Episode #378: Cullen Roche, Discipline Funds, “QE Is Not As Powerful As A Lot Of People Like To Think It Is”
Guest: Cullen Roche is the Founder of Discipline Funds. Discipline Funds is a financial advisory firm with a focus on helping people be more disciplined with their finances. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Date Recorded: 12/1/2021 | Run-Time: 1:19:22
Summary: In today’s episode, Cullen begins by sharing his framework for thinking about inflation and the impact of both monetary and fiscal policy. He explains the difference between the response to the Great Financial Crisis and what we’re experiencing today and then shares what he expects inflation to look like over the next few years.
Then we get into Cullen’s newest venture, the Discipline Funds ETF, ticker DSCF. He walks us through why he chose to start the fund, the tax benefits of holding low cost index funds in an ETF wrapper when rebalancing, and what the process of launching an ETF was like.
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Links from the Episode:
- 0:50 – Sponsor: GiveWell
- 2:52 – Intro
- 3:40 – Welcome to our guest, Cullen Roche
- 4:27 – Cullen’s thoughts on the macro economic environment today
- 12:09 – Top misconceptions about inflation
- 15:57 – JP Morgan quarterly update (link)
- 16:33 – What quantitative easing means and where people go awry
- 23:02 – Sponsor: Public.com
- 24:17 – Are buybacks good?
- 28:49 – The Discipline Fund ETF; Launching his new fund and the idea behind it
- 37:50 – Cullen’s take on rebalancing
- 41:04 – The Agony & The Ecstasy (JP Morgan)
- 53:56 – Thoughts on active and passive labels
- 57:57 – Why don’t more advisors use an ETF structure?
- 1:00:42 – What the future looks like for Discipline Funds
- 1:04:30 – The ways crypto has him excited and worried about the future
- 1:09:33 – His most memorable investment and learning to build a house
- 1:15:46 – Learn more about Cullen; disciplinefunds.com; pragcap.com Twitter @cullenroche
Transcript of Episode 378:
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.
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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.
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Meb: Welcome, everybody. I got a fun show today. Our guest is a long-time friend, and the founder and chief investment officer of Discipline Funds, a low fee financial advisory firm with a focus on helping people be more disciplined with their finances. In today’s show our guest begins by sharing his framework for thinking about inflation and the impact of both monetary and fiscal policy. He explains the difference between the response to the great financial crisis and what we’re experiencing today. And then shares what he expects inflation will look like over the next few years. Then, we get into his newest venture. The Discipline Funds ETF, ticker DSCF. He walks us through why he chose to start the fund, the tax benefits of holding low-cost index funds and ETF wrapper when rebalancing and what the process of launching an ETF was like. Please, enjoy this episode with Discipline Fund’s Cullen Roche. Cullen, welcome to the show.
Cullen: Meb, what’s up? How are you doing?
Meb: It’s a cold foggy day in California. People are watching on YouTube. I’m wearing a sweatshirt. It’s in like the high 60s. I think it’s freezing. Where do we find you today?
Cullen: I’m in North County, San Diego. I mean, I grew up in D.C., so I still remember what real weather is like. I’ve been here for 15 years. But even for people who grew up in real weather, it’s still, this place will delude you of what reality is like, these 60-degree days where you’re wearing a beanie in the morning and a jacket to go outside. It’s crazy.
Meb: It’s bizarre for people like us. The holidays, we’re used to snow and cold. On the other hand, Sunday, I think, I got a mild sunburn from being at the beach so I can’t complain too much. We’re going to dive in all sorts of stuff. I feel like you’re one of the few people that actually understands a couple of the topics we’re going to talk about today. So it’s good to have you on to talk about it, because I feel like the areas that you particularly write about and understand deeply are some areas of big misinformation in our world. So, let’s start with the macro. You talk a lot about macro concepts that people seemingly consistently get wrong, professionals too, kind of across the board, whether it’s interest rates, government spending, inflation. What’s this sort of the economic environment look like? We got Jack over here talking about hyperinflation. Maybe he sees something we don’t, that’s the narrative. I don’t know. What’s it look like from your perch?
Cullen: With my clients and everything, I’m so hyper-focused on behavior that, over the years, I’ve weirdly ended up writing a crazy amount of subject matter on, mostly trying to clarify mythology about, mostly a lot of like the fear mongering that goes on around the macro landscape, basically, to try to help people understand stuff so that they can kind of navigate it without succumbing to… I think the mentality, for a lot of people, is to read something scary and feel like you’ve got to like almost treat your investment account like it’s like a gambling account, where you’re moving all in and out based on these very hyper-emotional reactions to something you saw on CNBC, or something you read in The Wall Street Journal, or on a YouTube vlog that’s predicting doom and gloom. And so over the years, I’ve spent a crazy amount of time just developing an understanding of the Federal Reserve System, and the Treasury system, and interest rate dynamics and kind of trying to focus on a “first principles” perspective of how this stuff really works to sort of providing an unbiased and objective view on how these things work, just so you can navigate through a lot of the nonsense that’s out there.
So, these big moments, like the pandemic and the financial crisis are these huge moments where the correlations of a lot of the asset classes go to one. And everything kind of becomes a function of big macro policy because the government, especially after the financial crisis, they got so involved in really unusual ways through things like quantitative easing and government spending. These packages become a lot more impactful inside of these big macro events. And so they’re really unique in that you can have these periods where these huge policies are implemented. And then they have this big, long drawn-out effect on, not just the economy but the financial markets. And the pandemic, to me, was like a repeat of the financial crisis, in a lot of ways. It was different but very similar in the way that a lot of people responded with the very negative doom and gloom type of mentalities. And it was kind of cool actually having gone through the financial crisis because when the financial crisis started, I understood a lot of this stuff, but I didn’t understand it nearly as well as I did probably by the end of 2009. Because I spent most of 2009 basically talking to people who worked at the SOMA desk, the Fed trading desk. And literally people inside the Federal Reserve, who were like the counterparties, dealing with all of these big operations, very boots-on-the-ground people who, they really knew the accounting and the operational dynamics of all this stuff.
So, it was kind of cool going through the pandemic. Well, cool from a financial side, at least. I had such a better understanding of the way that a lot of this stuff would filter through to the rest of the economy. So, never would have predicted that the stock market would do what it’s doing today. But understanding the operational side of a lot of this stuff helped me, I think, avoid the doom side of a lot of what was going on, especially in March and April, because I understood the way that government spending would ultimately filter through to corporate profits. I was talking about, in April of 2020, how a lot of the government spending was ultimately going to flow right through to corporate balance sheets, that this was ultimately a pretty good thing for corporations. And in the long run, that, while this was inflationary to a large degree in the short-term that…and I still think this, that in the long run, I think that we’re seeing sort of a repeat of the 2010 year, where the government ramps up all these big programs. And I think the main lesson coming out of the financial crisis was that it’s not the Fed policy that causes inflation so much, it’s the Treasury policies. And that was kind of, I think, the big lesson coming out of the financial crisis was that QE is not as powerful, I think, as a lot of people like to think it is in the media. And I think the reason why we never got the high inflation or the hyperinflation coming out of the financial crisis that a lot of people predicted was mainly because the government spending packages weren’t that big.
