Even the biggest and most successful investment firms need guidance sometimes.
That’s where Rob Arnott comes in.
Serving as chairman and chief executive of Pimco subadviser Research Affiliates LLC, Arnott has made such a name for himself that even the industry’s foremost experts rely on him for advice.
While his firm doesn’t directly manage assets, it provides ideas for others. And the list of Arnott’s licensees is a who’s who of investment elite — Invesco, Charles Schwab and, of course, Pimco. In total, those firms oversee more than $200 billion using fundamental indexes maintained by Research Affiliates.
This set-up is no fluke. For years, Arnott has spread the gospel of an investment strategy known as “smart beta,” which has evolved into one of the world’s hottest investment strategies.
More specifically, these firms license indexes maintained by Research Affiliates, which employ a technique pioneered by Arnott known as “fundamental indexation.” It’s a practice that involves buying high and selling low, and then using that rebalancing as a source of alpha. After that, any time the link between the price of a stock and its index weighting is broken, the strategy sells on strength and buys on weakness.
And while legions of copycat strategies have popped up under the “smart beta” label, it was Arnott’s initial efforts following the tech bubble that gave rise to what’s now a $730 billion industry.
But don’t confuse Arnott’s more academic efforts — he’s published more than 100 papers, by the way — with a lack of market prowess. He watches macro developments like a hawk, constantly fine-tuning asset-allocation decisions that help dictate his investing worldview.
An area of the market with huge future potential
In order to locate the area of the market favored by Arnott over the long term, one has to travel to the far outskirts of current market consensus. That means coasting past areas being touted as sure things, like US stocks, which many experts across Wall Street say will continue to climb despite recent headwinds.
Arnott ultimately wants to steer clear of any asset he thinks could be classified as being in a bubble— or even anything that comes close. While US stocks don’t meet the traditional definition, he says that certain slices are undoubtedly in bubble territory.
In the end, Arnott is on the hunt for bargains. And since he’s allocating assets for the long term, he can afford to invest in areas that are flailing today, but offer massive future upside.
With all of that established, it’s time to reveal Arnott’s big investment pick going forward: emerging markets.
Business Insider recently spoke to Arnott and got the details around his big contrarian recommendation. Note that his responses have been edited for clarity and length (emphasis ours).
“We’re in a world where most assets are fully priced, and others are very expensive. There are a number of areas that are sensibly priced, but there aren’t a lot of bargains. The best opportunities in terms of objective measures of value are in the emerging markets — stocks, bonds, and currencies are all trading cheap.
You’ve got one-third of EM stocks trading at less than six times cash flow. If I’ve got Tesla trading at 47 times fantasy, and one-third of EM stocks are trading at less than six times cash flow, I think I want to own this.
The Shiller P/E ratio for fundamental index in emerging markets was below 6. It’s still below 10. That’s cool. If you can buy more than half the world’s GDP at less than 10 times sustainable 10-year average earnings, you don’t necessarily ask the question of whether this is precisely the right time to buy. You say, this is the best pricing I can find anywhere in the world, so you just do it.
Am I going to be right in the coming year? I don’t know. In five years? There are extremely high odds. Let me do that, and let me be patient. Patience is arguably the biggest lacking element in investment management today.
Our bias in favor of EM value stocks got whacked over a couple weeks. Did I panic after that? No. It just meant it was cheaper — time to top up a little bit.
Our approach to investing currently brings us in the direction of big overweights in EM stocks, bonds, and currencies, and a big underweight in US equities. Is that going to work for us and our clients this year? I have no clue. If it doesn’t, I’m going to ramp up the size of the bet. I like the analogy of a coiled spring.”
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