Episode #127: Radio Show: Meb and Elon Musk Talk Shorting… Conflicting U.S. Valuation Indicators… and Listener Q&A

Episode #127: Radio Show: Meb and Elon Musk Talk Shorting… Conflicting U.S. Valuation Indicators… and Listener Q&A

Guest: Episode #127 has no guest but is co-hosted by Jeff Remsburg.

Date Recorded:10/22/18

Run-Time: 1:02:21

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Interested in sponsoring an episode? Email Jeff at jr@cambriainvestments.com

Summary:  Episode 127 has a radio show format. In this one, we cover numerous Tweets of the Week from Meb as well as listener Q&A.

We start with Meb telling us about his recent back-and-forth over Twitter with Elon Musk, discussing short-selling. Meb uses this as an example to give us more information on shorting in general, as well as short-lending.

We then answer a question we’ve received (in various forms) for years – “why is the S&P (or whatever) outperforming your strategy?” For anyone looking longingly at S&P returns for the last many years, you might want to listen to this one.

Next up, we tackle some of Meb’s Tweets of the week. There’s a discussion about mixed valuation signals – on one hand, there’s the Russell 3000, with the number of companies trading for more than 10-times revenue now approaching levels from back in 2000. On the other hand, there’s a tweet claiming that “if history is any guide, with 90% confidence rate of positive correlation, this market is going to deliver between 3 to 4% per annum for the next 10 years.” Additional tweets support both sides so Meb tries to resolve it for us.

Then there’s a tweet about the challenges of sticking with your strategy during bad years. It references how the little voice of doubt in your head is all it takes “to turn the hardest resolve into the emotional putty that has destroyed generations of investors.”

There are several other tweet topics – how Research Affiliates views the probability of 5% real returns at just 1.5%… how one forecast for private equity is calling for just 1.5% returns while a different private equity manager is trumpeting the asset class’s superior performance… and how marketing is nearly as important as performance and fees when it comes to attracting investor assets.

We then jump into listener Q&A. Some you’ll hear include:

  • You often say that over the long term, asset allocation doesn’t matter much. However, isn’t it important to note that because the nature of compounding, a small difference in CAGR over time can amount to a large dollar amount difference in your savings?
  • What are your thoughts on using leverage with momentum?
  • Do you have any recommendations for someone looking to diversify their trend following sleeve by applying a few different rules? For example, I’ve been doing 1/3 50-DMA, 1/3 200-DMA, and 1/3 crossover.
  • You speak frequently about the benefit of taking a lump sum and investing now versus later. With current equity valuations (at least US) so frothy, is that still true?
  • I’m wondering about how to take losses and how to determine when it’s appropriate to take one and when it is not. Do you, as a quant, have set rules in place?

All this and more in Episode 127.

Links from the Episode:

Various articles on lump sump and/or dollar cost average investing, some including CAPE:

Transcript of Episode 127:

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.

Meb: Hello podcast listeners, it is getting down to near the end of October, and we’ve had so many awesome guests on the podcast lately. I’ve been dealing with the avalanche of requests to bring Jeff back, time for a radio show. Remsburg how goes it?

Jeff: It’s going good, glad to be back.

Meb: We’re winding down the end of October, do you have a spooky costume or what?

Jeff: It’s a good question, I do not have anything planned yet. I might have to dig back up one of the ones I’ve broken up for like the last four or five years.

Meb: Would you like to share your kind of go to costume with the podcast world?

Jeff: Well, there’s a couple, the one for many years was Wooderson from the movie “Dazed and Confused.”

Meb: Also known as Matthew McConaughey’s probably the most iconic role.

Jeff: Yeah, there you go. And then I kind of slipped into just some general bad sort of the last-minute party city type costumes like an Indian and then there was a biker. It just did poorly, my favourite of yours is the incredible average Hulk.

Meb: Yeah. And then I was the kid from “Up” with all the balloons once when I… I think I met my wife and she was trying to come up with ideas for his costumes as a young toddler, and she was trying to suggest that. And I said, “That sounds like so much work,” I was just, “Can we just do the skeleton, and put just skeleton pyjamas and be done with it?”

Jeff: Well, Deke and your dog will be dressing up too.

Meb: Oh, boy. So, anyway, listeners, been doing a lot of travel, it’s been great seeing some of you in Nashville, San Antonio, Rhode Island, all over the place. We’re going to be in Las Vegas this weekend, if you’re there for the AAII conference, come out and say hello, with lots of our other friends who are also speaking in the conference, the resolved guys, all sorts of other people we’ve had on the podcast. So, if you’re in that part the world come to say hello.

Jeff: All right. Well, today we have, you know, plenty of stuff to go over but let’s just start with some fun stuff first. Some of our listeners may not be aware of this amazing little tweet battle you got into with Elon Musk. And it’s more entertaining to me than anything else, but I’m sure some listeners will find it a little bit comic too. So, why don’t you just explain to everybody what was going on with that?

Meb: Like Elon, I probably shouldn’t be on Twitter, like most people should not just be on Twitter. Twitter’s it’s kind of…gone from a pleasant distraction to I don’t even know what now, but Elon, who by the way let me preface this by saying, I think he is a generational entrepreneur, I’m actually a huge fan of all of his companies, I don’t have any positions in any of his stocks, but love everything that he does. I do like many people if I was the chairman in the board would say, “We’re probably gonna delete your Twitter account, or we’re just gonna staff you with an intern, and every time you tweet it has to go through compliance.” But anyway, so Elon, you know, it really struggles with the shorts particularly in Tesla, and I can sympathize with a little bit of that.

The shorts it’s kind of crazy dealing with nothing brings out emotion more than short sellers with an axe to grind and an incentive for the stock to go down. So you do see companies where the short sellers target them spread misleading information, it’s even worse on Twitter in this modern age of media. Anyway, but Elon made a comment basically that short-selling should be illegal, and he was actually replying to one of his own comments from years ago, being like, “Hey, short sellers are fine,” like it’s like I basically changed my mind, they’re the worst. And I said basically to summarize it I said, “Look, we actually…” This is prior to the Tom Barton podcast, who if you haven’t listened guys it’s a great one a lot of fun, but basically, said, “Look, I love what you’re doing Elon, but shorts aren’t the enemy, they shouldn’t be illegal, they’ve exposed, if you listen to Tom’s podcast, so many frauds, they act as a wonderful check in reality.”

And Elon had responded, I can’t remember what exactly, but basically, he had a couple tweets to where he said, you know, and I was like, I said, “I love Elon Tesla, but he’s got this backwards, “Not all shorts are bad just like all, not all longs are good,” and he said, “Not all, but however shorting applied to market as a whole it’s obviously negative and sends negative GDP, moreover it stops private companies from going public, preventing access by retirement funds and small investors thus increasing wealth divide.” Then he posted a chart that showed the general decline in the number of companies, and I think my opinions changed on this over the years because originally, I thought that was due to a lot of the new legislation, Sarbanes-Oxley, the challenge with being a public company and the new reporting requirements, but a lot of the Vanguard has followed up a study showing that in reality was a kind of an echo of a lot of these tiny micro-cap companies going public in the late 90s.

