Episode #455: Eugene Fama: A Life in Finance
Guest: Eugene F. Fama, 2013 Nobel laureate in economic sciences, is widely recognized as the “father of modern finance.” His research is well known in both the academic and investment communities. He is strongly identified with research on markets, particularly the efficient markets hypothesis.
Date Recorded: 10/12/2022 | Run-Time: 42:23
Summary: In today’s episode, we talk to Professor Fama about whether he thinks the Fed can control inflation, where the phrase efficient markets came from, and his take on the global market portfolio. As we wind down, we hear the last time he bought an individual stock.
Sponsor: Masterworks is the first platform for buying and selling shares representing an investment in iconic artworks. Build a diversified portfolio of iconic works of art curated by our industry-leading research team. Visit masterworks.com/meb to skip their wait list.
Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- 0:38 – Sponsor: Masterworks
- 2:40 – Intro
- 3:14 – Welcome to our guest, Professor Eugene Fama
- 3:53 – Professor Fama’s take on the Fed & inflation (link)
- 8:04 – Insight on the origin of the 60/40 portfolio
- 9:26 – The inspiration that lead to his thesis on efficient markets
- 10:10 – Negative interest rates and how to live in a higher inflationary world
- 12:04 – The global market portfolio
- 15:58 – How much the collective earnings of his former students might amount to
- 17:27 – Why he’s never written anything on trend following
- 18:38 – Best practices to overcome the challenges of not mucking things up
- 24:02 – Topics and papers that never got the attention he feels they deserved
- 25:59 – The role ESG plays in the investing world today
33:28 – When was the last time he bought an individual stock
- 34:29 – His most memorable investment
- 35:08 – What’s on his mind as he looks towards the future
- 37:32 – All of Professor Fama’s papers
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.
Sponsor Message: Did you know that 99% of stocks lost value in a single day in September? Now, we’re riding out the S&P 500’s longest quarterly losing streak since The Great Recession. Many institutions are allocating 30% to 50% of their assets outside of stocks and into alternative assets, according to a study by McKinsey. I’m investing in alternatives myself, some with Masterworks. They let you invest in contemporary art, the best of the best from artists like Picasso, Warhol, and Banksy. Morgan Stanley says, “Investing-grade art has a low correlation to other major asset classes and often experiences lower price volatility.” And while the S&P is down over 20% through the first nine months of the year, the art market has surpassed even its pre-pandemic levels, according to a report by “Artnet News” and Morgan Stanley. The report also said the average price of a work sold at auction during the first five months of 2022 was up 26% from 2021.
So, check out Masterworks. I’ve been talking about ’em for years. I had the CEO on the show and even invested in three paintings myself. In fact, due to demand, Masterworks has a waitlist. You can skip it at masterworks.com/meb. That’s masterworks.com/meb. See important Regulation A disclosures at masterworks.com/cd. Last time, masterworks.com/meb. Masterworks is not registered, licensed, or supervised as a broker-dealer or investing advisor by the SEC, the financial industry regulatory authority, FINRA, or any other financial regulatory authority or license to provide any financial advice or services.
Meb: Hello, my friends. We got a huge show for you today. Our guest is the legendary professor, Eugene Fama, a 2013 Nobel laureate and widely recognized as the father of modern finance. In today’s episode we talk to Professor Fama about whether he thinks the Fed can control inflation, where the phrase “efficient markets” even came from, and his take on the global market portfolio. As we wind down, we hear the last time he bought an individual stock. Please enjoy this episode with the legend himself, Professor Eugene Fama. Professor, welcome to the show.
Prof. Fama: Thank you. My pleasure.
Meb: I am so excited to have you today. There are so many questions I have. I even prompted a bunch of former podcast guests who are former students of yours to give me some really hard, probing, difficult questions, so I have a long laundry list. And I’m not going to tell you which of the students asked which ones, but they gave me some good ones. First off, I feel like we got to start… You’ve written over 100 papers. What are you up to now? Do you know?
Prof. Fama: Hey, I don’t count the number of papers. I count the number of citations to my papers.
Meb: I like it. So, let’s just say a lot, and I’ve read many of them, I don’t think all of them. But there’s one paper that I thought we would start with because we’re recording this October 12, 2022, and tomorrow’s CPI day, so all the market participants are focused on that, but you had a fun paper that I think is a pretty anti-consensus view, as many of yours are, but it was talking about inflation and the Fed. Do you want to talk to us a little bit about this because I got some great quotes, but it was talking about inflation, which is something most people haven’t had anything to do with for the majority of my career. Tell us a little bit about your thoughts on those two and kind of what your paper was talking about.
