Gregg Fisher, Gerstein Fisher, “Sometimes The Best Investment Strategy Isn’t The Right Investment Strategy”
Guest: Gregg Fisher founded the investment management and advisory firm, Gerstein Fisher, in 1993 with the pioneering vision of offering a quantitative investment management approach rooted in sound economic theory and more efficiently implemented through technology.
Date: 9/29/16 | Run-Time: 52:35
Summary: If you’re a factor-investor, Episode 23 is for you. In fact, about 10 years ago, Gregg actually trademarked the term “multi-factor” in the use of mutual funds. Meb asks Greg which factors they use. It turns out “price-to-anything” isn’t bad. The conversation gravitates toward the behavioral side of investing, leading Gregg to an interesting comment: “Sometimes the best investment strategy isn’t the right investment strategy.” He goes on to illustrate by saying how if we bought nothing but small cap value stocks and held them for the next 50 years, we’d look back and realize that such a strategy would have been one of the most successful ones anyone could have chosen. The problem is the volatility of that strategy is off the charts, so most investors can’t see it through. In many ways, the experience of investing is as important to us as the outcome. Meb agrees, referencing a recent article detailing how Harvard’s endowment has posted a small loss over the last two years and some folks at Harvard are finding this totally unacceptable. But that’s to be expected with factor investing. As Gregg says, the whole concept of factor investing is to be different than the average investor. Next, Meb asks how to put together value and momentum. Turns out, there are lots of ways to slice this. Greg tells us to start with diversification, then differentiate across risk factors, tilting toward those factors that are well-rewarded for taking the risk. The guys then touch on factor investing in real estate, followed by top-down investing (Gregg doesn’t really adhere to top-down), then they move on to losses. We all know this intuitively, but huge losses can scar people – even to the point they never come back. So one of the keys to avoiding this is diversification. This bleeds into the topic of written investment plans. Gregg agrees that nearly no one has a written plan (though it would be great if they did). There’s far more, including currency hedging and smart beta factors. The episode winds down as Meb asks what advice Gregg might have for young investors who have only been exposed to the past 7 years of bull market. What’s Greg’s answer? Find out on Episode 23.
Sponsors: The Idea Farm and Soothe
Comments or suggestions? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
Some great blog posts and pieces by Gregg and team:
What is Multi-Factor Investing?
Should You Tilt Your Equity Portfolio to Smaller Countries?
Practical Applications of Risk Parity Optimality
The Trouble with 100% Value: Why What Looks Good on Paper May Not Be Great for Real Life
Think an All-Bonds Portfolio is Safest? Think Again
Investment Insights: Taking a Global Approach to Investing in Public Real Estate
How to Protect Investments from Cataclysmic ‘Fat Tails’: Rare, Shocking Events Can Be an Investor’s Friend
Ongoing series, beautiful useful magical:
Meb: Touch your index finger to thumb, left hand makes a “b” and right a “d”….for where bread and water is on the table (HT Ferriss).
Transcript of Episode 23:
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Meb: Welcome to the podcast, everybody. We’ve got a special guest today. Gregg, welcome to the show.
Gregg: Thank you so much. It’s great to be here.
Meb: So Gregg Fisher is from New York. He is the CIO founder of the Gerstein Fisher funds. They have traditional investment advisory, manage $2 billion, including over $400 million in a handful of mutual funds, and we are going to be a little bit like-minded in a sense. He’s a quant, they employ a multi-factor approach, and we’ll talk a lot about this today. So…And by the way, I wanted to compliment you, your waiting music on your phone. I’m not sure if you’re aware, but it’s some of the best waiting music I’ve ever heard. Do you…You may not have ever called in to your own line. You familiar…Do you get to pick out the songs on there?
Gregg: Oh, absolutely. I’m very familiar. I’m someone who generally has a hard time listening to the normal hold music at various financial institutions so we try to do something a little bit cooler, and I’m a drummer so music’s an important part of my life so I take it seriously.
Meb: Well, my co-host Jeff was really appreciating it. He’s a bassist and we’re rocking out to Boston while getting ready for this call so, kudos.
Gregg: That’s great.
Meb: All right, so why don’t we get started? You know, I was reading a lot of y’all’s material, material on the blog which, by the way, listeners, awesome blog if you go to gersteinfisher.com. There’s a lot of blog posts, white papers and everything else in between. But I figured we’d start talking a little bit about factor investing, which is something that’s pretty popular amongst our listeners. We’ve got a lot of questions and comments, so why don’t you start talking a little bit about y’all’s approach to factor investing, and then we’ll start to…we’ll start to deviate from there. But why don’t you give us a broad overview about how you think about this world?
Gregg: Sure, yeah, it’s so amazing and I’m sure that you can appreciate this given your background, that the concept of factor investing is so popular. You know, at Gerstein Fisher we’ve been applying forms of factor investing for…we’re in business about 25 years, and we’ve never done it any other way. We used to throw around the term ‘factor investing’ at parties and everybody would look at you like you had three heads, but now it’s become so popular and, just, you know, the industry and people talking so much about it. About 10 years ago we trademarked the term ‘multi-factor’ in the use of mutual funds. Not that we, of course, invented multi-factor investing; I think most people would think it was somewhere in the 1970s by Stephen Ross or, you know, Merton or somebody.
