November 27, 2020- Today, we get to celebrate the Absolute Return Podcast’s 100th episode with Meb Faber, co-founder and the Chief Investment Officer of Cambria Investment Management and the host of The Meb Faber Show podcast. Today we discuss:
- what got him interested in investing and how he started Cambria
- his 2006 paper, “A Quantitative Approach to Tactical Asset Allocation,” and the trend-following multi-asset strategy
- strategies he manages that resonate the most with today’s investors
- his greatest lessons learned from interviewing investors on The Meb Faber Show
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by Accelerate financial technologies. Accelerate, because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Hey, Meb, how are you? Welcome to The Absolute Return Podcast.
Meb Faber: Great to be here, man. Thanks for having me.
Julian Klymochko: Yeah, no problem. So super excited to have you on the show today. Before we really get into the weeds today, why don’t you tell us and our listeners a quick background about how you came into the industry? What got you interested in investing and ultimately the backstory behind Cambria?
Meb Faber: Sure, if I can do this in one minute, you know, I saw you out on the slopes recently made me jealous. I’m originally a Colorado native. So, a skier though. Although I have boarded over the years, may have to try it again this year. Spent a little time in North Carolina as well. So, you may hear me say ‘y’all’ during this pod. Went to school in Virginia, I was an engineer. I was a biotech guy before you know, I was always interested in finance, investing, more into investing than finance, but had graduated during the real great bubble of my career so far, knock on wood. The great internet bubble, which was so much fun, right into the teeth of that, and worked as a biotech stock analyst while going to grad school up the road at Hopkins, and then moved out to the west coast.
I was in San Francisco for a few years, sort of gravitating more and more away from biotech and science, more towards pure investing and more towards quant and more away from discretionary. Did a stint in Lake Tahoe, mostly as a ski bum, but also working as analyst at a quant commodity trading advisor start-up, didn’t go anywhere. And after that a lot of the research at actually conducted in Tahoe, in San Fran, laid the foundation for work that we started at Cambria. So started that right prior to the global financial crisis and have survived. And now fast forward, man, what, 12 years later, we’re still here. The business has evolved a little bit over the years. Added a lot more people still based in the land of milk and honey in Los Angeles, Manhattan Beach. So, if you’re nearby, come say a six-foot hello anytime. It’s easy to do on the beach, kind of like on the trails, up in Canada, you know, we’re still quant based at heart. We invest in everything, stocks, bonds, asset allocation, inverse, everything. Something I want to put my own money into is a little different. I think a lot of service providers and fund companies just do the old spaghetti against the wall, but I know this resonates with you. That we try to be a lot more thoughtful about ideas and strategies we launched. And so anyway, yeah, we got a dozen funds now, and I’ll pause there. I think that was almost under a minute.
Julian Klymochko: Yeah, it was a great summary. So, thank you for that. And actually, came across some of your work a long time ago, specifically your 2006 paper, the quantitative approach to tactical asset allocation, which is right up my alley. I love checking out different research papers on SSRN you know, quantitative studies and things of that nature. And what’s surprising is that it’s actually the second most downloaded paper on SSRN. I just checked on Friday; I think they’re about a quarter of a million downloads.
Meb Faber: Second, who knocked me out of first place? I have been in first place for years.
This is garbage, I got to update that. Well, you know, the main reason is people have lost their interest in trend following as there’s really only been one trend, which is the US market continues to shoot upwards. But you know, an interesting tidbit on that paper. This is back when we used to write academic papers. And now we just throw everything online. I feel like it’s a lot easier to get a bunch of critical reviews from millions of people instead of, you know, just one or two academics. And plus it takes like a year to publish these things. So anyway, the original name of that paper was A Simple Approach To Market Timing and everyone rejected it. Everyone hated it because we all know market timing is impossible, right? So, then I changed it to the much more, probably, PC version called Tactical Asset Allocation, and then everyone loved it. You know, it didn’t hurt that it came out directly before the financial crisis and would have kind of saved your hide. But anyway, we actually did a 10-year retrospective for The Journal Wealth Management that sadly is behind a paywall, but, you know, you’ve given me the bug to update that sucker. So hopefully we find a little time to escape from the family over the holidays. I’ll see if I can put pen to paper and walk forward. Cause yeah, it’s been 12 years out of sample now.
Julian Klymochko: And perhaps the modification of the title. It’s an early lesson in digital marketing and how to be successful online. And I wanted to get into a bit of the strategy behind the paper. So ultimately, it’s a multi-asset trend following approach. Would you care to kind of share exactly how it functions on a high-level basis?
Meb Faber: Sure, and I think it actually, it’s funny, you know, a decade later it’s a similar foundation to the way we launched funds, which really there’s four criteria and then we’ll hop back to the paper. The first is it’s something that no one else has launched or there’s we think we could do a much better cheaper and cheaper is rare in 2020. Second, is there some academic research or is it something that we can do that demonstrate some understanding on how it works? And so, the two big pillars we spend most of our time with are value and then trend following and momentum. In both of those. Look, I claim zero originality on either of those. They’ve been around for a hundred years. Value’s been around well before the time of Ben Graham. Trend-following, Charles Dow. Both of these are a hundred years old, you know, talking about Dow Theory. The very first paper, I had no intentions of writing a paper, but had to sit for a designation. This was the CMT designation. You used to have to write a paper, you could write a paper instead of taking the test. And there were so much on the test. I was like, oh God, I don’t want to just go memorize this. And you can get back up, you know, I said, I’ll do the paper. What can I write a paper about? And so, I said, simple trend following.
