Episode #374: Phil Huber, Savant Wealth Management, “Expected Returns For That Classic 60/40 Stock Bond Mix Is Significantly Lower Today Than It Has Been In Recent Past”
Guest: Phil Huber is the Chief Investment Officer for Savant Wealth Management, an independent, fee-only wealth management firm providing comprehensive financial advice to individuals, families, and businesses across the nation. He worked for Huber Financial Advisors from 2008 until it joined with Savant in 2020. He’s also the author of The Allocator’s Edge: A modern guide to alternative investments and the future of diversification.
Date Recorded: 11/17/2021 | Run-Time: 1:14:02
Summary: In today’s episode, we’re talking all things alternatives! With the traditional 60/40 portfolio facing some headwinds going forward, investors and advisors may be looking to add alternatives to their portfolios, so Phil wrote an overview of the different alternative asset classes. We walk through the different alternatives, what sleeve of the 60/40 they should replace, and then talk about the behavioral aspects of implementing some of these ideas.
Be sure to stick around and hear what Phil thinks about the collectibles space as they’re becoming more accessible to investors, and what collectibles he has himself.
Sponsor: Public.com is an investing platform that helps people become better investors. On Public, ownership unlocks an experience of content and education, contextual to your portfolio, created by a million+ strong community of investors, creators and analysts. Start investing with as little as $1 and get a free slice of stock up to $50 when you sign up today at public.com/faber.
Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159
Interested in sponsoring an episode? Email Justin at jb@cambriainvestments.com
Links from the Episode:
- 0:00 – Sponsor: Public.com
- 0:50 – Intro
- 1:25 – Welcome to our guest, Phil Huber
- 4:36 – The inspiration for writing Allocator’s Edge
- 7:41 – Episode #57: Radio Show: 17 Different Million-Dollar Fintech Ideas; Phil’s background
- 12:39 – How Phil thinks about and defines alternative assets
- 15:09 – Breakdown of the Horsemen and the past, present and future of alternatives
- 17:28 – Mental challenges of addressing alternatives and when to include them in a portfolio
- 20:58 – Sponsor: Public.com
- 22:10 – Rules of thumb when including alternatives in a traditional portfolio
- 25:57 – Overview of insurance linked securities
- 30:05 – Catastrophe bonds, managed futures and trend following as diversifiers
- 33:06 – Position sizing
- 41:22 – Advisor risk
- 43:53 – Nobody Ever Got Fired for Buying Vanguard…
- 44:41 – Thoughts on the collectibles space and owning wrestling memorabilia
- 48:54 – Nobody Wants to Invest in Your Shit
- 49:32 – Why it’s important to be open and curious an investor
- 51:44 – What’s in Phil’s nostalgia portfolio and speculative assets
- 56:14 – Three implementable alternatives to incorporate today
- 58:58 – What Phil would love to allocate to but finds undeveloped or too difficult to integrate
- 1:06:43 – The current interest in alternatives and feedback on his book
- 1:09:09 – Phil’s most memorable investment
- 1:09:46 – Learn more about Phil; bpsandpieces.com; Twitter @bpsandpieces; savantwealth.com
Transcript of Episode 374:
Sponsor Message: Today’s episode is sponsored by public.com. Visit public.com/faber and get a free slice of stock or ETF up to 50 bucks when you join today. I’ll tell you why later in the episode.
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 y’all? Great episode today. Our guest is the Chief Investment Officer at Savant Wealth Management, an independent fee-only wealth management firm, and the author of the new book, “The Allocator’s Edge: A Modern Guide to Alternative Investments and the Future of Diversification.” Today’s show we’re talking all things alts. With the traditional 60/40 portfolio facing headwinds, investors and advisors may be looking to add alts to their portfolios, so our guest wrote an overview of the different asset classes they’re in. We walk through the different alternatives, what sleeve of the 60/40 they should replace, and then talk about the behavioral aspects of implementing some of these ideas, like cat bonds, trend following, and more. Be sure to stick around and hear what our guest thinks about the collectable space as they’re becoming more accessible to investors, and which collectables our guest has invested in himself. Please enjoy this episode with Savant Wealth Management’s, Phil Huber. Phil, welcome to the show.
Phil: Thank you, Meb, for having me. It’s been too long, man. I’m used to seeing you once or twice a year on the conference circuit so it’s been a while since I’ve seen your face. Hope you’re well.
Meb: I was going to do a big intro for you where I was going to be in the left corner, weighing…you look nice and slim post-pandemic, 185 pounds, in the right corner out of his bedroom with his mom visiting in town, which is where I am, currently. I just got back into town. But it’s good to see you.
Phil: Yeah, speaking of wrestling introductions, I got to say, of all the endorsements on my forthcoming book, on the book jacket, yours is probably my favorite. I know when I reached out to you and asked if you’d do the favor, your response was sure, but on one condition. There’s going to be at least one wrestling reference in there. So, yeah, if we just take a look at your little blurb, it’s got reference to a body slam and ringside seats. So thank you for keeping me on brand.
Meb: We’re going to come back to that in a little bit so don’t get… to make you a little nervous. I have a very clear memory from Lawrence Joel Veterans Coliseum, I think that’s where it was, watching Hogan as a child. Would it have been at Lawrence Joel? I’m trying to think, as a young fellow. Were your family wrestling fans or this is, you’re just kind of, like, the outlier that…
Phil: My dad got me, like, super into it when I was like four or five years old. I remember just the action figures and he’d bring home VHSs from Blockbuster of “Survivor Series” or something, and you look on the case and it’s got all the characters. It just seemed like a super cool thing. I think what got me really hooked was just going to some live events as a kid. My dad had a friend who worked in, like, Chicago Media and knew some of the people backstage. And so there was a couple of times where my brother and I got to go backstage during shows and meet Hulk and Macho Man and stuff. So I think just getting to kind of see your real-life superheroes in person, that kind of sold me for life. I’ve got a picture in my office and…
Meb: You seem like an “Ultimate Warrior” sort of guy. Who was your man?
Phil: In that era, I loved the “Ultimate Warrior.” I was big into The Rockers tag team, which ultimately Shawn Michaels was part of that and he broke off and went on his own. I would probably say Shawn Michaels might be my favorite all-time wrestler. I was this huge fan of his.
Meb: Good. Well, my goal is to work in as many wrestling references throughout this podcast. We did one where we were talking with Chris Cole about elements of portfolio and he was talking about Dennis Rodman and I was trying to say, okay, well, you’ve got 95 balls, whatever year we use, was Jordan even on, 95, 98 balls. Who does each person represent? MJ was, like, U.S. equities. I forget what Rodman was. He was like tail risk or something, long ball. So we have to try that with maybe some…
Phil: Definitely a long ball, yeah.
Meb: Yeah. With some wrestling moves. What does a private equity represent as a wrestling move? It’s probably, like, the face rake.
Phil: “Million Dollar Man” Ted DiBiase.
Meb: Yeah, it depends if you’re the LP or the GP. If you’re the GP, it’s Ted Dibiase, if LP, it’s the face rake.
Phil: Yeah. Exactly.
Meb: All right, so you wrote a book. Listeners, it’s probably out by the time this drops. It’s called “The Allocator’s Edge.” I saw an early version. It’s awesome. It’s even got the periodic table in there, which you’ll see what I mean. You should buy it. It’s great. What was the inspiration? Or you just said, “You know, I got this…”
Phil: You were the inspiration. It’s the only book that has trend following and Farmland in the same book. So those are two areas near and dear to your heart that I know. So in a way, I think I wrote it directly for you but…
Meb: Well, it is good you didn’t ask me because if you’d asked me I would say, “Absolutely don’t write a book.” Did you find the experience enjoyful? Is that a word?
Phil: I found it fulfilling but I also found it incredibly time-consuming, and challenging, and difficult, and probably why it was so fulfilling in the end of getting to the finish line. But, yeah, I mean, it’s a big-time commitment, especially when you’re not a full-time writer and it’s not your day job. You got to find the time on nights and the weekends to get the job done. So it’s tough. I’ve got a young daughter at home and time away from her on weekends. So I’m glad to have it behind me now and I’ll be back to family life on weekends and just a more normal schedule. But, no, I’m super proud with how it turned out. It was like a bucket list type of activity that I’m really happy that I did. So it remains to be seen whether there will be a second book at any point. If you asked my wife, she would tell you absolutely not. Well, let’s talk in a few years.
Meb: The writing experience, you now get to call yourself an author instead of a writer. Author means you, like, everyone writes. But to actually publish something, you’re now an author, no matter how many copies you sell. I have a summary of quotes on writing on my blog somewhere that are pretty funny that you will certainly relate to. But one of them is, “There’s nothing hard about it. You just sit down at a typewriter,” in this states the quote, of course, “Sit down at a typewriter and just open up a vein.” But the writing process, so much of it, it’s not the actual writing process, it’s the editing process.
Phil: And the research process too. Like, that was what I found. Probably the most surprising was a long time spent on it, just how little of it was actually spent writing. Part of that was procrastination but part of it too is just this is a very comprehensive book and a pretty broad topic, which is alternative investments. And there’s a lot going on underneath the hood and alternatives, a lot of different categories and asset classes and things like that. So there’s just a ton of research. And a lot of areas that I was very familiar with, others less so and I really had to bone up and do a ton of reading for it too.
Meb: Well, don’t forget too is that you write a tweet, you write a blog post, you get something wrong, you can correct the link. You can correct the figure. You can delete it. When that sucker is in print, that’s going to be there for a non-insignificant amount of time. I remember getting my very first book. So excited. I remember this like it was yesterday, going into like a local coffee shop, I think was actually a Pink Berry. But I was trying to remember Pink Berrys were even around then. Sitting outside and trying to read the whole thing and finding a table where they had misprinted part of the table and it just being, like, the saddest day of my life. Just like nails on a chalkboard. No one else in the world would probably notice, so you definitely will get a few of those.
Phil: I already found a couple of typos and it feels like a gut punch when you find them but then…
Meb: It’s just like how did I miss this? Like, this has been… Like, we went through this 500 times.
Phil: Every single book ever written, I think has at least one typo and you’re going to worry about it far more than anyone reading it. So, I’ve moved on.
Meb: So the cool thing about this book, we wrote a blog post, which became a podcast. This may be like 7 years ago, but it was basically like $17 million Fintech ideas. And one of the Fintech ideas which has not been well pursued, that I think this book fits part of the overall idea was basically a guide to alternatives, investable alternatives. Walk us through the inspiration. Why did you start this book? Why’d you write it? Why did you need to get it out there and what’s sort of the premise? And then we’ll get into all the different parts as we go along.
Phil: Probably a good opportunity as to backpedal a little bit and give a bit of background and my role and what I do. So my day job is I’m the chief investment officer for Savant Wealth Management. We’re a registered investment advisor based in Rockford, Illinois, but we have a footprint across a number of different parts of the Midwest and even out East and West as well. I think we have around 20 office locations, 7 states, about $12 billion in assets under management. And so we do comprehensive planning and wealth management for our clients and I oversee in my role as CIO, the investment portfolios that we build to offer our clients.
Meb: Didn’t you guys team up with someone and then also acquire someone? You’ve been busy.
Phil: I’ve been a part of Savant now for a little over a year-and-a-half. Prior to that, I was the CIO for Huber Financial Advisors, which was an RA that my father founded back in 1988. I was there for 12 years of my career and we were in business for over 30 years in total, and then we merged with Savant in February of 2020. So similar role today I have at Savant that I had at Huber. And so, when I think about why I wrote this book and this topic, the target audience for this book is ultimately, I would say, financial advisors and other professional investors and allocators who are trying to get a better grasp on how to understand, implement, and communicate alternative investments for their end clients. And so really, A, the topic was just near and dear to my heart because I just felt very passionate about it. It’s one of the areas I’m constantly fascinated by and doing my own reading and research on.
But also, in my own day-to-day, because my role is really there to support advisors and conversations they’re having with clients, and it became very clear that despite the average alternatives allocation for our clients being in that kind of 10% to 20%, ballpark, that sleeve or in the various strategies underneath the hood and that sleeve, we’re accounting for the vast majority of the questions that clients had about their portfolio, because it is a lot of new areas that people aren’t as familiar with relative to stocks and bonds. And so, I saw an opportunity where there was, and I think, a decent size education gap that still needs to be filled, not just for our end clients, but also for the professionals and the advisors and the CFPs that are serving them. And so, that was kind of my mission behind it was to really try to demystify the why, what, and how of investing in alternatives.
Meb: I mean, I feel like the initial starting conditions we have today, which is seemingly well-known, but also well-known for a few years now as far as the narrative on the challenge that everyone faces, which is U.S.-centric, 60/40, 50/50, whatever you call it. I think it’s probably a bagel or a doughnut over the next decade, as far as real returns, depending on what you guys eat for breakfast, where you’re located or you going to get nothing for the next decade. But until that starts to play out… It hasn’t played out yet, stock’s up 20% this year, so.
Phil: You’re fond of saying that the valuation is a blunt timing tool and people have been proclaiming the future death of the 60/40 portfolio for many, many years now, which I think speaks to why you can’t necessarily time these sorts of things and you don’t necessarily want to make all or nothing moves with your portfolio. But I think the math is pretty clear that expected returns for that classic 60/40 stock-bond mix is significantly lower today than it has been in recent past. And so I think that’s where this book actually starts is Chapter 1 is literally called “Hindsight is 60/40” because I think our collective hindsight is quite fond of 60/40. Because it’s treated investors quite well for many, many years, and particularly over the last decade, where we’ve seen abnormally high returns for both the stock and bond sleeve, relative to the risk being undertaken. So it’s been, not just a great return experience, it’s been lower risk than typical as well. And so, that kind of smooth ride, it becomes easy to figure out why it’s been so challenging and difficult for advisors and their clients to step off that 60/40, broaden out the spectrum to other diversifiers.
Meb: Yeah, I mean, the challenge was 60/40. That’s well-known in the U.S. in particular, everyone thinks of it in terms of just one country. And if you were to say, okay, well, let’s say you move to Spain, are you going to do a 60/40 in Spain? I’m assuming, no, that’s crazy. Why? I mean, that’s what people do in Spain. If you do it in Japan, do it in Australia, UK, everyone would say it’s crazy everywhere else except for your own country. And that goes on at home country bias. But let’s not spend time on 60/40 because your portfolio is, depending on your perspective, a whirlpool, a rabbit hole, a treasure chest of different ideas and places that you can put your money. You have a quote in there. “We live in an area where alternatives can stand on equal footing with stocks and bonds as a third pillar.” Is that you?
Phil: Yeah…
Meb: Let’s talk about how you think about alternatives because that means a lot of different things to different people. Like, if I talk to someone at lunch today, they may think that real estate is alts. You talk to someone else, they may think foreign stocks is alts. It’s probably changed over the years, but we obviously know some things are alts, like managed futures. Like, no one considers that plain vanilla. What does it mean? Like, as we start to move away, how do you think about that world? What’s next?
Phil: That’s what makes it so hard. And that’s why the second chapter in the book talks about how alternatives is the most loaded word in investing because it means many different things to many different people. The definition is not constant and there’s no necessarily universal agreement on what constitutes an alternate. I actually included a snapshot of a tweet poll I did a couple of years ago, where I kind of asked the audience, how do you classify publicly-traded REITs? Is it alternatives, part of stocks, real estate in a real asset category? And the results were pretty much split down the middle. Some people, again, REITs are one of the 11 gig sectors. Most people view it as the stock allocation, others viewed as an alternative, some as part of a separate kind of real asset category. So, we can’t even agree on what to call things. So it’s very much a semantics issue. The other part of it, too, is that it’s constantly evolving. I think you alluded to this a minute ago, but things that were once deemed alternative 10, 20 years ago, are quite commonplace today, things like high yield bonds, emerging markets, commodities, tips, etc.
There’s a lot of sort of satellite categories that are typical in most model portfolios today, but were actually pretty novel 20 years ago. And so you kind of expect that to continue to evolve over time. Like digital assets or crypto is another good example where a lot of it depends on who you ask. If you ask the grandparents, then yeah, that’s probably very much the definition of an alternative. If you ask someone in their late teens or early 20s with crypto in their Robinhood account right next to their stocks, they’re kind of interchangeable. It’s almost more foreign to them to own bonds as opposed to crypto. So, there’s so much grey area when it comes to alt that I think that’s part of what makes it so interesting is the fact that there is so much to dig into and it’s also why there’s a lot of confusion and that’s why I thought there was a good opportunity to try to demystify and address some of that here.
Meb: Yeah, I mean, real estate’s always a funny one because you talk to people and it’s probably the most commonly owned asset anywhere. I mean, they own their house. And they own it often, usually with leverage. And so those two topics by the way, like real estates, for some reason being an alternative asset and also everyone being uncomfortable with this concept of leverage, which is weird because everyone already uses it almost on a daily basis. All right, well, let’s talk about the horsemen. What do you want to talk about? Where should we begin on this journey around the world?
Phil: Yeah, the horsemen are kind of an interesting idea in that the whole middle part of the book really is a different chapters on the different buckets of alternatives.
Meb: Who’s molybdenum on the periodic table? Do you actually spend your time lining them up? You’re like, okay, I want to do a little secret Easter egg where carbon is actually, you know, the oil and gas energy or something?
Phil: I’ll let you find that Easter egg. The middle part of the book kind of part two is really the past, present, and future of alternatives. That’s the way it’s designed and structured. And so, the first chapter in that section is what I call the four horsemen of alts. They’re the things like if you say the word alternatives, what are the areas that most people kind of conjure up in their mind? And, for me, that was things like, it’s private equity, it’s hedge funds, it’s real estate, and broadly speaking, natural resources, which you can say gold, commodities, etc. Those are kind of your too big to ignore categories. They might not necessarily be appropriate for every investor, but they’re generally where people go when you say the word alternative. And so, I spent some time there. Not all those categories are appropriate for the average individual investors but then from there, it’s kind of a progression into some of the more modern alternatives, things that are a bit more liquid, a bit more accessible to the average investor.
And then we finish that section with this idea of the future investable universe. What are some of the novel asset classes that are a bit new today, but might be more mainstream and in 5, 10 years, call it, so? The categories covered in the book are those four I mentioned earlier, those kind of four horsemen, things like alternative risk premia, which is really quantitative systematic approaches to hedge fund strategies. And then we have insurance-linked securities, things like catastrophe, reinsurance, real assets, alternative credit, and then things like digital assets and other more novel areas. So that’s kind of the progression of how I go through each category.
Meb: So much of it is, like you mentioned, where you’re from your background. If I talk to my Canadian friends, if you even considered mentioning precious metals and mining as an alternative asset, they would lose their mind.
Phil: Because it’s traditional to them, right?
Meb: Yeah. Yeah. And you talk to people in other parts of the world about bonds, if you’re over in Europe and bonds are negative-yielding sovereigns, it’s a totally different perspective. You go to Japan and talk about equities, the culture of equities in Japan is totally different. That market’s gone nowhere for 30 years. Let’s talk about some of the weird stuff, the different things. As I think about alternatives, one of the challenges other than they’re often confusing new to people, is it often feels like an excuse just to charge a ton in fees. Hey, the local L.A. stable center is now getting named after crypto and it’s getting named…
Phil: I just saw that this morning.
Meb: It’s getting named after crypto, and not because of anything other than probably that they’ve made a ton of money, and crypto has some of the highest fees of anything anywhere, oddly enough. As you think about alternatives, a lot of the challenges like when I said this a long time ago about the liquid alternatives newsletter, where you’re like writing about these ideas, one of the challenges I had was one of the problems of newsletters is you’re going to end up saying so often that, hey, look, this is something you should avoid, rather than invest in. So how many of these categories do you think it’s something that checks the box as being okay, this is a valid category, I think, almost universally. Is it most of them? Is it a fraction of them or is it, like, totally dependent on how you implement it? How do you think about approaching this, the mental, huge challenge of even addressing this entire world?
Phil: I try to make it as comprehensive as possible. But that comes with the caveat that not everything I’m writing about in the book is something that we would necessarily recommend or include in a client portfolio. I would say the majority of things written about in there have some place for a decent amount of people we work with, but others that are maybe more, I would say client-specific. And a lot of that has to do with there’s certain alternatives that are literally restricted to people that are purchasers only. So 5 million and above in assets others that are restricted to accredited investors, and each has its own definition. We have clients that fit all three of those, non-accredited, accredited, and qualified purchasers. So, right out of the gates, that can kind of limit your universe of what you might be able to even consider. The other portion of liquidity, a lot of clients or a lot of people, in general, have very specific intentions or designs and wanting to be fully liquid in their portfolio.
So, again, there’s certain less liquid asset classes that if you’re not open to some portion of your portfolio being a non-daily liquid investment, that whittles down your universe a bit more as well. And so, ultimately, it’s going to depend on a lot of functions that your tax sensitivity is going to be one area. Like, it’s hard to generalize completely, but a lot of alternatives can be somewhat tax-inefficient, depending on their ability to generate capital gains that get distributed or maybe it’s a high degree of ordinary income that gets taxed at the highest marginal rate. You have to be very cognizant of some of the tax considerations involved, some of the liquidity considerations involved. And so there is no one size fits all alternative portfolio out there for each investor. It’s going to be ultimately something that has to be figured out based on your own personal circumstances, hopefully, working with an advisor that can help you figure out some of those nuances.
But it is a tough nut to crack when it comes to, there’s no perfect portfolio. And I think a lot of it, people have come to the table with their own experiences and their own expectations when it comes to alternatives. So sometimes when there’s a mismatch or a prior bad experience, that might color their thinking on alts because, again, even if it’s totally different categories, like…managed futures versus real estate, if it’s all bucketed as alts and someone had a really bad experience in a non-traded REIT 10 years ago, they might just swear off alts altogether, regardless of whether what you’re putting in front of has anything to do with what they’ve previously invested in.
Meb: I don’t know what you mean. I have a perfect portfolio.
Phil: You’re the exception to the rule.
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Meb: Did you ever hear of the YouTube channel back in the day, I don’t know if he’s still around called Will It Blend? This was kind of like when the iPhones were first coming out. This guy would just, like, put stuff in a blender and see if it would actually like chop it up or not, and just like get 1 million views because they put the first iPhones in there and they would blend them and…
Phil: I had not but now I kind of want to check that out…
Meb: Yeah, well, we’ll add it to the show note links, because people were just like, “Oh, my God, he has a $500 phone into this one.” Anyway, I was thinking in my head is you’re talking about this as like this personalized situation is there should almost be a alts website where you have your portfolio and you’re like, hey, will it make a difference if I put 5% into this gold ETF or this Farmland fund? It’s like, will It blend? But I feel like 99% of the time, like, the output would be like, “Nope, you shouldn’t use it. Like nope, nope, nope forget about it.”
Phil: Are we going to be racing to GoDaddy after this to see you can claim willitblend.com first?
Meb: There’s zero chance Will It Blend is available. So as we look around, do you have any rules of thumb, where you look at a traditional portfolio, you’re talking to these advisors and say, look, let’s say they got stocks, bonds, globally allocated, and let’s say they have real estate already, what do you think….? This is Phil’s hat. You’re chatting with some of these people, what are some of the ideas where you would say, “Okay, these are some we should start to think about that I think are thoughtful.” This could be personal and not firm view. This is your own personal commentary.
Phil: A high degree of overlap in both. I would say, you know, if we’re thinking of that classic, retiree or almost retiree investor who historically has been in that sort of 60/40 type mix. For us, the bigger concern going forward longer-term for someone who’s got multiple decades through retirement and other financial goals that they’re trying to accomplish, the bond pieces is a little bit concerning. But at the same time, the answer to bonds being unattractive going forward doesn’t necessarily mean just own a lot more stocks. That creates a sequence of return issues or just clients that just can’t stomach the volatility of having significantly more inequities in their allocation. And then, of course, valuation considerations as well. So if you stick with the status quo, do you take on more equity risk or do you open up a third pillar in your portfolio? And if you do, how are you sizing it and where are you sourcing it from? And so when I think of what we are largely trying to accomplish, like, yeah, like, I would agree that stocks are quite expensive today, but they’ve been expensive for a while. That’s not a great timing tool.
And at the same time, you often see the valuation numbers pointed at something like the S&P 500 U.S. only large-cap stocks, heavy allocation to the big tech names, etc. The way we design equity portfolios is very global in nature, very much factor tilted, biased towards value. So not that our equity portfolios are extremely historically cheap levels, but certainly not apples to apples with, like, the S&P 500. So, I think the stock part, we were confident that longer-term it’ll still accomplish a lot of the heavy lifting for a diversified portfolio. And we don’t necessarily want to dismiss or not own bonds. Bonds can still play a critical role in our portfolio for deflationary environments, like providing liquidity, providing a stable source of income, despite the actual yield being relatively low. You know, we don’t want to forego it completely.
