October 18, 2024 • 50 mins
For decades, investors have been told that diversifying is a good thing. You should hold a basket of stocks across different sectors and geographies, plus bonds, maybe some commodities or real estate, and so on. But, it turns out that you probably would have done better if you just bought large-cap US stocks in the form of an S&P 500 ETF like SPY. So why haven't diversified investments performed better? In this episode, we speak with Meb Faber, CIO of Cambria Investment Management, the host of the Meb Faber show, and the author of one of the most-downloaded research papers on SSRN. He says the last 15 years have "arguably been the worst period ever for an asset allocation portfolio.
Read more:
Great ‘Bear Market’ in Diversification Haunts Wall Street Pros
The Fate of the World’s Largest ETF Is Tied to 11 Random Millennials
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:03):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:20):
Hello and welcome to another episode of the All Thoughts Podcast.
I'm Tracy Alloway and I'm Joe Wisenthal.
Speaker 3 (00:26):
Joe, do you.
Speaker 2 (00:26):
Ever feel like the investment gods are punishing you?
Speaker 4 (00:30):
Oh? My god. I think about this all the time. Like,
you know, when I first started investing my money, I'm like,
I'm going to be a very prudent diversifier, and I'm
going to buy some bond funds.
Speaker 2 (00:42):
Some hard assets, some star funds.
Speaker 4 (00:45):
I'm going to invest internationally. I'm going to invest a
little bit in emerging markets. I'm going to buy some
ETF so I get a little income. Yes, I thought
I was being very smart for that, but all it
turns out is I should have just bought QQQ or
you know, the big tech stocks how to inspire die? Yeah, yes,
(01:07):
or over time I've become a little bit more aspired.
Speaker 5 (01:10):
Dye. H.
Speaker 4 (01:11):
You capitulated, Yeah, it capitulated probably means it's the top.
Speaker 2 (01:15):
Now I have the same thing. So obviously we're journalists
and we can't really invest. We don't trade, right, we
don't trade. H But for instance, we have retirement options yeah, right,
And there are retirement options that are like, oh, an
ex Us dividend fund or something like that. And I
remember in the sort of mid twenty tens people talked
(01:35):
a lot about international equity. Yeah, and like, don't just
put all your eggs in the America basket. Make sure
you have exposure to emerging markets in China and like Europe,
even coming out of the Eurozone crisis. And it turns
out that was a bad idea totally.
Speaker 4 (01:52):
You really should have just bought us big caps.
Speaker 5 (01:55):
You know.
Speaker 4 (01:55):
You mentioned like retirement like in our like four to
one K options. I think I have money and some
sort of target date funds. Yeah, which is a cool
idea because as you get older and one right, I
think so, you know, and like in theory, as you
get older you're supposed to take on less risk and
stuff like that, and so great, it seems like a
good idea to want to like think about it too much.
(02:17):
So it'd be nice if we're just sort of automatic.
But man, all of this diversification is killing me. What
a mistake.
Speaker 2 (02:25):
All right, Well, today we need to talk a little
bit about why diversification for the past ten years or
so at least, has turned out to kind of be
a bad idea. You would have made a lot more
money just putting stuff in the S and P five hundred.
You certainly would have made a lot more money if
you just, I don't know, bought Apple.
Speaker 4 (02:44):
Or QQQ, Yeah, just big cap tech.
Speaker 2 (02:48):
So why is that we need to talk about why
we're being collectively punished for being prudent. We have the
perfect guests to talk about this. We're going to be
speaking with someone who I actually can not believe hasn't
been on the show before. I feel like he has,
but then I realized that, like he's sort of like
the Rocky Mountains in the sense that he's just always
(03:09):
kind of been there, but you kind of take him
for granted. He's like out there, you know him, you
read all his stuff, maybe listen to a show, see
him on Twitter, certainly, and yet we've never had him
on the show. We've just taken him for granted.
Speaker 4 (03:21):
Or outrageous oversight that we must now rectify.
Speaker 2 (03:24):
Yes, Okay, so I'm very excited to say we are
going to be speaking with Med Faber. He is, of course,
the co founder and CIO of Cambria Investment Management and
also the host of the Med Faber Show the podcast,
So meb thank you so much for coming on all blots.
I feel so bad that you haven't been on before.
I can't believe it.
Speaker 3 (03:42):
It's great to be here y'all. As a Colorado native.
Maybe the Mountain analogies spot on.
Speaker 4 (03:46):
Oh that was better than you real. By the way,
we're still out even though it's long past. We are
recording this at the future Proof conference in Huntington Beach, California.
Maybe you live like an hour away.
Speaker 5 (03:58):
Huh.
Speaker 3 (03:58):
Yes, Sadly we invited Joe and Tracy come surfing. They
skipped out again for our surf lessons. But beautiful day,
glad y'all are here.
Speaker 2 (04:04):
I'm not good with cold water, so I'm just gonna
be like one hundred percent honest. It's like sixty five
degrees at the moment in Huntington Beach. I could not
fathom going willingly going into the water in this temperature.
Speaker 3 (04:16):
Who just talked about surfing, Actually, Joe mentioned that he
likes getting punished in the market. Surfing will be perfect, right,
It's the ultimate humility. You get out there and just
get tossed.
Speaker 2 (04:26):
Pounded by the waves of bad decisions over and over again. Yeah,
that sounds about right. Okay, Wait, so I mentioned that
you've sort of always been out there, and certainly for
as long as I can remember, in financial journalism, you
were always there. Cambrio was always there, and so I
never really stopped to think about what it is that
you actually do. But what does Cambria do?
Speaker 3 (04:45):
Yeah, So we like to think of ourselves as the
odd lots of ETFs.
Speaker 5 (04:49):
You know.
Speaker 3 (04:50):
See, But I'm being serious, you know. We fast forward
from getting started pre GFC the company launched its first
ETF and twenty thirteen, so over a decade old now,
and we often tell people the best compliment you can
give anyone in investing, but also in the asset management
and entrepreneurship is just surviving. So Alpha all that extra wonderful,
(05:12):
but just surviving is a big compliment. So we're near
three billion in assets, sixteen ETFs now, but we often
say it's the best time ever to be an investor.
The choices are limitless. You can invest in ETFs for
near zero fee, thousands of choices. But in that world,
if you're going to charge more, you better be doing
(05:34):
something weird. We're concentrated in different and so we try
to only launch funds that don't exist in in a
world of ten thousand plus funds, that seems like a
hard goal, or that are sufficiently we think we can
do cheaper or quote better and better off is a
lofty goal too, But it has to be something I
want to put my own money into. It has to
be something that's backed by academic and practitioner research, and
(05:57):
so that versus a lot of the industry. And I
love our friends here that throw as much spaghetti against
the wall and see what sticks. We want products that
we want to invest in that don't exist.
Speaker 4 (06:07):
Speaking of academic research, didn't you write some like it
was one of the most downloaded papers ever on SSRN
about market timing?
Speaker 3 (06:17):
Yeah, well, it's funny you mentioned market timing. The original
title was a better Approach to market timing, and no
one would read it. I got a lot of really
nasty responses from probably some prior a lot guests, but
a lot of famous investors and a lot of really
wonderful thought for responses too, and I changed the title
to Quantitative Approach to Tactical Asset Allocation. Oh more, sounds
(06:37):
way more like consultant speak. But it also there's a
lot of luck. It came out pre financial crisis. Is
a very simple trend following methodology, and trend falling goes
back one hundred years, so nothing particularly new, but it
would have worked great as trend falling tends to do
during crisis and big bear markets, which we haven't had
in a long time, and so it became very popular. Clearly,
if I published in twenty ten, probably have zero downloads
(07:00):
as well.
Speaker 2 (07:01):
It did better under the second title than it did
under the market timing title. That's kind of crazy from
a headline perspective.
Speaker 4 (07:08):
Well, tactical, I think is a great word to have,
all right.
Speaker 2 (07:12):
The headline of this episode is going to be like
med Faber on tactical allocation. Yeah, all right, okay, Well,
so you mentioned in the beginning that if you are
charging clients more, you better be doing something interesting and worthwhile.
Convince me why I shouldn't just put all my money
in spy.
Speaker 5 (07:32):
Long dramatic pause. So a couple of things.
Speaker 3 (07:35):
We always say the global market portfolio is the best
starting point. And what is the global market portfolio's If
you buy everything in the world, all the public assets,
and that is roughly half stocks, half bonds, half US
half foreign roughly speaking, and that's actually a really really.
Speaker 5 (07:51):
Hard portfolio to beat over time.
Speaker 3 (07:53):
But if you were to go back one hundred years,
one hundred and twenty years, we were doing odd lots
in London, sipping on some tea, drinking some champagne in
eighteen ninety nine and trying to project what would be
the successful country. You know, maybe we pick the US,
Maybe we pick Argentina, you know, maybe we pick other
countries and areas and stock markets. And my favorite investing book,
(08:13):
Tryumph for the optimists, you know, outlines the historical returns
of stocks, bonds, bills and all these countries. People always
think the US is the best. It hasn't been. I
think Australia and South Africa had better returns. But the
US has darned near over two thirds of the world
market cap today. So even if you invest in the
global portfolio, you're putting ten times as much in the
(08:34):
US stock market as any other country. And let's be honest,
US has been on a roll. You guys know. I
love to do my polls on Twitter. We did a
poll the other day and listeners, you got to answer
this before I give the answer up, I said, what
do you think US stocks have done since two thousand
and nine? And the multiple choices were do you think
they've doubled, do you think they've tripled? Do you think
(08:55):
they've quadrupled? And the fourth answer, which I had to
google was non you polled, which is nine times, and
then deck you polled, which is ten times. So listeners,
think about what do you think stocks had done? The
answers is almost a ten bagger. So one hundred grand
in stocks in two thousand and nine, if you didn't sell,
or you held, or you bought in March, you now
(09:16):
have a million bucks million bucks. You got ten million
bucks amazing fifteen percent returns. So you should have invested
in spy right like you crushed everything in the world.
But historically that concentration has not been rewarded. If you
look at the other forty five countries and you talk
to someone in Greece or Japan, or China or the UK,
(09:37):
they would tell you that investing all their money and
their home country was a terrible idea. But diversifying globally,
particularly into the US, has saved their bacon for the
past ten fifteen years.
Speaker 4 (09:48):
So Tracy mentioned that much to our regret we've never
had you on the podcast before. I have interviewed you, however,
once maybe twice on TV, and you're talking about some
of these similar themes about international diversification, and I think
if I recall, he was talking a little bit also
about like sort of international extension of some of the
(10:09):
ideas that Robert Schiller has talked about, and the idea
of Schiller cape ratios, looking at market valuation from that
point and opportunities to essentially invest in cheap markets overseas,
and this idea that if it works in one country,
maybe it works internationally. What's the basic idea behind that?
And then you know, you mentioned, okay, the US has
(10:31):
just like totally clobbered everyone else. Give us the rundown
of like, I don't know, it was probably ten years
ago or maybe eight years ago, what's happened over the
last eight years internationally?
Speaker 3 (10:40):
So if you rewind the clock and look at these
various regimes, and everyone wants to focus on what's the
FED doing, what are earning? Is going to be what's
going to happen this month, the election next month? A
lot of these regimes play out over not.
Speaker 5 (10:53):
Just years, but decades.
Speaker 3 (10:55):
Right If you look at not that long ago, from
two thousand to the financial crisis, the US stock market
got creamed by everything.
Speaker 5 (11:02):
Else in the world.
Speaker 3 (11:03):
Reads, gold, foreign stocks, merging market stocks, and so you
go through these periods where various assets have their time
in the sun and day in the shade. If you
look at the US market, say nineteen eighty super cheap, right,
the US has been a long term KP ratio of
five before, it's been as high as forty five at
the peak of my favorite bubble ninety nine.
Speaker 4 (11:24):
Mine too.
Speaker 3 (11:25):
Yeah, it's a great time in the nineties, but if
you look on average, it's usually like in the low
twenties if inflation is chill. But you have all these
countries and other examples. The classic we always talk about
is Japan. You know, Japan was darn near one hundred
in the nineteen eighties and then went nowhere for multiple decades.
