Art Johnson dived headfirst into “quantland” when he helped Dimensional Fund Advisors launch in Canada more than 15 years ago.
The company is run and influenced by some of University of Chicago’s finest, including Eugene Fama, who won the Nobel Memorial Prize in Economic Sciences in 2013.
The partnership began Johnson’s path towards founding SmartBe Wealth and last week’s launch of its SmartBe Global Value Momentum Trend Index ETF, which started trading on NEO on Tuesday and seeks to replicate the performance of the Alpha Architect Value Momentum Trend for Canada Index.
In truth, though, 55-year-old Johnson’s curiosity with quant began decades ago as a young trader and then manager on the Alberta Stock Exchange. A guy dating his sister, and desperate to impress, got him his first job on the floor at 18 and, after university, he was subsequently offered the position of manager.
“I thought, I’m very smart and they’ve finally recognized it,” he said. “But the reality was what they wanted was a young guy who was clever enough to tell the IBM programmers how to automate the trading floor.
“So my first introduction into quant was working with the IBM programmers and I got a sense of how technology was going to transform this thing that had been very static for hundreds of years. It was shocking in a bunch of ways.”
He noticed two things: people’s algorithm aversion and inherent belief computers could not replace what they did, and the opposing reality that change was coming fast. Five years later, trading floors as we know it in Canada were no more.
Calgary-based Johnson thinks about quant as a labour issue and the increased ability of a computer to carry out routine tasks of screening and looking for certain variables. It’s no surprise, therefore, that he disagrees with critics who believe algorithms will accentuate and accelerate a market crash, and points to the way technology has simply changed, rather than hurt, the investment landscape.
A veteran of the 1987 crash, he remembers how the onset of tech-fuelled global investing influenced it and how after the meltdown, breaks were put in place to halt the market if it suddenly dropped.
He said: “What algorithms will do is make stocks trade differently. It’s no big deal. They will actually trade a little less volatile, I would argue, when it goes into an ETF because a large ETF holds the stock as opposed to portfolio managers, who are in and out of stocks a lot more.
“You have to know, however, that it trades in a more systematic fashion than it would with people – it’s just different. It’s not that anything has changed – it just went from a portfolio manager’s portfolio to an ETF now. It’s just held differently.
“People think that this new entrant has come into the market and is displacing things. It actually is not. The ownership just went from what used to be a guy that was probably closet indexing and charging you too much over to an exchange traded fund. And that guy lost his job because, to be quite honest, his labour for the amount of value you got out of it was too expensive.”
After working with Dimensional, Johnson got to know Wes Gray from Alpha Architect, who had started working on his quantitative algorithms with a large family office that wanted to replace processes used by hedge fund managers in order to save costs.
Johnson said that through understanding what Gray was doing with momentum and value, he was bringing a level of screening into the ETF process he hadn’t seen before.
He said: “I always want to be anti-black box; I want to be radically transparent. If someone is transparent and showing me the data, I can understand if the model is wrong. If it’s a black box, I can’t tell.”
Quant is heading to more concentrated portfolios with robust and sophisticated screening. And what sets SmartBe’s ETF apart, according to Johnson, is how it builds a number of different portfolios into the product in order to promote better behaviour from the investor and stop performance-chasing from one ETF to another.
At its core is an Index that is based on three factors: value, momentum and trend-following. Value is a strategy that focuses on the common stock of companies with low prices relative to fundamentals, while momentum focuses on the common stock of companies that have strong relative past performance. Trend-following, meanwhile, is a risk management technique that advocates investing in equity markets when the trend is positive and moving to lower risk assets when the trend is negative.
The latter practice is vital, said Johnson, who explained how the market has to have already started falling before SmartBe will buy your insurance of a treasury bill or a bond. He said: “Instead of trying to predict when the market is going to crash, which is what an active manager tries to do and I would argue everyone gets wrong, we are saying the cow has to stick its head out of the barn before we are even going to buy the insurance. Then the shoulder and head has to come out before we go 100% to cash.”
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