Animal Spirits Podcast - Investing is a Game of Relative, Not Absolute Skill (EP.02)

Episode Date: November 17, 2017

We discuss the difference between portfolio managers and portfolio management, Michael’s favorite investment book ever written, how to think about financial television, the amazing run in tech stocks, the future of the asset management business, the psychology behind dividend payments and much more. Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.   Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Animal Spirits, the podcast that takes a completely different look at markets and investing. I hate the people who talk about it all the time, so I didn't want to be one of those people. From two guys who study the markets as a passion. Can I count on you to talk me off the ledge partner? Yes, and that's what this podcast is for. And trade for all the right reasons. That's my due diligence. I'm in. Dude, if you're in, I'm in.

A line of thinking is the higher the volatility on an asset, the higher the volatility on the opinions. so I feel like you have crazies on both sides. Here's your host of Animal Spirits, Michael Batnik. I can say that I was never driven by money. So you were trading three times leveraged ETFs for the love of the game. Exactly, man. I'm a purist. But anyway, and Ben Carlson.

This is true. I do not drink coffee. I've never been on Facebook. I've never done fantasy football. Oh, one last thing. Michael Batnik and Ben Carlson work for Ritt Holtz wealth management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritthold's wealth management.

This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain positions in the securities discussed in this podcast. Now, today's show. So Bill Gross has been the beneficiary of a 30-year bond bull market leading some people to suggest that the wind was at his back and he might not be that skilled of a bond manager, but he was in an environment where yields went from 15. percent down to two, so he could really do no wrong. But there were a lot of other bond managers

managing bonds in the 80s that didn't turn out to be Bill Gross. So what do you think of the idea that investing has gotten a lot harder, but if we were around in the 80s, we surely would have been Bill Gross. He just got lucky. I think that there's obviously always an element of skill and luck involved in any of this stuff, but obviously he's one of the people who took advantage, like you say. So I think it's hard to separate the two. Obviously, he invested in one of the great bond bowl markets of all time probably that we'll ever see. You could say that for a lot of hedge fund managers that came up in that time, too, that they had the wind of their back. They had, the competition was much less than it was, but they still took advantage of it.

But getting back to the idea of now being one of the harder times to invest, I think that that's probably true for a number of reasons. The competition's higher. There's more people out there. the, you know, the valuations are higher, interest rates are lower, but I don't think that takes away from what he did at all. Yeah, so there was a recent chart going around, the number of CFAs per stock, and that number has just been going up and up and up and up over time. So I think it's not black and white. It's obviously a lot more nuance than that, but there were a lot of managers, like I said, in the 80s that turned out not to be Bill Gross. I actually did a few CFA talks in the last couple of months, and I used that chart in my presentation.

the number of CFAs per stock, and it just, yeah, it's gone up ever since the 90s. It gets a lot of laughs at that from that crowd, but it's kind of funny because everyone in those rooms assumes that, you know, I went through this program, I'm well educated. I should probably be doing pretty well with my investments, but there's just so many people out there these days that it makes it so much harder. And I think it's just going to get harder from here too. Right. So investing is a game of relative skill, not absolute skill, as we know.

Yes, exactly. And speaking of Bond Kings. A week ago, Jeff Gunlock tweeted, The moment of truth has arrived for secular bond bull market. Need to start, I'm sorry, exclamation point. Need to start rallying effective immediately or obituaries need to be ridden. Talk about the difference between being a portfolio manager and being in portfolio management. I actually wrote about this.

This must have been a couple years ago now. But, you know, I think these are the types of calls that portfolio managers kind of have to make. or at least they think they do. But the thing with that is that they can change their mind on a dime, and it really won't affect them, because there's a difference between what these people say in public and how their portfolios are positioned. But, you know, the idea of someone running a fund

is much different than someone who's actually managing a portfolio of different asset classes and strategies. So this is a book that I know that we both, like, might stole this from Adam Smith, who wrote in the money game, which was what, in the 1960s? 1960s. Yeah, you're the one to put me on to that book. Speaking of, I think that I'm ready to declare that my favorite investment book ever written.