So, coming out of the pandemic, the packages were much, much bigger. So, I was never worried about a really high inflation or hyperinflation, and it’s probably been a little bit higher than I expected. But the understanding coming out of the pandemic was that the government spending side of all this was really substantial. I mean, these were huge, huge packages where we ran $3 trillion deficits for the entirety of the last two years. So, I mean, to put that in perspective, the U.S. government basically ran like an $800 billion aid package coming out of the financial crisis. So, these were colossal packages that we ran coming out of the pandemic. And that’s why we’re seeing the inflation readings that we’re seeing right now. So, we’re still kind of in this period where the big fiscal packages have had this big inflationary impact. But in the long run, and especially next year, you’re going to start to see a lot of this stuff have the opposite effect, where the fiscal packages are winding down to a large degree. We’re not continuing things like the unemployment benefits anymore. And so you’re going to see a little bit of a giveback, I think, on the inflation side, where we’re probably not going to see pre-pandemic level of 1% to 2% inflation. But I think the people that are predicting the hyperinflation, they’re dramatically overestimating the long-term impact of the government’s packages.
So, I think that as this is starting to get over the hill here with 2021, and some of the recent packages that have expired in the last few months, you’re going to start seeing inflation readings that, by this time next year, probably are much closer to the historical range of something like a 3% CPI. And a lot of that’s just due to the fact that, while you’ve got these short-term packages coming out of these, basically financial panics that the government responds to, you get a very short-term burst of government policy. And then as the government peels back, people get a little bit scared of inflation, the government starts to get kind of a feedback loop from that, they peel things back, you get this giveback effect, where the long-term trends start to play a much bigger role. And in my mind in the long run, it’s the long-term impact that is much more significant with a lot of this stuff. Because you’ve got these huge, huge macro headwinds, mainly coming from things like technology, demographics, inequality, and globalization that these things put a huge amount of secular downward pressure on inflation that it makes it very hard to actually create inflation in the long run, because the government basically has to run huge, sustained policy.
Meb: I know you talk a lot about the differences between the government versus the differences between a household. What are some of the biggest misconceptions when it comes to people thinking about these topics, inflation, government spending, everything that you encounter? Is there like a top three Cullen triggers where you see it and you’re like, “Oh, god, this again? Like, we’re going to talk about this? People don’t understand this as important.” Like, what are some of the top ones, and we can kind of just walk through them?
Cullen: God, the two big ones are probably quantitative easing, and then the way that the government can afford to spend. So, one of the nice things about thinking of things from like, a really big picture, macro perspective, is that you end up taking this big sectoral view of the economy. And technically, there’s millions of sectors in the economy. There’s the Meb sector, and the Cullen sector, and the corporate sector and yada, yada, you could filter down and account for all this in a million different ways. But at the big picture, there’s really like four, there are the corporate sector, the foreign sector, the government sector and the household sector. And when you look at these sectors and the way that they relate to one another, it’s nothing like it is at the household level. So, the way that a lot of people like to think about government spending, for instance, is that people basically compare it to a household, and they say, “Well, the government needs to pay back its debts in the long run, and it should operate with more fiscal constraint.” And the government is just a huge, big sector, just like the whole household sector is. And if you look at the whole household sector as one sector, the reality is that the whole household sector doesn’t pay back its debts. So, while the Meb sector might pay back its debts, the Meb sector actually, in the long run, relies on other sectors, like the Cullen sector to be expanding their balance sheet. And so someone is always borrowing, issuing equity, issuing new debt, you know, and funding new spending in various ways in the future by expanding their balance sheet from nothing, basically.
And so that’s the big kicker is that balance sheets are always expanding, in the long run. The assets are growing, the liabilities are growing. And hopefully, in the long run, you’re making the stuff that makes the assets worth more than the liabilities in the long run. But the kicker is that at the sector level, the household sector is basically always expanding its balance sheet, the corporate sector is always expanding its balance sheet in the long run. And typically what you find is that the government is also expanding its balance sheet, mainly because…my theory is basically that the government gets more involved because the economy just gets more complex. So, you get more rules and more involvement, because you have more streets that need to be kept up with, and more fires to put out, and more wars to wage or whatever it is in the long run that results in the government being a little bit bigger. I have no idea what the right size of the government is.
But the kicker is that, in the long run, there’s nothing surprising about the fact that the government’s balance sheet is basically perpetually expanding, just like the household sector is perpetually expanding its balance sheet. It’s just a great big macro sector that the assets and liabilities are both going to expand in the long run. So, I think a lot of people get that one wrong by thinking of the government as sort of this individual entity that will pay back its debts. The reality is that the government’s actually this great big…it’s actually a multi-sector within its own sector because it’s got a billion different entities by this point inside of the one sector. And all of those entities are expanding because typically the economy’s growing, and things are getting more complex, and, for whatever reason, people think it’s a good idea to keep making the government bigger and bigger. So, the kicker, though, is that the government doesn’t pay back its debts like an individual does, any more so than the household sector does, or the corporate sector does.
Meb: I was laughing when you’re talking about the Meb sector. I’m like, “Come on, man. I’m like the Lannisters. We pay our debts in the Meb sector.” The interesting part to me always was, I think Ken Fisher may have been one of the first to do this that I had seen. And you see it a lot with JP Morgan on their quarterly updates and elsewhere, where it looks at the actual balance sheet of, say the U.S. government. Ken did it, we’ll add this to the show notes links, and then for the individual consumer as well, because everyone’s always focused on the liability side. It’s always interesting to see the asset side too, which people tend to forget about. It’s an interesting way of framing it. So, I’ll add that to the show notes links later. All right. Quantitative easing. What does that mean, and where do people go awry?
Cullen: Yeah, so the thing with QE that I think a lot of people mistake is that the way to actually best understand what QE does is to think of it in terms of its interaction with the rest of the government. So, the Fed is technically… I mean, they’re actually part of the U.S. Treasury, for practical purposes. And so the way that QE really works is that what technically happens is that the U.S. government… so the U.S. Treasury spends a certain amount of money, and let’s say they’re running a trillion-dollar deficit in 2022. And let’s say that the Fed comes in, and they decide to simultaneously run a $1 trillion quantitative easing project at the same time. Well, what does that actually do to the financial assets that the private sector actually holds? Well, the Fed comes in after the fact. So the Treasury expands their balance sheet, they create a trillion dollars of actual new financial assets, new Treasury bonds.
And the Fed comes in after the fact and what the Fed actually does is the Fed basically just expands their own balance sheet to go buy a bunch of the bonds. And they make what is essentially just a clean asset swap with the private sector. So they buy a trillion dollars’ worth of the bond, the bonds come out of the private sector, they go onto the Fed’s balance sheet. And this is the thing that most people mistake is that the Fed’s balance sheet, for all practical purposes, it’s like a black hole. It doesn’t really exist in the real economy. The Fed’s not out there going to Walmart and competing with the rest of us for goods and services. The Fed’s balance sheet is just sort of a nebulous, black hole that it’s there in an accounting sense, but the Fed doesn’t really have or not have a certain amount of money. I mean, they’re just a big bank that they can literally create as much money as they want.
But the kicker is that when they expand their balance sheet, they create deposits through the banking system, in essence, and it results in an asset swap. So what happens is that the person who bought the Treasury bond from the Treasury, in the initial instance, they have a bond initially. But after quantitative easing is implemented, now they just have a deposit. So they actually have an instrument that is of similar or equal credit quality, but they actually have a reduced income. All else equal, there’s actually a decent argument that quantitative easing as its own program is somewhat deflationary, and that it reduces the net income of the private sector, because the Fed’s basically taking that income, and they’re giving it right back to the Treasury. It’s this weird thing where a lot of people look at quantitative easing, and they think that’s where the money printing happens because technically, they’re converting bonds into what we call money. But the reality is that the real asset increases occurred at the Treasury level.
