Episode #31: Mark Yusko, Morgan Creek Capital Management, “Asset Allocation Matters Most”

Episode #31: Mark Yusko, Morgan Creek Capital Management, “Asset Allocation Matters Most”



Guest: Mark Yusko is the Founder, CEO and Chief Investment Officer of Morgan Creek Capital Management. Prior to forming Morgan Creek, he was President, Chief Investment Officer and Founder of UNC Management Company, the Endowment investment office for the University of North Carolina at Chapel Hill, from 1998 to 2004. Until 1998, Mark was the Senior Investment Director for the University of Notre Dame Investment Office where he joined as the Assistant Investment Officer in October of 1993.

Date Recorded: 11/29/16     |     Run-Time: 53:09

Topics: Episode 31 starts with some background information on Mark. After some early-career twists, he got his “big break” – working for his alma mater, Notre Dame, in its endowment department. Several years later, The University of North Carolina came calling, and Mark took the helm for UNC’s investments. Eventually, he moved on to private wealth with his current group, Morgan Creek.

Given the heavy institutional background, Meb asks about how endowments invest. Mark tells us that every large pool of capital manages its money the same way – investing in stocks, bonds, currencies, and commodities. That’s it – though how you own those assets might change. Yet despite different wrappings, they all have the same risk factors. This leads Mark to focus on asset allocation, as “asset allocation matters most.”

The conversation turns toward money managers (Mark uses various money managers at Morgan Creek). Meb asks how a retail investor can get access to the truly great money managers. It turns out, it’s very difficult. But Mark says you don’t necessarily want the well-known superstars who’ve been in the limelight for 20 years. You want to get onboard with them far earlier in their careers when no one is looking, before they become famous. As to how you actually find them, Mark says you have to “kiss a lot of frogs.”

Meb follows up with an interesting question – forget about how to find great money managers…how do you know when it’s time to get rid of one? After all, it can be hard to tell when a manager’s investing system is flawed versus when he/she might simply be distracted by personal issues, or just going through a rough patch.

Mark’s answer? Stop focusing on performance. Instead, focus on the other three P’s: 1) people 2) process, and 3) philosophy. If all you’re doing is looking at/chasing performance, chances are you’re going to underperform. So expand your analysis.

Meb adds that this focus on performance isn’t limited to retail investors – institutions do this too. Mark agrees, having had personal experience with this. His group was hired, fired, re-hired, and so on, as one particular client chased performance.

The guys then switch to venture capital, a huge area for outperformance. Institutional investors have the advantage here – the “illiquidity premium” as Mark calls it. Meb asks how retail investors can try to take part in this space. Mark tells us that, unfortunately, retail investors have one arm tied behind their backs courtesy of the SEC. Its philosophy is “If you’re not rich, you’re not smart.” So yes, investing in venture capital is very challenging for retail investors, despite some recent gains.

Eventually, the conversation drifts back to asset allocation. Mark has a 3-bucket system he recommends. Bucket 1 – “liquidity.” This is about 2 years’ worth of spending. Call it 10-15% of your wealth in cash-like investments. Bucket 2 – your “get rich” bucket. Also 10-15%. He recommends investments like businesses and real estate, though most people use this money to chase the latest hot stock. Bucket 3 – your “stay rich” bucket. This one is all about diversification (whereas your “get rich” bucket was all about concentration).

Meb agrees with this, telling us how the asset allocation required to get rich is different than the asset allocation needed to remain rich.

The guys then move to predictions. Each January, Mark writes his financial predictions for the new year. So how did he do in 2016? They go over the results, with topics that include interest rates, the Japanese equity market, black swan events in Europe, roaring commodities, and the strength of the Dollar.

This leads the guys into a more detailed conversation about U.S. interest rates, comparing us to Japan. Mark warns us about the Killer D’s: demographics, debt, and deflation. It’s a fascinating conversation with the short takeaway that we may not see the bottom in interest rates until around 2020-2022 (when demographics finally shift back in our favor).

There’s far more in this episode, including “Red Ferrari Syndome,” a Twitter question to Mark about the biggest learning experiences of his career, and an asset class that’s about to be down a whopping 6 years in a row. What is it? Find out in Episode 31.

Episode Sponsor: The Idea Farm and Lyft

Comments or suggestions? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

Morgan Creek Capital Management

Twitter @MarkYusko

Notre Dame Endowment

Grantham Foundation and here

10 Surprises 

Save FairUS Q3 MCCM Quarterly Letter

The Value of Value Q2 2016 Market Review & Outlook

Two Thousand Zero Zero, Party Over, Oops, Out of Time… Q1 2016 Market Review & Outlook


Beautiful, Useful:

Mark: The Tao Jones Averages: A Guide to Whole-Brained Investing

Meb: San Juan Hut System

Transcript of Episode 31:

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.

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Meb: Welcome to the podcast, ladies and gentlemen. We have an extra special guest today. Mark Yusko, welcome to the show.

Mark: Thanks, Meb. Always great to hang out with you. I’m looking forward to the conversation.

Meb: Where are you calling in from? Are you in Chapel Hill right now?

Mark: I am in Chapel Hill, North Carolina, home of the Tar Heel basketball team that is looking good after winning the Maui Classic. Two out of the last three times we won that. We ended up winning the national championship, so looking good this year.

Meb: Well, great. My alma mater, Virginia, is a top 10 team as well. So hopefully have something to cheer for.

Mark: Well you got a better-looking coach. You got that going for you.

