Episode #88: “I Still Believe that Alpha Is Available and Possible, and Beating a Benchmark is Possible”
Guest: Eric Clark. Eric serves as a Portfolio Manager and a member of the Investment Committee at Accuvest Global Advisors. His focus is on AGA’s suite of Alpha Brands strategies. As a member of the Investment Committee, his responsibilities include research, investment analysis, technical analysis, macroeconomic commentary, and portfolio strategy & implementation.
Date Recorded: 12/14/17
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Summary: In Episode 88, we welcome portfolio manager, Eric Clark.
As usual, we start with Eric’s background, which spans 25 years in the investment industry. After working for an asset manager, Eric realized he wanted to do something passion-based – a “timeless equity strategy.” So, when he felt he had the answer, he created a suite of consumption-based brand strategies.
Meb asks about these brands and how they play a role in Eric’s portfolio construction.
Eric tells us he tasked himself with identifying some stable, persistent themes he could anchor to (for the purposes of building a portfolio). He tells us that “nothing is more persistent than a consumer’s propensity to spend.” With this in mind, he looked at the U.S. economy, and what drives it. Eric tells us that the consumption component of GDP has annualized at about 3.5% a year for 50 years. And of that, about 70% of our GDP is consumption. Now, take these two pieces together – “if consumption…is predictable then how do I build a strategy that taps into that?” The answer points toward buying great consumer brands.
Next, Meb asks about the framework. Eric says you need an index. Therefore, they created the Alpha Brands consumer spending index. The goal was a broad universe, tracking a lifetime of spending. For instance, a Millennial spends differently than someone from GenX. So, the idea was to create an index consisting of the most relevant and recognizable brands that track a lifetime of spending.
Meb asks how it works going forward? For instance, how would Eric see companies like GE and IBM? Are they great buying opportunities or dead brands?
Eric points toward IBM as a brand they’ll likely hold onto, as it’s still a powerful B-to-B brand. But he tells us the food packaging industry, for example, is coming under pressure. That’s because the type of food we buy is changing. He identifies Kellogg as a company facing challenges.
The conversation bounces around a bit, referencing valuation, where this brand-based type of investing fits into a broader portfolio, and how this type of strategy might be expected to hold up during a recession. Eric speaks to this last point by discussing consumer discretionary versus consumer staples, including the risk of rising rates.
There’s plenty more in this episode – where Eric believes the market is going in 2018 (he mentions some thoughts on earnings)… how international sales affect the brands-strategy… how the asset management industry seems to be moving toward the commoditization of portfolio construction, where advisors just want to own everything (in response, Eric tells us “I still believe that alpha is available and possible, and beating a benchmark is possible if you understand a bunch of things”).
We wrap up with Eric’s most memorable trade. It involves an ill-timed attempt to short banks in July ’09.
Hear all the details in Episode 88.
Links from the Episode:
- 00:50 – Welcome and background on Eric that led him to Accuvest
- 5:06 – Eric’s interest in cycling
- 6:02 – Closer look at brands and the role they play in portfolio construction
- 7:10 – One Up On Wall Street: How To Use What You Already Know To Make Money In The Market – Lynch
- 9:17 – Eric’s process for analyzing a brand
- 14:08 – The human role in their back test
- 16:18 – What is the criteria for kicking out a company?
- 20:04 – Sponsor: Health IQ
- 21:12 – Does valuation become part of the decision-making process?
- 22:37 – How does this investment fit into a portfolio?
- 25:23 – What does the brand index sector look like?
- 25:53 – What are the risk factors of this investment?
- 27:35 – Eric’s outlook for 2018
- 29:11 – “2017 Least Volatile Year Since 1964” – Bespoke
- 31:42 – How to determine the allocation to international sales
- 32:55 – Looking into the future of the asset management industry
- 36:21 – What are some alternative investment ideas that can be added to a traditional portfolio?
- 39:04 – Exploring brand deterioration
- 41:10 – Eric’s most memorable trade
- 43:06 – How individual/retail investors can get involved
- 43:56 – Accuvest Investment Strategies
- 44:39 – The Accuvest Blog
- 44:47 – Iconic Brands Index
- 46:15 – Riskalyze (Eric Clark’s illustration)
Transcript of Episode 88:
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 the Cofounder and Chief Investment Officer at 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.
Meb: Welcome, podcast listeners. Happy holidays. Today we have a great different show for you. Our guest is a portfolio manager and is focused on something we haven’t discussed that much yet on the show. He leads the Alpha Brand effort at Accuvest Global Advisors where he also performs investment analysis, portfolio strategy, and implementation. Welcome to the show, Eric Clark.
Eric: Hey Meb. How are you?
Meb: Doing great. You’re just down the road in San Diego. We should’ve dragged you up here in an Uber and made you do it in office. But it feels like summer time in the holidays. I haven’t quite gotten used to wearing shorts in December. I’m more used to snow but I can’t complain. So for the listeners who aren’t that familiar, we always start with a little background for our guests. So why don’t you give us a couple of minutes on your background, and what you’ve been up to, and how you got to where you are today?
Eric: Sure. You know, I’ve been in the business for about 25 years, done a variety of things through that time, you know, started at Merrill Lynch as a rookie with a big team and soon realized I wasn’t probably the kinda guy that would be an advisor, but I love the capital markets and the asset management part of the business. So my next step was to go work for an institutional money manager out in the Bay Area called Jurika & Voyles. They were part of Natixis which is a big holding company. And I knew that I should be on that side of the business. Spent a little time on the portfolio side with primarily…I was kind of focused on doing that for the rest of my career and for a lot of reasons I ended up getting pushed out into the sales and the marketing side to cover some meetings when we had a few people leave. And I ended up liking it, and staying, and spending a lot of time working for different money managers throughout the years representing strategies and working with institutions and advisors etc.
And then after about 2004 I took a step back and decided I wanna do something completely different. And even as a sales guy I’ve always been a capital markets-focused person so I wasn’t really a traditional sales guy, meaning I’m just gonna go out and pitch you an idea whether it makes sense or not. I was much more fact-based and data-based. I was, kinda, known as the chart guy when I was out in territories. And I think most people respected that because I wasn’t just trying to sell them something versus show them why something might make sense. So I started a small RAA. I called it Breakaway Partners. I’m a cyclist so there was that little cycling metaphor. And it was kind of distancing yourself from the pack. And, you know, I created some kind of trading portfolios using ETFs and single stocks, and that’s really where I spent a lot of time getting to know the brand theme. And, you know, most of the best investments I’ve ever had have been investing either as a trade or a long-term theme in a lot of these great brands, and focused on the consumption theme etc. etc.
So then we had ’08. That was a good time as everybody knows. And I ended up deciding to go back to the safe, comfortable world of working for asset managers. And I guess two years ago I finally just said, “You know, I’m really tired of talking about things that sound really good and somehow seem to fall short a lot.” And, you know, I think everybody in their career has a…that comes to a crossroads where you think, “You know, I could either stay doing what I’m doing, I make great money, I have a great life or I can do something radically different that I believe in and have it be passion-based.” And so I spent some time thinking about, you know, of how we’re gonna create the perfect strategy. And I know there’s not…you know, the word perfect is, obviously…just sets you up for frustration but if I was gonna set up something that was in a timeless equity strategy, you know, what would its characteristics be, and what would it look like, and how would it be run? And so I spent a lot of time thinking about that, and when I felt like I had the answer I decided to quit my job. And, you know, my wife was…I have an amazing family. They were willing to support me along this crazy ride, and so here I am two years later. I work with Accuvest, and we created this suite of consumption-based brand strategies, and now we’re having a lot of fun doing it.
Meb: Perfect. Well, we’ve long been good friends with the Accuvest crew. I’ve enjoyed having tacos with your co-compadre, Mister Garf down in Mexico. But before we get into the brands, quick question. This is an office debate. Do you ever do… So I assume this is all road cycling?
Eric: You know, I started mountain biking when I lived in the Bay Area. I also then did road cycling and I just decided it’s much more fun to be on the dirt, and jumping rocks, and acting like an eight-year-old than to be flying down the road when I’m worried about cars and people texting. And so, yeah. I haven’t road biked for many years. Probably when I lived in LA in like 2007, I probably stopped road biking. So it’s all mountain now.
Meb: I love mountain biking. I’m terrible at it. I crash a lot but it’s one of my favourite things. But the reason I ask is we’re debating getting a Peloton for the office. So that was my singular focus. All right. Sorry, podcast listeners. Totally off topic. Let’s get into brands. Meanwhile, Peloton, great brand. I think any time you can sell a bike for like $2,000 or $3,000, exercise bike that people won’t use. I think the strategy’s gotta be, you buy that in, like, February when everyone’s done their New Year’s resolutions. Okay. My Lord. Okay. So let’s take it from the top. Talk to me about brands. Talk to me about Alpha Brands. What does that mean and how does that play a role in portfolio construction?
Eric: Yeah. Well, you know, going back to my little whiteboard experience a couple of years ago I sat down and I just, I think I tasked myself with trying to figure out what are some really stable, predictable, consistent themes that I might wanna anchor to because looking at trailing returns for different styles, that never helps. There’s not a lot of consistency there. So I chose to try to figure out, well, are there things that tend to be pretty persistent that I can anchor to and then build a portfolio around? And, you know, the reality is, it’s very common sense. In fact, I think the first book that I ever read in the industry was Peter Lynch’s “One up on Wall Street” and it’s essentially, “know what you own.” And his view… And I re-read it, you know, a couple of years ago and I was actually laughing because he pretty much mocked his industry. He basically said, “You know, ‘mom and pop’ on Main Street probably can be better analysts than most Wall Street people because they shop. They go around the community and they understand what companies are doing well and what isn’t doing well and you can usually connect the dots into owning a lot of those companies.” And he was, you know, way before his time. Fidelity, when he took over Fidelity, I think it was like a $20 million fund. He ran it up to about nine billion which was a lot of money back then. And probably, you know, if he did it today it’d probably be a $60 billion fund. But it had the best track record of its day, and it was a very simple thing, and “know what you own.”
And so I realized that really nothing is more persistent than a consumer’s propensity to spend. I mean, I challenge anybody to go a day not spending money on something. Certainly, if I can do it, my wife isn’t doing it. So that’s something that I thought is a pretty predictable thing. And then if you look at, you know, what drives the actual economy it’s not…you know, I’m less focused on the brands part right now and was more focused on the fact that it’s just spending. The consumption component of GDP has annualized at about 3.5% a year for 50 years. And so it’s been…you know, if you look at a lot of the components of GDP, they tend to be pretty volatile but there’s this smooth line in the middle that’s consumption. And so, you know, 70% of our GDP is now consumption, and not so surprisingly most other countries are the same. Most of them aren’t at 70%. I mean, China is probably 30% last I checked, but it’s a pretty persistent theme across the world. And then, you know, from there now you can figure out, “All right. So if consumption and people spending on what they want and what they need is predictable, then how do I build a strategy that, kind of, taps into that and benefits from that?”
Meb: So talk to me a little bit about how you do just that. What’s the framework for going about deciding on what’s a good brand, what’s a bad brand, is it purely subjective, is it quantitative? What’s the process?
Eric: Yeah, no. It’s a little bit of both. I mean, so the first thing that we did was… Okay, if we’re gonna track a theme we need to have an index to do that. And so we created what’s called the Alpha Brands Consumer Spending Index. It’s been on Bloomberg since September of last year. We had it going for longer but we didn’t have it published through INDXX until, I think it was like September 28th of last year. And essentially, we wanted to have a broad universe and we wanted to track a lifetime of spending. So it’s a little bit different than consumer discretionary, consumer staples because, you know, the spending that we do is much more than just staples and discretionary. I mean, in some ways it’s very demographic-spaced. A millennial spends differently than a Gen X which is where I am, and when I look at my mom at 77 she spends completely differently than I do. You know, 45% of her discretionary income is healthcare. So the goal would be with…you know, create the most relevant and most recognizable brands, 200 of them, tracking a lifetime of spending. And brands are very interesting because it’s not…generally speaking they’re intangible assets. So you can’t really, you know, go look on a balance sheet. Occasionally you can see something on the goodwill line for certain companies but it’s very difficult to track this intangible asset. And so we realized that we have to go find them where they live meaning we went all the way down to the industry level, you know, when creating the index.
So we looked through the indexes and we said, “You know, there’s about 150 industries to choose from. Let’s decide which ones are the most correlated and tied to consumers and consumption.” And then also we wanted to have B2C brands as well as B2B brands, business-to-business. And so we also included what we call brands that were vital parts of the consumption supply chain, meaning if travel was a big theme for the consumer… Boeing obviously is the largest airplane manufacturer. They don’t directly sell to consumers but they do build planes that sell to airlines, and that’s the way we get our lead in to travel. So essentially, identified 200 companies, 10 sectors, 70 sub-industries, and that’s where a lot of the quant work begins. So we created a ranking system that just was designed to kinda drive us into the leaders in those industries. It includes market cap, and three-year sales, and three-year sales growth. And then we just rank every company that’s in those industries from top-scoring to bottom-scoring. And then we did a bit of an asset allocation plan where we just said, “You know, we don’t need every company in each one of these industries.” The goal would be to get as much exposure to the total revenues of that industry by taking as few names as possible.
So, for instance, you know, if there’s five home improvement names to choose from you get 95% of the revenues just by taking Home Depot and Lowes. So we kinda did that same process, pretty granular, across the 70 industries knowing that we only had 200 slots to fill. So we had to be very specific about, you know, how many we took from a parallel [SP] retail, versus packaged foods, versus, you know, tech hardware or something. And a lot of that was based on the names that we had to choose from and some of the qualitative work that we did within the, you know, the balance sheet and saying, “Okay. If your revenues are X, what percentage of the revenues are really tied to the consumer are part of that theme?” And we just chose to include the number of brands that made the most sense.
So like, for instance, food packaging. There’s a lot of brand recognition in there. You know, General Mill, Smucker, Campbell Soup, etc. So I think last year’s 200…the largest number came from the food package. I think there was 11 or 12, and then some industries we only needed one. All we wanted was, you know, an anchor tenant, if you will, in that particular industry if we deemed it important to track. And then 20% of the 200 will always be international. And we did that because there are a lot of companies that are not US-based that are very prevalent, very recognizable in the US. And so we thought, you know, if we create 200 and we give a slot to 20 different names for international that are making inroads or had made inroads into American society and American consumerism that’s a decent exposure to those names.
Meb: This is interesting because it’s a little bit of what I would consider to be both a subjective as well as quantitative process, right? I mean, is there some, you know, kind of manager input on? Is this a brand that’s recognizable or Alpha Brand? Am I speaking to that correctly or is it…? It’s not purely quantitative, correct?
Eric: It isn’t, yeah. I mean, you know, candidly the backtest…because some industries weren’t even around 10 years ago. So in some ways, you had to find… Okay, you know, Sherwin-Williams was in that category but it’s clearly the largest paint and coating company in the world. We might’ve had to include it in one industry when it’s in another industry currently. So the nice thing about… You know, and we all know nobody’s ever created a bad backtest so you have to take every backtest with a grain of salt. For us, this exercise was about just creating an investible universe with a framework that I just described that ultimately we could adapt over time as the changing consumers and their habits changed over time. So as the Baby Boomers pass away and their ways of spending changes in lieu of the Gen X, and the millennials, and the Gen Z probably some of the…you know, our exposure to certain industries might be reduced or increased depending on our work on the demographic side. But the backtest, if you will, was a static look and we just said, “Okay. We’ve made a choice to say, ‘This industry, we take the top four. This industry, we take the top seven. This industry, we take the top three.'” But going forward we have a little bit of latitude to make sure that we’re capturing the spending that’s happening in the way that we wanna do that. So obviously as an ETF, we’re, you know, creator and provider, that’s not… The Alpha Brand’s index is probably not one we would create a passive ETF on because there is some of that latitude and some people have a problem with that. But there are a plenty of examples of ETFs that were created where there was, you know, “an investment committee” that made those decisions.
Meb: I’ll take issue with, you never created a bad backtest. We create dozens of those probably every day. Talk to me a little bit about how that portfolio works going forward. So what is, kind of, the criteria for kicking one out? So as I think, I’m sitting here…you know, there’s a handful of what I would consider to probably be Alpha Brands that have been around for decades but more recently may have fallen on hard times. I’m thinking more recently about say, General Electric cutting its dividend or is IBM, you know, seen as a dinosaur? Is that still considered an Alpha Brand, you know? And does it make it a buying opportunity or is this time different? How do you guys, kinda, think about kicking names out as well as, you know, continuing to include them in the portfolio?
Eric: Sure. We’re actually gonna do our index reconstitution next week and that’s a super fun exercise to go through. And, you know, in some ways the ranking system is still what we lean on. So, you know, if you use IBM as an example, if you look at the industry that IBM is in, the data processing and outsourcing, I think, that’s gonna be a number one or a number two. And so we’re probably still gonna have an IBM, and candidly it’s still a pretty powerful B2B brand that just lost their way for a little while. I think the things that might fall out are, for instance, if we took the food packaging, you know, that industry is really coming under pressure. The old way of buying those brands has changed a little bit with our focus on healthier foods and certainly, millennials are changing the way they view buying food. And so some of those brands have just lost their way. Some of them are buying emerging brands. I mean, Kellogg just bought, you know, a four-year-old company for 600 million bucks, this RXBAR, I think it was called. And, you know, they’re clearly looking at their product lineup and saying, “We are heavy, high fructose corn syrup, and hydrenated oils, and very low on organics,” and all those buzzwords. So in some ways a company that is losing their appeal by some of the work that we do qualitatively and quantitatively, they will be pushed out understanding that, you know, if we need to make room for more companies in another industry, we have some choices to make. So it’ll be interesting to see that process happen.
Last year we added PayPal because mobile payments are obviously a very important driver of growth. And that was a spinout from eBay, so we had a chance to add that one. Ferrari went public, so we added Ferrari. And then we added Square and Zillow, you know. So a lot of this is looking at trends, and deciding what are less important, and what are more important, and what names do we have to choose from to be able to pick and choose. And, you know, certainly from a retail perspective, we may choose to lighten up on the number of department stores. We have three now. We might even go down to one. Maybe we just need Nordstrom. Macy’s, I don’t know that we need Macy’s. It’s just a real-estate play at this point. So, you know, like I said, it’s a fun time to go through that process, but part of it is very quantitative in the ranking system and what choices we have. And then some of it at the end is, you know, let’s talk about that brand and see…you know, maybe it comes in as number seven and we’ve only chosen to have five, but is Live Nation…actually Live Nation was another one that we added last year. Clearly, a very important company in the experience category, in concerts and it’s been a great stock here today. It wouldn’t have made the top five from a ranking system, but we chose to include it because it’s a clear winner in an area that’s becoming much more popular.
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Meb: Talk to me. I don’t know the answer to this. Is valuation something you consider as a part of your inputs? I mean, as I think of some brands you have like on one hand what we’d consider to be, by most valuation metrics a pretty expensive but dominant brand like Amazon and maybe on the flipside same, general industry, you know, Apple which may be a cheaper company but also dominant brand. Do you guys take into account valuation at all or is it something that you see as secondary or not relevant to the core methodology?
Eric: You know, we don’t really take the valuation into consideration because the exercise of creating the index is more based on capturing the most important brands and then, you know, some of the other products that we run that are powered by that index…obviously valuations are a part of those decisions, but from an index creation it’s just more about, let’s capture the right 200 companies. And the index, it literally is a horse race. We don’t rebalance it during the year. It’s just, we pick the 200 companies. They’re equal-weighted. It’s a horse race the entire year and then we reconstitute at the end of the year simply because we just wanna track that theme and then over time, you know, it’d be really fun to look back at this, you know, 20 years from now to see how we’ve changed. You know, 20 years ago you would’ve had Sears and, you know, plenty of other…J.C. Penney would’ve been in there, I’m sure. But clearly, those brands have peaked and are going away.
Meb: It’s interesting as you talk about brands because, you know, you think about not only brands over time…as you were saying, Peter Lynch, I think the example, God, if I remember this from reading it 20 years ago was… What’s the name of the pantyhose? Was it LEGOs? Not LEGOs. L’eggs? I think I feel like he might’ve used that in his book.
Eric: The Egg.
Meb: Yeah, the Egg. And so I was laughing when you were talking about department stores because I was gonna interrupt you and say, “Listen, millennial listeners, a department store is actually this building you go to and you can actually buy things, you know, in the store and take them home as opposed to them getting delivered by Amazon.” So it’s interesting to think about deterioration of brands, and new brands taking over, and the process of replacing and introducing new ones. But intergenerational, where millennials have such a totally different brand loyalty than parents and grandparents might. Interesting. So where does this fit in as far as the portfolios? Is this just a pure equity substitute, is this something you see as a satellite? Like what’s the general, kinda, thought there?
Eric: Yeah, I mean, I think it’s two things. One, I mean, certainly if you are inclined to invest in the consumer and you’ve been using, you know, the XLY or the XLP, that’s the consumer discretionary or consumer staples ETFs… You know, to me this just gives you a much more broad and comprehensive allocation to that same theme, to we’re just approaching it from a lifetime of spending perspective. And then the bigger picture, I think it’s just a better core. I mean, you know, all of us that somehow arbitrarily have to be benchmarked against the S&P 500, you know, it bothers us all at certain times, but from our perspective, you know, if you look at the S&P 500 index methodology language it says the S&P US indices are designed to reflect the US equity markets and through those markets the US economy by investing in leading companies. But here’s my problem with that. If they are supposed to be a proxy for the economy and the economy is 70% driven by consumption, why does the S&P only have 12% consumer discretionary and 8% staples? That’s 20% yet GDP is 70%. Now I know a lot of the other companies are in there in other sectors, so it’s probably a little bit higher. But we just think a better core, if your goal is to track the real economy, the real US economy, is to just in some way tilt your portfolio, your core portfolio to the consumer because just doing that, just being lazy and doing that part of it, is gonna get you to beat the market a lot more than you might imagine.
Meb: What is the brand, sort of, index sector composition look like?
Eric: So literally, if you look back the entire backtest period roughly 40%, somewhere between 38% and 40% is always consumer discretionary and then another 15% to 20% is in staples. And so you’re clearly, I mean, you know, if you’re gonna make an active bet on this strategy in any of the stuff that we run, you’re making a bet that you wanna be tilted towards the consumer for a variety of reasons.
Meb: Does this have any sort of risk factor to consumer spending in general, say recessions or other times as strategy? Do you think it would be particularly challenging in certain parts of the business cycle?
Eric: Yeah. I mean, you know, when we first did this, I think one of the first videos I did with Dave in the Accuvest office was I took a look at every recession and every bigger, you know, kinda, correction, 15% or more and obviously there hasn’t been that many of them. But what I found interesting is you would think that if consumption drives the economy, and maybe the economy is slowing, that consumer discretionary would be an absolutely dreadful place to be. And the reality is all of the data says that consumer discretionary as a sector looks pretty much exactly like the market, the S&P, in those difficult periods. But the staples component actually acts as a life raft if, you will, because of their defensive and predictable characteristic. So, kinda, you’re essentially creating a risk barbell where consumer discretionary, that cyclicality helps you when the market’s doing well and maybe gets market-like when things are difficult, but the staples component really has acted as a stabilizer. Now, who knows? We all know that staples are very sensitive. They’re kind of bond proxies, if you will. So who knows if interest rates go…if the 35-year bond bull market is finally over and interest rates start to trend higher? Then I would suspect that there will be a haves and have-nots within the staples in other defensive industries. But, you know, strictly from a look-back perspective, it’s been a pretty good barbell to have.
Meb: Let’s talk about that. As we approach, kinda, 2018, you know, it’s a good time to reflect but look ahead. So how do you see the coming year? You know, as you mentioned recession is almost like an outdated concept. I don’t think we’ve had one this decade. There hasn’t been a decade ever where there hasn’t been a recession. Usually, you’re in for a good one to three. So how do you see 2018 shaping up? We can talk about consumption, volatility, broad market, winners, losers, anything you wanna talk about. What’s, kinda, your outlook?
Eric: Yeah, I mean, well, you know, since we know the Fed now has smoothed out the business cycle to ward off any recessions possible…ha, ha, wink, wink, the business cycle still matters. And, you know, I think the biggest thing…personally, when I’m out… You know, I spend obviously a lot of time talking to advisors whether they be independents, or RIAs, or wirehouse folks there is a bit of complacency out there. I think people are as checked out from the capital markets portfolio management process as I certainly have ever seen for 25 years. And, you know, we’ve all, in some ways, we have opted for cheap beta and I think that’s a good thing in part. I don’t know that I am the believer personally in a 100% cheap beta broad market allocation strategy without having some tactical or thematics around there. But my biggest concern about 2018 is that stocks are expensive, volatility…we’re coming off of a year in 2017 where volatility was as low as it’s been since I think… There was a bespoke chart not too long ago. Vol’s been as quiet as it’s been since 1964. So the natural question is what happened in 1965? And you had some bouts of…and spasmic volatility, you had a 10% correction but the year ended up okay.
And I suspect that’s what we might see with some complacency, with earnings expectations that are getting much more difficult to beat next year. So I mean, I’m even worried about tech. There’s obviously within every industry there’s slivers of winners and losers but, you know, tech is the one sector that most people have an overweight to, ourselves included in the index and in a lot of the portfolios that we run. But one tech is extended from its, kind of, long-term channel. The more it gets extended the more difficult the forward returns tend to be. And comps skipped pretty hard for a lot of these companies next year. So one of the things that we’re doing right now is I wanna know where I can tiptoe over expectations. So I know within the brands index what sectors, what subsectors, what companies might have an easy time with expectations because I don’t wanna be too over my skis with companies that have high valuations and have just, you know… They’re still doing well in general, but on a rate of change basis they’re gonna have a harder time meeting expectations. High valuations, not meeting expectations tend not to be rewarded that well in markets.
So, you know, if I had to close my eyes and say what happens in 2018 I’d say volatility wakes up, people aren’t really… I think it will be a bit of an eye-opener for people that their portfolio didn’t perform like they thought it was going to perform in that kind of environment. They’re probably a little too exposed to credit in general. And they’re probably exposed to things that have a harder time beating expectations, and they probably don’t have enough exposure to things that look more interesting, you know, emerging markets. From our perspective, the brands obviously, 80% of them are US companies, 20% of them are international. But in some of the strategies that we run one of the factors that we have been heavily involved in this year is making sure we have enough international sales exposure as a proxy to get access to that kind of emerging market theme.
Meb: How did you guys, kind of, arrive at that number, the 20%? Is that just kind of a ballpark? Because, you know, one of the pushbacks I think to something that you had talked about would be that, you know, a lot of the global markets on a number of valuation indicators may look cheaper. So there may be more opportunity in global brands. You know, is there a reason that kind of 20% was chosen, or was it just kinda, you know, ballpark estimates, or what was the thinking there?
Eric: Which 20%?
Meb: I thought you said the 20% of, kinda, the global brands concept was in foreign stocks. Did I mishear that?
Eric: Sorry. Twenty companies of the 200 or 10%. I’m sorry.
Meb: Oh, okay.
Eric: Yeah. And that was decided two years ago. So this was obviously a primarily US-domiciled index, understanding that many of these brands have a global footprint. But 10% of that 200 or 20 names will always be international brands. And so, you know, between buying a US company that has high international sales or owning one of the 20 or multiples of the 20 companies that are international brands, we get access to, you know, kind of that emerging market and XUS thematic revenue base.
Meb: Interesting. And so, you know, you mentioned you’ve been an advisor in this industry for a while and then we’ve kind of seen this compression on beta assets. You can basically buy an old portfolio for, all intents and purposes, almost free. Kinda, when you look through your lens of your experience but also looking forward, kinda, what’s the future from an advisory standpoint of the industry given the robos fee compression? And do you have any thoughts on the, kinda, asset management industry in general?
Eric: So I just spent two weeks on the road and met some huge teams, some wirehouse teams, some RIA teams. And there was this persistent statement that is like nails on a chalkboard for me, and it’s this notion that the investment portfolio, part of the relationship that an advisor has, has become a commodity. And they don’t really care about trying to add that alpha, and create that excess return, and have this timeless portfolio. They’re more interested in just owning everything at all times and just doing it as cheaply as possible. And, I mean, maybe it’s just that I’m a dinosaur, and I still believe that alpha is available, and alpha is possible, and beating a benchmark is possible if you understand a bunch of things. And I understand, you know, advisors are very busy. They have a lot of clients to service. They’re out looking for new business. And they generally don’t have a lot of the resources or data that’s available to them to make, you know, big, important portfolio decisions at very vital times. I am an absolute believer in owning cheap beta as part of your portfolio. In fact, you know, coming out of a recession, just own everything and do it as cheaply as possible.
I think that makes a lot of sense, but fast-forward eight or nine years we’re kind of late cycle. Maybe we go on for another couple of years. I would bet, and I’ve seen some stats, that active tends to outperform at different parts of the cycle. And certainly, if you have an interest in really creating a more unique and timely portfolio for the kind of market that we’re in, I just don’t see that. I see most people just kinda throwing their hands up in the air and saying, “You know what? It’s not my core strength. I don’t have the data. I don’t have the time. I get constantly hit up from, you know, wholesalers, from mutual fund companies and ETF companies and, you know, everybody’s got a great idea.” And my rule has always been like, if there are 70 people trying to get a hold of an advisor and they all have a good idea how can there possibly be 70 good ideas?” It’s just not possible. So you have to be able to understand good information from just a thinly disguised sales pitch. But my view is that you absolutely can do some really interesting things to a portfolio and you shouldn’t… Again, my own personal opinion, you should not be fully exposed to risk all the time. A couple of the strategies that we run are they’re run as if that was your only asset pool. And so sometimes it’s gonna look like a fully invested equity strategy and sometimes it’s gonna look like a balance fund. And I’m totally fine with that.
