Latest / Masters in Business / Antti Ilmanen on Expected Returns

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Antti Ilmanen on Expected Returns · Masters in Business

0:02
Speaker 1: This is mesters in Business with Very Results on Bloomberg Radio.
0:09
Speaker 1: This week on the podcast, I have an extra special guest.
0:12
Speaker 1: Auntie Elmanin is a QRS co head of the Portfolio
0:17
Speaker 1: Solutions Group. He is the author of a new book,
0:20
Speaker 1: Investing amid Low expected Returns, making the most when the
0:24
Speaker 1: markets offer the least. He has an incredible CV full
0:29
Speaker 1: of all sorts of awards and has worked at all
0:31
Speaker 1: sorts of places like Salomon Brothers and Brevin Howard before
0:36
Speaker 1: ending up at a q R. If you're at all
0:40
Speaker 1: interested in value investing, factor investing, understanding how you're starting
0:46
Speaker 1: condition leads to future returns that might be better or
0:50
Speaker 1: worse than historical averages, you're gonna find this to absolutely
0:55
Speaker 1: be a master class in investing. I found it absolutely fascinating,
0:59
Speaker 1: and I think you will as well. With no further ado,
1:03
Speaker 1: my conversation with a u RS Auntie Elmanen. Welcome to Bloomberg. Thanks, Perry.
1:10
Speaker 1: I'm really looking forward to this same here. So so first,
1:13
Speaker 1: I found the book to be quite fascinating, very in depth,
1:18
Speaker 1: and you managed to take some of the more technical
1:22
Speaker 1: arcana and make it very understandable. Will circle back with that.
1:25
Speaker 1: Let's let's start just by talking about your career. You
1:29
Speaker 1: you began as a sang Central Bank portfolio manager in Finland.
1:34
Speaker 1: So yeah, my really first stroke of luck, I think,
1:37
Speaker 1: was getting that job. Before that, I had been nerdy
1:41
Speaker 1: kid with interesting esoteric things like royal family trees or
1:46
Speaker 1: or track and field statistic, not trading, and when I
1:49
Speaker 1: was studying in university economics, I did not really get
1:52
Speaker 1: the passion. The passion came when I went to invest
1:55
Speaker 1: the country's foreign exchange reserves there and it was it
1:58
Speaker 1: was very much global government bond markets, so thinking about
2:01
Speaker 1: macro picture. I never never then then or later had
2:06
Speaker 1: I don't know much much interested on a single stock picking,
2:09
Speaker 1: so so think thinking of the big picture. And there
2:11
Speaker 1: were some lovely, lovely things like I was there in
2:14
Speaker 1: the October eighty seven crash and saw two year yields
2:17
Speaker 1: falling in one one overnight from nine and a half
2:20
Speaker 1: percent to seven and a half percent. You don't see
2:22
Speaker 1: those movements, yeah absolutely, Yeah. So so anyway, so that
2:26
Speaker 1: was that was That was a great, great learning experience.
2:29
Speaker 1: And and then my second related stroke of luckworse that
2:32
Speaker 1: Professor ten French came there. Yeah, he came to educate
2:37
Speaker 1: nine and sort of what we were doing, what we
2:40
Speaker 1: should be doing, and and I was an enthusiastic kid there.
2:44
Speaker 1: Well by that time, I was already almost twenty eight
2:46
Speaker 1: and and he when I was expressing some interest about
2:49
Speaker 1: studying in the US, he was only, you should do
2:51
Speaker 1: it soon. You have yourself old enough to do that.
2:53
Speaker 1: And and and a few months later I was. I
2:55
Speaker 1: was in the US. And it was so lucky in
2:57
Speaker 1: my life because because that year I met then H.
3:00
Speaker 1: Cliff Asnest and John lou who later founded uh a
3:04
Speaker 1: q R so as my fellow students. I met my
3:06
Speaker 1: wife there. She was NBA student from Germany. And it
3:09
Speaker 1: would have left a few months later University of Chicago, Chicago.
3:12
Speaker 1: So all of this, all of this luck sort of
3:15
Speaker 1: was related to my wonderful first jobs. And Gean Farmer
3:19
Speaker 1: teachers there and his research partners Can French. Yeah, both
3:24
Speaker 1: both Cliff, actually all three, Cliff, John and I. We
3:27
Speaker 1: we had Farmer and French as our dissertation chairman. And
3:30
Speaker 1: and that's a small source of pride, a little little intimidating.
3:34
Speaker 1: So so you go from Chicago, is that how you
3:37
Speaker 1: ended up at Salmon Brothers? Yeah? So that that relationship
3:41
Speaker 1: actually already started when I was a portfolio manager, right funnily,
3:44
Speaker 1: in effectually like one of these Michael Lewis's la spoke
3:48
Speaker 1: as good guys was one of my sales sales context. Yeah,
3:51
Speaker 1: he didn't have many good guys, but one was anyway.
3:53
Speaker 1: So so and and and I got to know people
3:56
Speaker 1: like Marty Leebovitz before I went to Chicago, and I
3:58
Speaker 1: think he helped. He may have again had a hand
4:01
Speaker 1: hand somewhere there. And so when I finished my studies,
4:04
Speaker 1: it was pretty clear that I wasn't sort of academic enough.
4:07
Speaker 1: I wanted to go to either by side or sales side.
4:09
Speaker 1: I even talked to them ge some Ware, Cliff and
4:12
Speaker 1: John Ware didn't go there. Uh sort of thought from
4:15
Speaker 1: my eighties experience ad by side, this dust the wrong
4:17
Speaker 1: choice anyway. So so I then went to Salomon Brothers,
4:22
Speaker 1: did bond research for a couple of years on yield
4:24
Speaker 1: curve strategies, then moved to Europe. That was always a
4:28
Speaker 1: deal with my wife to um to be a bond
4:31
Speaker 1: strategist at Salomon for for many years, initially very discretionary,
4:37
Speaker 1: but gradually becoming more and more systematic. And uh, and
4:40
Speaker 1: eventually turned from this customer oriented role to prop trading
4:44
Speaker 1: for a while and then her gender up Brevan Howard. Yes,
4:47
Speaker 1: so I think that from from these times when I
4:50
Speaker 1: was strategist, I was talking to my two great people,
4:53
Speaker 1: but like you know, earlier on some LTCM and then
4:57
Speaker 1: various other people and including Alan who came actually from
4:59
Speaker 1: Salomon and so somewhere all three he sort of invited
5:03
Speaker 1: me to try to be a mini cliff Uh systematic
5:07
Speaker 1: systematic trader with a small team there at Brevan Howard,
5:10
Speaker 1: which was in some sense great, but it is sort
5:12
Speaker 1: of a misfit because it's a very discretionary place, and
5:15
Speaker 1: so trying to do systematic in that environment was harder,
5:19
Speaker 1: and I think none of us were doing extremely well,
5:21
Speaker 1: none of us were doing extremely badly, but it just
5:23
Speaker 1: it just didn't become a um it's not a great
5:26
Speaker 1: third yeah yeah, yeah, but it was. It was. On
5:28
Speaker 1: the other hand, it was just a great place well
5:30
Speaker 1: first to try it. But the second thing is that
5:32
Speaker 1: when two thousand and eight came along, it was one
5:34
Speaker 1: of the few places that we're making money, so it
5:36
Speaker 1: was a very comfortable vantage point for for that environment.
5:40
Speaker 1: How did you go from being a Mini clif firstness
5:42
Speaker 1: to a Maxi Cliff first. Yeah, so so, um, I
5:46
Speaker 1: had stopped that systematic trading, but I had been talking
5:48
Speaker 1: with those guys often possibly um. Joining It was a
5:53
Speaker 1: matter also of them opening European office because that's where
5:56
Speaker 1: I was physically and so so so that that was
5:59
Speaker 1: a coaching. It also helped that I was I basically
6:03
Speaker 1: decided to write this book expected returns, and when I
6:07
Speaker 1: when I wrote it, I asked Cliff to write the
6:09
Speaker 1: foreword for it. And and by the way, like if
6:11
Speaker 1: you if you looked like check some time the first
6:14
Speaker 1: words he has there, like it was, I was sweating
6:17
Speaker 1: when I read read that. Um, it's just by telling
6:20
Speaker 1: that first time I met Anti, I thought he was
6:22
Speaker 1: insane and I was right so so so that that
6:26
Speaker 1: that was a little stressful, but it turns it out
6:28
Speaker 1: very nice. But anyway, so that experience reminded I think
6:32
Speaker 1: both of us how aligned our thinking is based on
6:34
Speaker 1: this common common background, and that's somehow I think motivated
6:38
Speaker 1: them to I think them to offer, and me to
6:40
Speaker 1: me to say yes yes to uh to the idea
6:43
Speaker 1: of joining them. Really, what I would think is getting
6:46
Speaker 1: to my natural home, and it happened in twenty eleven,
6:49
Speaker 1: so you've been there for more than a decade. You're
6:51
Speaker 1: now cohord of Portfolio Solutions. What is that role like?
6:55
Speaker 1: What's your what's your day to day work like at
6:58
Speaker 1: a QR Capital. Yeah, so the Portfolio Solutions group advice
7:04
Speaker 1: is mainly institutional clients on all kinds of challenges that
7:08
Speaker 1: they haven't thinking about expect it, returns, portfolio construction, risk management, etcetera.
7:12
Speaker 1: And then in addition, we write lots of papers, I
7:15
Speaker 1: speak in many conferences. And then in addition to that,
7:18
Speaker 1: I've had a hand in designing and improving some of
7:21
Speaker 1: our strategies, especially related to style premium. That was something
7:24
Speaker 1: I was quite passionate about when I joined. And and
7:28
Speaker 1: by now i'm co head. The guy who has collaborated
7:32
Speaker 1: very closely with me, Dan Bill alone has taken more
7:35
Speaker 1: and more over the day to day running of the thing.
7:37
Speaker 1: And I, you know, I took time to write a
7:39
Speaker 1: second book recently and now I'm talking about it. And
7:42
Speaker 1: I think, with with with my age, I'm happy to
7:44
Speaker 1: sort of moved part time status. I think so. In
7:47
Speaker 1: the book, Cliff Fastness again does the introduction and he says,
7:53
Speaker 1: you overshare a great characteristic for someone research, but he
7:58
Speaker 1: sometimes says he's afraid you're gonna feel the secret sauce.
8:01
Speaker 1: So what explain over sharing of financial research? Yeah, so
8:08
Speaker 1: this is this is related to all of us having
8:10
Speaker 1: this University of Chicago experience where where we were really
8:14
Speaker 1: taught the value of being open and and putting your
8:18
Speaker 1: research out there for public scrutiny too, to improve it
8:22
Speaker 1: and to educate. But of course there are possible downsides
8:25
Speaker 1: to that, and and and that has been always always
8:28
Speaker 1: a question. So so I'm not and we are not
8:31
Speaker 1: writing about all the proprietary proprietary strategies that we have,
8:34
Speaker 1: but we are talking quite openly about some things like
8:38
Speaker 1: against styles, factory investing, alternatively premium things that are relatively
8:42
Speaker 1: widely known. And I have this I don't know, Yeah,
8:45
Speaker 1: I'm sort of leaning that way of being too transparent
8:48
Speaker 1: and and and then somebody may have to control me
8:52
Speaker 1: a little. So so let's just talk a little bit
8:55
Speaker 1: about um. Two of the key themes in the book.
8:59
Speaker 1: The first is alpha. It's the holy grail but also
9:03
Speaker 1: allusive and costly explain. Alpha is something we all aspire for,
9:09
Speaker 1: but in reality the evidence is very limited that that
9:13
Speaker 1: most investors can deliver alpha. Moreover, there's there's a lot
9:17
Speaker 1: of good research by others and us showing that much
9:21
Speaker 1: what people think is alpha can be explained by either
9:25
Speaker 1: you know, heads funds running, taking on lots of equity
9:28
Speaker 1: correlation or then correlation to these various styles that are
9:32
Speaker 1: not quite quite market better. But it's it's certainly not
9:35
Speaker 1: pure alpha either. So somehow this type of demystifying, I
9:38
Speaker 1: think is helpful. But it's it's clear that investors tend
9:41
Speaker 1: to be managers and investors tend to be over confident
9:44
Speaker 1: in their ability to find that. So I'm glad you
9:47
Speaker 1: brought that up, because there's another bullet points in the
9:51
Speaker 1: last chapter the book which strikes me. Let me let
9:55
Speaker 1: me read it. Quote discipline, humility and patience UM as
10:00
Speaker 1: a key to invest in success. That sounds more like
10:03
Speaker 1: behavioral finance than factor investment. Yeah. Yeah. So one other founder,
10:09
Speaker 1: David Cabilt, he's he's always had this very good point
10:12
Speaker 1: that good investment results require good investment strategies and good
10:16
Speaker 1: investors and and so we wrote the paper together almost
10:21
Speaker 1: a decade to go on bad habits and good practices
10:24
Speaker 1: and and really think thinking about those things, and it
10:26
Speaker 1: does definitely get to behavior our advices in general, I
10:29
Speaker 1: think behavioral finance literature focus is way too much on
10:32
Speaker 1: how you can exploit other people's mistakes as opposed to
10:35
Speaker 1: looking in the mirror and reducing your your own own mistakes.
10:38
Speaker 1: So really, really quite interesting. So so let's talk a
10:42
Speaker 1: little bit about UM. Some of the concepts about expected
10:46
Speaker 1: returns UM you mentioned in the beginning of the book,
10:51
Speaker 1: lower asset yields and richer asset prices have pulled forward
10:57
Speaker 1: future returns. In other words, a lot of the games
11:01
Speaker 1: we've seen in the twenty tens and our guess twenty
11:05
Speaker 1: one and twenty two weren't so much based on that
11:09
Speaker 1: multiple and of earnings, but future multiples that were pulled forward.
11:14
Speaker 1: And so that time period explain that it's always good
11:17
Speaker 1: to think of starting deals and valuations sort of as
11:19
Speaker 1: two sides of the same coin. So starting deals of
11:22
Speaker 1: all major assets were coming down in last decade and
11:25
Speaker 1: last decades actually several decades. So something that I try
11:29
Speaker 1: to make investors see that, Uh, they naturally think of
11:32
Speaker 1: this way this way also of expected returns with bonds,
11:36
Speaker 1: but when they think of equities or housing they sort
11:39
Speaker 1: look at the rear view mirror and think of historical
11:41
Speaker 1: libraries returns that can be distorted by this returning or
11:44
Speaker 1: cheapening quite a lot. So I think it's helpful to
11:47
Speaker 1: think that all of these long only investments are priced
11:51
Speaker 1: by thinking of expected cast flows discounted by a common
11:55
Speaker 1: discount right to risk less part and some varius as
11:57
Speaker 1: a specific premier. And now when this common discount rate
12:01
Speaker 1: has been at all time lows and was coming down
12:04
Speaker 1: for a decades, so that was making everything expensive. At
12:07
Speaker 1: the same time, whatever happened to the expected cast flows
12:10
Speaker 1: and other premium and so that that situation has gotten
12:14
Speaker 1: us to this sort of everything bubble less. Some some
12:17
Speaker 1: saying I think it's a bubble is a bit wrong
12:19
Speaker 1: word there in the sense that there is a fundamental
12:21
Speaker 1: story behind it. The low real yields that were influencing
12:25
Speaker 1: all kinds of investments makes a lot of sense. You
12:28
Speaker 1: wrote this book in one or at least finished it
12:32
Speaker 1: in and you describe in the book what you see
12:36
Speaker 1: as an unquote investment winter ahead. I have to say
12:40
Speaker 1: that seems pretty president considering since you handed the book
12:44
Speaker 1: in to be published last year, markets have pretty much
12:48
Speaker 1: done nothing but roll over and head south in two.
12:52
Speaker 1: Was this just lucky timing or were you a little president?
12:56
Speaker 1: I'll put it largely too lucky timing. But so the story,
13:00
Speaker 1: I was always saying that we know that we've got
13:02
Speaker 1: these low expected returns given those low starting deals. And
13:06
Speaker 1: and by the way, related to what you're saying, I
13:08
Speaker 1: really like another statement, we borrowed returns from the future
13:11
Speaker 1: when we were when we were capitalizing everything at those
13:14
Speaker 1: expensive levels, and so that locked in low future returns.
13:17
Speaker 1: We just didn't know whether that's gonna materialized through slow
13:20
Speaker 1: pain staying in this low expected return world, or fast
13:23
Speaker 1: pain cheapening. And so then in the in the book
13:26
Speaker 1: I was I was saying that I don't really have
13:27
Speaker 1: a strong view on this one. But but in conclusions
13:30
Speaker 1: I did put there that that it just seems that
13:33
Speaker 1: stars are aligning for some fast pain. And it wasn't
13:36
Speaker 1: just the high valuations, but there was a catalyst. There
13:38
Speaker 1: was this basically inflation problem was seemingly getting as close
13:43
Speaker 1: to the day when FED finally has to make some
13:45
Speaker 1: hard choices, and so so so that I got got right.
13:49
Speaker 1: But but I would say that I was really lucky
13:51
Speaker 1: because I could have written in six months earlier, and
13:53
Speaker 1: in general I've had other market timing calls. I'm not
13:57
Speaker 1: famous for being good at market. I mean I don't
13:58
Speaker 1: know anybody who is. There are no old gold market
14:02
Speaker 1: timers in France Billionaire list. There's there's old in this bowl,
14:05
Speaker 1: but there's not both. Um, let's let's talk a little
14:09
Speaker 1: bit about the pushback to low expected returns, you know,
14:13
Speaker 1: following the financial crisis and the FED cutting rates economy
14:18
Speaker 1: and the market starts recovering late two thousand nine and
14:21
Speaker 1: then two thousand and ten, and we kept hearing from
14:25
Speaker 1: a lot of different value corners. Hey, everything is richly priced.
14:30
Speaker 1: Bonds are the most expensive they've been in thirty years.
