With John Reese, Founder of Validea.com, Author of The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies
John Reese And Validea
John Reese holds a Harvard MBA and a Computer Science degree from MIT and is the Founder of Validea.com, a website that aggregates the investing strategies of Wall Street legends such as Peter Lynch, Ken Fischer, Warren Buffett, Marty Zweig, Joel Greenblatt, and others, providing deep strategy, portfolio, and individual stock analysis, among other research tools. You can find out more about Reese’s actively managed ETF, an unusual hybrid fund, which blends 10 strategies from 10 different “Wall Street legends” on https://www.valideafunds.com.
Some of John’s goals for Validea are to help make the strategies and historical track records of some of the most successful professional investors usable and understandable to individual investors; to offer strategic frameworks that help investors overcome the emotions and biases that lead to abandoning and switching strategies; and to offer an ETF—named Validea Market Legends ETF—which executes a method or set of rules based closely on the books written by these investing gurus, rules that define criteria for stock evaluation, selection, and portfolio management.
From MIT Artificial Intelligence Lab To Learning About Investing
Asked to tell the backstory of Validea, Reese starts by talking about his early efforts at MIT’s artificial intelligence lab to extract wisdom from books and create programs that could then do things by following rules and instructions derived from these books. Many years later, after getting burned in the stock market and deciding to broaden his education about investing, Reese came across Peter Lynch’s book One Up on Wall Street. Because Lynch’s track record of out-performing the market and competitors was so well established and because the book was exceptionally clear in detailing the methods he utilized in his mutual fund (the most successful one of his era) Reese decided to revisit his AI experiments and find out if he could translate Lynch’s advice into algorithms that a computer could follow. Encouraged by the success of this project, he decided to move on to books by other famous investors: first Benjamin Graham’s Intelligent Investor, then to others like Warren Buffett, Ken Fisher, Marty Zweig, and more. With Graham’s book, Reese was able to integrate a database of 6000 stocks and write programs which would scan through all this historic data to find out where they were consistent with Graham’s strategies.
Teaching Computers To Understand Texts On Investing Strategy
Steve wonders how Reese is able to distill and replicate the strategies of some of these legends who did not write with as much painstaking organization as Graham and Lynch. Reese says the main thing is that he carefully reads the books by these gurus over and over again until he understands exactly what they mean, and how they execute their process. It’s not always easy, Reese admits. Sometimes they’re just not clear enough to reduce to a rule, as would be the case if, say, they recommend buying a low price/earning stock. A simplistic statement like this involves too many unknown variables, for instance, do you calculate earnings based on past or future performance? Reese gets his code to replicate the exact method and criteria of the investment strategy as closely as possible, and then checks on stocks mentioned by the investor legend to see if they fit the model described.
Sticking With A Strategy Vs Chasing Trends
Steve talks about the difficulty of sticking with dependable but somewhat boring strategies when markets are on fire with growth stocks, not just for individual investors, but at every level of the finance industry, from financial planners to brokerages and banks. Reese believes that investors ought to try to educate themselves on investing strategies so that they are not so prone to jumping ship when everyone else seems to be getting rich, or your own portfolio is sagging. He brings up the example of the dot.com bull run of the late ‘90s where value investors felt themselves being used to mop the floors, and virtually everyone else in tech stocks thought they were a genius. That rout ended with a 95% loss. The main takeaway is that it’s imperative to stick to a long-term, winning-but-not-always-spectacular strategy through thick and thin. Steve mentions how institutions were feeling tremendous pressure during the dot.com era to shift their offerings towards tech stocks. Merrill Lynch finally caved and launched an internet stock fund, and it quickly raised over a billion dollars. In fairly short order, however, it was obliterated, and the fund essentially disappeared. Reese agrees with this assessment, cautioning investors “not to look for the most recent things that have tremendously high performing gains or appearing to be popular in the media.”
Validea Market Legends ETF
In December 2014, Reese and Validea opened an ETF – the Validea Market Legends – which incorporated decades of work designing sophisticated models based on the portfolios and strategies of the all-time most successful investors. The ETF is something of a fund of funds; it’s composed of 10 portfolios, each based on a different legendary investor’s strategies, with each of those portfolios containing 10 individual stocks. Each portfolio is managed using a monthly evaluation based on that particular guru’s methods, and this determines whether a stock stays in that portfolio or is dropped.
