Episode #265: Rusty Vanneman, Orion, “To Manage Portfolio Risk, I Think You Have To Be More Creative Moving Forward”
Guest: Rusty Vanneman serves as Chief Investment Officer for Orion Advisor Solutions. In his role, he is responsible for leading CLS’s Portfolio Management Team and overseeing all investment operations at CLS, including investment philosophy, process, positioning, and performance. In 2018, Mr. Vanneman took on the role of President of CLS, in addition to his position as CIO.
Date Recorded: 10/7/2020 | Run-Time: 53:15
Summary: In today’s episode, we’re talking asset management programs and markets. We talk to Rusty about the state of the industry for turnkey asset management programs, which effectively allow advisors to break out on their own with built-in back office support and a suite of investment options. He gets into direct indexing, and why these customized solutions carry unique advantages for investors in areas like ESG implementation and tax-loss harvesting. Rusty shares his thoughts on markets and some reasons to maintain a bullish attitude.
As we start to wind down, we dig into balance, global diversification, bonds, and getting creative to manage portfolio risk moving forward.
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Links from the Episode:
- 0:40 – Intro
- 1:29 – Welcome to our guest, Rusty Vanneman
- 1:39 – Orion’s The Weighing Machine Podcast
- 1:42 – Rob Arnott episode of Orion’s Weighing Machine Podcast
- 4:10 – Startup scene in Omaha
- 5:32 – Overview of the Orion company
- 7:16 – Overview of the TAMP (Turnkey Asset Management Platform) space
- 10:12 – Orion’s approach to direct indexing
- 13:16 – Why direct indexing is perfect for ESG implementation
- 15:14 – Sector industry strategies and direct indexing
- 16:58 – Maximizing tax alpha in these portfolios
- 19:48 – Rusty’s view on the markets today
- 23:11 – US Crash Confidence Survey
- 24:22 – Franklin Templeton Survey of Investors
- 25:13 – What balance means to them and their investors
- 27:22 – Defining real assets
- 29:03 – The state of bonds
- 31:43 – The importance of story and narrative when he talks to advisors/investors
- 36:14 – Advice to get people to stay the course
- 39:14 – Incorporating new strategies into current investments
- 42:54 – Is value overstated
- 43:11 – ‘I Can’t Believe I’m Saying This, But I’m Passing on Seth Klarman’
- 45:59 – What has Rusty excited: behavioral finance
- 48:48 – Most memorable investment
- 51:47 – Connect with Rusty; orion.com, orionportfoliosolutions.com, clsinvest.com, Orion’s The Weighing Machine Podcast, Meb Appearance on The Weighing Machine Podcast
Transcript of Episode 265:
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 friends, fantastic show today. Our guest is Chief Investment Officer at Orion where he oversees the portfolio management team, investment operations, and research focused on the market environment and current investment strategies. In today’s episode, we’re talking markets. We’re talking about the state of the industry for Turnkey Asset Management programs otherwise known as TAMPs, which effectively allow advisors to break out on their own with built-in back-office support and a suite of investment options. We get into direct indexing and why these customized solutions carry unique advantages for investors in areas like ESG implementation and tax-loss harvesting. We cover our guest’s thoughts and some reasons to maintain a bullish attitude. As we wind down, we dig into balance, global diversification, bonds, and getting creative to manage portfolio risk moving forward. Please, enjoy this episode with Orion’s Rusty Vanneman. Rusty, welcome to the show.
Rusty: Meb. Great to be here.
Meb: I’m excited because not only do we have a fellow CIO, we got a fellow podcast host. I was listening to one of your podcasts this morning with Rob Arnott.
Meb: That was an awesome show. Listeners, we’ll post those in the show links. But what a great guest he is.
Rusty: He is a totally fantastic guest. I mean, I’ve been a big fan of his for years, following his stuff, investing in strategies and designs, always thought-provoking. He’s got a lot of conviction. There are a couple of things he said I still pulled out of that. Despite all this stuff that I read from him, I still learned some things. He did have, I think a 10-minute answer one time, which was a little long, but it was loaded with goodies.
Meb: Well, Rusty, you’re where? Where in the pandemic quarantine in the world are you?
Rusty: I am in Omaha, Nebraska. So I’m actually right now in my office, but most of my office isn’t here, probably less than 10% of people are here. I do a lot of my stuff in my home, which is a great setup. All good.
Meb: I’ve been to your office. It’s a beautiful spot. You guys have a much nicer podcast studio than we do. But you grew up right down the road from the Faber Family Farm. Whereabouts?
Ryan: I grew up in a town, there’s actually two small towns in Nebraska I claim. And so all of my family is basically from North Central Nebraska in a place called the Sandhills called Valentine, Nebraska, ranching families. But I actually end up being raised in Holdrege Nebraska, which is a farming community, just west of Hastings, Nebraska.
Meb: What’s the scene like now, in Omaha? Things back to normal? Things open?
Rusty: The midwest is always, I mean, it’s the middle country, it never has the extremes of that the coast have. I mean, I lived in Boston for many years. And the thing about Omaha, Lincoln, and really Nebraska, the midwest, in general is just that it’s just so middle of the road. I mean, we just don’t have the extreme stuff. Nebraska, Omaha in particular right now is having an uptick in COVID cases right now, but it’s really never been like this humongous societal, I mean, actually, the roads are, like, empty. People are reacting to it, but I don’t think it’s like what you see, like in Boston or LA.
Meb: By the way, last time I was in Omaha, I rented a hotel room downtown this, like, gorgeous art deco building, had essentially an entire floor. It was like a four-bedroom apartment and it was like 100 bucks a night. So we may have to set up office space, Cambria team if you’re listening, in Omaha. I mean, it was just astonishing. What’s the startup scene there? I’ve heard you talk about the startup scene in Nebraska. Is that something that’s growing? There’s certainly a lot of dollar signs from people who live there.
