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Podcast Episode #25: “Listener Q&A”

Episode #25: “Listener Q&A”

Guest: Episode #25 has no guest, but is co-hosted by Meb’s co-worker, Jeff Remsburg.

Date: 10/17/16

Run-Time: 1:06:54

Topics:  We have some great guests lined up in the coming weeks, so we figured we’d squeeze in another Q&A episode. This week, Meb is back from traveling yet again, this time to The Caymans. The show starts with Meb giving us highlights from the trip, as well as one low-light (waking up one morning to find a welt on his head, and hoping it isn’t Zika). This transitions into a topic recently covered in one of Meb’s blog posts; of all the animals that people find most terrifying, lions and sharks are near the top of the list. But statistically, lions and sharks are responsible for only a tiny amount of human deaths per year. You know what kills 725,000 humans per year – yet few fear (until recently)? Mosquitos. Similarly, many investors are terrified about the outcome of the U.S. Presidential election. But this election isn’t likely to “kill” a portfolio. On the other hand, you know what is? The mosquito known as “fees.” Eventually, the conversation gravitates toward listener questions. A few you’ll hear Meb tackle are:

  • What are some of the best ways and resources to learn about markets and investing?
  • (Dovetails into…) Why don’t we hear Meb discuss single-stock fundamental analysis more often?
  • What does the typical day look like for Meb and other successful investment professionals? Habits? Amount of reading? How much sleep? And so on…
  • How does an investor tell the difference between an investment strategy that’s simply “out of favor” (and therefore, underperforming) versus a strategy that has truly lost its effectiveness (and underperforming)?
  • One of the variables in Bogle’s formula for estimating returns is dividend yield. Why wouldn’t you substitute shareholder yield instead?
  • What are the pros/cons of protecting the downside by buying puts versus using trend following?
  • Assuming an investor is a huge risk taker and can handle it, should he put all his money in the asset class with the highest expected return – for instance, be “all in” Russia?

As usual, there’s lots more, including Meb’s upcoming travel schedule. He’s going to be in Orange County, New York, Richmond, and D.C., so drop him a line if you’ll be in the areas. All this and far more in Episode 25.

Episode Sponsor: Lyft and Founders Card

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Comments or suggestions? Email us [email protected]

Links from the Episode:

Suggested Reading from Top Hedge Fund Managers:

The method for achieving peak productivity referenced in this episode:

  1. At the end of each work day, write down the six most important things you need to accomplish tomorrow. Do not write down more than six tasks.
  2. Prioritize those six items in order of their true importance.
  3. When you arrive tomorrow, concentrate only on the first task. Work until the first task is finished before moving on to the second task.
  4. Approach the rest of your list in the same fashion. At the end of the day, move any unfinished items to a new list of six tasks for the following day.
  5. Repeat this process every working day.

Transcript of Episode 25:

Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is co-founder and the Chief Investment Officer of Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Sponsor Message: Today’s podcast is sponsored by the ride-sharing app Lyft. While I only live about two miles from work, my favorite means of getting around traffic clogged Los Angeles is to use the various ride-sharing apps and Lyft is my favorite. Today if you go to lyft.com/invite/meb, you get a free $50.00 credit to your first rides. Again, that’s lyft.com/invite/meb.

Meb: Hey everybody, Meb and Jeff here for a pre-Halloween spooky Q&A. We’ve got a bunch of really awesome interviews coming up. So we thought we’d squeeze one of these in before we start to get into the wintertime holiday period. So Jeff, welcome to the show.

Jeff: How is it going?

Meb: It’s good. and you know I’ve just taken nine flights in the past five days, if not more. So I’m a little road weary but happy to be back in Los Angeles for about a month. Good to be home.

Jeff: Yeah. I’m aware that you’ve been traveling and you did not invite me to the Caymans with you, which I’m a little disappointed about.

Meb: You know, they actually pronounce it. I learned Cayman. Into a local grand Cayman. Yeah. I was actually incredibly impressed, it was a global investment conference for the CFA Institute. They have been doing it for a handful years, really well done. There was over 200 people. Almost no Americans, all over the world. A lot of South Africans, a lot of Canadians. A lot of people from various islands and a wonderful lineup. We had Harry Markopolos, who was an Enron whistleblower, who by the way said he had multiple Ponzi schemes still in existence, multi-billion dollar Ponzi schemes, which is just fascinating to me why people would still think they could get away with these sort of dumb things.

Jeff: Wait, he had them?

Meb: He’s looking into them. So he consistently does whistleblowing. Anyway, one of the funniest speakers, he had a great quote where he said a whistleblower is like a great fart, silent but deadly. And I said if you’re an accountant with a funny talk, kudos to you because CPAs are not known for their public speaking. And then a couple of other great speakers. Really good time but my favorite part of being down there…the worst part was the Broncos losing, which I watched from a little Caymanian bar which was owned by a Canadian. So there was Blue Jays flags hanging everywhere. My favorite part was, is checking into the hotel, they put…In every single room, you had canisters of bug spray.

Jeff: Oh yeah? Did you come back with Zika?

Meb: I might, I don’t know. I need to go get tested. I don’t think I saw a bug the whole time. I did have a big welt on my forehead one night. It came from something biting me. But it was funny because that experience sort of informed…I kinda rushed the day before my speech and added some new slides and thoughts, and it ended up being part of the speech and it became a blog post that we talked a little bit about you and I last week. Which was election informed, right? Which is a lot of people, these elections coming up, I get asked a lot of questions where people say, does this election, you know, does Hillary winning or Trump winning, is it gonna cause the markets to do X?

Jeff: I saw something this morning about a Democratic kind of landslide, it could be awful for the entire stock market.

Meb: Well, I mean right, exactly. Who knows? And so you had one where there was an article, I think you said Mark Cuban said, “If Trump wins, the market could crash.” And Mark Faber said if Hillary wins, the market could crash. And so I said the world is doomed. So no matter who gets elected, the market is gonna crash. What’s the most likely outcome, probably amazing is a big market rally that nobody is expecting. My whole point of this article and checking into the hotel inspired this was what we’re most afraid of, in this case, the elections is not a good example necessarily of what we should be afraid of.

In the chart that we use in the article was from an old Barry Ritholtz post I had seen. And it’s a chart of the animals that kill the most people per year. And if you were to query some listeners things, see if you can write down the top five, hit pause, top five animals that kill the most people. Number one is almost a million. And just for perspective, shark is about 10 per year globally. Although, did you see that recent YouTube video, the shark getting stuck in the divers cage?

Jeff: Yeah, busting out.