So, if we think about where we’re carving it from, it’s more so from the bond side, but not entirely. And what we’re trying to include in that mix is things that we think have compelling diversification of stocks and bonds, but also the ability to generate meaningful real returns net of inflation, but we’re not trying to outkick stocks here. We think stocks are still going to be the long term winner when it comes to the highest returns in the portfolio, but we think we can get somewhere in the middle, somewhere where we’re getting better returns than bonds, but still offering good diversification in different market environments. And so, the types of things that are I think, critical for that type of objective would be things like catastrophe reinsurance, cat bonds…
Meb: Let’s pause there, I’m going to interrupt you so we can explain what that is. That’s actually something I don’t think we’ve done a single episode on that actually is, like, a huge pet interest of mine. I think it’s fascinating. If you go back 10 years, we used to have the CATB ticker reserve because I was like, “Man, I would love this as a fund but there’s basically no way you’d get this in an ETF structure unless you were to do some swaps or something.” Walk us through what insurance-linked securities and cat bonds are?
Phil: For those unfamiliar, reinsurance is essentially insurance for insurance companies. When I talk about catastrophe reinsurance, it’s insurance for natural large scale events, things like hurricanes, earthquakes, wildfires, etc., across the globe, where an insurer is looking to offload a portion of the risks they hold on their balance sheet to a reinsurer. And so, insurance-linked securities, broadly speaking, is a way for investors to participate in that risk transfer mechanism. And so, there’s a number of ways that can be done. There’s a few different types of insurance-linked securities. The most common and the most liquid form of ILS is cat bonds, catastrophe bonds. It’s an interesting category in the sense that it’s existed for many centuries, but the ability for investors to access it is still pretty much in its infancy. Third-party capital participation in this asset class is still relatively new. It’s largely just been kind of held on the balance sheets of the large reinsurers across the globe, lot of them publicly traded companies, companies like Swiss Re and Trans Re and Munich Re, etc. Historically, it’s been a pretty attractive risk-return profile in that there is an index for cat bonds. It’s called the Swiss Re global cat bond index. And it’s got a history going back to don’t quote me on this, but I want to say the early-mid 2000s?
Meb: Might even be further than that.
Phil: I think it’s got about 20 years. And what you’ve seen is that, and this includes Hurricane Katrina, all the big hurricanes of 2005 and some of the activity of the last few years, but what you see over the full history is that you’ve gotten, not equity returns, but pretty high single-digit returns and relatively low volatility, and basically zero correlation in stocks and bonds. And so, these are floating rate insurance, generally speaking. So no interest-rate sensitivity. They’re typically held in special purpose vehicles. And so there’s no credit risk being assumed. It’s purely accessing this uncorrelated risk premium for burying the uncertainty around catastrophe risk. And so, it can be a little frightening to some because it just sounds very, you know, scary and dangerous. But at the same time, it’s been quite a rewarding diversifier for those that have held it long-term. And what’s unique is that there are a handful of 40 Act registered investment products out there today that provide access to this asset class.
And so, depending on the type of ILS you’re targeting, some are available in mutual funds, which are daily liquid, but part of the 40 Act regulation around mutual funds is your capped at holding 15% illiquid investments. And so cat bonds are deemed liquid enough to fall into that liquid bucket, but there’s other forms of ILS things, like quota shares and other types of ILS that are completely illiquid. They’re like annual contracts. There’s no secondary market liquidity for them. And so, they can’t be held in size inside of a mutual fund. But there are a couple of funds structured as interval funds, which we can get to more if you want as well. It’s kind of an emerging fund structure that is a bit of a middle ground between truly private funds and 40 Act registered funds. It’s got some commonalities with both that we can walk through but that interval fund structure is less liquid.
There’s quarterly repurchase offers, which means you can hold asset classes that you couldn’t otherwise necessarily hold inside of a mutual fund or an ETF. So that’s been a growing fund segment that’s opened up the doors for things like illiquid insurance-linked securities, but also different forms of private credit, real assets, things like Farmland and infrastructure and Timberland. All things that are accessible now in the interval fund structure that prior to that adoption, you probably would have had to go into a typical kind of GP, LP private fund structure to get access to which, again, would be a limited audience and significantly longer timeframe from a liquidity standpoint.
Meb: Yeah, I mean cat bonds, this whole area, we talk a lot about this when it comes to trend following, but also with certain asset classes, Farmland would be another that people don’t really allocate that much to. But if you were to blind it, meaning say, “Okay, I’m going to give you 5 asset class characteristics since 2000,” for example. Which ones you’re going to pick or run your optimizer, and how much are you going to put in these? Cat bonds would be a decent chunk. Because the beauty is it doesn’t correlate to anything. An earthquake in Japan may not affect fires in California, which may not affect…and there’s 20 different types of risks. It doesn’t have to just be natural disasters. And you can have them across the globe in different variations. And it’s like one of the all-time uncorrelated, particularly if you diversify it. And again, we don’t allocate to this. What’s the name of the group that’s famous for the public funds, is it Stone something or rather?
Phil: Stone Ridge, Pioneer is another fund family that’s got some ILS products. I think there might be one or two others. And so, that’s the type of stuff that for us kind of fits the bill of what you’d want to include in a diversifying bucket. A few other examples are things that we’ve mentioned earlier, managed futures, trend following, which is typically what managed futures funds are doing. If you look blindly at just asset class characteristics over the last 20 years, you’ve gotten great correlation benefits, like decent returns, maybe not so much in the last few years but it’s been a valuable diversifier, especially in the time that you want diversification most. If you look at the worst quarters for the S&P 500 and measure that against something like the SG trend index, which is a compilation index of underlying CTA managers, that’s historically delivered fantastic relative returns in the worst times for equities. A lot of things can be diversifying most of the time but then when you know what hits the fan, that correlation goes out the window and everything spikes, whereas we’ve had much more reliability with something like managed futures. So that’s another example.
A few other buckets would be middle market direct lending is an interesting credit allocation. By real assets, I’m referring to all-cash flowing but non-real estate types of real assets. So infrastructure, Farmland, Timberland. There are interval funds that access those asset classes too. And then the last category would be something like event-driven. It’s a broad catch-all for things like merger arbitrage, where it’s sort of systematic hedge fund-type strategies where you’re trying to capture liquidity premium in different types of corporate actions or activities. And so, ultimately, what we’re trying to aim for is not necessarily alpha-granted managers or strategies, but more so different types of alternative betas, if you will, that we think have a high degree of intuition, but also data supporting the fact that they’ve worked in the past. And then that intuition kind of gives you that confidence that, hopefully, they’ll work their work in the future too. And so, I think you want that with any alt is, yeah, like, has it made money historically? Like, you want to check that box, but we’ve certainly seen our fair share of great backtests. And anyone can create a great backtest but if it lacks that sort of intuition as to why should I expect to make money in this over time? What risk am I being compensated for? Like, you need to check that box too.
Meb: Yeah. And, listeners, one of the nice things about Phil’s book is he actually named some names. So you can see examples of some of these funds in the appendix and elsewhere. So it’s not just like a lot of theoretical. And there are a lot of great charts. I want to come back to some of the strategies and keep going on those. But I thought it’d be instructive. One of the big challenges for a lot of people, CalPERS, listeners, individuals, advisors, everyone really, is how do you put it together? So you have a portfolio of traditional assets, how do you start to think about how much position sizing…which one of these make it and which ones don’t? So, as you accumulate more of these 60/40, then, okay, I’m going to add 5% of capons, 10% of managed futures, 3% to merger ARB? How do you think about position sizing, one, and as a part of that same question, how do you think about then adding and deleting things?
As the portfolio gets more diversified, do you have more bets? How do you start? Because going back, we’ve had some conversations in the past. And I recall an old Goldman article that they tried to run an optimizer and it said, “You should put 50% in trend following.” They were like, “But you can’t do that because that’s too much.” Right? And so then they just limited it to 20%, in which case, it was 20%. How do you think about putting this together? Because that’s a really hard question that a lot of people are rambling on, but there’s a lot of people that’d be stressed for days and months about, should they buy gold and then they put in 1% and say, “Well, that’s never going to even do anything?” So how do you think about putting it together?
