Episode #166: Radio Show: Greece and Russia Are Having Monster Years…Geographic Diversification…and Meb’s 401(k)
Guest: Episode 166 has no guest but is co-hosted by Justin Bosch.
Date Recorded: 7/9/19
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Summary: Episode 166 has a radio show format. We cover a variety of topics, even Meb’s investment portfolio:
Bonds, stocks, and valuation
- A Tweet from Movement Capital showing the various phases on 10-Yr Treasury return. Annualized Real total return from 1-1926 to 9-1981 was flat. 9-1981 to 1-2013 annualized a real return of 6.67%. Those two periods aren’t captured in the total real return from 1-1926 to 9-1981 of 2.38%.
- Negative yielding bonds, and the case for investing in them.
- From strategies outlined in the Global Asset Allocation book: The average yearly spread between the best and worst performing strategies was 18%. From 1973-2018, the spread between the best and worst performers was 2%.
- Emerging and foreign developed stock markets remain inexpensive relative to US stocks.
There’s this and plenty more in episode 166.
Links from the Episode:
- 0:50 – Welcome and announcements
- 1:22 – Cannabis fund
- 1:51 – Jay-Z is a billionaire and the importance of building wealth through being an owner or investor
- 2:35 – Jay-Z Is Officially a Billionaire
- 7:24 – Good year for the markets
- 8:28 – Movement Capital tweet about Bond market
- 11:15 – S6 E2 Jeffrey Gundlach, CEO – DoubleLine, The Sherman Show
- 12:04 – Mean reversion in the markets
- 13:05 – Geographic Diversification Can Be a Lifesaver, Yet Most Portfolios Are Highly Geographically Concentrated (Saphier, Karniol-Tambour, Margolis)
- 16:48 – Research Affiliates Interactive Tools
- 19:36 – Meb’s ideal portfolio given current valuations
- 24:02 – Factors from Scratch: A look back, and forward, at how, when, and why factors work (Livermore, Meredith, O’Shaughnessy)
- 24:10 – The Earnings Mirage: Why Corporate Profits are Overstated and What It Means for Investors (Livermore)
- 26:42 – Return chasing vs implementing momentum
- 30:23 – Invest With The House: Hacking The Top Hedge Funds (Faber)
- 30:31 – Expectations for the future and the power of being different
- 35:58 – Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies (Faber)
- 37:48 – Meb’s 401(k)
- 38:34 – The Meb Faber Show – Episode #161: Brandon Zick, “In Row Crops You’re Generating A Lot Of Current Income”
- 41:21 – The Meb Faber Show – Episode #165: Chris Mayer, “I Do Think The Biggest Challenge…Is Keeping It, Holding On To It”
- 41:52 – The Meb Faber Show – Episode #78: “If You’re Going to Be an Angel Investor… You Have to Be Devoting Significant Time to It”
Transcript of Episode 166:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, podcast listeners, guess what? We got a radio show for you today. It’s full-on summertime here in Los Angeles. So I dragged my coworker Justin into the studio. Hello.
Justin: Howdy Meb.
Meb: How goes it? How’s your summer going?
Justin: Going great.
Justin: Enjoying the weather down here.
Meb: Well, you briefly came by our annual Fourth of July barbecue getting settled in and the SoCal lifestyle.
Justin: Yeah, it’s pretty easy to get settled in down here. I can’t complain.
Meb: We gotta get you back out on a surfboard. Well, some quick logistics and housekeeping. We got a new fund coming out so if you’re interested, check out cambriafunds.com. We’re launching a cannabis ETF we’ve had filed for a very long time. As far as the radio shows go, we’re gonna start doing these bi-weekly now. You guys have been asking for them a lot. We’ve had so many good guests though is the problem, we’ve just been inundated with massively awesome guests and recording even more next week, so keep an eye out. I’m really excited about them. But we miss you guys so we’re gonna do some radio show. So what’s going on in the world? What do we know? What should we talk about today?
Justin: Well, an interesting point I think we should hit on for sure is Jay-Z, he’s a billionaire.
Meb: Hobo man. He came out a billion dollars, first hip-hop mogul. I mean, there’s a few that have certainly made a fair amount of money, P Diddy, Dre. But you bring up an interesting point, I think we tweeted a little bit about this, which is really instructive is that I think a lot of people who wanna get rich and become millionaires and billionaires, they often think in terms of celebrity, right, you know, athletes, musicians. And while a lot of those people make a lot of money, they don’t become really wealthy, like the big money unless they’re investors. And it’s funny if you look at Jay-Z’s wealth broken down, there’s an article in “Variety” you know, his number one chunk of his billion dollars, which is a $300 million stake in a champagne company. Then he’s got some private investments in things like Uber. He’s got a cognac company worth $100 million, Tidal, $100 million, Roc Nation $75 million, art collection $70 million, and music catalogue, only $70 million. I mean, that’s nothing to shake a stick at. Obviously, he uses music to parlay. But I think it’s such a good lesson.
We have a book that I’d really like to write. But it’s summer and it was supposed to be a sabbatical. But it’s basically this topic of if you really wanna get wealthy you have to be an investor. And I mean, if you look at Dre, he did it with Beats. If you look at almost every athlete or musician that’s actually become wealthy, it’s almost always from being a businessman. You know, that’s what Jay-Z famously said, right? “I’m not a businessman. I’m a businessman.”