Yeah, it's really good. So he has a line there where he says, you know, security analyst dog down information and comp with an idea about what should be bought or sold, but they don't necessarily make good conductors for the whole orchestra. And so I think that's a way to think about this. You know, whether you agree with what gunlock or any of these portfolio managers say, you know, you have to think about it in terms of what they're saying and why and what you're doing and why. So making changes to the security level selection is much different than making changes to a portfolio. So these sort of bonded bull bear market calls, while interesting, are not very useful for most investors. Yeah. So who knows if Gunlock is acting on what he's saying. But he has had some really funky, interesting calls that were probably mocked at the time that turned out really, really well. In 2013, he said to you, short Apple and go long natural gas. Do you remember?

that one? Yes, of course. I put it on in my portfolio letters three times. So that trade was in the money from day one and was never negative. So that was pretty spectacular. And then he also set to short Chipotle, which I think he was on the wrong side of that for a little while, but as we've seen recently, Chipotle's come crashing down. So obviously, Jeff Gondick is not short in Chipotle and his total return fund, but nevertheless, he's certainly an interesting fellow. So I think the idea of listening to portfolio managed because these guys are way more in the news these days than they were in the past. So these guys used to be very secretive and not talk very much. And now, you know, every day there's a new call from a hedgeman manager or portfolio manager or someone. And I think it's a good

reminder for investors. It's almost like the difference between, you know, entertainment and advice. So if you're watching financial television, I think you have to go in with the right mindset. And that's whether you're following someone on Twitter or reading something they wrote in a news clip or whatever it is. And trying to understand, you know, is this person talking, their own book or talking about themselves or are they talking to me personally? And obviously, just like these portfolio managers have no idea who you are, the same thing applies to people on financial television. And the job of the networks, as we know, is to be loyal to their shareholders and the way that they make money is to sell advertisements, not to make you a better investor.

Right. So people get mad at the people on CNBC and Bloomberg and Fox business about what they say, but they're not talking to you personally. They're just giving their opinion and they have to fill that airtime. So it's not like they're giving you advice for your friends. 401K. They're just, like you said, they have a job to do, and that's what they're doing. And sticking with the bond theme, there was an article last week from Bloomberg talking about unconstrained bond funds, which was all the rage in, I think, late 2013, early 2014 after the taper tantrum. And we haven't really heard much about it since. But in the article, somebody wrote, one of our investment beliefs is that predicting interest rates is extremely

challenging and that very few people have been able to do it consistently. Obviously, you and I would agree with that, and taking a step further, you could replace interest rates with literally anything, because predicting the future is inherently a very difficult thing to do. Tell us more about your beliefs, please. So whenever I would meet with fund managers back in the day, I would always laugh when they would roll out their quote-unquote best ideas portfolio. It's like, why aren't you using your best ideas everywhere else? You're using your not best ideas?

and obviously it's because they would have a more concentrated version or something, but it never made sense to me because, first of all, these people don't even really know what their best ideas are. You know, before, if they knew what their best ideas were, they would put all their money in them and not invest anywhere else, correct? Right. I guess it's their highest conviction, but, but 14th best idea just doesn't roll off the tongue. True.

And I think the other thing about the unconstrained thing, it sounds really sexy in a pitch. Like, we can go anywhere. We're, you know, we can invest in any, any sector or strategy. or we can go long or short. The problem with having no constraints is that it's really hard to measure. So, first of all, what's the bogey going to be? What's the benchmark? And second of all, how do you find it?

And how do you then understand what the risk is compared to that bogey? So I think that's where a lot of investors have. It sounds great in theory, but that's where a lot of investors run into problems with these things. My personal benchmark for this year is the VIX, and I am doing extremely well. Way to go. Yesterday, Franklin Templeton announced. Eric Balchunas tweeted, Franklin Templeton just vanguard the whole world, literally, launching dirt cheap country ETFs this week, three to four times cheaper than peers, nine basis points. So you hear three to four times cheaper than peers, but then

you see the spread. It's, you know, where does this end? Are we going to see negative fees for ETFs? By the way, before we get into that, can we talk about the fact that you can now use a company name as a verb. So vanguarded. I saw the other day that someone got Amazoned. I didn't know this was a thing. Can we say that we writ holds someone? What does that imply? Let's not go there. Okay. True. Okay. Anyway. Yeah, no, I think it makes sense, I mean, it's like this is the best thing that could happen to individual investors probably in some ways. I mean, investing is going to be free if it's not already. It's a rounding error. So in the grand scheme of the thing is it's great. But, you know, at a certain point, does it really matter?

