The good people over at Guru Focus did a nice Q&A covering 21 questions that you may or may not find interesting. It’s pretty short and painless so you won’t endure too much agony reading it if you choose to:
How and why did you get started investing? What is your background?
Like most people, I got into finance for a simple reason – it’s where the money is. Literally. But as I’ve gotten older I’ve realized that the fascinating part about investing isn’t so much the accumulation of money, but trying to understand the monetary system for what it is. To me the world of money is a puzzle that we’re all still trying to solve. I approach solving that puzzle in much the same way that an engineer might solve the problem of flight. That is, how can we understand the world for what it is within the context of the way its users engage in that world in order to understand the various dynamics that might allow for certain things to happen. To me, understanding the puzzle and how it fits together is the key to solving it. As a result, I spend a lot of time building a blueprint for understanding the world with the hope that putting the puzzle pieces together will lead to better investing results.
Describe your investing strategy and portfolio organization. Where do you get your investing ideas from?
I am a strong advocate of low cost countercyclical indexing. In essence, I believe that most investors should implement a form of contrarian based indexing. This involves broad diversification, low fees, low taxes, but management of a portfolio within the context that risk management is imperative to maintaining an appropriate risk profile across the market cycle.
What drew you to that specific strategy?
I developed my Countercyclical Indexing strategy as a result of the financial crisis. The crisis exposed a weakness in many standard indexing strategies like the 60/40 stock/bond portfolio which declined by an astounding 38% from peak to trough during the crisis. This exposed the reality that a “balanced index” like Vanguard’s 60/40 Balanced Index really isn’t very balanced when we consider its exposure to permanent loss risk. In fact, the exposure to permanent loss risk is much higher than 60% as the stock volatility dominates the bond volatility and exposes us to an outsized degree of negative volatility. My strategy is a low cost attempt to correct this weakness.
What books or other investors changed the way you think, inspired you, or mentored you? What is the most important lesson learned from them? What investors do you follow today?
William Sharpe and Ray Dalio have influenced my work more than any other people. Their approaches to macro investing, adaptive asset allocation and risk parity were important influences on the way I developed my own strategy. I can’t say that I follow many investors for day-to-day ideas though. I follow a more philosophical route when reading influential people. That is, they influence my general theory of the world more so than they influence my day-to-day activities.
How long will you hold a stock? How long does it take to know if you are right or wrong on a stock?
I am not an advocate of stock picking since I am a macro indexing advocate. I much prefer to focus on aggregates within the scope of a global asset allocation. Time horizon is extremely important in this context, as I always emphasize tax efficiency. This means trying to maintain a long-term capital gains rate when possible. Paying ordinary income rates can be extremely destructive to long-term results. As it turns out, Uncle Sam is a much bigger expense to the average investor than any high fee fund manager.
How has your investing changed over the years?
My investing style has become more and more focused on managing risk within a portfolio. When I was younger, I was more inclined to reach for return even if it meant taking a lot more risk. As I get older and handle other people’s money, it has become more important to treat portfolios more like “savings” as this tends to be more consistent with the way most people actually view their portfolios.
Name some of the things that you do or believe that other investors do not.
Over the years I’ve really moved against the grain on many ideas. I was one of the first to argue that QE is vastly overrated and doesn’t do much. I was one of the first to argue that QE would lead to lower rates and not high inflation. I think the Fed is generally overrated and not nearly as powerful as some portray it to be. I believe that the pursuit of “alpha” is generally a destructive pursuit. I believe that passive investing is a myth sold by certain indexing firms in order to create the illusion of differentiation. I could keep going, but I don’t want to make too many heads explode.
What are some of your favorite companies, brands, or even CEOs? What do you think are some of the most well run companies?
Although I am not a micro stock picker in some sense I am the ultimate stock picker since I have made a huge investment in my own company. I like to think that an entrepreneur is the ultimate value investor as they put their money where their mouth is and always assume that their own company is undervalued. That said, my favorite companies are the ones I try to emulate – the Vanguards and Charles Schwabs of the world are up there on that short list. These are firms that have led the way in the fight to develop low cost indexing strategies.
Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
I don’t believe the empirical evidence supports stock picking. Most investors should spend less time picking stocks and more time hitting golf balls.
Name some of the traits that a company must have for you to invest in, such as dividends. What does a high quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.
I am very wary of the idea that investors should spend a lot of time trying to pick the right companies based on certain criteria. There is an abundance of evidence showing that most individual stock pickers cannot beat a correlated index. Most of us are better off not even trying.
What kind of checklist do you use when investing? Do you have a specific approach, structure, process that you use?
Macro indexing is all about process and planning. Macro investors don’t do much after all. We think of the financial markets like a marathon. You win by having a solid plan and sticking with it through thick and thin. Some people think that a marathon is won by the person who just runs the fastest, but the person who runs the fastest is usually the person who planned for the race in advance. I approach macro investing in much the same way. If you don’t have a good plan that you’ll stick with, then you will make all the wrong mistakes at all the wrong times.
Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
I try to keep things simple. Owning fewer positions in my portfolio is usually owning more. Because we’re so well diversified across various funds there’s no need to own a slew of options. That’s the amazing thing about today’s financial markets. You only need to own a handful of funds to own the entire basket of the world’s assets. But in my view, the important part of this is not just what assets you own, but the relative proportions of those assets relative to your risk profile and market cycle. It’s not just about owning a diversified portfolio of stocks and bonds, but owning the right mix of those assets.
How do you go about valuing a stock?
Value is dynamic and relative in my view. At the end of the day you could probably call my strategy a value investing approach, as we are always trying to be underweight assets when they are excessively risky, however, I don’t utilize most of the traditional value metrics when assessing the market’s value. I approach value from a much more fundamental macro view by trying to assess the market’s riskiness in relative terms. That is, stocks could actually be quite undervalued by many traditional metrics, however, in a relative sense they could still look quite unattractive relative to other various asset classes. This relative assessment is much more important when allocating assets than simply viewing stocks as the only asset class in the world.
What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas?
Bargains? What does that even mean in a ZIRP world!? Ha. Everything looks a bit rich in my opinion, however, if you held a gun to my head and forced me to buy one asset class for the next 10 years I’d probably pick foreign stocks, high quality corporate bonds and coastal California real estate.
How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
The market is in a typical late cycle environment. This means that future returns are likely to be lower than historical average and returns could be riskier. In other words, the next 5 years could look a lot like the market that we’ve seen over the last 24 months which has not been a very fun risk adjusted ride. I think it is prudent to be a little concerned about stock market returns, however, I also believe it’s imprudent to let the permabears convince you that the stock market should be abandoned altogether.
What are some books that you are reading now? What is the most important lesson learned from your favorite one?
I am in the initial stages of reading Ryan Holiday’s “Ego is the Enemy”. So far it’s wonderfully philosophical and enlightening. As a macro thinker I tend to spend most of my time thinking about things that are bigger than money. This book will satisfy anyone who has the same thought processes.
Any advice to a new value investor? What should they know and what habits should they develop before they start?
My advice to new investors is always the same – start slow and learn fast. This is a marathon race and you’ll be at it for a long time. Invest your time and effort in becoming smarter and more knowledgeable. That is the investment that will most pay off. And don’t be in a rush to get rich. The financial markets aren’t a get rich quick scheme.
What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
My favorite macro resource is definitely FRED, the St Louis Fed’s research database. They supply all the data necessary to properly understand the macro investment landscape.
Describe some of the biggest mistakes you have made value investing. What are your three worst investments? What did you learn and how do you avoid those mistakes today?
There have been too many mistakes to list off! But that’s the best part. Mistakes are only mistakes if you don’t learn from them. So, I like to think I have only experienced lessons. I would emphasize that people should embrace their mistakes. After all, it’s in learning to be wrong that we can learn to be right.
How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?
I developed my countercyclical strategy in large part because I am obsessed with the behavioral side of asset management. A systematic contrarian approach takes the behavioral side out of things. When you invest systematically in a contrarian strategy the behavioral problems that so many other investors confront are not a problem as you’ve created a system specifically designed to hedge against your own behavioral weaknesses.
If you’d like to share, how has the last five to ten years been for you investing wise?
I’ve been lucky over the last 10 years. I’d argue that the key driver of that was my macro focus on understanding the bond markets. By not getting scared out of long-term bonds over most of the last 10 years I have continued to generate returns that, on a risk adjusted basis, are not too shabby. I’d further add that my generally optimistic macro outlook since 2010 has served me well. I can’t say if it’s luck or skill though. Maybe a little bit of both? But I attribute it more to process than anything else. I’m no smarter than anyone else. I just know myself well enough to implement a strategy that hedges me from, well, ME. Having a systematic plan has always served me well.