Meb: Yeah, we’ll add it to the show notes if you haven’t seen it. Poor shark, though. It must have been terrified. But yeah, they had it caged, it was in Mexico, I think? Cage diving and this shark busted into the cage and then had to jump out of the top of the cage. Guy didn’t look like he got hurt. But anyway, so we’re obviously very fearful of sharks. Lions, I think kill about a hundred a year. But on the other end of the spectrum is like what you should really be afraid of and the Caymanians were. This was relevant, so they knew the answer because of all the Zika going on. Number one is mosquitoes, of course from malaria and all the other diseases. Two is humans. Although if you average that out, I bet over time the humans has gotta be up there for higher. Three was…what was three? There were some weird ones in there. Like there was a tapeworm, there was snails top 10, dog was top 10 for rabies typically. Men’s best friend. And snake was actually…so reasonable, to be…I hate snakes, reasonable to be scared of snakes.

But everything else, the big predators…so anyway but the point of the post was everyone is afraid of the Trump elections and everything else you see in the headlines, in the news. Brexit or what’s going on with Zika or what’s going on with who knows, whatever the news of the day is. But, and then we show the problem of investing in high fee funds. An example I gave, I said, “Look, there currently exist today five asset allocation ETFs which are buy and hold by design, strategic asset allocation, that charge under 0.3% per year.” And we have one. And I think the other four are I shares. Its combined total of all four of those ETFs is only two billion dollars. Which sounds like a lot, but then if you compared it to the 500 plus mutual funds that charge over 0.3 percent per year and many charge above 1, one and half, 2, they manage almost a trillion dollars.

So the point of this we were saying is that all these people who allocate to these buy and hold mutual funds and are paying Wall Street this additional fee of eight billion dollars that they don’t need to, they are focusing on the wrong problem. So…

Jeff: Also, is this just naivety on behalf of the investor or is there a broader behavioral issue going on here?

Meb: There’s a couple of things. So mutual funds historically, the high fee ones, and again, I’m not talking about liquid [inaudible 00:07:42], I’m not talking about people that actually do probably value added, something different. But this is by definition buy and hold stuff. So you’re not doing, I mean in your charter, you’re not really doing anything. It’s a strategic allocation. So high fee is a big one here. So historically, mutual funds have been sold. Somebody comes into a financial adviser’s office, they’d say hey, you should buy these mutual funds. Financial adviser buys them, forgets about them. Client forgets about them, they hold them forever. A client dies or transfers, they get sold.

So this will be a generational transfer of assets. This isn’t something that people wake up tomorrow and say, “You know what? I don’t like this mutual fund, I’m gonna sell it.” It’s usually when something happens. So an ’08 could happen again, in which case they get washed out and replaced. But very rarely do you see a high expense mutual fund that charges one and half or two that gets sold and gets replaced with an ETF. No one ever goes back.

Jeff: Well this seems like a glaring oversight on behalf of the adviser and frankly the investors as well. I mean if you’re talking about paying a hundred bips or whatever for something that should cost you 20, it’s really no excuse for that.

Meb: A lot of people don’t know, too. There is a huge education gap. So people that hold a lot of these…I mean, our buddy Josh Brown calls this mutual fund salad. You’ll have a investor that comes into the office and they’ll say here’s my portfolio and he’ll own 30 mutual funds. And it ends up, you end up getting the global market portfolio and you feel the risk factor because you own a lot of things, they have different names from different companies. But really, you could buy one ETF and have the exact same exposure.

And so, there’s a lot of problems and reasons why but it’s something that will slowly change. And so when people talk about this ETF disruption, I’m like,”Look, it hasn’t even started yet. It’s started in a few areas, in indexed equities, you’ve seen a lot of the flows and Vanguard flows. But in asset allocation funds, I mean that’s a trillion dollars that should be in lower cost funds. So anyway, meanwhile probably the irony of this is I probably have Zika now.

So it’s what I should be afraid of is what I should be afraid of. But it’s good to be back at home and in town for a little bit. I’m giving a speech in Orange County on Thursday to the CFA Society and then in a whole 10 days in New York for a few conferences. So I’ve got a few speeches. This was the first time we did this one, it’s a new one. So if you’re coming out and you’ve seen our old comic routine, we’ve got a new one. So come on out and see some of these new talks.

Jeff: So we’ve got any Q&As; today?

Meb: Yeah.

Jeff: What are we talking about?

Meb: Always. We always have great questions from the listeners, appreciate you guys writing in. Keep them coming.

Jeff: And that’s [email protected] Shoot us an email, we’ll read it. We should tell our listeners to start recording the questions. So if you recorded this on Skype or audio or on your phone even, send it in and we’ll start playing you all the questions. How does that sound? We’ll try it out. It could be…anyway, record your email and email them in, [email protected] All right. What have we got?

Jeff: All right. So this week, why don’t we start off with some broad or like 30,000-foot questions and then we’ll narrow down a little bit later. But we had a handful that was more topical in nature, so I figure we’ll just start there. All right, one. What are some of the best ways to learn about markets and investing? I found resources like the Wall Street Journal helpful but often times, it seems these articles are more about current news than investing strategies.

Meb: So we did a number of blog posts over the years and there is a few called Five Million Dollars FinTech Ideas. And some were media content based but there were a few where I said, look, there is a few business opportunities that people should be doing because a lot of it was born out of my frustration with the content space. One is we ended up starting Idea Farm, you know, a curated investment research platform which people seem to love. It’s targeted a little bit more towards the pros but it’s kind of like getting an MBA, honestly. You get two research, three research pieces a week. We think it’s wonderful there has been other people that have done similar.

So podcasts are a great one, we love Ritholtz’s, Michael Covel’s. There’s a few other investing ones. Patrick, who we’ve had on the show just started his own. And of course, reading, tracking, invest with the house. We actually have in the back of the book, which is our highest rated but least read book, by the way, in the back of the book, we have reading lists from a lot of famous hedge fund managers. Buffet, Seth Klarman, all these guys who at some point have said, “Hey, here is a good reading list.” So go read all those books.

As far as websites and ideas, so when we were in the Cayman’s, there is an old global Hedge Fund manager who writes a research service, Raoul Pal. And he lives there but he started a service called Real Vision TV. So we filmed a really fun, hour-long video type production quality. I’m a subscriber. And he said he’d let me send it out to our audience on the Idea Farm. So if you don’t have a subscription, go get a free trial so you can watch his video. He’s really funny, Raoul’s really a bright guy. He’s doing a lot of cool things.

