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Episode #111: Radio Show: Which Portfolio Hedge for This Market?… Is Short-Termism Harming Your Investments?… and Listener Q&A

Episode #111: Radio Show: Which Portfolio Hedge for This Market?…  Is Short-Termism Harming Your Investments?… and Listener Q&A

Guest: Episode #111 has no guest but is co-hosted by Jeff Remsburg.

Date Recorded: 7/02/18

Run-Time: 1:16:12

To listen to Episode #111 on iTunes, click here

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To listen to Episode #111 on Pocket Casts, click here

To listen to Episode #111 on Google Play, click here

To stream Episode #111, 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 111 has a radio show format. In this one, we cover numerous Tweets of the Week from Meb, as well as some write-in questions.

Before jumping in, a few housekeeping items… Meb discusses a proxy campaign with which we need your help, an award Cambria just received, Meb’s new Office Hours, when the Trinity ETF will launch, a new webinar we’re going to put on later this summer, and more.

We start with some of Meb’s Tweets of the Week. We discuss a WSJ op ed piece penned by Jamie Dimon and Warren Buffett, in which they suggest short-termism is harming the economy. Specifically, they believe public companies should reduce or eliminate the practice of estimating quarterly earnings.

Next, there’s a quote from Jim O’Shaughnessy: “Money is like manure; if you pile it up it stinks to high heaven, but if you spread it around, it does a lot of good.” This is a springboard into a conversation about the role of cash in a portfolio, especially in today’s market.

This segues into the next subject – how Americans are reaching retirement age in worse financial shape than the prior generation, for the first time since Harry Truman was president. This leads to a conversation about starting investing early, but also focusing on active income and delaying the retirement age.

Next, there’s a tweet about early stage private investing. We use this as an opportunity to catch up on Meb’s private investments.

Other topics are fund-flow differentials between ETFs and mutual funds, as well as Meb’s dissection of Wealthfront’s latest fee structure. If you’re a Wealthfront client, you’ll want to listen to this.

We then get into listener Q&A. Some that you’ll hear Meb address include:

  • Given today’s valuations, I’d like Meb’s perspective on the pros and cons of allocating to the following “hedges” – cash, gold, tail risk/put strategies, and managed futures.
  • What advice does Meb have for people trading companies in their field? For example, a realtor making a move on home builders or a programmer stock-picking an AI firm.
  • Would Meb please share his opinion on multifactor funds and the role they should play in an investor’s portfolio?
  • A question about advisor fees and whether they’re deserved.
  • Besides portfolio construction and behavioral coaching in times of stress what are some other advisor value-adds? Are we reaching the limit of value added services?
  • As ETFs grow, under what circumstances could securities lending become a substantial risk to one’s personal assets and possibly a systemic risk to the financial system–are processes in place now to prevent that problem before it happens?

All this and plenty of other rabbit holes in Episode 111.

Links from the Episode:

Transcript of Episode 111:

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’s 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 cambriainvestments.com.

Meb: Welcome, listeners. We have a special 4th of July podcast radio show, live with Jeff Remsburg. Welcome, Jeff.

Jeff: What’s happening.

Meb: What do you got planned for the 4th?

Jeff: It’s a good question, we…wow I hadn’t thought about that. Listeners, what…

Meb: Barbecues, sunshine, bikinis.

Jeff: Well we have our annual sort of midsummer beach party down at Meb’s place, or on the weekend preceding the 4th. And sometimes it actually falls on the 4th obviously if the calendar works that way, but we just had it so.

Meb: The 4th on a Wednesday is tough. I feel like we pulled into work today and 75% of the parking lot was empty.

Jeff: Yeah, people already taken off.

Meb: Mailing it in. All right look, we’ve got a couple housekeeping to touch on before we get into this episode, lots of good stuff to talk about. First of all, Cambria funds, if you are a shareholder we’re going through a proxy, which means you’ve got something in the mail. If you didn’t get something in the mail, either way you can call-in and vote, it takes two minutes of your time it would be a massive, massive favour to me. And if you’re a shareholder… by the way, if you’re a Betterment shareholder you don’t have to do it, because they voted it for you.

But if you own any Cambria funds you can call the following number, 866-963-6135, and vote your proxy. For those who don’t know what that is, it’s a really annoying and expensive process. We’re gonna spend well over $100,000 on this. And I doubt anyone listening has ever voted a proxy in their life, but it’s something you have to do. After Erick passed away, we had to update our adviser agreement and so we had to file this proxy. So if you’re a shareholder it would mean the world to me if you did it again, 866-963-6135, it’ll take less than two minutes, and I would really, really appreciate it. Couple other pieces of Cambria news, “Financial Times” named us one of the top investment advisers in the galaxy.

Jeff: Was “galaxy” the term they used?

Meb: Technically it’s just the United States, but…

Jeff: I’m kind of let down now, I was hoping galaxy.

Meb: Some of our ideas could probably… people would see them as far out, but no, so that was pretty cool. At the same time, I just noticed that, and told you about this, or brought it up, but our oldest fund now just passed a five-year track record shareholder yield, five-star fund. We’re really happy with the entire shareholder yield suite. We’re very enthused with how it’s done over the years. We’re gonna put out a new piece this summer, so keep an eye out, as well as the webinar.

By the way, we just opened up our very, very popular office hours, so if you’re not on our mailing list, I’m sorry, but that’s where the link went out. So sign up on any of our websites, get on the mailing list, and that’s where we do one-on-one conversations. We’ve done…do you think we’ve done over 1,000 at this point? It’s gotta be in the hundreds, probably not 1,000.

Jeff: Probably not quite 1,000 yet, but you have had over a few hundreds shows.

Meb: Average like 5 a day for a couple weeks, that’s 100 per quarter at least. Anyway…

Jeff: This one’s got an RIA theme, right? You hold off…

Meb: Yes, so the problem…I mean the challenge is like we love talking to everyone but the number of individual investors we have kind of dominates the number of advisers just by scale. And so we wanted to let our adviser friends get their time in the sun, so we said to try to let advisers…it’s like you’re on a plane and you let the people connecting flights get off first. Let the advisers have a chance to call in, so if it’s not full up, sign up, if it is, tough darts.

Jeff: By the way, a minute ago you mentioned milestones, a very happy birthday to you.

Meb: Thank you, Jeff. I am looking for my birthday cupcake, but don’t see it.

Jeff: Do you wanna reveal your age here or do you wanna keep that a mystery?

Meb: I feel every bit 41 this morning, but every morning for me is getting out of a coffin. I love these people they’re like “This is a successful person, here’s this morning routine, he drinks green tea, and then meditates for 45 minutes. And then you know, does yoga while being thankful for everything.” I literally crawl out of a coffin to the coffee and that’s it. I’m genetically…I guarantee you when 23andMe gets a little bit better they will say, “You have the night gene. You are essentially a vampire.”

Jeff: Does Jackie not have coffee waiting for you, with her loving embrace every morning?

Meb: Once a year, she actually did today. And it was so rare, when I went upstairs I made coffee again. I poured my own, she’s like “What are you doing, did you not get the coffee I brought you?” I said, “It was so out of character I didn’t even notice,” so wonderful when your wife doesn’t listen to your podcast because you can just give her…

Jeff: It’s a hall pass.

Meb: So much crap. One more housekeeping, a lot of you have emailed in asking about when we’re launching our Trinity ETF. Due to this proxy, it kind of took the backseat, but hoping to have it out in August, end of summer. So you guys go take a little time out, barbecue, go surfing, go camping, go fishing, whatever it is, and we’ll hopefully get that out by August. By the way, we have a new offering that by the time this comes out, we listed our Trinity portfolios in M1 Finance, which is a pretty cool, younger, new, automated service that allows you to basically have a free robo-adviser with no commission trading.

Jeff: Yeah, it’s a very sleek interface.

Meb: It’s awesome. And by the way, huge news today also, Vanguard just announced they’re moving…its not all but all normal ETFs, which hopefully includes all of ours…all normal ETFs to commission free on their platform. So basically this day and age, you’re kind of a moron if you pay commissions, not a moron, maybe just lazy, or in some cases it’s small enough that it really doesn’t matter. But in general, there’s really no reason to be paying commissions anymore.

Jeff: You keep saying this is…

Meb: The $75 option commissions you trade for trading 100,000 options of penny stocks, Jeff.

Jeff: That would be foolish. Even I’ve learned that would be a bad idea.

