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Episode #95: Radio Show: The Short-Vol Trade Blows Up… Meb’s Rare Coin Purchases… and Listener Q&A

Episode #95: Radio Show: The Short-Vol Trade Blows Up… Meb’s Rare Coin Purchases… and Listener Q&A

Guest: Episode #95 has no guest, but is co-hosted by Jeff Remsburg.

Date Recorded: 2/26/18

Run-Time: 1:11:11

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To stream Episode #95, click here

Comments or suggestions? Email us [email protected] or call us to leave a voicemail at 323 834 9159

Interested in sponsoring an episode? Email Jeff at [email protected]

Summary:  Episode 95 is a radio show format. We start with a recap of Meb’s recent travels to Nicaragua and San Francisco, but then dive into a discussion about volatility. With the VIX spiking at the beginning of the month, some short-vol funds suffered massive losses. We discuss the short-vol trade, then the long-vol trade.

Next up, Meb gives us a quick (overdue) update on his trip to see Van Simmons, including which coins he purchased (photos below). But we quickly dive into a different topic – a recent offering from Wealthfront that’s raising some questions for Meb. The conversation touches upon a risk parity market approach, robo fees, and general transparency.

We then jump into listener Q&A. Some of the questions you’ll hear answered include:

  • I’ve heard Meb say it may be appropriate to allocate up to 20% of your portfolio in a hedging strategy. I’ve also heard him say you need an exit plan. What is his exit strategy regarding this play?
  • How/when should an investor use leverage?
  • What’s Meb’s take on a vanilla Vanguard Target Date fund vs Trinity over 15-20 years?
  • With fee compression and product commoditization, how do you see large, active-focused publicly traded asset managers faring in the next 5-10 years?
  • How would you think about asset allocation for a millennial (sub-30) with retirement accounts? The typical 60/40 doesn’t seem great.
  • With rising rates, I am in short-term notes to limit duration; with hints of higher inflation do TIPS make sense?

All this and more in Episode 95.

Links from the Episode:


Transcript of Episode 95:

Meb: 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 Co-founder 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

Meb: Welcome, podcast listeners. Today, we have a radio show. Welcome, Jeff.

Jeff: What’s happening?

Meb: Thought after…What’s the right ratio? Maybe doing three episodes with guests to one radio show?

Jeff: Say, five or six.

Meb: Shall we start doing a weekly radio show?

Jeff: There’s no need for that.

Meb: A solo weekly Jeff radio show on Mondays.

Jeff: Well, I would become far more popular…

Meb: Friday afternoons, that way, you will be in the office.

Jeff: …than you can be. I can’t do that to you, Meb.

Meb: Listeners, Jeff likes to work from home on Fridays in Venice. So maybe if we do Friday Jeff podcast. I’ll get you in the office. Set up a studio at home.

Jeff: Definitely not gonna happen.

Meb: What’s up, Jeff? what’s new?

Jeff: Well, some Palm Springs this weekend. That was a nice little change of pace, but everything else is about status quo. What’s up with you? You’ve been in Nicaragua and San Fran.

Meb: Yeah, Nicaragua was actually work which surprises a lot of people, but was down at a great research conference and catching up with some good friends as well. One of my favourite investment researchers, Steve Sjuggerud, and all of the crew down there. You know, it’s fun Steve is a macro guy and, you know, he always says, his favourite investments are cheap, hated but entering an uptrend, which where we kind of originally intersected at years ago, and why we kind of see eye to eye on a lot of things.

But it was fun to listen to him tell stories about building out some of this property in Nicaragua and, you know, he still has some land there, and listen tell stories while we’re out surfing about being able to…doing the due diligence on the land. Said they had to get there by horseback, you know, and so looking at this. And I think he said he bought it for…apologies, Steve, if I get this wrong, but like $10,000 you know, and whatever it’s worth now.

But it’s fun. I love…I’m a sucker for the old Jim Rogers style investment biker adventure capitalist travelling the world sort of global macro sort of investment ideas. Plus, it was a lot of fun. And the guy that gave a speech after me was a musician in the group Rusted Root. So it was pretty eclectic crew.

And then on the exact flip side of that, San Francisco was a family office conference a very buttoned-down. It was wonderful really good crowd, great questions. But it was funny because they immediately…I was gonna join some attendees for their lunch which is like a buffet lunch it was at the Wharton campus in San Fran. Beautiful spot right down by the water, and they organisers were like, “Sorry, but we don’t really allow the speakers to stay for lunch.” And I was like, “What? What do you mean? You just flew me up here.” I was like, “Okay.” She’s like “Did I tell you you could stay for lunch?”

Jeff: That’s a specialised rule just for you. I’m sure all the other speakers are there.

Meb: They’re like, “You need to get out of here.” So I was like, “Okay, I’ll go eat next door.” Anyway, it was kind of funny of all them mozilion [SP] conferences and speeches we’ve done never a dull day.

Jeff: Did you talk to Steve Moore about his… listeners, Steve Sjuggerud who Meb was referencing in Nicaragua, he has an investment thesis that were in the melt up phase right now, the bull sort of the last chug of it. Did he speak to you about that all? Any thoughts on that?

Meb: Steve’s been one of the very few who’s been really right this cycle, and you can go back. I mean, there’s a speech he gave at the New York Stock Exchange in like 2012, where he outlined this thesis and he’s been right. I think another person I give credit to is Richard Bernstein has been kind of consistently right during this cycle, and a few others. But it’s created a graveyard for a lot of money managers, 2017, for a lot of hedge funds, some of the most famous hedge funds in the world closed up shop last year.

It just has been a very difficult environment for a lot of people, but the irony of that is it’s been a pretty great time to invest, you know, really since the financial crisis, and increasingly so in all other sorts of markets. We’re getting close. So by the time this comes out, we will know the answer to this, but the stock market is currently down on the month. It’s February 26, we’ve got two more days, we’re about a percent or percent a half away. If we close up, it would be the longest streak in history about months in a row. So I’m cheering for it I love for records to be broken, but it’s coming down to the wire. So by time this comes out, we’ll know one way or the other.

Jeff: That’s sort of an interesting segue. We talked about, you know, been a tough market for a lot of people, 2017 blew up a lot of funds. You obviously know but we’re talking about a way to differentiate this episode was talk a little bit about what happened at the beginning of the month, how the short vol trade kinda blew up, and actually it did cause the closing down of one fund.

Meb: It was more than one. So it’s funny because it’s been such a long mellow period in the markets we talked about…I think my most famous tweet, most popular tweet ever was, “Last year was the first year in which a calendar year when every single month was up for the stock market,” 12 months in a row which is crazy. And you just have really mellow low volatility environment, and I think a lot of people…you start to feel that complacency. And the beginning of the month you started to see the market jiggle a little bit, but not even that much. I mean, you had a pretty quick 5% to 10% decline.

Jeff: So I’ll give you a quick stat here, I mean the… I don’t know the top to bottom decline from it, but February 5th, the S&P were both down over 4%, which was apparently the worst fall in six years. The VIX went from about 17 to about 50, and three short vol funds got nailed. Let’s see here. Velocity shares short term ETN lost 85% of its value and closed down 93% the next day. Let’s see here. ProShares product lost 96% over the same period, and the short term inverse velocity shares ETN shut down completely because of that. The ProShares one kept open saying the quote was, “It acted consistent with its objective and reflected the changes in the level of the underline index.”

Meb: You know, it just goes back to the old know what you own, you know. It’s kind of curious as to head-scratchers to why these products exist in the first place. The short vol world, in general, is not something that’s that attractive to me. We’ve been writing about it for years. And listeners, that’s a lot of different ways to express that, but there historically been a lot of these short vol funds and what happens is you make a consistent like 1% a month or a half-a-percent a month maybe. And you have a sharp ratio of like four.

