Episode #70: Radio Show: The 13F Guru Meb Would Follow Today
Guest: Episode #70 has no guest, but is co-hosted by Jeff Remsburg.
Date Recorded: 8/31/17
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Summary: Episode 70 is a radio show format. We start with a quick catch-up, discussing the recent eclipse and Meb’s upcoming travel, including Iceland, Reno, Orlando, Amsterdam, among others.
Before jumping into listener questions, we get Meb’s thoughts on Episode 69, which featured Jason Calacanis (Meb dabbles with some angel investments himself). Meb tells us a bit more about his own angel experiences and his reflections on interviewing Jason.
This dovetails into a question about how Meb allocates his own money between private investments, public investments, debt, and so on (with a “capital allocation” comparison to Thorndike’s book, The Outsiders). You’ll hear Meb’s thoughts on his personal asset allocation.
This segues into our first set of questions from listeners, focusing on where to put “safe” money right now. Meb gives us his thoughts, leading into a discussion of which asset could be right for listeners wanting to keep some money on the sidelines, yet without inflation taking too big a chunk of it.
What follows is an assortment of questions and rabbit holes: If Meb had to short just one market right now what would it be and why… How an individual investor should look at leverage in a portfolio (includes a recap of risk parity)… Who is Meb’s favorite 13F guru… What hedge fund replication strategies Meb finds most interesting… And even a cryptocurrency challenge to listeners from Meb.
What is it? Find out in Episode 70.
Links from the Episode:
- 1:57 – Introduction, a look at vacation and what’s new
- 3:20 – Invest Like the Best Podcast
- 4:26 – Podcast episode #18 with Rob Arnott
- 4:50 – Meb’s travel schedule
- 6:32 – Jason Calacanis episode and what impact it might have on Meb’s angel investments
- 8:24 – Robinhood app
- 12:01 – Does Meb consider himself a capital allocator in his own investments and how does he allocate his own money into different investment categories
- 13:05 – Latest on Meb’s portfolio
- 13:56 – mebfaber.com
- 15:22 – “Take Lots of Risk, Or None at All? My Portfolio Allocation For 2016” – Faber
- 17:17 – Listener questions: Best way to invest in bonds and where would you put safe long-term capital right now
- 18:12 – “The Best Way to Add Yield To Your Portfolio” – Faber
- 19:30 – MaxMyInterest.com
- 20:00 – Best cash substitute that will match inflation while sitting on the sidelines
- 21:49 – “Sovereign High Yield Bond Strategy” – Faber
- 22:21 – Twitter question, if Meb had to short only one market what would it be
- 24:23 – cefconnect.com
- 27:59 – Meb’s feelings on bitcoin
- 28:41 – WhatIfBitCoin.com
- 30:15 – “Nervous About the Market? It Might Be Time for This Strategy” – Faber
- 35:05 – Memoirs of Extraordinary Popular Delusions and the Madness of Crowds – Mackay
- 35:12 – Sponsor: Roofstock
- 36:20 – How should an individual investor look at using a leveraged based approach to help maximize returns
- 42:50 – What does Meb find attractive about trend following
- 43:36 – If Meb could follow on money manager and their 13f strategy, who would it be?
- 44:32 – “Baupost, Tiger, Buffett Two Years Later July 18, 2012” – Faber
- 45:03 – Invest With The House: Hacking The Top Hedge Funds – Faber
- 46:45 – Can it add value to do a hedge fund replication strategy
- 48:48 – Andreas Clenow books
- 51:39 – closing thoughts
Transcript of Episode 70:
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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Generating great income from rental properties has never been simpler. To learn more, visit roofstock.com/meb. Again, that’s roofstock.com/meb. And now, onto the show.
Meb: Happy Labor Day, podcast listeners. I hope you had an awesome summer. We’re welcoming Jeff back. Jeff, welcome.
Jeff: How’s it going?
Meb: You look awfully tanned. Just got back from the beach?
Jeff: Yeah. Was celebrating my parents’ 50th wedding anniversary, which was great, except for my brother and his three kids were there. And they are a handful, to say the least.
Meb: Yeah, I have seven nieces and nephews. I can sympathize. My brother brought his out to California and we did the whole…I said one day at the amusement park is enough for me, and it’s, kind of…I have a lot of respect for the listeners here who have birthed and raised children. It’s a lot.
Jeff: I don’t know how you do it. I mean, they showed up with these hard plastic swords, my shins and knuckles are just…it’s just a sea of bruises.
Meb: Well, you look tanned. What else did you do in the south? Did you go shag? Eat some barbecue? Have some sweet tea? Some bowl of peanuts.
Jeff: A lot of barbecue. Barbecue is the greatest. You just can’t beat Eastern North Carolina barbecue.
Meb: What does that mean? Is that vinegar?
Meb: There’s a couple of these websites that do like southern food which get delivered out here, and do like an end of the summer Jeff-sponsored southern barbecue.
Jeff: I’d like that. Hey, did I say we got another bottle of tequila while I was gone?
Meb: Yeah, but since you took the last one home, I bought a bunch of limes, some triple sec. We’re gonna do margarita today or tomorrow, catching up with Patrick O’Shaughnessy on the podcast since it’s been about a year.
Meb: For clarification, that’s his podcast, not ours.
Jeff: Yeah, but maybe we should record and put it on ours too. Listeners, if you don’t find it here, go to Patrick’s. How was your time in Colorado with the eclipse?
Meb: You know, I found out, like in investing, there’s lot of parallels, there’s a big difference. We saw it…so we were in Colorado, and we went to a brewery with my mom and newborn. And it was 95% in Colorado, and one of the reasons we went to the brewery is because you couldn’t find the glasses anywhere. And I bought them, of course, but then left them in LA. So we saw it at 95% and it got dimmer and it was cool, but apparently, the difference between that and 100% is literally night and day.
