Episode #190: Radio Show: Buying Stocks At All Time Highs…Fund Manager Sentiment…Year End Questions for Advisors and Brokers
Guest: Episode 190 has no guest but is co-hosted by Justin Bosch.
Date Recorded: 11/26/19 | Run-Time: 43:02
Summary: Episode 190 has a radio show format. We cover a variety of topics, including:
- Buying stocks at all-time highs
- 2010 Fund Manager of the Decade
- Jim Simons
- Year-end questions for advisors and brokers
Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159
Interested in sponsoring an episode? Email Justin at firstname.lastname@example.org
Links from the Episode:
- 0:40 – Welcome to the show and a big thanks
- 1:44 – L.A. Business Journal Ranking – Fastest growing companies
- 1:52 – Hiring
- 2:55 – The Idea Farm
- 3:41 – Meb’s reaction to all-time highs and sentiment reaction
- 5:01 – All time highs
- 6:35 – Trend following paper 2007
- 6:58 – How I Made $2,000,000 in the Stock Market
- 8:59 – Morningstar top performers of the decade’s performance and reviewing our last 10 years
- 13:02 – Buyout valuations and private equity
- 17:18 – The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution (Zuckerman)
- 22:02 – What to discuss with your advisor during your year-end review
- Do we own any funds that cost above 1%?
- Do we pay trading commissions?
- Do we earn a reasonable amount on cash balances?
- Does our broker lend out our shares and earn short lending revenue?
- Do we own stocks/mutual funds in taxable accounts?
- Will the advisor disclose how they allocate their own money?
- What is major value add for the fee paid and what will it be in the future?
- Is there a home country bias in the portfolio?
- Do you listen to Meb Faber podcast?
- Suggestions for more questions
- 31:38 – Listener questions: Is there a scenario that makes sense to wait for a pullback in global funds before allocating there or should I just invest now
- 34:37 – Listener question: Episode #183: Ben Inker, “The Problem With Good Returns In The Near Term Is They Have To Be Paid Back Sometime” – Benefits of passive ETFs with a focus on foreign markets
- 36:41 – Listener Question: Episode #178: Nobody Wants To Invest In Your Sh*t – Creative investment ideas
- 39:01 – Listener Question: The Best Investment Writing Volume 3: Larry Swedroe – Investment Strategy in an Uncertain World – Fund fees and what to consider
Transcript of Episode 190:
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, we got a great show. It’s a radio show time and we got Justin in the studio. Welcome.
Meb: It’s Thanksgiving week. You’re a vegan. What do you got planned? Tofurkey?
Justin: Something like that yeah, yeah.
Meb: My go-to has always been green bean casserole and one year I tried to make it for my wife’s family and I made the big mistake of going fancy. Tried to like fry the onions, do it all with a fancy recipe. It was still good, but I feel like Thanksgiving like making the hits like the old school Campbell mushroom soup version is what the people want.
Justin: It’s delicious.
Meb: It’s so good. Anyway, I try to hide it behind all the other stuff because I actually don’t want people to eat it so that it can be leftovers. But in this theme of Thanksgiving and giving thanks, a couple of notes and logistics before we get started. First of all I wanna give a shout out to all our clients. We have over 45,000 investors now. So a big thank you to all the investors out there and all the various funds. Also I wanna say thanks to LA Business Journal, which just ranked our company Cambria, one of the top growing, fastest growing private companies in LA. And so along those lines, listeners we’re hiring. Check out a post I did on mebfaber.com for what we’re hiring for and why, and shoot in your contact info or if you know someone who’s amazeballs and should join our small but growing company we’d love to hear from you. Also I wanted to say thanks to a few listeners who have been sending in and bringing in some very thoughtful gifts. We had one podcast listener Bob thank you, who brought us three bottles of Faber hooch. There was a gin, a vodka, and a pomegranate.
Justin: Vodka right?
Meb: All the way from Pennsylvania. So really appreciate it, he even biked them in. That’s dedication. Airplane and bike. We also love hearing feedback from you guys. We’re gonna to do some questions at the end but we need some new questions. Shoot us some questions feedback at the mebfabershow.com. We love reading them and answering them on air and also love to read you guys’s reviews. So if you enjoy the show, it’s free. You wanna give thanks go on to Apple on iTunes leave us review. We really enjoyed reading them. And lastly, check out The Idea Farm, this has been a fun sort of passion project over the last many years but people seem to love it. We put out top three podcasts of the week on the investment side every week, we send out the top one to three investment pieces that come across my desk. That could be white papers. It could be proprietary research from banks, it could be newsletters, whatever it may be, some weeks it’s zero. We send that out and plus you get a free 30 day trial theideafarm.com. Check it out. You also get an Excel backtester, I forgot, that lets you test almost any asset allocation strategy back to the 1970s as well as updates on things like valuation, the CAPE ratio. So enough logistics, just wanna say shout out thanks to all you guys for all you do. And let’s get in the episode. What are we talking about today?