And so they raise a bunch of money because they’re incredibly consistent and then you have sort of the sentilab [SP] Thanksgiving turkey moment where he’s got a great chart, and I think is his first book where he shows turkeys happiness. So every day goes up, goes up until Thanksgiving one year, and then it just goes to zero right gets it’s neck chopped. Nassim actually got a new book out looking forward to checking it out, it’s called “Skin in The Game.” Anyway, so short vol in general, to me, has not been that attractive like a strategy it’s not…

Jeff: Well the analogy is pennies in front of a steamroller.

Meb: Correct. And so we used to write about this a bunch, and we wrote about it in the mid 2000s on the blog where we profiled a lot of these options owing funds. And there was a couple problems with them. One is they almost exclusively focused on one market. So they almost always did say S&P 500 and maybe they would write a stringo [SP] or a strato [SP], so sell both or put in a call. And I always scratched my head I said, one, why wouldn’t they at least trade 10 equity markets around the globe? But even then, you’re still equity, so why wouldn’t you then do a diversified options selling portfolios across wheat and the Japanese yen and etc., etc., commodity is everything?

And we did research back when I was in Tahoe and found a lot of potential there but even more potential was selling vol away from the direction of the trend. So if a market was uptrending, you’d be selling more puts than calls. Anyway, so there’s…in general it’s a strategy that’s not that interesting to me, especially when its doing kind of dumb stuff like these did in a leverage basis. So there’s a lot of people that called this correctly.

So we had a Vineer Bhansali on the podcast who was great on this. You know, Chris Cole was pretty prolific about writing about this, we sent out some of his stuff to the Idea Farm. A lot of people were talking about this kind of crazy low vol environment. It just came out, by the way. I mean, my guess is a lot of people were gunning for this, it turned up Peter Teal you know, Facebook, PayPal everything else he’s been involved with, had bought like $240 million worth of puts on these products. So he made probably a pretty penny.

So the bigger question is were people gunning for these products knowing that they would close up shop? It’s kind of a fun example, too, of our tail risk fund you know, we published the paper last year, launched this fund it’s kind of a real time example of what that sort of fund would do. Anyway, the one fun question I have is what return would you require if you had a strategy? And we can talk about it but you knew it was gonna blow up at some point, so it was gonna have a 100% loss in some way, what return would you require for that strategy?

And obviously, that’s essentially the whole catastrophe bond space that Buffett invest in. But if I was to say to you, Jeff, look here’s the deal, the strategy is just 20% a year but went out of…and that’s the hard part because the blow ups are a little more rare.

Jeff: [Crosstalk 00:10:15] of it. Yeah.

Meb: One out of how many years will make it reasonable for you to invest in that. What if it’s 50% a year? What if it’s 100? So that’s hard because people invest in these, and we have that Storify link wired to the the show notes called “Stories of this Bull Market,” and it’s all the really dumb stuff that’s going on this point of the cycle that you see in bubbles. And it’s got everything from crypto to Tiffany’s selling $10,000 rulers to you know, stuff like these funds and you know, there’s a guy in Florida that’s made millions you know buying these funds and then losses 90%, like just dumb stuff you see.

So I mean the big takeaway in general is know what you own. Now, that having been said, there is also a handful of funds, and I tweeted this the last time we did that short vol options hedge fund profile. We did it back in, I think, 2006 or ’07 were like at some point these fund are gonna blow up. ’08, ’09 happened, they all blew up except for one which was called LJM. And I had tweeted about it maybe a year or two ago, I’m like, “Hey, by the way, looking back on this, all these funds don’t exist anymore except for LJM.” And they were multi-billion dollar firm, guess who has mutual fund loss, whatever, it was 90%? LJMs.

And so you know, they…who knows what they were doing. That’s crazy to me, that you could even have that possibility. And the name of the fund was something like preservation and growth, which is the worst possible name choice. And so, you know, you see these sort of low [SP] to sleep but in general it’s shocking, too, because you know, you need to have some common sense about what’s going on. And, you know, if you’re a fiduciary or adviser, and you’re allocating these funds think about how bad of a black eye that is if you’re allocating and you have any of these funds in your accounts.

Jeff: How many do you know that went under? I just had that one.

Meb: You know, there’s some where it’s a mortal wound, you know. They’ve been stabbed and it’s embarrassment and investors will pull all their money.

Jeff: So even though the VIX has… I’m sure it’s obviously come way back down since, it that still the death blow for all [crosstalk 00:12:23]?

Meb: If you went on vacation in January and came back at the end of February, the market is essentially unchanged and volatility is unchanged. That’s a great example to listeners also of we used to have people ask this all the time about a lot of our trend following ideas that updated monthly. And they said, “Well, Meb, these can’t possibly can’t work because what happens if the market’s down 10% in the middle of the month? You know, you’re too slow.” I said it was actually one of the benefits of using a longer timeframe as you ignore the interim month or whatever it is jiggles because you can have an example of this month where it goes down a bunch and then back up.

People will usually only think about one kind outlier. So anyway, it just goes into that category of do your homework, but in general, in my mind, the bar should be so much higher for these complicated products, you know. It’s like you have to have 10 reasons to want to invest in one of these really complicated products versus just investing in some basic plain vanilla stuff.

Jeff: You know, we talk about the short vol a lot right now, but a long vol is also probably less understood or misunderstood. You know, I completely am guilty of that. Years ago I got into VXX just a long vol product because I hadn’t done my homework and thought basically I could sit there and just let the market, you know, explode at some point and I’d make tons of money, didn’t realise the issue with Contago [SP] it was basically just burning me every day that I held this thing it’s not a long term product.

Meb: That’s a hard product for people to hold, too. People hate slowly bleeding products, you know, and you should read Buffett’s annual letter always. One, because they’re wonderful, but, two, because this one talks about some of that cap bond and reinsurance ideas were, you know, it’s the same general concept he says, you know, we do a lot…Buffett does a lot of reinsurance where they’ll insure against catastrophic risk say a hurricane and they say well maybe it’s only gonna happen once every hundred years. But we don’t know that maybe it will happen two or four. So we try to put in enough of a buffer, but every once in awhile we’re gonna get smacked. You know, I think last year with a number of the natural disasters, it was more than usual. It’s the same thing with the options, long, and short vol, right?

Jeff: Was it Munich Re? One of those blew ups, I feel like.

Meb: It’s the same general principle, you know, is that people just miscalculate the risk, in particular, what magnifies this is leverage right, so the dial you have this false sense of precision where you say this only happens 2 out of 100 years, and it happens 5 or 10 and you’re done. So you wanna avoid the almost in all of investing.

I mean the same thing with designing a system, and Cliff Asness has a great quote on this where people ask him about a historical simulation he says, “I look at the drawdown, I double it,” because even when you are a student of history, there will be times that exceed the past, you know, that’s the traditional way as a money manager when things kind of gyrate, you know, you’ll see these letters they type out the RAs and say, “It’s okay calm down this has happened in the past.” And say the markets done this and that, and that, and that, right?

But at some point something will happen that hasn’t happened in the past, the drawdown will be worse it will happen in a different way, 1987-style event. Or if you’re in Cypress you know, they confiscate your cash deposits. So the history is always a great guide but you could always…you have to be a little thoughtful of, you know, how things could happen differently.

Jeff: All right so let’s wrap this up any final words to listeners about vol in general?

Meb: No, I mean I think you know, being mindful of the sort of jump sort of events, and it’s just not…In general, the short stuff that can cause me 90% or 100% losses is not an attractive investment.

Jeff: Let’s hop into some listener Q&A. Actually before that, couple of updates. Number one, people have been writing in asking about your trip down to see Van Simmons and the coins, you wanna give us a quick take away?