But, you know, what we did do is we started applying the ideas of factor investing pretty early on for retail investors and launched these multi-factor funds. But for me, this idea that maybe markets do a decent job on average pricing risk, but I certainly acknowledged very early in my career that investor behavior was also extremely real and that you could combine these two ideas. You know, risk-based pricing, efficient markets, behavioral finance, and try to identify the kinds of things that drive returns in markets from both sets of ideas in our world.
And for me, that was what got us started. When I started the firm, Gerstein Fisher, it came, really, out of…my family had an accounting business when I was a kid. You know, in the ’70s and ’80s, we were basically doing tax returns in my family by hand, and then my generation – or, our generation – was that first generation of home computer users. So somewhere in the late ’70s and ’80s we got computers and started doing these tax returns with a computer, and my job was to do the Schedule D which was where, you know, here in New York City, every investment firm in New York at the time was working with our tax clients and I was doing all the buys and sells. And basically, there are four boxes on your Schedule D, you know, the date of purchase, date of sale, what you paid for the investment and what you sold it for. And, back then, we were trying to fill this information out but so few investors actually had it, and then when we would call investment professionals to find out if they had it, they didn’t either.
So it became pretty interesting to me that, you know, at that time, Wall Street was making investment decisions that seemed really unorganized, were not really thinking about taxes being present in the decision. The idea of using computers to organize information – I was telling someone the other day – for me, I always wanted to, you know, put a number in a cell, like, I didn’t want to hear the long story about why they did or didn’t have something. I just wanted to, at that time, complete the return and put a number in a box. So I think the idea of putting numbers in boxes and organizing information and, you know, looking at the way traditional investments were being managed…And, ultimately, it’s the early 1990s and I started Gerstein Fisher which is…most of us know that’s when a lot of, you know, academics and ideas and finance became really popular in the late ’80s and early ’90s, and we kind of ran with it and, ultimately, that’s what got us interested in factor investing, that experience.
Meb: By the way, a quick aside, I remember I was going through all of my father’s tax returns and he must have kept them to the ’60s, and seeing the graduation from essentially hand-written to dot matrix printers to everything else, I can barely do my taxes today with the assistance of Turbo Tax. I can’t even fathom them doing them years ago but…So, okay, so you graduated to kind of thinking about factor investing, so what was some of the early factors you guys were using as you were starting to select portfolios and manage money? Was there any favorites or early ones in the, kind of, how you graduated to the way you think about combining them and multi-factor portfolios today?
Gregg: Well, I think like probably many of us, you know, kind of, think back to some of the original ideas around value investing, right, you know, price to book, price to earnings, price to cash flow, I mean, price to anything. As long as price was in the numerator – because there was so much information in price – and the idea of tilting portfolios toward value over gross investments which, you know, Fama and French and others in the late ’80s and early ’90s, there was lots of research talking about this concept of value investing, so that was – of course – for probably a lot of us, one of the earliest things we looked at.
But one thing I realized at that point, probably by the mid-’90s, I had realized that value investing had become so popular, that so many quants were doing some form of value investing, fundamental indexing, give it in tilts, price to book, small cap…I mean, in our world, I think, most of those things are, in some capacity, value investing. I had found that there were very few quantitative investment firms that were actually using lead ideas amongst growth stocks and then, later, REEDs, that there were many more traditional, fundamental, active managers in that space. So, you know, you sort of fast forward 10 years later, we launched two growth funds and a REED fund because we thought that we could add value there since so many quantitative managers were doing some form of value investing. But value investing, whether it be the size, premium, small cap, and/or traditional price to book and a few others, was probably some of the early things that we were doing.
Meb: Okay, when you’re talking about growth, can you elaborate a little bit what you mean there, because different people kind of mean different things when they talk about growth. And by the way, I’m going to steal your comment on price to anything. We often talk about value indicators and we use a composite of a number of them, and we often say that, for us, in many ways it doesn’t really matter which one you pick, we use a lot, but rather the suite of them. But let’s talk about growth for a second because…How do you guys think about growth and what does it mean to you, and what factors do you consider when you’re talking about growth?
Gregg: I think that in any country, in any market, you can look at all stocks traded. You can put a price in the numerator, something fundamental in the denominator, and then, ultimately, compare companies to one another. And when you do that, those that are all the way off to the right, the ones with high prices relative to something fundamental would be considered growth stocks, and the ones that are all way off to the left – low prices – with something relative to something fundamental would be value stocks. And, as long as you’re comparing them all to one another, you can basically determine which are growth in value as long as everything’s the same. So if you cut that market that you’re looking at in half, and you might even get rid of the ones in the middle, you know, ultimately, you’ve got the very [inaudible 00:10:22] growth companies and the deep-value value companies, as long as you’re comparing them all to one another.
Now, to some degree, you could let the index providers do the work for you, because what I just described is depending on which index, fairly similar to what a lot of the indexes are doing; you know, the growth index or the value of decks. But ultimately, you can let the market do the work on what’s growth and what’s value. When looking at growth stock in any country, ultimately, you can think about the kinds of things that do a good job explaining the difference in returns across securities.