Prof. Fama: Well, I think the world focuses too much on the Fed and their power over inflation. And my view is they don’t really have that much power over inflation. And now, especially, for the past, oh, 15 years or so, they’ve been in this quantitative easing game, which is an entirely new experience. So I don’t think they really know how you will go about controlling inflation and that with that set of policy tools that they’ve been using. They’re trying now, but I think it’s an experiment and we’ll see how it turns out. I’ve been waiting for this experiment because as soon as they started doing quantitative easing, I said to myself, “What are they going to do when inflation comes along?” So, now we’re going to find out. They’re raising the federal fund’s rate. That’s the policy response, but I’m not sure that’s going to work.
Meb: So, we do a lot of polls on Twitter because I like to kind of gauge the sentiment, what people are thinking, and I think the broad expectation is very much that inflation is under control and coming back down. So, let’s say the Fed calls you tomorrow. They say, “Gene, we listened to you on this great podcast. We’re here to listen. What would you have us do?” What would you be your suggestions?
Prof. Fama: That’s why I say it’s an experiment because I don’t really know. So, you’ve got inflation running at 8+%. You’ve got the federal funds rate around four now. I guess maybe they raised it a little bit more, but that’s still minus three real or minus four real. So they’re nowhere near where they may have to be in order to turn that thing up, and we’re not sure it will work anyway. So, that’s why we’re going to see. I would not know what’s the answer to that because I think this quantitative easing regime has changed all the rules of the game, so you don’t know what’s in it but…
Meb: What’s your general take on kind of the role the Fed in general then? Is it something we should say, “You know what, we can reduce the headcount over here down to, like, five people.” I have a theory. I’ll see if you like my theory, Gene, or you can bust some holes in it. I think the Fed should just show up at their meetings, get a six-pack of beer, watch “Seinfeld” and just peg the Fed funds rate to the two-year or something similar, and then just go on their day. Now, I said they couldn’t tell anyone they’re doing that because then it involves all sorts of different signaling, but, like, maybe that’s what they should actually do. Terrible idea? Good idea?
Prof Fama: It sounds similar to Milton Friedman’s idea. Milton’s idea was let them raise the money supply by some small number every month and not do anything else, and it’s the way to go so the money supply is in line with the rate of the global economy where inflation will take care of itself. That was Milton’s idea. So, yours is kind of of in a similar, simplistic way vein. I think his was probably good advice, but, of course, then, you get policymakers in here and they want to do something powerful
Meb: Well, you got to have this perception of activity, right? If they just did that and they weren’t doing anything, and there’s a lot of parallels to buy and hold investing, right, where people need to look like they’re doing something during a crisis. Otherwise, what’s their job description for? What are they doing? We’ll post a show note, listeners, to the paper because it’s a lot of fun. But there’s some killer quotes in there, one of which was, “The Fed losing control price of level doesn’t mean high inflation. It just means inflation is what it is, that is, out of Fed control. I read the Fed as quietly acknowledging this cost of QE in its statements about inflation for the last few years amounted to keeping an eye on it, which is not the same as controlling it. Who doesn’t keep an eye on it?” I thought that was such a great quote.
Well, this has been a year so far for the history books, looking at a traditional 60/40 portfolio. Certainly, on a real basis, one of the worst ever in the past 100 years. I had a question, and as a historian, a long-time market participant, do you have any insight as to the origin of the 60/40? Why has this become so ensconced in finance, this, like 60% stocks, 40% bonds? Why wasn’t it 50/50? Was this a Markowitz thing? Was this Fama thing?
Prof. Fama: No, it wasn’t. So, I’m not a particular fan of that. What I would say is most investments should just go to a market portfolio. A true market portfolio would have the market proportions of stocks and then bonds. But then, you can deviate from that depending on your attitude toward risks. So, you might want more stocks, or you may want more bonds. Hey, if you’re less risk-averse, you go more stocks, more risk-averse, you go more bonds. If you’re really risk-averse, you go short-term bonds. Risk aversion is an important player, even if you’re best in investing.
Meb: I’m always, like, curious where the actual… the number 60 came from if it was like some paper or some consultant somewhere, and he just kind of like used that number, and then forever it was a part of…
Prof. Fama: Okay. I could tell you it was there when I came into the game, and that’s more than 60 years ago. So…
Meb: Well, there’s a similar question I had for you that was kind of fun, as I was reading. You know, you’ve become synonymous with the phrase “efficient markets,” but you said in one of your pieces that you didn’t cite that phrase in your thesis, like, it came in a later paper. What was the inspiration for that? Do you remember?
