Episode #81: Radio Show: Notes from Meb’s Office Hours – Listeners Are All Making the Same Mistakes



Guest: Episode #81 has no guest, but is co-hosted by Jeff Remsburg.

Date Recorded: 11/13/17

Run-Time: 1:06:04

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Interested in sponsoring an episode? Email Jeff at jr@cambriainvestments.com


Summary:  Episode 81 is a radio show format. Meb starts with a note of thanks to listeners. It involves a milestone Cambria just passed as a company.

Next, Meb walks us through the common themes he’s hearing from his office hours. In short, all listeners are generally making the same investing mistakes (though everyone seems to believe his/her situation is unique). Meb tells us what everyone is doing.

Then, it’s on to listener Q&A. Some of the questions and topics you’ll hear are:

  • What’s the latest on global CAPE values? Which countries are cheapest?
  • Buffett was on CNBC the other day opining that stocks were cheap because you have to view them in relation to competing investment opportunities, and interest rates are still quite low. Thoughts?
  • Is it possible to construct a CAPE index for other asset classes besides stocks?
  • How do you recommend getting exposure to commodities? Aside from the physical metals, it’s hard to get good exposure because most of the ETFs invest in futures which get hurt by contract rolls. What’s the answer?
  • In the typical asset allocation, would muni bonds produce more alpha than Treasuries? What different risk would it introduce, and is it worth it?
  • Trend following is primarily a binary thing: You are in if your signal has triggered, otherwise out. But is it better to be in a market that is trading, say, 10% above your trigger than a market that is 1% above?
  • Is low volatility a valid and sustainable outperforming factor?

As usual with the radio show formats, there are plenty of rabbit holes. Plus, Meb is about to do some travelling overseas. Where’s he headed? Find out in Episode 81.

Links from the Episode:

Transcript of Episode 81:

Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing. And uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.


Meb: Hello, podcast listeners. Before we get started on today’s radio show, I wanted to share a personal note. This is a letter we sent to our investors on a pretty big milestone we just passed recently with my company, Cambria, so I wanted to share with you guys because we see the podcast listeners as part of the family too. So here it goes.

Just a quick note to say thank you. As most of you know a common measuring stick in our industry for company size and capability is assets under management. In the past few days, Cambria passed a significant AUM milestone. We crossed a billion dollars in assets under management. That means, while certainly not a big company, we’re no longer a small one. This achievement has been more than a decade in the making. It was anything but certain in Cambria’s early days. I remember sleeping on friend’s couches all around the country just so I could give bleary-eyed, get-the-word out speeches to audiences that likely forgot the name Cambria five seconds after I finished.

Then there was the excitement of my first published white paper, only to be humbled when they misattributed the authorship to Melanie Faber. And of course, there’s been setbacks common to any young company, lean financial years, and the general headwinds of being a small fish in a big pond. But for every challenge, there’s been an even greater sense of reward as we watch Cambria evolve and get to where we are today finally at a billion in assets.

That would never have been possible of course, without a great team surrounding Eric and me. So a big tip of the hat to Sarah, Keetz, Himanshu, David and Jeff. While countless partners also deserve thanks for their roles in reaching this point, none more so than the investors that have placed their hard-earned capital in our hands. Thank you.

Cambria doesn’t have a large advertising budget or any advertising budget for that matter. As such, our growth has come from friends like you who have supported us, reading our books and white papers, listening to our podcast, investing in our funds and portfolios, endorsing us to friends, partnering with us as equity investors in our company.

In short, we’ve reached this point on the backs of our supportive and loyal friends who have helped carry us here.

Looking forward, we’re excited to tackle our next crazy research projects, improve our current offerings, and launch new ones. All with the goal of delivering a better portfolio and experience to the end investor. But for the moment, we wanted to pause and simply express our gratitude to each and every one of you for helping us get this far. So, on behalf of Eric and the entire Cambria team, we thank you. And now onto the podcast.

Hello, podcast listeners. We’ve done so many interviews lately. I thought you guys are going to start to miss Jeff so we squeezed in an extra radio show. Jeff, welcome.

Jeff: Hey, what’s happening?

Meb: I don’t know man, I’m starting to get e-mails and people were like kind of starting to miss you a little bit.

Jeff: Well, they know where the real talent is. They’re tired of hearing you.

Meb: You got all these big guests on and we may have to start doing a radio show every week. I feel like people…or just spin you out. We’re just going to give you your own show.

Jeff: How to use high-leverage ICOs to maximize your portfolio.

Meb: Bass and options.

Jeff: Is there anything better?

Meb: Wow, man, let’s see. So, what’s going on? What do you know?

Jeff: Why don’t you give us a little update? You’ve been holding office hours for the last few weeks.

Meb: Yeah, man. It was office hours, I was also traveling. I was in New York, got in some fights on CNBC, lost my sunglasses, went to Orlando. Orlando was really interesting, by the way, it was AII crowd. And I could have sworn the last time I gave a speech there and I mistook it for when I gave a speech to the “Money Show.” Do you know that conference?

Jeff: Yep.

Meb: It’s pretty snake-oily. If you’re listening “Money Show,” I’m sorry. They have good speakers, but the break out, like sponsors are…it’s like what not to invest in. But I mistook the two because I remember giving…the last time I gave a speech in Orlando, there was literally like five people there. And so I was fully expecting there’d be five people in the room. And then it was like out into the hallway, like 300 people or 400 people or something. Anyway…

Jeff: Must have thought somebody else was speaking.

Meb: They loved my jokes. Never heard any of my jokes. Yeah, I know. They’re like, “Where’s Swedroe? Oh, wait, this isn’t Swedroe room?” He was actually speaking there too. But the best part about that, other than I had dinner with Wes Gray’s family… We talk to Wes a lot on the podcast at the buffet, was that my hotel…you could take a water taxi to Universal Studios.

Orlando is this ridiculous place, in general. It’s just like, it’s one giant theme park. But, good time for the economy. It seems like business and vacation is booming.

I was also in New York and then finally home. And will soon be back to Amsterdam, Switzerland. We got any Swiss listeners, we’ll be there. And then that’s it for the year. I’m not going anywhere for a while after that.

Jeff: That’s a lot of travel, you’ve to come back to Colorado.

Meb: Except back to Colorado. If you’re in Colorado, look me up. We’ll go cry in our beers about how awfully terrible the Broncos are now. It’s really depressing.

Jeff: All right. All right. Let’s focus. Let’s focus. Take us back to “Office Hours”…

Meb: “Office Hours.”

Jeff: …and give us a sort of an overview about what are you hearing? What are the concerns? What are the interests? What’s the takeaway?

Meb: You know, so the “Office Hours” for podcast listeners, if you’re not subscribed to our email lists, you need to go to one of our websites and subscribe because we do a bunch of updates, notices, and one of the things we started doing every quarter it’s called “Office Hours.” And I’ll block off time and do call-in with anyone in the world. You know, so people block off 30 minutes. And I mistakenly, the first time I did it, didn’t set my calendar correct, so I had phone calls from 9:00 a.m. to 5:00 p.m. How many…is that like 20 phone calls a day?

Jeff: I’ve never seen Meb so tired.

Meb: Oh, my God. For two weeks. And this time I’m smart. I did from 10:00 to noon, so what is that? Four a day for a couple of weeks. But it’s nice because it gives you a pulse on what is going on the world, what people care about. But it’s been a full spectrum. It’s people from Russia, it’s students, it’s everything from the…mostly institutional sort of other professionals. But it’s full spectrum, individuals as well. The vast majority are normal conversations, but on occasion somebody will call and go like, “Yeah, I really don’t have anything to talk about, but I didn’t want to turn down the opportunity to talk to you. So now that I got you.” I’m like, “Well, okay. What do you want to talk about? Fishing? Broncos? Farming? I don’t know.”