14:32
Speaker 1: Stocks are pricy, lower your return expectations. But yet the
14:37
Speaker 1: tens sore returns and equities and bonds close to double
14:43
Speaker 1: historical averages. How do we explain why that advice took
14:49
Speaker 1: so long before it started to work. So I think
14:52
Speaker 1: there is a fair risk that we anybody who was
14:56
Speaker 1: talking like that, he's thought that's the boy who cried
14:59
Speaker 1: wolf and Lucy losing credibility then by this time, and
15:02
Speaker 1: I think that would be said because I think sometimes
15:04
Speaker 1: it's going to really work, and this year really looks
15:07
Speaker 1: like it can be can be that sometime. And I
15:09
Speaker 1: felt always somewhat good that we were at least we
15:12
Speaker 1: were not pushing for we were not predicting me and
15:14
Speaker 1: reverting valuations that we have made things work. We were
15:17
Speaker 1: saying it, let's be really humble about any market timing
15:19
Speaker 1: use of this stuff. But low starting heels do anchor
15:23
Speaker 1: expected returns lower. But it's true that and and what
15:26
Speaker 1: we saw then in that in that decade, that rich
15:28
Speaker 1: things can get richer, and that doesn't take quite a
15:30
Speaker 1: long time. And so actually my favorite quote is to
15:34
Speaker 1: think about what happened to SMP five shielder p that
15:37
Speaker 1: went from mildly above historical average too empty to double
15:42
Speaker 1: and wildly above average forty in ten years time. And
15:45
Speaker 1: that type of thing gives you well, basically seven percent
15:48
Speaker 1: annual returns pro rated then and so so that's the
15:51
Speaker 1: key reason. And something similar happened. Real yels on bonds
15:54
Speaker 1: were already low, they went even lower. Um rental heels
15:58
Speaker 1: on equities, credit spread, anything you look at had basically
16:02
Speaker 1: tail winds from from these following years, and that repricing
16:06
Speaker 1: then gave high returns. And that there's a danger that
16:09
Speaker 1: people then look at the rear view mirror and become
16:11
Speaker 1: complacent just at the wrong time. So so let's talk
16:14
Speaker 1: a little bit about that. How significant was the ultra
16:18
Speaker 1: low rates of the Fell reserve to making all of
16:23
Speaker 1: these different asset classes richly valued and continuing to generate
16:28
Speaker 1: strong returns right up until the FED started raising rates.
16:33
Speaker 1: So I think so short term what happened this year
16:35
Speaker 1: was really there was a catalyst of inflation and FED tightening.
16:39
Speaker 1: But the long term story was always always about valuations
16:42
Speaker 1: and and the important thing, as I said, is related
16:44
Speaker 1: to this common part low real deals. And should we
16:47
Speaker 1: blame FED for that or should be blaming somehow greedy investors.
16:51
Speaker 1: I buy more the stories that there was this fundamental
16:54
Speaker 1: fundamental effects, most importantly proper probably savings glad excess savings
17:00
Speaker 1: coming from pension savers. Also another story is that that
17:03
Speaker 1: when when the wealthy we're getting a bigger share of
17:06
Speaker 1: the pie, their savings rates are higher. There are there
17:08
Speaker 1: are research on both fronts which which sort of explain
17:11
Speaker 1: why we've gotten this exceptional savings clot which was then
17:15
Speaker 1: pushing all assets yields lower and and creating this and
17:21
Speaker 1: fed them. Investors were basically then responding to that situation
17:25
Speaker 1: rather than driving it. Now, we heard a lot about
17:28
Speaker 1: the savings clout from then chairman Ben Bernanke in the
17:32
Speaker 1: early two thousand's. Is this savings clot qualitatively different than
17:37
Speaker 1: what we saw two decades ago? Yeah, it's it's it's
17:41
Speaker 1: it's the same idea. So always when you think of
17:42
Speaker 1: real years, you think that, okay, there's a there's either
17:45
Speaker 1: an issue with investments or savings, and it's it's a
17:47
Speaker 1: balance between those two. And he was highlighting that this
17:49
Speaker 1: probably is more coming from the savings side, and then
17:52
Speaker 1: he was symphasized this is the this is a China
17:54
Speaker 1: and and often often emerging market foreign reserves, those those
18:00
Speaker 1: types of excess savings where sort the culprit for the
18:03
Speaker 1: conundrum in two thousand five or whatever it was. And
18:06
Speaker 1: and I think that that story still has some legs,
18:09
Speaker 1: but sort of the key culprit then became demographics and
18:13
Speaker 1: retirement savers And the latest story now we center in
18:16
Speaker 1: the sort of one percent. So so the flip side
18:19
Speaker 1: of that, if there's a savings glut, meaning a big
18:23
Speaker 1: uptick in demand for that paper, does that also suggest
18:27
Speaker 1: we have a dearth of high quality sovereign paper of
18:32
Speaker 1: bonds issued by countries like the US or the UK,
18:36
Speaker 1: or is it just whatever. The existing supply of paper
18:42
Speaker 1: is what, Liz, And it's the demand that has spiked. Yeah,
18:45
Speaker 1: I think the demand has been driving things and and
18:49
Speaker 1: and well, the supply has been there like there's there's
18:52
Speaker 1: there's been plenty of plenty of supply as well to
18:55
Speaker 1: to cater for it, and and really really given the
18:58
Speaker 1: need for the to to cover public deficits and so on.
19:02
Speaker 1: But again, I think I think if one thinks of
19:04
Speaker 1: what what sort of started this among fundamental forces, I
19:07
Speaker 1: choose to go with that savings plat That's my best
19:10
Speaker 1: reading of the literaty and it makes some sense. So
19:13
Speaker 1: you wrote the prior book a decade ago, two thousand
19:16
Speaker 1: and eleven, just expected returns in the decade between that
19:20
Speaker 1: book in this book, What have we all learned? What
19:23
Speaker 1: what has the markets taught us? And how did you
19:26
Speaker 1: work that into the new book? Well? I like that.
19:29
Speaker 1: I like the basic framework still still in the book.
19:32
Speaker 1: But I think certainly it was a terrible decade for
19:35
Speaker 1: all kinds of contrarian strategies and and I have become
19:39
Speaker 1: even more humble. It's sort of funny that I I
19:41
Speaker 1: wrote my dissertation four the years ago in duration timing,
19:44
Speaker 1: and I've thought about all kinds of market time. Every
19:46
Speaker 1: decade I become more humble about about the endeavor. And
19:49
Speaker 1: yet even as I told at the end of this
19:52
Speaker 1: latest book, I'm still mentioning star start aligning. And it
19:54
Speaker 1: might be so, so the temptation is there. But I
19:57
Speaker 1: think the main point I want to say is I
19:59
Speaker 1: think what we should really try to think of investing
20:01
Speaker 1: as a strategic effort good diversification and so as opposed
20:05
Speaker 1: to some great tactical timing, because that doesn't do too well.
20:08
Speaker 1: So I think I think that would be and part partly,
20:11
Speaker 1: you know, relearned through the difficulty of contrarian timing strategies.
20:15
Speaker 1: Then then another thing, which which was very important in
20:18
Speaker 1: this decade, was there was a growing interest in these
20:22
Speaker 1: diversifying return sources. But I think by now the most
20:25
Speaker 1: popular one is related to a liquid investments, whereas my
20:28
Speaker 1: favorites where then and are still now more liquid strategies
20:32
Speaker 1: Vario style, premium value investing, trend following, and so on
20:35
Speaker 1: and so so. One of the interesting things to talk
20:37
Speaker 1: about in the book is that we continue to find
20:40
Speaker 1: more data, and not just the decade of data that
20:44
Speaker 1: went by, but historical data, old data going back to
20:47
Speaker 1: the eighteen hundreds. I have to ask, where is this
20:51
Speaker 1: do we call it ancient? Where is this nineteenth century
20:55
Speaker 1: data coming from? And how can you apply it to
20:58
Speaker 1: investing in the twenty one cent Yeah. So the first
21:01
Speaker 1: point is that we accrue out of sample new experience
21:05
Speaker 1: so slowly that that that it's sort of pain painful
21:08
Speaker 1: to do to do that waiting, and and therefore it
21:11
Speaker 1: is helpful supplementary source to get some old data. Most
21:15
Speaker 1: really studies were done with datas in nineteen sixties to nineties,
21:18
Speaker 1: and then it was extended to beginning of CRISP data
21:22
Speaker 1: six and now we've had people going further back and
21:25
Speaker 1: and I am so I haven't been one of those
21:27
Speaker 1: in the archives, but but I'm one of those looking
21:29
Speaker 1: at that that data and studying it critically and and
21:33
Speaker 1: seeing what what we can learn from there, mainly whether
21:36
Speaker 1: you whether you get similar patterns. I do love it
21:41
Speaker 1: when I find that some strategies have worked persistently over
21:46
Speaker 1: different centuries, pervasively across different countries and asset classes and
21:52
Speaker 1: robust with different specifications. So that makes me more confident.
21:56
Speaker 1: But I do I have recognized And that's something I
21:59
Speaker 1: say in the book as well, that that when people
22:01
Speaker 1: see my hundred and two hundred years of data there
22:04
Speaker 1: some just roll their eyes and and and why is that? Why?
22:08
Speaker 1: Why do why do I care about two hundred years
22:10
Speaker 1: of data? I really care about last three years with
22:14
Speaker 1: my old portfolio. Well, obviously that's a very specific example set.