We had a bunch of friends who were up in Jackson, it sounded awesome. I was supposed to be up there. I know, West, The Alpha Architect crew was there. They said it was pretty killer. So…
Jeff: Next time, I’m expecting to see some major dimming. And, you know, nothing…it didn’t even seem like there’s the slightest bit of darkness. So it’s very [inaudible 00:04:17].
Meb: It happens like once in a month, right? So it’s just, you know, a normal event. I’ll catch it next month. I think there’s one coming up like it’s in Texas within the next 10 years, so. Well, but that goes back to, if you remember Rob Arnott’s podcast, which if you guys haven’t listened to, is one of the best certainly in the first year. Rob’s beautiful, useful, magical, which is a question we ask all the guests in year one was to go watch the eclipse. We’ll have to ping him next time and say, “Where did you watch it?” Actually, he was going to Oregon or something.
Jeff: Yeah, I wanna say Portland. But we’ll have to get him back on and see where he went. You got some fun travel coming up. Where’re you off to?
Meb: A bit, you know, I’ve been more homebound with the newborn but I’m going to Iceland with my brother for a week, do a little fishing. Never been excited. It’s a lot cheaper than it was post-crisis as the currencies come down but it’s still I think really expensive. So any Icelandic listeners, come say hello.
Then I have about five work events. So in October, we’ll be in Lake Tahoe and Reno and also in LA. In November, we’ll be in Orlando, San Diego, New York, in Amsterdam. So if you’re in any of those places, shoot me an email. I’d love to say hello.
And then in early 2018…these are all work talks, by the way. Most of them public speeches. You might have to pay for some.
Jeff: I feel like you’re gonna need a lot of help in Amsterdam. I should probably come and assist you.
Meb: Well, early 2018 is Nicaragua.
Jeff: There too.
Meb: So I don’t know. You’re gonna have to take your picks. I think, Jeff, you’re probably most needed in Orlando. That seems more of your speed.
Jeff: You know, I used to learn from…that’s…
Meb: We’ll go to Universal Studios. So anyway, if you’re listening and you’re not in any of those events, but in those towns, shoot me an email, grab lunch, grab beer, coffee, say hi.
Jeff: Any early thoughts on when you’re gonna open up the office hours for people calling in?
Meb: Yeah, so that was a lot of fun. It’s really a lot of fun. It was a little overwhelming because I just booked too many. We’ll do it once a quarter and we’ll just do it a little more in moderation. So like anything, it makes perfect sense to do it just a little more spread out. But yeah, we’ll do it once a quarter. So once October rolls around maybe.
Meb: Once I’m back from Iceland.
Jeff: Cool. All right. Well, today, I thought we would hop into some listener questions. We haven’t done those in a while. But actually before we hop in, I wanted to bring up the last podcast with Jason Calacanis. I thought that was a great one and I haven’t had…
Meb: One of our longest ever. It was like an hour and half, if not, longest ever.
Jeff: You and I, our schedules were sort of misaligned. So right after we recorded that, you took off, and then I took off. So I haven’t had much of a chance to download with you on it. Curious, just your overall thoughts as it relates to your own experiences with the angel investments you’ve done. And if it gave you any sort of new perspectives on it. And if you’ll be doing anything new in your own accounts.
Meb: The concept of angel investing, we talked about it, and if you haven’t listened to our podcast, please go listen to it. It’s really, really interesting. You know, there’s a few benefits to that world that I think are unique. You know, one is that like small or micro caps, it has much less information. You know, it’s much harder to find information about private companies, particularly ones that are just starting up. It’s like selecting hedge funds. You know, it helps to have domain expertise. So be familiar with that scene, and the founders. What have they done before? Are they new? You know, what’s worked? What hasn’t?
Obviously, to have a little understanding of the terms of the deals, you know, all that’s just kinda basic. But some of the huge benefits being…we mentioned that Jason talked about it in his next version of the book. But he did mention that there’s huge tax benefits for investing in these angel companies, that if you hold them for five years, I think it’s up to 10 million or a certain amount is exempt from tax. So really monster tax benefits. So even if you could just match the SMP in the angel investments, it would be a big tax benefit.
And then the behavioural one, which is, because it’s private, you can’t sell. So the cool thing about these investments is they’re not quoted. So here’s the difference. Let’s say you do 50 angel investments, $1,000 each, whatever. Or you put money into a Robinhood account, which is free trading, and you buy 50 stocks. Those 50 stocks, you can look up every day. If the market crashes, if the person gets elected, you don’t want to get elected. Or there’s a catastrophic flood, you know, all these geopolitical events, Russia invades someone, you know, whatever it maybe.
They say the active investors on Robinhood check their account 10 times per day. Versus a private angel investor, like you can check it. Like, you don’t even know what the valuation is until someone else does a round, they get acquired or IPO, and, you know, if they do updates. So there’s a lot of…I’ve, kinda come around on a lot of people decry private investing for their liquidity, but it’s actually for individuals, I think, actually a big benefit.
Now, but a steep learning curve, you know, I think a lot of his advice, take it slow, commit to a long period, you know, start with small amounts you can afford to lose while you get educated, follow like a lot of the 13F stuff we talked about, follow the top investors. That’s the easy way to get started.
So it’s been a lot of fun. You know, I’ll certainly report back on results of it and how it’s going in the coming years. I mean, for me, it’s been a…I’ve been doing it for three or four years now, wonderful learning curve. Out of the, I think, 25 that I’ve done…the very first and only one has had the exit. Positives so I’m batting 100 or 1,000. So it’s been interesting.
Jeff: Were you vetting them individually yourself or were you investing along with the syndicate that you really know what you were doing?
Meb: It’s almost all those are syndicate or someone else, you know, has brought it to me.
Jeff: To what degree were you familiar and in what depth were the investments that you were putting money into?