And one of the many things that we find works quite well amongst growth stocks that doesn’t work as well in value stocks is momentum investing. We happen to be working very closely with Professor Sheridan Titman from Austin, Texas, who wrote some of the original research on momentum investing in the late ’80s and early ’90s, and I’ve always enjoyed his research quite a bit. But the idea that momentum investing works better amongst growth stocks than in value stocks, and it’s an example of a factor that we apply in our growth world that…although in a value strategy it’s a little bit harder to apply for a variety of reasons.
Perhaps another example of factors to think about amongst growth stocks is this idea of research and development. I think [inaudible 00:11:46] wrote about that a while back. There are some things that people can look at to determine how valuation characteristics amongst growth stocks, looking at things like profitability which has, of course, become very popular over the last five or six years, or capital expenditures, you know, these various forms of corporate financing decisions. Change in assets, these kinds of things do a pretty good job telling us those growth companies that might be a little bit more value-oriented than one another, although you’re only looking at the universe of growth stocks. So I think momentum investing and these, you know, various forms of cost of capital or corporate financing decisions are interesting things to look at, and factors that, based on research that is out there – not only our own, but research that’s been done by many others – seems to do a good job of explaining returns amongst growth stocks.
Meb: And so, one of the things when you’re talking about these individual factors, you know, you guys have a paper called “The Trouble With 100% Value: Why What Looks Good on Paper May Not Be Great for Real Life”, and maybe you want to talk a little bit about that and how it kind of leads you to more of a multi-factor approach where, if you’re relying on only one factor, you know, it may be sub-par for a number of reasons.
Gregg: I think…I’m so glad you brought that up because I think that…I have often told, you know, handfuls of friends of mine or some of the brightest people I know that I have, just, huge respect for, that have done great research, but if you’ve ever sat across the table from, you know, Mr. and Mrs. Smith, you just can’t understand this concept which is, sometimes, the best investment strategy isn’t the right investment strategy. You know, this idea that investors…Sure, it probably makes good sense empirically, and I think for good economic reasons in the future, that probably we’d all be well off if we bought nothing but small cap value stocks across the globe and held them all for the next 50 years. I would actually go on record as saying that, 50 years from today, when we look back, that probably will have been – if not the most but certainly one of – the most successful investment strategies that anybody could actually do.
The problem is the volatility of that strategy is off the charts and most investors, unless they’re robots, won’t stick it out to see it through. So that’s where, all of a sudden, investors think about diversification because, the reality is, by adding other things like larger companies or growth companies or bonds, or whatever else we add to our portfolios, ultimately we’re smoothing out the ride. That may or may not reduce the long-term return but I think it would likely increase the long-term return the actual investor earns, because the experience that an investor has over a period of time is probably the most powerful factor that drives your investor returns. I think this point I made there, that 100% value is probably 100% wrong, I wrote that, you know, maybe a year or two ago. It was…We went through almost a decade recently where growth stocks did significantly better than value stocks, and that doesn’t mean that value investing is less good than growth over the long term; perhaps it will do better as it has in the past. It’s just simply that most investors are not going to stick it out for that long enough to see it through, and that’s where I think growth and value combined is better than either one of them.
Meb: And so we actually talk a lot about this in our writing where we say, you know, the best portfolio – much like you mentioned – is the one that people will stick with. But the funny thing is, it’s not just individuals, and we see this just as much with institutions where…One example is a recent survey across foreign institutions that said, “How long will you tolerate under-performance for a smart beta manager,” and 89-99% was under two years. And so, forget under-performance for a decade, like you just mentioned value under-performing growth. You know, many of these people that are chasing returns, it’s not just an individual investor phenomena, it’s institutional as well.
And then, there’s a article I’m getting ready to write later tonight, there’s some recent news out of Harvard where their endowment hasn’t been doing as great, but printed a -2% return for the last fiscal year, which is very low loss but did worse than, say, you know, nearby Yale, and the whole editorial staff wrote a long piece about how it’s unacceptable. And so, basically…I’m getting ready to write a piece called…Basically, the entire editorial staff of the Crimson needs to take an Investing 101 class, because not only can your strategy under-perform for years but, second of all, that’s a very minor loss. And so, anyway…
Gregg: I love the point you just made. It’s so important, I think, the whole concept of factor investing is to be different than the average investor. If you are, you know…If you’re a low tracking area investor, if you know the market’s up two and you’re only up one or down one, you know, that would be totally acceptable for a factor investor. But if you’re if you’re a tracking investor you can’t be a factor investor. That’s really important for investors to know who they are, and it’s interesting to hear someone like an organization like Harvard, you know, actually thinking like that. I think it’s great to write about that.
But, yeah, I mean, I think that the nature of factor investing is to be willing to be different than the average investor. This whole idea of risk in return being related, efficient markets and indexing that’s all wonderful. But it doesn’t say that all risks are rewarded equally; risks are rewarded differently. I have a good friend of mine that drew a cartoon for me because I talk about risk in return being related. It’s horrible, but it’s a guy jumping out of a building and he said, “This doesn’t look like a risk that’s rewarded.”
