Episode #132: Radio Show: Since 1989 80% of Stocks Had a Collective Return of 0%… A Goldman Bear-Market Indicator at Its Highest Point in Decades… and Listener Q&A
Guest: Episode #132 has no guest but is co-hosted by Jeff Remsburg.
Date Recorded: 11/30/18
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Summary: Episode 132 has a radio show format. In this one, we cover numerous Tweets of the Week from Meb as well as listener Q&A.
For our Tweets of the Week, a few we cover include:
- A chart from Longboard about returns. Since 1989, the worst performing 11,513 stocks – which is 80% of all stocks, collectively had a total return of 0%. The best performing 2,942 stocks (20% of all) accounted for all the gains.
- A tweet about another option selling fund blow-up.
- A Jason Zweig post about how many investors should question the dogma of “stocks for the long” run since history shows that a portfolio of bonds has outperformed stocks surprisingly often and for long periods.
- The statistic “According to Goldman, its indicator at 73% marks the highest bear-market reading since the late 1960s and early 1970s, which (with a few exceptions) is consistent with returns of zero over the following 12 months.”
We then jump into listener Q&A. Some you’ll hear include:
- In your book, Global Asset Allocation, you compare the results of well-known asset allocations and find that the returns are quite close. Over a long period of time, would you also expect the results of a momentum / value strategy to be similar? Is the main advantage that it allows for better behavior (lower drawdowns, etc) or would you also expect the performance to differ (net of fees)?
- Would you rather own a stock with a high free cash flow yield or high dividend yield?
- I was wondering if you could touch on the process of launching an ETF. What are the startup costs, how much AUM and at what fee would the ETF breakeven?
- I’ve heard you (and others) extol the benefits of a diversified global allocation but I rarely (if ever) hear the counter argument: that the US deserves a premium to the rest of the world because it has the largest and deepest capital markets, has comparatively lower regulation and fosters innovation and creative destruction. Do those factors warrant an over-allocation to US equities?
- How much should the average investor be willing to spend (as a percentage of portfolio value) in order to carry some protection in the form of puts?
- What beats the 60/40 portfolio over the next 5 and 10 year periods?
As usual, there are plenty of rabbit holes. You’ll find them all in Episode 132.
Links from the Episode:
- Tweets of the Week
- 0:50 – Welcome to the show and recap of Thanksgiving holiday
- 2:16 – News about the team
- 3:34 – Longboard chart about returns
- 4:22 – BlackStar Funds: The Capitalism Distribution
- 5:33 – Do Stocks Outperform Treasury Bills?
- 7:48 – Dealing with capital gains
- 9:03 – Year-end portfolio housekeeping
- 10:27 – What does Meb like
- 10:42 – Mebisode Podcast Episode #129
- 14:26 – Option fund blows up
- 16:22 – iasg.com
- 18:55 – James Cordier YouTube video
- 21:12 – EquityZen Spot
- 22:40 – Fate of bonds
- 22:41 – Sometimes, It’s Bonds For the Long Run
- 25:39 – Mailbag question: Longest flat period for a global portfolio
- 26:56 – Advice for older investors facing a flat market
- 27:40 – Signs of the top
- 29:08 – Value factor at historical lows
- 29:10 – Eric Falkenstein Podcast Episode
- 32:19 – Listener Question: Expectations for momentum/value strategy over a long period of time
- 32:29 – Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies
- 34:45 – Listener Question: Process of launching an ETF
- 35:15 – How to Start an ETF
- 40:44 – Listener Question: Meb’s thoughts on commodity linked investments
- 47:02 – Listener Question: Stocks with free cash flow vs high dividend yield
- 48:32 – The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success
- 49:47 – Listener Question: 2-Year CD vs intermediate bond fund
- 52:32 – Listener Question: Bonds as a wealth preservation play vs source of capital gains
- 54:53 – Listener Question: Over allocation to US?
- 56:09 – Listener Question: How much should investor spend to carry protection in the form of puts
- 57:53 – cboe.com
- 59:44 – Meb’s interest in a tail risk insurance fund
- 1:00:06 – If You’re a Financial Advisor, You’re 4 Time Leveraged to the Market
- 1:02:48 – Listener Question: What beats the 60/40 portfolio over the next 5 and 10 year periods
- 1:02:54 – Not One Ivy League Endowment Beat a Simple U.S. 60-40 Portfolio Over Ten Years
- 1:03:53 – Listener Question: Favorite beer and ski destination
Transcript of Episode 132:
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 the 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, we’re winding down towards the end of 2018. Welcome, Jeff.
Jeff: What’s happening?
Meb: How was your Thanksgiving?
Jeff: It was very laid back, very chill.
Meb: Do you want to share with the listeners what your Thanksgiving meal was?
Jeff: Well, it did involve the traditional Thanksgiving treat so to speak. I was…
Jeff: No. Basically had some soup and some peanut butter. Took it easy by myself out of here. Not much of a chef.
Meb: My wife’s family, my in-laws, historically don’t eat green bean casserole. And the first Thanksgiving was somewhat of a meltdown where I showed up and I’m like, “Wait a minute, where’s the green bean casserole?” It’s mainly all I care about…
Jeff: Yeah, I remember this and then you started bringing your own green bean casserole.
Meb: Yeah, so then I’m like, fine, I’m just going to show up and hide it in the corner so I have leftovers. A couple of years we tried to make fancy green bean casserole and that was kind of a disaster.
Jeff: By the way, you guys have not kept me on the guest list invite for that Thanksgiving meal, which was very noticed this year.
Meb: You embarrassed yourself. You embarrassed yourself one year and so we had to…
Jeff: Yeah, I don’t remember that at all.
Meb: You gotta make cuts, you know. You gotta make cuts each year.
Jeff: Yeah, that impressed everybody.
Meb: But the Campbell’s Soup green bean casserole is just the crowd pleaser.
Jeff: Oh, really?
Meb: I think my family in Kansas puts tater tots on top of it. There was something amazing on the dish that just makes it even more absurdly awesome. So anyway, we got some leftovers. We also got some news listeners. Jeff is getting ready take a sabbatical.
Jeff: Yeah, well, when you refuse to implement my idea for putting the masseuse on the payroll, I realized I had to escape this draconian work environment.
Meb: We have to get Sue to start sponsoring the podcast again because I think I got like one entire massage out of that.
Jeff: Hey listeners, just so you know, like, what I’m dealing with and why I’m trying to escape this, Meb didn’t join in or, you know, basically share the spoils of all this. He had his personal account linked up to Sue the recommendations.
Meb: Yeah, let’s be clear.
Jeff: So he racked up all these free massage points.
Meb: To be clear, you ate all the Virginia peanuts. Most of the gifts that have accrued to the podcast, you have consumed because it’s been mostly food. So listeners, if you want to thank Jeff for his time as podcast host, you can send him a thank you email, firstname.lastname@example.org. Or you can send a gift and I’ll promise to share it with him. Cambria Investment Management, 2321 Rosecrans Suite 3225, El Segundo, California 90245.
Jeff: Wow. All right, I’m excited.
Meb: The more caloric value, the better. Jeff much prefers peanuts and angel food cake, [inaudible 00:03:30] cake to nice long love letters. Anyway, the finale radio show, what do you want to talk about?
Jeff: Let’s dive into some of your tweets of the week. And then we got a handful of great listener questions. So we got plenty to talk about.
Meb: All right, number one here, you had a post from Longboard, and these guys posted a chart about returns. Since 1989, the worst performing 11,513 stocks, which is 80% of all stocks. They collectively had a total return of 0%. The best performing 2942 stocks, which is 20% of all of them, they accounted for all of the gains. So to single stock pickers, that probably sounds a bit terrifying. So, you know, you’re an ETF guy, but how do you view this in general?