No. I mean, I think at this point it's more of a distraction. If you're managing billions of dollars, then a few basis points makes a huge difference. But for normal people, whether you're in a country, ETF at 22 basis points or nine basis points, like honestly, that is not changing your life at all. Right. And the thing is, especially with these type of ETFs, people are using these to trade them and to make an implicit bet somewhere. They're not using them for long-term investing, you know, more than likely. in most cases. So unfortunately, the access to these things is great, but the number of choices

we have now is going to make it really hard for people to actually invest the right way because they're just going to be hopping around. And so the behavior ends up being way more expensive than the expense ratio. Yeah, wasn't there a study that front load funds cause people to behave better because they had already paid the 5% up front and wanted to really get their money's worth so they tended to hold onto it longer? Makes sense. I mean, that's one of the the pros people give about investing in something like private equity or venture capital that you have no choice but to be locked up for 10 or 15 years. Obviously, there's a lot of downsides to that too, that illiquidity. But I think having that sort of constraint in place

can be helpful. Yeah, so there was another article, the Future Price of Investing Zilch, I think this was from Bloomberg also, of the $738 billion that investors put into index funds in ETFs in the past 12 months, $509 billion went to funds costing 0.1% or less. Quote, investors are really cost obsessed, so these asset managers are betting that if they lower fees,

they'll make a little money because they'll get all the assets, and that's also from Eric Baltunis. So we are just in a wild time. The asset management business is not a place that I would like to be right now. I honestly think people in that business are totally underestimating

what's coming down the pipe in a few years. I think there could be massive amounts of people out of the asset management business in the years to come, especially as these other places, you know, this is Franklin Templeton getting into this. As places like Fidelity get more into index funds and ETFs, the number of bodies needed at these places is not going to be nearly as high. I think that there's a huge reckoning coming in the asset management industry in like the decade ahead. Yeah, so Josh has written about this. The reason why there's no euphoria, even though there might be euphoria or complacency. or whatever, is because this is the only bull market that hasn't been led by Wall Street because people are so afraid of being replaced by, not machines, but by low-cost products,

and I guess machines to a certain extent. Well, yeah, and everyone's getting beat by the index funds. What are the 5-10 and 15 years? Speak for yourself, buddy. That's true. Well, your bogey is the VIX. But, yeah, I mean, the 90% of active management funds over the last 3, 5, 10, 15 years have lost index funds.

So it's kind of like, if you can't beat them, join them, everyone's thinking, which, you know, works until it doesn't, but... Yeah, Fidelity International had an interesting article, and Abigail Johnson was very anti-ETFs, but now she is forced to make some hard decisions, and one of the things that they're doing, not Fidelity, but Fidelity International, is instituting fulcom fees.

So they're going to lower the fee on some of their active products and institute performance fees, which I think is a really good idea. Like, I don't, they have to stop the bleeding somehow. Yeah. No, I give him credit for that, too. I think that the old way of just charging one or one in a quarter for a mutual fund that is a closet index and is not going to do very well for you, just it doesn't make any sense. So I think doing some sort of performance fee, you know, does make sense and people shouldn't be penalized when they underperform. Yeah, and you've written about this in the past. Maybe we won't get too far into it right now, but does it really matter for long-term investors, whether you're in a mutual fund that underperforms an index fund by 40 basis points a year?

I think the much, much, much bigger danger is being out of the market entirely. Right. Yeah, my point was that you could have been in a very suboptimal mutual fund since 2009 and still done okay for yourself and made some money. Whereas if you listen to your favorite perma bear and went to cash or have been holding a bear market fund since that time, you know, you've probably lost money or haven't made any. So that asset allocation decision is, you know, three quarters of the way there if you just are in the market. even if you're in a suboptimal fund. Yep.

So the $15 trillion asset management, active asset management industry is definitely dead. Is it $15 trillion or did I just completely make that up? You know, it sounded right to me. We don't have a stat checker here, so I think we'll just go with it. Okay, $15 trillion. With a T.

I saw a cool poll on Twitter this week. I don't know who wrote it, but I wanted to ask you this one. I thought it was kind of an interesting question. So it said, what would be harder on you emotionally? A 25% drawdown that lasts a month or a 15% drawdown that lasts a whole year.

So I assume the 25% one you'd draw down and you'd come back pretty quick and be back to even. So which would be harder on you psychologically? Hmm. I thought this was an interesting question. I think the 25% drive-down in a month would be really, really scary.

What do you think? Right. So it's basically, yeah, so it's basically a 1987 situation. Yeah, actually, I don't even think that's close. If you're in a 15% draw-down over one year, Big fucking deal. That happens all the time. Right. Yes, that's true. Right. I agree. Yeah, I think that people would panic much greater in the 25% situation. That's fair.