Hybrid ETFs: Taxes, Fees, And Active Management
Reese notes that this process does not trigger capital gains taxes in the same way that sales within mutual funds do, which helps keep the costs down. Steve asks about internal costs – aka management fees – and Reese says they’re a modest 0.79%. Steve notes that that’s quite high for an ETF, and Reese avers that they should be compared with actively managed funds instead of ETFs because the Market Legend funds are in fact managed twice. Reese concedes that this fee demands that his fund returns an extra, offsetting 0.79% to make it more attractive. Steve comments on how this ETF has characteristics of both an ETF or index fund and an actively managed fund freighted with higher fees. Funds like Reese’s Market Legends fund enjoy the tax advantages of ETFs while still offering sophisticated, active management strategies. The emergence of this kind of actively managed ETFs brings more choices to investors, which is in most ways a decidedly good thing.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: I’ve been in the investing game for over 30 years and I’ve seen a lot of so-called gurus who soar high and then crash—and they take their investors with them. However, there are those who have created much wealth over the years and they continue to create it after weathering storm after storm.
So there is something special to their disciplines and the way they think about investing. Now, some of these investors and books about these investors are listed on our website as a resource for all of you to learn how to get things right. These investors range from Warren Buffet to Ken Fisher to the Martin Ford and some other who may not even have heard of.
Each investor is characterized by having a set of rules of disciplines which have served them well over these many years. So, what if you could find these strategies all in one place?—one ETF or Exchange Traded Fund which uses these rules that either have been written by the gurus themselves or by others who have studied them.
What if you could find one place to invest in this? Well, I think I’ve found one. It’s new and it’s quite interesting, and I’ve asked the founder to talk with us today. He is the founder of Validea Market Legends ETF. His name is John Reese. Hey, John, welcome to the show.*
John Reese: Steve, thank you for inviting me.
Steve Pomeranz: So quickly tell us about the background story on Validea.
John Reese: Well, it starts when I went to MIT and worked in the artificial intelligence lab there, with the goal of extracting the wisdom from books and making a computer program smart enough to actually do what the book actually said.
Steve Pomeranz: Mm-hm.
John Reese: Many years later, after going to Harvard Business School, I was going at an industry, starting my own technology company, and selling it. I was then looking how to invest my own cash. And I started the way that most investors do. I went to a broker. I got the recommendations.
That didn’t work so well. I started reading newsletters. I started reading out of periodicals. Finally, after reading a number of books on how to invest, I came across one particular one, and that was Peter Lynch’s, One Up on Wall Street. So, here’s somebody who had a fantastic, long-term track record. He grew the number one mutual fund in the world who was able to relay this book step by step.
Steve Pomeranz: Yeah.
John Reese: How he went about taking stocks. And, furthermore, it was specific enough that I felt that I could use that computer expertise, that artificial intelligence expertise that I gained at MIT to actually translate that into code that a computer could actually follow.
And I did that. That worked very well. I then went on to other books, like Benjamin Graham, The Intelligent Investor. And I was able to then attach it to a database of some 6,000 stocks. And now the computers could go through, looking through all the stocks in the stock market, identifying stocks that pass the criteria of these legendary investors.
Steve Pomeranz: I talk to many investors, and I sometimes ask them, “So what is your methodology?” And I’ll often get blank stares. But some say, “Well I’m a growth investor or I’m a value investor.” And some of them may actually try to shadow investors like Warren Buffet. Maybe Carl Icahn is one now that people are excited about.
It seems like you’ve taken this forward in multiple steps by, as you said, adopting these specific principles. I mean, Peter Lynch, one of the things that was really so terrific about his books is, he made his ideas, he laid them out very simply and in a very organized fashion. And made it kind of easy to understand how to set up a discipline. And I know Ben Graham was very lucid on this too, but a lot of these investors really haven’t laid this out. A lot of it, many of them, kind of keep it close to the vests.
So how do you figure out what they’re doing?
John Reese: I look at what they said very, very carefully. And they have to be very clear, in terms of their criteria. For instance, you really can’t just say buy a low-price earning stock. How low is low? What type of earnings do you use when considering the price-to-earnings ratio?
Sometimes you can use trailing 12 months. Sometimes you can use a 3-year average. Sometimes you can look forward. So, I’m able to read and re-read, sometimes five times, very carefully what they said they do and translate that into computer code. Then I look at the examples that the authors usually give in stocks that they purchased, and how well that actually fits in the model, that usually reveals some additional clarification.
So that’s how I get the actual detailed rules, that these legendary investors use, and then implement that in a smart computer program. And as I mentioned, tie that to a database with some stock, and let the computers check which actually matches the criteria of the legendary investors.
Steve Pomeranz: Now speaking with John Reese, he is the founder of Validea Market Legends, ETF. If you wanna hear more about this, or you wanna join the conversation, don’t forget to join us at The Steve Pomeranz Show.
Some of the investors that you’re following, you mentioned Ben Graham and Peter Lynch and Warren Buffet. I remember Marty Zweig from the old Wall Street weekdays and David Dreman as a great value investor.
What other names are you following, that we may not be more familiar with?
