Transcript of The Value Perspective Podcast episode – Meb Faber

04/04/2022

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

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Juan Torres Rodriguez (JTR), April 2022

JTR: Meb Faber, welcome to The Value Perspective podcast. It’s a pleasure to have you here.

MF: Great to be here, my friend. Thanks for having me.

JTR: I’m a little bit nervous because you are a legend of podcasting. How long have you been podcasting yourself?

MF: Legend at this point just means you have been doing it for a long time! So you are saying I am old – but I’ll take the compliment! Man, what are we – 400 episodes in now? It feels like an eternity ... maybe five years would be my guess. It is a lot of fun, though, as you know.

JTR: You must have been one of the very first finance podcasts to go live. Where did the idea come from?

MF: I mean, if you take the Wayback Machine, we used to do things like academic papers and books and blogs and then that became Twitter and podcasts. And pretty soon, you and I are going to be talking on TikTok or maybe holograms or whatever it may be. But we love putting out investing research and ideas and connecting with people all over the world.

You are in London – in a pub right now, it looks like! – and I am in Los Angeles. Where else could we do this? But it is a lot of fun because you put research out these days and there is no better place than the internet – or blasting it out into people’s ears and brain. It used to take about six months to get feedback on academic papers – now you get it within 30 seconds on how big of an idiot you are. So it is a very quick feedback cycle versus 10 or 20 years ago.

JTR: I can’t wait to hear you sing about CAPEs on TikTok!

MF: I don’t have any good dance moves so I will disappoint!

JTR: We are good fans of the show and, I have to say, I recently read one of the best books in my life, which was a recommendation by one of your guests in your show. So I am going to thank you in advance for that. The book is Ship of Gold – do you know the one I am talking about? It was absolutely fantastic. You are also an author and you have written how many books now – three, four ...?

MF: Written five, edited two and I am sad to say – you are actually the first person to ever hear this – I am almost done with a new one. Every time I write one, I swear on anything that I will never do another book again. But here we are. I can’t help myself, I don’t want to do it – and then it just it happens at some point. I just don’t want to write books – until I have to and they just come out of me. It is a labour of love – but we have got five.

JTR: Can we have a snapshot of the topic of the new book?

MF: Yeah. One of the topics we spend a lot of time with is the struggle of the income and wealth gap all around the world. I talk a lot about it in the US and trying to think how to alleviate that. Traditional politicians either come at it where they want to bring the top down – through taxes and other measures – and that is always tough to me because I want to celebrate the world’s greatest scientists and engineers, not demonise them, which often happens in the media. Or they want to bring the bottom up.

And I think you can do both through a lot of ideas and policy – and we wrote a blog post called How to Narrow the Wealth and Income Gap. But, from my tiny corner of the world, one of the ways I want to do it is to try to help everyone become an investor – everyone on the planet. And the huge takeaway from that is – you just have to be an owner. We see this play out over generations where this power of compounding ... we try to drill it into everyone’s head – just look, if you do 10% a year and give it 25 or 50 or 100 years, you make an enormous amount of money.

But the challenge is always getting people started and so the book we are putting together ... the title may change but, essentially, it is called Be the Owner. And we are trying to meet people where they are. In this case, we are demonstrating how a lot of celebrities and athletes made real money – so Michael Jordan but also Rihanna, George Clooney ... it was not their career but rather their business where they made all their money. But then also a lot of regular Joes – on how they made money just by saving and investing. Anyway, it will hopefully be a fun book and be out sometime in 2029, I imagine! But we are, I promise, trying to sabbatical this summer and get that done.

JTR: I have just realised I started asking a lot of questions about your podcast and your books but I did not give you the opportunity to introduce yourself. So, for those who do not know you, who is Meb Faber?

MF: Yeah, so my day job is in the investing world – I am a quant. We manage 12 ETFs – public funds – here in Los Angeles, California. They are quant-ish, which just means they are rules based but they focus on very niche strategies to very broad strategies. We manage almost $1.5bn in assets under management for around 100,000 investors all around the world. I am a fairly poor surfer and a great skier – and, like you said, put out a lot of content and try my best to behave on Twitter and elsewhere.

JTR: How did someone who was born in Virginia – I hope I am correct in saying that – end up living in in LA?

MF: Man, there are even a few more stops. I was actually a Colorado native, went to University in Virginia – so you caught that – I was actually an engineer, a biomedical guy, and graduated at the peak of my favourite investing bubble, the internet bubble in 2000. It was also a ‘double bubble’, if you remember back then – it was not just the dotcom names but biotech had a bubble as well. And that was my background and my hobby somewhat became my career.