And so I think that, one, the investment community has to be willing to be a little bit different. You know, one point on that and I’ll stop talking on this because I think we’ve made the point, but this issue of international investing is one as well. If you’re…If you buy the total market you’re 50% U.S., 50% foreign, but we all know that foreign investments have done much worse than U.S. investments over the last ten years because of the dollar strengthening and the European crisis and all the other things going on, and I see so many investors bailing out of the foreign markets just because of a five or six year period where they’ve done worse than the U.S.
Meb: Believe me, I’ve been talking, giving talks on foreign stock valuations for the past four or five years, and it has been a very unpopular talk not only in the U.S. but it’s even unpopular…I was so excited, I gave it in Eastern Europe this summer; it was unpopular there because, even when I said, “Hey, your markets are very cheap,” at that point, when you’re that cheap, they don’t care, they don’t have any money to invest. And so, no matter what, I am giving up giving that talk because you kind of shoot the messenger no matter what.
But it’s particularly interesting now, in one of your pieces I saw a recently, there was also talk about valuations being cheaper in foreign developed and particularly emerging. You know, it makes a lot of sense to allocate away just from the U.S. You guys have a great chart on globalization, past, present and future, and listeners will tag all these in the show notes on the blog so…but it’s but it’s world GDP and it looks back to GDP in the 1870s where China was the biggest chunk of world GDP, and then how it’s changed in the 1900s, 1913, and the U.S. being the biggest chunk then, and including the ’50s, but a nice steady decline since then, and most people don’t know the U.S. is only about one-fifth of the world GDP. So market cap-weighted U.S. is about half, GDP-weighted U.S. is only about one-fifth.
And so, maybe we’ll transition a little bit. There was a couple other questions I wanted to ask regarding, you know, we were talking about value and momentum in particular and, look, we absolutely love that topic, and I’ll link to your white paper. It’s actually our smallest fund so it’s been the least popular for whatever reason, but we also think those are two factors that work wonderfully well together. Can you comment at all about how you think about putting together value and momentum, because a lot of different people do it different, and some people go sort all stocks by value and then sort all stocks by momentum and take an average, and some people go say, “No, we’re going to take the top value stocks but only take out of those the best momentum.” Do you think it matters? Do you care? Do you have any thoughts on any particular way to do it better or worse?
Gregg: Oh, our overall philosophy on our strategies is that we we start with the idea that we want to build a basket of securities with a lot of diversification. We’re not looking to pick up any significant amounts of return for many business specific issues, so our strategies have, you know, a couple hundred names in them. They’re a little bit like indexing in that respect, you know, match the risk and return characteristics of the market, but then we deliberately differentiate across these different risk factors. And ours are more of the sort of relative tilts more or less than the market basket in areas where we think that a risk is rewarded for taking and/or maybe others that are not, and then how to combine these things. So, you know, we may have more exposure to high momentum names in our strategy or less exposure to negative momentum names, but it will be a small weighting of additional momentum exposure and then combined with, in this example, value exposure – value exposure amongst growth stocks – we may do that through things like profitability, change in assets, and other things we’ve talked about.
One of these we’re very careful about is how we trade these things. There’s another paper on our website about this. I had heard a couple of academics talk a couple years ago about how momentum investing looks great. The premium for momentum investing is so significant, probably the most significant of all of them in many ways. But, it’s such a fast moving factor and the turnover’s so high and the transaction costs are so high you can’t really gain much from it. That might be true if your strategy is 100% momentum, you know, but when you combine momentum with other things where, for example, a value tilt would slow down your momentum trades. These things, when combined, you can accommodate the trading costs in addition to adding the diversification.
Meb: I think that’s an important point. I was looking at that, the conclusion in one of your papers, and then it also talks a little bit about it allows you to better utilize the negative information from signals and long-only portfolios, which I think is an interesting point because we often tell people, “Look, you know, one of the reasons a lot of these factor portfolios work is it’s not necessarily that you’re just buying the cheapest or the best momentum, which you are, but it’s also you’re avoiding the worst, so you’re avoiding the really expensive stuff and, in this case, the really expensive stuff that’s also going down.” You know, it’s just as important as investing in the cheap stuff. You guys do quite a bit in real estate which is an area that we certainly are big fans of, it’s had a monstrous run over the past handful of years, particularly in the U.S. in the REED space. Do you think about multi-factor investing a little differently in REEDs or is it applied just the same? Any comments there?
Gregg: Yeah, thank you. So, you know, we have this global reach strategy which is also a multi-factor strategy, but each asset class around the world, you have to think about these things a little differently. An example with our real estate strategy, there are two things we do that are probably unique to REEDs but one in particular is leverage. What we found – and Professor Titman did some research on this just after the financial crisis, and there’s some other work that’s been done since then – where, because of the way REEDs are structured where, you know, if they wanna…if they have to distribute all of their earnings every year, so if they want to borrow from the market they basically have to go sell stock or borrow; they don’t really retain back the profits or earnings they have.
So what happened is, when the world fell apart, during the crisis all over the world, the more levered REEDs did less well then the less levered REEDs. Now that makes sense, you’d expect that, leverage usually magnifies the downside. So if you look at leverage like the kind – is it short term or long term – or how much, you know, is it more or less, what we found was that the REEDs that had more leverage or shorter-term leverage performed worse during the decline. But then what was interesting is, on the way up, when the markets recovered, normally you’d expect leverage to also magnify the up-side but that didn’t happen with REEDs. Actually the less levered REEDs did better on the way up but they also did better on the way down, and that was because the cost of capital of these REEDs to go out and buy the depressed properties during the decline was much lower because the market favored them. So they were able to borrow from the market at lower rates and ultimately go out and grow their businesses. So full cycle, the less levered REEDs performed better.