Meb: There was also an SEC, just came out…by the way, if we can just play some fireworks noises on the podcast. The SEC just announced their ETF rule, which God bless them, they got it right, they did everything they should have done, they streamlined the ETF filing process, which I don’t really care about now, but is probably the right thing to do. But more importantly, they streamlined the creation redemption process, which means it’s a huge benefit for the end investor. They levelled the playing field. It’s not final yet, they do like 30, 60-day comment period or something, but it should go into production. But it’s also, very quietly, I think, the death knell of active mutual funds, because it means that any ETF is gonna be vastly more tax efficient than most active mutual funds.

Jeff: And are end users gonna see this immediately or is this gonna take a while to trickle through?

Meb: I don’t think anyone notices at all anyway, people don’t really think in terms of tax efficiencies unless they’re really looking for the funds. But they will notice in their pocketbook in the coming years. And so if you’re an adviser, if you’re an investor, it quickly becomes the base case where the default, in my mind, is using ETFs and you have to justify using something else. Say, look, you’re gonna add a hedge fund, you’re gonna add an active mutual fund, like you need to justify it not just because of the double, triple, quadruple fees, but also because of the massive tax difference we talked about in earlier podcasts where it’s like the average tax hit mutual funds take over ETFs in general was like 80 basis points. So it’s huge hurdle and this just levelled it for active equity ETFs, which are a tiny, tiny, tiny, fraction of ETF assets, by the way. A lot of people don’t know that, but the vast majority equity mutual funds have been active historically. We already got wonky in the first five minutes I didn’t mean to but…

Jeff: You’re taking us off track.

Meb: You have nine pages of notes so let’s get started, what do you wanna talk about?

Jeff: Real quick, any other travel coming up towards the end of summer?

Meb: Gonna be in Omaha.

Jeff: When is that?

Meb: In like peak heat of the summer, where actually we should be doing wheat harvest right now in Kansas, and knock on wood that we’re not gonna burn down the entire field again this year.

Jeff: Talk about rabbit holes, you and your farm.

Meb: And I’ll be in Omaha, so if you’re in Omaha, come say hello. It’s a private event but I’m happy to do meetings. Be in Seattle this weekend somewhere-ish, I don’t know. Hit me up. If you’re an adviser, you want me to come say hi, let me know, email me.

Jeff: All right, with that behind us let’s talk about this radio show. Let’s do some tweets of the week, and then let’s hop into a few listener questions, and then see what happens.

Meb: Do it.

Jeff: All right, number one…

Meb: By the way, send questions, Jeff has a full laundry list, you guys have been sending them, and keep them coming, [email protected]bershow.com.

Jeff: We need to find a way to sort of put up the most common questions on the website, because the challenge is we get a lot of the same questions all the time. And I understand a new listener comes in, they’re not gonna listen to our entire back catalogue to hear every radio show and the same questions but…

Meb: They should.

Jeff: We get so many [crosstalk 00:09:19].

Meb: Start at the beginning, 100 episodes.

Jeff: Anyway, all right, so one of your tweets. Jamie Dimon and Warren Buffett pinned a “Wall Street Journal” op-ed piece, about how short term-ism is harming the economy. They believe public companies should reduce or eliminate the practice of estimating quarterly earnings. One quick bullet point from the article, just to give listeners a little more colour on it, it says, “Companies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts that may be affected by factors outside the company’s control such as commodity price fluctuations, stock market volatility, and even the weather.” So Meb, what’s your quick take on quarterly earnings, you think it’s a pain? You think it’s worth it?

Meb: I have somewhat of a barbell opinion, as an investor, the more information in general the better. And it’s kind of conflating two different things. Like the problem with the solution, do I think that people shouldn’t be focusing on the short term? Yes, absolutely, but I don’t know that having quarterly earnings and guidance and everything else is really the issue. The issue is that people need to focus long term. So I don’t know that it’s a…like that’s the solution if you just have less information somehow people are gonna stop checking stocks every day or trading them or doing whatever.

There’s the old quote “Like what if the stock market was only open one day a year?” sort of thing. But again, it’s like can you figure out a way to really…I mean first of all, it’s human nature I think. But can you figure out a way to create a system where you focus on long term? So it’s like the example where people talk about buybacks, and they say, “Oh my god, buybacks are causing CEO pay to go crazy because CEOs are focusing on short terms option packages.” I say no, it’s not buybacks that’s causing the problem, it’s the idiot board that designed a horrific payment structure, compensation structure for the CEO to focus on the short term.

So the solution is not make buybacks illegal like Elizabeth Warren, solution is have a better board that has the right incentives to place for long term focus. So yes, the goal is long-term focus and getting away from this quarter-to-quarter. And the same thing, by the way, happens in our investing world you know, where people are focusing on the day to day gyrations and the behaviour we all see that it’s fairly terrible, when really their goals and everything they profess is long term.

Jeff: Somebody writes in and says you know, your funds doing terribly. A lot of the responses… your view is too myopic, you have to look closer to a full business cycle or at least a few years to get a full flavour for how it’s doing. Do you think that that is any different than a longer time period in terms of needing to evaluate the fundamental health of a business? Are they the same period are they different periods?

Meb: There’s a lot wrapped in this I wanna touch on. So first is…I have a really funny answer so if you’ve gotten this email I apologise, because it seems a little bit rude where people often email me and say, “Hi Meb, like I’m kind of disappointed in XYZ.” They never email in to say they’re really happy with something. They say “I’m disappointed in this fund or this something,” and I say, “Well, you know you’re kind of…you’re disappointed or you’re upset with an algorithm. Maybe you need to recess your feelings on how you relate to algorithms, because it’s sort of weird to be upset with an algorithm.” I said, “Do you ever call S&P and say, ‘I’m really mad about the performance of your index?’ No, no one does.” So no one obviously thinks that’s funny other than me.

But it’s easy to be dismissive of the people that email in. It’s actually often I see as a failure of my side as a portfolio manager to convey the correct expectations. And so we had a guy email in like a week or two ago and he said, “Hey Meb, I’m really upset. I see the returns on my account are 1%.” He goes, “Once again, in my long investing life, a good theory doesn’t mean good results.” So first of all, I looked up his account and he’s up 12%, so let’s ignore that. But let’s say, theoretically, he was even up 1%, my response should be…we probably need to draft an expectations document. I think that’s a good idea lets add that to the list.

Where I say, “Look, here’s the deal, we fully expect that this strategy could be down 10% in a month, in a year, in a quarter. It’ll probably see 20% drawdowns at some point. The worst case historically has been X, but it could be bigger than that.” You can’t really find an asset allocation portfolio that doesn’t lose a quarter after inflation at some point. And people get upset about that, but it’s true. You literally can’t even put in cash because cash has lost 50% after inflation at some point. So you can’t put together assets and come up…almost impossible to come up with an asset allocation that hasn’t lost at least a quarter, any formation.

So listeners, if you’ve got one let me know, and don’t dare say permanent portfolio because the global permanent portfolio is lost a lot more. Permanent portfolio’s close, however. But say, “Look, not only can you lose 10%…so forget 1% even though your account did 12%, there can be a scenario where you’re gonna be negative multiple years in a row, and that doesn’t disqualify the long-term success, because you can look back and show these various periods where any investment strategy is done poorly.”

So it’s a bit of expectations, challenge, and education. Now, here’s the problem. I tweeted this out and got a lot of responses. There’s a very popular personal finance guru. And he’s, I think, to his credit…this is Dave Ramsey, by the way. He sounds like the nicest guy on the planet. He’s got a good kind of Southern drawl. I think he’s from Tennessee, maybe. I think he’s done wonders for millions of people on the personal finance side of helping them get out of debt, to save, to budget. Which is, by the way, like going back to our investment pyramid podcast and whitepaper, which listeners, by the way, just came out, new whitepaper called “The Investment Pyramid.”

Which, as podcasters, you heard like three months ago, but it took us forever to actually publish it. You know, we talk about where the personal finance pyramid is way bigger and more important than most people’s investment pyramid, which only kinda happens at the top. Once you get your personal finance house in order, only then do you really start to tackle the investment side. Which is a great example as someone was talking about, they said, “Well, Suze Orman has sold 4 million copies of her last book, but the very top academic journal of finance only has like 8,000 subscribers.” So it affects way more people.

So Dave Ramsey sounds like a great dude, wonderful on the personal investment side. I started to listen to his podcast because he’s been doing radio show for a year. However, his investment advice is really, I think, dangerous. Where he had a quote, and I tweeted it out, where he talked about his sort of personal portfolio and his recommendations for investing. And first of all, he was recommending load mutual funds, which is already like one strike, in a world of TPTFs tax efficient, why you would ever recommend anything with a load is really questionable already…

Jeff: Remind anybody who doesn’t know what a load is.

