Episode #138: Yariv Haim, “You Should Never Try To Reassess Your Risk Appetite When Markets Crash”
Guest: Yariv Haim has over ten years of experience in strategic investments, risk management and asset allocation. Yariv is the key executive and investment manager at Sparrows Capital.
Date Recorded: 1/10/19
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Summary: In episode 138, we welcome Yariv Haim. Yariv begins with his backstory. He had been working for a family running marketing and business development. He was asked to get involved with the investment management needs of the family, and through a path of his own, had gained enough knowledge to crystallize an approach he now follows at Sparrows Capital.
Yariv discusses how he focused on evidence from impartial academic institutions and research, and refers to the strategies derived from them as evidence-based investing strategies. After doing his research, he saw an informational gap in the industry, and it still exists today.
Yariv then gets into 6 core principles 1) return is primarily a function of risk, 2) certain risks attract persistent premium, 3) Diversification works, 4) stock picking and market timing seldom add value, 5) remain invested across the full cycle, 6) costs matter (although it isn’t the only prism to evaluate investment opportunities).
Next, Meb asks about factors and smart beta. Yariv discusses his opinion that Wall Street is a marketing machine, and the term “smart beta,” while it sounds sexy, ends up becoming an umbrella for all things. When asked about factors and when it’s time to stop using them, Yariv responds by discussing resources available, and the importance of doing the homework, and not to invest until you fully understand what you are investing in. As far as favorite factors go, Yariv talked about not having one, and expanded by saying he sees factor timing as a problem. He recommends a blend of factors to clients, starting with the most diversified portfolio, and building tilts.
The conversation then shifts to a discussion of behavioral investing. Yariv talks about how investors are all human beings, human beings are filled with biases and emotions, and feelings of optimism and pessimism can affect the way we make decisions. He finishes his comment by saying he feels that for people who wish to invest on their own, that it is always helpful to have someone by your side who is potentially slightly less emotional about the way your portfolio behaves in the short term.
As the conversation winds down, Meb and Yariv get into socially responsible investing and environmental and social governance themes. Yariv believes it is a trend that nobody can ignore today. He discusses some research conclusions the efficiency of markets and how higher returns investors have earned on vice companies is compensated for the additional risk they bear for owning them. He makes the point that there is more to investing than purely outcome in the form of returns, and that if an investor’s ethical compass steers them in the SRI/ESG direction, it is sensible to invest that way.
The pair then conclude with how Yariv puts all these ideas together to form investment portfolios.
This and more in episode 138.
Links from the Episode:
- 00:50 – Welcome and Yariv’s origin story
- 2:54 – How did Yariv develop his investing approach
- 5:29 – Key tenants of evidence-based investing
- 13:35 – Factor investing and smart beta as a marketing ploy
- 14:22 – To Beta or Not To Beta – Haim
- 20:27 – How does Yariv think about when it’s time to abandon a factor
- 22:00 – Credit Suisse Global Investment Returns Yearbook 2018
- 24:28 – Timing factors
- 28:40 – Biases that are detrimental to people’s investing strategy
- 36:03 – Socially responsible investing
- 37:21 – Credit Suisse Global Investment Returns Yearbook 2015
- 43:55 – How does Yariv put this all together, understanding the risk profile of the client
- 47:07 – Best resources
- 47:41 – Triumph of the Optimists: 101 Years of Global Investment Returns – Dimson, Marsh, Staunton
- 49:56 – Things that have piqued Yariv’s interest for the future
- 51:15 – Savvy Investor
- 51:44 – Advice for transitioning to evidence-based investing
- 54:32 – Most memorable investment
- 58:52 – How to follow Yariv: SparrowsCapital.com, LinkedIn
Transcript of Episode 138:
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 podcasts 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: Welcome podcast listeners. We’re kicking off 2019. It is January 10th. Today we have an excellent show for you. Our guest has over a decade of experience in managing strategic investments, risk management asset allocation. He’s written a number of thought pieces on evidence-based investing, which we’ll talk about today, also factor investing, socially responsible investing. He’s the founder, key exec and investment manager at Sparrows Capital. Welcome to the show, Yariv Haim.
Yariv: Thank you very much, Meb and thank you for the introduction.
Meb: So, Yariv is joining us from London, one of my favourite places. And Yariv, I think it’s great…I know a little bit about your background and origin story, but I think it’s particularly interesting because you didn’t necessarily start out in asset management. So, I would love to hear a little bit how you got to starting Sparrows Capital and what led you to it?
Yariv: Well, I originally came from, as you specified and rightfully so, from a very different background. I used to work in the line of business with a Jerusalem-based family in Israel. And I did marketing and business development positions with them. And then in 2006/07, they actually offered me to step aside from what I was doing and try and assist them with what can effectively be called their wealth management. So, I entered a space where I had no prior knowledge of. It was an exciting year. I had done a lot of studies, read many interesting books, research papers, and I essentially crystallized an approach that we have adopted and followed ever since, before the global financial crisis, through the crisis and ever since. The outcome of that work has basically stemmed what is today Sparrows Capital, which is a kind of a boutique wealth management business in London.
