October 24, 2020

U.S. Stocks Are Overvalued: Playing Defense And Offense With Cambria’s Meb Faber (Podcast Transcript) (BATS:EYLD)

45 min read
Editors’ Note: This is the transcript of the podcast we posted last week. Please note...

Editors’ Note: This is the transcript of the podcast we posted last week. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast, embedded below, if you need any clarification. We hope you enjoy.

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Jonathan Liss [JL]: For reference purposes, this podcast is being recorded on the afternoon of Wednesday, September 16, 2020.

My guest today is the Co-Founder, CEO, and CIO of Cambria Investment Management, Meb Faber. Meb manages Cambria’s ETF’s and separately managed accounts. Cambria’s Tail Risk ETF, ticker symbol TAIL, which we will definitely discuss during today’s show was named the 2020 alternative ETF of the year at the Fund Intelligence Mutual Fund and ETF Virtual Awards. Meb has authored numerous white papers and books and is a frequent speaker and writer on investment strategies.

He has been featured in Barron’s, The New York Times, and The New Yorker. Meb is a fellow podcaster. His Meb Faber show routinely ranks in the Top 50 Finance and investing podcasts. Meb is also a social media powerhouse. His Twitter handle @MebFaber has 80,000 followers and counting. He graduated from the University of Virginia with a double major in Engineering, Science and Biology. Currently resides in Manhattan Beach, California. Anyway, enough of an intro, welcome to the show Meb.

Meb Faber [MF]: Great to be here. Thanks for having me.

JL: So, I guess before we get into discussing the ETF issuer you started, why you started it and some of the strategies there because you guys have so many interesting and unique funds in your lineup. Just curious, you know, COVID is still dominating the news here, obviously, and just been asking different people how it’s changed your work life and how you’ve been managing to maintain a work life balance during this whole ordeal?

MF: I think for a lot of people 2020 has been a long decade already. You know, we’re only three quarters into the first year of the first decade, and it feels like 10 years for most of us, particularly anyone who’s got children at home. You know, I think it’s been an adjustment for everyone. I think, you know, we’re blessed here to – my company has been half remote already.

Where, you know we have people in Southern California, people in Illinois, Colorado, Texas, kind of all over. And so it’s been Arizona, it’s been less of a dramatic shift, I think than most, but we’re adjusting, you know LA when things started to go a little sideways here and one of the biggest cities in the world, they closed the beaches, that was the dark moment, because everyone sort of uses that as their backyard here. We packed up the car through my three-year old in there and went and hung out with the family in Colorado and Montana and Wyoming, little easier to socially distance there than other places, but we’re optimistic. Hope things are getting a little better.

JL: Yeah, definitely. And who knows, maybe there’ll be some upside in that after like a 100 years ago, basically, to the date. I guess it was 102 years ago after the influenza pandemic of 1918, what’s mistakenly called the Spanish flu, because it most certainly did not originate in Spain. We ended up with a Roaring 20s afterwards, so who knows maybe it’ll be a Roaring 20s Redux or something.

MF: You know, it’s funny, at the end of last year, I had a very casual tweet and said often, the end of decades mark turning points, big inflections in markets, really just decade defining sort of setup. So at the end of the 1980s, you had the biggest stock bubble we’ve ever seen in history, which was Japan. The end of the 1990s, of course, we had our own little version here in the United States, the internet bubble. And in the 2000s, of course marked by the global financial crisis.

And I jokingly said at the end of last year, I said I wonder what the 2020 inflection point will be and we have our answer. It’s been quite a different year. We did a four part series this year on – it’s called The Get Rich Portfolio, The Stay Rich Portfolio, investing in a time of coronavirus, which was in March. And then lastly was how I invest my money, but the investing in the time of the coronavirus, the reason I’m bringing this up is, I think a lot of people really struggle with having a view of the future where most of us want to forecast or have our belief on how the future will play out and investing so much as about the probabilities, even the ones that are somewhat rare.

And so we had written in March, you know what many assets were down 30%, 50% plus. You have to envision a world where there’s a bear case, and things get worse by the end of the year. And there’s a bull case where things get better. And we’re hitting all time highs. And almost no one thought that was even a possibility in March that the stock market by year-end would be back to all time highs. But here we are. We had the fastest from all time highs to bear market and the fastest from bear market to all time highs in the U.S. stock market ever.

JL: Yeah, totally.

MF: And we got three months to ago.

JL: Three months and a fairly consequential election as part of that. So, yeah, who the hell knows what’s coming up the pike here. So, just before we get into some of your specific funds here, and I know the listeners are going to want to get into specifics, because you guys have, I’d say pretty much a whole lineup, actually 11 funds are all relevant to the kind of a market environment that we’re in right now, but what made you decide to start your own ETF issuer is obviously not an easy industry to break into. It’s so top heavy. There’s about five companies that dominate almost all of the assets and you’ve broken in, you’ve managed to carve out a real niche for yourself. So, what was that decision making process like?

MF: So, going back over a decade prior to the last financial crisis, you know, there – when we started Cambria, we didn’t quite know what we wanted to be when we grew up, you know, we had managed hedge funds and separate accounts and the ETF structure. You know, I’m in general structure agnostic, and there’s positives and negatives, almost every structure, but the ETF structure has such an advantage when it comes to a number of things. One, the main one we always talk about is tax. And we’re not going to pour everyone, but the tax benefit and a taxable account for traditional equities and other asset strategies like that is probably a larger benefit than the fee discussion.

JL: Sure.

MF: So, that gets glossed over, you know, fees are an obvious one, but you could charge low fees in any structure, people just don’t with traditional hedge funds and mutual funds.

JL: Yeah, I mean, people talk about saving 5 basis points when they’re not thinking about the fact as you pointed out that if you would execute some of these strategies in your own account, without [in, kind of transactions] and all the other benefits that ETFs offer, you literally end up having to give up 20%, 30% of your earnings every single year.