And actually, the decline isn’t that big of a deal because it’s a lot of just this tiny companies that existed. So, you know, I’d passed that along, I said, “Also, you know, most of the good fund companies out there that do short lending,” we started talking about short lending, I said, “Actually return the revenue to the investor instead of keeping it, in many cases there’s free ETFs where the retail investor actually has a negative expense ratio.” I was trying to say this is actually great for retirement funds, small investors, and decreases wealth divided. I go, “You know, it’s great that they pay you to own them,” because a lot of people don’t know about this. And, of course, he responded, “When something sounds too good to be true usually is, the way the trick works is companies like Blackrock keep up to half the short interest revenue, but so far almost none of the equity client is there just passive managers Blackrock made 600 million in shorting last year.”

And I’d pass along a chart where most of the fund companies the way that it works is, you have to have someone manage the short lending operation, so in our case it would be Brown Brothers, BBH, and they get paid to do that otherwise, well, obviously, someone has to do it. And so, most fund companies kind of outsource partner with someone, and so they pass along the revenue say 80, 90% to the investors, but the company running the short lending book gets paid to manage the process. Some of these companies like Blackrock do it internally, so technically, they’re paying another division within Blackrock to run it. And then, you get into the question of are they, you know, profit-maximizing it or are they keeping it. Obviously, Blackrock’s a huge company, it’s a 600 million, you know, they’re keeping it, but in general, I think it’s a great positive for investors.

So, anyway, that was kind of the end of the Elon-Meb tryst.

Jeff: Sort of you got me thinking you mentioned Barton and his short selling experience. You know, Barton was doing the majority of just exposing outright frauds versus taking calculated gambles on potentially overvalued companies. And then you mentioned also how shorting is a good sort of check, so I guess to what degree do you think are shorts now really sort of keeping certain stocks held accountable in terms of aloft evaluation versus is it just a pure gamble, like how is it really affecting the market?

Meb: Well, you know, like the best part about it is like shorting is not guaranteed, like, you’re an active investor you short something Tesla or something else, and it doubles, or triples, or quadruples like that’s… It’s not some risk-free game, which is funny because you’re talking about price and shorting and fraud. Year-to-date it was something like if you look at the buckets of companies sorted by price to revenue in the U.S. stock market by far the best performers are the ones with the highest price revenue on average is like 300 price revenue, and then it stair steps all the way down to the cheapest stuff is performing the worst. Because maybe… I may have to update this after the last week as markets declined, but that was the case for… So shorting expensive stocks while that works overtime, short-term or anything can happen.

So, the challenge is, you know, fraud, in the day and age of the internet fraud is so much harder to get away with one would think with public companies. I mean, if you’re a fraud why wouldn’t you just go play around the crypto space? Right. It’s something, you know, this is a joke, but, you know, the challenge as a CEO or someone who’s managing a company, say look, the best defence against the shorts is build a kick-ass company that builds value over time that everyone loves and just ignore them because eventually, they have to buy back in the stock. And Amazon very heavily shorted company over the years is just to deliver, build a world-class company and that’s like the best revenge, is your company goes from 10 billion market cap to 50, to 100, to 500, trillion.

Jeff: Just on the side note, if you were evaluating an individual equity and you happen to notice that the short interest was X%, what would sort of raise red flags for you to sort of be like, “Whoa, maybe I don’t wanna invest in this until I…

Meb: Traditionally as a factor, short interest is a…has information. It’s not something you traditionally want to own, it’s high short interest companies. Like people that are shorting it usually have an information edge. The challenge is because we used to look into a lot of the short lending, and obviously, the highest short lending is the stuff that’s most in-demand because people know that it’s probably gonna go down. I remember I was tweeting about Tilray the marijuana company that was like, went vertical in this past quarter. I was looking at the options and how much the puts were priced, and the puts for like the end of the year, the stock had to go down by at least half for the puts to break-even. You know, so, people at this point were fairly well aware that, you know, that’s how it gets priced.

And so, short lending been shorting outright high short interest stocks, it’s a nice, in my mind, it’s like a nice balance, where traditionally you wanna avoid the high short interest stocks, but we don’t actually use it as a factor in any of our portfolios.

Jeff: Just as a general educational tool for listeners, what’s that sort of line in the sand in your mind as to what a high short interest looks like?

Meb: I don’t know that there’s a specific number because then you get into other areas like as a percentage of float, how much is freely traded, I would have to look up and recall, but you could easily just quartile or quintile or decile all that into [inaudible 00:10:58] So it’s a certain bucket, but we can look at what some academic literature, we’ll talk about it on the next radio show.

Jeff: All right. Well, since… Well, the last time I was on we’ve begun to have a little bit of market gyrations here, and I think that you know, we’ve seen some emails come in from some Cambria followers who’ve been asking about our funds compared to putting everything in this SPY and sort of what’s gonna happen. Any given thoughts or any general thoughts on the market number one and then sort of following SPY and [inaudible 00:11:29] and what’s happening now.

Meb: Okay. So, a couple things, one is we consistently get emails over the last decade, where people ask, hey, why is X strategy underperforming Y? And as people know we run very diverse strategies, all sorts of different things, and it’s just whatever happens to be going on in the world at that time. And so, over this past cycle and particularly year-to-date, U.S. stocks have outperformed almost everything and including this year. And so, we’re starting to get some emails, “Hey, why don’t I just put all my money in the U.S. stocks?” We actually have like a fair amount of canned responses about this at this point, and I’d like to write a little short white paper on just expectations in general, but I said, “Look, let’s put this into perspective, let’s say you have the S&P 500 and let’s say you have a beautifully designed diversified global asset allocation.”

So something like the global market portfolio which is roughly half stocks, half bonds, and of that it’s half U.S.-half foreign. You can take that back to the 20s, it’s done great, we published in the GA book back to the 70s, we even did an article where we’ll compare it to cloning the largest hedge fund in the world with Bridgewater, does a fantastic job. In that case, you need to add a little leverage, we compared it the CalPERS Harvard always have great allocation. However, here’s the challenge of being a money manager, an investor, an advisor is that no matter what strategy you have, there will be periods of outperformance and underperformance. First of all, U.S. stocks is not a good benchmark to a global asset allocation portfolio because the global asset allocation portfolio only has like one-quarter of the portfolio in U.S. stocks. So first of all, it’s kind of a wonky benchmark, but that’s the way investors are built to think, they wanna compare everything to U.S. stocks.

