Episode #270: Terri Spath, Sierra Investment Management, “We Use A Quantitative Rules Based Process To Go Risk On, Risk Off”
Guest: Terri Spath is Chief Investment Officer and Portfolio Manager at Sierra Investment Management, the parent company of the Sierra Mutual Funds and Ocean Park Asset Management. She joined Sierra in 2015 and is responsible for market and economic analysis, portfolio allocation, investment strategy and building client solutions at the firm.
Date Recorded: 11/4/2020
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Summary: In episode 270, we welcome our guest, Terri Spath, Chief Investment Officer and Portfolio Manager at Sierra Investment Management, where she’s responsible for market and economic analysis, portfolio allocation, investment strategy and building client solutions at the firm.
In today’s episode, we’re talking about her rules based approach to investing. Terri talks about Sierra Investment Management’s different funds, including their tactical junk bond fund and their muni-bond fund. She gets into the benefits of applying a trend following approach to her strategies, what she’s seeing across different asset classes, and why she’s bullish on municipal bonds and South Korea.
As we start to wind down, Terri offers ways to implement some of these ideas with your own portfolio, whether it’s with the equity or fixed-income part of your portfolio.
Please enjoy this episode with Sierra Investment Management’s Terri Spath.
Links from the Episode:
- 0:40 – Intro
- 1:28 – Welcome to our guest, Terri Spath
- 4:02 – Investment philosophy of Sierra Investment Management with a focus on Tactical Bond Funds
- 10:58- Moving in and out of positions and what they do with cash on sidelines
- 11:36 – Sierra Resources
- 15:15 – Their thoughts on whether US bonds could go negative
- 18:40 – Their flagship concept
- 22:01 – Portfolio construction for them
- 24:58 – Their view on the markets today
- 25:58 – Commentary: Three Ways to Invest for the Rest of 2020 (Spath)
- 26:20 – Around the World in 80 Days (Verne)
- 28:01 – Their municipal bond strategy
- 30:46 – Their focus and strategy in emerging markets
- 37:50 – Four Horsemen of the Economic Apocalypse
- 37:52 – The Meb Faber Show Podcast – Episode #172: Cam Harvey, Duke University, “This Is A Time Of Considerable Risk Of A Drawdown”
- 40:29 – Research process at Sierra and how they manage their models
- 44:14 – The passion for investing
- 49:27 – Investing in the Time of Corona (Faber)
- 51:10 – How would advisors put their funds into practice
- 54:16 – Most memorable investment
- 56:52 – Connect with Terri: SierraMutualFunds.com, OceanParkAM.com
Transcript of Episode 270:
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: What’s up, friends? Super fun show today. Our guest is the chief investment officer at Sierra Investment Management, where she is responsible for market and economic analysis, portfolio allocation, investment strategy, and building client solutions at the firm. In today’s episode, we’re talking about applying a trend following approach to investing to manage downside risk. We talk about Sierra Investment Management’s different funds, including their tactical junk bond fund and their immunity bond fund. We get into what she’s seeing across different asset classes and why she’s bullish on municipal bonds in South Korea. As we start to wind down, she offers ways to implement some of these ideas to your own portfolio, whether it’s with the equity or fixed income part. Please enjoy this episode with Sierra Investment Management’s Terri Spath. Terri, welcome to the show.
Terri: Well, thank you for having me, Meb. It’s great to be here.
Meb: Normally I don’t mention the context of when we’re recording, but this is the day after Election Day, the aftermath. Where in the world are you?
Terri: I am sitting in my home office in Malibu, California. Our offices are in Santa Monica, so great weather day here for us, but lots going on in the markets as usual, pretty stormy.
Meb: It’s awesome. It’s beautiful. I feel like we could have done this conversation up at the real end or Malibu Seafood. I love those little fish taco spots up in your neck of the woods. I can probably see you from here if I had a telescope out my window.
Terri: Oh, good. I’m literally up the road from Malibu Seafood. So come by anytime for some tacos as well as anyone on this show, I highly recommended it, it’s right on the beach and just a beautiful spot.
Meb: Good. We’ll do a socially distant taco soon. All right, listeners. Terri, when I heard Sierra, this is a name I’ve been familiar with for years as a shop that’s been around. I always assumed they were just going to be located in Tahoe or Mammoth or something, but y’all are so Cal-based. Tell me a little bit about you guys. What are you up to?
Terri: So Sierra Investment Management, as you mentioned, is in Southern California, despite the fact that we’re not near Sierra. And I think that the name came from the two founders of the firm, Dr. Ken Sleeper and Mr. David Wright, created the firm a little over 30 years ago. And it’s interesting because they couldn’t be more different in every way that you think about it and disagree in practically everything, which actually is a brilliant way to manage money because you got a smart other point of view. And I think the only thing that they could agree on with Sierra as a name since it had nothing to do with anything else, they managed to agree on that. So that’s where our name comes from, Sierra Investment Management. We are based in Santa Monica. We manage money for clients in Southern California directly, but we also sell a suite of mutual funds nationwide under the Sierra logo. They’re all tactically managed. And then we also have an Ocean Park subsidiary that you may not have heard of, but that’s part of Sierra, Ocean Park comes from Ocean Park Boulevard, which is a road in Santa Monica that we’re located on, and through Ocean Park, we work with tamps, turnkey asset management programs, across the country selling similar models, but just under that name.
Meb: It’s funny. I got a good buddy who lives on Ocean Park. Was just there the other day. I’ll have to bike on down next time I’m there. So you guys got a lot going on and a lot of different models and approaches, but I wonder, what’s the general philosophy? Maybe just give us how do you guys think about markets? I mean, you’ve survived numerous decades and cycles, which, to anyone in our world, is a massive compliment. Tell us a little bit about y’all’s philosophy.