Meb: And so, the funny thing about, you know, learning about investing and we always tell people it’s a lifetime endeavour, but you have a lot of people that get educated from kind of university or textbooks and there’s a traditional curriculum that is taught, and then you have other people that are sort of learn from the streets, taught themselves and others that did what you did, which is an interesting, almost like a sabbatical or it didn’t come from the field and says, “You know what? I’m going to soak up, learn as much about this as possible.” What was the process? You know, how did you even begin to find your…you know, everyone’s got a personality and a market approach, they gravitate towards Buffett famously says, “You know, I was inoculated with the value gene early.” I mean, how did you kind of find and settle upon your approach?
Yariv: I think it’s, as you say, very personal and everyone needs to find his own way. I would say this, you’re absolutely right in pointing out that different directions or different routes may lead to very different outcomes. I chose to focus primarily on the evidence that comes from impartial academic institutions, and therefore, I ended up following what I refer to as evidence-based investing strategies. Other people tend to prefer to go down the route of simply practicing the subject and they may end up in very different positions and I’m sure that their journey may be just as exciting as mine was. I would say this though, what I have articulated in the family I worked with, after doing an extensive research, is that there is exactly that. There is an informational gap in the industry today. And if you read the evidence that comes from academics and research and, you know, impartial papers, and you look at what, you know, a lot of the practitioners tell you in their sales pitches and their marketing presentations, you sense immediately and you identify very quickly that there is a substantial gap between the promise of many practitioners and the actual evidence that is being extensively researched by academics.
Meb: So, talk to me a little bit about that. What are some of the key tenets and thinking is about evidence-based investing, some of the conclusions? You know, you mentioned it’s an exciting process, particularly exciting when you started in 2006, you know, you got your feet to the fire pretty quickly with the financial crisis that rolled through after a year or two. Talk to us a little bit about some of the ideas and concepts and your current thinking around the evidence-based investing topic.
Yariv: I think if you start with a, you know, blank canvas, and just go and read all the research that has been written for over four, five decades today. I mean, some of it stems from, you know, the efficient market hypothesis which was introduced in the 1960s. So you’ve got decades of research. And I think if you read them and you look to crystallize the principles that are kind of persistent throughout time, you end up with, or at least I ended up with about six of them. And they’re quite intuitive, I would say, make a lot of common sense. And I think that’s a plus.
The first is that return is primary a function of risk, the two go in tandem. So, if you’re want to seek higher returns, if you want to pursue a higher potential returns, then you need to take higher risks. There is no way to differentiate the two.
The second thing is that certain risks attract persistent premium. Here I specifically refer to an extensive research done by Fama and French, for example, the founders of Dimensional. And you can see that if you look at, for example, the equity markets, certain risk factors have attributed enhanced return. And when I say enhanced returns, I mean risk adjusted returns, so in essence, better Sharpe ratio. Just as an example, one that is quite, well, familiar, value stocks, so stocks of firms that tend to be underpriced compared to their book value. Value stocks tend, over time, to do better than growth stocks. One of the first, the individuals, the investors that you’ve mentioned, Warren Buffet, he’s a well-known value investor. So for many, many years and decades today, he has been following this approach, trying to select value stocks that will outperform, say, the general market.
Then the third principle, again, is something we all heard of is diversification works. Essentially, it’s as close as an investor can get to a free lunch. So, by mixing different asset classes that behave differently under similar market conditions, for example, mixing equity with fixed income, the mix will perform in a better way than simply selecting one of the two asset classes. So, that’s third.
Then the fourth principle, which is potentially the most controversial one I think, is that stock picking and market timing seldom add value. And I think this is quite counter-intuitive. And again, talking about that informational gap, this is where I think many practitioners differ from the evidence that comes from the academic world. Because for many asset managers, it is about promoting their skills to select stocks, to differentiate between companies who will do good or better in the future compared to those who will not do as good, or alternatively to time markets. And it seems, according to all the research that has been conducted, that both of these promises, the vast majority of that of them do not materialize. They simply do not work. And it’s much better for an investor to hold broad diversified indexes, index funds, ETFs, than it is to pay handsomely to an asset manager who will try to pick better stocks or who will try to overweight or underweight certain markets at certain times according to a global view he may have over the world or whatever it is.
Then the next principle is that you need to remain invested across the full cycle. And this touches a lot about our behavioural biases. We do not like to see losses, we just don’t like it. We much prefer to see our portfolios grow 10%, 15%, 20% every year than to see a loss of 10% per annum. And that’s natural. Nobody likes to see losses. However, because it is impossible or very improbable to time markets, one needs to be very disciplined and overcome these biases. So, if you defined a portfolio that meets your risk parameters and you set it on track and said, “Now I’m simply going to let him harvest whatever market returns will be,” then you need to be disciplined about it. You should never try to reassess your risk appetite when markets crash. It is probably the worst time one can have to reassess his risk appetite.