I was in grad school and, while working at a biotech mutual fund, I was scratching my head as all the stocks proceeded to decline – I don’t know – 60%, 80%, 90%, 100% during that bubble! And then kept gravitating more and more towards the quantitative side of the business and further away from biotech. I started Cambria, I believe, in 2006, started launching ETFs in 2013 and here we are in 2022 – still surviving. Not just for investors but entrepreneurs alike, the biggest compliment you can give anyone is just ‘still surviving’. So we are still here.

JTR: That’s fantastic. Correct me if I’m wrong but I think you and I have something in common and that is a favourite investor. He is someone people tend not to refer to that much in the industry because he is not that well known outside of value investing circles but I am a huge fan of Seth Klarman. He is the reason why I became a deep value investor in the first place – and I think you have made reference to him in the past.

MF: That is great but I’m sorry – value investor is somewhat of an affliction! It is a very odd sort of personality trait ... Warren Buffett talks about whether you are inoculated at birth with a certain concept. I am even more of an outlier because one half of my brain is value investing and the other half is trend-following, which means they are often at odds with each other. My favourite is when they sort of overlap but that tends to be pretty rare.

We certainly love following Seth – in particular, because of his writings – but I love the value or stock investors where you look at their portfolio and the names are unique. You know, it is not as interesting to me to see the ‘hedge fund hotel names’ where 75 hedge funds own them. I like the ones where I look at their positions and say, man, I’ve never even heard of that company before – let me dig in. So he is certainly on the Mount Rushmore of value investors.

JTR: So this is a podcast that aims to understand how people make decisions under uncertainty – trying to improve ourselves as investors and human beings and to be better over time at making decisions. I don’t think we have ever asked this question before but I guess, this time, with what is happening in the world – and we are recording this 11 days into Russia’s invasion of in Ukraine – it is more important than ever. So I am going to ask the question – what is the best way for investors to make decisions when faced with so much uncertainty?

MF: Well, there will be a day – maybe it will be me, just to tease the host – but I have certainly never heard anyone yet go on CNBC and say, you know what, here is my thesis: these are just certain markets. You know, these certain times – it seems so clear, right? Like, the default base case is uncertainty. That is the world we live in – not just investing, but everything we deal with on a daily basis – and I think, once we learn to embrace that, it becomes more a question of expectations.

So there are two things you can do. You can study a ton of history and that at least gives you a framework to base some decisions around and say, oh, OK, I realise that normal stockmarket returns are extreme, for example. Everyone expects10% returns in the stockmarket – except Schroders. You guys – this triggered me more than anything in the past couple years as you do your global surveys and the US investors said they expected 16% returns, two years ago, and last year I think it was 17% or something, which just made me almost fall out of my seat.

But if you look back in history, you get an understanding or a framework, with which to think about the world. So you can say, OK, I understand stocks historically have done 8% to 10% – however, that is pretty rare and, two-thirds of the time, they are outside of that zero to 10% range. They are down 10%, up 30%, flat, minus – on and on. And so embracing that uncertainty is the norm.

But, on top of that, it is not just stocks – you can look at the outliers on every side. And so, if you look at the history of stockmarkets in general ... look at what has happened in Russia this past week. Certainly, that has surprised a lot of people but you say, look, the Russian stockmarket closed down in 1917 during the Bolshevik Revolution. That was it – it went to zero.

But plenty of other markets ... they may not have closed down but they go nowhere for decades or, essentially, for most investors, they have the experience of almost shutting down, where they lose 80%. And that has happened in the US, too. And then most of my British friends ... I was over in the pubs pre-pandemic, when everyone was talking about the ‘topic de jour’, which was Brexit, and I said, you know, I think the UK stockmarket is cheap. They would just groan and say, man, are you crazy? This is a horrible [situation].

So history giving you this guide of what can happen, I think, serves as a good framework for a guaranteed uncertain future. Now, it ends up looking a lot like blackjack or any game of probability and statistics, where are there the most likely outcomes? Yes. And then be prepared for the outliers on both sides. But it gives you, more than anything, a framework for both what can happen and expectations about what is most likely to happen – and then that leads to portfolio design and how to think about the future.

We end up with a lot more non-consensus views on this topic than many but I think the biggest fractures come when people have expectations that are not met or grounded in reality and something comes along and upsets that. That is when people really, really, really make the bad decisions, which almost always or universally are emotional in nature.