And of course, my daily favorite newspaper, Abnormal Returns. And there is a few newsletters, etc, that we subscribe to.I’ll throw some links up. I’m trying to think on top of my head, we’re gonna have some of our good friends from some of these authors on the podcast in the next few weeks. Other than that, a lot of the traditional media outlets I don’t really consume. So I watch a little bit of CNBC and Bloomberg when I’m traveling or in a hotel room or sometimes when coffee’s on. It’s not something we have on the offices, you know. We may have sports on the TV, that’s about it.

Jeff: I don’t if this is where the reader was going or the listener was going with the question. But let me dig deeper on one angle. For instance, when I got my MBA, I spent a hell of a lot of time learning about financial statements. What would you say are sort of the broader tectonic subjects that somebody who is beginning to learn about investing in the markets should focus on in order to sort of get their toes wet? Because you’re mentioning several places to go but should an investor be worried about learning how to analyze a balance sheet? Should they be looking at how to analyze different ratios?

Meb: So that’s very dependent. We get a lot of questions from people who say, hey Meb, how do I get a Hedge Fund job? I’m thinking about moving. I used to be a biotech engineer and now you’re a PM and CIO. How would I make that transition? And my answer is always, it depends. If you want to be say a financial planner or a wealth manager, there is a skill-set and a knowledge base that is much more useful. And that is more of a relationship business. And I would honestly say it’s probably less of an investment related business.

So yes, should you get your certified financial planner designation? Probably. Would something like getting a CFA help? Not that much. I mean, it will, it’s good to know. But it’s incredibly hard three-year program unless you are actually analyzing individual stocks. Which I would argue is not the value add for most planners and wealth managers. It’s how to design trusts and do insurance and behavioral coaching. So it’s a different skill-set. Now if he said, Meb. I wanna be a Hedge Fund manager or I wanna be a quan CTA or, these have very different skill-sets.

So a lot of the quants, as a full spectrum, it’s a financial engineering masters from Berkeley. Or who is it in New York? There are a couple of programs that are really strong. But if you wanted to be a hedge fund manager, so in that case if you are picking stocks, learning how to pick stocks is a much different…and even within picking stocks, learning how to short stocks is a totally different skill-set then say learning how to be a value added stock picker in the vein of Buffet or Peter Lynch.

So people often ask me that question, I always say it’s so broad. And let’s say you even wanna be a fund to fund manager. Then that’s more like getting a CAIA designation. CAIA, which I have, it is incredibly useful for learning about the alternative space in fund to funds and allocation and all the esoteric products out there. So it’s almost like if someone came up and said, “Hey what kind of dog should I get?” You say well, if you live in a tiny apartment in New York, probably not gonna wanna get a Border Collie because they need a ton of exercise.

Jeff: A lot of listeners really are saying…I think seem to associate with you and find a lot of value in what you do. And knowing you for 25 years, I can’t remember the last time that you and I discussed the valuation of a single security. Does that play into your investments at all? Or are you purely looking at assets with lots of underlyings? And if so, then how do you…do you look purely at Shiller to value those or is there is a whole different set of rules?

Meb: Oh, okay. Again, that’s somewhat of a broad question. So yes, I mean many of our strategies are based in valuation. But it’s not me going to visit Google and saying hey, let’s talk to management, let’s look at the balance sheet, let’s work through the true…let’s get really our hands dirty in the financial statements the last 20 years and see if we could tease out something that a quant couldn’t. So doing channel checks or running satellites to…I mean, that’s a true fundamental stock picker value-added mindset.

And again, going back to the book, “Invest For The House,” we had even back in college when I was taking security analysis class, there’s a great checklist that we had posted years ago from Tiger Cub, John Griffin, that says hey, look. You wanna analyze a company? Here is like a four-page checklist of what you should go through. And that’s a wonderful way to go about it but that’s if you’re a true fundamental. That doesn’t fit my personality. I would much love to take a sort of equities or whatever the asset class, a quant approach and be able to…because historically it’s a great way to be able to get exposure to a lot of these factors.

Do I think in a different lifetime, would I have been able to have been a purely focused fundamental guy? Yeah, absolutely. And I think it’s fun, it’s a lot of hard work and it can be very rewarding particularly in the less efficient areas of the market. But again, a totally different skill-set and totally different approach. I mean, if you wanna talk about stock valuation, I’m happy to, by the way.

Jeff: I’ve dabbled in that myself and despite all my best efforts, has still seemed to lose money on specific stocks. So no, it’s all right.

Meb: I look at it a lot and particularly with private companies now, so with angel investing I’m very curious always with a lot of these platforms and have been dabbling, as I mentioned on the podcast last few years. I was looking at one that came across–I can’t say which platform because they’ll ban me because they hate you talking about them–but it’s a sock company. These are socks that, I love these socks. They’ve been life changing socks and you would think that a sock company is not gonna be…

Jeff: It’s an impressive sock to change your life.

Meb: Yeah. Let me see if I’m wearing them today, I’m not. Yeah, I’m wearing them today. They make dress socks too. So I was reading this pitch on them and they said, in the pitch they said we should do six figures of revenue this year. And they were going off with a $350,000,000 valuation. I said, huh, that sounds a little high to be doing less than a million in revenue and 300 million. And I’m like, first of all there is no way that’s possible and then I had forwarded it to a hedge fund buddy of ours and said…because meanwhile, I’ve been talking about these socks for like three years. I’m like, dude, you have to wear these socks. And he said, “Six figures? That seems a little odd for the fact that they just raised a $50 million round on top of a $30 million round.” I had emailed them and I said, “Are you sure?” Then they corrected it and said, “No, no. It’s nine figures.” Totally different, totally different.

Jeff: There you go. Changed things a bit.

Meb: Yeah, of revenue. So yeah. So it’s kind of a fun distraction for me. I would never bet my assets on it, particularly in the public space.

Jeff: Okay. All right, sorry, I got us sort of off down a rabbit hole there. So let’s return back to the questions. All right, another broad one for you. What does a typical day look like for yourself and other successful investment professionals? What are your daily habits and routines that lead you to success? What time do you wake up, go to bed? How many hours per day do you read? How do you manage your time? How many hours are you in the office? Things of that nature.

Meb: Let me do this again and this is gonna start to sound old for listeners. But I think a lot of these answers…so one would be interesting and I’ll tell you mine. But it’s different strokes, different folks. I know people who are incredibly happy and proud to sleep four hours a night and that would literary be a version of like my hell. I need eight hours, I can sleep more. I’m happy to, I’m not a morning person. I start to get really cranky if I don’t exercise on a consistent basis. If I don’t have both social time and quiet individual time. I have a, for me, a very big novelty gene. So if I’m not trying out new restaurants or doing new things or learning and meeting new people. I start to go a little insane.

