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Excess Returns
Replicating Hedge Funds, Lessons from Bridgewater and the Outlook for Inflation with Bob Elliott
01:11:06
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- [00:00]
Justin Carboneau
Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long term investor.
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Jack Forehand
Justin Carboneau and Jack Forehand are principals.
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Bob Elliot
At Bolivia Capital Management.
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Jack Forehand
The opinions expressed in this podcast do.
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Bob Elliot
Not necessarily reflect the opinions of Valida Capital. No information on this podcast should be construed as investment advice.
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Jack Forehand
Securities discussed in the podcast may be.
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Bob Elliot
Holdings of clients of Validity Capital.
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Justin Carboneau
Hey guys, this is Justin. In this episode of Excess Returns, Jack and I sit down with Bob Elligatt, co founder and CEO of Unlimited, an investment firm that uses machine learning to create investment strategies that seek to replicate the major types of hedge fund approaches out there. We talked to Bob about his investment process, his long career at Bridgewater Associates, the advantages of deploying this type of investment method in an etf, and we also get his take on the Fed, the possibility of entrenched inflation, and much more. Bob brings a great energy level to the podcast and has some very interesting views on where he thinks the markets might be headed. As always, thank you for listening. Please enjoy this discussion with Unlimited's Bob Elliot. Hi Bob, thank you very much for joining us today.
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Jack Forehand
Thanks so much for having me.
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Justin Carboneau
We're going to talk about hedge fund replication strategies and the various types of hedge fund strategies that are out there, the investment process and approach that you are deploying at your firm Unlimited. And I think we want to kind of take some time to get some of your thoughts on some of the big ticket items on investors mind. Things like inflation maybe what coming out of the debt ceiling, how the markets and different asset classes might start to behave as we kind of come into the second half of the year. But before we get into that, and I hope this is okay and we'll definitely get into the hardcore investment strategy stuff, but you know, we kind of would really like to spend maybe the first couple minutes just talking about your, your experience and your really investing career at Bridgewater. I think you started as a investment associate and you worked your way all the way up to the investment committee over a 13 year period. So if you don't mind, I just kind of think we could start there because that's a great, awesome experience. We'd like to hear from you.
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Jack Forehand
From. Yeah, yeah, I mean, I, I came to Bridgewater right out of college without basically any professionalized investment or macroeconomic experience. I had done a fair amount of development and public health work while I was in college, which, you know, over time you quickly realize that matters of Economic development and public health are really tied to overall macroeconomic dynamics and global macroeconomic dynamics. And so, you know, in many ways I, I went to Bridgewater in my. Right out of college with the thought it was kind of going to be my master's degree in, in, in macro. It was just I had the benefit that they were going to pay, pay me to go through it. And there's an extensive training course which I took then and eventually for almost 10 years, actually led. And I think in many ways what I'd say about the experience is that it was really an incredible environment to develop that sort of fundamental understanding of how the macroeconomy works, to get beyond just one particular asset class or one particular type of investing, but really see the whole spectrum and work with some of the most sophisticated investors in the world. And it was also a place where I developed a real deep appreciation for the benefits of systemization. And systemization can sound kind of like black boxy and kind of out there. I mean, really all it is is when you have or you're making investment decisions. Take that understanding, take your reasoning and assess whether if you applied the same reasoning over time, it would be effective at accomplishing the goal that you have, whether it's predicting what's likely to transpire in the macroeconomy or whether it's predicting what's going to happen with asset markets. And so that combination of things really was, I think, served as an incredible foundation for developing a wide ranging understanding of the economy of markets, of how investors work and behave. That, you know, in a lot of ways is the foundation that, you know, is now what critical foundation for what I'm doing now at Unlimited.
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Justin Carboneau
We were joking before the podcast started and you kind of looked over my shoulder and you said, you know, I don't have as many degrees on the wall as you do, Justin. And they're not, I'm not. Those are great. But, but then we kind of turned to you and said, you know, but you have your probably master's and PhD from, you know, working effectively at Bridgewater for 13 years. So I think you've, you've kind of done your, your hardcore learning in the real world.