Rusty: Omaha Lincoln does have a startup scene and I had been involved at the angel investing scene, though, to be perfectly honest, not for a few years. But I think it’s one of those situations where it just taps into all that intellectual capital and energy from a college town. So a lot of it comes out of university, Nebraska-Lincoln or Creighton. There’s kids with ideas. There’s a lot of entrepreneurial aspirations. There’s some really bright kids that come out of those schools. And yeah, there’s money here just like everywhere, and so it’s calling into some of those ideas.
Meb: On my bucket list, and listeners I promise we’ll get to the episode in a minute, is we did a long Western tour trip, didn’t quite make it to Nebraska. But my favorite thing of the farming states is floating down the rivers on the big metal farm tubs instead of an inner tube, which we did this summer in, where was it? Was it Montana? In the actual tubs. Have you ever done that? Because that looks like so much fun.
Rusty: You know, believe it or not, though I floated down the Niobrara River many, many times, floating in those big water tanks is more of like I call it a dismal river thing, I have never done it. No, I haven’t. But I’ve been down a lot of rivers.
Meb: We’ll do it together next time I’m in town.
Rusty: I like it. Come on out.
Meb: So you’re involved in kind of this big, huge company that has many tentacles, listeners will know it as Orion. There’s a CLS part. There’s the asset management tech and then the recent merger acquisition, I don’t know what you guys designed it as, with Brinker. Give us a little background of the company and what you guys are up to. We’ll start to drill down into some different silos here in a minute.
Rusty: Orion Advisor Solutions, we do have some things going on here. But in short, it’s really we’re a technology provider for fiduciary advisors, but we also provide advisor technology. But we also have a Turnkey Asset Management or a TAMP, a multi-strategist TAMP so you can get different strategies from different investment strategists from around the country. And then we’re also Investment Management. So we do have in-house investment management capabilities. We’ve had big news just recently where Orion did acquire Brinker Capital out of Philadelphia, and they are an asset management firm. So basically what’s gonna happen is our in-house investment management firm here at Orion called CLS investments, been around since 1989, will actually basically merge into Brinker. So there is a lot of stuff going on. I mean, business is great. I mean, Orion Technology has been on fire for years. Brinker is a formidable force. The Orion Portfolio Solutions, which is the name of the TAMP, has grown considerably. Obviously, it’s been a tough year for our society in many ways. It’s been a great year for our company. We’ve been moving fast, we’ve just never slowed down.
Meb: What’s the combined AUM ballpark on those two new entities? Any idea?
Rusty: Forty-five billion.
Meb: Okay, Starting to get in the big boys now. Talk to me a little bit about, I’m just curious about the TAMP space. This is an interesting area for listeners. That stands for Turnkey Asset Management…
Meb: Program. I think…
Rusty: You know what, that’s a great question. I’ve been staying TAMP for so long I don’t even know what it is.
Meb: We need to do a fintech jeopardy one of these days.
Rusty: It’s a program.
Meb: There’s so many acronyms.
Rusty: But it is a platform. But actually, TAMP is a program but it is a platform, same thing.
Meb: Explain to our listeners a little bit what a TAMP is and what kind of state, because TAMP’s has been around for a long time. What’s the kind of state of the industry today? What’s it look like?
Rusty: It’s growing considerably. I think the big reason is, there’s a lot of financial advisors, who basically just wanna, like in our case, our terms of our typical client, it is sort of that stockbroker that’s leaving a wirehouse, and she or he wants to start their own thing, and they basically need all that back-office support, to really get up and running, and they also want a menu of investment options. And then there’s a different degree of how much investment support they want. Maybe they just want a menu of options, and they’ll build a portfolio, or maybe they just want a little bit of a structure, and they’ll still pull the trigger. Or they’ll just farm it out to some investment manager and say, “You just do it.” So they have that range of options.
Meb: I had a theory that I don’t think has really transformed or taken place, which was a lot of the custodians like TD, which is now Schwab or something, were starting to introduce some of their own kind of model marketplaces. But that’s something you guys do as well. Is that true or how’s?
Rusty: We have that as well, yeah. The model marketplace is also exploding. The reason for both of these happening is that financial advice is, I mean, it’s needed, and it’s gonna be continued. It’s a growth area. A lot of people are advisors, and more people are becoming advisors and they need support. And the other thing that’s happening is that really a lot of these home offices really don’t want advisors building portfolios on their own anymore. Now, some people obviously have those skills, some probably really don’t. But a lot of them are really good at interacting with people, counseling them, educating them, managing their emotions, all that sort of stuff. And outsourcing makes a lot of sense for them. I mean, they can meet more clients, they can support the clients they already have. And so but that outsourcing trend has been big and financial advice has been big, and you put them both together, the TAMP business has been growing.
Meb: Yeah, I mean, it seems like the financial advice side, we talk a lot about this, and obviously, I could be wrong, but it seems like a pretty future proof sort of job category, where the asset management side to me isn’t the big draw, I mean, isn’t the big value add. It’s so many of the other things the financial advisor does, the estate planning, insurance, taxes, behavioral coaching, laundry list on down. A lot of asset management in many ways, once you thoughtfully get it set up can be put on autopilot. There’s a lot of ways to do it, of course, there’s mutual funds, ETFs. You guys have an offering that we haven’t talked about that much on the podcast, I’d love to hear you talk a little bit about it, which is direct indexing. You want to explain to our listeners what that is and how you guys approach it?