So all those show up in a daily routine. One of the coolest pieces of advice I heard and I am blanking on where this is from. I emailed it out to the team in Cambria maybe a month ago because I love the idea. And it was from an old management book or an interview, and you may be able to correct me because whether you read my emails or not, I’m not sure. But it was basically like a work style advice. And it went on something along the lines of this where this manager each night, he would write down the six things that he hoped to accomplish tomorrow at work, in order.

So one is most important down to six and you couldn’t start at number two until you finished number one. And I thought that was a profoundly wonderful way to go about it. Because how many of us come in, we start to do things and emails are coming in and calls, and the next thing you know it’s 5:00 o’clock? And you’ve accomplished none of the major things but a lot of…you’ve accomplished a lot of busy work. So I’ve implemented lists, not to that degree yet. I’m going to try.

Jeff: I remember this. You did send this out. This was a consultant did this for…it was turn of the century. It might have been some tycoon or baron, who was asking how to be more effective, how to get his employees to be more effective. And this guy gave him this piece of advice for free. The guy implemented it and apparently it was…he asked if he could pay and he said no, you can pay me what you think is worth if it’s effective. The guy turned around and paid him like the modern day equivalent of like a million bucks or something.

Meb: Yeah. I think it might have even been Ford was the company that he was pitching to. We’ll add it to the show notes, we’ll dig it up. But I think it’s such a wonderful piece of advice. I’m gonna try it and it fits for me personally because for especially a lot of bigger projects, and listeners have heard me say this about the book writing, I can only focus on like something like that very intensely. I get a little bit manic and do it very intensely for a short period of time. So for a lot of these big to-dos, it’s hard to have them just kinda drag on mentally for me. It’s a huge drag. So compartmentalizing and doing less for me is a big one.

As far as standard day, it’s pretty varied. I don’t eat a whole lot in the morning during the work week. I love brunch when I’m not…breakfast is one of my favorite meals. But if I eat a big breakfast, I’m worthless the rest of the day. And I actually feel the less I eat during the day, I’m much more productive. So there’s the days when I don’t eat till 2:00, 3:00 PM. Just because of things go crazy. Those are probably by far the most productive I am, I don’t know why. So maybe we’ll start doing a…what do you call it? Like an intermittent fast, where I just don’t eat until 3:00 PM every day. We’ll see. Probably terrible for having in the office, I’d be really cranky.

Other than that, I mean a lot of reading. I still struggle with being able to curate the best things that come across my desk. So I end up reading a lot of stuff that’s probably not that related necessarily to the day-to-day but might be interesting. And for me, that continues well into the evening. And so I’m trying to read a little more non-market related stuff.

Jeff: What’s your take on giving yourself exposure to a wide array of content and subjects, versus really narrowing down? And underneath that subject is a philosophy I’ve heard where some of the most effective people tend to know their niche and they become experts at it versus trying to be just more of a jack of trades and having a wide exposure.

Meb: Well this goes back to my favorite advice quote which is from the most successful hedge fund manager of all time, James Simons, who said, “Again, I can make the cliche either way.” And I’m gonna, this will be the last time I bring up that reference because people are probably getting really tired of it. But yes. Do I think a broad-based education is very important? Sure. Do I think that once you have that starting to specialize and do things, is that important? So here’s a good example and this goes back to thinking about the whistleblowing.

You know, years ago we were writing about fSquared. And if you’re not familiar, fSquared is at the peak over a 20 billion dollar ETF strategist. That was a quant approach and they were doing ETF strategies that looked like they had an amazing track record and they were raising money hand over fist. To being a young quant at Cambria, we just started the company and we would get these marketing emails all the time. And I would look at the strategy and say, “Damn! That’s a good strategy.” Look at that historical record and as with my analyst at the time, I said let’s replicate it. Knowing what we know about their strategy. And it was a momentum trend style, [Inaudible 00:25:25] strategy which is obviously something that I know quite a bit about.

The problem is for most advisers who are very well versed in investing, if you don’t spend enough time on investing history or theory, you would have looked into that and just said, great, amazing track record. You wouldn’t have questioned it because you would have said, huh, that high of a sharp ratio, that low of a draw down, that’s probably not gonna fly. Either it’s the Michael Jordan of investing or something is fishy, right? So we couldn’t replicate it and so I wrote a blog post about it, fSquared’s lawyers called me and said take this down.

Jeff: Really?

Meb: Yeah. So I took down about a half of it and I said look, it’s whatever. And I was too young to say, “Who am I?” We managed like $10 million at the time. I’m like, these lawyers sue us, it takes out our whole company. We can’t afford to defend ourselves even. I’m in no business to be picking fights with these big guys. Because there is still a chance that it was reasonable, that they were doing what they said they were doing.

Jeff: Was your article actually calling them out or just…?

Meb: Yeah, it’s still up there. You can find the skeleton of it and then we’ll get to what’s happened since. And if you looked, a lot of disclosures, a lot of historical stuff, it just didn’t add up. It stunk and a lot of the problem with a lot of these shops that are doing the sketchy stuff is they never charge a low fee. You’re never gonna find a shop…I mean, you may. But in general, they’re charging 2% a year plus loads, all these other stuff. Which makes it even harder to fill the tracker. Long story short, if you’re not familiar what happened was is that they had had an index historically. One that they said was real performance which wasn’t.

So that’s obviously fraud already. Two, when they implemented it, they shifted that index a week into the future. So they had a weak crystal ball. So they took the index and made it even better. So yeah, right. Again, a couple of problems and then it perpetuated. And then there was a bigger firm that then distributed their strategy through mutual funds. So no one was really doing due diligence. I took one look at this and I’m like something is amiss. And here is the problem, here is the irony is that…and so the SCC went after them, fined them not nearly enough. The company is now out of business, someone bought them, the ashes. But the parent company who was distributing their mutual funds, it’s knocked a billion off their market cap. But it was a fraud, share fraud. And it was an easy fraud.

And the irony is the actual underlying strategy works. It’s a good strategy, momentum and trend. We took their strategy and took it all the way back to the 20s and said, hey look, this is…it works just fine. There is no reason to…and so there’s been a couple that we’ve tweeted about this a few times. These marketing guys, if you’re a marketing guy listening to this podcast take me off of your distribution if you’re committing fraud because I’ve gotten two where I’m like those numbers are just not…it’s not possible. Again, we’ve gone off on a huge tangent as always. If you didn’t have a long perspective and history on markets in general and all strategies, and let’s say your financial adviser or a fundamental analyst and you say, oh man, look at this quant strategy that’s doing XYZ, that’s reasonable. Well, you wouldn’t know necessarily.