When markets crash, we all want to get out of the market, but we will never know when to put the money back into the market. It is as simple as that. And we will never know when the market’s bottom. So the best outcome can be achieved by simply sticking to your guns. You can rebalance portfolios in a systematic fashion. It’s actually advisable, but you should not change your approach because of market conditions.
Now, the last thing I would say, and again, it’s not a controversial statement, costs matter. The higher the costs, the more one needs to deliver to compensate for the costs charged. So, in order to simply follow what markets generously offer over time, one should probably be best positioned by holding low-cost instruments. It does not say that the only prism one should look through is the prism of cost. There are other matters, important matters, you need to take care of when you select your investment instruments. But just as an example, tax, one needs to be tax-efficient. Having said that, the general rule is if two instruments offer you the same exposure, then principally, there is no reason to pay more for what you can get for less.
Meb: All right. You got a lot to unpack in there and I agree with you on a lot of these things. You know, it’s funny, we talk a lot about expenses and taxes on the show and say it’s not the sexy part, but probably some of the most Alpha people can generate is on those two areas. But nobody wants to talk about those. They want to talk about, “Is Google a good buy? Is Brexit going to happen? What’s Donald Trump doing?”
I’m going to start at the beginning and then kind of hit you on a few different questions. You know, you talk about kind of some concepts of value in factor investing and one of the challenges we all have is Wall Street is a marketing machine. So, Wall Street can come up with a million different ways to come up with an idea and spin it and usually it’s an excuse to charge higher fees by the way, not always. But, you know, there’s a topic where you wrote about in a white paper a few years ago talking about smart beta. And, you know, you talked about it as being somewhat a little more than an empty marketing shell used by product providers to push merchandise. While it can be argued that smart beta [inaudible 00:14:35] factor investing, the motivation to sell rule-based portfolios that go way beyond the scope of a limited number of factors expanded and evolved with the concept of smart beta. What sort of your evidence-based approach as you think about factor investing in…you know, there’s this famous French-Fama factors, but now Wall Street has, I don’t know, dozens, hundreds, probably thousands at this point. What’s your thinking here on kind of on how you look at factors? And also, you feel free to expand on the smart beta idea.
Yariv: Well, I still feel the same way I felt when I wrote that letter, and I thank you for pointing that letter out. I mean, it is, as you rightfully said, it is a marketing machine. And the concept of smart beta sounds much sexier than the concept of rule-based or evidence-based or passive investing. It just sounds great. What’s not to like about being smart? Nobody wants to be on the other camp, right? But the problem with smart beta is that it can pretty much become an umbrella to just about anything. And as you pointed, sometimes, on certain occasions, it may just be a kind of a wrapper that justifies extracting higher fees. And for that, I would argue that good advice is still in high demand.
And when you look at the market today, I mean, let’s just take the…let’s assume for the time being that an investor says, “Well, you know, I’m happy with allocating a certain portion of my portfolio and simply hold the broad American market.” And let’s us assume for the time being that he identified the S&P 500 as a good representative of the American market, the stock market, the equity market. In today’s world, if you go and you search for an investment vehicle that tracks the S&P 500, you will find dozens of them, different replication strategies, different costs, different tracking errors, and obviously different assets on the management. So, how do you pick one, and how do you know you pick the right one? And to get back to your question, if I am being more selective and I want to choose a factor, a risk factor, a genuine risk factor, how do I make sure that it is indeed a robust one? And again, for that, there’s a difference between smart beta and what I would call evidence-based.
Evidence-based strategy will only follow one that has been robustly proven by the academic world. And by that, I mean, it has been tested over times and it has been tested over geographies. And there are other tests as well, but primarily these two. So, it’s not a phenomenon that you have identified somewhere in a country somewhere in the world which cannot be proven elsewhere, and it is not something that you simply sat and data mine the, you know, the database and you found something that has worked over five years, but has not worked for much, much longer than that. And this is, unfortunately, on certain cases, some things or principles that are not meant when marketeer go out and market what is referred to as smart good instruments.
Let me give you a very simple example. If you want to pick a rule, okay, any rule. You can say, “I actually like new-listed companies, companies who have just gone through an IPO.”
Now, you can very easily screen companies who have been IPOed on the stock market in the last X weeks. And then you can build a rule that says, “Let’s hold them for another Y months,” whatever the rule maybe. But this is rule-based approach, and you can simply follow that rule and very easily follow that rule. But the question is, does the rule makes sense? Do investors or should investors expect a better outcome by sticking to this rule?