Terri: If there’s one thing to take away from Sierra, Sierra mutual funds, Ocean Park, it’s that we’re tactical. And when we say tactical, like what does that really mean? It means we’re not passive and we’re not active. And when I say that, I mean, we’re not passive in that we’re not hugging benchmarks. We’re absolute return. We want to make money in any type of market, not just sort of outperform a benchmark that might be deeply in the red at any given time. That’s just not okay for us, but we’re not active either. Like I don’t wake up in the morning and try and make a projection as to who’s going to be in the White House in January or anything else. So what we do is tactical, meaning we’re rules-based, that’s the simplest way to think about it. And those rules drive the basic decisions that me as chief investment officer and my team needs to make on a daily basis. All I have to decide is what to buy, when to buy it, and when to sell it. And all of those are dictated in a rules-based process so that I would take that fear, greed, all those emotional things that can really ruin a great investment decision, are all overridden essentially by our rules-based process. And so that can deliver the goals that we have, which are absolute return, performing well certainly in down markets, as well as participating in up markets. And it’s something that we’ve written through over decades at Sierra and at Ocean Park. So we’re really proud of that. And we really stick to it. We’re very disciplined when it comes to these rules.
Meb: Well, that will sound familiar to all of our listeners. We spend a lot of time talking about rules-based process. Let’s walk through some. You got a framework for a particular strategy fund, composite, whatnot. Let’s talk a little bit more about the approach to kind of how you guys manage one of these strategies.
Terri: I’ll highlight kind of a basic simple one that we call our tactical bonds. So we have it as a mutual fund, a Sierra tactical bond fund. We also have it as a program for our clients under Sierra or Ocean Park. It’s relatively new, but it’s not. It’s sort of a version 2.0 of a program we had in place already. I’ll just walk through it. So high yield corporate bonds, I suspect your audience is very familiar with junk bonds. This is a really intriguing asset class. And in fact, I started my career out of graduate school at Columbia, in New York City, across the country and started working at Franklin Templeton, a large mutual fund company up in San Francisco Bay area. And I started as a junk bond analyst, interestingly, just looking at individual junk bonds, deciding whether we’re going to get paid back. It’s a great way to learn how to invest in the real markets.
So fast-forward to where I am now, Sierra has had a high yield corporate bond tactically-managed program almost since they opened the doors. So the intriguing thing about high yield corporate bonds is that because they’re risky, they don’t really behave like bonds, they have that coupon that gives the cushion, but they are more highly correlated to the U.S. stock market. However, they’re less risky. They have less drawdown, less standard deviation than the stock market. So a tactical approach to buying and selling high yield corporate bonds works beautifully. We have a terrific rules-based process for when to buy and when to sell. It’s based on moving averages. We can get into this. It’s actually really intriguing to me. But it’s based on moving averages that dictate when an uptrend has begun or a downturn has begun. That’s when we buy or sell.
Meb: Yeah. So let’s dive in. You hinted at, is it a classic trend following methodology? Any more you want to tell us? We’d love to go in deeper.
Terri: I guess I would classify it as trend following in that we want to participate in up trends and we want to get out of the way of down turns. Junk bonds, like any other asset class, are pretty much anything in, like, take the stairs up, but the elevator down, meaning you can lose money a lot faster than you can make money. So we want to make sure, get out of the way when things are falling, but we also want to participate in that long uptrend. So we have moving averages that we use, banded moving averages, and they allow a certain amount of volatility. So there’s noise in the market. What we want to do is separate that noise from a real signal, that things are moving up, and we have very tight bands that we will allow something to move around. And the interesting and intriguing thing about junk bonds is they’re not as volatile as you might think. They do behave like bonds that way while participating in uptrends.
So if a jump-on is start of fund…and let me make that point too. We participate in mutual funds and ETFs. We’re not buying individual bonds so that we can smooth out the risks that can occur by just holding an individual bond. And we wait for an uptrend. We have a couple of different signals that need to be crossed to define an uptrend. We want to be really confident that that has begun. So we’re never going to buy at the absolute bottom. I wish that I could look at the chart and be like, “This is the bottom and from here on out we’re going out.” That will never happen because we’re waiting for an uptrend. And on the other side, when those moving averages start to flip over, we have a cell signal that’s a line on the chart. Let me say it a different way. As the price of something is moving up, our sell level moves up with it, much like a trailing stop. When that stops moving up and starts to move down, it locks in that sell level. And if the price moves through it, it’s a sell. We have real proof of concept for a new tactical bond program that we have in place, which doesn’t only buy high yield corporate bonds, but will flip to long-duration treasuries if we have buys in that. So that’s our tactical bond program.
And in March of this year, for example, when the S&P 500 was down 17%, this program was actually up. And the reason for that is we were in long-duration treasuries. And then in May, when the S&P 500 was up, this program was also up because we had flipped back into high yield corporate bonds. So we use a quantitative rules-based process to go risk-on, risk-off. And the proof of concept was beautiful this year. I’m really proud of that. We did a ton of research to create this program, and it’s delivering exactly as we hoped it would.
Meb: Junk bond concept is certainly near and dear to the Angelenos here with the Milken and the whole crew of decades past. How do you guys think about it? Does it tend to be sort of all in, all out methodology? Are you scaling in and out of the positions? And then when you’re out, you’re sitting in treasuries, or is there are signals that sometimes shifted to long-term or to short-term or zero coupons? Like what’s the portfolio, like could you wake up tomorrow and it’s all in treasuries and then the next day it’s back in junk? Kind of what’s the practical way that ends up looking like?
Terri: We’ve got a lot of papers and marketing collateral on our website too that I think describes this very, very well. And we’re about to publish a white paper that shows our quantitative rules with a little bit more detail. And we ran a new test to see if our signals are still working the way we want them to. Test and refine and improve is near and dear to my heart. So that’s something that we’ve got coming out very, very shortly, and it solidified our view and our quantitative rules for high yield corporate bonds. So just to get into the specifics that you asked about, historically, our firm bought high yield corporate bond funds. Again, I want to be very careful. When I’m talking about junk, I’m talking about junk funds, mutual funds that are run by a PIMCO, or a BlackRock or any slew of actively-managed funds, or ETFs.