Meb: Most of our listeners are probably familiar with you. I’ve quoted and probably misattributed a number of quotes to you in podcasts past. But for those who aren’t familiar, why don’t you give us just a two-minute overview of kind of what you’ve been up to prior to starting Morgan Creek, starting with… Did I hear right? You were a fellow biology student at one point, or thinking about a…

Mark: Absolutely.

Meb: A career in medicine?

Mark: Greatest training for investing. I’m a big believer that the sciences, whether it be biology and chemistry, my majors, or really any science is just great training for investing. I got into investing by happy accident kind of my whole life is a series of happy accidents. But I went school to be an architect. didn’t like that. Liked biology and chemistry, did that but I wanted to be a doctor. Decided not to do that. Went to business school. Went to Notre Dame undergrad, business school at Chicago. Took a job at an insurance company, like 40% of the people in the world. It’s an amazing step that 40% of the people work for an insurance company at some point in their career, or some related company to insurance company.

The guy who was doing investments retired, took over the portfolio. I like to say I hired Dan Fuss before he was famous. So it’s the first hire I ever made as a fixed income guy. Then went to work for an equity firm called Discipline Investment Advisors, couple of Ex-Northwestern profs and then I got the call. So, way back when, Lou Holtz had a clause in his contract, lifetime contract at Minnesota unless Notre Dame called. I kind of had the same deal at Discipline. We were a billion dollars back when a billion dollars meant something. There were five of us, the two professors kept all the money but eventually young guys were gonna get something.

But I wanted to be at my alma mater more than I wanted to be in Evanston, Illinois. Went back, learned the endowment business. Had a big epiphany that picking stocks and bonds was not all there was. It was really about asset allocation. It was about this thing called the Endowment Model. I spent five years as a number two. Was always gonna be the number two. I didn’t really care because it was the alma mater. But I got a call that they were looking for someone at North Carolina. I told my wife, she said, “Take it.” I said, “Don’t you wanna know what it is?” She said, “No. I just wanna live in North Carolina.” She was right. We came down to North Carolina, had a great run, spent seven years as the CIO at North Carolina. Really honed the craft of this endowment model, focusing on hedging and risk reduction and not losing money and keeping the portfolio stable from 2000 to 2002 when everyone was getting killed. And also taking advantage of the liquidity premium.

Then got approached by two families in ’04 to come be their CIO. Decided I didn’t want to work for just one family, so I opened up Morgan Creek. We advise a handful of wealthy families and institutions. We run some fund to funds, we run some direct funds. We dabble in some private investing on the direct side as well. Have gotten to know you over the years and enjoyed our relationship, and glad to be here today.

Meb: Great. Well, we’re gonna have a pretty wide-ranging conversation, but why don’t we start a little more basic and then we’ll get into some themes and ideas and some more specifics. If you’ve read any of Mark’s writing, it’s pretty wide-ranging. I mean, I’ve printed out the last handful of quarterly reports and he talks about everything from Ferris Bueller, to Seth Klarman, to Prince, to skiing, to Shakespeare.

So there’s quite a bit in there. We’ll post links in the show notes for those interested in reading more later. But let’s start with the basics. So, thinking about the endowment model, and you’ve been a practitioner of kind of asset allocation sort of ideas that are very heavy in what most would consider alternatives. I know if you probably said your wheelhouse would be the long, short equity space. But maybe talk a little bit about kind of your thoughts on the endowment model but also how your views have evolved over the past 10, 20 years with particularly with one thought, one hand on as institutions practice but also how individual investor could attempt, or in many ways, not track some of the best concepts of the endowment model?

Mark: Look, I think it’s a really important conversation and topic, and I spent a lot of my career thinking about it and trying to find a way to craft a strategy that would allow individuals to gain access to that model. It’s really interesting. If you think about every large pool of capital in the world that I’m aware of, large family, large institution, foundation, endowment, pension fund, sovereign wealth vehicle, they all manage their money the same way. They’ve got a heavy allocation to… I use air quotes, “Alternatives,” because I hate that term. Whoever thought of the term was not a marketing genius because people don’t like alternative stuff. They like traditional stuff.

So, I like to think of investing as very simple. You know, you can own stocks, you can own bonds, you can own currencies, and you can own commodities. And how you own them, it doesn’t matter whether it’s in a hedge fund wrapper, a mutual fund wrapper, a separate account, a partnership, private partnership, it’s all the same risk factors, credit risk, equity risk, illiquidity risk, and structure or leverage.

When I got to Notre Dame, I didn’t really know what this whole endowment model was. Cambridge Associates really the pioneers there. But what I realized is that you can agonize all day, “Should I own Ford or GM?” And the answer is, over the last decade, you should own Tata Motors and you should have overweighted India and underweighted the U.S. over that period. And that’s an asset allocation call, not a security selection call. If you think about the four steps of managing capital, asset allocation, manager selection, portfolio construction and security selection, security selection which is what gets all the air time on CNBC, etc. There’s only 10% to 15% of returns. All the returns come from asset allocation, the manager selection, the portfolio construction, how much you give to each individual manager, which asset classes you’re in.

And so the big endowments and foundations and sovereign wealth funds and big families all figured this out and they realized that talent is gonna migrate to the place where they can make the most money, whether it used to be inside bank trust companies, then it was in independent asset managers, and then it was in hedge funds, private partnerships. But I believe in talent, and people manage money, not institutions, and so you want to follow the talent. And in every business I know, doctor, lawyer, football coach, basketball player, investment manager, the best person always charges the most.

So this idea that you should minimize fees, I just think is ludicrous. I think you should want to maximize your net return. And if that happens to be that you can do some good stuff with low fee stuff, great. But most of the great investors, the Seth Klarman’s of the world, the David Teppers of the world, exist. The Jim Simons of the world exist in a structure where you have to pay high fees to get access to them.