Unfortunately, the academic world has found and pointed out that newly-listed companies are probably one of the not-so-great strategies for investors. They actually perform relatively poorly against firms who have been on the stock market for many, many years. And there are various reasons for that. But if these firms who go through the IPO machine, system, process, if they are hyped, if investors want to bind to that hype, just like you said before, you know, “Can I get the new Facebook? Can I get the new Google? Can I get the next, whatever, Apple?” When there is a demand from investors, even if it is an irrational demand, there’s always going to be someone in the market will provide the supply. And the smart beta umbrella unfortunately allows to sell it or as an attractive proposition. I would argue that it is not.
Meb: Well, there’s always the challenge too of we, as allocators and investors, you know, the results play out over such long horizons and it’s easy on the marketing side to be able to come up with almost any back test or a shorter-term horizon performance that looks beautiful. Talk to me a little bit about the challenge there. So you mentioned, you know, looking at a factor that works in over time and in most, if not all, geographies and hopefully it has some sort of intellectually rigorous premise or basis why it works. You know, we like to say we want to be able to explain a lot of the ideas to, you know, someone, niece, or nephew, or a child who’s kind of high school, college age. But talk to me a little bit about the opposite. And this isn’t a softball question. This is a hard question that I think a lot of people… There’s no real easy answers to me. How do you think about kind of the flip side of the inside of the evidence-based, which is thinking about a factor or an approach that may become less effective over time? Or how do you think about a factor that, you know, is there a process for thinking about it when it’s time to toss it or say maybe it just doesn’t work anymore for various reasons? Any thoughts there?
Yariv: Yeah, I think it is a challenging one. And I think one needs to do proper homework on that. I already mentioned Fama and French, and I think some of their papers are a must read. But let me try and help by pointing to another source of information which is the Dimson, Marsh database and annual yearbook. They publish on an annual basis. First, let me just say this, for full disclosure, first of all, Professor Dimson himself is a consultant to our board at Sparrows Capital, but other than that, both Dimson and Marsh and others have been doing a tremendous work in sorting out all this information and analysing it from Judge Business School in Cambridge, and they publish a yearbook which is sponsored by Credit Suisse. And I would strongly recommend people to read it. And they go and revisit all the factors that they have been discussing for many, many years, and they go back and they show the evidence across geographies, across times. They make sure that all of the information is persistent and consistent.
And I think they probably have the most comprehensive database that one can have today in the investment space. So, there’s, unfortunately, no shortcut here. You need to do your homework, you need to look at the…and you need to read and you need to educate yourself. But I will just say this to conclude my point on this matter. As a rule of thumb, I personally advise anyone not to start investing in anything until he understands what he is investing into. So if you’re still in the process of learning, do not feel that you are in any under kind of urgency to move quickly. Because, again, this is just a, you know, if somebody urges you that you need to do something today rather than wait for tomorrow, then it’s probably more of a sales pitch than a robust strategy for long-term investors.
Meb: That’s one of the best pieces of advice, I think, out there on investing is so many people feel this pressure or it’s almost like it gets into the game of, you know, like the deal and the excitement of, “Right now, I have to do it right now.” And, you know, the concept of, you know, this is your life savings. You’re working on this isn’t a game and if you have to make the decision now, that would be any different next month. It’s really probably the wrong idea. Gun to your head, if I had to press you for it, and you don’t have to answer this if you don’t want, but do you have a favourite…? And that’s not really a good question to ask an evidence-based investor. But personally, do you have a favourite factor? Is there one that stands out? You’re like, “You know what? This is just my…this is my pet factor. I like this one.”
Yariv: I don’t, unfortunately. And the problem with factors is that sometimes people try and time them. So, you know, they will take a position. They will say, “For the next five years, I think, you know, value stocks who underperformed over the last five years, they’re probably going to outperform the next five years.” And then they take a position. Again, trying to time the market is extremely difficult. And timing factors is not an easier task. So, what I normally do, and for our clients, we normally advise them, simply to build a blend of factors. Do not take a single position on one factor that may or may not, you know, outperform in the foreseeable future. Simply build a mix, start with the most diversified portfolio and then build tilts, towards factors. In that way, again, be persistent, be consistent, and be disciplined. That’s it. There’s no one secret source, one, you know, ingredient that will ensure your success. You need to mix, diversification as we’ve pointed out before.
Meb: Yeah, it’s hard, you know, I mean, I think a lot of people, the seduction of wanting to time factors is very attractive and people, again, the challenge is think in terms of weeks, months, quarters, even years. We had an investor ask us about one of our funds the other day that said, “Hey, I see your fund did this today?” And I said, “Today?” I was like, man, you got a…even years can be misleading and even decades.” I joke now that I said I used to think a decade was a reasonable time to look at evaluating strategy. I think now I’d probably say it’s probably two, probably 20 years at this point. So no easy answers. All right. I want to touch on a few other topics because we only have you for an hour.
Yariv: May I just say one additional thing on that matter. You know, unfortunately long-term investing, so investing for the long term, is probably one of the most boring things one can do. It’s just not exciting. You know, Warren Buffett goes out and tells everybody, “You know, if you’re a long-term investor, you should just buy the S&P 500 and hold onto it and that’s it.” But then again, you know, that’s boring. What do I have to tell my friends at the golf club? That I bought the S&P 500? You know, so people, it’s the behavioural bias again, it kicks in and, you know, it’s inevitable, to be honest. We want to have some excitement.
And by the way, our approach at Sparrows Capital has always been a mix of a bit of both. You know, you need to keep your core portfolio, you know, simple, high efficiency, tracking the markets over the long term. But then around that, if one wants to build a bit of excitement, he can do that. And he can do that to satisfy other objectives, not just financial ones.
Meb: Okay. There’s a lot in here I want to unpack as well. I just thought about this as we’re talking. I think it might be kind of a fun idea. It’s a way to kind of probably give investors excitement. I think advisers that use something like S&P, I feel like you should write like a quarterly, yearly letter and say, “This is what we own, the S&P 500. However, look at some of the stocks we own that did amazing in that index this year. We had XYZ that went up 200% and another one. So, you own these. You should be happy. You can now go tell people at the golf or football club that you owned the stock, because you’re guaranteed to own it, if you own the market cap weighting.” Maybe that’ll serve that concept. I doubt it.
But anyway, all right, two other concepts you talked about. Let’s talk about behaviour a little bit. You know, as someone who started right before the financial crisis, who, you know, talks a lot about… It’s easy to say we’re unemotional, but, you know, as you’ve, you know, worked with a family… And I don’t know the answer to this, but maybe you can talk a little bit about some of the types of clients you serve, if you do individuals as well institutions. What do you think are some of the most dangerous biases that people have? And this, by the way, long-time listeners know that one of the reasons I became a quant and rules-based investor, I have all of them. I’ve got all. I’ll take as much risk as you give me. I’m overconfident, everything else. What are some of the ones do you think are the most challenging detriments that the people have as far as the biases?
Yariv: Well, I would say probably that, first of all, if I’ve learned anything in the 15 years or so that I’ve been, you know, practicing this industry is that investors are all human beings. And human beings are filled with biases, emotions. We all like to think that we’re very logical. I have never sat across a person who told me, “You know, we’d like to behave irrationally.” Never, not even once. They all appear or believe, genuinely believe, that what they do is logical and it is the best one can do for the long term. Having said that, when the reality presents itself, and the reality is always surprising, always. You know, every year, you know, we sit here, it’s January 2019. You go out and you ask people, “What do you think about the year ahead?” And everybody are telling you, “Oh, it’s going to be a very challenging year.” For the last 15 years, I did not see a year that was not challenging.
So, there are different challenges of course. But, you know, the world is buzzing and things are happening, and every year is a challenging year. And the problem is that we have many biases that tie us into the events that occurred today. So, you know, I’m just sitting here in London and in less than three months we’re going to have a Brexit. For the last two and a half years, people have been asking, “What is Brexit? And what is the outcome of Brexit?” And I’m sitting here today and I still tell you, I do not know. And people still speculate. Is it going to be a hard Brexit? Is it going to be a softer Brexit? Does it mean A or does it mean B? The truth is that nobody knows. Nobody has a crystal ball. So, what do we do as investors?
Just saying to people, “Relax, do not change the course.” This is good advice that is one, rare, and two, I personally believe is an advice worth paying for, because we are susceptive to our biases. If I am today feeling worried about Brexit, then fear creeps in, and if I am fearful, I will make decisions that are illogical, irrational because they are subjected to the fear, that I now feel. Similarly, if I have a very positive focus or view on Brexit, if I think it’s the best thing that will ever happen to Europe, to Britain, to both parties and to the world, then this feeling of optimism also affects the way I make decisions today.
So, when people tell me, you know, maybe the best strategy is to simply be my own adviser. I often tell them it’s always helpful to have somebody who is sitting by your side, who is potentially slightly less emotional about, you know, the way the portfolio behaves in the short term, will keep reminding you why it is you do what you do. Because at the end of the day, saying you are a long-term investor means little. What defines you is how you act. If you act like short-term investors, even if you convince yourself that you’re a long-term investor, your outcome will not be as good as those who actually act as long-term investors. And many times, long term investing delivers better returns because of, unfortunately, those who acted in different ways under different market conditions.
Meb: You know, we talk a lot about this where people always say that they have a long-term perspective and then in reality they don’t. And I often think and brainstorm, and I don’t have any answers about this yet. We talk a lot about how I’d love to come up with a fund structure concept, essentially locks people down for 10, 20, 30, 40, 50 years. And then the problem is that the structure that does it here in the U.S which is the probably the annuity or annuity concept is, doesn’t check the box of one of yours and my criteria, which is they’re usually super expensive, you know. And so, maybe that’s a 2019 project for me is to try to figure out a way to lock up some sort of these so that it aligns with people’s real time frame. It’s tough. I think it’s really hard for people.