When the Treasury created the new bonds, that’s where the new asset creation actually was implemented. And I think, coming out of the pandemic, this was a pretty definitive understanding because when you compare it to the financial crisis, the big difference between those two policy errors was that the Treasury created a lot of financial assets while the Fed was simultaneously implementing QE. That resulted in quantifiable inflation that we’re seeing now. Versus 2008, the Fed expanded their balance sheet enormously. The Treasury didn’t do nearly as much. And so to me, that kind of proved that the real money printing entity is essentially the Treasury, and the Fed just comes in, and they mess around with interest rates, and they can change the composition of the outstanding assets. But they’re not the true money printer in the sense that a lot of people commonly think they are.
Meb: What are the implications of this sort of misunderstanding, and how does it play out in how you think about markets? Is it something that’s just theoretical and esoteric where you’re just, like, people don’t understand this, but it doesn’t really impact what they do? Or do you think it does bias them towards certain behaviors, and allocations and investments?
Cullen: For a lot of people, I think it results in this behavioral bias where they feel this fear of something that might be the result of quantitative easing that is actually not very likely to play out. So, Jack Dorsey predicting hyperinflation. I mean, I don’t know how many people are selling all of their cash or getting rid of all of their bonds, or piling into tips or piling into Bitcoin or the stock market, or whatever it is, and creating what results for a lot of people, in like an asset imbalance in their portfolio where they’re no longer diversified, because they think that something is going to play out because they read something about hyperinflation occurring that is actually very unlikely to occur. So, a lot of it is just that it creates this imbalance in the way people ultimately view a lot of this stuff because they feel like they need to be hyper protected from something that is a very unlikely event. People scream about stock market crashes, and you read about this seemingly once every few months from some people about how the stock market is going to crash. And if you’re prone to believing in stuff like that, no matter how likely it is, while you’re more likely to remove basically all the equities from your portfolio. And we kind of know, in the long run, that’s a terrible way to try to manage your money, these big all-in all-out types of moves.
And John Bogle was super famous for telling people, you know, stay the course, build a proper asset allocation, and just stay the course with it. Be diversified and make your portfolio behaviorally resistant. And that’s what a lot of this is. I write about a lot of this stuff, not because I’m trading credit spreads on like interest rates or something and trying to take advantage of hyperinflation narratives and stuff like that. I write about it mainly because I’ve got probably like a retiree who needs to maintain a 25% or 30% bond allocation, and they’re standing over the ledge of this asset allocation that they’ve constructed. And they’re thinking, “We need to move all into the stock market,” or “We need to move all into Bitcoin because hyperinflation is coming.” And I think understanding these narratives and really getting a better grasp on how this stuff works, it gives you a better foundation for being able to mainly psychologically navigate a lot of the BS that’s out there.
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I feel like the macro side is always a head spinner for people and you see people that kind of clamp on to the narratives to fit their worldview or fit what they’re selling, I guess would be a reasonable summary. As we think about inflation, and, of course, nobody knows but from your sort of catbird seat, you’ve seen expectations that you think it’s going to stick around for a little bit or the breakfast burritos. What’s San Diego most known for? Is it breakfast burritos, fish tacos?
Cullen: Fish tacos.
Meb: The price has been going up or what?
Cullen: Yeah, I mean, everything’s more expensive. So the fish tacos in San Diego were always undervalued, though. They’re getting closer to their market equilibrium.
Meb: All right. Well, before we leave the macro world, is there anything else either that Cullen believes that no one else does. So, as you like, you look around to your professional peers and say, “All right. I did a whole list of these a year or two ago.” Or you’re like, “You know what? I believe this, but most people don’t.” Or another thing that people are still confused about. Is there anything else kind of in your mind space that you think is an important one to talk about?
Cullen: I mean, we have a lot of, I think, similar views on…we kind of run in the similar small group of people who we don’t think buybacks are bad. And…
Meb: I got to play devil’s advocate. Part of my job as host is not to just to come up with all the stuff we agree on. So, I got to have some fodder for debate. Sometimes I’ll just ask questions and things that I don’t even believe in just to get some discussion.
Cullen: But it’s crazy. It’s really hard to remember in this industry. I think the differentiation between what normal people do every day, which is other stuff, and the nerds like us who sit around and debate about the arcane topics, you know, “Are buybacks good?” or “Is passive investing even a thing?” Most people don’t give a shit about that stuff. And so it’s very hard to sort of remember the language barrier and the thought process barrier between a lot of professionals and the things that we think about all day, probably because we’re bored of dealing with basic asset allocation and stuff like that. The average person who they actually do want to just think, they want to know, “Tell me how much bonds and how much stocks I should hold in my portfolio, and then let me go play golf or work, or whatever I have to do.”
Meb: A good way analogy that I say a lot. It says if you’re a casual observer, new to Twitter, hadn’t been following Cullen an eye for a decade, and countless wasted hours tweeting and were new to like one of our discussions where we were debating some esoteric part of our world, you would think that this is like a huge, impactful wedge or lever we use in our world, when in reality, you and I, and I’m not to put words in your mouth probably agree on the first 90% of the really important things. But because we agree on that, we only end up debating the final 10%, which is less impactful, but probably more interesting and kind of a philosophical discussion because the 90% is almost like a given, like there’s no point discussing it.
Cullen: That’s what’s crazy about finance is that most of the big discoveries in finance have already been made. I think it’s one of the reasons why people spend so much time talking about Bitcoin. I’m always telling people… like, I have a lot of clients who come to me and they’re like, “Hey, should we own this? How much of this should we own? Blah, blah, blah.” And I’m like, “This thing, just to put it in perspective. I know that it gets 50% of the media airtime right now, but this thing is literally 1% to 2% of all of the world’s financial assets.” So it is still a minuscule part of the global financial asset portfolio, but it’s one of those things that it’s new, it’s undiscovered. And so it’s a really sexy topic that I think people are still navigating and trying to understand. And so even though it’s 1% of the actual asset space, it fills up 50% of the media narrative space. Just because, like you said, the 90% of the other stuff has pretty much been turned over. And you sat down, me, you, and Wes Gray, and Cliff Asness and a bunch of other professional asset managers and got us all talking. Well, we’d agree on the vast majority of the principles, and we disagree on the extent to which we want to be involved in factor investing or dividend-paying stocks, and stuff like that. But big picture, most of the portfolios would look pretty similar to a large degree, and I think agree to some degree.
Meb: Let’s talk about the puzzle pieces coming together. You launched a new fund, congratulations, with our friends at Alpha Architect and Wes, listeners, you can hear the Old Wes and crew alumni podcast episodes called Discipline ETF, DSCF, is that right, DSCF?
Cullen: Yep. David, Sam, Charlie, Frank.
Meb: Discipline, but also sounds like discounted cash flow. Was that unintentional or was that just kind of a random that…?
Cullen: No, that’s not intentional. It’s so far from anything that’s just kind of cash flow, or like stock-picking focused. This thing, it owns 10,000-plus underlying stocks and bonds. And so this thing is like super, super diverse. It’s a very first principles-based type of asset allocation, where I’m basically taking the tax efficiency of the single ETF wrapper and putting other funds inside of it and building a multi-asset asset allocation so that we can rebalance somewhat dynamically, and, most importantly, tax efficiently across time. It’s funny, I was talking to the lead market maker of the Fund a few weeks ago, and he was telling me how this fund of funds space is kind of just growing. We were developing the fund and stuff, I was thinking about it. And I’m surprised that Fidelity and iShares has a bunch. But Fidelity and Vanguard, they don’t really have these core fund of funds really built out yet. And it’s weird to me because the ETF structure is literally perfect for running a fairly passively managed fund of fund structure where you can jam a bunch of stuff into one fund and rebalance in a relatively active manner, you know, without all the tax inefficiencies that you find in a lot of mutual funds and the other structures that we see in the world.