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Jack Forehand
Yeah, I mean, you know, the reality is when it comes to investing and understanding how markets work, there is, I don't think there's a problem with going through and developing understanding through an academic lens. I think there's a lot of value in the discipline and the perspective that that brings. But there's also incredible value in rolling up your sleeves and Putting bets on, in markets. And there is no greater or faster learning than when you are on the wrong side of a trade and that, you know, people who have, you, you can tell the people who have been in markets and have, have felt that pain over and over again and, and have learned from it. Right. You can, that's, it's a, it's a different, it's a different type of investor, different type of real world perspective that's so critical in over time developing, you know, increasingly rigorous and better investing process. You can't do it just out of books. You got to do it on the field.
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Justin Carboneau
And the other thing with your career is, you know, because I was looking at your LinkedIn profile and like, you know, you were there a few years and then the great financial crisis hit. So know, sometimes in the investment business you can sort of start, let's say at the beginning of a long bull market, but you know, you effectively really, really were gaining valuable experience during the financial crisis. And Bridgewater was sort of a thought leader and Dalio was out there sort of talking about the economic cycle and all of that stuff. So you kind of went early on in your career, you saw this big event happen in history, which I'm sure was very important in formulating your overall mindset and approach.
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Jack Forehand
Yeah, for sure. I mean, I think it was one of the times, one of the fastest. There's nothing better or nothing like learning during a crisis. A big part of my job and really where sort of I cut my teeth in the investing world was when was was leading Bridgewater's work on assessing and understanding the housing crisis. That was before, before it was the GFC, it was the housing crisis in the US and I remember back 2006, 2007, you know, Ray turned to me and I was, I led his investment research team for about a decade. He turned to me and said, this housing problem, big or small, go figure it out. And then, you know, I came back months later, like very big sheets of paper, very small numbers, like an understanding of every bank balance sheet, every insurance company balance sheet in America. And I sort of carefully walked through all those different numbers on this huge sheet of paper and the gist of the conclusion was like, every financial institution in America was likely bankrupt as a result of what was going to transpire. And he looked at me after hours and hours and he says, good, all right, big, we should go tell people.
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Bob Elliot
It's funny that such, such an enormous amount of like detailed quantitative research can start with big or small.
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Jack Forehand
Big or small.
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Bob Elliot
Right, right.
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Jack Forehand
A lot of work. Right. And, and, and I actually think, you know, it was kind of an incredible moment just again, developing as a, as a investor was I had no expertise in the banking system. And so I had to go learn, you know, I had an expertise essentially in macro and how macro fundamentals work, but I had to go learn all the under, you know, learn how to, you know, at 25 years old, how to look and understand bank balance sheets, what's in there, how do you predict it, how do you visualize it, et cetera, et cetera. And I think it was actually a great. I was lucky in that time to not just start with not knowing anything and to rebuild an understanding from scratch of how it worked, frankly, with the help of tons of people who were experts in the field, but they were experts. They were in some ways almost so expert that they kind of missed the big deal thing for the small deal understanding. So you talk to the AAA Cielo expert and talk to the, you know, AAA subprime RMBS expert and you talk to all these different people. And then when you put all the pieces together, what it looked like was the banking system had failed. But if you talk to each one of the individual folks, they didn't quite see the whole elephant, right? They only saw the foot or the trunk or the ear. And so it was one of those moments where you recognize, like, have the humility to walk in to these people who have spent their lives working on this stuff and just ask questions and understand what they're doing and then apply that sort of rigorous or systematic perspective with that humility that allows you to then learn and understand what's going on. And you can come up with insightful, unique conclusions. But you need kind of all of those elements for it to work, right. You have to have the systematic or sort of fundamental approach and understanding. And then you also have to have the humility to recognize that you have no idea what you're talking about from the start and take in that input and understanding in order to develop that insight. So it was really a very neat. I mean, it was obviously, it was a very scary time in markets. People today who talk about this regional banking crisis and think that today was anything like what happened in 2008. Like 2008, we were like staring at the abyss at the regional banking crisis. We were complaining about some venture companies that lost some money or gathered deposits frozen, like very, very different, totally different environments. And it really was formative in my, in my, in my development, for sure. Yeah.