Meb: Yeah, I totally forgot about doing this, we’ll post some pictures on the website, but I gave Van some criteria said, you know, “I would like to spend $10,000 that we did on the podcast.” I said, “I would like to tilt towards undervalued and until towards beautiful, and I don’t just want one coin, I want somewhere between 2 and 10, you know, so I wanted a few.” And so he came up with a handful, there are some gold type coins, gold commemoratives such as $5 Liberty, $10 Liberty, $10 Indian, $20 liberty. There’s some 19th century type coins which for a lot of people would claim to be kind of the cornerstone of the rare coin market in the last 100 years or so. So we got a silver proof seeded dime.

Jeff: What’s your favourite?

Meb: I don’t know that I have one. I’ll tell you a funny story and it’s good because my wife doesn’t listen to the podcast, so she’ll never hear it. But you know Jackie, and so we had been displaced because our house had a bunch of mold in it, and because we have a new newborn, black mold is not particularly good thing to have around. So we got this place for a few months and we were at her family’s house, and like any, you know, family that’s been around for a while, you just accumulate stuff.

And so, look, we’re guests. So I have no leg to stand on complaining about this, but you know, it’s essentially like her bedroom from growing up, so it’s just accumulated. It’s just a mess. I’m a pretty neat person and so I kind of finally had it, I was like, “Jackie, can we at least just clean this up a little bit? Let me help you get rid of all this stuff.” And so we spent an afternoon cleaning up and started with the bathroom, and the bathroom it was like four garbage bags just of junk, right?

But I was starting to like throw stuff away like over my shoulder and eventually there’s like a little, you know, kind of cute box in the back of the one of the bottom drawers in the back of the kind of counter in the bathroom. And I happened to open it and there was a coin in there, and I was like, you know, having been studying this for the past six months, I was like oh that’s pretty interesting, that looks like it might be at least a piece of jewellery right, like a necklace that some people wear with a coin or something.

I said, “Jackie, you know this?” And she’s like, “I think my grandmother gave that to me.” “Yeah.” I told her, “She did, you know, it’s pretty, isn’t it.” So, of course, I Google and it’s worth probably more than my entire coin collection, by the way. So just goes to show you guys, listeners, do a little spring cleaning you’ll be surprised at what you find.

Jeff: Wait, wait. Are you gonna give the coin to Jackie? Or you’re taking for yourself?

Meb: Yeah, I just pocketed it. No. But it’s funny about stuff like this too because, you know, as you think about collectibles… and there’s a lot of research on collectibles and you know, in general it’s hard because many of the fine collectibles have appreciated and it’s easy to look back and say man I wish…we were talking with Van we should have bought that Mickey or Batman number one. And I was a huge collector as probably many people our age were because that was really when baseball cards and a lot of collectibles kind of exploded in popularity, right?

And so probably anyone that’s the age between 30 and 50, you would probably remember the 1989 Ken Griffey upper deck card, or, you know, when baseball cards really hit their sort of peak. And so I had a bunch of comic books, by the way, that my mum still has. Thank you, mum, if you’re listening. But we went through at one point when I was younger and catalogued all of them and priced them out. And, of course, she came down from the attic she’s like “I have some comics up here.” And sure enough her comics were worth more than like all mine combined.

It was something like cowboy comic from like the 50s or something. And on top of that, she also bought like the Jordan Rookie card when we were collecting because she liked basketball, and my brother and I like base. So it just goes to show that investing in what you know usually can work out, so spring cleaning, on top of that, is a good piece of advice. We’re way off topic.

Jeff: Let’s tie back to your coins real quick. What is your plan for this? Is this just something that’s gonna be beautiful for you to hold forever? Are you gonna have this priced every 5, 10 years as an investment or what’s the plan?

Meb: Yeah, I think it’s just in the category of collectibles. I think it’s kind of cool different, I mean it’s not something that you can go down to 7- Eleven and buy anything with. You know I don’t love the argument that a lot of people…that my goldbug friends do where if you’re Armageddon at least you have some gold or something. I mean, come on. I mean…

Jeff: This is a numismatic it’s not bullion.

Meb: Yeah, either way I don’t believe that otherwise, too, by the way with bullion. But it’s something cool to have, I’ve always leaned towards sort of the collectible world but I also am kind of a big minimalist. So it’s a very fine line for me because I like getting rid of stuff, but I actually just bought a new product called Mural, which is basically a frame, it looks like a TV in a frame, but you can subscribe or set up play lists of pieces of art. And it’s probably coming into the office, by the way, because it’s not appreciated at our house.

But you walk by it and you can flick your hand and it’ll go to a new painting, or you can set up a playlist or random, whatever you want. You can also flick up and it’ll tell you the history of the painting. So it’s like having a museum, it’s like a word of the day calendar for art. Anyway, and that only costs way less than buying a bunch of original art.

Jeff: When are you gonna get your coins put in some display case and…?

Meb: I don’t think they’re gonna be in a display case I think that I should probably…

Jeff: [Crosstalk 00:21:53].

Meb: I should probably get a safe. [Inaudible 00:21:55] just put them like a lock box?

Jeff: Well, I mean…

Meb: It’s like Buffett with a stock certificate, he’s said, “You can take it out once a year look at it, fondle it, put it back.” I don’t know what to do with them.

Jeff: Well, that completely though it chops out the knees one of your entire criteria for having this thing. It’s a beautiful and then rare.

Meb: They are beautiful.

Jeff: All the more reason to put it away and never look at it again come on.

Meb: But if I put on display, it’s just kind of asking someone to come and steal them.

Jeff: No, your logic is flawed right now.

Meb: Okay, we’ll put them in the office.

Jeff: There you go. Give them to me. I’ll hang on to them. All right let’s hop into some…Actually, you know what? One more general topic first. You have been sort of on a tweet fest recently talking about a new offering from Wealthfront. Why don’t you give us an update and what the interesting situation there is?

Meb: You know, look, there’s a lot of times where you see a lot of offerings that kinda make you scratch your head, and, you know, look we’ve been commenting on the automated space since like 2000 pre-crisis, like 2007 probably. And there’s been an evolution of all these products, and in general, they’ve been an outstanding development for individual investors. So I put this on the category automated investment platforms, what a lot of people call robo advisors.

So Wealthfront was one of the first. A lot of people who don’t recall history they came out of a startup called KaChing!, which was a Facebook trading app, which then pivoted into being a kind of follow the genius model, where you could allocate to some money manager who was a genius and you paid up to is it 3 or 4 percentage points fee. And that business model has been a graveyard. It gets tried like every three years. Corvex tried it, Marketocracy tried it in the last bubble in the late 90s, but they’re still around, by the way, they have a mutual fund that still exists.

It’s just a really I think flawed premise. I think it’s hard. My interpretation which we’ve always mentioned it if you’re gonna follow quote smart money or geniuses then follow at least the ones that probably have the best talent, which is a hedge fund which is 13 [inaudible 00:24:07] which is our book, “Investor of the House.”

So then they pivoted to being a kind of modern portfolio theory buy-and-hold automated service, by the way, which is a totally fine great offering I recommended it to people in the early days. They charged 25 basis points, gave you a buy-and-hold asset allocation, rebalance tax harvest all that good stuff right totally great. And then, you know, Betterment being another independent competitor but we always said you know, because of structural reasons that the custodians would eventually dominate this, because they could use their own funds, thus have a huge price advantage and that’s come to pass.

So Vanguard is now well over 100 billion, Schwab is north of 20, and then Betterment and Wealthfront are both at 10. So, you know, we’ve said a lot of things, we said there may be room for 10 of these. You’ve seen a lot of little ones sprinkle up that I think this is probably the killer app eventually for a lot of the ESG stuff. Because ESG has been a big area where…

Jeff: To find that [inaudible 00:25:09].

