Episode 68 - Value Investing in Public Equities with Dave Beatty
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Today’s guest is David Beatty, co-founder and managing partner of Veriti Management. On today’s episode, he is going to share the value of Direct Index for helping Faith Driven Investors screen for deals that reflect the investors’ Christian values.
You’ve heard of positive screens and negative screens, but Dave joined us to explore how Faith Driven Investors can invest at a high degree of excellence using both positive and negative screens, as well as using direct indexing to customize their filters.
If you’re interested in public equities, or already involved, today’s episode is for you...
Episode Transcript
Some listeners have found it helpful to have a transcription of the podcast. Transcription is done by an AI software. While technology is an incredible tool to automate this process, there will be misspellings and typos that might accompany it. Please keep that in mind as you work through it. The FDI movement is a volunteer-led movement, and if you’d like to contribute by editing future transcripts, please email us.
Dave Beatty: It's just common, you know, have you ever disagreed with someone about what's allowable behavior and, you know, the chapter really encourages us to come at it with love, and I'm both convicted by that. And also doesn't say, though it doesn't deny Paul is really one who ate meat and thought it was fine. So he wasn't saying both positions were right. He was talking about how we love one another. So I've just been thinking about how that applies and the work we're trying to do together and Faith Driven Investor and.
Henry Kaestner: Welcome back to the Faith Driven Investor podcast. I'm here with Luke, my partner, Sovereign's Capital
Dave Beatty: Luke, welcome.
Luke Roush: Wonderful to be here.
Henry Kaestner: It's great to have you back. And we've got Dave Bayti in the house all the way from Boston, Massachusetts. Dave, thanks for being with us.
Dave Beatty: Thank you for having me, Henry.
Henry Kaestner: So today's a big deal. We're going to get into an asset class and investment strategy that is doubly new. Number one, we rarely talk about public equity investing and then as a subset that we've never talked about, direct index investing. And so we're going to do both of those. And the reason why I think that this is super important is that while we all do get excited about private equity investments because of the ability to work with the company owner and being able to really talk about chaplaincy and faith driven employee resource groups and just the individual discipleship of the entrepreneur that we're working with, most private equity investments are not accessible to 90 percent plus people that would want to get into faith driven investments. The minimums are too high. The lockups are too long. A whole list of reasons why a lot of times private equity investments aren't successful. And yet where we're coming to understand through the leadership of people like Dave and others is that we can get a lot of the spiritual integration we're looking for in our portfolio from public equities as well. And that's because public equities are run by Christ followers. Many of them are where there is somebody like a Pat Gelsinger from VMware is really serious about his faith and really serious about excellence in the work that he does. And there's just great spiritual integration in play. And to help us to understand the world of public equity investments and then in particular, as I said before, direct index investments. We've got Dave Beedi with us on the program. So, Dave, thank you very much for joining us.
Dave Beatty: I love the topic. Love you, Henry, and look forward to the discussion.
Henry Kaestner: Thank you, brother. So before we get into what you do right now, Varity Daintree, some of your companies start at the beginning. Who are you? Where do you come from? You found yourself on the Faith Driven Investor podcast. So presumably your Christian faith is a part of your life. When did it start? Help us understand who Dave Barry is.
Dave Beatty: Well, you know, I'm an old guy, so I should think what's really relevant here, maybe I'll organize it by some places that were turning points for me and faith that connected with values or place kind of the nexus of faith and vocation kind of around that. I'm remembering when I was I was probably like 13. You know, I'm in middle school, which means it's already difficult. Right. And my family was one of those that provided meals, but never any other time, really. And I only prayed when I needed something. And I remember this distinct realization like this probably isn't how it's supposed to work, either I need to be all in or I'm not in on this thing, you know, kind of a matter of my conscience. Right. And so actually, soon after that, I really went deeper with God. So that's one turning point I remember. And then another one would be in college. And I was good at science and I chose to do the humanities and history and government and that kind of thing. This isn't the way you should think about things. I'm just confessing how I I was thinking, gee, you know, if you're a scientist, you just get stuck in a lab and you're not really where decisions are made and where you have those choices about what matters and have influence for God. So I studied history and so forth. I thought process. Right. And then I think and grad school kind of a similar thought process. And I studied not for profit management, or at least that's what I started at business school. And it was very conscious, like, how can I make a difference for God? I'm not saying that was a good choice. In fact, I found out it wasn't later because later in my 20s, I was working for a not for profit and I was a controller and I just had the distinct impression, you know, I'm really not making a difference here and this doesn't really suit me. So I quit my job and just did consulting. Well, I kind of took a semi sabbatical and thought God and read books. And I mean, I'm an action guy. So doing this is actually kind of hard, you know, like take time to think about it and talk to people and pray, you know. And I kind of realize I think I want to go into finance. It's where I have talents is where I have interest. And there's all sorts of moral ambiguity and ways to influence things for God. So that's when I got engaged. I could tell kind of how that path went. But eventually it ended up I started a company, multifamily office,
Henry Kaestner: say that last part again, I'm just in front of myself, just kind of gravitated towards that statement. I'm drawn into finance because I'm good at it. I'm interested in it. And there's all this moral ambiguity. Say more about that.