But there’s actually…I think this is actually useful to the listeners because almost every call has the same threads and the same themes. And it’s interesting because a lot of the people that have the calls, they often think they’re the only one that has the same issues. But in reality, it’s like almost every call is similar.

And so I’ll kind of give you an outline and we can talk about it in general but particularly for individuals, and even professionals, here’s kind of the takeaway. So first, I do not think a single conversation I’ve had with a single investor…and so we’re talking 200 or 300 at this point. And by the way, if you’re a financial adviser, this is an awesome way to connect with not only current investors but future ones too because the people really appreciate it. And a lot of times people would never call in or they would never email me to schedule a call, but because of “Office Hours” it just seems more casual. I don’t know. Financial adviser is a good idea, by the way, because you connect with a lot of current and potentially future clients.

Anyway, first one, I don’t think anyone has a formal plan, like a written investment plan. Almost every single person I talk to they’re like, “Yeah, you know, so this is what I do. I’m this years old, I’m married, and here’s my portfolio. It’s kind of like this. But like a couple of years ago I used to do this and then I switched, and now I don’t know. I kind of do a little bit of this and I’m thinking about that.” Like it’s just a mess. Like it is a patch…you should almost describe it as the patchwork portfolio. Almost every single one is just like, it’s a bowl of soup.

And, you know, as you listen to this podcast, if you’re new, we often talk about how useful it is to have a written investment plan. This could be one bullet point, it could be 20 pages long. But in the same vein of like dieting or anything else like unless you have some framework, it’s just asking for you to go mess with it.

Jeff: Do you think this is based upon laziness? Or is there an inherent fundamental like behavioral issue that’s preventing people from [crosstalk 00:09:07]?

Meb: I don’t know. So one is, I think most people, it may not have even occurred to them, like no one’s ever told them, “Hey, you should write down and have an investment plan.”

Jeff: We’ve been talking about this in various forms for at least eight months and feel like…

Meb: Yeah. And I gave a speech and I said, “Who here has a written investment plan?” I’ve actually done this a couple times, like no one raised their hand.

Jeff: All right. So, how do you get people to motivate to do it?

Meb: Well, so that’s the second part, is the people that do think about it… And so the podcast listeners who’ve been listening to our episodes before, I’m sure you still haven’t done it. Yes, you, listening podcast listener. You know, do you have an investment plan? No. The answer’s probably, no.

So that kind of blends into number two though. It is, people are really…their starting point is always their current situation. So they’re wedded to their current situation. And first of all, there’s a lot of people that have a great deal of trauma and scars from last two bear markets. I’ve talked to a significant amount of people that say, “You know what? I got hammered in the dot.com, then this went up and then…oh, wait, I sold and I’ve just been in cash since.” I mean, that is not a…it’s not even a minority, it might even be the majority of people.

And so, there’s two parts to this one. So one, you know, and I was talking to a family member the other day. And they were talking about their holdings and they say, “Hey, you know, wanna look at my portfolio and give me some suggestions?” And I say, “What’s this? What’s this?” They say, “I don’t even know what that is.” Right?

And so I’m looking at the current portfolio, but it’s like, “Should I sell or should I keep it?” I’m like, “Well, you should sell it.” And it’s like, “Well, I don’t know.” I’m like, “You don’t even know what it is, right?” So what I want you to do listeners, think about this. Jeff and I talked about this. We’ve written article about this called “Zero Budget Portfolio.” And it’s based on what the guys did at 3G Capital. It’s 3G, down in Brazil. Buffet’s partners on a lot of deals. You know, they do this with budgeting, they’re called the zero…but for companies, is it zero budget, budgeting? No, Zero… Whatever.

It’s a concept where the company they beginning in January 1, they say, “All right, your expenses are a blank paper. Would you add these expenses again?” And so, by the way, this is a good thing to do with personal finance. So you could try this on your own. But with your portfolio. Pretend your portfolio is a blank piece of paper, and then write down your ideal portfolio. Not perfect, but just what you would buy today. And if it’s not the same as your current portfolio, you should liquidate your current portfolio and buy the new one. But people don’t do that, you know, and it’s, Richard Thaler partially won the Nobel for this. It’s called the “endowment effect.” People value, for whatever crazy reason, what they own more than if they didn’t own it.

Jeff: Side note. Do you put any weight though on let’s say those investments that are kind of in that grey area? They are not inherently cheap. They’re not inherently overvalued. But if you do sell you’re going to take a hit on capital gains and really on taxes.

Meb: Okay, so we’re gonna ignore taxes. So taxes are obviously a consideration. But I feel like most of the people I talked to, might have some embedded losses anyway for the way they’re trading. But even so, let’s ignore taxes for a second.

But again, if the current portfolio you have, which a lot of people…it’s nowhere near what they want to be, is not your ideal portfolio, then you’re doing it wrong. Like you just have emotional baggage to something for some unknown reason.

And so the best way to think about it is pretend you own nothing, would you go by the exact same holdings you have currently? Almost no one says, “Yes.” You know, they’re like, “Well, I’ve had this fund. It might come back. Like it’s done bad this year.” I say, “Well, pretend you sold it, would you buy it tomorrow?” “No, it’s been terrible. Plus he charges 2%.” You know, I could just…it’s nonsensical.

But this is the related part to this, every single person I talk to wants to think in binary terms. So say, “Well, Meb, you know, I’m in cash. But I know that stocks are expensive, like, should I be in or out?” Or, “I have this fund, should I sell it?” Or, “I’m thinking about, you know, maybe transitioning your trending portfolio but I just…I don’t know.” And I say, “Look, there’s no reason for any investment to ever think in or out, binary terms.” But everyone does. And I think there’s a lot of reasons why, but I think it’s a terrible thing to do.

And so, whether it’s for example…let’s say we’re talking to the guy who has 100% in cash. He says, “I want to get back in the market.” Or, “I want to do The Trinity Portfolio, whatever it is. I just, you know, I don’t know, there’s an election and then stocks have gone up.” And I say, “Whoa, whoa, hold on. You don’t have think of all in or out. You know, you’re 100% in cash. How about you put 10% to work? And then next quarter, your investment plan is you add 10% for the next three years and till you get fully allocated. But they’re like, “Whoa.”

And the reason they don’t want to do this is they secretly want to gamble. You know, they either want to do one or the other. They want to be right and look back and be like, “God, that was the right thing to do.” But the flip side of that, whereas you do whatever it is in binary terms and think about, “Should I buy gold now? Should I buy stocks? Should I sell them?” You get that wrong… So if you go from 100% in cash to 100% invested this month and you get that wrong, and the portfolio goes down 20%, you’re either going to have hindsight regret, scarred for life. Like, you’re gonna hate yourself. Like there’s no reason to be going all in and all out on any decision ever, almost.

Now, the logical, mathematically-correct thing to do if you’re going to go is a lump-sum invest because if something has a positive expected return, the longer you invest it, the better it is. But, from a psychological perspective, that’s probably not the best.

So what I tell almost every investor where they have this patchwork, terrible portfolio, and they say, “Meb, you know, what do you recommend?” All right. The starting point is always the global market portfolio to me. If you were to go to buy the world. And that’s so simple.

Think about this way, it’s half stocks, it’s half bonds, and of that, it’s half U.S., half foreign. So it’s like four fund portfolio. U.S. stocks is only 25%. So a lot of people say, “Oh, Meb, but the market’s expensive…”

Jeff: Wait, wait, wait, hold on. Sorry. Let me back up. Half-bonds though, even right now with yields where they are, some negative global yields, I mean, isn’t this the end of the historic, you know, bond bull-like, are you really buying right now?