John Reese: You’re right, I do run Marty Zweig and David Dreman. I also run Ken Fisher, based upon his 1994 book, Super Stocks. I run Warren Buffett’s, of course, everybody knows Warren Buffett. I’ve a few models based upon James O’Shaughnessy, What Works on Wall Street.
John Neft, the famed manager of the Windsor Fund. Joel Greenblatt wrote some great books, hedge fund net manager, a Stanford accounting professor, and a book based on what the Motley Fool, the brothers wrote on the small-cap value strategy.
Steve Pomeranz: Well, this also sounds great, but there are times when these models don’t work or they’re out of favor and they’re less popular than others.
One time comes to mind as the late ‘90s when growth stocks were just roaring ahead and Warren Buffet’s kind of investing was way out of favor and people were starting to think that he had lost his edge. So, as having these managers in this ETF, does one necessarily offset the other or are they very highly correlated, would you say?
John Reese: There are a couple things to consider. First of all, you picked up on something that is extremely important for people to understand and educate themselves on investing and that is know strategy. And I’ve looked at 250 different strategies. Works all the time, whether we’re talking for a period of years or if we are talking for a period of months.
And investors need to be prepared once they have adopted or decided to go with a strategy that has been successful in the long term. They need to stick with it through what will be the inevitable ups and downs. And that’s very, very, hard for many investors, particularly as they’re starting to just come up the learning curve and learn about investing.
As soon as the strategy they’re in goes cold, they’re ready to abandon it. So, let’s take the period of time that you’re talking about, like the late ‘90s, early 2000s. This was the hot internet phase. And growth stocks, but in particular, the segments of anything to do with Internet-related stocks really took off, leaving what looked like all these value strategies absolutely in the dust.
And if you were a value investor at that time, you were getting hit, not just quarter by quarter, but year after year of tremendous underperformance. You look like a fuddy-duddy, then obsolete. But what happened, those people who continued with the high-grossed strategies, it looked like they were winning because, after all, their one-year returns looked so hot.
End up losing about 95% of their money because you don’t know when to get out of that, but when it crashes, it crashes. And the value investors who look so fuddy-duddy ended up, over that period of time, earning. Finally, when it was all over, about a compounded 18% return per year, therefore proving, stick with the strategy through thick and thin.
And I wanna rephrase that. Stick with the proven strategy through thick and thin.
Steve Pomeranz: Well, I remember seeing bumper stickers back in that time that said hug your value manager. These guys were really feeling the pressure, and I will tell you I want my listeners to think about this, too.
If you have an advisor or someone who’s helping you with your investments, and they’re underperforming because they’re sticking to these strategies year after year, there’s a lot of pressure on them, too, to make you feel better by kind of switching strategies just at the wrong time. As a matter of fact, a little anecdote here: In the late ‘90s after a lot of pressure and a lot of resistance Meryl Lynch decided to come out with an internet fund. They raised well over a billion dollars and then two or three years later it blew up terribly and then it disappeared. You can’t even find it in the records anymore because they kind of like rolled it into another fund and it disappeared. But these firms find there’s tremendous pressure for them to follow the average investors’ desires too, so it’s not just the individual investor that struggles here.
It’s the way the system is set up. Any thoughts on that?
John Reese: Yes, I want to second exactly what you said. It’s really important in invested education to understand exactly that. Because there is so much pressure, both on the media that’s out there and on the financial advisors and on the big brokerage firms to offer what appears to be popular.
When something goes on past a year, the trend goes against them; there is very strong pressure internally, on both large companies and small, to change what they’re doing and to offer something that appears to be working. And the vast majority the time that tremendously hurts investors; it’s the wrong thing to do.
The right thing would have been to stick to their guns for a long period of time. It’s difficult to do that when your clients are saying, “Boy you look really stupid. Why don’t you invest in XYZ?” And if you hear that, not just one year, but two years in a row, and your assets are shrinking, you feel compelled to change what you’re doing.
So, yes, it’s very important that investors understand that pressure and not to look for the most recent things that have tremendously high-performing gains or appearing to be popular in the media.
Steve Pomeranz: My guest is John Reese, he’s the founder of the Validea Market Legends ETF. John, let’s talk a little bit more about that.
And by the way, to listen to this conversation again go to our website and join our conversation at stevepomeranz.com. So this CTF is really brand new. When did it start to trade?
John Reese: It started to trade December of 2014.
Steve Pomeranz: All right, well, we’re here in June, ending June.
So it is a brand-new baby, isn’t it?
John Reese: It sure is. But it is doing very well. It’s met a one-year target. It now has $25 million of assets under management in just that six- month’s period of time.
Steve Pomeranz: Congratulations.
John Reese: Thank you.
Steve Pomeranz: How many portfolios does it actually contain, and how many stocks would you say, about, does it actually contain?