Justin: All right, well, we’re at all time highs again, in stock market. Jerry Parker had a thoughtful tweet that you shared. I’ll read what he has here. “So everyone is bullish, right? Hardly. Per barons, 27% of money managers are bullish on stocks over the next 12 months, the lowest in 20 years. All time highs make people more cautious. Hopeful with losses, afraid with profits. A reason why trend following works.” So, yeah, give us your thoughts here.
Meb: So I haven’t followed this particular sentiment study, the AI tends to be concurrent in the opposite way as far as sentiment. It mania peaks and bottoms, it tends to say in the opposite direction. So maybe this is advisors, I’m not that familiar with it. Maybe it’s just people are a little nervous after 10 years of romping and rolling returns. It’s been an awesome year in U.S. stocks. So maybe they’re just kind of reflecting and saying things are getting expensive, I don’t know. But it’s interesting because people in general…. and Jerry hits the nail on the head like I love this phrase, and I’m going to steal it and use it in the years to come, “Hopeful with losses afraid with profits,” because people really struggle with markets that are hitting all time highs. And we did a post on this years ago where we said, “Look, there’s only two state for markets. They can either be at an all time high or they can be in a draw-down.” In most markets in whether that’s down 10%, 20%, 40%, 60%, 80%, 90%, from an all time high, there’s no other possibilities. That’s it. In most markets spend most of the time in draw-downs. So it’s something like around two thirds 70% of the time, market spend in draw-downs and very little time in all time highs.
But so I ran a little fun test. And it was a little surprising to me, but shouldn’t be that surprising in retrospect, I said, “What happens if you buy the U.S. stock market at an all time high?” And it turns out, is that a good idea? Or is it a bad idea? It’s not a good idea. It’s actually a great idea. And had you bought stocks at all times high you actually, and we replicated this across foreign stocks, commodities, real estate, gold, you actually often have better returns but certainly with lower volatility and lower draw-downs, so you can develop systems, such as the original idea of the post was we went back to 1928 and said, “What if you just bought world stocks so if this month ended at an all time high, you would own stocks for the next month, and then re-balance every month going forward? You end up with great returns on par with actual stock market but with almost half the volatility and way less draw-down in a higher Sharpe ratio. And if you can combine that into a portfolio across many assets, you end up with pretty great returns.” Part of that is simply it’s a cousin, maybe a first cousin of our old school trend following methods in a paper we published back in ’07. So that was one way to look at it where you’re trend following based on moving averages. This one’s trend following based on what you would call almost like a channel breakout.
And we’d love to say, “Look, nothing’s new under the sun. Trend following with moving averages and sort of concepts goes all the way back to time of Charles Darwin or earlier.” And a popularised channel breakout strategy was a great old book called “How I Made $2,000,000 In The Stock Market,” and that doesn’t seem like much today, but I think it was literally published in like the 1950s by Nicolas Darvas. And I think he also used to be a fine dancer, maybe a ballerina, he did some sort of classical dancing, anyway, was a speculator and he used channel breakouts. And so this isn’t anything more than a channel breakout strategy. The nice thing is, it’s also not that correlated to a traditional trend following strategy. The problem is, of course, you actually have the opposite exposure, where you’re invested in cash and bonds most of the time. So it’s not a great strategy, because you’d be trading too much, probably. But what you could do, you could do it where you’re writing puts. Say the markets an all time high this month, you could write puts for one to three months or whatever it may be. Or you could say if you own stocks already in a portfolio, and it isn’t in an all time high, you could also do covered call and write calls on the portfolio. So there’s all sorts of different ways to manage a portfolio based on this that are interesting and thoughtful, but the big takeaway is you should not be afraid of markets when the all time highs, you should actually be afraid of them when they’re not at all time highs namely they’re going down from those all time highs.
So U.S. stock market is complicated just like everyone’s Thanksgiving will probably be with your families. We actually do, by the way, like a “Wedding Crashers” style football games, to thank the Lord it’s gonna be raining, but it’s complicated because the U.S. stock market is on the expensive side but it’s still in an uptrend. And going back to a really old study we did on the four quadrants of uptrend downtrend, expensive cheap. The best is cheap uptrend, but second best is expensive uptrend. So we’re still in that bucket as the year winds down, as the decade winds down. So it’s complicated in the sense that all time highs and uptrend is nothing to fear, but valuation is. So it’s sort of a still positive but when the trend changes whenever that may be that sort of the red stop sign.