Now it looks great today after an entire generation has
(11:45):
made no money in the Japanese stock market. But that's
how long it often plays out in Japan's not some
tiny economy, you know, this is a top three world
economy in stock market, and what's the biggest stock market
in the world at that time where the US is today,
and the US isn't expensive today, it's in the mid thirties.
It's not a bubble, but it tends to be a weight, right.
It tends to be a headwind over time, because you're
(12:08):
buying all the.
Speaker 5 (12:08):
Future cash flows.
Speaker 3 (12:09):
The good news is most of the rest of the
countries around the world are reasonably priced to really cheap.
Speaker 5 (12:14):
The really deep.
Speaker 3 (12:15):
Value like GMO and others talk about, is exceptionally interesting
right now, So we manage these shareholders yield ETFs, and
so the market cap in the US, the Achilles Heel
of market cap indexing is there is no tethered to
value whatsoever. It's the stock price times shares outstanding. And
that's good most of the time because you're guaranteed to
own the winners. But it's bad in the sense when
(12:37):
things go crazy, they're really expensive, and everyone's talking about this,
right the bag seven everything else, the really expensive stuff
gets the highest weights, and so much like late nineties,
a lot of the cheap companies high quality look exceptional
not just within the US but in foreign developed and
emerging as well. But everyone's forgotten about foreign stocks. Emerging
(12:59):
market stocks wants any but that sets the stage for
the next next outperformance as well.
Speaker 2 (13:04):
Wait, talk more about the role of the benchmark indices
in all of this, because this is one thing that
I've been really interested in in recent years. This idea,
I mean, this is where the flows before pros kind
of comes from. This idea that like, if you want
to pick a winner, maybe rather than looking at the
fundamentals or trying to see if something is underpriced or whatever,
(13:24):
you want to look at where the flows are going.
And a lot of those flows nowadays are dictated by
index construction. And so how big a role does that
indexing actually play in I guess the outperformance of concentration
or US versus diversification and rest of the world.
Speaker 3 (13:43):
We always say flows drive performance, and you know in
a particular small asset class or a concentrated strategy has
a much larger impact. You've seen some active funds, some
very famous fund managers over the past ten or so years,
where the flows a dramatic impact on the way up
and also on the way down. But this could also
(14:04):
be if you're buying Brazilian small cap tech stocks, right,
you can move those around with a lot less money
than you could the SMP. But look, you go back
fifty years, the concept of the market cap index set
off just this neutron bomb across the industry. But it
actually wasn't the index. That was the innovation, you know,
John Bogo, Wells Fargos and others. It was what indexing enabled,
(14:27):
which is low cost investing because you don't do anything
and you're guaranteed to own the winners. So quote passive
investing was an amazing invention. But here we are in
twenty twenty four and you don't have to do market
cap indexing to deliver the low cost right. We always
say ETFs are eating the asset management industry. So you
(14:48):
have all this historical very expensive mutual funds with conflicts
of interest and front end loans and twelvey one fees
that maybe index funds. But the index is not the innovation.
It's the low fees, which is what John Bogo used
to say. You know, it's not about index active passive.
He's like, the debate is really high fee, low fee,
and so now you can deliver these much more interesting
(15:12):
exposures instead of just passive market cap waiting.
Speaker 5 (15:16):
That should do much better over time.
Speaker 4 (15:33):
You know, one of the things that really strikes me.
And I think this is an important point that you've
already touched on a couple of times, that the beauty
of like the sort of modern ETF world is it
used to not be trivial right to have substantial foreign exposure.
And you know, especially thinking like before mutual funds proliferated,
you might say, like, I've like Brazil, but when you like,
(15:55):
go out and have a broker make a buye order
for every individual stock, Like that's a cost process and
now that's not costly anymore. And I think that's a
really underappreciated fact about investing. But just sitting aside the
US outperformance, what's going on in international markets so that
investors haven't loved them, Like, yeah, why you talk about
(16:19):
there must be great Latin American companies, Latin American tech companies,
Latin American tire companies and beverage distributors and everything they have.
Why haven't investors liked these companies?
Speaker 3 (16:29):
The US has certainly had great earnings growth, yeah, for
the past ten to fifteen years, right, so it's led
the charge.
Speaker 5 (16:38):
It's done really well.
Speaker 3 (16:39):
But if you look around the rest of the world,
you know, and we manage my largest look, by the way,
my largest fun long only US stock fund. So talking
my book here, But looking at the foreign and emerging
you see great companies, and so here's an example. You know,
we run a value quality strategy. US shareholder yield doesn't
have much tech exposure. Okay, surprising because tech stocks in
(17:01):
the US on average are pretty expensive, but they also
do a bunch of share issuance based on stock based compensation, right,
so they have a negative buyback yield because they're issuing
and issuing a ton of shares. But if you look
at foreign, developed, and emerging, our emerging market fund, tech
is the largest sector allocation, which is surprising to many
(17:22):
people because it's a value strategy.
Speaker 5 (17:23):
But we always say.
Speaker 3 (17:24):
There's opportunities, people just aren't necessarily focused on them. As
an example, our largest holding was a better performer than Nvidia,
and it's a semiconductor stock, but nobody knows about it.
Nobody talks about it because nobody cares about emerging markets.
Speaker 4 (17:37):
But used to be clear, setting aside what people care
about at a given time, earnings growth in the US
since two thousand and nine or really at any point
has been extraordinary and over time. It just there are
companies that buy and large are just continue to grow earnings.
Has that not been the case internationally?
Speaker 3 (17:56):
Yeah, you haven't had the same earnings growth. But also
within the US, you have had this tailwind of multiple expansion.
Our buddy Cliff was talking about, He's like, the percentage
of the returns that are attributal to multiple expansion is
pretty high. Right, So you've had the US So back
in two thousand and nine, right, we're hanging out in
March somewhere at a pub in New York City, drowning
(18:17):
our woes about the world going crazy. The US stock
market talking about back to the Shuler cap ratio was
low teens, but so was foreign developed and emerging. So
the US has gone from twelve to let's call it
thirty six today, whereas the rest of the world hasn't.
It hasn't had that multiple expansion, and so that can
be a massive tailwind and headwind over the course of
(18:38):
a decade of like three, four, five seven percent per year,
depending on what people are willing to pay for those stocks.
Speaker 2 (18:46):
So just on this point, one of the criticisms that
is sometimes leveled against diversification or strategies that are focused
on diversification is the idea that well, your purposefully kind
of adding losers to your port, Like you're not really
trying to choose winners, You're trying to distribute your risk
among a bunch of different entities. And the analogy that
(19:08):
I sometimes use, which probably will not resonate for either
of you or like most of our listeners, but I
sometimes think it's kind of like trying to find a
single guy over forty in New York City, Like there's
a reason they're desirable to single women. But on the
other hand, like, there's probably a reason that they're single
(19:28):
over forty. There's probably something wrong with them, right, and
that's why this is good, That's why they're single. So
I sometimes think about diversification or like value investing in
those terms, why should you seek out things that are
probably going to be losers at least for you know,
the short to medium term.
Speaker 3 (19:47):
There's the late Peter Bernstein had a great quote which
I'll get directionally correct, which was he's like, look, acid
allocation is a defensive strategy, but it's also an aggressive
strategy because you never know where the next windfall is
going to come from.
Speaker 5 (20:00):
Look around the.
Speaker 3 (20:00):
World, today gold all time highs. Nobody's talking about it,
at least at this conference that I'm chatting with. But
you never know if you look at various assets, whether
it's coffee, whether it's the yen, whether it's foreign stocks,
merging markets, reads, bonds, even US stocks value right quality,
you never know the exact timing of it. And that's hard,
(20:21):
you know, And we have a lot of non consensus
views when it comes to acid allocation. I actually don't
think if you're doing buy and hold, your allocation matters
much at all, which I think it's like my mom
is a Southern cook and you know, you make She
makes chocolate chip cookies with just by by a feel right,
She tastes some. But as long as you have the wheat,
the flour, the butter, the chocolate chips, like it's going
(20:43):
to end up okay, you totally omit one thing and
it's probably going to be suboptimal. And that's the way
with this ass allocation. You have some global stocks, some
global bonds, and some real assets, meaning like tips reads,
the allocation percentage doesn't much.
Speaker 5 (20:56):
And when we wrote this book, this.
Speaker 3 (20:57):
Acid Allocation book a decade ago, which were updated, we
actually found that if you look at overtime the last
fifty the last one hundred years, and compare the best
performing strategy relative to the worst. And we looked at
all of them en DOWNMNT permanent portfolios sixty forty, on
and on, we found the spread was actually pretty tight.
They all returned about within a percent or two percent
(21:18):
of each other. And the crazy part is if you
took the best one, you say, all right, Joe Tracy,
I'm gonna give you crystal ball. We'll hop in the Dolorean,
go back fifty hundred years. I'm going to tell you
which asset out case and strategy was best. How much
would you pay me that? You know, PIMCO probably give
me a billion dollars for that knowledge. But I said,
hold on the genie. There's one rule. You have to
implement it with the average mutual fun feed of today,
(21:41):
not back then one point two five percent today that
takes the best performing allocation makes it almost as bad
as the worst.
Speaker 5 (21:47):
Wow.
Speaker 3 (21:48):
So all this time we spend on the FED, on
gold or whatever. And this is for buy and hold,
just market cap indexing. We're not talking about all the
good stuff that we do. Trend following value, YadA YadA,
just the basics. And so we often say, you're acid,
alt care doesn't matter that much, but what does matter
is expenses, costs and taxes.
Speaker 4 (22:06):
Yeah, yeah, I remember seeing I think, well, it might
have been like the bulgel Head Forum is back in
the day, and it is so much about like the
cost matter is hypothesis as being a more powerful idea
than the efficient market hypothesis for this exact reason. So,
you know, we've been talking about Okay, since two thousand
and nine, we know US stocks have clobber the rest
(22:27):
of the world. When was the last time, Actually that
wasn't the case.
Speaker 3 (22:30):
Well, so we wrote this piece. It's called the bear
market and diversfication. Yeah right, and so since two thousand
and nine, US stocks again, listeners, think in your head
fifteen percent per year. Yeah, that's only happened on a
ten year rolling basis four times in history. And they
all have names. Roaring Twenties, in fifty fifty, the Internet bubble,
and then whatever we're calling this COVID meme sonk Ai
(22:52):
era right now, you don't know how long it's going
to last.
Speaker 5 (22:55):
And on the.
Speaker 3 (22:56):
Backside, they also all have names, the Great Depression, the
inflation seventies period, the dot com bubble burst in GFC
echo and whatever comes next.
Speaker 5 (23:06):
Who knows.
Speaker 3 (23:06):
It doesn't mean so during.
Speaker 4 (23:07):
Those periods that we don't have good names for, international
diversification has paid off.
Speaker 3 (23:14):
If you look at this period has arguably been the
worst period ever for an acid allocation portfolio. And we'll
just use the Global market portfolio versus the SMP. The
only comparable period is post World War two. And this
is not just in terms And first of all, didn't
do bad, did like seven percent a year? Totally fine,
Joe's four to one k seven percent a year not bad.
(23:36):
But if you look at in terms of underperforming your neighbor,
so an absolute underperformance versus the sb But the worst
part is not the absolute poortance, it's the years in
a row. It is something like thirteen of fifteen years.
It's funder perform the SMP. So it's just bodyblow after
body blow of looking less smart than your dope neighbor
(23:58):
who bought the cues.
Speaker 4 (23:59):
And that's upsetting. Yeah, I know it's not fair.
Speaker 2 (24:05):
I'm trying to process this because it bothers me so much. No, okay, well,
since you brought up taxes and the cost base as
such a big factor to investment success or outperformance. Talk
to us about what you're seeing there in terms of
I guess innovation, because we often talk in the investment
(24:25):
space in ETF certainly about the race to the bottom
in terms of costs. And to me, I look around
at some of the tax yields on these things, it
feels like you can't get that much lower, but maybe
you can.
Speaker 3 (24:37):
There's a lot about ETFs that I think that people
don't know. First of all, a lot of public funds
will do short landing and return that revenue to the consumers.