Meb: A load is when you have to pay like 5% just to buy the fund, so if you put in $100, you now have $95. And so it’s a way to compensate intermediaries, so it’s already like a questionable fiduciary. As a fiduciary you probably get an X on that, it’s not something that anyone reasonable should do. But second he had a quote he said, “Look, my personal mutual fund portfolio is in growth, growth and income, aggressive growth, and international. And that mix outperforms the stock market every year.” And I said, “Whoa,” and I like rewound and I said, “Okay, hold on, let me make sure I heard that correctly.”

Jeff: Bold comment.

Meb: First of all, that mix is…I like kind of smile at that mix because you’ll definitely just end up with 75% U.S. stocks and 25% international, but whatever, growth, growth, and income-aggressive growth. Anyway, was that fund that just blew up? It was preservation and growth, the options fund that blew up in February? So anyway, I was laughing at that, and that mix outperform stock market every year. And it’s funny because there are some people that responded to me on Twitter and they’re like, “Yeah, you know, actually he said his personal portfolio, so it could be possible.” I said, “No, I’m sorry, but it is not possible for you to outperform the stock market every year, just it’s not, I’m sorry.”

And then like two minutes later, and he’s like “Look, if you can live on less than 10% and you’re invested in the market where you’re making more than 10%, you can go on in perpetuation.” And he often would make reference to making 12% in the stock market. And I said, oh boy, this is trouble because like those expectations are one not related to history, right, U.S. stock market. And you can find periods where it did 12%, but certainly if you look at valuations like that’s a pretty wide spread between expectations and realities. So here I am telling our clients, I’m like, “Look, your expectation is 4% real. That’s what asset allocation has done historically, add on a couple percent for inflation, there you go.” Twelve percent, maybe I just need his mutual fund manager.

Jeff: I feel like most of the people listening to the show are aware of that discrepancy, and they’re aware of the expectation flow of returns, may not like it, but they actually know. I think the broader populace tends to have this sort of misconstrued idea of what they can get, part of that is I think they don’t really wanna know the truth because they’ve been told stuff like this by Ramsey. And so how do you get through to them?

Meb: Well, it’s a challenge because you gotta remember that because of this huge expectations gap…the education gap on investing, we come back to so many times, and I waffle between feeling like this is a really noble effort, and we can conquer this and really help people, and other times, just throwing up my hands and saying, “This is impossible.” People continue to be morons.

Jeff: I think it’s impossible because it’s recycling, you know, you’re getting new people coming along every 5, 10 years, 20 years. New generation, it’s the same problem [crosstalk 00:19:08].

Meb: So when you’re young, you know, and you don’t know better and you talk to a money manager he says, “Hey look, I can deliver 4% real” like I just said. And he finds someone else who says, “No, you just invest in these load mutual funds they’re gonna do 12%,” what are you gonna go with? You say, “Why would I ever choose the…?” You know, so anyway, it’s really tough. And so going back to your original question which is the short term-ism, long term-ism, I think it’s really hard.

Jeff: Before we go down like that too much of a different rabbit hole here, back to short term-ism. The reality that you just pointed out, which is, you know, our strategy, any good strategy, in any given year can be up not just 1% but down, call it 5% or 10%. That puts a lot of weight on the individual investor and where they are in their own personal investing cycle. If you’re down 5% or 10% at age 25 starting, whatever. If you’re down 5% or 10% at age 55 or 60 with a different financial situation, that’s a different situation. So to what degree can you like try to factor in where you are in your own life cycle with these realities of funds that may have bad years for a stretch, a long period?

Meb: I mean, again, and so much of this is personal. We talked a lot about, on the podcast, where there’s the 80-year-old who has plenty of money and says, normal, “You type me into a optimiser,” and it’ll say, “Hey, you need to be in munis and cash, because you’re 80 and you’re gonna die soon, sorry.” But this guy, they may have…”Look, I have a bunch of money and I’m not investing for myself, I’m investing for my foundation and to fund these projects, and so bring it on. I put half my portfolio in emerging markets and the other half in XYZ.” And you may find a young person who doesn’t have a risk tolerance that can emotionally handle any drawdowns.

And then you have people… so it’s funny, people will talk to us about our funds, say, “Meb, I’m so excited about your funds going down because that means I can buy more and average in.” I say, “Well, you must be young, right, because the retiree who’s investing in some of those probably has the opposite opinion.” So it’s challenging, but again, like everything we’ve said today, it’s all about becoming comfortable with your own situation and having a long-term perspective, having everything we’ve talked about, you and I, in this podcast many times, having a written investment plan, sharing it with someone so that you have some ability to stick with it, it’s tough. But it’s a journey, I don’t think it’s a one size fits all.

By the way listeners, if you know of a…I don’t know of a website that lets you go online and craft a sort of policy portfolio, like, statement or investing plan. I know there’s a lot that let you do financial plans, but not necessarily here’s how I’m going to invest plan. If there is let me know, I don’t know of any.

Jeff: All right, next tweet, this is from Jim O’Shaughnessy. He had a great quote, which he attributes to his grandfather. Said, “Money is like manure, if you pile it up it stinks to high heaven, but if you spread it around it does a lot of good.” So this is a bit of an extension. I mean you kind of touched on the personal finance element with Suze and her book, and then Dave Ramsey, then our own investing pyramid piece. But kind of going to a little more broad right now, we have a lot of smart investors who in this market are calling for more of a move into cash as sort of a defensive position. But then you have O’Shaughnessy saying, you know, “If you pile up too much cash, it stinks to high heaven.” So help us understand, where’s the line between when piling cash can be helpful, especially in this market, versus when it’s really just stagnating and really hurting your returns?

Meb: I think this is…we’re starting to talk about a little two different things. I love Jim, and I think he’s talking about, if I had to guess, a little more about lifestyle and philanthropy. Meaning if you just get old and hoard all your money versus funding new ventures, or venture philanthropy, or donating, or passing it along, some more of that bend rather than necessarily portfolio allocation.

Jeff: I’m more interested in portfolio allocation. I am not of Jim’s age and sort of philanthropy…

Meb: I want him to finish…we’ll have to ask him to finish the quote with what did his grandfather say if you don’t have any cash? How does the analogy work?

Jeff: Reach your hand out very long.

Meb: You know, the older I get the more I think that behaviourally, you know, whether you make 5% or 6% isn’t gonna really matter. We talked about the research that showed that under periods of like 20 years, savings matters a lot more. How much you save matters a lot more than your return.

Jeff: At 25 years.

Meb: And it depends on the return, depends on the savings assumptions, right? But however, the takeaway was that only if you’re compounding for many decades does that really become the big differentiator. So I also think that the cash, whether you make 5% or 6%, or 10% or 12%, whatever the number may be, cash gives you that ballast to not do dumb stuff. So any time you’re fully invested, it’s always hard for people because there’s no more chips, and the market goes down 50% you have this feeling of, “Oh, well, I have nothing left on the table to…I wish I had these opportunities.” There’s a great book on the Great Depression, I’m blanking on the name, but it’s basically a guy took his father’s diary…I think it’s “Great Depression: A Diary.”

And it’s really interesting to read because it would talk about people’s emotions and how they’re thinking about stocks and bonds, and everything else that was going on in the world. But often it would talk about basically like everyone knows stocks are a great buy right now, no one just has any money. And this was actually my experience along the same lines when I was travelling a lot of these countries post global financial crisis in a lot of Europe. Where you talk to people in some of these countries that the stock market is down 50%, 80%, 90%, and be talking about the stocks being really cheap and them saying, “Well, thanks, but no one has the assets to invest.”

So cash gives you that optionality. As we mentioned earlier on after-inflation basis, cash is dangerous too because if you have a high-inflation environment you can really get hit at a tax every year. So right now that’s 3%, but other years it’s has been a lot more in history. So having some is, I think, totally fine. In the U.S. right now where bank CDs and bonds get up to the 2% to 3% range, woo-hoo, you’re getting up there. That’s one of the higher-yielding bonds in the world right now probably. So it gives you some feeling, I think, of dry powder. Little different than Jim’s take, but I do agree in both instances that I love the uses and optionality of it.

Jeff: It’s kind of tangential. But in terms of this bull market, in terms of the broader U.S. investor, have you had enough touch points or recent touch points with enough retail investors? Can I get your own feel of if most people are fully invested, if they’re hoarding cash, if they’re…?