Meb: I think people have been saying that for like 10 years, right? I mean, people say, “Interest rates, so I can’t…they’re 3% and 2%.” People have been saying that in Japan, that’s the widow-maker trade.

Anyway, so, I say, “Look…” I’ll come to that a second. So I say, “Look, global market portfolio.” Because they’d say, “Oh, you know, U.S. stocks are expensive. And Meb, you say U.S. stocks are expensive.” And I say, “I know, but in the global market portfolio, U.S. is only one-quarter of the portfolio.” That’s not that much for most people to think about.

If you said you’re only going to put 25% in U.S. stocks, most would people say, “That’s really low.” Right?

Anyway, so, I say start with the global market portfolio, and so now you want to talk about bonds, but again, this goes back to the whole sort of thinking in binary terms. The nice thing about the global market portfolio is you get everything. So you get expensive U.S. stocks, you get cheap foreign stocks. You get terrible-yielding bonds, like Switzerland and Japan, which are negative for a lot of them. But you also get emerging-market bonds. And higher-yielding sovereign bonds that yield 5%, 6%. You get corporate bonds, which by the way, is a huge slug of the bond percentage.

So, it’s actually bonds have a higher percent in the global market portfolio than stocks do. But because they’re corporates we give a nod to the stock side because corporates act like half-bonds, half-stocks.

By the way, this is just the public-market portfolio, so if you include private-global-market portfolios or private real estate through housing, through commercial real estate, and the biggest one, and this one I actually talked about at the Ritholtz Conference in New York, was a commodities panel, was farmland. Which is a huge, actually world allocation. But no one can allocate because there’s no way to allocate to it.

But if you just do the public-market portfolio, that’s global-market portfolio, half stocks bonds, half U.S. foreign. And I say, “That’s the starting point.” So, that’s the ultimate in diversification, you can start there.

But you talk to people and you say, “Okay, are you like ready to implement?” They say, “Okay, you know, here I’ve got a good plan, it’s a good idea, da, da, da.” But no one’s gonna do it. You know, it’s like starting a diet, “When are you going to start to diet?” “Tomorrow.” “And are you gonna write down this investment plan?” “No.”

I mean, I’m answering for them, they’re not going to. Listeners, if you did, I’d be shocked. But that’s the problem, so much of this feels like personal finance and behaving well, there’s so much of this, there’s so much crossover with exercise and dieting.

Jeff: Well, put on your behavioural therapist hat. You know, we’ve identified the problem. What suggestions do you have for actual implementation?

Meb: Well, there’s one more. There’s one more fifth, and then we’ll go to that. And the fifth is people like to gamble. Okay? So, every single conversation is basically…the number one question on every conversation is basically asking me to forecast the future. They say, “Meb, how does the world look to you, essentially what are you predicting for asset classes?” I’ll say, “Look, by the way, everything we do is quant, is rules-based. So, I’m happy to gossip. I will talk for 45 minutes on the way I see the world, the way the world should be. But that’s not how I manage money. I manage money with rules.”

Now, some of that aligns with the way we see the world. But a lot of these people, they say, we’re talking about all these specific investments, “Well, Meb, what do you think about Tesla? What do you think about Bitcoin? What do you think about Greek stock market? What do you think, you know, about this, that?”

And so…but again, I think the way that it comes to this implementation now, how to do all this? So one, try to have a written formal plan. It could be simple. Try to share it with someone, it could be your wife, your daughter, your son, your neighbour to try to keep you somewhat compliant. But a lot of people are very guarded about their finances, so they probably won’t. But it would be nice to have something written down.

Two, try to be agnostic. And so have your white piece of paper, write down your ideal portfolio. If that’s not what you have, get there. And two, in your written investment plan, have a path on how to get there. So, don’t think in binary terms, “All right, fine, I listen to Meb, I’m going to sell it all tonight. I’m going to buy the rest tomorrow.” Because that could introduce some regret. So have a plan where you just scale in or out, dollar cost average, whatever it may be. And have a path to implementation.

And lastly, if you want to gamble, if you want to go by Ethereum and short oil, and trade Tesla, whatever you do, take 10% of your portfolio. If you’re a crazy person take 20%. And take the lesson that even if you do well, that was probably because of luck, and gamble away. Blow it up to your heart’s content because people want to do that. But at the core with your real life savings, stuff that matters, you know, think about [inaudible 00:20:02].

The biggest question not a single person ever talks about, no one asks me, “Hey, Meb, you know, how can I optimize my portfolio for fees?” You know, “How can I do things to where I implement this in a low-cost, thoughtful manner.” Partially because that’s not sexy to talk about, like, “Hey, you just go buy a bunch of Vanguard funds.”

Jeff: That reminds me of the article we did…

Meb: Put them away for 20 years.

Jeff: …the article we did with the most dangerous animals. Remember the mosquitoes versus the lions and sharks?

Meb: And, you know, but again, there’s also a lot of undiversified risk people are taking. I think a lot of people still have a couple stock holdings. And I’ll say, “Look, you know, that could work out, you holding that. It could also not work out. And give you examples either way.” Anyway.

And then, of course, there’s the odd Bitcoin, crypto-currency questions. And I say, “Look, I tell you what? You know what? You want to buy crypto, you can buy crypto as a percentage of the world’s market cap. So just throw it in the global market portfolio. I’m cool with that.” And so people, “Okay.” That’s 0.01% or something. Right? So, good. Put in that. The good news is, it goes up a thousand times, good, you’ll own 10%. That’s fine. And if it goes down, you only lost 0.01%.

But anyway, I mean, it’s been very useful and I think…but the good news is, I think most people, like they want to do the right thing. And I think there are a lot of people who are actually really interested in building a good portfolio. I think a lot of people don’t know that they’re their own worst enemy still. And they don’t think in these terms.

So if you’ve done “Office Hours” conversations with me, if you have a portfolio, you know, be honest about yourself, do I do these things? Do I think in binary terms? Am I trying to predict the future? Why am I not implementing what I should be? Do I still own 2% mutual funds? Do I even know what my funds charge? A lot of people have no idea.

Jeff: All right, so Meb, pulling back just as a sort of summation of this entire section, can you add any sort of hardline, real-world implementation strategies for us? How do we do this?

Meb: Yeah. So, for someone who’s implemented it on my own, as well as for over 500 clients, I cannot fathom ever going back to managing my portfolio on my own. And what I mean by that is not that I’m not controlling it, is that having an automated investment plan or automated investment service. Some people call these robo-advisers but the word is morphing enough these days to where, I don’t even care which one you use, you know, whether it’s Vanguard is the largest, number two is Schwab, the two independents. You know, there’s Betterment, and then a lot of the wirehouses are adding them. Pick a low-cost robo-adviser. These all do the same thing, by the way, which is fine. Low cost, global asset allocation, but it just whirs in the background. It places the trades for you, it tax laws harvests. You don’t literally do… And I find myself checking the accounts less…like I don’t even worry, I don’t even think about it. And it’s checks so many of the boxes.

Now, the challenge, of course, will be, will you shoot yourself in the foot when markets go down? Like probably. But at least it gets rid of a lot of the other hassles. And so, of course, the comment I would make the way that we do it in our firm with The Trinity Portfolios. The biggest problem with the buy and hold side is the draw-downs, right?