And each individual holding has its own sell level. We’re not an asset class, flip the switch on or off. And the reason for that is very precise, which is that these funds are managed very differently. Some are more double B, some are more deeper into the chunk spectrum. And so they behave very differently. Their price behavior can be different. So we have a specific buyer and a specific sell for every single holding. And that’s what dictates what is owned if we have a sell. So for example, the end of February, we were hitting sells right and left in every junk bond holding that we had. Historically, before we create a tactical bond, we would sell and sit in cash, wait for new buy signals in junk bond funds. Well, I’ve been at the shop now for a little over five years, and I looked at the track record for this high yield corporate bond program and I thought, “This is brilliant. This is wonderful.” But I’ve been in the markets long enough to remember when you used to make some decent returning cash or money market funds of 3%, 4%, or 5% even, now we’re making nothing. So what could we do in that interim period? And in hindsight, this was very clear, but we thought, “What has a negative correlation to junk bonds? Oh, long-duration treasuries.” And we ran a bunch of tests and did a lot of research to see if, historically, rather than go into cash, we’re going into long treasuries. If they’re in an uptrend, could we have had better results? And the answer was yes. And that makes a lot of sense. These are negative correlation to each other. So if you have an effective rules-based process for when to own each, you can have even better results, and that’s been the case.
So at the end of February of 2020, things were starting to fall and dip, and we hit sell after sell in high yield corporate bonds. And then shortly thereafter, we got buys in long-duration treasuries. Why? Because when markets go risk-off, when they start to get nervous, they start selling, they flee risk on, and they go to the safest thing they can find, and that turns out to be long-duration treasuries. So we were 100% in that in March. If junk starts to have buy signals, which it did in late April, we’ll flip back into that. So it’s really three assets that we will hold, junk bond funds, long-duration treasury funds, or cash, if neither of those are an uptrend. It’s really, I guess, three versus two, but it’s had terrific results this year. We’re really proud of it.
Meb: Yeah. I mean, it makes sense. I think a lot of people outside of the trend world assume that bonds aren’t as trendy, which is not really the case, the junk bonds, corporate, and emerging as well seem to all display some pretty nice trends over time. How do you guys think about the possibility? It depends on our guests. And sometimes I say probability, possibility, impossibility, I don’t know, of the U.S. creeping into sort of zero negative yields in the sovereigns. The rest of the people always think it’s crazy, but then a lot of the rest of the world is there already. You think it’s possible? Some of the bond shops right down the road from you, I think Minerd or Guggenheim certainly thinks that’s likelihood. You guys got any general thoughts on that?
Terri: Interest rates going negative here in the U.S.?
Meb: Yeah. And if so, is there anything you guys would do differently with the models or that’s just something that becomes a part of the trend calculation and that’ll take care of it?
Terri: So I have some thoughts on that in terms of interest rates. So we started the year in the 10-year treasury at 192. I checked that the other day, I was doing a year in review and I thought, “Is that right? It just sounds so high at this point.” I mean, we’ve seen a 10-year treasury. I think it got down to as low as 34 basis points at the height of the fear episode earlier this year. And what we have been saying, what I have been saying for quite a while now is that this lower for longer interest rate environment that people have come to accept has really become lower forever. I can’t imagine an environment where we’re going to start to see rising interest rates. You don’t have to go very far to read the minutes of the federal reserve and listen to Jay Powell say that he’s committed to low-interest rates, to just follow the fed as they say, and it’s pretty clear that interest rates are going to stay really low.
Are they going to go negative? The fed has been very, very clear that they do not want negative interest rates. Personally, I think that’d be a big mistake. It doesn’t work. We’ve seen that it doesn’t work. Is it possible? Absolutely, it’s possible. But I think the probability is fairly low. We have come up from the very bottom of interest rates, but I think every pundit out there has been pretty close to wrong on what direction interest rates are going to be and where they’re going to be 12 months from now. So how does it fit into our investment decisions? What we do is we look at what the market is telling us. We look at pricing data, we look at trends. Everything is quantitatively driven as to when we buy and when we sell. And so if we see interest rates going negative, that’s going to mean prices are going to go higher. If that hits buy signals for us, then we’ll participate in that. And if it doesn’t, we participate in different asset classes that benefit from a more positive interest rate environment. So don’t have a forecast, and fingers crossed, they don’t go negative because I don’t think that that’s a good thing.
Meb: I’m just waiting for negative yielding mortgages like they have in…where is it? Denmark and South Bay, because the prices are so expensive here. LA, I’m waiting for on both sides, both the corporate, real estate, as well as residential. It’s interesting because you talk about this year already. It feels like a decade thinking back to bond yields at those levels. It’s such a weird time to be thinking about the possibilities, but you at least got to consider it, I think, but that’s also one of the benefits of being able to kind of move in and out of what you mentioned, like junk, treasuries, cash, wherever you may find opportunity. Is this a similar framework you guys use in the all-asset fund? Is that a similar sort of philosophy in that fund as well? And then is that seen as sort of the flagship, or is there some other strategy that would be considered more of the flagship sort of concept you guys run?
Terri: We’ve talked a lot about tactical bond, which is really our newest, latest, and greatest, and we’ve had a ton of inflows into that. And it also…it’s an easier story to tell in that we’re just sort of looking at high yield corporate bonds or long-duration treasuries. Our all-asset mutual funds, the Sierra Tactical All Asset Fund, which is similar…not similar, it’s the same exact allocation pie chart as our conservative allocation, which we run for our clients. And I think those are the only names we have. We name things differently depending on who we’re working with, but the tactical all asset fund is a go-anywhere, anytime mutual fund. And what that means is that it will invest in domestic stocks of any kind. And let me be very clear, always in mutual funds or ETFs, but stocks, bonds, commodities, currencies, you name it. It’s on a list and we run screens to help us see what is trending. It’s the same exact rules. Every single holding has its own buy and its own sell.