Meb: Remember there’s this big difference between what people say and what they do. So if you look at almost all of the studies, what they do is simply just follows the market based on performance and size. So if you look at equities as a percentage of net worth, or of your portfolio, it looks like an S&P 500 chart. So it hits peaks in 2000, hits a trough in ’09. It’s, I think, recently hitting a…I don’t think ’99 peak as a percentage but it’s darn close. And versus the ’80s it was really low. So that’s simply people’s balance sheet expanding and contracting based on how stocks have done. So that’s what they do. What they kinda say is only at extremes is this sentiment really helpful. But we’ve mentioned this many times, the AAI sentiment readings where it hit the highest for stocks it’s ever been in December ’99, like the worst possible month in history.

Jeff: You’re talking about optimism, right?

Meb: Optimism and pessimism. So they would say “Are you bullish on stocks?” And the most bullish people ever were January ’99, and the most bearish they ever were was in March 2009, the exact opposite of what they should be. So usually they coincide, so people were getting…if you remember there’s the other study, credit to Luthold [SP] on this, where if you looked at average optimism for the course of the whole year, you could take this back to the ’60s for a different survey called Investors Intelligence. They found that if you looked at the top 10 most optimistic years, the next year return of stocks was poor, and the bottom 10 most pessimistic years stocks next year were great. And guess what, at the end of 2017, it was like the second highest on record maybe, and so far not looking too good for stocks this year. So we’ll see, we got six months to go.

Jeff: Barring just sort of emotional optimism or discouragement and looking purely at their actions as manifested by the use of cash or the storing of cash, do you have any feel for whether or not people are fully invested at this point?

Meb: No, most of the sentiment stuff I have a second hand. So everyone was hot and heavy for crypto December, January, and then that mania has largely subsided, 70% declines will do that to people. I think I saw a chart was like every single crypto is down somewhere between 50% and 90%. The average is everyone’s down but most between 50% and 90%, and whatever, maybe that’s the base for the next period, maybe it’s the end.

Jeff: You and I were talking about that in a radio show some months ago, they were about to start trading the futures on it and…

Meb: Futures, futures literally rang the bell on the peak of bitcoin. It was like 20,000 and then it just took a cannonball.

Jeff: All right, let’s do the next one, it’s all kind of if…it feels more personal finance-y today, but whatever, we’ll take a deviation from the usual investing stuff. So you posted about how Bob C. Wright had actually posted an article from “The Wall Street Journal,” how Americans are approaching retirement worse off than the prior generation, and how this hasn’t happened since Truman was president. So just a few quick stats from this just to give listeners some context.

The 401(k) retirement funds, the average 401(k) retirement funds will bring in a median income of under $8,000 a year for household of 2. Median personal income of Americans 55 through 69 levelled off after 2000 for the first time since data became available in 1950. Households with 401(k) investments and at least one worker aged 55 through 64 had a median $135,000 in a tax advantaged retirement account as at the end of 2016. And for a couple aged 62 through 65 who retire today, that would produce income of just about 600 bucks, an annuity income for life. You know, kind of grow grim. I guess this ties back into our discussion earlier about investing at different stages in life, but do you have any thoughts on how our older listeners who might be in these situations, you know, what they can do? What they have to deal with? Any advice or is it just, hey, this is kind of it?

Meb: You know, I mean I think a lot of it is start early, save, do all the basics if you can. But as you remember, like that’s such easy advice to give, and you’re in your 20s, how hard that is actually to implement. So to the extent you can do it, awesome, more power to you. I mean gone are the days of defined benefit plans. You know, most people now have to take charge of their own sort of retirement, and I encourage you to do it, and it’s totally doable. One of the more interesting takeaways by the way, on the returns…and I didn’t really come to this understanding until somewhat late in life.

And I think Rob Ornot [SP] may have talked about this in the podcast, where if you think about a basic portfolio, say 64 to your diversified portfolio, that portfolio is income. So if you need income, let’s call it 4% percent. Okay say you have $100,000 and it’s 4%, and all of a sudden stocks went down by half or the bond yield…you know, bonds also went down by half. So you say, “Well, hell, I only have $50,000 now principal.” But the interesting part is the income stayed the same, which is really cool takeaway and another way to think about it.

So after inflation basis, we model this back to 1900, real income is actually pretty darn stable from that portfolio. So if you can ignore the principal swings, which is hard for most people, the income that portfolio generates is actually pretty consistent. So if you can come up with a number where you’re generating income off a portfolio, there’s a lot of ways to make that more stable almost the way the endowments do it. So instead of just spending 3% a year maybe do a 5-year average and all these other ideas. But there’s no magic wand that’s gonna give you the Dave Ramsey 12% in retirement.

Jeff: Reminds me of those funds we’ve seen that are coming out with a marketing pitch of they’ll distribute X percent of yield…

Meb: Managed payout funds, those have been around for a long time in mutual fund format and other formats where they just payout a certain percentage per year. Now the problem with that, of course, is that if you don’t have the yield then you either have to take leverage or just return capital to people. So you could do a 10% income fund, but you’re gonna be giving back about 5% of that just giving them money back. A lot of people will know that, or taking leverage.

But you know, the retirement equation, I mean would suggest people go back and listen to Merriman episode, where he talks about his concept for giving young investors the gift upon their birth that is only gonna mature when they turn like 60 or something, whatever it was, but it would…I forget the exact math, but he put $10,000 in an account and after 60 years it turns into a million.

Jeff: Would be great if someone had done that for us.

Meb: I can’t remember the math. Yeah, I know, what the hell, grandparents? Come on.

Jeff: Part of the challenge though, I think is…I mean just from an infrastructure perspective it seems like…obviously you talked about how pensions are gone, but were also living longer, we’re also healthier, and the old sort of retirement age seems a bit antiquated and kind of foolish at this point.

Meb: So back to the old Edelman [SP] podcast.

Jeff: I mean having no income, no work for like the last third of your life…

Meb: Said people are gonna live to 130, you and I are not, but other people are gonna live to 130.

Jeff: How long are we gonna live?

Meb: And by the way listeners, if you wanna send me a happy birthday present, you’re more than welcome to, I will not say no to that.

Jeff: Make it tequila and address it to Jeff.

Meb: I got excited, I had a present today, it showed up on my desk, and it turned out it was my mom sending my child a stuffed animal.

Jeff: All right, next topic here, it’s…

Meb: So by the way, retirement is pull up your breaches and take sole responsibility for it, that’s my advice.

Jeff: Its also I mean you put in so much effort in talking about…back to the pyramid piece. The investment pyramid, all of that fits into just the top level of your personal finance period. So in this case, worry less about the investment income and worry about active income. You know, how can you maintain more [crosstalk 00:34:10]?

Meb: How do you better yourself, get a better education, get paid more, all that good stuff, save more? I mean there’s a really fantastic quote. Morgan Housel, who I just caught up with at the Ritholtz Conference, which is wonderful as always, evidence-based conference, Morgan was there and he’s one of the better writers of our generation. He’s younger than me, so maybe I can put him into my generation almost. But Morgan had a really great piece. I didn’t agree with all of it but he had a really great line that I’m gonna paraphrase and murder it. But basically says, “Almost everyone wants to be a millionaire, but they don’t actually want to be a millionaire, what they want is they want to spend a million dollars.”

They wanna buy a house, they wanna go on a vacation, they want to eat at nice restaurants and do…which is literally the exact opposite of being a millionaire. To get to be a millionaire you’re saving and you’re not buying all those things, and you’re not…” So it’s actually a really interesting takeaway in my mind, and there’s this new somewhat frugal movement that’s popularised, and there’s a phrase for it. I’m blanking on what it’s called. Mr. Money Mustache is one of the guys, but basically it’s saying like how can I optimise my life to not spend on all this junk, and all these things that everyone assumes they need and really don’t?

Jeff: Feels a bit like Kiyosaki and “Millionaire Next Door.”

Meb: However, I love my lattes and avocado toast so I’m probably not the best person to agree with that on that side. But I agree with a lot of it’s tenets, I mean so much of it is savings. And a great way to frame it would be to say, “Hey, look, you’re thinking about buying that $1,000 TV, would you rather have a $1,000 TV now, or have a extra $100,000 in retirement at 12% a year?”

Jeff: Lets bring Dave Ramsey on the show.

Meb: Meanwhile, I’m giving him a bunch of crap, he seems like the nicest person and his general person finance advise I think is wonderful. I think it’s really dangerous if people start to tether their expectations to such high numbers.

Jeff: All right, let’s switch into early stage private investing. You had a quote on your tweet page, which said “Almost every term sheet that I’ve written to a company that turned out to be a spectacular home run, I had no competition, nobody would invest in the company.” So that was on a podcast with Tim Ferriss. Tell us what this quote means to you, give us more context for everybody listening so they can understand, what the significance?