So 2008, 2009, the draw-downs occur but it coincides…well, I think what a lot of people get wrong is it coincides with recession. So you have a higher chance of losing your job or the economy going down the pooper. You have terrible geopolitical news usually. So the headlines are bad., CNN’s talking about unemployment going up, and the recession, and bad times. So it all kind of hits at once. So it’s not just the damage of your portfolio, it’s also everything at once.

So, what have we done? Well, everyone knows my investment philosophy is trend following. But trend following has its own challenges. And namely, it’s looking different.

So think of this cycle, what’s outperforming the S&P? Well, nothing. So if you do anything, any sort of trend following, and that means a lot of different things. Obviously, managed futures like this year is having a horrible year. But there’s other trend following strategies that are up 15% of the year. So I have a few different types. But the way that we do it, we put The Trinity Portfolios, half in trend following, half in buy-and-hold.

And to me that exists this sort of really nice yin yang, where you have the global asset allocation as an anchor. but you also have this trend-following approach that hopefully, will provide some diversification, and some risk management, and dampen some of the volatility in draw-downs. And on top of that we like to tilts towards value and momentum as well.

So my advice is for all the people we said, “Look, have an investment plan. Write it down. Think about the zero-budget portfolio. A blank piece of paper, write down kind of your ideal portfolio, and implement a launch plan.” So whether that’s three months, or a year, or two years, come up with a way to implement it. And also think about just outsourcing it. So automate investment plan or even a financial adviser. But if you’re gonna do a robo, I think you want to go low cost. I mean, we charge nothing or the platform fee, whatever that may be. And by the way, a lot of these robo-advisers also don’t charge any commissions. Anyway, that’s the simple answer.

Jeff: Rant over.

Meb: Done. What else we got? We got the Q&A?

Jeff: Well, yeah, yeah. But tie into that, so we’re basically looking at the global-market portfolio. And one of the questions that is from a listener which we might as well touch on right now, it’s on global CAPE values, specifically equity values. Might as well hit on it. What do you like right now? I know it’s emerging markets. But beyond that, is there anything specific?

Meb: Jeff, you’ve already managed to violate every…did you listen to anything I just said? Or is this a reader question?

Jeff: Reader question.

Meb: Okay. Well, reader, did you listen to anything I just said? That…

Jeff: Well, just from an a valuation perspective.

Meb: I’m just kidding. The cheapest countries…and we like to average across a number of valuation metrics, so we don’t just use CAPE but we use C-A-P-S, so sales, cash flow. So we use CAPS, CAPFA, AND CAPBA, cyclically [SP] just to price-to-book. We use about four or five of them.

And the averages…is it comes up with a lot of Eastern and emerging Europe. So Czech Republic… By the way, I had a really angry listener that had listened to our talk at Google which was in like 2014, email me the other day to make sure that I was well aware that it is Czech Republic, not Czechoslovakia. And then wrote a half page history lesson. And I said, “Dude, are you giving a speech in front of a ton of people and your waxing and you’re just ranting about something? Sometimes some of these things slip.”

Anyway, I’m well aware it’s Czech Republic. Beautiful country, great beer. Do you know when I was in Czech Republic they had a spa? And they advertised as having…you would take baths in beer. I can’t imagine. That beer’s probably recycled all day, you know. I didn’t do it. I wish I had. It’s just a great like almost Instagram photo because they had faucets…you know, like faucets you’d see in a tub, but beer comes out. Anyway, it was amazing.

Jeff: Meb gets so happy when this beer called Pliny the Elder is available on tap locally. It’s just great beer that’s not marketed, or the marketing is great because it’s not available all the time. Meb gets so happy.

Meb: I think we should do that with our money management company. We just say, “You know what? We’re closing to new investors. We’ll only open it at random times, not tell you. The Trinity Portfolio is only available on certain days of the year.”

What was the question? Okay. So eastern Europe, emerging Europe, the pigs are still in there, though because the performance, a lot of foreign countries have gone up quite a bit over the past two years. Some countries are graduating. Russia is still bargain basement. I think technically Czech Republic is the cheapest, but it only has like 10 stocks in its index. So it’s the equivalent of buying, you know, a mid-cap stock. So that’s not really fair. Brazil, I think, is still in there. We have, let’s see Singapore. I think Turkey.

So we publish this list by the way “The Idea Farm” every quarter. So if you’re not subscriber, check it out. Free trial. Star Capital and Research Affiliates also publish some. And Research Affiliates has a beautiful tool website that lets you look at expected returns, and for all asset classes, and portfolios. They actually did a fun article the other day that was along the lines of the like “Optimal Portfolio Owns No U.S. Stocks.” For that reason, because the valuation…anyway.

But as you think about that as a portion of the global-market portfolio, a lot of the conversations I was having…I always say global-market portfolio is a starting point. And so I give these speeches, I say, “Here’s why market cap weighting is not ideal.”

So, you could tilt towards value. You could tilt towards momentum. But value…if you were to look at the global-market portfolio, the U.S. is half of global market cap and stocks. But I said if you were to weight that GDP, I think the U.S. is only a quarter of global GDP. So if you global-GDP weighted the portfolio, you’ve 75% in foreign which makes more sense because the U.S. is one the most expensive in the world. So it’s better to have a higher percent in foreign.

But you can make the argument of none. No U.S. I don’t think anyone would. But I think you make the argument.

Jeff: Over rotate.

Meb: Yeah. Over rebalance. Over rotate would be…

Jeff: Works both ways.

Meb: That’s like a golf instructor. It would be like, “No, no, Jeff, you’re over-rotating.” So, yes, I mean look, our strategy that does that ETF form is now our largest, by the way. We’re actually going to write a follow-up. We need to get on this. This is going to be my holiday to do, to escape from my family, will be to write 2.0 version of global value. I think that needs an update. What was the question? Where are the best-looking countries?

Jeff: Yeah, CAPE valuations.

Meb: Yeah, and so put some numbers to perspective, U.S. is trading at a CAPE of around 31. We calculate it is the second most expensive country in the world. Foreign developed is around 20, foreign emerging is around 15 or 16. And the cheap bucket, the cheap is 25% is around 12. Now, that’s up from about 9 because the market that’s ripped two years in row, 20% plus back-to-back years.

Jeff: So that 2016 summer pretty much when it turned?

Meb: I think so. I’m trying to remember right now. Is it the 2016 summer or 2015 summer. Twenty-sixteen was a big year for Russia and Brazil, if you remember. And then this year has been a big year for almost anything else. I mean, even the S&P is having a good year, but if you look at particularly all the countries going back to even when we published our book, and remember CAPE didn’t work particularly well in 2014, almost everything lines up in this beautiful manner with valuations. A couple of the outliers, Greece is an outlier, and U.S… Greece is an outlier on the bad side. U.S. is an outlier on the expensive side. But everything else kind of falls into a nice pattern.

Jeff: Anything else on this or move on?

Meb: We can move on. So, like we publish the list. You want to see a list good “Idea Farm” or one of those other websites.

Jeff: While we’re on the topic of CAPE, another question from a listener says, “Do you think it’s possible to construct a CAPE index for other asset classes besides stocks? If so, how and how useful might that be?”

Meb: So, one of Shiller’s best papers was on CAPE, on sectors. So he did sector rotation using CAPE, and we’ll show note this. I can’t remember the name of it. It’s actually a lot of fun because he takes like utilities and the industrials back to the 1920s. And the utilities hit…they were like the internet stock of the day in the 1920s. Or I should say, like the Blockchain of the day, of the 1920s. They hit some absurd CAPE. I can’t remember it was like 40 or 60 or something like that. That was the hot stock.

