Episode #10: “Listener Q&A”
Guest: Episode #10 has no guest, but is co-hosted by Meb’s co-worker, Jeff Remsburg.
Date: 8/1/16 | Run-Time: 45:58
Topics: Episode #10 is our second “Listener Q&A” episode. This time, instead of spending the entire episode answering one question, Meb tackles many. Here’s a sample of a few of the topics you’ll hear him address:
- How should young investors balance low expected returns (ZIRP, U.S. CAPE, etc) with the need to invest young/early?
- How much should you allocate to your best idea or opportunity? You hear Charlie Munger talk about betting big on great opportunities. What is “big”?
- I get the gist of your global asset allocation strategy, but I’m not an expert on it. Does my lack of knowledge make it dangerous for me to invest this way since I don’t fully understand it? (As opposed to Peter Lynch’s mindset of “buy what you know.”)
- What does your (Meb’s) ideal portfolio look like right now?
- I’ve stayed away from low volume/liquidity ETFs I would like to own because volume is basically non-existent. Is that fear unfounded?
There are many more questions and answers, which dovetail into different topics including Meb’s thoughts on investing in private businesses, as well as several new business ideas which Meb would love to see an entrepreneur tackle. What are they? Find out on Episode 10.
Comments or suggestions? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- “Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio” – Ian Ayres
- “The Handbook of Portfolio Mathematics: Formulas for Optimal Allocation & Leverage” – Ralph Vince
- “The Leverage Space Trading Model: Reconciling Portfolio Management Strategies and Economic Theory” – Ralph Vince
- How Brazil’s Richest Man Lost $34.5 Billion
- “Has Einhorn Lost His Mojo?” – Meb Faber
- SSGA Survey with the FT – Return Expectations
- “How to Beat 98% of All Mutual Funds” – Meb Faber
- “6 Million Dollar Fintech Ideas” – Meb Faber
- “Take Lots of Risk or None at All? My Portfolio for 2016” – Meb Faber
There are three great websites for new ideas:
Below is a list of conferences that are a good source of new ideas:
- Wine Retreat(Spring)
- AFG Research(Summer)
- Ira Sohn(Spring NYC, Summer SF, Fall London)
- Value Investing Congress (Spring Omaha/LA, Fall NYC)
- Value Conferences (Online)
- The Big Picture(Fall)
- Boston Investment Conference(Fall)
- Grant’s Conference(Spring, Fall)
- Invest for Kids(Fall)
- Santangels Forum(Fall)
- Robin Hood Investor’s Conference(Fall)
- Barron’s Roundtable (Recurring)
- UVa Investment Conference(Fall)
- Great Investors’ Best Ideas(Fall)
- Bloomberg Global Summit
- Harbor Investment Conference(Fall)
- Alpha Hedge West(Fall)
- Early Investing
- CB Insights
Transcript of Episode 10:
Welcome Message: Welcome to the Meb Faber show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the 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.
Sponsor Message: Today’s podcast is sponsored by The Idea Farm. Do you want the same investing edge as the pros? The Idea Farm gives small investors the same market research usually reserved for only the world’s largest institutions, funds, and money managers. These are reports from some of the most respected research shops in investing. Many of them cost thousands and are only available to institutions or investment professionals, but now they’re yours with the Idea Farm subscription. Are you ready for an investing edge? Visit theideafarm.com to learn more.
Meb: Hey everybody, welcome to the show. We have Jeff Remsburg back for our tenth podcast. Jeff, welcome back.
Meb: One of the biggest complaints so far is you don’t talk enough. So we need a little more out of you today.
Jeff: Well, you don’t give me any chance. That’s the problem.
Meb: We’re gonna do a Q and A in between us. So you all have been sending lots of great feedback to feedback@ themebfabershow.com, so we’re gonna read maybe half a dozen questions. We’ll see how many we get to with time and just answer them as we go along. But before we start, we’d love to ask you guys a huge favor. Take 10 seconds, you can put the podcast down now. Leave us a review. We’ve had over 50,000 downloads, which is pretty awesome. Only got about 20 reviews, so that’s like 0.001% of you guys. So we put tons of hours into this, many thousands of dollars. We’d love for you guys to give us a little feedback. It doesn’t matter if it’s good or bad, just feedback on iTunes.
Jeff: On that note, we’d also be curious whether or not anyone finds the transcripts valuable. If you could let us know.
Meb: So we’ve been posting transcripts on the show notes in addition to all the links. I don’t know if anyone reads that or not. Anyway, if you do and you love it, let me know. Otherwise, let’s get started. Let’s fire away. First questions, Jeff?
Jeff: Yeah, this time, what we’ll try to do as you mentioned is go through a lot more. We got held up on that one bond question last time. So we’ll try to pop through as many of these as we can.
All right, number one, just reading as they come. “I’m curious what your thoughts are regarding ETFs with very low volume or liquidity. I’ve stayed away from them in the past simply because I want to own something I can easily sell if necessary. However, there are a bunch of quant ETFs I would like to own, but the volume is basically not existent. Is this fear unfounded?”