Meb: You know, I agree with you. It’s a trend that I don’t think is well-appreciated yet. We talked about this in years past where we say, “Look, these all-in-one concept funds, people get it when it comes to target-date funds.” They haven’t been that adopted yet in the ETF space, in the HiFi world. It’s still almost like a trillion in the mutual fund inefficient tax inefficiencies. And we looked at this, and we’ve talked about this many times. But on average, this is speaking on averages, the spread between the average ETF and average mutual fund is about 70 basis points and ditto for the tax efficiency. So, just from having the ETF structure, you’re looking at probably a ballpark 150 basis point difference per year. And so that dam breaking, and that flood, it’s like when it’s cracking and all the water shooting out in different directions, it hasn’t totally exploded, and we’ll see what causes that. Usually, a bear market causes people to sell what they’ve got, and then afterwards, you know, reallocate. They never go back to the fund that charges 2% for nothing. So, off my high horse, let’s hear about this Fund. Talk to us about it. What was the inspiration? And then let’s dive into how you, guys, go about it.
Cullen: I got started on this road, like a lot of you, guys, did, because I was running separately managed accounts for clients. And I’m running 100-plus different portfolios that are running a version of some broader strategy that I’m customizing at the client level. And even though it’s probably a lot better than what the client would be doing individually, it’s still a much less efficient version of what you could do if you were running a fund structure. So, I’m not a Bogle head, but I like taking the big picture perspective. Building out very diverse multi-asset portfolios for people, typically stocks, bonds, maybe some commodities on occasion, but typically stocks and bonds, and just building something that’s very financial planning based. And my big focus over the course of, especially the last 5 to 10 years has been behavior. Because my overarching view is that if you put together a planning-based portfolio that’s sufficiently diversified and behaviorally appropriate for you, your probability of meeting your financial goals is super high. But the kicker is that it’s got to be behaviorally consistent. Like, you’re seeing this I was looking at Twitter before we jumped on here. The money-weighted flows in Cathie Wood’s Ark Fund are crazy bad. And it’s because of this psychological thing where people see good performance, they chase the money, they chase the returns, they pour money into the fund, and then the fund has an awful next couple of years.
The classic one was, what was it? Ken Heebner’s CGM Focus Fund. I’ll never forget that in like 2008, 2009. The thing was up, I don’t know, a couple 100%, or something like that during the big oil boom. And he had crazy, crazy amounts of money. And then exemplifying the horrible structure of mutual funds, the guy gets redemptions like crazy all through 2009, 2010. And the Fund falls like 90%. But for me, behavior is just so so important. And so the way that I ended up basically coming around to this structure was talking to guys like you and Wes, I realized, “Wait. I could take the six to eight ETFs that I typically buy for a client. I can jam them all into one ETF, and I can basically build a much more tax-efficient and systematic version of what I’m already doing.” But the kicker is that what’s so cool about the ETF structure is that I’m not actually building one-stop-shop fund portfolios. I’m basically building, for most clients right now, I’m building like three to five fund portfolios where the Discipline Fund is basically operating as your core position. But the cool thing with the way that it’s structured is that, to kind of backtrack, your typical multi-asset index fund, for instance, like a 60/40, it grows to like 70/30, and they just rebalance it back to 60/40 every year. That was always inconsistent with the way that people actually perceive risk in the portfolio. Typically, when the stock market goes up a lot, people look at the stock part of their portfolio and they say, “Is this part riskier than it was? Does it actually make sense for me to rebalance back to the same weighting? Or does it actually make sense to maybe rebalance differently?”
And for particular people, I think it makes a lot of sense to actually rebalance a little bit more dynamically in the opposite direction. So, that’s what our ETF does. If 60/40 grows into 70/30, the Discipline Fund might rebalance back to 50/50. So we have a 50/50 benchmark over time. And so like right now the Fund is 44% stock. So it’s underweighted its benchmark, and it’s consistent with an environment where the equity market by our metrics is riskier than it is on average. And so you’re building in a behavioral buffer there, where you’re a little bit better insulated from the risk of the stock market if the stock market was to undergo a large decline. And so you’re building in without doing this all-in-all-out thing, you’re staying the course, you’re staying fully invested, but you’re tilting the portfolio in a very tax-efficient way that’s rebalancing just like a 60/40 does. It’s just rebalancing slightly more dynamically because we’re actually trying to assess, is that 60% slice as risky today as it was a year ago before it grew into 70/30?
And so the cool thing with this structure is that, and the way that I’m primarily using it now is, if you know what a core and satellite strategy is, it takes a core and you’ve got your satellites. And the cool thing about the Discipline Fund structure and the way that it’s counter-cyclically rebalancing like this is that it inverts the core and the satellites. What’s cool about this is that you’ve got a core fund, and typically your core fund is just something like that 60/40, it’s always rebalancing back to the same weighting. And that’s fine. I don’t actually have a lot of hate for 60/40 or anything like that. I mean, there are a lot of great things going on with 60/40.
But the problem is that, over time, especially in a taxable account, your satellite, if you have an aggressive satellite, for instance, that thing is growing. This year, the last few years, that thing’s growing a lot. And so if it’s creating an imbalance in your risk profile, let’s say where now…your goal was to be 60/40 on average, and you’re 70/30. Well, even though your core rebalances, your satellite, your aggressive satellite creates this huge portfolio skew in your risk profile. You’ve got to whittle that thing down, buy more of the bond satellite, and you pay a big capital gain because of the equity piece that you whittled down. The Discipline Fund basically does the rebalancing inside of the core position without kicking off the cap gain distribution, so your aggressive piece can grow. The Discipline Fund is actually rebalancing counter-cyclically against it, and it reduces, in the long run, the need to rebalance this aggressive component. So, not only is the goal to create more behavioral consistency across time with your profile but it’s creating a more tax-efficient way of rebalancing this type of portfolio because we’ve inverted the core and the satellite position, basically.
Meb: You touched on an interesting concept on this rebalancing. We’ve had a few prior guests, Rob Arnott being one, this concept, he called it over rebalancing, and Howard Marks called it calibrating. And so I think both of those are useful constructs to think about this approach. And it’s funny because with $1 cost waiting, I was pulling up the Heebner column, and, I mean, it’s down to like $300 million now, which is just crazy, because this fund, I feel like it was like in the tens of billions at one point.
Cullen: Yeah, it was huge back in ’08, ’09.
Meb: What Cullen is referencing, listeners, is this very consistent trend of investors to chase returns. And so they see a fund, and often it’s not the manager’s fault, right? They manage the portfolio, and they can’t control the flows. But people love herding in after it’s had a good run or performance, and then they sell it after it does poorly, which is the exact opposite of what you should be doing. And so the Ark example is timely because it’s happening as we speak, where this fund complex people really piled in a ton last year and over the past, whatever the peak would have been, February of this year? Is that right?
Cullen: Yeah, that’s probably about right.