And so yes, there is a lot of benefit to having a broad-based understanding of markets and strategies. But it also has huge benefit to, in this case, with fSquared for example to have very deep domain understanding because then you can say oh, wait, well…

Jeff: I mean, that’s one of the challenges though. Clearly, you can’t be a masters, it’s very difficult to be a master at everything. So like even in your book, “Invest With The House,” you talk about how stock picking is extremely hard. Why not outsource that to these amazing managers, the Buffets of the world who have consistently outperformed over the years? So in essence, you are putting your trust in these guys, just as somebody was putting their trust in this fund that was obviously mismanaged. I can’t remember what philosopher it was. But at some point he says I don’t really care…I’m not gonna evaluate what you say, I’ll first evaluate you and whether or not I trust you to say it. Then that’s sort of whether or not he’ll buy into the subject. So here, how do you know who to really trust? Because…

Meb: It sounds like the Calvin and Hobbes Financial, philosopher. Well, look, so there is getting be a much higher and harder bar for active managers. And you’re starting to see a lot of institutions, I saw in my Twitter feed today three very large institutions. There was like CalSTRS, Alaska and the one on the New York pension funds, bringing more and more assets in-house because of these problems. And it’s particularly hard for pension funds and or financial advisers when you have a client that’s not onboard with the mission statement or doesn’t understand that well and having an active manager that underperforms. It’s a huge headache and a huge problem.

So many people, the solution is just passive investing. I’m done and it eliminates a lot of the conflicts, a lot of the headaches. And that’s fine. Now, does that mean that it’s not…? And an example we always give in the last few podcasts is the Buffet example where he’s underperformed seven of the last eight years, everyone would have fired him on the planet. Do you think he’s a bad manager? Well no, of course not. He’s one of the best managers of all time. It’s just hard for an investor to stick with an active manager and all the evidence shows that they don’t. They sell them after a couple of years, meaner version happens. This manager does great, over and over again.

So if you’re going to do active management, you have to, and we said this, one, write down your policy portfolio. Write down your plan. Say, you know what? I’m gonna hire this manager for these reasons. We’re gonna give it 10 years or 20 years, whatever the number is. Because otherwise, just go put your money in an index. And I think that’s a reasonable strategy. We actually, when we gave my speech because we saw some stat that was clearly wrong that in a newspaper it said a third of individuals have financial plans, investment plans. I said there’s zero chance. And I asked this CFA meeting, over 200 CFAs, how many of you have an investment plan, two people raised their hand.

And so…and that’s a realistic number in my mind and those two were probably financial advisers who have done it for all their clients. So for the active managers, it’s hard. It’s very hard for the end investor to live through it.

Jeff: This ties into a great question actually from a listener that’s on our list here. It says the recent studies have shown that we less sophisticated investors tend to not stick with strategies that have multiple losing years. Given that strategies do sometimes fall out of favor, for instance, the Dogs of the Dow, what would be a prudent strategy for an investor to use to decide if the current strategy is just in a down cycle or if in fact, the strategy has lost its effectiveness?

Meb: First of all, I much prefer Cows of the Dow, which is a shareholder yield approach, rather than Dogs of the Dow, which is just dividends.

Jeff: That’s actually gonna lead to our next question. So hold on that.

Meb: Okay, hold on. Summarize the question for me again. How do you know when to get rid of an asset class or strategy?

Jeff: You’re in a strategy. How do you tell if it’s just sort of having a few years of down, versus if the strategy has completely lost effectiveness and you’ve got to bail entirely?

Meb: Okay. So if you rewind to asset class level, for the asset class level, you should know why you’re in them in the first place. So stocks, you’re owning a part of the company. You’re owning a business. You’re getting paid because the business makes money. For bonds, you’re essentially the bank. Those have long-term expected returns and if you have reasonable expectations, you know that stocks can decline, any country can decline 80-90%. On average, the market cap global portfolio probably have 50% drawdowns and could have many losing years in a row.

Bonds have…many of the sovereigns have declined. In the U.S., U.S. government bonds have declined 50% real after inflation. So understanding that, say if bonds decline 50% again, that shouldn’t surprise you. If stocks decline 90%, that should not surprise you. So you’re in it with that small chance of that happening. You shouldn’t when stocks go down 50 or 80%, say I wasn’t expecting that because it’s happened. So you should be fully prepare for that to happen. So it’s not broken even if they go down that much. It’s not a broken situation.

And then there is other asset class. I mean, in the same vein, same thing with reads, with commodities, with the main asset class. You should understand what’s possible. It’s a harder question for active managers and active strategies. So in particular, we’ve talked a lot about factor strategy. So dividend investing is one that we just talked about, Dogs of the Dow. What other ones is that, again, understanding those strategies can go through many years of cycles of under and outperformance. And this is a topic that’s been on the media a lot, lately with research affiliates and AQR, etc, talking about factor of cycles where you should be more interested in those types of strategies when they’ve done very poorly.

So when dividends stocks have done very poorly for awhile, you should be more interested. When dividend stocks are trading at a cheaper valuation in history, you should be more interested rather than the opposite. But also that requires you to look at when they’ve done really well. So dividend stocks for the last 7 years, 15 years, you wanna be getting rid of them when they’re expensive. You wanna be getting rid of them. A lot of people never do, they do the opposite, of course. They underperform, they sell them. They never sell them when they do well.

And the hardest part…and so that’s hard already. Individuals, it’s hard for them to find valuations of baskets other than just yearly performance which is pretty good way to gauge it. But two is so an active manager, and this is the hardest. So Dave Einhorn, Greenlight, long, short manager, crushed it. Had amazing outperformance for many years and then has struggled in recent years. So do you say to yourself, okay, is it because value has just not much since ’07 and Buffet, the same thing? That’s a totally reasonable estimation. Or is it because he only thinks about playing poker now or is kind of moved over a little bit into global macro investing which may not be his wheelhouse? Or is it because his assets are too big?

And these are questions that institutions struggle with. And for many of them…I mean again, it’s like having a checklist. You need to have checklists for managers just like you would for a stock. Hey, did he just get a divorce and he’s kind of going on tilt? These are all checklist questions and it just went in order from probably easiest to hardest, from asset class, to passive strategies, to active strategies. In active strategies, particularly where you’re betting on the jockey, where you say is this person, I’m betting on his special ability and his team and/or approach to do this, whether it’s Seth Klarman, Warren Buffet, David Einhorn, that’s the hardest of them all.

Jeff: Yeah, that’s tricky. It’s a lot more opaque. I mean, you don’t really know what the underlying issue is.