Phil: The portfolio at the end of the day, like, I think Cliff Asness has come up with this made-up word, it’s called stick-to-itiveness, where the client’s got to be able to hold on to it. So I think that sort of limits the upside of how much you can allocate to alternatives because you are starting to deviate into a lot of different areas and you’re adding more line items to the portfolio. So anytime you sit down with a client, the more individual holdings or line items and asset classes you have exposure to the, you know, higher likelihood you going to have something at any given point in time, having poor relative performance in the short term and the client wanting to own less of it or not at all. And so that’s the behavioral risk. On the flip side, you’re not doing much good if you say, “Hey, we going to put 2% or 3% or 5% in alternatives and spread it across a bunch of things because it’s just not enough to make a difference.” So it’s got to be enough to make a difference, but not too much that it’s going to create some behavioral risk. Using best practices, I’ve found that range to be like 10% to 30&. Like, above 10% starts to matter a little bit, above 30%, you’re probably in a risk of going too far away from convention.
Meb: Are you talking about for an individual allocation or all the alts together?
Phil: For alts in total. And then I would say, like, once you decide what your overall pie looks like and then what the components underneath are in terms of where you’re sourcing and how you’re sizing it, like, I think, if the intent is I want to maximize diversification, then you probably want to overweight the strategies that have a little bit more history of doing well when things are going poorly. Again, like, if we’re comparing a couple of things here, like a good example would be middle market direct lending, that’s got some credit data, that’s got some correlation equity. You expect in a recessionary environment, that’s probably going to not necessarily do as bad of stocks or as bad as things like high yield bonds, but it might not have its best outing during that type of environment. Whereas something like trend following, we have a long history now of seeing that trend following works pretty darn well in prolonged bear markets.
So if that’s your downside protection and equity diversification is your utmost objective, then you might want to tilt more towards the things like cat bonds and trend following that are a little bit more structural and they’re non-correlation. Whereas if you’re looking to maximize current yield or income, then maybe you’re tilting heavier towards credit and real assets. A lot of it will have to do with investor objectives. And some of it, like, you might have a roster of alternatives and you might just have a higher degree of conviction in one over the other, so you might want to just kind of conviction weight it. Just have a higher weighting of the things that you truly, strongly believe in. You’re going to hold on through thick and thin, and these are hold-for-life type allocations that you might have that you might want to give those a higher degree or something you’re not as sure of, but you feel somewhat decent about, maybe you give that a lower weighting if you’re not feeling as good about it.
So a lot of different mechanisms. There’s also the argument for just equal weighting it. Like, you have a 20% target, you’ve got 5 alternatives or 10 alternatives. Try not to get too cute with it. At the end of the day, no matter how you weight it, they’re all going to roughly come up to the same place. So I think just for simplicity, there’s an argument to just equal weighting whatever your mix is. You even wrote a book on this and had a study where you looked at a bunch of different asset allocation constructs over time, and you found that despite their different methodologies, a lot of them arrive at similar spots. So I think same thing here, like, you could try to optimize in how you weight these different buckets. But I think the key is, like, are they adding valuable benefits to you from a risk and return standpoint? And if so, then have some inclusion in their portfolio. But whether that’s 1% to 3% relative, so products being 1% or 2%, 3%, like, try to keep it simple and not overthink it.
Meb: There’s two pretty important points you made. One is almost this topic of you see the old asset allocation or strategy quilts, where usually it used to be like U.S. sectors or world assets but you could do it with alts too. And it shows they bounce around and every year, the diversified approach is kind of the middle steady Eddy. The challenge with alts, in particular, because people are less familiar is that investors often will allocate and they have a string of underperformance and it’s gone. Whether that’s 1, 2, 3 years, whatever it may be, that it doesn’t matter what it is. That’s the consistent churn. So having enough to where people can kind of see it as a poll, I think, is an important framing. And I was also thinking, you know, it’s trending in my head as you go down the line where you’re like, the most impactful additions to a traditional portfolio, almost like a four shrank. I’m not going to make you do that right now. But it’s an interesting idea where you say, “Okay, well, if you’re going to add something, these are the ones you should consider first, and then second, and third.
Phil: There’s certain ones that even if they make sense for your portfolio, you might want to just think of them differently than an alternative. Like, if you’re interested in private equity or venture, like, that should really be part of your equity bucket, not your core alternatives bucket.
Meb: Different investors, you’ll see them frame it different ways. So some people will say, stocks, bonds, alts, and then they’ll just those throw everything in the alts bucket. Other people will say, like, growth. So equity, like, sort of investing assets, in which case, the private equity wouldn’t be an alts. It would be in the equity buckets where it should be, like you mentioned. And then they frame it that way, sort of inflation bucket, deflation bucket. Whatever the narrative is, as long as you have the mental framework to work through and think about it, I think is what’s important.
Phil: The beauty is, like, there’s no rule telling you have to categorize things a certain way. So I think I even mentioned this in the book, in that this idea of kicking the bucket of alternatives, I think just throwing everything into one mixing pot can be a little dangerous because you’re lumping things together that have nothing to do with one another. So I think some creativity is a good thing when it comes to how you define categories and how you communicate them to clients. I’ve seen some interesting approaches from different institutional investors and how they bucket things differently. And so I think advisors have their own reporting software. It’s pretty customizable. Typically, you don’t have to follow that canonical stack bond alt framework. There’s ways to probably rethink how we define and refer to these things to try to make them easier for people to hold and easier for them to understand what their role is in a portfolio.
I remember one of the points I was going to make earlier, which was, you start to, like, add in more and more things, and that creates that sort of behavioral risk, I think, you know, one of the things advisors grapple with is, should I build or buy? Should I be building each of these individually or should I outsource that decision to a third-party through some sort of multi-strategy or multi-manager approach where maybe, you know, I get a little less ability to tailor it how I want to tailor it, but at the same time, if I can put a lot of these different, valuable diversifiers in one line item, as opposed to five, and that might be easier for my clients to stick with because it’s one line item versus five. So I think, I mean, ultimately, that’s a decision any allocators are going to have to make based on their own experience or wisdom. But, you know, that’s an interesting decision too. Do I go single strategy and mix it up myself, or do I hire one or two multi-strategy managers to do that for me? One of the main debates is this.
Meb: That’s hard too, because, I mean, one of the biggest challenges, and this is not looking down upon allocators because I have the same problem is that in a world of thousands of funds, and this is why I think that original idea of the liquid alts letter would do so well is that there’s a very real career risk to owning some of these funds. If you own SPDR, if you own bonds, you own real estate, any client gets that and there’s not the risk of them showing up and saying, “Wait, can you explain this funs? Why do we own this? Why is it down?” And the adviser getting upside down on that amount of research it takes to really thoughtfully understand. I mean, a good example was a couple of years ago when you had some of those options funds blowing up, and all of a sudden you have a client that’s like, “What in the F do we own this fund that’s down 90% for? Like, A, how could you ever bought it, and B, can you explain what this actually does? And how many advisors really spent the time to look into it?” And that’s hard. Like, that amount of due diligence, timing, and keeping up to date with it and then how much benefits does it make? Like, it’s a real struggle on the amount of offerings out there. And so, a lot of people just throw up their hands say, “Look, I’m just not going to even fool with it.”
Phil: It’s something I totally can sympathize and empathize. That is a challenge. And I think when I think about, like, why certain advisors might have not yet moved off of 60/40 or why they’ve been hesitant to incorporate alts, it’s for that very reason. It’s not like they’re denying the math facing 60/40. I think they’re smart enough to understand, like, what that’s telling them, but at the same time, there’s that fear or that career risk of I don’t have the bandwidth or the know-how to do this myself and I don’t want to risk getting fired. And that’s understandable. It’s a tough nut to crack. That’s a big part of why I wrote the book was to try to help advisors in that endeavor. I think they kind of know they need to make some decisions and get a little bit more creative with how they build portfolios, but it’s overwhelming. There’s so much product.
There’s such a broad universe of asset classes to choose from. If you’re more of a CFP type advisor versus a CFA or your day-to-day is more focused on client relationship management and financial planning, like, your plate’s full. You don’t have the time to also become the portfolio or investment expert. So it’s easy to understand why the 60/40 is almost like IBM, where it’s like no one ever got fired for recommending IBM. No one ever got fired for recommending 60/40. It’s the easy security blanket, balanced portfolio. It’s just tough. I think it’s going to disappoint a lot of investors over the next decade if they’re not willing to make some changes and broaden the toolkit a little bit.