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Justin Carboneau
Like in 2008, it was like, you don't want to be long going into the weekend basically because you didn't know on Monday what was going to, you know, what companies are going to be left standing or not.
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Jack Forehand
Right, right.
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Justin Carboneau
So, well, just one more on Bridgewater here before we get into the investment stuff. So what do you think? I'm curious how you would view this. What do you think the biggest misconceptions are that the public has about Bridgewater in your mind?
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Jack Forehand
Yeah, I think in, in many ways there has been quite a, quite a myth developed and I mean that sort of in the sociological way about the culture and what generated the outcomes that helped build the world's largest hedge fund. And I think, you know, and I was one of the small handful of investors that helped it go from challenger to incumbent and, you know, was in the, in the room, so to speak, through that life cycle. And, and what I'd say is that I, I focus less on the myth and more on what are the types of core ways in which high performing organizations operate. And I think in many ways, you know, Bridgewater was one of the sort of normal high performing organizations. And so you can get lost in the idea that there was something truly unique about the constellation of things that were going on there. In reality, any business and its success is really down to the quality of the talent and the people in the room and whether they operate in a way that prioritizes, you know, what, whatever it prioritizes. And so if it's, when you're trading financial markets like, you know, you have to prioritize a deep, rich, unvarnished understanding of how the world works in order to then trade markets. Right. Relative to other elements of, you know, what might be prioritized in a, in a business. And so, you know, that, that's very similar to, you know, if you read, if you read what happened in Netflix or in Apple or in, you know, Army Rangers and things like that, it's not that much different in, in spirit in terms of how it operated. So I'd focus less on the, on the mythos of the whole thing and much more on just what are the attributes and ways of operating of high performing organizations that, that lead to those sort of outcomes. Regard, you know, whether it's hedge funds or, you know, normal corporate environments or normal corporate outcomes.
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Bob Elliot
Before we talk about hedge fund replication, I just want to get the lay of the land a little bit with hedge funds. First, I want to ask you about performance. I mean, we know some of the best performing managers of all time have been hedge fund managers. But also I think in aggregate there's some data to suggest that maybe hedge funds don't add as much value relative to their fees as they could. So I'm just wondering, like, what, what does the overall performance data tell us about the performance of hedge funds?
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Jack Forehand
Yeah, well, I think I'd first start with hedge funds in general are actually not that exciting. That's surprising to people. If you look out there, there's 3,000 hedge funds in the world. The vast majority of them are working to create a pretty good risk return profile that is beneficial to their clients at the fee points that they have. And very few funds are really trying to, you know, the funds that make the news are the ones that are like up 50 or down 50 or something like that. But that's not actually how most hedge funds are working. They're much more focused on generate that sort of consistent return stream over time. And so under that, under that umbrella, like when you look at what hedge fund performance is, the strategies, not, not the net of fees returns, the strategies themselves are pretty good. Like over the last 20 plus years, returns that are a bit better than stock returns with about half the monthly volatility and about a third of the drawdowns, which is a pretty good return. And, and you know, something like 60% of that is generated through traditional or I'd call it sort of True Alpha. About 30% of it is generated from beta or smart beta strategies. Better, you know, better packaged beta. And then about, you know, then there's cash return that you get for free regardless. And so the big problem, the big problem with hedge funds, it's not the strategies. The strategies are, you know, generally pretty good. The big problem for he, for hedge funds is the, is the fees. I like to say, you know, hedge funds have a, a fee problem, not a strategy problem. And the problem is when you take that return that I just described and then you take 400 basis points off of it, like a 2 and 20 strategy, you know, typical 2 and 20 like fees against, you know, a 10% top line return that then gets you something that is meaningfully worse, basically takes all the alpha for the manager. You know, 80 or 90% of the alpha goes to the manager, leaving the investor not that much better off than they could do on their own. And so that's the main issue, the main issue with hedge funds that you're describing is a fee problem, not a strategy problem.