So there’s two other examples of sort of this be an owner mentality. The first was a tweet from Darren Rovell where he was talking about old-school, Upper Deck. And I’m sure you remember Upper Deck, there’s not many things I’ve lusted for more in life than a Ken Griffey Jr. rookie card. But there was a funny story he mentioned were a couple of players, Wally Joyner, pretty famous for Spaceman, Wally’s World. And then DeWayne Buice which I think we pronounce that correct, which was the Angels reliever, they had compensation for helping Upper Deck out in the early days. Joyner got paid 10 grand. Boyce decided to take that compensation instead in stock, which later became worth $17 million.
And of course, you can always show the example and probably retrospect, hindsight bias of plenty of people that took stock then it was worth nothing. But my favourite example is Facebook. I don’t know if you remember this, but there was a graphic designer in, I guess, Palo Alto or wherever, where Sean Parker, the Napster fella who helped out Facebook, had hired a pretty famous graphic designer to paint some murals. And the guy’s quote was 60 grand, which at the time seemed a lot. But then he said he could also take stock, which then became, drumroll, $200 million. I mean, that has to be the biggest outsized sweat equity I’ve ever heard of. But again, it’s a good example where, you know, I think if you think super long-term, it gives you that optionality. And again, it’s not always gonna turn it into $100 million. But the concept of being an owner and having some equity skin in the game often gives you much longer runway than just getting paid by the hour or short-term upfront profits. But the takeaway in my mind is you have to be an equity owner.
And so we’re trying to figure out a topic for this book I liked, “Be the Owner, Hold the Keys, Be the Bank,” or “Own the Business, Hold the Keys, Be the Bank,” meaning kind of three big paths to wealth of being equity owner in a business. And a lot of people think you have to start the business, but that’s not the case. So obviously, stocks is a good one, you can build wealth at 10% returns over time. This also parlays our old “Get Rich” portfolio, which is also still not done, but be the bank meaning lending and, of course, real estate being holding the keys. So anyway, it’s awesome. Congrats, Jay-Z. If you wanna come on the podcast, talk about investing, let me know. But pretty cool biz news.
Justin: Yeah, good, strong points about being an investor, I think it’s critical. And the other underlying theme here is not only being an investor but be patient, let things grow.
Meb: Another point that I spend a lot of time oscillating and kind of flip-flopping about is this concept of a lot of celebrities and people getting involved in the investing world. You see a lot of people…you hear these private companies doing these big rounds, I say all investors are Kevin Durant, or maybe it’s Ashton Kutcher was early to this, I think, so kudos to him, or Nas. And it’s easy to pooh-pooh those and say, “Oh, my, gosh, this is a bubble. This is so stupid when these celebrities get involved.” But actually, I think times have changed in many ways, you know, a lot of these guys have some pretty thoughtful advisors.
People that, I think, many of them don’t need advisors, of course, but you know, I think it was in the past easy to say it’s just dumb money. But now you have people like Kevin Durant, you know, or Iguodala who actually, like, use their positions and location to actually see that as a big beneficiary. My favourite was always Rod Smith. I’m a Broncos fan. So you know, Elway did it, made a bunch of money in car dealerships, Rod Smith made a bunch of money with real estate. I wish that there was more kind of broad instruction about that, that concept of becoming an investor. And of course, the easiest way to do it is just invest along with people in the stock market and private markets.
Justin: Well, let’s get into some market topics today, speaking of markets. So we had a huge year so far.
Meb: Yeah, man, where’d that come from? Q4 straight down, Q1 straight up this year, S&P is up 20%. It goes back to our old concept of normal market returns are extreme. You know that if you look back in history, the yearly returns, the S&P, very rarely does it return like 8% to 12%, which is what people expect. It’s either up 20%, 30%, 50%, down 10%, 20%. But you have a lot of the foreign markets romping to two of the biggest our performers. I mean, I think Greece and Russia are up 40% and 30% year-to-date, as people have kind of forgotten about them. You don’t hear about Greece and Russia in the news much anymore but they’re really having monster years and not surprising, you know, they’re some of the cheapest in the world. So it’s good to see the U.S. continued resilience is a bit of a surprise but Amen. That’s markets for you.
Justin: Yeah, bonds are up too, seems like everywhere you go, everywhere you turn and who knows.
Meb: It’s a mirror image of last year, everything down. Hey, even the cryptos are romping, so.
Justin: Speaking of bonds, treasuries, Movement Capital had a tweet that was really instructive and giving some good perspective on time periods and rates of return. And if you look back from ’26 to 2013, you look at a total real return of 2.38%. If you go from ’26 to ’81, returns were basically zero. But if you look at the entire period from ’81 to ’13, you’ve got 7% return so I think that’s instructive.
Meb: You know, people think in terms of asset classes on a monthly, quarterly, even yearly basis. But these things play out over such long time horizons. I mean, bonds for the better part of 20th century, like you mentioned, no real returns, particularly the ’70s. Older, no hairs, grey hairs in the audience will remember times of super-high inflation, you’re back now to where bond yields are pretty darn close to inflation. And when they dip negative, meaning you have a negative real yield, we call that financial repression, and depending on who you are, you know, that’s either good or bad, but it certainly sets the stage for a lot of asset classes like gold. Bridgewater has been out and publishing some research talking about how they love gold here.