Meb: So tell me about a couple of those strategies. What are some things that people can add, you know, that might be additive to a traditional portfolio?
Eric: Sure. We started as most do with separate accounts. So we run a core strategy that’s called CORE Brands. That is, it’s not fully quant but we call it internally, kinda, quant-informed. We run off of three different multi-factors. One is what we call Operating Kings. That’s more growthy in nature. One is Sustainable Yield. That’s more value and dividend in nature, and then one’s Price Momentum. And that strategy has done super well this year but it’s equal-weighted among the three factors, and it’s about a 35 stock portfolio, and it’s very diverse. All being powered by the 200 index. And then we also run a strategy called DYNAMIC Brands. And, you know, my personal view was there’s a lot of different ways to categorize an advisor, but very simply some advisors wanna control the asset allocation. They wanna make those decisions, they wanna know exactly what they own. And then when they need to tweak it they can just do that. They can move, kind of, the chess pieces around the board. You know, if you’re that kind of advisor the core strategy is great for you because you know it’s gonna be fully invested, it’s gonna be equities. And then on the other side of the ledger some advisors say, “You know, it’s not my core strength. I would rather the money manager makes the decisions, tell, you know, how much risk to take, when to dial it up, when to dial it down.” “If you believe it’s smart to be holding some cash or even to have a little bit of short exposure, that’s up to you. I’ll judge you based on your benchmark and whether you were right or wrong at that. But I wanna turn that onus over to you.” And that’s the DYNAMIC strategy.
So to me, I wanted to have both. When we sat down and talked about, kind of, the landscape we just wanted to have something for both kinds of advisors or investors. I mean, we have some direct clients as well. So those separate accounts are available to advisors through most intermediaries and a few wirehouses. Obviously, it’s in a dual contract perspective. But as you know, from separate accounts it’s a slow-moving train to get big distribution. So we’re just letting those cook and, you know, three years from now we’ll look at the performance, and we’ll have some assets in there, and if we decide to do that we’ll be able to get some bigger distribution. And then we sub-advise a mutual fund using the DYNAMIC model as well as creating an ETF. And so we at least wanted to have some mass market products available for the consumption theme whether they be CORE or DYNAMIC.
Meb: Very cool. You know, the brand stuff…I mean, I think a lot as…just this conversation, so many questions pop up in my head. I mean, you know, so much of this could be survey based on the brands but, kinda, tracking declining brands and then you gotta wonder…I mean, obviously it’s privately traded, but stuff like Uber where it’s this just monumental brand but it’s had so much bad publicity and so many misfires. I imagine there’s a dozen Harvard case studies talking about how brands…. And, you know, a close cousin to this would probably be some of the moat indices because I’m sure they go hand in hand where business has a big, fat moat. One of the reasons being brand loyalty like Coca Cola. But thinking about how brands deteriorate, is it simply a business model? Is it change of times and perceptions? It’s an area that’s probably a ton of not just quantitative and financial research, but psychological as well where you could probably apply some really interesting studies overlays. Anyway, that’s just me just thinking out loud.
Eric: Well, look at Chipotle. I mean, Chipotle is a perfect example. That was, you know, kind of, the fast-casual food with integrity brand, and they had a couple of food scares. And I mean, the stock has gotten absolutely annihilated, and now they have a new CEO coming in. And, you know, they’re trying to get the brand back together, no pun intended. But I think consumers are very sticky and they’re very loyal. Once you can prove to them that you care and that you’re creating products and services that are important to them and hopefully you have maybe some good corporate branding, people will stay loyal to you. And I suspect people will be back to, you know… People haven’t fully left Chipotle but that’s certainly a good example of a recent company that had a really strong brand image that lost its way a little bit for a variety of reasons and is now trying to get back on track. And I’m sure that they’ll probably do that.
Meb: That’s what happens to your brand when you give everyone diarrhoea. That should be a lesson learned.
Eric: That’s not a memory we all wanna have.
Meb: Yeah. Well, look, Eric, it’s been a lot of fun. We love asking investors at the end of a podcast what their own personal, most memorable trade has ever been. So is there anything that comes to mind for you that’s either positive or negative, or the first thing that pops into your head when you say what’s the most memorable investment you’ve ever made?
Eric: Oh, man, that’s easy. I put all of my money in Bitcoin three years ago. No. I wish, I wish I did that.