Meb: So ETF liquidity, you gotta remember, is that ETF is just a basket of securities. So stocks. SPDR’s is just a basket of S&P 500 stocks. And so really, when you talk about liquidity, and let’s talk about someone who wants to put in 50 million tomorrow, theoretically. They wanna put it into a fund that only has 10 million. Most people think, oh, you put 50 million into a small cap stock, it’s gonna move the stock huge. Well, with an ETF, because of the arbitrage mechanism, there’s liquidity providers out there that if you’re gonna put in a big order and you got to Jane Street or KCG or [inaudible 00:03:40], one of these big shops, you’re gonna almost always execute within a few cents of that asset value. Now, the challenge is you need to go through a desk. So if you are executing through Schwab or E-trade or whatever, you probably need to call them up. But it’s really the liquidity, the underlying. So if you’re gonna execute SPDR and put in 100 million, no sweat. If you’re gonna execute something in maybe low liquidity corporate bonds or emerging markets, small cap value stocks that don’t trade much, the liquidity provider may say net asset value plus five cents, whatever it may be.
So a second level would be, all right, if you’re actually just trading ETFs through your broker and you’re only gonna buy 1,000 shares, 100 shares, 10 shares, whatever it may be, all that really matters is that just use limit orders, right? If it’s super liquid like SPDR, that’s fine, you can market in. Otherwise, use limit orders, it will eventually get executed. Just don’t be in a huge rush.
Jeff: And chances are, if you’re dealing with an ETF, you’re unlikely to have as many as sort of gap up or gap downs that could really mess with you since you’re having so many in the underlines, correct?
Meb: Yeah, and again it goes back to what it’s trading and tracking. Obviously, the more assets the better. If something on has 5 million in AUM, likely it will be less liquid quoted display, but not less liquid true liquidity. So, you know, we know plenty of shops that put in 50 million into what you would consider a non-liquid ETF with no sweat.
Jeff: All right, second question. “I’m 30 and have a decent amount of money to invest, the majority of which is U.S. equities. I think I understand what you preach about global asset allocation, but how wise is it to invest in things I barely understand? I’m of the mindset of Peter Lynch, and I tend to buy what I know. Do you think that at some point, global asset allocation is not good for investors if the fact that they are involved in things they don’t understand means they’re more likely to make rash decisions?”
Meb: You should have this Q and A with Wes here, don’t even get him started on Peter Lynch. So there’s a couple of questions in there, but the main one is, “How do I invest in what I know or don’t know?”
So first, congrats to this reader for being 30 and having a great portfolio. That’s a big step up on most. Usually, most people in their 20s or younger, a lot of the personal finance decisions matter a lot more than actually the investing decisions, but the fact they you’re getting started and having investments already, kudos. And the good news is you probably out-perform greatly, because you had a U.S. stock allocation with that home country bias we always talk about. But talking about what you know, and here’s kinda of a good example. So a lot of people have this sort of mirage of what they understand. So you’ll talk to someone who invests in a stock. Maybe it’s Apple, for example, and they’ll say, “Yeah, you know, I use…I got a Mac. I got a iPhone, I got an iPad,” yadda, yadda. And say, “Okay, well, have you read the last 8, 10 Ks and Qs? Have you read their annual reports for the last decade?” He’ll say, “Well, no. As Peter Lynch, I understand the product.”
Well, understanding the product, you can have…this is the big distinction, you can have a great company, it’s not the same thing as a great stock. So you can have a great company, world-changing like Tesla that’s super expensive, or you could have a really crappy company that’s actually really cheap. And so that big distinction…but going back to what you know in our book, “Invest with the House”, there’s a quote in the beginning, and I’m gonna have to summarize it, but it’s where Lee Ainslie, who’s the hedge fund manager of Maverick…and Lee was actually as UVA guy well before me, but an engineering guy. And randomly, all of the undergrads of UVA actually have to write a thesis. So I’m probably the only person on the planet other than his adviser who’s read Lee Ainslie’s thesis, which is pretty funny, because it’s printed on that, like, old school, perforated computer paper from the ’80s. Anyway, let’s just say he wasn’t an A-plus student, so he manages many billions of money now, world-class money manager.
Anyway, so Lee was talking about an experience where he came up under Julian Robertson, one of the top hedge fund managers of all time at Tiger, and the quote goes something like, he was walking down the hall, and Julian stops him, and says, “Hey, what’s your opinion right now on XYZ stock?” Lee says, you know, “I’m bullish,” whatever. He says, “And who’s the CFO?” And he starts stammering, and he says, “I don’t know.” And the whole point was being that unless you know everything about a company, you know, this illusion of knowing something, of having this Peter Lynch mindset, I think is really tough. And another example is how much do you really know about you buy the S&P 500? I think a much more important on this asset allocation level is having a respect for history and understanding how asset classes behave when having realistic expectations. So this individual who wrote in says, “I have most of my portfolio in equity,” say, “Okay, maybe you know everything about these stocks, but FYI, stocks have had an 80% draw down, can you sit through that? Is that an okay allocation for you to go through now that you said you had a big allocation?”
So I think unless you’re doing pure security analysis with all your time, and you gotta remember who you’re up against, these best hedge fund managers in the world, best quant algorithms out there. I think the Peter Lynch methodology, while fun and a good way to keep you interested in stocks, is actually pretty tough to execute.
Jeff: And isn’t a global asset allocation actually, in and of itself, it’s a bit of a defense from what we really don’t know.