Dave Beatty: Well, it was the sense I was thinking of going into personal financial advice for. And I saw how, you know, the typical advisor was somebody at Goldman Sachs or Merrill Lynch, and I kind of comprehended the conflicts involved and how could it be done differently? And I just like there are unending questions of what it means to follow God in those circumstances. I'm interested in that.
Henry Kaestner: So if you're at Goldman Sachs, maybe I'm being presumptuous or prescriptive here, but if you're one of the traditional Waterhouses and you get paid on assets under management is probably morally ambiguous for you to think about suggesting that your client lean into their heart and give away 20 million dollars to their favorite African orphanage,
Dave Beatty: they can be giving the money away. And of course, you know, I'm an old guy. So this is back when commissions were dominant. So just the fact of you got paid on whatever you recommended and that was a conflict. And I actually started out wanting to study taxes because a lot of taxes permeated issues and they were often ignored. And that's kind of the backdrop for how I happened to be a very doing direct indexing to get you. You know, it's a matter of conscience, you know, and that's part of what we're dealing with in Faith Driven Investor.
Luke Roush: So direct indexing is something that's probably a new concept for some of the listeners of the podcast. Could you give them just a brief overview of what it is, how it works and how you use it as sort of a screen or filter for some of your clients?
Dave Beatty: Sure. First of all, know that it's just hot right now. The two biggest companies in the space are being sold and that's just got announced in the last couple of months. And it's that Parametric and Aperio. And I could talk more about that. Direct indexing has been around for quite a while, but not really big. So it's natural you might not have heard of it. It really means you're acquiring the public equities in a separately managed account. But think of it as mimicking what an index fund or an ETF would do. So I would describe that as writing three ways. The passive wave or indexing the second wave would be tax efficient and the third way would be around values and ESG and all that. It's writing all those waves in one package and I explain how it works, but that's the big picture of what it's doing.
Luke Roush: How individualized is your approach at Varity or is it is it something where, you know you've got a menu and people choose off the menu, or do you actually consult with them to try to understand for believers who are clients or others who are values driven in different ways? Maybe just speak to a little bit of how you help folks arrive at the right product, so to speak?
Dave Beatty: Yeah, typically, Luke, what do most people do? That's where people start because it's so complicated. What do most people do? They just want to know it's possible. That's the first step. But if you really want to get into it, you can customize it however you want. So, yeah, we have menus. My goodness. We had a I say client. We really have advisors are our clients and their end clients. So this is an end client working with advisor and they're coming from some faith perspective, but they're also Armenian. And they were like, I don't want to invest in Turkey. So they went deep down that path and now they have nothing niche. Yeah. So they could express that in their portfolio. And that was tremendously satisfying and motivating for them.
Henry Kaestner: So I happen this goes hand in hand with some of the other things that might be obvious to some about investing in terms of tax harvesting and some of the other controls that you give and maybe just go through that real quickly. So somebody listening to S.C., I think I get it so I can invest in an index. I understand that the index tends to be two thirds of the financial managers anyway, and index team can have really, really low expenses. OK, help me to understand, what are the three or four things that a parametric or a verity can provide you that make this really super compelling? It's such a hot space right now.