Meb: Environmental social governance I think, where there’s been a ton of people, media loves it, everyone knows at some point there’s somehow gonna be money there, but there’s just no money has flowed to it for the most part. And I don’t know if it’s marketing or the message or whatever, but so if someone says look I don’t want gun stocks, I don’t want tobacco stocks, I don’t want whatever, you can exclude them, and so automated platform is perfect for that.

So we’ve written a ton on these investment advisors and I think they’re fantastic offerings. So first of all, by and large, they’re far better than a lot of the junk you’ll get where asset allocators will charge you one or two percentage points per year, plus underlying fund fees and do the same thing, right? Now, the model has shifted a bit because it’s hard for the independent, so Betterment now offers financial planning as well as does Vanguard, and then the pivot that you saw Wealthfront making currently is they’re launching a proprietary mutual fund.

Look, first of all, I have no problem with companies making money. I have no problem with companies charging high fee funds. There’s plenty of funds out there 1%, 2% I’m totally cool with that. But the challenge with Wealthfront has been you know, over the past few years they’ve been very aggressively attacking people for non-transparency, for questionable business models, so they have all these public articles about attacking Schwab and Betterment, everyone else, financial planners, like really kind of on borderline nasty, right?

And so then they come out they say we’re gonna launch this mutual fund, it’s gonna be risk parity which, by the way, doesn’t jive with their historical investment strategy, but whatever. I have no problem with risk parity, I like risk parity we used to own risk parity domain we told that story on the podcast probably but…

Jeff: Yeah, you talked about your second URL.

Meb: Risk parity, I actually thought I had risk party, but it’s risk parody. If you want it, listeners, let me know. You can just type in the old one and see where it goes like a…

Jeff: Risk party.

Meb: Swiss hedge fund or something. So risk parity is a great concept, and you know, a journalist wrote about it and it’s like you know, “Wealthfront is launching this ground groundbreaking mutual fund.” I said hold on, let’s journalist…it was a good thing because this is Barron’s, there’s no journalist name on it, so I just said, “Journalist, just a little history lesson here. Risk parity has at least been around since the time Ray Dalio starting Bridgewater, the all weather fund. The genesis was he wanted to fund that if he croaked, he could put his family’s trust in something it’s not gonna depend on alpha type of ideas.” So for those who aren’t familiar Bridgewater world’s largest hedge fund, risk parity, they have two offerings. One’s called all weather which is the risk parity offering, one is called Pure Alpha which is the go trade everything.

So the concept of risk parity which is that there’s no reason to accept prepackaged beta as the way they are, so if you have stocks and bonds, stocks are inherently leveraged, they have debt, right? But you don’t have to accept them at the 17% volatility that the S&P 500 ETF has given to you at, you could say add leverage or you could subtract leverage and add cash. And so you could target U.S. stocks at 10%. So then it becomes a question of correlations and then expected returns and so you can leverage upon. The whole take away we have a chapter in our book “Global Asset Allocation” on it, You guys could get a free copy of it, we talk about risk parity.

But the whole concept is totally fine, but the practical takeaways you end up with a lot more in bonds, so you’re leveraging the bonds up and you make sure you have other assets like real estate, etc. But first of all…so I made a comment I said look, risk parity has been around at least since Ray Dalio started this in the 90s. There was even a book before Dalio called “Diversify” that I found. I love reading old investment books that literally has an all weather. It’s called “The All Weather Portfolio,” in the book there is a risk parity allocation.

You go back further than that, every commodity trading advisor in the 70s allocated their portfolio based on volatilities and correlations, that’s a risk parity style allocation. You go back further than that Harry Browne’s Permanent Portfolio, that is a risk party allocation. The entire genesis of modern portfolio theory by Markowitz is literally a risk parity concept. And then the joke I made I said, “If you go back 2000 years the Talmud [SP],” is that how you say it Talmud?

Jeff: Talmud.

Meb: I think it was a third each in land, cash, and like businesses, that’s kind of risk parity. So I was just joking. I was laughing because there’s nothing new about this. And, by the way, you can essentially match Bridgewater’s all whether. We did a article on this called “Cloning the Largest Hedge Fund in The World.” You can match their performance almost identical by investing in the global market portfolio with a little bit of leverage, right?

And as everyone knows, that’s read our book asset allocation, if you’re doing buy-and-hold, the actual allocation doesn’t matter that much over time, it’s really how much you pay in fees. All that having been said, so I said look, it’s great there’s another risk parity mutual fund. I’m totally cool with that, and they said that they were radically lowering the fees for risk parity. And they came out and the management fee is 50 basis points, .5% or 1%. That’s great, and it’s lower than the cost of the other mutual funds out there.

Jeff: What’s the the average out there, ballpark for this?

Meb: You know, probably like 80, 90, 100, you know. It falls under sort of a liquid altz [SP] kind of category. The weird thing to me is philosophically speaking risk parity should be 100% on your portfolio. So if you believe in an asset allocation, it’s like if we had the global market portfolio and went and added 60/40, that doesn’t make any sense. Like, if you’re gonna do buy-and-hold asset allocation you should design the entire portfolio and be done with it.

Jeff: It’s holistic.

Meb: It defeats the whole purpose right, it’s like someone reading my book and saying, “You know what? All right we’re gonna allocate a third to the global market portfolio, a third to permanent portfolio, and a third to Buffett’s allocation.”

Jeff: Thirteen Fs.

Meb: Then you just have this whole chicken soup of allocations and it’s just a mess, and it makes no sense and you end up in the same thing. It’s like the example is…the soup example I think is very apt, where you can take all these ingredients you could eat them separately or you could just eat them as soup, but no matter what, in your stomach, they’re all gonna end up as one sort of, you know, amalgamation. Anyway, so it makes no sense to me really to…because risk parity is really a philosophical approach to asset allocation, so it should be the whole occasion but whatever.

Jeff: So we’re talking about fees.

Meb: Right so it’s a 50 basis points and the whole thing…so Wealthfront charges 25. So now they’re adding a proprietary mutual fund which is 50, so already that, you know, adds a little bit of questions.

Jeff: Wait, wait. So we’re talking about 125 total?

Meb: No, no. So their service is 25 basis points…

Jeff: Twenty five.

Meb: …for your robo adviser and a lot of people used to talk about this over the years, they said this model really isn’t sustainable unless you already have your own funds like Schwab and Vanguard. Schwab charges nothing. Vanguard charges 30 basis points, but gives you a financial adviser. So Wealthfront was charging 25, so they said, “All right, we’re gonna launch our own fund,” but here comes kind of the problems, right?

So first of all, is it a red flag that you’re using your own fund? Not really but it’s something. Okay? I mean, look Cambria uses many of our own funds. We don’t charge a management fee on any of our individual accounts for that reason, but we do use our own funds. We as a lot of other people’s funds, too. So that in and of itself is not to me a conflict of interest, but it’s an issue. Two, they’re opting in. So it’s not an opt out, they’re just buying it for 20% of all their taxable accounts over 100 grand.

So to me that’s a little questionable because you’re departing from your stated sort of investment approach, but whatever. These aren’t huge issues. But I’d ask them because I had recommended Wealthfront in the early days to a lot of people, so I have plenty of friends probably listening to this that have Wealthfront accounts, right? And the bigger issue I had is that this gets complicated quick, listeners, but one of the ways that they could’ve allocated that say AQR others do maybe risk parity is because you’re targeting a higher level of leverage, so this fund is probably targeting 200% net leverage that you have to get that leverage exposure somehow. So people use futures, they may use options, they may use forwards, notes, whatever. The way the Wealthfront did is they’re using a total return swap and I said in my mini tweet…

Jeff: Wait, define that real quick.

Meb: I will. So in my tweet I said this is probably above board, they’re probably doing this the exact correct way, however, total return swaps have a enormous black eye on history for investing for individuals. Because historically…and this is the “Wall Street Journal,” Jason Zweig has written articles about it. “Morningstar” called it “The Worst Practice in Liquid Alt Funds.” Not one of them the worst, but what it is it’s a swap.