MF: So, when we think about launching funds, you know, the context is there’s over 10,000 funds out there. And the problem with that is, of course that it’s like going to the grocery store in the cereal aisle, like it’s just limitless choice, and does the world really need more funds. So, when we launch funds, it’s really four criteria. You know, the first is, the fun concept or strategy either has to not exist or we think we can do it much better or much cheaper. And cheaper is rare these days, you know with the world of Vanguard at almost zero cost and a lot of these funds, but of our 11 funds, and by time this publishes we should have 12 out.

JL: Nice.

MF: Every single one of them is cheaper than the category average. So, the world is still dominated by high fees, despite the fact most of the flows are going into low costs, people still have their money in these very high fee funds. So, universally, we’re cheaper and in some cases, we’re the cheapest fund in the category, but going back to the concept of it doesn’t exist, I mean, that’s pretty rare. You think about it, and we watch these fund issuers every day, just launch these copycat [me2 funds] and it doesn’t make sense. So that’s one. Two, is it has to be backed by a fair amount of practitioner or academic research, many of which we publish, you know, we’ve put out seven books and a bunch of white papers and blog posts.

You can download most of our books for free on our website at Meb Faber at Cambria Investment. And so we want like the two big pillars we base a lot of our theory on it’s nothing new, it goes back a 100 years, the basics of it being value investing going back to the time of Ben Graham and then also [trend following] goes back to the time of Charles Dow. Third, it has to be something that I want to put my own money into. You and I discussed previously that the sorry state of investing is that the vast majority of mutual fund managers don’t invest in their fund at all. And if they do invest, it’s less than 100K and so – but they’re happy to go on CNBC year or TV year, the journal and tell you why you should buy the fund. But of course, they don’t own it themselves.

So, I have, essentially all of my public assets in our funds, and think it’s very important to have that skin in the game. And lastly, does anyone actually want the strategy or the fund? And this one is probably the toughest for me personally, because there’s a lot of ideas and concepts I love that are a little bit wonky that probably no one else on the planet wants. So, it’s always hard to like the Field of Dreams problem, you build it does anyone show up. So, we try to be extremely in different and I’ll wind down here, because the way the asset management industry is moving in the future, it’s going to be a barbell, you’re going to have the giants, the Vanguard’s, the trillion dollar money managers at almost zero cost that are doing market cap weighted indexes. And that’s fantastic.

It’s never been a better time to be an investor, you can buy the world for essentially free, but if you’re going to charge fees, you know, whether it’s half a percent or more, you have to be doing something either weird or different, or something, you have the ability to do much better than anyone else. And that’s pretty hard. This is a pretty competitive game. So, we try to exist in that sort of dark corner that no one else wants to play in, have weird and concentrated and different. And the reason most don’t want to be over there with us is they’re not willing to bring on the career risk, you know, being different for most part for a lot of people is uncomfortable, but we think that’s the whole point.

JL: Nice. It’s great. And it definitely shows in the kind of funds, you launched, you said that by the time this drops, probably in two weeks from now or so you probably will have a 12th fund. Are you able to discuss that or give people just kind of a brief preview of what may be coming?

MF: Yeah, I mean, we have probably half a dozen more fun concepts filed and strategies in general are public. And so, you know, this one is a real estate strategy, you know you would think, my God, why would anyone launch a real estate fund in 2020? And the reason is that, you know, like most of the landscape, many of the funds are market cap weighted. And so having a fund, you know we could go on for hours about the drawbacks on market cap weighting, but the simple takeaway is that there is no tether – while it is the market there is no tether to value. And market cap weighting becomes quite sub optimal, because it will overweight, expensive stocks, and typically underweight cheap stocks. And there’s really no upper bound on that.

So, the Japan example we gave earlier, you know, Japan was the largest stock market in the world in the 1980s, and it hit a PE ratio of almost a 100. So, if you’re a market cap-weighted global investor, you put most of your money in Japan, when it was one of the most expensive in the world. That’s actually the same true in the U.S. right now. You know, we track 45 countries around the world for long-term valuation metrics, and the United States is in the top three most expensive. Now it’s not a bubble. It’s not crazy, like the 90s, although you are seeing some rhymes, but it is expensive. And then if you’re a market cap weighted investor, you put most of your money in the U.S., most of your money in the big stocks, most of those are – have no tethered value.

So the same thing applies to a sector like real estate. Historically, using some of these same concepts of just very common sense value, investing in quality has been a tailwind to performance, just breaking that market cap related link in general is, I think, a thoughtful idea.

JL: Yeah, sure. I definitely want to get into the value conversation a bit more, because I think there’s been probably over the last few years numerous head-fake’s where, you know, tons of market pundits were saying, all right, now’s the time when we’re going to start the rotation from growth back into value. And it just seems like gross dominance has been accelerated by this entire COVID market. I think a lot of that has to do with the fact that a lot of those companies are also really high quality companies pristine balance sheets, likelihood, they’ll go under these massive, you know, [indiscernible] stocks, or Microsoft to the world is pretty low.

And I think that’s probably encouraging for many investors that they will get return of capital, if not return on capital with many of these companies. But still think it’s – the conversation needs to be had because obviously, you guys are a value shop and so curious for your take there, but before we get into that, I’d love to do a lightning round, let’s say where we go through a bunch of your funds and actually did this with the CEO of Global X, Luis Berruga back in July and I thought it went really well. So, I’d love to do it with you too, because I think so many of your funds are particularly suited for the environment that we’re in right now.

MF: Let’s do it. I’m terrible at brevity.

JL: Well, it doesn’t have to be that brief, just, you know, a couple minutes, just because I know we could probably spend an hour discussing each of these funds. So, you know, maybe we’ll try to cap it to like, you know, five minutes or so on each fund. So, I’d love to start at the top with tail. It’s your largest fund, by far nearly 400 million in AUM, possible it’s past that, I looked that up about a week ago, but the ticker (TAIL) is the Cambria Tail Risk ETF. And it really is an institutional strategy that thinks to the advent of the ETF is available to retail investors, as well. So just because you may not be allowed to discuss performance here, but I obviously can, I don’t have the same legal rules that you do.

