“Seven Years of Just Being Tortured”: Why this Longtime CEO of Active Management Started an Indexing Company

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When David Barse stepped down as long-time managing director of mutual fund company Third Avenue Management in December 2015, he had at least two years before he could take his next step in asset management by because of a non-compete agreement. Shortly before he left, he said Third Avenue was suffering from risky bets made by a high yield bond fund and that its value-oriented equity funds had struggled to beat benchmarks since the crisis. 2008 financial year.

“I was facing this constant war that I was losing to passive strategies that both outperformed and pooled assets,” Barse said in a telephone interview. According to him, active management of funds has become all too difficult after the crisis. “It’s too hard to do,” he said. “It’s really hard to pick the winners, and it’s really, really hard to do it consistently.”

Last year, Barse entered the world of passive investing with the creation of his company XOUT Capital. He concluded that it’s probably easier – and more important – to focus on what to leave out of a portfolio than what to include. So he crafted an investment formula that seeks to identify the losers among the top 500 U.S. stocks based on market value, with particular emphasis on the technological risks companies face.

“If you don’t solve this you will be left behind,” he said. “What matters is how fast a business grows and the kind of divide it builds around it that will accelerate it beyond the competition,” he said. “Forget about traditional valuation metrics. “

The process of selecting his company’s investment model doesn’t start with the Standard & Poor’s 500 stock index. Barse explained that XOUT’s constituency of US large-cap 500 has 90 companies that are not on the S&P 500, including electric car maker Tesla. He had some success at first.

GraniteShares XOUT US Large Cap ETF – the exchange-traded fund that tracks the performance of the XOUT US Large Cap index developed by Barse – has gained 32% since its inception on October 7. It beats the S&P 500 this year.

The ETF, which trades on the NYSE Arca under the symbol XOUT, rose 19% in 2020 through August 26. This exceeds the 7.7% gain of the S&P 500 over the same period.

“Every quarter we rebalance,” said Barse, explaining that XOUT takes seven factors into account in its scoring system. For example, JPMorgan Chase & Co. was knocked out of its portfolio in January because it scored “poorly” on the basis of the XOUT formula despite heavy spending on technology – and the bank did not return to the table. index of the company.

“Getting into the pandemic has been a great call because the big banks haven’t performed well,” he said. Slowing deposit growth could hurt banks’ chances of being included in its XOUT index, according to Barse.

Bank of America Corp. was reinstated in the index in July, he said, after showing “sufficient improvement” in his rating. Wells Fargo & Co. has yet to perform well for inclusion in the XOUT portfolio, Barse said.

[II Deep Dive: How Many Funds Outperformed in 2016, 2017, 2018, and 2019? Less Than 13%.]

Barse founded XOUT in April 2019, with the idea that ETFs were the way for asset management to continue to grow. “It’s the fast growing part of the industry,” he said. Active managers “will continue to be challenged”.

Morningstar’s recent research contains some of the latest evidence that active managers are struggling. The company said in a report this month that “actively managed funds have failed to survive and beat their benchmarks,” particularly over the longer term. Morningstar found that only 24% of active funds exceeded the average returns of their passive rivals in the decade through June.

“Long-term success rates were generally highest among foreign equity, real estate and bond funds and lowest among large-cap US funds,” said Ben Johnson, director of global research on ETFs at Morningstar, in the report.

Barse, who had been CEO of Third Avenue for about 25 years, said he had “fantastic experience” as a mutual fund manager until the financial crisis. The period that followed was painful, in part because “value almost uniformly became value traps,” he said.

It was “seven years of just being tortured – watching our strategy systematically fail, being outperformed by passive indices, seeing capital flows dominated by passive indices,” said Barse. He doesn’t see much of a future for traditional active management.

“Just give it up,” he said.


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