Meb: Then you see the flipside happening, and it really struggling. And so it’s unfortunate. And unless you have some systematic controls or guardrails, I mean, it’s like putting ice cream in your freezer and pizza in your fridge all the time. Like, unless you have rules, it’s just there. And so I think this type of rebalancing is really thoughtful. It’s often overlooked because it’s boring as hell, but the tax has probably had a bigger impact than just about anything we talk about.
Cullen: That’s the big problem is that people, for whatever reason, they want this to be sexy. They want to be in the fund that makes them rich quick. And, you know, I always tell people that the stock market, the bond market, the financial markets, for the most part, they’re not the place where people get rich. I mean, people will make good returns, in the long run, if they stick to a solid plan, but it’s not proper to think of the stock market as like a get-rich-quick plan. I think the media feeds into a lot of this, where the short-termism of a lot of these narratives and things, they confuse people into thinking of these markets as places where the returns happen quickly. And sure, inside of certain entities and certain stocks, that will inevitably happen. And there’ll always be managers who are able to take advantage of either their brilliance or their guesswork on being able to find those things.
But in the aggregate, coming back again to the big macro picture, I mean, corporate America, for instance, it makes like a 7% profit per year in terms of growth, in the long run. And so if have you thought of corporate America as an entity that basically paid out all of its profits to its shareholders, in the long run, as a dividend, well, something like 7% would be relatively close to what type of long-term return you could expect. But people are constantly going in and picking apart that 7% and trying to find the part that does 100%. And in the long run…like JP Morgan had a great study, you’ve posted it a million times, I think. I can’t remember. The ecstasy and agony, or something like that of long-term returns. It’s an awesome study because it shows how hard it is to actually find that 100% return. Because the returns are super skewed by a handful of names, and the failure rates are a lot higher than people expect.
And so it’s part of why indexing has become really popular in the last 20 years, it’s because I think, increasingly, people have realized how hard it is to pick stocks and to find those big winners that result in the big gains. But it’s human nature, 2021 and 2020 we saw, it’s like the late ’90s, feels like, happening all over again, in a lot of ways, where people… You get new entrants into the market who, they haven’t seen the downturns, they haven’t learned these lessons yet. And you see a lot of people chasing these names and chasing performance. And then a lot of the worst-performing names this year are the names that did really well last year, in large part because people were chasing performance.
So, there’s nothing new about any of this, but it’s hard to get people to be disciplined. I mean, I always compare it, for myself, to dieting. I have this constant struggle with dieting, where everyone knows the way to get healthy in terms of dieting. So, there was this really great study that came out a couple of years ago that talked about how. It didn’t actually matter which diet people adhere to, as long as they adhere to any diet, they lost weight. And so it was interesting that it didn’t matter whether you were trying to find the optimal dieting strategy, or whether you were using what was quantifiably the worst dieting strategy. As long as you were dieting at all and you were being disciplined and sticking to it, you lost weight. And so that to me was like a really eye-opening analogy to the way that the stock market works in a lot of ways. Because with a lot of people, it’s what you find across time, is that people are always looking where the grass is greener, they’re switching strategies, they’re switching out of funds, or stocks or whatever it is. And in the long run, they’re doing all these undisciplined things that result in the equivalent of eating pizza every day, that sort of an undisciplined approach results in all these little frictions that make your portfolio fat in all the wrong ways.
Meb: Here’s the challenge, I could say not with certainty, but with confidence that my belief is that a fund like yours will probably outperform the vast majority of people and institutions for the next decade. And the challenge though, of course, is that people… what you just described, again, is total common sense. People know how to eat, chances are though I’m not going to go home and have some steamed broccoli, and some water with lemon, and a calorie-restricted diet. I’m probably going to have…
Cullen: Yeah, I just ate a platter of enchiladas. I’m worried that I’m going to have to go to the bathroom in a few minutes.
Meb: Yeah, but you’re going to go dig around framing your house for the next two hours and burn off all those calories as well. We’re doing some renovations at our place, and I was Googling how much to put in a barrel sauna. So, I said, “Maybe I should get Cullen to come build it for me.” My carpentry taps out at fifth-grade shop class, but you seem to be much more capable.
Cullen: No, buy the barrel one.
Meb: Do you have one, or it’s like you just know from friends and experience?
Cullen: I bought an indoor sauna, and I put it outdoors because I learned how to build a roof over the course of building my house. So, I bought this five-person indoor sauna, and I just stained the teak on the outside, so weatherproofed it. And then I built a real roof on the thing. It’s fully weatherized and protected. But I bought this right before the pandemic hit, and it totally saved my life going through the pandemic. I’m not like a crazy, crazy rich guy, but when I sit in my sauna, I feel like a crazy, crazy rich guy.
Meb: Good. I mean, you may have just pushed me over the edge. All I cared about in our housing renovation was one thing, which was I want an outdoor warm shower, you come back from the beach that just seems like the world’s greatest luxury. And then number two was maybe potentially a sauna.
Cullen: Those are literally the two best things. So, when we knocked down this old 1970s house, we basically ended up rebuilding the whole thing. And literally, the two best things I did was putting in a warm outdoor shower, put it in a sunny spot, because taking a hot shower or a cold shower in the bright shining sun is the best thing ever. And then if you’re into hot heat, I mean, a sauna is 20 minutes a day, and you feel amazing.
Meb: All right. Well, you pushed me over the edge. You, guys, 50% of Cullen’s tweets are about macro nerdery. If you’re not watching this on YouTube, you don’t get the nerd joke with his T-shirt. But the other 25% is like chicken Twitter, and the other 25% is his carpentry Twitter, probably. But so the challenge with a fund like yours, and we have some too, and I think much like Thana said, like it’s inevitable, these funds will be 100 times the size. And you’ve already had a good launch, so kudos, and congrats, will be 100 times the size they are, and eventually, they’ll take all the assets from the tax-inefficient higher few mutual funds. However, there is a challenge, and the challenge with a lot of people is twofold. One is that it’s this concept of all-in-one. People, for whatever reason, like what we call a mutual fund salad, they like having 10, 20, 50, 100 positions. It gives them a false sense of diversification despite the fact your fund has 10,000 underlying securities. And on the flip side, it’s a little bit boring. That’s the way, personally, I think it should be, but I think a lot of people come to our world seeking excitement, and I think much to their detriment. So, any general thoughts on like, how do you plan on growing this and scaling it? How do you deal with the narrative when you’re talking to people about this fund and any pushback you get from people on why they may or may not be interested?
Cullen: The big one that I run into… I mean, I tell people… I’ve had a few people come to me and say like, “Hey, why wouldn’t I just put my whole portfolio in this?” And I’d say, “Well, I mean, you could, and I would have no problem with that, totally fine.” But a lot of people are just psychologically, I think, afraid of having all of their money in one position. So, I mean, personally, what I always tell people is, “Look, you start from a financial planning-based foundation, you should put enough of your money into buckets of your asset allocation where you’re very likely to meet your long-term goals in the long run. If you want to take 10%, 20%, 30% of your portfolio and do fun, silly stuff, whether it’s stock-picking or buying cryptocurrencies, and whatever it is, taking a lot more risk, there’s totally nothing wrong with that.” But I think a lot of people struggle with that idea that their whole portfolio is just going to be in this boring… I mean, frankly, like, I’m trying to be pretty honest with people about what the future returns of something like this would look like. And you think the stock market is overvalued and you’re looking at the bond market generating like 2% returns, well, I’m hopeful that we get 4%, or 5%, 6% returns on average in a diversified portfolio in the next 10 years. I mean, hopeful.