So it’s a long rambling answer to your question but I really believe that asset allocation matters most, where you invest. Let’s take since 2000 and what I call the new abnormal, the compound return on an index fund, even with all the low fees, is 3.5% net. There’s a technical term for that. That sucks. If you had hedge funds, even though hedge funds have sucked, another technical term over the last five years, over that 16-year period, you made 7.5 instead of 3.5 net of all the fees. That’s better. And if you did private investments where you get the illiquidity premium, you made 11, and 11 is way better. So, again, every large pool capital I know has a big waiting in private, has a big waiting in alternatives or hedge funds.

I’ll just give you one idea. If you think about GMO and I know a lot of your listeners know GMO, Jeremy Grantham, great value investor up in Boston, great value shop, 100 billion in assets. Jeremy has taken all of the money that he’s made running that firm of traditional asset management and put into a foundation to save the planet. His asset allocation for that foundation, which happens to be the number one performing foundation since 2000, outperformed the Yale, outperformed everybody else is 40% venture capital, 40% hedge funds, 13% emerging market equities and 7% cash.

Meb: That’s fascinating. I didn’t know that. That’s an interesting stat. There’s a couple takeaways and questions here for you. So, one, and I think this is a quote I’ll attribute to you, is one of these challenges with the alternative space and finding these top managers, is you said something along the lines of, “Look, when I’m looking for the managers, I want the guys that don’t want my money.” Meaning like they need to close or it’s hard to get access to these. For a lot of institutions but then on down to individuals, they hear these names like Simons, which is only internal money, or whether it’s Klarman, etc., and it access is kind of the biggest problem. What’s your thoughts on that from kind of an individual? Is it something where you think, “Look, there’s a whole swath of alternatives that’ll just never be accessible,” or do you think there’s areas that they can replicate? What’s kind of your thought there in the broader, kind of nontraditional core passive space?

Mark: Yeah, look, I think it’s a really important point. You know, the very, very best of the best. At this point, aren’t reachable. Now, I’m gonna make an argument from that you don’t necessarily want the best of the best after they’ve been doing it for 25, or in Seth Klarman’s case, 33 years. When you want Seth Klarman is in 2000 when nobody wanted to invest with Seth. Seth was a value manager, you know, basically, he came out of Harvard Business School. I wrote about this in the letter, that the professors hired him. They started interviewing managers and they realized, “Wait, the managers don’t invest the way you’re telling us to invest. So why don’t we just do this ourselves?” So they created a value focused strategy that said, “Seth, you’re gonna do it.”

And for the first kind of 13 years that he ran the business, he did fine, you know, he compounded around 10%, 11% but the market was running 15% in that late ’90s period. And people just didn’t want to hear about value. Value is dead. And no one wanted to talk about hedge funds. Tiger Management went out of business in 2000. So nobody wanted to give him money in 2000. The average person could have given him lots of money, but they didn’t because they wanted to buy index funds and record setting flows into index funds. Then the next 10 years, the S&P 500 made minus 1% compounded per year, even with low fee, and Seth made 17.

So you want to get with these guys before they become famous. The line I would say is that, Groucho Marx would never join a club that would take me. And that’s true. The very best that we know about got that way by being really good undiscovered gems for a long time. Now, the problem is how do you find them? Well, you actually have to kiss a lot of frogs. I mean, you’ve got to go meet hundreds and hundreds and hundreds of managers. I mean, I’ve done 250 to 300 manager interactions a year for 25 years, and I’ve kissed a lot of frogs and I’ve probably invested in 1% or 2% of the people we’ve ever met.

Part of it is you got to be in the business or you have to have a trusted advisor, and I think the average person isn’t gonna do it themselves. They’ve got a life. They’re earning their money to retire on. They don’t have time to manage it fulltime, so they need a trusted advisor, and there are some good trusted advisors out there, if you can find them to help you.

Meb: And this touches on a couple things, and I want to come back to private equity here in a minute. But the interesting part about this, you know, we wrote a book called “Invest with the House” that talks about looking at a lot of these managers. One of the most often asked questions from people is, “All right, Meb, how do I find these guys?” And then conversely, “How do I also know when to get rid of them?” So, if they’ve been underperforming for X amount of years, like a lot of the value guys have since that global financial crisis, you know, Buffett’s picks done terrible for the past eight years, etc. At what point do I know when to fire them at what point do I know to invest in a drawdown? My comment is always, reminded everyone that I’m a quant, so this particular area requires a massive amount of kind of domain expertise and you have to be interested because if that manager is going through a divorce or he’s on tilt or he’s growing, you know, just happy with his wealth or whatever it may be, style drift, there’s all these reasons. So it requires a lot more effort. That having been said, and this applies to quant strategies too, but when thinking about allocating to a strategy that you believe in or a manager, and every manager strategy goes through years of under-performance and drawdowns. What is your perspective on either allocating during a drawdown and then also saying, “You know what, this time is different, either the strategy is broken or this manager’s done.” What are your thoughts there?

Mark: Yeah, look, I think this is maybe the most important point in all of investing, which is a big statement, but I think you’ve hit on the number one point, which is the bulk of people spend all their time on the wrong P. They focus on performance. You should basically almost never think about performance. You should be thinking about the other three Ps, People, process and philosophy. The most profitable strategy of any, and you know this is as a quant, I know it as a qualitative guy, the absolute most profitable strategy of any strategy there is, is to buy strategies that have been out of favor for, you know, between one and three years. You have the rule of 90%. When an asset class goes down 90% or stock goes down 90%, you have to buy it, assuming the other three things have stayed the same.