So, I said, “Look, it’s 50/50 which one outperforms the other in any given year, U.S. stocks versus global asset allocation? However, U.S. stocks outperform a global asset allocation by a mile, meaning you look like an incredible idiot one out of every four years as measured by at least 10% underperformance versus S&P 500.” Okay. That’s pretty often. On top of that there’s been times in history where you can easily go five, six years in a row where every single year U.S. stocks outperform a beautiful asset allocation portfolio. If you go back to the 1940s and 50s, remember the nifty 50s listeners, the stocks, there was a period where S&P 500 beat a global allocation portfolio 13 of 15 years. And so, the challenge like any investment strategy is looking different, is periods of underperformance, but despite all that you get similar returns, you get lower volatility, lower drawdowns, higher Sharpe ratio in the asset allocation portfolio.

And most people in the S&P… If you would say just invest in the S&P 500 you have to be willing to have 50% drawdowns regularly, so we’ve got two of those in the past 20 years, and on top of that in the Great Depression, you lost over 80%. So, I think… And this applies to any other asset class any other strategy, people always ask us about expectations and it’s funny because my response is so much worse than what they’re worried about. They’re like, oh, Meb I see this is underperforming this past quarter like what’s going on? And I almost laugh and say, “Oh, no, it can get much worse than that, this could last for years, this could go on for five more years and still be underperforming. It can underperform by 200 percentage points, not basis points, 200 percentage points.”

And so, I think most people are just not well built to deal with underperformance and looking different.

Jeff: This ties in perfectly with one of your tweets of the week, I might butcher the guy’s name but Nick Missoula [SP], there’s a quote from the article which you referenced in the tweets of the week. He basically says, “Even when we have reasonable evidence that a particular investment strategy will work, the hardest discipline is sticking to that strategy through thick and thin.” And it’s so difficult because that little voice in your head says, “What if this signal doesn’t work anymore, what if it was just a data mined result, what if I’m wrong?” That little doubt is all it takes to turn the hardest resolve into the emotional putty that has destroyed generations of investors.

Meb: Yeah. Well said, Nick.

Jeff: Actually, while we’re on that topic… Actually let me back up, anything else you wanna add to this before I sort of rotate us a little bit?

Meb: No, I mean the classic example we’ve always given, listeners are probably sick of hearing this, but as the Buffett example where, you know, you go back to 1999, you just look at a stock pics, he outperforms the market by four percentage points per year, would be in the top 1% of all mutual funds, you don’t pay any fees, it takes five minutes a year, but he’s underperformed 8 of the last 10 years. And so most people don’t have a two-decade-long time horizon, and that’s one of the biggest challenges with expectations is, is one people already expect way too high returns, the average is always 10% plus, and two, research affiliates recently had an article where they say, you know, the chance of hitting that real 5% return, so let’s call it eight-plus percent nominal is less than 1% over the next 10 years. There’s…

Jeff: One point five less… Is it less than one [inaudible 00:16:58]

Meb: No, I think it’s less than 1%.

Jeff: Let’s see here, let me double check what we have here, I’m looking at one of your tweets of the week from research affiliates. It says, “If the odds of an average diversified portfolio hitting 5% real is just 1.5% then what’s the answer?”

Meb: Well, then I’m pessimistic, but I think they said in the U.S. the expected 60/40 is essentially at zero.

Jeff: Oh, okay.

Meb: So, anyway expectations is tough though, people because the problem is investor expects 10% returns, they come to someone like me and I tell them to no, 5% first of all real has been the historical benchmark, add some inflation. But in the U.S. specifically, for a U.S. manager the opportunity says way worse for U.S. stocks, but a lot of investors what do they do they go find someone else that will promise them the potential of finding that 10% return magically somewhere.

Jeff: Wanna be told what they want.

Meb: They wanna be told what they want to hear.

Jeff: All right. Well, let’s actually rotate now into some of these valuation topics because you’ve had a lot of tweets that have touched upon valuation and it’s a little bit of a mixed signal. So, let me just ramble here for a minute, and then I’ll let you sort of go with it. On one hand, you have a tweet talks about the number of Russell 3000 companies trading for more than 10 times the revenue is now approaching the 2000 level of absurdity. Then we have another tweet back to the whole Nick Missoula thing in which he says that one of the best predictors of future stock returns is the average investor allocation to equities, and basically higher investor allocation equities corresponds to lower future returns. And that signal basically would have just activated a get out of equities signal.

Then, on the other hand, you’ve got stuff like Ned Davis is saying how one of the most enduring features of this recovery is the absence of economic imbalances, their careful review doesn’t reveal any signs that were at the top of the current economic expansion. And then you’ve got another tweet talking about how if history is any guide with 90% confidence rate of positive correlation this market is going to deliver between 3 to 4% per annum for the next 10 years. So, how do you… I’m not asking you to say which is gonna be accurate, but how are you balancing all this conflicting information. And we always talk about the negative side, I think the sort of knee-jerk reaction is be like, yeah, we’re lofty, these valuations are big, but what weight you give the opposite side that’s talking about how now there’s probably more juice in this bowl, what do we do?

Meb: I think it’s not that we talk about the negative side, it’s that we talk about the realistic side. And so, on the same side of the same coin, we say look U.S. stocks showing low returns, romping stomping ball on the rest of the world is much cheaper, you know, that’s you could say I’m a huge optimist, that I believe that foreign, developed, and emerging will do much better and the cheapest will do much better for the next 10 years. Again, people wanna look at this on the next month time horizon, but really the next 10 years. Well, let’s start with just U.S. stocks. Let me go back to our old quadrant analysis where if you put a market in cheap, expensive, uptrend, downtrend, what is the best quadrant? And historically, it’s been cheap uptrend. Worst has been expensive downtrend, but second best has been expensive uptrend which is where we are now.

And where we’ve been saying this for years now that’s like a yellow flashing light, but the trend has still been up, and so valuations could keep going up who knows, but the problem comes when that trend rolls over that could be October of 2018. It’s gonna be close for most of our trend measures and a lot of other asset classes. If you look at our old-school timing model 2006 white paper, a lot of asset classes have already exited, right, over the course of this year, so you’ve been de-risking over the course of this entire year, there’s a few remaining holdouts, commodities are still there, U.S. stocks are still there, there’s…real estate is potentially hanging on by a thread and depending on the foreign market there’s some, but the average foreign market is down by like a quarter this year. So, you’re already in the bear market territory with a lot of the foreign markets. Now, depending on your perspective if you’re a younger person or still allocating a lot to life savings, you say, “Damn is an awesome thing, I want stocks to go down by another 50 to 80%.”