But anyway, I mean, these things play out over such long time horizons and it’s easy to forget that, you know, yesterday’s darling or even the last 10 year’s darling sets the stage for often muted returns and vice versa. So everyone, right now at this point in the cycle, hating on emerging markets and commodities. My god, commodities, no one wants commodities because they’ve done terribly for the past 10 years. But you know, that’s usually, there’s been some good pieces put out by AQR as well kind of looking back of chasing returns of the past 5 or 10 years, pretty bad idea.
But bonds you know, it’s a great example where, you know, the historical, going back to our old five-to-one rule of thumb, if you look at real returns after inflation, global stocks around five, global bonds around two, and then T-bills or short-term bonds around one. But there hasn’t been a huge premium to owning bonds, you basically just keep up with inflation and at some point, you lose half. But going from an interest rate environment of double-digits to one that are low digits now with low inflation, that’s a pretty nice tailwind. Will we see that going forward? Who knows.
I have an old tweet I just retweet every once while, I think it’s in 2014. It says, “Wake me up when bonds are yielding 50 bps.” It’s this kind of joke that we’re in this sort of like Japan scenario where yields have been muted, where in Japan, they have been for decades. But you never know, I mean, the U.S. is one of the highest-yielding countries in the world right now. And I was listening to a fun podcast with our friends at DoubleLine this morning, Sherman and Gundlach, where they said there’s potential of, you know, even negative rates in the U.S. kind of like the rest of the world. So who knows, they could certainly go either way. But what happens at this sort of low yield is, you know, it can be quite a bit more volatile. Small moves and interest rates can have a much bigger impact on the price moves versus when they’re much higher yield. So interesting times we live in we had a great piece we’ll link in the show notes from former guests. Vineer Bhansali had a great piece on low yielding bonds in Europe but having to deal with currency fluctuations. So yeah, “Wake me up when bond yields hit 50 bps.”
Justin: Earning positive returns with a currency hedge as well.
Justin: Figuring out how to make something out of that.
Meb: Never an easy choice.
Meb: What else is going on in the world?
Justin: Well, I think an important point that is worth covering, I mean, you talked about it, I think broadly, this idea of mean reversion, some people would talk about that. But I think there’s some interesting data that shows that there could be something to this. ’99 to 2009, U.S. was the lowest-performing across regions, but from 2009 to 2019, was the highest performing across all regions. I think that’s an important point. Europe outperformed almost all those holding periods. So that’s also something to keep in mind as well as we have a, you know, romping, stomping U.S. bull market. It’s easy to forget about other regions in the world and that this might not go on forever, it could.
Meb: Seems this is a great topic to trigger people, certainly on Twitter, love picking fights on this topic because there’s a few quotes that I have that just send people insane. Then that I love that Bridgewater took up the torch as has Vanguard and many others research affiliates about this topic where…and we’ll link to in the show notes. It’s called “Geographic Diversification Can Be a Lifesaver, Yet Most Portfolios Are Highly Geographically Concentrated.” And so everybody’s looking at this period since the financial crisis in the U.S. where U.S. stocks have just romped. Pat yourself on the back, you’re overweight, U.S., way to go because you’ve had a massive tailwind and people loves saying all the reasons why the U.S. should be exceptional. And there are a lot of reasons.
But historically, looking back, you know, you’ve had a valuation premium that people expect right now, that U.S. is trading a long-term P ratio around 30, rest of world’s around 20, emerging markets around 15, and the cheapest, cheapest stuff at the bottom down around 12. And people say, “The U.S. deserves a premium.” But if that were true, then there should be a historical premium and there’s not, the U.S. actually has no historical premium over the rest of the world. And so, so much of this performance has come since 2009 has been multiple expansion, you know, U.S. stocks traded a P ratio down around 12, maybe a little bit higher, at the end of the financial crisis, but so did the rest of the world. The only difference is the rest of the world hasn’t had multiple expansion. And so all of this outperformance of the U.S. versus the rest world over the last 7 years has come since 2009, which is crazy to think about. So people extrapolate this recent period as if this is gonna continue forever, and it’s not.
And so Bridgewater, in this paper, I’ll read a couple of quotes. You know, they said, “In this past century, there have been many a time when investors concentrated in one country saw their wealth wiped out by geopolitical upheavals, debt crises, monetary reforms, the bursting of bubbles, while markets in other countries remain resilient. And no one country consistently outperforms as outperformance can lead to relative overvaluation,” Meb’s quote here as is right now, and a subsequent reversal. “So geographic diversification has big upside and little downside for investors. To illustrate the impact of geographic diversification, we begin by looking at the characteristic of returns streams from single countries relative to weighting portfolio equally across countries and rebalancing annually. An investor concentrated in Russia or Germany in the early 20th century would have lost most or all of their wealth. On equally weighted mix, the five countries does almost as well as the best performer.” And side note, China also went to zero.
You know, and so looking at these decades over time, and a lot of things line up in the decade periods, whether humans just think about in terms of decades or not, but often they do. You know, if you look at this past decade, the U.S. has been the best performer so far. But it’s also been one of the weakest performers in the prior decade, 2000, the financial crisis, is one of the best performers in the 1990s. But before that, you had to go all the way back to the 1920s to see the U.S. as one of the best performers. And the U.S. stock market is underperformed equal weighting in 8 of 12 decades. So let that sink in. That’s a really important point.