Prof. Fama: Yeah, the first real appearance of it was in a special little paper that the business school where I worked has a series of these little papers that they take from the faculty, and I use it there. And I don’t remember why, but it stuck.
Meb: It’s funny. You go back to, like, that little tiny decision, and then, like, if you could tell that young guy now, say, “This phrase that you didn’t even think about but you just typed in is now going to be everywhere, it’s funny to look back on that. One of the things is I was thinking about various topics and what’s going on in the world, and then there was that very brief period where in many places, including sovereigns, interest rates went negative. As a professor, was that a pretty weird period?
Prof. Fama: It was pretty weird. People thought before that that, you know, you always have the alternative of just taking the cash and putting it in a closet, and then the interest rate would be zero and you couldn’t go below zero, so they thought zero was the lower balance. And it turned out nope, stirring cash has costs, so it’s …
Meb: So, as we think about inflation for investors, and I think many that are kind of struggling with how to think about, okay, well, stocks, bonds haven’t been a good place to hide so far this year with inflation, is there any general thoughts you have on how to think about living in a higher inflationary world for most people that just haven’t experienced it or whether that’s personal finance or investment related? Is there any general constructs or frameworks you think about?
Prof. Fama: Well, so inflation tends to be slow-moving. When it’s high, it tends to stay high for a while. When it’s low, it tends to stay low. Historically, short-term bonds were a good hedge against inflation. Interest rates moving pretty much with inflation. I wrote several papers about that back the ’70s and in the ’80s. But for the past, whatever, 10 years or so, you know, that’s not worked because interest rates went down so low that they couldn’t adjust very much to inflation at the level they were. So the inflation hedge wouldn’t have been a good idea [or] available, but at that time, inflation was not very uncertain, so we weren’t really concerned that much. I’m kind of a market portfolio person. Basically, you have to talk yourself outta the market portfolio, you talk yourself out of even … bonds or lower-risk small bonds.
Meb: We actually talk a lot about the global market portfolio over the years and I feel like there’s been an increasing amount of investment research on what that’s looked like and how to estimate it. I mean, there are certainly some private assets that don’t get included that are a little harder, like farmland. We come from a farming background, but it’s surprising to me that you haven’t seen… There’s some that are closed and approximated, but you haven’t seen more just one simple global market portfolio offering, funds. You got any insight as to why?
Prof. Fama: A global market portfolio is kind of a risky venture because the problem is that countries go to war with one another. We thought we were past that, but now we’re finding out we aren’t. And wartime is subject to expropriation risks. So in other words, each side expropriates the investors of the other side, and they never get made whole after that. Everybody forgets about investors. So, that’s the fundamental risk. In my view, the fundamental risk of international investing is if you get expropriated by the other side, those numbers never appear in the historical data. They’re just not there. So, that risk is just put aside like it isn’t there, but it is. So, I would think that, for some reason, you may just want to hold the U.S. market portfolio.
Now, the volatility of the U.S. market portfolio of stocks is very similar to the volatility of the international market portfolio of stocks. There’s not much of a diversification effort that’s lost by doing it. I think that’s a reasonable strategy. If you’re not concerned about the expropriation risk, you might even go into an international portfolio that held Western European, you know, common market countries. But even within the common market, there have been periods in the past 20 years when countries wouldn’t let foreign stake their money out because they were having local problems. So, that’s always a risk with investing. It never shows up in the actual numbers.
Meb: Well, I think it’s particularly a front-of-mind risk this year. I think it was, like, 95% of all emerging market funds held Russian securities, which are currently somewhere frozen in purgatory. Maybe they’re worth something, maybe they’re not, but the funds have all written them down. But for the most part, Russia is small. The concern of many investors, it seems like, today, where this really is front-of-mind is it becomes, you know, China, which is not an insignificant percentage of the global market portfolio if you include foreign securities, perhaps one of the reasons why the Chinese stock market valuations have cratered over the past couple years. But as someone on my side who is a big proponent of global investing, I think your points are very real for consideration on what to think about in this world. Sadly, you know, I was hoping we’re kind of moving away from this at some point, but wars seem to be a feature of us humans.
Prof. Fama: Political risk is important. You know, you have to really take it into account. I mean, you have to really be aware because you get one guy like Putin who runs a whole country, so it all depends on what does or what the people right around him allow him to do. So you have to be very worried about that.