Meb: That was with Steve Jerviston, I think, who’s a venture capitalist, and it was a really fun podcast that I was listening to on a jog in Bologna, Italy, and got sort of lost and also saw this enormous rat swimming in a river.

Jeff: God, were going down a rabbit hole right now.

Meb: And I have never seen anything…I was like kind of afraid for my life. What did you the name of the rat was?

Jeff: Just listeners, he came back, all in a tizzy, just all sort of beside himself, turned out to be a nutria. Now if you guys down in sort of the south area are familiar with nutria then you can understand it’s sort of a big radish-looking thing.

Meb: It like almost attacked me. I was like kind of horrified and then I saw like four more and I was kind of nervous about where I was. Anyway listening to this podcast and it was fun because he was talking about venture investing and some other ideas. And the comment about having no competition, I think it’s…or no one would invest in the company. I don’t know if that’s necessarily good advice on just in public investing in general. But what it is I think is ample opportunity for value-added insight.

So if you’re following a small cap that no institutional investors are following, you know, all the institutional sell side, which is less relevant these days, but used to fall the big 100 analysts for Apple. But this $100 million market cap company based in Toledo, zero people following it, right. And so, is their opportunity for value added research? Absolutely. It doesn’t scale is the problem, you can’t be managing $100 billion with that. But most people that do that value-added research can find it. So even more on private because private has even less information than public.

And so I don’t know how you can necessarily extrapolate the fact about no one else would be interested, because that also probably has…unless you’re really smart and that’s your business. If you’re just going around investing in a bunch of no one else would invest in this, it’s probably terrible advice because probably most people know better. But it’s funny if you go back like you remember Uber, I mean I’m not gonna invest in that. I mean these guys are gonna probably murder their passengers and rape them. The same thing with Airbnb like you’re gonna be in someone’s house and they’re gonna trash it.

So there’s very obvious…interesting construct for me is, I forget who said it, but it’s basically says on the kind of angel venture investing, “What if it did work?” That changes the framework a little bit on some of these ideas, what if it did work, what’s the capability and size? One more really interesting thing that he said in this podcast, and he’s probably to the size we’re he’s wealthy and then it’s, you know, obviously day-to-day living he’s not worrying about. But he says, “I plan on never selling any shares of any of my investments. So once I make the investment, like it’s there, like if it gets acquired then I get the cash back.”

But in general, he goes on, “That aligns me to the founders, so they’re not worried that I’m some venture capitalist that’s just optimising for a 100x return in 10 years and that’s it. So I plan to never sell them.” And so I love the concept going way back to our original conversation on Jamie Dimon and Warren Buffett where…and I think Buffett talks about this, where he’s like “All right, you get six bullets and that’s all you’re allowed to use on buying stocks over the course your lifetime, you’ll be a lot more selective.”

But the cool thing to me is the same things thing he said, “All right, you allowed to buy investments by pretend you can never sell them,” that be a wonderful way to build a portfolio. Because either those things are…you know, one, you spend a lot more time before you get suckered into something, and two, it’ll eliminate some of the behavioural biases. Now, it’s not necessarily anything anyone will ever, ever do.

Jeff: I know that when it comes to your own personal angel investing, you know, you’re largely a syndicate guy following other people who understandably have a lot more experience in the field. But has your own personal due diligence process become more refined or polished as you’ve been doing this over the last year or so now?

Meb: You just reminded me of something I wanna talk about. It’s not necessarily what we’re talking abut right now, but if we don’t talk about it I’m gonna forget it.

Jeff: We know you love rabbit holes. Do your thing.

Meb: We’ll come back to this, the…whatever this question is, I’ve already forgotten it. But at the Ritholtz Conference I was on a panel and we were talking about the future a bunch of advisers in the audience. And I said, look you know, we quickly live in a world where the brokerage is a commission free, Vanguard just announced that today, trade ETFs are free, Robin Hood, M1, all that free. You can get advisory business for free, our digital adviser has no management fee, Schwab’s has no management fee.

Essentially you can get automated rebalancing, portfolios, trading all for free, which is again a pretty amazing time to be an investor. On top of that you have the QSBS rules for private investing. So I said to an adviser, I said, “In a world of that’s your competition you need to find ways to be value added.” I said, “I’m gonna give you guys two ideas today that I guarantee 99% of you are not familiar with. The first one is you could take your clients and say, ‘Look, we’re gonna start to invest in some private investments. The good news is you’re gonna be stuck in these for 5, 10 years or forever. Even better news is if and when you do have a capital gain, if you held this for 5 years, the first $10 million or 10x, whichever is greater on this investment, is zero capital gain. So we buy a basket of these investments, all we have to do even if we just keep up with the S&P minus, I don’t know, 2% a year will outperform public markets, and you can’t do anything to mess it up.'” And I said, “How many advisers in here know what QSBS?” are and very few do. Second, which is rules that are coming out…

Jeff: Wait, do you wanna explain what it is?

Meb: No, that was it. So if you do make an investment in private company and there are some industries that are eliminated, of course, RAs are eliminated, and you hold it for five years…and there are some other rules. I think the market cap has to be less than $50 million and some other things. We’ve talked about it on the podcast before, Ribicoba [SP] podcast goes into detail about it.

Jeff: Is there an issue like accreditation?

Meb: No, I don’t think so. You have to google it, just google “QSBS.”

Jeff: All right, whatever.

Meb: But the other one, which is being finalised currently, which is equally interesting…and we need to get an expert on the podcast for this. So that’s your task for the next week is to find the best opportunity zoner. There’s a thing called opportunity zones. And this is new legislation that got passed in the last tax cut, that was really pushed forward by a non-profit that was founded by Sean Parker who’s the old Napster guy, the old Facebook guy, and whatever else he’s up to now. He does some sort of medical funding now.

Anyway, they developed this language that basically said each state…and this is gonna be broadly accurate, but probably very wrong. Each state is allowed to designate 25% of the land mass or counties as opportunity zones. And they’d fulfilled some criteria, like the median net worth and income must be less than something, something. And it’s up to each state to designate and they had to do it by, I think, June of this year. And if you have any capital gains you sell a house, you sell a stock, you sell anything and you have a monster capital gain, you can then roll that capital gain into an opportunity zone fund.

Now you could set up your own fund, which is simply just the LP partnership, or you can invest in one. You roll it into this fund, you then have 180 days to make an investment in an opportunity zone. So to my knowledge that could be a real estate, could be farmland, it could be a private company, I don’t know yet. I doubt if it is, but it would be amazing if it was, if you could invest in public companies, and you have 108 days. If you do roll that forward here’s the benefits, if you hold the investment for…so let’s say you had a million dollar capital gain you roll it into this fund, if you hold it for five years you get a step up in basis on the capital gain. If you hold it for 7 years, a 10% step up, you hold it for 7 years, you get a 15% step up.

If you then hold it for 10 years, so essentially you’ve had a 10-year loan for free, you get a step up of 15% on the capital gain. Any gain on that million-dollar investment is totally exempt. It’s like a real estate 1031, is that what it’s called? So all of a sudden like if you’re an investor and thoughtful like there’s basically no reason at this point why you should ever pay capital gains again, between your retirement accounts and then QSBS and if you already have capital gains to roll them into these opportunities zones. Just think, by the way, if you could actually do public stocks in an ETF. You have to do is certifications. The rules are getting finalised and none of this is final, but we’ll try to add some FAQs to the show notes.

Jeff: So none of this is active, you can’t actually do it right now?

Meb: I think it’s literally getting finalised like this month. So you can go and see the opportunity zones. This is actually kind of like what made me smile and think it’s kind of funny, because it’s like half of San Diego is an opportunity zone, and literally like one part of Stanford University that’s an opportunity zone. So all of a sudden you can have like every tech company domiciled in like one apartment building. So I think it has good intentions, will it get probably abused and…like hopefully it would really help, like who knows. And I think there are some stipulations, like if you do real estate you have to make some improvements on the land yada, yada. We don’t know enough about it, but if you’re opportunity zone expert listener, or you know some, email us, we would love to connect.

Jeff: Yeah, that would be great. There’s a tweet from Matt Hogan[SP] we just had on the podcast about fund flow since 2009. So we’ve talked a lot today about ETFs versus mutual funds, this ties into that. ETF have seen positive flows of, let’s see, $2 billion.

Meb: When is this since, 2009? Yeah, that’s gonna be a T.

Jeff: And then mutual funds, 24, looks like a million, [crosstalk 00:46:24].

