Pin the Tail Risk on the Quant

get creative next time. Yeah, next week. But anyway, this week on the show, worries of a so called second coronavirus wave are growing, and questions over the pace of the economic recovery abound. With stocks now trading at pretty expensive levels, how worried should you be about a fast turnaround? Our guest runs a tail risk et that game your thirty percent back in March by investing in out of

the money put options. He share his thoughts, and as always, will close out the episode with our tradition, the craziest thing I saw in markets this week? Uh? And if you saw something crazy by all means, give us a call on the podcast hotline and leave a voicemail. The number is six four six three two four three four nine. Oh and maybe we'll play your voicemail on the show, Sarah.

I actually, I don't know if you realize this, but you cut me off before my crazy thing last week, Um because we were going we were all going too long. I think you've droned on a little too long and had to cut me off, which is fine, Which is fine. So that means you have too this week. That just fun because I couldn't find one this I saved up last weeks for this week. Okay, well, I apologize about cutting you off number one, but it betould be really good.

I think it was actually Cameron His craziest thing lasted like it could have been its own podcast of talking about the box options in in I'll have to go back to listen to it. But anyway, very happy to have uh the guests on the show this week. I think a lot of listeners have probably heard of him. He's a very prolific writer, has written several books on the market, a lot of really interesting columns and blog posts. On top of all that, he's actually the co founder

and chief investment officer of Cambria Investment Management. His name is meb favor meb. Welcome to the show. Great to be here, you're all thanks for having me, dad, fellow podcaster. I know a little bit of competition here, uh in podcast land. But Sarah met maybe smarter and better looking than me, but he doesn't have a hit millennial charming podcast co host like like me. So no, no pructure. But I really need you to lay it on thick this week. All right, well, we'll try it out. We'll

bring our best. Well, but let's let's start with talking about that notion of tail risk and and the Cambria tail risk ETF. Boy, this is the year, I think, when a lot of people realize the value of tail risk hedging. UM. So I'm curious just to hear sort of how you develop that product. I know it relies a lot on on options, uh put options on the market. Um. And I'm surprised to read in one of your blog posts recently, uh, how heavily you are allocated in at

least in your personal investments. So it's tail risk and in Cambria as it Well, I correct me if I'm wrong, but at as of that writing, it was something like in your own portfolio and as far as the firm's cash. It was it was something like, you know what, I'm wondering, at what point, um, do you sort of balance back down out of that? Do you sort of take the profits on that? Or are we in the type of environment where it makes sense to keep a pretty heavy

allocation to to sort of a tail risk strategy. So coming into this discussion, had we been doing this, uh, say in December, would have been much more theoretical than practical. And uh the SMP just finished one of the best decades ever, put it in the top five or probably the past dozen or so decades. Ended the decade at a pretty lofty valuation. But if you rewind about three years ago, we had written a paper called Worried about the Market, It might be time for the strategy. A

little early. You had the first time in history the stock market went up every single calendar month. But we what we wrote about in this paper was thinking about hedging risks, and we said the first way to think about it, and the one that we most traditionally think about is US stocks don't take the risk in the first place. That's the best way to hedge it. So if you have a hundred percent portfolio in stocks, maybe you should have eight or sixty and the rest in

cash and bonds. Second, Uh, it's great to diverse by into other sort of investment, traditional things like foreign socks and bonds, real estate commodities. So in this paper we looked at what historically hedged US stocks and their very worst months when they were down like ten in a month and during bear markets, and the things you expected probably not hedge foreign stocks, real estate commodities didn't. Historically, things you expected to help bonds did, but they didn't

have hugely strong returns. They're mostly flatish. Gold did a good job, but not always one time it was down, and then the best during the bad times, of course, was buying puts. The problem with that is, uh, the cost in the good times, right, Um, the same way people think about car insurance or house insurance or anything else. And so we looked at historically how that worked with

the portfolio. Now walk forward to it's been uh only six months into the decade, but my god, it's felt like an entire decade already with with six months and you played out in real time, uh playbook from this paper and the same exact strategies and ideas that helped historically, going back fifty years helped again. And the things you expected not to didn't. Foreign stocks, real estate commodities member traded negative at one point, with the futures on on