Looking at those 23 days in February and March of this year, where the S&P 500 was down 37% from peak-to-trough, the fastest sell-off in history, as you said of greater than 30% while the market was tanking TAIL was up 30%. Now there’s obviously different ways of providing downside protection and TAIL is meant to protect against tail risk, specifically, which I assume you’re using the standard definition of tail risk there of the move of three standard deviations or greater, how does this fund achieve its objective?

MF: So, about four years ago, we looked around the investing landscape and was thinking about adding some sort of inverse exposure to some of our strategies and did a survey of the funds that were available and shook my head and said, my God, either these funds are ridiculously complicated. You know, like it was hard to explain, it was confusing, unnecessarily, or they were just absurdly expensive. I mean and really expensive, and so, I said, look, let’s do a study, and figure out if there’s a better way to go about hedging. And so we wrote a paper, it’s called worried about the market, maybe it’s time for the strategy.

And we walk through, we said, historically, let’s look at the worst months and stocks in this case, we’re doing U.S. stocks, but applies to any country or asset. And we said, okay, you know, these big 10%, 20% down months, which have happened in the past, you know, what helped to protect during those times, at least, let’s look to history and what you would expect to help did. So bonds helped, gold is kind of like [you’re crazy] [indiscernible], like it helps sometimes not others, but on average it helps.

JL: Up sometimes and then does nothing for two decades straight.

MF: Yeah, I mean, like one bad month in the S&P it was also down 16%. So, you can’t count on it. And the things you expect not to help didn’t. So, foreign stocks, you know, ex-U.S. didn’t help, real estate didn’t help, commodities, other commodities like energy didn’t help. And that makes sense. Those are all growth, sort of assets, you would expect to do well and expansions, and not well during recessions and contractions. And so, we said, you know, is there a way to come up with a strategy that pairs, owning bonds, so that most of the fund just owns the collateral of owning 10-year U.S. government bonds, but then buy a ladder of puts and do it in a way so that it’s not a huge cost.

So, the benefit of the bonds, of course, is that you get the capital appreciation usually, when the market gets whacked, you also get the income, which of course, is less now than it was when it was at 4%, or 5%, or 6% in treasuries. So, historically, we modeled it out going back four or five decades. And it turned out, it’s a great strategy for the bad times. The bad days, weeks, months, quarters, bear markets, you know, years. And so we kind of laid out a thought process on, on why and when people could use this, you mentioned, it’s found a bit of a product market fit where people are starting to apply it, you know, part of it, of course, is that it’s the single cheapest fund in the entire category, but also that it’s kind of done what you would expect it to do.

And I also laid out an interesting thought experiment that I think is useful to think about because it applies to all facets of life, not just investing. And that’s actually thinking about your human capital too. And in the appendix of the paper, if you make it that far, is if you think about the traditional asset manager or financial planner, you know we make the argument that they’re actually four or five times leveraged one risk, which is the U.S. Stock Market. So, the average planner for example, owns U.S. stocks in their own accounts and retirement accounts, that’s one. Two, they own U.S. stocks in client accounts, where even if they have a diversified portfolio, the volatility of stocks, swamps the bonds. So, if stocks go down 50% their revenue goes down. 50%.

We often know that clients act rationally, because they’re human during bad times, I mean, how many conversations have the listeners had with people that sold in 2009, never to buy again. So, people tend to panic and so then you have that risk as well. And then lastly, if you don’t work for your own company, but rather for someone else, you know, you’re exposed into during recessions and contractions, layoffs, and downsizing. So, you’re like five times leverage the stock market. So, I laid out the theory that theoretically, you know, if you’re an asset manager, you could make the argument that you could either not own U.S. stocks at all, which sounds crazy, or hedge them, and most multinational companies hedge their main risks, think about airplanes, they hedge their cost of fuel. If you think about cereal companies, they hedge the cost inputs of crops.

And so the same thing I said, you know, and some asset managers have actually started to do this. I mean, we keep a significant portion of our company’s balance sheet in this fund. I personally probably have more allocated to this fund than probably anyone else on the planet. Particularly, I think it’s instructive now, when, as we mentioned U.S. stock valuations are pretty high and long-term PE ratio is in the low 30s, that’s almost double the historical average now, during low inflation of around 21. The PE ratio is going to around 21, verses average around 17. And it’s not as bad as the 90s, but it’s not good. And so the concept, you know people use it different ways, some use it as like a bond substitute to bring down their stock beta, some use it tactically, some use it simply as behavioral tool with clients where they say, look, you think back to March, when people were watching the futures overnight, when people – markets were limit down, and the goal or the hope that there’s at least something green on the screen that can get you to the finish line.

And that’s the whole point of this, you know, to me, people often asked me. I say, look, you don’t need a tail or a strategy, you know, if you are [indiscernible], sort of just emotions, you don’t think about accounts, you don’t open your E*TRADE or Robinhood every day. You know, you just sock it away, and don’t think about it, you may not need something like this, but for a lot of people, the path is hard, because it’s so volatile. So, anything that helps you reach your goals and finish line and you want to own businesses, right, you want to own stocks, and we haven’t even got into it, but, you know, you want to own stocks outside the U.S., in my opinion, is the biggest attraction. But yeah, so it’s, you know, I think it’s a useful tool.

I think it’s one that that, you know fit all the criteria we mentioned before. And, interestingly enough, I think it’s found a lot of interest from investors this summer, because many, I think, feel a big disconnect between what’s going on in the economy and Main Street and what’s going on in markets. You know, if we took a crystal ball, we went back last year, I would just say, look, I’m going to give you the playbook in the next year. Gold is at all time highs, unemployment went from 3% to 15%. PMI has cratered, oil at one point trades negative, you know, on and on and on. By the way, there’s a global pandemic, you know, where do you think stocks would be trading?

And if you said all time highs and year-over-year, they’re up like 20%, you would probably, you know, say, I’m crazy. But, you know, here we are. So, I think a lot of people will say, I’m going to take some chips off the table or reduce some of my exposure. I mean, particularly with, we also have an election coming up, you know in the United States. And that’s – if 2020 is proven anything, it’s that anything can happen. And who knows?

JL: Yeah, definitely. I mean, and I think markets, at least traditionally have hated uncertainty more than anything. And I feel like there’s the distinct possibility that this election may not have a clean result. It may be up in the air for weeks or months afterwards, but, you know, you hear people talking about, well, what happens if one party gets the White House and other party, you know, holds Congress? What does that mean, for markets? I haven’t heard many people discussing.

Well, what happens if it’s like the situation in 2000 where? We don’t know who won except we have a, you know, President who’s like a flame thrower with the whole situation. But you know, what does that do to markets exactly? I think there’s the possibility for, you know, a ton of additional volatility both on that on the fact that I think people are very hopeful that there’s going to be a vaccine very soon. I don’t know how realistic that actually is. So, yeah, it’s definitely a reason to take chips off the table here. So, moving over to another set of products that you have.

You have these three shareholder yields ETFs U.S. focused, Cambria Shareholder Yield ETF (SYLD). The developed markets focus Cambria Foreign Shareholder Yield ETF (FYLD) and the highest yielding of the bunch by far the emerging markets focus Cambria Emerging Shareholder Yield ETF (EYLD). Obviously, rates have already been in decline for roughly 40 years at this point, I think really since the early 1980s, but with the pandemic and accompanying economic recession and the need to load up balance sheets with debt, global rates have really never been as low as they are really unlike anything we’ve ever seen, not only in the U.S., but really everywhere. And so obviously, there are many investors that are looking for yield in this environment. These aren’t the highest yielding equity income ETFs out there. So, I assume there’s some other factor like safety built into them. What’s the underlying approach you’re taking care?

MF: If you were to be an alien and come down to earth and talk to someone about investing based on cash distributions and income, sensibly speaking, you would say, okay, well, I need to determine all the ways that a company uses its cash and there’s only five, there’s only literally only five things coming to do with cash. They can pay a dividend. They can pay down debt, if they have any. They can do share buybacks. They can reinvest in the business, if that’s, you know, an op – that’s the sexy part that everyone always talks about, and you know, develop new products, all that good stuff.

And lastly, they can go buy another company. And that’s it. There’s no other options. And so, to only look at one of the ways a company uses its cash, which is what hundreds of billions, if not trillions of dollars do based on dividend yield alone, seems to me to be somewhat sub-optimal. You’re not using all the available information, and so, particularly in the United States, but increasingly over the past 20 years, the rest of the world, you’ve seen a transition from a lot of companies using the dividend route, which is traditionally tax inefficient, meaning as a shareholder, you have to pay taxes as you get the dividends, but rather the flexibility of share buybacks.

And a lot of people really struggle with the concept of share buybacks for various reasons. They – it sounds nefarious, but we have a link on our blog called FAQ on share buybacks for politicians and journalists and gurus and everything else. And it walks through. You know, at its core, it’s finance one-on-one, buybacks and dividends are the exact same thing if a company is trading at intrinsic value. And if it’s actually trading at cheap, you have people like Warren Buffett say there’s no better use of cash for a company than to buy back its shares if they’re trading for less than intrinsic value. And he gets that [Berkshire’s] essentially never paid a dividend, except in the very early days, and Buffett jokes that he was in the bathroom when that decision was made, but they do buy back stock, because it’s more efficient and you can do it when stocks trading at low values.

Now, the last thing you want is an expensive company trading buying back stock, but yeah, you can filter that out by using valuation metrics. So, shareholder yield concept is one is that you have a holistic approach. You combine dividends and net share buybacks, and it’s important to use net because companies also issue shares, you know, where they’re issuing options and everything else involved in that, but the combination means that you’re agnostic, and there’s companies out there. Apple is a perfect poster child. Apple never show up in a dividend screening fund because it does equal if not more amounts of buybacks. It may not show in a buyback fund and has been one of the best performing stocks of this entire cycle. It’s now, you know essentially one of the world’s biggest companies that over a trillion and knocking on two any given day of the week, it may be over two now, I’m not sure.

JL: Yeah.

MF: They get it right. Like they understand that it’s this combination. And when viewed holistically, you end up with a much better screen, now historically, and you can take this all the way back to the 1920s shareholder yield has been a better performing strategy than any combination of dividend strategies you can come up with, it’s very high correlation to cash flow, the way that we do it. We use it, you know, valuation filters too to come up with a valuation composite. So, we want cheap companies that have lots of cash that are returning it to shareholders. There’s a third input that gets a little wonky, but companies paying down debt is another way of returning cash to shareholders because the equity holders have a higher claim on cash when they’re not leveraged up.

So, it’s a little bit different in foreign developed and emerging than it is in the U.S. because many of these countries and companies don’t have as much of a culture of buybacks as we do in the U.S. But it’s been changing. A great example is Japan. A lot of the corporate culture over the last decade has started to evolve in Japan. So, you know, I think it’s a totally sensible strategy that right now also you end up with a pretty high holistic yield all around the world. Dividend is obviously more and developed and emerging just in the U.S. But if you think from just a common sense, starting fundamental principles, I think it’s a much more sensible approach than income alone.

JL: Yeah, sure. Makes a lot of sense. And I assume, because you do have, you know, equity risk here, I assume there are people that are just taking these three funds and getting their entire equity exposure through this approach.