Justin: Well thanks for the detail there. On another note Morningstar, you noted this in a tweet that in 2010, there were five U.S. stock fund managers nominated for fund manager of the decade. Zero outperformed, this decade. And the average underperformance for the five nominees was 5% per year. And the winner underperformed by 8% per year.
Meb: Yeah, I think a lot of Twitter took this in a different way than my conclusions are. It’s hard to write really what all your thoughts are meant to be in 240 characters or whatever it is on Twitter now, but the point I was trying to make these were five very famous managers, in my opinion, very legit, decent managers that I would have no problem allocating them, any of them. The point I was actually trying to make is that… probably three. One, this has been a very difficult decade for almost any active manager. I mean, it has been a graveyard for hedge funds in particular, but also lots of other active managers as well. And a lot of traditional styles have really struggled whether its value, whether it’s long, short equity, whatever it may be, really had a hard time keeping up with the romping stomping U.S. bull. The second point, which is what I was really trying to make was that you could have a manager that is totally legit, that you plan on allocating to, that is awesome. In this case, these are five of the top performing stock funds of the 2000s that can then go on and have these periods of underperformance of 1, 3, 5, 7, 10 years and still be totally viable. And I think that’s the thing that people really struggle with. And we’ve talked about this many times on the podcast in the past, people don’t like hearing it, but I said I used to say that you need 10 years to evaluate a strategy, now you need probably 20. Because 10 years is nothing in the time-frame of underperforming and outperforming managers and asset classes. And the example we give a lot this decade is the U.S. has stomped everything else in the world as far as asset class, foreign stocks, the ones that we love to talk about as emerging markets.
Emerging markets have underperformed by something like 200 percentage points this decade. But what people forget is the last decade they outperformed by 300 percentage points. So, and that’s what 30,000 basis points. So it’s just huge numbers. But these things play out over very long periods. And so I wasn’t trying to dunk on these fund managers. I wasn’t trying to dunk on Morningstar, because I think it’s actually a great analysis, but it just does go to show how hard picking active managers and strategies are and then aligning those with actual a time-frame that people are willing to allocate to and I’ll tell you something, you know, I thinking about this the other day, we might have been talking about this, I said, thinking about how everyone in 2019 says, “Hey, it’s important to me, we base our decisions on process, not performance.” Well, that’s the way that it should be. Then I thought about it. I’d say “Okay, we’ll give people the benefit of the doubt.” And let’s say they do actually base their buy an allocation decisions on process and not on performance. But say they do, I would say most, nearly all, base their sell decision only on performance, not on process.
And I think that’s something that is probably a big mistake and as an allocator, you should probably write down what am I willing to sell this investment or strategy for in 1, 3, 5, 10 years whenever the review period is? Is it these 1, 2, 3, 4, 5 reasons? And if it’s simply because the strategy or asset class has underperformed, that may be the exact opposite reason to be selling it. You should actually be adding to it or reallocating. Anyway, it’s an interesting study and it’s easy to get caught up in a lot of these managers that are crushing it, but it’s always take a step back and say, “Okay, maybe this is the time to actually be trimming rather than adding and vice versa.”
Justin: Well, let’s shift a little bit to valuations. So you noted that buyout valuations are now far higher than they were in 2009 when it comes to leveraged buyouts. So expand on this a little bit. I notice on the chart we have in front of us here, there was a dip in 2008, 2009. But that trend has generally gone a little bit higher over time.
Meb: The thing with private equity in this cycle is that I fully believe that at one point, there probably was a benefit to adding to private equity because of valuation spread versus public markets. But almost all the research we’ve seen in the subsequent last 10, 20 years is that because of so much money flooding into private equity, that the valuation spread has condensed if not, private equity being more expensive than public markets. And so if you think about it, there’s not really any real reason that private equity markets… private market should have a valuation discount other than what you would call illiquidity premium, which I don’t really think there is one, I certainly don’t believe there is one. And so the funny thing about private equity, if you were to ask me “Meb, what do you think the defining problem of the next decade will be?” I think private equity is a big piece of it. And the reason being is that so many institutions and endowments and in funds out there that are trying to hit this 8% return target in a world where by almost any measure, certainly the fixed income universe is not going to deliver that. U.S. bonds are one of the highest yielding in the world and they’re sub two. And so then you need others to make up for it and U.S. equities being some of the most expensive in the world, where people looking for it and universally you hear these pension funds looking for private equity as the saviour.