The U.S. stock market, despite being one of the best of the 20th-century, has underperformed equal weighting in 8 of 12 decades. So Bridgewater goes back and says, “You know, there’s plenty of instances in which you geographic diversification has been a lifesaver.” I mean, if you’re listening to this podcast in Greece, or Cyprus, or Brazil, or Russia, or Turkey right now, you know, a lot of these places, Europe, all of Europe, essentially U.K., all my U.K. friends going through Brexit, that’s a really cheap stock market now. Bridgewater says, “You know, there are plenty of instances in which geographic diversification has been a lifesaver, preventing wealth from being wiped out. Most countries have worse drawdowns in their history than the equal weight portfolio ever has.”
And so quick summary, as you think about this, 2019, God, man it will be 2020 next year, that’s bananas. As we look around the world, we already talked about bonds, we know what bonds are gonna do. Even if you’re optimistic and magically say they’re gonna do 3%, round up, but more likely closer 2%. The U.S. stocks, almost everyone looking at historical expectations would assume the U.S. stocks to do probably about the same, 3%, 4% if you’re lucky. Research Affiliates has a great interactive tool on their website we’ll link to that allows you to estimate future expected returns in a bunch of asset classes.
I was laughing because they had private equity in the U.S. essentially at zero real returns, which can be fascinating because that, private equity, seems to be the saviour. Which almost every institution is hanging their shingle on believing that they’re magically gonna hit their 8 to 10 performance numbers by magically allocating to private equity because that’s worked in the past. And I think it’s gonna be a really rude reckoning for all these institutions that think that if…certainly if Research Affiliates is accurate, that these big, massive private equity funds…There’s also some recent research, so Paul Kedrosky was talking about this where it’s like almost half a private equity firms don’t hit the 8% return target, so good luck.
Anyway, the U.S. opportunity set is poor. We’ve mentioned 1,000 times this podcast diversifying globally can save your butt, particularly in times when stocks are cheaper abroad, which is the case now. And in some cases, much, much cheaper. We think that investors should move to 50/50 U.S. stocks, foreign stocks, which is the global index. That means you still have I don’t know 10 times the amount in the U.S. stock market than you do in the rest of the world, which is still massive overweight. But if you’re value-conscious, you can even move past that. But most of the listeners that are U.S. based, you guys know this, I’m a broken record at this point, but most U.S. investors have their stock allocation put in 80%, which is bananas. So consider adding value rather tilts like either equal weight, that’s pretty uncomfortable for some. You know, the example we love giving is certainly career risk Greece and Russia and others are romping this year. But let’s say you listen to this podcast, and you know, Meb is brilliant, you go by those countries in a year from now if you’re an advisor, and they’re down 20%, 40%, 60%, you know, you get fired because what crazy person buys foreign stocks? But that sets up part of the benefit too.
So there’s a ton of literature on this. Our friends at Star Capital put out a great piece that showed Europe and the U.S. had essentially the same returns since the 1960s. They show that equal weighting or GDP weighting, remember the U.S. as a percentage of the world GDP is only quarter. Certainly, have been better investing strategies than the market cap weighing and we’ve detailed all of the problems with that. This is a problem, by the way, Justin, you got to interrupt me otherwise, I’m just jabber for the entire hour.
Justin: No, this is excellent. You know, just I’m sitting here listening. This is amazing. Keep going.
Meb: Yeah, I mean, that’s the whole thing, you know, to me, is that this is a very basic concept. It’s one that we just would have not shut up about over the past five years. And I think it’s an important one.
Justin: Yeah, I agree. I think it’s really important. I think they’re fundamentals. And I don’t think we can ever reiterate them enough. So I wanna talk a little more about let’s get a little more into the valuation. You talked a little bit about emerging markets being on the cheaper end of things or less expensive end of things, however you’d like to put that, listeners. And I wanna hear from you right now, 2019, what would an ideal portfolio look like for you? What would you like to see people do? You know, of course, everyone has various abilities to take on risk and all those things, that’s individualized. But looking out at the landscape, looking out at what we’ve seen so far, even in the last decade, what do you like to see here?
Meb: You know, I mean, the default I always go back to starting point global market portfolio, which is 50% U.S., 50% foreign, and 50% stocks, 50% bonds. And to me, that’s a starting point. And there’s a great John Bogle quote I’d never heard but I heard recently from somebody on Twitter where he said along the lines of, “Look…” and he wasn’t referring to the global market portfolio to be clear, because he would never invest in the global market portfolio, he was very U.S.-centric. But in the quote, it’s like, “Are there some portfolios that are probably gonna be better?” He’s like, “Sure, but there’s an infinite amount of portfolios that are worse.” And I think that’s a good way to frame this and think about it, you know, that that historically has been an outstanding asset allocation portfolio. It’s a set it and forget it, you can get it essentially for free in 2019, with short lending, you’re probably actually having a negative expense ratio on that portfolio. It’s astonishing, really. But that’s market cap-weighted.
And so to improve upon that, I think there’s some very simple things you can do. Factor tilt sort of an obvious one, we love the big two. Two probably most famous that I think are fantastic, which by the way, have just been dog poo over the past cycle in the U.S. Market cap has stomped everything. A lot of people have been very vocal about how much a lot of the traditional factors in the U.S. have struggled, whether it’s been value, whether it’s been momentum, whether it’s been a combination of the two. That’s actually hasn’t been the case abroad. A nice piece by Jack Vogel over Alpha Architects was talking about this where value is actually worked quite well in international markets during this period.
But anyway, tilt away from our cap weighting. I don’t really care how you do it as long as you do it. Again, our favourites are value and momentum, which again, currently pushes you away from the U.S. more and more, the momentum not so much, but the value. And then, of course, we talk ad nauseum about this. We love trend following, we’re probably the biggest outlier in the world on trend following ideas. We allocate as default in our Trinity Portfolios half to trend following strategies, lots of different ways to do that. But I think the main benefit, which again, also hasn’t helped you much in the U.S. it’s helped you abroad, it’s kept you out of all sorts of stuff. You’ve sat out commodities, you’ve sat out a lot of these massive drawdowns in foreign markets over the past decade. But you know, it’s mostly long, a lot of these places now, which is great.
I’m cheering. My favourite investment, if I had to pick subjectively, is when there’s an investment where value and momentum and trend intersect, you know, which tends to be pretty rare. But when the cheap stuffs going up, that tends to be the favourite. So you see that happening with a lot of the cheap stuff now, we mentioned Greece and Russia and other places. And if that catches a tailwind, you could see some, you know, really massive numbers, you know, that those guys can put up and it’s happened in the past. Of course, caveat, they can go down too. So you know, for me, it always goes back to the global market portfolio on the buy-and-hold side. If you wanna add the trend stuff, great. You don’t have to, but we love it. I love it.
And then the last caveat that I’ve been very vocal and transparent, Josh Brown recently did this so kudos to him about, you know, publishing your portfolio and how you invest. And we’ve done this, at least going back every year back to 2014 and we talk about my portfolio and how I invest. And we should probably do a whole episode on that at some point again, updates, because there’s some interesting ones. But in general, I mean, for me, it’s the broad Trinity ideas and concepts that we talked about in our white paper that I think gives you exposure to all the things you want, the tilts, the trends, the value, all that wrapped into one. But going back to Vogel, I’m cool if you just do the global market portfolio too.
Justin: Curious, have you done any work on the time periods or amount of times those factors of conversion been working together in your favour?
Meb: O’Shaughnessy put out a recent piece on this, they’ve been hard at work this summer cranking out some massive white papers. I think one was like 100 pages. It’s like a book, but it was a good one with Jesse Livermore. But it talks about this concept of factors. And I forget what they named the dataset, it has as a name, but they take it back to the 1920s. And, you know, show that, yeah, look, you have these periods that go through a long time with underperforming. And, you know, we’ve had comments with a recent client who’s, “Hey Meb, your XYZ fund is over the last couple months,” he’s like “I’m gonna be patient,” and he’s kind of laughing. I’m like, “Well, you know, by the way, my comment to this not just our fund, but any strategy, any asset class, any approach I used to say you need to give it 10 years.” Now, I say 20 and I’m not joking about that. People who are listening saying that’s crazy but well, you know, look at Buffett has underperformed for the past decade. Values underperform, you know, and foreigns underperform U.S. and this, that, and the other, doesn’t mean you wanna put all your money in U.S. stocks right now. In market-cap-weighted names, like, you know, Amazon and Netflix, everything else. That seems crazy to me.
Anyway, any approach I think can go very long periods with underperformance. But that’s kind of what sets the stage. You know, once everyone’s finally saying, “We should put all our money in SPY,” that’s probably a good time to be looking abroad. And so, you know, we often tell people, say, “Look, man, if I was discretionary looking to add names…” And Carl Richards had an interesting tweet about this where he was talking about investing approach that invests in emerging market stocks, real estate, I think it’s small-cap value. When he says, “Just rebalance every year but if you have new contributions, invest in the one that’s down the most over the past year.” That’s totally reasonable to me, hard to do, but it makes total sense. So you have this sort of mean reversion of investing what’s not working.
One of our strategies that we’ve written about, it’s been by far one of the worst performers because it includes like nine different headwinds of value and momentum ideas, is probably one of my favourite going forward. But you know, that’s, I think, the correct way you have to think about this. And if you get into this game of returns chasing the research shows over and over and over again, not just individuals, but also institutions, there’s been academic papers about this that have looked at like 8,000 hiring and firing decisions and it shows that everyone does it. And it’s a really, really dumb idea to chase returns, the way that people like to do it is over the last two to three years. So you look at what’s performing the last two or three years, they extrapolate it to infinity, and they fire the bad guy, they hire the good guy, and it works in the exact opposite way they would expect it to.
Justin: So I wanna interrupt you there because I wanna get into that concept just a little bit. And I want you to differentiate between return chasing and implementing momentum, for example. And how do you do that? How do you think about it? How do you like to see it? And how do you separate the two? Because in a high-level sense, you could argue that momentum is, in a sense, returned chasing, but talk to us about like the difference between the two and how you think about that.
Meb: There’s two parts. So first, let’s talk about, you know, I think one of the most challenging…and I sympathize with people that have this is a career and a job because I cannot imagine picking discretionary managers. And having that as a job like if you’re like an endowment, if you’re a CIO, a wealth manager, or a brokerage, sitting around and picking these discretionary managers is like, you know, what do you do? A guy gets a divorce or the portfolio manager decides to have, you know, a bunch of children, or maybe they just get rich and wanna play poker, or maybe they focused on, I don’t know, charity events and galas all the time. Are they gonna continue to focus on their stock-picking? Like that’s such a hard…that’s why I’m a quant, by the way.
So but going back to the topic of, you know, it seems like momentum and return chasing are similar things or the same thing, and in some ways, they are a cousin. I think that momentum works for a lot of reasons that are well established and behavioural or structural. Usually, that markets don’t adjust to new news as quickly as probably they should. I think that there’s statistical reasons that momentum works, namely that you’re trend following. And so the statistical distribution or avoiding the 40%, 60%, 80%, 90% loss, which is really the losses that matter. It’s not the zero to 20%, I don’t think, that really contributes to the big negative skew in portfolios, it’s the big doozies. So momentum, however you measure it, you know, momentum traditionally is a relative measure, whereas trend following is a time series measure. But they’re kind of a close cousin.
So what’s the difference between that and just chasing hot managers? Chasing hot managers, the problem is the way most people do it, they don’t have a plan. So CGM, Heebner’s fund, one of the most famous managers out there, fund manager of the decade in the 2000s, put up like just monster double-digit numbers, average dollar invest in that fund is negative. Not double-digit, not even single-digit, it’s negative because people went in after he had a really good returns stream, sold it after it did very poorly. So the whole point is it goes with everything, just no one has a process. So theoretically, ignoring commissions and taxes and all the problems with chasing hot managers, theoretically, if you apply a thoughtful momentum approach, it would probably work. But that’s not the way people do it. They don’t think in those terms. And so the problem with a lot of the discretionary managers also is they’re moving targets. So Heebner’s fund today and in six months could be totally different. He could be long-short, he could have moved out of all the stocks into something else, which is totally different than looking at, say, momentum on across asset basis around the world or looking at futures markets long-short, it’s just a different animal.
But that having been said, could you develop an approach that would thoughtfully and systematically rotate managers? Probably, I mean, you can certainly do it with sectors, you can do with industries, you can do with asset classes. Could you do it with managers in a way that would work? Probably. Just too much work, man. Following these guys, it’s just…We wrote a book on it, it’s free to download, “Invest with the House” but… It sounds like such a headache.
Justin: Yeah, well, a project for somebody else, maybe. Well, let’s get into expectations. We talked a little bit about valuation. And there’s some big names out there talking about their expectations for the future. And really, they’re not that different than the ideas you’ve been talking about recently. So first, we have Vanguard talking about future expectations, foreign stocks looking to have the highest returns over the next 5 years out of 17 asset classes. And Rob Arnott, the great Rob Arnott looking to emerging markets, you know, looking forward to emerging markets having great future expectations. So talk to us a little about that, are you…that’s in line with what you’re thinking and…?
Meb: There’s two different ways to think about it. The first is look, if the opportunity set is poor, I mean, again, we think about it in terms of gambling or statistics where you look at the percent probabilities of the U.S. from a starting point now with dividend yield and earnings growth. I would have said the exact same thing in the beginning of the year and U.S. stocks are up 20%. So the whole point is the probabilities, you can still have great returns, you can still have periods where U.S. you know, may have an earnings Renaissance. And maybe you just have this situation where we grow into it, but the odds are against you. And historically, betting on that has been a losing proposition. So usually, you want to invest in places where it’s cheaper and where future returns are expected to be higher.
So there’s two ways you can do it. One, you can say, “You know what I’m a buy-and-hold investor, I don’t care.” But if you’re gonna do that, you should just be mindful of the likelihood your returns will be lower is probably high. So spend less, save more, that’s good advice for almost anyone anyway, by the way. And to be honest, whether your portfolio does 4% or 5%, it’s not gonna matter as much as the decision to spend and save in the first place. And when you invest, the decision to invest, and doing it early.
That having been said, you know, again, I think that if you don’t mind looking different and weird and, you know, underperforming at times, diversifying your portfolio globally, and certainly adding a bunch to these emerging markets, I mean…who did I see? Was it…I’m gonna probably massacre this. I don’t think it was Research Associates, I think it was GMO, it was talking about not owning U.S. stocks at all. They said, “Yeah, you should just own foreign stocks, emerging markets,” and they’re willing to look very different. GMO, I apologize if that wasn’t you guys said that. Well, we’ll add it to the show notes. But I think it was GMO that was talking about what I said, “Look, if you don’t mind career risk, you just shouldn’t own U.S. stocks.” But who’s gonna do that? Probably no one listening to this.
Justin: So the message, don’t sweat, you know, you might be trailing significantly over the next year, maybe even 2 or 5, but play the probability game and give it 10 more years.
Meb: And that’s too hard for some people. And you know, if that’s too hard, fine, just buy a global market portfolio and be done with it. And don’t worry about looking different, because you’ll just always be the global market portfolio and that’s fine, like, I’m okay with that. I mean, one of our investment funds is one of the lowest cost ones in the world that does that. I mean, it obviously tilts towards things like value momentum. So obviously, I’m cool with it. But at the same time, it’s not how I think about the world.
But again, to be different, one, you have to be really different, you have to be really concentrated. You know, you mentioned Movement Capital earlier, where they had a great post that showed the effect of adding a 5% position into a traditional portfolio. We’re like, “Hey, a lot of people think, man, you can put 5% in gold? That’s a ton.” But like the equity curve is indistinguishable, right? It’s like it doesn’t move the needle enough, just an example is you got to be really different when allocating to a lot of these assets and approaches. And otherwise, you’re just gonna end up looking exactly like a global market portfolio but paying more for it, which is useless and probably having more in taxes and transaction costs, and certainly in management fees. So if you’re gonna be different, you have to be really, really weird and different. And for most people, it’s just too hard.
Justin: Yeah, it’s tough, especially when it’s real money on the line and you’re looking at neighbours, colleagues that might be smoking you.