Meb: You’re going back to the old, and I just interrupted you. So I’m already doing the “let Jeff talk” problem. Yes, it’s a bit of…you know, Vanguard always talks about just being average. So you’re reducing the outlier, both on the good and bad side, events and diversification. So it’s not just investing in U.S. companies, but you’re getting Chinese, Greek, Russian, Brazil, France, Germany, everything in between, plus bonds and real assets and everything else. In U.S.-centric allocation, you end up some pretty steep concentration risk.
Jeff: Okay, it’s actually a bit of a tack-on. Somebody else wrote in with this question, but it applies here. It says, “How should millennials balance low expected returns including ZIRP, U.S. CAPE , etc., with the need to invest young and early?”
Meb: So one of the common, I think, mistakes that people often talk about is investing based on age. And so they’ll say young people should invest all their money in stocks, because they have a long-term time rise and they have a ton of human capital. And in general, that’s right on paper. The biggest problem, again, is you may have a 20-year-old who is really a nervous Nellie that they see their stocks go up and down, they go through a 50% bear market, and they’re like, “I can’t take this. This is horrifying for me. This is very emotional.” Whereas you can have an 80-year-old who says, “No, look, I have this pension and social security. I need my allocation to be 90% in stocks, because I can take risk here.” You know, whereas most people should say that 80-year-olds should be in CD. So age is a bit of a false benchmark to start from.
Jeff: it’s just a red herring for risk level.
Meb: Yeah, I think it’s okay starting point, but you really…you know, and this is the benefit of an adviser that you can’t really necessarily get from a questionnaire. And maybe these improve eventually, but I think it’s really hard to just determine someone’s risk [inaudible 00:10:40], particularly if it’s a young person who hasn’t lived through a bear market yet. You can’t teach that. You can’t teach on paper what if feels like to lose your job and then to watch your portfolio go down by 50% and still say it’s rational to put 90% to 100% of your money in stocks. And there’s even some writers out there, and I’m blanking on the guy’s name, but he says, “Actually, young people should not only buy 100% in stocks, they should lever to 150%.” And on paper, that math may make sense. I think it’s really tough to live with.
Now, the question I think was really asking how do we balance starting young with low expected returns? And we do expect low returns in the U.S. We expect bonds are gonna yield a percent and a half. U.S. stocks, maybe 4% or 5%. Well again, that’s the beauty of diversification. So you’re getting into foreign assets, which we expect to be much cheaper within emerging markets, commodities, resetting the stage for much higher expected returns. So one, have a reasonable outlook. Going crazy just thinking about this, but State Street just had another presentation…survey where they looked at 400 institutions, asked them what their expected returns are, and the average was 10.9%. And in my mind, that is just absolutely, frigging delusional. There is no chance those funds are gonna print 11% a year. I mean, if you look at this fiscal year right now, I’m guessing there’s hardly any institutions that do better than 2% in a fiscal year. Most of them end in June, 2016.
So one is to have realistic expectations. Two, simply start early and start to dollar cost average. So a much bigger success will be determined by just starting early and putting in money every month, every quarter, every year, particularly into tax-deferred investments, rather than starting valuations. Because valuations matter less the much longer the time frame. So will U.S. stocks have lower returns? Yeah, I think so. But one, you’re blended with foreign stocks. And two, you have the beauty of having 60 years ahead of you. You know, it’s good to start early, have no rush, but certainly have muted expectations, I think, in U.S. stuff for the next 5, 10 years.
Jeff: So you suggest setting up a recurring schedule and just doing it automatically of depositing more money versus potentially, let’s call it pooling your money, and then you wait until there’s a trigger. Like, say the CAPE gets below 12, and then sort of dump it all, and then…
Meb: You know, the coffee can style portfolio, which is these old-school portfolios where they talk about you just buy something, and essentially, you never sell it. I think that’s a fun idea, and I have no problem with that in general. It’s a great way to invest, where each month… So yes, there’s automated ways to do it, but particularly for a young person, trying to do the timing say on U.S. stocks, I think it’s problematic. Now, if U.S. stocks were trading, let’s say at a CAPE of 40, then I would say absolutely yes, actually, because when you get to a certain level, common sense takes over and says, “Look, there’s just no point in putting your assets at risk.” I mean, they’re trading it at a high valuation, but it’s not awful. You know, a world-diversified portfolio is still gonna have decent returns, but certainly, what I’ve tried to time U.S. stocks, no. But they’re not horrific valuation right now.
Jeff: Okay, so if a 25-year-old invests right now in a global asset allocation portfolio, should he be looking to re-balance once a year, or does the re-balance depend on age?
Meb: The fun thing about the global market portfolio, and most people scratch their head on this, is that technically, it never re-balances. So if you were to buy the global market portfolio today, you never need to re-balance it ever, because that’s the global market portfolio. If stocks go down, it just means the global market portfolio has lessened stocks. Now, practically speaking, if you come up with an allocation percent policy portfolio, like a global asset allocation market portfolio, I think you wanna re-balance that, because it gives you the added benefit of what Robert and I calls over-rebalancing, meaning you’re tilting towards value, because you’re always buying what’s going down, and you’re always selling what’s going up, and you never get a too-stretched allocation in some weird way. So yeah, I think once a year is fine. So if you’re taxable, you can re-balance based on cash flows. If it’s tax exempt, you can look at it once a year, and if things have moves very much, re-balance. But really, you could even re-balance every three or five years, and it’s not gonna make a much of a difference. So be very tax mindful is the big part.
Jeff: All right, well, good thing we’re talking about allocations. The next question is “How much allocation should you put behind your best idea or opportunity? You always here Charlie Munger or Mohnish Pabrai mention betting big when the great the opportunity arises, but what is considered big?”
Meb: Actually had lunch with Mohnish a few weeks ago. We had some dim sum, if you’ve ever been to Din Tai Fung, which is incredible dumpling restaurant. They have one down in OC next to him. But they also have one in San Gabriel Valley. It’s just funny, because I remember the first time we went to it, my father…you know, this is a very authentic Chinese restaurant, and he’s chatting with the waiter, and he says, “I would like what you would order, the soup, and what the locals would order.” And the guy is kinda shaking his head, and he’s basically saying, like, “You don’t want this soup.” And he’s like, “No, no, come on.” And he’s pretty adventurous, and it comes out, and it was literally a bowl of broth with a chicken leg in it. And when I mean chicken, though, not like a drumstick. Like a talon, you know? Just like a leg. And so he kinda just chuckled a little bit and says, “Okay, I deserve that.” I said, “Well, you better eat it.” Anyway, they have great soup dumplings. So anyway, what was the question? “How much do you put in your best idea?”
Okay, so this is a good question when it comes to any sort of betting, and you can think of gambling, you can think of sports betting, you can think of investing. You have to have an expected win rate and expected value you’ll get from this bet. In investing, one of the challenges is you don’t really know over time for an asset allocation. So you diversify. You can tilt toward expected values. For the most part, is you’re not making large bets in asset allocation.
Now, take a step back. Let’s say you’re an active trader, or you’re doing managed futures, or you’re doing active bets. In that case, you can have large, concentrated positions. And so question from mathematically speaking, you can read books like Ralph Vince’s books. We’ll get him on the podcast one day. I’m blanking on the title of the book, but it’s something like “The Mathematics of Money Management,” talks a lot about optimal f and what are the…is it optimal f. God, I’m blanking. I don’t know. It’s Monday morning. About the ratios you can…mathematical formulas you can develop for what’s the ideal allocation, given your expected value, or something like blackjack. You know, if you count cards and you have a slight edge, what’s the amount you bet? Well, in a game like blackjack, I think the bet ends up being it shouldn’t be higher than 5% of bank roll. But if you go to a blackjack table, how many times do you watch people that have $100 on the table, and they’re betting $50 bets. I mean, they’re going to go broke, eventually, no matter what.
But let’s say you’re doing a portfolio, and it also depends on the correlation. If you got a stock portfolio, you know, and you’re making very large bets. Look at Bruce Berkowitz or a lot of these active managers. They make huge bets, and I think that’s great, but you’re gonna have very outlier outcomes. So it’s kind of like what you’re comfortable with. Are you comfortable with putting all your eggs in one basket? What’s the famous quote? You know, “Put all your eggs in one basket and just watch that basket.” So that’s fine, but it also goes a little bit not just the mathematical expectations, but your psychological comfort level. Can you live with if you have 10 bets on the table, one of them going to zero? Most people could live with that. Could you live with having 250% bets and one going to zero? Probably not.
So it’s kind of a squishy answer. For me personally, I would never wanna have something of a portfolio more than like 5%, just because it’s something that would start to make me…I would have trouble sleeping, and I like sleeping. So I would start to worry too much. But for other people, you know, they’re totally okay. I mean, a great example, there’s a quote that says…this is Buffet again, that says, “The two biggest risks to a portfolio…” or maybe it’s Munger, I can’t remember, “are liquor and leverage.” But leverage is one…there’s a great example, one of the top five richest guys in the world, worth over $30 billion maybe five years ago, is now bankrupt. And this is Batista in Brazil, because he had, essentially, outsized concentrated exposure to one asset, his company and family of companies, and then leveraged it. It’s a good example of people using too much leverage when they’re young or small, but also…I mean, literally, the five richest people in the world, how can you not be like, “You know what? I’ve got 30 billion, let’s dial this back a little bit. I’m not gonna have concentration risk.”
So I think it’s a tough question to answer. I mean, it’s two sides to the same coin. If you want a concentrated portfolio that’s gonna outperform, it has to be big enough to matter. So you can’t have 400 names, because it’s not gonna do anything. We talked a little bit about this, I think on both the Wes and Patrick podcast, where if you’re a quant guy and maybe 50 names, you know, 20 is probably the minimum. So 5% for me. We’re just starting to bleed into long answers for these questions. I gotta try to remember to keep them short.
Jeff: I mean it makes me think of looking at a portfolio less by different asset classes and almost more in terms of risk tolerance, like you’d want X percent or 80% very conservative, safer ideas, and then you sort of swing for the fences with 5%. But is that getting into, like, risk parity?
Meb: No, that’s like a Taleb barbell approach, and that’s totally fine. The challenges, of course, is that, you know, it depends on correlation. So you used to have all these bank risk models, value-at-risk and all these other risk models, and one of the challenge is if the correlations change. So like in ’08, people for example, hadn’t seen that market environment since the Great Depression, and so they didn’t think that all those assets could decline at the same time, and they ended up doing that. So it gets complicated, but in general, I think for me, I wouldn’t want more than 5% in any one bet.
Jeff: Okay, another question is about…
Meb: Let me add one more. We have a good common friend, very wealthy in money, investor, trader, and I remember listening to him talk, maybe a year or two ago, and he’s like, “I’m making a huge bet on gold,” or whatever it was. But let’s say it’s gold. In my head, I’m thinking this entire audience thinks he’s putting like half of his net worth. He’s like, “This is huge bet for me.” And someone either asked in the Q and A or asked later, I can’t remember, and I said, “Hey, out of curiosity, what is huge bet for you?” And he ‘s like, “Oh, I’m increasing my 2% allocation to 4.” You know, for him, that was a huge bet. For most people..
Jeff: A 100% raise.
Meb: Yeah, most people think that would be a rounding error. So it depends. For someone, you know, when they think, “A huge allocation,” they may think going all in a 100%. You know, most investors don’t think that way.
Jeff: Okay, moving on. “Along the lines of bench marking returns of active managers with factors, how does that account for the truly exceptional returns by some managers?” And the reader…excuse me, the listener wrote in a couple names, which I’ll hold off. But he’s claiming that one manager has audited returns of 42% for almost 30 years. So how is that explainable?
Meb: If you remember in some of the last podcasts, we looked at the really impossibility of 20% returns and north, sustainable over time. It is you end up owning, essentially, the entire market. If you’re a Buffet, and you compounded 20%, you’re the richest person in the world, right? If someone’s compounding at 40, it means they’re the richest person in the world in a much a shorter timeframe, so probably unlikely. Or the guys that you see audited, it may be because they found a certain, very, let’s call it non-efficient niche, where they can do it, but they can only do it with maybe like 100 grand. So I know a few people that managed some portfolios, they’re like, literally, “Meb, it’s not scalable north of a million bucks.” So yes, the smaller amounts could be more inefficient. There’s no way that exists on a large platform. Otherwise, he’s the most successful hedge fund manager in the word.
Jeff: Well, they’re claiming 30 years, which seems some improbable if you’re gonna sustain that. Your capital is gonna get so large after so many years.
Meb: Yeah, you would. If you started with 100 grand, you’d probably have 50 billion by now. So you’d be the richest person in the world. Again, it could be something particularly niche that’s not scalable. And another pet peeve, you know, I should write a book called “How to Design, Market, and Build the Perfect Track Record Legally.” You know, because there’s a lot of ways to do this, but what you see with a lot of funds, particularly the private hedge funds and CTAs, is they’ll have a monster year somewhere in the first one, two, three years. And that’s kind of the prescription, because otherwise, if they have a monster terrible year, they’re out of business, right? So they’ll have a monster year where they’ll do 50% or 150%, and then you’ll see them dial back the volatilities, they get bigger. As the assets get bigger, either it gets more fit, the market’s more efficient, or they just can’t allocate to the ideas anymore. And this is one of the challenges of talking about when to fire a good manager.
We did a post a couple of years back called “Has David Einhorn Lost His Mojo?” You know, really famous, great investor at Greenlight. We looked at this 13F tracking performance in the 2000s, and for he first seven years…and this mirror Buffet, first seven year of the 2000s, I mean, he beat the market by something like 25% a year. But assets grew, and now he’s this huge money manager, and he’s underperformed by 5% a year since then. Now is that because he spends all of his time playing poker? Is it because he has ton of AUM and simply can’t scale it? Is it because he’s moved into global macro and starting to do a bunch of macro trades? So style drift. You know, I don’t know. Or is it simply because values have been out of favor for seven years, and it’ll return in time. I don’t know. We don’t, you know, invest based on Einhorn, and he’s not someone I have money with, but I’m just saying this is a challenge of investing in a money manager.
In that same study I just talked about…I’m gonna turn red starting to talk about this, when it quarried those institutions, they said, I wish I had the right, exact wording, but it said “How much runway…” oh, no. “How many years of underperformance will you tolerate?” And tolerate being the word that set me off. “Will you tolerate for a active or smart beta manager?” For active, 89% said they would only tolerate one or two years. And for passive, it was 99% said they would only tolerate one or two years of underperformance. And this literally explains why that one stat explains everything wrong with our industry. These 400 managers manage a trillion, and they alone don’t even understand active management. You know, that could go seven, eight years of underperforming and still be a totally viable strategy or asset class. And so it’s kinda dismaying to read from institutions. I would expect it more on individuals, but it just goes to show that they make the same dumb mistakes as everyone else.
Jeff: It’s reminds me of this story you tell abut Buffet, and how he was underperformed, was it seven of the last nine years?
Meb: Yeah, same thing. That’s his 13F clone portfolio, but yeah, his stock portfolio has underperformed seven to the last nine, but had you followed it since 2000, you would have outperformed, including this period, by five percentage points a year, which would have beaten 98% of all mutual funds. So as an example of strategy, they would have been one of the top two percent of strategies over the last 15 years, but you would have to sit through the last 7 years of lean times, and most people can’t do that. They can’t sit through one or two, so seven or eight, forget about. But that’s one of the reasons why he’s been so successful, because he’s been able to stick through his methodology for not just 5 or 10 years, but for decades.