Set up a generational buying opportunity. If you’re older living off your investment returns it’s a little harder to stomach that, but, this is a good frame of reference for the home country bias. Yes, we’re trying to be realistic using Bogle’s old equation, you plug it in for the U.S., I get low single-digit returns. Some people get minus 5% real like GMO does for the next decade, some people… I don’t know if there’s anyone I’m trying to remember if anyone’s projecting over 10% returns for U.S. stocks at this point. Colombia was really high on the list, but anyway, most people tend to be pretty quantish that’s why I like the way research affiliates does it, as they have like a heat map of potential probabilities. So, most likely is zero, but then are there potentials that you could do one, two, three, four or, you know, minus one, two, three, four? Sure. Those are just less likely, but the trend has been enduring, we’ll just see when it starts to roll over.

Jeff: I mean, if you had to focus your analysis the only reasons why just the U.S. market alone will keep going up, forget being pragmatic and talking about better examples or better markets around the world and all that, we’re just looking at U.S. for a moment. What argument would you give if you had a gun in your head as to why we’re going to keep climbing?

Meb: You haven’t seen the historical mania yet, and you’ve seen it in pockets, you saw it in crypto earlier in the year, you’ve seen it in marijuana equities recently, and have we gone to visit our cannabis co-working space in West Hollywood yet? This is on your to-do list by the end of the year, powered by blockchain by the way, what’s the name of it? So you’ve seen pockets of mania, but you haven’t seen broad-based mania, I was laughing because I gave this speech in Rhode Island and it was at a private club, and I walked in they have like a bar, you know, the two TVs over the bar on each side and one TV was on Weather Channel and the other was on CNN or Fox or something, but neither of them were on CNBC or Bloomberg etc. So, it’s a sign of the times where people just aren’t that euphoric.

I mean, we’ve been talking about the Jay Cutler Bull Market, right, so, I don’t know, I don’t know that’s a requirement for a market to end or just can kind of just fizzle out on being expensive and the weight drags it down, but we do know if you look at a lot of the historical studies not just in the U.S. but international, when you are these valuations you have a much higher chance of a big fat drawdown in the next five years.

Jeff: Oh, you’re a student of history, can you recall any bull in the U.S. that ended without mania, or have is…

Meb: Yeah. I haven’t been around for three-quarters of them so it’s hard to as a student of history and [inaudible 00:23:59]

Jeff: You’re an academic.

Meb: …is a little tougher, but obviously, you had the two Biggie’s the roaring 20s in the 1990s, both of those were full-on manias, right. But others you could certainly have a top without a mania I think.

Jeff: Just kind of switching back the research affiliates’ tweet.

Meb: Who were we talking to? Was it Howard Marks who said that it was a mania that was kind of required for…

Jeff: I remember I was gonna ask you that question because we asked is mania required for there to be…

Meb: I don’t see why it would be though.

Jeff: I mean, stock market…

Meb: It is [inaudible 00:24:29] its own weight just sinks.

Jeff: But it’s gonna sink based upon the emotions, you know, just a high valuation it’s gonna sink.

Meb: Well, historically one of the worst times to be investing in stocks is when unemployment’s this low, it’s counter-intuitive for a lot of people.

Jeff: Let’s switch back to research affiliates really quick because we were talking about how they were saying the odds of hitting 5% real is just 1.5%. So, tying back to our knot and his whole concept of over-rebalancing or what’s the other phrase that was just used?

Meb: Marks used calibrating.

Jeff: Calibrating, all right. So, to what extent then would over-rebalancing or calibrating way more and to say emerging markets be a wise decision if you can’t stomach these incredibly low returns. Is that taking on too much concentration risk?

Meb: You gotta remember that most people have nowhere near the global market portfolio already, which is half, if you’re doing stocks it’s half in foreign stocks and emerging market stocks, then no one does that already. So that’s already… That’s the literal Vanguard index if you’re doing stocks is half in the U.S. and a half in foreign, so no one does that. So, getting to go getting to the starting line of not hugely overweighting the U.S. is the first step most will never do and that’s the starting point. So then, if you were to say, “Okay, Meb,” let’s say you’re totally rational investor you do half in foreign, and then now you say, “You know, what I wanna tilt towards value,” then only then is it starting to get uncomfortable where you say okay I’m going to add, I’m gonna have 75% in foreign equities.

And one of the ways to do this, so, instead of trying to rebalance it yourself is simply to allocate to say a global Value Fund that does value investing, could be one of ours, could be one of someone else’s, where you’re looking at go anywhere, where the fund itself does the value tilts, so that you’re not trying to go by Russian and Brazilian ETFs. That’s a lot harder for people to let the funds do do the work themselves for you.

Jeff: All right, let’s do this, let’s switch to one more sort of tweet comparison and then let’s hop into some listener Q&A, and we’ve got some good ones.

Meb: And sadly, by the way, that was a Blackberry-Cumber La Croix, that was not a Budweiser or Pale Ale.

Jeff: It’s like sadly.

Meb: Sadly.

Jeff: Feel like drinking right now…

Meb: No, I don’t.

Jeff: On a Monday afternoon at 3:00?

Meb: No, I don’t.

Jeff: I don’t know, that’s not the tone I just picked up.

Meb: Let’s go.

Jeff: All right. So, here we go, private equity, we got two tweets that seem to be a little contradictory, I’m curious about your thoughts. So, we’ve got research affiliates, in your own words here, “Laying the hammer on private equity expecting 1.5% returns for leveraged buyout and 2.9 returns for VC over the next 10 years.” Then we have Dan Rasmussen whom we had on the podcast, great guy who is a private equity guy, he says, “Of the more than 3,100 news stories referencing private equity this year, the positive to negative sentiment ratio was nearly 16 to 1. There is no stronger consensus in markets today than the view that PE is a superior asset class.” So, how are you viewing these seemingly conflicting ideas?

Meb: I think a lot of real money institutions over the past few decades have allocated to PE in the beliefs and hopes that it’s an asset class that will deliver them alpha. And all the historical research has shown it’s possible, you need to be in the highest quintile of managers, well, and the old research used to be that that quintile was sustainable or there tended to be the same managers would stay in the top quintile. That has faltered over the past couple decades. On top of that you’ve seen more and more research come out that basically says, “Look you can basically get private equity returns by doing small cap value.” And private equity also it smooths some of the returns so it looks less risky than public market equities, but in reality, public market equities, if you were to mark them to market like PE private funds do, would be pretty darn similar. So, my view is on top of that by the way if you’re a taxable institution, vastly better to be in a strategy that would replicate private equity in something like an ETF, so all of a sudden you’re not doing this in a taxable way.

There’s lots of caveats to these things, we’ve talked about all the tax hacks like USPS and Opportunity Zones and retirement accounts all that good stuff too, but private equity in general, I think my belief is that it’s essentially you can replicate it with public equities.

Jeff: The forecast of 1.5% returns, is that just because there’s so much money sloshing around that has flood the markets?