And let me explain a little bit more that buy and sell decision. If something is… Let’s say emerging market debt versus junk bonds, it’s a little bit more volatile, will allow more noise, essentially, more volatility. We give a broader band, a wider moving average band for an asset class that’s more volatile. And we determine that band by looking at the historic volatility for the asset class and putting it into our programs to test and see how much volatility we would want to have allowed historically to give us productive results. The all asset fund will, again, will hold commodities, currencies, global equities, global bonds using the same exact buy and sell decisions for every asset class. It’s more complex. And you ask, is it our flagship? It is absolutely our oldest program that we have run for clients, real money track record that shows phenomenal results for 2007, 2008, 2009.
Avoided the drawdowns. The biggest drawdown we’ve had as a firm from day-to-day for anything that we manage is less than 6%. And that covers every crisis that you could imagine. So the all asset fund, which can hold any asset class, has a real money track record that shows less than 6% drawdown at the worst of times. And then if you go into… As we came out of the recession in 2007, 2008, and into 2009, up 35%. So it’s the flagship in that it shows what to expect from our investment results. So it’s our most diverse program that we offer and will hold the widest set of asset classes. So it’s the most interesting to manage, I suppose, as our chief investment officer because I get to look at so many different opportunities that are out there.
Meb: And talk to me a little bit about portfolio construction. Like, how hard in the paint will it go? Does it have sort of bands that say U.S. stocks can be 0 to 10, or is it like the whole portfolio could shift to being all in emerging debt to all in real estate? How does the actual construction…what are the expectations for what it can look like?
Terri: I mean, our all asset is completely unconstrained in every way. It’s unconstrained in terms of asset classes, it’s unconstrained in terms of size of the pie slice for any particular holding or asset class. And it’s unconstrained in how much cash, even, that we’ll have in there. If we don’t have buys in anything, if we don’t see up trends, we’re not going to put money to work. I’m old enough to remember the time before, like tons of benchmarks and tons of style boxes. And I think that that’s been a real benefit for investors because they better understand what’s going on with various mutual funds or ETFs that they’re looking at when it’s supposed to be a certain style or a certain benchmark, but it also means that you’re constrained and you’re hugging a benchmark all the time. What we do not do is say that the S&P 500 was down 30% and we were only down 25%. Like, that just doesn’t work for an absolute return shop like we are.
And so when it comes to the asset allocation, we are very hard to, I think, understand because we don’t belong in a certain style box. We don’t have a consistent benchmark that will consistently define how this thing is going to behave. What I can tell you about all assets is that we’re going to protect on the downside. We’re outstanding. I’ll give us an A+ in defense. Again, less than a 6% drawdown for anything we’ve ever had, but then participating in the upside. So the asset allocation decision is very quantitatively driven. We run rankings every weekend over the entire universe of mutual funds and ETFs and have a bunch of statistics that we’ll look at in terms of price strength and risks that will put things at the top of the list. On a weekly basis, I drag everyone on my team into a room and we don’t leave until we have determined our asset allocation for the next week.
Any adjustments that we need to make most weeks is not much of an adjustment. The same asset classes are showing the same strength. There’s a lot of serial correlation, meaning what happened yesterday is what happens today. But there are other weeks when we’re having big shifts, so we’ll make big changes to our allocation. But I’ll just kind of close with saying we don’t sell anything unless it’s a sell signal. We don’t come in and say, “Well, this thing looks a little bit better. I’m going to sell X to buy Y.” We trust the process, stick to the rules, stay disciplined, even when it’s hard, sit on our hands when something’s not a sell, but also quick to hit that sell button when necessary.
Meb: So we find ourselves… This is literally the day after the election, listeners. So for context, the world, alien invasion could have happened by the time this gets published. Who knows if the election will even be called by the time this is published. So time capsule this as you may, but, Terri, what does the world look to you like today as far as the models? Are you guys aggressively positioned? Is there a certain asset classes that tend to have more tailwinds or exposure? Are there some you guys are shying away from? Any general thoughts on this as we start to wind down this very unique year?
Terri: Oh, my gosh. I know.
Meb: It’s left.
Terri: It’s equally hard to believe that we’re in early November as it’s like the slowest year and the longest year all in the same year, and it’s just sort of classic 2020 that we have Election Day and it comes and goes, and we still don’t know who’s going to be sworn in in January. We just published a piece, actually, I think it’s going out today that I wrote before the election, but for compliance reasons, it takes a little bit longer to get things out the door. But essentially, it’s three ways to invest for the rest of this year. And the point of this was regardless of who gets sworn in in January. We’re about 80 days from that date. I only say that because in that book, “Around the World in 80 Days” by Jules Verne, the concept of that book was that there was this guy, he was a wealthy mathematician and he did all these calculations in the 1800s to show that he could go around the world in 80 days and I thought, “That’s exactly what we do.” Everything’s based in math for us, and if we can show it in the math, it makes sense. And so regardless of who is sworn in 80 days from now, there’s a couple of asset classes that we’re seeing strengthened, and that fundamentally makes sense also.
So before I lose your audience, I’m going to talk about a very boring asset class, which is municipal bonds, which are a wonderful, brilliant way to make some terrific income that’s not taxed. When you can pretty well say that regardless of who wins in January, we’re not going to see lower taxes. Taxes are not going down. They might go up by a lot, they might go up, not at all, but we’re not going to see them lower. And muni bonds obviously offer tax-exempt income, and high yield muni bond funds, in particular, have terrific trends right now to the upside because if the economy is starting to recover, municipalities will recover with them because the default rate risk is quite low in muni bonds. And so I’ll stop talking about muni’s because I don’t want to lose the audience, but you should really pay attention in how part of your taxable wealth in the muni bonds sector, in particular, high yield muni bonds, because the benefits there are very good and not just from an income perspective, but also from the uptrends that we’re seeing quantitatively for those.