Meb: This episode is brought to you by Cambria. Cambria’s mission is to help investors preserve and grow their wealth with strategies spanning from global asset allocation to deep value and even tail risk hedging. To learn more, email us at the following address, firstname.lastname@example.org, or if you’re a financial professional, check out the “Contact Us” page on our website and reach out to your local representative today. Investing involves risk, including possible loss of capital. Past performance is not indicative of future results.
As I was kind of asking some friends for questions, I had a thought, and you may not like this conclusion. You may or may not, we’ll see. A few years ago I was tweeting. I said, “I wonder who has generated the most progeny/assets as, like, a parent of the family tree.” I said, “You know, there’s a lot of Julian Robertson’s Tiger Disciples, George Soros’ Rubin’s Treasury Desk.” But then I was like, “You know, Professor Fama, students over the years have to have a pretty close claim to that. I can think of two that probably add up to over a trillion.” What do you think is the AUM on your former students now managing assets in the world? Do you have a guess?
Prof. Fama: It depends on what you call former students. So, would you take the entire passive investing in efficient markets? Because then, you get a really big number.
Meb: You get a really big number. And so, the challenge though, is that we said, if we aggregate all the active managers you spawned, do you see that as a… is that a positive thing? Is that a slight failure? We’re like, “You know what? I wish Cliff was doing something more useful for the world than active management.”
Prof. Fama: Cliff’s pretty passive, actually. He was very arrogant when he said, “No, we’re not taking sides I don’t think.” But if I just consider the people who were direct students of mine, it’s probably in the trillions.
Meb: Yeah, that’s a lot. One of the things… I’m just going to kind of pepper you with some various questions or thoughts that I’ve never seen you write about. And we’ll see if you have an opinion on, is the concept in either academic or practitioner of trend-following. So, I’ve seen you comment on momentum in stocks, you know, the factor-based model, but kind of this traditional commodity trading advisor trend-following approach that has been around I guess since the ’70s and ’80s, is that something you’ve ever thought about? Do you think it’s interesting? Not too interesting?
Prof. Fama: Well, I mean, lots of the early testing of market efficiency was directly concerned with trend-following and if related things actually worked. And nobody could ever find evidence that they do, so that’s been a dead issue for research in financial for a long time. Nobody does that anymore.
Meb: Well, you know, it’s for many styles, whether it’s value investing or managed futures or U.S. first foreign a lot of these go through periods of outperformance and underperformance.
Prof. Fama: That’s with 2020 hindsight.
Meb: A hundred percent or you could say 2022 hindsight with this year, the way it’s going. But, you know, one of the things I spend an enormous amount of time on, you know, I’m a quantitative investor, is the challenge of not mucking things up. To me, this isn’t just a retail, this is institutions too, whether it’s chasing performance, whether it’s following whatever the hot theme of the day is. What do you think is any just best practices or good advice?
Prof. Fama: You go back to where we started it. You need to start with the market portfolio and then you talk yourself out of it. But you better have a good reason to talk yourself of it because it’s very difficult, historically, to beat the market portfolio. See? You better have a really good story. It better not be, you know, cryptocurrency or something like that, that’s got a big potential downside to it. So, you really have to talk yourself out of the market portfolio.
Meb: I asked a fellow Nobel, Professor Sharp, months ago, I said, “Do you think crypto has a role in the global market portfolio?” And he kind of smiled and nodded and he said, “Yes it does. Unfortunately, it’s not a positive one.” So I said, “That was a thoughtful way of conveying your opinion.” But as it’s come down, I think it’s what probably… Is the global market portfolio, like $200 trillion, somewhere around there? I don’t know.
Prof. Fama: This is the way to think about it. If it doesn’t have a value, some use, its value depends on other people thinking that it has value, and that’s going to bust eventually. So why isn’t it useful? So take Bitcoin, for example. You might use it to execute transactions, but the problem is monetary theory historically says something with a variable real value isn’t good as a medium of exchange because, for example, if I’m a business and I take Bitcoin payments for my goods, that can put me out of business in itself because its potential downside is so big, the variance is big, it could kill me.
So, I don’t want to transact in that. If I do take it, I’m going to get rid of it as fast as I can. So, it isn’t really a useful medium of exchange, which means in the end, it’s not going to have any value. People are not going to use it. Maybe some banana country is going to think that Bitcoin is less variable than its own local currency. Okay, maybe it’ll work there. But what’s happened historically in places like that is they dollarize. They start doing transactions in dollars, not actually settling in dollars, but just quoting prices in dollars. So, I don’t see a big future in cryptocurrencies.