Meb: In evaluations the deals are going off and so you can track kind of what traditional metrics of enterprise value to EBITDA. Dan was talking about that I think it’s continued to go up and you can track sort of what that world is transacting at, and what debt levels and everything else that kind of goes along with it. But, yeah, I think if the world looks like what our friends at research affiliates and many other quant shops ends up looking like, I think I’m getting more and more of the belief that a lot of these big institutions particularly pension funds are in for a world of hurt if you end up getting 1% returns on U.S. stocks on private equity bonds. Bonds may be the saviour, they’ll give you 3%, but certainly, there’s no way you get to the 8% with traditional U.S. assets.

Jeff: Do you know offhand what the sort of general expectation for these pensions in the large institutions are wishing for?

Meb: They’re all at 8% a year.

Jeff: They’re still at 8% a year.

Meb: But some have dipped down to seven and a half, which by the way is the most ridiculous thing because they should benchmark them to real returns plus inflation. It makes no sense to say 8% of inflation is 0 and 8% of inflation’s at 8% percent. It’s the most nonsensical benchmark on the planet but that’s just what they’ve have done, right. So, we’ll see it’ll be fun I mean, not fun. Fun is not the word. It will be interesting to see how this plays out.

Jeff: Actually, one more tweet before we jump into Q&A, found this is pretty interesting, you were referencing in your own words, “This is why most portfolios we see are a high fee hot mess.” And it was Michael Kitces who was talking about the necessity of marketing and how that’s nearly as important as performance and fees in attracting investor assets. Did you have any sort of additional thoughts on this whole optics element?

Meb: I think it’s well known at this point that most funds historically had been sold not bought, meaning someone has… You always follow the incentives, someone has the incentives to sell you a fund, there’s so many in advisors and investors that have incentives to buy funds that are not necessarily in their best interest. I mean, you’re seeing tons and tons of class-action lawsuits against 401ks now, and I completely sympathize with that. If you’re some crappy 401k, I mean, and even some of the big dudes like Fidelity are probably not innocent here, and you got a bunch of funds that charge these high fees. And so we also had a tweet we said, you know, in today’s world can you call yourself a fiduciary and only use your own funds, and I don’t know that that’s a reasonable check-the-box.

You can say like how do you…how can you say you’re a fiduciary and say you’ve come to the conclusion that only your own funds are the best choice? You know, look there’s much worse offenders than Vanguard putting people at a bunch of Vanguard funds, you know, like so to me that’s probably more appropriate than some other platform that are putting you in a bunch of funds that charge 2%. But almost everything in our world [inaudible 00:32:38] management and finance is dominated by incentives and so you have to check those. So, for example, with this, this is a deep hole but if you have a brokerage account and you’re listening to this, ask yourself where does the cash go?

So, if you have $1 in cash in a brokerage account, if you have a million in cash in your brokerage account, where does that go? Chances are you don’t know the answer to this. Second chance is you may say, “No, that goes into like a money market fund.” Well, half the time it’s a money market fund, the charge is like 70 basis points and yields like 20, and then they go and take that cash balance and they invest it at 2% per year.

Jeff: [inaudible 00:33:21] has written a lot about this.

Meb: Yeah. And so many of these hot FinTech startups, you know, and so many brokerages make half their money or more by your cash balance sitting idle, and like you say, “Well, I got a $100,000 dollar account and I have like $200 in cash it’s just like but that $200 in cash adds up. And so, that’s one reason we love that betterment feature called smart saver where they’ll help manage your cash balance with short-term bond ETFs where you can earn two-plus percent now in short-term bond ETFs. And so again, it goes back to incentives, and so, you look at a lot of the stuff coming out on many of the brokerages and will say, “Oh, well, how does that free brokerage make so much money? How are they at five billion dollar valuations?” And say, “Oh they sell all the order flow.” You know, and so, if you put in a market order, you know, where that ends up is probably not in your best interest and Schwab bungled this when they launched the intelligent robo.

Jeff: Explain this more just to make sure all the listeners understand the [inaudible 00:34:21].

Meb: Which was Schwab launched their robo for free at zero and however they require the individual investor to have a large chunk in cash, in some cases it’s like a third and they pay zero on that or low, I don’t know that it’s zero but it’s low, and yet they turn around and invested at 2% plus. So, really, if you got a third of the account that should be earning two and it’s earning zero, then, in reality, you’re paying 70 basis points. So, they earn their money and on top of that, they use Schwab funds. So, you just got to be careful with all the incentives and different ways, and the problem is like I sympathize with a lot of end customers because they don’t know, you ask the average person what the fees are and the retirement like 401k, I think it’s like half say it’s zero.

We went on this rafting trip and this young lady was in our boat and was chatting with us and she’s like, “Oh, what do you do?” And I just kind of like pause, and I was like, “Oh, man, should I say I’m a writer? Meb say you’re a writer.” My buddy goes, “He’s a financial adviser,” which we all know is not true, but close enough, and she’s like, “Oh, I went to this dinner the other night and wow, what were we talking about? It was a free dinner… Oh, yeah, it was, “What do you think about annuities?” And I just kind of like took a deep breath and I said, Oh, well, you know, like they could be okay but you just gotta be careful because a lot of times they’re really expensive,” and she goes, “Oh, no, they’re free, there’s no fee.” And I said, “Okay.” So, the challenge is on a lot of these things with your brokerage account, with your cash management, with your order flow, with all these things is short lending, you want a fiduciary, you want someone who has your best interest.

So, you see shops like Betterment, I get more and more impressed by Betterment over the years and less impressed by a lot of other shops that do things that are questionable. I mean, I would also love a feature of a robo and say, you know what? Check the box I want to allow short lending that, by the way, I may have already checked the box and you’re just keeping it, but I want to check the box and I want to share in the short lending revenue that I would get off my stocks or holdings. I want to invest my cash balance in a reasonable yielding alternative versus what you’re probably earning on it. So, there’s a lot of these, there’s a whole full degree of bad behaviour and worse behaviour, you know, at the top is charging 2.2% for an S&P 500 mutual fund like that’s way worse than some of these but in some cases the hidden costs add up.

Jeff: What would you do at say somebody had relative easability or ease of the ability to take his chunk of cash out of a brokerage account and just wire it over to wherever? So, what would you do to maximize a big chunk of cash right now?

Meb: Well, so, of course, you could invest in an ETF and that solves these problems, I mean, Vanguard is always kind of a default for us, you open up a Vanguard account. Almost all of their ETFs are commission-free.