Julian Klymochko: Right.
Meb Faber: And what does that mean? We could spend two hours talking about this, but we said at its core, you know, all the main asset classes, if you look at them you know, global stocks, US and X US, it could be things like real estate and REITs, things like commodity indices, even long-term bonds, you know, in general, the history of capital markets, it’s paid to own those assets. You could also lump in gold. We’ve got a Canadian audience here, so I better talk about gold, put gold in there too.
Julian Klymochko: Yeah cannabis as well.
Meb Faber: Yeah, but the takeaway was that you have a long enough time horizon at all these assets. Have been good investments over time, but you are stuck with these just massive volatility and drawdowns at some point. I mean, you basically can’t find an asset, particularly after inflation. So real returns, that doesn’t lose 50, 60, 70, 80, 90% at some point. And so, I said, look, is there a way we could look at some of this really old theory, a hundred years old and apply it. And the reason this paper was so attractive to many people was twofold. One, it was simple. You know, you read so much quantitative literature, financial literature, academic literature, it’s like the venn diagram, worst possible three circles of jargon and complicated. My all-time least favourite thing about academic papers too, is they put all the charts in the back.
Julian Klymochko: Oh my God, that drives me insane. It’s like, why did they do that?
Meb Faber: It’s moving away from that. Thankfully, I think. The more I read in 2020 that they seem to be in line. But anyway, we wrote this super simple paper, again, no one really liked it. Came out of the Journal Wealth Management, and then the financial crisis hit. And this strategy, which at its core, the simple rule was, I said, look, I’m lazy, so, I only want to look at my investments monthly. What’s the most popular indicator in all of technical analysis? The 200-day moving average, it’s been around forever. Let’s do the monthly version of that. It’s called the 10-month moving average. And then the indicator doesn’t matter. It’s irrelevant. But we said, what if we just apply this indicator and the only rule, we used US stocks, for example, S&P 500, the end of the month is the S&P, is the price above the long-term average or is it below? If it’s above, you’re long the asset. If it’s below you sit in cash or bonds. And lo and behold over the history, you know, and we took it, I think back to 90’s with longer assets back to the seventies from the modern era and lo and behold in every asset class, you had similar returns to buy and hold, but with much less volatility and drawdown, the reason was. You were chopping off the big left tail of these massive bear markets.
And so, you know, not the 5 or 10 or even 20% losses maybe, but the haymakers, the 60, the 80, the 90, and then you put all those assets together in a portfolio and it worked great. And the reason, again, it’s very clear of course, that the paper was so popular was it was published before the crisis and during 08-09, it would have been flat. You know, it would have survived just fine. Now there’s been times since that, hasn’t done as well. It depends on the asset and depends on the portfolio, but really the takeaway for me. And we wrote about this in the retrospective, was that the biggest key in our whole world of investing and this applies to gambling too, for the people out there that play poker or blackjack or sports. The worst thing that can happen to you is you get your bankroll taken away; you can no longer bet. So, you zero out your account. You can no longer play the game. And if we’ve learned anything about markets, is that it’s hard. I mean, 2020, what amazing reminder of how emotionally difficult certain investment approaches like buy-and-hold are to be able to sit through that, you know, remember back looking at the futures, people were watching CNBC again.
Julian Klymochko: Limit down every Monday morning.
Meb Faber: So, you know, the philosophy of trend following I believe is a sound one. Again, it’s one that’s been around forever, but it’s not some holy grail. And I think there’s a lot of benefits. You know, we talk quite a bit about the concepts of blending some money and buy and hold in some and trend following. And that does a really good job, I think, psychologically of giving you the best of both worlds. Anyway, so the paper was interesting enough. Our first venture into writing, I was never publicly writing and then came a blog and then came books and more papers and more modern era, sitting and chatting on podcasts and Twitter and YouTube and everything else. But it all came down to just not wanting to take a test. So much in life, right? That inertia that students would do anything to avoid taking a test, so lesson learned.
Julian Klymochko: That’s interesting and so to give you an update, the paper that offset your number one spot is Basics of Game Theory by Matthew Jackson. It’s a head by roughly 10K. So perhaps if you did update The Quantitative Approach To Tactical Asset Allocation, perhaps that could get you back on top, but would be super interested in an update was wondering do you have any indication of how it would perform in 2020 because the current year is like notoriously bad for certain quantitative strategies. In Renaissance Technologies, their market neutral fund is down like 27%. And what they indicated was that, you know, it’s hard to perform when basing on historical relationships when 2020 is, you know anything but average. So, it’s definitely a crazy year. We run a quant long-short strategy multi-factor and, you know, this month has been pretty awful just given the whiplash on the short side, you had this, you know, massive decline in certain industries back in March and in November after the COVID vaccine was announced, they just had a massive short squeeze. So not sure how that would have affected trend following strategies, but would be interested if you have looked at any of those numbers.
Meb Faber: Well the beauty of, as you know, putting things out on the internet is everyone in the world will be very quick to tell you just how much of a moron you are. And also, the benefit, you know, it’s the soapbox, you get a platform. And so, there’s the good and the bad, of course, you never are as brilliant as you think you are or as foolish. And so, the cool part about this idea was that it’s totally transparent. You know, we published it, here are the rules, take it. We’ve talked to so many people over the years that have co-opted it to their own purpose. They tweak it, they add their own assets. They’d have different rules. And so, there’s actually, we used to track it on my blog and then I just stopped because there’s so many other sites to track it.
So, there’s about four, one’s called AllocateSmartly. One’s called Extragenic, one’s Portfolio Visualizer. These are mostly all free or some are ETFreplay. And I was actually just trying to log on to see how because I don’t even track it. I just let them do it at this point and say, you guys let me know, how this would have done. But my guess would be that it did just fine.
Julian Klymochko: Right.
Meb Faber: You know, trend following in my mind this year, depending on the system, did anywhere, most did just okay.
Julian Klymochko: Right.
Meb Faber: Some did fantastic, and some did terrible. I see it on AllocateSmartly. I just looked it up, flat on the year, so not bad, you know, but it didn’t seem to lose any in March. It was up a little bit in April. So basically, just started going to cash. The challenge that I think a lot of people have with something like we published, well, what we publish is very binary. You were either in stocks or you’re out. And if you have an example like this year, or my favourite is 1987, if you had an indicator, something like the 200-day moving average or faster, you would have been out during the 1987 crash, that’s a 20% day. If you had a much longer indicator, you would have been invested during that. That’s a very different outcome. Now it’s hard to tell people this, but over the course of years and decades, it’s a wash. It doesn’t matter. And so there’s a lot you can do in practice that if you wanted to smooth it out, you can use what’s called an ensemble or a composite, or instead of just using one indicator, maybe you’re using three or four instead of updating it just once a month, maybe you update it once a week, yada, yada, all these different things.
That having been said, it’s always surprising to me that the very simple model usually ends up stomping all of my brilliant additions and you know, proprietary tweaks and upgrades and concepts, we overlay it. It seems to be pretty sound. So, it’s hanging in there. The challenge with that strategy by the way, is that you know, a lot of people don’t really care about lower volatility and lower drawdowns except during the massive bear markets.
Julian Klymochko: When it’s too late.
Meb Faber: Yeah, it’s like buying the insurance after your house burns down. And so, it’s actually, I think a hard strategy to stick with. Trend following is notorious for not having a high batting average. And what I mean by that is you could have multiple trades in a row that lose money. And for some people that’s totally fine. You know, because these really long, big winners more than outpaced the little death by a thousand cuts. But for some people that’s really hard, they want to win 60, 70, 80, 90% of the time. So, the challenge is of course always find something that works for you. And so, for some crazy people like me, I love trend following. But for others, if you don’t need it, that’s, you know, that’s cool too. Now the irony of course, is that most market cap indices are pure trend following indices. And a lot of people don’t know that and we can get into that if you want it to at some point, but most of the investment approaches are trend following in nature in some form or fashion.
Julian Klymochko: That’s interesting.
Michael Kesslering: Obviously with your strategy, there’s a certain level of discipline required from a psychological basis. Who are somebody, the thinkers that have really influenced your psychology behind your investing?
Meb Faber: Oh boy, a lot. You know my favourite investing book, we talk a lot about this as Triumph of the Optimist and the reason being is, I think to be an investor of any stripes, you certainly need to be a student of history, not just market’s history, but investing and economics as well. There’s a post on my blog. I can send you guys a link, it’s something like the number one investing book, where we’d broke it out into like five or six categories and had people vote on the number one book in each category. And it comes up with, I mean, you could read all of them, of course. And that’d be like 30 books or you could just read the top from each. Triumph of the Optimists up there, but you need a perspective of history and the beautiful thing that book does. And by the way, it’s about a hundred bucks. So, it’s by a few professors in the UK is that you can get free versions each year from Credit Suisse, it’s called The Global Investment Returns Yearbook. It’s a mouthful, and they’ve put out like a dozen of them, and in each year, they tackle a different topic, maybe its factor investing, ESG or emerging markets, but they look at history of markets going back to 1900 and there’s such a wealth of information. You know, I want to be a quant to distil certain ideas down to keeping all my emotions out of the way, but also quants, the most seductive challenge of course is fitting everything to history, to applying our rules and strategies to curve fit things so that our strategies look amazing in the past. And of course, fall apart in the future, which you see often in our world.