You think about utilities now, you’re like, “Oh, my God. I won’t even pay like a 10 P/E for those. Why would anyone want a utility?” But it does the sector rotation on stocks. You can download free valuation data from [inaudible 00:32:14] if you want to go test it yourself.

So it works just fine. I mean, but that’s just valuation. I’ve gotten a couple emails. People love to keep sending me emails and tweets about CAPE and why they can’t figure out a way for it to work on the U.S. stock market. And it’s usually almost always they can’t figure out a way to time the U.S. stock market using CAPE.

My first response is always, “Look, I’m happy you can’t find a way to do it. I’m happy we can.” One, I don’t say that because that though, because that sounds kind of rude.

But second is, I always tell them, I say, “Just substitute the word value for CAPE.” You know, just use any value metric, and if you were to do give a speech and use the word “value” instead of using “CAPE,” no one would argue with you. Like, “Oh, this stock is cheap.” You know, I’m a value investor. And, you know, I invest in these companies because they’re cheap based on value. Like people’s brains don’t explode with that. They’re like, “Oh, no, no. I use the CAPE ratio to the stock is cheap or this country’s cheap on the CAPE ratio.” People just go crazy. The same thing with dividends and buybacks.

I try to tell this…I gave a speech were I was like, “You know, by the way, dividends or buybacks are the exact same thing.” I mean, the entire audience jaws are then like, “What is he talking about?” And so you can go and write…It’s really funny, and reporters are particularly bad at this, is they’ll write an article just totally disparaging buybacks. And just crushing them all the way through. And I say, “Go back and replace every instance of buyback with dividends.” They’re like, “Oh, my God. It’s so ridiculous. All these companies are buying back their stock. And they’re just destroying all this money.” I’m like, you never see an article it’s like, “These companies…they’re buying back stock instead of investing in their company.” Right?

How many times have you seen that article? You see it like every day. Jeff’s just nodding his head by the way. I think he’s falling asleep over here.

But have you ever seen an article, “Oh, my God? All these companies have a high-dividend yield, and they’re returning cash to shareholders instead of investing in their own company.” You never see that article.

Jeff: You should write it.

Meb: No, it’s not a good article. It’s just a total misunderstanding of Finance 101. I mean, this is literally freshmen-level investing, and people get it wrong. But I no longer take up these fights. I don’t engage.

Jeff: You gave up.

Meb: So, I gave up on CAPE fighting with people like two years ago. At this point, I only answer with like a shrug emoji.

Jeff: What do you think about, if you look at CAPE a different way, you know, you’re really looking at reversion to the mean in a lot of ways. If you apply that to other asset classes besides just equities like, you know, depending on when we air this we’ll have also aired the episode with Claude Herb [SP] talking about gold, the golden constant. You know, if you believe that gold’s purchasing power remains constant over the years, then there’s basically a set point. And it’s a line that should not increase. It should be static, or it should be equal. Do you think that that applies to gold, to commodities, to other asset classes that there’s also a similar reversion to the mean that you can sort of count on to give you an idea of better or worse buying prices?

Meb: I think the question is, first, does the asset have cash flows? You know, is it a business? Is it a bank? Is it a bond? And if it doesn’t, it gets a lot harder quick. You know, and so commodities, we can go down that rabbit hole if you want. But, you know, the original question of talking about, you know, CAPE to other…again, scratch CAPE and say value. Can you apply value to other sectors or asset classes? I think you can to an extent. And then there’s areas like sovereign bonds. We wrote a paper on this. You know, where we just said, you know, we consider carry or interest rates a value approach to bonds. Is it? Yeah, I mean, kind of. But it’s not quite the same. And so then, I think, something that a lot of people write about, and a number of papers written about this. Analytic wrote a paper about it, I know Cliff Asness wrote a paper about it. Cross asset, and then I think Rebeco…some others…I can try to remember it. Anyway, cross-asset valuation.

So if you were to look at the universe of stocks versus bonds versus real estate versus commodities on a valuation basis and doing rotation like that, I think that’s hard. And I think one of the only ways to do it is to say, “Let’s look at this investment compared to its own history and then weight the portfolio based on that.” So if stocks when the bottom 10 decile valuation you’d overweight and if real estate was in the top decile you would underweight it.

But it’s hard to say, “Hey, stocks have a 5% earning yield, rates have a 6% in bonds yield.” So a lot of people will do this, and they’ll try to make some assumptions, and all of a sudden you add a few assumptions, and it’s totally wonky. I mean, no matter what, it’s betting on mean reversion.

Jeff: Yeah, it also gets, again, challenging you when you don’t have cash-flow oriented assets. I mean, you factor into commodities? You know, what’s to say what’s super-expensive versus not?

Meb: Yeah.

Jeff: All right. Well, let’s stay on valuation sort of while we’re on CAPE and whatnot right now.

Another listener question. Buffett was on CNBC recently opining that stocks were cheap because you have to view them in relation to competing investment opportunities and interest rates are still quite low. It’s my understanding that there are at least two ways to value stocks. First, as you Meb do with ratios, priced, whatever, etc. By that measure, stocks are overvalued. Another way, Buffett’s way, is to evaluate a form of discounted cash flow analysis to ascertain intrinsic value. Real interest rates are still quite low, and I’d love your view as to how these two different methods compare in evaluating how cheap or expensive stocks may be.

Meb: I think they are pretty similar. That’s channelling Charlie Munger, who’s like…I have nothing to add, next.

I mean, most of the valuation stuff ends up in the same place to me. I mean, I think if I had to guess what that person is actually asking…

Jeff: Go ahead, you, real quick. Buffett is saying, according to this guy, Buffett is saying, “Stocks are cheap.”

Meb: No, he’s not saying that.

Jeff: You are not saying stocks are cheap.

Meb: He’s not saying stocks are cheap.

Jeff: Well, I am repeating what the listener has written.

Meb: There is some quote that he said relative to interest rates. Something about, it wasn’t stocks are cheap, it’s…

Jeff: Apparently it’s on a relative basis, stocks are cheap.

Meb: Which has been proven empirically to not be a good model. It’s essentially the Fed model. And there’s… Listeners if you found a good way, and I swear, do not send me some long rambling email that’s just like philosophy on interest rates in equities. If you can find me a model that uses the stock interest rate that works, let me know.

But most of them is simply are interest rates going up or down? It’s not necessarily the level. But this line of thinking is a dead end, in my mind. So I don’t think the level of interest rates…it matters in a minimal amount. The reason it matters is because I think of inflation. So people will pay a higher multiple in stocks when inflation is low. But it doesn’t go infinite. You know, it’s not like some curve that just goes straight up to where if you have 0.1% interest rates you can now pay P of 200. Like that’s totally nonsensical.

So, if you look at the history of inflation and valuations of CAPE even…so historical CAPES are around 16, 17. When inflation is low, the average is around 21. So, yes, it makes sense that when inflation is tame, people will pay a higher multiple on future earnings. But it’s not infinite. Like it doesn’t go to 50.

And meanwhile, by the way, Buffett has a hundred billion in cash right now. So if he thought stocks were cheap, he would have zero and he’d be buying every company. But I think he’s particularly bearish. His favourite indicator’s hitting some of the highest levels ever. The market cap to GDP or GNP. You know, so I think that with Buffett it’s, “Do what I say, or do what I do.” And I think it’s, “Do what I do.” It seems to me like he’s accumulating cash.

Jeff: All right. The last question on value. Not too long ago, Meb was interviewed by Patrick O’Shaughnessy and they did a fantasy football draft of factors. To my surprise, Meb’s first choice was a value measurement and not trend following. That seems strange since Meb always advertises himself as a trend follower first. Why value over trend?