22:18
Speaker 1: You want to go away beyond that. But it raises
22:21
Speaker 1: people rolling their eyes, raise the question how reliable is
22:24
Speaker 1: that data? How accurate is it? Can we have confidence
22:28
Speaker 1: that it's been cleanly assembled because the technology of the
22:32
Speaker 1: eighteen hundreds a little more manual than today. All fair,
22:38
Speaker 1: So I'll just I'll just say, well, first I said,
22:40
Speaker 1: you just do the best you can, and I think
22:42
Speaker 1: so there's some value in the data. But the problem
22:44
Speaker 1: there are data problems, There are investability questions. Even if
22:48
Speaker 1: the data verified, maybe you couldn't do for in diversification
22:51
Speaker 1: or something like well, actually before first maybe you could.
22:54
Speaker 1: That was pretty international era. Um, and then there's a
22:56
Speaker 1: whole criticism that the world has structurally changed and that
22:59
Speaker 1: creating sim has more bite the further back you go. So,
23:02
Speaker 1: I think for all these reasons we should be skeptical,
23:05
Speaker 1: but I still like it as a supplementary evidence, not
23:08
Speaker 1: as main motivation for anything. So you mentioned the versification earlier.
23:12
Speaker 1: In the last section of the book, you write an
23:16
Speaker 1: owed to diversification. Tell us about that. Sure, I do
23:20
Speaker 1: think you know it's a cliche, but diversification is pretty
23:25
Speaker 1: close to a free lunch, and it is a wonderful,
23:28
Speaker 1: wonderful aid to improving portfolios. I think it's much easier
23:33
Speaker 1: to improve your risk ad justed returns through good risk
23:35
Speaker 1: diversification than by getting somehow greater insights in one particular strategy.
23:41
Speaker 1: So and and so I write, I write about it
23:44
Speaker 1: both both. I don't know that the simple maths about
23:47
Speaker 1: it how you can double double sharp ratios with foreign
23:50
Speaker 1: uncorrelated strategies, and then remind us it's really difficult to
23:54
Speaker 1: find for uncorrelated strategies in long only world. You may
23:57
Speaker 1: have to get too long short world to take advance
24:00
Speaker 1: at each of those types of opportunities. And then I'm
24:02
Speaker 1: the flip side of that. I am saying that diversification
24:05
Speaker 1: has got some critics. Of course, there's diversification or the
24:09
Speaker 1: or or that diversification fails when most needed and so,
24:11
Speaker 1: and I think I can counter those to some extent,
24:14
Speaker 1: but I think there are challenges that good frisk diversification
24:17
Speaker 1: often then requires you to use some shorting and leverage,
24:20
Speaker 1: and there are limits to how much people want to
24:22
Speaker 1: do that. There's unconventionality issues. And then this's this what
24:26
Speaker 1: what we've highlighted in reacent Yes, that you sort of
24:28
Speaker 1: inherently you lack stories and and so it's it's it's
24:31
Speaker 1: very sort of math oriented or or algebra oriental type
24:36
Speaker 1: of thing as opposed to great stories, which which drive
24:39
Speaker 1: most investment passions. Right, that makes a lot of sense.
24:42
Speaker 1: You mentioned free launch. You talk about rebalancing arguably another
24:47
Speaker 1: free launch. Tell us your thoughts on rebalancing. Yeah, So rebalancing,
24:51
Speaker 1: I think is a way of ensuring that you can
24:55
Speaker 1: retain your risk targets and you can retain your diversification.
25:00
Speaker 1: So I think of it primarily has that there's a
25:02
Speaker 1: follow up question whether you whether you can get better
25:05
Speaker 1: returns and then how you do it and so and
25:07
Speaker 1: I talk a little lightly. I think I wouldn't be
25:09
Speaker 1: too strict and rebalancing I think like one one good
25:12
Speaker 1: idea is to be somewhat lazy with rebalancing strategy. So
25:16
Speaker 1: let me hear something like that or or maybe four
25:20
Speaker 1: times a year, but part of the portfolio, so you're everything,
25:24
Speaker 1: you don't you you don't get so um dependent on
25:26
Speaker 1: when you did it your year, So that that type
25:29
Speaker 1: of thing. But but basically, if you if you are
25:31
Speaker 1: a little lazy or patient with rebalancing, you let the
25:34
Speaker 1: near to momentum play out and you might get closer
25:36
Speaker 1: to the time when there's mean reversion advantages. So so
25:39
Speaker 1: you're trying to play a little bit these advantages that
25:42
Speaker 1: tend to be in financial markets with momentum mean reversion.
25:45
Speaker 1: So let's talk a little bit about low expected returns.
25:47
Speaker 1: We we already talked about the impacts on FED rates.
25:52
Speaker 1: What else goes into driving valuation factors that can lower
25:57
Speaker 1: future expected returns. It really depends on what rise on
26:00
Speaker 1: we talk about. So monetary policy macro conditions are very
26:03
Speaker 1: important for short term but I think I I'd like
26:05
Speaker 1: to focus in my focused in the book mainly on
26:07
Speaker 1: long term expected returns and then its terms being five, five,
26:11
Speaker 1: five to ten years something like that. And yeah, it's
26:13
Speaker 1: interesting if you go even further than sort of valuations
26:16
Speaker 1: even don't matter, so everything is gets diluted, and then
26:18
Speaker 1: you have to think about what's some theoretical long grand return.
26:21
Speaker 1: But so so for for ten years ahead, then starting
26:24
Speaker 1: ITAs and valuations are essential and and again so I
26:26
Speaker 1: think those those are very helpful anchor for thinking about
26:30
Speaker 1: those returns. Even though you can get this very ugly
26:33
Speaker 1: uh forecast. There ares like what happened in the last
26:36
Speaker 1: last decade. But when such setting happens, then it pretty
26:39
Speaker 1: much stores problems for the future. So like last decade,
26:42
Speaker 1: as it's rich and it's just ment at all, you
26:44
Speaker 1: are going to have even more problems in in in
26:47
Speaker 1: those future returns. And I think the only way you
26:49
Speaker 1: can sort of solve the low expected return problem here
26:53
Speaker 1: is at least for risky assets, is that there would
26:56
Speaker 1: be this much faster growth, this techno optimism that you
27:00
Speaker 1: some quarters and there there could be, but we've had
27:03
Speaker 1: we've had wonderful technological advance this last hundred years and
27:07
Speaker 1: and two per cent reial growth is pretty much as
27:10
Speaker 1: good as it gets. And that's the interesting thing because
27:13
Speaker 1: you're talk in the book about very often mom and
27:16
Speaker 1: pop investors individual investors tend to confuse uh GDP growth
27:24
Speaker 1: with expected returns. Academically, we know there's almost no correlation
27:28
Speaker 1: between the two, is there. It's surprising that whether you
27:31
Speaker 1: look at our time in one country or you look
27:33
Speaker 1: at across countries, the relation is very modest. And my
27:36
Speaker 1: my favorite poster boy on that one is China, which
27:38
Speaker 1: had this thirty years of very fast for equity investors,
27:44
Speaker 1: it was a really sorry story. Yeah no, it was
27:47
Speaker 1: a lost opportunity. If you piled into China, you missed
27:52
Speaker 1: a lot of opportunity elsewhere in the world. It's quite
27:55
Speaker 1: quite amazing, and there are some stories why that's why
27:57
Speaker 1: that's the case, Like basically, one on one logic is
28:00
Speaker 1: a GDP growth doesn't capture how the pie is shared
28:04
Speaker 1: between corporates and so on. And there's there's a different
28:06
Speaker 1: sector compositions. There's there's public versus an unlisted sectors, all
28:10
Speaker 1: all kinds of questions like this that can then mechanically
28:13
Speaker 1: explain why this happens. But it is. It's it's a
28:16
Speaker 1: it's a weird result and it's understandable, and I think
28:18
Speaker 1: it commonly motivates people to look for those fast growing
28:22
Speaker 1: countries and taking it for granted that that's a good investment.
28:27
Speaker 1: So when we're thinking about various asset classes, how does
28:30
Speaker 1: cash work into that allocation strategy? Is that a legitimate
28:35
Speaker 1: as at class or is it just a drug on
28:37
Speaker 1: future returns except for years like well even in two Again,
28:43
Speaker 1: in relative sense, cash is of course doing fine, but
28:45
Speaker 1: real real returning cashes whatever minus pipers and it just
28:48
Speaker 1: happens to be better than even more rice various results.
28:51
Speaker 1: And so so I think one one interesting uh thing
28:54
Speaker 1: is that you sort of you need to have some
28:56
Speaker 1: market timing ability, I think, to make cash useful and
29:00
Speaker 1: use it almost as an option. And and then it
29:02
Speaker 1: matters whether you have got um some interesting yield levels.
29:07
Speaker 1: Twenty years ago you had that three or four percent
29:09
Speaker 1: three or return. Cash not not around in this situation.
29:12
Speaker 1: So I do think that the main story with cash
29:14
Speaker 1: c is, like you said, there's there's there's something about
29:16
Speaker 1: the dragon. It dilutes. It's not a great diversify or
29:19
Speaker 1: dilutesive performance. It would be good if you have got
29:22
Speaker 1: some great market timing skills, but let's be humble about it.