And that’s the key, is if you look at managers, there’s so many reasons to fire a manager, right? You could have a change in personnel, you could have a change in process, you could have a change in philosophy, the three big Ps. You could have someone going through a divorce. I had a friend in the business, he lost two kids. I can’t imagine losing one child, how do you lose two children and function? How do you get out of bed? And as harsh as that sounds, that guy was not gonna be able to do a good job for the next, however long it took to heal from the grief.

I met guys call in rich and get red Ferrari syndrome. One of my favorite stories on that is I was… I talked about red Ferrari syndrome a lot when I first got in the business. And I met with this guy, Steven Feinberg who ran Cerberus, who’s a pretty famous manager. This was early days and they had been pretty successful but he wasn’t who he is today. He had heard me talk about RFS and he said, “Mark, here, I’ll make you a deal. If I ever move out of my house or buy a new car, I’ll personally double your investment.” Now, he lives in a little modest house in Greenwich, next to some castles that people have knocked down and rebuilt around him. So he still lives in the same house. But I could have actually won the bet because about five years later, he finally traded in his Toyota pickup truck with 260,000 miles, but he got another Toyota pickup truck. So I let him off the hook.

Meb: Those things last forever.

Mark: Exactly, exactly. But I think it’s all about the P of performance is what everybody looks at. So they want to sell the guy who’s down three years in a row and they want to buy the person who just had a great three years. But we know from mean reversion, what’s gonna happen? That person who’s been the hot dot for three years is now gonna have bad three years, and the person who was tough for three years is now gonna cycle back because everything’s cyclical. And whether it’s three years or three and a half years or four years or two years, it doesn’t really matter.

But the key is, if all you’re doing is looking at performance, which is why the average investor underperforms. Over the last 20 years, someone who bought and held stocks made eight, someone who bought and held bonds made six and half. The average investor made three and half. Why? Because they’re constantly chasing the hot dot, hiring at the wrong time, doing what human beings do so well, they buy what they wish they would have bought and then they sell at the bottom. It’s just crazy.

Meb: The interesting part is that we’ve been giving a speech recently. And one of the topics is this very topic, and we say, “Look, it’s also not just a retail phenomenon.” You mentioned the institutions. There’s academic papers that study all the firing and hiring decisions, and in almost every case, they would have been better with the manager they fired versus the manager they hired, because they’re just chasing the performance. I mean, there was a recent study that came out on State Street. I think it was with Financial Times, where they asked institutions, “How long would you tolerate an active or smart beta manager underperforming before you search for a replacement?” And 89% to 99% said two years or less.

Mark: Yes. We know that that’s the road to ruin. I mean, I can give you chapter and verse. The first firm I worked for, we had a client, they stayed with us for three years. They hired us when we were hot. We went through the recession because we’re a value manager, underperformed, they fired us, hired a growth manager. Three years later, the growth manager underperformed, we were hot. They came back to us. So for nine years, these guys underperformed because they were constantly chasing. In fact, if they just gave us each 50% of the money, they would have been better off.

Meb: Yeah. And this is gonna touch on a topic that we’re getting ready to talk about in private equity, is that we launched this digital advisor. And traditionally, most of these robo-advisors allow the individual investor to change their allocation, and we say, “Look, we need to lock this down,” because one of the biggest benefits of an advisor, traditional financial planner, RIAs, they keep people from themselves and wanting to do dumb things at the wrong time. And we often rail about how much financial advisors cost, but I say, “Look, they’re worth their weight in gold, if they can keep you from doing dumber things.”

And this touches on. So now thinking a little bit, and we’re shifting gears a little bit, but there’s an interesting takeaway on the private equity side. And historically, private equity, VC, buyouts is the monster area of outperformance for these private funds because they get access to the top guys. Historically, the little guys really have no chance. They’re better off in an S&P 500 fund. You’ve talked a lot about the illiquidity premium, meaning your money is locked up. So I’m gonna get to it in a second, but I’m gonna ask you one. First question is, do you think the individual investor has any chance in private equity at all, or are they better off just saying, “You know what, I’m gonna index this and just forget about it?”

Mark: Look, I think the average investor does have one arm, actually both arms tied behind their back, really by the FCC at this point. The FCC has this silly rule, I hope they’re listening and they heard me say silly, because it is silly, that if you’re not rich, you’re not smart. If you don’t have $2 million in assets or you don’t make a certain amount of money, you’re not smart, and that’s just insane. The real reason they have that rule is because I believe the mutual fund lobby spends millions of dollars a year to make sure that rule exists because every dollar that goes into private equity or venture capital or real estate or any other asset, it’s coming right out of mutual funds. The Tax Act of ’86 ensured that all the money went into mutual funds into the DC plan, which is another soapbox that I could get on. It’s absolutely ridiculous to think that a person who’s trying to work a job, live their life and who has no experience managing capital is gonna manage their retirement better than a professional in a DB plan. It’s just not gonna happen, and the data shows that.

I do think right now it is incredibly hard to get access. I’ll tell you how bad it is, and it is my one soapbox and I haven’t figured out how to fix it. My daughter called me, she’s a nurse down in Santa Monica. She called me and said, “Dad, help me with my 401(k),” or 403(b), I guess, not for profit. She has 11 choices, seven stock, four bond, no real estate, no commodities, no private, no nothing.