So on top of the fee you have, let's say
like we charge half or percent well the short landing revenue,
and some funds at may be ten basis points, at
maybe twenty. In some cases it could be very material
(24:59):
fifty over one hundred basis points. So there are plenty
of ETFs out there that actually already have a negative
expense ratio. So let that sink in. You're getting paid
to own this fund. That's pretty cool, right. Second is
the ETF expense ratio is also tax deductible. Right, It's
coming out of the income. So if you're comparing that
to a traditional separate account, which is not deductible. That's
(25:22):
an additional essentially benefit of the ETF over these traditional structures.
But here's the challenge. If you've been participating, you're one
of the lucky ones. You bought a bunch of stocks,
you own a bunch of Nvidia since two thousand and nine.
You're sitting on a ten bagger gain. And if you
talk to older generation, if you look at Buffett, you
(25:42):
know all these decisions that he has to make on
Apple where he has to eventually pay the taxes. Right,
you talk to the order gender and say, well, I
just can't sell my Microsoft or GE or IBM because
the taxman would kill me. We had Hank Bessenbinder on
the show recently, who did the famous paper to stocks
outperformed T bills. We had Hank run for the past
one hundred years. I said, hey, what's the best forming
(26:03):
stock of all time? And listeners, you have to guess
this too.
Speaker 5 (26:06):
You may get it.
Speaker 3 (26:07):
Of the top five, the top three, I don't think
I could guess two or three ever heard of them,
but Vulcan Materials I think two.
Speaker 5 (26:14):
Kansas City was.
Speaker 3 (26:15):
Third and number one was railrud Yeah, okay, and this
is just you are optimizing on length of compound.
Speaker 5 (26:24):
Yeah, so one hundred years.
Speaker 3 (26:25):
But Altria you put It's like you put one thousand
dollars in al three hundred years ago, you now have
two billion. Anyway, the point being is that if you invest,
you eventually have a bunch of capital gains. Great good
problem to have, right if you're in a taxable investor,
and if you have been invested in the US stocks
in two thousand and nine, you have ten x capital
gains on average. Right, So that's a problem for investors, right,
(26:48):
because you got to make a decision. Am I just
going to bite the bullet? Sell this, pay the taxes
and move on. Because these power laws dominate everything we
do in investing. It's in VC, it's true in public
markets where the best performers, it's like five percent of
stocks generate all the return. So if you end up
with one of these, your whole portfolio is now this
appreciated stock or portfolio. What I'm getting at is what
(27:11):
do you do well. There's actually been something that's been
around for one hundred years called the exchange fund. It
was popularized really in the nineteen seventies by eat Advance
by now Morgan Stanley Goldman does it. And it's like
a ten thirty one exchange.
Speaker 5 (27:25):
If you have a portfolio, this is it.
Speaker 4 (27:26):
The ten thirty one is that how real estate investors
never have to pay ten.
Speaker 2 (27:29):
That's like when you buy a house, if you buy
an if you sell it and then buy another.
Speaker 3 (27:33):
One commercial you buy it, you buy a hotel, you
buy some farm.
Speaker 4 (27:37):
Commercial real estate. People love this. This is like the essence,
what's it?
Speaker 3 (27:40):
Indefinite tax referral. And it builds generational wealth. And it's
why you see so many people that you know, they
they talk, well, my grandmother bought this property at ten
thousand dollars and now it's ten million. You know, So
it's great. It's a huge wealth compounder over time. But
so with stocks, you eventually have to pay the pipers.
So there's this thing that's been around forever called exchange funds.
(28:03):
And the way they work is if you have highly
appreciated positions, you get a bunch of other people, you
contribute them to a portfolio, and there's some rules. You've
got to be accredited or qualified. You've got to hold
it for seven years and at the end of seven years,
you get back at diversified portfolio, so you you eliminate
your concentration risk. But the problem of the course is
it's run by the traditional asset managers who love to
(28:25):
charge exceptionally high fees. They're going to ding you probably
a percent or two just to get in, and then
they're going to ding you a percent or two every
year for seven years for the privilege of having this
exchange fund. So there's others trying to do this. There's
a company called cash that's doing this, trying to disrupt this.
But if you think of the ETF structure, which is
a massive innovation where you're having actively managed portfolio at
(28:48):
index portfolio, you're only paying taxes when you sell that fund,
so the turnover doesn't matter. I think that's well understood
by most investors today, hopefully. But if you look back
at Spy, if you bought it in ninety seven, I've
paid no capital gains at all, despite the fact that
trades consistently. That's not a feature of mutual funds or
hedge funds, and that's why ETFs are eating asset management.
They're vastly more tax efficient, which on average is probably
(29:11):
about a seventy basis point after tax benefit relative to
mutual funds. Monster number probably more important than the expens ratio. However,
what if you've got a bunch of stocks have gone
up a ton, so you could go to this exchange
fund route, you're stuck.
Speaker 5 (29:25):
You could sell it.
Speaker 3 (29:26):
But what you've started to see over the past five years,
you've seen the riding on the wall, and the traditional
mutual fund industry is doing one of two things. They're
going Ostrich style head and sand I'm just going to
ride this till I retire and we'll just deal with
the outflows and someone else's problem. Or their shops like DFA,
they say.
Speaker 5 (29:45):
You know what, we're going to convert.
Speaker 3 (29:46):
We're going to They do fifty billion of mutual funds
to ETFs. And then you see some innovation going on
where a group we're partnering with Wes Gray and his
team at Alpha Architect ETF Architect, they we're able to
go to an asset manager and say, okay, well.
Speaker 5 (30:03):
Let's convert your clients.
Speaker 3 (30:05):
So they had five thousand clients from separate accounts to
an ETF and it's not a taxable transaction. And so
I started to think about this. It's called a three
fifty one exchange again, been around for one hundred years,
and you start the brain working in an odd lot's
way and taking this to its logical conclusion. I say,
this is a really cool idea, and to my knowledge,
(30:26):
we're going to be the first to do this. And
so I said, why can't we open this to everyone?
Why can't we make this so that it's disrupting the
entire industry. You make it democratize it where you don't
have to be a qualified investor. You can just be
any investor that's sitting on capital gains.
Speaker 5 (30:41):
And so the way that works.
Speaker 3 (30:42):
Is you can contribute a portfolio of stocks ETFs whatever,
and there's some rules like one position can't be over
twenty five percent, the top five can't be over fifty.
You contribute a basket of stocks, you get an ETF
in return, and you get essentially a tax deferral diversified
portfolio that now has a diversified strategy. It could be
whatever strategy. The first one we're doing is actually a
(31:05):
riff on an old paper we wrote which demonstrated that
if you're a high tax investment in it plays like
California or New York. The last thing you want is
dividends or high dividends. So we demonstrated that if you
had a value strategy that targeted stocks that paid load
to no dividends your act after tax, you do much
better than the SMP or high divinut strategy. So this
(31:28):
takeaway of this idea is that you can contribute a
basket of stocks end up with a great ETF and
you could launch a series of these every year, every
three months, every six months, and let people opt in.
Speaker 5 (31:40):
What do you think, great?
Speaker 4 (31:42):
This sounds good. I wish I had some gigantic capital
gains that I needed to solve for, but a loss
that's not my problem. But let's just talk a little
bit more mechanics. So let's say ten years ago, I'd
bought a bunch of Apple and Nvideo and Microsoft and
whatever else, JP Morgan, a bunch of names that have
(32:02):
done well. Okay, So I have these and now I'm thinking, Oh,
the market's kind of expensive these days, I'm nervous, et cetera.
I'm thinking about I want to sell them, but I
don't want to like write a huge check come next April. Okay,
so that's my problem. Talk to me the specific mechanics.
Now your fund suddenly, your new ETF suddenly exists. Walk
(32:23):
me through the specific mechanics of what I have to
do to swap them.
Speaker 2 (32:27):
I don't understand how you like deliver it.
Speaker 4 (32:29):
Yeah, so I swapped that into this thing so that
now I'm in a diversified portfolio that's a little bit
de risked. Thanks to diversification, I don't have my concentration problem,
but I didn't have to pay the taxes. Talk to
me about exactly.
Speaker 3 (32:42):
This is why we're partnering with our friends ETF architect
like you have things like ten thirty one, have very established,
templated rules how to do it.
Speaker 5 (32:49):
And this is the first time we going through it.
Speaker 3 (32:50):
So I'm sure it's not going to be one hundred
percent without headaches and hiccups. But the first thing you inquire, right,
So we set up camera investments dot com, forward slash tax.
Put in your name, your info. I got this portfolio.
Joe's got a portfolio. Swab Yeah, it's I literally do have.
So you know, here's I'm interested. Send me more information.
(33:11):
I'm sure we'll do a webinar, we'll educate everyone and
we'll say here's the menu, here's the process of what's
going to happen on I'm just making up this date December. First,
your portfolio will contribute to the ETF.
Speaker 4 (33:24):
Everybody, How does that work?
Speaker 5 (33:25):
Magic?
Speaker 3 (33:26):
Hopefully you know the plumbing and the pipes of it.
We'll have to get Wes on the show and get
him to get really deep on it. But they just
did it with a five thousand account.
Speaker 4 (33:35):
But like Schwab or whatever, like, they have mechanisms for.
Speaker 3 (33:39):
Yeah, I mean, I'm sure, like I don't know whether
it's going to be you know, acadding and whether it's
going to be just electronic transfer.
Speaker 4 (33:45):
Okay, but you can do that with shares, yeah, okay, Okay.
Speaker 3 (33:49):
So we wrangle up a bunch of people with all
sorts of different securities and they all contribute them, and
then the next morning they have an ETF in their
swap account.
Speaker 5 (33:59):
It's beautiful.
Speaker 3 (33:59):
And then there you know they have a diversified portfolio.
And we have a few different ones lined up. We
have an endowment style. You guys probably seen me pick
my fights with cowpers.
Speaker 5 (34:08):
Over the years.
Speaker 3 (34:09):
We have a global shareholder yield style. So the menu
will be different for people that may want different ideas,
but the first one, at least, we're doing US stock exposure.
Speaker 2 (34:18):
So once you're in the diversified portfolio the ETF, presumably
if you sold that you would still have to pay
capital gains, but the benefit is that you're getting out
of that like big concentrated position and going into something
more diversified.
Speaker 5 (34:31):
That's the hope.
Speaker 2 (34:32):
Okay, that sounds interesting.
Speaker 4 (34:35):
It sounds very interesting. Can I ask a question? You
mentioned Wes's company, Wes Gray. You mentioned Wes's company is
called Alpha Architect. Since you've been in the ETF game
for a long time, can you talk a little bit
about how, you know, if Tracy and I have an
idea for an ETF, some strategy that we think could
(34:56):
be interesting, how much easier is it today in twenty
twenty four to build What is the process of Like, okay,
we want to build an ETF around this versus say
twenty fourteen or two thousand and four.
Speaker 5 (35:10):
It's night and day.
Speaker 4 (35:11):
So what's the what's it like?
Speaker 3 (35:13):
You know, we originally were gonna sub advise on a
couple of funds. The Forbes family was gonna move into ETFs.
It's a fun fact they didn't because it was two
thousand and nine. So we eventually sub advised on a
fund with advisor shares. Because back then it costs half
a million a million bucks a year just to get
the trust permission to launch ETF, so a huge pain.
(35:33):
We eventually bit the bullet starting launching funds in twenty thirteen.
Fast forward a decade in the ETF rule which was
passed a few years ago that really streamlined everything, changed
it all. And so the two main companies, so ETF
architect and then Title, which are both groups that do
this white label ETF business. You could go to them
now and say, Joe's got his idea for this ETF.
(35:57):
It's only going to invest in companies in North Carolina.
The letter M like, whatever it may be. You know,
who knows. Three months from now you could have a
fund out. Wow, it's going to cost you, I don't know,
fifty grand and startup fees. But the big problem, and
you know everyone sees the gold at the end of
the rainbow, but you really need to be able to
get to twenty thirty forty million. So a lot of
(36:17):
people sit at zero.
Speaker 2 (36:18):
Is that just to make the economics of actually like
managing and trading the ETF actually work well.
Speaker 3 (36:23):
If it sits at zero, you're on the hook for
probably quarter million expenses per year two hundred and fifty grand.
But that's if it sits at zero, and so then
you're subsizing. You know, writing twenty k checks per month
adds up over time.