Eric: You know, I hate to say it, but I think part of who we become is based on who we were and what we did. My worst trade is so silly and so stubborn that it changed me as an investor. And the focusing on what should happen versus what is happening is a driver of how I personally manage money today. And that was as a trader just trying to do a cute, little, countertrend trade short banks in July of ’09. And getting absolutely run over and then backed over as banks were just beginning their massive comeback from, you know, the depths of despair. So sometimes, you know, you read Zero Hedge and you get all these people on the media, they get into your head, and you try to invest that way. But the reality is the bull market or the bear market ended on March of ’09 and trying cute, countertrend trades just is silly. Just wait, be patient and buy dips instead of trying to go the other direction on a one-way street. And that thing, it was silly, it was stubborn, and it certainly lost me a bunch of money. So, you know, we learn and we move on.
Meb: Yeah, you often hopefully only have to learn those lessons once, a lot of the painful ones, for sure. You got any final words for our listeners, particularly on the retail side that are interested individuals in, kinda, some of these concepts? Is there any particular resources, or books, or ideas, or papers, or things that you think is particularly interesting as, kinda, the year winds down?
Eric: Yeah. I think a couple of things. Number one, whether you’re an advisor or you’re an investor, you are not without help from a resources perspective. You know, my line going back the last couple of years has always been, “Use me as a resource, as kind of an outsource-to-research analyst.” And, you know, we run a lot of factor data in-house at Accuvest, and so we have what’s called a horse race. And it’s multiple factors. So we, literally, every day, I can see, within the 200 index, different factors and how they’re performing. And so it’s a wonderful real-time view of, you know, watching it this year and seeing international sales, high growth companies, and price momentum. Those three factors were what was clearly, what was driving returns. And so if you see that data and you don’t have enough exposure to those things then you have… You know, there’s an ETF for everything out there. So you have the ability to do that. So certainly use Accuvest and myself as a resource because we create a lot of data. We have two blog sites, the Accuvest, on the accuvest.com site. We have a blog, and then we also run an index for the ETF through Global X. It’s iconicbrandsindex.com, and we’ll blog on that one too, and put some great information.
And then lastly, in some ways, brands are…investing in brands that we like and that we trust, it’s a wonderful hedge against the spending that we have on all those companies. And so I just did some work for fun and I said, “Okay. If you spend on Amazon regularly, Amazon Prime’s 99 bucks a year. Maybe you spend 1000 bucks a year on Amazon. Maybe, you know, now that they own Whole Foods, maybe you spend 6,000 bucks a year on Whole Foods. That’s a total of $70,990 over a 10-year period. If you had put 25,000 bucks in Amazon stock 10 years ago your gain would’ve been 289,000 bucks.” So it more than paid for all the spending that you did across the Amazon platform. And the same could be true with…I did the same thing on Starbucks. I mean, your gain in Starbucks far outweighed the money that you spent. If the average consumer spends 1,100 bucks a year on coffee and Starbucks is their brand of choice your gain in owning that stock far paid for your enjoyment by, you know, taking those products and services. And so, you know, building a portfolio of those brands and all those industries that we spend money on is a pretty compelling…number one, it’s a compelling portfolio.
You know, I did a fun illustration on Riskalyze, a really unique analytics site, and I took each one of those industries that we tend to spend on. And it was 20 companies, and they were just a lot of the bigger companies, absolute hindsight bias FYI. That’s fine. But, you know, names like… You know, I spend at Costco when I go to Home Depot for home improvements, and I spend at Comcast for my cable, and I buy Nike in Lululemon on the athleisure side, and UnitedHealthcare for my healthcare spending. That 20-stock portfolio, literally equal-weighted, it crushed the S&P. And it’s literally a portfolio that you know exactly what you own and why you own it. And that’s the whole point of this exercise. Not really for the good times, but for when times get tough we all wanna know, “Okay. What do I own, why do I own it, and should I still own it?” And then once you look at the brands and the consumption theme you probably say, “Well, gosh, I love these companies. I know they’re not going out of business. Maybe I wanna add to that in difficult times.” And over time that probably helps you more often than it hurts. So I would say we’re here at accuvest.com and I’m always available to talk and it’s a pleasure to have the conversation and just talk about the consumption and the brands theme.
Meb: As you were describing that in my head I’m like, “All right. How long till we see a robo-advisor that aggregates all of your spending data and then helps you hedge with your investment portfolio across your biggest expenses?” So for Jeff, that’s Campbell Soup. I was trying to think what it might be for me. Maybe New Belgium Brewing Company or something. I don’t know. But that’s an interesting idea. We talk about hedging a lot here, and that’s one of the more unique hedging ideas I’ve ever heard. We talk about hedging the asset management business with puts but actually hedging your spending by owning the companies you spend on, that might be a new one. I’ll have to marinate on that. Eric, it’s been a blast. It’s been a lot of fun. Thanks for joining us today.
Eric: Awesome. Thank you guys, and have a happy holiday.
Meb: You as well. Listeners, we’ll post a bunch of show notes, links to Accuvest, and everything else on mebfaber.com/podcast. You can always find almost a 100 podcast episodes now in the archives. And subscribe to this show on iTunes, leave us a review. We love to read them. That’ll be your holiday present to us. Thanks for listening, friends, and good investing.