Jeff: It makes sense. You know, we’ve talked about this few times on the podcast, it goes back to their old white paper called “The Capitalism Distribution” back when Longboard was Black Star. They basically showed the returns of all stocks going back to I think it was the ’80s. And they showed that the stat was something like two-thirds of stocks underperform the index, and half stocks had zero rate of return over their lifetime. And another quarter essentially went to zero. But the takeaway was that a very small percentage accounted for a very large percent of the gains. And that makes sense because the McDonalds, the Walmart’s, the Microsoft, the Apples of the world that become these $500 trillion, $700 trillion companies, that’s why a basic market cap weighted index, like the S&P 500, which is a trend falling index, you’re guaranteed to own the winners.
And all the losers get smaller and they simply go away. So you’re guaranteed on the Amazons of the world. And that’s why investing in stocks works. But it’s a numbers game. That’s also why it’s so hard to invest in stocks because if you’re just throwing darts, the percent chance that you’re going to hit one of these big winners is pretty small. Another white paper’s come out, called something along the lines of “Do stocks outperform bonds or treasury bills?” And in general, most don’t, right? It’s only these very few small ones that generate most of the return. So it’s normal. I mean, that’s capitalism to me.
Meb: Well, so if you’re not investing…let’s go to ETFs now. If you’re not investing in a market cap weighted fund, if you’re invested in something else, and a broad market fund, don’t you have a lot of deadweight stocks in that ETF that are likely drawing back returns or drawing down returns?
Jeff: Well, let’s flip it. If you have the broad base index, S&P 500, Russell 2000, etc, you’re guaranteed to own all the losers. So you have the winners and losers. The good news is over the past 60 years, 80 years, we’ve developed a lot of literature in both academic and practitioner that shows, “Hey, here’s some things you can do to increase your odds of owning the good stuff and excluding the bad stuff,” such as value, such as momentum, profitability, quality. It gives you hints as to stocks that will have higher returns.
Meb: Well, I mean, if we’re looking at just quality, what would be your thoughts on look at companies that have been around or iconic for many years, like GE…
Jeff: Well, that’s funny, asking that question. I was about to think, well, GE, is the one that would be burning your portfolio right now.
Meb: Brings up another example that we tweeted about, which was taxes are important. You should always consider taxes when managing your portfolio. But for a lot of people, it should never be the first consideration. So someone who’s owned GE for 10, 20, 50 years, same thing applies to Microsoft, Walmart, etc., you have these big capital gains and it becomes 10%, 30%, 50% of your portfolio. So I can’t sell it now because I have all these capital gains.
And the next thing you know, GE goes down 10%, 20%, 50%. Next thing you know it’s in single digits and you’ve lost all your money anyway. And so that applies to every investment you make. How many people own crappy mutual funds that charge 1.5%, 2% still today that are closet indexes or straight-up indexes and say, “Well, I can’t sell because I have all these embedded capital gains?” Well, you’re also paying 2% a year fee for holding that crappy fund.
Jeff: Well, do you have any particular recommendation for listeners as far as dealing with capital gains? Is it just take your medicine…?
Meb: I am. Be a patriot, just deal with it. You know, I mean, in general, yeah, look, you weigh the balance. Is it better to have a sub-optimal holding that you can defer capital gains on for…I mean, it’s a simple mathematical exercise usually. Or, you know, is it better to clean slate and invest in what you want to be investing in? And this is one reason that so many people hold total dog crap portfolios still, you know.
We talked so many times about this, three-quarters of our listeners and followers said they don’t have an investment plan. And so they end up owning this patchwork junkie portfolio full of legacy terrible names, part of which is, “Well, I just have capital gains, I don’t want to pay it.” People hate paying taxes, right? But you end up with this ridiculous portfolio that sub-optimal, which probably in many cases is worse than paying taxes in the first place and moving on.
Jeff: I think it’s not just taxes, people don’t like the idea of actually realizing a loss. And so they are waiting for the stock to come back, meanwhile, it’s going over.
Meb: Well, but then they wouldn’t be paying taxes if they had a loss. So that’s different.
Jeff: Well, we have a lot of issues. We’re talking about a bad portfolio and what to do about it. By the way, it’s about that time of year where, you know, we posted that article about revisiting your portfolio and clearinghouse if necessary. So always a good idea to treat this end of the year time as…
Meb: Yeah, time to reflect, listeners. We posted on the podcast a note that you could do phone calls with me, and I think they’re all full up. We didn’t post it to Twitter or the blog. So kudos to the podcast listeners. We’ll do it again next quarter of the new year of people that can take time and chat about their portfolios and what they’d like to accomplish and what they’re thinking about. It’s been pretty useful because into the year is always a good time to sit back and reflect at what a terrible portfolio you have. And all the mistakes you made.
2018 has been tough for people, you know, it’s almost…there was a stat from I think it’s Deutsche Bank, which by the way, is one of the worst performing stocks in the world. But it showed…and I don’t know how they came up with 70 asset classes because there’s really only a couple real asset classes. But they’re getting down into sub-asset classes, sectors, and industries. But of these 70 they track somehow back to like 1920, I think this was the highest year as far as percentage asset classes that were down on the year. Everything seems to be down 0% to 10% this year, which is funny because I looked at the Barron’s end-of-year 2018 forecast, 10 of 10 said stocks would be up this year.
Jeff: All right, well, what do you like right now? I’m just gonna push you on this. And if everything’s down…
Meb: I’m a broken record, you know. Listeners know what I do with my own money. We’ve talked about it many times. As you look at the world today, you have a scenario where we’ll talk about value first. We did this in the speech podcast if you didn’t listen to it, the Mebisode where I was solo. You can revisit that one, it’s long. We talked about my beliefs here. But, you know, certainly still believe U.S. stocks are expensive.
I think the rest of the world is reasonable to downright cheap to really cheap. So you should have a global perspective if you’re in stocks. Sovereign bonds are interesting because U.S. government yields have come up quite a bit. All of a sudden we have yield again in the U.S. U.S. is actually one of the highest yielding countries in the world if you look at a basket of 45 countries, and ironically, the rest of the countries that have high yield are like emerging markets. So it’s like the U.S. Greece, Mexico, Russia.
Jeff: You have a gut on one when we’re going to see 4% or 5% in the U.S. treasuries?
Meb: Yeah, I do.
Jeff: And what do you think?
Meb: Sometime in the next 20 years, 50 years, maybe.
Jeff: That’s such a bad answer.
Meb: It’s an accurate answer.
Jeff: Listeners, I always try to pin Meb down for y’all’s benefit. Meb always squirms away out of giving very definitive answers.
Meb: And so that’s the way the world looks with sovereigns and so creating global portfolio tilting towards foreign, I think is really a smart idea. Now, if you’re looking at trends, tactically speaking, we already mentioned that a lot of asset classes are down. If you look at a lot of our tactical strategies, many have been de-risking over the course of this year at or near full conservative positioning. So they’re either near or fully hedged or near or fully cash. And that is usually not a good situation for markets. But that having been said, it’s been a really tough year for a lot of factors, for a lot of strategies, trend falling through the lens of managed futures, stinking it up again.
Jeff: Is that just the whipsaw factor?
Meb: Yeah, you know, I mean you had a year where in the beginning of the year a lot of foreign markets were ripping and rolling, commodities have been all over the place, this massive move in oil both up and then back down. So it’s been kind of a whipsawing sort of year. But there are some areas of glimmer were some markets are perking up. But it’s been a tough year for, I think, a lot of people. But not awful. It’s just been kind of a not great year.