Meb: Let’s pause on muni’s for a second, because I don’t know that I’ve ever seen a tactical muni fund, which you guys have as a strategy, which sounds so cool to me, tell us a little bit about it. You would also think that certainly taxes won’t be going down. I don’t think that’s a scenario that’s really a possibility. And so I’m thinking about muni’s, and rates, and state finances. Tell me a little bit about this tactical strategy. That’s fascinating to me.
Terri: Yeah. Thanks for bringing that one up. We don’t actually get asked as much just because, like I said, a lot of people start to get bored by muni bonds. They shouldn’t. Pay attention. We do have a tactical muni strategy. I think you’re right. We are not aware actually of other managers that manage muni bond funds in the way that we do, because, like any other asset class, they will also take that elevator down after taking the stairs up. Four years ago when Trump won the presidential election, muni bonds actually fell out of bed. Why? Because there was a belief that there was going to be a lot more economic growth, inflation was going to go up, infrastructure projects. It was like all these punches to muni. They weren’t even sure the tax exemption would still exist. Those prices lost months, even years of returns in a couple of weeks.
So you need to be tactical with muni’s as well. You can be more productive in muni funds. A lot of people want to own the individual muni bonds because they feel like, “I can really map out when I’m going to get my coupon payments and when they’re going to pay me back.” And in our view, it’s just not the way to own muni’s. If you own the fund, you can have hundreds, sometimes thousands of bonds in the same fund and you can go out on the credit spectrum. So high yield muni’s can make a ton of sense. High yield muni bond funds can make a ton of sense. They’re absolutely in an uptrend, we’re 100% invested in our muni bond fund and have been since April. Got completely out of the way in March, which, again, every asset class, except for long-duration treasuries, collapsed in March. So you want to get out of the way because you can lose everything you just made over the past year. So that’s why we’re tactical.
When we get sell signals, like I’ve mentioned, when that rising trend, not just kind of flattens out but moves down with enough strength that it hits our sell level, we hit the sell button and get out of the way and wait for that downtrend to end and start moving back up to an uptrend. And so a tactical approach to muni’s is actually…it’s unique for us, but we think it’s absolutely the way to participate in that. And so I’m glad you brought up that approach to muni’s because I don’t think you just sort of buy and hold them, even though sometimes people think they can. It can be a recipe for losing money in bad situations.
Meb: So CIO, we’ve talked about bounce around a lot of different topics today, as you look to the horizon, and I mean, 2021, which isn’t that far away, what else is on your brain? Anything you guys are thinking about, any other general thoughts, things you’re writing about that is either exciting, interesting, concerning?
Terri: So again, regardless of who wins, we’re going to follow our… And I mean win in the presidential election or senate races, and all these other political things, and also we have this health crisis that’s going on. I think the headlines will go back to that. In short order, we’re going to follow our rules-based process. And where we’re seeing trends, we’ve talked about two of them so far. We’re seeing uptrends in junk bond funds and we’re seeing uptrends in muni’s. So here’s the third one that we haven’t touched on. We’ve got lower interest rates, bigger deficits, and that’s a recipe for a weak dollar. And we’re seeing strong trends in certain emerging markets. So muni bonds, yes. Junk bonds, yes, and even emerging markets stocks is something that, I think, haven’t gotten a whole lot of attention, at least in this conversation, but even more broadly, that looking outside of the U.S., there are certain country ETFs that are showing some nice uptrends because they’re coming out of the health crisis. They don’t have the political issues that we’re facing right now here in the U.S. And with a weak dollar from lower interest rates, bigger deficits, textbook case for a weaker dollar, we’re actually seeing some strength in unique country ETFs. So South Korea is an ETF that is showing a strong uptrend. It’s gold standard, really, for how they’re managing their political environment, their economic environment, and the health crisis that is touching the entire globe. So you can barbell your strategy with muni bonds and emerging market stocks. And we think that based on our research and our study, those both make sense right now, surprisingly.
Meb: That’s music to my ears. I love emerging markets and have been kind of very vocal about this for the past few years. And part of it is just a demographic sort of economic allocation idea concept, but it’s also that most U.S. investors, even relative to the global index, are so woefully under-allocated. I think Goldman said the average stock exposure that they see in client accounts for emerging markets is like 3%. And it doesn’t mean that it has to be a ton, but I think the index is like 15 or something. But when you think about world GDP, it’s actually now a majority, and you have so many tailwinds and you have this rare scenario where you have about three things going for it. One, you have the trends, which I love to see. On the other hand, they’re cheap across most value metrics. Most of these emerging markets are half or less the valuation in the U.S., and then you have these demographics and under allocation. It’s like a perfect storm of everything, and people hate it. There’s like… I post on Twitter about emerging markets and there’s no more contrary indicator than how angry it makes everyone. So this is like my favorite asset class, because it’s got everything going for it right now. So I love…
Terri: We’re going to incorporate the Meb Faber tweet rule into our emerging market decisions. That sounds like a good one.
Meb: I don’t know why. There are a few topics, but this one, in particular, just triggers people. And part of that has to do, of course, with investor time horizons. You and I have been at this long enough to remember a time, not too long ago, the past decade from 2000 to the financial crisis where emerging markets stomped U.S. stocks. And then before that, they had their moments over time and also they love to go into crisis mode every few years, but everyone does.