And so all this money moving in, it makes me really nervous. And so if I had to pick one thing that’s gonna cause some trouble, it’s that. But the thing about private equity is… I was at a conference recently. I’m not gonna name it, not gonna name the panel, but one of the panel hosts asked the panel and these guys manage hundreds of billions. He said, “Would you expect your 5% historical outperformance of your private equity portfolio to continue?” And I was just smiling because that’s such a massive amount. And if people could be doing that, and continue to do that, they should only be managing private equity and leveraging it, but I just kind of laughed about it, because what a hard thing to do. But the thing about private equity is if.. it’s like one of the biggest wink handshake situations in the entire asset management business, because if you’re a major endowment, and I’m a private equity fund, and we got a great name on our door, and we’ve had good returns, and we charge 2 and 20 and you give us a $500 million allocation, you’re not gonna know if we were good or not for 10 years, and chances are you’re not gonna be around in 10 years. You’re gonna be in a different job, be doing something else.
And if you are around in 10 years, and the private equity allocation did well, great, congrats. If it did poorly, you can also shrug it off and say, “Well, that’s the vintage” or whatever it is now. It’s such a long time horizon that it doesn’t cause the same career risks that other allocations do. So if you buy a hedge fund or public market separate account manager some ETFs, and they do poorly in the next year, you can sell those or you can get fired and say, “That was a really stupid allocation. Why did you buy that? Why do you allocate that person?” Private equity, you have no idea for a decade. And so part of that, I laugh because it’s actually behaviourally a good thing is it locks people in but for most of the research we’ve seen is that you could actually be replicating this in public equity markets and an ETF that’s much more tax efficient, but you don’t have it in your lockup, so we were joking at one point that we should have an ETF which we’re gonna put into a private fund with a 10 year lockup and charge some more, just so people can’t sell it, but I think it’s just another coincident indicator as far as the valuations that show that it’s something that is probably not going to be the saviour that it was when valuations were half of what they are now. That was the short answer.
Justin: I love it. So recently Gregory Zuckerman came out with a book. I haven’t read it. Have you?
Meb: Shame on you. Yes, of course, great book.
Justin: I listened to a couple of interviews he’s done on podcasts. And it’s just been really great. But there’s a great quote you shared from Jim Simons from the book. “Sometimes I look at this and feel I’m just some guy who doesn’t really know what he’s doing.”
Meb: So the book you’re referencing, we’ll post a link on the show notes, is “The Man Who Solved The Market” about renaissance technologies, arguably, I don’t even think it’s arguably at this point, the best performing hedge fund in the world of all time, and it’s a really fun story. He’s a world class mathematician was a professor, worked as a codebreaker, started his own fund and had just lights out performance and lights out performance while charging massive fees, and he’s a quant. And the funny thing is, about reading the book is you realise what a human element there still is in this story and in managing a business and investing where, look, here he is at age 41, which is one year younger than I am now. And he’s got this major imposter syndrome. I mean, this dude is chairman of a mathematics department. He’s running a fund, but also really struggling. And it showed, by the way, it was like a decade of struggling before the fund started to do well and raise money. And even then, when he was like 10 or 20 years into his career, and I think it was right down the road in Beverly Hills he was talking about the human emotions creeping in where he was talking on the phone about, “Hey, is it time to sell? Should we be hedging this?” You know it’s like the whole point of this. You’ve been doing it for 20 years is taking the emotions out of it. So it’s a really fun story.
And by the way, Greg and I were actually speaking on a conference together at Prime Quadrant in Toronto, and we had actually competing panels at the same time. And also, that was one of the best speaker gifts I’ve ever received from a conference which was they gave me a stamp with just my face on it. Have you seen this? It’s awesome. I gave it to my son, but we have Meb face tattoos everywhere on anyone that comes to the house. Really good book. It’s a lot of fun. I actually ran across Simons once. I had my own personal Michael Jordan moment when I was at a wedding in Long Island and we were in Stony Brook area, on a hike through the woods and passed Simons and a bunch of his friends. And he’s a very unmistakable person. He’s kind of a hunched over older guy. I was so excited. I was like, “Oh my God, you know who that was?” And I was with a bunch of philosophy PhDs and so they said, “What? No,” and I said, “Jim Simons. He’s like the Michael Jordan of our industry.” They were like, “Well, go talk to him.” I was like, “What am I possibly gonna say in the woods, pester this poor person?”
Anyway, so Jim, if you’re listening, it was fun running into you. Anyway, great book, check it out. Just underscores how… Two important points. One, how important the human element is. And two and we talk a lot about this, in a world of zero commissions and zero management fees, we say over and over again, fees are merely just a bar from which it gets harder and harder to jump over. But if you have a team and a strategy and approach that is as good as what they are doing, you can charge 2 and 20. You can charge more than that, and it’s the best deal on the planet.
Justin: And what was their fee structure? Do you remember?
