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Episode 127 has a radio show format. In this one, we cover numerous Tweets of the Week from Meb as well as listener Q&A.

We start with Meb telling us about his recent back-and-forth over Twitter with Elon Musk, discussing short-selling. Meb uses this as an example to give us more information on shorting in general, as well as short-lending.

We then answer a question we’ve received (in various forms) for years – “why is the S&P (or whatever) outperforming your strategy?” For anyone looking longingly at S&P returns for the last many years, you might want to listen to this one.

Next up, we tackle some of Meb’s Tweets of the week. There’s a discussion about mixed valuation signals – on one hand, there’s the Russell 3000, with the number of companies trading for more than 10-times revenue now approaching levels from back in 2000. On the other hand, there’s a tweet claiming that “if history is any guide, with 90% confidence rate of positive correlation, this market is going to deliver between 3 to 4% per annum for the next 10 years.” Additional tweets support both sides so Meb tries to resolve it for us.

Then there’s a tweet about the challenges of sticking with your strategy during bad years. It references how the little voice of doubt in your head is all it takes “to turn the hardest resolve into the emotional putty that has destroyed generations of investors.”

There are several other tweet topics – how Research Affiliates views the probability of 5% real returns at just 1.5%... how one forecast for private equity is calling for just 1.5% returns while a different private equity manager is trumpeting the asset class’s superior performance… and how marketing is nearly as important as performance and fees when it comes to attracting investor assets.

We then jump into listener Q&A. Some you’ll hear include:

  • You often say that over the long term, asset allocation doesn't matter much. However, isn't it important to note that because the nature of compounding, a small difference in CAGR over time can amount to a large dollar amount difference in your savings?
  • What are your thoughts on using leverage with momentum?
  • Do you have any recommendations for someone looking to diversify their trend following sleeve by applying a few different rules? For example, I've been doing 1/3 50-DMA, 1/3 200-DMA, and 1/3 crossover.
  • You speak frequently about the benefit of taking a lump sum and investing now versus later. With current equity valuations (at least US) so frothy, is that still true?
  • I’m wondering about how to take losses and how to determine when it’s appropriate to take one and when it is not. Do you, as a quant, have set rules in place?

All this and more in Episode 127.

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To celebrate the milestone of reaching 100 episodes, we’re thrilled to welcome Professor Elroy Dimson, author of Meb’s favorite investing book of all time, Triumph of the Optimists.

Per Meb’s request, Elroy starts by giving us a summation of his research history which led to Triumph of the Optimists. He had a heritage in producing indexes and began reaching out to researchers across the globe in hopes of accessing different data sets. Looking at all the aggregated data, it became clear that from a long-term perspective, people who had invested in risky securities at the beginning of the century had done very well. People who had bought bonds and T-bills had not performed as well. The optimists had triumphed.

Next, Meb brings up a quote from Elroy about a controversial finding regarding the lack of correlation between economic growth and stock market performance. If anything, the relationship was reverse. Elroy expounds upon this, telling us that if it’s obvious that a market is growing, that’s public information. You can’t trade that since everyone else knows too. So, if you investing in countries where GDP has been growing, that could mean you’re too late.

Meb steers the conversation toward valuation, market cap weightings, and home country bias. Elroy walks us through the market cap concept, touching on the historical Austrian empire as well as the Japanese bubble. This leads to a lesson in finance, which includes real yields today, the Gordon Model, the multiple people are willing to pay today (which is higher), and the takeaway that “high valuations don’t necessarily mean that we’re going to see asset prices collapse” – they’re a reflection of the low interest rates we have today.

Meb asks about bonds, and whether Elroy has seen another historical period of negative yielding sovereigns. When you look at real rates, how does it play out for future returns?

Elroy tells us that real (inflation adjusted) rates are better to consider than nominal rates. And it turns out, real rates have been lower. Negative real rates are not all that rare – what is rare is so many countries experiencing them at the same time. This dovetails into a conversation about inflation and currency hedging. Elroy provides some color on currency issues but notes that hedging is not required if you’re a long-term investor.

There’s plenty more in this centennial episode: factors… growth stocks versus value stocks… historical returns of housing… even stamps, musical instruments and the investment returns of a good Bordeaux.

How does it compare to that of equities? Find out in Episode 100.

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In Episode 93, we welcome entrepreneur, author, and quant investor, John Reese.

We start with John’s background. When John was a child, his father was a subscriber to Value Line, and John related to the charts and numbers. Later, this love of numbers took him to MIT, where he researched how to take the wisdom from books and turn it into computer programs. Years later, when he sold his company to GE Capital, John needed to learn how to invest the proceeds. Yet, he wasn’t sure which investment guru to follow in doing this. He decided to study a handful of gurus, and was disappointed to find that there was no repeatability and sustainability of outperformance over multiple time periods.

However, John then came across Peter Lynch’s One Up On Wall Street. In the book, Lynch had provided enough detail about his strategy that John was able to translate it into a computer program designed to pick the stocks that Lynch might have chosen. The results were solid. John then moved on to Ben Graham, eventually codifying 12 different guru strategies. He then put his research up on a website, which eventually morphed into Validea.

Meb asks about the challenges of this – namely, many managers have a qualitative component to their stock selection as well quantitative. How did John account for this?

John tells us this was very challenging. He had to re-read the various books multiple times, determining whether the printed word actually matched what the guru did in the market, versus his actions revealing more information or biases. Meb asks about filtering the incredibly long list of potential gurus to follow, and John tells us the list actually wasn’t too long. Most gurus didn’t have a sufficiently-long track record of performance, or they didn’t describe their strategies in sufficient details as to be able to be codified.

Meb then asks how John determines when a period of underperformance reveals a manager has lost his touch, versus the manager’s style is simply out of favor.

John tells us that he first looks at the length of time in which the strategy worked. If it was long enough, he tends to believe that, at some point, the strategy will come back into favor. He goes on to tell us that in all of his research, he found that there was not one strategy that outperformed the market every single year. They were these periods of going-out-of-favor that paved the way for the outperformance that occurred when the style came back into favor.

The guys then jump into an actual example of how John’s guru quant strategies work, using Buffett. Be sure to listen to this part for all the details.

Moving on from Buffett, Meb asks if there are any common attributes to the models that tend to do the best – any broad takeaways.

John tells us that, over time, the more successful strategies tend to have a value orientation, some kind of debt criteria, and they’re all profitable.

Meb asks – “Okay, gun to your head, which strategy has outperformed?” I’m going to make you listen to find out John’s answer, but odds are you’ll be surprised.

Next, the guys turn to factors, with Meb asking if there are any combination of factors that John tends to prefer. John says he likes momentum and mean reversion. This leads into a conversation on timing factors.

As usual, there’s far more in this episode: practical guidelines for listeners looking to follow along… portfolio construction in today’s challenging environment… what John would have done differently if he could start over again on Day 1… a roboadvisor for income investors… and of course, John’s most memorable trade.

This one happened the day after Black Monday. What are the details? Find out in Episode 93.

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In Episode 90, we welcome Founder and Portfolio Manager of Verdad, Dan Rasmussen.

We start with a brief walk-through of Dan’s background. It involves a Harvard education, a New York Times best-selling book, a stint at Bridgewater, consulting work with Bain, then his own foray into private equity.

Turning to investments, Meb lays the groundwork by saying how many people misunderstand the private equity market in general (often confusing it for venture capital). He asks Dan for an overview, then some specifics on the state of the industry today.

Dan clarifies that when he references “private equity” (PE), he’s talking about the leveraged buyout industry – think “Barbarians at the Gate.” He tells us that PE has been considered the crown jewel of the alternative world, then provides a wonderful recap of its evolution – how this market outperformed for many years (think Mitt Romney in the 80s, when he was buying businesses for 4-6 times EBIT), yet its outsized returns led to endowments flooding the market with capital ($200 - $300 billion per year, which was close to triple the pre-Global Financial Crisis average), driving up valuations. Today, deals are getting done at valuations that are nowhere near as low as in the early days. And so, the outsized returns simply haven’t existed. Yet that hasn’t stopped institutional investors from believing they will. Dan tells us about a study highlighting by just how much institutional managers believe PE will outperform in coming years…yet according to Dan’s research, their number is way off.

Dan then delves into leverage and the value premium, telling us how important this interaction is. He gives us great details on the subject based on a study he was a part of while at Bain Consulting. The takeaway was that roughly 50% of deals done at multiples greater than 10x EBITDA posted 0% returns to investors, net of fees.

Meb asks about the response to this from the private equity powers that be… What is their perspective on adding value improvements, enabling a higher price? Dan gives us his thoughts, but the general take is that doing deals at 10x EBITDA is nuts.

Next, the guys delve into Dan’s strategy at Verdad. In essence, he’s taking the strategy that made PE so successful in the 80s and applying it to public markets. Specifically, he’s looking for microcap stocks, trading at sub-7 EBITDAs, that are 50%-60% levered. With this composition, this mirrors PE deals.

The guys then get neck-deep in all things private equity… control premiums, fees, and illiquidity… the real engine behind PE alpha… sector bets… portfolio weights…

Meb and Dan land on “debt” for a while. Dan tell us how value investors tend to have an aversion to debt. But if you’re buying cheap companies that are cash-flow generating, then having debt and paying it off is a good thing. Debt paydown is a better form of capital allocation than dividends or buybacks because it improves the health of the biz, leading to multiple expansion.

The guys cover so much ground in this episode, it’s hard to capture it all here: They discuss how to balance quantitative rules with a human element… The Japanese market today, and why it’s a great set-up for Dan’s PE strategy… Rules that should work across geography, asset classes, markets, and time… Currency hedging… And far more.

For the moment, we’re still ending shows with “your most memorable trade.” Dan’s involves a Japanese company that had been blemished by a corporate scandal.  Did it turn out for or against him? Find out in Episode 90.

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