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Bob Elliot
Can you just talk a little bit at a high level about, I know there's certain groupings in terms of the strategies hedge funds employ, can you just talk about what those major groupings are in terms of the types of strategies hedge funds use?
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Jack Forehand
Yeah, yeah. I mean, in some ways I think probably the best way to sort of what the heck is a hedge fund? Right. In general, what hedge funds are, are trading and investing in public markets in an attempt to generate, you know, better than index returns. And there's a couple of different flavors or ways in which funds do that or strategies that are typically achieved. So you have something like global macro, right. Where those funds would be typically trading directional views on major asset classes like fixed income or commodities currencies, credit equity indices, something like that. So generally not stock pickers, generally trading macro asset classes. Then you have something like an equity long short where they're trading typically specific equity views or sector views or country views in the context of overall long and short positions in stock sectors. In the stock market in one form or another, you have kind of a different flavor which is what's called often fixed income arbitrage. But really it's just a set of fixed. In the same way you can have your equity long short trading. There's another set of funds that typically make money in trading fixed income products, fixed income and credit products. There's hedge funds that specialize in event outcomes. So specific elements of the capital structure, mergers, things like that that are happening amongst companies. So they're real specialists in. That's called event driven. There's funds that focus on emerging markets. That's a reasonable chunk. So not typically many of the big funds will focus on developed world equity markets or developed world fixed income markets. And so in contrast, many funds will focus on equity markets. And then finally, I think a big, you know, an important area is something called managed futures, which is typically those are trend following or similar strategies using futures as, as the primary way in which those, those are exhibited or those positions are held across a wide variety of markets. In some ways there's some overlap between those managers and what global macro is doing in terms of the opportunity set. They're just approaching it in a particular way. Whereas global macro might include things like value or intermarket action or fundamental views. Typically your managed futures investors will be applying views on trends of price across asset classes in order to develop views. That's a whirlwind tour.
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Bob Elliot
There's a lot going on there. So is it fair to say most of them are pursuing like an absolute return type strategy, they're trying to manage drawdowns?
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Jack Forehand
Yes. I mean most funds are trying to Beat cash is the basic idea. I think practically what you see is that most hedge funds have a little bit of beta in their returns. And the reason why that is is because I should say, just when you think about the sources of return, beta is a passive exposure to asset classes. Alpha is making bets in markets in order to generate return above that, passive investing. And typically these funds will have a little bit of passive portfolio exposure primarily because, you know, beta or the holding passive holding of asset classes, you would expect to go up over time. So it's a positive expected return trade. And, and so therefore, and it is often complementary with the alpha that they're generating in order to create a more consistent return stream in aggregate. I think the hedge fund index has like an 0.25 beta or something like that, you know, which is, it is not zero, but it is 0.25. And actually what we've done some work on this, that 0.25 beta is actually constructed in a way, when you think about all the allocations that happen in the hedge, amongst all the allocators into hedge funds, it actually is a portfolio construction that is pretty close to optimal to be a pairing to a traditional 60:40 portfolio. So the idea there is like, from an overall portfolio construction standpoint, hedge funds have basically constructed the strategy weighing across the hedge fund industry is basically the optimal or close optimal mix from a portfolio construction standpoint to pair with the 6040 portfolio.
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Bob Elliot
Can you talk about how you decided you wanted to maybe replicate these return streams and sort of how you went about it? I mean, it would seem like, given all the stuff we just talked about, this is a pretty daunting task to try to replicate all these various things.