Rusty: That’s a great question. Direct indexing is kind of one of those big new hot things in the industry. And I like to say that if you’ve never heard of it, I mean, it’s definitely an underrated topic. But there are others meanwhile, saying it’s just gonna like destroy the ETF industry. Now, that’s overrated. So basically, what it is, is, basically, you’re building a portfolio, but you’re directly investing in the underlying securities of an index. So let’s say the S&P 500. You’re not necessarily buying all 500 stocks, you might buy 50 or 100, and basically, you’re trying to replicate the return on the risk of the S&P 500. Yeah, that sounds like it’s really complicated. Why would you do all that? Well, if you’re a taxable investor, what you basically have created is a portfolio of 100 different positions, 100 different tax slides, that you create all these opportunities for tax-loss harvesting. And it’s a real deal. I mean, it’s meaningful. Various studies have shown you can get tax alpha of 1% to 2% a year. So think of all the things that advisors already can do for investors. And let’s say a typical advisor charges 1%, obviously, depends on the market, stuff like that. And there’s so many different ways that they can add value, there’s various studies that say you can add 3%. When you bring in direct indexing it’s another thing, tax off of 1% to 2%, boom, that takes care of the advisor fee.
And so it’s a way for advisors to kind of be on the cutting edge and show how technology can help add for taxable investors additional value. But there’s so much more that direct indexing can do too. I mean, the customization aspects of it, they can customize based off of your social values, based off of risk considerations, such as concentration, they might have a preference for a style of investing. you can customize in those ways. I think the real, really powerful thing about that is I think we know like when people like, customize, it can be really sub-optimal in a lot of ways, but at least in terms of the sheer rational economic sense, but from a behavioral standpoint, if the investor, the advisor has the ability to customize they, kind of buy into it, it makes it stickier, and they’re more likely to stay with the plan. And that’s a win-win, first and foremost, obviously, for the investor, but also for the advisor. So that’s another cool thing about it. And then the last thing, well, I already mentioned was the social investing stuff. People have been talking about ESG forever, and I think a lot of people kind of get behind it. Obviously, there are some dissenting voices out there. But it’s really hard, I think for if you’re really passionate about a topic, I mean, then you start like, arguing over the definitions, and then… So it really hasn’t taken off to the individual investor, but it could with direct indexing, because when you set up the accounts, you get a little more granular on what kind of exposures you want. I mean, so, I’m actually pretty optimistic about ESG investing, I’ve been kind of like, that’s kind of like an institutional thing. But I think for more individual investors, direct indexing is gonna be a way for them to articulate those views in the years ahead.
Meb: You’ve hit on a couple, I think pretty important topics. One, direct indexing has been around for a long time in the general application. The tax-loss harvesting is a massive benefit, in my mind, so an obvious one. But to me, I’ve always said, and obviously, I could be wrong, but that the implementation of ESG is perfect for direct indexing, and the reason being is it is so personal. It’s such a hot topic but if you were to ask 10 people, what’s important to them in the ESG criteria, you’re gonna get 10 different answers. Some people are gonna say, “Look, I care about climate sort of ideas.” And other people say, “No, no, no, I care about being invested in or out of gun companies.” Whatever it maybe it’s such a, and in some cases diametrically opposed values that direct indexing seems like such an obvious choice. Because ETFs are such like blunt tools when it comes to that. It’s really hard to drill down the same way you could with direct indexing. Are you finding that from conversations with advisors?
Rusty: Totally true. I mean, I always remember, kind of like, what really kind of drilled the point home to me is, it was years ago. I was sitting at a table full of advisors and talking about some topic, and I can’t remember exactly what the topic was kind of ruins the story a little bit. Let’s just call it climate change. And so there were only like two advisors at the table that were like you could tell we’re passionate about it. So you just can’t create a product called climate change, because then those two started arguing over the definition, and how they wanted to see it in the portfolio. So it’s like, “Man, it’s tough.” Anyway, but I think what’s happening is you’re seeing in the industry, a lot of people coming out with various ESG environmental and social and governance indexes, they are getting much more granular. And so eventually, you’ll be able to see accounts being set up where you kind of have that menu of options, people kind of drill down to it. So yeah, again optimistic about it.
Meb: And you guys have also, there’s some ability to do even sort of sector-based, I know you guys have done some work in biotech, sort of sector industry strategies as well?
Rusty: Well, one of the things that we’ve been able to do to Orion is that we can move pretty fast on some ideas that really, it all comes from advisors, investors, sort of the groundswell of what they’re looking for what they want. And obviously, with COVID, it was kind of a pretty easy idea to come up with a direct index for biotechnology. And the idea there is, to many that have very attractive pre-tax potential, return potential. But now think of all those securities. I mean, each of them on a stand-alone basis are volatile, there’s gonna be winners and losers. I mean, yeah, there’s an industry effect going on. But nonetheless, you’re gonna get, I mean, they’re just gonna be zigging and zagging. There’s so much opportunity for tax-loss harvesting. This year at Orion it’s interesting, some of the accounts that we’ve had, because the volatility has been so extraordinary, we talk about that expectation of tax off of 1% to 2% a year over like a 10-year time frame. I mean, this year, some accounts have blown that away, that 1% to 2% already. And what I think is really, really cool about that, just think you’re one of the advisors that, and again, years ago, I used to do this too, I did all my tax loss stuff in the fourth quarter. I mean, some advisors only did in December. Now, let’s imagine this year, let’s just say we get a nice rally going in a year, and the market has a nice gain, you know, somebody who’s waiting to do a tax-loss activity on your client accounts in December. It’s like, “Wait, a second. you just had this humongous opportunity early in the year.” And so it’s possible that some of our accounts will have really nice, knock on wood, returns for the year and also have this big after-tax benefit as well. So it’s really cool.
One thing I wanna talk about tax alpha, though, which I do hear a lot of people say that 1% to 2% for everything, it really does depend on the portfolio. And talking about biotech kind of touches on that point, to really maximize your tax alpha opportunity there’s a couple of different things that are important. One, you need more tax lot, you need more opportunities. So a portfolio of 400 securities is gonna have more opportunities than one with 50. And then you also need volatility. And so you need a lot of those things just moving around a lot. And the other thing, of course, that’s getting fancy is you can call it cross-sectional volatility or the correlation between them. If all are zigging and zagging and they’re doing different things again, that’s more opportunities. So like, if you’re doing a direct index on the S&P 500, or if you’re doing a direct index on a small-cap portfolio, your tax loss expectation is gonna be a lot higher for small caps than it is for the S&P. So a lot of people just kind of blanket it. And then there really is, it’s just different expectations for different strategies.