Jeff: Let me back up. They want to keep it kind of liquid, keep the cash somewhat available, don’t want to, I mean…

Meb: You could buy a CD, like it’s literally the oldest school investment on the planet, but there are CDs like one-year CDs are two plus percent now. I think they might even be like two and a half. You go to the Old Bank of America you got to go into a…millennials this is actually like you go into a branch it’s called a branch. Someone will probably try to sell you a mortgage, but in general you can buy a CD it’s like two and a half and that’s protected, you know. What you don’t want to be doing is just sitting on zero. You could buy a short-term bond fund. You could invest in smart saver, you can put in a diversified ETF. There’s just a lot of things you could do with it, but just being aware of all the various ways that Wall Street bleeds you, I think is really important, and if you’re not aware and you’re like, “Oh, my god I just listen to this entire thing, I have no idea what a money market fund even is,” that it’s important to have fiduciary in your corner, and have someone that’s actually looking out for you.

Jeff: That’s like if you look around the poker table and you can’t find the fish, you’re the one. All right. Let’s move on to Q&A here. You got any more general thoughts you wanna hit on before we launch into some of these questions?

Meb: No.

Jeff: All right. Number one, Meb, I know you often say that with a long-term asset allocation doesn’t really matter much, a 60/40 portfolio and the portfolio with almost any mix of stocks bonds and real assets will end up producing around the same CAGR over time. However, isn’t it important to note that because of the nature of compounding a small difference in CAGR overtime can amount to a large dollar amount difference in your savings, potentially, tens if not hundreds of thousands of dollars?

Meb: Well, the simple great takeaway is absolutely a little bit of CAGR makes a big difference over time, just go and tell me where that CAGR is, right? But my point with the asset allocation strategy is that if you’re doing buy and hold asset allocation, it doesn’t really matter what your asset allocation is dot-dot-dot assuming you have all the main inputs, and that’s global stocks, global bonds, global real assets. And so then if you have 30% in global stocks or 50%, I don’t think it’s gonna matter. It matters if you have 95% and then nothing in everything else, right? And so, it goes back to our old analogy in the book of baking as long as you have flour, butter, or paleo, whatever, almond flour, chocolate chips. As long as you have the main ingredients they’ll probably end out okay, it doesn’t matter if you have a pinch of chocolate chips or a whole handful, it’s probably still gonna be all right. The question presupposes that you know what asset classes will outperform. So, then you say look the global market portfolio to me market cap weight is the starting point, that is the asset allocation is a commodity you should be paying nothing for that, it’s already free, if you’re paying more for that, you’re just giving money to someone, but that’s the starting point.

You say, “I wanna start to outperform that.” There’s lots of stuff you can do, we talk about a lot. The most important on the equity side as you break the market cap related link, so you could value, tilt towards value stocks, you could tilt towards momentum stocks. Right now that means value. It would put you in a lot more foreign than the U.S., you can do similar things with the fixed income universe and on and on. You know, there are ways you can increase CAGR, but the bigger question is how much confidence do you have in what you’re doing will actually improve the return. And if you are, if you have some amazing badass trading arbitrage system and there’s plenty of people that have had those throughout history. Yeah, absolutely, you wanna leverage that, but for broad asset allocation, I say it doesn’t matter, but then once you could yes, are there things you can do to tilt, calibrate that help that? I think for sure. And you want to do those things.

Jeff: I don’t hear you denying that over 30, 40 years, you know, a few basis points when compounded add up to something material, but your point obviously is you don’t know what’s gonna produce the increase in those various [inaudible 00:41:14]

Meb: If you have confidence in where those are, I would say one of the biggest that everyone neglects is taxes and fees. So look for the basis points on fees, look for the basis point on taxes. I mean, there’s so many people that invest in hedge funds, in taxable accounts, and totally neglect to realize that it takes like 20% returns to get down to relatively reasonable equity returns of like 8% after taxes because most hedge funds are run totally without any regard to taxes. And they charge 20. But what do people see? They say, “Oh, it’s the sexy side of hedge funds, it’s the returns and everything else,” and once you factor in the taxes and fees it’s not so great.

Jeff: All right. Next question, what are your thoughts on using leverage with momentum? From my own testing, momentum plus leverage plus a stop loss seems to be more winning or less losing than say plain vanilla momentum.

Meb: Leverage is sort of like the same thing as giving someone money. Who said this the other day? Maybe it was Josh Brown, is it makes you really more of who you are. So leverage you give someone money, they won the lottery or whatever, if they’re already a great person they’ll be probably an even more generous wonderful person. If you’re already an asshole, it probably makes you an even more unbearable asshole. The same thing with leverage, like if you have a good strategy, sure, it will amplify those returns, and a bad strategy will amplify those returns. The problem with leverage is the path. And so, usually most investments are already pretty volatile for people, just look at the general news flow, people talking about stocks which by the way already have embedded leverage because of debt, a lot of people don’t know that. But stocks are already pretty volatile.

And then, on top of that you wanna add more leverage to that, yeah, that’s… I’m totally agnostic by the way, you leverage it three times I don’t care, but most people can’t already deal with the volatility and drawdowns. And so, this runs into some of the challenges of risk parity. So you see in risk parity which is a strategy that puts a lot more in bonds and a lot less in traditional asset classes and then leverages the whole portfolio on a formulaic basis is fine. Now, on a basis of like, you know, how much you leverage that I’m not gonna get into our biggest punching bag the wealth front, risk parity fund, but I think in the document it said it could get up to like 3x leverage or something, it might even been four. Buffett tells a great old story where they used to have like a third partner, and I forget what his name is, but he wanted to be able to use I think leverage to help maximize his gains, and you know eventually essentially they bought him out he went broke, and they said what’s the problem and Buffett said, you know, he couldn’t, he’s like, “I always knew I would be rich,” and he’s like the person his old partner he’s like he wanted to get rich quickly, you know. He didn’t wanna get rich slowly.

And so that the problem with leverage is it just magnifies everything, and I don’t think people can handle normal leverage anyway of just buying the stocks.

Jeff: Well, I think the assumption here was he’d be throwing on a stop loss, but then, of course, you might get whipsawed out and that gets really hard from a behaviour perspective.

Meb: Yeah, my advice for the vast majority of people is you don’t need it.

Jeff: All right. So, while we’re on the topic here of sort of trading, another question, let’s say you were looking for a trading advantage and you woke up tomorrow and found yourself to be a programming expert. What would you do or explore in your programming to find alpha, would you do anything different than you doing now?

Meb: So, the whole point of active management and this can be quantitative, it could be high frequency, it could be low frequency, it could be betting on sports, it could be betting on horses, it doesn’t matter. You only have two potential sources of alpha. You have a better model, so you look at the data that currently exists and say, “I can massage this better than everyone else,” or you have a data set that no one else has. There was a really fun podcast recently with Ted Seides’s capital allocators where they have a guy that invests in minor-league baseball players. And just investing in… And so he gives them some money up front because being a minor-league baseball player sucks and you have to like deliver pizza in the offseason and drive Uber because you don’t make much money. But out of the 8,000 minor league like baseball players like 3% eventually, make it to the majors and then make millions.