Jeff: Back to Einhorn, I just read an article about how he took a bath on Macy’s, recently. They just got out of that position, and he lost pretty substantial amount on that. Well, back to this, in a sense. So when would you cut bait? Let’s say you’re following Einhorn, you know, he’s had X many bad years. At what point would you say, “No, he’s gotten off,” and you bail?
Meb: That’s the trouble. So there’s two distinct parts of this. That’s the beauty of smart beta and quant strategies. You can look back whatever 10, 20, 100 years and say “This is what expect for this strategy. This is what makes sense.” With active managers, you’re betting on the manager. And so he could be going through a divorce, he could be getting lazy, he could be starting a drug problem, he may just have been lucky in investing during a good period. It makes it so much harder with active managers that you’re betting on their process. It doesn’t mean it’s not impossible. I mean, we wrote a whole book on this topic, “Invest with the House,” which ironically, is our highest reviewed book, but least purchased, for whatever reason, who knows?
Jeff: Well, tying back to that question earlier about investing on what you know, given that there’s so much more potential for things we don’t know when following a manager, as you just said, is he going through a divorce? Does he have some other thing going on? It presents a lot of murkiness in terms of that whole strategy, because you don’t know what’s happening within a given manager. So is that a questionable philosophy?
Meb: I mean, so let’s say you are picking active managers. There’s about a dozen things you could do to put the odds in your favor. And Morning Star writes a lot about this. So you know, one, select bottom quartile of fees, you know. B, invest in what Morning Star gives a parent company a gold or silver rating, meaning they tend to be shareholder-friendly. C, make sure he’s active enough for it to make a difference. So if he owns 500 stocks, you probably don’t wanna allocate. So the active share needs to be high.
You know, a number of things you could check the boxes to come up with a list of probably decent funds, and then you have to be comfortable with their process. So say, “Look, these are the reasons I would sell this investment,” which I think is good for any investment. If you make an allocation to an ETF, to an active manager, to any investment and say, “This why I would sell this.” So then when you’re panicking when it’s down 50%, you pull your piece of paper and say, “Is this one of the reasons I would sell?” And if it’s not, you probably shouldn’t sell it. But if you make your list, and one of them is, “I’m going to sell this manager if he gets to 10 billion in assets,” Then you should follow that methodology, and I think that’s a reasonable one to do. But simply selling because he does poorly is actually probably the opposite. If you still believe in the manager and the approach and his style, it’s probably not a great reason to be selling it.
Jeff: Would you suggest diversifying managers in the same way you diversify assets?
Meb: Yeah, of course. I mean, and we’ll probably talk about this more in another podcast about the 13F stuff, but we look about a dozen or 15 managers in there that we, like David Tepper. I think we talked about Einhorn, and two of my favorites being Seth Klarman of Outpost, whose…his stock picks are in like a 40% draw down right now. Probably a great time to be allocating to his picks. But I like the ones that invest in names that are really different. The stocks that if they’re just buying Google, Apple, and IBM, I’m probably not as interested as the ones that are buying stuff that no one’s ever heard of. Typically because they are names that are less trafficked, but we’ll talk about that book in another episode, I imagine, or this one will end up taking another hour or two.
Jeff: All right. Let’s squeeze in a couple more of questions here. “Is following financial news programs a good method to discovering out-of-favor or disliked stocks? It seems like the financial media oftentimes pushes disliked stocks even further than they should go.”
Meb: Short answer’s probably no. What are good resources? I mean, you know, look, I love going on CNBC and Fox and Bloomberg and chatting with my friends, but it’s really hard to distill a very thoughtful conversation into 30-minute sound byte. And so are there resources for a stock picker out there? And Wes has done a few papers on this that showed that there is value in sites, like SumZero is one where people share ideas. Another one that Joel Greenblatt started, called “The Value Investors Club.” I think you have to apply to that one with an investing idea. What are other good ones?
You know, a lot of people do idea dinners. I mean, I think sorting through 13Fs is a good one, seeing what is it Seth Klarman is buying as an initial screen and then diving into it. But as far as TV, there’s a few other newsletter-type resources, I think, “[inaudible 00:31:45] Deep Dives.” “Manual of Ideas” is one we featured on The Idea Farm. “Real Vision TV” is a recorded interview-style video format that’s kinda like The Idea Farm. But for videos, it’s a little challenging for me to watch, because it’s kinda like, you know, I cue up a bunch of documentaries on my Netflix but never watch them. So this is kind the same category, but I think they’re very nice video production with a lot of good hedge fund managers like Kyle Bass and etc. And then some of the conferences, I think, are pretty useful to go to. You have, like the Ira Sohn, and we have a list of this on The Idea Farm website of about a dozen idea conferences to where you go, and somebody presents, like, an idea. Problem for me with those is they all sound good to me. I sit through 12 presentations, I’m like everyone of those sounds good. Those are all good initial screens, but TV, it’s tough. I would say financial TV is tough.
Jeff: Too much noise.
Meb: A lot of noise. The more in-depth…and we’ll add some other…I can’t think of them off the top of my head, but add some other resources on the show notes as well.
Jeff: Do you follow Markets Daily, or given your sort of broader macro, global asset allocation sorta mindset, do you just steer away from that?