Say I wanna get exposure to 200% portfolio, right? I could do it through futures, but instead I say, “Jeff Bank, can you give me the exposure returns of this allocation? And for that I’ll pay you a fee.” And so it’s a swap you give me the returns and you promise to track it. So what happens is you replicate it on your own, you know, through futures or whatever, cost-efficiently and I will pay you a fee for that. The problem is that fee does not get included in the fund overall fee, so Wealthfront can claim a 50 basis point fee, but in reality that fee is probably, I guess, 25… so I don’t really count the leverage because of used futures, you know, the leverage is kind of a wash.

“But Jeff Bank, I have to pay you something for doing this exposure otherwise why would you do it?” So we asked around some trading buddies and it is probably 25 basis points, but that’s half of the fee that they’re charging. I don’t know. So, again, because I have friends that use the service I emailed them, I called them, I tweeted about it, got no answers. The emails said, “Read the white paper.” And the white paper said, “It’s live or plus 75 basis points.” So if that’s the case, then you’re not paying 50, you’re paying 125.

And so it’s just like…it’s going back to our short option exposure. It’s a product that’s not…it’s complicated and it’s kinda hidden fees. So the reason that “Morningstar” calls it the worst practice is that it’s particularly prolific in the managed futures space. So they’ll be a managed futures funds to say, “Hey, we charge 1% for this fund.” Great. That’s not that big of a deal. What they’re hiding is that they get access to underlying managed futures managers through a total return swap which, oh, by the way, that in manager gets paid 2 in 20 performance fee. So that swap could cost literally 5 percentage points.

Jeff: And that doesn’t have to be stated?

Meb: No. No. So you’ll see it. I think you see it year two in the prospectus, where they’ll mention kind of estimates of the cost, but not year one. So…

Jeff: Seems like an egregious fiduciary lapse [crosstalk 00:36:10]…

Meb: Well, so then this is an example where if you look at…so they’re not including it in retirement accounts which…So two other problems. One, is they’ve always been huge on tax loss harvesting, all of a sudden you’re just opting people in you you have to sell one-fifth of the portfolio to allocate to those funds. That automatically create stocks [inaudible 00:36:30]. Okay?

Second a swap. And it gets complicated but is usually in my mind targeted tax at either 60% long term, 40% short term kinda like futures, or 100% short term. So it’s a very tax inefficient vehicle in taxable accounts. So there’s just a lot of things that are kind of questionable. Now, a cynic, and this is what I said in my tweet, I said a cynic would say that the entire reason they’re doing this is that if you say 25 basis points on 10 billion that’s 25 million of revenue, adding this fund generates another 10 million in revenue.

So you go from 25 million to 35 million in revenue, that’s a 40% increase in revenue. So are they doing it because, you know, they wanna really believe in this fund probably. Like, I tend to take people’s…I believe in them right like I believe them and here’s…The weird part is I said look, you could have charged 1% or 2% and 1.25% is the average cost of a mutual fund, but from a firm that historically is claimed to be so transparent, I said, “It’s weird to me that they won’t disclose that fee.”

So if you do charge 1.25 just own it, you know, just say you charge 1.2. I mean, look at Cambria we have funds that charge 1% and a little bit more, we have funds that charge 30 basis points, you know, we have…but don’t kind of beat around the bush, don’t claim you radically lower the fees and then not disclose. But, again, qualifier, this could totally be all above board, it just seems conflicty. And the fact they’re not putting the retirement accounts mean they have concern about the UL [SP] rules and being able to put it in retirement accounts.

Jeff: Well, if there’s a greater clarity in communication then the uncertainties will vanish and you’ll know what you’re dealing with, so it might be complete above board, but there’s no reason to not be very transparent about it.

Meb: Yeah, so who knows? I mean, hopefully they’re doing the right thing. We’ll see. But it’s a little bit of a head scratcher.

Jeff: All right let’s knock get some Q&A and then move on. So start off here. “I’ve heard Meb say recently that given the current climate, it might be appropriate to allocate up to 20% of a portfolio in a hedging strategy. I’ve also heard him say many times that you need an exit strategy to follow. What is Meb’s exit strategy for the hedging strategy?”

Meb: So this is kinda maybe get a little repetitive for, listeners, you know, we talk so much about my philosophical allocation views. I mean, first remember that I think every person is different on their allocation. If you want to sit in T-bills, if you wanna sit in gold, coins comic books you know, it’s whatever works for you. If you’re Warren Buffett, you wanna put 90% in the U.S. stock market, 10% in T-bills. Totally fine. Whatever you wanna do.

You know, my beliefs were pinned in the trinity portfolio which is what I do with all my money which is half in a global asset allocation portfolio with U.S. stocks, foreign stocks, bonds, real estate commodities, half in the U.S. half in foreign, tilts towards value in momentum, and the other half of that portfolio is in trend following and tactical ideas, and that’s it.

You know, and then we’ve talked about I do some private investing. And then I personally have a tail risk exposure. And that’s I think what the question was hinting at, because hedging strategies could mean a lot of different things that are parts of the portfolio. But assuming they’re talking about tail risk, you know, to me, again, I’m an outsized example which is why we didn’t historically automatically add tail risk to client portfolios is because it’s not necessarily on a logical mathematical basis a great investment. It might not even be a good investment but it’s a good sort of diversifier.

And for me, being someone who’s particular exposed to the asset management industry, it’s a potentially wonderful anti-correlated sort of investment. And for all the reasons we mentioned in tail risk paper, why it’s probably a more comfortable investment right now with lower volatility, high valuations, etc. I’ve mentioned publicly in the past that I would probably add to it if and when the U.S. stock market ever enters into a downturn, which it’s not…downtrend, excuse me.

Now, so the question is when do I sell? This is probably the only investment that I don’t have like a hard and fast objective rules-based approach to getting rid of it. But, to me, if and when, the tail event happens you know, if and when, U.S. stocks get cheap again, if and when, you go through a long bear market and everything washes out, then that time. So there’s a couple inputs, it could be I add more when the market enters a downtrend and sell it all when it enters back into an uptrend. You could sell it all…

Jeff: Are you measuring that out…

Meb: …off it goes 20%, 50%, 60%.

Jeff: Are you measuring that by potentially 200 [crosstalk 00:41:18] ?

Meb: Yeah, something like that you know, but again to me particularly right now it is a bleeding insurance type vehicle that will probably lose 5% a year or more if we have another 2017 where every month is up and no volatility. But in general, I would, you know, I probably should put in limit orders at 40% and 80% above the market currently in case we have a 1987 style event and you don’t have time to sort of react. That’s a reasonable idea.

But, again, I’m an outlier. Most people are not gonna put 10% and I’ll probably take it up to 20-plus of their portfolio in that, and it doesn’t make sense they don’t need to. If you have a 10, 20, 30-year horizon and you’ve done all the other things we’ve talked about diversifying globally, value tilts, adding all sort of uncorrelated assets, like you probably don’t need the tail risk sort of idea. But I just like the idea of something going up on everything else puking. I like the idea couple weeks ago when all this VIX stuff was happening. I love the idea that something was up 5% on the day.

Jeff: Did you buy more during then?

Meb: No.

Jeff: I’d love to see…

Meb: I mean, historically the research has shown that the volatility explodes and returns are worse for stocks when they enter into a long term downtrend which hasn’t happened. You know, we’re still in an uptrend us across almost any metric with the exception of maybe U.S. reits. I think there are now officially in a downtrend, which interestingly enough, was the first thing to go in 2007 was reits. Slowly just topped off. So hopefully that’s not a repeat.