So anyway, that’s the world looks. I mean, I think two things I would tell people, assuming you already have a plan, and if you don’t, to think about is the nice thing about, you know, the portfolios that we run as they adjust as needed for value and trend. So many of the portfolios we run been increasing risk-off for the last few months. So it’s much higher percentages and bonds and cash. But to think about is that idea, that concept, it’s historically as you move particularly in U.S. stocks, from an expensive uptrend to an expensive downtrend, that’s usually been kind of a dark place.
So think about managing your risk if you perhaps have too much over the last few months, if you’ve had a hard time sleeping, start to think about that a little bit. But all of this is within the framework and construct of having a plan in the first place. So nothing should change if you already have a plan. And if you don’t, or if it’s been a hard, tumultuous year for yourself, put a plan into place. But I would say it’s sort of a binary world where you have, on one hand, really cheap global stocks, but on the other hand, a lot of downturns as well.
Jeff: Yeah, I mean, a lot of the cheap emerging market stuff is still headed south right now.
Meb: You know, so the young person says, hallelujah, I hope all these countries get down to a cape ratio of five or two because it will be a generational buying opportunity. I mentioned, that’s what I do with my 401k is I simply…because we can’t do Cambria funds, I just plop it all into a recurring deposit into Vanguard emerging markets.
Jeff: I thought you were doing a lot of options with that.
Meb: No, no, no.
Jeff: Well, that leads me…
Meb: It was a Jeff joke.
Jeff: …leads me to the second tweet from you. You posted about how seemingly about every five years an option selling fund blows up and happened a few weeks ago. Why won’t you walk us through what happened and what the takeaways are for listeners?
Meb: There’s a website called optionsellers.com. It’s run by, I believe, a few guys out of Florida, James Courtier. I think it’s how you say it. Actually, the name rang a bell when I saw this. I’d actually read his book maybe 10, 15 years ago. And I actually thought it was a decent book. And at the time, I would have been living in Lake Tahoe as a glorified ski bum. And at the time, would have been doing some research into markets and so actually spent a few months developing some options strategies. And so I was thinking about…so listeners, if you’re doing naked selling of options, it can be highly risky if the options move against you, if the market goes against you because you have essentially unlimited downside.
So the problem with that is most people reduce that risk by either doing spreads or having a position like a selling calls against your stock position where it’s balanced. But some people do naked option selling. And so there’s been a lot of famous option selling funds, essentially selling insurance. So you can come up with option selling strategies that make a percent or two or three per month every single month, and it’s consistent. If you backtest it, it does wonderful. The problem is…and you have a Sharpe ratio of like three. The problem is this can go on for one, two, three, five years, and eventually, it hits a road bump and you lose 50%, 80%, 100%, depending on how you construct it.
The interesting thing that I did when I did the studies, is most of the options selling funds historically have been limited to one market. So if you look on IAESG is a great managed futures CTA platform that shows you performance of a lot of these funds going back to the 1980s, but you can look up some of the option sellers. And so we used to do…we have these archive posts on the blog where I was talking about option sellers in the mid-2000s having done this research. And I said, you know, “One, I don’t understand why these guys usually only focus on U.S. stocks.” So the same way you’re diversified portfolio globally, why wouldn’t you sell options across instead of 1 market, 5, 10, 20? They’re uncorrelated because we’re selling options on gold and smaller portfolio management size, position sizing, and selling options in wheat and U.S. stocks and German bonds, all these things, it’s more diversified, you have less risk.
Two, you know, you could also sell options on both sides, so do straddles or strangles. Three, we actually found out that if you then tilted the option strategy towards the trend, meaning if the trend was going up, you would sell more puts than calls. And basically, it’s like a mini, mini month chasing my tail and then just saying, “Well, if you’re going to do a trend following strategy, why not just do a trend following strategy in the first place and be long volatility and do trend?” And that’s what my personality gravitated towards because a trend falling approach for its many drawbacks, you know, you usually don’t have that exposure of a blow press.
So what happened, look at the blog, and I said, eventually these funds will blow up. And sure enough, I think they’re all gone. So I wrote a follow-up post like two years later, and all the funds are gone. But what happens is, a bunch of new funds get started, they get two or three years of track record, they market to a bunch of people who look at it like, “Oh my God, this makes 20% a year. It’s got a Sharpe ratio of three, they raise a bunch of money, and then they blow up again.” Long-winded answer. So what happened recently was these moves recently in the energy markets where you had an unusual move where oil was tanking, but natural gas was ripping. And I assume these guys had written a bunch of options and they had something like 300 clients and posted that the clients had all lost all their money.
Not only had they lost all their money, there’s a note this past week that says that they owe extra money, so the brokerage is going after them to the tune of $30 million or $40 million. And this was all made slightly weirder by the video that the founder and PM posted on YouTube, which you can find if you search for “options sellers,” which was a really odd video where he’s talking about bass fishing and wildlife fishing with clients and etc. But, you know, again, it’s going back to this concept of building ideas and portfolios that…I mean, the last thing you want is anything that will take you out of the game and make you go broke. And option selling, in particular, if you don’t know what you’re doing, will do that.
Jeff: You know, the analogy is picking up pennies in front of a steamroller.
Meb: Yeah. And so, I mean, look, there are plenty of ways. You know, we manage funds that use options, but in a thoughtful and non-expose way, that’s going to make you go broke eventually. So, anyway, it’s unfortunate, but again, like everything in our world, buyer beware, you know. I mean, if you look at the recent news with…we had tweeted about this last year. There was a curated list I did of the most ridiculous stories about the bull market and stocks, but also crypto and everything else. And, you know, one of them was a lot of these coin offerings and the nonsense going on there. And so many people were like, “These aren’t security offerings.” I’m like, “You just wait. You wait until the SEC thinks these are not securities offerings.” And all the hallmarks of the fraud and ridiculousness going on there. And recently this week, Floyd Mayweather and DJ Khaled, both got busted for crypto fraud.
Jeff: What happened?
Meb: They were promoting a bunch of these dog crap ICOs, not disclosing they were getting paid to promote them. So SEC said, you can’t do that, idiots, and slapped them with some fines. And I think they’re also barred from ever being involved in crypto again.
Jeff: But it’s so much pain in Bitcoin right now for so many people.
Meb: Yeah, you know. But again, it goes back to buyer beware, if you’re buying coin offerings that Floyd Mayweather is promoting, you probably need to look into that and do your homework. Where else are you gonna lose 97% your money?
Jeff: I think Floyd’s got a beat on the crypto market. I think you should go along with whatever he’s doing.
Meb: Yeah, but applies to everything. You know, most people, they don’t know what fees they pay for their investment counts. They don’t know what they own. So part of it is, you know, look, you got to be an adult and take ownership of it. But also realize that there’s a lot of predators out there too.
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Jeff: All right, let’s move on. Jason’s blog posted an article about how bonds have outperformed stocks much more often and for much longer in the past than many investors believe. The quote is, “Maybe investors should question the dogma of stocks for the long run. History shows that a portfolio of bonds has outperformed stocks surprisingly often and for shockingly long periods.” All right, so Meb, is this due to basically the 40-year bowl that’s been going on bonds? Do you see it continuing or now that it looks like we might be bouncing our rates have like a sustained climb? Is it different now? What’s up?
Meb: There’s a couple comments. You can look back at history and come up some guideposts. We did a fun tweet, they got a lot of crap maybe last year where I said, you know, stocks have outperformed bonds by 2% per year. I think it’s 2.2% for the past 40 years. How much of that has come since the global financial crisis? And the answer is, all of it. And so what people don’t understand, you know, stocks can certainly go nowhere for a decade. On an after-inflation basis, they could certainly go nowhere for 20 years, which is a long time. You know, how many people sitting here in their 40s or in their 20s or 80s, are investing in stocks, if you’re 80 years old, and say, “Man, I can have zero return by the time I’m a hundred?”