So, listeners, if you’ve got any good ideas, email me, I’d love to hear them because I feel like most of my good ideas come up in this area of, I ended up getting…we’d probably get sued. But education is a big one. Trying to convince people that to stay out of their way, you know, that there’s a lot of behavioural nudges that some of the software companies are developing. I know Betterment, the Robo here in the U.S., has a feature where if you try to change your allocation or do something, it’ll pop up a box and say, “That’s fine if you do this, but FYI, you’re going to generate $5,000 in taxes.” And everyone hates taxes. So that’s a particularly good one. And they say that it’s been a good nudge to get people from not doing stupid stuff.
So, the behavioural side, but one of the best behavioural sides is what you mentioned is having a fiduciary that acts as the Chinese wall in between you and your money. We often say that the biggest benefit of a financial adviser often is not investment management process, but keeping you from doing dumb things. So, I want to talk about one or two more topics that I know are of interest to you. One is an area we haven’t talked a lot about which is socially responsible investing. And I know a lot of our investors have pretty big interest in this area. Maybe talk a little bit about how you guys think about ESG and everything that’s kind of wrapped around it and how you implemented it in your portfolio if you do.
Yariv: So, first of all, I think it’s kind of a trend that no one can ignore today and there’s a lot of people arguing that it’s because, you know, the millennials are stepping in and maybe for other reasons as well, global warming and such a phenomenon. But there is no argument that the whole responsible investing theme is growing. And it has grown especially, say, in the last 10 years. Now, when I look at this relatively new space, one again needs to start with collecting data. And if I may, I will point out that again, one of the very first research papers about this concept of SRI or ESG was published again by a Marshal and Dimson. And they actually show something quite interesting. When they look at the last hundred or so years. the industries that outperformed other industries were actually…let me call them vice industries. The two best industries over the last hundred or so year were alcohol and tobacco. And there’s very little argument about tobacco, for example, being a kind of a, let’s call it, vice industry.
So, the first thing one needs to acknowledge is that actually these vice companies have outperformed responsible companies or like say more ethical companies. Now, let me say the following, one that does not mean that this trend will continue to the next 10, 50 or 100 years. Again, the future is unknown. But the but interesting question is why? And I think the researchers actually said something that makes a lot of sense. When you invest in vice companies you bear as an investor additional risk because of the underlying business. For tobacco companies, as an example, an investor should expect more legal risks or perhaps, you know, social risks and others. So, in a way, what the researchers concluded is that the markets are again quite efficient. If they invest in companies who have more risks then over time, you will be compensated for taking that additional risk.
So, the first outcome or the first conclusion I draw from the very little [inaudible 00:39:34] that we have so far, is that one needs to be careful with the concept of, “Let us take all the responsible companies because surely, they will outperform the irresponsible company.” That is again a pitch, a marketing promise that eventually will be hard to deliver. And if you create or build the wrong expectations, then again, investors may end up disappointed.
So, once we understood that it’s actually vice companies who have done fairly well in the past, at least, does that mean we need to invest in companies? Well, the answer is obviously no. I am not a person who will argue or suggest to our clients that they should invest in such companies. However, there is more to investing than purely, you know, outcome in the form of returns. If an investor understands that by deselecting, by filtering out certain companies he may give up on a certain potential return, but his ethical compass directs him in that direction, then I feel that it is very sensible to screen firms who meet his restrictions, whatever restrictions one may have.
So, for example, if you are a trust that collects donations and your purpose is to fight cancer, it is very unlikely that the people who donate money would want to see you put that money and invest it into tobacco companies. This a simple example. So it it’s very sensible for charities and sometimes even private funds and trusts to come with certain ethical restrictions. Ten years ago, if you had met an investor who wanted to deselect certain sectors, you would have had to direct him to an actively managed fund.
Fortunately for investors, the industry has evolved over the last 10 years. And today you can do or follow the same principles by still adhering to evidence-based high-efficiency strategies. So you can find indexes today that form the way to score companies that are traded according to whatever ethical scale you may have. And then, on that index, you can build an instrument, be that an ETF or any other fund that tracks an index. And you can do that for a relatively low cost. These are still somewhat costlier than the plain vanilla ETFs. But they still far less expensive than an actively managed instrument.
Meb: You know, it’s interesting, this is an area that almost everyone believes that there’s a lot of promise and potential, particularly a lot of the younger generation and how…what the correct or the killer app for this is, as far as screening out companies, or excluding them, or whether it be index ETFs, that the money hasn’t quite yet flowed as much as people think. But everyone seems to be in agreement. This has huge potential, myself included. I’m not sure what the killer product is yet, but somebody will figure it out, hopefully.