Meb: Like anything, I mean, the devils in the details. I think the ability to correctly manage the tax-loss harvesting with a software rules-based approach is pretty important. I mean, advisors have been doing this forever on their own. But the problem, I mean, there’s a, might be an unnamed robo-advisor out there, that trumpets, they call it Yield, actually somehow, but like 4%, plus tax-loss harvesting and then got fined by the SEC for managing it improperly because of the wash-sale rule. And then for the listeners who aren’t familiar with tax-loss harvesting, it’s the ability to switch out of securities that are essentially similar, but not the exact same, because if you buy and sell IBM within 30 days, that’s called a wash-sale. So you have to be mindful of how you do it, but you can book the losses and have the ability to have capital gain losses, instead of at least matching the gains.
Rusty: There is some educational aspects to direct index. I mean, doing a direct index portfolio on the S&P again, is a lot different than doing a direct index on let’s say, you wanna do a factor-based direct index, let’s say you wanna do a momentum direct index. Now, kind of the implied turnover for the momentum, even if you don’t have tax-loss opportunities, there’s a turnover involved into it. And one thing we didn’t talk about, there’s so many reasons why direct indexing is becoming popular and obviously, the technology has caught up, commission-free is also made a lot more attractive. But the transaction costs there’s still a transaction cost kind of behind the scenes. And even though transaction costs in terms of like bid-ask spreads have really dropped, so transaction costs are really dropped throughout the industry, there’s still a transaction cost. And so if you’re in a direct index portfolio, let’s say momentum-based, factor-based, I mean, you’re gonna have a lot of trades, and there is gonna be a little bit of performance slippage from transaction costs involved with that.
Meb: All right. Let’s start talking markets. This would be the fun stuff. What’s the world look like you today? And from your perch in farm country, is everything look totally normal? We still got this, someone said this to me the other day, by the way, we’re recording this, listeners in the first week of October for context, the world could have changed markedly in the one week or so in the time that this comes out, we still have 25% of the year left, we’re only 75% done, we have an entire quarter of 2020, feels like the longest year ever. What’s the world look like to you today?
Rusty: You’re right. Now, every week, I do a weekly video. And it’s amazing when you look back over the week that was how many big things happen. So much big stuff. I guess the shortest answer is that I mean, in terms of an outlook, if I had an outlook between now and the end of the year, and going into next year, I’m actually kind of net positive for the U.S. market. But my return expectations over the next five to 10 years are definitely below average, most likely positive, but below average. And I think for this year right now, I mean, just to kind of keep it simple, I think there’s three reasons why to maintain a net bullish attitude. And one, things are getting better. The economic data, I mean, we’re coming out of a deep hole. it’s almost just sort of the math, just you have to come out of that hole. And so the numbers are looking good. And obviously, some economic numbers look great lately, and so that’s a positive. The second positive is the whole cliché of, “Don’t fight the Fed,” just don’t fight the government, I mean, monetary policy, I mean, it’s the most monetary support ever. And when it comes to fiscal policies, the second most ever next World War Two, and who knows, it might even take that high out. Put it together, that’s just a ton of liquidity and support of the system. I mean, if you do nothing else, just don’t fight. the liquidity. I think, over my career, I’ve always appreciated liquidity. And even though I’ve appreciated it, I think I still underappreciated how powerful it is. And then the third thing, and I’m just a huge fan of this, and I’m a huge fan of the next category, because, I mean, not only am I managing money, but I’m also writing commentary. And in fact, I’m an investment counselor, and I’m looking at investor sentiment. And, you know, there’s so many different ways to slice and dice sentiment. But to me in the aggregate, there’s still a big wall of worry out there. And when there’s a wall of worrying, there’s a lot of caution. And granted, there’s a lot of little anecdotal stuff where there’s obviously, pockets of, that the markets will have bubble issues, and stuff like that. But in the aggregate, I think people are cautious. And we can look at a couple of different surveys, which are anybody here could just like, listen to it and play with the video themselves.
There’s one study, The American Association of Individual Investors. Now, I can sell the reason why I don’t like that survey, but I can tell you what I like about it, it’s weekly and you got data going back decades. You can take the data, drop into a spreadsheet, play with it yourself, and you’re gonna find when sentiment is really negative, the market tends to produce above-average returns the next month, three months, six months, 12 months, and vice versa when it’s really bullish. The last time it was bullish was the week before the market flipped over, and it’s been like net negative ever since. If you didn’t like the results before, I mean, it’s in your face now, because all those results have been, like, massively fortified based off those numbers since then, and it’s still negative. And then another one, I have to admit, I’ve not tested this as much, but I think it is pretty interesting, but you can find this, if you go to the Yale website, Bob Shiller stuff, I mean, that’s really cool spreadsheet again, people wanna play with it themselves. But then they have a crash index survey. And on that when you look at individual investors, they’ve been doing this data since the early ’90s. The last reading was the highest percentage of investors say stock market crash is imminent. Just the contrarian in me, and also it isn’t just the contrarian, that’s the investment side. I wanna keep people balanced in their portfolios because, and I’m making up a number, 90% of investors a balanced portfolio is a right answer. And volatility, again, as we know, volatility is an opportunity for managers, but probably again, 90% of investors, is destabilizing and freaks them out. And so you want to bring it back to the center. So people are getting really scared. I’m trying to say it’s not that scary out there, that people are really greedy say, “Man, you see all that scary stuff out there?” I’m always trying to bring people back to the center.