You know, most people don’t think that’s possible, but it’s happened in the past for sure. And then you have a higher bar, which is stocks versus bonds. And there’s been plenty of periods of 30 years and not just in the U.S. but globally, where stocks in a particular market underperformed bonds. And if you go back to the 1800s, which you start to, you know, get a little bit take it with a grain of salt of what markets did in the 19th century, but there was a period of something like 68 years where stocks underperformed bonds.
And you know, this is one reason people diversify, of course, but certainly, it can go on a long time. And so, as people think about allocating to managers and strategies, you know, I think I’ve changed my tune a little bit. People always email in and ask what this fund strategy or portfolio is doing. They say, “Meb, can you explain this performance this quarter? I don’t understand this performance this quarter or this year.” And often you say, well, you know, you probably need to 10 years to evaluate a strategy or an investment. I think it’s probably wrong about that. I think it’s probably 20 years.
Jeff: Well, let’s…
Meb: [inaudible 00:25:08] laughing, I think I probably will get this wrong, but Cliff Asness at AQR was talking about, you know, some of the strategies they run and recent struggles this year. And someone was asking him about…I think it’s [inaudible 00:25:21]. Cliff, I apologize if I get this wrong, but had said something along lines of like, how long do you need to know if this strategy could be invalidated? And I think he said something like 50 years, you know. So ask me again when I’m 100, we’ll look back and do a retrospective.
Jeff: Oh, this is a good segue into a question I was going to ask you later from the mailbag. Let’s just dive into it right now, it ties in. The listener writes, “I’ve seen a reference to some studies saying stocks historically have periods where they can go as long as 20 years with 0 returns. I think that’s only for a single country though. So my question is, what is the longest flat period you found for a global diversified equity?”
Meb: No better.
Jeff: No better?
Meb: No better.
Meb: Granted we’ve had some major world wars and everything else but it’s no better. You should you should easily plan on a nominal basis for stocks to go nowhere for a decade. On an after-inflation basis, you should easily plan for stocks potentially to go nowhere for 20, 30 years.
Jeff: All right, so that’s stocks. What about now an asset diversified portfolio? You got, you know, real assets in there, if commodities, whatever else, bonds…
Meb: It should be less.
Jeff: What do you mean less? Less…
Meb: I mean, obviously it’s going to be less than 20 or 30 years. I can look it up exactly what the numbers are. But you would expect a diversified portfolio because has lower drawdowns meaning less time and drawdowns as well. It should be cut in half easy.
Jeff: Okay, so our 80-year old listener who is sitting on 20 years of going nowhere, now it’s only 10 years of going nowhere?
Meb: Yeah, hopefully.
Jeff: While we’re on this topic, any practical suggestions for people in that situation where, you know, they still need income, still need growth, and they’re older and they’re looking at a market which could really be sucking when for a while?
Meb: It’s all the same stuff we always preach. It’s diversify globally. So right now you have a time when the U.S. stocks are expensive but everything else is cheap. Flip to the 1980s, you had a time when the U.S. was cheap and a lot of other stuff is expensive.
Jeff: Well, but everything non-U.S. right now might be cheaper, but it seems like it’s stuck in a drawdown.
Meb: Yeah, that could change in a week, in a month. I mean, like, value plays out over years. Trends is a lot shorter timeframe as far as how you need to monitor it.
Jeff: Good. Well, in terms of signs to the top we’re kind of talking about it here. Another tweet from you, Jesse Felder posted something reading, “According to Goldman, it’s indicator at 73% marks the highest bear market reading since the late 1960s and early 1970s, which, with a few exceptions, is consistent with returns of 0 over the following 12 months.” So I assume that you read this and you’re…
Meb: Doing what?
Jeff: Excuse me? I’m just reading the quote.
Meb: Are they stocks?
Jeff: I would assume stocks but it wasn’t specified.
Meb: Okay. In U.S. stocks, I assume.
Jeff: I’m assuming that you are reading this as having no profound impact on what you’re doing market-wise. But I mean, is there something you would read that would cause you to rejigger with your…?
Meb: No. I mean, we already talked about it. I mean, the portfolios we manage are probably more outside of traditional allocations than almost any advisor in the country. You know, I don’t know any advisor that allocates half the trend falling. Most have a huge home country bias. So, you know, our starting point is half in foreign stocks but it can easily get higher and that’s uncomfortable for a lot of people. But it’s happy for us. It hasn’t made any difference this year. You know, we’ve been kind of stinking it up with everyone else. But in general, I’m much more comfortable with that than being stuck in expensive countries being my number one stockholding.
Jeff: Next topic. Eric Falkenstein, the guy we just had on the pod not too long ago, was tweeting about how the value factor is at historical long-term low. So given this, would you personally view this as a time to sort of over-calibrate or over-balance in terms of rebalancing toward value? Or do you wait until you’re seeing value combined with momentum?
Meb: We already do overexpose ourselves to value. I mean, I think we always mentioned the global market portfolio is a great starting point. But then you tilt away from our cap indexes, we always use value, we always use momentum and trend. And so that’s consistent. But the cool part is they update themselves. Like, you don’t have to go dig around, you know, as an investor and say, “Okay, I need to update this more towards value because it’s already rebalancing towards value in some cases yearly, some places quarterly, so you’re always going to be buying stuff that’s cheap.
But it’s funny, I mentioned on Twitter, I asked one of my least favorite interview questions in that interview, at the end of the interview. And I said, “Hey, what great books have you read recently?” And I hate that question more than any other question on the planet because I can’t answer it. I can never answer. If someone says, “Hey, what great books or movies have you seen recently?” Like, my brain does not work that way. If you said, “What do you think about XYZ movie?” I could do that all day, or XYZ book. Like my brain doesn’t recall the movies I’ve seen in the last year.
Jeff: That’s one of the reasons I’m going on sabbatical. We get to go to the movies.
Meb: But I said the universe struck me down for asking that stupid, terrible question. At the time, I thought I got the romaine poisoning. I just happened to get food poisoning the exact same time as the romaine scare. But what’s interesting, listeners, and this will save you, one of you eventually, as the doctor was going through the potential culprits and I had already just assumed it was romaine because I had been forced to eat a lot of salads with Jeff who eats two salad today. But he said, “Did you have any shellfish?” I said, “No.” “Did you have any sushi?” No. “Did you have fried rice?” I said, “Yeah, we had fried rice the day before I got sick.”
And he goes, “Aha,” because fried rice is apparently this huge culprit because when people order Asian food delivery, they’ll eat the food, leave it out in the containers on the counter for an hour or two. And remember, it’s probably already sat half an hour, an hour, in delivery. And then put the rice in the fridge and then use it a day or two later to make fried rice.” And he says, “The problem is, rice very quickly picks up a bunch of bacteria. And then you put it in the fridge and then you cook it and it doesn’t…even though you’re doing a high temperature for fried rice, it doesn’t kill it.” So the good news is I had a huge caloric deficit the day before Thanksgiving. So I was able to add about 5000 additional calories I wasn’t intending to add. And it made for actually very pleasant Thanksgiving.
Jeff: Listeners, in appreciation for this tip, please send Meb tons of fried rice.
Meb: Yeah. I said I’ll never ever eat fried rice again. Two days later, I was eating fried rice. I’m never making it again by the way. But meanwhile, I was also, “I am never eating romaine lettuce again.”
Jeff: That did throw me. Our favorite place to get lunch around here has a great salad and I couldn’t get it the other day.
Meb: Yeah, very discouraging.
Jeff: All right. Let’s move on to some listener Q&A here. Unless you want to add anything more to that general discussion.