Speaker 2 (36:50):
Here's something I always wanted to write about or talk
about reverse inquiries in ETFs. I think this is sometimes
like an underappreciated perspect of how ETFs come into being.
But I have heard that, like a hedge fund or
an investor will go out and say, we want the
opposite exposure to this particular thing. We want to take
(37:11):
the other side of the bet. Will you create an
ETF that allows me to do this?
Speaker 3 (37:16):
Yeah, you see that more at a lot of the
trade specific shops and firms that want those thematic exposures.
You know, we tend to focus on ideas I want
to put money into. You know, the average mutual fund
manager has zero dollars invested in their own fund, which
is an astonishing statistic. And half of all public funds
close over the course of ten years, so there's a
(37:39):
massive amount of turnover and people that don't have skin
in the game, and so a lot of these ideas.
You know, I want nothing to do with a lot
of these tradeable thematics, right, but if people build them,
they want to invest them, God bless them.
Speaker 5 (37:50):
Right.
Speaker 3 (37:51):
But we we air on the side of things that
we think make a material impact to investors, you know,
future returns and portfolios and.
Speaker 5 (37:59):
A lot of out there.
Speaker 3 (38:01):
You know, I wouldn't touch with a ten foot pole,
but some of them raise a billion, ten billion dollars
or what do I know.
Speaker 4 (38:06):
It's interesting hearing you describe how much easier ETF creation
has gotten, because it strikes me that it's like the
ETF physation of the ETF industry, because ETFs, of course
make investing in a country or a theme much easier
than if you had to do it by hand and
buy a bunch of stocks. And this is essentially taking
(38:30):
that same idea except applying it to the creation of ETFs,
where you have all these white label things. The infrastructure
is already there, so all you have to do is
supply the idea. This gives me just something I've always
just sort of been wondering about what happens when in
the ETF dies. So Tracy and I launch our fund
where we only invest in North Carolina stocks where the
ticker has the letter eminem and then, for whatever reason,
(38:55):
in two years we have five hundred thousand dollars under management,
which is probably high, but clearly not enough to build
a business on. You're like, you know what, we don't
want to do this. We don't want to write the
twenty thousand dollars checks a month to support this. When
we decide to wind it down, what happens.
Speaker 3 (39:13):
They go to the ETF ticker in the sky graveyard,
you know. I mean it's a pretty orderly process. There's
a lot of prior arity, of course, you know, I
think on very very rare cases.
Speaker 4 (39:24):
The investors get distributed the stock or do they get
distributed the cash.
Speaker 5 (39:28):
It's usually cash.
Speaker 3 (39:29):
But the correct answer for the vast majority of investors
just sell it before close it down, you know, you
sell it on the secondary market. Yeah, like, hey, we're
going to close this into the year. We'll just sell
it now and just be done with it. But you know,
I think a lot of people take a negative view
of the amount of products out there. You often hear
people say there's more ETFs than stocks, right, and say, well,
there's more words than letters like that, that doesn't ye like.
Speaker 4 (39:50):
It doesn't more sentences than words, but.
Speaker 3 (39:52):
You have sort of the ability to have this limitless
grocery choice. There's a lot of areas that I think
haven't developed the way that they will eventually in One
example is the all in one acid allocation ETF. We
have three of these, but if you look at the
traditional mutual fund asset allocation industry, it is multiple, is
more expensive and tax inefficient compared to the ETFs, and
(40:16):
yet they still have about a trillion in assets. And
you know those type of assets, it's usually death or
divorce or bear markets where they all come out all
the money at some point, but they never go back
to paying two percent. And so I think you'll see
over the next ten to twenty years a big shift
and assets and structures, but eventually it all leads to
the ETF.
Speaker 4 (40:36):
You know, you mentioned the sort of global market portfolio,
and we can never own the global market portfolio truly,
so you only are like trying to get close, right,
because the global market portfolio also includes all real estate
in the world and just a number of things like
you can approach it maybe asymptotically, but you'll never truly
(40:57):
own the global market portfolio. But the old academic Reais
search says, like to own the global market portfolio every
asset in the world. How close do you get in
one of these funds? Are you like ninety five percent
of the way there?
Speaker 3 (41:10):
I'd say it's closer to like ninety nine, you know.
The if you look at one of my favorite examples
we always joke on these assy action from portfolios. We
have one called the Talmud portfolio, which is based on
there's a piece of advice where it was like, let
every man invest a third in business, a third in land,
and a third keep in reserve, which we interpret is
a third in stocks, a third and real assets, and
(41:31):
the third and bonds. That portfolio is almost impossible to beat.
And if you look at a lot of like Cowper's Bridgewater,
and we do all these articles and say should these
big institutions just be managed by a robot? And they,
for the most part, usually can't beat these basic asset
allocation benchmarks. It's really hard for them. Some you include
a little leverage because they have a lot of private
equity and leverage vehicles, but these basic portfolios are a
(41:54):
heart high.
Speaker 4 (41:55):
Bar that's funny.
Speaker 2 (41:56):
I hadn't considered talmudic investment philosophy for the wind, but
I guess it works. Okay. So this whole conversation has
reminded me that I am old enough to remember when
active ETFs were first becoming a thing and they were
going through like regulatory approval process. Obviously they've become much
more of a thing since then, and we've seen mutual
(42:19):
funds convert into ETFs. As you mentioned, what's the next
big thing in the etfification of the market.
Speaker 3 (42:27):
Now, there's a few areas we're always interested in. And
when we look at the Vinn diagram or you make
the columns of things that are totally fine, Okay, good,
there's plenty, right.
Speaker 5 (42:38):
You know.
Speaker 3 (42:39):
I was chatting with someone last night and he's like, look,
I used DFA, Why should I use your funds? I'm like, don't.
DFA is fine, you know, but the bad news is like,
there's a whole universe of absolutely awful, god awful, terrible.
I have a Twitter thread that's just instant. I made
the mistake of bookmarking a spammy, sleazy Instagram ad for
(43:00):
private real estate. It's always private real estate, right, fifty
percent per year.
Speaker 5 (43:04):
You know, they're.
Speaker 4 (43:05):
Claiming those guys got closed. There's twenty See.
Speaker 2 (43:07):
Some of the videos are like, if you just commit
investment and tax fraud, you can make like a two
hundred percent return in six months.
Speaker 3 (43:15):
So all my all my ads are now these scams. Right,
I just get delivered because they I bookmarked it, so
I get all these So just avoiding and doing the
really dumb stuff is the key to almost all of this.
Speaker 5 (43:26):
Right.
Speaker 3 (43:27):
We did an old article about the food pyramid. You
remember the food pyramidal?
Speaker 5 (43:31):
Yeah, you know.
Speaker 3 (43:31):
The base of that when we were kids was eat
a bunch of cereal and bread and pasta, you know,
and it's kind of inverted now where thinking about it.
But the same thing with investing is like the basics.
Get the basics right, payloa fees, payload taxes, get your
money invested. That's the number one piece of advice of
all this is get to work, let it compound, right,
and then the other things take care of themselves. So,
(43:53):
but because this is the Wonky Show and we get
into this, I think the things like the three fifty
one exchange idea we're talking about are going to be
extremely material when we're talking about.
Speaker 5 (44:01):
This in a year or two.
Speaker 3 (44:02):
I've seen some other companies and we don't do this,
But I love the idea of taxable target date ETFs.
We see people behave better in target date style funds.
I think there's some ideas and concepts around building personal
pensions where people are locked into their investments and get
them to behave in a good way where you know,
(44:22):
these fiduciaries, you're kind of forced to hold investments and
let the compounding do its work. There's a lot of
innovation in some of those ideas. But if you go back,
I have a joke, I'm like, so many of the
fintech ideas are just vanguard with a shiny coat of paint, right,
Like you already have pretty great out there. But there's
there's some more ideas we're working on too.
Speaker 4 (44:42):
I love the idea of like a sort of like
forced pension because it intuitively it seems like a most
people make mistakes when they're like left on their own,
so you just sort of want to lock it up,
would be. It also seems like there's probably excess returns
for like that commitment where if like you trade off
the liquidity profile, then you get paid more anyway, med favor.
(45:04):
It's so great to finally have the show. Great to
catch up with you in your natural environment at.
Speaker 2 (45:09):
The surfing on a beach.
Speaker 4 (45:10):
Yeah, it's like okay, like, yeah, we didn't have MeV
on for a long time, but if we when we
did finally have it, we're like literally on the beach
right now, listeners.
Speaker 5 (45:18):
You heard it here.
Speaker 3 (45:19):
They're committed to us serving with this future.
Speaker 4 (45:22):
I don't know.
Speaker 2 (45:22):
Only I said only if the temperature is above eighty
degrees or someone like loans me a what you.
Speaker 4 (45:27):
Just it's freezing.
Speaker 3 (45:29):
I'm really cool care of it.
Speaker 2 (45:30):
I've been cold for two days.
Speaker 4 (45:32):
It all right, thanks so much, man, take.
Speaker 5 (45:34):
Great, y'all.
Speaker 2 (45:48):
Well, I'm glad we were finally able to do that, Joe,
as you say, in Meb's natural environment. One thing I
was thinking was just about that new fund and the
sort of tax focus of it. It is in interesting
because you know, our whole conversation was about how over
the past ten years or so, those big concentrated yeah
investments are what have paid off the most, and I
(46:11):
guess people are now trying to think through how they
actually crystallize those wins and so it's interesting to see
the market trying to come up with a solution to
that problem.
Speaker 4 (46:22):
The solution of the problem of people having to pay
tax and people having to eventually pay taxes. You know
what I think is interesting to me to going back
to the sort of diversification story and getting punished for
diversification where we started. I like the idea that one day,
like the sort of I'm still kind of diversified, you
(46:44):
know that, like my prudent approach is going to pay off.
But it's also interesting that like the periods that were
paid off are like not great periods. So it's like, Okay,
I want my.
Speaker 2 (46:55):
Diversification yocer and forgettable.
Speaker 4 (46:57):
Yeah, or like the aftermath of a craft and so
like I want my diversification to pay off, but I
don't want to crash.
Speaker 2 (47:04):
This is exactly what I was thinking. The trigger for
diversification coming back would be something very bad happening that's
right in the US. Yeah, And as people who live
in the US were de facto over levered.
Speaker 4 (47:17):
Yeah, we're always going to be levered to the US.
I mean, our jobs are levered to the US economy, right,
So I think about this a lot, which is like Okay,
it makes me uncomfortable as not just someone with money
in the market, but it makes me uncomfortable as a
press of the world that, like, we have this market
that is just so heavily concentrated and so levered to
(47:38):
the success of Meta and Nvidia and Amazon, and I
don't really like that. It rubs me the wrong way.
It doesn't sit right with me as something. But on
the other hand, if I think about what would change that,
it's nothing good. Yeah, there doesn't seem to be like
a positive version. Now I would see the one exception
where maybe this doesn't have to be the case would
(48:01):
be kind of like a market in which the investments
that are being made in things like the Inflationial Reduction
Act and the chipsy Act, where there's like this industrial
renaissance in the US and that really started taking off,
or where you have such above trend growth and productivity
that a lot of the so called like real economy
(48:22):
stocks really start to do well, et cetera. So there
is like that sort of golden.
Speaker 2 (48:27):
Scenario where more winners come in this right right, and
so like having more exposure to potential winners that pays off.
But on the other hand, it feels like the downside scenario,
where like the current winners just get just.
Speaker 4 (48:40):
Are no longer the winners and everyone loses, and then
seems more probable. It seems more probable, and so it's hard. Yeah,
it feels like when the regime shifts, which will happen
because regimes shift, and maybe it'll be one hundred years
from now and it will be dead and whatever. But
it seems most likely that when the regime shifts, it
(49:01):
will not be because things are good.
Speaker 2 (49:03):
Yeah, nothing last forever shed dramatic tear, including our time
at Futureproof on the beach. So shall we leave it there?
Speaker 4 (49:11):
Let's leave it there.
Speaker 2 (49:12):
This has been another episode of the oud Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 4 (49:19):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our guest meb Fabor. He's at meb Faber. Follow
our producer Kerman Rodriguez at Kerman ermann Dashil Bennett at Dashbod,
and Kelbrooks at Kelbrooks. Thank you to our producer Moses Ondam.