Meb: So, I feel like there’s some famous philosophy or psychology experiment where you’re not supposed to predict like the most beautiful…there are some contest where you predict the most beautiful person, but then it was like the second derivative. It’s like to win the contest, you’re predicting what everyone else would say the most beautiful person is.

Anyway, I will put in the show notes. But so when you’re doing a draft like that…I was trying to also block Patrick from using the stuff that I wanted. So it’s like if you’re Belichick, you know, drafting…

Jeff: This is game theory.

Meb: Yeah, it’s a game theory of trying to draft something before Patrick did to block him because I knew he wasn’t going to go first with momentum or trend. Are you kidding me? No way.

Jeff: All right. Meanwhile, you’re confusing all these people out there who think they know what kind of investor you are. You [crosstalk 00:41:06] on that.

Meb: Well, that was in the rules. The rules was that it was a draft, and I knew Patrick wouldn’t even…

Jeff: By the way, your draft team this year is awful.

Meb: Oh, in football?

Jeff: I’m so happy I’m beating you.

Meb: Yeah. Well, I am self-professed horrific at fantasy. But as all the listeners know, I’ve given you the keys of the kingdom on pick ’em leagues, and we’ve had a bunch of investors by the way, that email us and say, “I use your pick ’em strategy.” Which by the way is nothing more than using contrarian. As long as it’s a controlled group, you just print money. you just clean house. Although, listeners, Jeff has co-opted my model and now takes the same exact bets and tweaks one or two, so he gets the correct direction but just enough volatility that he takes a few of my wins away all season long.

Jeff: I hear a lot of whining going on because frankly, you are now…what? Seventy-five percent down in terms of the overall group. I’m leading the group. I’m winning your bottom quartile.

Meb: I win this week if Carolina wins. Or maybe it’s…

Jeff: You did pick Carolina?

Meb: Maybe I didn’t.

Jeff: All right, this is going off the rails. Let’s refocus.

All right, trend following, we got a couple of questions here. Trend following is primarily a binary thing. You are in if the market is above the 10-month simple moving average and otherwise out. But is it better to be in a market that is trading 10% above the 10-month SMA, rather than a market that’s say only 1% above?

Meb: There’s someone out there that might have better answers to this. I mean, it was a study that I went down the rabbit hole of going into trying to tease out information on that. So it would make sense to say, “Oh, man. Look, S&P is on an uptrend, but it’s 20% above its long-term moving average. Maybe it’s time to pull back or adopt a covered-call approach or buy some puts or something”, you know, and I just could never find anything that particularly worked well. It makes sense, so I’m sure there’s probably something. I just don’t know what it is. And my inquiry dead-ended.

Jeff: I would be curious, steal an idea that you just discussed earlier in this podcast, what if your signal was shorter? Let’s say you’re not way over the 200-day, let’s say you trigger earlier, but then you start scaling in rather than binary, where you just…

Meb: So, wait, wait. And by the way, trend following is not a binary strategy, it’s applying it in binary fashion as a binary strategy. So, if someone applies 200-day moving average, right? And that’s it. You’re in or out, U.S. stocks. That’s a binary approach to trend following. Trend following could also be, “I’m going to use 50-day, 100-day, 200-day, 300-day, and I’m going to scale in, in 20% chunks or 25% chunks. I’m also gonna use 20-day breakouts, and 40-day, and 100-day.” So you could literally be moving in 5% increments across seven different parameters.

Now, the benefit of that is it gives you the average. It gives you, you know, the full spectrum of trend-following returns, short term to long term. And it captures the beta of trend following. It’ll never be the best performer or the worst performer. We talk about you want the broad parameter stability anyway, so the paper update we just did, you know, we showed 10-month moving average out of sample, not the best parameter. Not the best parameter in the end sample either. But it was in the middle. So it’s reasonable.

But the 1987 crash is a great example. I love giving it. Trend following, 200-day moving average or longer, you would have been invested during the crash, lost 20% of the day, 200 moving day or shorter, you would’ve been out. That’s a huge difference. But, if you diversified across four different indicators, you would have been in the middle. So you’d probably lost 10%, but it’s better than 20%.

Now, if you’ve been out, you would have zero on that day and you have been a hero, and managed $100 billion by now. But I would rather be out.

And the same thing is why we use valuation composites. And in all of these trend metrics, we often use multiple measures because being binary is not compensated.

Jeff: At what point though, if you are going with added granularity, I mean, in a real-world practical implementation sense, that gets expensive fast if you have more trades obviously, racking up and trade costs and whatnot…at what point does it become prohibitive to increase your added granularity?

Meb: Yeah, I mean, look, I think you don’t even need to do trend following in general. If you want to do buy and hold fine. You know, if that works for you. If you want to do trend following, you can do it on part of the portfolio. You could do binary. If that works for you, that’s fine. And binary actually works great historically. It’s just some people really struggle with that all and one out.

Now, if you’re an institutional investor, the staging in and out helps with liquidity too. So I don’t really have a strong recommendation either way. For some people, it’s just whatever floats your boat.

Jeff: Okay. All right, let’s hit on bonds real quick. From the listener, “In the typical asset allocation would munis produce more alpha than treasuries? What different risk would that bring in? And, is it worth it?

Meb: This is probably something I’ve changed my mind about over time which is in a taxable account, I think it makes more sense to use munis almost across the board. Like you shouldn’t use treasuries. You should probably just use munis and be done with it. And treasuries you could use in your tax-exempt account.

Jeff: How do you protect yourself against the Flint Michigan’s of the world? By the way, I haven’t followed it in a while. I have no idea [crosstalk 00:46:39].

Meb: I just think use the broad indexes. I think the broad indexes are probably fine.

Jeff: Okay. All right. So, yeah, you like it.

Meb: It’s a good thing there’s not a Puerto Rican, muni ETF, or is a bad thing? Probably a lot more price discovery. So when Trump tweets that the debt…what did he say? He said, “The debt’s gonna to have to be written off.” Or something, “Which is a shame.” You know, it opened up down like 20 points, 20%.

Jeff: Anything more on munis? You good?

Meb: No, that’s it.

Jeff: Okay. Commodities, “Meb, how do you recommend getting exposure to commodities? Aside from the physical metals like gold and silver, it’s hard to get good exposure because most of the ETFs invest in the futures which get hurt by contract rolls. So not only are you paying an expense fee for the ETF, you’re also paddling upstream with the negative effects of the roll.” What’s the answer?

Meb: So we talk a little bit about this on the “Herb” [SP] Podcast, which may or may not be before or after this one, but commodities are unique. So, you can’t really invest in spot with the exception of say gold, you know, or things you can store. You can’t invest in oil. You can’t keep a barrel of oil in your house. So the way that most people do it is through the financialization which is the futures, okay? So you buy a basket, let’s say these two big papers came out in mid-2000s, talked about commodities, everyone rushed into commodities. Then they’ve just got destroyed the last 10 years. And now everyone hates them.

Now, I love them. I love them. But, I like them from kind of three different standpoints. I like them long only. I like them long-short, so managed futures, which is that trend following. And I like them as actual the companies producing them. So like farmland, for example, producing wheat. And all three are different. It’s almost a “Green Eggs and Ham.” I like them long. I like them long-short. I like them in the farmland.

So let’s talk about it, but they’re harder. So long only, for example, you have to use futures. And by the way, the write-in question was wrong. Roll is not guaranteed to be a cost, it could be a benefit. So roll yield, listeners, commodity returns you get collateral. So say in a portfolio, 100 bucks, $90 of that sits in collateral which is 10-year Treasury bonds. So that historically has yielded like 5%, now it yields 2%. So there is a difference already right there.