Terri: Well, and you mentioned that home country bias. In every country, investors tend to be over-weighted in our home country stocks, and you see that with emerging markets, absolutely. There’s so many different behavioral biases that once you’re aware of them, you need to try to overcome them. You said you went to the University of Virginia. I went to the University of Michigan undergrad. I did my business degree at Columbia Business School, but undergrad, I went to University of Michigan and I had two majors there. One was economics because I love the logic and the rules of it, but the other one was psychology. So I majored in a very logical major, as well as like a behavioral study and the decision-making aspects of human behavior and learned about all of these biases that we have, that you need to be aware of. And so if you hate something, that’s not a reason not to own it. You need to be aware that there’s opportunity sometimes in that your emotional biases can wreak havoc on the overall return of your investment portfolio.
Meb: South Korea, definitely an interesting one. Are there any other countries popping their head up above water or is it sort of a broad swath?
Terri: I think you can do a broad swath and, again, emerging market equities versus the debt. And specifically, South Korea is the one where we’re seeing the best strength right now. And I think it’s because of this sort of economic recovery. If we were having this conversation a year ago, the biggest question that we were getting, and maybe you were talking about it a lot too, was when are we going to enter a recession? And now the question is, how do we benefit from coming out of a recession? I mean, a year ago I talked a lot about what I call the four horsemen of the apocalypse, which is just four metrics to watch that said a recession is coming and you need to get out of the way, and they all occurred, but that inversion of the yield curve that’s such a consistent indicator, we saw that in August of last year, where the two-year treasury yield was higher than the tenure. It’s not normal when that happens and it happened this time to, like clockwork, there’s a recession in the next six months or so. And that exactly happened. Well, now, the question should be, what we should be asking is, who’s coming out of that? Whose directional growth it is to an economic rebound? And if you look at emerging market stocks, as you pointed out, I mean, they’re stronger growth rates, younger populations. We’re seeing a shift now, economically, that hopefully continues. And so you absolutely need to put those on the radar. I don’t have other countries that we’re recommending right now. You can take a broad basket through EEM as an easy way to participate in it or look at specific countries. And again, for us South Korea, which maybe is not even an emerging market anymore, but for us, it’s showing strong uptrends as we hopefully are starting to rebound out of the depths of the decline that we’ve seen globally in the economy.
Meb: It’s interesting you mentioned that about the yield curve. We had Cam Harvey on the podcast and he was talking about this last summer and. I think it was last summer. I will post the link to it in the show notes. But the critics, of course, will say, “Well, yeah, but there was a pandemic. We have never have seen that coming.” But a lot of the indicators, like you mentioned, were already sort of flashing either yellow or red warning signs. The four horsemen, what are the other three?
Terri: So we used to talk about the four horsemen of the apocalypse, and that comes from…it’s a biblical reference, actually. That when you see these four horsemen galloping towards you, the end of the world is coming. So that was the analogy here. So what were four things that we could have shown historically mean that the end is near? So one of them that is the most consistent was that inversion of the yield curve between the 10-year treasury and the 2-year. So just again, briefly, it’s normal for a 10-year rate to be higher than a 2-year, and every once in a while we see that flip. And for the past 50 years, every time that’s flipped, there’s been a recession in the next 6 to 9 months. But there are other things that also occur. We see housing starts peak and start to fall ahead of a recession.
So you mentioned that interest rates and you want housing prices to come down in certain areas, but when people are more confident about their job, about the prospects for it, about the future, they’re making money, they’ll buy a house. Homebuilders are very, very sensitive to that and they stop building when people aren’t buying. So when housing starts to peak and starts to fall, that’s another sign. Consumer confidence falls ahead of a recession. And then unemployment rate rises above its 12-month moving average ahead of a recession. That was the last one that we saw. But if you see three of these flashing, it means that there’s probably a recession coming. And one of the reasons we studied it wasn’t because we were trying to make a prediction about the recession, but when you see a drawdown of 10% in the U.S. stock market, if there’s a recession coming, the next leg down, the probability of the next leg down is much higher. If you have a 10% decline in the S&P 500 and there’s no expectation of a recession in the next 6 to 9 months, it’s an opportunity. So this view of whether the next leg down after a 10% drawdown is down or up, you can better inform your investment decision based on that view. And so in February into March, when you start to see a 10% drawdown, the next leg was down because we were entering a recession. And in hindsight, these four indicators works beautifully and that inverted yield curve, you could almost just use that one in the future.
Meb: Talk to me a little bit about… You have a background at some pretty storage shops. You mentioned Franklin, they are world-famous fixed income. And certainly in the early days, some of the emerging market debt and some of these just massive funds, and even further back, some of the really first investors all around the globe as a true global investor, and then other shops like TS and Mercer, you then joined Sierra, and you talk a little bit about there’s rules-based process, but you come to it with a background and ideas. What does the research evolution look like? You mentioned, you’re not coming in the Monday morning meeting and saying, “Hey, we need to go buy IBM, or we need to think about wheat futures or something.” But how’s the research process worked about tinkering with the models? Is this time different? Are they broken and we need to update them? I know it’s something a lot of investors consistently struggle with, is asset classes or models go in and out of sort of favor. Or is it just a soft spot or is it broken? Talk to us a little bit about just the whole approach.
Terri: I think what’s kind of cool about the investing profession is that experience really goes a long way, sort of living through different environments and actually managing money in them is a real great learning. So I came out of Columbia Business School, which is a value background with an outstanding understanding of balance sheets, and cash flow, and projections. That’s the alma mater also of Warren Buffett. I mean, we were a value shop, and I absolutely applied that learning out of the box at Franklin. And we’re a value shop in many ways. Again, I think I mentioned I was a junk bond analyst to start. I worked on the Franklin Income Fund. I also worked at the Franklin Small Cap Fund, which, at the time, was the largest small-cap stock fund in the country. We had to rename it the mid-cap fund because all of our small-cap buys kept going up and launched a new small-cap fund. But that was deep, fundamental research, roll up your sleeves, kick the tires, visit companies, look at a lot of statistics in the world, and then make a projection as to how things should work.