JTR: You are a quant investor, as you mentioned at the beginning of our chat – and I think you are actually the first pure quant investor we have had on the show. So I should ask: how does having a quant mindset help you make better decisions as an investor? Do the quant aspects of your process allow you to block of some the human behaviours that makes us prone to mistakes?

MF: So when I say ‘quant’ – you know, it is like describing the average dog right? A beagle looks totally different than a Great Dane which looks different than a bulldog and so on. And so some quants are super-high-frequency traders but all it means for me to be a quant is to be rules-based and we love to ask investors –and if you are listening to this, you can answer your head or write it down –  do you have a written investing plan? And the vast majority people do not.

But it does not have to be complicated. It does not have to be a 10-page policy portfolio document – it could be three bullet points on how you have a 60/40 portfolio rebalanced once a year and that’s it, you know. But the reality is, many people do not – even professionals. You talk to a lot of professionals and they put a tonne of time into a buy or sell decision. Is gold cheap? What about inflation? What is the Fed doing? Are US stocks an opportunity? What about commodities?

On and on ... but they almost never institute a sell discipline at the time they make the buy decision – they just sort of wing it with ‘I am going to buy this and see how it goes’. And, as we know, all sorts of psychology creeps in – if anyone does not believe me, walk into your garage and see all the junk that’s there and ask yourself, would I go buy all this junk, if I did not own it today? Of course not – you would never buy any of that stuff in the garage.

It is the same thing with a portfolio – people have an attachment to something that is totally different once they buy it than prior to owning it. So having these rules about how to put together an investing portfolio and process is extremely important. Nobody does it but it is a great first step because, when you have environments like you do now, you say, OK, what am I going to do if interest rates ... I mean, just look at the past 10 years. I don’t know about you but, when I was an undergrad, they weren’t teaching me about negative interest rates. They weren’t teaching me about what happens when oil futures go to minus 30.

All these outlier things that happen – if you do not have a basic framework for how to think about a portfolio, it outs you at a huge disadvantage because what happens? You wake up and you see an invasion or a pandemic or wheat being marked up at $14 a bushel, and then you have to react emotionally – your stock is up or your stock is down. So it is not just the downside, by the way – it is also when you have outlier outcomes to the upside.

You have a stock that goes up 10x – what do you do? In many cases, if someone has a stock that doubles, they sell it – oh my god, amazing, I just doubled my money! They are thinking about the vacation they are going on, they are thinking about the car they are going to buy but that 2x is often the first step on the way for a stock to go 5x or 10x or even a 100-bagger – you know, a life-changing amount of wealth.

Most people would sell too soon for reasons they may look back on [and regret] – you know, a good example, of course, is Apple or Amazon. Apple has had, I think, a 75% decline in every decade of their existence and here we are at a $2 trillion market cap or more. So I think having a very basic written plan ... it is like a diet, you know – if you do not have something down on paper, you are probably not going to stick to it.

JTR: You get asked a lot – or you comment a lot about home-country bias. It is an interesting topic but, when we talk about different biases on this podcast, people have never mentioned it. So I want to ask you – what is home-country bias, why do most investors suffer from it and what can they do to counter it, especially at times like the ones we are living in?

MF: Home-country bias is a very simple concept – that most people invest most of their money in their own stockmarket. So, for me, the US is only about 60% of the world’s total stocks but the average US investor puts 80% of their stock allocation in the US. Now, that is a huge active overweight – and maybe you are OK with it – but the reality is, you at least need to be aware of it.

It is even more problematic for most of the countries around the world, where they may only be 3% of the world’s market cap but domestic investors still put 90% or 95% in their own stockmarket. We tweeted out a recent statistic that showed the average Russian had 95% of their stock investments in the Russian stockmarket

If you look at the history of research – we have a summary article called The Case for Global Investing – an equal-weighted or GDP-weighted or index-weighted global portfolio almost universally beats any single country. It is just a risk that’s not compensated for across time. Now, there are periods ... if you talk to the average American today, they would be really happy that they were overweight the US for the past decade because it stomped everything else. But if you look at the decade prior – from when I graduated university through the financial crisis – the US is one of the worst-performing markets. Then, before that, you had the US outperform in the 1990s – but, before that, you have to go all the way back to the 1910s.