Meb: I think that’s mistypes.

Jeff: Maybe I have missing a period or a comma somewhere. Anyway, the point is ETF flows are vastly outperformed…

Meb: You’re missing tres commas.

Jeff: All right, so does this surprise you at all?

Meb: No, and I’ve said many times, I think eventually the dumbest thing mutual funds ever did was allow ETFs to happen. By the way, a great podcast to go listen to about this, I actually learned a few things that I didn’t know about ETFs and creations and redemptions and the history, was Bloomberg’s ETF reporter, Eric Balchunas, did an interview on Patrick O’Shaughnessy podcast, which he gets pretty deep into it. And I highly recommend everyone to go listen to it on the reason ETFs are so tax efficient and kind of the history of that. But there’s a couple tailwinds going on there, I mean it’s the slow erosion of the fact that mutual funds charge twice as much as ETFs do on average, and they are less tax efficient, so there you go.

Jeff: We had a listener actually write in and they were asking if you wanna explain more about the differences between ETFs and mutual funds particularly in the tax efficiency, and some of the intricacies. Can you give us sort of a bit of parameter?

Meb: The simple answer is that there’s a creation redemption process, the way that it occurs with the authorised participant lets the ETF be a lot more tax efficient. So then you have a scenario where like the SPY or many ETFs that have been around 10-plus years have literally never paid a meaningful capital gains distribution ever. Whereas if you own a mutual fund, all that money sloshing in and out ends up being the…you could even own a mutual fund have a loss and pay capital gains in a given year. Like what an all-time kick in the nuts, just to put it bluntly.

I mean, look, I would be totally on board, by the way, if mutual fund companies could somehow adopt ETF tax efficiency as well, like that’s in the interest of the investor. I wouldn’t be upset about that. It would be wonderful if you guys spent your billions of dollars lobbying the government to fix that. That would be really cool, but if you really wanna get in the rabbit hole of that, I don’t wanna talk about it now because it will officially cause everyone to crash their cars. Go listen to Eric’s podcast.

Jeff: All right, we’re on fees. Do you wanna give us a post-mortem on the Wealthfront, by the way?

Meb: Oh Lord have mercy, the post-mortem was that…

Jeff: Explain the background for everybody who’s just tuning in.

Meb: So as a reminder, Wealthfront launched a risk parity mutual fund, and they opted in all their clients, if they didn’t automatically contact them and opt out to this fund. So we’ll ignore the whole philosophy and portfolio allocation whether that’s a smart addition or not. So certainly creating a taxable event to do this was foolish, so they did that. They couldn’t put it into retirement accounts because of the possible belief that it wouldn’t pass fiduciary rules. So it’s only taxable and then they required you to…you had to sell a quarter of your portfolio to do it, so there’s no way that’s tax efficient already. So it’s a questionable decision already.

Now the reason they did it is because originally the Wealthfront fund had a 50 BPS management fees all of a sudden they’re generating a ton more revenue for their own company. Really questionable fiduciary decision, but I said whatever, you know, the actual decision there’s way worse funds to invest in. However, as with many times Wealthfront does, they made a lot of claims that were pretty questionable. So they made one claim where they said…and then they reduced the fee to 25 BPS because of the client uproar.

But both of those are sort of irrelevant numbers, because that’s just the management fee on the funds. We talked about this a lot, there’s a couple people Anonymous Jake, Econompic, and Jason Zweig and others, journalists were on top of this. And they honestly deserve some sort of award for it. Because Wealthfront never really commented publicly on it, the reason they didn’t is because the reality was complicated, but also pretty bad.

And so we talked a lot about hidden fees, and so the way that they access the risk parity strategy, which traditionally is levered at two, in this case two-and-a-half, times on average is through swaps. And total return swaps are what I think Morningstar called one of the worst practices in mutual funds, because traditionally they’re used to hide fees. And for whatever reason, the SEC doesn’t require you to disclose those fees as fees in the fund. So people look at the Wealthfront fund and Wealthfront claims were cheaper than I think they said 85% of all ETFs because we’re 25 basis points.

Jeff: Is it necessary to get into the mechanics of how swaps work?

Meb: Sort of, but the reality is they’re more expensive than 98% of ETFs when you factor the fees correctly, and I’ll explain how. So swaps, Wealthfront could have used futures, in which case you get leverage at roughly Libor rates. They could have used ETFs, like some of our funds to funds do, in which case the fees actually do show up in your total management fees. So for a swap you can unbundle the fees in sort of two components. One is the leverage cost, so you have to pay to get leverage somehow. So if you use futures, it’s roughly Libor. In this case they were paying Libor plus 30 to 60 basis points, which is essentially the fee they’re paying the bank to replicate this underlying ETF.

And it’s also really weird because they were paying way more on…because you have to disclose, they had to disclose it online and people published it. And the fees for some of like the very basic indexes were more expensive than like the emerging market index. That was already confusing, that makes us…I still don’t understand that, no one does, okay. Because theoretically it should be way more expensive to replicate say emerging market index than the S&P 500.

So technically the all-in cost of doing this at 2.5 times leverage is 6.5%, but that’s not fair because part of that’s leverage, and part of that you get some yield back, because 90% of their fund sits in T bills or whatever it was that was yielding like 1.5%. So not to lose your real quick, okay, some takeaway on apples to apples basis if you were to compare this fund correctly, in my mind, to a normal fund that did it with futures but paid the Wealthfront cost is you end up…it costs 1.5%. So the investor who thinks they’re paying 25 basis points are actually paying 1.5% for that fund.

Jeff: They don’t have to disclose this.

Meb: They do not have to disclose that, but they have to disclose it because they publish the swap cost. So anyone who knows what they’re doing can then just go put it in Excel and you figure out what the total cost is. There’s a reason Wealthfront has never publicly commented on this. Now, again, going back to everything I’ve said about Wealthfront, I think all these robo-advisors or wonderful, basic, automated digital solutions. They all have their warts. Schwab optimises their cash balance so you get hosed on your cash balance, because they’re not paying you the full fee.

Vanguard is probably the only one that’s not screwing you in some way. I like Betterment too. Betterment, obviously we partner with them, but outright trying to kind of like weasel some money out, you know. So Schwab’s doing it where they optimise your cash balance. Wealthfront is doing it through this really expensive mutual fund. You know, as I said the beginning I said, “Look, if you’re gonna charge 1.5% or whatever just own it.” I’m fine with that. There’s plenty of funds out there that charge way more than that that are probably worth their weight in gold.

But you can’t try to be kind of shady about it because someone’s gonna find out. The Jason Zweigs of the world eventually will find out. My nightmare is having like Nadeg [SP], and Balchunas, Matt Hogan, and all these guys, like they will eventually…like all of fin twit [SP] is investigative journalists. So if you do something shady, man, I don’t ever wanna get on their bad side.

Jeff: The rotten smell happens when they don’t comment on it. As you said, it’s one thing if they disclosed it’s gonna be 1.5%, and yes, its high but here’s our rationale or whatever. The issue is when everybody knows the reality, publishes it, but then they stay quiet, then it looks a little bad.

Meb: Almost a billion in assets too. So if you’ve been opted in, that’s a tough…in my mind, like I don’t wanna be extreme and say like its a breach of trust in my mind. It’s unfortunate because I think a lot of these automated solutions are nice, are great offerings, and it’s like it goes back to like a lot of these other ones like these Acorns that…

Jeff: But if they’re largely commoditised then price becomes the preeminent factor [crosstalk 00:54:49].

Meb: Right. This goes back to Vanguard is the default, like why not just use Vanguard here? And this is why Vanguard’s $100 billion, and it’s way bigger than all the others combined, is because they don’t have a lot of these conflicts. I have an article I wanna write. Like, I love Vanguard. I think they’re fantastic. We use a lot of their funds, I think BoBo’s [SP] a national hero. And there’s a famous phrase among advisors where they say, “You don’t get fired for owning Vanguard.” I wanna write a piece that says that, that’s the title, and it says, “Maybe you should be.” And the takeaway is that not every fund is great and not every fund is great all the time.

So their largest dividend fund…and investors know my huge distaste for dividends during the cycle as well as in general that has $20-plus billion in it, it’s underperformed a massive amount over the last few years because the valuation of the stocks in the fund, and the valuation of stocks are still really expensive. So in this piece we wrote, and we’ll update it this summer, on ideas about how shareholder yield is a better approach than dividend investing, it’s an example of, look, not everything that a fund company does is great all the time, or in every environment, and not all funds are great either.