Dave Beatty: Yeah, that's a good way to ask it, Henry. I find most people that can't get to the values until they understand the core part. So let's say you didn't even care about the value slice. Like I said, two waves. One, it's just it's an index product. So you want to get the results of the index and let's say it's five hundred. Can I invest in it at low cost? Well, of course you can. You can go buy the spider ETF, that really low cost or whatever vehicle. So why would you do something else? Well, you can if you had enough money, you can just go replicated in your own account. You buy all five hundred stocks in the right proportions and you get exactly the results of the index. You can do that. Well, why would you want to ETFs just fine? Well, if you had enough money and you can do that at low cost, all of a sudden you can add tax benefits because you can get first thing we do is we do sampling. You don't have to actually buy all five hundred to get the same results. You can buy a couple hundred. And using statistics get very close to. The same results. So that's the first step. The next step is, and you still have some oil stocks, you still have some tech stocks, you still have some consumer stocks, but if you classically cook goes up, Pepsi goes down, you can sell Pepsi by Coke and still be mimicking the index so you can actually harvest losses. Sometimes short term losses get a tax benefit now and at least defer taxes, and it's surprising the benefit and I could go over that. So that's the reason you have a separate account. You're using sampling and you get the index results, but better even after your expenses. Your result after taxes is better than you can get with the ETF. So that's step one. And once somebody becomes convinced of that, we say, well, you also can express your values. And it could be anything, could just be environmental concerns. It could be your issue is abortion, whatever, because you're sampling. It helps you imagine it. Oh, you mean I don't have to buy every drug stock I can avoid Johnson and Johnson, that manufacturers abortifacients and buy this other drug stock and still have exposures and still get the results of the index a little more? A little less maybe. But really close. Yes, you can do that.
Luke Roush: How do you think I'd love to just have you expound on that a little bit, that the S&P delivers eight percent this year and you've got someone who is not incorporating their values. How do you think about sort of the bips benefit of being able to do tax loss harvesting relative to maybe like an eight percent benchmark? And then maybe also talk about two different scenarios, someone who's really narrowly defined, like I'm really sensitive to abortion and alcohol and tobacco and gambling and all these things. How do you think about the likely track near for them versus and then maybe somebody else who's not so narrow but does have a couple of issues that they're really sensitive to call it sort of abortion and perfectly OK.
Dave Beatty: So your first part of your question is around essentially the benefits of the tax. Is it really worth it? And then we'll shift to the values on the I'm calling it tax. So that's my lingo. You know, you don't know what investment Alpha is will on taxes if you're saving taxes. We're just calling that the alpha. And if you can save present value about one percent a year on your taxes, that's real money. And if the cost of the direct indexing is a fraction of a percent, so your tax benefit is usually multiples of your cost
Luke Roush: down to 70 or 80 bips on an eight percent base. Is that accurate?
Dave Beatty: Yeah. If you had a target and remember, we do have tracking here. So if the index got eight percent, well, most of the time you might be between seven and nine. On average, you still have eight. And then you have tax alpha, let's call it on average, an extra one percent will after taxes, you're really getting, you know, better. Now, what makes that even I could give you lots of detail about what makes the tax AlphaBeta worse. It actually diminishes over time. It's usually a lot more than one percent up front. It's less later. Another thing to understand is if you're charitably minded, I could explain how, but you could double your tax benefit. So it could even be more than that, approximately one percent. So it's for real. It's predictable. No investment, alpha, hard to predict. Tax Alpha, very predictable. Even in up markets, you still get it. So that's the first part. Is it OK to move over to your question on the value?
Luke Roush: Absolutely. Absolutely. Thank you.
Dave Beatty: OK, yeah. If you have those concerns, you listed a few and the ears were kind of the classic conservative Christian. You know, I want to screen out a few things tobacco, alcohol, etc., abortion, maybe those usually. And we could show you a menu. And actually, how many would drop out of the S&P 500 when you did those restrictions? That's not going to increase your tracking error around the index. Every time you take something out, you screen it out. It means you've reduced your universe, which means we have fewer tools to work with in trying to still mimic the index. So, yes, it ups your tracking error a bit, Luke, but we can estimate that change. And I've never seen anyone balk at their when you can have a problem, if somebody just says, you know, you're taking lots of stocks out of your universe, say you say, you know, it's not just you low carbon, it's I don't want anything with carbon in it. You take up all the oil stocks, you start up and you're tracking your substantially. You can see where I'm going. And we can always estimate that for people ahead of time so they know what they get into. Even in our menu, it kind of shows you how many stocks might I weed out if I have that exclusion.
