Odd Lots - Meb Faber on the Big Bear Market in Diversification and Tactical Allocation

Episode Date: October 18, 2024

For decades, investors have been told that diversifying is a good thing. You should hold a basket of stocks across different sectors and geographies, plus bonds, maybe some commodities or real estate, and so on. But, it turns out that you probably would have done better if you just bought large-cap US stocks in the form of an S&P 500 ETF like SPY. So why haven't diversified investments performed better? In this episode, we speak with Meb Faber, CIO of Cambria Investment Management, the host of the Meb Faber show, and the author of one of the most-downloaded research papers on SSRN. He says the last 15 years have "arguably been the worst period ever for an asset allocation portfolio.  Read more:Great ‘Bear Market’ in Diversification Haunts Wall Street ProsThe Fate of the World’s Largest ETF Is Tied to 11 Random MillennialsOnly Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlots See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, Odd Thoughts on Amazon Music. Bloomberg Audio Studios. Podcasts, Radio News. Hello and welcome to another episode of the Odd Thoughts podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, do you ever feel like the investment gods are punishing you? Oh my God. I think about this all at a time. Like, you know, when I first start, invested my money, I'm like, I'm going to be a very prudent diversifier and I'm going to buy some bond funds. Some hard assets. Some equity funds. I'm going to invest internationally. I'm going to invest a little bit in emerging markets. I'm going to buy some re-ETF so I get a little income.

Yes, I thought I was being very smart for that. But all it turns out is I should have just bought QQQ or, you know, the big tech stocks. And I would have been. doing so much better. Spire die, yeah. Yes. Over time, I've become a little bit more spire die. You capitulated. Yeah, it capitulated. It probably means it's the top. No, I had the same thing. So obviously we're journalists and we can't really invest. We don't trade. Right, we don't trade. But for instance, we have retirement options, right?

And there are retirement options that are like, oh, an ex-US dividend fund or something like that. And I remember in the sort of mid-2010s, people talked to. a lot about international equities. And like, don't just put all your eggs in the America basket. Make sure you have exposure to emerging markets in China and, like, Europe even, coming out of the Eurozone crisis. And it turns out that was a bad idea. Totally.

You really should have just bought U.S. big caps. You know, you mentioned retirement, like, in our like 401K options. I think I have money in some sort of target date funds, which is a cool idea because as you get older and theory. It's the vanguard one, right? I think so. You know, and like in theory, as you get older, you're supposed to take on less risk and stuff like that.

And so great, that seems like a good idea. I don't want to like think about it too much. So it'd be nice if it were just sort of automatic. But man, all of this diversification is killing me. What a mistake. All right. Well, today we need to talk a little bit about why diversification for the past 10 years or so at least has turned out to kind of be.

a bad idea. You would have made a lot more money just putting stuff in the S&P 500. You certainly would have made a lot more money if you just, I don't know, bought Apple or something. Yeah, Apple QQQQ. Yeah, just big cap tech. So why is that? We need to talk about why we're being collectively punished for being prudent. We have the perfect guests to talk about this. We're going to be speaking with someone who I actually cannot believe hasn't been on the show before. I feel like he has. But then I I realized that he's sort of like the Rocky Mountains in the sense that he's just always kind of been there. But you kind of take him for granted. He's like out there. You know him. You read all his stuff. Maybe listen to a show. See him on Twitter certainly. And yet we've never had him on the show.

We've just taken him for granted. Outrageous oversight that we must now rectify. Yes. Okay. So I'm very excited to say we are going to be speaking with Meb Faber. He is, of course, the co-founder and CEO of Cambria Investment Management. And also the host of of the Meb Faber show, the podcast. So Meb, thank you so much for coming on odd lots. I feel so bad that you haven't been on before. I can't believe it. It's great to be here, y'all, as a Colorado native, maybe the mountain analogy is spot on. Oh, that was better than your eyes. By the way, we're still out. Even though it's long past, we are recording this at the Future Proof Conference in Huntington Beach, California. Meb, you live like an hour away, huh? Yeah, sadly, we invited Joe

and Tracy to come surfing. They skipped out again for our surf lessons, but beautiful day. Glad y'all are here. I'm not good with cold water, so I'm just going to be like 100% honest. It's like 65 degrees at the moment in Huntington Beach. I could not fathom going willingly going into the water in this temperature. Can we just talk about surfing, actually? Joe mentioned that he likes getting punished in the market. Surfing would be perfect, right?

It's the ultimate humility. You get out there and just get tossed. Pounded by the waves of bad decisions over and over again. Yeah, that sounds about right. Okay, wait. So I mentioned that you've sort of always. been out there. And certainly for as long as I can remember in financial journalism, you were always there. Cambria was always there. And so I never really stopped to think about what it is that you

actually do. But what does Cambria do? Yeah. So we like to think of ourselves as the odd lots of ETFs, you know. But I'm being serious. You know, we fast forward from getting started pre-GFC, the company launched its first ETF in 2013. So over a decade old now. And we often tell people the best compliment you can give anyone in investing, but also in the asset management and entrepreneurship, is just surviving. So alpha, all that extra, wonderful, but just surviving is a big compliment. So we're near $3 billion in assets, 16 ETFs now. But we often say it's the best time ever to be an investor. The choices are limitless. You can invest in ETFs for near zero fee, thousands of choices, but in that world, if you're going to charge more, you better be doing something weird

or concentrated and different. And so we try to only launch funds that don't exist in a world of 10,000 plus funds that seems like a hard goal or that are sufficiently, we think we can do cheaper or, quote, better. And better off is a lofty goal too. But it has to be something I want to put my own money into, has to be something that's backed by academic and practitioner research. And so that versus a lot of the industry, and I love our friends here that throw as much spaghetti against the wall and see what sticks. We want products that we want to invest in that don't exist. Speaking of academic research, didn't you write some like, it was one of the most downloaded papers ever on SSRN about market timing? Yeah.

Well, it's funny you mentioned market timing. The original title was a better approach to market timing and no one would read it. I got a lot of really nasty responses from probably some of. some prior odd lot guests, but a lot of famous investors and a lot of really wonderful thoughtful responses too. And I changed the title to quantitative approach to tactical asset allocation. Oh, that sounds more. It sounds way more like consultant speak. But it also, there's a lot of luck. It came out pre-financial crisis. It was a very simple trend-falling methodology. And trend-falling goes back 100 years. So nothing particularly new, but it would have worked great as trendfowing

tends to do during crisis in big bear markets, which we haven't had in a long time. And so it became very popular. Clearly, if I published it in 2010, probably have zero downloads as well. Wait, it did it, it did better under the second title than it did under the market timing title? That's kind of crazy from a headline perspective. Well, tactical, I think, is a great a great word to have. All right. The headline of this episode is going to be like Meb Faber on tactical allocation. Yeah. All right. Okay. Well, so you mentioned in the beginning that if you are charging clients more. You better be doing something interesting and worthwhile. Convince me why I shouldn't just put all my money in spy. Long, dramatic pause. So a couple things.

We always say the global market portfolio is the best starting point. And what is the global market portfolio? That's if you buy everything in the world, all the public assets. And that is roughly half stocks, half bonds, half US, half foreign, roughly speaking. And that's actually really, really hard portfolio to beat over time. But if you were to go back 100 years, 120 years, we were doing odd lots in London, sipping on some tea, drinking some champagne, in 1899, and trying to project what would be the successful country. Maybe we pick the U.S. Maybe we pick Argentina. Maybe we pick other countries in areas and stock markets. And my favorite investing book, Triumph for the Optimus, you know, outlines the historical returns of stocks, bonds, bills,

and all these countries. People always think the U.S. is the best. It hasn't been. I think Australia and South Africa had better returns. But the U.S. is darn near over two-thirds of the world market cap today. So even if you invest in the global portfolio, you're putting 10 times as much in the U.S. stock market as any other country. And let's be honest, U.S. has been on a role.

You guys know I love to do my polls on Twitter. We did a poll the other day. And listeners, you've got to answer this before I give the answer up. I said, what do you think U.S. stocks have done? since 2009. And the multiple choices were, do you think they've doubled? Do you think they've tripled? Do you think they've quadrupled? And the fourth answer, which I had to Google, was non-yopold, which is nine times, and then decupold, which is 10 times. So listeners, think about what do you think stocks are done? The answer is almost a 10-bagger. So 100 grand in

stocks in 2009, if you didn't sell or you held or you bought in March, you now have a million bucks you got 10 million bucks amazing 15% returns so you should have invested in SPY right like you crushed everything in the world but historically that concentration has not been rewarded if you look at the other 45 countries and you talk to someone in greece or japan or china or the UK they would tell you that investing all their money and their home country was a terrible idea but diversifying globally particularly into the U.S. has saved their bacon for the past 10, 15 years. So Tracy mentioned that much to our regret, we've never had you on the podcast before. I have interviewed you, however, once, maybe twice on TV.

And you're talking about some of these similar themes about international diversification. And I think, if I recall, I was talking a little bit also about, like, sort of international extension of some of the ideas that Robert Schiller has talked about and the idea of Schiller-Cap ratio. looking at market valuation from that point and opportunities to essentially invest in cheap markets overseas. And this idea that if it works in one country, maybe it works internationally. What's the basic idea behind that? And then, you know, you mentioned, okay, the U.S. is just like totally clobbered everyone else. Give us the rundown of like, I don't know,

that was probably 10 years ago or maybe eight years ago. What's happened over the last eight years internationally? So if you rewind the clock and look at these various regimes, and everyone wants to focus on what's the Fed doing, what are earnings going to be, what's going to happen this month, the election next month. A lot of these regimes play out over not just years, but decades, right? If you look at not that long ago from 2000 to the financial crisis, the U.S. stock market got cream by everything else in the world, reeds, gold, foreign stocks, emerging market stocks. And so you go through these periods where various assets have their time in the sun and day in the shade.

If you look at the U.S. market, say 1980, super cheap, right? The U.S. has been a long-term cap ratio of five before. It's been as high as 45, the peak of my favorite bubble in 99. Mine too. Yeah, it was a great time in the 90s. But if you look on average, it's usually like in the low 20s if inflation is chill. But you have all these countries and other examples. The classic we always talk about is Japan.

You know, Japan was darn near 100 in the 1980s and then went nowhere for. multiple decades. Now, it looks great today after an entire generation has made no money in the Japanese stock market. But that's how long it often plays out. And Japan's not some tiny economy. You know, this is a top three world economy and stock market and was the biggest stock market in the world at that time where the U.S. is today. And the U.S. isn't crazy, expensive today. It's in the mid-30s. It's not a bubble, but it tends to be a weight, right? It tends to be a headwin over time because you're buying all the future cash flows. The good news is most of the rest of the around the world are reasonably priced to really cheap. The really deep value like GMO and others talk

about is exceptionally interesting right now. So we manage these shareholder yield ETFs. And so the market cap in the U.S., the Achilles heel of market cap indexing is there is no tether to value whatsoever. It's the stock price times shares outstanding. And that's good most of the time because you're guaranteed to own the winners. But it's bad in the sense when things go crazy, the really expensive, and everyone's talking about this, right? The Mag 7, everything else, the really expensive stuff gets the highest weights. And so much like late 90s, a lot of the cheap companies, high quality look exceptional, not just within the U.S., but in foreign developed and emerging as well, but everyone's forgotten about foreign stocks, emerging market stocks. Nobody

wants any. But that sets the stage for the next outperformance as well. Wait, talk more about the role of the benchmark indices in all. of this, because this is one thing that I've been really interested in in recent years, this idea. I mean, this is where the flows before pros idea kind of comes from, this idea that, like, if you want to pick a winner, maybe rather than looking at the fundamentals or trying to see if something is underpriced or whatever, you want to look at where the flows are going. And a lot of those flows nowadays are dictated by index construction. And so how big a role does that indexing actually play in, I guess, the outperformance of

concentration or U.S. versus diversification and rest of the world? We always say flows drive performance. And, you know, in a particular small asset class or a concentrated strategy has a much larger impact. You've seen some active funds, some very famous fund managers over the past 10 or so years where the flows made a dramatic impact on the way up and also on the way down. But this could also be if you're buying Brazilian small-cap tech stocks, right? You can move those around with a lot less money than you could, the S&P. But look, you go back 50 years. The concept of the market cap index set off just this neutron bomb across the industry,

but it actually wasn't the index that was the innovation, you know, John Bogle, Wells, Fargoes, and others. It was what indexing enabled, which is low-cost investing because you don't do anything. And you're guaranteed to own the winners. So quote passive investing was an amazing invention. But here we are in 2024. And you don't have to do market cap indexing to deliver the low cost, right? We always say ETFs are eating the asset management industry. So you have all this historical, very expensive mutual funds with conflicts of interest and front-end loans and 12b-1 fees that may be index funds. But the index is not the innovation. It's the low fees, which is what John Bogle used to say. It's not about index active passive. He's like, the debate is really high fee, low fee. And so now you can deliver these much more interesting exposures instead of just passive market cap waiting that should do much better over time.

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Watch us on Bloomberg Television. Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two, of Leading by Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to Leading by Example, Executives making an impact on the IHeart Radio app, Apple Podcast, or wherever you get your podcast. You know, one of the things that really strikes me, and I think this is an important point that you've already touched on a couple of times.

that the beauty of like the sort of modern ETF world is it used to not be trivial, right, to have substantial foreign exposure. And you know, especially thinking like before mutual funds proliferated, you might say like I've like Brazil, but what do you like go out and have a broker, make a buy order for every individual stock? Like that's a costly process. And now that's not costly anymore. And I think that's a really underappreciated fact about investing. But just setting aside the U.S. outperformance, what's going on in international markets that investors haven't loved them? Like, yeah, why? You talk about Latin, there must be great Latin American companies, Latin American tech companies, Latin American tire companies and beverage distributors and everything

they have. Why haven't investors like these companies? The U.S. has certainly had great earnings growth for the past 10 to 15 years, right? So it's led the charge. It's done really well. But if you look around the rest of the world, you know, and we manage my largest fund, look, by the way, my largest fund, long only U.S. stock fund. Yeah. So talking to my book here, but looking at the foreign and emerging, you see great companies. And so here's an example. You know, we run a value quality strategy in U.S. Shareholder yield doesn't have much tech exposure.

Okay. Not surprising because tech stocks in the U.S., on average, are pretty expensive, but they also do a bunch of share issuance based on stock-based compensation, right? So they have a negative buyback yield because they're issuing and issuing a ton of shares. But if you look at foreign developed and emerging market fund, tech is the largest sector allocation, which is surprising to many people because it's a value strategy. But we always say there's opportunities. People just aren't necessarily focused on them. As an example, our largest holding was a better performer than Nvidia.

And it's a semiconductor stock, but nobody knows about it. Nobody talks about it because nobody cares about emerging markets. But just to be clear, setting aside what people, people care about at a given time. Earnings growth in the U.S. since 2009, or really any point, has been extraordinary. And over time, there are companies that by and large just continue to grow earnings. Has that not been the case internationally? Yeah, you haven't had the same earnings growth.

But also within the U.S., you have had this tailwind of multiple expansion. Our buddy Cliff was talking about he's like the percentage of the returns that are attributable to multiple expansion is pretty high. So you've had the U.S. So back in 2009, right? We're hanging out in March somewhere at a pub in New York City, drowning our woes about the world going crazy. The U.S. stock market, talking about back to the Schiller-K.

ratio, was low teens, but so was foreign developed and emerging. So the U.S. has gone from 12 to, let's call it, 36 today, whereas the rest of the world hasn't. It hasn't had that multiple expansion. And so that can be a massive tailwind and headwind over the course of a decade of like three, four, five, seven percent per year, depending on what people are willing to pay for those stocks. So just on this point, one of the criticisms that is sometimes leveled against diversification

or strategies that are focused on diversification is the idea that, well, you're purposefully kind of adding losers to your portfolio, right? Like you're not really trying to choose winners. You're trying to distribute your risk among a bunch of different entities. and the analogy that I sometimes use, which probably will not resonate for either of you or like most of our listeners, but I sometimes think it's kind of like trying to find a single guy over 40 in New York City. Like there's a reason they're desirable to single women, but on the other hand, like there's probably a reason that they're single over 40. There's probably something wrong with them, right? And that's why.

This is good. That's why they're single. So I sometimes think about diversification or like value investing in those terms. Why should you seek out things that are probably going to be losers at least for, you know, the short to medium term? There's a, the late Peter Bernstein had a great quote, which I'll get directionally correct, which was he's like, look, asset allocation is a defensive strategy, but it's also an aggressive strategy because you never know where the next windfall is going to come from.

Look around the world today. Gold, all-time highs. Nobody's talking about, at least at this conference that I'm chatting with. But you never know if you look at various assets, whether it's coffee, whether it's the yen, whether it's foreign stocks, emerging markets, reits, bonds even, U.S. stocks, value, right, quality. You never know the exact timing of it. And that's hard. And we have a lot of non-consensus views when it comes to asset allocation.

I actually don't think if you're doing buy and hold, your allocation matters much at all, which I think it's like my mom is a Southern cook. And she makes chocolate chip cookies with just by feel, right? She tastes them. But as long as you have the wheat, the flour, the butter, the chocolate chips, like, it's going to end up okay. You totally omit one thing and it's probably going to be suboptimal. And that's the way it is allocation allocation.

You have some global stocks, some global bonds and some real assets, meaning like tips, reeds. The allocation percentage doesn't much. And when we wrote this book, this asset allocation book a decade ago, which we're updating, we actually found that if you look at overtime the last 50, the last 100 years, and compared the best performing strategy relative to the worst, and we looked at all of them, endowment, permanent portfolios, 60, 40, on and on. We found the spread was actually pretty tight. They all returned about within a percent or 2 percent of each other. And the crazy part is if you took the best one,

you say, all right, Joe, Tracy, I'm going to give you a crystal ball. We'll hop in the Delorean, go back 50, 100 years. I'm going to tell you which asset Alcayson strategy. was best. How much would you pay me with that? You know, Pimco probably give me a billion dollars for that knowledge. But I said, hold on. The genie, there's one rule you have to implement it with the average mutual fund fee of today. Not back then, 1.25% today. That takes the best performing allocation, makes it almost as bad as the worst.

Wow. So all this time we spend on the Fed, on gold, or whatever. And this is for buy and hold, just market cap indexing. We're not talking about all the good stuff that we do, trend following value, yada, just the basics. And so we often say your asset allocation doesn't matter that much. But what does matter is expenses, fees, and taxes. Yeah.

Yeah, I remember saying, I think, well, it might have been like the Boglehead Forum is back in the day. And someone talking about like the cost matters hypothesis as being a more powerful idea than the efficient market hypothesis for this exact reason. So, you know, we've been talking about, okay, since 2009, we know U.S. stocks have clobbered the rest of the world. When was the last time actually that wasn't the case? Well, so we wrote this piece called the bear market and diversification. Yeah. And so since 2009, US stocks, again, listeners, think in your head, 15% per year. Yeah. That's only happened on a 10 year rolling basis four times in history. And they all have names, roaring 20s, the nifty 50, the internet bubble, and then

whatever we're calling this, COVID, meme, sunk, AI era, right? Now, you don't know how long it's going to last, and on the backside, they also all have names, the Great Depression, the inflationary 70s period, the dot-com bubble burst and GFC echo, and whatever comes next. Who knows? It doesn't mean to ask that. During those periods that we don't have good names for, international diversification has paid off. If you look at this period is arguably been the worst period ever for an asset allocation portfolio, and we'll just use the global market portfolio, versus. versus the S&P. The only comparable period is post-war War II.

And this is not just in terms, first of all, it didn't do bad. Did like 7% a year. Totally fine. Joe's 401K, 7% a year, not bad. But if you look at in terms of underperforming your neighbor, so an absolute underperformance risk of the SMB, but the worst part is not the absolute performance. It's the years in a row.

It is something like 13 of 15 years. It's underperforming the S&P. So it's just body blow after body blow. of looking less smart than your dopy neighbor who bought the cues in Dogecoin. That's upsetting. Yeah, I know. It's not fair. I'm trying to process this because it bothers me so much. No, okay.

Well, since you brought up taxes and the cost base as such a big factor to investment success or outperformance, talk to us about what you're seeing there in terms of, I guess, innovation because we often talk in the investment space in ETF certainly about the race to the bottom in terms of costs. And to me, I look around at some of the like tax yields on these things. It feels like you can't get that much lower. But maybe you can. There's a lot about ETFs that I think that people don't know. First of all, a lot of public funds will do short lending and return that revenue to the consumers. So on top of the fee you have, let's say like we charge half a percent, Well, the short lending revenue in some funds, it may be 10 basis points, maybe 20.

In some cases, it could be very material, 50 over 100 basis points. So there are plenty of ETFs out there that actually already have a negative expense ratio. So let that sink in. You're getting paid to own this fund. That's pretty cool, right? Second is the ETF expense ratio is also tax deductible, right? It's coming out of the income. So if you're comparing that to a traditional separate account, which is not deductible,

that's an additional, essentially, benefit of the ETF over these traditional structures. But here's the challenge. If you've been participating, you're one of the lucky ones, you bought a bunch of stocks, you own a bunch of Nvidia since 2009, you're sitting on a tin bagger game. And if you talk to, you know, older generation, if you look at Buffett, you know, all these decisions that he has to make on Apple, where he has to eventually pay the taxes, right? You talk to the order, generally, say, well, I just can't sell my Microsoft or GE or IBM, because the taxman would kill me. We had Hank Bessonbinder on the show recently, who did the famous

paper to stocks outperform T-bill's. We had Hank run for the past 100 years. I said, Hank, what's the best performing stock of all time? And listeners, you have to guess this too. You may get it of the top five. The top three, I don't think I could guess two or three ever heard of them. But Vulcan materials, I think two. Kansas City was third. And number one was... Kansas City Rail Run? Yeah. And this is just you are optimized. on length of compound. So 100 years. But Altria,

it's like you put $1,000 in Altria 100 years ago. You now have $2 billion. Anyway, the point being is that if you invest, you eventually have a bunch of capital gains. Great. Good problem to have, right? If you're in a taxable investor.

And if you have been investing in U.S. stocks since 2009, you have 10x capital gains on average, right? So that's a problem for investors, right? Because you've got to make a decision. Am I just going to bite the bullet? sell this, pay the taxes, and move on, because these power laws dominate everything we do in investing. It's in VC. It's true in public markets where the best performers, it's like 5%

of stocks generate all the return. So if you end up with one of these, your whole portfolio is now this appreciated stock or portfolio. What I'm getting at is what do you do? Well, there's actually been something that's been around for 100 years called the Exchange Fund. It was popularized really in the 1970s by Eden Vance, by now Morgan Stanley, Goldman does it. And it's like a 1031 exchange. If you have a portfolio. The 1031, is that how real estate investors never have to pay taxes? That's like when you buy a house, if you buy a, if you sell it and then buy another one, like commercial, you buy a hotel, you buy some farmland. Commercial real estate people love this. Like this is like the essence of the whole game. It's indefinite tax referral and it builds

generational wealth. And it's why you see so many people that, you know, they talk, well, my grandmother bought this property at $10,000 and now it's $10 million. You know, on and on. So it's great. It's a huge wealth compounder over time. But so with stocks, you eventually have to pay the Piper. So there's this thing that's been around forever called exchange funds. And the way they work is if you have a highly appreciated positions, you get a bunch of

other people, you contribute them to a portfolio, and there's some rules. You've got to be accredited or qualified. You got to hold it for seven years. And at the end of seven years, you get back a diversified portfolio. so you eliminate your concentration risk. But the problem, of course, is it's run by the traditional asset managers who love to charge exceptionally high fees. They're going to ding you probably a percent or two just to get in.

And then they're going to ding you a percent or two every year for seven years for the privilege of having this exchange fund. So there's others trying to do this. There's a company called Cash that's doing this, trying to disrupt this. But if you think of the ETF structure, which is a massive innovation, where you have an actively managed portfolio, index portfolio, you're only paying taxes when you sell that fund. So the turnover doesn't matter.

I think that's well understood by most investors today, hopefully. But if you look back at SPY, if you bought it in 97, you've paid no capital gains at all, despite the fact it trades consistently. That's not a feature of mutual funds or hedge funds, and that's why ETFs are eating asset managed. They're vastly more tax-efficient, which on average is probably about a 70 basis point

after tax benefit relative to mutual funds. Monster number, probably more important than the expense ratio. However, what if you've got a bunch of stocks that have gone up a ton? So you could go to this exchange fund route, you're stuck, you could sell it, but what you've started to see

over the past five years, you've seen the riding on the wall and the traditional mutual fund industry is doing one of two things. They're going ostrich style, head and sand. I'm just going to ride this till I retire and we'll just deal with the outflows and someone else's problem.

or there's shops like DFA and says, you know what, we're going to convert. They do 50 billion of mutual funds to ETFs. And then you see some innovation going on where the group we're partnering with Wes Gray and his team at Alpha Architect, ETF architect, they were able to go to an asset manager and say, okay, well, let's convert your clients. So they had 5,000 clients from separate accounts to an ETF. And it's not a taxable transaction. And so I started thinking about this.

It's called a 351 exchange. Again, been around for 100 years. And you start the brain working in an odd lot's way and taking this to its logical conclusion. I say, this is a really cool idea. And to my knowledge, we're going to be the first to do this. And so I said, why can't we open this to everyone? Why can't we make this so that it's disrupting the entire industry and make it democratize it where you don't have to be a qualified investor?

You can just be any investor that's sitting on capital gains. And so the way that works is you can contribute a portfolio, stocks, ETFs, whatever. And there's some rules like one position can't be over 25%, the top five can't be over 50. You contribute a basket of stocks. You get an ETF in return. And you get essentially a tax deferral, diversified portfolio that now has a diversified strategy. It could be whatever strategy.

The first one we're doing is actually a riff on an old paper we wrote, which demonstrated that if you're a high tax investor in a place like that. California or New York, the last thing you want is dividends or high dividends. So we demonstrated that if you had a value strategy that targeted stocks that paid low to no dividends, you're after tax. You do much better than the S&P or high dividend strategy. So this takeaway of this idea is that you can contribute a basket of stocks, end up with a great ETF.

And you could launch a series of these every year, every three months, every six months, and let people opt in. What do you think? Great. It sounds good. I wish I had some gigantic capital gains that I needed to solve for, but alas, that's not my problem. But let's just talk a little bit more mechanics. So let's say 10 years ago, I bought a bunch of Apple and Nvidia and Microsoft and whatever else, JP Morgan, a bunch of names that have done well. Okay, so I have these. And now I'm thinking, oh, the market's kind of expensive these days. I'm nervous, et cetera. I'm thinking about, want to sell. them, but I don't want to, like, write a huge check come next April. Okay, so that's my problem. Talk to me the specific mechanics. Now, your fund suddenly, your new ETF suddenly exists. Walk me through the specific mechanics of what I have to do to swap those. Yeah, I don't understand how you, like, deliver the portfolio. I swap that into this thing so that now I'm in a diversified

portfolio that's a little bit de-risk things to diversification. I don't have my concentration problem, but I didn't have to pay the taxes. Talk to me about exactly how much stuff. This is why we're partnering with our friends, ETF architect. You have things like 1031, have very established templated rules, how to do it.

And this is the first time we go in through it. So I'm sure it's not going to be 100% without headaches and hiccups. But the first thing you inquire, right? So we set up camryinvestments. com forward slash tax. Put in your name, your info. I got this portfolio. Joe's got a portfolio at Schwab.

Yeah. It's got. I literally do have a portfolio at Schwab. So, you know, here's, I'm interested, send me more information. I'm sure we'll do a webinar, we'll educate everyone, and we'll say, here's the menu, here's the process of what's going to happen on,

I'm just making up this date. December 1st, your portfolio will contribute to the ETF. But how does that work? Magic, hopefully. You know, the plumbing and the pipes of it will have to get Wes on the show and get him to get really deep on it. But they just did it with a 5,000 account.

But like Schwab or whatever, like they have mechanisms for, yeah. I mean, I'm sure, like, I don't know whether it's going to be, you know, ACATING it, whether it's going to be just electronic transfer. Okay, okay. But you can do that with shares. Yeah. Okay. Okay.

So we wrangle up a bunch of people with all sorts of different securities and they all contribute them. And then the next morning they have an ETF in their Schwab account. It's beautiful. And then they have a diversified portfolio. And we have a few different ones lined up. We have an endowment style. You guys probably see me pick my fights with CalPERS over the years. we have a global shareholder yield style.

So the menu will be different for people that may want different ideas. But the first one, at least, we're doing U.S. stock exposure. So once you're in the diversified portfolio, the ETF, presumably if you sold that, you would still have to pay capital gains. But the benefit is that you're getting out of that big concentrated position and going into something more diversified. That's the hope. Okay.

That sounds interesting. And so it's very interesting. Can I ask a question? you mentioned Wes's company, West Gray is it? You mentioned Wes's company is called Alpha Architect. Since you've been in the ETF game for a long time, can you talk a little bit about how, you know, if Tracy and I have an idea for an ETF,

some strategy that we think could be interesting, how much easier is it today in 2024 to build? What is the process of like, okay, we want to build an ETF around this versus, say 2014 or 2004? It's night and day. So what's it what's that like? You know, we originally were going to sub-advise on a couple funds. The Forbes family was going to move into ETFs. It's a fun fact. They didn't because it was 2009. So we eventually sub-advised on a fund with advisor shares because back then it costs half a million, a million bucks a year just to get the trust permission to launch

ETF. So a huge pain. We eventually bit the bullet starting launching funds in 2013. Fast forward a decade in the ETF rule, which was passed a few years ago that really streamlined everything, changed it all. And so the two main companies, so ETF architect and then title, which are both groups that do this white label ETF business, you could go to them now and say Joe's got his idea for this ETF. It's only going to invest in companies in North Carolina with the letter M, like whatever it may be. You know, who knows? Three months from now, you could have a fund out.

Wow. It's going to cost you, I don't know, 50 grand and startup fees. But the big problem, and, you know, everyone sees the gold at the end of the rainbow, but you really need to be able to get to 20, 30, 40 million. So a lot of people sit at zero. Is that just to make the economics of actually, like, managing and trading the ETF actually work? Well, if it sits at zero, you're on the hook for probably a quarter million expenses per year.

So 250 grand, but that's if it sits at zero. And so then you're subsidizing, you know, writing 20K checks per month adds up over time. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories. Episodes are published throughout the day with the latest information and data to keep you informed. Yes, there are other products like this from a very first.

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It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts. Here's something I always wanted to write about or talk about. Reverse inquiries in ETFs. I think this is sometimes like an underappreciated aspect of how ETFs come into being. But I have heard that like a hedge fund or an investor will go out and say, we want the opposite exposure to this particular thing. We want to take the other side of the bet. Will you create an ETF that allows me to do this?

Yeah, you see that more at a lot of the trade-specific shops and firms that want those thematic exposures. You know, we tend to focus on ideas I want to put money into. You know, the average mutual fund manager has zero dollars invested in their own fund, which is an astonishing statistic. And half of all public funds close over the course of 10 years. So there's a massive amount of turnover and people that don't have skin in the game. And so a lot of these ideas, you know, I want nothing to do with a lot of these tradable

thematics, right? But if people build them, they want to invest them, God bless them, right? But we err on the side of things that we think make a material impact to investors, you know, future returns and portfolios. And a lot of what's out there, you know, I wouldn't touch with a 10-foot pole, but some of them raise a billion, $10 billion, so what do I know? It's interesting hearing you describe how much easier ETF creation has gotten because it strikes me that it's like the ETFization of the ETF industry because ETFs, of course, make investing in a country or a theme much easier than if you had to do it by hand and buy a bunch of stocks. And this is essentially taking that same idea, except applying it to the creation of ETFs where you have all these white labels.

things. The infrastructure is already there. So all you have to do is supply the idea. This gets me just something I've always just sort of been wondering about. What happens when an ETF dies? So Tracy and I launch our fund where we only invest in North Carolina stocks where the ticker has the letter M in them. And then for whatever reason, in two years, we have $500,000 under management, which is probably high, but clearly not enough to build a business on. You're like, you know what, we don't want to do this. We don't want to write the $20,000 checks a month to support this. When we decide to wind it down, what happens?

They go to the ETF, ticker in the sky, graveyard. You know, I mean, it's a pretty orderly process. There's a lot of prior art, of course. Yeah. You know, I think on very, very rare cases. Do the investors get distributed the stock, or do they get distributed the cash? I believe it's usually cash. But the correct answer for the vast majority investors, just sell it before close it down.

You know, you'd sell it on the secondary market. Yeah. Like, hey, we're going to close this in a year. We'll just sell it now and just be done with it. But, you know, I think a lot of people take a negative view of the amount of products out there. You often hear people say, there's more ETFs than stocks. Right.

And say, well, there's more words than letters. Like, that doesn't really have. Yeah, right. More sentences than words. But you have sort of the ability to have this limitless grocery choice. There's a lot of areas that I think haven't developed the way that they will eventually, in one example is the all in one asset allocation. ETF. We have three of these, but if you look at the traditional mutual fund asset allocation industry,

it is multiples more expensive and tax inefficient compared to the ETFs. And yet they still have about a trillion in assets. And, you know, those type of assets, it's usually death or divorce or bare markets where they all come out, all the money at some point, but they never go back to paying 2%. And so I think you'll see over the next 10 to 20 years a big shift in assets and structures, but eventually it all leads to the ETO. You know, you mentioned the sort of global market portfolio, and we can never own the global market portfolio truly. So you only are like trying to get close, right? Because the global market portfolio also includes all real estate in the world. And just a number of things like you can approach it maybe asymptotically, but you'll never truly

own the global market portfolio. But the old academic research says like to own the global market portfolio, every asset in the world. How close do you get in one of these funds? Are you like 95% of the way they're like? I'd say it's closer to like 99. You know, the, the, if you look at one of my favorite examples, we always joke on these asset allocation portfolios. We have one called the Talmud portfolio, which is based on there's a piece of advice where it was like, let every man invest a third in business, a third in land and a third keeping reserve, which we interpret is a third in stocks, a third, and real assets, and third, and bonds, that portfolio is almost impossible to beat. And if you look at a lot of, like, Calpers, Bridgewater, and we do all these articles and say,

should these big institutions just be managed by a robot? And they, for the most part, usually can't beat these basic asset allocation benchmarks. It's really hard for them. Some, you include a little leverage because they have a lot of private equity and leverage vehicles. But these basic portfolios are a high bar. That's funny. I hadn't considered Talmudic investment for a lot of for the win, but I guess it works. Okay, so this whole conversation has reminded me that I am old enough to remember when active ETFs were first becoming a thing and they were going through like regulatory approval process. Obviously, they've become much more of a thing since then and we've seen mutual funds convert into ETFs, as you mentioned. What's the next big thing in the ETFification

of the market? No, there's a few areas. We're always, interested in. And when we look at the Venn diagram or you make the columns of things that are totally fine, okay, good, there's plenty, right? You know, I was chatting with someone last night and he's like, look, I use DFA. Why should I use your funds? I'm like, don't. DFA is fine, you know. But the bad news is like there's a whole universe of absolutely awful, god awful, terrible. I have a Twitter thread that's just, I made the mistake of bookmarking a spammy, sleazy, Instagram ad for private real estate. It's always private real estate, right? 50% per year. You know, they're claiming. Those guys got clobbered in 2020. Some of the videos are like,

if you just commit investment and tax fraud, you can make like a 200% return in six months. So all my all my ads are now these scams. I just get delivered because I bookmarked it. So I get all these. So just avoiding and doing the really dumb stuff is the key to almost all of this. right. We did an old article about the food pyramid. You remember the food pyramid? Yeah. Oh, yeah. You know, the base of that when we were kids was eat a bunch of cereal and bread and pasta, you know, and it's kind of inverted now where thinking about it. But the same thing with investing is like the basics, get the basics right, pay low fees, pay low taxes. Get your money invested. That's the number one piece of advice of all of this is get to work, let it compound, right? And then the other things take care of themselves. So but because this is a wonky show and we get into this, I think the thing. like the 351 exchange idea we're talking about, we're going to be extremely material, and we're talking about this in a year or two. I've seen some other companies, and we don't do this, but I love the idea of taxable target date ETFs. We see people behave better in target date

style funds. I think there's some ideas and concepts around building personal pensions, where people are locked into their investments and get them to behave in a good way, where, you know, these fiduciaries, you're kind of forced to hold investments and let the compact, do its work. There's a lot of innovation in some of those ideas. But if you go back, I have a joke. I'm like so many of the fintech ideas are just vanguard with a shining coat of paint, right? Like you already have pretty great out there. But there's some more ideas we're working on too. I love the idea of like a sort of like forced pension because intuitively it seems like, A, most people make mistakes when they're like left on their own. So you just sort of want to lock it up.

But B, it also seems like there's probably excess returns for. like that commitment where if like you trade off the liquidity profile, then you get paid more. Anyway, Memfaber. It's so great to finally have the show. Great to catch up with you in your natural environment at the beach. Surfing on a beach. Yeah. It's like, okay, like yeah, we didn't have meb on for a long time. But if we, when we did finally have it, we're like literally on the beach right now. Listeners, you heard it here. They're committed to serving with us next year and future I don't know. I said only if the temperature is above 80 degrees or someone like loans me a wet.

Yeah, just get wet. It's freezing. I'm really cold. We'll take care of it. I've been cold for two days. Yeah, it is cold. All right. Thanks so much, Mep.

It's great, y'all. Well, I'm glad we were finally able to do that, Joe. As you say in Meb's natural environment, one thing I was thinking was just about that new fund and the sort of tax focus of it. It is interesting because, you know, our whole conversation was about how over the past 10 years or so, those big concentrated investments are what have paid off the most. And I guess people are now trying to think through how they actually crystallize those wins. And so it's interesting to see the market trying to come up with a solution to that problem.

The solution of the problem of people having to pay taxes and people having to eventually pay taxes. You know what I think is interesting to me to, and going back to the sort of diversification story and getting punished for diversification where we started. I like the idea that one day, like the sort of, I'm still kind of diversified. You know that like my prudent approach is going to pay off. But it's also interesting that like the periods where pays off are like not great periods. So it's like, okay, I want my diversification. I'm very like mediocre and forgettable.

Yeah. Or like the aftermath of a crash. Yes. And so like I want my diversification to pay off, but I don't want to crash. This is exactly what I was thinking. The trigger for diversification coming back would be something very bad happening. That's right. In the U.S.

Yeah. And as people who live in the U.S. were de facto over levered to stuff in the U.S. I mean, our jobs are levered to the U.S. economy, right? So I think about this a lot, which is like, okay, it makes me uncomfortable as not just someone with money in the market, but it makes me uncomfortable as a purse of the world. that like we have this market that is just so heavily concentrated and so levered to the success of meta and invidia and Amazon. And I don't really like that. It rubs me the wrong way.

It doesn't sit right with me as something. But on the other hand, if I think about what would change that, it's nothing good. Yeah. There doesn't seem to be like a positive version. Now, I would see the one exception where maybe this doesn't have to be the case would be, kind of like a market in which the investments that are being made in things like the inflation reduction act and the chips act where there's like this industrial renaissance in the U.S. And that really started taking off or where you have such above trend growth and productivity

that a lot of the so-called like real economy stocks really start to do well, et cetera. So there is like that sort of golden scenario where more winners come in here. That's right. That's right. And so, like, having more exposure to potential winners pays off. But on the other hand, it feels like the downside scenario where, like, the current winners just get wiped down or something. And everyone loses and then... It seems more probable.

That seems more probable. And so it's hard. Yeah, it feels like when the regime shifts, which will happen because regime shift and maybe it'll be 100 years from now and it will be dead and whatever. but it seems most likely that when the regime shifts, it will not be because things are good. Yeah. Nothing lasts forever shed dramatic tear, including our time at Future Proof on the beach. So shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Allo. And I'm Joe Wisenthal. You can follow me at the stalwart. Follow our guest, Meb Faber. He's at Meb Faber.

follow our producer, Carmen Rodriguez at Carmen Erman. Dashel Bennett at Dashbot and Kel Brooks at Kel Brooks. Thank you to our producer, Moses, Ondom. For more Oddlots content, go to Bloomberg.com slash oddlots, where we have transcripts, a blog, and a newsletter. And you can chat about all of these topics 24-7 in our Discord where we have a markets channel and people talk about stocks and debate the market. Discord.g.g. slash oddlots.

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But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example,

we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts.