Jay:  Today’s show guest is Meb Faber. Meb is the cofounder and chief investment officer of Cambria Investment Management. He’s also the host of the Meb Faber Show Podcast, which is one of my personal favorite investing podcasts out there. He’s also a frequent speaker and writer on investment strategies, and he’s been featured in Barron’s, the New York Times, and the New Yorker.

Meb’s a quant, so his investing style tends to be a little bit more on the technical side, but we have a pretty engaging conversation which I’m sure you’ll find interesting nonetheless. Please enjoy.

Meb, thanks so much for joining us. Appreciate having you on.

Meb:  Great to be here.

Jay:  For the audience tuning in, Meb is based in the States. He’s pretty active online. He’s got a great blog and a great podcast. I’m a fellow podcaster, so I appreciate the work that you do there. He’s also an ACC guy. I’m a Tarheel; he’s a Cavalier. So we have a little bit in common. I appreciate some of the references you make to that part of the world. Anyway, maybe you can give us a little better background of yourself and how you got into investing.

Meb:  Yeah, that’s a pretty good start. I grew up a little bit in North Carolina, a little bit in Colorado so did spend plenty of time on Franklin Street and around Chapel Hill. I love it there, ACC in general, college basketball. But, yeah, I went to Virginia. I was a biotech engineer guy. Started out in the biotech world, equity analyst for a biotech mutual fund before gravitating a little more towards the quant side of the business for a CTA firm and then eventually starting Cambria in 2006. We started managing money in 2007. So it’s been about 10 years in. Now we’ve got about 10 ATFs, severed account business, private funds, and it’s all quant-based, all rules-based, everything from stocks to bonds, global macro, and everything in between. We just came out with our sixth book, although this one doesn’t really count as my book because I was just the editor, but the best investment writing.

That’s the quick introduction.

Jay:  Awesome. We’ll definitely talk about that in a little bit. I just wanted to take a step back. You said you started off as a biotech analyst at like a mutual fund. It’s interesting. I want to hear about your progression from that to going into something that’s more quant and less sort of value-based, because I feel like… The big religion-type discussion that often happens for investors is obviously value versus everything else. And there’s many ways to make money in the market. We all know that. How did your progression happen?

Meb:  Like most, a lot of it is accidental. Part of the concept was it was late ’90, a pretty fun time in biotech but also a pretty interesting time in investing because the internet bubble, stock market’s been going up for the late ’90s boom. So you had a lot of confluence forces going on in both worlds. I had an interest in investing ever since a child.

I thought about taking a year off before going back for getting a PhD to make some money and have the opportunity to kind of marry the two disciples, to do both biotech and study a lot of these companies and concepts in the applied world rather than just theoretical. And so I did it for a year, and I actually took grad school at night down the road at Johns Hopkins. So I did both. But that one year became two, and a lot of just pleasant accidents or whatever it may have been — lived in San Francisco for a while as well as Lake Tahoe. It was just kind of those little decisions you make when you’re younger that end up being lifelong decisions ten years later.

Jay:  Definitely. If you could, for some of the audience members, maybe if you could — it’s not easy to do in such a short amount of time, but if you could unpack quant. What is a quantitative strategy? What is… Smart beta is one of these buzzwords. Not buzzwords, but it’s a word that even within the investing realm… I’m a long-short guy, so even myself, you hear that word being thrown around, but I don’t think a lot of people actually know what factor investing is or what smart beta is. So maybe if you could give us a quick overview of that.

Meb:  Yeah. Quant is anything rules based. It means it’s objective. So we’re not waking up today and deciding to go long Tesla and short Amazon or whatever it may be. But anything rules with rules baked in. One of the reasons that I was probably drawn to that from an early age was, one, my experience working for the fund, a long-only shop where, whether or not you could pick the relative merits of a biotech company in the late ’90s versus a company that didn’t have as much chance for success, it didn’t really matter when they all went down 50 to 80%.

So thinking about other concepts and rules and macro ideas as well to be able to implement to protect was probably the genesis. But also, for my own personal trading, I made all the mistakes that every individual probably makes, thankfully, in my early years with a lot less money. But I certainly was overconfident, would take way too much risk if given to me — on and on. All the listed behavioral biases, I had them all.

So the ability to make that somewhat of a non-emotional process was important to me. It takes a while, and I think a lot of people have to learn those lessons in person rather than on paper. It’s tough to really convey the emotional side of investing until you go through it.

That’s kind of what ended up taking me to that area, but there’s a million ways to be a good investor or make money in markets and plenty of people do it just fine subjectively or fundamentally or whatever it may be. Quant just resonated with me the most.