And so at least understanding concepts like hey, and many people don’t understand, many of these are like, you know, most individual markets can and will have catastrophic drawdowns where they’ll lose 60 to 90 plus percent included some markets, China shut down in 1949, Russia in 1917, those are zeros. You never got your money back. And similar for things like bonds and bills. You know, most people will think that T-Bills, and short-term government bonds around the world are riskless. But when you apply a real methodology, like after inflation returns, you realize they’re just as risky as stocks and you can lose half your money. As far as other thinkers, you know, I’m sure it’s a laundry list on both sides of the aisle of you know, a lot of the great names that would not surprise everyone. The Buffets of the world. You know, the Tudor Jones of the world. Even you mentioned Renaissance earlier. Simons has one of my favourite quotes, not really applied to markets, but was applied to, he was talking about math at the time. And a student was asking him a question and I now extrapolate it to other parts of life. And of course to markets, which was, they were asking me if they should study a particular topic, really deep one, just very niche topic, or get a more broad exposure to a curriculum of math. You know, it’d be more well-rounded. And he said, look, you know, I can make the cliche either way. And that’s such an interesting takeaway because everyone wants to give you the opinion, like here’s what you need to do. And the challenge, not just within markets, but life is that it’s pretty easy to show how that fork in the road could work out or not work out in each instance. And we have investors all the time, say Meb, I’ve got a million bucks. I’ve been sitting out markets for 10 years and should get back in. Do I just get back in today? Or what should I do? You know, and thinking through that prism of what I just mentioned, where you can make the argument either way, you know, and the only way it’ll be obvious, is the pure hindsight of history in certainty. Going back to March, we wrote an article called Investing in the Time of Corona. And I said, look, it’s super panicky. Everyone’s going crazy right now. It feels like the zombie apocalypse, certainly in LA, the beaches were closed. The parks were closed. You had to house lockdown. And I said, however, any real investor has to at least consider the bull and the bear case from here, the bear case is, hey man, things get worse.
This virus just haymakers, the entire system. Policies are poorly designed. Hospitals are not well adapted. This is like great depression era sort of outcome. And stocks go down, you know, 60% from where they were. I said, but you have to at least consider whether it’s probable or not. The positive outcome and the bull case. And when we walked through it, treatments are developed. Vaccines are developed. Markets are forward-looking for the most part. Countries do a good job of coordinating fiscal monetary policy, healthcare policy. The virus goes away in the summer and we’re hitting all-time highs in stocks by the end of the summer. And people were like, you are absolutely out of your mind. That is impossible. And we’re getting a little off-topic here, but my point being is that I think, (A) having a healthy respect for history at least gives you the foundation of what’s possible, which is already crazier than what most people expect. You know, most people have a hard time thinking, whoa, interest rates in double digits, there’s been deflation and the rest of the world where bond yields are negative. Could gold go to 200 or 20,000, you know? And I think it’s hard. Most people want to associate just like they’re cheering for a sports team. They want to associate with one certain future. And you know, going back to, I was tweeting about this yesterday. It triggered me, but expectations, people tend to extrapolate the very recent past in the US. Historically people expect 10% on their investments. Now they’re expecting 15% on stocks and that’s just unlikely. Could it happen? Could Elon invent the perpetual motion machine that has free energy forever and diamonds on the moon, maybe. But what’s the most likely outcome? It’s not that.
Julian Klymochko: Well, Tesla is going to be in the S&P 500, and it only goes up 500% per year. So perhaps that could help investors in meeting these lofty expectations and yet a good notion such that many investors view putting money to work as either being a hundred percent invested in the S&P 500 or a hundred percent cash with really nothing in between. So many have like a binary approach. You have your trend following strategy. I wanted to get into additional strategies that you manage such as asset allocation, real estate, tail risk, shareholder, yield and momentum. They’re all very differentiated and provide different risk-return profiles, all in the name of diversification, outside of, you know, the traditional plain vanilla. I was wondering what strategies are really resonating with investors in the year 2020?
Meb Faber: There’s two, and we can probably get into both. You know, some of the strategies that we run are extremely niche. Like it’s like a Lego building block. You mentioned real estate, if you’re going to do real estate, this is our approach, favourable approach to real estate. Others are extremely broad. We have a suite of three asset allocation funds. You could literally buy one fund for your entire portfolio and be done with it. And going back to, we were talking about this in the early part with tens of thousands of funds out there, all over the world, you know, why are we launching funds? Isn’t everything already covered? And so, we mentioned the beginning, it either has to not exist, or we think we do a way better or way cheaper. It has to be something with a bunch of research, whether ours or else, you know, has been produced. It has to be something I want to put my own money into. It’s a sorry state of affairs. And people don’t know this, but the average mutual fund manager in the US has $0 invested in his own fund. And if you go up to a lot less than a hundred thousand, it’s like 80% have nothing invested in their own fund. So, I put all my money into our own funds, want to have skin in the game. I think that’s important because otherwise you see these crazy products. And I look at them like, why would anyone ever invest in that? And the manager’s on TV saying, you should invest in this and then they don’t have anything invested in it.
Julian Klymochko: Inverse VIX.
Meb Faber: So, it’s the conflict of Wall Street. It’s as old as time. And lastly, the hardest part for me is, does anyone actually want it? And so, we have a lot of strategies that are so wonky and weird or concentrated that people just, it’s not a narrative or a marketing angle, anyone really wants. So, okay. The two that people have really gravitated or want to talk about this year, we’ll talk about both super fast. As you talk about valuations. You know the nice thing about valuations is they give you an anchor. And so, hey, are things reasonable? And valuations are a blunt tool. If you’re doing it to the right of the decimal place, you’re doing it wrong, we think. It’s really, are we in the right universe? Are things cheap or are they expensive? So, we use ten-year PE ratios. Again, these have been around for a hundred years. They’ve been popularized in the last 20. But it’s nothing that Ben Graham was talking about doing a long time ago has been popularized by Professor Shiller as the tenure cape ratio. You can use dividend yields, it doesn’t matter. And the point I’m making is that evaluations workout or the periods of a decade or more. People want to talk about this week, this quarter, or this month, even this year. Valuation’s not going to help you.