Meb: I think at one point, they were at a 4% management fee and like 44% performance, and the reason that it was a 4% management fee was because that’s when they started the company, they needed that much money they budgeted to buy the computers, I think was the reason but they’ve eventually kicked everyone out. And also by the way, this is an important point. Now it’s for Medallion fund. They since the 2000 launched all sorts of other investing strategies that haven’t been the sort of standout performance, they launched a managed futures trend falling fund. They launched a factor based equities fund and I don’t know if those are still around, I think they shut down the futures fund. But it’s just interesting to note that Simons is also a trend follower and factor base multi-factor model, but they didn’t have the same pedigree as Medallion, certainly, but I think the IRS is coming after him now because they did some sort of tax dodges. So we’ll see how that turns out. I also did a post on Twitter that had Simons on it, where it showed for perspective from Brian Livingston’s book, “Muscular Portfolios” which is a fun book if you haven’t read it, how much CEOs and celebrities make and I was like, the top 10 CEOs and celebrities make all sorts of great money. And then you show the top 10 hedge funds in comparison and it’s like, you don’t even see the CEOs and celebrities’ charts. It’s like a totally different scale. Anyway, what else?
Justin: Well, now that we’re closing in on the end of the year, you had a really good tweet, talking about things to be thinking about when people are addressing their brokers and advisors that their year-end reviews or reviewing their accounts at year end. Why don’t you take us through some of those? I think they’re really thoughtful. And it’s really good advice, things I think people should be thinking about.
Meb: Yeah, so this was sort of an offhand reflection, it’s a good time, year end, to always reflect. I mean, I think it’s important as you look at your portfolio, we’ve done a lot of discussions on this in the past with people talking about the zero budget portfolio where you take out a blank sheet of paper, write down your ideal portfolio and compare it to what you own now, and if they’re not the same, there’s a problem. And a lot of people that are never the same for the same reason. The analogy we gave, we were back at Virginia giving a talk and I said, “If your house burned down, what are the chances you would go buy all the exact same clothes you had in your closet afterwards? No way.” I mean, most people would never go buy them again. They just won’t throw them out. The same thing goes for the garage, if you’re not self aware to know that you have a bunch of junk in the garage, just let’s use the example of your parents or your brother or sister or children, and just walk into their garage and be like, “Look at all this crap, what a bunch of junk.” I got some hoarders in my family. So I can say this. But how many people would go buy all that stuff? Again, no one. So it’s a good time to reflect and try to be honest with your portfolio and tax loss, harvest and do all sorts of stuff, just get your house in order. But I also said, this is for the investors out there who use advisors or brokers or fiduciary or someone to help you. Here’s some questions to think about. And if you’re an advisor, also these are some useful questions to think about with regards to your clients too.
So there’s about 10 of these and these are just kind of fun. But the first question was, do we own any funds that cost above 1%? If so, and why? And going back to the RenTech example, look, that doesn’t mean there’s not funds that are worth one, one and a half, 2% but on average, the weight of the evidence says you should pay as little as possible. Global market portfolio is free. So the base case today, Vanguard has automated portfolios that are free, all in cost is like 20 basis points if you include all in the funds. So if you assume that as a starting point, to pay more means you have to have a good justifiable reason why someone is worth that. But the problem is, most people own all these funds that have been sitting around for 1, 5, 10 years. They’re really high fee that are just a consistent drag, that aren’t great outperformers. Many of them are simply or closet indexers that are very expensive. So the starting point we say is if you have something over one, you cut it unless you have a strong reason why you should be using it.
Two, do we pay trading commissions at all? If so, why? We live in a world where most brokerages now are totally commission free, and so it is trending towards zero already, but there’s still plenty of traditional brokerage shops that are charging a lot more than zero on your trading commission. So if you don’t know you should at least ask. Three, do we earn, and this was 2% of the time but the Fed has since cut raise, so say do we earn a reasonable amount on our cash balance? So it should be 1.5% or more? If not, why not? And this is a big one. So as all these brokerages went commission free, a lot of people and it was like dominoes. They said, “Well, how are these brokerages gonna survive?” There was big news with Schwab just recently agreeing to buy TD Ameritrade is that people don’t understand that the way that most of these brokerages make most of their money in Schwab is like 60% or 70% is from interest spread. So, the cash balances in your brokerage account very often do not get swept into something like a money market fund or a high paying cash balance that is one and a half or more. So you have a spread of say they may pay 0 or 50 basis points. So the example that we give is Schwab’s automated intelligent advisor, says “it’s free.” But then for individual investors, they make you hold up to about 30% in cash, and they pay you about point 0.5% on the cash when they could be as a fiduciary and probably should be, and I think this is a little bit questionable practice, is that if you’re a fiduciary and willingly and on purpose, say, “I’m not willing to pay you 1.5%” when you could, can you call yourself a fiduciary? And I don’t know that you can.