29:25
Speaker 1: Often I'd even say that cash may be best used
29:28
Speaker 1: as a basically on on the other side, like you
29:30
Speaker 1: want to use it for leverage for some long shot strategies,
29:33
Speaker 1: and so that may be a helpful answer what you
29:36
Speaker 1: do with that In the book, I like the way
29:39
Speaker 1: you describe certain investor types based on their future liabilities.
29:44
Speaker 1: So pensions endow minds to find benefit plans. You point
29:50
Speaker 1: out that they're particularly sensitive to low expected returns. Tell
29:55
Speaker 1: us what makes them so susceptible? Is it the future
29:59
Speaker 1: liability as they have? Why is merely the concept of
30:03
Speaker 1: lower expected returns so problematic for them? Yeah? Well, I
30:06
Speaker 1: think it is. It is for any investor, But if
30:09
Speaker 1: you have made some commitments for the future, then it
30:13
Speaker 1: is maybe more legally binding, and and that that makes
30:17
Speaker 1: it tougher than for somebody who can who can basically
30:20
Speaker 1: adjust expectations um or or try to just live through
30:25
Speaker 1: these things without without recognizing the low expected return until
30:30
Speaker 1: until somewhere far into the future. So so let's talk
30:33
Speaker 1: about for into the future, how long should we expect
30:36
Speaker 1: lower returns for? Is this a question of quarters or
30:40
Speaker 1: or years and decades? Is the cyclical? Does it eventually
30:44
Speaker 1: turn out? And tell us a little bit about duration
30:47
Speaker 1: of expected returns? Sure? So the main story of the
30:50
Speaker 1: book is about those low starting years, and therefore we
30:53
Speaker 1: are talking of long run story. Then I'll sort of
30:56
Speaker 1: turn into more speculative pandit here by thinking about the
30:59
Speaker 1: current situation soon where I do think that we are
31:02
Speaker 1: now in this fast pain situation where we will probably
31:05
Speaker 1: get more where we will surely get more monetary policy tightening.
31:09
Speaker 1: And I suspect that the latest latest market positive positive
31:13
Speaker 1: is on yels is maybe way too optimistic. I think
31:15
Speaker 1: I think you will need you will need more tightening
31:17
Speaker 1: to control inflation. And again this is this is a
31:19
Speaker 1: speculative talk here. So I think fast pain will be
31:23
Speaker 1: with us for various risky assets, but I think there
31:29
Speaker 1: will be a limit to it because of the structural forces.
31:32
Speaker 1: I refer to the savings. But but but I think that's
31:34
Speaker 1: not going away anytime soon, and therefore there's going to
31:37
Speaker 1: be a lead on how far heels can rise, and
31:40
Speaker 1: that and basically those bond deals they have been underwriting
31:43
Speaker 1: high valuations and all other on stocks and real estates
31:46
Speaker 1: and so on and and and those rising yields have
31:49
Speaker 1: been very important in cheapening those other asset classes. And
31:52
Speaker 1: so I think there's going to be more pain on
31:54
Speaker 1: that front, but not too much. I don't think we
31:57
Speaker 1: will get so much higher yields and cheaper asset valuations
32:00
Speaker 1: that we would sort of solve the long run problem
32:03
Speaker 1: of low expected It turns we will. We will still
32:06
Speaker 1: get some pain, but but well, I think the slow
32:07
Speaker 1: pain will be with us quite a long time. So
32:10
Speaker 1: so let me see if I can explain that. If
32:12
Speaker 1: I if I understand that we've had a savings glot
32:17
Speaker 1: that has put a cap on interest rates, which means
32:20
Speaker 1: that the cost of capital has been very low, and
32:24
Speaker 1: therefore that allowed us to speculate in real estate inequity,
32:28
Speaker 1: and that allowed valuations to go high. And what's going
32:32
Speaker 1: to determine how much those multiples compress is how high
32:36
Speaker 1: rates end up going up? Am I oversimplifying that? I
32:39
Speaker 1: know that? Is? That is right? And again we have
32:41
Speaker 1: got now the cyclical situation where where basically the inflation
32:44
Speaker 1: problem forced finally central banks to to act quite aggressively
32:49
Speaker 1: then on well anyway, on on the interest right front.
32:54
Speaker 1: And and then how much more they have to do
32:58
Speaker 1: is going to be important in the near term. But
33:00
Speaker 1: I just don't see your scenario where they would race
33:03
Speaker 1: rate so much that we would get back to the
33:05
Speaker 1: kind of four or five uh expected real return from
33:10
Speaker 1: sixty portfolios which used to be there. We are about
33:13
Speaker 1: half of that nowadays. We've come from the lows, but
33:16
Speaker 1: we are still like, let's say sixty two percent three
33:19
Speaker 1: yels roughly the number as opposed to the four plus
33:21
Speaker 1: long run. So so we're recording this the first week
33:24
Speaker 1: of July. The FED has already raised seventy five basis
33:28
Speaker 1: points on top of their previous fifty basis points for
33:32
Speaker 1: a while. The consensus is that the end of July,
33:36
Speaker 1: I think it's the seven meeting seemed to be seventy
33:39
Speaker 1: five basis points. Uh. It sounds like fears of recession
33:45
Speaker 1: might drive that down to fifty basis points. But clearly
33:48
Speaker 1: there's no consensus there yet. How far do you think
33:52
Speaker 1: the Fed's going to go in tightening and do we
33:55
Speaker 1: run the risk there were behind the curve in one
33:59
Speaker 1: all running the risk that they're getting ahead of themselves.
34:02
Speaker 1: And two yeah, First, just a qualifier here that that
34:08
Speaker 1: nobody knows. Nobody knows and and and we don't trade
34:11
Speaker 1: on my views. We don't like this is this is uh,
34:15
Speaker 1: that's that's important, and it is it's incredibly difficult. But
34:19
Speaker 1: but yeah, we we certainly do think about those those
34:22
Speaker 1: social attempts. And my I'm pretty much in a letty
34:25
Speaker 1: Larry Summers came there thinking that it's very hard to
34:27
Speaker 1: get immaculate disinflation here and and and you will need FED.
34:32
Speaker 1: FED needs to do more to get that inflation into control.
34:36
Speaker 1: And if it does, either if it acts more or
34:39
Speaker 1: financial markets dropping up, then then there's going to be
34:42
Speaker 1: some pretty bad outcomes too risky assets. Without that, I
34:47
Speaker 1: think we are we are going to continue to have
34:50
Speaker 1: that inflation problem. There's a there's a narrow path how
34:52
Speaker 1: it could go in a more benign way, and market
34:54
Speaker 1: seems to be clutching that straw right now. So what
34:58
Speaker 1: would make you change your mind? Mine? What would lead
35:00
Speaker 1: you to say, oh, I've been too cautious about future
35:05
Speaker 1: expected returns, and because A, B and C happened, I
35:08
Speaker 1: think we could get a little more confident. Yeah, so,
35:12
Speaker 1: I think the long horizon estimates are very difficult to change.
35:19
Speaker 1: The starting yields are are heavy anchor, so I think
35:23
Speaker 1: it would be it would really require the growth environment
35:26
Speaker 1: to change. Again, I mentioned earlier technological progress, those types
35:29
Speaker 1: of things, So short term anything can happen. But but
35:31
Speaker 1: but somehow you have to have this type of idea
35:35
Speaker 1: of the greater internet usage globally and all all kinds
35:38
Speaker 1: of technological progresses moving us from the two percent to
35:41
Speaker 1: three or four, which is hard to do, hard to do,
35:44
Speaker 1: has not happened, right, And then you mentioned earlier the cheapening.
35:49
Speaker 1: If stocks got much cheaper, that could potentially change the
35:54
Speaker 1: starting valuation. But do we really think that's a likely Probably, yeah,
36:01
Speaker 1: I I would be surprised that we would get that
36:03
Speaker 1: much cheaper. And again, the economic logic I have is
36:06
Speaker 1: there the savings somehow that that basically really ills are
36:09
Speaker 1: not going to allow that we have to I don't know,
36:11
Speaker 1: fragile economy, too, fragile financial markets to to allow that
36:15
Speaker 1: much step in we would we might be talking of
36:19
Speaker 1: further further market force and that and that that seems
36:23
Speaker 1: pretty unlikely from at least with the state of the
36:25
Speaker 1: world today. Obviously that can change any any time. That
36:29
Speaker 1: that's really that's really quite interesting. So let's talk about
36:33
Speaker 1: some things that seem relatively cheap. Cliff Fastness in the
36:37
Speaker 1: forward of the book wrote quote value premium seems record
36:42
Speaker 1: cheap today, that was the end of one. Is value
36:46
Speaker 1: premiums still cheap today? Value premium is still very cheap.
36:50
Speaker 1: And it's been a lovely year in the sense that
36:52
Speaker 1: we have had positive returns, and yet the value spread,
36:56
Speaker 1: this forward looking measure of how cheap value stocks have
36:59
Speaker 1: versus growth stocks, has remained wide. And part partly it
37:01
Speaker 1: is that you get some pullbacks like we have recently
37:04
Speaker 1: recently gotten, but also we are basically rotating into new
37:07
Speaker 1: value stocks and growth stocks, and and and the fundamentals
37:10
Speaker 1: have actually further had sort of favorable um developments favoring
37:15
Speaker 1: values stocks versus growth stocks. So for all these reasons,
37:17
Speaker 1: we see that value stocks the way we tend to
37:20
Speaker 1: trade them are as cheap or even cheaper than they
37:22
Speaker 1: were at the worst times during the dot com bubble.
37:25
Speaker 1: And it is important to just distinct with sen Cree
37:27
Speaker 1: wrote about this in a in a blog recently that
37:30
Speaker 1: that dot com bubble was very much about tech versus
37:33
Speaker 1: others and and across sectors. We haven't got into the
37:36
Speaker 1: new heighst but we tend to focus on within industry
37:40
Speaker 1: um stock selection in our value strategies. And with that,
37:44
Speaker 1: the key story of this recent bubble was really markets
37:48
Speaker 1: favoring these disruptive, profitless growth companies within every sector, and
37:53
Speaker 1: that opportunity remains still very wide. And we we love
37:57
Speaker 1: seeing like pretty good performing behind us and then then
38:01
Speaker 1: very good runway because those values spreads remained quite right.
38:04
Speaker 1: And in the US, I've noticed that small cap value
38:07
Speaker 1: has done much better than the larger cap companies and
38:11
Speaker 1: then emerging market small cap value. Last I looked, it
38:14
Speaker 1: might have even been green for the year, might have
38:17
Speaker 1: been positive returns for the year. Why are small cap
38:20
Speaker 1: doing so well on the value spaces here? Well, it
38:23
Speaker 1: often happens, like you just you just get bigger movements
38:27
Speaker 1: in good and bad on the small caps than large caps.
38:31
Speaker 1: So so I mentioned the quote from Cliff he's a
38:35
Speaker 1: big character. What what's it like working with him? It's
38:37
Speaker 1: mainly it's great though if you had him with us
38:42
Speaker 1: here on the studio, I think you wouldn't hear much
38:45
Speaker 1: of me. And and that's just as well, because he
38:47
Speaker 1: is he's uh, he's faster on his feet than he's
38:51
Speaker 1: he's with here. So so that's that's in everybody's benefit.
38:53
Speaker 1: But it so seriously, it does help that our investment thinking,
38:58
Speaker 1: investment beliefs are so similar. So I I really rarely
39:00
Speaker 1: have got any any any wish to second guess anything
39:03
Speaker 1: he says or does, so so that's great. And then
39:06
Speaker 1: most importantly, I do love his ethical antenna and this
39:10
Speaker 1: kind of truth telling obsession that he has. I mean
39:13
Speaker 1: sometimes there's there are overshoots there, but it's really it's
39:17
Speaker 1: it's it's a reason for me why I love it
39:19
Speaker 1: to work in a q R more than in any
39:21
Speaker 1: other place in financially because of Cliff. You know, usually
39:24
Speaker 1: you get a guy who's quantitatively oriented, you tend not
39:28
Speaker 1: to get that sort of articulate nous and you also
39:33
Speaker 1: tend not to get that sort of um sense of humor,
39:36
Speaker 1: which is very very specific to him. He's a very
39:40
Speaker 1: funny guy. He's yeah, and and and a bit mixed
39:44
Speaker 1: feelings because there's no way to beat him one of
39:46
Speaker 1: those things. But that's okay, that's very funny. Um. So
39:50
Speaker 1: so let's talk a little bit about the things that
39:53
Speaker 1: have changed since you wrote this this book. Um, what's
39:57
Speaker 1: going on in the current market. Is it just confirming
40:00
Speaker 1: what your expectations were for for future returns? Tell us
40:04
Speaker 1: a little bit about how two has now that it's
40:08
Speaker 1: half over, How has this impacted um the general premise
40:11
Speaker 1: of of the book. Yeah, I think overall, I feel
40:15
Speaker 1: totally blessed that that we got The book came out
40:17
Speaker 1: at the time when when markets were roughly acting the
40:21
Speaker 1: way the title was saying, talking about low expected it
40:24
Speaker 1: as we've got low realized returns of that. That sounds
40:26
Speaker 1: sounds great. And it also turns out that some of
40:28
Speaker 1: our strategies, value strategy trend following these types of strategies
40:32
Speaker 1: are doing very well. So so I'm getting like great,
40:35
Speaker 1: great response. But of course things have some some things
40:39
Speaker 1: have happened as expected related to inflation, central bank tightening.
40:42
Speaker 1: But then I had no idea of what you know,
40:45
Speaker 1: the geopolitics Russia Russia, U train or or the greater
40:49
Speaker 1: split we have between us we are and China and
40:51
Speaker 1: so and so, and I don't have I don't have
40:53
Speaker 1: great insights to this for us. When I think of
40:56
Speaker 1: the longer unexpected returns, the key stories that assets have
41:00
Speaker 1: cheapened as one would one would have expected in this situation,
41:04
Speaker 1: and and the question is whether there's going to be more.
41:06
Speaker 1: I think it's it is interesting that we've had we've
41:08
Speaker 1: seen the biggest moves in bonds smaller moves. When I
41:11
Speaker 1: think of yield heel space, not not price space, but
41:14
Speaker 1: in heal space, equity yields have written uh more, and
41:18
Speaker 1: then illiquidy heals have risen so far very little, And
41:21
Speaker 1: of course there is a smoothing effect, and so that's
41:23
Speaker 1: a but. But I do expect that there's going to
41:26
Speaker 1: be an issue. I I saw in March when when
41:29
Speaker 1: equities didn't instantly respond to rising years, it reminded me
41:35
Speaker 1: of Wiley Coyoity running running over that Cliffland, sort of
41:39
Speaker 1: waiting for gravity to hit and and I think something
41:41
Speaker 1: like that maybe still happening with the private tesseets, that
41:44
Speaker 1: they are sort of waiting, waiting to price things. So
41:47
Speaker 1: so let's talk a little bit about that. There's been
41:49
Speaker 1: a lot of discussion about private markets and and the
41:53
Speaker 1: illequidity premium they get. Um, what what are your thoughts
41:58
Speaker 1: on there? Should should now untraded assets get an eloquently premium? Yeah,
42:04
Speaker 1: so I've written a lot about it, Cliff of course,
42:06
Speaker 1: uh also, and and and more and more weatily on this,
42:10
Speaker 1: and I think it is it's dangerous that people I
42:13
Speaker 1: think too automatically that if I invest in a liquid investments,
42:16
Speaker 1: I'm going to earn an illiquidity premium. I think after
42:18
Speaker 1: equity premium. That's probably the second most confident statement people
42:22
Speaker 1: would have on longer expectators, and data doesn't really support it.
42:25
Speaker 1: So we've done lots of empirical evidence on this, and
42:27
Speaker 1: so the logic why why the data is then so
42:30
Speaker 1: maybe disappointing is I think that that people somehow confused.
42:34
Speaker 1: They think that UM that the I liquidity is the
42:38
Speaker 1: only important feature. So so yes, I think it is
42:41
Speaker 1: fair to require liquidity premium for locking your money for
42:45
Speaker 1: ten years. But then there's this other characteristics lack characteristic,
42:49
Speaker 1: lack of market market, the smoothing service service as I
42:53
Speaker 1: call it, and that may totally offset the amount of
42:58
Speaker 1: access return that you get. So if there's a two
43:00
Speaker 1: or three percent require liquidity premium for for looking money UM,
43:04
Speaker 1: we might accept the same return for public and private
43:07
Speaker 1: equities UM because with the private equities you don't get
43:11
Speaker 1: the great que actility that you see. Now. You also
43:14
Speaker 1: show a chart in the book that that shows how
43:18
Speaker 1: the bottom third of um I liquid markets have you know,
43:23
Speaker 1: by definition, they're underperforming the top third, but that gap
43:27
Speaker 1: has just been widening and it seems like, in addition
43:31
Speaker 1: to whatever I liquidly premium are in private markets, there
43:35
Speaker 1: also seems to be a pre substantial I don't know
43:38
Speaker 1: if I want to call this quality factor, but the
43:41
Speaker 1: best of the liquid investments seem to really dramatically outperform
43:48
Speaker 1: the bottom. That spread is much bigger than we might
43:51
Speaker 1: have anticipated otherwise. So so, apart from thinking about illiquids overall,
43:57
Speaker 1: one of these great selling points there is is why
44:00
Speaker 1: this person between our performers and under performers. And to me,
44:04
Speaker 1: that's such a lovely example of investor over confidence that
44:08
Speaker 1: when people see this this person, they think, oh, the
44:11
Speaker 1: upside is for me, the downside is for someone else.
44:14
Speaker 1: And so so clearly this opportunity involves some risk as well,
44:17
Speaker 1: and and and it is. It's it's just somehow that
44:19
Speaker 1: that industry doesn't seem to have anybody getting that that downside.
44:22
Speaker 1: So sorry, I I do think that some investors have
44:27
Speaker 1: got a decent claim to expect to get those top
44:29
Speaker 1: quarter alright, let's say, top half half managers. But but
44:33
Speaker 1: for others, I think it's it's somehow it's better to
44:37
Speaker 1: just think that, okay, if we get the industry level
44:40
Speaker 1: returns that's that's reasonable. So Will Rogers used to always
44:43
Speaker 1: advise people only by staffs that go up. If they
44:46
Speaker 1: don't go up, don't buy them. Does the same thing
44:48
Speaker 1: apply to private markets? Only invest in private markets that
44:52
Speaker 1: I'll perform. If they don't now perform, stay away from Yeah,
44:56
Speaker 1: it's only example. Hindsight is great, but but it is
44:59
Speaker 1: so I would say just positively there. Historically, in particularly
45:03
Speaker 1: if we look at private equity, it has a great
45:05
Speaker 1: thirty thirty five year history of outperforming smp I five
45:09
Speaker 1: foundered by by three percent or something like that. And
45:12
Speaker 1: that's after five six percent fees. That gross alpha is
45:15
Speaker 1: just mind boggling in some sense. But but looking ahead, um,
45:19
Speaker 1: we should be much more com cautious because the gap
45:23
Speaker 1: has already been much narrower the last fifteen years, and
45:26
Speaker 1: it seems to be narrower because the money was flowing
45:28
Speaker 1: in because of the popularization of the Yale model. Since then,
45:31
Speaker 1: the forward looking opportunity has been much narrower, and realized
45:35
Speaker 1: opportunity has been much more, much more modest, and the
45:38
Speaker 1: fees are the good old fees. So I think next
45:41
Speaker 1: decade will be more disappointed. And when we look back
45:44
Speaker 1: to the early days of that our performance there were
45:48
Speaker 1: a tiny fraction of the number of funds. Then what
45:51
Speaker 1: is it like ten thousand private equity funds there used
45:54
Speaker 1: to be there, used to be numbered in hundreds, not thousands. Yeah. Yeah,
45:58
Speaker 1: the same as as the HENE fund and the venture
46:01
Speaker 1: capital worlds. Success has attracted a lot of capital, which
46:04
Speaker 1: leads to other performance. Yeah. And one further thing is
46:07
Speaker 1: that these questions were already relevant a few years ago. Um,
46:12
Speaker 1: but private equity did very well the last few years.
46:14
Speaker 1: And uh, and I saw Dan Rasmussen wrote quite nicely,
46:18
Speaker 1: so recognized. I mean, that's that's rare and probably when
46:20
Speaker 1: somebody does it sort of um post mortem on my mistake.
46:23
Speaker 1: That's what he did there, And he said he got
46:25
Speaker 1: it sort of wrong because, um, because they private equity,
46:30
Speaker 1: like hedge funds and especially venture capital, we're pushing a
46:33
Speaker 1: lot into the growth sector. And that worked very well
46:36
Speaker 1: for a few years. And I think to the extent
46:39
Speaker 1: that we write about the value versus growth, that benefit
46:42
Speaker 1: will turn into disadvantage I think in the coming years.
46:44
Speaker 1: And so it's really interesting. We haven't talked about a
46:48
Speaker 1: couple of other um alternatives, credit spreads, commodities, what else
46:54
Speaker 1: are you thinking about in the old space. Yeah, I
46:56
Speaker 1: think commodities is the most most interesting case, and so
47:00
Speaker 1: I bet a double positive story on that one. The
47:02
Speaker 1: first one is the obvious one that when we look
47:04
Speaker 1: for inflation hedging investments, they are pretty much the best.
47:08
Speaker 1: There is also most portfolios that invest most constituents of
47:12
Speaker 1: anybody's portfolio stock spons and so on day, they have
47:15
Speaker 1: got this inflationary deals that was helpful for a long time,
47:18
Speaker 1: but not recently. And so if you want to have
47:19
Speaker 1: a pretty neutral portfolio, you should have some some allocation
47:22
Speaker 1: to commodities. Then the second point is that many investors
47:25
Speaker 1: things that you don't earn a positive long run reward
47:28
Speaker 1: and commodities, but the data says otherwise. Basically, really yeah,
47:31
Speaker 1: diversified combination of commodity futures has earned something like three
47:35
Speaker 1: four percent long run reward. And that's it's it's a
47:38
Speaker 1: weird thing, and I focused on it in the commodities
47:42
Speaker 1: sector telling that it's part of it is related to
47:46
Speaker 1: commodity role maybe, but but important part is related to
47:49
Speaker 1: diversification returns. Basically, this is getting very big. But let
47:53
Speaker 1: me just try commodities on a single single commodity basis
47:56
Speaker 1: have got thirty percent molatility, which means that that that
48:00
Speaker 1: type of volatility hurts compound returns a lot. And and
48:05
Speaker 1: when you combine lowly correlated commodities together, you can reduce
48:10
Speaker 1: that volatility roughly half it, half it, and you can
48:13
Speaker 1: get this volatility drag much smaller, and so forth. If if,
48:17
Speaker 1: as the evidence suggests that a single commodity has pretty
48:20
Speaker 1: much not outperformed cash in the long run, portfolio of
48:23
Speaker 1: them has done it because of this saving on this
48:27
Speaker 1: volatility drag thanks to diversification. So it's a basket of
48:31
Speaker 1: energy and industrial metals and precious metals and food stuff
48:35
Speaker 1: and lots of yes and lots of single ones of them,
48:38
Speaker 1: and so again you get you commodities. You know, these
48:41
Speaker 1: types of effects happen in any investment on your equities,
48:44
Speaker 1: on your bonds and so on. It just doesn't matter
48:46
Speaker 1: so much with them because the correlations tend to be higher,
48:50
Speaker 1: or volatilities lower. Commodities have got this glorious combination of
48:54
Speaker 1: high high volatility and local relation that makes this really
48:58
Speaker 1: matter very very interesting. Let's talk about E. S g um.
49:05
Speaker 1: There have been some estimates that it's now over twenty
49:08
Speaker 1: trillion dollars. You talk a little bit about UM E
49:11
Speaker 1: S G investing, tell us about your thoughts. Yeah, so
49:16
Speaker 1: it is clearly growing force and and I would argue
49:20
Speaker 1: also largely a force for good. But expected return impact
49:27
Speaker 1: is debatable. And so Cliff Roath already a blog a
49:30
Speaker 1: few years ago highlighting this simple logic that well, one
49:33
Speaker 1: logic is that constraints always should have a cost. But
49:35
Speaker 1: another logic is it, if you want to be virtuous
49:38
Speaker 1: and you want to raise the discount rates for sinful companies,
49:42
Speaker 1: well you do that by maybe investing let's less in them,
49:45
Speaker 1: or even in some cases you could you could short them,
49:47
Speaker 1: and so um, if you do that and you raise
49:50
Speaker 1: their discount rate, you also raised that discount rate. This
49:54
Speaker 1: flip side of expected return makes the more charted. Yeah,
49:57
Speaker 1: so somebody else who is willing to basically buy the
50:00
Speaker 1: sinful companies, then we'll earn higher return. So that is
50:03
Speaker 1: pretty much the long run story that should happen. UM
50:06
Speaker 1: when when investors really like something for non monetary reasons,
50:10
Speaker 1: and that includes E S G, then the I think
50:13
Speaker 1: the reasonable counter argument is that we may be in
50:16
Speaker 1: a transition phase here where where we are getting the repricing.
50:20
Speaker 1: How do we get to those higher these countries. Well,
50:22
Speaker 1: we get it basically by making those those companies cheaper.
50:25
Speaker 1: And then we can debate now whether we are in
50:27
Speaker 1: early innings or late innings on on that that question.
50:30
Speaker 1: So so so in the long run, I think there
50:33
Speaker 1: will be some cost, and I think most investors who
50:36
Speaker 1: are sc on oriented should be willing to take some
50:39
Speaker 1: cost as a flip side of their virtuous investing. But
50:43
Speaker 1: but in between they might get sort of the win
50:46
Speaker 1: win outcome that day. So now you weren't getting the
50:49
Speaker 1: win when outcome in the past six months, especially if
50:52
Speaker 1: you were low carb and low oil any of the
50:56
Speaker 1: energy stacks have just on spectacle in the past year.
51:00
Speaker 1: Is that going to be the long run trade off?
51:04
Speaker 1: Is that if you're staying away from some of these,
51:07
Speaker 1: you take a chance that there's a big move up
51:10
Speaker 1: in a sector that you've reduced your exposure to. Yeah,
51:14
Speaker 1: I that that that possibility always exists, and now we
51:17
Speaker 1: now that we had it, I think it is gonna
51:20
Speaker 1: raise more discussions in some organizations than um how to
51:24
Speaker 1: deal with any financial trade of friends. I must say
51:27
Speaker 1: that in Europe, I think that investors will largely um
51:32
Speaker 1: stay with their E s G beliefs, and there's not
51:34
Speaker 1: going to be a question if they if they think
51:37
Speaker 1: they there's there's some financial of course that's okay. In
51:40
Speaker 1: US there's more doubts, and it has become such a
51:42
Speaker 1: political issue that it's going to be I think harder.
51:45
Speaker 1: Just I I everything or anything I can say on
51:48
Speaker 1: this one, I think is that is that there was
51:51
Speaker 1: a sort of easy travel towards more E s C
51:54
Speaker 1: for the last few years, and now I think we
51:56
Speaker 1: are we are in a in a world where it's
51:58
Speaker 1: going to be harder. I think the trade the still
52:00
Speaker 1: the same, but it's going to be more jagged going ahead,
52:03
Speaker 1: and maybe especially so in the US. And and before
52:06
Speaker 1: I get to my favorite questions, I gotta throw a
52:08
Speaker 1: curveball at you, Cliff, ask this mentioned you like to
52:12
Speaker 1: go in a hundred and twenty degree sauna and then
52:15
Speaker 1: jump out and roll around in the snow. Is this
52:18
Speaker 1: a Finland finish sort of thing? Tell us tell us
52:22
Speaker 1: about your heat and cold habits. That is, that is
52:26
Speaker 1: exactly what we do for cheap fun. And sadly there
52:29
Speaker 1: are a few opportunities with the global warming. But but yeah,
52:32
Speaker 1: so so how hot does the sauna get I was
52:35
Speaker 1: thinking whether you're talking fire in you know, we are
52:38
Speaker 1: talking with centigrade. Now we do go go closet degrees. No, no,
52:45
Speaker 1: we go to degrees centigrade. Yeah. Yeah, so that's like
52:50
Speaker 1: a hundred sixty eight. You'll do the translation there. I
52:56
Speaker 1: think of you know, the I do my father and
52:59
Speaker 1: height and closing that. But still eighty degrees is very
53:03
Speaker 1: you're just that's very warm. It's it's it's nice, nice
53:06
Speaker 1: to sweat that. And then when you jump into the snow,
53:09
Speaker 1: it's not a little bit of a shock to the
53:10
Speaker 1: system or or you go to um, you know, call out,
53:14
Speaker 1: you go into I see what that shows. That's that's
53:16
Speaker 1: even better. But that's that's that's hard. But yeah, no,
53:19
Speaker 1: it's it's uh, it's great fun when you can really
53:22
Speaker 1: do that. Quite interesting. All right, So let's jump to
53:25
Speaker 1: our favorite questions that we ask all of our guests,
53:28
Speaker 1: starting with what have you been streaming these days? Tell
53:32
Speaker 1: us about your favorite whatever kept you entertained during the
53:35
Speaker 1: pandemic or whatever podcast you listened to. Sure, sure, yeah,
53:39
Speaker 1: I thought about these in recent months when I have
53:42
Speaker 1: heard you ask these questions. And by the way, I've
53:44
Speaker 1: gotten some good tips I got, I got the Leboro
53:47
Speaker 1: and called my agent the friends once and some Israeli
53:50
Speaker 1: shows in from here. So yeah, that's why I ask it,
53:55
Speaker 1: because you know, I get to speak to people who
53:58
Speaker 1: have interesting sensibilit it is, I want to hear what
54:01
Speaker 1: they're seeing and here. Yeah, well so so as the
54:04
Speaker 1: first non obvious or non interesting answer, I think, like recently,
54:07
Speaker 1: I think we better call soul looking forward to the
54:10
Speaker 1: to the last few episodes. But so that's that's been great,
54:14
Speaker 1: but I thought that I'd rather highlight than some less
54:17
Speaker 1: well known older theories. So my favorites I think in
54:20
Speaker 1: the last ten years where sort of slow burn, um,
54:23
Speaker 1: the Americans the Russian Spies that that that one or
54:26
Speaker 1: or rectify it was a story from southern US, and
54:30
Speaker 1: and just just I think I think lovely stories got
54:34
Speaker 1: to take time for those. And likewise theny podcasts, um,
54:39
Speaker 1: I listen a lot to history and so beyond beyond investing,
54:42
Speaker 1: and I'll just leave well on near investing, I would
54:44
Speaker 1: say Tim Harford's um Cautionary Tales is fun, and and
54:51
Speaker 1: Zingalis and Bethany McLean Capitalism task got very thoughtful topics.
54:55
Speaker 1: So I think they are, they are good at but
54:57
Speaker 1: I love in his history area. I love Dan Carlin,
54:59
Speaker 1: Mike Duncan, Patrick Wiman and this British show called The
55:03
Speaker 1: Rest is History, which just always makes me laugh. So
55:06
Speaker 1: so that's a good that's good. That's a very interesting list. Um,
55:12
Speaker 1: let's talk about some of the mentors who helped to
55:14
Speaker 1: shape your career. Sure, so obviously I told the dissertation chairman,
55:18
Speaker 1: Farmer and French. So they've been very influential in many ways.
55:22
Speaker 1: But but I would especially then highlight Marty lebe of
55:25
Speaker 1: it so before, during, and after Salomony yea so and
55:29
Speaker 1: he's he's such a such a mention that it's it is,
55:32
Speaker 1: it's wonderful to have known him for the case. Uh
55:35
Speaker 1: what about books? What are some of your favorites and
55:37
Speaker 1: what are you reading right now? Yeah? So I am
55:40
Speaker 1: a voracious reader, lots of investing fiction, non fictional, all
55:45
Speaker 1: kinds of things. Um, I thought I will highlight from fiction.
55:51
Speaker 1: Um really big one, Hillary Mantell's trilogy on Thomas Cromwell
55:56
Speaker 1: Wolf Wolf Hall. I was thinking, I think maybe I
55:59
Speaker 1: heard in or You're so also the three Body problem
56:01
Speaker 1: very different to sci fi, the Chinese one so I
56:03
Speaker 1: guess that was great, and then on on on nonfiction. Um,
56:08
Speaker 1: I think the most impressive book I read in the
56:10
Speaker 1: last couple of years was Joe Henrich is the Weirdest
56:14
Speaker 1: People in the World. So this is this is weird?
56:18
Speaker 1: Is uh? Western educated? Uh, it's rich, democratic, and it's
56:24
Speaker 1: basically telling telling how different the people who are most
56:28
Speaker 1: often studied in various psychological studies, the Western University students,
56:32
Speaker 1: how different they are from most cultures. And then it's
56:34
Speaker 1: explaining why things went that way, and it's it's it's
56:37
Speaker 1: both parts of the story are very interesting. But but
56:39
Speaker 1: again a very long book, really really intriguing. Yeah, and currently, um,
56:44
Speaker 1: Zach Carter, I think, is your author of the book
56:45
Speaker 1: on Cain's Price Price Price of Peace. Good. That's a
56:51
Speaker 1: good that's pretty good. Lust what sort of advice would
56:53
Speaker 1: you give to a recent college graduate who is interested
56:56
Speaker 1: in a career in either investing finance value quantitative investing.
57:03
Speaker 1: How would you advise them? I'll go with the old
57:05
Speaker 1: fashioned I think, don't sacrifice your ethics. That integrity matters.
57:11
Speaker 1: M hmm. But that's really good advice. And and our
57:15
Speaker 1: final question, what do you know about the world of
57:17
Speaker 1: investing today that you wish you knew thirty years so
57:21
Speaker 1: years ago when you were first getting started. I thought,
57:24
Speaker 1: I'll say this lightly, that bond deals can go negative.
57:28
Speaker 1: You know, I didn't expect that to happen. But the
57:30
Speaker 1: funny thing is that I thought that, really I would
57:33
Speaker 1: have then expected that to coincide with barish equity markets,
57:37
Speaker 1: but into any tenls, it actually happened with with with
57:40
Speaker 1: a big bullmarket. So it wasn't that that equities um
57:45
Speaker 1: pushed equity weakness pushed bond deals down, but it was
57:50
Speaker 1: that low bond deals pushed equities up. So courseality went
57:53
Speaker 1: that way, and and that's surprising. So I think that's
57:56
Speaker 1: that's that's one. And then another serious, serious point is
58:00
Speaker 1: is how important and how hard patience is. So so
58:04
Speaker 1: with all of these ideas I talk about these longer strategies,
58:07
Speaker 1: and you just it doesn't matter too much if you
58:10
Speaker 1: don't have the stickiness. So I think one has to
58:13
Speaker 1: really calibrate one's investment to the amount of patients one
58:16
Speaker 1: one can reasonably expect to have. Huh, really really intriguing.
58:21
Speaker 1: We have been speaking with Auntie il Nannen, co head
58:25
Speaker 1: of Portfolio Solutions at a qu are. If you enjoy
58:28
Speaker 1: this conversation, well, check out any of our previous four
58:32
Speaker 1: hundred or so podcasts. You can find those at iTunes, Spotify,
58:36
Speaker 1: wherever you get your favorite podcasts. We love your comments,
58:40
Speaker 1: feedback and suggestions right to us at m IB podcast
58:45
Speaker 1: at Bloomberg dot net. You can sign up for my
58:48
Speaker 1: daily reading list at Rid Halts dot com. Follow me
58:51
Speaker 1: on Twitter at Rid Halts. I would be remiss if
58:54
Speaker 1: I did not thank the crack team that helps put
58:56
Speaker 1: these conversations together each week. Justin Milliner is my audio engineer.
59:02
Speaker 1: Atico val Bron is my project manager. Sean Russo is
59:06
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59:11
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59:15
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