Second, you then invest in all these future contracts, you buy some gold. You buy some oil. You buy some whatever. But the funny thing is, the academic evidence if you’re purely evidence-based, you could come to two totally different conclusions. You could come to, “It’s stupid to invest in commodities.” Or, “It’s great to invest in commodities that give you stock-like returns with uncorrelated risk.” And it depends on how you weight them. So the Goldman Sachs Commodity Index, 80% in energy. You might as well just buy oil. Dow Jones, CRB, different ones are weighted differently. And commodities in general, have basically zero real return, they kind of keep up with inflation. But because they bounce around a lot, depending on how you rebalance them, you get a benefit from that mean reversion.

On top of that, the roll yields, the commodities, the price you pay for a commodity, a future today, and then the future goes out every three months for the next couple of years and depending on the price of the futures, the curve could either be in backwardation or contango. And depending on which type the curve is in, by buying that future and letting it roll down or up, that could either be a headwind or tailwind. Historically, it had been…and for many it’s a tailwind, but since the kind of global financial crisis of 2007, it’s been a headwind. And so you can’t guarantee.

But however…so the first generation indexes were kind of down. They just did the first-month roll and everyone was picking them off. There’s been paper estimates that cost 3% or 4% a year to index commodities if you’re explaining how you’re doing the rolling because these people just pick you off.

So, you could have a more intelligent roll system. So you’re picking the different roll dates, and you’re betting on the ones that have the most favourable role. You could be shorting the ones, or avoiding ones that have the worst. And so and on top of that, you could add momentum on. So there’s a lot of factors in commodities too.

And so if you look at the different type of commodity funds, ideally you want the ones that have the kind of 2.0 structure. That’s just for long only. See? I told you, by the way, commodities are hard.

Jeff: This reminds me of Emil Van Essen when he talked about how they would jump the roll dates. Make a lot of money.

Meb: Yeah, so exactly. I think long-short works particularly good in commodities through trend following. So, I think that’s a great way. But that’s traditionally just managed futures, okay? Both of those are excuses to pay a lot in fees. So you want to try to find the providers that have lower fees for these offerings.

And, what was the last one? Oh, yeah. So the last one, by the way, the global market portfolio we talked earlier about farmland. Farmland has been one of the best investment out there for as long as it has existed, okay? You get price appreciation on the farm. Same way as you would a house. Keeps up with inflation. Plus you get the yield. And historically, that’s been equity-like.

Jeff: Yeah, but how do you access that?

Meb: This is the problem. So farmland is one of the hardest, and I’d put single-family homes kind of in that bucket, until the past few years, there was a lot more REITs that have come out.

Jeff: Yeah, Silver Bay.

Meb: Yeah. In the past few years that are single-family home expose. A commercial real estate you can get exposure through public re-marketplace. Single-family homes have been harder, but that’s probably one of the large asset classes of the world, 100 trillion at least, if not 200. Real estate in general. And then farmland, it’s almost impossible. There’s like two REITs that do it in the U.S. I think it’s a huge opportunity. I don’t know why more don’t launch farmland REITs.

Jeff: But there is a problem with it, so like…

Meb: But it’s all private. So it’s private funds do it. So Calipers [SP] will go buy a bunch of farmland. And the beauty would be if you could diversify, you buy blueberry crops and coffee and wheat and corn and everything. Like I would love… And by the way, this is coming from someone who has the vast majority of their, you know, investment portfolio in farmland, right?

In the probably the world’s least profitable farm on the planet.

Jeff: But isn’t there a fundamental issue with that? So I’m thinking right now of was it like Plum Creek? They’re timber, right? Let’s just say there’s more and more traditional farmland ETFs. But by the basic fact that it’s an ETF, that’s gonna change the complexion of the investment.

Meb: No. Because if someone owns it already and if farmland is 20 trillion, you know, I mean, ETFs is a drop in the bucket, right? Or a REIT.

Jeff: The concern though is you own a farm.

Meb: The big money that buys the farm…

Jeff: You have no liquidity on your farm investment, is basically right now, you can save… There’s also very little price discovery. So you, in a sense, are protected from your own bad behaviour. If you buy something with a click of a mouse, then all of a sudden, it’s going to trade for more like an equity versus its traditional complexion.

Meb: Oh there’s no question. So one of the biggest problems with a lot of the commodity producers…and so by the way, there are plenty, I mean, there’s an entire energy complex, oil, gold, right? Canadian listeners, Utah, just perked up, South Africa. I mean, there’s plenty of commodity producers that trade as equities. It’s just not traditional farm. So it’s a lot of the metals and energy producing. So they’re already in the indexes.

And, yes, they do trade like equities. They have equity…way higher than equity volatility often. They have a high attachment to their own commodity and rules, but in general, yes, they move with the equity market. But the big money that’s moving in and out of the farmland…and by the way, this is also one of the reasons that farmland appreciated so much in the past 15 years minus the last 2, is I think it’s the best performing asset class across the board since 2000, is because a lot of institutions were moving in and pushing prices up. Because it’s uncorrelated yield. Anyway, I just wish there was more options out there. Same as some other asset classes.

Jeff: Okay. All right, let’s do two quick ones on factors and then we’ll call it a day here. All right, let’s see here, “As factors, investing has picked up popularity in the mainstream, I see a lot of multi-factor investments out there that focus on factors like value, momentum, quality and low volatility. Rationally I understand why investor behaviour would cause factors like value, momentum, quality to perform well, but why low volatility? The low-vol factor to me seems to be when I hear mixed messages on in terms of its validity and sustainability as an outperforming factor.

Meb: I mean, it’s funny. If you go back to the original finance theory it was the beta, you know, the higher volatility, the higher returns and vice versa which turned out to be correct. But with the wrong sign, 180 degrees the wrong way. It turned out to be low volatility was much better.

And there is actually a professor Houghan [SP], who had passed away a few years ago, lived in Durango, who wrote a lot of great factor books way before it came mainstream. And we’ll link to some of them. Fantastic books. But he was one of the pioneers. Doesn’t get a lot of acknowledgements, I don’t think, in the marketplace.

But, yes. So you actually wanted to invest in lower volatility and avoid the high volatility. The problem is that’s now well recognized and a ton of money has flowed into low-vol to where it’s now in many cases expensive. You know, same for high dividends, right? Like, so this is what…there’s been this battle last couple years of research affiliates talking a lot about it. They have this awesome tool on the website that shows you historical factors like value, momentum, quality, low-vol whatever. And their current valuation relative to history.

And I really want to believe it’s possible to adapt your factors and change them or get exposures than just leave them static. But a lot of people disagree. We don’t do any of that yet currently. But, so, yes, low volatility historically but it’s an example of flows changing factors. And that applies everywhere. It applies to currency baskets, it applies with real estate, it applies with farmland. Enough money goes in and it changes. The example we always give is a swarm of bees, like alpha for example, like it changes over time, it moves. But still there in some formats.

So, yeah, low-vol in general, would I rather have lower volatility than higher volatility? Probably, but you should become agnostic and just adjust for the volatility, I think. Go anywhere.

Jeff: Back to this guy’s question, value, momentum, quality, low-vol, do you sort of treat them like commodities, they’re all the same and just invest based upon their relative valuation?

Meb: No, well, I mean, if you try to be factor agnostic, I mean, do you still want the ones that pass the kind of a sixth-grader test. What’s the quiz? Are you smarter…?

Jeff: Smarter than a fifth grader.