Meb: And which is why it’s important to automate it. That’s a lime LaCroix, by the way, if you think we’re just ripping Budweisers on the podcast, which we probably should, loosen me up a little bit. You know, it’s the whole point of looking weird and different, like you have to, and a simple way to do that, for example, so let’s talk about like the value investing the cheap stuff. Like if you have to go get off this podcast, and you go, “You know what, I gotta log on to E-Trade and Robinhood and buy Greek and Russian stocks,” like what’s the chance of you actually complying with that investing strategy? Like very low, but having it set up in an automated fashion, you know, we use Betterment, we have portfolios at Betterment that just automatically…the funds tilt towards these things automatically and then they just rebound. So if one’s doing poorly, it’ll add more, if one’s doing great, it’ll take some off the table. And you don’t have to worry about it, just words in the background. I think it’s just otherwise, you let the emotions creep in anytime you don’t have a rules-based automatic process. And in many ways that those emotions just getting under the door causes non-compliance and fractures. And that’s where people, they become their own worst enemies.
Justin: Yeah. Well, you know, there’s an interesting fact, here, you have with allocation strategies, stuff you outlined in the “GAA” book, you can have a yearly spread between the best and worst allocations of 18 percentage points. But you take that out, you know, over longer-term periods, I mean, you’re looking at very minimal differences in performance just between allocations.
Meb: This is a very simple takeaway I think describes almost everything about why people behave so poorly. Then we talked about all these asset allocation strategies in our book called “Asset Allocation.” They all almost end up in the same place. You know, as long as you have the main ingredients, stocks, bonds, real assets, global, a little bit of each, almost all the portfolios end up in the same place. They cluster around a 1% to 2% performance spread from best to worst over the entire period. I mean, that is a tiny, tiny, tiny, tiny, spread. But like you mentioned, the average yearly best or worst spread is 18 percentage points.
Justin: That’s huge.
Meb: And so people look and they’re like, “Oh, my God, risk parity is doing amazing this year, I gotta use risk parity.” Last year is like, “Oh, my God, an endowments style approach did great, I gotta use endowment.” And so they consistently just chase. And again, we found that chasing the best-performing asset allocations and rotating, you end up costing yourself a fair amount of cash. It’s just so dumb. So it goes back the whole point of set it and forget it, it doesn’t matter which one is…one of the best performers in the entire book is like 3000 years old, or 2000 years old, Talmud. It’s like invest a third in real estate, a third in business so we call it stocks, then a third keep in reserve, which is bonds. So a third, a third, a third, stocks, bonds, real estate portfolio, literally beats, like, almost everything, 2000 years old. So that’s our whole point on the buy-and-hold stuff, it doesn’t really matter. But what does matter is just not doing dumb stuff and shooting yourself in the foot.
Justin: Well, and as we wind down here, speaking of being different, you’re quite different in the way you’re investing your 401(k).
Meb: Oh, God, people lost their mind on that one, too.
Justin: Speaking of being different and stuff that’s probabilistically, hopefully, in your favour.
Meb: A quick review of how I invest my money. I mean, look, you have the realization that probably somewhere between, I don’t know, 50% and 99% of my net worth is this company. But let’s say this company didn’t exist. The next biggest part of my network is a family farm, where we grow very low-yielding crops like wheat, corn, and milo. Although the corn’s seen surprising appreciation this year, but it’s very sentimental and great asset class that we love over long periods. I would actually love to diversify into other farm ideas. We’ve had some great farmland guests, Brandon Zick was awesome. If you guys missed that, go listen to that podcast, it was really, really fun.
Justin: By the way, when’s harvest this year?
Meb: Yeah, well, we should go do a podcast there. And we should head out to Kansas, let you drive the tractor.
Justin: Oh, yeah.
Meb: The tractor just drives itself at this point. So I’ll have to coordinate with everybody and see what’s going on. But it’s so hot in the summer. My god, it’s like, my father used to torture us by driving around and not turning on the air conditioning and it caused me to hate Kansas for like a decade, it is so hot. We don’t have air conditioning in my house in L.A. So there’s like, it used to be like a week now it’s like a month where it’s intolerable. So I gotta get an AC unit.
Anyway, going back to my portfolio, you know, an increasing part over the past five years, we’ve talked about this journey, has been private investments, which is a good hack because you can’t sell them even if you wanted to. So we’ve made almost 100 investments at this point, would love to do a more detailed podcast on that at some point. But has been a pretty fun…you know, the goal, in the beginning, we mentioned this back in 2014, was to hopefully match the returns the S&P, well hopefully, just break even. If we match returns the S&P, gravy, and then hopefully would do better but considered it tuition. And so it’s been a 5-year experiment, invested 100 companies.
Justin: I love your perspective there. Not to interrupt you, but that looking at it as tuition, I mean, jeez, how much have you learned?
Meb: It’s a low expectation. Well, so it’s funny because if you consistently research all these amazing kick-ass founders who are starting these just world-changing companies, many of them already having traction. So for the sweet spot for me is sort of that late-stage seed or series A where they have some product-market fit, they have a product that’s earning some revenue. So ideally, it’s like 500 grand or a million or it could be more. So most of the companies I’ve invested in are in that mark cap range of probably $5 million to $30 million, but most around $10 million to $20 million. So early-stage, and there’s only been liquidity in about 4 of them out of the 100. But, you know, the goal is to invest in about 10 to 20 per year. And you know, the cheque size is small per investment, but let’s call it like $5,000 so that anyone of those goes down, it’s not gonna be life-changing. But you know, you’re in for 10 years on those. In many cases, you may be in forever.