People love to extrapolate the recent history of what is going on into the indefinite future. You are Colombian – I was down in Bogota years ago, when the stockmarket was ripping and roaring. I gave a speech and I said, look, I love this country – the people are super nice, the food is amazing it is gorgeous ... however, your stockmarket is really expensive.

This was maybe in 2014 and the responses I got were, Meb, you just don’t understand, we are putting X amount of money into the market each month from the pension funds, they are flush because of oil ... whatever it was – the things people say when markets are at all-time highs and the market has done well. Contrast that with probably now, if you were to give that talk – I haven’t been invited back so maybe you can help me out here!

But I also gave talks in many places in Eastern Europe, when their countries were super-cheap – and we are finding them again here today in the same situation – and the opposite was true: no-one was interested. And they would say, Meb, obviously, our stockmarket is cheap – we know that because it is down 80%. The problem is, we don’t have any money, right?

You find these things rinse-repeat over and over again and the reality is ... take the US as an example. The PE ratio – we like to use the 10-year price/earnings ratio or Cape Shiller ratio but it really does not matter – has traded as low as 5x and as high as 45x. There are other countries in the world, like Japan, that have got darn near 100x. So you have these investments that people love to chase and, I think, a great quote on this is ‘People love to buy what they wish they had bought’.

And so you are starting to see people clamour into commodities again – for the first time in forever. Commodities was a very trendy allocation post-2000 bubble – all the institutions bought some and then they have all sold it over the past five years because it had 10 years of terrible returns ... and then here we are, again.

So one of the challenges, we often say, is it is really hard to be ‘asset class agnostic’ – and, to circle back to the beginning of this question, this applies to your own country. Like, I am a Denver Broncos fan so it would be really hard for me to cheer for the Raiders but, when it comes to investing, you have to diversify globally and also with asset classes – not just stocks but bonds, commodities, real assets – and realise every asset and every country has its moment in the sun and moment in the shade.

JTR: It is interesting what you said about the Colombian market back in 2014 because, every time you make a reference on Twitter that X or Y is expensive, it seems people get super-hyped and actively pushing against the argument – actually even offended sometimes.

MF: Everyone is always offended on Twitter – that is kind of table stakes for social media, right? But that more than anything, I think, is true. When people are in an investment that is doing well, no-one wants to be told the party is ending. If I come and see you guys in London and we go get a few pints, you are probably going to have to drag me out – you know, I don’t want to go home. When the good times are happening, people don’t want some wet blanket saying hey, the odds now are not favourable to your investment.

I think this is very much the case in the US – market cap-weighted. You know, they craziness seems to have peaked last year – last February – but the market cap weight has continued to go up and we will see if it has peaked or not, for this cycle, in the last couple months. But it got to a PE ratio of 40x, which historically has portended the next decade of no returns on a real basis. So I think that would be my expectation – that you would have no returns in the US stockmarket for the next decade.

I think there are opportunities within value and other ideas but the broad market cap weight – if you look at all the coincident indicators and there are like seven. It was like the Schroders’ high sentiment; you had people trading risky options; meme stocks; all of the Robin Hood crowd; you had unrealistic expectations; you had high valuations and the final ‘boss’ that we would always say was the trend. When the trend rolls over, you go from yellow to red light – and here we are now because the trend is finally negative.

JTR: Why do you have a preference for the cyclically-adjusted price /earnings or ‘CAPE’ ratio? We had better define the idea first – but why do you find it so powerful?

MF: I actually don’t have a preference for the CAPE ratio – I just like to talk about it because it is simple. But what is it? Professor Robert Shiller, who is now a Nobel laureate, came up with a way to say, look, the markets are noisy so let’s try to take a step back and look at a market on a macro level on a long-term time horizon. Everyone says they have a long-term time horizon but they really don’t – and we could come back to that – but Shiller said, I am going to takes 10 years of earnings, adjusted for inflation, and look at the price/earnings ratio on this metric.

And he goes back to the 1800s – you can do it for sectors, you can do it for countries. You can find a lot of free resources today and we were the first ones, to my knowledge, to do a tracker for 45 countries around the world.

I am of the belief that your valuation metric does not matter. When you have a country that is super-expensive and in a bubble, every valuation metric will say the same thing. And it is my belief with the US market ... every single valuation metric says US stocks are expensive – you cannot find one that says they are cheap. And, on the flipside, when a market is really cheap, it does not matter which one you use – they all say the same thing. That is my belief.