Meb: We have an old article called, “No One’s Been Fired for Buying Vanguard. Maybe They Should Be.” I don’t even remember what the conclusion is, but we’ll add it to the show note links. That’s why it’s a hard problem. You know, I mean, cat bonds are great examples. It’s like you look through some of these bonds, and if it’s a hurricane, maybe deep in the language, the triggers that winds have to cross 150 miles an hour and they only hit 148 in one place, in another place, they hit 170. And it’s harder. It doesn’t mean it’s not worthwhile. It’s absolutely worthwhile. If you look at, I think 60/40 in every country around the world on a real basis, has had a decline, certainly over 50%, but I think it’s like 2/3. That’s a big Haymaker drawdown. But the alternative, not a pun intended, is hard too. Your book is a great resource to start to go down these rabbit holes on what to invest in.
I want to pick a few and talk about them a little bit and ping you some more questions. One of the areas that I haven’t traditionally invested in that is having its moment and we’ll see if this moment is longer than a few years and has legs is sort of this platform in collectable space. So, whether it’s digital assets, whether it’s art, how do you think about that space? And along that lines, how do you recommend the toolkit for looking at an asset class that… And maybe not totally new is a good description of this one because alt things have been around forever, but has some new apps elements? How do you start to think about analyzing a new asset and what you think about this one in particular?
Phil: I love the topic of collectables. Got kind of two lenses here to think about it from one…
Meb: I’m looking for some collectable wrestling memorabilia in your background. I don’t see it.
Phil: If we were at my home office, you’d probably be pretty creeped out with the amount of wrestling stuff on the shelves. But it’s interesting, like, from a CIO client-facing perspective, I don’t know if the collectables asset class is something that’s like ready for primetime, so to speak, in terms of us having the confidence to say, “Hey, a diversified mix of collectables make sense in your asset allocation.” At the same time, as an individual investor myself, I have a rally account. I have a notice account. I’m entertained and interested in what they are building because I think it’s fascinating. I love this idea that technology is helping to unlock something that historically had… Again, collectables, different types of collectables in art, they’ve been around for a while. Hobbyists have been participating and things like trading cards or what have you. But at the end of the day, for really valuable collectables or art, you’re only privy to it if you’re ultra-wealthy.
What’s fascinating is the ability to not have to take possession of a collectable but you’re participating in a securitization of that collectable and owning a fractional share. I think it’s a really cool concept where you’re broadening this asset class to a whole new generation of investors. And the experience, they’ve built a great experience whether it be Rally or Otis, so I think I’m bullish on that is a growth area of alternative investing. I just think time will tell as to whether that becomes something that’s more direct-to-consumer, as opposed to something that advisors are considering or using inside of their client portfolios. So, I have fun with it, but it’s a relatively small, modest, amount of my own portfolio. Just intrigued enough to kind of play around with it. The collectables are tough, you know, art’s tough, because these are, again, like any non-cash-flowing asset, they’re difficult to value or put a price on. They’re very sentiment-driven and those can flow over time and can go through boom and bust cycles, but fun to watch, like, the different categories that are starting to emerge.
Like who would have thought sealed videogames would be, like, the hot item now? That’s becoming… Again, I think it’s like, as you see certain generations reach their peak earning years, you go back to what brings them nostalgia from when they were little kids and that’s going to be what becomes popular. So whether it’s early Nintendo games or different types of trading cards or, for me, and I’ve got the digital collectable stuff on Rally, but this is a hobby I got back into in the past year, just being locked up with COVID and bored out of my mind, was I collected action figures as a little kid and my parents kept most of them. And they moved houses, so they dropped them off for me. And that kind of triggered my emotional visceral nostalgia to that and I just was like, “You know what, I want to get back into this.” And now I’ve literally got a giant collection of, like, actual figures, like, in my office and basement. That drives my wife nuts, but that’s my personal… But to me, that’s more of a hobby as opposed to an investment.
Meb: My brother’s older, but he had a “Planet of the Apes” bank, and also glow in the dark dinosaur. The “Planet of the Apes” bank was like 4 feet high and the glow in the dark dinosaur that gave me nightmares basically every night. But he had the old school Darth Vader, “Star Wars.” And my mom and family, in general, err on the side of hoarding, which I hated as a youth but now I appreciate because they’ve kept all these things, some of which are probably worth more now. There’s two, I think, lessons here in the way that I approach these asset classes. The first being, the default to me is always like a no meaning, like we wrote an article called “Nobody Wants to Invest in Your Shit.” There was a riff on a famous book and basically being like, look, everyone’s going to market stuff to you. The default is no, but don’t be dismissive. Be curious.
And, for example, these platforms, you and I have been in this world long enough. We know, historically, that’s been a hard asset class. There have been countless wine funds, art funds. They never really scaled. The returns were always okay. Part of that being simply the fees. There’s giant tolls. But at the same time, being mindful and curious. And so some of these platforms now have, for various reasons, having their moment, whether it’s the technology, whether it’s the fractionalization, and they’re having phenomenal success, and the investments themselves, obviously, as well. And so, I should say, one of the biggest mistakes I think any investor can make, and I’ve done this many times, this is speaking from experience, rather than looking my nose down on people is being dismissive or being a naysayer about something forever. Like the way you have to approach almost everything investing is to be curious and engaged because otherwise, you find there are people that are like, “Look, I’m a gold bug and all I do is invest in gold no matter what.” I was listening to a podcast the other day, it was like, “I invest 95% of Bitcoin and that’s it.” And look, good on you. But to not be curious and open, I think is a huge mistake.
Phil: Yeah, I agree. Another Cliff Asness quote I like and you can probably tell by him writing the foreword for the book, I’m a huge Cliff fanboy, so I quote him quite a bit. “Keep an open mind, but not so open that your brains fall out.” I would totally agree there. Like, that’s how I’ve approached some of these more novel areas is, yeah, like, they have a shorter history. There’s not as much data to kind of analyze how they fit in a portfolio. But like you said, be curious, get some skin in the game, play around a little bit. Because I think advisors should be aware of what’s going on in this kind of Fintech space, in that we’re so accustomed to using funds to allocate client money. There’s this growing number of apps and platforms. Like, these are effectively disintermediating the fund complex in a lot of ways and going direct to consumers.
And if you’re owning these, like in the case of Rally, like, you’re owning these collectables through them on this platform, you’re not buying a mutual fund or an ETF. So it’s just a different investment experience. I think it’s going to increasingly become popular and I think advisors need to spend time learning about it and paying attention to it because we could see a future in 20 years where the concept of an ETF or a mutual fund is non-existent anymore. The landscape today is wildly different than it was when we were a lot younger and so it’s going to continue to evolve and so advisors have to continue to adapt and change with the time. So, yeah, I think it’s really interesting stuff to kind of follow along with.
Meb: So what do you got in your portfolio so far on the collectable side without totally opening the kimono? What broad categories? My problem with most of these is I want to use them, so I bought sneakers, I bought a bunch of wine but I want to end up consuming them, so totally defeats the purpose of it being an asset because I want to actually consume them. Where have you participated? You said action figures. You got any art? You got any cars? What do you got?
Phil: I haven’t done any art yet. In terms like the Rally and Otis type stuff, I kind of anchor to the things that just like I’m interested in anything that bring me joy or nostalgia. I grew up in Chicago in the early ’90s as a child. So, fair amount of Michael Jordan memorabilia, things like that. Like, I’m not a big sneaker guy, so nothing really in that vein. Some sports memorabilia and cards. I got big into the video game. I just saw that growth area. So that was interesting to me. I’ve followed along with a lot of those. What was there, there was like a… I’m not even a “Star Wars” guy but I saw a Darth Vader original unopen action figure and action figures are my thing. So even though “Star Wars” is not my thing, like, that seemed like a cool offering, rare whiskies. But that’s a cool thing is there’s so many categories that they offer now, like, you can kind of pick and choose your own lane.