Did you read Brent B. Shores, his company is called, and I don't know if it's Adventur S. Adventures. I'm not sure how you pronounce it. But they did an incredible post over the weekend on Amazon. Did you get a chance to look at that? Yeah, it was like a, what, 30, 35 page PDF. Yeah, it's really worth taking the time. So we pulled some amazing statistics on Amazon, and Amazon really is disrupting not just every industry. It's disrupting fundamental analysis. There's really no way to analyze Amazon. So a few of the stats that were really compelling. The company has more than a 100 million square feet of distribution center space just in the U.S. 73% of 30-day trial subscribers convert for the first year. of membership, 91% renew for a second year, and 96% renew for a third year. That is insane.

Would you ever cut the cord with Amazon? No, it is so intertwined in my life that it's the prime stuff and we watch the prime video. I mean, anytime I need anything, the first place I check is Amazon because it's just so convenient. So I just, I read Be Shores report and his company's report of a suite. I just finished a couple months ago, the Everything store, which is a few years old, but it's basically the behind the scenes of how Amazon got started. So my favorite, a little anecdote, which I tweeted out, so in 97, right when they started the company and went public, Bezos flew out to Harvard Business School to give a presentation. And he basically said, here's our business model. And this is when they were still just selling books, but he was giving,

like, here's where we're taking this thing. We want to like take over retail. And some kid at Harvard business told him like, hey, listen, you sound like a really nice guy. But don't take this the wrong way, but I really think you just need to sell it to Barnes and Noble and get out now. And Bezos actually said, like, yeah, you could be right, but he said that I think you underestimate the degree to which the established brick and mortar businesses do things the same way and won't change. And I think there's a huge parallel there to the investment industry because it's like a lot of these places, things have always gone this way and we've always done this way,

so why change now? Why cannibalize an existing business? you know because well we've already done it this way and it works yeah that's an incredible story when amazon went public in 1997 they were a little bit smaller than barns and noble and now i think they're like a thousand times bigger or 10 000 or 100 000 times bigger whatever it is it's like it's insane yeah and we both we both looked at the new scott galway book where he predicts that amazon will be the first trillion dollar company yeah i think the market cap is only like 500 billion yeah it's a little less than it's like 450 billion so they and so

Apple has them by 50%. Now they're like 750 billion, so it's kind of an interesting take on it. I normally don't do this, but I'm going to put a timestamp out there. Amazon will not get above $647 billion. That is the ceiling. Okay. So another thing, something that... Is that a stop for your Amazon valuation short?

Yeah, that's my stop. So another thing that people have pointed out to screaming, Amazon doesn't make any money. How are they worth, you know, 30 times sales? and I made that up, whatever the number is. But this is pretty incredible between, and this is also from Brent B. Shores piece over the weekend, between 2008 and 2016, Amazon paid $1.6 billion in federal taxes, while Walmart paid $64 billion. That is crazy.

Holy shit. That's the big question for everyone is, when does the government step in? And I wrote about this last week, too, that was from Galloway's book. He's saying, you know, the government's going to step in at some point and realize, Amazon is putting all these people out of business. What was the stat from your post that you wrote about how many retailer cashiers are there in the country? Three million. Three million. Yeah. It's like more cashiers in the country than teachers, which is pretty crazy. Yeah. So do you think that Amazon is a monopoly because they are crushing everybody? But traditionally, monopolies have pricing power where they

could just gouge and their competitors and their customers and the suppliers can't really do anything about it. Whereas with Amazon, it seems like it's the exact opposite. They can keep lowering and lowering and lowering prices and putting out businesses that way. Yeah, it's definitely got to be one of the most unique large companies ever created because it's, they're almost causing deflation if you really thought about it. It would be funny if the government tried to step in and break them up because they're making things more convenient and cheaper for people. But if that's affecting other businesses, then, you know, who knows where that takes us. And sticking with tech stocks on Friday, October, whatever the day was, it was a crazy day for tech stocks.

The Wall Street Journal wrote that Amazon gained 13%, Google gained 4%, Microsoft gained 6%, and Intel gained 7%. The surge in those shares added a collective $146 billion in market value to the companies that one-day rise eclipsed the entire value of IBM at $143 billion. Is this like, is this 1999 or 2000? So I ran some numbers recently for the NASDAQ-100 ATF, the QQQ, which we're both fairly familiar with. So it's up every year since 2009. Annual returns have been like 21% per year in that time.

Man. So it's killed the S&P 500. And I ran the numbers just because of the largest holdings. So Amazon has a 42% annual return since 2009. Apple is 36%. Google is like 25%, so not much higher than the index. But it's crazy. I mean, people have been calling for a tech bubble 2.0 for the last, I don't know, 15 years, I guess.