So we use CAPE as a shorthand but, when we published our book a long time ago, we said you could use dividend yield. And then you come up with a darn near similar conclusion, which is you are simply using a metric for value and, historically speaking, if you sort based on any metric of value, it does better than not. Now it is not like 6% outperformance – 1% or 2% usually, I think, is a reasonable expectation. But the muscle movement there is not just that you are investing in the cheap stuff – it is all well and good you are investing in the cheap stuff – but it is also that you are avoiding the ‘stupid expensive’.

So, back in 2007, everyone was clamouring for the ‘BRIC’ economies, right? Indian and China had PE ratios in the 40s and 50s and 60s – total bubble territory, totally crazy, higher than the US has ever been – and then they had no returns for a decade. Japan, we mentioned, was the granddaddy – it was the biggest stockmarket in the world at that time, not some backwater economy. And it is still one of the top economies in the world.

In the 1980s, it got to a 10-year PE ratio of almost 100x – ad it has had no returns for decades since. So I think it is a simple indicator or heuristic to use but, if you use almost any valuation metric, you will sort of end up in the right galaxy, which is the way to think about valuation. It is nothing you are going to be measuring to the right of the decimal place.

JTR: We are recording this, as I mentioned, 11 days into Russia’s invasion of Ukraine, which is a terrible tragedy. Just sticking to the investment side of things and process over outcome, you have made the point in the past that people should allocate to emerging markets if they are looking attractive on whatever valuation metric they want to choose. Russia is one of those places that has gone through three or four different crises over the course of the last 20 years and there was always a lot of panic as valuations took a hit and went down to levels that, if you were brave enough and bought at those times, you would have made a compounded return that was very high in dollar terms. So having allocated capital to Russia in itself should not be seen as a mistake – despite what has happened over the last 11 days, given the probabilities and the balance of risk and reward, it could have been seen as a smart decision. Do you think this is the right conclusion to draw or is it too soon to tell?

MF: You know, I think the first lesson for any investor ... and particularly the older ones, if you talk to them, they tend to be very humble and very proud of what I call their ‘failure resumé’ – all their losing trades and what they have learned from them. And I tend to run away from the portfolio managers that are not – and we have certainly had hundreds of those.

And looking back historically, there are the cases where I would probably shake my head and say, look, either this process was poorly designed or there was a mistake I made, personally or emotionally. As you analyse Russia as an example – you know, geopolitics is hard. There is no question there. And so, if you are looking to build a global portfolio – and we have funds that focus on emerging markets, as well as funds that focus on all stocks globally – the first thing to take into consideration, for me, is always: how do you hedge against the risk of any one stock, sector or country imploding?

And you can apply that lens to anything – I mean, stocks all the time go to zero. You can have the best stock in the world and it turns out the CFO is fraudulent – you could not have done anything about them cooking the books – and that’s that, right? So you diversify by owning lots of stocks – never putting all your eggs in one basket.

Same with sectors. I mean, look at energy now – energy is ripping and roaring – but it was just a couple years ago when energy was only 2% of the S&P500. At one point, decades ago, the S&P energy weighting peaked at almost 30% and here we were at 2% and no-one wanted energy – and you had this devastation in energy land, where many of those stocks lost 80%-plus, so you diversify by not putting all your eggs in the energy basket.

Same is true with countries. It is certainly challenging to always be on track of what all the geopolitics are and, usually, if you are weighting in the cheap countries, you are often weighting in places that look absolutely terrible. It is the ‘who’s who’ of worst geopolitics and economics across the board. And that is one of the reasons the PE ratio ... the big takeaway of the PE ratio is usually not the ‘E’, it is the ‘P’. And if you go and take the 45 [investable] countries in the world and do a regression of valuation versus drawdown – meaning simply how much that stockmarket is down – the cheap stuff is just the stuff that has gone down 40%, 60%, 80%, 90% ... And the expensive stuff, traditionally, is the stuff that are at all-time highs. And, historically speaking, buying the basket of the cheaper puts you in a better place than buying a basket of the more expensive.

Russia .. so there are two ways to think about this topic. The first is – are there countries that are simply uninvestable? And I have a good friend, Perth Tolle, who thinks the answer is yes. She runs a fund that focuses on freedom-weighting emerging markets and so some of those just do not meet the criteria. So she does not invest in China, Russia, Saudi Arabia ... on and on.