Meb: And then investor asked a question, and this is a common belief, where he said a lot of retail individuals struggle with this. And a lot of institutions look down the retail and advisers say oh well, you individuals, you do dumb stuff over and over. Well you know, the institutions, they do the same thing. And we see it everywhere. We see…I mean the study that we reference always is Academic Study examined over 3,000 hiring and firing decisions. And the fired manager that’s going out has terrible three-year returns. The one they hire has amazing three-year returns. And then what happens the next three years, the one that was getting fired does great and the one that’s getting hired does terrible. It’s human nature.

And so it’s not just retail individuals. And it’s tough too, not even from whether you’re looking to hire or fire a manager but even understanding the interplay between a client and an advisor. I mean, the Harvard example right now. Did we talk about that on the podcast?

Jeff: We’ve written about it, I think.

Meb: So the Harvard endowment, one of the most successful endowments of all time. I think it be the…

Jeff: No, you talked about Greg Fisher maybe.

Meb: A little bit, okay. Well anyway, they just printed it down here, minus 2%. Forget the 2009, 27th down year they had. But the Crimson, which is the editorial newspaper, and everyone is howling about this is unacceptable. Because most other endowments did 1% positive and where they did -2. So it’s meaningless underperformance. So a couple of takeaways. One, it’s an active mandate. So you will underperform many, many years. Two, minus 2% is meaningless. But three, if you go back 7, 8 years when Harvard was crashing it.or 8, 9, 10 years, all of the complaints were you guys get paid too much.

So this is an example of a trend that is a very hard interplay between the managers of the fund and the base where the base isn’t onboard. And that could be totally…it could be an impossible situation where the students and the faculty say you guys are getting paid too much. It’s a public or a private institution but very public facing endowment. And the managers say we can make so much money elsewhere on Wall Street and we’re getting paid not as much. And our outperformance has saved more than [inaudible 00:38:45]. It’s kind of an unwinnable situation.

So unless the…and the same thing applies to a financial adviser and a client. Unless you both can get onboard with what’s going on, there is gonna be huge dislocations and that’s when people get upset. And my biggest nightmare is a client coming in and saying, “Oh, I’m hugely surprised by the performance of what’s going on in our portfolios.” Because that means we didn’t do a good enough job educating or at least talking about it with them. And that’s when problems happen. And then, that’s when people behave the worst.

Jeff: Yeah. I think a difference in expectations from a time perspective in returns because it’s such a huge issue, you always reference or it seems like you’re far more comfortable referencing much broader, longer investment returns. A decade, if not longer. So many retail investors seem to be looking at what happens in the next 12 months and there is a huge discrepancy there.

Meb: Next quarter, next week.

Jeff: Yeah. All right, so actually tying back to the next question, you referenced the Cash Cows of the Dow versus the Dogs of the Dows. A listener writes in, in episode 22 the formula for expected stock returns that Meb states includes dividend yield as the first terms. Remember that was when you were referencing like future returns. You took the dividend yield out of the assumed growth rate. Why not shareholder yield instead since later in the episode you talk about how bad dividend yield is?

Meb: The listener is referencing the Bogle’s, it’s not my formula. It’s Bogle’s, he published it 25 years ago. And it just basically says future stock returns can be in the simple formula of starting dividend yield, earnings growth, and earning dividends growth and change in valuations. It’s a simple formula. Buybacks end up getting reflected in the dividend and earnings growth formula for the expected returns. However, if you are to select an individual stock based on…it’s different. One is are you screening for current companies, based on their characteristics? And the other is what are you projecting the future returns of the market to be?

So the buybacks change the equation of dividend and they play out. It’s a wash, is what I’m saying, is they play out in the equation because the buybacks reduce share count. Which changes the overall picture, etc, etc. But if you are looking to screen, the reason why we say you need to make a differentiation between dividends and buybacks on an individual company is you’re ignoring half of how the company distributes their cash flow. And this is on a trailing basis rather than forward. You’re ignoring most of the picture. I don’t know if I answered that the right way. But if it didn’t get too confusing but…

Jeff: In essence, a wash if you’re looking for more…at a more market level, it’s a wash. If you’re looking in stock specific, then you need to factor it in.

Meb: Yeah. It’s a wash in the sense that the buyback, whatever happens with buybacks, whether there is net buybacks, no net buybacks, or share dilution will show up in the other numbers. Which is not the case if you just looked at a stock and said I’m gonna buy this stock based on dividend yield. Well, you’re ignoring everything else.

Jeff: All right, so let’s dig a little deeper here in some trend and tactical questions. First is just topically, address the tax consequences of being tactical.

Meb: You always have to be hugely conscious of taxes. That’s not just tactical, it’s for Buy and Hold, it’s for where you put your stocks and bonds, in a taxable or exempt account. It’s what type of stocks do you hold. We did a post earlier in the year on how much you should avoid dividend stocks and replicate them with a value strategy with no dividends in it. It’s much more tax efficient. And so you lay on top of that tactical strategies. Well obviously, this doesn’t apply to tax-exempt accounts because you’re not paying on the taxes. But also for transaction costs.

So you have to take all of these things into account. You know, I mean, look. Depending on the strategies…so there is a paper we sent out to the Idea Farm recently about a lot of factors. So value quality, momentum, etc. Some of those, depending on how they’re designed have a higher turnover. Which means you’re gonna likely have higher taxes and higher transaction cost. So you need to factor that in. A lot of these studies are publish gross and so you need to factor in.

And then second, think about where they are held and in what structure. ETFs can have 200% transaction cost and in many cases, never distribute taxes. Mutual funds can’t. Mutual funds, a lot of people are gonna get hit this year in particular with gains. At the end of the year, you’ll get mutual fund. If it’s turned over a bunch, you’re probably paying taxes on that. You could buy a mutual fund, have a losing position in that mutual fund and still have to pay taxes on gains. Which is a horrible situation to be in but it happens every year. So you buy a mutual fund, you can actually look. Morningstar is another report, what their expected gains that are held within the fund. Most ETFs don’t.

So most ETFs, I mean, if you look at the SPDRs back in ’97, they’ve never distributed capital gain ever. Going back to the disruption of mutual funds, the active segment of the equity market with mutual funds hasn’t even sniffed being disrupted yet. There is like almost no active equity ETFs, which have a vastly better tax structure than mutual funds do. There’s a lot of parts to that question. So one, yes. You need to be aware of the strategy. How it’s generating turnover, with transaction cost and taxes? And if you do it active, where it’s located, is it in tax-exempt and what is the structure?

Jeff: I still don’t understand that lack of disruption yet. I mean, the fee differential between an active ETF versus a mutual fund seems so significant. It kind of ties back to what we were referencing earlier in this podcast. Is it just lack of awareness?