Meb: One of the things I was thinking about that we wrote a piece about a while back that’s coming kind of to the forefront this year is let’s say you’re an investor or just a person, or even an institution, and you say, “You know what? My goal is not to maximize compounding returns at this point, but it’s, like, what is the safest portfolio or asset?” And we were kind of talking about, you know, I think the assumption for most is probably T-bills, right? Would you agree with that or do you think there’s something safer?
Prof. Fama: There are index service bonds if you want to, you know, really get something safe in real terms. But the problem is that the real rate is fixed on those. So if you have uncertainty about the real rate, it’s built into it. But for low variants, it’s hard to beat that. It’s hard to beat short treasury bills as well.
Meb: We kind of looked at it on an after-inflation basis. So we said, “Okay, if we look at real returns, but also, so not just the returns but the max draw-down, the volatility, but like, the worst 12 months, one of the interesting things is if you did, say, the global market portfolio, which you know, we kind of modeled as roughly just half stocks and bonds.” We did it global, and when we did bonds, we said, you know, “Using tenure and other things, but you put that portfolio together and mix it with cash, you can kind of come up with some really interesting low volatility, low draw-down, but higher-yield outcomes at least historically.” The problem with that, I think, the global market portfolio plus cash on paper, looks safer, but I don’t know if you could count on it the same way you could count on pure T-Bills. Any thoughts on…? Could you construct a safer alternative to T-Bills mixing in the global market portfolio…
Prof. Fama: No.
Meb: …on a real basis?
Prof. Fama: No. The risk of stocks is so much higher than the risk of short-term bonds that that’s not even a relevant comparison.
Meb: Yeah. The challenge is, like, it’s looking at the historical on one thing, but then, like, having the common sense to say, “Okay, like, in the future, like, you could see how the risky component could be problematic. But we’ll send these over to research and you can tear it up and throw it in the fireplace, but we’ll see what you have to say.”
Prof. Fama: Keep in mind that there are these events that I wrote my Ph.D. thesis on, these events I wrote my PhD thesis on, these historical dates when the market goes down 10 or 15%. So these stock loss numbers don’t work, and I was thinking you just can’t stop … losses. So, I don’t think there’s anybody who can mix stocks with bills and do better in terms of risk as well. It’s just holding bills alone.
Meb: One of your famous phrases though, if it’s in the data, it’ll change your mind.
Prof. Fama: Right.
Meb: What have you changed your mind on over the years, Gene, recently? So, the last couple years, anything where you’re like, “Hmm, I got a new perspective on something.” Anything come to mind?
Prof. Fama: I tend to forget those things.
Prof. Fama: They …
Meb: I know that it’s like having hundreds of children at this point, these papers you’ve written, but some of them get more attention than others. Are there any topics or papers that you think really never got the reception or attention that they deserve where you look at it and say, “Man, I thought this was brilliant? I love this topic. No one else cares, but it’s something that’s near and dear to my heart.” Are there any subjects that are in that fold for you?
Prof. Fama: I would agree with your initial statement, which is that at the time of writing these papers, I would have been a terrible predictor of which ones are going to be the most successful. If you go to a Google site and look at citations to the papers, my top three or four papers, I would not have predicted that those would’ve been the top papers. And then, there were some that got very few citations that I would’ve thought would’ve done a lot better. And you can’t go by the way people react to them at the time. It depends on how people, you know, look at them through time, and which ones survive and which ones don’t. So it is totally unpredictable.
Meb: Yeah, that’s been my experience. We had one paper that I love that was kind of talking about the tax inefficiency of dividends, and I think we cited you in this paper. You had a paper that was something along the lines of like, where have all the dividends gone, or disappearing dividends, I think. I love that paper, but I wrote a paper of kind of like, “Hey, you know, as a taxable investor you should consider perhaps you don’t necessarily want these really high-dividend stocks because you got to pay taxes on ’em if that’s what you care about, and on the after-tax return.” But as a product developer, I don’t think there’s anything more marketable in the world than trying to say, “Hey, we’re going to launch a no-dividend fund.” I mean, I think that would be an audience of like four people, perhaps. A low-dividend fund would be tough, but I don’t know.
Prof. Fama: Oh, it would be far from the market portfolio.