ESG sort of metrics are really hard, I think, because they change over time. A good example would be Prediction Markets put 20% probability of there being regime change in Russia by the end of this year. Now, that seems high to me but it is certainly not zero – and, if that happens, all of a sudden, theoretically, Russia could be totally investable again – you know, who knows? Latin America? I talk to certain friends and they say, Meb, you cannot invest in Colombia – are you crazy? You cannot invest in Brazil and Argentina – how many times have they defaulted on their debt? And on and on.

So there are different parts to this spectrum. It is a debate I struggle with. I see both sides of it. As a quant, I tend to prefer more breadth and I hedge my risk largely by diversifying – but let me give you a good example. Russia is a small percentage of global market cap as well as for emerging but you know who is not? China. For some indices, China is darn near half of emerging market exposures and free float weighted and so on. Add Taiwan into that mix and that becomes a much more significant allocation. So I am very opinionated about a lot of things but this one I fall somewhat in the middle on and kind of see both sides of the argument. We tend to let the regulators make the rules and we play by them and we are not trying to adjust on the ESG side. We could probably do a two-hour podcast on this on this topic alone!

JTR: Yes. In preparation for this session, I listened to the podcast you did with Jake Taylor on Five Good Questions about five or six years ago and some of the things you were mentioning back then seem every bit as important today. You were saying diversifying geographically is very important; pay attention to valuation levels; and don’t invest in the largest components of the index – and yet the last five years has only seen an accentuation of those risks. How do you communicate with clients that, just because the risk has not yet materialised, it does not mean it has gone away – and actually it may have even become greater?

MF: It is hard, you know. If you guys were to invite me over to London and we go to the pub and an investor comes up to me and says, hey man, I just bought one of your funds six months ago – and this is always the case because we have 12 funds so something is always doing terrible and something is always working ... usually! So someone comes up to me and says, Meb, I bought one of your funds. It’s not doing great but I like you and I listen to your podcast – how long should I give it?

And I used to say 10 years as an answer – and they would kind of laugh awkwardly and then I would say, no, I’m being serious. If you buy an asset class or an active portfolio, you should expect that there could easily be a 10-year period where the performance is poor while all of the justifications for buying it are still sound. That’s not what people want to hear, right? They want results and they want them now – even most institutions, their time horizon is two to three years, which is the exact opposite of what they should be. You know, if you are an institution judging on that, you should probably be fired, honestly.

My belief has changed, by the way – I don’t say 10 years anymore, I say 20. And then people really don’t want to hear that but it is the truth. If you look at anything – it could be gold versus stocks, it could be stocks versus bonds, it could be UK versus US, it could be value versus growth, it could be commodities ... I mean, if we were doing this three months ago, people would be laughing at us talking about doing commodities. And here we are, with $7 gas in Los Angeles. And that is a very different discussion.

So, to me, you have to build a portfolio with balance – yet most portfolios are woefully concentrated in a few risks. The problem with most of the buy-and-hold portfolios is they are concentrated in a risk that is also the same risk everyone has in their human capital, day-to- day life, which is their portfolio is highly tethered to the economic cycle. So when it’s hitting the fan – global financial crisis, Brexit, internet bubble crashing ... – your portfolio is also doing terrible, which is the opposite of what it should do.

And so we always say, as a starting point, that people should invest in the global market portfolio, which is what if you have if you just bought the entire world of public assets – so roughly half stocks, half bonds; half US, half foreign. That is a great starting point. And then we layer in real assets, which tend to be a little harder to invest in – single family, housing and farmland are not really represented as easily investable assets. But things like real estate, commercial real estate investment trusts, things like TIPS [Treasury Inflation-Protected Securities] or commodities – we talk a lot about trend-following and managed futures as a way to get exposure there but that gets a little more esoteric.

But having that base-case portfolio, to me, is a great starting point because you end up with the diversification for where something is not working for a long time – you know, the hated markets of today are yesterday’s darlings and vice-versa. And so it is hard for people not to get attached to being a gold bug or a dividend guy or a crypto gal – on and on, whatever it may be – and come up with the diversification. This goes back 2,000 years – in our book Global Asset Allocation, which is free to download online, we wrote about ‘the Talmud portfolio’, which is 2,000 years old. Now, it was not a portfolio as such but they were saying, let every man invest a third in business, a third in land and a third keep in reserve – and, in my mind, that is stocks, real assets and cash and bonds. That is a really hard portfolio to beat.