MF: You know, we’ve been on record saying that, if you look at global valuations, we said U.S. stocks are expensive that foreign developed is totally reasonable, normal valuations, foreign developed is downright really cheap, but there’s a subset of countries out there that are sort of the cheapest of the cheap PE ratios below 10. The one caveat that’s happened this year is that, you know, these funds or strategies are size agnostic. So, they could be small-cap, they could be mid-cap, they could be large-cap, Q1 this year, a particular subset of the U.S. market got absolutely pummeled, which is small-cap value.

JL: Yeah.

MF: And so you had, I mean, I think they were down 50% at some point, and in Q1. And so you had this dispersion from large-cap, and particularly large-cap growth to small-cap and small-cap value. So, whereas domestic U.S. traded at a significant premium to foreign and emerging that was no longer true, come this spring this summer. So, all three we think are significant opportunities versus, particularly large cap U.S. over the next decade, not maybe next quarter, who knows what’s going to happen next quarter next year, but the next 10 years I think you’ll see, one of the biggest valuation spreads we’ve ever seen, become a headwind for U.S. large cap and a tailwind for everything else.

JL: Yeah. I mean, it makes sense. We’ll see if or how it actually plays out. But yeah, definitely a lot of people waiting for that rotation to happen, which I think makes a good transition over to (GVAL), Cambria Global Value ETF. It’s your second largest fund, about 100 million in AUM. Since February of this year growth outperformance over value has only increased. And again, we can get into some of the reasons that that may be the case, whether it’s more of a momentum trade more of a quality trade, but the bottom line is that value has certainly been a laggard for quite a while now, small caps have obviously been a laggard also. And so, just curious, what is your approach to value with GVAL? What kind of screens are you running and kind of the fund come together exactly?

MF: Yeah, going back to our original sort of concept of breaking that market cap link, I mean, you know, I think it’s important over time to invest in the cheaper countries, stocks, sectors, whatever. Equally as important is to avoid the expensive, and often the expensive looks like roses, because they’re hitting new highs. And in the PE ratio or any other valuation metrics, they’re all the same, traditionally, when you’re at extremes is everything looks great, markets are hitting all time highs, but it’s the PE and the PE is usually what’s moving. And so, the cheap markets are simply markets that are down 40%, 60%, 80%, 90% already. Very high correlation between draw-down and price earnings ratio, and so in this global value fund, we look to simply invest in the cheapest core tile, or 25% of countries in the universe, that’s 45 countries, we’ll go invest in those, it only rebalances once a year and traditionally, there’s not that much turnover.

The beauty of this approach is, it gives you a lot of names that otherwise you probably would be very reluctant to buy, you would feel a lot of nausea and career risk going out and saying, You know what, I want to buy Brazil, and Russia, and Greece and on and on. And so, you get them all in one bucket. But historically, you channel John Bogle, Vanguard founder in the 90’s. He wrote a paper that was talking about forecasting stock returns. He probably wouldn’t use the word forecast, maybe expectations, but you plug in starting dividend yield, earnings, and dividends growth and change in valuation, you come up with a pretty good proxy for what stocks will do for the next 10 years. And before he passed away, he said U.S. stocks probably do about 4% a year, you know not great, not terrible, but low starting dividend yield, high valuation and valuations got even higher, but the rest of world you type in those numbers instead of a 2% dividend yield many countries got 4% or 5% and instead of a plus 30, valuation, you got low teens, or even single digits in some cases.

And so, you know, the simplicity of that concept keeps you from, in my opinion, doing dumb things. So, historically having the ability to have an anchor, meaning, do I have this common sense way point of saying, historically markets have been around PE around 17? Can I justify buying them at 30, or 40, or 50, or 60, or 100, which they’ve all traded out in the past, you know, and the U.S. has also been as [low as 5]. In this article we did about the biggest valuation spread in 40 years, you know, the U.S. stocks were not always expensive, they were cheaper than the rest of the world in the 80s. And, you know, again, Japan being the big outlier, but U.S. versus the rest of the world has had the same valuation average over the last 40 years, but it’s just been a massive dispersion over the last 10. And that’s not always the case, you know, the U.S. really has only beaten the global average in a few decades, it happened this past decade, and happened in the 90s.

And then before that, you have to go all the way back to the 1920s. So, you know, having a diversified global approach, [caught, we’ve caught breath], you know, why limit yourself just to one country, and then tilting towards value? I think it’s just a very sensible approach. Now, that hasn’t helped you for the past number of years, which you mentioned, it’s been somewhat of a laggard across the board in any way you construe value. But that’s the way it works. You know, these things play out over periods of 5, 10, 20 years, and having the ability to tilt sort of head into the wind and buy the cheaper stuff, at least historically speaking, you know, last 100, 200 years, has been the better approach than buying the really expensive.

JL: I do wonder though, if I mean, you know, I’m not going to say, maybe this time is different, because that’s always the statement that comes back to bite you in the ass, but I do wonder with the pandemic and just the rotation away from so many traditional business models, towards high-tech growth, and then you couple that with the fact that these mega caps are, you know, AAA ratings by and large, pristine balance sheets, and credit has never been cheaper for them. And so they can essentially borrow money for next to nothing, and just solidify their advantage over any small or mid cap companies that, you know, may want to be challengers to them.

And I wonder if maybe not to overweight growth over value, but if it doesn’t make sense in this kind of an environment, to try to be somewhat agnostic on that and not assume that values moment to overtake growth is coming in the next few years because of, again, low rates, the pandemic and the rotation to work from home and anything digital, and all of those things could very well add up to another couple of years of strong outperformance for, you know, NASDAQ-100 over an S&P 500 style portfolio composition.

MF: Yeah, I mean, the simple answer is to just not make the bets. You know, we tell a lot of investors that a great starting point is just buy the global market portfolio, which gives you it’s roughly if you were to buy every public security in the entire world, it’s roughly half stocks, half bonds, and of that half U.S. and half foreign. So, you know, look, that’s a perfectly fine portfolio, and we’re not ones to go say you have to do it one way or the other.

