Seth Cogswell

And at some point when I was in college and had a few hundred dollars to my name, set up a brokerage account, did a lot of really dumb things, which luckily taught me with a pretty small amount of money that maybe I should actually learn what I'm doing. Read everything I could find. Basically lived in the library. I'd run from math class to the computer lab and, day trade, which is maybe not the best. But did well. Loved it. And then when I graduated, I became a trader in New York. That firm technically created a small hedge fund around what I was doing. So between trading the fund, I did that for a while. And I always thought that was my dream job, partially because of the Market Wizards books.

I don't know if you ever read those, but they always made it seem so amazing to kind of trade on your own. But at some point I realized that I was basically just playing a high stakes video game. Right. For a very wealthy family. And at the best of times, I almost felt like I was stealing money from grandmothers. So it just wasn't very fulfilling. And so I, opted to pivot. My father had been wanting to go off on his own for a while, but he's a very introverted individual. So the odds of him being able to really execute on that, raise money was slim. And so I opted to go to business school to see if it made sense.

I partnered up with the investment management professor there, put it through the ringer and concluded that his strategy was actually far better than even he realized. And despite probably my better judgment and the advice of pretty much every single person I knew, I launched Running Oak with a whopping $800,000 under management. Some of my professors were my first clients, which is cool. But yeah, it was, it was a circuitous path that led to where we are today.

But I quit for very dumb reasons, despite loving it. And so when I graduated from college, I wanted to teach myself how to play saxophone, but I couldn't afford one. So I bought a clarinet for $200, taught myself how to play, played for a few years, and then just sort of, life got in the way. And then recently, over the last two years, my oldest kid started playing. And his music instructor also taught clarinet. And so she took me on. And so, any given Saturday morning, I'm probably online playing clarinet for 30 minutes. Maybe not the most macho of instruments, but the more I learn about it, actually, the more excited I'm about it.

But and then actually recently, I started taking lessons on the tenor sax, too. So that's there's so many benefits to music, not to mention. If done right, and I probably rarely do it right, but it has the ability to kind of speak to your soul. So it's it's a cool it's a cool hobby that I get a lot of fulfillment out of.

But the last thing you want to do is hold companies consistently or assets that should go down. And so, again, that goal is to maximize earnings growth to really kind of up that exponential growth for our clients. But then also nothing kills exponential growth like large drawdowns. And so the focus or that discipline on valuations and then there's an extra focus on downside risk in general. One of the main ways we look to protect clients in that regard is debt. But that's my father actually settled on those simple principles by and large. It's changed a little bit, but in the 70s.

And so it really hasn't changed much. We are effectively doing what he created and has been running for almost four decades. One of the reasons why it hasn't changed much is because it didn't need to. And that's because of the simplicity and kind of common sense nature of the investment strategy. And so that sort of simplicity has led to it being very robust and standing the test of time. So it really hasn't changed or evolved much. When I took it over, I have a lot of confidence in my intelligence, whether it's well-founded or not. We can debate. But I'm very good at making something better.

But on this, I've had to hold myself back. From the very beginning, my goal was to just let it be because it did so well for so long. I had my chance to create something that was better and I didn't. And so it really, what we do right now is almost identical to what we've been doing for four decades.

And I felt that the only way it wouldn't be very successful was if I ran out of money and I wasn't able to pursue it indefinitely. And so separate accounts made the most sense initially just because you can run them very efficiently. And there were a number of benefits. The ETF just wasn't a great option at that time. It just didn't seem like it. We opted to launch the ETF two years ago when a firm that I've known for seven years, I had actually cold called them quite a while ago. And spent tons of time with them grabbing lunch, grabbing drinks.

And then out of nowhere, they're like, you know what? We're not going to invest in S&M. I was like, well, why didn't you tell me that seven years ago? And then they're like, but if you had an ETF, we'd invest a significant amount of money. And I was like, well, why didn't you tell me that seven years ago? And so it was really ETF was always on the table. It was really just waiting for the right time. And the right time presented itself. I have a lot of made up statistics I like to throw around. But one of them is I have a feeling that roughly 80% of managers that launch ETFs regret it just because they're very expensive to manage. And they're very difficult to grow.

And so that was always at the top of my mind. Again, it's my company, right? It's my savings account, basically. And I have three children and a wife dependent on me. So I had to be very mindful of taking on that risk and launching it at the right time. And the perfect time presented itself. And so we launched it two years ago.

When you constrain your universe, you constrain your potential. And so the first thing is to be just very thoughtful of where you're going to apply those constraints. And we constrain our portfolio at $5 billion and below because it's hard to argue that you don't take on more risk as you invest in smaller companies. Whether they're less liquid, whether they're just simply less proven. But we're open to anything above $5 billion. So that is our starting point. Our goal is to maintain a portfolio consistently that has significantly higher earnings growth than the S&P. Because, again, nothing drives performance like earnings growth.

