A Q&A with David Barse, Founder and CEO of XOUT Capital
Is what you leave out of your portfolio more important than what you put in?
You previously were in the active mutual fund space as the CEO of Third Avenue for 25 years. What inspired you to make the switch to passive ETF investing and found XOUT Capital?
When I stepped down as the CEO of Third Avenue in December 2015, after much deliberation, I decided to pivot away from the active management space for good and transition into passive investing. While at Third Avenue, since the 2008-2009 financial crisis, I was facing a constant battle with passive strategies that were both outperforming and gathering assets more rapidly than our actively managed funds. It was a battle we kept losing and a war we could not win in the long term. In my view, active fund management became all too difficult following the financial crisis. As a result, I entered into the passive investing universe with the creation of index company XOUT Capital®.
At XOUT Capital, we believe what you leave out of your portfolio is more important than what you put in. After spending years trying (and failing) to beat the market by pinpointing winners, I discovered it is much easier and effective to simply exclude losers that are weighing on the portfolio’s performance. Our first index, the XOUT U.S. Large Cap Index, uses a quantitative approach aiming to identify and exclude the losers among the 500 largest U.S. stocks that are facing the highest risk of technological disruption. In October 2019, we launched the GraniteShares XOUT U.S. Large Cap ETF (NYSE Arca: XOUT) that tracks this index in collaboration with GraniteShares.
Can you tell us more about the strategy behind the XOUT U.S. Large Cap Index and what it seeks to achieve?
The fundamental proposition of XOUT is that the cult of chasing winning stocks has been a decades-long failed endeavor. Rather than pick winners, aiming to avoid weak and vulnerable stocks has proven to be an easier and more effective strategy, especially now since losing stocks have never been more plentiful amid the COVID-19 pandemic. This issue raises what I believe is the most obvious flaw of traditional passive investing: indiscriminately buying every company in the market, even those clearly in long-term secular decline. Before the pandemic, technological adaptiveness was simply a competitive advantage — it is now an outright imperative for companies that want to succeed long term. By leaving out lagging companies, XOUT not only outperformed the market, but took substantially less risk in the process.
What factors are used to evaluate which companies are excluded from the index?
The quantitative factors informing the XOUT proprietary model include a combination of fundamental growth signals designed to unearth industry and/or secular disruption such as:
- Weak revenue growth (companies failing to grow their sales)
- Lack of employee growth (companies that are not hiring or growing their workforce)
- Failure to reinvest in the business and/or company stock (companies not reinvesting in R&D and Capex or Share Repurchase)
- Negative earnings sentiment (companies consistently disappointing investors)
- Lackluster management performance (companies not focused on building shareholder value)
- Poor profitability (companies without pricing power and shrinking margins)
How has the index performed during the pandemic?
We believe the current market environment has created a wide bifurcation between companies that are facing technological disruption and those that are disrupting. Industry and secular disruption already in place have been accelerated by the pandemic, spawning the perfect opportunity for the XOUT index to generate alpha. Year-to-date, the index is up 12.2% vs. 3.0% (+9.2%) for the S&P 500 TR Index. Since the index’s inception in July 2019, the outperformance is even greater — up 25.7% vs. 13.3% (+12.4%). While past performance is never any future guarantee, here is a smart beta product that actually beat the market in accordance with a novel strategy!
What are a few household names the index eliminates?
As of our latest rebalance on October 15, 2020, the XOUT model has eliminated the following well-known names: Visa Inc. (V), Verizon Communications Inc. (VZ), Walt Disney Co. (DIS), Pfizer Inc. (PFE), AT&T Inc. (T), NextEra Energy (NEE), Exxon Mobil Corp. (XOM), Accenture Plc (ACN), T-Mobile U.S. Inc. (TMUS) and Chevron Corp. (CVX). Interestingly, Disney and Pfizer are both fresh eliminations for the fourth quarter. Index constituents are re-evaluated on a quarterly basis to accommodate the reality of the rapidly changing investment environment.