Meb: Yeah, yeah, for sure. There’s been a topic that’s been very trendy over probably the last decade, as many asset management marketing’s and narratives are, and it seems to have some shifting sands this year. As you think about investing, what role does ESG kind of enter your mind into the universe of what’s happening in the investing world?
Prof. Fama: That’s a very good question. And you see a lot of false advertising in that space in the sense that people promise that they’ll give you not only ESG-pure products, but pure products with higher returns. Well, that’s a pretty good game because what you’re telling me is you’re going to look at a subset of the assets, not the whole asset space, and you’ll pick a subset that will be what you can do with the whole asset space. A mathematician laughs at that. It can’t possibly be true. You have to do better by considering the whole space, and that’s by considering the ESG-pure stocks. But my answer to it, as it is, that’s not a decision for …
ESG is a siloed decision. You’ve got to decide what you think is legitimate. The society has to decide what it thinks is legitimate and what it thinks is not, and then go forward based on that. Now, still, individual investors can say, “No, I’m willing to take lower returns to invest in ESG-pure investments.” That’s fine, as long as you’re willing to accept the possibility that your returns are going to be lower as a constant because think of it first as supply and demand. If you have more people that are demanding these ESG-pure investments, that’s going to raise their prices and lower their expected returns. Simple. But I don’t think people are very clear on that narrative, so they want their cake and they want to eat it too.
Meb: Yeah, reducing breadth, you know, just by the math of it makes it a hard equation. I think the most that ESG crowd has the hope that they can get close to the normal returns before… It’s where they start marketing as having much better returns, it starts to get a little curious. I did a poll to summarize kind of what I thought market participants’ perspective on ESG was. And I did this with tobacco, Russian stocks, Chinese stocks, and something else, I can’t remember which. But it basically said, “Would you invest in tobacco stocks?” You know, and 70% of the respondents said no. And then I waited, like, an hour or two and I said, “Would you invest in tobacco stocks if you knew they were going to be at the S&P?” A very loaded question, right? Of course. But then, everyone said, the vast majority said yes. So, they didn’t really have that religion. They had that religion if it doesn’t cost them any money. So, I said ESG, you know… I think the big star caveat is people like it as long as it’s not costing them anything, which is a hard subtitle.
I wanted to circle back because I forgot to ask this, but I think it’s important. So, on the global market portfolio, or just portfolios in general, advisors, institutions, individuals, you mentioned a key phrase, which is something along this line, of like, you invest in this portfolio and then, you know, you don’t mess around with it. Are there any ways to formalize that? One of the benefits of private equity or venture capital, and there’s many, many drawbacks, is that you’re locked in. You can’t get out for 10 years even if you wanted to. Are there any hacks, ideas for kind of how you think about investors should approach these portfolios and behave? It’s kind of like talking about a diet, I understand, but anything that you’ve kind of thought of over the years and said, “Look, this is useful?”
Prof. Fama: Yeah. So, even if, like, thinking about the market portfolio, there’s a new entry all the time, which is the market portfolio, and then you have people exiting all the time. So it’s not that easy to get the two market portfolios. And then you have stocks and bonds being issued all time, so the proportions can change a little bit. I think that’s really… So, that’s really of second order though, relative too. I can approximate market portfolio pretty well by just, like, getting really diversified.
Meb: This is going to be Gene office hour. Are you ready? This is my new fund idea invention. All right, so we launch a fund, I’m going to call this the forever fund, right? And it’s meant to be, okay, you’re going to hold this for 10 years, 20 years, 30 years, 40 years, so really, like, people say they have a long-term horizon. Let’s hold you to it. And so there’s going to be a declining penalty and it’s going to be heavy. So, for the first 5 or 10 years, let’s call it, you redeem in year one. It’s going to cost you 10% on and on, all the way down to zero. You hold it for 10 years, you’re good. So, there’s the stick, right? The deterrent. And this will be a low, super low-cost, global market portfolio fund. However, the reward is all the fees that are acquired from this penalty of selling too soon gives dividend to all the other investors that remain in the fund. Well, how do you like this idea? Is this a thumbs-up or thumbs-down?
Prof. Fama: The problem is that unravels. That’s a game that unravels in the sense that if I think there’s any probability there that I’ll need the money, I won’t play the game because that means that I’m going to be possibly among the losers. So that’s the kind of game that unravels.
Meb: This is my specialty, Gene. It’s good ideas that will never raise any money. So…
Prof. Fama: Well, the only thing you’re going to get doesn’t know absolutely for certain this that they’re not going to take the money off. And who is that?