How many stocks?
John Reese: It contains ten good portfolios. So, they’re ten strategies, each of which picks ten stocks for a total of 100 stocks in the ETF.
Steve Pomeranz: Okay, all right. So how often are these stocks traded? I mean, how does that actually work? Is there an automatic rebalancing on a monthly or quarterly basis, or do the formulas themselves kick a stock out and bring a stock in?
John Reese: Once every four weeks, the models look for what are the highest rated stocks, according to the guru’s models at that time. And if the stocks are still most highly rated, let’s say, the top ten, they will basically stay in the portfolio. If they are not the top-rated stocks, they will be unceremoniously, unemotionally, kicked out of the portfolio and a higher ranked one will essentially be substituted that time.
That’s how the balancing process occurred, and we basically use equally weighted positions for each stock.
Steve Pomeranz: Okay, and because it’s an ETF the tax ramifications are minor. Is that right?
John Reese: Yes, and that’s the beautiful thing. If a mutual fund sells a stock at a gain, at the end of the year each fund holder gets distributed some tax gains.
Whereas in ETFs, for the most part, that doesn’t happen. These exchanges occur tax-free.
Steve Pomeranz: Mm-hm. So, the strategy here is to try to earn a higher rate of return and just, let’s say, a classic index. Would that be correct?
John Reese: The answer is yes.
Steve Pomeranz: Okay, and what would be the appropriate index to compare this to?
John Reese: Most generally, the S&P 500 would be the main index to compare it to. If somebody was a lot more sophisticated they might end up using an S&P value 2500 index.
Steve Pomeranz: Okay, now are there any foreign stocks in these portfolios?
John Reese: There can be. We’re allowed to use what are known as ADRs, which are foreign company stocks that trade on the New York Stock Exchange.
Steve Pomeranz: How many do you find are the models actually putting in the portfolio? What percentage on average?
John Reese: On average, I would say about 1 in 10, or 1 in 11 stocks these days are international stocks because they’re considered a really good value.
Steve Pomeranz: Okay, and I guess you’re looking at factors like liquidity.
Are those part of your, well, that would be part of the gurus’ models making sure there was enough liquidity and looking at the balances.
John Reese: Well, in general, we actually applied that to make sure there is absolutely underlying liquidity as one of the requirements for all of the stocks that we trade or put in.
Steve Pomeranz: So, it’s relatively new. I don’t know, but I would gather that you’ve gone through some growing pains, some initial kinks. What has the first six months or so been like for you?
John Reese: No, actually, it’s gone very, very smoothly. We’ve been very, very pleased in terms of how it’s grown and the volume that has been trading, and our ability to implement trades, and we’ve been successful in terms of the performance that we’ve shown even out of the gate here in the first six months.
Steve Pomeranz: All right, what are the internal expenses?
John Reese: It’s 0.79%, very low, 0.79%.
Steve Pomeranz: Okay, so 0.79 in the ETF world is kinda high. Wouldn’t you agree to that?
John Reese: In the actively managed world. Because this is, actually managed twice and not the index fund.
Steve Pomeranz: Right.
John Reese: No, it’s a pretty medium or attracted weight.
Steve Pomeranz: Yeah, for an actively managed fund, 0.79 is about average, I would say, it’s neither way high, nor way low. It’s okay. But again, you got to earn if it’s .05 and you’re at .79, your bogey.
John Reese: We have to make that up.
Steve Pomeranz: You have to make it up.
John Reese: I’ll earn that to make it a worthwhile investment.
Steve Pomeranz: Otherwise, guys, and I’m talking to my audience, then the investments are not worth it if the extra fee you’re paying is not bringing you excess return after you pay the fee. John, one final question. What is the symbol?
John Reese: Ticker symbol VALX.
Steve Pomeranz: VALX, all right.
John Reese: The Validea Market Legends Fund.
Steve Pomeranz: Okay, and I guess Validea is really like valid idea. Is that it, or what? [LAUGH]
John Reese: Yes, actually, that is how the name was actually formed.
Steve Pomeranz: Okay, very good. My guest is John Reece, he’s the founder of the Validea Market Legends Fund.
We’ve been talking about this fund, this new idea. It’s interesting how the actively managed world in which money has actually been moving out and moving into this passive world quite a bit due to the fact that actively manage mutual funds have some inherent disadvantages tax wise and other things.
So now this is an indication of the way the market is moving, taking actively managed portfolios, moving them into this more tax efficient ETS structure. And I think it’s all very good for all investors to have a choice in this particular area. So, choose wisely. We’re not recommending this fund.
We’re not recommending any fund on our show. This is more information for you to research on your own.
John Reese, it’s been a pleasure. Thank you so much for sharing your information with us.
John Reese: Thank you, Steve