Meb: Let’s think of the motivations. So look at the recent Wells Fargo scandal with people opening up investment, credit cards for people that had no idea and didn’t want them. So who is motivated to do that? Well the employees were because they were getting bonuses to open up new accounts. So they are motivated to…well I mean, this is illegal and fraud, but…let’s give a better example. You go back to the real-estate bubble in 2006, 2007. At various levels of the nodes, it made total sense for the people to behave the way they did. It made sense for the mortgage originators to drum up as much business as possible because then they could pass it off to the people that were packaging them. And the people who were packaging them, it made sense for them to do as much as possible because they’re passed off to the investment strategies. It made sense for, in the big short, for the stripper to buy three houses because she could get hugely, wonderful terms. You know, yadda, yadda. You put all of them together and you get a very bad behavior.

So in the high fee mutual fund world, for example, you had the same behavior. You have sales people who are hugely compensated on these funds that, let’s say charge 1.5% a year and have a 5% load and 1%, 12b-1 fees. All those fees are designed to ensure that fund gets sold. And so that’s a totally reasonable example for these people to push these junkie high fee funds because they get paid the most on those. In ETFs, because one they’re half the cost of the average mutual fund or less, it’s around 50 basis points for the average 0.5% for the average ETF and 1.25% for the average mutual fund. So it’s less than half. So there’s already less juice for people to get from selling them. And two, they don’t have sales loads, they don’t have 12b-1 fees. These are all investor friendly things by the way but it removes part of the incentive. Cambria doesn’t have hardly any distribution for us, right? And it’s much harder to track. It’s part of the incentives.

But people will only exist in that sort of investment world, holding those for so long. Look, financial advisors for the longest time have held all these junkie mutual funds. The average financial adviser that’s been in business, I forget if it’s been over 10 or 20 years, owns 200 mutual funds. Think about it for a second, 200 mutual funds. You’d probably ask them to identify more than 10, they probably couldn’t. Because they bought them and they held them and moved on. The financial adviser is getting pressured because in a world of 10-12% returns, which we had at various periods, your 1% fee and the 1.5 that’s sitting in that mutual fund doesn’t matter as much. As in a world of 5% returns or 4 and you’re still charging 1 and one and half, where do you think the financial advisers start to make the cut? Well they start to make the cut in the mutual fund because they charge way too much and they’ll start to use lower cost funds. Which is great and that’s what they should be doing. But the fees are a much higher percentage of the overall performance.

So yes, I don’t know how a lot of those funds will exist. And you may see the scenario where the flows which have been consistently, out of mutual funds, active mutual funds into ETFs, you may see a point where the dam breaks. I don’t know. You may see it in the next crisis, you may see it…who knows what may happen? But you may see that really start to accelerate in some of these funds that are traditionally high-fee mutual funds. I don’t know how they exist.

Jeff: So armchair investors out there listening, we’ve kind of talked earlier about if you have to be greater fundamental analysis or what not. There is all these things that can take up tons of time to become a master at. But researching any individual security you are in and the cost associated with it, it’s not that hard and it seems like it has a significant impact on your longer-term returns. So in terms of like practical steps here, where do they go? ETF database? Like how can you learn?

Meb: We put in one of our books that people spend more time researching their television purchase than they do on their retirement situation. And it’s not surprising if you think about it. By the way Wirecutter, a great site for if you buy anything electronic. I love it, it’s like a Yelp for anything…I don’t think I’ve bought anything for my house not on Wirecutter in the past two years. Anyway, what were we talking about?

Jeff: Would you say, in terms of resources, ETF database is a good way to look at…?

Meb: Where do people find out info, Morningstar is classically wonderful, etf.com, ETF Database are both great. Morningstar puts out a couple of publications, one called ETF Investor which is a great overview. I paid to subscribe to it. What else? Even some of issuer sites, Vanguard, iShare sites. They have a lot of good education. I think there is not…and etf.com still puts out a ton of great research on ETFs in general. But Morningstar is kind of always the default if you wanna look up a fund or a screen for funds or figure out what’s going on.

But in general that we think the disruption is just beginning. Now again, I’ve said this a million times. This does not mean that if you have a very high-value add, Michael Jordan manager, that they shouldn’t be getting paid a percent a year, percent and a half. If you’re Simons at Medallion getting paying 2% a year…they used to charge 4 and 40, it was amazing. Although ironically, a lot of their newer funds haven’t done as well. Somehow they opened up a managed futures funds and shut it down. Anyway, it doesn’t mean that you can’t charge high fees and have great performance and great offering. So I’m not one of these crazy people. It’s just like index, you have to pay as little as possible. No, I think that for the buy-and-hold stuff that you’re doing nothing for, pay as little as possible and go look for alpha elsewhere and then you still be mindful of fees and structure.

Jeff: Another tactical question here. I would be interested to hear a discussion of the pros and cons of protecting the downside by buying out of the money puts for the relevant investment versus using trend following to protect against the downside.

Meb: We send out a couple of publications that look at both. I mean, trend following is nice because it still has a positive expected return as does managed futures. I just had the funniest…by the way, it’s someone I did this interview. And I kind of have this weird, monotone, Midwest, southern mash-up accent. Which by the way, Apple now does the transcriptions. And…have you seen this? Do you have an iPhone?

Jeff: Yeah, but…

Meb: For the new operating system, for the voicemails which I hate listening to anyway, they will transcribe them.

Jeff: Does it get your accent down?

Meb: No. It gets everyone right, except for my mom who has just the most ridiculous Southern Accent. And hers, like it translates it basically into Latin, it’s really funny. I haven’t told her this yet. But I used to tell my mom if you leave anything more than a 15-second message, I am not gonna listen to this. If you wanna talks for minutes, call me and we’ll talk. But she has conversations on my phone which I was like, oh sweet. Now I can just read the transcript but the transcript for her it doesn’t work. So anyway, I gave a speech and the person who run it texted me to say, hey, were you saying Trin, T-R-I-N, or TRIM, T-R-I-M following? And I said that’s a really funny question because both of those mean something totally different.

Trin, by the way, T-R-I-N, is a technical indicator. I forget what it stands for. It’s something like The Daily Tick or New Highs. Trim obviously, it ends up in somewhat of a PG or R rated question. But I said, no, no. I said Trend, T-R-E-N-D. Trend following. So trend following. Trend following still gives you like a positive expected return as does managed futures. Puts, if you buy a basket of puts, you should have a negative expected return because you’re just buying insurance. Now that doesn’t mean that it’s not reasonable, particularly tactically to add puts to a portfolio. You could buy a basket of puts that at certain times, would be a wonderful hedge.