Meb: One of the interesting parts of this is probably only true in a modern world, maybe not so much but maybe easier is when you think about speculation, which is collectables, you buy something, you hope that you can sell to someone else for something more. There’s no cash flows, like a farm, real estate stocks have. However, theoretically is now developing an entire area of sort of alternative yield. And so Rally, I think, and others starting to consider this concept of either, obviously, you could have a museum that generates yield. You could have ways to monetize that asset, whether it’s lending it, whether it’s selling. So, like, I was thinking about paintings the other day, selling prints to people and say, hey, look, you can put this in your house and say, well, I own one one-hundredth of this Picasso. And obviously, this isn’t the real one, but that’s what rich people do anyway. They don’t put the real ones usually in their house unless you’re Wynn, you might. On and on, and so there actually theoretically could be some yield from some of these investments. You start to think a little wonky about it.
Phil: Yeah, didn’t Wynn stick one of his elbows through some expensive painting or something and ruin it?
Meb: Yeah, yeah, when you got that much money, whatever.
Phil: Yeah. You mentioned the word speculative. What’s becoming clear to me now, and maybe where I’ve changed my tune a bit in recent years is, I think it’s tough when you come from, like, background that’s focused on this evidence-based investing concept, and that all investing has to be boring and data-driven and all these things, right? I think if you’re smart about it, you can have your serious investment allocation 80% to 90% of your assets. But, like, there’s no reason why you can’t have a fun bucket or a speculative bucket. I think the word speculation, like, you want to limit it… You don’t want to necessarily just really just treat it as, like, this tsk, tsk, like, don’t ever speculate. Speculating is entertainment. It’s fun. Like, I don’t think we should shame people, whether it be professionals, clients for wanting to engage a little bit in that speculative energy that they might have. And some people don’t have it at all and that’s fine. Like, if you want to just be boring with 100% of the portfolio, like, you should be boring with most of it and be rules-based and be process-oriented. But, like, I think you can strike a healthy balance too. If you’ve got the passion and the interest in these areas, whether it’s speculative stuff, collectables are art or if it’s just things like stock picking where you enjoy reading about individual companies and following them and being engaged in that universe. It doesn’t have to be an all or nothing proposition on either side.
Meb: As long as you have this self-awareness that you’re probably not the Stevie Cohen of trading Michael Jordan figures. Maybe you are. God bless you. But just realizing that you’re human and this doesn’t have to be boring as fuck endeavor and having a little fun with it.
Phil: I am the renaissance technology of wrestling figure collecting, that is for certain.
Meb: I was talking to Cory in the early days off Zed Run because he was talking about some of the digital horses. I said, “Cory, nothing would be funnier to me as if you became a gazillionaire from a quant approach to fake digital horse racing,” right? It’s like, all this work all of us do over the decades of, like, you know, an effort and then all of a sudden, you make all your money trading fake horses. I said nothing would make me happier.
Phil: Nothing surprises me anymore. Like, if there’s anything the last year and a half has taught us is that you’re going to be surprised every single day with something that you read about.
Meb: That’s the beauty of it. You know, it’s what makes it fun. So, we’re going to start to ask a few more questions and eventually, you got to catch a flight. If you look at a traditional portfolio, this is a Phil question, feet to the fire, you get up to three choices. What are some of the big dudes, the allocations that you say, “Okay, this is what I would start to add or think about,” as far as the alts in your entire book that really start to move the needle that are implementable today?
Phil: So I got to pick the three?
Meb: Yes. You get up to three.
Phil: Up to three. I’m picking favorite children because we have more than three in our mixes at Savant but…
Meb: Yeah, but that’s not the “Meb Faber” show question criteria.
Phil: No, it’s not. It is not. So I’ll give you three. Two I’ll start with, and I would just say because I think they are the most structurally uncorrelated and diversifying, I would say, reinsurance and managed futures is where I would start.
Meb: Wow, you’re going out on a limb today, buddy. I mean…
Phil: I am.
Meb: …you know, you’re speaking to your audience. When I listened to you on Josh Brown show and he asked the same question, you don’t mention trend following. I know you’re just trying to cozy up to our audience. Okay.
Phil: No. I’ll be all crypto when I talk to Michael and Josh.
Meb: Reinsurance, trend, and you get one more.
Phil: There’s such a Darth yield out there, and not to say you should blindly be chasing yield. I think that gets people into a lot of trouble But I think if you’re evaluating an allocation to credit, whether it be something like high yield bonds or bank loans, I think a better mousetrap, if you’re willing to take on kind of non-investment grade credit risk in your portfolio, is something like middle market direct lending, where there is still more substantial yields. So relatively similar realizes historical losses as those publicly traded categories. But because there’s so much more demand and money flowing into those publicly traded versions of non-investment grade credit, you’ve seen such compression in the yields. And so you’re just not really being compensated for the risk you’re bearing. Whereas in direct lending, these are hold to maturity type of loans. They’re not publicly traded. This doesn’t mean they’re not risky. It’s not that volatile experience that you have in typical high yield bonds.
And so I think something like direct lending, which you can now access via something like an interval fund structure, I think, again, it’s something you want to source responsibly from a moderately risky part of your portfolio. But I think given the yields there relative to what you can get and their publicly traded counterparts, I think that’s a compelling trade-off. And so that was something… You know, we have a lot of income, kind of starved investors that are looking for ways to add some yield to the portfolio without taking a ton of undue risk. And so I think this is a category that fits the bill there.
Meb: Listeners, we’ll direct you to the book there. There’s a lot more discussion of that. That’d be a-whole-nother hour podcast to talk about it. But there are funds that do it. And that’s not one that I traditionally see a lot of people really allocating to. So, cool. What of these strategies in the book in alts do you think you would actually like to allocate to, but either the status today is mostly garbage or it’s too hard, meaning there’s no structure that works for it or it’s just not developed enough as an asset class? Are there any areas where you’re like, “Man, I would love to allocate this, but it’s just not there yet?” What are your thoughts?
Phil: I would say a couple of areas that we are spending a lot of time on the research team level on the investment committee are things like private equity and how there might be opportunities to provide access points to our client in that realm. And then, like, many others, we’re just trying to figure out what digital assets and crypto, what do we think about it? What’s our position? The client demand is not going away? There’s weekly, not daily emails that advisors are getting from clients. Should I add Bitcoin to my portfolio? How should I think about crypto? It’s too big to ignore at this point. And so I think, even if you’re not adding crypto to your model portfolios, which I don’t think many are doing, I think good advisors need to start thinking about how they sing from the same hymn book within their firms on how to respond to the client inquiries on crypto and how to think about it for not necessarily a blanket, yes, all of our clients should own Bitcoin or Eth or whatever crypto mix, but trying to determine who is it appropriate for? Who’s it not appropriate for? Should we be recommending it or not?
But even for the clients that want to do it with or without your guidance, I think we run the risk of…there’s a plenty of bad ways, I would say, to do crypto. I think the futures-based products have an inherent number of flaws, but at the same time, they’re available on all the major brokerages. Same thing with, like, the traded trusts and the premium discount issues. I think for us, it’s more like, we’re a little bit worried on the bad ways that people can get exposure to the asset class. We want to guide them in the right direction so that they’re not paying too much in cost or fees. They’re not getting diluted exposure just because it’s easy to implement it. So I think we’re just trying to be thoughtful about how we engage with clients and have conversations about this growing area of digital assets. And so I think there’s some interesting opportunities. And I think if we talk at this time next year, there might be a chance that there’s an offering that we have in our mix.
So, we’re spending a fair amount of time there. But yeah, we want to help people and guide them and keep them out of their own way a little bit too. And that if you just sort of send somebody off to Coinbase there’s always the risk that they thought they were going to go buy Bitcoin and they saw this Shiba Inu, you know, think some random coin that could blow up.
Meb: And now they’re billionaires.
Phil: They’re either billionaires or get their face ripped off. And we don’t want to have that happen either. So, all right, I guess we’d love if they became billionaires because then they’d become the clients who…
Meb: The crypto space has been odd to me so far because it’s like the inherent message of decentralization or disrupting Wall Street almost at every turn. It’s been an excuse for the toll-takers to charge ginormous fees.
Phil: What’s fascinating too is crypto is one of the few examples of an alternative asset class that kind of went the opposite direction. I like to call it the Benjamin Button of alts, in that most things start with the institutional world and eventually, “get democratized” to a broader audience of individual investors, where the whole crypto ethos and movement started at the individual level. Now, you’re starting to see that institutional adoption or interest. So it’s almost going a bit backwards than most alternative categories go.