Meb: So some…I do a cursory, kind of, inquiry into all of them, of course, because there are some businesses that I would just never invest in. There are some that I gravitate towards. Like, I think we talked in the podcast, I’d love the subscription boxes. You know, like anything that has a product and has revenue that’s growing, like that’s just a no-brainer to me. And some of them just makes so much sense. But a lot of the ones, and Jason echoed this, he says, “You know, if it doesn’t have a product or any traction, like it’s just a promise, that seems to me to be such a high percent just uncertainty.” I don’t know why I would ever do that. You know, you could wait and the biggest problem I have is…and one of the reasons I’m a quant, is…you know, at my core, I’m an optimist. So everything sounds like a yes to me, where in that world, you need to start…who is talking about this? Morgan, Hauser or somebody was talking about this where he said, “You need to start at no, and then get to a yes.” But I have come up with some parameters. I said, “Look, I’m gonna, you know, allocate a few percentage a year, and committing to 10 years of it.” Because in the next cycle down, if we ever have one, you know, certainly, valuations will come down, it gets more favourable for the investor of these different companies.
So just like Yale would at their private equity, you know, they do rolling vintages. So they’re putting new money to work every year rather than, you know, you’re just buying and forgetting about it. So we’ll continue to report back. I don’t know how. Maybe, we can end up doing some, sort of, research. Like, I really would love to do a research boutique focused on the space. So we’re off to spending out and hire four to five people to do it. But what kind of a fun dream job for young people? You know, just to track these deals, do deep dive research.
Jeff: I’m curious. I’m about to throw what’s in a completely random direction based upon something you just said. And I’m kinda curious to see where it goes. We might cut this off here in a second, but the outsiders, Thorndike, capital allocation. For listeners out there, the general idea is some of the CEOs who have done the best have been really skilled at capital allocation. Knowing when to buy back stock versus when to use excess money to pay dividends versus when to pay down debt, yada yada yada.
So Meb, to what extent…have you ever considered yourself as more of a capital allocator in your own personal finances? You’re just mentioning about throwing more money towards angel investments if the cycle turns. But if the cycle turns, chances are that, you know, publicly-traded companies, obviously, the stock market will be down as well. So to what extent, do you think about your own personal monies, and how do you allocate between the various opportunities available to you, public markets, private markets, paying down whatever debt might be in your own life, that sort of thing. Is there a plan?
Meb: I pay a lot of dividends. I pay a lot of dividends, which is buying our unemployed actor friends happy hours, you know, whatever.
Jeff: I thought you’re gonna mention your wife.
Meb: Entertainment umbrella. She doesn’t listen to the show, I don’t think. So we can start ripping on Jackie, too. I’ve been super-transparent with my portfolio the past five years. We publish it on the blog, and the way I think about it, you know, for new listeners, that summary and the way it is, it’s like, look, I don’t know what the percent number is but let’s call it somewhere between 70 and 99% of my net worth is in Cambria, right? And we also talk a lot about it this.
Hey, look, if you wanna build huge exponential wealth, you either gonna need to start a company, you need to invest in early stage companies or just a company or stock or an investment that has potential to b a, you know, a ten or hundred thousand bagger. Or you need to have equity, some sort of equity ownership in a company that can go exponential.
Most of the asset allocation stuff, we’ve talked about for a long time, you know, and in the “Global Asset Allocation” book, which, by the way, we’ve re-upped that at freebook.mebfaber.com. You can download that.
We just did a poll, by the way, and that was our most requested second edition. So we may have to update that book. Most asset allocation strategies are gonna get you 5% ROI per year. Okay? Great. Five percent ROI per year will make you incredibly wealthy over 40 years. It won’t make you incredibly wealthy over 5, 10, 20, if that’s your goal. So we’ve said before, when you’re thinking about, you know, kinda big ways to make money, whether it’s to start a business, hold the keys, meaning a lot of people have done it through real estate, which is, kind of, like, owning a business. You know, you own real estate and rent it out.
Jeff: What was fascinating, is what you just mentioned not too long ago about how the white…some reason white paper pointed out that rental real estate was the best performing asset class.
Meb: Well, because we had said historically, housing is not a great investment, but that’s because you’re living in a house and using it. But if you were to buy a house and rent it, you know, you’re getting that income. Same as if you bought farmland and did nothing with it, you’ll probably keep up with inflation, but if you farm the farmland, same as renting a rental property, you know, you’ll get that income.
And there’s definitely a delicate balance. You know, a lot of that works out to where it’s in, you know, a lot of the big asset classes are in balance, you know, for their volatility holding periods. But okay, so going back to your original question, we’ve already gone off on the tangent.
You know, so most of my net worth is in Cambria. So you know, we did a fun blog post, which was along the lines of given that…and, you know, a couple of other, I mean, Idea Farm, a couple of other private companies. So given that, you could theoretically, like, you could do a debate with pro and con, where someone could say, “All right, Meb, given that most of your wealth is in this company and you’re young, you could have a portfolio that’s extremely risky.” Quote, “risky,” right? “Because the outcome is gonna be determined by this, so you may as well be really risky with this.” Or you can make the argument, “Well, because your outcome is gonna be determined by this, there’s no reason to take any risk with that.” And like I think both of those could be totally acceptable for different types of people.
So anyway, my kinda takeaway is like after you take out Cambria and Idea Farm, and the $68 we make a year on selling books, if that…probably not even that much. Then the public portfolio is it’s Trinity…I think I’m now like a Trinity three or four, and everything just goes into that. Then, you know, I announce when the tail risk strategy TF came out that I put 10% into that. And maybe even put more. I mean, to me, that’s…at this point of the cycle, it’s a great, sort of, cash parking bond substitute. And if and when, I think the market rolls over to its…you know, into a down trend, which may not happen for 10 more years, who knows, that could be an additional re-up on that. You know, to me, that’s, kind of, a cash bond substitute at this point.
And then, oh, sorry. I neglected farmland is probably as large, if not larger than my public equity portfolio. So that’s obviously inherited. It has sentimental value. It’s kind of like a bond. The government has made it so that farmland is kind of subsidized to the point where it’s okay investment, but, you know, not fantastic with wheat prices where they are. If wheat prices quadruple, it’s a different story.