Historically, the portfolio has averaged around 12% to 13% earnings growth versus the S&P, which is around 6% to 7%. The S&P's earnings can be wildly volatile. But over the long run, they average around 6% to 7%. And there's reason to think that maybe even that begins to decline a little bit. But regardless, that's about a 6% to 7% gap on average that we maintain that we would expect to drive performance. In order to reach that 12% to 13% average earnings growth, we have to have a cutoff that's below it. So generally, it's 10%. Anything that we don't expect to perform at that level going forward, we eliminate. We then run our valuation model on everything that made that first cut.

The valuation is – the way in which we value companies is certainly one of the biggest differentiators. I haven't seen other people doing it the way that we do it. Many do either discounted cash flow models where you're sort of trying to kind of predict the future and discount it back. And for us, we don't feel that that's something that we really – that we do best. Many will look within a sector and invest in the cheapest price to book or PE. We don't do that either. Instead, what we do is we really measure the wealth creation of a company over an extended period of time, compare that to the S&P 500, and then create a relative comparison for the price too.

It's a lot more complicated than that, but just to give like a little bit of an overview, it's relative valuation, which I really haven't seen other people doing. Anything that's deemed to be overvalued, we cut. we don't want to invest in companies that should go down. And then at that point, we look at a number of simple metrics that we believe very clearly lead to greater downside risk, the most important of which, especially over the next decade, is debt. As individuals, we know if we take on too much debt, it's not going to work out well. And that's the same for small businesses and large corporations. And so we invest away from companies with high debt levels, and we look at some other smaller things.

We then score each company that made it to this point based on those different qualities or characteristics. Obviously, higher earnings growth is preferred, more attractive valuation, lower debt levels. And then we force rank the less and invest from the most attractive to the least. As we do, there's a few considerations that we have in mind. We know we want 50 to 75 companies. Right now, we hold 54. Usually, that number starts to decline as we get later in bull markets. On average, it's probably in the 60s. And then we look at industries, which is a little more granular than sectors. Value line breaks the market up into 99 different industries. And we want to make sure that we're diversified in that way as well.

And so our goal is to maintain a portfolio that has a minimum of 30 industries. Usually, it's in the low to mid-30s. We have a hard cutoff of 25. And then we'll cap any one industry at 15%. So the end result is you get this portfolio that is very risk-focused as far as the stock selection. Right? They have to be attractively valued per our numbers. And they have to be lower risk in a number of ways. And then we build the portfolio with risk in mind as well. So it's diversified across names. There's a larger number of names. Again, 50 to 75. It's equally weighted. And then it's also diversified across industries with the goal to really reduce idiosyncratic risk so that one company doesn't really matter.

The goal is to just consistently maintain those qualities that we feel are highly likely to provide higher return and lower risk over the long run, which, again, are higher earnings growth, track evaluations, lower downside risk.

And that really touches on an important philosophical point of our strategy, which is many managers have heard, maybe not heard, but lean toward more concentrated approaches. Because that's a way to differentiate yourself from the indexes, potentially provide outsized returns. And if you're taking a concentrated approach, maybe you do a very deep fundamental dive on a company and you decide this is a great investment. You do that for some other companies and now you've got a portfolio of high conviction names. We have a totally different approach. We have, particularly me, I have absolute conviction that if we maintain a portfolio with higher earnings growth, attractive valuations, lower downside risk, that we will, over the long run, provide higher return, lower risk.

Nobody will ever be able to convince me otherwise. Now, we don't necessarily have that level of conviction for the individual companies, though, right? We're not talking to management. For us, we don't feel that's where we have an edge. And so we look at each company, as long as it meets our criteria, as a coin flip, basically. If you think about flipping a penny, you can flip a penny 10 times and get 10 tails in a row. It's unlikely, but it could happen. The more you flip it, though, the more likely it approaches 50%, right? So 50% head, 50% tails. We look at each company as a coin flip. Each company gives us an opportunity to deliver those qualities that we aim to provide our clients.

You could easily argue that our strategy is index-like. Now, it's not a black box. There is a little bit of complexity there, but it's largely defined as active because it's thoughtful and it's not just run-of-the-mill. Now, as far as the role that we play otherwise in an active manner, the purpose of the rules-based nature is really to remove us from it. It's well documented that a well-thought-out process will outperform a thoughtful individual most of the time. Just because as people, we are inherently emotional. We have opinions. I certainly don't lack for opinions.

And the goal of the rules-based nature is to really remove those opinions, remove those emotions so that we are very consistently providing precisely what we tell clients we'll provide. And so, again, the goal is to not be especially active. There's very rare moments where we step in, and those are kind of one-offs. And largely, just if the data, if the world has changed but the data doesn't yet reflect it, maybe we'll step in. So if there's a SEC investigation or something, we'll step in. But otherwise, we really try to adhere to the rules with as much discipline as possible. That's their job and purpose.