Jeff: But the fund companies aren’t under any necessary fiduciary obligation to disclose that. It’s sort of like a…

Meb: Get mad at my algorithm, bro.

Jeff: It’s almost like…

Meb: It’s just an algorithm.

Jeff: …a food company, you know, having disclosed all the sugar content and whatnot, and then make an editorial comment about how it’s really bad for, don’t eat it.

Meb: Like you didn’t realise that cold sirloin burger out of a can is gonna be bad for you, and it’s kind of on you.

Jeff: It’s caveat emptor, man, that’s up to you. All right given today’s evaluations, I’d like your perspective on the pros and cons of allocating to the following hedges: cash, gold, tail risk/put options, managed futures. What do you think is best positioned to be the best hedge in today’s current market climate?

Meb: Well, you know my opinion and that’s go read the white paper we wrote on literally that topic that covers all four of those hedges. I mean you know you’re gonna get with each. Cash, you’re gonna get cash returns and that’s it. So you get no downside real protection, doesn’t really help. They didn’t list bonds, but bonds, historically, has been a good one. You can’t count on it. Gold, historically, has been a good one. You can’t count on it. We looked at the top 10 worst ones and stocks, gold, one month had like minus 16%. So historically it’s been good but you can’t count on it.

Same thing with managed futures, historically great, can’t count on it. Puts will be great. By definition, it should do awesome if the market goes down. But the flip side of that coin is it’s expensive insurance if the market’s not going down. So you know the market’s going down, buy a bunch of puts, hallelujah. The problem is if the market continues to go up, and we’re in a situation right now where we’ve been saying this for years now. We look at the two sides of the coin on U.S. stocks, there’s valuation, there’s trend. And we have the yellow light of expensive valuations but we’ve not yet had the red light of down trend, which in some areas has been hitting and in some areas is not. So when that finally rolls over, you know, historically markets get a lot more volatile and are returns worse when below long-term moving averages. So we may get it by the 4th of July, I don’t know. If we’ve had it already, sorry, but it not there yet.

Jeff: A lot of people might think about a strategy with puts where you wait until you’re sort of getting all those signals, and then buy, but the flip side of some of that is if you’re buying at that point then the value of the put option is already gotten so expensive that you’re not necessarily getting the deal that you might wanted to get, say, 6, 12 months ago when you could buy them a lot cheaper on leaps, so they don’t necessarily get the best thing.

Meb: We had some friends that just…I don’t know if they filed or launched [SP] for it, but there’s a black swan fund came out, which I was laughing because I was like, “Man, I thought we still had that ticker swan, they just gave it back in the pools, so more power to them.”

Jeff: All right, next question, what advice do you have for people trading companies in their field, for example, a realtor making a move on homebuilders, or a programmer stock picking an AI firm? Would you recommend these individual stay away?

Meb: No, I mean if you have value-added knowledge it’s a huge opportunity to apply that knowledge. I mean my father was an aerospace guy and he historically used some of that insight to invest in companies in his field and did really well. I think that if you’re an expert, you need to be a little bit honest about do you actually really know what you’re talking about, or do you just have a little bit of dangerous knowledge?

Second is that I think a more global perspective on this question is actually as an investor it goes back to your old comment on if you’re an advisor you’re actually four times leverage the stock market where you shouldn’t invest in areas…if you like really want to hedge your life, you shouldn’t invest in certain areas and sectors that…The J.P. Morgan “Guide to the Markets,” which comes out every quarter, which I think just came out today, has a fun stat where we talk about home country bias with stocks. A new white paper, which just won the AQR Insight Award, talks about home country bias, and debt, and currencies, so it’s worse there.

And lastly, the J.P Morgan “Guide to the Market” shows sector bias by geography in the U.S. So sure enough, people in Texas invest over way too much in energy. People in California invest too much in technology, and on and on. People on the Northeast, guess what, finance. So they’re doing the exact opposite what they should be doing, which is probably hedging parts of their world. So you know, we made the argument in our old piece, said if you’re an advisor, or an asset manager, or an institution that has most of your beta in revenue, and earnings, and life tethered to the U.S. stock market, you can make an argument you shouldn’t own any U.S. stocks.

And that will smooth out your earnings the same way that owning Alaska or…there’s been so much consolidation in the airlines, I was getting ready to say Virgin America, doesn’t exist anymore. If you’re an airline, you hedge fuel cost and if your cereal producer, you hedge wheat cost. If you’re an asset manager you should probably either not own U.S. stocks or hedge it out with something like a tail risk ETF. And so I probably own more of tail risk than probably anyone else in the country that I’ve talked to. I probably own more tail risk and managed futures than certainly any institution. We talk to institutions…I don’t know if I’ve talked to one ever that has more than 10% in [inaudible 01:01:11] strategies. They all own the same thing, modern portfolio theory, endowment style.

Jeff: Well, as was pointed out though, I can’t remember where we said it…

Meb: Managed futures has been stinking it up the last 10 years.

Jeff: Well, the institutions are investing on sort of a perpetual life cycle, you know, they sort of a different goal and different sort of targets than you do as an individual.

Meb: We have a paper to write this month because the endowment cycle comes out at the end of June, so you start of seeing endowment results. And you know, our goal in launching our no-fee asset allocation ETF years ago was for it to become the global investable benchmark. And so I really wanna start comparing it to all these endowments, and CalPERS, and institutions because we’ve also written a couple probably unpopular articles called “Should CalPERS and Harvard Be Managed By Robots?” But meaning [crosstalk 01:02:00]…

Jeff: Why was that unpopular?

Meb: The good news is you’re starting to develop years of real world evidence now where you can point to the performance of these investable benchmarks. And so you’ll eventually see ones that are a little more endowment focused or perhaps private equity focused. There’s a couple private every replication ETFs now. So all these sorts of ideas that you say, “Look, you no longer have to pay 2 and 20, you no longer have liquidity and tax inefficiencies of these investments, you can invest in a public market ETF that replicates better than 80% of what the universe performs.”

Jeff: Meb, would you please share your opinion on multi-factor funds and the role they should play in an investor’s portfolio?

Meb: Who put out some research…Research Affiliates put out some research on this recently where they looked at…and they had a phrase for both sides and I’m gonna totally mangle this. It was like compiling and adding, I can’t remember. It’s basically saying, Okay, look, here’s a value and momentum. One way to do it is take the top 100 value stocks, and then you take the top 100 momentum stocks, put them together in a portfolio.” And the other way says, “Okay, you rank all the stocks by value, you rank all the stocks by momentum, you take the ones that have the best average across the two.” So it’s kind of potato, potato, and their conclusion was that one was slightly better but they’re both better than the alternative, which is buying expensive stocks that have poor momentum of some format, right. It’s like how did you blend it, how do you put it together?

There’s another example where, someone asked me this other day, where for example, you have a fund like ours that picks the top down 12 cheapest countries in the world. Or you have a fund, like our buddy’s Wes’s, which starts at the bottom up and buys stocks anywhere based on certain characteristics. I say the funny thing is you kind of end up at the same place despite the fact if you compare these two portfolios they look totally different. One may have 20% in Japan, one has 5%, one has 10% in Korea, one has 0%.

But if you actually chart them on a chart they actually have similar performance, and here’s why. And a lot of people get this wrong. You gotta remember that value investing, and extrapolate this to any other factor, is not just about buying the cheap stuff, it’s also about avoiding the most expensive. We’ve said 100 times in the podcast, but if you take a universe and whether you skim off the top first and then pick out what’s on the bottom, or you pick out the bottom first, you kind of end up in the same place despite totally different characteristics.

I actually went and did this. I said, “However this creates biases that you should be aware of, they’re neither good nor bad, but be aware of them.” So for example, let’s say you do the global one we’re talking about, if you do top down that’s going to bias towards certain countries that have fewer stocks. If you do bottom up, it’s gonna bias you to the U.S. and Japan simply because of the breadth. You have 3,000 stocks in the U.S. you can choose where you only have 20 in the Czech Republic. So by definition, you’re gonna end up with a lot more stocks in U.S. and Japan, and then on down the list. So it doesn’t really matter which one you choose, just be aware that one approach will skew you towards one idea and one towards the other.

Jeff: Okay, sounds like you’re discussing multi-factor fund construction. I think this guy might be asking what about arbitrarily pick whatever fund, regardless of how it’s been constructed, if it’s multi-factor, looking at it within the confines of an investor portfolio does it make a difference?

Meb: The acronym you’re looking for is ABMC.

Jeff: Always be making…

Meb: What were gonna say, always be making sweet love, always be making…

Jeff: C, cash.