I started to get really angry because I thought, first of all, my daughter, who is a beautiful person, incredibly bright. She’s a pediatric oncology nurse, so she does God’s work. But she has no business trying to manage her money because she doesn’t have any training or any knowledge. And then every time, she works nights, she’s tired. I mean, just really bad idea. Plus, she can’t touch the money by law, for something like 46 or 47 years. So why shouldn’t she have 100% of that fund for the first 30 years in private investments, where we know you pick up an extra 400 to 500 basis points per year, compounded in an illiquidity premium? But you’re not allowed to do that, it’s against the law. Instead, she can put it 100% in cash, which to me is almost criminal because then you’re gonna lose to inflation, but that’s perfectly all right.

So, the deck is stacked against the average investor today when they try to get access to private. Now, it’s getting better. There are some new things. There’s some registered investment companies. There are some good things out there that are being formed. But, you know, one of these days, I’m gonna chuck everything and go to work on the soapbox and try to break down this barrier because it is wrong that Yale, Princeton, Stanford, Harvard can get access to the client or the sequoia, etc. and the average investor can’t. But that’s gonna change, it’s gonna change.

Meb: I wrote a very constructively critical suggestive article about the SCC three weeks ago, and then the SEC turned around and said, “By the way, you’re getting audited next week.” So, well done, SEC. We love you, if you’re listening, by the way.

Mark: Oh my gosh.

Meb: We’re confident whatever your case.

Mark: Well, you’re in good company, Meb, because that happened to Asness too.

Meb: One comment, there’s actually an interesting takeaway in the private side, because I’ve kind of gone back and forth many times on the private side, my ideas, and there’s all these new angel networks and there’s all these new secondary networks, like equities in where you can get access. You still gotta be accredited for most of them, but a lot of the crowdfunding rules are changing. I think, in general, it’s gonna be a terrible place for investors to probably invest a lot of their money because it’s kind of like the Wild West. So the people that do a lot of due diligence, it’s probably a good spot. You could probably pick and choose and do well, but I think like talking about the hedge funds, it’s kind of on you. You got to be able to pick the right companies. And this is coming from someone who just is closing a crowdfunding round.

But one of the most interesting thoughts that I’ve changed my mind on, and this came from I think listening to a Tim Ferriss podcast, who’s not historically in the finance space, is he said, “One of the benefits, not drawbacks of VC and private markets is the lockup period,” meaning you would make an investment in a private company and you can’t sell it. So forget one or two years bear market, whatever. You can’t sell that thing until there’s a liquidity event, in which many cases are five or 10 years, which for most retail investors would probably actually be a behavioral benefit rather than drawbacks. So not only are you capturing the illiquidity premium, you keep yourself from doing dumber things, which I hadn’t really thought about. Anyway, I think it’s sort of an interesting takeaway.

Mark: Couldn’t agree more. Could not agree more.

Meb: I wanted to ask you one more topic on asset allocation then we’re gonna move on. I was listening to one of your interviews on RealVision TV, which, listeners, if you haven’t subscribed, it’s a great Charlie Rose style video. We did one with the founder when we were down in the Caymans. Mark was talking a little bit about his asset allocation advice model for individuals, and you may or may not remember this but could you elucidate a little bit on that, you’re kind of three buckets that you talk about for most people?

Mark: And I think this is really important. Look, I think RealVision is the future financial media and it really is an amazing product and service. So for those who don’t subscribe, you should.

I believe that all of us, every investor should have three buckets. You’ve got your liquidity bucket, and that is to fund the next two years of spending. So it should be 10% to 15%. That 10% to 15% should be in truly liquid, cash-like, bond-like, you know, very low-risk things because you’re gonna need it to spend. And if you spend 5%, two years is 10. If you spend 7% a year, then two years is 14, so round to 15. So 10% to 15% in the liquidity bucket.

Then I say everybody should also have a get rich bucket. Now, the get rich bucket, I tell people that should be to own pieces of businesses, it should be income, real estate or whatever. But really, what people do with that, it’s their punting money. It’s the hot stock tip from their broker. It’s the thing they hear on CNBC. You know, God forbid it’s the friend’s condo deal or another friend’s venture deal, I would say, “It’ll lose all that. So just keep it small.”

So 10% to 15% is play money. Be willing to lose it. And if you hit a big home run, fantastic. If you focus on it and you’re really spend time on it, it can be incredibly productive.

So that get rich bucket has a hole in the bottom and it drips down into the middle, which is the biggest bucket, 70% to 80%, which is the stay rich bucket. And that stay rich bucket then has a hole on one side of it and it drips down into the liquidity buckets. So every year, you take 5% to 7% out of the stay rich bucket, replenish the liquidity bucket and hope the get rich bucket generates some good stuff. But in that stay rich bucket, that’s where it’s all about diversification. Because getting rich is all about concentration. Every large fortune in the world came from a concentrated position, concentrated stock position, concentrated business ownership, concentrated real estate, whatever it is. It came from concentration. And every small fortune also comes from concentration. How do you make a small fortune? Start a large one and stay concentrated.

So you need to diversify that stay rich bucket, and that’s where the endowment model, the sovereign wealth model, whatever you want to call it, the pension model. So you want to have some traditional assets, some alternative assets and some private assets. And there, I think a diversified portfolio, like you said, with a locked down asset allocation that you’re forced to rebalance to, because rebalancing does work if you do it on a periodic basis not monthly, weekly, quarterly but over annual and two and three-year periods, really rebalancing.

You know, it was an amazing piece that I saw recently. Michael Mauboussin reprinted it from something he wrote years ago, like Mason, that people who check their portfolio every day underperform those who check on it annually by 7% a year. I mean, think about that number.

Meb: It’s the old fidelity study that says the best performing accounts for people that either forgot they had an account or had died.

Mark: Yeah, or people who are my father in law’s accounts whether he has people owns cost basis in Exxon Mobil’s like 25 cents.