Jay:  So quant is essentially using data-backed and creating rules to hopefully take the emotion out of it.

Meb:  It doesn’t mean that they’re good rules. A good example is the most classic index — the market. A market cap weighted index on US stocks, for example. S&P 500 is something like that. But where you simply invest in the biggest companies by size — size being price times shares outstanding. That’s not a particularly good way to in—. Sorry. It’s not the optimal way to invest. It’s not a bad way to invest.

And so we often joke. We did a speech at UCLA recently where we talked about a hamburger index, and we said indexing meant something in the ’70s when John Bogle started the first indexes. They were all market cap weighted, low cost, low turnover. And it’s a perfectly fine first way to invest. But over the years, the term has been somewhat polluted. You mentioned smart beta earlier, but really, people can come up with almost any sort of rules-based system.

The example we gave was, well, you could come up with a passive index fund that sorts CEOs whether they like hamburgers or cheeseburgers. And then you would weigh the companies in the index based on how many cheeseburgers they ate per year. And then you would charge 2% a year for that. That’s a passive index, and I think it’s a lot of what the media gets wrong about this whole active versus passive debate and everything that’s going on. That’s a nonsensical investment approach, and you’re charging a ton for it. It’s a terrible way to invest.

The whole rules-based objective in and of itself doesn’t mean it’s a good investing strategy. It just means that there is some code or rules behind it, for better or for worse.

y:  I actually wouldn’t to ask a question myself. I’ve read some articles — not any research papers but articles — saying that market participation has changed in the last handful of years where it’s now up to 80% dominated by quant, algo, high frequency trading. Is that accurate, would you say?

Meb:  I don’t know the source you’re referring to. There’s a lot of commentary. Part of it comes back to me as, does it matter? What’s the point? Who cares?

A great example… When you look at the whole active-passive, rules-based algos or not — and part of this is conflating two different concepts, one being high frequency trading… But Vanguard, for example, the most famous indexer on the planet, the CEO literally invented index funds. Well, they run more active mutual funds than they do passive. A lot of people don’t know that. A third of their assets are in active strategies.

And so the term, while it might have meant something 30 years ago, is meaningless now.

A lot of the concepts the media talks about, you look at the media talking about ETFs being a very destructive force, and I laugh at that because EFTs will have one-fifth of the assets as mutual funds do. And then the percent ownership in ETFs globally of institutions is like one percent.

So in the media, a lot of these concepts, whether it’s algorithmic trading or high frequency or active-passive, I think it’s a very shallow investigation in many cases. But in general, markets will adjust. If there’s a company out there that’s trading for way less than intrinsic value, whether it’s an index that picks up on it or whether it’s a hedge fund manager, someone will eventually arbitrage that away because people like to make money and don’t like losing money. So the market simply will get more efficient over time.

Jay:  So what are some of the cognitive biases that us human beings are subject to and maybe some of the ones that you yourself caught yourself doing time and time again that led you down this path to creating your own fund that’s more rules based?

Meb:  I think it’s illustrated by my worst trade ever which was in my early 20s. It was an options trade on a biotech company. And so I had put on either a straddle or strangle, meaning buying calls and puts in the anticipation of a large market move one way. And it was a company that had a drug coming in, trial results coming out. And so the thesis was that you could buy the strangle, and the volatility would expand over the coming weeks as every portfolio manager on the planet would probably want to hedge this position. And so, sure enough, by the time the results came out, the position had already doubled. So a reasonable trader probably would have took some chips off the table.

And I had a bias towards non-approval. The drug ended up getting approved, and so the trade was still in the money. And so the bias already, which was probably — this one just being greedy — said I’m going to let it run a few more days because the price was, in general, moving in my favor. And sure enough, the company pre-announced earnings early for no reason. Stock went back down to the strike level, ended up losing all your money.

And so it’s a good example of a number of things. One, taking on way too much risk, meaning that the trade size is way too large relative to my account balance or what I should be risking on any one position or trade. Two, being overconfident in knowing all the possible outcomes. By no means was that a black swan. That’s something that’s probably happened many, many times in history where a normal market event simply causes the stock to move, but it wasn’t something in my thesis would even have been considered. I was so focused on the drug trial approval or not.

So you learn a number of lessons there. And in general, people, as they lose money, will get riskier. You see this at the poker table. They call it going on tilt where they get riskier and riskier as they have more losses and lose more. Those are just a handful of them. But you could probably open up the dictionary of behavioral biases. I probably have 90% of them.

Jay:  Yeah. Speaking of biases, here’s something else that you talk about often — home country bias. I know that’s an area that you’ve studied quite a bit and put out some good work on. People think the US has a large home country bias, but that’s actually the case for everywhere. I’m here in Hong Kong. Hong Kong investors are just as bad.

What can you say about home country bias? And what are some ways that you can get around that?

Meb:  The concept of home country bias, the simple takeaway is that people invest more in what they know. The example — and this is Vanguard Research. If you look at the global market portfolio, say just stocks, if you invest in the global market portfolio by size, the same as you would in the US where you’d invest most in Apple and Amazon and Walmart, etc., the US is about half the global total, but in the US, investors invest around 70% of their equity allocation in the US. And that’s the same everywhere else. You mentioned Hong Kong, but it’s also true in Italy, Australia, everywhere else, where people invest a lot more in their own market. And a lot of that is just comfort. But usually it’s a pretty terrible idea.

It’s terrible for two reasons. One, you have very large concentration — it may or may not be justified — but very large concentration, and that’s a very active bet. It may be a good bet. But in general, with market cap indexes, it’s usually a bad bet. The reason being is that a lot of the countries get over weighted by value. And so the US right now, we calculate is one of the most expensive countries in the world. And the average investor putting 70% in the US here is making a huge bet on US equities to continue to outperform.

And so we say a starting point is the global market portfolio, and you can deviate from that, and that’s fine, but that’s where you should begin.

Another example of that is that in the ’80s, Japan was the largest market cap weighted country in the world, and it was the largest asset bubble we’ve ever seen in equities, and it hit almost, I think, half the world market cap.

This bias also applies to sectors. If you look at the US demographics, for example, and do it by states, certain states that have exposure to certain industries often will overweight those industries. Whether it’s through a pension plan and you ask people, say, from Enron, if that was a good example, if you work at a company and put all your assets in that same stock, also an example of that sort of bias.

You can find examples of people that got rich or it made a lot of sense, but more often than not, it’s an uncompensated bet. It doesn’t really make any sense.

Jay:  Yeah, that’s a perfect example, actually, because I myself was subject to that twice. I worked for Lehman for a while, and then after that, I came here to Hong Kong, and I worked for Bear Stearns. And both times I was long the company stock, way more than I should be. Yeah, I learned that one.

Meb:  You have a knack for picking these. Maybe you should start shorting the company’s stock when you go work there.

Jay:  Funny story is after that, the team at Bear Stearns ended up going over to China Construction Bank which is like the second largest bank in the world, so I was like, if I can bankrupt this one, then I definitely have something going for me.

Meb:  Super powers.

Jay:  That’s right.

Let’s talk about strategies for just the little guy. This might be one of the reasons why… Maybe you can say what led you to starting Cambria and your own solution to this sort of thing. I think a lot of investment news and recommendations and this sort of thing out there are meant for large institutions. And it doesn’t really help the regular average guy that wants to protect his assets. So what solutions do you have for that?

Meb:  There’s a lot of good choices out there. We mentioned Vanguard earlier. There’s also an extreme amount of junk and predatory behavior. So the concept of Cambria was we wanted to launch strategies that we wanted to invest our own money in. It’s something like mutual funds on some level. It’s like 50 to 80% of these fund managers have nothing invested in their own funds. So there’s no skin in the game. The incentives are skewed.

So we wanted to invest in strategies that we wanted to put our own money into. I have 100% of my net worth in our funds and strategies. And so we wanted to launch funds that either we thought we could do better or that didn’t exist or in some cases we thought we could do cheaper than anyone else had out there. And so some are in equities. Some are in asset allocations. Some are in tactical and macro. But in general, those are the criteria, lastly being does anyone actually want it. There’s some ideas we think are fantastic, but no one really cares. But that’s a little hard to judge too, because a lot of times that tends to be cyclical. What is in favor a lot of people bought what they wish they had bought over the past few years.

That was kind of the genesis. We have 10 funds now. We launched a digital offering and have a handful more funds filed, but that’s the thesis. It’s looking for funds or strategies that don’t exist that we think we can offer that do it somehow better or cheaper in some way.

Jay:  What are your current views globally? You look at market globally, obviously, to get away from that home-country bias. What are your thoughts globally about Asia in particular? Any thoughts there?

Meb:  If you look at our two investment approaches that go back over, say, 100 years, that’s value and momentum and trend. Almost every approach we have has one of those or a combination of both as fundamental anchors as to how they approach the world.

Our largest fund is a value fund, devalue fund that invests in the 25% cheapest countries in the world based on long term PE ratios. It’s called global value. If you look at the world today on a valuation perspective, there’s good and bad news. The bad news is the US is one of the most expensive markets in the world. If you look at, say, Shiller 10 year PE ratio, it’s trading at a value around 30, average historically is around 17, and in low inflation environments, around 21. So expensive but not as expensive as it was in the late ’90s when it hit 45, which is a real true bubble.

And we’ve seen markets in the 40s and 60s even in the past decade with India and China. And then Japan is the highest we’ve ever seen when it hit a value right around 95.

So the US is expensive, but all that means is low, single-digit returns.

The good news is a lot of the rest of the countries around the world are reasonably priced to downright cheap to a bucket of them being extremely cheap. And in general, foreign developed is reasonable. Foreign emerging is really cheap. And then this bucket of super cheap countries trades at a PE ratio of around 10. That’s a lot of… Ironically, even though the emerging markets are much cheaper, the basket of that bucket is a mix of developed and emerging. So you have a handful of European countries, a lot of the countries that never really recovered from the global financial crisis, a lot of Eastern Europe, emerging Europe. Of course, what people label the PIGS — Portugal, Italy, Spain, and Greece. Throw in a little Russia and Brazil as well.

As far as Asia, there’s only really a couple of countries that are sort of on the cheaper side. I know Singapore is one. We used to own China, but because of appreciations, it sort of came out of this bucket.

But even in the middle bucket, most of the countries are reasonably priced. We use a number of valuation indicators. It’s not just price earnings. But the good news is most of the rest of the world is a lot cheaper than the US is.

Jay:  Right. So with the US market being so expensive right now, what are your short-term thoughts? What might bring this bull market to an end?

Meb:  Our favorite lens to look through the world is both value and trend. So if you chop the US bucket — this applies everywhere — into two sides, cheap and expensive, and then uptrend and downtrend, historically, the best results come from cheap uptrend, which makes sense. The worst is expensive downtrend.

Interestingly enough, the second best quartile is expensive in an uptrend, which is what the US is. Right? The trend has been up. It’s been one of the strongest, most low-volatility trends we’ve seen in my lifetime. So you’ve had this outperformance of the US since the global financial crisis versus foreign markets.

US versus foreign, historically it’s a coin flip. It’s 50/50. But the US has outperformed. It’s been the number one performing market until about a year or so ago. You started to see the momentum shift.

In a lot of these foreign countries, initially it was the really cheap stuff. So Russia and Brazil had monster returns last year. And then this year, it’s almost everything else but including… A lot of countries are having really strong results this year. And you’re starting to see them rebound.

Our thesis of a lot of the cheap countries in the rest of the world will start to outperform the US is finally coming to fruition, finally in the last couple of years. We’ve been talking about this since we put out our book in 2014 on the topic called global value.

But the valuation is kind of a yellow flashing light for the US, but it doesn’t really become a hard stop red light until the trend rolls over.

This is unintentional, but this painting behind me is an old Western painting by Bev Dolittle which has a bear crouching in the woods. You can’t really see it. So that’s kind of the US right now. It’s ready to pounce, but it’s not there yet. The trend is still up. At some point, it will roll over, and that’s probably the sign to reduce risk and exit some more of the US equity exposure.

Jay:  Yeah, I guess from a momentum perspective, a lot of gains are made at that expensive uptrend period.

Meb:  The bubbles. That’s the fun part — right? — that finally melt up. A lot of people don’t talk about it. My buddy Steve Sjuggerud talks a lot about it where these possibilities of the end of bubbles where everyone is rushing in, and you can have the parabolic moves up. The challenge, of course, is when do you get off that, and it becomes musical chairs. That’s a great example of being a quant and having a rules-based exit. Otherwise you’ll simply ride it up probably and all the way down.

We wrote a paper called “Learning to Love Investment Bubbles: What if Sir Isaac Newton was a Trend Follower?” You can download it for free on our website. It takes a lot of historical bubbles. It’s a pretty fun read.

Jay:  Interesting. Well, thanks for your views on the market and this sort of thing. I don’t know how you produce so much content, but like you said, you have six books now, ten ETFs, and I heard on your podcast that you just recently had a baby. So congrats on that.

Meb:  I did. Thank you.

Jay:  Let’s talk about your latest book, Best Investment Writing. What’s that all about?

Meb:  One of the common themes I struggle with is curation, the amount of news and investment news. But not even that but people are just inundated with a firehose of information every day. Forget about politics but just investment news in general. And so we started a research protocol at the Idea Farm years ago that was trying to solve this for professional researchers. And then I started doing an annual post where I just asked my friends and say, “What’s the best thing you wrote or read this year?” I try to compile it every year around Christmas time to be a resource. And then eventually a publisher said, “Meb, why wouldn’t you just cobble this together, and we could do it as an annual book?”