From our odd Lots content, go to Bloomberg dot com
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(49:39):
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Speaker 2 (49:49):
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Speaker 2 (00:20):
Hello and welcome to another episode of the All Thoughts Podcast.
I'm Tracy Alloway and I'm Joe Wisenthal.
Speaker 3 (00:26):
Joe, do you.
Speaker 2 (00:26):
Ever feel like the investment gods are punishing you?
Speaker 4 (00:30):
Oh? My god. I think about this all the time. Like,
you know, when I first started investing my money, I'm like,
I'm going to be a very prudent diversifier, and I'm
going to buy some bond funds.
Speaker 2 (00:42):
Some hard assets, some star funds.
Speaker 4 (00:45):
I'm going to invest internationally. I'm going to invest a
little bit in emerging markets. I'm going to buy some
ETF so I get a little income. Yes, I thought
I was being very smart for that, but all it
turns out is I should have just bought QQQ or
you know, the big tech stocks how to inspire die? Yeah, yes,
(01:07):
or over time I've become a little bit more aspired.
Speaker 5 (01:10):
Dye. H.
Speaker 4 (01:11):
You capitulated, Yeah, it capitulated probably means it's the top.
Speaker 2 (01:15):
Now I have the same thing. So obviously we're journalists
and we can't really invest. We don't trade, right, we
don't trade. H But for instance, we have retirement options yeah, right,
And there are retirement options that are like, oh, an
ex Us dividend fund or something like that. And I
remember in the sort of mid twenty tens people talked
(01:35):
a lot about international equity. Yeah, and like, don't just
put all your eggs in the America basket. Make sure
you have exposure to emerging markets in China and like Europe,
even coming out of the Eurozone crisis. And it turns
out that was a bad idea totally.
Speaker 4 (01:52):
You really should have just bought us big caps.
Speaker 5 (01:55):
You know.
Speaker 4 (01:55):
You mentioned like retirement like in our like four to
one K options. I think I have money and some
sort of target date funds. Yeah, which is a cool
idea because as you get older and one right, I
think so, you know, and like in theory, as you
get older you're supposed to take on less risk and
stuff like that, and so great, it seems like a
good idea to want to like think about it too much.
(02:17):
So it'd be nice if we're just sort of automatic.
But man, all of this diversification is killing me. What
a mistake.
Speaker 2 (02:25):
All right, Well, today we need to talk a little
bit about why diversification for the past ten years or
so at least, has turned out to kind of be
a bad idea. You would have made a lot more
money just putting stuff in the S and P five hundred.
You certainly would have made a lot more money if
you just, I don't know, bought Apple.
Speaker 4 (02:44):
Or QQQ, Yeah, just big cap tech.
Speaker 2 (02:48):
So why is that we need to talk about why
we're being collectively punished for being prudent. We have the
perfect guests to talk about this. We're going to be
speaking with someone who I actually can not believe hasn't
been on the show before. I feel like he has,
but then I realized that, like he's sort of like
the Rocky Mountains in the sense that he's just always
(03:09):
kind of been there, but you kind of take him
for granted. He's like out there, you know him, you
read all his stuff, maybe listen to a show, see
him on Twitter, certainly, and yet we've never had him
on the show. We've just taken him for granted.
Speaker 4 (03:21):
Or outrageous oversight that we must now rectify.
Speaker 2 (03:24):
Yes, Okay, so I'm very excited to say we are
going to be speaking with Med Faber. He is, of course,
the co founder and CIO of Cambria Investment Management and
also the host of the Med Faber Show the podcast,
So meb thank you so much for coming on all blots.
I feel so bad that you haven't been on before.
I can't believe it.
Speaker 3 (03:42):
It's great to be here y'all. As a Colorado native.
Maybe the Mountain analogies spot on.
Speaker 4 (03:46):
Oh that was better than you real. By the way,
we're still out even though it's long past. We are
recording this at the future Proof conference in Huntington Beach, California.
Maybe you live like an hour away.
Speaker 5 (03:58):
Huh.
Speaker 3 (03:58):
Yes, Sadly we invited Joe and Tracy come surfing. They
skipped out again for our surf lessons. But beautiful day,
glad y'all are here.
Speaker 2 (04:04):
I'm not good with cold water, so I'm just gonna
be like one hundred percent honest. It's like sixty five
degrees at the moment in Huntington Beach. I could not
fathom going willingly going into the water in this temperature.
Speaker 3 (04:16):
Who just talked about surfing, Actually, Joe mentioned that he
likes getting punished in the market. Surfing will be perfect, right,
It's the ultimate humility. You get out there and just
get tossed.
Speaker 2 (04:26):
Pounded by the waves of bad decisions over and over again. Yeah,
that sounds about right. Okay, Wait, so I mentioned that
you've sort of always been out there, and certainly for
as long as I can remember, in financial journalism, you
were always there. Cambrio was always there, and so I
never really stopped to think about what it is that
you actually do. But what does Cambria do?
Speaker 3 (04:45):
Yeah, So we like to think of ourselves as the
odd lots of ETFs.
Speaker 5 (04:49):
You know.
Speaker 3 (04:50):
See, But I'm being serious, you know. We fast forward
from getting started pre GFC the company launched its first
ETF and twenty thirteen, so over a decade old now,
and we often tell people the best compliment you can
give anyone in investing, but also in the asset management
and entrepreneurship is just surviving. So Alpha all that extra wonderful,
(05:12):
but just surviving is a big compliment. So we're near
three billion in assets, sixteen ETFs now, but we often
say it's the best time ever to be an investor.
The choices are limitless. You can invest in ETFs for
near zero fee, thousands of choices. But in that world,
if you're going to charge more, you better be doing
(05:34):
something weird. We're concentrated in different and so we try
to only launch funds that don't exist in in a
world of ten thousand plus funds, that seems like a
hard goal, or that are sufficiently we think we can
do cheaper or quote better and better off is a
lofty goal too, But it has to be something I
want to put my own money into. It has to
be something that's backed by academic and practitioner research, and
(05:57):
so that versus a lot of the industry. And I
love our friends here that throw as much spaghetti against
the wall and see what sticks. We want products that
we want to invest in that don't exist.
Speaker 4 (06:07):
Speaking of academic research, didn't you write some like it
was one of the most downloaded papers ever on SSRN
about market timing?
Speaker 3 (06:17):
Yeah, well, it's funny you mentioned market timing. The original
title was a better Approach to market timing, and no
one would read it. I got a lot of really
nasty responses from probably some prior a lot guests, but
a lot of famous investors and a lot of really
wonderful thought for responses too, and I changed the title
to Quantitative Approach to Tactical Asset Allocation. Oh more, sounds
(06:37):
way more like consultant speak. But it also there's a
lot of luck. It came out pre financial crisis. Is
a very simple trend following methodology, and trend falling goes
back one hundred years, so nothing particularly new, but it
would have worked great as trend falling tends to do
during crisis and big bear markets, which we haven't had
in a long time, and so it became very popular. Clearly,
if I published in twenty ten, probably have zero downloads
(07:00):
as well.
Speaker 2 (07:01):
It did better under the second title than it did
under the market timing title. That's kind of crazy from
a headline perspective.
Speaker 4 (07:08):
Well, tactical, I think is a great word to have,
all right.
Speaker 2 (07:12):
The headline of this episode is going to be like
med Faber on tactical allocation. Yeah, all right, okay, Well,
so you mentioned in the beginning that if you are
charging clients more, you better be doing something interesting and worthwhile.
Convince me why I shouldn't just put all my money
in spy.
Speaker 5 (07:32):
Long dramatic pause. So a couple of things.
Speaker 3 (07:35):
We always say the global market portfolio is the best
starting point. And what is the global market portfolio's If
you buy everything in the world, all the public assets,
and that is roughly half stocks, half bonds, half US
half foreign roughly speaking, and that's actually a really really.
Speaker 5 (07:51):
Hard portfolio to beat over time.
Speaker 3 (07:53):
But if you were to go back one hundred years,
one hundred and twenty years, we were doing odd lots
in London, sipping on some tea, drinking some champagne in
eighteen ninety nine and trying to project what would be
the successful country. You know, maybe we pick the US,
Maybe we pick Argentina, you know, maybe we pick other
countries and areas and stock markets. And my favorite investing book,
(08:13):
Tryumph for the optimists, you know, outlines the historical returns
of stocks, bonds, bills and all these countries. People always
think the US is the best. It hasn't been. I
think Australia and South Africa had better returns. But the
US has darned near over two thirds of the world
market cap today. So even if you invest in the
global portfolio, you're putting ten times as much in the
(08:34):
US stock market as any other country. And let's be honest,
US has been on a roll. You guys know. I
love to do my polls on Twitter. We did a
poll the other day and listeners, you got to answer
this before I give the answer up, I said, what
do you think US stocks have done since two thousand
and nine? And the multiple choices were do you think
they've doubled, do you think they've tripled? Do you think
(08:55):
they've quadrupled? And the fourth answer, which I had to
google was non you polled, which is nine times, and
then deck you polled, which is ten times. So listeners,
think about what do you think stocks had done? The
answers is almost a ten bagger. So one hundred grand
in stocks in two thousand and nine, if you didn't sell,
or you held, or you bought in March, you now
(09:16):
have a million bucks million bucks. You got ten million
bucks amazing fifteen percent returns. So you should have invested
in spy right like you crushed everything in the world.
But historically that concentration has not been rewarded. If you
look at the other forty five countries and you talk
to someone in Greece or Japan, or China or the UK,
(09:37):
they would tell you that investing all their money and
their home country was a terrible idea. But diversifying globally,
particularly into the US, has saved their bacon for the
past ten fifteen years.
Speaker 4 (09:48):
So Tracy mentioned that much to our regret we've never
had you on the podcast before. I have interviewed you, however,
once maybe twice on TV, and you're talking about some
of these similar themes about international diversification, and I think
if I recall, he was talking a little bit also
about like sort of international extension of some of the
(10:09):
ideas that Robert Schiller has talked about, and the idea
of Schiller cape ratios, looking at market valuation from that
point and opportunities to essentially invest in cheap markets overseas,
and this idea that if it works in one country,
maybe it works internationally. What's the basic idea behind that?
And then you know, you mentioned, okay, the US has
(10:31):
just like totally clobbered everyone else. Give us the rundown
of like, I don't know, it was probably ten years
ago or maybe eight years ago, what's happened over the
last eight years internationally?
Speaker 3 (10:40):
So if you rewind the clock and look at these
various regimes, and everyone wants to focus on what's the
FED doing, what are earning? Is going to be what's
going to happen this month, the election next month? A
lot of these regimes play out over not.
Speaker 5 (10:53):
Just years, but decades.
Speaker 3 (10:55):
Right If you look at not that long ago, from
two thousand to the financial crisis, the US stock market
got creamed by everything.
Speaker 5 (11:02):
Else in the world.
Speaker 3 (11:03):
Reads, gold, foreign stocks, merging market stocks, and so you
go through these periods where various assets have their time
in the sun and day in the shade. If you
look at the US market, say nineteen eighty super cheap, right,
the US has been a long term KP ratio of
five before, it's been as high as forty five at
the peak of my favorite bubble ninety nine.
Speaker 4 (11:24):
Mine too.
Speaker 3 (11:25):
Yeah, it's a great time in the nineties, but if
you look on average, it's usually like in the low
twenties if inflation is chill. But you have all these
countries and other examples. The classic we always talk about
is Japan. You know, Japan was darn near one hundred
in the nineteen eighties and then went nowhere for multiple decades.
Now it looks great today after an entire generation has
(11:45):
made no money in the Japanese stock market. But that's
how long it often plays out in Japan's not some
tiny economy, you know, this is a top three world
economy in stock market, and what's the biggest stock market
in the world at that time where the US is today,
and the US isn't expensive today, it's in the mid thirties.
It's not a bubble, but it tends to be a weight, right.
It tends to be a headwind over time, because you're
(12:08):
buying all the.
Speaker 5 (12:08):
Future cash flows.
Speaker 3 (12:09):
The good news is most of the rest of the
countries around the world are reasonably priced to really cheap.