Jeff: So you mentioned earlier you might take it to 20%, whatever you’re at now, call it 10. I don’t know. So you might be adding then. So I’d be curious, you know, in the future, if we could look back and see the timing of when you would add more if the market does hit a downtrend, because this can be a trade off. On one hand, you could be adding more protection but at some point…

Meb: If it’s a puke down, I won’t be adding more. If it’s a rollover, I will. Makes sense?

Jeff: Yeah, it makes sense.

Meb: If the market is up down 20 tomorrow, I’m not gonna buy more because the events kind of already happened.

Jeff: But I mean…

Meb: This is a tactical…

Jeff: But that’s a…to use your own term…

Meb: This is not a good long term investment.

Jeff: To use your own term, that sort of binary thinking isn’t there the possibility that you might have a little bit of both in terms of there could be some puke days followed then by some sort of slow rolling drawdowns?

Meb: Puke to me is like a 10% down day, or a 20%. Ten percent plus down month, 20% down month, that’s where you get into the real puke. You just think about that, listeners, this happened plenty times in the past as far as 10% down months. That’s a pretty painful month.

Jeff: That hurts. All right. Let’s keep going here. Leverage. How, when should an investor use leverage? What would it take for you to use it with GTAA? And just tell [inaudible 00:44:11] by what GTAA is?

Meb: It’s investment acronym that stands for Global Tax to Asset Allocation. You know, leverage is a tricky subject and we almost…I agree with Warren Buffett almost always where he said, “You don’t need leverage. And if you compound it 15% or find a way to do that, eventually you’ll be an incredibly rich person.” A lot of people are seduced by trying to get to that 15% by leverage. And he also says…or Charlie Munger says, “You know, the three biggest things that have caused people to blow up or are problems is ladies, liquor, and leverage.”

Both those guys, I love them to death.. They definitely get a little pervy in this sort of #metoo environment, you go read a lot of their old letters and they’re definitely cut from a different generation. Anyway, which by the way, you and I are from the south and probably 90% of the way that men interact with women would be considered like offensive this day and age like…

Jeff: Clutch my pearls.

Meb: Calling girls darling, and sweetie, and sweets and…anyway. So I mean, leverage you know, again going back to the concept a lot of things are already leverage. Reits are already leveraged. Equities are already leveraged. So I mean, if you think of the risk parity concept, you’re finding the “optimal point” on the securities market line, and then leveraging it up and down based on what you see fit. So it’s a whole portfolio you’re leveraging.

And you know, it’s in general there’s not a lot…I mean, it’s a very specific question…Or, sorry, the answer is very specific to the example of what it may be but a much better generalisation is that you should just avoid it. You know, most people say I can take…I’m gonna leverage it two to one, close my eyes, because I can take the drawdowns. And very rarely can people. You’re like you can be that rational when you look at…a lot of these small cap strategies that people are gunning for and leverage them, say, “I can do two to one leveraging in small caps because I’m rational.” So you had to sit through multiple 50% to 80% drawdowns.

Jeff: You know, it’s interesting claiming you can take like a 20%, 30% drawdown, even that is so different than actually applying that percentage to your actual capital base, and looking at burning that much money, I mean, it’s such a different a visceral impact when you think about that.

Meb: And, you know, if you look at one of my favourite tweets from I think is one of the Red Hot Boys or Morgan, who knows? But it was something along the line of all these journalists love saying something like, “If you just bought 10,000 of Amazon and 95 you would be worth 4 million today,” and their quote was, “and had you held it, you’d have been a complete psychopath because you would have sat through 250% and 190% drawdowns like no one…like one out of a 100 people can do that.”

And even Berkshire, in his letter this year, said that, you know, essentially Berkshire had four…I think, it was 40%-plus drawdowns including 250s, and so you have to endure though. And they have the great quote Charlie is like, “Look, if you can’t handle 50% drawdown you have no point owning quoted securities.”

Jeff: I mean, I think that same article, someone was trying to make the point, the author was trying to make the point to how Buffett’s rule about never lose money, rule number two, don’t forget rule number one, that’s, you know, a load of BS because of Buffett having been down so many times, it’s just it’s inevitable

Meb: That’s like goes back to my favourite high percentage trading rules. If you wanna never lose money, you have like a 95% success rate is if you have a newsletter, you just make recommendations and never close out the trades until they become profitable. You say I have 99% winning trades because you just buy a 100 stocks and close them out on the first profitable close, and the ones that aren’t profitable, you just let them go. It’s a great strategy.

Jeff: New business direction.

Meb: If you have a long enough time [inaudible 00:48:10], that’s the same thing about valuations, you know, valuations matter heck of a lot for shorter periods of under 20 years, under 10 years. But when you get to the really long time horizon, it’s more kind of in line with GDP, sort of, it’s gonna wash out.

Meb: All right next question. “Meb what’s your take on a vanilla Vanguard target date fund versus Trinity over 15 or 20 years?”

Meb: You know, target dates are great. They’re great because people mentally for some reason bucket them a little bit different and I think most of the research has shown that people behave best in target date funds. And I don’t know if they…just because they think about it as a retirement vehicle that they’re consistently dollar cost averaging into that they don’t really know. It’s not like they’re investing in just the S&P 500 funds so they don’t really know what to cheer for or not because there are some bonds and some stocks.

So I think they’re wonderful and I think they’re a great solution for a lot of people. And Trinity, I mean, it’s a similar but kinda cousin of that concept, the target date funds automatically become less in equities as you get older. There’s a huge amount of variability in the targeted funds. You could look at to have the same concept but very different paths and approaches. But in general, like we’re totally fine with them. I mean, Trinity, again, I’ve said this a million times, Trinity is…I design it because it’s what works for me, but there’s plenty of great investing solutions including, you know, we have one of the lowest cost buy-and-hold asset allocation funds on the planet. So that’s fine, too.

Jeff: I think target is brilliant from a marketing perspective because it taps into that, sort of, the illiquidity, sort of, dynamic that you’ve talked about so many times when we’ve referenced private investments, which is how it’s such a tailwind because you can’t access it. And, you know, the idea of the target date fund, you’re just gonna, sort of, turn away and not even look at it. I don’t know why people don’t always think of that with other investments that are part of their retirement bucket.

Meb: Maybe we should launch one called “target date trinity.”

Jeff: Done and done. Next question with fee compression and product commoditisation, “How do you see large active focused publicly-traded asset managers fairing in the next five to 10 years?”

Meb: I think you’re gonna continue to see what you have been seeing, which is a lot of the in the old guard try to launch funds, and there’s such so many bad of me to funds. It’s like they’re trying to do the same model they had with mutual funds and they know they need to be in the ETF or low cost space and they’re trying. And I just continually just kind of shake my head be like these guys have no, sort of, clear messaging and no clear, sort of, product lineup.

I think you’ll see a lot more acquisitions. I mean, it’s every day you hear…Our good friends at Global X just got acquired 10 billion shop by Mirae. In that same article, it was talking about all the other firms bidding on them. And I think it’s Aberdeen and J.P. Morgan and all these others are looking to acquire firms. So it’s kind of either/or but it’s the same thing about businesses has always been, these huge incumbents have a huge cash balance sheet plus kind of a dwindling, but still fantastic business like the American Funds of the world, they have a great business but will probably be declining and lose every year, so you know, they do what incumbents do. They start buying up some of the small innovators and shops out there.

So you’ll see a lot more consolidation, but it’s still a good business. The question I had raised many times in this podcast is, is that transition a phase shift where it happens in just a few years? Or is it a multi decade and I don’t know the blockbuster Netflix moment. I think it will all last. I think at the trends will accelerate, but I think it’s, sort of. scenario where people wise up to this stuff slowly you know, when someone dies, when someone gets divorced, when you inherit assets, that’s usually when they get liquidated and then invest into the kind of cheaper better products. But this is a world we live in where there still exists a 2.3% fee S&P 500 mutual fund. Like, how is that possible that that still exists? How is it possible that there is a ton of literally S&P 500 mutual funds that charge over a percent? Like, in a efficient world that should never ever ever happen.