And so, what you have there is good news and bad news. The bad news is the US stock market’s expensive from my seat here in the US. And as a Canadian, you know, the US is still half a world for market cap is actually a little more right now. It’s about 55%. So, if you’re an index investor, you put about half your money in a market that the PE ratio, long-term PE ratio is around 32 or 33. It’s probably 33 today.
Julian Klymochko: Yeah.
Meb Faber: For contacts, the long-term average is 17. And in mild inflationary times, like now it’s around 22. So, on any standpoint, on any indicators its expensive, there’s a handful of other indicators that look at US stocks and they are all-time expense, highest they’ve ever been.
But in 1999 we hit a peak, a CAPE ratio of 45. So not as high as it’s ever been, but one of the highest in history of the last 120 years, historically, that’s not been a great starting point. And you can use John Bogle formula and you type in, there’s three inputs. Starting dividend yield, earnings or dividends growth and change in valuation. I’m an optimist, we’ll round up to 2% dividend yield in the US, it’s not 2%. We will roundup, we’ll give you historical earnings and dividends growth. And the problem is because of valuations, you’re likely over the next 10 years to have a multiple compression. So, the most likely outcome, again, probability of future distributions, most likely outcome is US stocks to about 1 to 4% per year for the next decade. Not great, not horrific. Vogel before he passed away, he said 4%.
Julian Klymochko: Right.
Meb Faber: He wouldn’t have said forecasting. He would have said, you know, set your expectations, save more, spend less, don’t expect 15%, which is what people are expecting. That’s the bad news. Now, you know, again, going back to the Elon Musk conversation, there are scenarios where it could be minus 5-10% a year, and there’s scenarios where you could still get 10% a year. Those are unlikely to happen. To hits people’s expectations, you need multiple expansion to the highest it’s ever been and then up. So, the bad news is US stocks are expensive. And half the world market cap, if you’re an indexer, goes into the US. You’re putting half your money into what we calculate is the second most expensive market in the world. The good news is most of the rest of the world is totally reasonable. So, a foreign developed XUS is down around 20 for emerging is in the low teens. And then if you get the cheapest of the cheap it’s around 10, so a huge valuation disconnects relative to the US. People expect that to be the norm that as if that’s always the case, it’s not. The average of the US versus the rest of the world for the past 40 years is the same. It’s been right around 22.
So, the good news is most of the rest of the world’s cheap. So, all this long-winded discussion was that think about markets outside of our borders. You know, I think in particular value tilts within foreign developed and particularly emerging markets. These are scary names, but places like a lot of Europe, I mean, even the UK which historically has had the same valuation, the same returns to the US stock market. It’s currently less than half the valuation. But again, so there’s a world of opportunity outside the shore. So, we have some funds that do this. We have four equity funds they all have a value slant, some focus on cashflow and returning the cashflow. There is the shareholder yield ones. We have a US, a foreign emerging. We have one fund that buys the 12 cheapest stock markets in the world. And you got to be pretty weird to like that one. I love it, but you end up in places like Greece, Brazil, Russia, even Turkey, Poland. But you know, you end up having a pretty nice yield. I mean, you’re at 4% plus yield in many of these countries. And so that’s the value side. That’s the equity part. I’ll pause there. You guys asleep yet?
Julian Klymochko: No, that’s great. And it’s funny how you mentioned CAPE, cause actually, you know, I was tweeting about US equity valuations over the weekend. And then I mentioned CAPE, which isn’t quite at it. 99 tech bubble peak of low forties or 43-44, because you mentioned currently around 33, which only exceeded its 1929 peak, but also tweeted the market cap to GDP, which was an all-time record in addition to others, such as EV/Ebitda and the debate on the CAPE ratio, the Shiller PE was that, oh, interest rates are low and no wonder that multiples should be higher, but as you indicated that’s not the case for a UK or even a Europe and Japan, they’ve had negative rates and you certainly had these massive multiples. And even in Canada, you don’t have excessive valuations. So outside of the interest rate argument, once that’s debunked, others are like, oh, more profit growth. US exceptionalism, but you know, for the most part, it just seems like some sort of, you know, tech mania 2.0, but I digress. So, you mentioned value and, you know, investing based off earnings ratios, et cetera, shareholders yield. What other strategies are you finding is resonating in 2021? That I do find super interesting these days is the notion of tail risk, especially coming out of, you know, Q1 scenario where you had this massive drawdown, the quickest of all time in terms of most risk assets and investors were wishing that they had insurance at that point. And tail risk is an interesting product because, you know, you’d probably expect over the long-term to lose money. However, you know, it does provide this insurance like payoff such that it does well when basically everything else is tanking.
Meb Faber: Yeah, you know, so about four years ago we were doing some research and looking into some funds and I wanted to include some inverse exposure into some of our asset allocation tactical strategies and looked around the space and was just like, wow, these funds are so confusing. They’re complicated. Many of them were extremely I thought poor designed and expensive. And so, we said, okay, you know, if I could design a strategy, what would I want? So, I spent a whole summer doing this, sadly, because I figured out later you could just replicate it with some of the work that Cboe had done already, but it was good to have gotten the hands dirty with it. And the concept was this. If you look at the worst days, months, bear markets in the S&P we said, all right, what historically would help your exposure to US stocks?