And what I learned there was great. And I think there’s real value in value investing in fundamental study of companies. But also what was really frustrating is that you can be right on paper, and I’ve made the right decision and the stock is cheap and it should go, “It’s too cheap and I want to own it.” But things can stay cheap for a long time, or you can catch a falling knife. I like to use that phrase, when a stock is really falling and it’s falling too much. And what I’ve learned over the course of my career is a technical overlay and a quantitative overlay can help drive that final buy and sell decision. So having a fundamental background and a quantitative background, I think, is really beneficial, as well as sort of a hardcore econ and also a behavioral understanding of the markets. Because I think that the technical side actually, really, is driven in a large part by human behavior. Where I am now is having a very clear understanding as to what’s going on and what’s driving the markets, but also that quantitative overlay about when to buy and when to sell, because you can be wrong for a long time and you don’t make money in those periods. In fact, sometimes you lose money just because the market’s not recognizing perhaps what your research is showing. So we run serious studies now, quantitative studies to test and refine the rules that were already in place at the shop to tweak them as necessary or confirm what we have been doing. So I think that’s a great way to invest, is to use all the tools that are out there to make your decisions, but then stick to them in a disciplined way.
Meb: Yeah. You know, it’s funny, the evolution, I talk to so many value investors, and depending on their stripes and flavor, you really have been going through a tough period. And we have some value funds, so I can relate, but there’s almost… For all the value investors I know that have implemented some form of risk management across their portfolio with what you mentioned, some sort of trend, trailing stops is something that’s a little harder, particularly at scale to talk about, but same general concept. It almost universally improves their performance, and the main reason being is that it removes the fault all the way to zero outliers. And those can kill a portfolio, particularly for those that struggle with the concept of, like, a martingale double down all the way down, and then kaput.
Terri: In my experience, having been in the investment world now longer than I want to quantify, but most people, when they come into investing, they come in with a love for it. My mother’s father gave me some paper shares of Union Pacific when I was 16. “Here are your shares.” And I was like, “Thanks, grandpa. What am I going to do with this?” But it really piqued my interest in investing. And what I have found since then, and always being involved in this, is that usually when you start out and even sort of in it for a while, you can be kind of better at buying or better at selling, but you typically don’t come in better at both. And I think that the thing that I learned, I think I learned I was better at buying. I was better at finding the upside potential and finding something that was cheap, but that selling thing was something that had to come with some time.
And so I think, for your audience, if you feel like you’re better at one than the other, you really need to study, “Okay, when am I going to sell and how am I going to make that decision and really practice it?” And that’s something that I think absolutely can improve your performance if you, for me, and for our programs and our work, getting out of the way, because that elevator goes down so fast and can wipe out returns so quickly, that if you don’t have something to kind of protect against that and then start growing from that higher level, instead of all the way down in the pit, all the money that you’ve lost, your returns are going to be better. And we found that consistently in our own research and our studies, and I think our results show that, that downside protection, kind of making money by not losing money is something that we’re very good at and that I apply on a daily basis.
Meb: It’s not just the optimal from the portfolio and performance risk-return statistics, but from a behavioral and psychological standpoint, drawdowns are the emotional killer. And we usually tell clients, we say, it’s like a Richter scale in reverse. So every 10% down, it gets exponentially more painful and emotional and worse compliance with your strategies. So down 10 is usually people are complaining, they’re angry, but it really flips after that, down 20, and then everything down after that, 30, 40, 50, 60, 70, 80. This is like talking to everyone in Texas right now in the energy patch, which is down like 80. It gets worse, and worse, and worse. And as everyone knows about investing, but also speculating, gambling, anything, if you don’t have a bankroll, you can’t bet. And if you get taken out of the game, that’s the worst thing that can happen. So many people want to optimize on the best risk and return and all that. It’s all well and good, but making sure that you can at least sustain is the thing that we say is by far the most important, which is hard for people, the losses are what creates the most problems.
Terri: I would agree with that. And you can control the risk. You can’t control the returns as well or at all, but you can control your risk. And so a huge takeaway, I think, hopefully, for this discussion that we’re having is have a sell discipline, have a rules-based sell discipline that gets you out of the way for exactly the reasons that you just outlined now. But I mean, you can lose so much money, and then the more you lose, the harder it is to sell and the harder it is to come back. Our sell discipline is pretty tight, very tight because you want to manage that risk and get out of the way fast.
Meb: And it’s important on a rules-based process, whatever it may be, is you have both sides, the buy and the sell. I mean, we talk to so many people who just kind of wing it. I would say 95% of investors we talk to don’t have any form of written investing plan. And this, in many cases, includes advisors. They often will just kind of say, “Well, here’s what kind of what I do.” And then when it hits the fan, like the zombie apocalypse this year, back to the financial crisis or the internet bubble, 50 others, we can talk about, people panic and they sell. And I know that you probably have spoken to many, and it’s so disheartening people that say, “I sold all my investments in 2009, I just couldn’t take it and never invested again.” And it’s heartbreaking.
Terri: There was that last decade where it just…you couldn’t make money.
Meb: Well, you’ll probably see it again this year, where people in March, they said, “I can’t take it. I got to sell everything. The world is ending.” And then here we are. We wrote an article in March talking about this. I said, “Regardless of what you think the world’s coming to, you have to at least consider in your head a bull and a bear case.” And there’s a scenario where stocks are hitting all-time highs by year-end and people are like, “That’s crazy.” And the benefit of having the rules to say, “We don’t know, we can’t predict the future.” At some point, we’re going to start reinvesting in whatever your approach is if you have one that gets in and out. The buy and holders, they just go ostrich, head in the sand. That’s fine. But that takes a pretty steely resolve to be able to survive that, I think.