Meb: I didn’t even answer the question. But let’s give it…all right, fine.
Jeff: Meb, in your book, “Global Asset Allocation,” you compare the returns of a number of well-known asset allocations and find that return to quite close. What would you expect of a momentum/value strategy? Over a long period of time, would you also expect the results to be similar as a main advantage that it allows for better behaviour in terms of lower drawdowns or would you also expect the performance to differ in net of fees?
Meb: Okay, so we’re going to update that book, hopefully, early 2019, where we can actually take the historical research probably back to the 1920s. I don’t know why I didn’t think about this in the first place. But if you only exclude a couple asset classes, like reads and broad base commodities, which usually are pretty small portions, you can actually take it back an additional 50 years. So we’ll update it, which is pretty cool. Same takeaway I’m sure will apply. But what happens when you move from a great global asset allocation to a factor tilted portfolio? I think you can add a couple percentage points to performance. So a percent or two.
And that’s not like all world, it’s not crazy, but is it worth doing? Absolutely. Still worth doing as long as you don’t pay too much for it because the global market portfolio is free. So if you tilt towards value or momentum, I think you add some performance, but I don’t think you reduce the volatility to draw down at all. Okay? However, people often, you know, conflate the two terms momentum and trend, right? Momentum is relative strength through comparing assets. So if you’re looking at, say, a stock fund, you’re picking the stocks with the highest 12-month returns and picking the top hundred, you know.
But trend is saying, is this one stock or is this one’s index going up or down? And often when it’s in a downtrend, it’ll move to cash or short. So does adding trend following, what does that do? And I think trend following does not increase return but it does reduce volatility and drawdowns. So it’s different. So yes, I would think that adding factors…basically, any factor that breaks the market calculated link will add some performance, I think over time. You can even equal weight. And I think adding trend following will smooth the ride.
Jeff: Okay, so you’re adjusting both the behaviour element and the return element?
Meb: Yep. That’s the goal.
Jeff: All right, next question. I was wondering if you could touch on the process of launching an ETF. What are the startup costs, how much AUM? And what fee would the ETF break even?
Meb: Curious, we never really talked about sort of the bones of running this type of shop.
Jeff: So any thoughts on this?
Meb: First piece of advice, don’t do it. It’s like the old Warren Buffett. First rule, don’t lose money. Second rule, don’t lose money. Third rule, read the first rule or something, whatever it is. My advice would be, don’t do it. Don’t do it. We’ve actually touched on this at some point, I wrote an old article called, “How to launch an ETF.” You can find on the blog. It doesn’t really pertain specifically to launching an ETF. It could pertain to launching a mutual fund, they’re pretty similar. And it’s changing very quickly if the SEC approves their new ETF rule, which is streamline it.
Up until now, it’s been a very patchwork process where you had to get an exemption which gives you permission to launch ETFs, which back in the early 2000s probably cost a million bucks, and then it costs $500,000, and then it costs $200,000, I think it’s what it cost us, to probably now boilerplate 50 grand or something, I don’t know. But then once you have that, you have permission to launch funds, which again, the SEC will streamline and then you say, “Okay.” Let’s say I want to launch a fund. It’s going to cost about 20 grand in legal, maybe 30. It’s complicated, but that’s not the big expense. The big expense is that everything else that surrounds it, how much you got to pay your board and trustees, how much you got to pay for insurance, how much you got to pay for rent, all the other things going on.
But let’s say you already have an investment business running and you already do all those things, somehow, magically. Then it’s like, all right, how much does it cost just to keep the fund open? And I think that’s probably 10, 15 grand a month. You’re on the hook for, what does that expense? You have service providers, you have admin, you have custody, distribution, all these things, and they usually have minimums, they’re not going to do it for free. They’ll often charge you a basis point fee to do the fund. So theoretically, let’s just call it 10 basis points for that. But they have a minimum. So my comment is always, let’s say you launch a fund and it sits at zero, that means you’re on the hook for writing a check for, let’s call it 150, 200 grand a year.
So a pretty good check, but it’s not a million, it’s not $2 million, right? That’s the cost of probably an analyst at Goldman, right? But it also sucks if you launch one, and it’s for five years, it sits there with no assets because then you just wrote a million dollar check. Okay? So there’s two different schools of thought. There’s our school ofthought, which is the rifle approach, which is we only want to launch funds, we have four criteria. I mentioned this million times to the listeners. But first, it has to be something that doesn’t exist. Or if it does exist, we think we can do it much better or cheaper. There’s thousands of ETFs. The last thing the world needs is another large-cap value fund, smart beta. There’s 70 of those probably, or high dividend fun.
So it has to be something that’s better, if it does exist, we’re better, cheaper. Cheaper is harder these days with the big three race to zero, but we still operate in a couple of those categories. Second, it has to be something that there’s a lot of academic and/or practitioner research that supports the concept. Third, it has to be something I want to put my own money into. So you see so many fund providers just throw all these preposterously stupid ideas against the wall, hoping to chase some hot theme and get $500 million in management because…and it’s predatory, but investors are like catnip, they find the hot theme and you can do…every two years and it’s a different one.
It could be MLPs, it could be floating rate funds, it could be smart beta, it could be anything, you know, crypto related, if they can ever get one out. I’m sure it will be a billion dollar fund. But those fund companies like, those are fine vehicles for trading and plenty of people use them and that’s fine. But is that a sustainable good solution for most investors’ portfolios? Probably not, you know. So it’s catnip. So there’s plenty of people that will throw a bunch of funds against the wall, see what sticks with hopes. It’s almost like a venture capitalist portfolio that if they launched 10, one goes to a billion and it pays for the rest and then I’ll just close them. I think we’ve already had over a thousand ETFs close, which is amazing, which is good because there’s 1000 more that should close.
Jeff: Well, if 80% of stocks sit on zero, that makes sense.
Meb: So we try really hard to never…we’ve never closed a fund of our own. And I try really hard to only launch funds…The fourth criteria is the hardest, is that something people actually want? And so there’s plenty of ideas we have that I think are brilliant ideas that I’m fairly certain no investor on the planet will ever invest in. So we try to launch funds where we know that there’s either pent up demand of at least break even, which is that $20 million to $40 million range. If you’re a super low-cost fund complex,$ that maybe 100 million. But there’s also no reason to launch a fund if it can’t get to $20 million or 30 million because it’ll have no volume, it’ll have the perception of being an orphan or it’s not supported, it won’t get approved on any of the platforms. No one will want it.
There’s a big kind of snowball effect of people assuming more assets means it’s been blessed. And in some ways it has. So there’s a lot of considerations. But again, the cost isn’t that bad. So when we launched our no-fee fund, my belief was like, we can do cool things like that and be innovative and give the middle finger to the $300 billion, $400 billion-plus of super high fee asset allocation mutual funds that are tax inefficient for the cost of a Goldman analyst. So worst case scenario, I launch something like that, it doesn’t scale, whatever. But best case scenario is, it disrupts the entire asset management business by offering a low fee competitor to a lot of these high fee junkie funds.
Jeff: That was way more of an answer than I expected to get out of you.
Meb: Yeah, you have two more minutes.
Jeff: So the takeaway is launching ETF is a big ball of fun then.
Meb: Yeah, don’t do it, ever.
Jeff: Next question, Meb has been an advocate of including an allocation of the 2.0 versions of broad basket, commodity-linked securities. Meb mentioned that not many advisors recommend these commodity-linked investments. But given their very low correlation to, say, the S&P 500 and strong expected returns, why are they not more widely recommended by advisors and included in more robo-portfolios?
Meb: One very large reason is because they’ve stunk it up over the past cycle. That’s a simple one. You know, when people are building portfolios, they really don’t want to include something that’s looked terrible for the past 10 years.