And the things that I think all of us would expect to not help didn’t historically. So foreign stocks, real estate, commodities, none of that helped. What did help, bonds helped, gold helped, gold helped only sometimes, you know, gold is kind of like your crazy uncle. Going to show up at Christmas. Like you don’t know who’s going to show up like crazy uncle Eddie. Sometimes it helped, but sometimes it did not. And bonds had a high batting average, but, you know, they would usually not, it’s not like they would help if the S&P was down 10, they may be up a percent or two on average. And so, we said, okay, well, what else? You know, there’s things like value, there’s things like trend following, but the thing that almost guaranteed to help, you can never say guaranteed in our world, but of course is buying puts. And the problem with puts, as we all know, is they’re expensive. Their insurance, and most of the time, you don’t need them. The same way you don’t need insurance on your house or your car to protect against your house burning down or getting into a wreck. And I said, is there a way, and just curious, how much costs would there be historically? And I said, let’s come up with the most simple concept possible. So, we wrote a paper called, Worried About The Market? Maybe It’s Time For The Strategy. And all it did is it put 90% of your money and tenure US Government bonds. So, we got the bond exposure, and then with the rest, the way we actually do it in practice is we buy a latter of puts. I believe that one used a fixed maturity, but we buy a ladder of puts from 3 on out to 15 months. And what that ends up looking like at least historically, was you get about a one to negative one exposure in the bad times. So, if the S&P is down 10, the strategy you’d expect it to be roughly up 10, whether that’s a day, a week, a month, quarter, but you don’t lose as much when things are doing well in 2020 is a great example. You know, when the first quarter happened, this and all the other inverse funds did great. And the problem with the rest of the year is that so many of these other hedging strategies not only gave it all back, but many of them are down 10, 20, 30%. And that’s hard as an investor.
It’s hard as an allocator you know, to have both sides of that. Hey, it worked, but then now you’re just getting, you know, kind of pummelled. And so, the beauty of the putts is well, the beauty it’s also the problem with it is that, you know, it’s a cost in the good times, but it’s not a pure inverse cost. So, the nerdier description would be up and down capture. My fear when we launched this was that pupil would herd into it, like many of the public funds chase performance. And we’ve seen this with asset classes, strategies managers for the last 50 years, they have a good year. Everyone herd in my favourite example, always was CGM Ken Heebner fund. Mutual fund manager of the decades during the 2000s was up like 10% a year. But the average dollar weighted in that fund and was not only not up to 10%, it was negative. Because everyone came in after he had a 70% up year, and then he added down 50 and everyone came out.
And so, my fear was that everyone’s going to buy this after the event already happened. And actually, hasn’t been the case. So, I’m happy and maybe it’s our audience, or maybe it’s everyone. You know, didn’t panic buy in March, but rather has been adding mostly this summer. And one of the interesting things and a couple more quick comments and I’ll stop. The simulation historically actually had a positive carried, but that was in a world of 4, 5, 6% interest rates and interest rates declining. In a world of sub one, you know, I don’t expect the strategy have positive carry. It’s going to lose money any given year. You know, I think, I can’t say with certainty.
Second is you don’t need this fund. And what do I mean by that? If you are a buy and hold person, like many are. You have an asset allocation and you got that steely resolve, God bless you.
You put your money in, you don’t worry about the drawdowns. This year was a walk in the park. Good for you. Like, you know, that’s wonderful because this fund could end up being a cost or the long-term. But if you’re not someone who is like that, you know, the beauty of a fund like this is that back when the market was, you know, again, going limit down, at least something is likely to be green on the day. And if that helps you survive, if that gets you to the promised land, if that helps you behaviourally hold equities or hold more equities even at least sustain, the worst possible thing can happen is your emotions creep in. You have the fracture. A lot of people don’t have a written investing plan as you should definitely. And they panic and they sell it all and then never investigate.
And you, and I probably know many people, not only they did that this year, but did that in 2009. So, you know, this fund to me you know, acts as a balance. Now, two more points is that I think it’s particularly interesting now because of the valuation of US stocks. And we have sort of the, if you go red, yellow, flashing lights, green, red, yellow it’s easy quadrants. You can do cheap, expensive uptrend downtrend for US stocks, any asset class for equities. And historically the best simulation is cheap uptrend. The worst is expensive downtrend, but the second best is expensive uptrend, which is where we are now. So, it’s kind of like a yellow flashing light, but once that rolls over, you go all the way to the worst. So expensive downtrend, but that’s not where we are yet. So, adding this strategy tactically, whether stocks are expensive or they’re starting to go down you know, I think it can be thoughtful and can be helpful, particularly for people in our world and for all the listeners. This doesn’t just apply to financial folks, but applies to anyone. So many people, the problem with buying hold is it gives you great returns, but when does it do poorly? It does poorly when everything else is doing poorly. When the economy is tanking, when a recession is happening, when the world’s going crazy and geopolitics, think to this year, everything was going down in Q1, all the risk assets, the exception of bonds, mostly. And so, your human capital is highly correlated to your investment capital. And that’s not what you want. You want something that helps you to zig and zag a little bit. Otherwise you’re just getting leveraged. It’s even worse for financial folks. You know, your average financial advisor is like five times leverage the stock market. He got stocks in his own portfolio, stocks for his clients, revenues based off those clients, clients panic when markets are down on top of that, if you don’t own your own company you could get fired in a recession.