So, look, we talked about a lot today: factors, evidence-based investing, behavioural, social. I want to hear a little bit about kind of on a hide level, how do you put it all together? How do you think about diversification? How do you think about asset allocation? How do you think about in the future, including new evidence-based approaches or excluding them? How’s the chef combined all the ingredients?
Yariv: So, it’s always important to start at the beginning and the beginning is always was and always will be to the investor, be that private or institution. It doesn’t matter. The first thing one needs to understand in order to try and help an investor is his risk profile. Because risk drives everything. And once you have understood, not just you as an adviser, but also the client himself, which is as important, I would argue, once you understood together what are the risk parameters, then whatever the risk parameters are, one can design a strategic asset allocation that will fit the risk profile. It is the best chance that the investor will have to gain or to reach his long-term goals. So, when you have that strategic asset allocation identified, then it is a matter of applying the restrictions that will come with the indexes.
You need to be diversified. You need to follow all the rules as you design the portfolio. But it all stems from risks. If clients are more risk averse, then risk should never be dug up just in order to achieve their, you know, the objectives they have in mind. And I think unfortunately, I’ve seen some cases where people work backwards. The objective was to generate, whatever, 5% per annum and then, you know, you design the portfolio hoping to achieve that, but without ensuring that the risk parameters fit the investor. And lo and behold, the first instance of a crisis or a downturn and the investor sees losses that he cannot cope with, he was not prepared for, and then he bails out the strategy. And that’s probably one of the worst things one can do.
So, make sure you understand the risk correctly. The strategic asset allocation will follow quite naturally once you understood the risk parameters. And from the strategic asset allocation, you move to indices, you move to investment instruments, and you can, as you go, apply the different criterias or the different restrictions that the investor chose to present, be them ethical, be them currency related or whatever it is. Everything stems from risk.
Meb: Oh man, you just brought up currencies. It is almost the end of the podcast. We’ll have to bring it back on to talk about that one because that’s an area that a lot of investors are particularly interested in, currencies in general, but I feel like that’s an entire…another hour-long topic. So, someone who’s interested in going deep here, want to learn as much possible. I want to talk a little bit about resources. You know, what are some of the best places you look to as far as learning more, doing research, thinking about a lot of that topics involved today? I know you mentioned my favourite investing book, “Triumph of the Optimists” and their subsequent “Global Investment Return Yearbook,” which are always free to download from Credit Suisse and the crew at Dimson, Marsh, Staunton. We’ll add links to those in the show notes, but where else do you look? Any particular resources you think are helpful?
Yariv: Well, I would say this, generally speaking, and it very much depends on the area you wish to collect data for, but generally speaking, I find that University of Chicago is a very good source for information. Not surprisingly, a lot of the research from fine friends stem from that university. I think that, again, Judge Business School in Cambridge, Saïd Business School in Oxford is another good source. Mind you, if you want to look for research about an area which is less studied so far or not as extensively studied so far, the space of consultants in the industry, then I can recommend papers that have been written and designed by professor Tim Jenkinson from the Saïd Business School.
So the good news that I have for all people interested is that in today’s era, there is no handle for obtaining information. Like, you know, if you remember how the world used to look 20, 30 years ago, which is not that far ago. It was very different. Today, we simply log on to the network, to the web, push a button, code whatever, Google, whatever search engine you use, and you have all the information available at the tip of your finger. The challenge today is not to obtain the data. The challenge today is to do proper work in order to crystallize information from all that data that is available. And by that, I mean meaningful information. Information that can actually help you with designing the way you make decisions, build portfolios, etc.
Meb: So, as you sit at your perch in London, anything in particular that’s got you excited or you’re interested in as we look out to 2019, 2020? Any topics that you’re researching or do you think are particularly fruitful for study?
Yariv: I’m excited about everything, but I never know where the excitement is going to come from. So, I’m not running a research facility. And I’m sure that there’s going to be a lot of debates and discussions and research papers on the back of what will unfold during 2019. Where are the interesting areas? I don’t know. But I’m interested in pretty much anything. So, I would just say keep an open mind. Don’t be shy to be surprised. Every day something surprises me, and it’s all fun. It’s not a dragon performance.
Meb: Yeah, I agree with you. I’m easily distracted. So I love going down rabbit holes on reading. One of the better sites that sprung up in the last few years on the academic side and practitioner too, it’s a lot of institutional research, it’s called Savvy Investor. The SSRN does a good job of having all of the academic papers on it. The biggest challenge there is just so many of them, which is a struggle. It’s funny. I had read so many investment outlooks for 2019 there. It seemed like they all said the same thing, which is funny because so many people, the rights, some of the investor outlooks, you know, it’s a rules-based process for a lot of them and then a lot of the macro charts are just there for I think colour, but anyway.
All right. So, as we wind down here, let’s say investors said, “All right, you’re eve. I like what you’re talking about. I want to implement some of these evidence-based solutions in my portfolio.” Any advice to them as they transitioned from there, sort of what we call mutual fund salad where people just have a portfolio and they want to get to somewhere else? Any advice to people who are now really revaluating their investment approach, particularly after 2018, which was a year in which almost every investment decline, which is pretty rare? Any thoughts?