Look, you want to buy your 10 favorite dividend stocks, God bless you, it works for you, good for you, you know, it’s so – for ages, and that’s the biggest thing about investing. It’s for coming up with something that fits your own personality, your own thesis, and that you can stick with, which is important thing, having the knowledge of at least how history is played out, gives you the ability to withstand the extremes and market returns, which are normal, you know, we say this all the time that normal market returns are extreme.

So, whatever your investing approach may be at least understand what’s possible in the past, because definition of the future is it’s going to go outside those boundaries at some point, you know, I would say the number one determinant of investor failures is simply themselves. It’s not the actual approach. So, even if you do invest in expensive stocks, it’s not the worst thing in the world, but at least understand the consequences and what comes along with that.

JL: Yeah, certainly that’s really well put and I think, good advice for listeners. So, moving along here, you have, as you said, because you take a [quantum style] approach to your funds, you kind of are balancing between a value approach and a momentum approach. And you even have a fund, which I think is value and momentum. And those two approaches can often be in opposition to each other. So, value will often be things that are the reason that the valuations are good, you know, based on how you’re measuring it, is that they don’t have momentum.

They haven’t really been moving up all that much, and so, relative to where the share price is, there’s real value there. Momentum, I think often you end-up with those kinds of high flying growth stocks, certainly in this environment. That’s been the case. You have Cambria Global Momentum ETF (GMOM) and great ticker names, by the way, probably a lot of fun to come up with them. How are you using momentum there? This fund is actually not equity only, it’s momentum across asset classes, which I think is a pretty interesting approach to momentum. So, if you could just talk about how you’re using momentum to underpin a global asset allocation strategy, I think that’d be interesting?

MF: Yeah, it’s one of our big pillars we mentioned in the beginning, which is momentum and trend and they’re kind of cousins, you know, momentum is, which racecars running around the track better. So, is gold outperforming stocks, stocks outperforming bonds, and then trend is simply is something going up or down? And the goal with both momentum is really looking for our performance trend as you’re looking to just kind of save your hide and try not to be invested in a market that goes down 40%, 60%, 80%, which most markets have at some point.

And so the ability to combine the two, you know, at least historically speaking has been a great way to invest. It gives you concentrated exposure and the assets that are outperforming and then only tries to invest in them as they’re going up. That’s a tall order, of course. Historically, that sort of strategy and fund will really shine and distinguish itself when U.S. market is going sideways or has a long bear market, which we haven’t seen in over 10 years now. We saw a quick one this year, but not an extended one.

JL: Yeah.

MF: Or if there’s concentrated assets that are doing well, you know, that are untraditional assets. The goal in this fund, and it’s philosophically, you know we have an Asset Allocation Fund, GAA and we have the momentum in trend fund, (GMOM). And philosophically speaking, they’re like two ends of the spectrum. One is buy and hold, don’t do anything. The other is highly concentrated and tactical. Both philosophies I think at the end of the day will get you to roughly the same place over time. I think they will take very different paths to get there.

And so, you know, we have this concept called Trinity, which is roughly half in each, where, you know, the biggest problem with buy and hold is you have to be able to have the fortitude to sit through the long draw-downs and that can be very painful for people. This year is a very recent reminder, but 2008, 2009 you know, the internet bubble, whereas momentum and trend tends to struggle in choppy markets, sideways markets, markets where your neighbor is making a ton of money and you’re not, but they traditionally do really well perform great when there’s long bear markets.

And so, the philosophically speaking putting half, I mean this is a very technical term, we call putting halfsies, you know in each as an allocation is a nice diversifier because traditionally they zig and zag. And so, you know, I’m at my [core a momentum] and trend following trader, goes back to our very first white paper over a decade ago. And if you had a [desert island me], you know that the strategy that I would say would have the best outperformance for the next decade is buying the super duper cheap global stocks. But if I said, look your goals survival in any market environment, you know, and you had to do with your entire portfolio, the momentum and trend makes a lot of sense to me, because it adapts, it adjusts, and if bonds have a monster run or real estate or commodities, or stocks, or we go through a Great Depression, like it should survive that which is really the whole key to all of this, you know, is biggest compliment you give any investor or founders is simply survival.

And so thinking of it under the lens of gambling or speculating is the worst thing you do to gamblers take away their bankroll. Because when you lose all your money, you can’t bet anymore. So, to be able to withstand, and the whole point of that game we’re playing is to try to end up with more money than less. And so the trend following approach to my mind is a very sensible, it’s worked in most of the markets as far back as we can, you know, examine them in history. And it keeps you out of the ones where you get taken out of the game, where markets go to essentially zero. And we’ve seen that, you know, unfortunately many times in markets and will probably continue to see it in the future.

JL: Yeah, it makes sense. And I guess if you had to kind of put it into the dichotomy or a yin and yang, a trend following strategy, I think is probably for people that maybe can’t handle that pain of seeing those kind of draw-downs because if you’re looking at a long-term value strategy, you’re going to have to endure a lot of pain in certain markets to ultimately you know, get to that reward of well kept on plowing money in and eventually, you know, things are just up hundreds of percent. So, definitely interesting side-by-side approaches there. Alright, so the final fund I wanted to discuss here and I want to get into this space more broadly in a top down kind of a way is your fund Toke, T-O-K-E.

The Cambria Cannabis ETF (TOKE), amazing ticker symbol, obviously, definitely a fun one. This obviously been a very emotionally and psychologically taxing period. Social attitudes to cannabis have changed dramatically over the last decade with a much higher level of acceptance for straight up legalization, certainly medicinal applications of candidates, both in the U.S. and globally. So, just curious starting out you, you don’t really have any other thematic funds. There are nine other funds trading in the U.S., obviously lots of cannabis funds trading in Canada and overseas as well. It feels like somewhat of an oversaturated market. So, what made you decide to get into this space?

MF: Well, when we filed the fund, there wasn’t any out there, but, you know, the regulatory hurdles often can be lengthy and dry. And no pun intended.