Jeff: What do you think he’s referencing when he talks about strong? Well, excuse me, I misread that, strong expected returns.
Meb: Okay. Well, it certainly…I mean, commodities, I absolutely believe they have a place in a portfolio. And different people fall in different camps on this, I don’t really care either way. We think it’s an interesting inclusion and others do and others don’t. So this is sort of a whatever topic. However, you can’t just go out and buy a bunch of wheat and oil and put it into a fund, right? So it’s through futures. And then with futures, it brings more nuance where the indexing strategy needs to be a little bit thoughtful. And it’s the same with everything.
Otherwise, the strategy can get taken advantage of and it’s just sub-optimal. For the same way the S&P 500, it’s well known that the stocks coming out outperformed the stocks coming in. And so you could simply improve your S&P 500 strategy by waiting a year after you kick a stock out and replacing it. It’s a ridiculous scenario. But people game their Russell 2000 index every year. That was like one of the biggest moneymakers for like 10 years. People just knew the exact criteria, would buy the stocks going in, would sell or short stocks coming out, and you earn almost a near risk-free sort of profit. And there’s ways to get around that. So with commodities…
Jeff: Did you get that backwards? You mean by the stocks coming out?
Meb: Yep. No, buy the socks coming in.
Jeff: Okay, I thought you just said that stocks coming out will have better returns.
Meb: So okay, there’s two things. So when you have the Russell, when it back used to rebalance, and you could buy a month ahead of time before they announced what stocks were coming in. You could buy them because then all the funds have to go buy the stocks after the index comes out. So with commodities, the 1.0 version of the indexes were pretty basic and they weren’t very thoughtful. And now there’s been 2.0 kind of version of the indexes, they’re just more thoughtful about the way they index. And I think there are a lot better situated now.
You can then get into a philosophical discussion and say, should you be doing it long only, or a long-short approach to commodities? And I think there’s room for both. So the long-short approach, of course, would be managed futures. I think both have a place in the portfolio, but this isn’t something I’m willing to, you know, stake my flag and die on this topic. Like, I like them, but if you don’t include them, whatever. I also like farmland equities and funds and strategies, but there’s almost no public ways to express that, so.
Jeff: Let’s go to sort of a side note, I don’t want to go too far down the rabbit hole. But in terms of commodity funds, the 2.0 versions of these, how well do you think they handle like role yield issues?
Meb: Better, but, you know, some of it…
Jeff: Would you explain that real quick because I want to understand.
Meb: Yeah, so with any investment, a lot of people don’t know this, but half of the investment roughly comes from just inflation. You know, if you look at stocks, 10% historical return, like 4% of that’s inflation on a nominal basis, right? And so people always say, “Well, commodity futures and portfolio is half the return comes from cash sitting in collateral yield.” Well, again, that’s just inflation. It’s the same with anything. So I would expect commodities to do in the same ballpark as bonds.
I don’t think they’re as high as equity-like returns. Maybe somewhere in the middle. But low expectation would be bonds, if you’re lucky, high would be stocks. And so you get that collateral yield, which is like half of the return. And then on top of that, you’ll get the spot return, which is all over the place, and you get somewhat of a rebalancing return from that bouncing around and then being mean reverting. And then you get the role return, which depending on how the futures are positioned, it can be positive or negative.
Jeff: Explain that real quick.
Meb: Yeah, so if you’re buying a futures contract, and so, you know, futures traditionally, if you think of one where there’s contracts every four months on, say, wheat, and the contracts that say wheat’s trading at $4, it’s not because I just sold a bunch of mine. I’m the world’s worst wheat farmer, by the way. But let’s say it’s five bucks. I’m an optimist. Let’s say it’s five bucks. But in the future, the future contracts could be 5.25, 5.5, 6 bucks, or they could be 4.75, 4.50, 4 bucks.
And so, whether they’re in these backwardation or contango situations, you have what’s called a roll yield as those far out contracts rolled down to the present. And so if you buy or sell a long day to contract and it rolls to where you are now, you can theoretically get a positive or negative role yield. The problem would happen in the mid-2000s is everyone wanted commodities because commodities helped a lot in the 2000 and 2003 bear. As we’re talking about marketing, whatever is popular, everyone wanted commodity funds, all the endowments were buying some, everyone else was getting pitched commodities.
And then it got saturated and then commodities stunk it up, and then financial crisis, and had been bad since and they had crappy indexes. Now everyone’s selling their commodity funds over the past five years. Rinse repeat. This happens with everything. You know, emerging markets happens with bonds, it happens with real estate, yada, yada. Anyway, I think they have a place in the portfolio. But I also think managed futures do too. But I’m not…like if you came to me with portfolio that was global stocks and bonds and writs and tips and didn’t have any commodities, I wouldn’t pull my hair out and gnash my teeth. i’d more just shake my head.
Jeff: Next question. Would you rather own a stock with a high free cash flow yield or a high dividend yield?
Meb: These listener is clearly trying to trigger me because they already know the answer. The answer is free cash flow yield. Dividend yield is a value tilt, but not a good one. And it’s pretty tax inefficient if you’re a high taxable investor. So free cash flow yield.
Jeff: Okay. Would it make a difference to you if they were just sitting on the cash and not redeploying it and just value add…?
Meb: Well, I mean, a free cash flow actually has a very high correlation with shareholder yield, meaning price to free cash flow, meaning it’s a great value metric and it means that the company is probably pretty darn profitable and has a bunch of cash to do something with. And it’s cheap as opposed to a high dividend yield, which all that means is a company or stock is paying out a lot in dividends. So actually, probably has a high dividend payout ratio, probably has a bunch of debt, and is a junky company.
Jeff: So let’s say, how long often do you…
Meb: Remember that the highest dividend yielding company is actually…that bucket isn’t the best performing bucket, it’s usually worse than the next quartile or decile of dividend yield.
Jeff: How often are you seeing companies use debt to fund their dividend?
Meb: It varies. Sometimes they do, sometimes they don’t. Same thing with buybacks.
Jeff: Is that always a red flag for you?
Meb: No, it’s not always a red flag. Not always a red flag.
Jeff: Okay. When would that be acceptable?
Meb: It comes down to every company very specifically. So, you know, the ultimate goal, the CEO…can go back to reading one of our favorite books, “The Outsiders,” talks about this where, you know, they need to find a use of the best use of capital and how to deploy it. It’s so bad on Twitter, people talking about buybacks again. And this guy said, “Look at GE, they’ve been buying back stock, they wasted $14 billion over the past however many years and yada, yada.” Our capital markets are broken, you know, or capitalism is broken or something. This is venture capitalist, by the way. I’m just saying this.
And I said, “Man, if you’re upset about this, you’re gonna be really upset to know how much they spend on dividends the past five years.” Which was like double the buyback. Because anytime you see the word buyback and you replace it with dividend, if it changes your conclusion, then you’re looking at it wrong. So it just depends. I mean, it’s also an uncertain future. It’s hard for CEOs and people to know, you know, what opportunities present themselves. And so you try to do your best. As an investor, you want to buy cheap companies. I like companies that are paying down debt or have less debt. So that can be a quality metric. And I tend to like companies that are paying out those cash flows through dividends, buybacks, or a combination of both, shareholder yield.
Jeff: You are big shareholder yield fan, I know that. All right, next question. Meb, you can buy a 2-year CD paying 3.1% right now. Would you rather have that or an intermediate bond fund for the next two years?