Jeff: Well if you get a longer term, seems like if you get it right on puts your return is gonna be held a lot more than on the trend. Does it balance out over time?

Meb: Depending on how you do the trend. Again, there is a lot of million different ways to do it. And same thing with managed futures. But puts to a traditional portfolio of equities or puts on everything to a traditional portfolio, stock bonds, leads, commodities, will it reduce your return over time? Yes, probably. Will it reduce your volatility and drawdown? Maybe. I mean, it probably will. It’s like an insurance. So periods like an ’08, periods would have done great. Obviously in 1987, it would have done unbelievable, 2000, 2003, maybe. You know, there’s a lot of caveats to the role methodology, to how far out you’re doing it.

A lot of the tail risk Hedge Funds, I mean, we have one file. We’re gonna launch one at some point because I think it’s a great way for people to get exposure to a basket like that. And of course, if you wanted to short a basket of puts, you just go short the ETF. But I think it’s a reasonable, for a lot of people, I mean again, these big losses, if they can buy some insurance and reduce the drawdown and lower the return? I am cool with that.

Jeff: What are you doing? Buying maybe 12 months out and rolling them monthly?

Meb: Yeah. I mean again, the short-term puts you’re losing the most to the time decay. So the longer stuff that you would enroll, you know however you do it, once a quarter, once a month, once a week. I don’t think it matters that much. But yeah, if you look out to 12 to 14 months, you lose less time decay. And volatility is relatively cheap right now. You know, you start to buy those when VIX is up around 30, 40, 50 and it’s…you’re kind of….

Jeff: It hasn’t been that high in a long time.

Meb: It’s been awhile.

Jeff: All right. I think we’re getting kind of close here to a long episode. Why don’t we do one more question and call it a day?

Meb: Yeah.

Jeff: Let’s assume I can handle risk, that I am a heavy risk taker. I can handle an 80% drawdown and stick to the strategy for many years, no matter what. Should I then put all my money in the asset class with the highest expected return? Let’s say I would currently go all in emerging markets or just all in Russia. I would rather be very concentrated and not go for a basket of cheapest countries. What’s your opinion on this?

Meb: I think this would actually be a fun book. This is a book idea that I was thinking about the other day. Where I was to say, if someone asked me. Meb, I don’t care about highest risk it has to return. I don’t care about the best portfolio that I can live with and load drawdowns. Just show me the money. What is the biggest return I can get? How would I put that together and what’s the best way to do that? I think that would be a fun book, we’re gonna call it Big Returns. First of all, I would never just wanna go all in on…first, back up a second. There is no way that guy can withstand 80% drawdown. No one can withstand 80% drawdowns. 50 is one thing, 80 is a lot.

But let’s say you can, hypothetically. I would come up with maybe four strategies that were probably uncorrelated that would give high returns but did have a very high chance of either blowing up or having large drawdowns. So if you do an option selling portfolio and you do straddles or strangles, biased on the direction of the trend do it across 10 or 20 global markets. That’s a good high sharp ratio, short-ball product. And I don’t know that that actually exists. You see the option writers out there, usually they only focus on the US stock market. But if you diversify…we did research on this a dozen years ago. It’s a great portfolio stream and you don’t run the risk of blowing up like most of these guys do that simply write options in the US stock market.

And then if you look at the option selling funds, you Google on my blog at the bottom of the show notes, we used to do posts on this where there is like six option funds, unbelievable sharp ratio. Because they have this 1% returns every month and then explode and lose all the money, right? But if you diversify that and come up with ways to be smart about it, I think that’s a great high returning portfolio. You pair that with the managed futures, I think that’s actually a pretty cool allocation. Then maybe do a leveraged micro cap, quant strategy. You can do a long only, you could maybe short out some of the market exposure. And then yes, you could add a tactical bucket where you’re buying the bombed out stuff. It’s the cap ratio stuff, which is having a monster year this year. A lot of the global countries in Russia is up 30%. Spain, Europe is still lagging. But Brazil is up 70%. We wrote an article on this at the beginning of the year, cheapest stock markets in the world. So podcast listeners, hope you put all your money into Brazil. I’m just kidding.

Jeff: It seems like though, answering this guy’s question, you would not endorse a single asset class or a single country. I mean, you still…even with a heavy risk taker, you wanna spread out a little bit.

Meb: Yeah. I mean, you could come up with enough high expectancy bets or high return expectancy bets and at least put them together to come up with a return stream where it’s not all in on the roulette table or all in on one single outcome. Maybe you just inspired us to write a new book. I said I’m done writing books but this would be…I think would be a fun one.

Jeff: I like the idea of selling sort of a directionally tilted strangles.

Meb: Yeah. Here is the challenge, it’s hard to model. So you have to go to someone like CSI who has historical option series. Which you got to remember is multiple series per year. Then you got to find the correct strike price, then you got to align it to the futures market or whatever market. And then you need a basket of about 10 to 20 of those instruments. So think about how long that takes to back test. So we did it and it is reasonable but again, I mean it’s a huge pain. So if any readers have done this, you’ve seen research on this. There was a book that came out about a decade ago that was on option writing in this format.

I don’t think there is any funds. IASG is a great…CTA and options database lets you look at performance for a lot of these funds. There was one or two that might have been doing diversified option selling but I don’t know that they exist anymore. We’ll have to look.

Jeff: Real quick, back to the idea of buying puts as a protection. How far out of the money would you go?

Meb: Well I think you’d go anywhere from strike at the price, at the market…

Jeff: It’s pretty pricey, though.

Meb: …to all the way down to minus 20% price and you can talk about deltas and everything else. But in general, it depends on what your…again, it totally depends on your goals and expectations of what you’re trying to achieve. And tou could also do spreads, you could do all sorts of other stuff that give you all your various outcomes. Because some people say you know what? I don’t care about losing 0 to 20, but I don’t wanna lose more than 20. Some people say, no. I just wanna reduce some of the upside and add some…there is a million ways to do it.

Jeff: Yeah. That’s all I got today. Why don’t you take us out?

Meb: Cool. Well look, if you find yourself in Orange County, Thursday, October…what is that? The 17th. I’m giving a speech to…no, sorry 20th. 21st, I’m giving a speech to CFA Society. I’m in New York for an entire week giving three speeches then Richmond, then DC. If you’re in one of those cities, we’ll post it to the travel show notes. Thanks for taking the time to listen today. We always welcome feedback, questions. Mailbag, [email protected] As a reminder, you can always find the show notes and other episodes at mebfaber.com/podcast. Please subscribe to the show in iTunes, Overcast. And if you’re enjoying the podcast, leave us a review. Thanks for listening friends and good investing.

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