Speaker 5 (12:14):
The really deep.
Speaker 3 (12:15):
Value like GMO and others talk about, is exceptionally interesting
right now, So we manage these shareholders yield ETFs, and
so the market cap in the US, the Achilles Heel
of market cap indexing is there is no tethered to
value whatsoever. It's the stock price times shares outstanding. And
that's good most of the time because you're guaranteed to
own the winners. But it's bad in the sense when
(12:37):
things go crazy, they're really expensive, and everyone's talking about this,
right the bag seven everything else, the really expensive stuff
gets the highest weights, and so much like late nineties,
a lot of the cheap companies high quality look exceptional
not just within the US but in foreign developed and
emerging as well. But everyone's forgotten about foreign stocks. Emerging
(12:59):
market stocks wants any but that sets the stage for
the next next outperformance as well.
Speaker 2 (13:04):
Wait, talk more about the role of the benchmark indices
in all of this, because this is one thing that
I've been really interested in in recent years. This idea,
I mean, this is where the flows before pros kind
of comes from. This idea that like, if you want
to pick a winner, maybe rather than looking at the
fundamentals or trying to see if something is underpriced or whatever,
(13:24):
you want to look at where the flows are going.
And a lot of those flows nowadays are dictated by
index construction. And so how big a role does that
indexing actually play in I guess the outperformance of concentration
or US versus diversification and rest of the world.
Speaker 3 (13:43):
We always say flows drive performance, and you know in
a particular small asset class or a concentrated strategy has
a much larger impact. You've seen some active funds, some
very famous fund managers over the past ten or so years,
where the flows a dramatic impact on the way up
and also on the way down. But this could also
(14:04):
be if you're buying Brazilian small cap tech stocks, right,
you can move those around with a lot less money
than you could the SMP. But look, you go back
fifty years, the concept of the market cap index set
off just this neutron bomb across the industry. But it
actually wasn't the index. That was the innovation, you know,
John Bogo, Wells Fargos and others. It was what indexing enabled,
(14:27):
which is low cost investing because you don't do anything
and you're guaranteed to own the winners. So quote passive
investing was an amazing invention. But here we are in
twenty twenty four and you don't have to do market
cap indexing to deliver the low cost right. We always
say ETFs are eating the asset management industry. So you
(14:48):
have all this historical very expensive mutual funds with conflicts
of interest and front end loans and twelvey one fees
that maybe index funds. But the index is not the innovation.
It's the low fees, which is what John Bogo used
to say. You know, it's not about index active passive.
He's like, the debate is really high fee, low fee,
and so now you can deliver these much more interesting
(15:12):
exposures instead of just passive market cap waiting.
Speaker 5 (15:16):
That should do much better over time.
Speaker 4 (15:33):
You know, one of the things that really strikes me.
And I think this is an important point that you've
already touched on a couple of times, that the beauty
of like the sort of modern ETF world is it
used to not be trivial right to have substantial foreign exposure.
And you know, especially thinking like before mutual funds proliferated,
you might say, like, I've like Brazil, but when you like,
(15:55):
go out and have a broker make a buye order
for every individual stock, Like that's a cost process and
now that's not costly anymore. And I think that's a
really underappreciated fact about investing. But just sitting aside the
US outperformance, what's going on in international markets so that
investors haven't loved them, Like, yeah, why you talk about
(16:19):
there must be great Latin American companies, Latin American tech companies,
Latin American tire companies and beverage distributors and everything they have.
Why haven't investors liked these companies?
Speaker 3 (16:29):
The US has certainly had great earnings growth, yeah, for
the past ten to fifteen years, right, so it's led
the charge.
Speaker 5 (16:38):
It's done really well.
Speaker 3 (16:39):
But if you look around the rest of the world,
you know, and we manage my largest look, by the way,
my largest fun long only US stock fund. So talking
my book here, But looking at the foreign and emerging
you see great companies, and so here's an example. You know,
we run a value quality strategy. US shareholder yield doesn't
have much tech exposure. Okay, surprising because tech stocks in
(17:01):
the US on average are pretty expensive, but they also
do a bunch of share issuance based on stock based compensation, right,
so they have a negative buyback yield because they're issuing
and issuing a ton of shares. But if you look
at foreign, developed, and emerging, our emerging market fund, tech
is the largest sector allocation, which is surprising to many
(17:22):
people because it's a value strategy.
Speaker 5 (17:23):
But we always say.
Speaker 3 (17:24):
There's opportunities, people just aren't necessarily focused on them. As
an example, our largest holding was a better performer than Nvidia,
and it's a semiconductor stock, but nobody knows about it.
Nobody talks about it because nobody cares about emerging markets.
Speaker 4 (17:37):
But used to be clear, setting aside what people care
about at a given time, earnings growth in the US
since two thousand and nine or really at any point
has been extraordinary and over time. It just there are
companies that buy and large are just continue to grow earnings.
Has that not been the case internationally?
Speaker 3 (17:56):
Yeah, you haven't had the same earnings growth. But also
within the US, you have had this tailwind of multiple expansion.
Our buddy Cliff was talking about, He's like, the percentage
of the returns that are attributal to multiple expansion is
pretty high. Right, So you've had the US So back
in two thousand and nine, right, we're hanging out in
March somewhere at a pub in New York City, drowning
(18:17):
our woes about the world going crazy. The US stock
market talking about back to the Shuler cap ratio was
low teens, but so was foreign developed and emerging. So
the US has gone from twelve to let's call it
thirty six today, whereas the rest of the world hasn't.
It hasn't had that multiple expansion, and so that can
be a massive tailwind and headwind over the course of
(18:38):
a decade of like three, four, five seven percent per year,
depending on what people are willing to pay for those stocks.
Speaker 2 (18:46):
So just on this point, one of the criticisms that
is sometimes leveled against diversification or strategies that are focused
on diversification is the idea that well, your purposefully kind
of adding losers to your port, Like you're not really
trying to choose winners, You're trying to distribute your risk
among a bunch of different entities. And the analogy that
(19:08):
I sometimes use, which probably will not resonate for either
of you or like most of our listeners, but I
sometimes think it's kind of like trying to find a
single guy over forty in New York City, Like there's
a reason they're desirable to single women. But on the
other hand, like, there's probably a reason that they're single
(19:28):
over forty. There's probably something wrong with them, right, and
that's why this is good, That's why they're single. So
I sometimes think about diversification or like value investing in
those terms, why should you seek out things that are
probably going to be losers at least for you know,
the short to medium term.
Speaker 3 (19:47):
There's the late Peter Bernstein had a great quote which
I'll get directionally correct, which was he's like, look, acid
allocation is a defensive strategy, but it's also an aggressive
strategy because you never know where the next windfall is
going to come from.
Speaker 5 (20:00):
Look around the.
Speaker 3 (20:00):
World, today gold all time highs. Nobody's talking about it,
at least at this conference that I'm chatting with. But
you never know if you look at various assets, whether
it's coffee, whether it's the yen, whether it's foreign stocks,
merging markets, reads, bonds, even US stocks value right quality,
you never know the exact timing of it. And that's hard,
(20:21):
you know, And we have a lot of non consensus
views when it comes to acid allocation. I actually don't
think if you're doing buy and hold, your allocation matters
much at all, which I think it's like my mom
is a Southern cook and you know, you make She
makes chocolate chip cookies with just by by a feel right,
She tastes some. But as long as you have the wheat,
the flour, the butter, the chocolate chips, like it's going
(20:43):
to end up okay, you totally omit one thing and
it's probably going to be suboptimal. And that's the way
with this ass allocation. You have some global stocks, some
global bonds, and some real assets, meaning like tips reads,
the allocation percentage doesn't much.
Speaker 5 (20:56):
And when we wrote this book, this.
Speaker 3 (20:57):
Acid Allocation book a decade ago, which were updated, we
actually found that if you look at overtime the last
fifty the last one hundred years, and compare the best
performing strategy relative to the worst. And we looked at
all of them en DOWNMNT permanent portfolios sixty forty, on
and on, we found the spread was actually pretty tight.
They all returned about within a percent or two percent
(21:18):
of each other. And the crazy part is if you
took the best one, you say, all right, Joe Tracy,
I'm gonna give you crystal ball. We'll hop in the Dolorean,
go back fifty hundred years. I'm going to tell you
which asset out case and strategy was best. How much
would you pay me that? You know, PIMCO probably give
me a billion dollars for that knowledge. But I said,
hold on the genie. There's one rule. You have to
implement it with the average mutual fun feed of today,
(21:41):
not back then one point two five percent today that
takes the best performing allocation makes it almost as bad
as the worst.
Speaker 5 (21:47):
Wow.
Speaker 3 (21:48):
So all this time we spend on the FED, on
gold or whatever. And this is for buy and hold,
just market cap indexing. We're not talking about all the
good stuff that we do. Trend following value, YadA YadA,
just the basics. And so we often say, you're acid,
alt care doesn't matter that much, but what does matter
is expenses, costs and taxes.
Speaker 4 (22:06):
Yeah, yeah, I remember seeing I think, well, it might
have been like the bulgel Head Forum is back in
the day, and it is so much about like the
cost matter is hypothesis as being a more powerful idea
than the efficient market hypothesis for this exact reason. So,
you know, we've been talking about Okay, since two thousand
and nine, we know US stocks have clobber the rest
(22:27):
of the world. When was the last time, Actually that
wasn't the case.
Speaker 3 (22:30):
Well, so we wrote this piece. It's called the bear
market and diversfication. Yeah right, and so since two thousand
and nine, US stocks again, listeners, think in your head
fifteen percent per year. Yeah, that's only happened on a
ten year rolling basis four times in history. And they
all have names. Roaring Twenties, in fifty fifty, the Internet bubble,
and then whatever we're calling this COVID meme sonk Ai
(22:52):
era right now, you don't know how long it's going
to last.
Speaker 5 (22:55):
And on the.
Speaker 3 (22:56):
Backside, they also all have names, the Great Depression, the
inflation seventies period, the dot com bubble burst in GFC
echo and whatever comes next.
Speaker 5 (23:06):
Who knows.
Speaker 3 (23:06):
It doesn't mean so during.
Speaker 4 (23:07):
Those periods that we don't have good names for, international
diversification has paid off.
Speaker 3 (23:14):
If you look at this period has arguably been the
worst period ever for an acid allocation portfolio. And we'll
just use the Global market portfolio versus the SMP. The
only comparable period is post World War two. And this
is not just in terms And first of all, didn't
do bad, did like seven percent a year? Totally fine,
Joe's four to one k seven percent a year not bad.
(23:36):
But if you look at in terms of underperforming your neighbor,
so an absolute underperformance versus the sb But the worst
part is not the absolute poortance, it's the years in
a row. It is something like thirteen of fifteen years.
It's funder perform the SMP. So it's just bodyblow after
body blow of looking less smart than your dope neighbor
(23:58):
who bought the cues.
Speaker 4 (23:59):
And that's upsetting. Yeah, I know it's not fair.
Speaker 2 (24:05):
I'm trying to process this because it bothers me so much. No, okay, well,
since you brought up taxes and the cost base as
such a big factor to investment success or outperformance. Talk
to us about what you're seeing there in terms of
I guess innovation, because we often talk in the investment
(24:25):
space in ETF certainly about the race to the bottom
in terms of costs. And to me, I look around
at some of the tax yields on these things, it
feels like you can't get that much lower, but maybe
you can.
Speaker 3 (24:37):
There's a lot about ETFs that I think that people
don't know. First of all, a lot of public funds
will do short landing and return that revenue to the consumers.
So on top of the fee you have, let's say
like we charge half or percent well the short landing revenue,
and some funds at may be ten basis points, at
maybe twenty. In some cases it could be very material
(24:59):
fifty over one hundred basis points. So there are plenty
of ETFs out there that actually already have a negative
expense ratio. So let that sink in. You're getting paid
to own this fund. That's pretty cool, right. Second is
the ETF expense ratio is also tax deductible. Right, It's
coming out of the income. So if you're comparing that
to a traditional separate account, which is not deductible. That's
(25:22):
an additional essentially benefit of the ETF over these traditional structures.
But here's the challenge. If you've been participating, you're one
of the lucky ones. You bought a bunch of stocks,
you own a bunch of Nvidia since two thousand and nine.