Jeff: To what extent do you think that the broad investing populace out there is aware of the, sort of, fee compression and the, sort of, transition in the industry? Because in one sense…

Meb: Because there’s a…

Jeff: Hold on, everybody listening to this podcast is probably within a bubble. I mean, anybody listening here is somewhat educated and invest in and probably this is all over the radar. But I mean, there’s a much bigger world out there who feel like is still probably 15 years behind in a sense.

Meb: When you see it playing out in totally different areas, I mean, look at what’s going on at Harvard. Harvard has just been this mess in the endowment for years now, where you see this sort of education gap, but on top of that is misaligned interests and, you know, different people like alumni and faculty, and investment managers, and students all having interest, but also maybe not a great understanding of investing, so it creates huge problems.

And the same thing we see it every day in these office hours summaries we did, where we talked to people and there’s often an education gap. I mean, the basics today…I had tweeted out…because kind of around the Berkshire meeting, I tweeted out, I did this all chart we had invest with the house where we did the, “Hey, here’s what Warren Buffett’s top 10 stocks have done back to 2000 versus Berkshire, and they’re pretty close neck to neck.” There was a tech “clone” actually wins, and how they both beat the S&P by four percentage points a year but have underperformed 8 to the last 10.

But it’s funny to read the Twitter comments because a bunch of people, they totally missed the point of that, which was you would have had one of the best performing managers on the planet since 2000, but you would have had to allocate through this whole period, and active managers go through these long periods of underperformance. So the takeaway was supposed to be, if you’re in search of alpha, you have to being willing to allocate for 10 plus years to a manager, otherwise, you’re just gonna chase performance like all these other idiots. And that’s not just individuals that’s institutions as well. But if you read the Twitter comments its so funny, because people are like well, you could have allocated to an ETF and that would beat Buffett the past eight years. I was like that’s not the point. The whole point…you’re describing the problem. The point was that you would have beaten 99% of all mutual funds but you would have had to endure a 10 year period of underperformance.

So it’s hard. So I think the way the world’s going and this is, you know, the internet sort of effect on everything is that the disinfectant sunlight of the internet, like at some point, the 2.3% S&P 500 mutual funds won’t exist. At some point the S&P 1% ones shouldn’t exists because everyone will figure out you can buy that for literally five basis points is exact same thing. Literally, it’s the exact same thing. There’s a good website called FeeX that you can type in a fund and it’ll spit you out a cheaper alternative.

But will the kind of, you know, kings of the kingdom hedge funds still exist? Of course, people always be attracted to different strategies. And even the thing when I was talking about earlier, you know, we talk a ton about low fees but my comment, fees are just to me it’s like a bar. It raises the bar for what the criteria is for to invest in something. I absolutely believe and kind of Swenson’s conclusion at Yale, all that matters is after fee after tax performance and that’s it. That’s all that matters.

The problem is just the bar in general is so much higher for higher fee products. If you have somebody is charging three percentage points and 30% of profits, he better damn well be David Tepper and Stevie Cohen’s, you know, lovechild, right? Because otherwise, it’s just really hard and it just creates much bigger…

Jeff: Would you pay 2% for anything right now? 3%?

Meb: Sure.

Jeff: I mean, off-hand?

Meb: I told you Steve Cohen and Dave Tepper’s love child. I would absolutely pay for that.

Jeff: I’d like to see that, too.

Meb: I mean, look, I pay 20% carry on almost all of these private fund deals. Now, I’ve talked about a million times and I think, you know, I’m doing is an education it’s a very small percent of the portfolio, are there allocators out there that are worth, you know, these high fees? Absolutely. Are there strategies that are worth high fees? Absolutely. It tends to be more niche.

Jeff: Private though has a different feel than public ones.

Meb: Yeah, I mean, it tends to be more niche. I think the public markets you know, they get more commoditised every day by a lot of the quants, you know. I think it makes the world more efficient. But fees in and of itself is not you know the final… like in general, we prefer low fees because it’s a big difference. Particularly if you’re doing buy-and-hold, then it’s really stupid to pay high fees. But if you’re doing active and weird and different, high fees are fine. But again, going back to the closet indexing, you only wanna pay high fees if you’re doing something super active, weird and different. These closet indexers that look exactly like the S&P and charge you 50, 100, 200 base points, it defeats the whole purpose.

So fine. Go invest in a fund that does Timberland or trailer parks or litigation fund, like whatever. But to me, it just makes the bar higher. And a lot of people don’t understand. I mean, we talked about this back in 2007, I said the hedge funds, you know, to overcome that 2 and 20 fee you have to do something like 17% gross to get down to a stock like return of 10% historically. So you need to create a massive amount of alpha, and on top of that, it’s probably tax inefficient to be able to be additive.

Jeff: [Inaudible 00:58:33] Wes’s article about if you consistently compound at 17, 20, whatever, 25 a year, you’re going to own the entire market.

Meb: You’ll own the the entire world, right. So if someone’s marketing you 20%…So you’re right that’s what they have to hit. And it doesn’t mean it’s not possible. I absolutely have met a ton of people where I think it’s, you know, possible but it’s tends to be much more nichey, concentrated it’s just..It’s a lot harder.

Jeff: Two more questions . We’ve got a handful of questions this week about generally asset allocation for the younger generation, so I’ll roll them up into just one aggregate question, but in essence it’s, “How do you think about asset allocation for a millennial sub 30 with retirement accounts? The typical 60/40 doesn’t seem so great.”

Meb: I mean, again, the starting point we always say is global market portfolio. So that’s half stocks, bonds, half U.S. foreign. That’s a pretty good starting point the cost on that is probably sub 30 basis points, for sure. But Matt Hogan, excuse me, has written… who by the way was the former CEO of Now, he just went to go join a crypto firm, and Matt’s great. Anyway, he wrote a consistent article called “The Cheapest Portfolio In The World.” Every year it gets cheaper and cheaper. I think it’s now down to like eight basis points.

Anyway, you know, to me that’s a starting point but you’re young, you’re in your 30s, you can also spend some time learning. Go ahead and put that 10% of the portfolio. So 80%, 90% put at automated solution whether it’s targeted fund, whether it’s one of these robo advisors, whether it’s a group of ETFs, and just kind of forget about it. You wanna go light the other 10%, 20% on fire, trading ripple and etherium and everything else, and Jeff’s options and who knows whatever, go for it.

I mean, the best situation would be to spend zero time in the market and read some history books. And we did that old article called “The Best Way to Add Yield to Your Portfolio” is to do nothing and probably work harder and try to get a better job. But there’s actually a great Vanguard piece we just sent out the Idea Farm that went through, I think it was our 2018 outlook. And at the end, they showed a chart of kind of what were the biggest determinants of long term investment success. And the first one was saving more and starting early, which is obvious but it’s pretty profound.

And the other three…Essentially, it had nothing to do with investing. It was spending less you know, lower fee funds was one, but only were like the asset allocation decisions, and adding commodities, and thinking about all that other stuff really important. It’s like the old food pyramid. It’s like what’s most important you go down eventually some of the investing stuffs important, but it’s almost all personal finance decisions when you’re young.

Jeff: You should write that sort of Maslov’s hierarchy for investing.

Meb: You should write it and I’ll edit it is the correct way this works, because you are a much better writer than I am but was that what it’s called?

Jeff: What?

Meb: Maslov?

Jeff: Maslov’s hierarchy of needs that’s the original sort of back to… it’s a pyramid app where at the beginning…

Meb: It’s like sleep or something?

Jeff: It’s your basic like shelter, protection, food, and then as you go up yourself actualising which is….