So anyway, they’ll all have worries in place. You got those three things, and granted, you’ve got COVID-19, which is dangerous. It’s a battle. I can’t stress it enough. Obviously, it’s dangerous and highly contagious, and wishing you the right things. That all said, I still feel as if some people think it’s more dangerous than it is. Franklin Templeton did a study recently that surveyed investors, like the average American still thinks that 20% of all the deaths are people 34 years old and younger when the numbers like well, less than 1%. And it’s kind of a function of people’s attitudes towards COVID is, it’s related to a couple of variables, one, how they take in their information, and the other thing is their political bias. And I just feel like right now everybody’s taking in so much information and obviously, political motions are high. Once we got the other side of the election, maybe it’s just me being an optimist and hopeful, but I think from an emotional standpoint that people will manage COVID a little bit better. I’m speaking from an investor’s standpoint, not as a parent, not as a son but as an investor. I think actually the markets are kind of seeing through that a little bit.
Meb: Well, you mentioned, the political bias is funny because when I was watching the debate the other night on Twitter, this is the first debate, it was almost like watching two different planets of the people responding on both sides of the spectrum, as if like, they’re in their own totally different universe. And that’s what everyone’s been talking about when it comes to social media. But that applies to markets too. You have people who are, “I’m a stock guy. I’m a dividend guy, I’m a gold bug.” So you mentioned this concept of balance. Now, I wanna hear what balance means to you. You’re based in Nebraska, so is it mean like, 50% of your portfolio in farmland and the other 50% in Berkshire? Or what do you guys do? And what does balanced mean to your investors?
Rusty: Close, two-thirds farmland, one-third Berkshire.
Meb: Well, that’s probably an amazing portfolio for the last 50 years?
Rusty: Well, professionally, I am an asset allocator so I do believe in broad diversification too. So, I mean, again, I just intuitively, it makes sense. Long-term, practical experience, academic studies, it all leads to being globally diversified over time. You want the wider opportunities set. So balance, I mean, balance is, really, I mean, it can mean a lot of different things. But just on a pure portfolio context, it is just simply a balance of major asset classes between growth assets, stabilizing assets. I actually think that really an important third category is, there’s different names for it. You call it just real assets? You talked about farmland. Real assets, things, I mean, stocks and bonds are financial assets. And there are other asset classes that have different drivers, such as real assets. Going back to Walmart, earlier and Research Affiliates, you know, we kind of going through a concept called the third pillar, which I’ve always thought was a great phrase for it too. There are different asset classes that respond differently to inflation and inflation expectations for a good example. And commodities, natural resources, real estate, all those to some extent, just behave differently than your conventional stocks of mine. So balance really means having exposure to different asset classes, and then really depends on your own risk tolerance, your objectives, your capacity to take risk.
Meb: You were talking a little bit about real assets. How do you think about… What does that mean to you? Is that mostly REITs? Is it, commodities? Is it commodity equities? Is it farmland somehow? Is it TIPS? What’s incorporated for you guys in real assets?
Rusty: It’s really all the above with a couple of exceptions there. First of all, TIPS. I love talking about TIPS. I mean, TIPS, everybody always thinks TIPS, is an inflation play. It’s easy because inflation is in the word. But if you really think about it, TIPS are inflation agnostic. They’re linked to inflation, it’s actually nominal bonds are making a bet on deflation. So actually, I don’t really love I mean, obviously, if I’m making a decision between TIPS and nominals, inflation expectations come into play. But that’s not really a plan inflation. To me, it is a basket. I mean, in terms of liquid securities, it has to be a basket of commodities, natural resource stocks, and REITs. It’s imperfect. It’s not I wish it was better. And you touched upon farmland. I mean, that seems to me, just a huge opportunity, because that’s such a viable asset class. And there ways people can get into it, but not like with daily liquidity. And for the general public, you need to have higher account balances to lock up that money it’s harder. There’s some REITs out there. And I know you’ve had a podcast with one of those REITs, but REITs somehow still get impacted by overall market and interest rates a little bit. I mean, it’s still a viable play on farmland, but I still feel it’s imperfect as well. There’s some cool stuff out there kind of the crowdfunding stuff, as well, when it comes to farmland, which is pretty intriguing. But again, that’s not like daily liquidity. But I think for some investors is a viable option.
Meb: You listed the bond challenge, and many investors we talked to particularly advisors increasingly, are scratching their heads and getting a little bit nervous about bonds. In the U.S., at least we have a positive yield here in many countries around the world they don’t. How do you guys think about bonds’ role in the portfolio? And also as a side question, you think we ever received zero or negative on the 10 year in the U.S., or is that totally preposterous?
Rusty: A couple of things going on there. So okay, let’s first of all, let’s think about is it possible? The one thing we do in terms of investment team here, when it comes to our forecasts, everybody in the team is forced to put their forecasts into probability buckets. And there’s one rule to those probability buckets. Well, first of all, we always show like the long-term history and we put it in return percentiles. And then the other thing, the only other rule is you can never…the lowest number you can have for anything is 1%. So that means anything is possible. And so that’s just the way we just think about building portfolios. And, obviously, there’s been so many surprises this year, energy prices going negative and go on and on and on, there’s been a lot of crazy stuff. So I think it’s possible, I’m not betting on it. I mean, I don’t think it’s gonna happen. Of course, I didn’t think they’d get as low as they did anyway. And my call on interest rates, even though I’ve been a defender of the asset class, I don’t know how many times I’ve been in a roomful of advisors, or investors who somebody hates bonds so much, and I’m defending the asset class. But even I still don’t think interest rates can go much lower. Bonds are a stabilizing asset class. And there’s nothing like long duration, high-quality bonds to diversify against equity risk. And if you’re trying to manage a portfolio for a given risk level, it just it has to remain part of the toolkit. That said, to manage portfolio risk, I think you have to be more creative moving forward. And I think what comes into play is other asset classes and thinking about other types of strategies and the mixture of them. I mean, commodities, of course, is not like bonds, it’s a whole different thing. But in a portfolio context, if you’re trying to manage an overall risk level it remains part of the toolkit too if you’re trying to think of stabilizing a portfolio over time. Alternative strategies, terrorist strategies, there’s so many different ways to kind of manage portfolio risk. And I think because interest rates are so low. And because if you’re thinking about managing for risk-adjusted performance moving forward, I just think people have to be more creative and more active in their fixed income as well. I just don’t think you can just buy an aggregate index exposure, and just let it be right now.
