As many of you know, I’ve finished my 5th book, due in early December. I think you all will really like this one. The focus is on 13F investing and tracking some of the most brilliant stock pickers in the world. Below is a last minute study I added to the book. It was generated from a Q&A at my Seattle speech I gave last weekend. The question was – what performs better, investing in Berkshire Hathaway stock, or in Buffett’s stock picks?
Below is the answer. We used the standard top 10 13F holdings, updated quarterly 50 days after the quarter.
The good news is, either strategy worked great and beat the S&P 500 by about 4-5 percentage points per year. And note, that outperformance has occurred while Buffett and Berkshire have underperformed the S&P 500 since the bottom in 2009 in six out of seven years. This is also an instructive lessons of investing across an entire business cycle. How many investors would abandon a mutual fund or ETF that underperformed 6/7 years?
The best news? You can allocate to Buffett and not pay any hedge or mutual fund fees!
Are coal stocks a buy? They are likely to finish 2015 down a whopping 5 years in a row, along with another hated sector, gold stocks. Both are down over 80% from their peak.
I’ve written a lot about reversion strategies on this blog and my books. It is always hard to try and decide when an investment has declined and is a true value, or when it has simply declined with more to go? There are lots of famous investing quotes to use here that may or may not be funny depending on your current holdings.
“Buy when there is blood in the streets”
“What do you call a market down 90%? It is a market that was down 80%, and then got cut in half from there.”
“Investing is the only business that when things go on sale, everyone runs out of the store”
“You want to be greedy when others are fearful. You want to be fearful when others are greedy.”
There is a FREE database of investment returns over on the French Fama website, so you can go play around with your own ideas. Such as – what happens if I were to invest in a sector after it had two down years in a row? Three? Four? etc. What about down 90%? It’s a fun exercise, and you can see just how rare down 4-6 years in a row actually is. Below is the data back to the 1920s. (Note these groups are often small groups of stocks. Thus, while their arithmetic returns will look higher the geometric will be lower due to volatility. So, the market didn’t really do 14%, but probably closer to 10% etc…)
So it often pays to be investing when others are fearful.
Ironically, the only industry to ever print 6 down years in a row?
Coal stocks. (ending 1933)
You can see the chart here and how it set the stage for great future returns…but it wasn’t until the early 1940s before they really started their bull run…
I’ve talked to death about roboadvisors, asset allocation, and ETFs over the past year. In general it is a wonderful time to be an investor, and many robos have reduced the cost of managing an asset allocation portfolio down to about 0.25% (plus ETF fees) with tax harvesting included. I think they are wonderful and have recommended them to many individuals. Many advisors have been wringing their hands over the fee compression – how can we compete in a world where asset allocation is a commodity?
The answer is – because asset allocation has always been a commodity.
Look, the vast majority of financial advisors don’t offer any investment alpha. Hell, the vast majority of investment managements don’t either! So the advent of the robo technology should be seen as a boon to advisors – it simply frees up your time to focus on what matters most to your practice. And that is where your value is, and has always been. Josh Brown often says that behavioral coaching is probably the top value add, and I agree. Look at this table I posted on Twitter the other day from AdvicePeriod on the behavior gap in investing:
Since almost every custodian and brokerage will have no cost robo technology for their advsiors in the next year or two, advisors should spend as little time as possible on the asset allocation solution, and more and more on their value ads. But that is a beautiful thing! Clients would appreciate more attention, estate planning, insurance, tax management, microbrew tasting events etc etc. Not to mention it would free up advisors to spend more time on prospecting if they so choose.
So don’t fret advisors, see the robo/ETF revolution as a major benefit to your practice…but looking out, what is the next evolution in the robo tech world? Actually, I think the next step is the evolution of the ETF as an investable asset allocation benchmark at a 0% fee. Let me explain as many don’t quite get this.
Roboadvisors usually charge about 0.25% (though Schwab is 0-.10% with some weird issues), but are still at a fee disadvantage to a no management fee ETF (of which only one exists, but more coming). If I had to pick just one platform to invest in for total performance, tax efficiency, and simplicity – an ETF wins out. (But again, they’re both good choices.)
But the really cool area that no one talks about, mainly because it is a little arcane, is that through share lending an ETF could eventually get to expense ratio negative. Think about that for a second. You could eventually hold a fund that pays you to own it…See below graphic (and PDF download here) for more info…there are many ETFs where the management fee is actually negative. If you could then lend those underlying ETFs as well…
I would like to have included a lot more tactical ideas in the book but there is a constant struggle between keeping an idea/book simple, but satisfying the supernerds like me with enough of a deep dive into the data. Ironically I spent a ton of time on editing the books down to only include the basic info, and the biggest complaint for those books – they’re too short! People somehow equate length with value, but I can’t think of anything worse than long books that should be much shorter. There was a tweet the other day that said, ” Most books should just have been mag articles, most articles should be blog posts, most blog posts should be tweets & most tweets never sent.” So, I didn’t go down the rabbit hole of tactical ideas but just directed people to prior works.