Yariv: Well, again, let me just stress this. I don’t think people need to feel stressed about it. If you want to reassess, take your time, do a proper process. I personally think that considering adding even an ingredient in one portfolio, which tracks an evidence-based approach, makes a lot of sense. I will be happy to make that case to anyone. However, there is no need to lose sleep tonight because you might lose on something tomorrow. Well, most investors should focus in the long term. And when you make a change because you have concluded after a thorough work that you’ve done, that a change is required and needed, then make it in a way that suits you, in a time frame that suits you, and, you know, you can make changes gradually. One does need not to change his strategy overnight from A to B. It’s not a binary choice. I don’t think investors today look at actively managed mutual funds and look at evidence based in ETFs and say, “I need to think whether A’s right or B’s right.”
I think that was the case a few years ago when the traction seemed to be kind of binary. You either believe in A or you believe in B. But I think we moved on from that. And I think a lot of us now acknowledge that there is a way to combine both of the approaches for the benefit of the investor. And I think this is crucial to understand. You are not making a choice here that excludes one area or space from your portfolio. You’re actually better diversifying. If anything, you at least get more of a strategic diversification. Certain elements will be active, certain elements will be less active.
Meb: Question we always ask in investors on the podcast, as you look back into your career, and this can be personal or professional, but what’s been your most memorable investment? Is it something…it can be positive, it can be negative? Anything that comes to mind as you look back over the years?
Yariv: You already pointed before that our timing couldn’t have been worse. I mean, we quickly ran into the global financial crisis. And I will never forget the meeting we had early 2009. I mean, with hindsight, if one can say that was probably the bottom of the market. And we looked at our portfolios, which were tracking market, and we have experienced severe losses. The portfolio’s dropped about 20%, even more so in value. That is a significant decline. And we were looking, you know, at other institutions and other investors and we saw that, you know, there was blood on the screen, so to speak. Everybody were losing. Nobody was sitting there happy about the crash.
And I very much remember saying that, you know, we just needed to be very disciplined and it will probably take us years to recover. But if we keep the discipline, this is the strategy that maximizes our potential to reach our objectives in the long term. And then eight months later, by November of 2009, we were back in positive territory. We recouped all the losses that we made during the crash by simply sticking to our guns, rebalancing and not, you know, running for the hills. And I was proven wrong. I sit there eight months ago saying it’s going to take us years to recover, but it just shows how little I know and how bad my forecasting is.
So, this is a very, in a way, a kind of a humbling experience. You look at the markets and you see how drastic they can move, one way and the other, and how swiftly they can move from, you know, from a complete collapse to a very quick rebound. And you just acknowledge that it’s very difficult to try and fight them or try to outsmart them. So, you know, I was not doing anything that made us better than our next co-investor. We just simply stuck to our strategy. And that is the benefit of long-term investing. If you have the right strategy, you’re going to stick with it through thick and thin. And you will, hopefully, get the outcome that you are expecting in the long term
Meb: Well, it’s funny, you know, I think the challenge for a lot of people, the older folks on this podcast will remember 2008, 2009, very vividly, 2000, 2003. And even some, you know, the bears before that. And the younger crowd, you know, I often chat with younger investors and say, “Yeah, yeah. I can handle a ton of risk. I fully accept my portfolio will go down by 50% at some point or whatever the number is because of my high-risk tolerance.” And it’s easy to relate that on paper or over a coffee until someone actually goes through it, you know. And we often tell people, say, your risk tolerance is one thing, but until you live through it is another thing. And usually people overestimate it in one direction, not the other. People very rarely say, “Oh yeah, I could have taken on a lot more risk. I could have been happy losing 80% or whatever it may be.”
But that’s comes with seasoning and aging and everything else. Yariv, this has been a lot of fun. We’ll have to have you back on post-Brexit. So we can see what the world looks like after that. But, listeners, by the way, I’m going to be over in London, Dublin, in Europe in March. So drop me a line and say hello. Where can people find more, if they want to follow your writing, your updates, what’s going on in your world, what you’re thinking about, where’s the best places?
Yariv: Well, the first source, obviously, it wouldn’t be our website, sparrowscapital.com, and they can also follow my LinkedIn profile, Yariv Haim. It’s as simple as it gets today, so there’s no problem getting in touch with me one way or the other.
Meb: Great. We’ll add the links to both of those on the show notes at mebfaber.com/podcast. Yariv, thanks for taking the time to join today.
Yariv: Thank you very much for having me.
Meb: Listeners, it’s been a lot of fun. You can find the show notes. We’ll link to these at mebfaber.com/podcast and you can find all the archives as well as the show on iTunes. Overcast, our new favourite, Breaker. Thanks for listening, friends, and good investing.