Meb: I think this is really important, listeners, because the stay rich bucket Mark talks about is, to get wealthy is often a different portfolio or skill set, and a lot of people that then grow to have a nice portfolio, wealth, whatever.

So whether it’s starting companies, selling a company, having a great concentrated stock ownership, whatever, they get wealthy but then they continue with the same concentration. William Bernstein talks about this, Buffett talks about this. Once you get to a level of wealth, the quote is you’ve already won the game. There’s no reason to put all of that at risk in a traditional concentrate. And you see it over and over. I forget the guy’s name in Brazil, one of the top five richest people in the world, but had a massively…

Mark: Eike Batista.

Meb: Yeah, like a massively concentrated position in life and then essentially lost it all. So, you know, one of the biggest things we say, we always talk about you’ve already won the game. Take a little bit less risk in the sense of concentration when you get to size, makes a lot of sense.

All right, let’s segue a little bit to some thematic and sort of investing ideas. You do a lot here on kind of a macro themes and thinking about… What are the main ones you’re thinking about today? And I’m gonna follow that up with following up on, Mark does a great article called “10 Financial Predictions Every Year.” And also, I’d like to say, what are the ones that you talked about last year that have surprised you that haven’t occurred?

Mark: Oh yeah, that’s interesting. The idea of the surprise, so I have borrowed this from Byron Wien, is a surprise is something that you think has a slightly better than 50/50 chance of happening, that if it did happen would literally surprise the market and would generate significant returns. Part of that goes back to this idea of variant perception.

Michael Steinhardt coined the term, and he said, “All of our big returns in life came from taking a variant perception, which is a materially different view than the consensus, because if it’s consensus it’s unlikely to happen.” So you have taken a materially different view and it’s not necessarily contrarian for contrarian sake, but when something becomes a broad consensus, you take a variant perception and you bet on the unexpected. In that theme, we expect to get about half of the surprises right every year. So, coming into this year, we had a couple that we are pretty confident about that the whole world thought that interest rates were going up, and we thought interest rates were going down. Interest rates are lower today than in the beginning of the year, even with the big rally in the last couple weeks.

That turned out all right. We thought that the Fed wouldn’t raise rates. You know, maybe they finally get around to raising them here in December, but I’m not so sure about that. So I feel like we’ve got that one. One that just did not work out at all is we thought Kuroda-San in Japan continued down the path of QQE and that the yen would continue to weaken and Japanese market would be a great market this year. And in January 29, he shocked everybody. When we thought he’d take out the bazooka, we didn’t know that he’d point it at his face and fire, with the negative interest rate policy. That was just a total disaster. So the yen, instead of going to 135 like we thought, went from 120 to 100, almost at 99 one day. And now it’s back on track and headed back towards 115, I think it was 113 this morning. But, you know, that one just did not work out at all.

Although today, we favor Japan again because we think this pinning of the yield curve is an interesting strategy for them. But that one didn’t work out. We had a view that the European banks would cause a black swan event in Europe because the big commodity trading companies like Glencore would go bust. That actually didn’t happen. The banks went down a lot. In fact, we kind of like them here, as a contrarian play, but not until the referendum on Sunday in Italy. See what happens there first. But Glencore did not go bust. In fact, it’s up like 300% this year. Companies that don’t go bankrupt are a great buy because they’re basically just an option.

If you had a very contrarian view on commodities, the commodities would have a great year this year after a five-year brutal bear market, one of the worst bear markets we’ve ever seen, some of the companies, again, with your rule of 90% were down 90%, 95%, 98% and we’re rare in for some big comebacks. So it’s been a very good view to have on commodities. And tied to that was our view that the dollar would not appreciate everybody, and I do mean everybody thought the dollar was gonna go up this year, and it’s basically flat year-to-date. It was down a lot before the election and it’s rallied a little bit post. Actually, it’s rallied really since July when Draghi said he was gonna cut purchases of bonds maybe next year.

We still think the dollar is headed down structurally, for lots of different reasons, which is a very contrarian view to, almost nobody agrees with us on that one. So we still think commodities look pretty good going forward. And then we thought high-yield was gonna be a lousy place. We believed Carl Icahn, with his danger ahead webinar that he did a year ago in November. I guess fortunately, we were right for the first six weeks of the year. High-yield bonds just got crushed, but then the world decided that they were not risky anymore, and they’ve been a great investment ever since. So we got that one totally wrong.

Meb: One of the things I do, and Mark has taken to the medium of Twitter quite nicely, I print out people’s top five most retweeted tweets, which is something you can actually search on a website called, Fav Star or Favstar. It’s a pet project of mine because I’m always talking about Twitter and all these curation services, they always get it wrong because the most popular tweets are always the ones that either have a quote or a statistic or photo, where the signal is to tweet themselves. Most of the traditional world looks at Twitter and says, “No, we’re gonna curate the links to like the Wall Street Journal’s, whoever’s talking about this link,” and that’s a completely wrong way to do it.

But unfortunately, you just answered about two or three of your favorite tweets. I’m gonna read them real quick just because I think they’re interesting. But there’s two quotes, one was… I think a Soros quotes but it says, “It’s not whether you’re right or wrong that matters, it’s how much you make when you’re right and how much you lose when you’re wrong.” So you touched on that sort of asymmetric payoffs.

Another one was talking about these big down markets, which is Templeton, which was, “To buy when others are despondently selling. Sell when they’re greedily buying requires greatest fortitude pays the greatest reward.” And then again, another one that you also touched on, which is interesting because I think I saw a tweet today from the Robin Hood conference where Druckenmiller was… And I just saw the tweets, so I could be taking it out of context, where he said, “There’s the possibility of interest rates going to 6% in the next year or two,” which obviously would be a very asymmetric move. I think it was only two days ago, it was one of your most popular tweets, is, “Everyone’s calling THE bottom in rates again, just like in 2013 and 2015, #KillerDs, #demographics, #debt.”