And I said, “I’d love to.” And so this was kind of the first volume, first try at this. There’s about 32 short essays, some of the best writing. I think some of them, you can read it one chapter at a time. You don’t have to sit down and read it all in one sitting. But a really fun review of pieces that are timely but also with a lean toward being timeless, so lessons that may apply today but that you could look back on ten years from now with some interest as well. So hopefully it comes out every year in the first quarter. We’ll look to do another one again in six months or so. But let me know what you think.

Listeners, if you read it, let me know anything. We’d love to hear some feedback.

Jay:  Absolutely. With regards to your other handful of books, was there one that — it’s like picking favorite children — but is there one that you are most proud of or one that you would most highly recommend to someone that’s getting in?

Meb:  Two things. The first is always kind of the baby, the first child. So The Ivy Portfolio was our first book. I think it holds a special spot for not only us but a lot of readers as well. However, if anyone has made it through this interview this far… We’ve given away over 100,000 books. So if you go to freeBook.MebFaber.com, we have a copy of Global Asset Allocation you can download, which is probably one that applies to the broadest audience thinking about how to put it all together. So you can download a PDF of that. And that’s a fun short read. That’s probably the highest rated of our six books, but all are four or four and a half stars, five stars.

Those two are great. It depends on my mood. I like some better than others sometimes. But those two in particular are great reads.

Jay:  Thanks for that. We’ll get that linked up in the show notes. I actually liked Invest with the House.

Meb:  Oh, that’s a fun one.

Jay:  Yeah.

Meb:  The cover art was designed in Transylvania. Interesting fact.

Jay:  Really? That’s interesting. That is a fun fact.

What other exciting things are you working on these days other than probably another book or another EFT launch?

Meb:  We have two white papers coming out in the next week or two. So it will probably be out by the time this is up. One is on tail risk and thinking about asymmetric outcomes to the downside in equities. We have a fund that does it, but it’s a little research summary.

The second will be on tax efficiency. So it’s something that probably no one has any interest in that is focusing on… Basically you should never own dividends in a taxable account and in a much better way of approaching US equity investing through a value lens but ignoring dividends and avoiding them. That’s actually a really fun paper that I’m pretty sure no one will read but has large implications. The boring stuff of fees and taxes have such a huge impact on returns, but it’s not the sexy part.

So keep an eye out for those, and if they’ve come out by the time of this interview, we’ll post some links. But those will have a fun component as well. It’s summertime, so it’s a little slow. But those will hopefully be out in the next quarter.

Jay:  That’s awesome. I had a quick question as well, kind of a side note. I just want to get your thoughts since you’re quite knowledgeable in this space. There’s a lot of investors talking about these robo advisors, Wealthfront, these types of guys. What are your thoughts overall on robo advisors?

Meb:  In general, I think the automated investment solutions — and I hate to call them… They’re more robo allocators. It’s a wonderful solution. The challenge, of course — and they all do the same thing, and that’s not a bad thing. It’s good. It’s low cost, diversified asset allocation, tax efficient. Vanguard is by far the biggest, then Schwab, then Betterment, then Wealth Front.

The challenge, of course, is that if and when the next bear market comes — we may never have one again, but history, if that’s the case, we probably will — it’s hard to behave. So maybe having a human element that’s in between you and your worst impulses is important. Some of them come with call center financial advisors. Some don’t come with any so that the value of a financial advisor, I think, really shines most in those sort of markets. So we’ll see. It will be interesting to see how they play out in the next big bear, if we have one.

But in general, I think every advisor will implement the technology at some point. We did it almost a year ago, and so we have a solution as well. It’s quite a bit different though. And I think everyone will implement the automated side of it. I think the best model will be the human-assisted, sort of automated investment process. That way you still have someone to talk to and help you out when times get tough.

Jay:  Awesome. Well, Meb, we appreciate the time. You’ve got a wealth of resources that are available for our audience between your book and your website, your podcast, which is great. Where is the best place that our audience can find you, follow you, connect with you, maybe learn a little bit more about what you’re working on?

Meb:  Type my name into Google. You’ll get just about anything, but my blog at Meb Faber has got a lot of the links for white papers, podcasts, Cambria Investments, or Cambria Funds, my work addresses, Twitter is just my name. Those are the best spots.

Jay:  Awesome. Well, thanks for your time. I appreciate it, and the audience appreciates you.

Meb:  Thanks.

Jay:  Alright. Take care.