Meb: Anything but market cap. So I don’t care what you do, almost any multi-factor weighting is probably better than market cap. Given the considerations that it’s not a closet indexer, and it’s not simply giving you market cap by another name. A lot of these funds…I mean go back pick on Vanguard, their $20 billion dividend fund is basically the S&P 500. It has a higher valuation and a worse yield, oddly enough, but it’s basically the S&P 500. So if you’re gonna make the effort of allocating to a multi-factor fund at least make the effort that it’s concentrated in different and weird, doesn’t have to be weird, concentrated and different. That at least the effort is worthwhile but breaking that market cap link is the most important starting point. So whether you go equal weight or preference being market cap…multi-factor, some form, you know, I think is the best part.

Jeff: All right, switching gears a little bit to advisors and advisor fees, it actually ties back to what we’ve discussed earlier in the show. Meb, I have a question about fees, advisor fees. Charlie Ellis states, “The portfolio manager is charging a fee based on the percent of assets under management, but the assets are already mine. The proper way to view fees is by looking at the cost of asset management compared to the difference in returns versus a low-cost index fund, which is a commodity. This doesn’t diminish the value of the advisor but it does help to properly frame the way in which advisor fees and underlying fund costs should be viewed.” Would you agree with the statement? If so, why? If not, why?

Meb: I don’t think it’s just asset manager but rather it also applies to kind of financial advisor too. I mean one of smartest things Wall Street’s ever done is the percent of assets under management fee, because it gets skimmed off the top and you never see it. We wrote an article where we talked about if you were a millionaire and you had to deliver a $10,000 briefcase to your advisor every year, would you still do it? And the chance is no one on the planet would do it, it’s behavioural. But you get your statement and you never see that money coming out every month, $1,200 or $1,000 every month.

And so it’s a bit strange to me that, particularly on the advisor side, that the model has continued. You know, if you go hire a lawyer you may be paying him 500,000 bucks an hour, but there’s no lawyers that operate that way. And so there are financial advisors that operate like a per hour, there are certainly other business models, our friends at Advice Period…Steve’s gonna on the podcast soon…that have evolved a different model.

Betterment used to this, I think they still do, but they actually have a cap, so it’s a 25 basis point fee until you have a million…it’s like a maximum fee. So all intents and purposes it goes down on scale, which a lot of advisors do. So there’s a lot of ways to kind of go about it. I don’t know that there’s one necessarily like preference or best model. You know, asset managers struggle with this all the time, there are some that say, “You know what, it’s only fair to charge 0% and 30% above this hurdle rate,” or the old Buffett partnership is I think you had to get 6% return and only then would he get paid on a certain percentage above.

They all create different…not necessary conflicts but different incentives, or some people are incentivised to go for really high returns, some people incentivised just to hold on to assets, some people are incentivised…I mean in general, I think there’s two types of firms on Wall Street. I think there’s the people that will charge as much they can and get away with it, and the people that will charge as little as they possibly can and still run a good business. There’s not a lot of overlap between the two.

Jeff: As transparency becomes more and more a factor in the industry and as the sort of compression continues to kick in, anybody who’s fighting against that current, aren’t they gonna get just toasted?

Meb: Wealthfront is a good example, I mean that is put $750,000 into client assets in the funds that are arguably way more expensive to create taxable events are not something that anyone understands. Like not to pick on them but there’s way worse offenders, of course there’s the S&P 500 mutual fund the charge is 2.25% that you can get for 5 basis points. So the average mutual fund, again, there’s so much fat to cut, but that’s why historically asset management is one of the highest profit margins in the world in industry. The old Bezos quote, “Your profit margin is my opportunity.”

Jeff: Next question, tying to advisors, it says besides portfolio construction and behavioural coaching in times of stress, what are some other value adds besides commonly available tax loss harvesting and rebalancing? Are we reaching the limit of value added services?

Meb: This loops back to the EBI comment I made earlier on the Ritholtz Conference where I mean no one I know in the audience really understand QSBS and the opportunity zone. There’s always more probably that could be done, I mean tax alpha, to me, far outweighs investment alpha opportunities for an advisor, and it’s not even close. So optimising there, I think there’s a lot more to be done.

And look, the political stands are always shifting, so there’s always gonna need for some solutions there and ideas. So yeah, I’m sure there’s plenty of ways to do…I mean I spent an entire night with our friends chatting about family offices and the challenges of these families that are already wealthy, and the debate was did you need to do behavioural coaching to the family, is it a waste of time? Could you proactively educate the families so that the inheritance and management of their wealth was sustainable and decent and not create any sort of weird family structures that would cause major problems? And I know we should probably get some family office big managers on here that have done it. And the concept was like yes, you could apply a coursework where it educates them through a process. And the others were less optimistic that that was doable.

Jeff: The education gap is in different ways.

Meb: Yeah, I mean there was one great quote where one of the fellows said, “I have four kids, one of them is probably gonna marry a terrible person or a total loser.” He’s like, “You can’t even control your kids, but you can try to raise them well and do a great job. And even then, that doesn’t guarantee you’re gonna have great children.” You certainly can’t guarantee who they’re gonna marry the first go-round or the second. So it creates even more challenges.

Jeff: All right, last question, let’s wrap it up here. As ETFs grow, under what circumstances could securities lending become a substantial risk to one’s personal assets and possibly a systemic risk to the financial system? Our process is in place now to prevent that problem before it happens. And quick, just give a quick primer on securities lending.

Meb: Securities lending, if you have a portfolio, like let’s say we have an ETF or a mutual fund, we have the stocks in there that we own, we can lend those out to short sellers and they pay you a fee. And so portfolio-wide, depending on the portfolio, you may only get five basis points, you can get a whole percentage point returns, and the good firms out there pass that back on to the shareholders. After the company that manages it takes their cut, usually it’s 80/20, 90/10 in favour of the shareholders.

That’s pretty awesome. Some people keep it, by the way, but not really best practices to do that. Traditionally you require 105%, 110% collateral, so the short sellers has to post collateral to be able to get access to that short, so that’s the protection. So usually like the risk are mitigated by thoughtful management of the whole process. If you have sort of global financial crisis going on, and you have some short sellers or companies that are doing naked shorting, I think…like I heard a lot of rumours that Goldman a lot of people didn’t ever actually borrow, they were just, you know, shorting companies. That’s a structural issue and they get in trouble for that, and then they pay fines.

So I don’t think they’re systemic because there’s checks and balances against it now. Really, the real risk is do you have a counter party or do you have a manager of the short lending process that’s thoughtful and conservative? And usually I think 40 act funds are only limited, they can only lend out like a third of the actual fund. And even then they’re optimising on lending out like the Teslas of the world, or some crazy biotech stock. And FYI, a lot of people still don’t know this but ETFs and other funds actually can earn more in short lending and distribute it to shareholders than the actual management fees.

You could have a scenario where the ETF has a 50 basis point managed fee, that’s half a percent, but get 75 basis points in short lending. And so, by all reality, you’re actually getting paid a quarter percent per year to own the ETF, negative expense ratio. Not a lot of people know that, still, talk about it a lot, not a lot of people know it. So I think there’s risk but as long as you kind of are aware of them they can be minimised.

Jeff: All right, so you’re not staying up late worrying about this?

Meb: No, I have no problem sleeping.

Jeff: All right, man, well, hey, I think we’re done here. What are you gonna do for your birthday tonight, have dinner somewhere?

Meb: Well I’ve only spent two hours with you podcasting, that’s kind of my dream. Let’s do another one.

Jeff: This is my gift to you, sir.

Meb: Let’s do another podcast. I would like to go have fried chicken and a victory Crema pils.

Jeff: Are you watching soccer tomorrow?

Meb: Which means Jackie’s probably cooking a veggie burger, can give me kombucha. I love soccer. I was a little sad for Mexico. Being an L.A. resident, was cheering for Mexico. But in my pool, I have…

Jeff: [crosstalk 01:15:19].

Meb: Colombia still left, I’m cheering for Colombia. I should have divvied it up by CAPE ratios. Russia, cheapest CAPE ratio in the world, is having their moment. They’re amazing, amazing. If you watch the game, they basically just played defence. Spain had the ball like 95% of the time and was playing solely for the opportunity of penalty kicks and then won, it’s incredible,

Anyway, all right, friends, thanks for listening today. We really love the feedback. Please send us an email, [email protected] Leave us a review, let us know what you think, send me a birthday present. Check out the podcast on Breaker, which is my new favourite, like it if you do, don’t like it if you don’t. You can always find more shows and archives at mebfaber.com/podcast. Thanks for listening, friends, and good investing.

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