Meb: Fifth grader. Where you could explain it to them. Value, you can explain. Momentum gets a little harder. Volatility kind of makes sense, but I don’t know why that it would be sustainable in a world that knows about it. By the way, what percent of the time when you say…? You know, back to the question, if I just don’t answer the question at all, I mean like half the time I don’t even talk about the question. So this one, yeah.

So the correct answer I think, is we don’t use volatility as a factor at all in stock selection. We use it for portfolio sizing. You know, if you have an instrument that’s way more volatile often you, I mean, and that goes back to the turtles, Gerry Parker, one of my favourite podcast interviews, where I learned to stop interrupting people, I still do it, but…

Jeff: We should get back him back on.

Meb: We should. He’s great. Yeah. That’s it.

Jeff: All right, the last question. “Is your recent white paper that disparages dividend investing going to have any effect on…?”

Meb: “Disparage” is such a strong word.

Jeff: Right… “That calls into question your dividend investing thoughts. Is it going to have any effect on your shareholder yield strategy? If dividends are so bad, would shareholder yield be improved by excluding dividends from its selection process?”

Meb: I love… So there’s been a couple of other people that have carried the torch. Larry Suedro for example, wrote an article about our strategy. So I’m letting him take all the arrows now. He probably hates, disparages dividends. I won’t speak for Larry, he’s great. Also another good podcast.

Jeff: Mm-hmm. Good guy.

Meb: But I think he’s honest about the focus on dividends is a misplaced.

So, the question is, a shareholder yield approach which is targeting total cash disbursements, right? Is that also fall under the lens of being tax inefficient? Well, it turns down the U.S., shareholder yields screen is going to generate a pretty low dividend. And the reason being… So think right now if you do a shareholder yield screen on that portfolio, you’ll probably get about a 2% dividend yield and a let’s call it 6% buyback yield.

So the buyback yields swamp’s the equation. You know, that’s the thing that is the big delta. It’s the big muscle movement, right?

Jeff: Is that standard just for the way the fund is constructed overall?

Meb: We’re going to talk about our fund, we’re going to talk about the shareholder yield strategy.

Jeff: That’s right.

Meb: The strategy…a shareholder yield strategy. Yes, it screens for dividends and buybacks. Although I did see a competitor is now launching a dividend and buyback fund. And I said by the way, any dividend or buyback or shareholder yield strategy that does not use a valuation filter is crazy. This is the whole point. You don’t want expensive high-yielding dividend stocks. You don’t want expensive stock. You really don’t want expensive stocks that are buying back their stock. That’s a huge destruction of value. And in the same thing, you don’t want a shareholder yield because companies are expensive.

So you have to use valuation. You just either use valuation first. So screen for cheap companies that then have all these characteristics or you do it after it. You take the high shareholder yield and take out all the expensive ones. You end up in the same place. But shareholder yield historically correlates very highly with price to free cash flow. Because companies that can buy back a bunch of stock and pay out dividends have to have money to do it, right? So they have to have cash flows in the first place.

But in foreign markets often in the shareholder yield, equation is flipped because they still have a history, a culture of wanting to pay dividends rather than buybacks. It’s changing. Has changed a lot in the last 10 years. So they often have higher dividends.

But we did a paper on this where we looked at our funds but compared shareholder yields as one of the lowest yielding. So that’s good. It’s efficient. Because I think CEOs get a bad rap, but they’re no dummies. I think it’s a lot more tax efficient to buy back stock than it is to pay out dividends.

But, if you were to do some sort of optimized value fund versus shareholder yield, which would be better in a taxable account? I’m not sure I know the answer. I would think that the tax optimized. But shareholder yield, I think will thump any dividend strategy in the next 10 years. Any one. All of them.

Jeff: Especially, if you’re adding, you know, the valuation component, super low value ahead of time, then it seems as though you would be closer to a low hurdle in terms of the opportunity cost of what to do with the money in terms of a dividend versus buying back at prices that are way too high.

Meb: And by the way, in the paper, I mean, you and I talked about this, and I’ve talked about it with a lot of people, we didn’t feel the need to include it. But I think it’s accurate is it behaviourally speaking if you…so the paper by the way, which we haven’t described, was that you had U.S. stocks and then dividend stocks have historically outperformed S&P 500, 1% or 2% a year. But after tax they underperform. Because you got to pay taxes on this dividends every year. And then we said, “Okay, well, what are dividends actually doing?” Well, it’s a value approach. Why not just use value and then screen out the high dividend yielders? And before and after-tax basis value beats everything. Okay?

Listeners, Jeff’s nodding his head. Didn’t have to explain to you co-wrote the paper.

But one of things we didn’t, I think elucidate correctly, was that, look, you should never own dividends in a taxable account, basically, high dividends. Particularly if you’re a high-net-worth investor with a high tax rate. You’re shooting yourself in the foot. Put them in a tax-exempt account. The one response I got from people, that I agree with, is, “No, no, Meb. But I need income in retirement, and I spend my income. And it keeps me knowing in a bear market that I have companies that pay dividends.” And if it keeps you from behaving better, it’s worth its weight in gold. Like, “Fine I don’t care what you do. Anything is better that keeps you from behaving versus not behaving.”

So I think it’s totally fine for people to like high-dividend stocks. Again, I think they’re expensive now. I think it’s tax inefficient. But if you like them, great. Like I’m not hating on dividend stocks. There’s plenty worse thing to do. It’s worse to invest in non-dividend paying stocks. They’re expensive. That’s a horrible investment strategy. But the big lever in my mind is value.

Jeff: Well, it sort of ties back to what you were saying at the beginning, have a plan, stick with it, you know, if you’re bopping all around and… You know, if you like dividends and you’re going to do that over the long term. All right, I’m sure you probably won’t yell too much.

Meb: But is it getting really bright in here? Or am I just like getting delirious for talking for last hour?

Jeff: It’s you getting delirious, for sure. It’s normal light.

Meb: I took my 10-year-old niece surfing this morning. She’d never been. Only person on the entire beach not wearing a wetsuit. She’s from Colorado. She’s like, “It’s hot out here.”

Jeff: By the way…

Meb: There’s literally people in Manhattan Beach wearing parkas.

Jeff: By the way, it’s sort of the idea of Meb as a the surfer…

Meb: This is a little [crosstalk 01:04:24] by the way.

Jeff: I’ve yet to see you surf.

Meb: I can’t surf. I’m terrible.

Jeff: I think you are cultivating this surfer image, I’m not…

Meb: I am a terrible, I am an awful surfer. That is very self-aware about that. My favourite board is a Wave Storm. If your favourite board is made out of foam, foam soft top, then you’re probably not a great surfer. I really want to go to the surf park in Texas. Kelly Slater, they have a…

Jeff: Oh, the man-made wave.

Meb: I think his is a separate, but there’s a man-made wave there that looks really fun. Cambria off-site. Austin, Texas, you find a reason for us to come give a speech. We’ll come and do a corporate off-site at that surf park.

Jeff: All right. We are done with questions. Do you want to revisit your travel plans coming up?

Meb: I don’t know, I mean, yeah, I mean, I’m going to be in Amsterdam, be in Switzerland, will be in Nicaragua, Colorado. Colorado’s big ones. So if you’re Colorado come say “Hi.” Other than that will be in L.A. Holding court in L.A. Is that it?

Jeff: That’s all we got.

Meb: All right, listeners, it’s been a lot of fun for a long rambling episode. We get a lot of fun guests coming up. We may start doing these radio shows because we need to keep the lines open. You guys miss Jeff. I feel bad depriving you of too much Jeff. Anyway, shooting questions. We’re depleting the question bank. So, you all fire some in, feedback@themebfabershow.com. Got any ideas for us? You could always find the show notes.

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