Jeff: Let me jump in right now because you touched on something that’s a good segue into some of our listener questions. So you mentioned how tail might be a proxy for cash right now. So we have two questions that are somewhat similar. Let me read them and we’ll launch into your thoughts. First is, “What’s the best way for a high net worth individual to investment in bonds? Because the high tax is in very low default rates and munis are a preferred method. What are your thoughts?” And related to that question, “Where would you put safe long term capital right now? Long term bonds? Short term?”
Meb: Okay. I think you just asked six questions in one, so…
Jeff: There’s a fair amount in there.
Meb: I think the original question was like angel investing, then your personal portfolio. And then somehow you had started the question with tail, and then went into bond. So okay, we’ll talk about a few different things.
So going back to the public market portfolios, I think you should be spending zero time on your public market portfolio. And we did a post on this called like “The best way to add [inaudible 00:18:12] your portfolio is to stop spending time on it whatsoever.” And it’s something like unless you have like 20 million or more, the time you spend on the portfolio, unless it’s fun and you enjoy history and being interested in investments, that’s fine.
But if you actually just care about the return on investment, you should basically spend zero time on your portfolio, and go spend your time doing other stuff. Whether it’s investing in yourself, getting more education, trying to get a better job, working harder, or at least focusing on investments where there is potential to add serious value.
But the public market portfolio, if you look at all the asset allocation portfolios in the book, they all did like 5, 6% per year. The spread was 1% total over the entire period. So why would you even mucking around with those allocations? Just set it, forget it, and move on. Now, if you’re then talking about some of the other stuff you’re talking about, so, like, you know, if you’re talking about bonds. You know, bonds play a role in that portfolio. You say, bonds, bonds means a lot of things.
So U.S. government bonds are totally different from corporate bonds which are totally different from muni bonds, which are totally different from…you know, even if you look at government bonds, zero coupon bonds, 30-year bonds are totally different than one year T-bills. You know, so there’s a very wide spectrum.
I mean, for the most part, short term government bonds are fine, cash substitutes. We mentioned CDs or a MaxMyInterest was a really cool website that maxes out your savings account. So you get one and a half percent or whatever it is that is protected up to the 250 grand limits.
So safe money is you don’t do anything. Now, if you say, “Look, I actually am super worried about inflation.” Then you do diversified portfolio. You could have more in bonds than the minimum global market portfolio, but that will kinda get you to that real positive returns, but it’s not risk-free.
Jeff: What cash substitute right now do you think is gonna be the best job of matching inflation and giving you some protection for the people who are, kind of, saying, “I want some money on the sidelines right now. I don’t wanna go into a tail strategy. I just wanna sorta sit and watch, but I don’t wanna get eroded too badly.”
Meb: I mean, T-bills historically keep up with inflation. So I mean, a bank account that pays you one and a half percent is gonna come pretty close to keeping up with inflation. Inflation, is kind of in that 2% ballpark. I mean, it’s not that big of a difference. And so, you know, if you want a super low ball portfolio, you could have 60% in that cash and then 40% in the global market portfolio. Like, the global market portfolio, historically, is what, drawdowns…most of the asset allocation portfolios will have a 25%, 30% drawdown at some point. Really, aggressive ones would have had, you know, 50% plus in ’08. And if you go back far enough, it’s probably two-thirds. So the more you add cash to that, the more kinda buffer that we’ll have. And I have no problem with cash. I also have no problem, like, if you wanna do 80% of your portfolio in cash, and 20% in angel investing, like, that’s reasonable to me. If you wanna put 100% of your portfolio in dividend aristocrats, like I don’t care. There’s ways that I do it, and ways that I think are better, but if you find what works with you, I’m cool with that.
So one more thought on bonds. So a lot of people get really worked up about, for example, government bonds in, say, Europe, or where there’s super low yields, Switzerland and Japan. You know, that foreign government bonds yielding like half percent, some of which were negative. And people pull their hair out and say, “How is this possible in this world?”
And there’s two things that commoners neglect. One is it’s, yes, I would not invest in those and in general. And two, is that if you’re going to invest in foreign bonds, you know, we did a paper that says, “Sovereign high yield bonds makes more sense that sovereign low yield bonds.” That’s just value, that’s carry.
There is a scenario though when low yield bonds are a great asset class. And from a, say, U.S. perspective, if the dollar is overvalued and those bonds, those currencies appreciate risk to the dollar. And also, it’s a really big deflation environment, where interest rates go even lower. But in general, yes, it doesn’t make a whole lot of sense to be buying 50 beeps bonds when you can get one and a half in a bank out here.
Jeff: Back to the question from Twitter here, “If you had to short one and only one market right now, what would it be and why?”
Meb: I love the Twitter questions because they have no context, right? It’s like, “Okay, well, what are my assumptions? Do I have a diversified portfolio? Am I sitting on 100% in cash? Or is it just like gun to your head?” You have to pick something to go down. That’s what I’m saying but in the last part…
Jeff: I would think it’s basically a proxy for what do you think is too richly overvalued that’s got a turn right now?
Meb: I mean, I think a safe bet is always sorting a basket of overvalued on a value composite basis U.S. stocks right now. That’s one. But putting that into implementation, is hard because, you know, you have to pay to borrow those stocks, whether where…most individuals, that maybe really expensive, depending on your brokerage. You may not get to borrow at all. If I had to short one thing and the borrow rate wasn’t crazy, it’s the close-end Bitcoin fund that trades at a 100% premium to the price of Bitcoin. I get states straight up on…like, you know, what the fund is valued at, but because it’s the only way for people to publicly trade Bitcoin, it trades at a 100% premium. That is a no-brainer, sure.