Now, we don’t know if there will be another financial crisis any time soon, and maybe that’s not gonna exactly happen again, but what we saw was leverage seemed to be something that didn’t really add a lot of value for REEDs and, by getting rid of that risk, we could add other risks that do seem to add value, and in the REED space there are a few, some we’ve talked about, but smaller REEDs over larger ones, the small cap premium seems to work well amongst REEDs, and also this concept of momentum investing in REEDs. So dialing up certain risks that appear to be rewarded risks are factors, and dialing down some others like leverage, and in REEDs, I think, leverage is a bit unique where is that something we completely ignore in our international growth and domestic growth strategies.
Meb: You know, I think y’all run mostly long-only portfolios, but is there…is there any time where you look at, kind of, top down for any of these asset classes? And my thinking being is that I don’t know if it’s today or if it’s two years from now or ten years from now, REEDs will go through another bare market. But do you ever look at the valuation of the asset class as a whole to make determinations, not just with the REEDs but the equities as well? Do you all have any sort of perspectives on could you or would you ever move to cash – maybe it’s under a mandate – or is there any sort of…or do you simply talk about expectations then? How does top down factor in, if at all?
Gregg: Now, in our world, it doesn’t. It’s not something that we focus on, so I think we are, ultimately, very often working with other advisors who might use our strategies and, you know, if for some reason an advisor has a view about getting in and out of a market or moving the cash, that’s a decision that we’d respect if they were to make it. But for our strategies, the three multi-factor strategies, they can be reliably counted on to be fully invested at all times, and then the portfolio managers that are doing the great work out there thinking about those kinds of things or making those decisions for their clients, that they know better than we would. But, you know, generally, philosophically, me personally, I have never been very good at predicting the future and tactically allocating assets. It’s difficult and it’s not something that we spend a lot of time thinking about.
Meb: Yeah, well, I mean, you guys did write a good piece this summer thinking about losses called “An Investor’s Cheat Sheet for Market Losses”, and it was kind of when Brexit was going on. But I thought it was a nice piece because you looked at a lot of the historical declines in the stock market going back to…I think you guys took it back the 19th century. But you talk about the size of these losses and how they’re inevitable and how they happen, you know, these 30-50%, and then plus losses, they come around. Let’s see, you said, “If you found that corrections of 20% or more happen about once a decade, 30% or more once every 20 years, one of the interesting things about the last 15 years is we’ve seen a couple of those, and I think in many ways, emotionally, that can that can kind of scar people for…you know, in a place like Japan or Greece or Brazil or Russia, where it can be a generational scarring where a lot of people never come back. But you talk about a few of the takeaways from, sort of, that study, where you say, “Look, there’s a couple takeaways,” and I don’t know if you remember any of them, but if you wanted to talk about them…but you started to talk about one of the most classic, of course, which is simply diversification.
Gregg: Yeah, well, I…You know, this…I do remember that was a near and dear one. I think that one of my favorite moments in my career, actually, was in 2008. You know, we’re here in New York City and we’re working with a number of investors, and we do an event every year called Real Talk where we, you know, try to bring in interesting ideas that are on people’s minds, share some of our research and…Anyway, so it’s 2008, we’re, like, just almost at the bottom of the financial markets in New York City. We had an event where we had about 600 investors in New York that are all – in some capacity – tied to financing, you know, lawyers, finance professionals, hedge fund managers, investment bankers, lots of people in New York, in the world. So everybody was in a really bad spot, losing their jobs, half their home, half their retirement accounts; you know, we can all remember that moment. We did this talk at the Museum of Natural History, underneath the whale, and we had Richard Thaler join us, and the topic was behavioral finance. I had asked everyone, at that moment, by a show of hands, to tell me, you know, how many people feel really good about the stock market in the United States, and one person raised their hand and it was my uncle.
Meb: And you told him the question ahead of time so that doesn’t count.
Gregg: Yeah, exactly. That was around the time we launched our multi-factor U.S. growth strategy, and my message that night…and it was great to have Richard Thaler there; it was a wonderful evening he had just come out with his book “Nudge” and, you know, it was a lot of fun but it was a difficult time for people. You know, the message there was, “Hey, if risk and return are related, then one of the greatest times to invest is right now.” We launched our international growth strategy during the European crisis. We launched our global reach strategy during a period of time where the world thought interest rates were going to rise dramatically. So I think investors always have to remind themselves that, you know, when the sunlight is shined on the risk, the markets do do a good job pricing those risks pretty quickly, and when prices are down relative to something fundamental, it’s probably a decent time to build positions and, you know, hang in there. But, you know, that’s where behavioral finance kicks in and it’s very difficult for people to do that.
