Do Valuations Matter?

But what exactly should we do with that information. We'll get into it with the founder of an investment management firm that focuses on dynamic index investing, and he's done on some really interesting research into exactly that topic. But first, vill Donna, I need to know, uh, now that the Buffalo Bills are out of it, who a you're rooting

for on Sunday in the Super Bowl? Well, I'm I'm rooting for are the Bengals because they're like, yeah, of course you have to root for them, like they're the underdog. Maybe I heard a rumor you had a lot of money riding on the rams though, is that true? I have a whole twenty dollars riding on the rams. But remember last podcast we talked about how I'm so bad at predicting who's going to win, and I just go by intuition. Yeah, that's why I'm betting on the Rams,

because that means that the Bengals will win. It's your kind and then if if they lose, you, you win bucks. You kind of hedged. It's like a good hedge. Yeah, and I think I win like a hundred bucks or something. Yeah, something, some one of those new you know, FanDuel Draftking type of things that are legal in New York. Now, one of those one of those type of things. Okay, But because because because I'm I'm betting on l A, it means that the Bengals will win. It's it's an official app.

You're not with a buckie name Lefty somewhere and uh, all right, fair enough. Well, I'm super excited for this week's guy. It's just a fascinating career on Wall Street. So let's get into it. I I'd love for you to introduce him. What do we know about this guy? I am too, I'm I'm really happy that he can join us. His name is Victor Hagani. He's the founder and CIO of ELM Wealth, and he is talking to us from Wyoming. So thank you so much for joining

us this week. Thank you great to be on the show. Yeah, thanks Victor. This might be our first Wyoming based guests. I don't know if we've had anyone in Jackson Hall. Very very exciting, but Victor, Victor, like I said, what a really fascinating career. Um, I feel like you've sort of lived through some of my favorite finance books. You know, you were at Solomon Brothers in the liars poker years. You went on to a long term capital management during the one Genius failed era. What a trip, and now

without partners. Just give us sort of a synopsis of your career. I mean, I feel like you sort of took the long scenic route into index investing if if that's a right way to phrase it it. Just give us sort of the brief highlights of your career from from Solomon's where we are now. Sure thing. Yeah, I think that's a good description along scenic route. Although you know, studying finance at university, you know we're kind of taught that owning the market portfolio is the right reference point

to start with. Anyway, I went to the London School of Economics and after that I got a job at Solomon Brothers and bond portfolio Analysis, the group led by Marty Lebowitz, and I worked for Bob Coprash. Eventually I was invited to join a trading group out on the

trading floor, John Merryweather's Government arbitrage group. I worked there, and when John and some of my partners from the arbitrage desk went to set up l t c M, it was right around when I was getting married, So I got back from my honeymoon and left Solomon and joined ltc M and stayed at lt CM through and stayed beyond that to both the help liquid a all of the positions that the consortium of banks took over, and then to help with my partners founding a successor

firm that kept some of the positions and tried to continue doing relative value trading in a sort of updated manner. And since about two thousand or two thousand and one, starting at that time, I took a long sabbatical of about ten years and spent a lot of time with my family, my young three children, and and did a lot of thinking and researching and catching up on different things. And and then eventually in two thousand and eleven, I started ELM Wealth, which is a wealth management firm that

tries to help people with low cost, diversified investing. And it was really based on how my own approach to investing had evolved after the Solomon and LTCM years and the beginning of my sabbatical years, when I was investing in hedge funds and private equity, and I kind of decided to really get back to basics and to get my family's savings invested in index funds as the main vehicle.

And I realized that that that decision was really the beginning of a number of decisions that needed to get made. That it wasn't enough to just say I'm gonna index, you know, you needed to decide, well, how much equities do I want, and how much US and non US, an emerging market and all these different things, and and you know, I realized that people needed help with putting their portfolios together, but that it should be very very low cost. It should be a very low cost product.

And so that was really how ELM Wealth started back then, with a bunch of my colleagues being the first clients. And you know, now after ten years, we have about one and a half billion of assets and three hundred clients that are are investing family and you know it's great, Well,

well one part I'll throw in. Their Alum has my favorite investment company website ever, because not only can you read a lot of good writings from Victor, but it's got a game on there where you flip a coin and the coin has a sixty probability of being heads each time, and you start with twenty dollars. You get ten minutes to flip the coin as many times as you can and bet as much as you want of your bounce. Victor, I was up to like ten grand on that thing by the end of my ten minutes.

I assume you pay out on that, right. We did pay out on that we you know, originally that's what

we did. We did it for real money with quantitatively trained mostly young people that were either you know, in university or in uh Wall Street firms, and we did give them to start and we paid them out real money based on their winnings after half an hour and we and if they got we we were gonna we had a maximum pay out and so if you got close to that, we would say you're close to the maximum payout of two fifty you know, you might want to bet accordingly, you know, sort of into the end.