Now, like, if you own a bunch of Bitcoin, why would you not short that? And the answer is probably because there’s no borrow. Like, I don’t know that you could probably get much of a borrow anywhere. I haven’t looked into it but I cannot fathom why you wouldn’t. I also can’t fathom why that trust wouldn’t issue a ton more shares while they’re trading at 100% premium. But that happens in the close-end fund world. And one of the beauties of ETFs is they trade pretty much always right around that asset value because of the creation redemption structure. Close-end funds don’t.
And so close-end funds, I mean, this can actually be an opportunity too, is, you know, often we’ll trade plus or minus 20% within that asset value. When asset classes go out of favour, and you could probably look it up right now, there used to be a great website, probably still. It’s called “Close-End Fund Connect.” And I think it’s CEF Connect and that someone bought them, maybe Nuveen.
But there’s a bunch of funds on there. You can sort them by discounts, some of them are leveraged. So you gotta pay a little attention. So you can go in and look for funds that are trading it, 10, 20% discounts.
Now, the problem is just people would say, “Well, Meb, why wouldn’t you just buy those?” Well, the problem is most of those funds charge like a percent and a half. So yes, you may get it at a discount, but waiting for the discount to realize, it may be worthless if you hold it 5, 10 years, and you’re paying what would be costing an ETF, 50 beeps, right?
Jeff: Also, in some of those situations, they trade at a discounted premium, sort of, in perpetuity.
Meb: So you want the ones that kinda osculate. I mean, my favourite example of markets not being rational is the Cuba fund. We’ve talked about this on the podcast before, tickers Cuba. It doesn’t own Cuban stocks, it owns stocks that the manager thinks has exposure to Cuba, but, you know, will trade it, plus/minus 50 all the time to that asset value.
And so some of the country ones will osculate, and some, like you said, are just forever…and by the way, it’s kind…like, the close-end fund structure is, it’s kind of amazing it still exists because the people that invested in the IPO immediately get hit with essentially like a 8% load. So if you’re a broker, and you put someone in to this close-end fund IPO’ing, like, I don’t know how that passes fiduciary rule because you could get wait one day and get it 8% cheaper.
So it’s this really like…I mean, it’s the best possible structure in the world for money managers because it’s pin-up capital forever. You launch a $200 million fund, charging 2%, sweet. You just got a fund that the money doesn’t go away. Like, the money can trade hands-on secondary, but that $200 million fund is there, essentially forever. So huge cash-flow generator, which is obviously why this structure exists, but it’s not for the end investor.
And I don’t wanna go as far as to say if my money manager put me into a close-end fund at IPO, I would fire them but I would be pretty darn close. I mean, it’s the same thing as going into mutual funds with these huge loads. Like, maybe in the ’90s, or ’80s, or ’70s, or ’60s like that that was the only choice to get into these. But you live in a world of opportunity where you don’t have to pay these huge loads.
So I think close-end funds are great from a tradable perspective. So if I had to short one thing, it would probably be that fund. You could do all sorts of pair-trades with other things in that, to just kinda shrink that premium. What was the first thing I said I would short? Oh, yeah, basket of expensive U.S. stocks.
Jeff: And on that note, a basket of expensive U.S. stocks, I’m curious how you see that trade off, because on one hand, you just said that you would short that. On the other hand, you know, I’ve heard you talk about the various four quadrants of the U.S. market, cheap and getting cheaper. Oh, well, basically expensive but well-valued cheap, well-valued, yada yada yada. So here we are right now…
Meb: I mean, I would love you to say, I’d buy…I mean, I have 10% of my net worth in a short which is long puts on the U.S. stock market partnered with long term bonds, right? That’s the fund we own. But I mean, if I could say a system, like, I would love to short that U.S. stock basket when stocks go below their long term moving average. Like that’s a great short.
Now, I would love to build an entire portfolio that will go short markets when they go below their long term moving average. Well, you just described managed futures, which we always allocate to. But I think the question was really just, “Hey, Meb, subjectively, if you could short something, what would it be?”
Jeff: So you hate Bitcoin.
Meb: And are we really gonna go there?
Jeff: No. No, we’re not. We’re not.
Meb: Because if you don’t have any more questions, I could go on for five hours. Dude, I just got, within the past week, almost every single person that shouldn’t be asking me about investing in cryptocurrencies has. And that is a great sign. I mean, we’re talking doctors, people texting me that I haven’t heard from in four years. And looking at the text, the last text thread was like 2014 asking about something other, just insane thing. And they’re all talking about cryptocurrencies. I mean, Floyd Mayweather just promoted too, before his fight. It’s just…don’t even get me started.
Jeff: Have you gone to the website, “What If Bitcoin?”
Meb: Ridiculous. But so the funny thing about…let’s talk about…you know, as we talk about asymmetric payouts, I mean, look, Bitcoin…and I don’t wanna sound like a bitter. I’ve never had any investment in crypto. I’ve been a pleasant happy cheerleader for crypto. I think it’s great. I would love to see it become ubiquitous. I emailed, a fellow that I had breakfast with in Mexico City a few years ago who owns like majority of the world Bitcoin ATMs. And I emailed him, you know, I said, “Hey, you’re still doing this?” Because I saw a chart somewhere online about all the Bitcoin ATMs, which is like the really smart way to go about it, which is, you know, the picks and shovels, right? The gold rush.
But look, I’ve been cheering for cryptocurrencies, but thinking about these huge 10, 100-bagger. And in the case of Bitcoin, depending on how far you go back, 1,000 or 10,000-bagger, and all the FOMO that people have about Bitcoin. Well, like that happens all the time in stocks too. You know, for a stock, let’s say, over the angel investing, if you got in at a million or 10 million, then it goes to a billion, that’s a 100 or 1,000-bagger. And then if it goes to 10 billion or Bitcoin would be right around market cap of like 70 million. So we said on Twitter the other day, that it’s around a Starbucks or an AMX. So yeah, that’s pretty awesome. I mean, that’s essentially what Uber has done. So like Jason did. He invested in Uber. And he went up all that way.
People also forget how hard it is to hold something like that. So if you look at these all kinda 10, 100, 1,000, 10,000-baggers is that, you know, they go through gut-wrenching drawdowns.
Jeff: Yes, it’s been brutal. If you look at Bitcoin it’s been brutal.
Meb: Same thing for Amazon. I mean, Amazon, we wrote a paper on this that should be out by the time this podcast comes out on tail rescheduling, you know, Amazon has had these multiple 50…I think it even had like a 95% drawdown, you know? And so, like…and if you would say you invested 100 grand, and went to a million, and 10 million, then your 10 million went down to 100 grand again or 500 grand, could you sit through that? I don’t…you know, that’s really hard.
So a lot of these theoretical charts that show, you know, the performance is…don’t include their behavioural aspect. Anyway, you’re seeing more and more speculative behaviour. And I think the question that everyone should ask themselves, say, let’s say they’re convinced they’re going to invest in cryptocurrencies or whatever. I say, “All right.” “Someone told me about this the other day.” I say, “Okay, what’s your plan there?” “Well, I think I’m just gonna buy some and see how it goes.”
And the buying is the easy part. Like you need to come up with either a system or a concept on how to sell it. So that’s not an approach because what’s gonna happen, it will go down at 50% and you’ll sell it, you just lost half, so, done. You could say, “Hey, look, I’m gonna buy them and hold it for 10 years.” And that’s my…I will literally not look at it for 10 years. I will not touch it, whatever. Or “I’m gonna buy the top 10 cryptocurrencies, and I’m going to rebalance that once a year.” That’s essentially market cap, equal waiting, same as stocks, you would. That’s totally reasonable.
I would love to see someone…all right, listeners. Here’s a challenge for you. If you can go get “The Original Turtle Rules,” so the trend-following rules published. I think Covel has done it, or there’s some PDFs floating around. Very simple trend-following methodology, and you apply it to, say, the top 10 cryptocurrencies each year for the past four years and build a portfolio of it, long flat. I don’t think you would wanna go long short. Although, I guess you could. I would love to see that simulation. It’d be a great article. That is a totally reasonable approach going forward.
Jeff: It would be a monster, I would think.
Meb: But, again, I don’t know how easy it is to trade cryptocurrencies. A lot of these wallets charge like a couple of percent per trade, just getting in and out. So you have a round trip of 5%. Anyway, so, look, I’m happily cheering for it. I don’t have any FOMO about it. I’m sorry. We just derailed the whole podcast.
Jeff: Well, are you ready to move on to another question?
Meb: Sure. And instead of two bottles of tequila, you guys can send Jeff and I…
Jeff: Some Bitcoins?
Meb: I was looking at an article today, it’s like, “The 10 Most Ridiculous Cryptocurrencies.” And two or three of them were meant to be jokes. Like it was literally like a joke, and one of them has a market cap of like, $200 million now, you know. It just…but, again, look, I say this with a smirk because you look at the equity space and look at half these companies that are in Utah and Vancouver that, I mean, my God, mining and biotech and internet in the late ’90s.
And actually, this might be a good time to read this. I printed out, this is from Twitter. It was an interview with Scott McNealy, who used to ran Sun Micro back in the day and they sold it to Oracle in 2002. And this journalist says, “Sun stock hit a high of $64 bucks. Did you think what tech stocks are doing two years ago was too good to be true?” And he talks about his wife for a minute, but he says, “Look, two years ago, we were selling at 10 times revenue when we were $64 bucks. At 10 times revenue, to give the investor a 10-year pay back, I have to pay you a 100% of revenue for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes, I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is also very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having that, would any of you like to buy my stock at $64? Do you realize how ridiculous these basic assumptions are? You don’t need any transparency, you don’t need any footnotes, what were you thinking?”
So I think with a lot of investments, you know, you start to do the math or you’d talk about some of the cryptos or whatever it was with people. And in many cases, they just don’t check the common sense box.
Jeff: Where do you see the biggest parallels to that quote right there, and where we are today?
Meb: Everything, I get in my inbox from people and friends and seeing the media about like these ICOs, Initial Coin Offerings, I mean, some of the most nonsensical stuff. One person sent me an offer…these are unsolicited, by the way. Please, do not send me any ICOs, listeners. You know, send me an offer and really had nothing to do with the business. And it all had to do with the potential price increase. And you know, it’s a lot of speculative behaviour. Go read, “Extraordinary Popular Delusions.” That will give you a lot of perspective. So I…anyway.
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Jeff: All right, moving on. Another question here from a listener. “I’ve read how institutions build portfolios with a low Sharpe and leverage up to a specified risk level. How should an individual investor look at using a leverage-based approach to help maximize returns or should they at all?”
Just backing up here, we haven’t really talked a whole lot about using leverage within a personal portfolio. Why don’t you just give some overall contextual information on, you know, the pros and cons, and then launch into your answer?
Meb: First of all, the person that asked the question, I think misstated it. It’s that, “Institutions try to maximize their Sharpe ratio and then leverage it.” You don’t want a small Sharpe ratio because that’s return per unit risk. The formula is literally return minus risk-free rate divided by volatility. So you want a high Sharpe ratio. But that goes way back to Sharpe and Markowitz, and everyone that was doing the capital market line. This is, like, investing 101 in college, where, you know, the risk versus return, you have all the asset classes as a shotgun blast. You have the curve that kinda shows the optimal amount per unit of volatility. And then you have the line that’s tangential to that that shows you what would happen if you de-risk the portfolio.
I mean, let’s say the global market portfolio was the optimal Sharpe. All right? So whatever that allocation is. And then you start adding 10, 20, 30, 40% cash. You know, that will take you down the line. Or you start borrowing money or leveraging it using derivatives, same thing. And that starts to take you to the 10, 20, 30, 40, 50, 60% leverage. Okay? There’s nothing inherently wrong with leverage. It simply is what it is. The problem is that most asset classes are volatile enough, and it just exasperates the…exasperates the…I can’t talk.