You're sitting on a ten bagger gain. And if you
talk to older generation, if you look at Buffett, you
(25:42):
know all these decisions that he has to make on
Apple where he has to eventually pay the taxes. Right,
you talk to the order gender and say, well, I
just can't sell my Microsoft or GE or IBM because
the taxman would kill me. We had Hank Bessenbinder on
the show recently, who did the famous paper to stocks
outperformed T bills. We had Hank run for the past
one hundred years. I said, hey, what's the best forming
(26:03):
stock of all time? And listeners, you have to guess
this too.
Speaker 5 (26:06):
You may get it.
Speaker 3 (26:07):
Of the top five, the top three, I don't think
I could guess two or three ever heard of them,
but Vulcan Materials I think two.
Speaker 5 (26:14):
Kansas City was.
Speaker 3 (26:15):
Third and number one was railrud Yeah, okay, and this
is just you are optimizing on length of compound.
Speaker 5 (26:24):
Yeah, so one hundred years.
Speaker 3 (26:25):
But Altria you put It's like you put one thousand
dollars in al three hundred years ago, you now have
two billion. Anyway, the point being is that if you invest,
you eventually have a bunch of capital gains. Great good
problem to have, right if you're in a taxable investor,
and if you have been invested in the US stocks
in two thousand and nine, you have ten x capital
gains on average. Right, So that's a problem for investors, right,
(26:48):
because you got to make a decision. Am I just
going to bite the bullet? Sell this, pay the taxes
and move on. Because these power laws dominate everything we
do in investing. It's in VC, it's true in public
markets where the best performers, it's like five percent of
stocks generate all the return. So if you end up
with one of these, your whole portfolio is now this
appreciated stock or portfolio. What I'm getting at is what
(27:11):
do you do well. There's actually been something that's been
around for one hundred years called the exchange fund. It
was popularized really in the nineteen seventies by eat Advance
by now Morgan Stanley Goldman does it. And it's like
a ten thirty one exchange.
Speaker 5 (27:25):
If you have a portfolio, this is it.
Speaker 4 (27:26):
The ten thirty one is that how real estate investors
never have to pay ten.
Speaker 2 (27:29):
That's like when you buy a house, if you buy
an if you sell it and then buy another.
Speaker 3 (27:33):
One commercial you buy it, you buy a hotel, you
buy some farm.
Speaker 4 (27:37):
Commercial real estate. People love this. This is like the essence,
what's it?
Speaker 3 (27:40):
Indefinite tax referral. And it builds generational wealth. And it's
why you see so many people that you know, they
they talk, well, my grandmother bought this property at ten
thousand dollars and now it's ten million. You know, So
it's great. It's a huge wealth compounder over time. But
so with stocks, you eventually have to pay the pipers.
So there's this thing that's been around forever called exchange funds.
(28:03):
And the way they work is if you have highly
appreciated positions, you get a bunch of other people, you
contribute them to a portfolio, and there's some rules. You've
got to be accredited or qualified. You've got to hold
it for seven years and at the end of seven years,
you get back at diversified portfolio, so you you eliminate
your concentration risk. But the problem of the course is
it's run by the traditional asset managers who love to
(28:25):
charge exceptionally high fees. They're going to ding you probably
a percent or two just to get in, and then
they're going to ding you a percent or two every
year for seven years for the privilege of having this
exchange fund. So there's others trying to do this. There's
a company called cash that's doing this, trying to disrupt this.
But if you think of the ETF structure, which is
a massive innovation where you're having actively managed portfolio at
(28:48):
index portfolio, you're only paying taxes when you sell that fund,
so the turnover doesn't matter. I think that's well understood
by most investors today, hopefully. But if you look back
at Spy, if you bought it in ninety seven, I've
paid no capital gains at all, despite the fact that
trades consistently. That's not a feature of mutual funds or
hedge funds, and that's why ETFs are eating asset management.
They're vastly more tax efficient, which on average is probably
(29:11):
about a seventy basis point after tax benefit relative to
mutual funds. Monster number probably more important than the expens ratio. However,
what if you've got a bunch of stocks have gone
up a ton, so you could go to this exchange
fund route, you're stuck.
Speaker 5 (29:25):
You could sell it.
Speaker 3 (29:26):
But what you've started to see over the past five years,
you've seen the riding on the wall, and the traditional
mutual fund industry is doing one of two things. They're
going Ostrich style head and sand I'm just going to
ride this till I retire and we'll just deal with
the outflows and someone else's problem. Or their shops like DFA,
they say.
Speaker 5 (29:45):
You know what, we're going to convert.
Speaker 3 (29:46):
We're going to They do fifty billion of mutual funds
to ETFs. And then you see some innovation going on
where a group we're partnering with Wes Gray and his
team at Alpha Architect ETF Architect, they we're able to
go to an asset manager and say, okay, well.
Speaker 5 (30:03):
Let's convert your clients.
Speaker 3 (30:05):
So they had five thousand clients from separate accounts to
an ETF and it's not a taxable transaction. And so
I started to think about this. It's called a three
fifty one exchange again, been around for one hundred years,
and you start the brain working in an odd lot's
way and taking this to its logical conclusion. I say,
this is a really cool idea, and to my knowledge,
(30:26):
we're going to be the first to do this. And
so I said, why can't we open this to everyone?
Why can't we make this so that it's disrupting the
entire industry. You make it democratize it where you don't
have to be a qualified investor. You can just be
any investor that's sitting on capital gains.
Speaker 5 (30:41):
And so the way that works.
Speaker 3 (30:42):
Is you can contribute a portfolio of stocks ETFs whatever,
and there's some rules like one position can't be over
twenty five percent, the top five can't be over fifty.
You contribute a basket of stocks, you get an ETF
in return, and you get essentially a tax deferral diversified
portfolio that now has a diversified strategy. It could be
whatever strategy. The first one we're doing is actually a
(31:05):
riff on an old paper we wrote which demonstrated that
if you're a high tax investment in it plays like
California or New York. The last thing you want is
dividends or high dividends. So we demonstrated that if you
had a value strategy that targeted stocks that paid load
to no dividends your act after tax, you do much
better than the SMP or high divinut strategy. So this
(31:28):
takeaway of this idea is that you can contribute a
basket of stocks end up with a great ETF and
you could launch a series of these every year, every
three months, every six months, and let people opt in.
Speaker 5 (31:40):
What do you think, great?
Speaker 4 (31:42):
This sounds good. I wish I had some gigantic capital
gains that I needed to solve for, but a loss
that's not my problem. But let's just talk a little
bit more mechanics. So let's say ten years ago, I'd
bought a bunch of Apple and Nvideo and Microsoft and
whatever else, JP Morgan, a bunch of names that have
(32:02):
done well. Okay, So I have these and now I'm thinking, Oh,
the market's kind of expensive these days, I'm nervous, et cetera.
I'm thinking about I want to sell them, but I
don't want to like write a huge check come next April. Okay,
so that's my problem. Talk to me the specific mechanics.
Now your fund suddenly, your new ETF suddenly exists. Walk
(32:23):
me through the specific mechanics of what I have to
do to swap them.
Speaker 2 (32:27):
I don't understand how you like deliver it.
Speaker 4 (32:29):
Yeah, so I swapped that into this thing so that
now I'm in a diversified portfolio that's a little bit
de risked. Thanks to diversification, I don't have my concentration problem,
but I didn't have to pay the taxes. Talk to
me about exactly.
Speaker 3 (32:42):
This is why we're partnering with our friends ETF architect
like you have things like ten thirty one, have very established,
templated rules how to do it.
Speaker 5 (32:49):
And this is the first time we going through it.
Speaker 3 (32:50):
So I'm sure it's not going to be one hundred
percent without headaches and hiccups. But the first thing you inquire, right,
So we set up camera investments dot com, forward slash tax.
Put in your name, your info. I got this portfolio.
Joe's got a portfolio. Swab Yeah, it's I literally do have.
So you know, here's I'm interested. Send me more information.
(33:11):
I'm sure we'll do a webinar, we'll educate everyone and
we'll say here's the menu, here's the process of what's
going to happen on I'm just making up this date December. First,
your portfolio will contribute to the ETF.
Speaker 4 (33:24):
Everybody, How does that work?
Speaker 5 (33:25):
Magic?
Speaker 3 (33:26):
Hopefully you know the plumbing and the pipes of it.
We'll have to get Wes on the show and get
him to get really deep on it. But they just
did it with a five thousand account.
Speaker 4 (33:35):
But like Schwab or whatever, like, they have mechanisms for.
Speaker 3 (33:39):
Yeah, I mean, I'm sure, like I don't know whether
it's going to be you know, acadding and whether it's
going to be just electronic transfer.
Speaker 4 (33:45):
Okay, but you can do that with shares, yeah, okay, Okay.
Speaker 3 (33:49):
So we wrangle up a bunch of people with all
sorts of different securities and they all contribute them, and
then the next morning they have an ETF in their
swap account.
Speaker 5 (33:59):
It's beautiful.
Speaker 3 (33:59):
And then there you know they have a diversified portfolio.
And we have a few different ones lined up. We
have an endowment style. You guys probably seen me pick
my fights with cowpers.
Speaker 5 (34:08):
Over the years.
Speaker 3 (34:09):
We have a global shareholder yield style. So the menu
will be different for people that may want different ideas,
but the first one, at least, we're doing US stock exposure.
Speaker 2 (34:18):
So once you're in the diversified portfolio the ETF, presumably
if you sold that you would still have to pay
capital gains, but the benefit is that you're getting out
of that like big concentrated position and going into something
more diversified.
Speaker 5 (34:31):
That's the hope.
Speaker 2 (34:32):
Okay, that sounds interesting.
Speaker 4 (34:35):
It sounds very interesting. Can I ask a question? You
mentioned Wes's company, Wes Gray. You mentioned Wes's company is
called Alpha Architect. Since you've been in the ETF game
for a long time, can you talk a little bit
about how, you know, if Tracy and I have an
idea for an ETF, some strategy that we think could
(34:56):
be interesting, how much easier is it today in twenty
twenty four to build What is the process of Like, okay,
we want to build an ETF around this versus say
twenty fourteen or two thousand and four.
Speaker 5 (35:10):
It's night and day.
Speaker 4 (35:11):
So what's the what's it like?
Speaker 3 (35:13):
You know, we originally were gonna sub advise on a
couple of funds. The Forbes family was gonna move into ETFs.
It's a fun fact they didn't because it was two
thousand and nine. So we eventually sub advised on a
fund with advisor shares. Because back then it costs half
a million a million bucks a year just to get
the trust permission to launch ETF, so a huge pain.
(35:33):
We eventually bit the bullet starting launching funds in twenty thirteen.
Fast forward a decade in the ETF rule which was
passed a few years ago that really streamlined everything, changed
it all. And so the two main companies, so ETF
architect and then Title, which are both groups that do
this white label ETF business. You could go to them
now and say, Joe's got his idea for this ETF.
(35:57):
It's only going to invest in companies in North Carolina.
The letter M like, whatever it may be. You know,
who knows. Three months from now you could have a
fund out. Wow, it's going to cost you, I don't know,
fifty grand and startup fees. But the big problem, and
you know everyone sees the gold at the end of
the rainbow, but you really need to be able to
get to twenty thirty forty million. So a lot of
(36:17):
people sit at zero.
Speaker 2 (36:18):
Is that just to make the economics of actually like
managing and trading the ETF actually work well.
Speaker 3 (36:23):
If it sits at zero, you're on the hook for
probably quarter million expenses per year two hundred and fifty grand.
But that's if it sits at zero, and so then
you're subsizing. You know, writing twenty k checks per month
adds up over time.
Speaker 2 (36:50):
Here's something I always wanted to write about or talk
about reverse inquiries in ETFs. I think this is sometimes
like an underappreciated perspect of how ETFs come into being.
But I have heard that, like a hedge fund or
an investor will go out and say, we want the
opposite exposure to this particular thing. We want to take
(37:11):
the other side of the bet. Will you create an
ETF that allows me to do this?
Speaker 3 (37:16):
Yeah, you see that more at a lot of the
trade specific shops and firms that want those thematic exposures.