So we didn't pay anybody ten thousand, but we paid a bunch two fifty dollars. And it was an amazing experiment, and it really got us thinking that there's not enough said about investment sizing right. I mean that everything that we hear about in the media and so on is about what to invest in, what's going up, um, what's

going down, what's going sideways. But we need to get the investment sizing decision right to In fact, you know, if you think about those two decisions, if I get the choice of investments wrong, but my investment sizing right, I'm gonna be okay. I mean, I'm not gonna be happy, I'm gonna lose money, but I'm gonna be okay. If I get the investment choice right, I choose the right things to invest in, but I get the size wrong

on bust. And you know, in some ways that's the story of LTCM, because you know, when we went down plus percent, there was a broad feeling that the investments that we had in the portfolio were good investments, and that was born out over the subsequent few years when most of those investments, you know, bounced back to being good investments. But we had the size wrong. And so even though we had good investments, you know that when you have the sage on. So think about the U

S stock market. I mean the last hundred and twenty years, the U S stock market, I don't know, has gone up nine let's call it nine percent a year. Right, So let's say you know you're sitting there a hundred and twenty years ago, and you knew that it was going to go up by nine percent a year. Well, if you were greedy, you might say, oh my goodness, you know, I want to really get rich. So you might have wanted to own as much of it as you could. Let's say that you were leveraged three x

or something like that. And if you were and if you kept yourself leveraged at three x, there were a couple of times when you would have actually gone bust or I don't know, three or three and a half x something, depending depending on exactly how often you were rebalancing your portfolio. But there was a certain amount of leverage. Even though it's like the best investment ever, you would have lost all your money and you would be bust today.

But if you invested, you know, the right size in it, you would have whatever was a forty x or something, uh from then until now, or it's a it's a fascinating point and that the questions at the end of the game were I think even trickier. And and now I get it. I kind of got it. I thought it was more about risk tolerance, but sort of same same side to two different sides of the same coin, I guess. But I almost busted out on the first flip.

I think I bet twentys on the first flip, so I am almost busted out, but at with ltcm of course. And it's it's the size in two different ways, the size relative to how big the market was too. I guess. You know, you guys were sort of the original whale as they as they say, uh these days, I guess yeah. I think in some of some of the positions, you know that they were positions that people were worried about what the impact would be when liquidation, when and if

liquidation was going to happen. That's right, And Victor Mike is right in that your website has so much research on it, so and I tried to read a bunch of it, so I might be mixing some things up here,

but correct me from wrong. I think you wrote a piece for Bloomberg last year and you said huge gains and things like Tesla, and I just checked because I put really behind me and I couldn't remember if seven was its actual gain for But you had said that that that games like that is sending the wrong message to individual investors, and so I wanted to ask you and the research that or the game that Mike just mentioned, I think was also part of that article that you wrote,

But so I wanted to ask you about that and also the sell off that we're seeing in some of those names now, especially in some of the meme stocks, or any of those names that had run up just so so much over the last two years. Yes, I mean the you know, it's all it's all related to

each other. I mean the the coin flip game, you know, really helps us to think about sizing in a you know, sort of on a blank slate, because you know, when you're thinking about how much should I have in the stock market, well you might say I should have or so it's kind of like almost within a range to

begin with. But when you've got this coin that you're flipping, and you could put all of your money onto one flip, then um, you know it's it's it's more of a blank slate with the full opportunity to to do well or to hurt yourself based on sizing. The main message of the whole thing is that when you're trying to figure out how much you should bet on something that's good, how much you should invest on something that you believe is good, that the objective is not to make as

much money as possible. The objective needs to be to maximize your utility. And and I know, you know, going this is now taking us into an economics course or whatever, but it's not. I mean, it's just that the more money we have, the less that it's improving our welfare at the margin. Right, So, um, there's this. You know, there's a curve that would be a concave curve. That's as our wealth goes up, our happiness or our utility

is going up, but it's going up more slowly. And this is what makes us makes normal people risk averse that word kind of self regulating. The more that we have of something, the less we want that additional unit of it. And so winning is good. We want to win, but losing is kind of worse than winning. And this is a classical economic idea. It's not uh, it's it's not from behavioral finance or anything like that. I mean, that is why we are and should be risk averse.