the oil base and so um. This concept, though, is I'm a quant and if you think about markets and optimizations and the ideal portfolio, it's so easy to do on paper, but when you play it out in real life, the very real pain of losing money, waking up every day to markets being up down, limit, watching overnight futures, that's not something most of us want to spend any time doing. And so this idea of adding something like tail uh, you know, is almost more from the behavioral

or psychological standpoint. And you noted my own personal investments that seem far skewed larger than than whatever makes sense for anyone. In the opinis of the paper. We had an interesting thought process experiment where we said, pretend you're a financial advisor or an asset manager, anyone involved in our world. Um, you're actually probably three or four times leverage the stock market, whether you know it or not. You have your own personal portfolio. If you're an investment

advisor or a financial planner. Your clients, uh, their main investment is in US stocks. If you're revenue based, if the stock market goes down, your revenue goes down. Clients panic at the bottom and they tend to sell and just can't take it anymore. And then on top of that, if you don't work for your own company, uh, you're

subject to layoffs and downsizing and recessions. So you can make the argument because of all your human, professional and personal capital are invested in markets, and no one else believes this, by the way, so to take that for what it is. But the same way an airline company would head fuel costs or a multinational company making cereal hedgess we it makes total sense to hedge the number one risk in our world, which is simply U S stocks,

and most don't. I do. I'm a little crazy, um, but it's a way of if you can just get to the finish line and sustain with the rest of your portfolio, if some things help you get there, to me, it's all worthwhile and the whole, the whole goal of all this is to not get taken out of the game. If you're at the casino and you lose your bankroll, you can't bet, and that's the worst thing that can happen. Well on this show, Mab, we really like crazy um. But like you said, I mean has seriously felt like

a lifetime. It's as though we have experienced this mini cycle in a way, and I've find it very interesting at this point in time because I think the fragilities in the market have been very clear. I mean, you mentioned the days when every single day we were experiencing limit up or limit down, and I will be totally upfront last Thursday, it was when we got that about

six percent self in the SMP. I was made to temple it out because that's what we do in the news industry, a circuit breaker story just in case that happened, because we're getting flashbacks of March. But even I mean, if you look at different metrics, like the c boat puts a call ratio, I'm I'm always so amazed at how extreme it is to the downside that people don't feel as though they have to protect it against downside loss, that maybe people are a little bit scared of missing

out at this point in time. I mean, psychologically, how difficult it is it to get people to grasp onto the idea of hedging against downside risk, especially coming off of such a forceful rally that we've now experienced. Well, there's two points that I think you bring up that are really important. The first is, you know, if you have a portfolio. What we talk about on these podcasts and about investments, it's the sexy part about investments. It's

talking about you know, what are stocks gonna do? Where's gold going? What about inflation? What about the Fed? But the whole point is you should have a plan ahead of the time. Right, the football quarterback I'm a Broncos fan, Peyton Manning goes the line of scrimmage. Uh, you know back in the day, he knew all of his options that were gonna happen when the defense lined up right, and so not having a plan, and then last Thursday comes along and all of a sudden, the markets down five, six, seven,

whatever it was. That's when people start to just totally panic and use a different part of their brains. So we tell all investors doesn't even matter. It could be two bullet points, it could be ten pages like an endowment policy portfolio. Have an investing plan, write it down, share it with whatever your loved ones are neighbor to try to keep you on plan and and and honest, because otherwise there's so much um seduction to just do really stupid things. And we'll talk about this more more

in a little bit um. But the challenge also is that there is a pretty wide spread right now between what most of us experiencing in the real world, in the economy and markets. And I said recently, I said, look, if you were to go back twelve months feels like a lifetime ago last summer and say, look, I'm gonna tell you what's going to happen the economy in the next twelve months. Unemployment is going to go from four

to Gold is gonna be up thirty. Oil at some point will trade negative in the futures market p M. I will go from positive to negative. Interest rates, Oh, by the way, the Fed go from two and a half to zero. Where do you predict stocks will be twelve months from now? And I guarantee you no one, no one would have said up ten or about where we are right even flat everyone who said down twenty down,

forty down, sixty down eight um. And so that disconnect, I think is is very challenging for a lot of people. But again going back to it, uh, the beginning of the discussion, having a balanced portfolio and strategies that you can at least simulate for last fifty hundred years. Despite the velocity at which we had the down draft and the bounce, most everything's looked, I hate to say it kind of normal, you know. Remember I correct me if I'm wrong. But I think is it's safe to call

you a value investor? Uh, if you were to sort of you know, have to pick a real broadbrush type of type of label. The two major foundational pillars that UM we base most all of our investing strategies on our value so again goes back to time at Ben Graham and before so a hundred years old and also trend following around the same time. Charles Dow been around for a hundred years. Both of those are sort of the yin and yang of our investment philosophy. We think

both are are equal contributors to a great portfolio. So it seems like a good time to be bullish on value, UM, especially you look at the US valuations are are are pretty high. Once again, the foreign overseas by ouations look a lot more attractive, but it almost seems to me that in these times of turmoil that we saw this year, it almost seems like growth and sort of large cap us growth UM at least the main components of what you think of is that cohort. You know, your your

big internet names, your alphabets, your Amazon's, your Facebook's. They almost seemed like a haven, uh in these times. So is it a good time to start looking for value and looking overseas if there is a lot of uncertainty about the macro backdrop or is there that risk that that once again valuations be damned, people are gonna want to be in those sort of mega cap growth names.

It's always confusing to me or curious is a probably a better description to listen to people talk about valuation, because you always got to ask yourself what's the alternative? And is the alternative just buying stocks without any regard whatsoever to value UM. That seems like a really optimal way to invest, And it turns out that's what market

cap waiting is. You just buy the entire market. The problem with market cap waiting you get extremely exposed to big booms and busts, and so a good example is UM. We wrote a recent article called the best valuation spread in over forty years. And if you look at market cap waiting globally, the US is a percentage of the world right now is about half. But if you go back to the nineteen eighties, Japan was the biggest stock market in the world and most peas we use a

long term tenure p ratio. We call it the KPE ratio based on Rob Schiller's work going back to again to the time at Ben Graham Um. It's a tenure pe ratio adjust for inflation, but the average over time is usually around seventeen mild inflation around twenty two. In the U S. It's been as low as five and as high as forty five in the late nineties. Massive bubble in the late nineties. Japan hit a bubble of

almost a hundred in the eighties. For the older people on this listening or the market historians out there that recall every cover of magazines, every TV show, every book was all about the Japanese business model is gonna take over the world. And it's really just the biggest equity bubble we've ever seen. We see a different flip flop story now and the seesaw has kind of gone the other way, where the U S stock market is trading at a value of around thirty pe ratio UM, which

is high by historical stands. There just not a bubble. It's not as crazy as the nineties, but it's high and future returns expected to be low single digits. Even John Bogel said this before he passed away, and so

it's more about expectations. The good news is the rest of the world for and developed is down around the high teens, for and emerging is in the low teens, and the cheapest bucket is around ten and so um, you have this major, major discount, these alligator jaws spread between the US and foreign The biggest we've seen except four years ago is US Japan. Now here's the funny thing. I guarantee you there's a million people listening to this that say, no, no, MeV the US deserves a premium.

It's it should trade it to higher multiple, to which I usually respond, well, what do you think the historical premium has been? And the answer is actually zero. Over the past forty years, US has had no valuation premium over the rest of the world um. And so it's only really this period post financial crisis. And if you say, what is uh US stocks have stomped foreign stocks over this period? How much of that has come since two

thousand nine? And the answers all of it. So you have this period it seems like it's lasted forever, but really has only been a decade. But it's setting it's this regime of US outperformance is setting the stage for future underperformance at least the rest of the world. So I'd say, yes, barish on large cap in the US.

Um the good news is the drubbing in Q one small cap value, which at some point was down created some wide disparities within the market, so you can now you can at least find some opportunities within the U s but certainly look beyond your shores to foreign particularly emerging markets small cap value around the world. I love the alligator jaws spread description. It really is a nice visualization of what we've seen. But how do you actually go ahead then and balance value investing with usage of

trend following as well? I mean, I would get the sense that at least if you're thinking about one asset class in particular, let's just use stocks because it's easiest. If you're thinking of yourself as a value investor, but you also want to employ methods of trend following that at times that may be flashing different signals. Okay, there's a lot on that question. So let's start with what

we call the global market portfolio. If you just went out and bought the entire world of public assets, what does that look like. It's roughly half stocks, half bonds. Of that, it's roughly half US and half foreign. If you look at most US investors portfolios, it's dominated by the US. The stock allocation is up around the bond allocation is almost always a percent US, almost no foreign bonds, despite the fact foreign bonds are the largest asset class

in the world. So at least getting back to the index starting point, the Vanguard die hard. You know, if you're a die hard index or, you should have half in foreign stocks and half bonds, and almost no one does. That's particularly problematic right now because the US is the largest stock market in the world, but it's also what the out of forty five countries we track, the second

most expensive. So you're putting most of your money in US stocks, and many people in US are putting so being valuation mindful, I think is important, and we tell people that are crazy like me, you can tilt even further away from the global market portfolio into value, but at least get back to the global index because the

same problem, this home country bias happens everywhere. My friends in Japan, Israel, UK, Australia everywhere put most of their money in their own markets and it's a really foolish idea. Now you've got a second topic, which is a little more esoteric, which is trend falling. And it shouldn't be that esoteric because every single index that's market cap weighted

in the world already is a trend falling index. The only variable they're doing price of the stock, time shares outstanding, So you own more of Apple and Amazon as they hit a trillion, you own less as they go down, So you're already a trend far. Most people just don't

know it. Um, But trend falling as a methodology has been around again as long as value has, and there tends to be a lot of misinformation when it comes to to be investing in trend falling and so UM we've written a lot of papers on this and books, but basically, you want to be invested in markets as they're going up and have some sort of systematic exit as they're going down. It's not going to protect you in the five or ten percent moves, but it will.

It's sort of the forty six moves which we've seen in markets in history. I shouldn't say it will, it should and so um. But that's very much a different psychological approach than just buy and hold buy and hold. The problem. The biggest problem with buy and hold it's totally fine investing strategy is that everything bad happens at once. You've gotta buy a whole portfolio. It gets smoked in

the financial crisis. It got for the most part, very challenged in Q one, So it's very high, highly correlated to the economic environment with people losing their jobs, everything else going south, and so you're sort of doubling up on what's going on in the world. Trend following usually does well during those periods, and for most part did a good job this year. Problem with trend following is the other periods um for the most of the two thousand the ads that are sorry. UM. Trend falling wasn't

great fantastic during the financial crisis. The biggest problem with trend falling is you look different, and usually it's it's not um great or fear, you know. Buffett says that really drives markets, it's envy. And so when the markets up thirty percent last year, uh, and all your neighbors are talking about vacations and buying new cars and houses, etcetera.

A strategy like trend folling that may have lagged is hard to keep up with, particularly because those can go I don't know, two, three, four, or five ten years uh, with some disparity in return. So we like to have both. It's sort of a guineyang. We probably put more in trend folling than any adviser in the country, but we like to go half and half technical term. We we like to call going have these to use the jargon,

to use the industry jargon. So you are a true Florida woman for picking up on that alligator reference there, I I uh, your true color is coming out there. We had an alligator behind our house supposedly the other week. So alligators are in front of mine, top of mind for me because I don't want to run into it. So i'd widger you have one behind your house probably

right now if it's Uh, I wouldn't be surprised. Uh. You had a really interesting hosts recently talking about how you invest your own money, and I think this is you know a lot of I've seen a lot of these pie charts of masset allocation. I think yours is my favorite I've ever seen because there's some small slivers. They're like comic books, less than one percent. I guess, um, crypto, and your rational for for awning crypto is I think

the best rationale ever. It's basically basically so that your your crypto friends don't don't badge to you to death about owning crypto. And and I tend to agree with that, you know a little little bit in case it goes up a million percent. But the really interesting thing to me is the farm land at thirty six percent. And I know you've talked about this on your own show

a little bit, and you've written about the rationale for it. Um. Obviously, for those of us out there who can't go and buy a farm, is there a way to sort of get invested or what is the optimal way in public markets to sort of get exposure to farm land in the US? So um as everyone thinks about their portfolio and this is what people spend like of their time on UM. We wrote a book called Global ASTs Allocaction. It's free to download on our website. Check it out UM.

And we did a fun study where we looked at all the different Guru ASCID allocations and down at risk parity UM permanent portfolio all the way out right, and we took them back to the seventies and we did a horse race and saw said, how do these portfolios perform? Well, it turns out they're all pretty darn similar, And it actually doesn't even really matter how much you have in these allocations, as long as you have some of the main ingredients, some global stocks, some global bonds, some global

real assets. The exact percentages didn't matter. And over time, actually what mattered with that portfolio the most was how much you paid to implement it. So if you paid really high fees like mutual funds, really tax inefficient h fees, you you removed any possible spread between the performance of the best and worst performing allocations. So the whole goal with your allocation on the public side, put that baby

on autopo isot. Let it be rules based. Let it we're in the background, be done with it and spend no time on it. And I know a lot of people that's not something they want to do. But in my view, it's reality. And so mine is actually modeled on a two thousand year old investing strategy and it was in the Talmud and it said, let every man put a third of their money in business, a third keeping reserve, and a third in land. And so that's

what mine actually looks like. And so farmland, you know, again, that's something UM it's it's more from from my family. Uh, my old man side of the family grew up in Kansas and Nebraska, so it's more of a connection to that part of the world. It has been an actual fantastic performing asset class over the years, highly non correlated to everything else going on. The problem. As you alluded to,

it's really hard to allocate to UM. It's probably the single largest asset that's not included in the global market portfolio through public securities, the other being single family housing around the world. Uh, although that's starting to get securitized a little more. I think it's a big business opportunity. By the way, if you're listening to h to come up with some farmland ideas. There's a few portals we featured on the podcast that that talk about investing in

farms and in smaller chunks as well as private funds. UM. I would love to see a lot more development there. Ours is really just because you can go right around on a on a a TV and shoot guns and I don't know play, but you'd think there'd be more reats farm reats. I don't know, there's only like one or two, uh, and would love to see people developed that. I think it's a billion dollar idea for the right enterprising person. Who would have known that the TOMLA had

such great investing strategies. Right, Oh, that's great. That's uh. I hadn't heard about that. That's pretty awesome. Well, one more paper of yours, mat, I want to ask you about before we get to sharing the craziest thing in markets, and that is one of your white papers that you wrote called all time Highs A good time to invest, no,

a great time. And you started off with this Beatles analogy about UH one Records executive who basically turned down the chance to sign the Beatles because he said that groups were going out, especially for man groups with guitars.

UM and saying, well, the Beatles obviously did great. You can kind of apply that to the stock market as well, and I think it's a really interesting concept that I was hoping you can kind of just briefly walk us through the findings of that study and how people can actually apply that to their psychology and they're thinking when they're thinking about making investments, So what does that strategy, what would that stay to do right now in these conditions, Well,

you can kind of walk around the world on all the different assets, but foreign stocks you would certainly be in cash US stocks depending on the index in day and time of day. I don't even know what markets are doing today, but this only looked at it once a month, you know, so it would be uh um, you know, I would be much more predisposed to the twelve month in the all time highs like I mentioned, um, and then others like real estate and and commodities. Depends

on the commodity. But again it has a high correlation with our old paper, which just used simple moving averages. So to be as usual, it's a mixed bag. But you want to be invested in most markets most of the time. But again, the problem with this system is not uh really the system itself, it's can someone follow it?

And the same thing with buying hole being so hard is people are so tempted just to fiddle around and muck with it and and uh try to turn the dials that they end up destroying any potential benefit of it in the in the first place. To follow you follow your own rules, I guess is the bottom line? Sarry. You know, the one rule we have on this podcast is you have to deliver the craziest thing you saw in markets this week. So man, let's start with you. What is the I know it's been a very irrational

samee market these days. Hard to find anything crazy. Um, I don't know if people can hear the start has in my voice over that, But what's the craziest thing you've seen these days? As usual? I'm not a great

rule followers. I'm gonna give you at least two. The one was this story, um, Buddy Jason's wide had written at the Journal where he said, the last person to receive a Civil War era pension, her name is Irene Triplet, just passed away and it was for her father's service in the Union Army, which seems like such a um impossible scenario. But just as a reminder that you know, history, particularly here in the US, uh isn't it is as long as most of us um typically think about. Second,

that's amazing bananas right, um, you know. On and then on the uplifting side, uh, we recently had a dive in the ocean to the deepest and longest dive ever, which is cool, it gets lost in the noise of

everything else going on. And then on the really depressing side, uh was we saw Fidelity publish some statistics about how their customers behave during Q one and there was some really depressing realizations and one that was the worst to me was that, uh, their investors that were aged mid sixties sixty sixty nine, almost a third of them sold

all their stocks in February to May. And you know, that just illustrates so clearly why you have to have some sort of plan um, you know, and and approach because otherwise it when things start to go insane, it's a you know, these these sort of behaviors are are

hard to recover from. That's atually, and you know, and Fidelity gives you that sort of granular data of what their customers are doing to an extent, you know, the the whole narrative we've heard and Stay's already written a lot of actually written a lot about this is how these Robin hood uh and through seemed to have been

the world's greatest market timers. But that really goes to show you that that's not shown the entire situation of sort of the individual retail investor that is said, I'd love to know what that union army pension fund was invested in the talk about no pension crisis. They're right, yeah, well they should have bought a few stocks. It's would be uh, people with a lot of money right now, all those old railroad stocks you bought back then with uh,

all right, all right, I'll give you mine. Mine's uh. We're giving a lot of props to the journal this week mind minds from a journal story last week actually too, and it's talking about this research done by some professors that uh U, C l A and TAL Berkeley, and they looked at the performance of analysts earnings estimates when the analyst shares her first name with the CEO of the company, and crazily enough, if the analyst shares the first name the CEO of the company they're earning estimates

are more more accurate um than someone without the same name. And I think one of the theories was that, uh, if the CEO shares a name with an analyst, maybe he's gonna be uh more likely to to take his calls and give him some heads up. I don't know how that all works with regg f D. I don't. I don't know how that maybe this this study predates regg FD. But Mad, if you, uh you find it's funny, that's a problem I would never have. I don't run

into too many other maps. So I was gonna say, if you can find a company with the CEO named mav I, I gotta be a lot of mics out there. I should. I should really get my cf A and get into this. Uh all right, Sarah, I think men gave us some stiff competition here with a less Civil war pensioneer being paid. But let's hear what you have. What's your craziest thing for the week. So I'll stay right off the top. I don't. I don't think I can keep up with that, so Mad, I'll give it

to you. Uh. But a little bit of self promotion. I wrote a story this past week on the website robin track dot net um. Really interesting story but also just a little bit crazy. Um, the amount of interest this site that tracks Robin Hood users is seeing. So before this year I spoke with the creator of it um side story. He's twenty three, he built it while he was in college. Robin Hood actually flew him out to interview and he didn't get the job. Now all

of a sudden his websites blowing up. But he said that before this year, on average day get like two or to four thousand users day. Now he's getting up to fifty thousand users a day. He says that we could check um the I p s of websites visiting and scraping his site, and he said there's evidence that hedge funds like d E Show and Points seventy two are all scraping his data. Uh so this pretty crazy the amount of interest there is in what retail investors

are doing right now. Um. But also that he's twenty three year old guy who built this website in college. Uh, didn't get a job with Brodhead and now all of a sudden he's like blowing up. Alright, sir, that is the the self promoting nest thing of and craziest thing of the week. I'll take it. I'll take good pretty good, and it was a really good story. I recommend everyone checking checking that one out. Um, but boy, I think we do got to get headed to MEB with the

Civil War pensioneer. That's a pretty good one with that side MeV. We will absolutely give you the w this week. But Mad Favor, thanks so much for joining the show this week. It's been great. Let's do it again, guys. Thanks absolutely What Goes Out. We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website and app, or wherever you get your podcasts. We love it if you took the time to rate interview the show on Apple podcast so more listeners can find us.

And you can find us on Twitter, follow me at Sarah pont Sack. Mike is that Reaganonymous. Our guest med Favor is at med Favor, and you can also follow Bloomberg Podcasts at Podcasts. What Goes Up is produced by Jordan Gospore and the head of Bloomberg podcast is Francesco Levie. Thanks for listening, See you next time.