Meb: We were chatting a little bit before we got started on the importance of story and narrative maybe explain a little bit about, what your conversations with advisors. Like I know, you talk to a lot of advisors out there, are they concerned about things we haven’t spoken about? What’s their biggest challenges? Anything in particular, that’s on your brain as you chat with professional allocators?
Rusty: Yeah, I think the biggest issue, I mean, I talk to advisors right now, I think the biggest issue with most advisors is one, getting investors to invest, I think there’s still just a tremendous amount of caution. And it’s easy to think of all the reasons why to stay on the sidelines. And then I think another common problem is the people who are investing probably aren’t diversifying their portfolios like they once did. And obviously, in the second group, a lot of them, they’re making some money, they might be an Apple stock this year. And it’s like, why do I need a diversified portfolio and I can just own Apple sort of stuff? So I think there’s a couple of different issues’ going on there. And, obviously, the point, number two, for the diversification, it’s just, it comes back to I mean, but all you can do is educate. And but I think in some of those cases, I’ve seen this story before, it’s the markets probably just gonna have to roll over and that’s how they’re gonna learn the lesson. As for the first problem, getting people to invest, I mean, obviously, that, again, education can apply there. But something we were talking about beforehand, something that’s kind of…so I’m in the industry for 30 years, and one thing that’s changed a little bit in the way that I think about stuff is sort of the about stories or investment themes. And to me, glamour stocks kind of fall into like the stories people can fall for the stories and pay and not think about valuations, not think about fundamentals, but just go for the story. There’s a lot of new strategies right now that kind of fall under this thematic label or category. And a couple of things, first of all, they are legitimately growing like an ETF industry, for instance, last five years ETFs obviously a tremendous growth growing 20% a year thematic ETFs have doubled that. And again, part of is because of performance. But I think another big reason is because there are stories that people can relate to, and can understand. And even if innovation some people kind of understand some of that other people, meanwhile, hear innovation, they just think disruption, how their lives are changing. But they probably wanna hedge that they know something’s happening, and they just want that exposure.
So I think the thematic investment themes are a way for some investors to re-engage with the markets. Now, again, for more I said, I mean, you still got to make sure those strategies have investment merit. That I mean, I was looking at from a risk perspective first. I mean, what do they look like in terms of their risk characteristics? And how do they fit into people’s portfolios? And I think a lot of these investment themes are pretty volatile on a stand-alone basis. But they’re kind of quirky and when you get a quirky strategy that can actually provide a diversification benefit to some portfolios. So it’s something that I’ve kind of come around to thing and it does make sense used appropriately. I have seen over the years, many, many, many pitches from ETF providers on different fund ideas. And you know what? It’s a bunch of CFAs in the room figuring something out. And quite frankly, it is solid. It is super solid. I mean, it is smart. And it’s intricate, and it’s thoughtful. And then you think like, how in the world are they gonna explain this to anybody? I mean, it’s like too clever. It’s not gonna actually help the investor. I mean, you have to have a sound product but I think it has to have that story.
Meb: Believe me, we have so many. It’s like my draft folder on Twitter, it’s just full of terrible responses and ideas. The same thing, it’s like all of our… it’s so many of these ideas that while theoretically, useful, interesting, etc. No person on the planet would ever be interested either because it’s too complicated. Or it just doesn’t really have that sort of, like you said story behind it. And that’s important I too, have kind of come to appreciate so much behind the storytelling narrative on all investments. Because it helps people stay the course which as you mentioned, so many people, we have conversations with all the time that 2009 this past year, sell whatever it may be. And over the years, it could be all sorts of different things to never to invest again. And that’s what we wanna avoid. Tell me a little bit do you have any sort of hacks, guardrails, suggestions, ideas for people, or advisors that this concept of saving, investing, staying the course. It sounds so basic, but infinitely hard in practice, any general thoughts?
Rusty: I guess I have a platform, and I don’t know hack is a strong word. It sounds like it’s working. And I can only hope it’s working. But I guess I do have a platform where I have a podcast and I do videos, and I do commentary. And it’s just my MO when it comes to content is just kind of fading those emotional extremes that people have. And then just educate as much as I can use the data to show how there’s like an emotional extreme. Most of the time, you don’t wanna go with it. Just stay put, stay balanced. As we know, it’s like investment success is less about intelligence and information as people might think it is it is really the temperamental factor. And people chasing performance is really the biggest problem. Obviously, chasing performance this year is worked out for a lot of people. And for somebody here preaching diversification and balance, it’s kind of hard, kinda reminds me of the late 90s. That was a pretty tough time too for the same stories. But again, when the dot-com era did finally break, globally diversified portfolios, held up way better and performing extremely well. I like to joke like during that, like right now, because I’m preaching diversification, global, don’t buy expensive stuff, like good basic messages. Right now, it’s like what do you know, man? Like, seriously? So if I like mentioned anything about anything, I feel as if like, you can even call the markets but 15 years ago, when everything was working, diversification was working, active management was working, value style was working. I could say like, “Man, I love this movie.” And it was like, “Everybody, watch it,” because obviously, I knew what I was talking about. So it is sort of, I think the message really is just staying on message. For me, it is for my audience. It is hopefully, It’s a reliable voice. But when it comes to investment products, investment strategies, the most important thing is that they behave as they expect. And even if they underperform, people know why they underperform, nobody’s caught off surprise. And that goes so far in terms of sort of keeping people to stay the course and stay on balance.