What is your view on the interest rate world? Because we talk a lot about this where we talk a lot about Japan, where we said, “Hey, look, when the Japanese bond went below 2% originally, hasn’t gone back above,” and that’s been years and years and everyone’s been waiting for this. But at the same time, we say you at least got to prepare or think about each possible scenario. What’s your kind of thematic view here? What do you call it, the lower for longer view?

Mark: Yeah, lower for longer and turning Japanese, #turningjapanese that I borrowed from Jonathan Davis. Look, I’m still in the camp. I hate to disagree with Druckenmiller because he’s way richer than me. So I do not like to disagree with the guy. What I believe and what I think is backed up by data and science is that the Killer D’s, demographics, debt and deflation, once they get control, they’re very hard to break. And again, we’ve seen this movie before. We went to zero interest rates in the ’30s during the great recession which eventually turned into the Great Depression after the Fed tried to raise rates in ’37 and plunged us into the Great Depression. But all from the mid ’30s up until 1944, we had zero interest rates. We did this thing called Quantitative Easing because no one would buy our bonds. So we had to buy them ourselves.

So this is not new, and people forget that working age population drives everything. So when you have lots of young people, so under 35, you have high inflation and you have low productivity and you have sporadic GDP growth. And that describes the 1960s and ’70s in the United States. You know, the Baby Boomers were all 25 to 35. Finally, 1980, they started turning 35, and boom, suddenly we took off. Everybody wants to say it was Reagan and the Laffer curve. No, it was demographics. When people start turning 35 to 55, they start being very highly productive. When they turn 45, that’s when you get the just massive increase in spending, consumption, wealth effect. People are buying their starter houses, they’re buying the trade up houses, they’re buying the extra car, their kids are in college. You know, massive spending. And demographics drives everything.

Then, once people start to turn 65, what happens? They spend less, productivity falls, and the government essentially has to issue debt to pay for all the entitlements they promised. So if you look at Japan, they’re precisely 10 and half years ahead of us, demographically. So their market peaked in 1989. Our market peaked in 2000. Their debt got downgraded in 1990, our debt got downgraded in 2001.

All the things that happen, they happen 10 and half years later. So, you know, everyone tried to short JGBs when they were 7%, when they were 6%, when they were 5%, when they were 4$, when they were 3%, when they were 2%, when they were 1%, when they were 0.5%. And it’s been called the Widow Maker. I think the same thing is true of the U.S., is in most of my career, people have been saying, “Rates can’t go any lower. You should definitely buy a fixed rate mortgage, not an adjustable rate mortgage.” People just don’t understand that in the United States today, every single day, 10,000 people turn 65. Same thing in Europe. Every day, 10,000 people turn 65, and 65 to 85 year olds do not spend like 45 to 65 year olds.

They’re not productive like 45 to 65. It doesn’t mean they’re not good people, doesn’t mean they’re not nice people, they just aren’t productive in the way productivity counts in terms of generating GDP and growth and velocity and money. I believe we’re not gonna see the secular low in rates until 2021, 2022, when the echo boomers finally start to turn 35 and start getting the family formation and the like. And the other piece of this, and this is not Mark, this is Van Hoisington Lacy Hunt, Van Hoisington Management in Austin, they have some great work that shows that government spending has a negative multiplier effect.

So deficit spending lowers growth and lowers interest rates. It does not increase growth and it does not increase interest rates, which everybody believes this new Trump policy is gonna work. It’s just not. People try to compare him to Reagan. How do you compare when we had debt to GDP of 30%, we had high interest rates, which are a sign of economic strength not weakness, we had 5.5% yield in the S&P? We had a PE of six, probably a cape ratio of low double digits, and that was a great time, demographically, because everybody for the next 20 years was gonna be in massive consumption mode.

Today, we’ve got 100% debt to GDP, we’ve got no yield in the S&P, we have no interest rate, sign of economic weakness. And you’re gonna spend more and expect to stimulate growth and higher rates. I don’t see it. I don’t see it.

Meb: It’s funny, I had taken to Twitter to ask if anybody has questions for Mark. I think we’ve literally answered every… There’s been about six or seven every question people have asked although. The most recent one was a little bit interesting, as you kind of segue away from sort of these sector thematic ideas a little bit about kind of your career. The most recent tweet question from Dad Invest was, “What’s your biggest learning experience during your career?” And that’s pretty broader question, so you may need to take a second to think about that one.

Mark: It’s a good question. It’s hard to pin it to one, but for me, well, I’ll give you a couple of answers. One, in terms of my business career, the biggest learning experience was trust your gut. And when you think someone’s a bad person, they are, and don’t stay in business with bad people. So that’s the biggest learning experience, is…

Meb: Quick to fire is great advice. I think it’s hard to learn that skill.

Mark: It’s hard. It’s very hard, but you know T. Boone Pickens had a great line to your point on that. He was on The Daily Show and Jon Stewart said, “Sir, you have this reputation of being kind of tough and quick to fire people.” And he said, “How do you know when to fire somebody?” He says, “The first time thatenters my mind.”

He’s exactly right, the first time you think it. The same thing with selling a stock, right? The first time you think it, do it. The other biggest learning in terms of investing is again to trust your instinct and not to overthink things, not to try to be precisely right. It’s okay to be approximately right. Don’t try to be precisely right because you’re gonna be precisely wrong. And that your instinct is really a very important thing. How do you get instinct? We only get instinct from experience and from learning and from making mistakes. Soros has the great line, you know, “I’m only rich because I admit my mistakes faster than other people.” And I believe that 100%, 100%.