Luke Roush: That's helpful. So, Dave, I'm going to ask an obvious question then I want Henry to chime in. But we have good clarity on why many investors choose not to do either real estate, invest in your private equity venture investing just because of the long whole time, illiquid, high beta or high binary outcomes. But why doesn't everybody do this? Maybe just speak to that. It seems everybody holds public stocks or most people hold public stocks. What's the constraining factor?
Dave Beatty: Really? Good question. One, there is an issue about minimums. It's so easy to just go buy the ETF. And it's cheap and it's easy and direct indexing, the minimums are coming down, but typically start thinking you need at least two hundred fifty five hundred thousand dollars in a separate account to do it. So that's a deterrent. Most of the rest is honestly, I just think people becoming accustomed to it. It's really hot. Now, look look at the sales that just happened of the two biggest players in the space. There's a reason that the biggest players, Parametric and their parent, Eaton Vance, was just announced in the last couple of months to be purchased by Morgan Stanley. And just in the last couple of weeks, we heard the second biggest player in the direct indexing Space Aperio, an announcement of their acquisition by BlackRock. And all the biggest players you can think of in financial services are pushing hard into this. They see it answers the trends and ESG customization, personalization. It is a big movement. If people aren't paying attention now, they will be.
Henry Kaestner: So if you're listeners from Goldman Sachs, listen to that. Here's the time they Badi Varity management. They're the number three guy out there in the space. You snooze, you lose. TOTUS is a is a Christ follower. As you look at and have looked at the public equity market. What are the opportunities that you see for somebody driven by their faith to not only necessarily say no abortifacients or nothing that has makes money on pornography? And actually, before I go there, do you have the ability to when somebody comes to you and says, listen, I know that I know that I don't want to be involved in pornography, but I have no idea which of the companies in the S&P 500 might benefit from that and where that might be de minimus. Do you have resources analyst, something where you can go back and say, OK, well, X, Y, Z company has gets two percent of their income from adult entertainment or somebody else gets a trace amount, but it's less than one percent and maybe it's de minimis. Do you walk people through how they can go ahead and say, OK, yes, that's right. I want to get that screened out or do they need to come to you having already done their own research?
Dave Beatty: Most of the time they come to us and they can work off the menu and we can help them with that if you take it. I'm not sure what example to use, but first, let me describe what's possible. Even on our menus, we have essentially strict and broader exclusions. So you can say in this area, I just want to have zero tolerance or very tight. I don't want to get close to abortifacients in another area. Maybe it's around alcohol. You're saying I'm interested, but help me understand the area and we could help someone understand. There's the manufacturers, the distributors. Here's the impact of advertising in the space. Advertising is the one of the most predatory effects of the industry. You know, it's often very specifically targeted in inner city neighborhoods next to a high school, et cetera. You know, we can go through some of those in education about the space and then we can show them how to apply it. It can have materiality limits that are based on just percentage of revenues. They could have materiality limits that are based on district dollar limits. I want no more than X dollars of revenue. Does that give you a window into it, Henry?
Henry Kaestner: No, I think that that's good. So in many cases, you're able to guide somebody through this process to go then let's take the other places headed, which is as a Christ follower, understanding that Christian leaders have an impact to make, have the ability to make an impact in really any sector of life in the military, in the arts, in government, and then also in business. What does it look like for Christ to say, I want to invest in leaders that share my values and maybe it doesn't have to do with a specific product or category, but maybe it's the type of leader want you riff on that a little bit. And just when you see the future of the industry and some of the different things that you're looking at, Varity, give us a sneak peek into how you're thinking about advising clients, maybe some of the new product segments that you think might be able to be possible for the Faith Driven Investor.
Luke Roush: That's going to also try and just interject. That's also going to tie into this idea of how do we move beyond just things that we're trying to stay away of, but how do we identify leaders that are positively impacting the world that they're operating within?
Dave Beatty: OK, that's great, Luke. But back to your question, Henry, I have to say, I think you've educated me on that more than I can educate you, because Verity is like these other companies. We start with publicly available databases to help people with their screens. And we don't have good databases on Christian leaders and companies. And some of the perspective that you've drawn, we are working on some of those things, but we don't have it off the shelf. So it's not easy to be my first answer on that.