And the problem was that identifying the top prospects is simple, top a couple hundred, but then it was finding the rest that were actually pretty good that would make it, and then so they would do it. This guy did a fund it’s actually a Virginia guy, did a fund where, I mean, actually, was a professional pitcher, but did a fund where they would give these guys some money up front in exchange for a percentage of future salary. And it’s traditionally what’s called income sharing agreement. I was tweeting about this and regardless of some other areas, but people react so weird to that. Anyway, the whole point was this guy was like look, I mean, he’s a professional baseball player, ran the numbers and found out that you actually just doing…offering players this deal you wouldn’t make good returns as a fund because so few made it.

But then he spent a year of 16-hour days building a model that tried to look at things a little bit differently and came up with a model that was more predictive of future success for these players than no model. And that one it turned did great and he’s now hired, go listen to the episode, but he’s now hired a bunch of other sports analytic geeks, and they just raise like another 200 million dollar fund or something.

Jeff: So you found a better mousetrap pretty much.

Meb: He had different data that people didn’t have and also massage the current data better. So, there’s whole worlds of inefficiency everywhere. I mean, I remember we had a friend that used to do arbitrage sports betting model across sports books, and it worked. The problem I always had was you have a sports book and you put a bunch of money in and it disappears into the Barbados ether, the Bayesian ether so that’s a different risk that people…it’s kind of like it’s a crypto world. So, yes, could you come up… So, the program…the question is not that you’re good at programming, can you come up with a data set that’s better or different? And one of the challenges as well is, you know, we watch our friends at Quantopian and a lot of these people building pure quant based models. And unless you have a little bit of historical knowledge and common sense about not data mining, about how markets work, about some general concepts, then you’re just potentially over-fitting the data and coming up with some model that has no chance of working.

And a lot of the purely technical stat odd ones as well, they work for a while and then they just stop for whatever reason different regime. But the fundamental ones where you can come up with a market inefficiency that’s printed billionaires all around the world in different businesses. Like, it’s not just investing, its businesses too. If you can come up with a way to massage whether inputs better or the old Netflix prize if you could massage the Netflix algorithm better, they paid, what was it? A million bucks to improve their algorithm.

Jeff: So, basically, I feel like this guy was pretty much asking you to sort of tell him the magic bullet of you what you look forward to outperform and I don’t hear you saying that. You’re telling them the process but not the [inaudible 00:49:11]

Meb: Yeah, but that’s kind of the whole point is process is much more important than like what is the actual formula. We have tons of formulas that already work, but finding one that’s kind of the Holy Grail or unique, you get a little creative. There’s a website and I can’t remember the name of it off top of my head that you can hold data competitions. I used to always wanted to try to talk my Morningstar friends and doing one called the Morningstar prize for mutual fund analysis, that was the same thing. Analyze mutual fund data to come up with a better model than Morningstar may have already, that’s what’s predictive in mutual funds. And there’s a lot that’s like that have slight benefits as does the manager invest in their own fund, are fees high, what’s the active share, and then coming up with a whole slew of factors and then saying, “Oh, here’s how…here’s a better way of selecting managers.

Jeff: So, this would be more predictive than a reflect replica.

Meb: Correct, and a lot of them are simple, I mean, fees is a big one. Does the manager drive a fancy sports car, and there was one that was like college wasn’t predictive but SAT score was.

Jeff: But do you think that all this would…

Meb: A male or female, females in general or better.

Jeff: But how much do you think any of this would truly offset just the basic valuation of where you’re starting?

Meb: Well, a lot of them are comparing the fund manager to their benchmark class, so if it’s a large value guy in the U.S., it’s large value competitors. I think some of the biggest ones are kind of obvious its course fees but it’s also active share, it’s like if they’re a closet indexer they’re probably just out by default, but it’s that world’s so hard, like trying to [inaudible 00:50:43] fundamental managers that it’s such a nightmare for me. I can’t imagine why anyone would want to do it ever.

Jeff: Well, let’s move you on from this conversation topic.

Meb: Yeah.

Jeff: All right. Next question, Meb I know you’re generally pretty ambivalent about which moving averages to use, but do you have any recommendations for someone looking to diversify their trend-following sleeve by applying a few different rules? For example, I’ve been doing a third 50-day, a third 200-day, and a third crossover.

Meb: I was hoping that question was just gonna end on, Meb, you’re pretty ambivalent and that was it. You know, like we’ve talked about this a lot before when we say parameter stability is important so I don’t really care if you were applying 50-day 200-day if 300-day breakouts whatever it may be. I think it’s important to come up with one where it’s kind of like in the middle of what broadly works and then not futzing around with it every time it doesn’t work as well as something else does. However, does spreading out and using multiple parameters is that a reasonable choice? Absolutely, because it helps break up into more granularity, their trading size. It helps give you more of an average blend of the possible outcomes, an example we used to always give was if you were using the 200-day moving average or shorter going into the 1987 crash, congratulations, you just made a career because you would have been out of the market like Paul Tudor Jones.

If you use the 200-day moving average or longer, you would have been invested in stocks going into that crash, congratulations, you were finding a new career. But had you used to say four different parameters at various links, you would have only been, say 25% invested or 50% invested. So, you’ll get the average blend of all the future outcomes and this goes back to another just general concept which is back to the original question of tying it all together with why not just put it all in the S&P 500? One of the reasons a lot of people think the diversification of equities globally gives you better risk-adjusted returns and it doesn’t for the most part. What it does is it removes the outliers. So the U.S. over the next 10 years could be the best foreign stock market of the world, it could be worst. It could go down 80, 90% but the average is likely to be somewhere in the middle. It’s not likely it’s going to be in the middle. It’s the definition of average. But, so on the flip side say, “Well, the U.S. has always done better,” but if you look back in the 20th century you had entire stock markets that disappeared, China, Russia yet other markets that essentially went down 90% never recovered and yet some markets had a zero return over the course of the whole 20th century and others that did even better than the U.S. like South Africa.

So, I think diversification of signals is fine, but again to me it’s you don’t wanna take uncompensated risk anywhere.

Jeff: That’s why you mentioned diversifying signals, and if you were using multiple signals then potentially and back to the crash, potentially you would have been only 75% invested or maybe 50% invested. And I thought you were going to go with this in the direction of the whole concept of most people have a binary orientation toward investing versus, you know, all in all out and versus just sort of grading in grading out different amounts, and, you, know, helping you sleep better.

Meb: Yeah, people want to think in binary terms, they wanna gamble, they wanna complicate the process. I think we should do a year-end podcast where it says, “Look, let’s reflect, how many of you have implemented our zero budgeting idea towards your portfolio, how many of you have written down a policy statement, how many of you cleaned house your portfolio invested in what you wanted to be…think you should be invested in rather than what you have been invested in? I bet the compliance is like 5% less probably.