You can make an argument, not only should you not own stocks, but you could hedge those anyway. No one does that besides me, by the way. We own this fund, both personally, as well as our company’s balance sheet to help smooth what’s going on in the world. But again, you don’t need it either. So, it’s kind of an interesting fund that I think is one that interesting strategy that is a bit different. And going back to the importance of fees too, it’s the cheapest fund in the entire category. And that’s not a huge testament that it’s like, it’s so cheap. The rest of the world so expensive there.
Michael Kesslering: And when you talk about tailored risk, I mean, there’s obviously a very strong argument to be made from an individual investor, but as well from institutions as well, right? Is do they have the wherewithal to stick with the strategy, because what you’ve seen lately, at least with some of the pension funds that were invested in some tail risk strategies, now they’re getting out of them when I guess really perhaps it’s the best time to be sticking with it, but just switching gears a little bit, you being an absolutely prolific producer of content both with your podcasts, which you’d be running for I believe over four years now. So, with that and all of your writing and especially interviewing different investors, as we were love listening to the guests that you have on your podcast, how has that changed your investment process over the years in interacting with a wide variety of folks on the podcast?
Meb Faber: Yeah. and by the way, you can say CalPERS, they’re referring to your tail risks comment, you know, I love to tease them and as well as a lot of the big institutions, it’s really easy. I think for a lot of the pros out there, including the CalPERS and these big money institutions that manage hundreds of billions of dollars to kind of look down their nose at individual investors. But they face all the same problems. They just use different words to describe them. You know, they have committees, they’re rigorous, they have 500-page policy portfolios, but they make all the same mistakes.
Julian Klymochko: Plus, on some of the underlying investment firms too, right?
Meb Faber: Yeah, and so they chase performance. I’ve seen this last 20 years, I used to go to a lot of conferences and the flavour of the day, you know, and just rinse and repeat. It could be emerging markets. It could be commodities, it could be tail risks, could be tax cross allocation. Next thing you know, it’s innovation. Like now it’s the large cap, US growth stocks. The technology’s like every three years. So, I love to tease those firms because (A) they deserve it. But (B) they have all the same challenges we do as humans with our smaller accounts that they do with hundreds of billions. You know, I think what’s changed over the years. A big one has been my perspective on, you know, what’s an optimal portfolio look like, and I’ll be the first to say, there’s plenty that’s just fine. You put it under this category of what works for you. What lets you sleep at night; you got all your monies in short-term bonds and CDs, God bless you.
Good for you. That’s what you want. You’re comfortable with that, that’s fine. You got all your money in dividend growing stocks and you’re an income investor and you stick to that, wonderful. I think the challenge though, is a couple: one, is that so many people get focused on their particular style and if they don’t know what’s possible within that style historically, that’s when you can run into big trouble. Let me give you an example. Used to be cocktail hour, but now, I guess on Zoom. I talk to investors and they would ask me, hey Meb, I bought your fund. One of your funds. Good and bad news about having 12 funds is some are always doing terrible and some are always doing wonderful. So, there’s always something to complain about. Investors will come up to me and pick your timeframe too.
So, they say Meb, I bought X, Y, Z fund. It’s not doing well. It’s underperforming. Who knows what, Amazon and Tesla? I’ve owned it for three months. I’m going to give it a few more months. How long do you think I should give it? And I used to say 10 years and they would laugh. They would laugh awkwardly thinking, I’m joking. Wait for me to repeat myself. I’d say no, I’m serious. And they said, well, I will never do that. Like, that’s crazy. Who would wait 10 years? And I say, well, do you invest in stocks? And they would say, yes, I do. Do you believe stocks outperform bonds over time? Yes. I actually don’t know a single investor ever, that I’ve ever met doesn’t believe that. So, I said well, how long should you give a manager an asset class before reviewing it? And the answer is always less than three years, maybe a year or two. If you underperform for a year, you know, you’re on notice. They’re grumpy, two years is like they may stick around if they like you. If they’re friends, family, whatnot, three years, you’re gone. Forget anything longer than three years.