Henry Kaestner: But it's in development, right?
Dave Beatty: It's in development, yes. With your help and there's other places, look, you're getting the positive and negative screens like one of the positive screens we're working on with our partner. Bright Light is a positive screen around racial reconciliation. Henry, I know you and your team, you've been very interested in the positive screens and how can we approach it, and that's really appealing. In the past, traditionally, most of the best data is to help with negative screens. We do have positive screens. We have ESG data. And I could talk more about that. There's a lot to talk about there. We have the UN Sustainable Development Goals, the UN Stig's that we can use positively, but we're working on how we can use more positive screens. But there are all of the peace, the positive and the negative together are what best help the investor apply their values.
Henry Kaestner: Tell us, what does that look like? How do you invest positively towards racial reconciliation? How do you say, gosh, Coca-Cola program towards racial reconciliation is outstanding, but Delta is not so much or vice versa. What does that look like?
Dave Beatty: I'm not going to give you a very complete or intelligent answer yet, although I think we're close to being able to roll it out. But I would say it reflects some of what else we see in the marketplace. The ESG positive screens come from lots of companies. This is a very indirect way of answering and they're problematic. What the data is, they're usually very dated, 12 to 18 months plus old. They're self reported. They're defined very differently by different players in the marketplace. The cross correlations between some Mkhize ESG data and another is usually in the order of like point five, five to point six for your investment. People here well, understand that's very low correlation and environmental scores. It's higher. But when you get into the governance once, like, are there women on the board and so forth, there's a few that correlate highly. But the labels are inconsistent. It's very difficult area to apply. So I think the first thing I would meant is this industry still has a long way to go. There's a lot of efforts you may be reading about to try to synchronize how we define ESG and the kind of force, a certain point of view on companies about how to approach those issues. And sometimes for Christian investor, those can be very welcome and sometimes they may not be. When you dig underneath, they may not align with your values. So I think that's one of the things Varity is trying to work at, is to try to make these things less opaque for the Christian investor so they can understand them and make those choices. And we're trying to make the right filters and screens available to those Christian investors. Very serves anyone I'm saying. But there's a particular gap in the marketplace in what's available to the Christian investor.
Henry Kaestner: Let me just ask this. Another kind of fundamental question back to direct investing is presumably something out of our listeners are having the wheels turn in their head, say I am just drawn to regional investing. I want to invest in the heartland. And so out of five hundred companies, maybe two hundred and twenty of them are headquartered not on the coast. And that's just where I'm drawn to. I'm just coming up with an example. If I came to you with a list of two hundred and twenty, could you tell me if I gave you that list, all the stock samples get uploaded into this incredible cloud computer that you have. Could you then come back to me and say, well, Henry, based on that list, our data would tell you that you're likely to be within four hundred basis points of the index or three hundred. Can you give that type of a sensitivity analysis? Because I'm intrigued by what you're saying before, which is you don't need to have all five hundred of the companies to approximate the returns of the S&P 500. You can do it on something less. So does your technology allow us to be able to say, if I give you my custom list, this is how close you can expect to track it with plus or minus in error?
Dave Beatty: Yes, and that's not very technology. We have to layer technology onto the tools in the marketplace. But there are a number of tried and true third party tools that have been in use for decades to do exactly that. So if we did the screening and it was companies in the Midwest, etc., and we got our reduced universe, the tools do allow you to come back and predict. And you told us my benchmark is Russell one thousand or whatever you said we'd say how much the universe would be reduced and what your new tracking error would be. Yes, that's tried and true technology that we can use.
Luke Roush: So as customers kind of come inbound to you, you talked a little bit about just asset thresholds that people need to be able to meet for today. It makes sense for them. What are most people coming in asking for? What are the first two or three questions? And maybe that's illustrated for some of the investors who are listening to this interview to understand how they might be able to either send folks your way or have a conversation about direct investing in a values driven manner with some of their clients, maybe just kind of where do people start?
Dave Beatty: Typically, remember, we work with both. Investment advisers and with institutions, when the institutions come, it's always they come in with their values, they want applied and it's very targeted and specific. When an adviser comes, it depends. And we've had advisers come in and all it is, it's only about tax. So that's what drives it. That's what they want to get. And we do that for them. And then some other advisers, it's mostly Christian clients, and they've had some client who's really important to them, that this issue is important to them when they're finally realizing, you know, Verity can help us make this client happy. It could be they have a tax transition issue because the direct indexing is a great multitool. It's not just put cash in the account. You can have a sum manager that's not done well for them, an active manager pick it and they want to migrate it to passive. And we can take in those positions some very low basis and migrated into a direct indexing solution with a lot lower transition tax cost than they otherwise would have to pay and start layering in values or whatever they want same time. So it's a real multitool to solve lots of problems with advisors.
Luke Roush: Makes sense to me. I think as advisors, there's clearly margin pressure in that industry and I think there's a lot of folks that are reevaluating how they align either with the White House or go independent and have a little bit more flexibility to deliver more customized solutions to their clients that they can't maybe instead of a major White House. So I think that the value for our eyes is very clear to me. Is that where you see most of the growth in your sector? Is that why these other two front runners got bought?
Dave Beatty: Most of the growth has been in private client assets, but I've been surprised at the trajectory we have in the institutional space, and that's with mostly faith based clients. And Verity is very responsive to that. So that's been a thrill for us. If you look at the major players, Parametric, I was talking to one of the parametric staff just within the last well year and a half or so, and they said it was only about 10 percent of their overall assets that were being applied with values, which is a remarkably low percentage for all the talk you get in the marketplace. So that's changing. But that gives you an idea where the industry is now.
Henry Kaestner: Yeah. So, Dave, I'm grateful for a time. I'm grateful for you helping us understand direct indexing the opportunities. I hope that our listeners are thinking about different ways that this can apply to their portfolio and what are the different ways that their values might be able to impact the type of portfolio that they put together that would look to an index, take advantage of some of the tax harvesting that you're talking about, and participate more generally in the public equity space. Because, again, so much of our focus on this podcast has been on the private equity space, which continues to be really, really compelling. But we find, of course, that our faith can guide us in every asset class, how we do our real estate investing, how we do our private equity investing, of course, how we can now understand how to do it with our public equity investing. So thank you for that. We look forward to staying in touch with you, hearing about the developments that you're seeing in the market and just how Faith Driven Investor might be able to apply this to their portfolios. We'd like to close out every one of our interviews with asking our guests what they're hearing from God through his word. And it doesn't need to be this morning, though. It could be, but sometime within the last week or so where you really feel that God is speaking to you and then maybe some area that we can be praying for you about.
Dave Beatty: Thank you. It's interesting because in just the last couple of weeks, I was marinating a bit on Romans fourteen. Now that's where it talks about the strong and the weak brother, you know, who thinks that they can eat meat and who thinks that they shouldn't and so forth. And it really does apply to the conversations we have around faith based investing, you know, to not judge one another, even when we have different opinions. It's just common. You know, have you ever disagreed with someone about what's allowable behavior? And, you know, the chapter really encourages us to come at it with love. And I'm both convicted by that. And also doesn't say, though it doesn't deny Paul is really one who ate meat and thought it was fine. So he wasn't saying both positions were right. He was talking about how we love one another. So I've just been thinking about how that applies and the work we're trying to do together. And Faith Driven Investor
Henry Kaestner: says very interesting. So maybe the extrapolation of that, of course, is somebody might say, gosh, my faith tells me that I shouldn't invest in anything that has a carbon footprint or it produces things in somebody else might not have that. And what your application is here is that let's not be judgmental necessarily. Maybe there's some other areas that are maybe less the greater, but maybe not. But you're. Larger point is, what I'm hearing from you is that you're hearing from God that we're to be known for our love for one another, not to judge what is helpful for somebody to come to know God in one instance may be different for somebody in another instance. And so let's make sure that we're erring on the side of loving and understanding and not judging.
Dave Beatty: That's right. And whatever our opinion, all of us, in the end, the Romans, 14, says, you know, every need shall bow and every tongue give praise to God, whatever our opinion, which is probably a good note to end on. Indeed. Indeed.
Henry Kaestner: Dave, I'm grateful for you. Thank you.
Dave Beatty: Thank you, guys. So good to be on this journey with you.