Jeff: Yeah, not more.

Meb: Yeah.

Jeff: All right. We’re getting down to the end, a few more here. You speak frequently about the benefit of taking a lump sum and investing that now versus later. With current equity valuations at least here in the U.S. so frothy is that still true, and if so why? Can you go deeper into the specifics of why the math works?

Meb: So…

Jeff: Hold. Related on a recent episode Meb jokingly said he would not put any new money to work in the U.S. equities. This seems to be a conflict with the aforementioned lump sum advice, what gives?

Meb: I’ve explained many times what I do with my money in blog posts and on the podcast, but theoretically, if you’re doing… Somebody comes to us and say I got a million bucks, I inherited it, or I liquidate my portfolio, whatever, I wanna start afresh. So I invested it all tomorrow or should I wait and do it part and partial? Statistically speaking because markets go up over time formulaically you wanna put all of it into now, however, lots of people struggle with hindsight bias to where if they invested all their money it’s not what we would do. But let’s say they put it all into U.S. stocks today and the market went down 50% in the next three months, they would feel pretty dumb and it would haunt them probably for the rest of their life. “So, what if I just waited three months?”

So, you could ease that burden by spreading it out over time if you wanted to. Second is if you are of the belief that U.S. stocks are expensive which is what we believe, you could dollar-cost average into that asset class. And so, if stocks go down and have a bear market you’re essentially dollar-cost averaging in lower valuations. Okay. If you thought that stocks were super cheap, it makes more sense to put it all in now, but again you run the same risk of stocks being cheap and going down by half as they’re apt to do. So, I’m agnostic. You know, I always say the default is to go all-in, but if you’re gonna have any psychological issues, I mean, we’re also not just investing in one asset class it’s globally diversified assets and our strategies are trend falling too.

Jeff: But there’s got to be some level just to push back. There’s got to be some level valuation at which you say, “No, this is crazy, it doesn’t make any sense to put money in now because the amount of time for me to make my money back, if there’s a crash, is gonna be forever.” For instance, Japan, let’s say Japan and your CAPE is at 50 and rising, are you still gonna say, “No, mathematically it’s gonna work out if I just put money in now and let it ride.”

Meb: Well, that’s what we said because if it’s expensive it makes more sense to dollar-cost average.

Jeff: Okay. But at what point would we say…

Meb: Granted it can be expensive and getting more expensive, but yes, you could design it in a way it says, “You know what? Let’s say the stock market’s at 32 in the U.S., I’m gonna only put new money to work as it goes down dollar cost average, but I’m gonna dollar cost average every five or two points the CAPE ratio goes down, or the stock market every 10% it goes down, then I’ll add more.

Jeff: Okay. By that token then you’re not investing in this roaring uprising market.

Meb: No, you are. You put some in…

Jeff: You’re waiting till it drops though.

Meb: I would say you would put some in.

Jeff: Okay.

Meb: But, again, I don’t really care that much. I mean, I could write a paper on this, probably come up with an idea what… Someone’s written one, it might have even been Kitces. Someone has written one combining CAPE and dollar cost averaging, we’ll find it readers, we’ll put a show link in the show notes.

Jeff: All right. Two more, you frequently advocate for ETFs versus mutual funds, but does that advice apply to index mutual funds or only active mutual funds?

Meb: The default on everything at this point is ETFs, and you have to make an argument going forward why a mutual fund would be better. In general, they’re twice the expense ratio of ETFs and in general, they’re much less tax efficient. So, could you make an argument for a mutual fund? Sure, but then you see all sorts of terrible behaviour like the recent fund that changed managers and just distributed a third of their capital gains. I mean, you could have an index mutual fund. Theoretically, you could own an index mutual fund, have a loss on the portfolio and still have a capital gains distribution. It’s unlikely. So, index funds, yes, theoretically probably better than active, generalization speaking, but the default in my mind is always ETS first and then go from there.

Jeff: Last question. I’ve struggled with how to know when to take a loss. I’m wondering about how to take better losses and how to determine when it’s appropriate to take one. Do you as a quant have set rules in place, for instance, do you use any sort of technical analysis, help me out.

Meb: Well, theoretically, let’s say you had buy-and-hold global portfolio asset allocations you would never take a loss. You just buy-and-hold and you rebalance and that’s that. Let’s say that you had a portfolio that you’re actually trading on your own which sounds like this person is doing, there is a world out there that let’s say you just own 30 U.S. stocks, if you had a trend-following process and procedure, yeah, absolutely. You sell stocks as they hit your rules. So, am I okay with stop losses? Yeah, but it has to be part of your system. Most of these questions people ask they don’t have a system already. So, if your system is I invest in assets or stocks, and once they go down by 15% or two trailing ATRs or, you know, whatever measure they have, is that a reasonable strategy? I’m fine with that, but you also have to have a strategy to rebalance and re-enter or pick new investments to enter into.

So, selling is only one half of the equation, how do you reinter, how do you manage the portfolio sizing, everything else? You know, so if you run a quantitative strategy that’s factor based often they simply just rebalance into the highest say 10% based on these factors, so you don’t really have a stop-loss you just clean house and reallocate to whatever’s in that bucket. So, again it all goes back to what are your exact rules and process, and if you don’t have one you just ask me if I think that our stop-loss is reasonable, they are, but they’re useless unless you have them as a one of the trading rules in an entire allocation.

Jeff: Oh, it ties back to what you were saying a moment ago, about how many listeners have actually written down their plan, know what they’re invested in, why, under what conditions they would get out, when are they gonna continue with strategy, for what reasons? So, it really is just sort of thinking through all these things ahead of time, so that emotions don’t trip you up in the moment.

Meb: Most investors plan is to win the… Is it Powerball or Mega Millions, the one that’s 1.6 billion?

Jeff: You mean the one I’m gonna win?

Meb: Yeah, which one is it? I think it’s Mega Millions.

Jeff: I don’t know, Powerball, I don’t know. All right. What else have you got? Anything else you wanna touch on before we wind down?

Meb: No, come to say hi in Vegas, I’ll take you to the buffet and buy you a crab leg, we’ll be… I think it’s…I think the conference is in Paris. Is it Paris Paris or just Paris?

Jeff: Paris Paris.

Meb: Okay.

Jeff: All right. Wind up.

Meb: Listeners, it’s been great. Send us some questions, we’re running out of questions, feedback at themebfabershow.com. As always leave us review, we love reading them, and we’ll post show notes, links a whole bunch of stuff on dollar-cost averaging to the show notes at mebfaber.com/podcasts. Listen to us on the various apps Overcast, Stitcher, my favourite Breaker for now. Thanks for listening friends, and good investing.