Anyway, look, it’s not the worst thing in the world. It’s just kind of shady. And I don’t like that they do it, but that’s how they make all their money. So if you say, “I don’t know what I earn in cash,” go look up your Bank of America, you probably earned zero. I had a preferred rewards account. I think it paid like 0.02% or something just ridiculous. The good news is there’s plenty of places now. Betterment for example, has a savings account. And you can tie it to a checking account with a debit card, I have one now it’s called Everyday Savings, that pays over one and a half percent. So if you’re not getting one and a half percent on your cash at this point, you’re just being lazy. So the Betterment offering, you know, we offer these Trinity portfolios, you can then have a side cash account, which is insured up to I think it’s a million bucks in check. Don’t take my word for it, but usually they’re insured for 250 grand per account. And then some of the brokerages will have insurance that goes up more.
So question three, was do we earn 2% of our cash? If not, why not? A lot of people don’t know. And if you don’t know, ask your advisor or ask your broker and you’re likely you’ll be surprised.
Number four, does our broker lend out our shares and earn short-lending revenue? Do we share in that revenue? If not, why not? A lot of people don’t know that. You may have checked the box on your brokerage application which lets your broker go and lend shares of Tesla that you own and ETFs and all sorts of other stocks. And a lot of them don’t give you any which is criminal in many ways. We’ve detailed this. We got into it with Elon on Twitter about it, but our funds all of them that do short-lending we return all the short-lending revenue to the shareholders. In some cases, its material. We’ve talked about this a lot on the podcast where an ETF that maybe has a 0.2% management fee, but returns more than 0.2% in short-lending revenue is for all reasons, essentially a negative expense ratio. So a lot of brokers, you can share in that or you can designate that they’re not allowed to lend out your shares. But a lot of people don’t know the answer to one or the other.
Number five, do we own stock mutual funds and taxable accounts that are expected to pay capital gains? If so, why don’t we own tax efficient ETFs? This is a no brainer. We’ve talked about this a lot in many cases. And by the way, this is about the time of year when people get the notices of potential capital gains, distributions and mutual funds. And some of these are awful. I mean, we’re talking like 5%, 10%, 20% of NAV, you get returned to your account as capital gains which then you have to pay taxes on. And we’ve calculated as of others, I think the broad based per year advantage of an ETF over a mutual fund and an equity stock strategy is about point 7%. So more important on a yearly basis than management fee. So if you own a mutual fund and a taxable account, you better have a strong reason why instead of an ETF and so ask your advisor and think about it.
Number six, ask your advisor, “Will you show me how you allocate your own money and what holdings? If not, why not?” A lot of advisors do the right thing and allocate and are pretty honest about what they do with their own money but some aren’t. And if they’re allocating you to shady funds that they get paid trailers and commissions on and they’re not investing in those same funds, that seems like a conflict to me. So anyway, give them an ask. Number seven, “For the fee that I pay you and 1% is the industry standard but plenty pay a lot more, what do you consider your major value add?” And what will it be in the future?” And this is interesting because I think advisors are worth their weight in gold. I think most of the things that they do for their value add are not necessarily an investment side. I think if it’s they prepare your taxes. They do estate planning wills and trusts. They help you with insurance. They do behavioural coaching with your family, intergenerational issues on and on and on, but just they should have an answer for it. If the answer is, “Hey, we buy some ETFs and we rebalance once a year,” probably don’t need them for that.
Number eight, do we have a home country bias in our portfolio? Meaning if you have stocks, do you have half in foreign markets? Chances are you do not. Same thing with bonds. But that’s kind of a lost cause at this point. I don’t know any advisors or investors that have anything invested in foreign bonds despite being the largest asset class in the world. But anyway asked them. Say “If we do have a home country bias,” meaning most Americans have 70%, 80% of their stock investments in the U.S. say, “look, that’s fine. By the way, congratulations it’s been an awesome decade. But why? Why are we making this very large active bet?” And they better have some reasons why they are. Number nine, do you listen to “The Meb Faber Show” podcast? If not, you’re fired. Just kidding. But we would be thankful for you guys to pass along the show, the funds, all the other good things as well. And 10 was let’s hear your suggestions. So we’ll add the Twitter thread and you guys can see what everyone else said as well. Hoof, that was a lot.
Justin: Yeah, that was a lot.
Meb: That was a lot. But important.
Justin: So let’s get on to some listener questions. We have a few good ones.
Meb: Listeners, remember send them in email@example.com.