Meb: Well, and that’s one of the big benefits of either having an advisor or having an automated kind of investing solution. You know, we saw…I tweeted out a quote I saw the other day which there is no possible way I agree with, and in a moment to ask you what your perspective is. But we saw a comment that 38% of all individual investors had a written investment plan, and I said, “That’s funny because we manage money for individuals and I have not had a single investor ever walk into my office and say they had a written investment plan, so maybe it’s Lake Wobegon where all these others magically have these investment plans.” I know you guys do money management for individuals and institutions as well. What’s your thinking there? I mean, is this something that you…that most of the clients that come to you guys, they come with a plan already in place or is it more of a shoot from the hip, you know, sort of money management style?
Gregg: Meb, there is no way. I don’t know who wrote that but whoever that person is I’d love them to prove that one to me. I have never…I don’t think…I’m doing this…Well, I’m doing this personally about 25 years but, you know, maybe even a little longer, depending, with my family financial service industry experience. I don’t think I’ve ever seen anyone come in with a written investment plan; there is no way that that is accurate. I don’t even know what a written investment plan would actually look like because I’ve never seen one. I mean, even though…I mean, maybe once in awhile, institutions have an investment policy statement that they dust off, having not looked at it for five years. It is so rare that people have a written investment plan and, even if they did, as you know, it’s very difficult for people to stick with it.
Meb: Well, and that was kind of the point we were making as we say, “Look, you know, if you put together an allocation or, even, this even applies to an individual security, one of things you do ahead of time is write down…” This goes back to Thaler’s Nudge book, and I think this is a perfect example, where you have the plan, “I’m going to do this asset allocation: 40% stocks, 60% bonds, rebalance it once a year, no matter what,” and they said, “All right, we’ll plan that what happens if interest rates go to 10%, what happens if they go to -2%, what happens if stocks go down 50.” You know, all of these things have happened in the past, so talking about all these outcomes in your written plan may just be, “Hey, I rebalance once a year and that’s how that takes care of it,” but a lot of people just don’t follow…you know, it’s like being on a diet, right? I’m sure 38% of the respondents would have said that they’re all, you know, they have a great diet and exercise every day as well, but we all know it’s a lot harder.
But…So I was trying to encourage people, say, “Look, go home, write down your investment plan, and then share it with your wife or kid or someone else and, in that way, it kind of helps you to stick to it or at least, you know, have someone to call you out if you’re doing something a little crazy.” But you also made a comment in the same piece where you said…you talk about one of the best ways to do it is diversification, and you guys talk about not only stocks and bonds and REEDs but also some commodities as well, real assets. But you also talk about…you say, “Very few investors have to worry about excessive diversification. In our experience, most are not diversified enough.” Maybe comment on that for a second.
Gregg: So, two things, I want to come to that, and just one point I want to emphasize, you mentioned something that’s great is the dieting examples, or health and nutrition and the discipline. There’s an article that we wrote a couple years back with another good friend of mine, Phil Myman, and it actually talks about the value of advice. We did this, probably, 2008 or ’09, and we gave that analogy, actually. There is a guy who did a research study about, you know, people that binge eat, and this study goes on and talks about this guy that basically gets up in the middle of the night and, you know, eats everything in his fridge so they tied him up. He got up, untied himself, opened the fridge up. Then they put a chain around the refrigerator and locked it, and put the key in the trunk of his car. He got up, opened up the trunk, unlocked the key, opened up his refrigerator. And we did this analogy of, like, you know, some form of written investment plan or an advisor being the chain on the refrigerator because, you know, everybody kind of needs the discipline and it’s very hard for people to do. When you think about how many books are written on nutrition or how many nutritionists there are out there…I know, we all know, if you exercise more and eat less you’ll probably lose weight, but it’s not so easy to do. You know, I think that’s such an important point.
The second thing, though, about people not being diversified, most people, when you think about it, you ask someone, “How much money do you have in the U.S. dollar?” All right, so they’ll tell you, well, they’ve got U.S. stocks, they work in America and earn dollars, so the present value of their income and their stock portfolio. Then, maybe they own a home in California or New York so that’s…So, you know, when you really look at the percentage of someone’s portfolio, that’s very concentrated in one thing, and so often people are working in industries like, maybe, technology and their portfolio is, you know, the S&P 500 with heavy weightings to the technology sector or, I mean, I think, ultimately, when you really look through this lens carefully of people’s actual portfolios and their levels of diversification, when you combine them with the homes they live in, the towns they live in, the present value of their income streams, you know, most people we meet are not well diversified.
Meb: Yeah, we see the same mistakes, kind of, over and over again. The funny thing is people can always make excuses for it in, and a lot of the excuses sound reasonable. But in general, we see that as a consistent mistake. But, one comment, you guys have also talked a little bit how you think about foreign equities and foreign bonds, and you talk a little bit about currency hedging or not. Let’s hear your perspective on that because I think a lot of people have some different opinions. How do you all think about the currency world?