People don’t love to hear that, they want to hear the Bitcoin return of 100% per year, or whatever it is. And so it’s hard to get people on board with something like that, that is boring. But the reality is that your asset allocation should be somewhat boring. You should build a portfolio that’s a lot more like a savings portfolio than it is like a gambling portfolio. And so that’s the big hurdle is getting people comfortable with the idea that their savings portfolio…and I literally like to call someone’s investment portfolio their savings portfolio. This idea, though, that your savings portfolio should be pretty boring. But for me, the other big one is just the whole active versus passive thing where I see a lot of people talking about our fund and being like, “Oh, well, this fund is just another active fund, and that means that it’s going to do poorly.” And I’m like, “This thing literally holds a bunch of passive index funds.” We’re technically an active fund, but really you get into the nuts and bolts, especially when you go through the whole regulatory process, so the definitions of active versus passive. I had a back and forth with our attorney about what really is active and passive because I was like, “Is 60/40 active or passive?”
Meb: He’s like, “Cullen, I’m only $1,000 an hour.” He’s just like, “What can I say that will trigger a three-hour conversation?” So…
Cullen: Yeah, he loved it. He was like, “Hey, let’s keep going. Let’s have this debate for hours,” like, you will…
Meb: “Tell me about this active-passive debate. And then afterwards, I want to chat about inflation and macro policy.”
Cullen: That sort of stuff is crazy. When you go through the actual regulatory process of seeing it, 60/40 is considered passive because they’re just creating their own benchmark and they’re adhering to the benchmark all the time. And I have a benchmark and an index, technically, that I maintain in a spreadsheet here, and I adhere to that spreadsheet like a robot. I don’t come in and say like, “Oh, what’s the Fed doing this month?” Or… The data goes in, and it outputs a number. And that’s literally how our algorithm works. So, it’s super systematic.
But from a technical perspective, people come to me, and they say, “Well, your fund is… when you’re 60/40 and it grows to 70/30, you might rebalance back to 50/50. And that makes you more active than the 60/40.” And I’m like, “Well, there might be a lot of years where 60/40 is constantly rebalancing and the Discipline Fund doesn’t do anything.” Yeah, the band over which we rebalance is technically more active in the sense that we rebalance more dynamically, I guess, but it throws a big wrench in this whole concept of “What is active and what is passive?” And a lot of people, they think that inactivity is what comprises a passive fund. And I think people are having a lot of struggles with this idea that a fund like mine that is actually very inactive in the long run. Like, we didn’t even rebalance this month, which is shocking to a lot of fund managers. So, it’s pretty inactive in the long run, but technically, we’re an active fund. And that’s a label that’s been applied to us that is very hard to overcome. Even though, compared to most other global asset allocation funds, we’re actually really low fee. Being labeled active is a huge psychological hurdle to overcome because people equate active to bad.
Meb: Just wait till you get more experience dealing with all the various platforms. It is the mind-numbingly dumbest conversations you will have dealing with a lot of these DDQs and gatekeepers. And look, I’d sympathize with their job because, in many cases, there’s thousands of products out there, many of which are total garbage that shouldn’t exist, and probably won’t. They’ll go the way of the dodo bird, eventually. But the simple thoughtful products like yours, they get caught up in these labels. And one, for the longest time, is you’ve got to remember, there’s a lot of vested interests that profit off the fat of the mutual fund ecosystem being very high fee. And so a lot of people don’t want that to change. And so the fact that you are a very low fee ETF that’s active, it just throws up one more gate which they can slow this process down. But in reality, the trend with Vanguard and the trend with ETFs…so Vanguard refuses to play the game. So a lot of their platforms that kind of take some dynamite and blow a lot of these open to where it’s inevitable that they have to change. And so the active-passive thing was one of the silliest of it you’ll ever encounter. But you’ll see there are some platforms that say, “No, we don’t allow active ETFs.”
Cullen: It’s funny though, I’m not sure who actually created the distinction for their own benefit, to begin with. I kind of think that it was Vanguard and the Vanguards of the world who created the passive distinction to start being able to categorize themselves as something different from everyone else. And it’s crazy because when you actually look at what Vanguard does, they’re known as this huge passive indexing company. Vanguard, they’re a hugely active firm. They actually market the hell out of their active funds.
Meb: They have more active funds than passive. Not in AUM, they’ve got more AUM in the passive. But, you know, if you look at some of the things they’ve launched, they have a market-neutral mutual fund, they have a new private equity mutual fund, on and on. You were mentioning the Bogle heads earlier, if you were to look at the Venn diagram of Vanguard, and Bogle and kind of the overlap, it’s interesting.
Cullen: It’s funny you bring up Bogle and the Bogle-heads because I started running a version of this strategy, I don’t know, probably in like 2012 where I was just very systematically rebalancing index funds in a countercyclical way basically. And I think it was around like 2018, 2019, Bogle actually did an interview in his office where he’s talking about the way that he rebalances his portfolio. And he talks about how he maintains a 65/35 asset allocation. And when that asset allocation grows out of whack sometimes with what he perceives is like a behavioral imbalance, he rebalances it really dynamically. And so he mentioned that the year like 1999, he said he rebalanced back to like 35% stocks. So, it’s weird to me sometimes, the saying is what? “You never want to meet your heroes.” Bogle himself talks about being super active in terms of the way that he rebounds. And actually rebalances in a way that is very consistent with what I’m doing. But I would argue is, you know, I always tell people, “Look, everyone’s got to be active. Everybody rebalances, everybody takes withdrawals, everybody contributes money to their portfolio. You got to choose how you lump sum, whether you’re going to dollar cost average.” There’s a lot of activity that goes into all of it. But the real kicker is that there’s stupid ways to be active, which is things like day trading and doing super short-term stuff that just is churning up taxes, and fees and stuff like that. And there’s smart, thoughtful ways to be active. You know, implementing long-term, either factor-based or multi-asset, broadly diversified strategies that we know, in the long run, have a very high probability of working, if you let them do the work. Everyone’s got to be active, and I’ll bag on 2% HiFi mutual funds all day long, even if they’re relatively passive, just because, in comparison, there’s lower fee versions that do the exact same thing. But once you start getting into this world where everything is super low fee, that whole active-passive distinction, it becomes much, much blurrier.
Meb: Yeah. Well, not to mention nowadays, you can have, a “passive fund,” and charge 2% and invest in stocks that start with the letter R, like that’s a passive fund under the “passive rules.” And now that’s totally nonsensical, and is it a good strategy? No, on a high fee. And you could have an active fund like yours, that’s super low cost.
Cullen: The thing that triggered me was, I was reading, I think it was the very first hedge fund ETF that ever launched. I was reading the prospectus for it, trying to understand the strategy and how it works. They literally, in the prospectus, listed it as a passive index fund. And I was like, “This is crazy. This thing’s charging 2% and 20%. It’s an ETF. And they’re labeling themselves as passive because they technically constructed their own index that they’d adhered to.” And it was like, that’s where this debate is going for the next 10, 20 years? I mean, ETFs really blew a hole in the whole active-passive thing and exploded the narrative around this, because you realize that, well, anyone can build an index. The S&P 500, what is that? It’s just an index that the S&P committee picks based on some relatively arbitrary set of rules. And we call that an index, but, you know, that’s all it is. It’s a subjectively selected index that Standard and Poor has created. And anybody can do that, literally. Anybody can do that. And if you’re willing to pay the fees, and the regulatory compliance costs, you can build your own passive index fund, and you can call it whatever you want. And the ETFs really blew up that distinction because of the way that it became so clear that having your own index doesn’t necessarily mean, in a traditional sense, that you’re passive, like the way that a lot of people think of index funds.
Meb: As we look at this trend, you launch an ETF. Why do you think more advisors don’t roll up their separate accounts and toss them into an ETF structure? I mean, it seems like an increasing amount of folks are doing it. Do you think this is something where it’s going to be a continual trend over the next decade? People you talk to, or is it people are still slow to see the light?
Cullen: To the extent that people like Wes and the Alpha architect team can make this thing affordable to people who it makes sense for. Like, it made a lot of sense for me, just because I run a very specific type of strategy geared towards people who are typically retirees struggling through some sort of behavioral problem because they’re just so uncertain about their retirement. They benefit from my sort of asset management because of all the uncertainty in the way that they’re handling the uncertainty around retirement, mostly. Or just people who have really well-known behavioral biases. Like, a lot of people will come to me are people who, they say, “Hey, I bailed in 2002, I bailed in 2008, I bailed in March 2020, I don’t trust myself.” And building something like my type of asset allocation is just a very simple way where you’re building up sound portfolio, and you’re building in a buffer that’s basically a low-cost behavioral hedge. That’s really what it is.
And so in terms of advisors adopting it, if you run a very specific type of strategy and you have these very specific client needs, I think that it’s like a no brainer. Like, this was a no brainer for me just because of my specific niche. It’s still going to be a big hurdle for a lot of advisors, just because most advisors, honestly, are not portfolio managers. And I think that’s the kicker is that if you’re going to start an ETF, you kind of need to be more portfolio manager, I think, than financial advisor. Because, I mean, my view is basically that in the next 10, 20, 30 years, I think the planning space is going to be where the high fees actually are embedded. If you’re charging 1% a year or something like that, I think planners are going to be able to protect that fee a lot better than asset managers are, in the long run. But the difference is that it’s hard to build a specific customized strategy that… Like me, I stepped in the arena with like iShares and Vanguard. There’s people who email me and are like, “Are you an idiot? You just created a multi-asset fund-of-funds that is competing with the biggest, cheapest money managers on the planet. And that’s a really hard space to compete in.” So it’s a big hurdle for someone who doesn’t have a really unique strategy, I think.
Meb: So, as we look to 2022, are we going to ever see Cullen do any other funds, is this one and done? What’s the future look like for you?
Cullen: I don’t know. I guess we’ll see if the fund makes it through 2022. No, actually, we’ve had a really good launch and the funds are off to a great start. So I had a few people email me, you know, like, the first few days, they were like, “What if this thing doesn’t make it through year-end, or next year?” I was like, “Don’t say that.”
Meb: I always laugh at the people that talk about a lot of these smaller shops, and particularly when we were young and starting out, they would say, “Well, you know, I’m worried about your funds closing.” I’d say, “Go pull up a list of who closes the most funds per year in all time.” It’s not the smaller issuers. It’s like iShares, and Direct Sun, and all these others.
Cullen: They just slinging mud at the wall, right?
Meb: Yeah, where they just… there’s no soul behind what off a lot of these shops are launching, meaning its products. And to them, it’s just a factory where they put them in. And if they don’t work, they close them and launch new ones. I think the difference for shops like yours and ours is like we actually believe. It’s like chefs, you know, we believe in our offering, as opposed to just turning out the McRib.
Cullen: I can’t afford to just sling mud at the wall and hope that some of it sticks. I actually have to, “Yeah, we’re making this and I’m eating, and I’m eating a huge piece of it.” I mean, in my own personal portfolio and across my whole practice. So, yeah. I mean, I think one of the advantages of being a smaller shop is that you have to have a much more thoughtful approach to what you’re doing. But yeah. I mean, in the long run, I don’t know. I mean, do I want to compete with the Meb Faber’s of the world with creating funds? I mean, I don’t know. One of the reasons I started with such a broad, somewhat simple fund was because you can mix and match other pieces around this thing in a very simple way where, like I said, I mean, I’m typically building three to five fund portfolios these days. I mean, I’ve put together a portfolio that was literally three ETFs for somebody with $4 million the other day. I mean, it was almost crazy simple when I looked at it, but it also was literally one of the most beautiful portfolios I’ve ever built. Just because it was so simple and clean, it met all of his needs across different time horizons and everything. So, ideally, I don’t know where this will go.
Meb: Well, the beauty now is you can sit down with people and say, “I’m going to build you a one-fund portfolio. Who needs three? Here’s one, there, you’re done.”
Cullen: It’s such a weird world that people still aren’t… It’s funny, I was talking to the guys that work at some of these big Robo advisors. And I was asking them, like, “Why didn’t you ever start like just a one fund ETF? You could have started like three one fund ETFs, and you would have vastly simplified your whole practice and the way that the asset management works.” And they were like, “People don’t want that.”
Meb: You got to remember, it’s hard to justify your existence and fees if you’re just allocating to one fund. That’s kind of like this trend, I think, and I agree with you that the advisor profession is a lot more future proof if, huge asterisk, like you, offer a bunch of value-added services such as estate planning, insurance, behavioral coaching, golf with the local club, whatever. But the asset management side, I think, is getting already, you know, disrupted by the likes of you and others. Well, you’ve hit the first unlock, there’s like three unlocks, $20 million, 4100 million, 3-year track record, that’s what a lot of the platforms, for whatever reason want, but just making sure you’re going to survive and not disappear into the ether, either is starting to take on different meaning. What’s on the writing nightstand for you? What are you thinking about else in the world? What’s got you confused? What’s got you interested, excited? What is your drafts folder on the blogging world? What are you thinking about?
Cullen: I mean, like a lot of people, I’m thinking increasingly about crypto and how it fits into… I’m a big market-cap-weighted guy. So like the fact that we mentioned earlier that it’s only like 1% to 2% of global financial assets, but that’s a lot of money. I think 5, 6, 7 years ago, you could still look at the cryptocurrency space and say like, “Okay, this is not going anywhere, this is not important, we don’t really need to be too thoughtful about this.” But it’s generated enough momentum at this point where I think that you at least have to be paying attention to it, you at least have to be thinking about it and the long-term potential ramifications. There’s so much brainpower now that’s being invested in all of this stuff that you have to at least try to be considerate of the long-term impacts, whether it’s going to grow into 3% of global financial assets, or whether it’s going to grow into like…some people think it’s going to completely take over the existing financial system, which I’m not in that boat. But I still think that there’s going to be a blending of all of this. And it’s the first really interesting thing that is changing a lot of the dynamics in the financial world. In my whole career, the crazy thing with gold is that, like I talk to a lot of people who traditionally would love owning gold.
And in the last, like two or three years have said, “I’d rather own Bitcoin than gold.” You know, when you think of foundational upending shifts in the financial world, like gold, for a lot of people has been looking at like Harry Brown’s permanent portfolio. That’s a core holding for a lot of people. It’s a really, really, arguably the most historically established asset class that has ever existed. And the fact that this new asset class is potentially upending that narrative and changing what the demand for that thing is going to be, potentially permanently. That’s super interesting to me. I don’t know. I’ve spent crazy, crazy amounts of time in the last couple of years trying to understand all of this and better wrapping my head around it. It’s crazy for someone who’s, you know, in the financial space, just because a lot of this whole cryptocurrency stuff is really… It’s like software engineering, you almost have to be like a tech guru to have actually fully understand what’s going on in cryptocurrencies. So, it’s a weird thing to wrap our heads around just because it’s not like understanding traditional asset classes. You don’t have to understand that…we study how stocks work. Well, stocks are pretty simple, you know, at an operational level, bonds are pretty simple, but cryptocurrencies and each one is so different. You’ve got to understand a whole different set of understandings to even begin to comprehend what these things are doing. So, that’s a big one for me right now.