Justin: All right. Question number one, I had a question about whether in some circumstances it might be better to wait for a pullback in emerging markets before plowing a bunch relatively speaking of money into a more global portfolio from one where all of the equity portion is in U.S. stocks and funds. I think that research has shown that it is better to invest money in the market ASAP, rather than dollar averaging or God forbid, trying to time the market. While I’m pretty sure that is true for someone with a long enough time horizon, I struggle with it being universally applicable. I’ve also heard many times that when the U.S. catches a cold, the rest of the world gets the flu. If the U.S. were to go into recession eventually and if that also caused or contributed to foreign equity markets dropping, might not happen of course, if the flu thing is wrong, wouldn’t that be a good time to use some excess cash to implement the global market approach? I’m 65. So in my case, I’d only be doing this once. So I’m not planning to try to time the markets on a regular basis.
Meb: All right, listeners, let’s keep the questions under three paragraphs. Just kidding. Look, I think we’ve talked about this before where, mathematically speaking, the correct answer is invest it all immediately. As far as if markets are gonna have positive expected returns over long period, the correct thing to do is to put it all in at once. That is not necessarily the correct thing to do, psychologically speaking for your well being, and a lot of people really struggle with hindsight bias. Because it’s really a coin flip 50/50, probably, maybe it’s 52/48, 60/40, I don’t know, about putting it in and then the market going the opposite direction. And so the advice is, do what is gonna give you the best chance of not shooting yourself in the foot. So if you want to dollar cost average in the course of a year, or even three years, that’s fine. I have no problem with that. People pull their hair out and say that “Oh, my gosh, that’s so sub-optimal, I can’t believe you’re doing that?” Well, obviously, if you’re keeping it in one of these high cash returning accounts, then you’re getting almost 2% return on that anyway, that’s pretty stable. So find out whatever the glide path is and set it up and automate it and be done with it.
And don’t worry about it, would be my suggestion. You could come up with all sorts of iterations of arcane rules. People who are like “Well, I’m I gonna allocate this much. And if the market goes down 10% I’ll allocate more, if it goes down 20%, I’ll allocate more,” and on and on. You can do the opposite, “Hey, I’m gonna wait till it’s above its trend or below its trend I won’t.” And there’s been oodles and oodles and papers and papers of the optimal way to go about that. For say target date funds, if a market is expensive you’re not allocating as much. If it’s cheap, you’re allocating more, if it’s in an uptrend route, yada, yada. Those just get more complicated, honestly. And so if you have an entire plan, an entire allocation that’s robust, then I wouldn’t sweat it. You can come up with the glide path, but it honestly doesn’t matter. The last thing you wanna do is put it all in today. And next month, look back really beat yourself up over the fact that you should have waited a month.
Justin: All right, question number two. I’m a new subscriber to your podcast and I really liked your most recent interview with Ben Inker on foreign emerging markets. I’m persuaded by your logic on foreign emerging markets as a value asset. I think listeners who are non-institutional investors would appreciate your views on the merits of buying a passive ETF similar to say Vanguard and foreign emerging markets and whether there are any significant differences when applied to these markets.
Meb: Passive ETFs are fun. I think they’re a great starting point, we detailed many times how we think that market cap weighting is sub-optimal. So assuming when people say passive, they mean market cap waiting, and market cap waiting and emerging markets means you get a big slug of China, and a couple of others and that’s fine. Maybe you want a big slug of China. But as we believe our philosophy for our approach to not just emerging but also for U.S. and foreign is certainly a value approach. We love the shareholder yield concept. So companies that are generating lots of cash and buckets of cash and returning it to shareholders, but are also cheap, and hopefully the stock has a little momentum. That’s a nice combo for us. That’s not a passive ETF, the way that they’re referencing it, although some of our funds may be “passive.” But for anyone, it’s the factor allocating new emerging in the first place is good because the average person has like 3% in emerging. That’s not even enough to move the needle. So it’s good that you’re at least thinking about it. But there’s going back to the old Bogle quote, the passive ETF, it’s Vanguard. That’s great. Are there ones that are better? Sure, but there’s infinite worse. And so there’s probably… the worst way to do it would be what we talked about earlier would be a closet indexing fund that charges you oodles of money, and is really expensive and tax inefficient. That would be a probably pretty dumb way to do it.
Justin: All right. Question three, I absolutely loved the “Nobody wants to invest in your shit” episode of your podcast. The four reasons for investing you put forward make so much sense. Do you have any thoughts on where outside investments fit into this, how creative endeavours can work in conjunction with a larger portfolio both as a solid investment and a way to diversify ?