Meb: I think that’s great. Another thing that we think about, is people often, we’ll talk about career advice and finance. So many people want to get started early these days, or so many hedge funds and investment funds and people feel if you’re not doing that in your 20’s or even your early 30’s. But I was listening to one of your interviews where you said, “Look, Kuperman, Soros, Robertson, all those guys actually didn’t start their funds until quite late in their career or quite age wise instead.”
Mark: Forty-eight, 49 and 50, yeah.

Meb: Yeah. And so they built up this huge kind of knowledge base before starting their firms. I mean, I look back and said, “Man, if I had started this, coming out of college or whatever, there’s so many lessons to have been learned.” Anyway, I feel like people are in such a rush that we had a good guest on the podcast a few weeks ago, what’d he say? He said, “20’s were for learning, 30’s were for earning.” And what were 40’s for? Owning? I can’t remember.

Mark: Capitalizing inject [SP]. The way I’m seeing is your 20’s are for getting educated, your 30’s are for building your reputation, the 40’s are for capitalizing on your reputation, the 50’s and 60’s are for enjoying your reputation.

Meb: I got a good education and learning how to ski in Tahoe in my 20’s, so that will be forever with me. We’re gonna start to wind down here. One question we always like to ask guests, going back to an old post, is there something that most people may or may not know about that you find particularly useful, beautiful, magical, you have some for us today?

Mark: I’ll kind of wrap it into three little things all around the same thing. So one is, one of the most useful things I think is getting outdoors. My thing is fly fishing. I also like skiing. But there’s something about being on a river, almost in a meditative state. That’s the second thing that goes to this, which is meditation. I’m still not very good at it, but it is an amazing practice. Mindfulness is an amazing practice. And all this wraps up to the one thing that really changed my life and the way I think about investing was a book called “The Tao-Jones Averages,” and DOW was spelled TAO. You can only get it now used on Amazon. It was out on print. It was written by this guy, Bennett Goodspeed.

He basically wrote about the merging of Chinese philosophy in investing, and how you need to use your whole brain in order to be a great investor. Most people think investing is all about the past and looking at data and being analytical, and it’s not. It’s about the future, which can’t be quantified, right? It’s that merging of past and future and being a whole-brained investor. And so, all of that which is, get outside, spend time alone, solitude.

You can’t think if you’re bathed in everyone else’s views. You need to be away, you need to be in that, I love your word, magical, in that magical state of being alone with your own thoughts so you can actually know what you really think. That’s why I love to write, because if I can’t read what I wrote, how do I know what I think?

Meb: That’s a good segue into mine because the one I have today, and I don’t think I’ve used this one. I apologize if I have. If I have, it bears repeating. It was an actual bike trip I did within the last five years but it’s called the San Juan Hut System. And I’m an okay mountain biker. I’m not great. But you basically go from the town of Telluride, which is in southwest Colorado, to the town of Moab, and it takes, I think, five nights or something. But the cool part is every night, you stay in a hut that’s stocked with food and beer and everything else. I think beds and sleeping bags, but meaning like cots and bunk beds. But it has everything else. All you have to do is bike in between the places each day, and it was one of the most magical, wonderful experiences. Now, granted by the end of the last day, I was kind of having a huge meltdown because I had crashed probably 40 times on this trip and had had enough.

But check it out. We’ll post a link on the show notes. Anyway, a really awesome, awesome experience. Mark, thanks so much for taking the time out today. I want to remind you that you still owe me dinner. I can’t even remember for what the bet was, but I’m not with you.

Mark: I do. It was the Seahawks, Denver, and I do owe you dinner. We will do it out your way because I need to come see my daughter and I’ll come buy you dinner.

Meb: Good. There’s lots of expensive sushi restaurants out here, I’ll take you up on that. People want to find more information on you. Where do they go? Where could people follow your writing?

Mark: A couple places. You can follow me on Twitter, @MarkYusko. You can come to our website, which is morgancreekcap.com. You can just search, Google for Morgan Creek quarterly letters and all my letters will pop up in PDF. But the website’s got links too. Those are probably the easiest places to find me.

Meb: When can we find the unveiling of your next year’s predictions? Will that be early January?

Mark: Yeah, third week of January, we will do the 10 surprises for 2017. On the 13th of December, we will do the review of what we call… Every month we do something called “Around the world with Yusko.” They’re a monthly webinar series. We’ll do the review of the year on December 13th at 1:00. This year’s called, “From Surprises to Soros,” because we did one on Soros’ first law, which is the worse a situation gets, the less it takes to turn around and the greater the upside. So we’ll talk a lot about those types of opportunities. And then the new surprises will be released that third weekend of January.

Meb: Listeners, I think we may have mentioned this before, but there’s one stock industry that’s gonna print six down years in a row. Mark, do you know what this is? Uranium stocks.

Mark: Uranium, wow.

Meb: Which I know nothing about but we did a fun article last year on coal stocks which are down five years in a row and they’re having a great year. Keep an eye out for Uranium stocks, listeners.

Mark: I will, because coal has done fantastic this year.

Meb: It was awesome having you. We’ll definitely have you out again sometime next year on the podcast. Listeners, thanks for taking the time to listen today. We always welcome feedback and questions for the mailbag, add feedback at the mebfabershow.com. As a reminder, you can always find the show notes and other episodes at mebfaber.com/podcast. Don’t forget you can subscribe to the show on iTunes, and if you joy the podcast, please leave a review. Thanks for listening, friends, and good investing.

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