Meb: So they’re different. The first comment I would make is, I think any investor who needs money for the next five years, whatever, yeah, plop it in a high-yielding bank account that’s protected. So we love the feature that Betterment added, the Smart Saver, which puts you in short-term bond ETFs, CDs are totally fine. That’s a pretty good return for sitting cash. What most people do is they sit in Bank of America. I got a Bank of America email here, it is so ridiculous. They’re like, “Hey, you should upgrade to Platinum Premium Plus that you are eligible for, you know, and double or triple your yields.”
And I look at it, and it goes from like 0.01% to like 0.03%. Like, that is such a dick move. But, by the way, listeners, if you don’t know this, most brokerages…and we’re including the big ones, make a ton of money from your cash sitting idle. So you’re probably getting paid almost nothing on your cash balance and many of your money market funds are probably crappy ones that may charge 50, 75 basis points and give you 25 basis point yield. But there’s no reason your cash or idle investment shouldn’t be earning 2% or 3% right now.
Jeff: Jason Zweig has written a lot about that in the “Wall Street Journal.” You can go back and find his articles that detail this and a lot more detail.
Meb: So that’s a big one. So all your idle cash can now be making 2%, 3%. But on top of that, so the question is, what strategic role do treasuries play in a portfolio? And treasuries are a little bit different if you’re looking at, say, 10-year, 30-year treasuries, because they’re going to have a much stronger response to what happens in interest rates. And so interest rates have been coming up over the past year or two. If you look at a chart of like short-term bond yields, it almost looks like a Bitcoin chart from last January, right? They’ve just gone straight up over the past year, which is great if you’re a saver.
But on the flip side, you know, you have 10-year bonds yielding 3%-ish, you can envision a world where yields come back down to 3%, 2%, 1%, in which case, you get a massive tailwind of capital appreciation for bonds. Of course, the bond yields go up 4%, 5%, 6%, then you have the opposite happen. So in a portfolio, the one investment that traditionally does great in a deflationary environment, think 2008, 2009, is bonds, U.S. government bonds. So that plays a unique role in a portfolio. So I’m fine with U.S. treasuries. It’s just a little bit different, I think, than CD.
Jeff: Sort of ties into an upcoming question we had, I’ll just ask it now. Meb, what’s your view on bonds as a pure play on wealth preservation versus bonds as a source of capital gains?
Meb: Well, it goes back to my old rule of thumb, stocks, bonds, bills, after tax, you get 5%, 2%, 1%. And that’s a good rule of thumb to look at those returns historically. You got to remember, bonds though, after inflation, historically have lost you half. You go through a period where you lose half your money after inflation.
Jeff: You’re looking at…these are long-term averaged returns, right?
Meb: As opposed to what?
Jeff: Well, I mean, I think everybody’s probably looking more towards…all right, in today’s environment, you know, give me something that’s more relevant to the next five years versus…
Meb: Well, the last five years’ bonds have lost money on an after-inflation basis.
Jeff: So you would say it be a poor wealth preservation?
Meb: No, I think it’s a good wealth preservation but you have to understand that, well, the alternative is you put in nothing, in which case it loses more. So bonds historically, or bills, have kept up with inflation. And you’ve had a slight premium over time. There are countries where that’s certainly not the case where you go through high or hyperinflation lose all your money, but historically, they’ve been a good preservation of wealth, T-bills, CDs, bonds, whatever, so have stocks. And this goes back to the old comment where you put them together, you end up with a better portfolio globally, stocks, bonds, but in no portfolio can you basically find any combination that doesn’t lose a quarter of your money after inflation at some point. Challenge you, listeners, you find one, let me know.
But there’s no way to include a bunch of global assets that’s not going to lose you a quarter. And so you say, “Well, fine, I’ll put all my money in cash.” Good, now, you’re going to lose half. So, you know, that’s the benefits of an asset allocation, wealth preservation, you know, you want these diverse streams of returns and you combine them and it’s better. A lot of people don’t think that. They think, well, cash will preserve my wealth, sure. But at some point, you have this, what they call financial repression, whereas inflation is higher than bond yields, which is the environment we’ve had since the financial crisis in an effort to get people to take more risk.
Jeff: Forget fee hikes, go all crypto.
Meb: The ultimate wealth preservation.
Jeff: Let me know how it goes. All right, Meb, I’ve heard you and others extol the benefits of a diversified global allocation. But I rarely, if ever, hear the counter-argument that the U.S. deserves a premium to the rest of the world because it has the largest and deepest capital markets, has comparatively lower regulation, and fosters innovation and creative destruction. Do these factors warrant an over-allocation to U.S. equities?
Jeff: No more detail either?
Meb: My Charlie Munger answer, no. I mean, look, I think that’s a very myopic view. I think it’s a very self-centered U.S. view.
Jeff: Okay. Just people looking for a reason to stay along U.S.?
Meb: Yeah, I mean, like, look, you can give out plenty of examples when you didn’t want to be in U.S. stocks, you know. And they had plenty of scandals and embarrassments and everything else. I think it’s crazy to think that the U.S. is somehow a magical outlier when it comes to global financial markets.
Jeff: Well, sounds like the answer beneath all this is that the factors he identified, the deep capital markets, low regulation, creative destruction, all that at the end of the day, is sort of the tail versus the dog in terms of what you’re looking for, valuation or returns.
Meb: Yeah, the answer is no.
Jeff: How much should the average investor be willing to spend as a percentage of portfolio value in order to carry some protection in the form of puts?
Meb: Usually zero. So most investors don’t need puts, you know. And this is from someone who manages a fund that utilizes this as its strategy, tailored strategy. So, you know, as you think about it, you know, we wrote a paper on tail risk ideas where we said, let’s say you have a risk exposure like U.S. stocks, and you don’t like how much risk you have. Well, the simplest answer is take less risk. So don’t own as much in U.S. stocks. Second answer, for some reason, say, look, I have to take this risk. It’s stuck in the stock that has huge capital gains, or it’s stuck in my trust, or my retirement, whatever, I can’t move it.
Well, then, you know, some other ideas are diversify, then you tilt away from doing dumb stuff like buying really expensive markets, then you add active strategies like trend falling. These are all good things to do, I think. You know, however, are their scenarios where using tail risk makes sense? And I think so. I probably own more tail risk fund than anyone in the country. That’s not true, but than most. And the reason being is there’s probably behavioural reasons to do that to where if owning some of a strategy that is an insurance-like payout, helps you sleep at night and makes you feel better, then that’s worth it, even though it’s a cost.
So back to his original question, how much would it cost to totally ensure a portfolio? The good news is there’s a CBOE website that has a bunch of option indices, you can go in and manipulate and look at how they’ve performed over the years. But the way the capital markets work, do you want to totally insulate a U.S. stock portfolio from any downside? So January 1, you buy a year-long put at the money so it completely insulates it from any downside, that basically is going to cost you the same amount that will take U.S. stock returns down to bond or cash. So it’s going to cost you, what, 5% a year, 6% a year, something like that.
Now, the good news is you can come up with ideas and strategies that pair puts with, you know, cost less to buy them out of the money. So obviously, if you wanted to protect a loss any greater than 10%, that’s not going to cost you as much as all the losses. You want to protect loss greater than 20%, that’s not going to cost you as much. So there’s other concepts that you can bake in that will be less expensive.
Jeff: Yeah, but the flip side of that is you’re agreeing to have that loss of 10% or 20% of the…
Meb: That’s the whole point is like, there’s no free lunch as far as it comes with returns. And if there were, people would take advantage of it, arbitrage it away until it’s gone. So, you know, most people I don’t think need it. But if it’s going to help you comply and behave with the rest of your portfolio, then fine. And it goes back to the old topic of, you know, for most people still love gambling and having a little play account. And we always tell people, you can do it, it’s fine, but make it as small as possible, 10% or less. And so you want to go toy around with a bunch of doggy coin and, you know, denta coin and whatever, go for it, just make it a tiny percentage of your portfolio. And same thing with if that will let you stay away from your core with 90%-plus of your money and not touch it and behave well there, go for it.