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Jack Forehand
Oh, it is, it is, for sure. Yeah.
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Bob Elliot
Can you talk about how you went about that?
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Jack Forehand
Yeah, I mean, I think it speaks a little bit to the, to the founding of Unlimited and my co founder, Bruce McNevin and I, you know, we both have decades of experience in the hedge fund industry and we're thinking about, you know, how should we take all the experience that we have and what should we do with it? Should we run our own fund? Should we try and do something different? I think the thing that really got us excited was this idea that we could leverage our experience, our deep experience, having built proprietary strategies across pretty much all these fund styles with real advancements that have happened in machine learning and statistical learning over the course of the last couple of decades, and be able to be able to work to develop technology that can let us create a pretty darn good Replication of what these funds are doing, not perfect by any stretch, but a pretty darn good replication. And that, that is actually quite exciting because the vast majority of investors don't have access to hedge fund strategies, right? If you're, you know, you need to have access to the most sophisticated hedge fund strategies, you've got to be and the biggest managers, you've got to have, you know, billions of dollars under management, right? Even someone with, you know, $25 million typically doesn't have access to a diversified portfolio of hedge funds. Or if they do, the challenge is that they're typically doing it through platforms. And now we got fees on top of fees and concentration and all sorts of issues or they go into fund of funds and those are known to have significant drag relative to the index. And so our idea was, I bet what we could do, our sort of intuition was I bet what we could do is we could take our experience and take these modern machine learning approaches, pair those together and develop this technology that allows us to replicate what they're doing. And that, you know, that was a pretty exciting problem to see whether we could do it, whether we could basically replicate the, you know, the 50,000 hedge fund analysts that are out there and all of them doing all their different things in real time. And sort of when we got through it and we built our first 1.0 of the technology, it was pretty exciting to see just how good it was at being able to capture what folks are doing. The wisdom of the hedge fund crowd is what I like to call it, right? All the different managers and you put it all together. And the way that we do it in some ways is pretty simple. Like I like to start with a very simple example. Like Global Macro funds had their best half year in the first half of 2022 ever, right? And so, okay, well, you know what Global Mac, we just talked about what global macro managers trade, right? They trade credit and commodities and currencies and stock indexes. And we know what happened to asset markets during that period, right? We know that, you know, bonds sold off, short rate sold off, gold went up, commodities went up, stocks went down. And so if we know that they did the best that they ever have done, and we know that that's what the asset class outcomes were, we know that they basically had that set of positions on at the time, right? We essentially solve for by seeing their returns. What we can do is solve for what position portfolio of positions best describe the returns that we're seeing in close to real time. And we get relatively real time Data, some daily data, best in quality data a few days into the subsequent month. And so just think about that approach, right, that solving of how you all of us kind of do that, right? We look at a return profile, we kind of know what happened in markets. We with our gut kind of solve for what portfolio they must have had on, right? What were they overweight and underweight? Well, all we're doing with our technology is we're, we're basically just applying a more rigorous systematic way to that sort of gut intuition that, you know, all of us have as market participants looking at portfolio managers outcomes and understanding what happens in the markets.
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Bob Elliot
So you're not looking at, are you looking at the types of strategies individually or are you more just rolling it all up and then, you know, saying how is everybody positioned together? And then kind of replicating that?