You know, we tend to focus on ideas I want
to put money into. You know, the average mutual fund
manager has zero dollars invested in their own fund, which
is an astonishing statistic. And half of all public funds
close over the course of ten years, so there's a
(37:39):
massive amount of turnover and people that don't have skin
in the game, and so a lot of these ideas.
You know, I want nothing to do with a lot
of these tradeable thematics, right, but if people build them,
they want to invest them, God bless them.
Speaker 5 (37:50):
Right.
Speaker 3 (37:51):
But we we air on the side of things that
we think make a material impact to investors, you know,
future returns and portfolios and.
Speaker 5 (37:59):
A lot of out there.
Speaker 3 (38:01):
You know, I wouldn't touch with a ten foot pole,
but some of them raise a billion, ten billion dollars
or what do I know.
Speaker 4 (38:06):
It's interesting hearing you describe how much easier ETF creation
has gotten, because it strikes me that it's like the
ETF physation of the ETF industry, because ETFs, of course
make investing in a country or a theme much easier
than if you had to do it by hand and
buy a bunch of stocks. And this is essentially taking
(38:30):
that same idea except applying it to the creation of ETFs,
where you have all these white label things. The infrastructure
is already there, so all you have to do is
supply the idea. This gives me just something I've always
just sort of been wondering about what happens when in
the ETF dies. So Tracy and I launch our fund
where we only invest in North Carolina stocks where the
ticker has the letter eminem and then, for whatever reason,
(38:55):
in two years we have five hundred thousand dollars under management,
which is probably high, but clearly not enough to build
a business on. You're like, you know what, we don't
want to do this. We don't want to write the
twenty thousand dollars checks a month to support this. When
we decide to wind it down, what happens.
Speaker 3 (39:13):
They go to the ETF ticker in the sky graveyard,
you know. I mean it's a pretty orderly process. There's
a lot of prior arity, of course, you know, I
think on very very rare cases.
Speaker 4 (39:24):
The investors get distributed the stock or do they get
distributed the cash.
Speaker 5 (39:28):
It's usually cash.
Speaker 3 (39:29):
But the correct answer for the vast majority of investors
just sell it before close it down, you know, you
sell it on the secondary market. Yeah, like, hey, we're
going to close this into the year. We'll just sell
it now and just be done with it. But you know,
I think a lot of people take a negative view
of the amount of products out there. You often hear
people say there's more ETFs than stocks, right, and say, well,
there's more words than letters like that, that doesn't ye like.
Speaker 4 (39:50):
It doesn't more sentences than words, but.
Speaker 3 (39:52):
You have sort of the ability to have this limitless
grocery choice. There's a lot of areas that I think
haven't developed the way that they will eventually in One
example is the all in one acid allocation ETF. We
have three of these, but if you look at the
traditional mutual fund asset allocation industry, it is multiple, is
more expensive and tax inefficient compared to the ETFs, and
(40:16):
yet they still have about a trillion in assets. And
you know those type of assets, it's usually death or
divorce or bear markets where they all come out all
the money at some point, but they never go back
to paying two percent. And so I think you'll see
over the next ten to twenty years a big shift
and assets and structures, but eventually it all leads to
the ETF.
Speaker 4 (40:36):
You know, you mentioned the sort of global market portfolio,
and we can never own the global market portfolio truly,
so you only are like trying to get close, right,
because the global market portfolio also includes all real estate
in the world and just a number of things like
you can approach it maybe asymptotically, but you'll never truly
(40:57):
own the global market portfolio. But the old academic Reais
search says, like to own the global market portfolio every
asset in the world. How close do you get in
one of these funds? Are you like ninety five percent
of the way there?
Speaker 3 (41:10):
I'd say it's closer to like ninety nine, you know.
The if you look at one of my favorite examples
we always joke on these assy action from portfolios. We
have one called the Talmud portfolio, which is based on
there's a piece of advice where it was like, let
every man invest a third in business, a third in land,
and a third keep in reserve, which we interpret is
a third in stocks, a third and real assets, and
(41:31):
the third and bonds. That portfolio is almost impossible to beat.
And if you look at a lot of like Cowper's Bridgewater,
and we do all these articles and say should these
big institutions just be managed by a robot? And they,
for the most part, usually can't beat these basic asset
allocation benchmarks. It's really hard for them. Some you include
a little leverage because they have a lot of private
equity and leverage vehicles, but these basic portfolios are a
(41:54):
heart high.
Speaker 4 (41:55):
Bar that's funny.
Speaker 2 (41:56):
I hadn't considered talmudic investment philosophy for the wind, but
I guess it works. Okay. So this whole conversation has
reminded me that I am old enough to remember when
active ETFs were first becoming a thing and they were
going through like regulatory approval process. Obviously they've become much
more of a thing since then, and we've seen mutual
(42:19):
funds convert into ETFs. As you mentioned, what's the next
big thing in the etfification of the market.
Speaker 3 (42:27):
Now, there's a few areas we're always interested in. And
when we look at the Vinn diagram or you make
the columns of things that are totally fine, Okay, good,
there's plenty, right.
Speaker 5 (42:38):
You know.
Speaker 3 (42:39):
I was chatting with someone last night and he's like, look,
I used DFA, Why should I use your funds? I'm like, don't.
DFA is fine, you know, but the bad news is like,
there's a whole universe of absolutely awful, god awful, terrible.
I have a Twitter thread that's just instant. I made
the mistake of bookmarking a spammy, sleazy Instagram ad for
(43:00):
private real estate. It's always private real estate, right, fifty
percent per year.
Speaker 5 (43:04):
You know, they're.
Speaker 4 (43:05):
Claiming those guys got closed. There's twenty See.
Speaker 2 (43:07):
Some of the videos are like, if you just commit
investment and tax fraud, you can make like a two
hundred percent return in six months.
Speaker 3 (43:15):
So all my all my ads are now these scams. Right,
I just get delivered because they I bookmarked it, so
I get all these So just avoiding and doing the
really dumb stuff is the key to almost all of this.
Speaker 5 (43:26):
Right.
Speaker 3 (43:27):
We did an old article about the food pyramid. You
remember the food pyramidal?
Speaker 5 (43:31):
Yeah, you know.
Speaker 3 (43:31):
The base of that when we were kids was eat
a bunch of cereal and bread and pasta, you know,
and it's kind of inverted now where thinking about it.
But the same thing with investing is like the basics.
Get the basics right, payloa fees, payload taxes, get your
money invested. That's the number one piece of advice of
all this is get to work, let it compound, right,
and then the other things take care of themselves. So,
(43:53):
but because this is the Wonky Show and we get
into this, I think the things like the three fifty
one exchange idea we're talking about are going to be
extremely material when we're talking about.
Speaker 5 (44:01):
This in a year or two.
Speaker 3 (44:02):
I've seen some other companies and we don't do this,
But I love the idea of taxable target date ETFs.
We see people behave better in target date style funds.
I think there's some ideas and concepts around building personal
pensions where people are locked into their investments and get
them to behave in a good way where you know,
(44:22):
these fiduciaries, you're kind of forced to hold investments and
let the compounding do its work. There's a lot of
innovation in some of those ideas. But if you go back,
I have a joke, I'm like, so many of the
fintech ideas are just vanguard with a shiny coat of paint, right,
Like you already have pretty great out there. But there's
there's some more ideas we're working on too.
Speaker 4 (44:42):
I love the idea of like a sort of like
forced pension because it intuitively it seems like a most
people make mistakes when they're like left on their own,
so you just sort of want to lock it up,
would be. It also seems like there's probably excess returns
for like that commitment where if like you trade off
the liquidity profile, then you get paid more anyway, med favor.
(45:04):
It's so great to finally have the show. Great to
catch up with you in your natural environment at.
Speaker 2 (45:09):
The surfing on a beach.
Speaker 4 (45:10):
Yeah, it's like okay, like, yeah, we didn't have MeV
on for a long time, but if we when we
did finally have it, we're like literally on the beach
right now, listeners.
Speaker 5 (45:18):
You heard it here.
Speaker 3 (45:19):
They're committed to us serving with this future.
Speaker 4 (45:22):
I don't know.
Speaker 2 (45:22):
Only I said only if the temperature is above eighty
degrees or someone like loans me a what you.
Speaker 4 (45:27):
Just it's freezing.
Speaker 3 (45:29):
I'm really cool care of it.
Speaker 2 (45:30):
I've been cold for two days.
Speaker 4 (45:32):
It all right, thanks so much, man, take.
Speaker 5 (45:34):
Great, y'all.
Speaker 2 (45:48):
Well, I'm glad we were finally able to do that, Joe,
as you say, in Meb's natural environment. One thing I
was thinking was just about that new fund and the
sort of tax focus of it. It is in interesting
because you know, our whole conversation was about how over
the past ten years or so, those big concentrated yeah
investments are what have paid off the most, and I
(46:11):
guess people are now trying to think through how they
actually crystallize those wins and so it's interesting to see
the market trying to come up with a solution to
that problem.
Speaker 4 (46:22):
The solution of the problem of people having to pay
tax and people having to eventually pay taxes. You know
what I think is interesting to me to going back
to the sort of diversification story and getting punished for
diversification where we started. I like the idea that one day,
like the sort of I'm still kind of diversified, you
(46:44):
know that, like my prudent approach is going to pay off.
But it's also interesting that like the periods that were
paid off are like not great periods. So it's like, Okay,
I want my.
Speaker 2 (46:55):
Diversification yocer and forgettable.
Speaker 4 (46:57):
Yeah, or like the aftermath of a craft and so
like I want my diversification to pay off, but I
don't want to crash.
Speaker 2 (47:04):
This is exactly what I was thinking. The trigger for
diversification coming back would be something very bad happening that's
right in the US. Yeah, And as people who live
in the US were de facto over levered.
Speaker 4 (47:17):
Yeah, we're always going to be levered to the US.
I mean, our jobs are levered to the US economy, right,
So I think about this a lot, which is like Okay,
it makes me uncomfortable as not just someone with money
in the market, but it makes me uncomfortable as a
press of the world that, like, we have this market
that is just so heavily concentrated and so levered to
(47:38):
the success of Meta and Nvidia and Amazon, and I
don't really like that. It rubs me the wrong way.
It doesn't sit right with me as something. But on
the other hand, if I think about what would change that,
it's nothing good. Yeah, there doesn't seem to be like
a positive version. Now I would see the one exception
where maybe this doesn't have to be the case would
(48:01):
be kind of like a market in which the investments
that are being made in things like the Inflationial Reduction
Act and the chipsy Act, where there's like this industrial
renaissance in the US and that really started taking off,
or where you have such above trend growth and productivity
that a lot of the so called like real economy
(48:22):
stocks really start to do well, et cetera. So there
is like that sort of golden.
Speaker 2 (48:27):
Scenario where more winners come in this right right, and
so like having more exposure to potential winners that pays off.
But on the other hand, it feels like the downside scenario,
where like the current winners just get just.
Speaker 4 (48:40):
Are no longer the winners and everyone loses, and then
seems more probable. It seems more probable, and so it's hard. Yeah,
it feels like when the regime shifts, which will happen
because regimes shift, and maybe it'll be one hundred years
from now and it will be dead and whatever. But
it seems most likely that when the regime shifts, it
(49:01):
will not be because things are good.
Speaker 2 (49:03):
Yeah, nothing last forever shed dramatic tear, including our time
at Futureproof on the beach. So shall we leave it there?
Speaker 4 (49:11):
Let's leave it there.
Speaker 2 (49:12):
This has been another episode of the oud Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 4 (49:19):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our guest meb Fabor. He's at meb Faber. Follow
our producer Kerman Rodriguez at Kerman ermann Dashil Bennett at Dashbod,
and Kelbrooks at Kelbrooks. Thank you to our producer Moses Ondam.
From our odd Lots content, go to Bloomberg dot com
slash od Lots where transcripts, a blog, and a newsletter,
(49:39):
and you can chat about all of these topics twenty
four to seven in our discord, where we have a
markets channel and people talk about stocks and debate the
market discord dot gg slash odd Lots.
Speaker 2 (49:49):
And if you enjoy odd Lots, if you like it
when we talk about the pain of being a diversified investor,
then please leave us a positive review on your favorite
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