And I actually say now when people ask me, how long should I give this? I say, 20 years. And let me give you an example. This year in 2020 in March, there was a period where US stocks had underperformed US long bonds for 40 years, not 5. And it’s not underperformed, excuse me. I think it was exactly the same performance. And so, for people, you know, to wait on the most ironclad rule, it’s like the thermodynamics, like its rule one: stocks out foreign bonds over time. But stocks for the long run, you’ve got to remember, it’s the long run. Long run does not mean a week or a month. It means decades. And so, this applies to anything. If you look at Warren Buffett’s performance, if you look at any asset class, could be gold, could be cannabis, come on, I’m talking specifically like Canadians now. My junior miners, it could be anything. You better have a long-time horizon or else it’s going to be big trouble. And so, I think my appreciation for that in designing strategies, that behaviourally let you succeed, almost always, that means sub-optimal portfolios. Trying to find the best portfolio that optimizes on return or optimizes on whatever it may be. You know, if you’re going to move away from the market-cap-weighted index, it means by definition, you need to be weird, concentrated and different. So, you tell someone they need to be in these a hundred stocks or this weird strategy that by design its point is to be different. So, it’s could go years and years and years of underperforming and still be valid. Buffet’s a great example. You look at his 13F picks he’s underperformed for like 20 plus years now. But then you incorporate a few periods like the late nineties, early two thousand, and then he destroys everyone, you know? And so, his major alpha was never, his strategy. Strategy is actually pretty simple. It’s that he sticks to his knitting. Long-winded example of saying whatever strategy you come up with, you need to understand what’s possible. And there’s a huge hysteria on top of that, that it’s going to be worse than the historical. This year is a perfect example, great reminder. You mentioned this earlier, US stocks, fastest ever from all-time high to bear market and fastest ever from bear market to all-time high. We’ve never seen that before. And so we’ll always be surprised, but at least trying to come up with a portfolio that is anti-fragile not just to the portfolio, things that zig and zag, but also to the the user, to the, to the consumer of that portfolio, which is why, you know, I personally, and our kind of flagship is half and buy hold and half and trend following. We call that the, the technical term going halvsies right, where you never have everything in one camp. And within those stocks, bonds, you own real estate, commodity you know, try to get as diversified as possible, but I’m also not out there saying that this is the promised land. This is what everyone else do, right. It’s whatever works for you.
Julian Klymochko: Yeah, and there’s so much uncertainty out there and everyone always seems to want the answer on what is the best investment, which obviously you never know without the benefit of hindsight. And so obviously you preach the gospel of diversification, but Meb. I want to put you on the spot here. We’re talking about this 10-year timeframe or perhaps 20 years. If you could hold just one investment over the truly long-term 10 to 20 years, what would it be?
Meb Faber: Okay, I’m terrible at these questions. So, I’m going to caveat it a couple of times. If meaning it has to be buying hold lockbox like I buy it and it’s done and you can’t trade it or anything. It would certainly be a basket of and depending on your framework, it could be emerging markets or it could just be all markets, value stocks. And that’s going to skew you towards small cap right now.
Julian Klymochko: Right.
Meb Faber: And after the pummelling, the value stocks had in the US in Q1 when they were down 50% small cap value, that now includes US too. It didn’t prior, and by the way, rewinding the very beginning part of our conversation were talking about valuation metrics. The big difference between now and 1999 is that there were more places to hide in 99. So real estate, small cap value, bonds. Those all were reasonable. Now, all the stocks are more expensive and bonds are sub 1%. It’s just, there’s not as many opportunities out there. So, my answer is small cap value everywhere. However, here’s my caveat. If the strategy is allowed to use rules and trade, so I can put it in like a computer and let it trade, it would be diversified long-term trend following approach, because that’s like my desert Island strategy is that it will react to whatever happens if emerging markets or value is going up, great. It’ll will own those. If it’s gold, if it’s stocks it’ll own those, but that requires some trading and buying and selling. So, I’m not sure depending on your rule, it would either be small cap stocks or a simple trend following approach.
Julian Klymochko: Yeah, it makes sense, you know, value and trend both proven their worth over the long-term. Even if in fact they don’t work over some short-term period. So certainly, it’s important to take that long-term timeframe and that view of things, perhaps a lockbox approach would be best served for most investors.
Meb Faber: I was going to interrupt you and say, look, you’re exactly correct. Like, that’s what I should be doing. Like I don’t have zero interest in mucking around with my portfolio. You know, my goal, I spent a lot of time working on this and I have not figured it out. So maybe you and I can brainstorm on this later about ways to literally lock investors in for periods of 10, 20, 30 years. And you know, that sounds like a bug, not a feature, but really what two investors say they really want, they want a long-term horizon, I’m in it for the long haul, I would put money in. I think there’s a way to construct it. And you have certainly annuities and retirement accounts and target date funds, but each one of them has some kind of pros and cons. So anyway, I haven’t figured it out yet, but I spend a lot of time thinking about that. Because in reality, that’s what we’re all here for. You know, it’s all this fancy finance stuff is there for a reason. It’s to finance goals, retirement, kids, college education, going snowboarding, freedom, pay the bills. You know, they’re a means to an end. And so most investors should be more you know, Rip Van Winkle than Nostradamus on trying to predict the future. Just go to bed, goes around for 10 years, we’ll figure out a good structure for that. I don’t have one yet.
Julian Klymochko: That’s certainly a great advice and would make everyone’s life a lot easier if you didn’t have to worry about these things’ day to day. So, before we wrap things up on the podcast today, I think it’s highly likely that most of our listeners listen to your podcasts and probably follow you on Twitter, just due to your large following, but to the extent that they don’t, where can people find you online?
Meb Faber: Yeah, not too many Meb in the world, so that’s easy, mebfaber.com, there is the blog. We got out, man, thousands of articles on there now. The podcast you mentioned picking fights on Twitter. That’s also my favourite day job, Cambria Funds in cambriainvestments.com.
Julian Klymochko: Okay, perfect. Well, thank you so much, Meb. Thanks for coming on the show and we which wish you all the best.
Meb Faber: See you on the slopes.
Julian Klymochko: All right, cheers. Bye everybody.
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