JL: I think, why not? You should have intended a pun there.

MF: We wrote an article last summer called the case for investing in cannabis and outlined a very lengthy reason why we launched this fund, you know, if you look at the rest of our line-up, it tends to be very buttoned down, sort of academic institutional level strategies and quantitative and rules based and say, oh, man, what are you doing launching a thematic fund? And we said, look there’s really only a couple of reasons in our mind to actually launch one, most people launching thematic funds, and it’s our belief that thematic funds don’t outperform, you know it’s more sort of giving candy to traders, often to fulfill their willingness to gamble on a very specific niche.

And so, a bit odd that you’re launching one well, we actually did a quant study, you know, we look back at history and prohibition and looked at stocks during the alcohol stocks and beer stocks when coming out of prohibition and how they performed and is a scenario that just has unbelievable amount of parallels with the current one, you have a massive black market, massive demand for an industry, essentially operating at the fringes that is going to get legalized. And in that case, you obviously know the story of what happened in prohibition, but in this case, you can see the writing on the wall, the mood, the sentiment changing, and all the catalysts that have happened in the past and continue to happen, and the maturation of an industry.

And so, we found that the companies in the alcohol and beer sector outperform S&P but it was, I think, almost 10 percentage points per year for a decade. Now it was lumpy, and it didn’t all come at once. And a lot of it actually came in the latter half the decade. But we expected that to be the case for the 2020s. And so – and actually when we wrote this article, we said look, you also can’t just be agnostic as devaluations. When we launched the fund, we had like a 25% or 30% chunk in cash. We said, you know, you have to be thoughtful on how you approach this. And not surprisingly, you know, the industry got smashed over the ensuing 6, 12 months. But you know, seems to have bottomed and is during coronavirus has certainly seemed to have turned the corner on news flow on revenue.

I mean, some of these companies are, you know, it’s not like the internet sector in the 1990s where they weren’t making any money. I mean, many of these companies are generating very significant revenue, and drawing the attention of the large multinational tobacco alcohol conglomerates. So, it’s a sector that I think is worthy of a long-term bet. You know, I’ve mentioned on social that I’ve, you know, doubled my investment and doubled it again, as it’s gone down with the intention of holding it for 10 years.

Now, we’re the cheapest fund in the category, you know, per a lot of our, you know, beginning of this discussion, but also touching on something I think it’s really important and applies to all funds is that, you know, many funds out there will do short lending of their underlying shares and not to get too wonky, but the good companies will then distribute that short lending income to shareholders, you know, so Vanguard does it and in the S&P 500 style funds it may only be 0.1% a year in revenue, or 10 basis points, but in many funds, and many funds black – BlackRock and others have detailed this and various educational pieces, where the shortly lending revenue will be more than the management fees of the fund.

So, you may have like a small cap, micro cap fund that has a 40 basis point fee, but it may distribute a 100 basis points in short lending revenue. Meaning for our intensive purposes, you’re getting paid to own that fund, and that’s pretty cool, right?

JL: Yeah, totally.

MF: So, I can’t claim the exact amounts because it’s not consistent, but you can look it up on the online documents and see that for this fund, not surprisingly, but many strategies like this can generate not just tens of basis points, but hundreds and hundreds of basis points. I mean, I think there was an example of back in the day where like the solar ETF was generating like 5 percentage points or 7 percentage points of income per year, based on the short-lending revenue. Now, you have to be careful because there’s some fund companies out there that keep it or keep a large portion of the short- learning revenue, which we think is pretty bad behavior, but we don’t keep any…

JL: They bury that in that perspective. It’s [on like Page 88], or something.

MF: Yeah, yeah. So, we distribute all of ours, which we think is important.

JL: Yeah, no, that’s great. And I guess because you’re dealing with companies with smaller floats, cost to borrow can be quite expensive in some cases, so you’re able to make real money by doing it. And then you’re passing it back on to people.

So, you’d mentioned, you know obviously, cannabis stocks publicly traded cannabis had a really great run up until 2018. Then the funds started launching and I’ve just, you know, somebody who’s been looking at the ETF space for 13, 14 years at this point, I have noticed often that when a – just a rash of genetic funds launched together, maybe four or five funds come out in a few months. That often signifies the top for that theme for at least some period of time because everybody wants to jump on the bandwagon.

In terms of current valuations of this space, you’re saying you think things have bottomed? Do you think that cannabis as an industry, publicly traded cannabis has reached a point right now in 2020, where the risk reward outlook is really in favor of these companies? Have they grown into decent valuations or shrunk into decent valuations at this point?

MF: Not universally, but many have. And, you know, let me make a comment, you mentioned which is important. You know, anytime you’re looking at a fund company, we have a lot of investors, we have over 50,000 investors that will say Meb you’re a small company; I’m worried you might shut down one of your funds. And I always laugh at that, because who shuts down most of the funds is the big guys, because these guys have hundreds of funds. And they’ll just throw everything against the wall. They’ll launch dozens of funds. And if one or two of those raise assets, they’re happy with it.

So, they just take the spaghetti against the wall approach. And so when you mentioned many people launching funds all at launch and thematic, it’s people just chasing assets. You know, they’re chasing the hot strategy, the hot topic de jour. And to me that is such a foolish and short minded approach to investing. We’ve never closed a single fund and we have been in business, you know, since 2013, launching ETFs. So, almost a decade now, but you start to look at these fund companies and percentage of funds they’ve closed, it’s often shocking. So, you know, our goal is to never close any funds, hopefully. But yeah, who knows, but as far as the sector look, you know, this is a 10-year play for us.

And I think that when you make some of these bets, that seem, obvious is the wrong word, but just sensible. The valuation that we talked about, you know, others I’d put under this category would be betting on Africa. You know, that’s a theme that I think has huge tail winds, but you’re not going to play out in the next month or quarter or a year. And you know, it’s playing out in the decade. So when you have me back on and 2030, we may be doing like hologram version of this. We can talk about what’s worked and what didn’t, and what we see is the opportunities in 2030, but, yeah, I mean, I think many of these companies are trading at absolute – I mean, they were down 50%, 60%, you know, some of them down more.