You have to put the caveat on all of this of that you have to be mindful of costs – fees, transaction costs, every single cost wrapped around that portfolio. But, once you have that base case, I think – and this is a non-consensus view – that is actually a much safer portfolio than even holding it in cash. And that argument, by the way, is coming to light now, with inflation picking up and interest rates being so low. We did a post on this called The Stay Rich Portfolio, which I think no one on the planet believes other than me. And Michael Saylor, perhaps, and he believes it with a totally different conclusion but it is a fun one! So having a long-term perspective, I think, is essential but probably really hard for most.

JTR: Thanks. I would like to explore a behavioural tool that came up in our discussion with Jake Taylor last year and is something I was reminded of while looking at one of your blogs. Maybe six years ago, you were writing about how you had been screening the worst performers and signalling to people that coalmining companies had done very poorly and then they doubled and you screened again and it was now the case that uranium was doing very poorly. The implication was, well, maybe it is a good idea to identify what has done very badly in the past – and uranium-mining companies had done very badly in the past. And so I want to explore this idea of maybe writing down a rule that, if this happens, I am going to make a contract with myself that, regardless of what is happening in the world, I will push forward and double down and buy at that level. I am going to close my eyes and buy this country or sector or commodity because it has been so bad in the past I am just going to count on it to mean-revert. Is that a smart thing to do? Why is it so powerful as a behavioural tool? And as a quantum investor, is that something you do?

MF: You know, ‘bottom-fishing’ or ‘catching a falling knife’ – this topic attracts a certain mindset. There is the old investing maxim of ‘What do you call something that is down 90%? Something that was down 80% that then got cut in half afterwards’. So there can still be a lot of risk. A lot of people see something went down 80% and they are like, oh my god, it can’t go down much more. Well, it can – it can go down all the way!

But we did a few fun studies back in my very first book, The Ivy Portfolio. I would not necessarily bet my whole portfolio on this but I think it is a fun way to look at the world because sentiment follows price. And so, if you were to go back to US stocks, for example, and look at the American Association of Individual Investors survey, which goes back decades, and look at the single most bullish month in the history of the survey – the time when people were most bullish on stocks was December 1999. So literally the most expensive month stocks have been in my entire lifetime was when people wanted them most. And when were they most bearish? You can guess – like, this is out of a comic book – it was March of 2009.

So our emotions work against us and we did a few studies. One was what happens when you buy things after they go down 60%, 80% and 90%? Another was what happens if you look at markets that were down multiple years in a row. So for the big indices – S&P, say, or EFA of foreign developed markets – you could look at what happens after they go down three years in a row. And, if you pair that with how far they go down ... you know, there is the old phrase of ‘Buy when there is blood in the streets’ – and sadly that is a little too literal today – but meaning where a market has been totally destroyed, there usually is some opportunity.

It goes back to John Templeton during the Great Depression. He said, look, I am just going to buy every stock that is trading under $5 or $1 – I can’t even remember – and just close my eyes, hold my nose and hold them. A lot of them went out of business but a lot of them were these multi-baggers –10 or 100 baggers from there. So we do like to look at things after they have gone down a tonne – we used to do this post, which you referenced, and the first one, I think, was Why You Should Ask For Coal (Stocks) In Your Stockings This Holiday Season, because they were down so much. Everyone had kind of left behind much of the agriculture ... and I come from a farming background so this is closer to me than most – a lot of these agriculture and energy inputs.

And then, many markets have gone up over the past handful of years so there were not a tonne that had been having these multiple down-years in a row – I think Pakistan may have been in there last year. But it is an interesting place to wade. Now, we often talk about using trend as an indicator on when assets are finally going from cheap and hated into an uptrend, which is really my favourite investment – a super-cheap investment, everyone hates it and then it is finally entering into an up-movement. You can get some pretty explosive returns but, as with anything, just because it is cheap, does not mean it cannot get a lot cheaper!

JTR: That is really interesting. And I like the post about coal because, again, given environmental concerns – which are very valid, of course – the coal industry had been given up for dead. But then things happen in the world and now coal has had quite a comeback over the course of the last few months – together with many other commodities that have gained quite a bad reputation.

MF: Yeah – and look, man, I live in Los Angeles and I drive a Tesla. So I get it but, at the same time, I realise many of these inputs into an economy are still vital and probably will be for a long time. It is hard to distance what has done really poorly from a lot of our interests but there is often opportunity everywhere.

JTR: We are coming to the end of our session, where we always ask our guests two questions. One is for a book recommendation – and you are welcome to recommend one, two or maybe all five books you have written or something different. And the second question is to give an example of a bad outcome to a decision that you can identify as coming from poor process and not bad luck – and it does not have to be investment-related.