Meb: Exacerbates. That almost got a little R-rated. It makes the behaviour worse. You know, people can’t handle volatility already. If you can’t handle 20 standard deviation of stocks, what makes you even handle 30, 40, 50? So people…the old Chinese expression, “Fish see the bait but not the hook.” But there’s nothing wrong with it and so that underlines a lot of the basics of, for example, risk parity thesis, which is, some of the earliest things we were talking about in the blog a decade ago is kinda the…Bridgewater was talking about it, a lot of the quant shops do it where if you get a little zing about it and say, “Okay, well, all asset classes, different correlations,” but in general, they have fairly similar Sharpe ratios.
In an efficient market, mostly efficient market will push the opportunities that have fairly similar Sharpe ratios because if one market gets too attractive, then people wanna invest in it and then push it back down to, you know, a reasonable. And if it gets on the flip side too [inaudible 00:39:13] people will sell it. So in general, it’s fairly efficient. And so, most asset classes have that Sharpe ratio 0.2, 0.3 over time.
I imagine if you look at the SMPs since the global financial crisis, it probably got a Sharpe ratio of like 1.4. It’s gone straight up, low volatility. But over time it’s 0.2, 0.3. Diversified portfolio, you get up around 0.4, 0.5., 0.6. Anyway…but the thesis was, when you think about leverage, there’s no reason to necessarily accept an asset class at the leverage and volatility that has pre-packaged that for you.
And here’s an example. SMP 500, almost all the companies in the SMP 500 stocks have debt. So they’re already leveraged. So you could say, “All right. Well, I’m gonna pair the SMP with 10, 20, 30% cash to take it down to instead of a volatility of 17, take it down to a volatility of 10 similar to 10-year government bonds.” So then, if they have the exact volatility, the returns are probably similar, but not necessarily. So then, it becomes a question mainly of correlation.
And so you can build a portfolio, and this is the basics of risk parity, is you build a portfolio of highly uncorrelated assets and as many as you can get. Unfortunately, there’s not that many betas out there. Stocks, bonds, real estate is kind of a mix of the two. Certainly, commodities. If you have the ability to others like cat bonds, farmland, etc. put them all together and target a certain level of volatility. Or a certain…that’s the way that most people do it. So say, you target 10 vol, or 15 vol, or 20 vol. It’s really easy to do, and then you simply can lever up or lever down that portfolio to whatever you desire.
The biggest critics of risk parity are that, kind of, by default, it means, you invest less in the more volatile stuff, which historically has been stocks, and REITs, and even commodities, but mainly stocks. And you invest more in what’s historically been low vol, which is bonds, particularly, U.S. government bonds. And the critics say, “Well, particularly, right now, after 30 year bull market in bonds, that may not be the best idea.” But it’s just another asset allocation strategy.
And so we featured a couple of this in the book. And so typically, they’re run…if you look at a typical risk parity fund, and there’s probably a dozen of these, they target maybe 130, 150% total exposure. So they’ll invest like 70% in bonds or 60% in bonds, and the rest in other, and then they’ll leverage it one and a half times.
So you could actually theoretically have that portfolio and leverage it one and a half times, and it’s less risky than stocks, right? Because it’s diversified and theoretically, a lot of the non-correlations bounce out. The problem with that, I think ’08 was tough for a lot of these kinda buy-and-hold funds is a lot of the correlations they expected to be consistent weren’t.
Now, if you’re a student in the market, you shouldn’t have expected that. If you went back to the ’30s and other times when kinda everything went down and the deflation area is sort of bare market. But I’m totally fine with risk parity allocation. And in some of the risk parity-esque allocations in the book, you could argue permanent portfolio is kinda risk parity-esque. There’s a couple more in the book that are similar to that, or some of the most robust across decades. But they also tend to be asset class agnostics, so you may see stuff in there that’s atypical like gold.
Jeff: Well, you’re a trend-follower at heart. What is it about trend-following that you find more attractive than risk parity?
Meb: Trend-following is the assumption that, at some point, you’re going to sell. So risk parity is still another buy-and-hold allocation. And that allocation could go down 99% or 100%. And trend following at least…at least you’re trying. It may not be better, it may not work, and I could come up with a lot of environments where trend-following does very poorly. Personality speaking, I think trend-following fits me because I have a hard time sitting through an asset when it’s having that large of a drawdown. Particularly, the famous assets, U.S. stocks or just stocks in general.
Jeff: All right, another question here. Your 13F strategy. We’ve talked about it in the past podcast, where you basically tracked a famous money manager, and you can look at what they’re investing in, and U.S. stocks and their 13Fs. Right now, if you had to follow one famous money manager with their 13Fs, who would it be and why?
Meb: By the way, I didn’t know this. I think a reader sent this in, Maverick, which is a pretty famous multibillion dollar, if not $10, $20 billion long/short hedge fund. Lee Ainslie runs it, a fellow Wahoo. They have a 13F tracking fund that trades in Europe. I didn’t know that. It doesn’t exactly say 13F, but it says, “Tracking the stock picks up other managers in our circle.”
Jeff: You said in Europe?
Meb: I think it’s in Europe or…oh, no. No, no, no, it’s in Australia. Anyway, that was just interesting to know because they’re one of the ones we look at in the book.
And if I had to pick one, you know, I’ve…hanging on the wall here is the only article I’ve ever published in Forbes print. August 2010, seven years ago, but I talked about Baupost and it was actually funny because I remember getting super heckled. There’s so much misunderstanding going on with 13Fs. Ninety nine point nine percent of the people have never looked at the historical data. So they said, “You can’t follow a manager if they bought these 10 years…” You know, like they’re just…it’s the most non…it makes CAPE look like a boring debate. Like these people are so uninformed…it drives me nuts.