Meb: Mine is not that way. Mine would go to sleep first. Shelter whatever. If you take away any of those things, sleep by far is the one that I fall apart. Food is yours. Food is absolutely yours. If Jeff goes [inaudible 01:02:05] three hours…

Jeff: I’d definitely meltdown.

Meb: …on calories. Listeners, you may not know this, by the way, Jeff has two lunches every day. The first is the spinach blueberries and almond salad. By the way…

Jeff: It’s delicious.

Meb: You know what we should probably do, we should..If anyone is still listening at this point, which I doubt. We should probably just get rid of sponsors and ask people to give support the podcast. We just got a great delivery of Memphis barbecue from a listener. Thank you, listener.

Jeff: Those as peanuts we get are great.

Meb: I know. So if you guys really wanna say thank you for the podcast, you can send Jeff food. It’s like a circus animal, you just throw him a steak every once in a while, and the podcast gets better. What’s been your favourite so far?

Jeff: In this podcast?

Meb: We just got six bottles of wine.

Jeff: Rasmussen’s was good.

Meb: No, no,no. I don’t care about the podcast which was your favourite gift you received? We got six bottles of wine. I haven’t had my Pinot Noir from Oregon.

Jeff: I think I took on a cab. I haven’t had it yet.

Meb: Yeah, that’s a good one.

Jeff: Wait, wait. Hold on. Let me back up, I got a question for you. I tried to ask this, I think, the last radio show but I don’t think I did a good job of communicating it clearly. You look at the global market portfolio right now, my impression, and tell me if I’m wrong, is a lot of markets around the globe are more expensive than their traditional averages. Sure, emerging markets are still cheap or whatever but as a whole we’re kinda pricey.

Meb: It’s kinda like Trump during one of the debates, do you remember that? When he was like “Wrong.” He just kept interrupting he said, “Wrong. Wrong.”

Jeff: All right so that might be…

Meb: Wrong.

Jeff: ..the way you take this.

Meb: Yeah. No, well…

Jeff: Well, what I was gonna say though is like we’ve gotten a few people who’ve written in saying, “I finally just got back in the market.” Now, I think they’re referencing the U.S. equity market. However, let’s just take it more broad right now. If you have a lump sum of money and people always ask about, “Do I allocate all at once or do I cost average in?” If somebody is going the global market portfolio right now with whatever, a million bucks, is it at such a state right now where it’s best just to throw it all in and let it ride? Or, do you think that we’re still on sort of the more expensive side and enough markets where it might make you pause at least in terms of just throwing it all in at once?

Meb: We tweeted about this the other day, speaking of Trump, at some point this is gonna be like there’s a tweet for everything. Like, you just go to my tweets, where I was talking about expectations and going back to millennials, you know, I said in that Vanguard outlook they had said expected returns 4.5% for a global portfolio so I said, reasonable Vanguard. And then I said unreasonable average pension fund 7.5, average investor says 10.2, average millennial says 11.7, and the average institution that allocates to hedge funds expects them to do 13.

So it’s crazy to me and I don’t understand why, by the way, soap box, why any pension fund in endowment has a fixed return when the biggest component of returns is probably inflation. And so, historically, you’ve had let’s call it 3% inflation over a reasonable period, and 5% returns over that for 8% total. Well, if inflation is one and you still get that historical five, then now you’re already down to six, so it makes no sense to talk about 3% inflation when there’s only one in the world. Anyway, but historical a great rule of thumb is just say 4% over inflation that’s what report was gonna do. Almost every portfolio in our book asset allocation did 4% to 5% over inflation, so 4% to 5% real but be conservative and say 4%.

Jeff: But that’s still your long term or average. Is there still a lot of volatility within that?

Meb: Yeah, of course, it’s all over the place. It could be plus/minus 20% any given year. Going back to the original question, is the world expensive? No, the U.S. is the second or third most expensive country in the world, but most of the world is totally average to cheap. And the cheap stuff is some of the cheapest has ever been relative to the U.S. in the world. So talking about dollar cost averaging, the correct answer in my mind logically speaking is…I think Cory Osteen just put out a piece on this is to invest at all today, that’s just math. But for a lot of people, psychologically speaking, the best thing to do is dollar cost average. So put in 500 bucks a month. In that way, you don’t have to worry about it.

As markets are going down, you’re adding more. As markets are going up, you’re still adding. So psychologically speaking, I think it’s really hard. that was one of the office hour takeaway is for people stop thinking binary terms. And the beauty of that is people are always worried about the market which is the U.S. stocks. Well, U.S. stocks are only a small percentage of global market portfolio. They’re a minority. But the good news is most the world is reasonably priced cheap. Now, you have pockets of things that are kind of crazy like foreign sovereign bonds that have negative yields, and U.S. stocks, but a lot of stuff probably totally reasonable.

Jeff: All right. You mentioned inflation, this ties into our last question, so let’s knock this out and call it a day. “With the rising rates, I’m in short term notes to limit duration. With hints of higher inflation, do TIPS make sense?” And as a quick tack on someone else was saying, “Meb, how are you planning inflation, and how are you diversifying within fixed income?”

Meb: Yeah, TIPS are fine. You know, I think that’s a reasonable thing to allocate to for almost anyone, U.S. and global.

Jeff: Clarify real quick just for anybody who is not familiar with it.

Meb: Treasury Inflation Protected Securities, I think, I got that right, launched in 97 in the U.S. They’ve been around for longer elsewhere but the coupon payments adjust for inflation, and the principal…God you catch me at the end of this long podcast. But essentially it preserves your purchasing power. So as opposed to most bonds that would really struggle with rising inflationary environment, even then, by the way, the coupon payments ratchet up. So if you get…It’s a see-saw you get higher payments despite price losses, but it’s the long periods of high inflation that kind of erode bonds typically.

Jeff: All right. Yes, then, TIPS work for you.

Meb: TIPS are reasonable.

Jeff: All right, anything else on your end?

Meb: No. Around for a while got a few writing projects but otherwise we’re trying to update…By the way, you know, something interesting, I don’t know if I sent you this. But do you remember when Amazon had a bunch of our books? Someone emails me is like, “Meb, I see your book is $700 on Amazon. Why is that?” And so I went and Googled Meb Faber on Amazon and I had like 30 book listings, so it would replica copy, coplica. Coplica is a copy replica of “Shareholder Yield” book. But the name was a little bit different so it would be like “Shareholder Yield 2013” was the name of the book, and the publisher’s Meb Faber instead of the Idea Farm or whatever.

There’s all these little differences, and so I have a good friend at Amazon. I emailed him, “Hey, what’s up with this? Like, how do I get all these taken down? It’s clearly not me?” So I said, “This is fraud.” So there’s some sort of fraud going on. And so this long article just came out recently and it turns out it’s not fraud the way that I think it would have been, which was people buying copies of my books, relisting them with the hopes that someone would buy it for $900.

It’s actually money laundering. So what people would do is they would set up the book copies, steal people’s credit cards, charge it so Amazon would pay the bank account that was linked to the book, as a way of just laundering money from stolen credit cards. Isn’t that fascinating?

Jeff: Part of the problem, Meb.

Meb: So anyway, but so that’s on the to-do list is to update particularly “Shareholder Yield Global Value” because they were in the early end of us doing self publishing, so I have no problem with the eBooks but the physical books look terrible. I think they’re like D plus quality. “Global Asset Allocation” and “Invest With The House” I think are B plus, A plus, not A plus, B plus and A. But the first couple are pretty bad.

Jeff: Stop travelling, start working.

Meb: Yeah, so that’s in the to do list.

Jeff: Take us out.

Meb: Okay, listeners, thanks so much send us lots more calories to Jeff, and reviews. We read all of them and really appreciate all of them including the one that just says “lame” on there. So leave us a review on iTunes. You can always subscribe on Overcast, Stitcher, Castro, all those good ones. And thanks for listening, friends, and good investing.

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