Jeff: I don’t know if we’ve ever really talked about this directly, but you mentioned how you own way more of a tail risk insurance fund than most people. I’m curious why? Because most of your net worth is tied up in Cambria…
Meb: We have talked about it.
Meb: Many times. Jeff has about a three-episode memory.
Jeff: I black out everything else.
Meb: Remember, so like when I wrote a paper, which you helped write, called something along lines of like, “If you’re a financial advisor, you’re four times leveraged the stock market.”
Jeff: Okay, but are we…
Meb: So the same theory applies, which listeners, if you haven’t read that paper, the concept was basically let’s say you’re an advisor at Morgan Stanley, you have the exposure to the stock market like 4x. So you probably own stocks in your own account, retirement accounts, your family accounts, your children’s account. Your clients also own stocks. When you go through a bear market, your clients are probably more likely to sell stocks. Maybe you’re an amazing behavioural coach but, in general, that happens. And lastly, if you don’t own your own company, your company is going to have lower revenues when the stock market’s down 50% because you’re in fees from stocks. So you’re like quadruple leverage the stock market. So he said, theoretically you could make an argument, philosophically speaking, that if you’re a financial advisor you should own no stocks or you should not only own no stocks, you should hedge out your stock exposure using derivatives or other strategies. If you’re a company like Morgan Stanley, you could smooth out your earnings by owning puts in derivative strategies that would do well when markets go south.
Jeff: Okay, hold on. I get all this. But this would make sense if you were acting on Cambria’s behalf as a company to deal with a put strategy. But my impression is you’re talking about in your own personal account.
Meb: I think it’s worthy to do it both.
Jeff: Which, as you’ve said, is a very small percentage of your overall net worth. Let’s say it’s 5% of your overall net worth, to what degree would having an over-allocation…
Meb: That makes me feel better. It makes me feel better.
Jeff: All right, let’s see. My point…
Meb: I wouldn’t sum numbers up when…
Jeff: …the real number is not going to shake out to be all that helpful to you…
Meb: We’ll see if stock markets opens up down 50% on Thursday, it will be a real number. You know look, I like the concept, the idea of having something that will increase hopefully if the U.S. stock market is going down. I think it’s particularly useful now when U.S. market is expensive and now in a downtrend. Okay? Historically, that’s been a time when volatility increases and returns are lower.
So I’m totally fine having it. In fact I would love to own a bunch more. And many ways you can see it as somewhat of a bond substitute because you can design strategies that most of the cash that’s in bonds, long-term treasuries, and with some of the remainder you buy some puts. So I’m perfectly happy owning a fair amount of tail risk insurance.
Jeff: We’re getting a little along here. Let’s wind this down. Two more questions for you. Meb, what beats the 60-40 portfolio over the next 5 and 10-year periods?
Meb: Anything. So there was actually an article “Institutional Investor” put out recently and it said 60-40 has beaten every [inaudible 01:02:59] endowment over the past 10 years. And that’s not surprising, U.S. stock market’s been one of the best performing stock markets in the world if not the best performing since the financial crisis. That’s probably not going to repeat going forward. You know, we estimate that U.S. stock 60-40 is 3% a year. It was 8% in the prior 10 years.
Jeff: You just jumped to U.S. What if we were saying, what beats the global 60-40 portfolio?
Meb: That wasn’t your question.
Jeff: Well, it is now.
Meb: THat is question B. It’s tough, 60-40 is a nice high bar. I think adding the tilts value in momentum help, I think adding trend following, I think all those things would help. I mean, look, the gun to my head strategy for the next 10 years if I was to pick the highest returning, I would buy a basket of cheap equity countries around the world, 10 years.
Jeff: All right. Last question is a fun one. Meb, what’s your favorite beer and your favorite ski destination?
Meb: You know, beer is very cyclical for me. So, you know…
Jeff: It’s gonna be an amazing answer.
Meb: I’ll tell you a few of my top 10. You know, I currently love any of the Citra pale ales. It doesn’t really matter which one so much, but I love the Citra pale ales. I’m also a sucker for the really light Japanese and Mexican beers. Like, it’s crazy to say but like an Asahi or a Pacifico would be my top 10.
Meb: I don’t like Hitachino.
Jeff: That’s because you don’t have good taste.
Meb: A Hitachino is a craft Japanese beer but their most famous is a white ale, and the only beers I don’t like are Hefeweizens and a white is a close cousin to that. And what’s New Castle? Like an amber. It tastes like syrup to me. And Hefeweizen tastes so heavy. It tastes so gross. It’s like you’re eating a loaf of bread.
Jeff: A Hefe, so heavy?
Meb: So heavy to me.
Meb: Yeah. So those are up there. Listeners, by the way, we gave Jeff, for is going away present, the most expensive box of wine you could find at BevMo.
Jeff: Why don’t you just give me a box?
Meb: It’s $21. I just figured, you know, you have high standards, high class, wanted to get you expensive box wine. And in a new crockpot because Jeff’s looks like it’s, you know, that like garbage compactor in Star Wars. That’s what Jeff’s crockpot looks like. So listeners, when you send Jeff a gift, don’t send him a crockpot. You can send him a box of wine. He loves tequila.
Jeff: [inaudible 01:05:30] mentioned, switch.
Meb: Can I flip the question?
Jeff: I don’t know. Can you?
Meb: I would rather list that my three bucket list places I want to go. I mean Japan has been my kind of near and dear favorite the past couple years. We did the Eastern British Columbia, Powder Highway a few years ago, but it wasn’t great snow, so that’s kind of a bummer. I mean, I’m a sucker for Tahoe, like I love Bluebird day in Tahoe nothing beats it. I mean I’ll ski anywhere. My wife is going to Taos without me. That was high on my list of to-dos.
Jeff: Why have your wife go away without you?
Meb: Do you see this is great commercial on fantasy football, you know? And they asked the guy like, “What’s your fantasy? You know, pick or whatever.” He’s like, “Quit my job, leave my family, just hit the road or something.” And they’re like, “No, Jim. Like, what’s your fantasy football pick?” No. So, okay, I would really want to try Silverton, which is outside of Telluride, I’ve never been.
Historically, it was guided only and I think you now…they have like one Lift. But it’s pretty sweet terrain, supposedly. I really haven’t spent much time skiing in Europe. I’ve been to St. Anton, which is more of a like, you know, beer festival than a…it’s more of a nightclub on a mountain. But we also went there when it had not very good snow. So I would love to ski France, and Italy, the Dolomites, that’s beautiful.
Jeff: We talked about last week. I think we should go to Chamonix.
Meb: Chamonix? So if we got any listeners in that area, let us know. Well, oh, yeah, I would love to go to South America for TO, ski down in Chile, Argentina, Bariloche.
Jeff: Last Linnaeus.
Meb: Yeah. So anyway, those are my to-do list.
Jeff: The last question, which I just thought about, Meb, tell us about your favorite book.
Meb: Great. Great exit. The great exit song. We’re going to delete that out of the interview. Passy, if you’re listening, delete that question. Just kidding. All right, listeners, thanks for listening today. Again, you wanna send Jeff a fond farewell, email@example.com or the address we gave in the beginning, which is Cambria Investment Management, 2321 Rosecrans Avenue, Suite 3225, El Segundo, California. You can come knock on the door and give him a big hug. Thanks for listening. As always, you can find the show notes, mebfaber.com/podcast. Give us a review. We love to read them. You can always download or listen to our podcasts on Overcast, Stitcher, my favorite, which is currently Breaker. Thanks for listening, friends, and good investing.