JL: You know, Aurora (ACB) I think is down 90% or more from it. So…

MF: That does a lot to cure valuation when you go down 90%, right. So, you know, and like many things, the [indiscernible] of the internet industry, you get some hucksters and shysters and people that are not great managers. And money always attracts…

JL: Unsavory types. Yeah.

MF: Right. So, we’ll see. But, uh, you know, I think it’s a bet worth making for sure.

JL: Yeah, no, definitely. And I guess I would take a bit of umbrage with your statement about thematic funds in general, because I think there are some other spaces where you can take kind of little direct bets with a few percent of your portfolio. Like, I think back in around 2007, when I started looking at exchange traded funds, I just looked at the situation with global population growth and water. And I said, you know what, I’m going to just put a little bit into water technology fund, because this is an industry that clearly must get significantly bigger. And that’s been – it’s been a good strategy. I think cannabis with the legalization coming up.

The other reason I think, thematic funds can be great is a behavioral one. And that is, so I’ve, you know have some friends that asked me advice, occasionally, I’m not a financial professional, or [indiscernible] or anything, but I’ll give them just basic sound advice. You know, depending on how much risk you want to take, you should have X amount allocated to stocks versus bonds, you know, split globally. And a couple of people, instead of taking their money and putting it into other kind of stupid, get rich, quick things, you have them put 90% or 95% of their portfolio into just kind of boring, you know, index funds, maybe some value or size tilted things. But then you give them 5% of the portfolio and say to them, you know, like what themes are you really into? Or what’s your cause, like, you really into gender diversity. So, here’s a fund that you can actually invest in.

Kind of gets people psyched about investing in a way that I don’t think the S&P 500 or the Russell 2K ever can. So, I think that there might be a positive aspect, even though I do agree that a lot of the thematic funds are kind of just a marketing ploy to some extent, but I do think there’s positive behavioral aspects to them for many younger investors in particular.

MF: Well said.

JL: Awesome. Okay, so getting back into cannabis here. We are obviously, coming up to a major U.S. election, there are at least some people who think that this may be an inflection point for cannabis becoming legal federally, not really clear looking at Joe Biden’s policies that he will be the one to push federally legal cannabis, but I don’t think it can be ruled out, but I think it begs a larger question of right now, one of my issues with investing in the cannabis space and why I haven’t bought an ETF in this space is that most of these funds and yours included, are loaded up on Canadian LPs and Canada is, you know, good for them for legalizing they’re relatively small market. They are, you know, tenth of the population of the U.S. And I just wonder how great the value proposition is before cannabis becomes federally legal in the United States. So, how important is federal legalization for cannabis to really reach its full potential if cannabis doesn’t become legal in the next decade? Does that blow up your thesis or not necessarily?

MF: You know, I think betting on politicians is always a risky proposition, but it does seem that the mood has shifted. I had commented earlier this year, I said there’s potential that within the U.S. that both the sides of the aisle are going to try to outwork each other and try to pass federal legislation at least for banking before the election. Well, we’re getting close to that. So, unlikely that’s going to happen, but it seems like the writing’s on the wall. I mean, the mood, all those sentiment, all the mood is shifted. And if there’s anything that politicians like it’s tax revenue and Colorado kind of being the first used case, you’ve seen that. I think it was within the first year that the tax revenue on cannabis outpaced tax revenue on alcohol, and Colorado’s big beer drinking micro brew state.

So you see politicians want to get their greasy hands all over a new source of revenue, I think that there’s very low chance of it not happening at some point universally. You never know, with elected officials, but that would seem to be a low probability event, I think. But if it doesn’t happen, you know, you’ve already built many billion dollar businesses that I think continue to grow and scale and really continue to do well, not just in the U.S. and Canada, but in many other countries all around the world. One of my biggest bullish parts of the thesis, which isn’t there yet was the biggest consumer of cannabis is Asia. You know, so as Asia comes online at some point, you know, that to me is a massive tailwind over time.

JL: Sure. And I did not realize that about Asia, anyway I’m mindful of your time here. I want to thank you for being so generous with your time today. It’s been great. We’ll have to pick it up some other time. Just tell listeners where the best place to further research everything we’ve been discussing here today is.

MF: Oh, almost anywhere. Come say hi in Los Angeles, we’re located at in Manhattan Beach, six feet away, of course. But we’ve got a blog Meb – yeah, we got a blog mebfaber.com. It’s got lots of podcasts on there. Meb Faber show. My day job is running Cambria Investment Management. You can also go to cambriafunds.com and find all of our various ETF offerings and you can watch me on YouTube and pick fights on Twitter or at least behave mostly academic investing fights, but …

JL: Those are the best kind of fights. Yeah, nice. And just so everybody out there understands you are long pretty much all of your company’s funds, right?

MF: Yeah, If I’m not going to believe in them who else is? I’m a big proponent of skin in the game.

JL: Nice, yeah. We’d like people that eat their own [indiscernible] Seeking Alpha it’s kind of our – been our methodology from day one, opposite of your Wall Street Journal paid coverage can actually own anything you write about environment who’s going to do better due diligence and the person that puts their actual money behind their investing thesis. So, anyway, stay well, wishing you health and sanity in the rest of this year and beyond. And hope we can do this again sometime.

MF: Awesome. Let’s not wait till 2030, we’ll do it sooner.

JL: Yes. Awesome.

MF: Cheers.

Disclosure: I am/we are long TOKE, TAIL, SYLD, FYLD, EYLD, GVAL, GMOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Meb Faber is long nearly all of his firm Cambria’s 12 ETFs.

Jonathan Liss is long QQQ, VOO and VLUE.

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