Meb: You know, I follow them casually. I don’t spend much…I mean, I read a lot, but mostly what I’m reading tends to be research papers, long, in-depth, quant research from the banks, from academia. It’s more about process. You know, I’m not reading much out there that’s like, “Hey, this is why it’s time to buy wheat,” or “This is why you need to short Tesla.” It’s an interesting aside to me, and it’s a curiosity. But really, what I’m trying to build are sustainable processes that will work in any market environment or fit together as pieces of a puzzle. And always trying to think of ways to improve the methodology. So if someone there is out talking about some new factor or some idea or concept or trading system, I’ll take much more notice. But the actual day-to-day media is much more concerned with whatever geo-political thing is going on, and particularly what stocks are moving a lot. None of that goes into my…only time I ended watching CNBC is usually when I’m traveling. I put it on in a hotel room. I don’t watch it on my day-to-day or in the office. The office TV is usually sports, if anything.
Jeff: All right. Last question here. Something kind of different, a little bit more theoretical in nature. “What’s the problem you see in the world that’s solvable, but not by you?” A little existential there for you.
Meb: God, that’s like most problems. I don’t think I could solve most of them. I keep a word doc on my computer of crazy ideas, and so I have about a dozen, some of which are financial. We actually used to do blog posts. I should probably update it. We used to do one called “$5 Million Ideas in Fintech,” and all of them have been done to varying degrees at this point, which is pretty cool. So there’s a lot of things I wish someone would do that I don’t wanna do. I’ll give you a couple right now. So if someone wants to do these, contact me. I would love to…let’s see them happen. I would love to see someone write it. This would be a fun book to write, is to ask that question or a variant of that question, being basically, “What’s your best idea right now?” Or “How do you make the world a better place?” Some form of that question, and go ask 50 leading scientists, politicians, whatever. Go out and say, “Hey, you got 1,000 words, answer this question.” That would be a fun book to write. I think someone should do that.
I think another fun book to write would be, you know how they do the…you see them at the airports all the time, the top science writing of 2015? So I think someone should do that for investing. Put out the 20 best investing articles of the last year. People would love to read that, because again, it takes a step back, and it’s not “What’s the news item of the week from CNBC?” but “What’s the best idea that’s happened out there? There’s a few other that I constantly rant about. I would love to see a Yelp for financial planners. You can’t really do it because the model breaks down, because the planners can’t pay to have testimonials or reviews, so you’d have to figure out a different monetization engine.
The Yelp for podcast, that drives me nuts. I actually was emailing with Liebsen [SP], who hosts a bunch of our podcasts, and said, “Why don’t you guys open up the API?” And he said, “Well, we can’t do that because it’s confidential,” yadda, yadda. And they also said, “Well, because a lot of people inflate their numbers too,” which was interesting. But you know, I said, “Look, because I would love to, the problem is if I go to my buddy Covel’s podcast, and he’s got 500 episodes,” I said, “Where do I even start? I either start at the beginning or start at the end. But you know, no offense, Mike, but I’m sure a 100 of those aren’t worth listening to, or 200, or 300.” And then there’s gotta be 20 where he’s probably like, “These are incredible. But there is no way to look that up.” And so the owner of the data, the Apples of the world, the Overcasts of the world, don’t publish the statistics. I don’t know why, but I wish they did. I could probably go on for 20 more minutes on this topic of crazy ideas, but that’ll probably be a different podcast coming up.
Jeff: All right, I said that was the last question. Well, let’s do one final one right now, just to tie it back to investing and what potential listeners can do right now. “What’s your ideal portfolio right now with what’s available?”
Meb: You know, I publish my portfolio every year, and this one, I think the title of this one was called “Take Lots of Risks or None at All.” And so my portfolio, I own 100% of our ETFs in our ETFs. And the landscape I give to people is I say, “Look, what’s right for me may not be right for you,” whatever. And I do it roughly in line with the trinity portfolio, so roughly half is in buy and hold investments, and with very heavy tilts towards things that I think are cheap or that that the fund will systematically invest in things that are cheap, so foreign stocks, for example. And the other half of the portfolio, my personality is in trend falling type of investments. But I often tell people too, I say, “Look, you know, I was having a conversation on a chair lift with a buddy, and we were talking about kinda portfolios and trading and investing, and I said, ‘Most of my net worth eventually will probably be dominated by ownership in Cambria and then in a handful of private businesses, our family farm as well, and then the portfolio’s down the list.'”
“So whether that portfolio returns 15% a year or 2 is probably not gonna be the major part of my investing returns long term.” So his point was he says “Why take any risk at all with that?” Which I thought was interesting perspective, because it goes to show just how much you could come up with the same equation that goes into an online questionnaire, and it can spit out a totally different answer based on the person. Because there’s many people that would answer that say, “Yeah, you should take no risk at all with this portfolio.” And there’s other people that say, “No, because you have these other investments, you can take a ton of risk.”
Jeff: You gotta swing for the fences.
Meb: Yeah. But I think it just comes down to what you’re comfortable with. I would struggle a lot with large draw downs. I would struggle a lot, which is not doing anything in the bear market. So I need the trend falling component, but I also know that value works over a long period. So I like allocating to things that are really cheap. So I publish mine every year. I’ll have to update it here in a few weeks, because we have some big announcements coming up. But in general, you can Google my portfolio 2016, we’ll link to it in the show notes and see exactly to the percent what I own.