But I’ve also said a handful of times that an allocation of 1/3 global stocks, 1/3 global bonds, and 1/3 trend strategies is a pretty hard allocation to beat. A lot of people have asked me to expand on that comment so I’m going to do so in this piece.
I also publish my personal portfolio each year that is roughly 50% trend or tactical strategies and 50% buy and hold strategies (with tilts) so people can understand I eat my own cooking. Not that my personal allocation should matter to anyone, but it let’s you know how I think about the world and implement it with my own hard earned money. Next time you sit down with your advisor, ask them specifically what they do with their own cash. It may surprise you!
I’m now going to go down that rabbit hole to explain those ideas I left out of the book in a bit more detail.
Subscribers of The Idea Farm get access to an Excel download that lets you backtest buy and hold and simple trendfollowing strategies back to 1972. We used a similar Excel model to run all the tests in the GAA book. I plan on updating it again in 2016 with new data.
So, first let’s refresh the ideas in the book with some of the standard benchmarks. The “GAA” portfolio is from the book, and is simply the global market cap portfolio with commodities added.
US Large Cap 18%
Foreign Developed 13.5%
Foreign Emerging 4.5%
Corporate Bonds 19.8%
30 Year Bonds 13.5%
10 Year Foreign Bonds 14.4%
I’ve yet to figure out why WordPress displays my charts blurry until you click on them – if you know please email me. In the meantime, click to enlarge the charts with more resolution.
So, now what about the 1/3 each model?
I took to Twitter for some ideas on what to call this portfolio. A few of the funnier names are below.
The Global Triumvirate
Jessica Biel Sextape
Trending with Meb
Cold cut combo
The Three Stooges
I sort of like the Trinity Portfolio so let’s go with that for now (via @). So, we’re going to use as the CORE the GAA portfolio from the book with the allocation above, which is pretty close to 50/50 stocks and bonds with some commodities thrown in. Then, we’re going to add trend for a third of the allocation, or GAA 66% and trend 33%.
But what trend index to use? There isn’t a great one that has existed back to 1973, so of course you’re going to have to rely on simulated data. (But to be fair most of our indexes in the normal allocation didn’t exist as indexes at the time either such as TIPs, commodities, emerging markets, etc).
So, we’re going to use two variants.
1 – BTOP50. This only goes back to 1987 so we are going to supplement it with the AQR simulation prior to that. Note also BTOP is after fee index, all of the rest are gross.
2. Global Momentum (GMOM). This is similar to the aggressive version from our old paper, basically invests in the top 1/3 of assets ranked on momentum, but only if above their long term trend, otherwise in cash. (You could also add the moderate or conservative allocations with vol reducing properties rather than return enhancing.)
Nominal returns. Click all charts to enlarge.
Nominal returns to 1973
And the incorrect Y axis that the marketing crowd would love…
So you can see that the trend component helps keep volatility low, but more importantly reduces drawdowns. Managed futures and trend systems are one of the few really decent strategies, along with US gov bonds, at diversifying a traditional stock heavy portfolio. Implementation is still a little tough as most trend/managed futures strategies can be very expensive (particularly the fund of funds ones) but there are some current mutual funds and likely some ETFs coming to market that are reasonable. If you recall the main conclusion from my book, fees can destroy any well built portfolio.
Why is this a great allocation (although my personal is more “extreme” at 50% trend)? It checks the boxes for most clients, institutions, and pros.
1. It has the global portfolio as the core. You get the benefit of all of the asset classes in the world that have delivered positive returns over the years. You’re also never “too different”. Stocks, bonds, REITs, commodities, gold – it’s all there.
2. It is a truly global allocation. No home country bias here, lots of exposure to foreign assets as well as domestic ones.
3. It does well in various market environments. Historically, the addition of trend systems improves risk and return numbers.
4. You are doing something during bear markets. Lots of advisors are challenged with what to do during bear markets. Telling clients to sit still, or just wait out the losses is tough. Allocating to trend strategies allows you to have a portion of the portfolio that is “doing something”. Even if you think that trend will not add any return or risk benefits, there can still be behavioral or psychological benefits to adding the system.
5. You’re not “all-in” anything. Investors often like to pick out a niche (a dividend investor, a bond guy, a value person, a gold bug, etc). This allocation lets you spread your bets across over 30,000 global securities, all the while never having all of your eggs in one style or strategy basket.
6. You can add tilts. I didn’t mention this here, but you can improve this portfolio by moving away from market cap weights in stocks and bonds and add another 1-200 bps to the returns. Simple value and momentum indexes can add a lot of value within asset classes.
Most advisors and institutions will never add trend to their portfolio, and if they do, they may add 10%. The funny thing is if you did a bling mean variance optimizer, one of the largest allocations is almost always managed futures and trend.
Let me know any thoughts or questions and I will update the post with more content!
Below is a list of conferences that are a good source of new investment ideas, roughly in approximate order of the calendar year.
Am I missing any good ones?
You choose – the winner gets published: