coming in after he had done the work and basically validating. Right. And so he began to focus on what he calls endogenous liquidity. Effectively companies that would return his targeted return level, not through price appreciation or through others recognizing it, but simply through cash return. Right. Now, the reason that becomes super interesting is if you actually think about the impact, if you think about the impact that the behavior of equities in their totality. Right. Equities effectively, and this is embedded in black sholes. And it's one of the reasons we have different pricing for options and rates than we do versus bonds. This is what an equity payout structure looks like. Right. You put a thousand dollars in 30 years from now. Maybe I know 150 bucks. And maybe I have a hundred thousand bucks. Right. I don't know. But that code of possibility expands over time. And this is literally what's embedded in all auction pricing models. They're simply saying that volatility gives me exposure to a wider range of potential outcomes further off into the future. Okay. And this is why I refer to equities as Ponzi assets, not because they're literally Charles Ponzi frauds, but because the return that you get is ultimately largely dependent on what somebody else is willing to be. Right. Okay. All right. Bonds, while they see, well, they are also financial instruments, behave in a very different fashion. And your high quality bond looks much more like in American football and flight. Right. And this is the ugliest American football you'll ever seen is the wrong color and the shapes are slightly off, et cetera. But the key point is that a bond returns a known high quality bond is going to return a known quantity over its life. Right. It's going to give you the coupon and it's going to give you the principal back. And that's just the path. Right. It's just the path. Right. Now, there is a low interest rate path in which the bond rises in price. And there's a high interest rate path in which the bond falls in price. But the net result, if you hold it to maturity is always the same. Right. In other words, these are not Ponzi assets. These are assets that have tremendous endogenous liquidity. Right. They're much more like David Einhorn's small cap problem. Exactly. Right. Even even more like David Einhorn. They're like, this is true in dodging this liquidity. I can sell it, but I don't have to. And I will still get my cash back. Right. That means it is less subject to distortion over its entirety of its life than equity is. And they're very, very interesting impact because a lot of what we're seeing in markets today, I would actually argue is a byproduct. I'm looking for. There we go. Is a byproduct of what's happened in interest rates. So I'm going to flip over to this different screen. So this is the structure of the total bond market index, the Vanguard total bond market index relative to the quantity of sovereign bonds, US government bonds that are out in notional value. Right. And what becomes very, very clear is they are overweight the front end of the curve. They are underweight all the duration components. And the reason for this is very straightforward. These are market cap weighted indices when the fed raised interest rates bonds that were issued in the 20 give or take 2015 to 2022 time period fell in price dramatically, which means that they are just like value stocks or small stocks receiving less bid per dollar contributed than the other bonds. Right. These bonds here trading it give or take 60 cents on the dollar. Right. That means that dollar in buys much less of them. This is in my analysis what is given rise to the bizarre performance that we're seeing, which is new issues are going on fine and auction. And then they become special. And effectively, this giant treasury basis trade exists where I sell the treasury futures and I buy the off the runs, which embed in them an actual unique signature unique feature positive convexity associated with the return profile of interest rates were to get. Right. So they become capital appreciation vehicles is compared to necessarily coupon vehicles again, a form of index arbitrage. One of the largest trades in the hedge fund space, just like index arbitrage and equities, but this one is perversely creating a narrative that exists in in rates markets that the fed has somehow or another lost control of the long end of the curve. Right. And so this is very actively influencing policy at this point. Is this is this largely just about liquidity? I mean, if we're seeing this kind of discrepancy between new new issues and also run. It's actually largely a function of the buying pressure that's coming from the passive vehicle, right. So this vehicle give or take is getting a hundred and one cents for every dollar that gets contributed. This one's only getting 60 cents. Right. So what it was effectively doing is the impulse that comes in to buy these bonds is less than it was before. Proversely, that's the opposite. Again, I can flip back to my presentation because I used to show this in a slightly different framework, which is that much of what we actually saw in the huge sell off was a byproduct of the opposite behavior. So if you actually look at what happened, I'm going to pull off to the bond market slides of on this. You know, so one of the great ironies is the question was always like, well, who's buying all the negative yielding bonds? What idiot would buy a negative yielding bond? Well, the answer was the passive vehicles. Right. Because they were in the bond indices and perversely and negative yielding bond trades well above par. And so you're actually putting more behind power towards the largest names. This is why when the Fed cut rates on a fairly consistent basis over an extended period of time, effectively, the bond indices picked up momentum for duration components. It extended the duration fantastically of the bond indices and set us up for the losses in 22. So like, the area that I'm spending more and more my research is actually on the bond side of the equation. The Bank of Canada actually just put out a paper in the last week identifying the impact of flows trading on Canadian bond yields. And they're beginning to wake up to this. Now, I will tell you that the conversations that I have with the US government around this are there's two ways you can treat this. You can manipulate it, right, which would involve the Treasury buying back low priced bonds and re-issuing it, fair and food bonds. And then when you cut rates, those bonds are actually going to rise in price. They'll be even more bid for them. You could re-issue again. Right. You can now start lengthening out your duration. Right. And that would be the manipulative approach. The other approach would be for the government to say, no, we're actually going to mandate changes to how this is done. A bias is that we're going to see the former before we see the lot. Yeah, I think so. What would the latter even look like? Like, how would they mandate changes into how people are doing this? Well, among other things, the argument that you should be doing a passive bond index weighted on the basis of market capitalization is far less theoretically supported than the same thing in the equity space. Oh, sure. No, no. Sorry, that I handled like academically. I understand that the ag is a dumb index. Yes. I guess it's a dumb index. But the more important point is people are being forced into that dumb index by policy at this point. Vingard will be very straightforward. If you ask them about railing, why would you possibly wait a bond index on the basis of market capital? And they'll say it's very simple. It's easy to explain. You know, I, I mean, I've been writing a bond indices for 25 years. They've always been stupid. And despite that, nobody ever manages to come up with something that's better. Anybody actually wants to buy. And that's, but that's the crux of my point is now you actually are suddenly you've grown to a scale that you're influencing outcomes at the political level that might actually affect you a change. It might not. Like, again, strategy operations is to like, I mean, from as a market guy seems like trying to like buying the cheap stuff and reissuing seems like the smarter way to handle this. Because I agree. That's why I think the bias is actually they're going to exploit it. Right. And I would expect nothing lost from Scott Benson and then seemingly smart markets guy. Right. But it's also really hard to do that. Right. Because it feels very counterintuitive. Why would I buy back my low yielding stuff and issue new high yielding stuff? Right. That feels counterintuitive until you accept this mechanism. So like, I'll be very straightforward. This is a discussion that is ongoing right now. Yeah. Boy, the interactions between that and the innegable pressure to get fed rates down to zero. So that real estate guys can have more of a field age. It seems like those two are going to interact in a non-positive way. Oh, I actually think so. So this is actually exactly the point. All right. The single best thing you can do if you want to actually make that happen. Oh, we've dropped into zero. Yeah. Yeah. Well, no, no, actually first, you re-issue that paper at four and a half percent. Because if you then drop interest rates to zero, you're going to see the Bose bonds rise dramatically in price and the bond index will shift. Let me give you one more example just to give you so many to have how profound this impact can be. Let me see if I guess the question of what you think the policy objective is is the policy objective to extend the duration of the liability portfolio for the federal government. If that's the policy objective, then I get it. I think it's on one, I agree with you. It does boil down to like, what do you actually think the policy is and what is the objective and ascertaining that might very well be the most difficult thing to do with this administration. Right. That's definitely agree with it. Right. And so, so you know, you end up in this weird place where like you're saying, well, one of the objectives I'm saying, I totally agree with you. But if the objective is exactly as you described, cause a boom in real estate. Ironically, this is the way. I mean, interesting. All right, well, I want to show you to my Korean, right. So just to give you like some idea how extreme this can actually get, right? This is just a super simple model of two year and 30 year. Like, so let's just imagine that the market only exists of two years and 30 years. Right. Look how radically I can change the construction of the index weights simply by changing rates. Yeah, but this also implies that nobody changes any of the index rules, which, you know, I think that there's, it's not inconceivable to me that we see a restructure of some of those indexes, the same way we have with things like how the NDX handles things, etc. So I want to be very, very clear. This is not changing the construction of the index. We literally just lived through this, right. We went from zero to five and we went from zero to five on the 30 year, taking 30 years from 60% of the index or, you know, 55% of the index to 36% of the index. That's really what just happened. Right. And so now that incremental dollar going in instead of buying 55 cents of the 30 year is buying 36 cents of the 30 year, that's not good. Right. And yeah, depending on your policy of death, right. I mean, that's, I don't, I mean, again, what we have actually created is a narrative, oh my gosh, we're losing control of the long end. My work says there's absolutely no truth to that whatsoever, which then puts me into a very uncomfortable position to say all the fears about inflation and everything else or effectively just a narrative that helps explain why people don't want to buy bonds. Like, you know, if you buy into the David model of buy and dodge this liquidity, identify areas that are being neglected by passive, candidly duration is the area right now. And I want to be really clear, like I could be completely wrong, right. It is entirely plausible that, you know, under administrative fee, we decide that we're going to give a billion dollars to every American as a dividend for, you know, collecting, you know, Republicans in 2026, who knows what the right answer is, right. It doesn't actually matter, right. There are any number of ways that we can change it, but boring, you know, if those catastrophic views are correct, and I would just emphasize that I think those kind of catastrophic views are heavily influenced by market behavior, right. We construct the narratives to explain price. And so, you know, I'm in a very uncomfortable position where I have a narrative that explains price. It also says, if we continue doing it this way, we're going to have a lot of problems, right. And there we're going to make choices that are non-optimal in terms of capital it allocation or investment, we're not going to have the society that we would like to, right. And you could be 100% correct, but the way that there's just not the appetite to change. And yeah, yeah, we just need to get the word sponsor to a much later point. Well, yeah, we get squeezed into a world where corporate oligopoly actually runs everything at which point policy doesn't matter because it's completely captured. So. And on that charming note, Mike, thank you so much for joining us again. I'm looking forward to see you in a couple of weeks, maybe we'll record something up at campkote.com. You know, this time I'm sure we'll have another clip show that I won't be the one that does the common thing on since I did this one. There you go. Perfect. Thanks so much for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on YouTube or your favorite podcast platform or leave a review or a comment. We appreciate it. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the participants or their clients.