Jeff: You mentioned a lot of your net worth is potentially tied up in private businesses. I’m curious, to me that sounds like venture capital, and that to me sounds a lot riskier.
Meb: No. For me, the vast majority is businesses that I control. So Cambria, The Idea Farm, or businesses I’m involved with, and then the Farm. But you know, I dabble in private markets, just because I find it very interesting, but is a very minor chunk of the overall portfolio. I’m very curious about it, so I’ve made about a dozen private investments, and there is about half a dozen of these sites that you can use, you know, whether it’s for secondary liquidity like EquityZen, AngelList is the most famous. The biggest problem I have with most of them is they charge a lot of fees. EquityZen is decent, I think it charges a 5% fee, and there is about half a dozen of these Angel ones, but the promise is they’ll charge like a 3% or 5% transaction fee and then like 10% to 25% carry, which you know, if an investment is successful, it’s a huge chunk. And so I expect those to come down over time, because it’s a pretty big number. But I think it’s a fascinating area, because you can invest in, you know, early stage companies. You know, we did a crowd fund a few years ago and may do another, but that what you said, the average allocation?
Jeff: No, what’s the average return of capital on that? Time length.
Meb: Well, here’s another benefit. And I credit Tim Ferris talking about this. He says, “The beauty of a private investment is you’re stuck with it. There’s no liquidity for that.” So they get bought, they go bankrupt, they get sold the IPO. That’s about it, or they start spinning out dividends and cash flow, which is unlikely. So you’re in bed with that company for the next 10 years. I think a lot of people would be a little more thoughtful, or maybe not. But it also keeps you from bad behaving where you would sell it if it went down 10% or 20% or what not. So you know, those of you expect to own for 10 years, you know, I think we’re probably at a point in the cycle where they’ve come off the ridiculous valuations, but you still see a lot that are trading at crazy valuations. So for the cheap bastard in me, that’s tough. But there’s some ideas out there that I think that are pretty fun and worth funding. But again, it’s more of a, kinda what you talked about, where the majority of your money is “safe,” or you kinda know this asset allocation portfolio, the land, the private companies, [inaudible 00:41:36]. This is kinda the play allocation for me. And I think it’s fun, and it may be it becomes a bigger allocation, but for now, it’s mostly just a curiosity.
Jeff: A private investment can be a fun topic for a future podcast, but really quick.
Meb: That’s another idea that I think someone should do, and we have one friend that’s starting to do it, which is a either newsletter or podcast would be good too, about the best…because there’s not enough research that’s going on. See, if you want information on these private companies, there is nothing out there. If you wanna go invest in this new app and you try to get their revenue or information on the company, I mean, forget about it, because they’re not required to disclose anything. So I would love to see a small investment bank or a research shop, you probably need a half a dozen people to do it, that would be covering these five or six platforms and saying, “Hey look, I think X investment, this is a buy this month. Put in a $1,000. I think Y investment you should pass, because the founder’s an asshole. I think C, you know, here’s another one that’s interesting.” And track a lot of these deals. You see a couple sites out there that do some of the analytics around the private investing. You don’t see a lot of people making buy and sell hold recommendations. The one problem is the platforms don’t like you to talk about them or the valuations, because it could run afoul of some solicitation rules. So it need to be a private newsletter, which is fine. So the podcast maybe could talk about them, but I think that would be really another interesting business opportunity someone should do.
Jeff: Do you have any success stories so far you can share?
Meb: I mean, I’ve literally started this in the last few years, and like, one for one of the, you know, ones that have done anything, and that was our buddy Howard Lindzon, who, you know, many listeners will be familiar with. He’s a very old-school angel investor. I joined him in on a deal. And you know, I think he got bought out for a 20% premium, so hey, that’s better than the opposite, so. But in general, no, it’s very early. My old colleague from a former job used to say that he has a 100% rate with investing in Venture capital. He’s lost money on every deal.
Yeah, I mean, the famous KREF study we talked about in one of our books, which is that people spend vastly more time researching a TV or, you know, a vacation than they do in any of their investments. I mean, I can imagine so many doctors and engineers and everyone else going on to these sites and be like, “Yeah, I’ll just toss five grand in this company,” having spent like five minutes researching it, right? But there’s a handful, if you start to do due diligence where you could probably get them early in their growth stage. And this is where probably a really serious Peter Lynch-style investor would add value. And you know, if you’re investing in companies that have market caps of 5 million or 10 million, you can really get some of the potential, you know, 10, 100 baggers, whereas the public markets, you know, the small caps usually start at 200 million and up. But who knows? We’ll check back in five years and see if my 100% success rate is everything going bankrupt as well.
Jeff: Sounds good. We’re at 45 minutes. Let’s wrap it up.
Meb: Good, man. How many questions did we do, about seven?
Jeff: At least.
Meb: Way better than our success rate last time. All right, look, you guys keep sending in the questions, and we’ll keep doing these answers. If we get a consistent stream, we may even start doing this weekly. So thanks for taking the time to listen. If you got the feedback questions or Q and A, send them over firstname.lastname@example.org. And as a reminder, you can always find the show notes and other episode links at mebfaber.com/podcast. You can always subscribe to the show on iTunes. And remember, if you’re enjoying or hating or totally agnostic, the podcast, go at iTunes, leave us a review. It would mean a lot. Thanks for listening, friends, and good investing.