Gregg: We’re not big fans of hedging currency. You know, generally speaking, it’s our view that if you’re a…Let’s just say you’re a U.S. investor in dollars, and your choice is to diversify, and you start 100% in the dollar and you want to diversify by adding foreign securities, and you go to 10% foreign, 20% foreign, 30% foreign, whatever number that’s going to be, generally speaking, our view is that 10, 20, 30% foreign should be unhedged because part of the benefit of the diversification is the currency diversification. Now, if you hedge away that, you end up losing some of the correlation across asset classes, and if you have a systematic rules-based investment strategy that rebalances regularly, you know, we think the unhedged strategy is better. Plus, a lot of the foreign companies are going to own in your strategy; their management teams are making decisions about hedging. So, you know, the companies themselves are thinking about that in terms of the business risks that they have. But ultimately, we think that adding the cost of…hedging the cost of the insurance for most investors that are at 10, 20, 30, 40% foreign is probably not a good idea long term, that the long-term returns will be lower when you hedge.
Meb: Yeah, we often say that we’re pretty agnostic there, we don’t really care if…I mean, most people, I don’t think, understand that real long-term currency returns are actually fairly stable and they net out over inflation. And so we often say we’re agnostic. I don’t care if you hedge or not but once you make a decision then you should probably stick with it. A separate side is if you think you have a value-added currency view, which there are some, you know, factors, just like in stocks, that can apply to currencies like valuation through purchasing power but momentum in trend as well as carry that could inform that, but it gets a little too complicated for most investors to try to certainly implement because it’s…you’re adding a whole another layer of questioning.
I’m gonna ask one or two more questions, then we’ll probably start to wind down. One of things I meant to ask earlier that I had forgotten is, you know, there’s been a lot of talk lately about the smart beta in factors and Rob Arnott – you know, I know you read all the academic literature – Rob Arnott was talking about certain factors that, top down, can be more or less attractive over time due largely to flows in valuations where, let’s say, you have a factor like profitability or momentum where, at any given point in time, it may be more or less attractive. We’ve talked about dividends before where they’ve, you know, been much more of an attractive factor, say, in the late ’90s when no one wanted them, and more expensive now. Does that play into y’all’s thinking at all where…do you think about any sort of factor rotation, or is it something you’re looking into? It’s something that we think a lot and scratch our heads; we haven’t really come to any conclusions. Is that an area that y’all are interested in at all?
Gregg: Yes, and I’m scratching my head, too. I mean, so I have two thoughts on this. I agree that that should make sense. I was just having a conversation with my wife not too long because, you know, for 25 years she hears me talking about finance and I think she’s finally getting interested. She said, “If everybody knows that stocks do better than bonds over long periods of time, why does that keep happening,” right? Like, in theory, you know, we have 150 of data that shows that investing in stocks is better than bonds over long periods of time, so we all knew that, shouldn’t that no longer be the case?
And I think the reason that continues to be the case is because of risk. Every couple years people lose 30-40% of their money and get scared out of them, and it’s a return, it’s a risk premium. So in theory, even though these things become popular, they should go on for many periods of time if it’s a risk premium. But, you know, when you look at other things, like if you look at the value premium, you know, value stocks over growth, ever since 1992 when Fama and French put all those papers out there, the value premium has shrunk considerably, like, the return for value over growth is nowhere near what it was when they first released all that, and the popularity of value investing has become so strong.
Also, we all you know the small cap premium, ever since Ralph [inaudible 00:42:21] did that paper, the small cap premium has disappeared. So, I think there is something to be said about, you know, when the sunlight is shined on these strategies and so much money flows into them, prices should go up and the returns should be lower. I am also scratching my head, I mean, is this compensation for risk? Is it, you know…what is this thing and should it keep happening? It’s a very difficult one. I am not presently doing anything differently as a result of that concept but I do think it’s something to be thinking about.
Meb: Good. I don’t have any easy answers either, but I was just thinking we’ll have you back on in six months or a year, once you’ve found the holy grail.
Gregg: Sounds good.
Meb: Because we don’t have any good, clear answers there either. I think a lot about it and it seems like something. Another good example for us is investing in markets that have just been obliterated, where we find really large returns across countries, sectors, industries, when those markets are down 60-90%. And it’s not an easy standalone strategy because it doesn’t happen that much. You know, one way to simply do it is, of course, to rebalance, which kind of takes care of this factor conversation as well, and we actually had Rob on the podcast a few weeks ago where he talked about the concept of over-rebalancing, meaning if a factor or a strategy asset class is really out of line then, maybe, instead of rebalancing, say, to 10%, you rebalance to 12, then I think that’s a that’s a simple solution, but I’d consistently think about that as well.
One more question. You know, you guys work a lot with individuals and you have some very sensible advice – it’s a little bit like taking your medicine – but you talk a little bit about…you do these, kind of, education days, you know, we have a lot of young listeners, a lot of millennials on here. There’s a recent survey that millennials expect stocks to return about 10-13% going forward, depending on where they live. Any quick takeaways? You know, we talked about a few today, diversification, but any other thoughts for our younger listeners that they may take away as a final thought from you before we wind down?
Gregg: My best advice that I’ve ever come up with is very simple, and it’s save more. It’s not about factors or investing or asset allocation or robo or automated or none of that. Actually, you know, I’m an investment business like you are, and have views on what’s good and what’s not. But ultimately, if you can only pick one thing to focus on as a young investor, it’s save more and spend less. I mean, that is probably going to make the biggest impact of almost anything you could do. You go back over time and you look at the difference of saving $100 a month or $200 a month or $1,000 a month. You know, it didn’t matter whether you earned 8% or 9% or 10%, the fact that you are saving more versus less early in your life is the big factor, so to speak. So that would be, you know, my five-star tip for anybody listening
Meb: Yeah, I agree with that one. That’s, of course, obviously tough for everyone to stomach, swallow, whatever, but it’s good, simple advice and, in many ways, that overshadows whatever your asset allocation may be or whatever your factor tilt. The fact that you’re putting some away, dollar cost averaging, a great starting point for the younger crowd.