MF: Sure. Well, the good news is you can download most of my books for free on my Meb Faber blog or our Cambria Investments website – but we are not going to talk about those. We are going to talk about my favourite investing book, which is from some professors right down the street from you guys – Elroy Dimson, Mike Staunton and Paul Marsh – and is called Triumph of the Optimists. This book is expensive so, listeners, pick it up at the library and check it out. Or they do yearly free updates, if you Google Credit Suisse’s Global Investment Returns Yearbook, which they have been doing for about a decade.

They do a different theme each year – sometimes it is emerging markets, sometimes it is factors, sometimes it is ESG – and you could probably learn more from those 10 years of updates than an entire MBA, I think. We did a podcast with the authors and I love that book because it shows returns on stocks, bonds and bills in dozens of countries back to 1900. And it shows all the things can happen – hey, tiny little South Africa had a great run but other countries like Austria not so much, and on and on about what has happened in history. It is a beautiful book to boot.

As for your second question, my bud Mark Yusko has a great phrase where he says: “Every trade makes you richer or wiser but never both.” So if you look back to your early days, being a young person ... and I was saying this to a lot of the Robin Hood crowd last year ... I’m like, you don’t want to hear this but most of you are going to lose money here – and take those scars with some pride. How can I say that with confidence? Well, I remember all the Forex brokers, anyone who is hyperactively trading – the long history of that is just a graveyard. When they disclosed what percentage of their customers lost money, it was like 98% – and I think a lot of the Robin Hood disclosures will be certainly in that ballpark at some point.

So, thinking about your mistakes, you should learn from them and take them with pride because it helps to inform the rest of your career and then, hopefully, you are not making these mistakes when you have a family and a bunch of kids and a job and a partner to support. Early in my career, I was a quant – a biotech guy – as I discussed earlier and I actually had a pretty successful time trading as an undergraduate and then coming out of college, on both sides of the market. So I used to do shorting too and I survived that.

But I made a very classic blunder – two blunders. The first was, I put on a trade and I had a thesis – in this case, it was a biotech company that had a drug that was coming up for approval. So my thesis was, it would not get approved, which would send the stock down 50%, 60% or 70%. However, I was aware that a lot of these meetings are coinflips and so I said I want to protect myself to the upside if it does get approved because it could go up 80% if that happens.

And so I put on a trade known as an options ‘strangle’ or ‘straddle’ – I can’t remember which – at the time but, leading up to the actual event, the premium and the options had already doubled because of the volatility. And so a thoughtful trader, maybe an older trader, would say, I am going to take a few chips off the table because this trade is already working. But I was young, and so I didn’t and then what happens? The drug does get approved and stock goes up so I made money but not much.

So the first lesson is your thesis, the event, has happened and the catalyst is done – it is time to close the trade. But I said, you know what? Maybe there will be some additional move – it got approved but it does not seem like the markets really reacted. I am going to give it a few more days and then close out the trade. And then the company decided to pre-announce their earnings – for no reason whatsoever. They just decided to do it. And that knocked the stock back down to right around the stock price, in which case I lost 100% of the trade. So the first mistake was not following your initial thesis.

The second part of the trade was bet-sizing. You can make almost any bet and, if it is small, you will not get taken out of the game. And the number one mistake that you cannot make an investing is you lose your chip stack – that applies to betting and poker and everything else too, right? It is the number one thing – you cannot lose all your money because, if you do, you cannot bet. So, in this case, my position sizing was way too high – essentially my entire bankroll, which I then lost – and ate mustard sandwiches for two years in San Francisco.

But that informed a lot for the rest of my career. You know, I have all the behavioural biases. I am overconfident. I will take too much risk if you let me, which is one of the reasons I became a quant. I said, look, man – I want these guardrails. I don’t want to have chocolate ice cream in my freezer at night because I will go eat it. Same thing on the investing – I don’t want to be able to make some of these dumb decisions because I will probably blow myself up if I am given the chance. So I wear that scar with a lot of pride and I have a lot more to go along with it – there is a whole family on me – but that one certainly gives me sweaty palms even to think about it today.

JTR: Meb Faber, thank you very much for coming to The Value Perspective podcast.

MF: It’s been a blast. Look forward to seeing you guys in person one of these days soon.

Author

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet, I was a member of the Customs Solution Group at HOLT Credit Suisse.  

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