And it's an idea. You know, it's been around for hundreds of years, so you know, so when you see people that are going all in on things that are super risky, it really is hard to make sense of that. You know, based on a typical or a sensible set of preferences with regard to risk aversion. And you know, the more attractive that something is, the more you should

want to have of it. Right, So if if in the coin flip game, if we had made the coin seventy instead of a sixty forty coin, you should have wanted to bet more on each flip. Then if you know, then then if we're sixty forty, if the stock market is offering higher expected returns relative to the safe asset that you would be invested in if you weren't invested in the stock market, then you should own more of

the stock market. But sometimes people just get a little carried away and are taking on so much risk that that the probability that they will lose money gets to be very high, even though they're expected gain in monetary terms is very high. But they're doing something which is not, you know, necessarily in their best interests. Of course, we can always say whatever somebody does, by definition is in

their best interest. But I think that we can sometimes talk to people about a framework and they might look at things differently and change what they think is in their best interest. In fact, I wanted to get back to that UH what I talked about in the introduction there this paper you and your colleagues have out about tape. You know, the cyclically adjusted price earnings or if you

prefer the inverseity cyclically adjusted UH earnings yield. You know, all the research shows that, you know, if the PE starts getting higher and higher, your future return expected returns get lower and lower. Your research showed is that UM trying to allocate along those lines doesn't seem to work on a sort of simplified level, that that you sort of a static allocation through all the valuations would would

have done better. UM can correct me if I'm bungling the the research there, but but then you took a step further to figure out, well, how how should we be using sickly cyclically adjusted valuation measures like this? So so walk us through that paper and what the main findings are. We we haven't we haven't published it yet, but it's forth it's forthcoming. We've been getting comments from friends and some academics, and that's what you said, is exactly right. That first of all, CAPE or it's a

little it's even nicer. Rather than thinking about the price to earnings ratio, it's nicer think about it as the earnings yield, which is just one over CAPE. And the earnings yield is a decent you know, it's not perfect, but it's a decent predictor of the long term real return after inflation, that that you should expect to earn from owning a diversified portfolio of equities. And that is

the case. You know that that predictive power has been uh there for the last hundred and twenty years in the US, and it's also existed in non US markets, and it just makes logical sense. It's based on the idea that a company, if a company paid out all of its earnings every year to its investors that it could keep its earnings level with inflation and paying out all of its earnings. If it doesn't pay out all of its earnings and keep some of them as retained earnings,

it can actually grow its earnings faster than inflation. You know. So it's just but the basic model is just saying, well, if it paid out all its earnings, could it keep up with inflation? And you know that's the underlying idea and why it seems to be the case. So when we look at the last hundred and twenty years, we see, wow, when the earning zeald was around four oh, the next ten or twenty years, equities delivered about a four percent return over inflation when the pe was sorry, when the

earning zield was seven and a half percent. You know, on average, you got around a seven and a half percent real return above inflation from holding equities for a long time. So you would say that's wonderful. So now all I need to do is just own more equities when they're going to give a higher return, own less

equities when they're gonna give a lower return. And I'm gonna do better than somebody that just does a static allocation of always being say sixty percent in equities in thirty five percent and say treasury build and you would think that that is what you would find. But when you run the numbers, you don't find that. I mean you you find that over the last hundred and twenty years that that extra information from the earning zeald didn't help you. And in fact, over the last twenty years

it's been really terrible. It would have had you very underweight equities because the earnings yield has been relatively low. I mean today the US earnings yield is in the percentile of bad, and so you would not want to own very many equities today based on that rule. But what's happening is it's missing the it's missing a critical component. What is it that you should be investing in if you're not investing in equities or what should you compare

those equities too? Well, you might say I'm going to compare it to bills because I'm either going to be in bills or I'm gonna be in uh in equities. Well, if you're going to do that, then you need to think about what's the expected real return of owning bills. You can't just say I'm gonna own this based on its expected return, or I'm just gonna own that without thinking about his expected return. And really what we should

be comparing is more apples to apples. You know, either equities that hopefully we'll deliver this long term real return including a premium for the risk we're taking, or something else that gives us a safe, long term real return. And that thing exists, and it's tips. It's it's US inflation protected bonds called TIPS, and they've been around since Unfortunately they haven't been around for a hundred and twenty years.

If they had been, I'm sure that the research that we've done in the understanding of this would be just second nature to everybody. But TIPS is still a little bit of a weird little corner, you know, like a lot of people haven't even heard of them exactly. Or it's like or those those I bonds that you can

buy at the post office. So what we did in our research, as we said, well, what if now we did this apples to apples investment program where you were either invested in equities or in tips, depending on the spread in expected return between the two. So let's take the earnings yield of equities minus the yield the real yield on tips, and we'll call that the excess expected

return on on equities or the excess earnings yield. And let's do our allocation according to that, and will either be in equities or will be in tips, depending on how attractive that is. So back in, for instance, amazingly and partly this is because the U S tips market was so young. Tips were yielding four four percent above inflation and US equities back then it was sort of a pretty uh builliant time for equities. The earnings yield

was around four percent. Why would you want to own equities if they're expected long term return it's four percent, But you could buy tips and get four percent. Well, there might be some reason is to own a little bit of equities, but you wouldn't want to own a lot. And sure enough, that was a really good decision ex post. But it made sense. It's not just it's not a cherry picking thing. Just makes sense. Right. And over the last few years, right, tips have been negative, I mean,

which is really weird, etcetera. But you know, in the real interest rate has been negative because inflation has been relatively high and expected to be high compared to what we can get on on treasuries. And so even though the earnings yield has been really low, uh, the spread between the earnings yield and tips has been pretty high. And so it made sense on that basis to continue to own a healthy amount of equities. And so then you say, well, okay, you know that's just that's really

a short time. What twenty five years, I mean, that's a really short time, and it's is super short when you're thinking about this stuff. So we said, well, what would it look like if we went back to Well, there's no tips, So we said, well, can we try to make believe, you know, figure out what Tips might have been trading at going back? And so in our research paper, we we did that. You know, it's far

from perfect. I mean, who knows where they would have traded, but we've made some guesses based on the information that

existed at each moment in time going back. And then we ran the analysis all the way back and you know, just as from until today it was a good way to invest your money, it was also good from hundred to So that's really the research paper and a nutshell, and it's really just based on this idea that the high all else equal, the more you expect to earn relative to your safe asset, the more exposure to take. And is right back to the the whole coin flipping,

the whole coin flipping exercise as well thell doanta. Every time Victor said, going back a twenty years, I was bracing for you to make a joke about you were thinking about your child, that's what. Yeah, that's when I was in high school or something. Yeah, but Victor, I could bottom line all that, Um, it sounds to me that with real yield still negative, it still makes sense to be sort of, you know, aggressively exposed to stocks. Is that is it as imposed that? Yes, I think

it is. Yeah. And and non US equities, um, you know, are are offering much higher have a much higher cyclically adjusted earning zeal than US equities. I mean that's a really interesting topic, worthy of its own long conversation. But so global equities are even more attractive than just US equities, So the whole world combined is even more attractive. And yes, you know that that the excess expected return is UH is pretty nice. You know, it's it's it's healthy. I mean,

it's it's really healthy. I mean, get an extra getting an extra five percent for taking equity market risk feels okay, you know, I mean, you know these are imperfect estimates. You know, the earnings. The one thing you know that is not going to have up been is uh, the you're gonna earn five percent. You know that's not gonna happen.

You're gonna earn six three, you know something. But you know that's our expectation, and we have to make our decisions based on, uh, you know, the expectations based on the distribution of outcomes, and you know that summary statistic is useful in combination with the risk. So Victor, obviously, I've been talking to a lot of people about the recent valuation reset that we've had since the start of

the year. So I wanted to ask you how you're thinking about the about a volatility that we've seen, especially when we have some people comparing, you know, making comparisons to two thousand eight or two thousand Well, you know, our perspective is to look at the broad market, and you know, the broad equity market, uh, globally and the US have been more volatile than they had been for much of the second half of two thousand and twenty one and more volatile than they are, say, on average.

But the performance in January, um, you know, it was a down month for US equities, it was a down month for global equities, and it was a relatively large down month, but it wasn't huge. The real story, the real you know, amazing stuff that's going on right is this rotation that's happening within the equity market where low price to book stocks have been doing so much better than high high price to book stocks or high price

to earnings. You know, growth stocks have been underperforming in particularly like certain sectors of growth stocks have been really underperforming value stocks. And that rotation, you know, has has been really dramatic. Um. But you know, we don't have too much that we can say about that because all right, you know that I don't have a great insight into the whole thing, because yes, it's been very dramatic. But you know that I find it so much easier to, uh,

you know, to to look at the broad market. It reminds me of my dad. I guess this joke is probably in many different cultures, but my dad was Iranian and he always loved this joke about this character named lan Astradin and he was looking around his house and his wife said, what are you looking for? And he said, you know, I I misplaced my wallet and she said, well, where did you lose it? And he said, well, I think I lost it in the barn And she said, well,

why are you looking for it here? And he says, there's no light in the barn. You know, I got to look for it here. You know, I can't see anything in the bar and started. So, you know that's how I feel that. Um, you know, when we're trying to think about investing, I want to look where the light is, where I can see a little bit what's going on. I think it's you know, for me, it's too hard to look at individual stocks. That's a really

tough thing. You know, that's a specialist thing to do, and there's lots and lots of capital and people that want to do that and are good at doing that. I want to look at these broad indusseries where I can have a better idea of long term expected return. And when it comes to you know, these different sectors and all of that, it's so difficult to have a view because it's like these things anything can happen, you know, within individual companies and within sectors you know as well.

So it's been really dramatic, but you know, from the broad market it's been more um, you know, a lot more tame. Still pretty painful, but tame. Yeah. I want to follow up on that Victor because I wanted to ask you about that. You know, people talk about how twenty was the year where every chart we like to look at was you know, basically ruined for life. You know, we we've never seen GDP contract the way it did

and then bounce back the way it did. You know, we've never seen some of these things that we saw during the pandemic and the aftermath. Does that sort of coming out of a situation like that, does that kind of affect your confidence in this academic approach you have to markets or does it make you believe in them

even more? That you know, his tree is somehow going to get us, you know, through this sort of unprecedented error that that we're we we've been through, you know what I mean to me, I almost it seems like a little bit of being risk averse makes sense in this environment, just because we're coming through uh, such unprecedented and at times, dude, does that plan you're thinking it all just sort of you know, the year where every

chart was was ruined by just COVID anomalies. I think that the the tendency to look at what's happened in our near term history is can lead to insufficient amount of concern and and worries about the future. We have come to the edge of the precipice a couple of times in our recent memory, I mean two thousand and two thousand eight, two thousand nine, the pandemic. These were points where we came to the precipice and we were

about to witness permanent destruction of capital. And then it came back at the last moment, mostly due to government intervention and printing of money and support and uh. And of course we saw the precipice and went over it, you know, in the nineteen thirties, um, where where we

did see that destruction. So you know, I think that, um that that if anything, you know, two thousand and twenty uh and two thousand and eight nine can kind of give this wrong to me, can give this wrong message you know, of buying the dips, of everything's gonna be okay, of even and and this is kind of an interesting thing. You know that within academia there's a lot of debate about what they call the excess volatility

of equities. It's kind of like the economy and and aggregate earnings are not that volatile, are much less volatile than equities are. And so it seems as though what's happening is when equities go down, it's a result of two things. One is that people are more negative on the future of the earnings. You know that that earnings growth and earnings just the real fundamental cash flows are

going to be lower. Fine, that's one thing. But the other thing that tends to happen when the market goes down is like that the discount rate goes out, the expected return is higher. So it's it's a combination of those things. And so if we kept if somehow the market kept the same discount rate, equities would be a

lot less volatile. And and that's really you know that I think we have to be careful about putting too much faith in that because at the end of the day, markets do can and do and have gone to zero and never come back. So you know, like the discount rate could get really high, but all of a sudden, it's like that market's gone, you know, and so the Russian market, the Chinese market, other markets have really got

an individual companies. That happens all the time. But even broad markets can go to zero row and then they just they're absorbed. They're absorbed there in the academic speak, you know, I guess different people get different messages out of it. Like, you know, somebody could look at two thousand and twenty and say, wow, that's really scary. That's that's what I think, because we didn't go over the precipice, but we almost did, and we have to realize that

we could have gone over. But other people could look at it and say, oh, everything's gonna be okay. I mean, that was nothing, you know, look at that, you know it was it was actually a good year, but we were almost over. We could have gone over, and we didn't go over, but we could have gone over, and so we should be reminded of that. So I'm certain

I'm agreeing with you. I think different people have taken both of those lessons that either it's scared the heck out of them and they're staying scared, and that's good because this stuff is risky, or it's like, oh, you know, by the dip, don't worry about it. Just well, so Victor, for the listeners who I feel like there's a cohort of listeners who are waiting patiently thinking, just tell me what to do with my money right now, Victors. So

it's to me, it sounds like you're you're bullish. You know, I would have a bullish allocation of stocks, and and perhaps even more so the rest of the world versus us. Is that fair? The first thing that the investor needs to do, I think the investor needs to look in the mirror and really know himself for herself, you know. I think that the what you should do is really

a function of your makeup and circumstances and everything. So what I would say is, if you look in the mirror and you see in the mirror somebody who is a long term investor, somebody who's thinking about the long term, saving and investing for their retirement and for later in life, and you know, and and somebody that is um is willing to be patient and disciplined and kind of boring

in how they invest. If that's what you see when you look in the mirror, then I think, yes, owning a healthy fraction of equities for the long run probably makes sense for for you with it if you have a typical amount of risk, aversion, etcetera. I think that

makes sense. But if you look in the mirror and you see somebody who's like, you know, who wants to make twenty percent a year and is like just reading everything to find out, you know, which coin they should invest in or which meme stock or whatever, and that's what your personality is, then don't do that because well, I don't you know. I would say, try to change yourself. But if that's what you see in the mirror, you know you're not gonna be happy with this sort of

boring long term allocation to equities. The coin flip experiment again is really interesting in this regard because what we found was that people would play it and they would

do poorly on it. You know, very few people or not enough people made the twitter and fifty dollars that everybody should have made a sensible strategy of like betting ten percent on each flip or team percent on each flip would have given you like a ninety eight percent chance of getting to two fifty dollars in walking out of that half hour at a very good with a very good reward. But they didn't play it like that, and they didn't know and they were under pressure, et cetera.

So there's all these reasons, but they didn't play well. Then we talked about it afterwards, you know, we were it was like in a class A lot of it was in a classroom, we're meeting room whatever, so that we talked about it, and we said, these are why, these are the reasons, this is how to think about it. These are the reasons why a constant proportional betting makes sense for most of the game. You know, you shouldn't been on tails obviously, all these different things we talked

about it. What we found was that, um, if we let people play again and some of the people did want to play it again, that they just all sat there and clicked away, you know, at fifteent per hand and just did that got to the two fifty. We didn't pay them anymore. But but but they got the message right. But the problem is that it's cool to sit there for off an hour and just keep clicking at bet each time, But try doing that for forty years.

Try being disciplined and boring for forty years and not saying, oh, the next one is gonna be heads, I'm gonna bet on that, or the next one is gonna be tails, I'm gonna bet on tails. I had my mom play the game for free, and I looked at her betting pattern and I said, Mom, you bet on tails And she said, you know, I knew I wasn't supposed to do that, but I just couldn't help myself. I just had to see what would happen. So it's it's really

hard to be uh discipline. It's even harder to be a journalist, and uh, you know, I think it was Jason Zwagas said, Oh, it's it's really hard being a journalist and giving sound financial advice because it's so bloody boring and just it's the same thing. He says, he's written the same column every year for but he's, well, he's shown that it's you can do it. You know you can. It is possible to be interesting and to keep going. But but anyway, so so that's that would

be my advice for long term investors. You know, you know, have a healthy allocation to equities, own some tips, you know, as well, don't you know? I think the tips are less risky for us then treasury bills are. Even though the price of tips goes up and down, it is giving us a real consumption, you know, it's giving us something of a real hedge of consumption. Yeah, they're yield is terrible right now, but you know who knows. I mean, they could go down or up. It's a you know,

it's a market. And uh, you know, I think that owning some tips is probably an okay thing too. And and if tips get back to yielding a couple of percent above inflation, that would be great. You know, I think we'll all be happier than Bill do. I think Victor's mom's strategy of betting on on tails explains the higher cryptocurrency market. What do you think? Well, I like a victory that you added in there that she played for free. Actually, if my mom were playing for money,

she probably wouldn't have been on tails. But we can't let you go. I want to ask you about, you know, the luck factor versus the skill factor and investing. And I know one of your most more famous papers is titled What's Past is Not Prologue, where you suggested that even if you look at two decades of performance, it's not enough to fully distinguish a fun manager from anything other than average. So can you talk about that, and can you talk about how you differentiate luck from skill

and investing? Sure? So, um, you know, there's definitely we definitely are programmed behaviorally to extrapolate the future from a statistically insignificant amount of data. And you know, there's all kinds of reasons that, uh, you know, cognitive and to say that we developed that way. So we did an experiment. We love doing these different experiments, and we did this experiment where where we asked people, imagine, um, you have two coins. Somebody is giving you two coins to flip.

One of them has a sixty chance of landing on heads. The other one is a fifty coin. But we won't tell you which one it is. But you can flip them if you want. You can flip them a million times, But tell us how many times do you need to flip them, sort of the minimum number of times that you need to flip them both and count up how many times they've landed heads and tails to have a confidence that this is the coin that's sixty and that's

the coin that is. And again, you know, like we when we are our readership are kind of quantitative financing people. You know, some of the people kind of gave the right answer, but we also as people to just answer it based on their intuition and not to do the calculation. And and and a lot of people thought it took you know, ten flips, you know, with ten flips you could tell or fifteen flips or twenty flips. Well, the answer is a hundred and forty three flips or maybe

a hundred and forty one. I think a hundred and forty three flips. I never would have guessed that, you know if you had asked me, is that nobody guesses that just you know, like a hundred and forty You have to do that thing a hundred and forty times to be that confident. I mean, I'm starting off fifty you know, like if I just choose that coin, I've got a fifty percent chance of choosing the right one.

But I've got to do a hundred and forty. So that's like an illustration because if we're thinking about active managers versus the index and index investment, that an active manager is going to be more like a sixty forty coin, you know, relative to the benchmark. But if he's not a good active manager, he's like just fifty fifty. You know that that he if it's just a manager, was like just flipping. You know, he's just throwing darts at

the wall. He'll be more like, in fact, he'll be worse, which I mentioned at the end, but let's just say who would be. And so what that tells you is you need a lot of data. You know, the world is not like coin flips that you know that when you by the time you get a lot of data on your manager, he's not even the manager anymore. Somebody else or he's not. I mean, you know that I'm not the same person that I'm gonna be ten years from now, you know, we you know whatever, No no

man steps in the same river twice. So yeah, I think that that was kind of the the the idea there was to both show the statistical power of of these things, you know, which is very weak, and and also to show us our behavioral bias, you know, to extrapolate from too little data. But on top of that, you know, if we're just talking about active versus passive,

I don't know if you've come across this. Bessem Binder Hendrick bessem Binder is a academic professor from Arizona, and he's done this research where he looked at all US equities and even though as we know, US equities outperformed treasury bills by like six percent a year over the last hundred and twenty years, he found that significantly more than half of all US equities have underperformed treasury build What that tells you is that if you are, if

if you are an active manager holding a concentrated portfolio of stocks, that a concentrated portfolio of stocks has a higher than fifty percent chance of underperforming an index because of that concentration itself. You know, it's it's like a

volatility drag phenomenon. So when you know that that somebody's gonna concentrated portfolio that is riskier than the broad market, you know, if they were just throwing darts, you know, if they had no skill, there's more than a fifty percent chance before fees and before transactions cost, that you would underperform the index because of this volatility drag. And then you've got fees, and you've got taxes, and you've got transactions cost and the whole thing is a bit

of a mess. I don't know, dot all. This talk about coin flips has me interested in the biggest prop bet of the Super Bowl at all. You can bet on the coin flip at the opening of the Super Bowl, so you might want to get in on that. Put put twenty on heads, which I think has has become popular thanks to what happened to the Buffalo bills. What happened refresh my memory to happen to them? No, no, don't do it, don't go there. Sorry, tiden up your

straight jackets. It's time for the craziest things we saw in markets this week? Well, speaking of knowing something, Bill Dana, I think it's that time to know what your craziest thing you saw in markets was this week. Let's hear it. I think I have an idea what it's going to be really good transition. Yeah, thanks, I think I think you might not know. But first, I had a submission come into my Twitter, which, by the way, I noticed, nobody send you submissions. They send them to me. I

get some, I get some first. I always forget about them, though I do. Anyway. This one is from and I really hope I pronounce this correctly. I even asked him how to pronounce it. But his name is Brian reich Cough And he sent a message that said fixed income feels a bit boomer compared to crypto, but it's wild. And he shared a tweet which actually was from last week. But somebody pointed out that equity investors, especially in the US, could be forgiven for thinking that the most important events

of the last forty eight hours were Facebook and Amazon numbers. Wrong. It was the six sigma move in European rates. The bond boogeyman is coming to an equity market near you. So I wanted to share that one, even though it was from last week, and just remind everybody that if if anyone sees anything weird, you can send it to my Twitter, not Mike's mine. That's a good point, Victor about this, the velocity of the move in rates. I feel like that is makes you have to rethink your

allocay a bit more frequently than you would otherwise. Or or what does the that sort of rate of change in yields that we've seen give you any you know, give you the spins at all? Does it? Does it make you you know, want to reallocate more than perhaps you would otherwise. No, I mean I think that, you know, keeping an eye on your portfolio once a month or once a quarter is not bad. I mean, you know, I think that if we if we moved sort of

in a straight line. Let's take us Tips for an example, So tenure, uh, Tips were trading it like minus one percent around the end of two thousand and twenty one,

and now I think maybe we're around minus half a percent. Yeah, I mean, I think that if if Tips went from minus one percent, you know, all the way up to two percent over a couple of months, you know, it would be a shame to have missed out on the opportunity perhaps to have reduced your equity allocation as that was how spending, assuming that equities did not fall as much as would have been called for by that increase

in in real yield. You know, you're right that the that the velocity of changes in everything, I mean, every everything has sort of got this. I mean the markets, you know, I don't know, over over time have sort of developed into this not much is going on, and then boom, you know, they make these big moves, and you know that they've become much more in in my feeling.

You know, they're much more discontinuous than they used to be, which I think might have to do with uh, they're just being much less market maker capital relative to the size of the market than there used to be. But I don't know, I'm not sure about that. Less of a shock absorber built into the system. I guess I think there's less shock absorber from from that, I'm not that worried, you know, I think that you know that.

Another I guess the reason I'm not that concerned about it is that when interest rates go up, if equities don't move at all, we'll want to reduce our equity allocation. But you know, when interest rates go up, equities are going to go down somewhat, and when you look at the whole thing, you're gonna want to reduce. You know, maybe you were you were at se and equities and you might want to reduce down two sixty four percent

and equities or something. It's not you know that that you know looking at it, even if you're looking at it every quarter for for our business and for the clients, you know that where we're managing capital, we're looking we're rebalancing their portfolio every week. We also have a risk indicator in the form of momentum that we're using to underweight or overweight in conjunction with with excess earning ZEALD. So you know, we're trying to stay on top of

all of that. But for individual investors who are men who are self managing, uh, you know, these long term investors that are looking in the mirror and seeing themselves as long term investors, it's it's okay too, it's you know, I think that you're okay doing this stuff. Looking at your portfolio once a quarter is fine. I think. All right, Victor, how about you? You see anything crazy in markets this week? Well that was a good one. That who that wrote

into bil donna Um. You know. The thing that just amazes me is what's going on in the options market in the US. Options trading in single stocks now is as big as trading in the stocks themselves. So we always thought of options as the derivatives, you know, but at these kinds of volumes, you're wondering which is the

real and which is the derivative. So we're getting I don't know, four five hundred billion dollars of options or trading every day, and that's about the same amount as is trading in the in the stock market in individual names. Even more remarkable than that is like one third of all of the options trading is in TESLA. That's amazing. And then amazing beyond that is like eighty percent of that trading is in options expiring out to one month.

So you know, it's really I think that there's I think there's no doubt that the securities markets are also functioning as a as an outlet for um for the same kinds of demand that take people to Vegas or or a c You know that there is a gambling. There is this sort of almost you know, risk seeking kind of behavior that we're seeing manifest itself in the securities markets, in the coin markets. You know, I think

it's uh. I mean, you know, look, Americans are spending I don't know, eighty billion dollars a year on lottery tickets, and and I haven't bought any I bet you know Bill Donna bottery lottery tickets recently, right, so, so, so like eighty billion dollars a year on lottery tickets. I think that's I'm not sure, but let's call that two fifty dollars per person, but the three of us haven't even bought any So there's some people out there that

are spending thousands of dollars a year on lottery tickets. Now, you know, these are just you know, mysteries. You know that that academic finance has not really explained this. These are mysteries, but they're also kind of um, I think that they're also problems. You know, I think that I I think society, I think ours we would have less inequality. I think we would have more wealth, you know, general welfare of everybody. You know, I mean, it's kind of

remarkable to me. And you know, that's seventy or eighty billion dollars pales in comparison two people buying and selling one week out of the money Tesla options that the Yolo effects, like what what what crazy happened recently? It's like, what what's happening? That's not crazy? It's gout and suffered to find h we'll have to change it to the

most rational thing I said this week. But it's a it's an excellent point, and I think we're all trying to wrap our heads around sort of the tail wagon the dog effect of it all when you have you know, everyone's talking about gamma hedging as being the main driver of a market on any given week. It's it's uh strange times and deeds. All right, I'll give you my crazy thing. I'm gonna take you both out of your comfort zones though, and get into the private markets a

little bit. And as you know, the term unicorn uh is refers to a private startup company that gets a valuation of one billion dollars or more in private markets before before they go public. Business Week kind of story talking about the whole unicorn phenomenon. And you know the reason they're called unicorn is because that that at one point was considered such a rarity to have a private company get that sort of valuation. You start up to

get that sort of evaluation before going public. So this Business Week story lists gives an account a number of the total number of unicorns out there currently. And vil Donna, you'd be smirking had you read this story. Usually you've read the story I'm referring, and I can tell you you have read Okay, so you know the answer, right. Well, let's see if we'll quiz Victor, Victor, how many unicorns do you think there are out there in the world today. Sorry,

it is it. Did you say it's private or yet private? Private? Yep? Private private companies? Uh. I think embedded in the definition is the notion that they're they're sort of a startup, some somewhat new. You know, you wouldn't consider say a you know, a private company that's been around a hundred years, but a startup that's a few years old that's worth at least a billion dollars. How many you think I'm going to embarrass myself? Can I can? I give the answer?

It's a thousand. I couldn't believe it. I couldn't believe it. The best quote from from this article is somebody said, when you have a thousand unicorns, that's almost an oxymoron. I love that. That's incredible. So a trillion dollars in unicorns, it's it's it's unbelieved, but it's it seems to me that, like suggest there's some sort of lopsided nous between the

private and public markets that needs to resolve itself. I don't know, it just seems like they're I don't know why, but there's so much money slashing around in those markets. People think they have an edge. I guess, I don't know. I don't I don't get it. I'm certainly out of touch. Elm Elm is not investing in the private market. I couldn't believe it either. That's why I brought it up. I never I never would have guessed that many. I

wouldn't maybe said, I don't know. Seven sounds about right, A couple of couple of hundred tops, but a thousand unicorns pretty amazing anyway, Victor, fascinating conversation. Really appreciate your time, and I hope, uh we can get you back next time. You've got some some hot off the press research. Even though this research isn't even on the press yet. I think it's it's pre press hot off the typewriter. I guess, yeah, yeah, we'll get it. We'll get it up on too ssr

N and on our website soon. But you heard it, but you heard it here. You've heard it here first. And I encourage everyone to go play Victor's coin flip game. It's a lot of fun. Thank you for joining us. Thanks guys, it was really a pleasure being on. Thank you very much for having me. What comes up. We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website or app, or wherever you

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