Well, realize losses before year-end, if it makes sense, and then kick gains just a few weeks out so that we can push that off. And then we split the difference in August. And then we'll rebalance the portfolio because, again, it's intended to be equally weighted. We usually rebalance the portfolio at that time. And then we'll also rebalance as needed, depending on what's going on within the market.

So that certainly helped. That's a nice little soundbite to get people's attention. And then again, hard work. A lot of people, I think a lot of people launch ETFs with a little bit of a field of dreams mentality, where if you build it, they will come. And it's just not true. It's very, very hard to grow. And I have never worked harder in my life than the six months leading up to the launch and then after it. there were times, hopefully this isn't overshare, but there were times where my wife couldn't find me and I was laying in bed in tears because I was just not sad, but just so exhausted from just pushing so hard.

And at the time it made sense and it was very fulfilling, but it was, it is not easy. Getting from, going from two to 370 million, there was some luck that helped, but it was again, a lot of hard work.

Keep in mind, mid outperformed large despite large and mid-cap destroying everything for the last decade. And mid still outperformed by 60 basis points. And why, so first of all, you've got that data, right? You also have the philosophy or the rationale backing that up, which is mid-cap stocks are, they've kind of graduated from small cap. They, they must have had some product that was successful to get to that point. And so therefore, we'd expect them to be less risky than small. Large, the bigger you get, the harder it is to grow. Generally speaking, now there's a network effect at times for some companies, but, if you think of Apple, it's such a large, massive company, it's really hard to see how they can double.

Whereas a mid-cap company, if they got there based on one product, now they only need one more product to potentially double. And so mid-cap is the sweet spot of asymmetric return and risk, which is what we should all be seeking. So again, higher return, lower risk. Again, there's a number of different ways I could be, I could really run with this because I love talking about this, but there's a few very important considerations as far as this goes. One is the idea of, actually, let me back up for a second. As I've spoken with more and more large firms and gotten a better view of how many people, most people, are building portfolios, it's become really obvious why, one, how few people actually have mid-cap

And two, why they should. One is most people build portfolios in a similar manner, many of the biggest firms. They start out with large cap, growth, because if you didn't have large cap growth over the last decade, you got fired. So you start out with that and then you complement it with most use mid, so small and mid. It's sort of a one-stop shop to just sort of add some diversification and then value. And the problem is many don't realize, we invest in these large cap portfolios thinking they're diversified when they're not. Not, and I would be guilty of the same, many don't look under the hood. So if you look at SCHG as one that I use a lot just because I see it

Regularly, very recently, SCHG had 60% of the portfolio invested in only eight companies. Those eight companies are very highly correlated. They're all mega cap. Like they're, and so you're getting 60% of your portfolio is in this tiny sliver. And the problem is people invest in it thinking they're getting this diversification when they're not. And then if you think about investing in SMID, that's centered around that small midline. And so you get very little upper mid cap. And so there's this huge gap in most people's portfolio in a place where we would never expect there to be absolutely nothing invested, right? So we're talking upper mid, lower large cap is a woefully underinvested area.

And we're not talking micro cap. We're talking big companies. And again, why that really matters and why people should seriously consider it is a very simple concept that I never hear anybody talk about. And that's investing where other people aren't. If you're investing where other people are. And so over the last decade, you could argue that the big tech names, the S&P 500 is maybe the most overcrowded trade in history. And so if you're investing in those companies, you're investing after everybody else or with everybody else, and just by supply and demand, that means that you're paying higher prices.

If you pay higher prices, you get higher valuations, which implies lower potential returns and higher downside. So lower return, higher risk. Not what we generally would say we're going for. Whereas if you invest where others aren't, you get lower prices because there's the demand's not there driving it up, which implies lower valuations, which implies higher potential return and a margin of error, lower downside risk. So that's where you get that asymmetry. You take less risk to get higher return. That is why I would say maybe not just mid-cap, but just really rethinking how people are investing or at least kind of diversifying.

Right? It's an uncertain world. it's a good time to really be hedging your bets a bit and make sure that you're not setting yourself up to for things to turn. Yeah.

And so, you get this diversified portfolio, very risk-focused, that fits just in the center of your portfolio and then it makes it really easy to complement with more innovative growth, right? So, think of, whether it's NVIDIA, Palantir, things that aren't yet, that for a while weren't profitable or the valuations got ahead of themselves. We won't invest in those because it just doesn't meet our rules. That's a great complement. And then you can complement on the value side as well as small cap. But again, it's really meant to be that very dependable core holding. And the rules-based nature means that you know what we're doing at all times.

We've been doing it for four decades, right? So, ideally, it's kind of that very consistent, steady, sort of foundational holding in the middle of your portfolio. Yeah.