All right, so, you know, we always ask everyone, we say…we did a fun blog post, but we talk about something that other people may not have heard of that is beautiful, useful, magical – I always forget it at this point, it’s been a while – somewhat magical. Do you have anything for the listeners?
Gregg: You know, one of the things that we’ve done at Gerstein Fisher and I’ve done personally now over the years – we are pretty active in a few small not-for-profits that do this kind of thing – is mentoring. You know, the idea of finding people that you can mentor in life in some way, in whatever way you can do that, I think the rewards for doing that are so fantastic. I think there’s so many people that have come in and out of our world over the years and, of course, I think of the people that mentored me and I’m thankful. I would just say that, you know, if you have any opportunity in your life to give in that way and help others in their careers that are, you know, their successes, both personal and business, I think it’s a wonderful thing to be able to do in any way that you can and that’s a very rewarding thing.
Meb: You know, I’ve…there’s two thoughts that immediately sprung in my mind. One, I was just back for a high school reunion in North Carolina and I have so much nostalgia and memories about, in particular, coaches. And it may have been in athletics, but also your favorite teacher, too, and how impactful those people were, you know, in my life in particular, in thinking about, like you said, paying it forward in some fashion.
Which, by the way, one of the most shocking things to me, you know, having talking about investing in these podcasts is also that personal finance is not part of any high school curriculum; at least it wasn’t part of mine. I don’t even think it’s a part of most college curriculums. Is that something you ever thought about where, most investors, we come, you know, have such a baseline, tough understanding of investing…is that something you’ve ever thought about or looked into?
Gregg: Yeah, there are actually one or two not-for-profits I’m aware of that are trying to bring finance and business into the classroom but it’s not pervasive. It’s definitely still not something that’s popular and, certainly, when we were kids it didn’t happen at all. So I think, like, more energy around that would be great.
Meb: Well, shoot me those names after the podcast. I’ll add them to the show notes and certainly look into them, because it’s something that we spend a lot of time thinking about and just even having the basics down, I think, would take people so far to get a head start on a lot of things we talked about today, even the basics that I think would be interesting.
All right, mine today is going to be super short and weird. And, you know, we’ve named a lot of beautiful, useful things in the past, everything from apps to websites to philosophies to things. This is one I actually heard somewhere else and, most people that know me, I get a lot of conferences. I tend to be very aloof and forgetful. And so, despite the fact my mom raised me very…in a southern household with lots of etiquette and properness, things like even remembering where the bread and what glass you’re supposed to be drinking at a table full of 20 people, and there’s a way that, if you put your finger and thumbs together, your left hand will make a B in your right hand will make a D for bread and drink and that will help you remember what drink you’re supposed to be drinking out of instead of drinking everyone’s drink to your right and left. So I think I got that from the Tim Ferriss pod. It was another pod, guys, maybe Tim, so thanks, Tim. But that’s one that I use to this day, so…
Gregg: You know, you and I have a lot in common. We’ll have to talk offline, but you reminded me of a story when I first got started in business, I remember, I never did my MBA, I did other things; you know, CFA, another financial education. But I think when you go to a certain type of school and do your MBA, you probably learn, you know, presentation skills or what fork to use over dinner, and I never picked up on those things. It took me about 15 years to figure it all out.
Meb: Well, I mean, having to do enough finance presentations I don’t think any of my finance buddies, for the most part, have got the presentation class down, but for another…that’s for another day.
Look, it’s been a blast today. Where can people go to find more on y’all’s writing and keep up with everything you guys are doing?
Gregg: We have, well, really, two websites, gersteinfisher.com, G-E-R-S-T-E-I-N F-I-S-H-E-R dot com. That’s our website where you’ll find most of our materials. But we also have our other website, gersteinfisherfunds.com, which is where there’s a slightly different set of information. There’s actually a short video we just put up on the Gerstein Fisher Fund’s website which is a cartoon, it’s about five minutes long, and it does a good job describing factor investing in a reasonably enjoyable format so, you know, I appreciate that and I certainly appreciate the opportunity to be here with you today. You’re doing such a great job to help people. I’m thankful to be a part of this.
Meb: Thanks, man. I actually watched that video, and you’ll have to send me what company you used for the animation. It was actually quite great. You guys, they’re also on Twitter and the other social media so y’all can find them there as well.
Well, look, listeners, we’re winding down. Thanks for taking the time to listen today. As always, we welcome feedback for the show in the mailbag. If you got any questions send them in to firstname.lastname@example.org. You can always find these show notes, we’ll link to all of these white papers and everything else we talked about today, and also find all the other episodes at mebfaber.com/podcast. You can always subscribe to the show on iTunes as well as Overcast, all the other podcast players, and if you’re enjoying it or hating it, whatever, we don’t care, please leave a review. Thanks for listening, friends, and good investing.
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