So a couple on paper, ironically, I think it was like literally the first investment I did as Reed’s unicorn status so I thought I was just brilliant out of the gate. Well, we’ll check back in in 2029 and see how this is all flushed out. But you know, the power laws of investments certainly apply to private equity, or the vast majority of returns are determined by the 100-baggers. Great podcast, by the way, we did with Chris Meyer, recently on that topic. It happens in public equities too, there’s a new update to that white paper, “Do Stocks Outperform Treasury Bills?” which show that like all the returns of stocks are also due to that, like, 1% of stock returns. There’s the massive winners like McDonald’s and Walmart and Amazon.
Anyway, so that’s been a big, increasingly large part. And it’s really important to talk about the fact too that there’s a massive, massive tax benefit to investing these private companies. We talked about it with Rubalcaba, the QSBS rules, Qualified Small Businesses, where you get exempted on like the first $10 million of a gain in…there’s a number of things that qualify, you have to invest in a company, original issuance has to be less than $50 million. You know, it’s like 10X or $10 million, whichever is greater is exempt from capital gains. So you have this situation where you’ve converted capital gains, and then not paying capital gains is a really massive benefit. Even then you could also, of course, throw them in your IRAs. One of the companies we invested in early, I think has also been sponsoring this podcast, can’t remember, Alto IRA lets you invest in private companies in your IRA, so you don’t have to worry about it then, it’s for sure non-taxable. I think it has a famous…isn’t that how Mitt Romney has…all of his money was in his Roth IRA.
Anyway, so that’s gonna become an increasing point. But for the public investments, it’s still I put all my money into our funds, we’ve disclosed, and there’s a white paper on our website that talks about it, the vast majority that’s just in one fund, so, but I own a couple of them. They’re like all my children, I’d like to own them all. But it’s automated, it is systematic. And I’ve changed over the years on this. I see it less as an investing account and I see it more now as just savings. And so we wrote an article about this called “The Stay Rich Portfolio” that showed the safest portfolio is actually not in cash and T-bills because at some point, historically, that’s lost half because of inflation. But rather, it’s you have to invest some of it. And what the optimal number is, I don’t know. But maybe a third, maybe a half, actually essentially gives you a higher yield for similar volatility and drawdown scenarios, which is a surprise to a lot of people.
And Dan Egan at Betterment kind of changed my thinking on this where treating your investing account as an automated savings. And I don’t even look at it anymore, it just works in the background. You know, we use Betterment, it automatically updates tax harvest, everything, and essentially all the way down to checking account. You know, I keep some money just to pay bills but other than that, everything just goes into the Betterment allocations. So automated, weird and different, but I’m okay with that. And I don’t even think about it. It’s like it totally changes your perspective on how you think about investments. So all these are kind of hacks, right? The private stuff, you can’t trade if you wanted to. The automated stuff, I don’t ever have to think about it. It’s got all the inputs that I want anyway. So, my god, I can’t think of anything worse than having to go to a brokerage account and make all these changes because as we know, they have all these psychological biases that prohibit you from doing well, and that’s the possibility.
Okay, so going back to the whole point of this entire tweet discussion, you know, I said in the tweet that I put my entire, I think it was 401(k) in emerging market stocks. But again, it was a bit out of context because the tweet said something along the lines of, “Here’s the five reasons, you know, I think emerging markets are amazing.” And it was like higher growth, lower valuations, better demographics, etc., etc., etc. “And this is why I invest all of my 401(k) in emerging markets stocks,” and people lost their mind. But again, I’ve just given you a bunch of the context where if you look at the pyramid first, it’s you know, most of my network is in the company, and then it’s in private farmland, then it’s in diversified Trinity allocations, all these things. Then only finally, once you get to the end of the pyramid, you have, you know, some sort of these bespoke accounts where some of the investment choices are limited.
So our company, for example, there’s not that many things you can invest in, we had to do it through Vanguard. So then I wanted that choice, I said, “Well, what’s just best investment opportunity?” In that case, was emerging markets. I do the same thing with my son’s 529, granted, he’s only 2. But the investment choice there, I think, was international equities. So same sort of choice. So what began as a little out of context, people went crazy. But if you were to ask me, gun to my head, the best investment in my mind over the next 10 years, it is that ex-U.S. equities emerging markets if you’re looking at broad areas. But if you’re looking at you know, a different way of forming it, I would certainly say the cheap stocks anywhere in the world, which in our opinion would be some emerging markets, but also some developed. So something where you go and pick the cheapest stocks around the world, I think you get into low teen or even high single-digit P ratios, that’s what I invest most my money if I had to choose. But again, I don’t have to choose because I prefer a much lower volatility investment approach across my whole net worth. That was a really long-winded answer to your comment.
Justin: Oh, no, I think that’s great insight. Thank you for going into that. We should talk about this in a little more depth one of these days. We’ll get into all the nuts and bolts.
Meb: But now we’re back to doing these every other week, I think we’ll have plenty of time to jabber about all sorts of ideas. Anything else before we wind down?
Justin: No, let’s wind her down. That’s all I got.
Meb: Awesome. Listeners, shoot us some questions, We love reading them on air. We’re gonna start doing more of these, firstname.lastname@example.org. Subscribe to the show on iTunes, RadioPublic, Breakers, anyplace good podcasts are found. We’ll post all these show notes to mebfaber.com/podcast. Thanks for listening, friends, and good investing.