I guess this bound to happen at some point. Pretty insane. So, our friend Meb Faber just wrote a piece on dividends. Did you get a chance to look at that? Yes. Yes. He sent it to, he sent the white paper to our secret investing Slack channel, and I did take a look at that. All right.

So two of the things that Meb said was, I was curious whether we could create a strategy that replicated a dividend strategy's total return and outperformance, but without the actual dividend. Then also, he said, I would argue that dividends have developed a great brand. So what Meb did with the help of our friends at Alpha Architect was he ran a bunch of different composites, so top 100 equal-weight stocks, X the top 25% of dividend payers, and top 100 equal-weight X all divs. And after taxes, these strategies actually do much better than the dividend-paying ones, which in turn did better than the index. But I will slightly take the other side of this because I think MEP hit on this in the post that there is such a behavioral bias with dividends that people

love nothing more than to see their dividends come in. So I don't necessarily think that high dividends strategies are like a good way to get exposure to the value premium. But I love when I get dividends because it gives me flexibility and it feels like, like, wow, I'm getting paid just to own American companies and international companies. And I love having the flexibility to take that and do whatever I want with it. So while it is very tax inefficient, the behavioral aspect is really hard for people to overcome. Right. It might not be rational because if you just took a strategy that performed the same as a dividend strategy and you could just sell your shares and create your own dividends. But I think a lot of people also think about dividends from the

perspective of it's actually cash flow in their hands. So I think a lot of people just really distrust the corporate world and the finance world. And I think if these companies are actually paying cash out to them, that it's actually a real return instead of just seeing a paper gain in selling. That's a little gold buggy for me. I just love. Coming from the guy who owns GLD, I'd like to point out. Yes, it's true. But yeah, there was a huge. huge behavioral thing where I just, I love seeing my dividends coming in every quarter. Yeah, no, I get that. And again, it's just it, it's, it sort of gets you in that frame of mind as I'm getting these returns. That's kind of what I'm getting at. Again, it may not be

rational, but I agree. And I'm sure that there's probably, I don't think there's ever been studies done that I've seen, but I'm sure that there is something with the fact that if a fund has an income in it or dividend, I'm sure more people probably buy it, and especially when you get into the retiree stage. People just screen for that. Yes, of course. Yeah, especially retirees who think in terms of income and not total return, it, you know, those, that's a huge thing for them is, is just, you know, this is what I want. I want to see regular income coming in. So the math is what it is. So I'm not disagreeing with the conclusion that Meb drew, but good luck launching a 100 stock portfolio without any dividends. And I don't think he's trying to do that because

he understands that that would be a very tough proposition. Yeah, agreed. So I just read a book called the improv. And this guy, Bud Friedman, who I had never heard of, was like the Lauren Michaels of comedy clubs. So he started a place in the late 60s in New York, and then he took it to L.A. And so in the book is stories about Ronnie Dangerfield and Andy Kaufman and Richard Pryor and all the classic comedians that we love. So this is a piece from the book that I thought you would like. Another time, I remember being with Rodney at Jerry Stiller and Anne Mirra's apartment for Passover. They lived in a gorgeous building on the Upper West Side, not far from me, and every year they had a satir. It was wonderful, and they'd invited 30 or 40

people, some of whom weren't even Jewish. One year, Roddy was there drinking martinis, and by the time dinner was served, he'd had about six of them. Then the next thing we knew, he'd passed out, faced out at the Stiller's dining room table. He was completely obliterated, but none of us did anything as we continued eating for about another hour. Good usage of the word obliterated there. That's pretty good. Yeah, we're both huge comedy fans and maybe sometime we'll share our story about going to see Judd Apatow together, but that may be a story for a time. I wonder if that's like you had to be there type of thing. Yeah, it could be. But yeah, we're both huge comedy fans and this sounds like a book that I want to get to too. So that's, yeah, I highly recommend it. It was an easy read. Very low energy output. So highly recommend that book. So why don't we start here? This is a good place to end it. You can sub-tweet us at Animal Spiritspod at gmail.com. I'm Michael Batnick on Twitter at Michael Batnick.

And Ben, your handle is a wealth of CS. Yes, the worst handle on Twitter. But yeah, get a hold of us. Send us your questions. We'll be reading our questions in the future. And give us feedback on how we're doing here and anything else you'd like to see you from the show. We're always happy to entertain any thoughts from the listeners. All right.

We'll see you next week. Thank you.