Meb: In diversification thinking back to February, March. I mean, bonds did their job this year. And it’s funny how many people when you start to get to these low yields, think that somehow there’s just nothing left. But if you even from here, you can have a hard move, and be that diversifying asset we talked about in a particularly deflationary environment. From someone who’s in your chair, who’s spoken to probably hundreds, if not thousands, of managers of all stripes, of all fun types, of all pitches you referenced a little bit about all the various great-sounding ideas. How do you think about incorporating new strategies, ideas into allocations today? Whether it’s upgrading funds or switching out allocations? How do you think about due diligence? Any general hints, ideas, thoughts on that topic?
Rusty: I’ve been doing manager due diligence for decades and I have talked to a lot of managers over the years. I guess to me, probably one of the biggest differences between managers is sort of that level of conviction and their own ideas. And that can be expressed in a couple of different ways it can be expressed, first of all, do they eat their own cooking? Are they actually managing a strategy that they’re gonna invest in? That right there is one of the biggest variables in terms of knowing you should be investing in that product as well. The other thing is sort of more of a technical term is where the tracking error. So how much risk are they taking versus their benchmark? And when it comes to managing money, that is an important philosophical consideration. How close you can see or benchmark? How much risk you’re gonna take? And there are viable reasons for doing both. But I prefer all these people to see if I’m picking an active manager, for instance, is that I wanna see the conviction, right is they’ll be expressed in a tracking error. When I say tracking error, again, that’s really the difference in their return versus the benchmark over time. And I think those are really important criteria. It isn’t so much about their return, I actually, I’d really honestly feel that probably the number one statistic that most investors use to pick a strategy. And I’m talking not just the individual investor, I’m talking to institutional types, I’m talking to investment committees, I’m talking to media, I’m talking everybody because it feels like it’s a sufficiently long-term number is a three-year number. It’s a three-year total external peer-group rank. And I think that number probably drives as much flows as any other number in the business. But what’s really interesting about that three-year number is if you just look…if you invest in nothing else, over the decades on a three-year number, you really wanna go opposite of it. So kind of the ideal fund to buy is that manager who has the strength and their convictions that say their strategy has underperformed over the last three years.
Now, underperform versus a benchmark, they’ve obviously executed their strategy, they’ve been disciplined. The important thing we’re gonna due diligence standpoint is, try to ferret outdid how much business pressure came into play? Did they enhance their process in some way, which you could tell was a concession to business pressures or sell things and you’re like, you got to change your way. So you need to find a manager that’s had that conviction, and then the market cycles will just play out. I mean, that’s probably kind of a simple way to think about it is when managers again, look at long term studies, I believe in active management but it’s really hard for me to consistently prove out, somebody can do market timing. But I think and I believe that there are some managers who can do still do security selection when you adjust for style, size, and sector exposures, that some managers do seem a little, have more of an edge than others. And so if you can find a manager like that, who has arguably underperformed over three years, that’s kind of a good spot. So it’s really about discipline a process, consistency of a process. Yes, hello, sometimes, okay.
Meb: So emerging markets, energy, and what else has been terrible for the last three years? Places that just it makes me like nauseous, I’m glad I didn’t need any breakfast because the thought of going to buy “Oh, the value guys, that’s the third value anything. But it’s funny, you see the coincidence sort of sentiment indicators. Institutional Investor had an article the other day, it was talking about how all the big allocators didn’t wanna allocate to Seth Klarman anymore. And you see these sort of things where it has so-and-so lost their touch has this style, is it dead? Or is it gone forever? And I mean, the energy patch, at one point as a sector was like, a quarter of the S&P and it’s like 3% now or something just astonishing low. But all the academic research supports you I mean, there’s paper after paper after paper that shows that the big money institutions do the exact opposite thing of what they should be doing, which is chasing three-year returns.
Rusty: I do wonder, I mean, you’re right, we’ve heard this song before. Have we reached an inflection point for value versus growth? It feels like we’ve seen a lot of turning around points already. Gosh, it feels like we’ve got a couple more data points here even of late. One thing was really interesting. And we didn’t do this research. But when you look at sort of the one day change between value and growth its different, of course, was that usually this huge difference, or see a lot of big differences on a daily basis of late. And interestingly over time, those usually company leadership changes between value and growth. So that can be a towel, it’s like a tide change going on. The other thing is another number is and I have to admit, I generally this number does not impact decision making historically ever for me, but it’s always sort of an interesting thing. But it is interesting to note is consumer confidence. So consumer confidence recently just came out with his biggest month over month increase like, in 17 years. And whenever consumer confidence has like this huge jump like that, that is usually towards the end of recessions or the beginning of expansions. Again, so both of those never mind coming out of a bear market coming out of recession you have all these different potential catalysts for value to work. Now, I come from a school for value investing that people always want catalysts. I think catalysts were talking points, because usually what changes in the market is a surprise of some sort, you don’t really know what it is. But to me, it’s like when the relative valuations and the relative performance gets so stretched like it is for value, that’s a good time to invest. You don’t know if it’s gonna be like, next quarter, next couple quarters, but it’s probably gonna happen relatively soon if you’re a long-term investor. And that’s how you wanna position tilt your portfolios. And now it feels like gosh, are these the catalysts? I mean, you could technically say values been outperforming nevermind, you got this catalyst now of the antitrust stuff that’s going on. Of course, as we’re recording, even a couple of stocks are still up on that news today. How are they not down? But nonetheless,
Meb: I have some conspiracy theories, but we’ll save those for another time. You do a lot of content. What else is on your brain that you’re either excited about, curious about, thinking about, keeping you up at night? Anything on the brain?