Terri: Yes, it does, the sort of set it and forget it. And there’s some benefit for that for a certain allocation of your wealth that you’re really just kind of setting aside and not going to look at. But for most people, as you pointed out, their time horizon is not 30 years, it’s not 20 years. It’s something less than that. And so to the extent that you can…selling with a discipline, and ours is quantitative, and based in math, can protect against those downsides so that you can make more money going forward. And it also protects against what you just described, that sort of like, “I’m getting out and I’m never coming back. I can’t take it anymore,” which is not a good solution either. It’s not a good solution at all. And it doesn’t have to be that way. So having a process and a set of rules and the discipline to stick to them, that I think is also a critical part of the conversation. You could have it written down, but you need to trust the process and have the discipline. And the way that we’ve become confident in that is, A, a track record and, B, that constant testing and refining as necessary, which I think helps.
Meb: So people that are listening to this, you guys have some funds and philosophy is that I love. Obviously, I’m a trend guy at heart, but how do most advisors, individuals put this into practice? I’m assuming you could make an argument that these funds could be the core or entire portfolio, other investors, they may be using a satellite. Like, how do they incorporate this into their overall allocation?
Terri: I’ll just use our tactical mutual funds as the examples and then we have similar SMAs, separately managed accounts that follow the same discipline. But the easiest to kind of look up online and study and understand are mutual funds. So we have a suite, we call it a suite because it’s four mutual funds. We touched on the Sierra Tactical All Asset Fund. That’s a one-ticket solution to all of your needs. It is conservative. I will highlight that because of our sell discipline and staying so tight to that, and a massive bull market, we’re going to participate, but we’re not going to be the sexiest fund out there, but it is the full ticket solution for everything if you just want to set it and forget it in a tactical approach. We also have our tactical core income fund, which has consistently outperformed the Barclays agg. So that’s basically a one-ticket solution for fixed income.
Our newer two funds that have been introduced since I’ve been on board are single asset class, the first, the tactical bond fund, Sierra tactical bond fund. Again, we were up in March and we were up in May. That’s up a little over 10%, I believe, year to date. And that’s that sort of risk-on on high yield corporate bonds are in an uptrend and risk-off when long-term duration treasuries are in an uptrend and junk bonds are falling. So that fund has been around for a little over a year. We already have over a billion dollars in that Sierra tactical bond fund. So that’s our latest. And then also the tactical muni, which we touched on. So for taxable fixed income, allocation in your portfolio, that is a great solution. So both of those, we’ve introduced it in the past several years since I’ve been on board and we’re really proud of the results that they have. And I think we deliver what we say we’re going to deliver, which is we’re going to protect on the downside and we’re going to participate in the upside, but really, we’re going to protect you on the downside. So if you have worries or clients that are fearful or just more conservative, we believe our solutions. That’s where our sweet spot really is.
Meb: I think that’s a conversation that seems to be increasing in nature on my side is, what to do about bonds in this sort of world of super low rates? Investors are looking for different solutions, certainly, that’s the sort of chase for yield has been going on for a while, but now there’s very little to no yield, people are starting to reassess, I think, a lot of the role of what is fixed income, what are bonds, how does it fit in their portfolio? These are just some interesting ideas, kudos to you guys. I think that’s some fun concepts. Terri, what has been your most memorable investment in your career? Is there anything that comes to mind that has been wonderful, terrible, but the one that’s just seared into your brain? It can be anything.
Terri: So many ways to answer that, my most memorable investment. Well, I mentioned I was given stock certificates, paper certificates when I was 16 for Union Pacific, which they’ve paid a dividend quarterly for like 100 years. And that really started my interest in investing. I started seeing trades, for example, thinking about, “Wow, how did that stuff get into the store that I’m shopping in?” But I think you learn the most when you lose money, unfortunately. And, hopefully, you do that in a small way. One of my first high yield bond recommendations at Franklin was a dog, and we lost money on it. And it was so painful and horrible because I really thought that my analysis was right. But you learn a lot in those situations. And I learned the time when you lose a lot of money. And then you asked for one, and this is my third one, and then I’ll stop.
The third one is absolutely this proof of concept that my team and me have been able to deliver in our tactical bond, this sort of high yield corporate bonds, long-duration treasuries signaling quantitative approach that has had such a great track record this year. It’s hard to sell, as you’ve talked about. It was hard to sell our high yield corporate bonds, which have been trending nicely for over a year. We didn’t want to sell those. And it was hard to buy long-duration treasuries. It’s like, really, if I buy long-duration treasuries, that means, I think that interest rates are going to continue to fall, and they are already at record lows, but it was a trust the process type of decision. So the pique my interest trade, the lose a bunch of money and be humiliated, but learn a ton trade, and then finally the proof of concept that we’ve had most recently. So I guess that would be my answers to your questions about memorable investments I’ve had.
Meb: Those are great. And my friend, Mark Yusko, has a quote that I absolutely love. I attribute it to him. I don’t know if it’s his or just an old investment adage, but it says, “Every investment makes you richer or wiser, but never both.”
Terri: That’s great. Love Mark. He’s a great dynamic. Richer or wiser, that’s a great way to think about it.
Meb: Never both. And this whole concept of, like, learning from failures in investments, so many people, you have those scars and that’s what you learned from. Terri, this has been a blast. Where do people find out more information on you guys, what you’re writing, what’s on your brain? Where do they go?
Terri: Thanks for pointing that out because we do publish a lot and I get to do interviews like this, but never for so long. Thank you for the time. You can learn more about us at sierramutualfunds.com for our mutual funds and then oceanparkam.com. So Ocean Park Asset Management, oceanparkam.com also shows different ways that people can work with us on a separately managed account fashion.
Meb: Great. Listeners, we’ll add those to the show notes. Terri, thanks so much for joining us today. I look forward to having some fish tacos in Malibu.
Terri: Awesome. I look forward to that too, Meb. Thank you so much for the time.
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 love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. My current favorite is Breaker. Thanks for listening, friends, and good investing.