Meb: So if you have your bases covered, say you have a global market portfolio, or maybe it’s something we do where it tilts towards value. And so let’s say you start there, and you have the gold market portfolio. And this is kind of answering the question the same way. How do you then make adjustments that are worthwhile? So we believe that moving away from market cap waiting to value, momentum, whatever it may be, makes sense. The big outlier for us is, we believe in trend following and so say, does this either add return or does it diversify in a way that causes the overall portfolio to either be smoother to reduce risk or increase returns? And so any allocation, you look in the future, so say, somebody looks at this and says, “Okay, I’m curious about investing in this fund that only invests in corn farms in the Midwest.”
And you say, “Okay, well, will this diversify, or is this is only gonna be trailer parks in California or I’m gonna invest in this movie set or I’m gonna invest in a basket of angel investment.” Whatever it may be, try to be honest and say, “Does this check one of those boxes of is it gonna increase returns? Or is it gonna lower volatility and draw-down?” It’s hard to know on some, but is it worth the mental brain damage of adding it to the portfolio too. I think a lot of people will once you have something that’s simple and works, it’s so easy to have the seduction of complicating endlessly a portfolio. I’m speaking to all the engineers and doctors out there who love to tinker till the cows come home on their portfolio and switch something from a 1% position to a 1.3% position. It’s really not gonna matter. So it’s fun to actually look back and say even in adding something as odd as gold, how much you actually have to add for it to even make a difference is a lot more than people usually are willing to add. So think about all those things as you add it, but once you have your base case set, it should be really a pretty high bar on what to add to the portfolio that you’ve set up.
Justin: Last question. At the end of the podcast this week. And Larry Swedroe says something like in this day, we don’t need to pay huge fees for active management and can get many of these factors with passive low fee ETFs. Then a second later, he goes on to talk about the Stone Ridge funds that have fees as high as 5%. Doesn’t that contradict what he said a second before?
Meb: I love Larry’s. He’s been on the podcast, we need to have him back on. He’s a pretty thoughtful and analytical and deep thinker when it comes to what he talks about evidence based investing the Stone Ridge funds, which I’m not super familiar with, and I’m surprised the fees reference say 5%. I’m assuming the reader is referring to some loads that hopefully, you wouldn’t be paying as an investor. Paying loads in 2019 seems like a very outdated practice, but I do know they do have higher management fees. So let’s call them one and a half percent, whatever they are. I do know, those funds invest in some pretty atypical investments like insurance linked securities, catastrophe bonds, which is actually an area we think is really interesting. I think, the last I checked, and I don’t remember this year, these asset classes and funds haven’t done that well in the last couple of years, which, if you’ve listened enough to what we talked about is actually makes me more interested in, not less. But going back to the last question, two questions ago, catastrophe bonds is an asset class that does fit that overall umbrella of weird enough and different to a traditional portfolio. So catastrophe bonds for those who aren’t familiar, are bonds that traditionally whether it’s a sovereign like Mexico, or a certain insurance company, or somebody would have so that if a hurricane was gonna hit Florida, when it hits these criteria, there’s a bond payment but if it actually does hit, it pays out $500 million or something. And so these securities are totally uncorrelated, and you could build a portfolio of them where it’s earthquake risk in California, earthquake tsunami risk in Japan, yada yada.
The problem from someone who’s not intimately involved who doesn’t track these in general. And there’s a great website that tracks these, I wanna say it’s like Artemis, or Anthemis or something, we’ll add it to the show notes. In this search for yield as this asset classes become more popular, the yields have come down. And Buffet, by the way, does a bunch and these sort of cap bonds for outcomes and doing derivatives where you say, “Hey, look, this is a 1 in and 100 a year, percent chance,” and then we’re gonna build it into a safety where we say “It’s okay, maybe it’ll happen 5 or 10 times in 100 years, not just 1,” and we have the yield enough to compensate to where we can absorb it actually happening 5 or 10 times in 100 years. And what’s the math? It’s just insurance business trying to come up with laying off the odds of any one person dying versus millions of people dying, etc. So I can’t speak to the funds exactly. But it goes back to the comment I made earlier on it’s a trade-off between do they offer something you can’t get elsewhere for cheaper or are they good enough that they’re active management of this strategy is better than not doing it and does it diversify the portfolio? So anyway, do your own due diligence. I’m not again recommending or not these funds but they could be something fun looking to certainly if Larry’s interested, it’d be a good first check.
Justin: All right, that wraps it up for us. It’s all I got here.
Meb: Yeah, man. Well, look, it’s been fun. Have a wonderful Thanksgiving to you Justin and all the listeners as well. Shoot us feedback. Again, we love hearing it. Subscribe the show on iTunes. Breaker is my current favourite. Stay tuned. We’ll hopefully post our favourite podcasts of the year and by the way, The Idea Farm is gonna publish its top 10 reads of the year. So sign up. It’s free trial, theideafarm.com. Thanks for listening friends and good investing.