Meb: So, when do we get to look forward to seeing you adding some crypto funds to the Discipline Fund global market portfolio here, Cullen?
Cullen: I mean, that’s the hard part is I’ve spent a crazy amount of time thinking about that is, is there a disciplined way to invest in an asset class that has 100% plus volatility? If you look at the crypto space on any given day, for the most part, all these things do the same thing, at least in terms of their correlation. They do it to varying degrees, but they’re all super highly correlated. And so it’s a weird space to try to start building into a diversified and disciplined portfolio approach just because it’s really hard to be disciplined around an asset class that is so, so volatile. Equities are one thing, but Bitcoin is literally five to six times more volatile than the equity market is. And the equity market scares the living daylights out of people when it’s bad, which means that if you’re in 100-plus vol asset, that’s a level of fear that I think if you’re someone who isn’t used to that or has a significant amount of assets in that, it’s just a whole different ballgame. And so, I don’t know, Meb, thinking about it a lot, maybe I’ll write about something like that in the next year or so.
Meb: I was saying on CNBC a thoughtful approach for the crypto value investors out there if there’s such a thing, I was like just put in a stop-loss order 20%, every 20% down on like GBTC because that one has the additional feature of being a closed-in fund that basically, if things get whacked, you get the price decline but also the potential conversion, at some point, as a call option. Now the problem with most closed-in funds, GBTC is no different, is they’re stupid expensive. And so you don’t want to hold this for 5, 10 years. But if the discount ever closes, you get an additional bump and potential arbitrage there. Do your own due diligence, it’s just an idea, people. What’s been your most memorable investment? Anything come to mind over your career, good, bad, in between?
Cullen: This stupid house I built, it’s sucked so much of my life and time out of me. For me, I’m sort of masochistic with something like that because if I don’t understand it, I’ll spend a crazy amount of time trying to understand it so I can actually, not just understand it but actually build it or take care of it on my own, in the long run. What’s the cool thing with building a house was that three or four or five years ago, I didn’t even know how a light switch worked. And then you start learning how this stuff works. And you’re like, “Oh, wait a minute. This is actually pretty simple.”
Meb: Do you learn on YouTube? Do you take a class? What was the process?
Cullen: It was a little bit of both. There are some YouTube channels that I watched, like, obsessively. Like, there’s a YouTube channel called Essential Craftsman. It’s an old guy. He’s an old framer, he’s now a general contractor, I think. And I don’t know where he is. He’s in the South, somewhere. He used to build like track homes in Vegas for like decades or something. And he’s just unbelievably talented. The videos are really well done, you search through his inventory, and you can learn almost anything from this guy. And he’s professional on almost all the aspects of building a house. And so it’s cool doing that. But I also was, like, I was just super hands-on with the build. Because when I’d have guys in the house, my day typically ends like 2:00 because I’m working East Coast hours, for the most part. And so by the end of the build, I was putting on a work belt every day at 2:00 and working on the house to like 7:00 at night. But super hands-on, like, learning by doing and kind of annoyingly interactive with the workers who were here, and… Like, my electrician, I insisted that he teach me how to do electrical work. So, I kind of was like, an annoying asshole with him the whole time, because I was always hovering over his shoulder as he was working on stuff. But little things like that that you just… you know, how does the water flow through your house? How does the electricity flow through your house? Learning to do stupid stuff like making a wall flat. Making a wall flat is crazy, crazy hard. We look at flat walls in houses and you’re like, “Okay, that’s just there, like, that can’t be that hard.” And then you actually go through the process of like, the framing, and the drywall and then the mudding of the wall. And it’s, “Holy shit. These guys are amazingly talented, much more so than I would have ever expected.” So it’s a cool process to go through. Just because it’s humbling in a lot of ways because a lot of this stuff is so much more difficult than you expect it to be, but it’s also just really interesting if you like knowing how things work.
Meb: Was this like a straight-up from a scratch situation, were you just building on like an addition? Give the listeners a little context, what’s been going on, on there.
Cullen: So, we bought this old beat-up house in North County, San Diego. And basically what happened was, we were going to just demo the garage and rebuild it. And what happened was, it’s on a relatively big lot for this area, but it has a creek on it. And so we ran into…and this is the other thing is like a new homeowner, I had no idea what the regulatory process was like in homeownership. And bit off probably way more than we could chew. But I spent basically 18 months fighting with the City over what this little creek was, first of all, and then how close we could build to it, and like all this crazy, stupid stuff that we never expected to get into. But over the course of these 18 months, we were working on the house. And so by the end of the time where we actually got our permit, we had gotten other permits to rebuild other parts of the house. And by the end of it, I mean, it took us probably two-and-a-half years to get through the whole process from initial permit application to actual finish of the build, we had rebuilt the whole house just because we were living in this thing while we were trying to get the permits and going through all these battles. And so it was like a compounding bad investment, was what it was, time wise.
Meb: It’s like the old Tom Hanks movie. What was like the defining moment or story of this adventure, where you’re just crying almost at challenges, or difficulties, or nonsense that happened?
Cullen: Oh, man, I don’t remember crying. I mean, it didn’t bring me to tears ever, but I spent New Years’ of probably 2019 I was framing. I framed an entire indoor wall on New Year’s Eve, and I was drinking the whole time. That was the low moment. It was also like the high moment, though.
Meb: It’s only a low moment if you’re not drinking San Diego craft beers because that’s like the brewery capital of the world. Now, if you’re just drinking Natty Lights, then it’s different.
Cullen: Well, no, it’s funny because like with a lot of these guys in construction, I mean, it’s really physically demanding work. And so a lot of these guys, they’ll either drink on the job or a lot of them will finish and then they’ll drink 10 beers in two hours. There were guys coming on the property that, you know, I would find drinking and I was like, “Okay, you know, I know you’ve been working hard and blah, blah, blah, but you can’t drive home like this, like, this is crazy. What are you doing?” But it’s such physically demanding work that you start to have some appreciation for why it drives certain people to drink because it’s just so hard on you. And I was at that point where like New Year’s Eve of 2019, we had a baby on the way like three months later, and I was pinned against the wall in terms of like time, and effort and everything. And I was so physically exhausted at that point because I’d been doing so much of the physical work on the house that… it was probably like my peak expertise because I was doing so much of the work that I actually knew what I was doing, at that point, but it also was like the low point for me psychologically because it took years off my life probably, physically, because it was just so physically demanding.
Meb: That with fatherhood, it’s a lot. Cullen, this has been a blast. Where do people go if they want to check out what you’re doing, follow along with the fund, follow along with your writings, your Twitter scraps, chicken advice on Twitter? Where’s the best place to find all things Cullen?
Cullen: So disciplinefunds.com is the fund website. I’m on Twitter @CullenRoche. And pragmatic capitalism is the blog that most people know me for, so it’s pragcap.com. I usually, write at least a couple of things a week there or something. So, still relatively active writing and trying not to use Twitter as much. It’s an addictive hellhole, so hard to avoid.
Meb: And you get a lot of Simpsons references, which is always good. Cullen, my man, thanks so much for joining us today.
Cullen: Yeah, thanks for having me, Meb. Good talking to you.
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 email@example.com, we love to read the reviews. Please review us on iTunes and subscribe the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.