The Compound and Friends - What Is Your "Investing Bible"? (Tadas with Phil Huber)

Episode Date: May 29, 2019

“Prior to reading Expected Returns, I had a very narrow view of asset allocation and portfolio construction. Like most investors, I viewed diversification through the singular lens of asset classes, i.e. stocks vs. bonds. Through the effective use of two visual aids, this book turned that notion on its head.” Phil Huber is an enthusiastic participant in the financial blogsphere and the CIO of Huber Financial Advisors. Tadas got Phil on the phone to talk about a recent post of his entitled “My Investing Bible” where he discusses how the book, Expected Returns by Antti Ilmanen changed how he thought about investing. You can read more about Phil at his blog bps and pieces: https://bpsandpieces.com/2019/05/20/my-investing-bible/ Enable our Alexa skill here - "Alexa, play the Compound show!" https://www.amazon.com/Ritholtz-Wealth-Management-LLC-Compound/dp/B07P777QBZ Talk to us about your portfolio or financial plan here: https://ritholtzwealth.com/ Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer if you seriously need this spelled out for you. https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey, Phil, it's Taddis. Hey, Taddis, how are you? Good. I'm on the line with Phil Huber, who is the Chief Investment Officer of Huber Financial Advisors, and he is the author of the Bips and Pieces blog. I asked Phil on today to talk about a recent post of his entitled My Investing Bible. You know, book recommendations are kind of a tricky business, which is why I'm kind of loathe to do them. But my experience has been that if you recommend a book to someone and it's either too technical or challenging, it can kind of put the reader off of

a topic. And if you recommend something that's kind of a little too simple or too easy, the reader may feel insulted. So that might be a good place to start. Phil, what was it about this book, Expected Returns, that changed the way you think about investing? So I think the first thing I'll point out is, as you mentioned earlier, it gets tricky when you're making book recommendations to people because, as you said, it could be too dense or technical and turn people off or the other end of the spectrum. So when people ask me, I kind of keep two in my back pocket that I will recommend. This one that we'll talk about here today, Expected Returns, is definitely for the professional investor. It comes in about 500 plus pages, very heavy and dense. For a more novice investor, I typically steer them

towards something like Howard Marks' The Most Important Thing, which I think is a lot more readable to your average person. But in terms of my own experience and how I look back on my career and think about what book has most influenced how I think about building and constructing portfolios for the clients that we serve at our firm, I don't think anything's really been as impactful as Expected Returns. Yeah, no, it's definitely, like you said, a book for professionals. And one of the things I liked about it, that it is, like you said, it is kind of highly structured and it really does cover the waterfront in terms of really anything in terms of investing, both publicly traded assets, private assets, and things like that. Yeah, that's one of the nice things about it is it leaves really very few stones unturned in the investment landscape. And, you know, I think like any book in our lives, it has a really profound effect on us. A lot of it has to do with the timing of when it came into your life. And, you know, this was relatively early in my career where all I really kind of knew at the time was very traditional asset allocation, the kind of whole, you know, stock and bond orthodoxy that most investors are accustomed to.

And so when I cracked open this book and started digging into some of the other topics that it spoke to, as well as kind of the way it framed thinking about asset allocation and expected returns, it kind of turned my thinking at the time on its head. And I think a lot of that can be traced to two pretty powerful visual aids that are found at various points throughout the book. The first is there's the old parable of the elephant and the blind men where you've got one blind man touching the tail of an elephant and thinking it's a rope, another touching the leg and thinking it's a tree trunk and so on and so forth. And all of these individuals have a very

narrow frame of reference to the elephant and are unable to see the bigger picture in front of them. And that's kind of a trap that investors fall into a lot of the times. And so if we think of how most investors view diversification, it's often through the lens of asset class diversification. How much do I own between stocks and bonds and real estate and cash, whereas this book then presents a second visual, which is this cube, where it looks at diversification through three kind of three-dimensional way, one being the traditional asset class approach, but then two others, one focused on risk factors, you know, economic growth and inflation and liquidity and tail risks. And then the other third element being what they call in the book strategy style. So these are

things that we, you know, hear a lot more about today in terms of being factor investing or smart beta, things that are more stylistic within asset classes as opposed to across them. So things like value and momentum and carry type characteristics. And so being able to kind of cull all those three things together and have a kind of a way to look at a portfolio through multiple lenses

as opposed to one that was really powerful to me and something that was new to me at the time that I read it. Yeah, no, the visuals which you can find in Phil's posts are really interesting. And one of the things

you had in the post, which I thought kind of gets to this topic as well, is you kind of talked about four things, kind of four factors, as it were, when thinking about returns. And the first one is, you know, that El-Manin talks about in his book, and the first one's historical average returns. And like you said, that's oftentimes where people stop. They essentially look at what a market has done or a stock has done over historically and kind of take that information kind of as gospel and really don't take any additional steps or think much more about an asset class than that. Yeah. And I think then the other ones that he describes are risk-based

and behavioral theories that you want to ascribe to different return characteristics that assets have because you want to have some level of confidence that these different return premiums are going to continue and persist into the future. And so there should be some economic rationale as to why you believe that would be the case. And then the other is this idea of time-varying returns and forward-looking market indicators using things like valuation, like trend to help inform asset allocation decisions. And then the last one that he talks about is discretionary views. That's, I think, what most investors should rely upon the least of anything. And certainly in our own practice, we don't really incorporate a lot of discretionary viewpoints into our asset allocation decisions just because we don't think we have as good a chance of anybody of making those kind of calls on a regular and persistent basis. And so we tend to focus more on the first three.

Yeah, no, I think that's right. But I think the discretionary part is interesting. Right. But I think the discretionary part is interesting. I read it a little bit more broadly in the sense that, you know, the thing that came to my mind was, let's say, let's just say ESG type investing, you know, you know, to my view, that's kind of a discretionary choice for the investor who wants to focus on companies or factors or screens in an ESG type of style. And to me, that's discretionary. There's nothing in theory and there's nothing in the returns that would tell you to do that or not to do it.

But if that's a choice that you make and it's one that you can live with one way or another, I think that's kind of where discretion, at least that's the way I kind of think about discretion to a degree in terms of portfolio construction. But I think your original point about thinking about either, like you said, either getting down to the new degree of a stock selection or things like that, I think that's absolutely correct. That's actually a great point, Titus. I hadn't thought of it like that.

And so, yeah, the other thing that I think is you mentioned it earlier was, you know, we've kind of had this explosion in factor investing and there's all sorts of vehicles, both ETFs and, you know, open end funds that are trying to take advantage of these different factors. And, you know, the second point that you mentioned, kind of talking about risk-based and behavioral explanations, I think that's the thing that's oftentimes missing is that you see a factor and it's had some sort of performance and then people project that performance into the future without really giving a second thought as to what it is that's behind that performance and why it might persist in the future or more likely not. Exactly. I think it has to have either one of those two underpinnings, if not a combination of the two, to give you the level of confidence you need to really, you know, believe that these things are going to deliver long-term because you actually do need a long-term time frame to capture some of these. As we've seen, you know, looking back at value, for example, for the past, you know, five to 10 years, a lot of people, if they don't really

have the confidence as to why they think value should work, then they're ultimately not going to have the wherewithal to stick with it when it goes through rough patches. And so you need that kind of understanding as to where and why these returns are available and knowing that they're also not free lunches. You know, they can and will go through very long, and they feel a lot longer as they're happening, periods of underperformance. And so there's definitely an element of mean reversion that can take place, but you've got to be able to stick through, as Cliff asks, hold on to these things like grim death.

Well, we're getting kind of to the end of our time, but I think one of the things you mentioned in the post is the need for having humility and being pragmatic. And I think those are kind of watchwords for everyone, no matter kind of what style of investor they are or how they approach things. Having a little humility goes a long way. Absolutely. And I would say to anyone who's listening to this and wants to give this book a read, it can be a bit intimidating at first glance, but it's not something that needs to be read through consecutively. I think the first few chapters and the last few chapters are probably my favorite, and then you can kind of cherry pick the middle chapters that delve deep into

individual case studies and asset classes and so forth. So that would be my recommendation if it seems a bit intimidating at first glance. Well, that's great, Phil. I appreciate you taking the time and we'll talk to you soon. Sounds good, Thomas. Thanks for having me.