Meb: Yeah. The concept would be, alright, you’re going to target younger investors. You’re going to target investors that are willing to hopefully take advantage of the poor emotional makeup of others. But I agree with you. It would need some sort… I mean, it’s an annuity-style structure, but the problem is so many annuities are so expensive. So, I’m not quite there yet. I’m still working on the idea, but we’ll let you know if we figure it out.
Prof. Fama: If somebody with the best of intentions about staying in there may come up, where you have an event or life events that forces them to take the money out, then, you know, they’ll pay a penalty because of that. Then that will end up deterring.
Meb: I agree on the deterrent, so we’ll have to come up with a sexier marketing because, I mean, look man, there’s all these closed-in funds and hedge funds that charge 2%, 3% and you get locked up forever. So, if they can raise it on those ideas, maybe we’ll just market it as magical outperformance. We’ll see.
Prof. Fama: Take a lesson from the death of hedge funds though, right?
Meb: Yeah. Well, the concept that I was considering, I was like, “Is there any sort of like private assets, like farmland or others you could include in a long-term fund, that you couldn’t on a short term?” But we’re working on it. I haven’t quite figured it out yet. I got a few more and then I’ll certainly let you go. Gene, when’ was the last time you bought a stock, by the way?
Prof. Fama: You mean individual stock?
Prof. Fama: When I was a really young fellow, I had a broker that was trying to convince me that he could do this. So I gave him, like, a year. I didn’t put in enough money that I cared about, and I just said, “Okay, we’ll test you out and see how you’re doing.” And, of course, he did so poorly, it was ridiculous. Look, I know I’m the prime candidate for somebody who shouldn’t be picking stocks. I have no special information about any individual companies. I’m not willing to spend the time on it. So…
Meb: There was a good quote from your common co-author and researcher, Professor French, who had a great quote where he said, “People are crazy when they try and draw inferences that they do from 3 years, 5 years, or even 10 years on an asset class, which I thought was, you know, in a world of very short-termism. But I was going to throw it back to you as I say, Professor, who knows, you could have given this young broker five… He needed 5 years, 10 years to show his… This could have been just a young Jim Simons, you never know.
Prof. Fama: Great. But wait now. See, I would say that fallacy that people make, I mean looking at people like Simons, I’m not saying Simons was one of these people, but the fallacy is, you pick them after the fact and that’s not legitimate. You have to pick them before the fact. You can’t take a game in which there are 10,000 people playing and pick out the winners at the end because they’re probably just lucky.
Meb: I was having a conversation with some young angel investors recently about if they could go back and look at the investments they made at the time and predict which ones would be the best performers, and almost to a T, most of them say no. Once you get to the buy decision or invest decision, it’s been pretty spread out. Do you have a most memorable investment in your career, good, bad, or in between over the years? Is there anything that sticks out for you?
Prof. Fama: I’ve been involved with Dimensional Fund Advisors since they said it. David Booth and … were two of my students. You know, they were unusual in the sense that when they sat at a firm, they thought it might be a good idea to have me involved. So, that was an unusual experience. That’s worked quite well.
Meb: Last I checked, they’re, what, $400 billion, $500 billion, $600 billion. They just started converting some of their funds to ETFs on the taxable side and have been very successful on it.
Prof. Fama: Right.
Meb: Alright. So, as you look forward to the horizon, 2023, what ideas, research concepts are on Gene’s brain? What’s got you confused, what’s got you excited, what’s got you worried? Anything that you’re working on that you’re pumped up about?
Prof. Fama: I’m always pumped up on what I’m currently doing. Currently, I’m working a lot on real estate, so we’ll see where that ends up, but it’s still in the beginning stages. So…
Meb: When you say real estate, are you referring to housing? Are you referring to commercial? Are you referring to…?
Prof. Fama: No, I’m referring to aggregates, trying to think how real estate sits in with different things that happen in different metropolitan areas and things like that. So, it’s not on a micro perspective, it’s more of a macro perspective.
Meb: Yeah. Well, real estate’s interesting because, you know, when you think of diversifying investments in the global market portfolio, real estate often for many individuals is by far their biggest chunk, but it’s extremely undiversified. I remember Professor Schiller had had some housing funds that came out that weren’t successful, but, like, looking at different markets and trying to hedge and think about investing and diversify that, the real estate space, I think there’s still so much innovation to be had. Having just gone through a mortgage, my god, what a still antiquated process. I couldn’t believe it here in 2022, how bad and how expensive that process was. But there’s a lot of innovation going on that I think is pretty thoughtful on the concept of housing and investing and real estate is sort of my nightmare, so I’m going to put my cards on the table.
Prof. Fama: Yeah. Well, like I said, I think that, you know, if you took the housing stock of the country, that’s by far the biggest asset, you know, on aggregate. So…
Meb: And it’s probably the biggest private asset class that’s not well represented in the public global market portfolio, right, would be single housing around the world?
Prof. Fama: Yeah. There’s a big agency problem associated with it. So, if I own my own house, I take care of it. If I own a share in everybody’s house, then nobody has an incentive to take care of it. Till that problem gets solved, you’re not going to see diversification in that.
Meb: There’s some startups that are kind of working on something similar that let you essentially be an owner, but only own a portion of your house and they’ll take on, you know, a certain part of the equity with you. There’s a lot of obviously costs involved in many of those that become problematic, but… We don’t have time today, but I’d love you had a… We’ll link in the show notes an entire paper on your summary on thoughts on taxes. But I was reading that on some of the ideas you had on property taxes and how you should think about that as a renter and an owner and what concept of a wealth tax there. If we could just like a magic wand to use czar of the taxes in the U.S. what’s your proposal?
Prof. Fama: One layer of taxes. Just decide where you want to tax. Do you want to tax firms at the firm level, or do you want to tax them at the individual level? But don’t do both because there’s always going to be games being played if you do that. So…
Meb: Well, so let’s nominate you. Which one are you going to go with? The president says, “Alright, Gene, you got to pick one. Which side are we going to tax?” What would be your pick?
Prof. Fama: If you could guarantee that you wouldn’t change it, I would say the simplest system would tax at the firm level. You have one tax return then rather than…
Meb: This is like a value-added tax style or what is it?
Prof. Fama: Oh, no. The value-add tax is fine. You have to be careful or you’re going to leave labor outta the value-add. You’re going to get incompetent among the value added on… in the value-add of the firm, so you have one level of taxation. You can get around that, but we’re never going to get…
Prof. Fama: Yeah, I have sort of a yearly tweet where I complain about the amount of time it takes me to do taxes every year. And much like Rumsfeld, I say, “I can guarantee you there’s something wrong with this. I’ve done my best, but even as a financial professional, it’s, like, so complicated and such a mess that I…” I’d say like a boy, I’d say, “I promise I’ve done my best, but I guarantee you there’s something wrong with this tax return because it’s just so hard to do.”
Prof. Fama: Well, you’re in California, so that’s the place where people want everything and they want different people to pay for it. So, that’s the big problem of democracy, is giving incentives to the poor to steal from the rich.
Meb: But then I go see the sunset, Gene, when it’s a beautiful 70 degree day, and it’s 10 degrees in Chicago, I can say, “Okay, well…”
Prof. Fama: But that’s precisely why they get away with big gains over there.
Meb: Yeah. At your home state, there’s some pension problems. You know, you guys have historically been known for, so I imagine this year’s not helping, but we’ll see. Gene, this has been a blast. Thank you so much for joining us today. Would love to keep in touch and hopefully do this again.
Prof. Fama: My pleasure.
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 to the show anywhere the good podcasts are found. Thanks for listening, friends, and good investing.
Past performance is not indicative of future results. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact Cambria or consult with the professional advisor of their choosing. Certain information contained herein has been obtained from third party sources and such information has not been independently verified by Cambria. No representation, warranty, or undertaking, expressed or implied, is given to the accuracy or completeness of such information by Cambria or any other person. While such sources are believed to be reliable, Cambria does not assume any responsibility for the accuracy or completeness of such information. Cambria does not undertake any obligation to update the information contained herein as of any future date. All investments involve risk, including the risk of the loss of all of your invested capital. Please consider carefully the investment objectives, risks, transaction costs, and other expenses related to an investment prior to deciding to invest. Diversification and asset allocation do not ensure profit or guarantee against loss. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Masterworks is not registered, licensed, or supervised as a broker dealer or investment adviser by the SEC, the Financial Industry Regulatory Authority (FINRA), or any other financial regulatory authority or licensed to provide any financial advice or services. Source: (2022, September 13). Wall St suffers worst sell-off since June 2020 after inflation data. Financial Times Source: (2022, September 19). Fund managers pitch ‘alts’ to retail investors as institutions max out. Financial Times Source: (2022, September 30). Inflation punches Wall Street again, ending knock-down quarter. Reuters Source: (2022, June 24). State of the Art Market: An Analysis of Global Auction Sales in the First Five Months of 2022. Artnet News.