Meb: Yeah. I’m surprised there hasn’t been the Vanguard on the public stuff yet. I mean, if you’re going to launch it, and they wouldn’t be in the ninth Bitcoin or Blockchain ETF, I’m just waiting for someone to say 25 bips, suck it. Everyone else.
Phil: Somebody will. I mean, I think the costs are going to come down a lot just based on the amount of competition there. But yeah, I mean, I think it’s still remains a big question mark on what the SEC ultimately ends up doing in terms of spot Bitcoin or other spot crypto ETFs or funds.
Meb: It’s fun to watch. Fun to watch.
Phil: Yeah. Absolutely. Yep.
Meb: We’ll do a big sushi party when the spot happens in the U.S., my evergreen tweet from 2013, saying this isn’t going to make it out is still standing. We’ll figure out a way to celebrate when it eventually makes it out 8, 9, 10 years later. The private equity is interesting. Vanguard made big news, was it last year or this year? I assume Jack is spinning on, like, a rock tumbler in his grave that Vanguard is doing private equity. But who knows? Maybe that’s the…
Phil: He had a hard time with just internationals stocks, you know?
Meb: And ETFs. But whatever. When you think about offering it to clients, do you guys think about doing your own fund? Are you thinking about allocating to various managers, or you think about doing a replication style? What does that mean to you guys? Because it means a lot of different things when you just say private equity.
Phil: We’re still in early stages, so we haven’t arrived at exactly what we want to do here yet but it’s been a topic of research and discussion. I would say what’s maybe the most intriguing is, again, like, there’s so much dispersion across managers within private equity and venture relative to public markets that you want to be mindful that just the idea of, you know, allocating to one manager and one strategy and one vintage year is not the best way to go about building a private markets program. I think, be it limited audience or larger clients and I think that’s just the nature of if you’re going to do true PE, it’s going to be for qualified purchasers and above. You want to build a diversified program and not do it over a certain period of time. It doesn’t have to be all at once. You want to kind of build that program over a multi-year period and eventually have some of your earlier allocations start to be cash flowing and maybe that could start to fund some of your future capital calls from newer allocations.
You know, a smaller part of what we would do if we end up doing anything there, but I think there’s an intriguing number of firms that kind of run these annual vintage programs, where on one hand, it’s an extra layer of fees, which you have to be mindful of. But at the same time, these firms that have this sort of expertise and background in having all these GP relationships, I think that if you could get pretty healthy amount of diversification across managers, across styles, across vintages over a three to five-year time period, then you’ve got, I think, a good way to access the private equity asset class where you’re not over-concentrated in one particular fund, and you can hopefully capture some of the long-term benefits of owning the asset class. So I think that’s probably the most intriguing way to get access through some sort of annual vintage program, but we’ll see. Time will tell.
Meb: Good I’m looking forward to the Huber-Savant alts interval fund launching in 2022.
Phil: You’re the master of ticker symbols, so I’ll have to consult with you if and when we get to that.
Meb: Is SLAM available? We could do body slam.
Phil: Slam, Slam X
Meb: SPLEX, S-U…
Phil: S-P-L-X…
Meb: S-P-L-X…
Phil: S-P-L-X, SPLX. Okay.
Matt: That’s a good one. I think that might be a little tough for people to be like why do we unslam? Yeah, one of the things you briefly mentioned, so we’re doing more work. Look, I mean, people listening to this and advisors too, it’s perfectly acceptable to be still like the Warren Buffett too hard pile, pass. You should never feel the urgency to have to allocate to something. I mean, the FOMO, all these things are going to be there tomorrow and next month and next year. And so this risk of just buying something just because you think, you know, you have to own it almost never is a reasonable choice to make, right? There’s no rush.
Phil: A great investment thesis is not my neighbor bought some or I read about this on the news or something. From our side, we don’t want to be force-feeding anything to people that they don’t want or shouldn’t have in their portfolio. And there’s certain areas of alternatives that are, I think, a bit more client-specific as opposed to, like, we’ve got our house mix of things that we think most if not all of our clients should own somehow. But then there’s other areas where maybe it makes sense for you but maybe it doesn’t make sense here. And so we want to have a little bit of open-mindedness there.
Meb: You talk to more advisors than I do. What’s the current vibe as people were talking about alts? Is that just like, “Hey, I’m fat and happy, because U.S. stock market just continues it’s ascent?” Or, “I’m worried because bonds are zippo, and my gas is getting expensive.” Like, what are people saying? Give us some feedback.
Phil: Most of the advisors I talk to were the ones within our walls here at Savant. We have a lot of advisors, so a lot of conversations. But I talk to other firms and other friends in the industry too. I think there is an openness now to alts. Hopefully, the book is timely in that sense. I didn’t specifically try to write it so that it came out at the time when inflation was spiking and bonds were not doing so high. But I think it just kind of worked out that way. So I think there’s definitely more interest in general on how do I think about thoughtfully improving and complimenting my existing portfolio holdings? And so in terms of like the serving we’ve done internally, the topic of inflation is far and away the thing coming up most often in client meetings. It is very top of mind for our clients, and I’m sure many clients of other advisors across the country.
And while there is no one perfect inflation hedge or a way to isolate a portfolio from that risk, I think we know from history and the kind of sample size of one that we have for the U.S. at least of what a high persistent level of inflation can do over a long period of time to a stock and bond portfolio. It’s sort of the one kryptonite that can cause the…the one variable that can cause both those asset classes to decline concurrently. And so I think having an open-mindedness and including things that either have some positive sensitivity to inflation or just no correlation to inflation, I think is going to become more commonplace now. So I would just say, like, there’s not one great mousetrap for that type of inflation hedge that people are seeking. But I would just advocate have an ensemble approach, build a collection of assets that can just make your portfolio more robust if and when this current environment runs…if it persists, if it’s ultimately manifest, which I’m not saying it will, I’m not predicting it will. I think…
Meb: You can predict, it’s fine. No one will remember.
Phil: No one’s got a great track record predicting inflation and I’m sure I’m no better than anyone else. But like anything in a portfolio, it’s not about prediction. It’s about preparation. And I think we don’t want to just have our portfolios be predicated on this notion of a constant rising stock environment or bonds doing heavy lifting for diversification. We know that’s likely not going to persist the way it has in the past. So I think the portfolios of the future are going to look a lot different. That’s what I tried to write about and communicate in the book.
Matt: Good. Listeners, check it out “Allocator’s Edge” available on Amazon. Phil, what’s been your most memorable investment? It could be garbage, it could be great. Whatever’s just you feel in your heart. I just said it, it popped up in your brain and you’re like, “Oh, that one.”
Phil: The biggest asset on my balance sheet is my equity in Savant, my employer. Prior to joining Savant, that was my equity in Huber financial. When the asset is tied to your blood, sweat and tears holds a different place for you. And so it’s been a great asset for me financially and for my family, but just the sort of proof of culmination of years of hard work. So I kind of view that as more sentimental than anything else I own in my portfolio.
Meb: Where do they go if they want to keep up with what you’re doing, your writings, come find you at your house, check out your toys?
Phil: Yeah, you want to come hang out and play with action figures, be my guest. Before even the book I’ve been writing for years now in my own blog which is Bps and Pieces, bpsandpieces.com. This is B-P-S. Same thing on Twitter, that’s kind of my handle @bpsandpieces. You’ll find me there making jokes and hanging out with Meb and others in the Fintwit world. So my firm websites is savamtwealth.com. Find me there too.
Meb: I don’t think I knew at a basis point, I’m trying to think of what year it was. It certainly wasn’t until after college. I remember hearing someone talk about Bps, I was like, what is he talking about? I have no idea what that is. Maybe I was like 24. Somewhere in that.
Phil: People that are subscribers to the blog, like, friends and family, they’re, like, what is Bps and Pieces? Like, they don’t get the play on words because they’re not in the industry and they don’t know what the shorthand is. So it’s definitely a little inside baseball in terms of the name there.
Meb: All right, my man. We’ll have to do it again soon. We’ll talk about all the weird stuff going on in the world of cat bonds and trend in 2022. Thanks for joining us today.
Phil: Yeah, this was a ton of fun and thank you again, Meb, for your support in the book with the endorsement, but also the help in the earlier drafts. It means a lot. And this was kind of fun today, so thank you for having me.
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 feedback at feedback@themebfabershow.com. We love to read the reviews, please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