So that’s originally why we eventually wrote the “Invest with the House” book. It was one of my favourite books. It’s up there as one of the favourite books we’ve written. But I feel like people have kind of lost interest in that world in the last few years. I don’t know why, because it’s just a gold mine of ideas. So if I had to pick one, it’s always…I got a special part in my heart for Baupost for some reason because that was the subject in this article. And so, I got all these hecklers in the comments, and within the first month or two, something like two of the stocks I mentioned in the article got bought out for like 50% premium. So this is like, immediately went up like a huge amount.
Anyway, of course, no one checks back in on an anonymous heckling comments they make on the internet months later.
Jeff: Did you follow Baupost with your money at all?
Meb: I used to. That used to be my whole IRA before I moved on to automating it and moving on. But I don’t see anything wrong with Buffet’s portfolio. You know, people…it’s under performed for like the last decade. So it’s probably a great time to be getting interested in the Burch portfolio. There’s a lot of those guys that are…You know, Appaloosa has certainly been the gunslinger, the one that’s had the best returns, I think. But there are still great personalities in that book. That was either the second or third most requested second edition update. That would be pretty easy to update actually.
And then we used to do a yearly piece back when I wrote “Ivy Portfolio.” In 2007, we listed a bunch of funds, and those funds used to be the SMP but it was like 4% a year for a few years, and I stopped updating it just because it was too much work. And individually just, I was like, “I gotta write the book.” But I think there’s a lot of interesting insight there.
Jeff: Let’s do one more and then call it a day this time. Okay? All right, there was a question about hedge fund replication strategies. Can it add real value? So why don’t you describe for us, generally, you know, what the average hedge fund strategy or preferred asset class is? Then tell us what these replication strategies are, and then whether they work.
Meb: That means three different things. So the one that we just talked about would be called a “holdings based.” So you’re literally replicating what they own. So looking through…and that’s you either use the public disclosures for 13Fs for equities or…and by the way, read the book because there’s so many bad ways to do a 13F replication. And so many bad ways that some of the biggest shops out there do it. Goldman’s VIP and anyone who invests in the most popular holdings, it’s like the worst way to do it. You’re just getting a crowded hedge fund basket. It back tests horribly.
Jeff: Just market cap based?
Meb: No. Like they invest in the stocks that the most hedge funds are owned. That’s a horrible way to do it. Anyway, so the second way you can replicate a hedge fund is like what they call “factor based.” So you look at the return stream of the hedge fund index. And there used to be a ton of papers out there, and replicate that return stream. The problem with that is you don’t want the betas of the hedge funds. That just gives you like a 60-40 portfolio leverage. Like it’s not interesting or whatsoever.
And then the last way to do it, which I think is the most interesting… Well, I like the 13F, if done correctly. The last way to do it, which is the most interesting and accurate is rules-based. So for a lot of the strategies and Bridgewater used to write a ton on this, and we used to publish on the blog. And so like managed futures for example. A former hedge fund alpha strategy that only a few people did, that’s now a fairly simple. A lot of people do it different ways, but most of them do it, trend-following and generally the same.
So you could write down some rules and replicate that strategy with high correlation. There was a book on this called…by Andres Klenel [SP]. I always murder his name. Sorry, Andres and I’m blanking on the book. Anyway, he replicates a lot of the famous managed futures’ managers and he comes with a very high correlation. We have to get him on the podcast, by the way.
And so, but you could replicated long/short equity. You could replicate, certainly like convertible arb, merger arb. That’s a really easy rules-based portfolio. Some, you can’t. I mean, short. You just short the SMP or short the Russell, that’s essentially what you get. So there’s a handful of…but the problem, again, with all of these, it’s fine if you’re teasing out the beta. So managed futures’ beta, I think is great, but a lot of these others, it’s not…like it’s something you wanna pay five basis points for.
And so that’s…I mean if you look at the hedge fund indexes, it’s one of the first articles I ever wrote. It got published in a European, I think it was in a London magazine, about the hedge fund replication indices. And the ones that you couldn’t invest in were already mediocre. The ones that actually were investible, were four percentage points worse than the broad ones.
So the indices have been pretty poor. I think managed futures have actually been a stand out. BTOP50 is kind of one of the famous ones.
Jeff: Was this another situation though where you would basically say, “Look, I mean, you’re splitting hairs.” The average investor listening to this, should not be wasting their time trying to worry about hedge fund replication strategies. You know, as you pointed out, 20, 30 minutes ago, you really shouldn’t be trying to…if you’re spending more than whatever the hell you said, 10 minutes a week, a month, you’re spending too much time on your portfolio.
Meb: The beauty of the hedge fund replication strategy is at least you’re not paying 2 and 20. So now you’re maybe paying 50-basis points, if anything. So yeah, you could replicate private equity in venture capital by investing in a simple quant screen that does small cap value, that’s a little bit leveraged or you invest in small cap value leverage companies. There’s a lot of academic papers on that.
So for example…so you don’t have to be Yale. You could just do small cap value but concentrated and certainly in really small cap. So yeah, I mean, rules-based, if you still think you can pick the perfect great managers, have at it. Wonderful. That’s awesome. But I think the rules-based, in some cases is useful, in some cases, yeah, just move on.
But a lot of the stuff that it is now, what people call “smart beta,” there’s this evolution from alpha to whatever you wanna call it, alternative, systematic beta to just beta. You know, so, at one point, all of these things may have been considered pure alpha, 2 and 20, but they got commoditised over the years. And now, for the most part, are things that trade for half percent or less.
Jeff: All right. Well, we are out of questions. Anything you want to add on this one?
Meb: No, as always I’d tell people, Jeff’s running of Q&A. Some of you guys just keep asking the same stuff. So the weirder, the higher chance it has of getting on the show. The more esoteric and unique, specific, personal in Jeff’s case, anything that you guys wanna ask, shoot us an email. Feedback at the mebfabershow.com. Is that it?
Jeff: That’s it.
Meb: Listeners, thanks for taking the time to tune in. You can always find show notes and other episodes at mebfaber.com/podcast. Subscribe to our show on iTunes. We’re now past 200 views. Thank you. We read all of them and appreciate it. Thanks for listening friends, and good investing.