Rusty: I guess it’s probably one of those topics out there that it’s around, it’s like a new idea. But I still think that you’re gonna see more firms continue to adopt these practices. But it’s the whole world of behavioral finance, and just how you can apply that. I don’t know if the application necessarily is to running a portfolio, as much as to just creating awareness for investors and advisors. And I just think that awareness, as it continues is just really important. Obviously, a lot of people already were being able to finance and those concepts. But that said, there’s so many more people still don’t know about it, I think that’s just a really important trend that’s taking place right now. And I’m excited about it a lot of cool stuff there.
Meb: I think about it, and hopefully, a listener will figure it out, because I haven’t been able to, but there seems to be a concept or product somewhere. Annuities fit this general category, they just historically have been so damn expensive that it sort of deletes any possible benefit of getting people to have this long-term perspective. So that essentially locking people down for 10, 20, 30 years, and a pension fund or target-date fund, they seem to think better correctly and don’t muck around with it as much if they have an advisor. But still, it gives the possibility of selling if you want to but actually having some sort of structure, that handcuffs people to avoid all these behavioral because we all have it the emotions. I don’t know, I would love to see some more development there but I don’t wanna do it.
Rusty: I mean, think about people who have built wealth. I mean, a lot of them have done it through just owning their house or doing like whole life Insurance, you could come up with rational arguments like that probably isn’t optimal. There’s better ways to get a return but it forced people to save, boom, you know, that’s how they built their wealth.
Meb: All right, well, we’ll marinate and brainstorm on ideas there but.
Rusty: Absolutely. 100% agree.
Meb: I talked to friends all the time. I say, “Look, the main reason real estate does so well is it’s not because the asset class it’s fine. But it’s because it forces you,” it’s money, you would spend otherwise on something. So the forced payment for anything is what eventually drives the return because people, every single person is like, “Oh, well, my mom bought this house 30 years ago, and look how much it’s worth now.” And you compare it to the S&P and it almost is always worse. But it’s just the concept of saving and investing in the first place.
Rusty: Right on.
Meb: Preaching the choir, I don’t know. What’s been your most memorable investment over your career personal or workwise good or bad?
Rusty: Gosh, there’s been a lot over time probably the first thing that strikes me. When I was in college, I basically knew I wanted to be an investment manager, which is pretty cool. And I had the opportunity to meet Sir John Templeton, who was very way cool. It was very, very cool. So even though I was going to school on the East Coast, I was in Nebraska, obviously, influenced by Warren Buffett. I was already familiar with Benjamin Graham, all that stuff. And I was basically already a value investor. But coming out of school, I had a good friend who was just brilliant. I mean, he like graduated from college when he was like 19. He was already in grad school just brilliant. And he came across this super-hot stock, like this penny stock. It’s like this thing is going to the moon. It’s like I got to believe this guy because he is the smartest guy I have like my peer group here. I didn’t have a lot but I invested in I got family and friends went to a completely opposite of anything I learned anything I believed up to that point you think I’ve done since. So I did get into it and, of course, it took off higher, which is great. And then back in the day, baron, well, baron silver obviously, but had the guy that would write towards the front of the magazine and trash stocks. And he said, “This company is like trash. You don’t want it.” So basically, it went to zero. So it’s like, I disregarded all the lessons I learned. I was only 22 whatever it was called.
Meb: What a great lesson though. I mean, that’s when you wanna have that you don’t wanna have it in 2020 when you actually have some assets as an older investor, you want to lose all your money at 20 that’s the best possible thing that could happen to you.
Rusty: You’re right. So that was a good investment for exactly the reason as you know, people who hit it big like when they get into investing right off the bat. I mean, that kind of sets them up for not good stuff to happen. They just feel like they’re infallible for a while until they learn.
Meb: We certainly saw that playbook with a lot of the cryptocurrencies a couple of years ago, we may be seeing it again this year with some of the stock offerings, everything else going on, it’s starting to seem a little loosey-goosey. Who knows?
Rusty: On that point, like the nifty 50 stocks, when people kind of think about all the one decision stocks on the stocks that are so big right now. I mean, it’s hard to imagine like Coca-Cola and McDonald’s, and Disney’s lost 75%, 85% of their value and took many, many, many years to ever come back. Those are obviously great companies. So that’s kind of one of those history lessons.
Meb: Even more recent, my favorite bubble the dot-com bubble, Cisco’s of the world. This is a great lesson in distinguishing between the business and the stock. This is done just fine. But the stock is just now a lot of those companies are just now getting to the peak from the dot-com bubble that was 20 years ago.
Meb: A lifetime for a lot of people. So anyway, Rusty, this has been a lot of fun. Where do people go, if they wanna follow your writings or podcasts or your to-do’s? What’s the best spots?
Rusty: Well, a couple of different places. So there is orion.com. So orion.com. And then there’s a lot of drop-down menus there. You can find a lot of my stuff still under either Orion Portfolio Solutions or CLS Investments. And then, of course, I have the podcast as you referred to earlier. It’s called “Orion’s The Weighing Machine.” So it’s kind of a play on the Benjamin Graham phrase and Warren Buffett phrase and other people’s phrase that the market is a voting machine in the short-term, but a weighing machine in the long-term. So, and again, you could find my interview with you back from 2018 on there too.
Meb: Oh, my, gosh, back when we were just young and impressionable and…
Rusty: Just kids back then.
Meb: The 2020s hasn’t had their effect on us yet. This has been a long decade, about 25% left. We’re almost done.
Meb: Rusty, it has been a blast. Thanks so much for joining us today.
Rusty: Thanks, Meb. That was fun.
Meb: Podcast listeners we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org we’d love to read the reviews. Please, review us on iTunes and subscribe to show anywhere good podcasts are found. my current favorite is Breaker. Thanks for listening friends, and good investing.