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Jack Forehand
Yeah, I mean, I think one of the key questions about this is, and really I think often people don't appreciate that systematic, developing systematic strategies is craft and the craft is really around understanding where is that balance between signal and noise in any sort of development of understanding. And so what we know is that, you know, the way that the opportunity set and the, and the way that like a global macro manager's managed money is quite a bit different than event driven or than let's say equity long short managers. And so the way that we actually approach this problem is by building technology that replicates each one of those underlying sub strategies that we talked about. So your global macro, your fixed income arbitrage, your equity long short, et cetera. And then from there what we do is we actually combine the views that come out of each one of those individual sub strategies in order to create for, for our, for our flagship product, a diversified, essentially a strategy diversified portfolio. And that has a number of different benefits, the biggest one of which is that while people often talk about diversification as being a benefit for passive investing, the same portfolio construction rules and the same benefits apply when you're thinking about combining alpha strategy. And so that strategy diversified approach is actually quite beneficial in creating typically you'd expect a more consistent return stream. And there's also benefits in terms of operationally, in terms of cross netting positions, rather than holding a bunch of different managers or a bunch of different strategies independently netting those positions, there is some benefit from the operational aspects.
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Bob Elliot
So is the end result, I mean, what do you end up holding? Is it like ETFs futures, a bunch of different things?
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Jack Forehand
Yeah, yeah. I mean in general what we're doing is we're Expressing views on 60 of the largest liquid markets in the world. So all the major stock indexes, sectors, factors, credit, commodities, currencies, fixed income positions across the curve and across countries. So all of those are in our opportunity set. And then for each one of those different, I'd call them concepts. Right. Like a concept is, you know, two year interest rates or a concept is, you know, secured credit exposure. Right, Those are concepts. What we do is we select the security that is the most efficient security to express that on a long and short basis given our fund size, given the liquidity in the markets, et cetera. Right now what that means is we're primarily trading long and short positions in the biggest, Most liquid index ETFs that are out there though over time, you know, we may trade futures contracts, we may trade swaps, we may buy cash securities if those are the most efficient ways to express that view.
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Bob Elliot
Yeah, you know, in addition to the obvious fees, I mean, I would think tax is another big advantage of doing it this way. I mean with the ETF wrapper, the ability to do all this and all these different strategies embedded inside of one ETF must be a significant advantage, I would think.
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Jack Forehand
Well, I mean it's amazing, you know, ETFs. Everyone thinks about ETFs as being, you know, the, the passive, the low cost passive solution for, for holding assets. And the thing that's so interesting about it, you know, all ETFs in many ways are, is it's a tax loophole, right? What it allows you to do is to have a multi asset portfolio and not have to take, typically not have to take capital gains when you rebalance across your assets. And the thing is that, you know, that is beneficial if you're holding, you know, an index of stocks, but it's particularly beneficial if you're holding moderate turnover cross asset portfolios in turn that you know, you're rebalancing positions or evolving positions over time. And so actually the ETF wrapper is way more efficient, a way bigger deal in maintaining tax efficiency for what we're doing in terms of a multi asset, you know, cross asset moderate turnover portfolio is way better for that than it is even for index investing. And so you know, in a lot of ways we came to the, I'm new to the ETF world, right? I was, I was an old, you know, 2 and 20 LP guy and I got, you know, rolled up my sleeves, got into understanding how ETFs work and, and their benefits for investors. And you know, I came very clear. It's it's the, it's the best structure by far for the vast majority of investors to be able to, to hold. And as you know, you know, ETFs typically, if you hold them for more than a year, are taxed at capital gains right at the time that you sell the securities. So I know 25%, let's say give or take, as opposed to traditional LP positions where you're forced to take K1 distributions and pay taxes annually, typically, which is often at your top marginal tax bracket, which is, you know, ordinary income, which you know, can be upwards of 50 plus percent depending on your jurisdiction, your tax rate. And so that is a real advantage is the, the tax efficiency. So, you know, not only are we doing what the managers are doing using technology so we can charge a lot lower management fee, 95 basis points, but we can also do it in a wrapper that's half the, the fees of a typical LP structure.
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Bob Elliot
This is something that probably sounds a lot better in theory than it is in practice, but one of the things you always see people who want to do is I'm going to replicate the best hedge fund managers. I'm not going to replicate everybody, but I'm going to pick out the guys that are the best and I'm going to follow them. And I'm just wondering what do you think about that type of strategy? Do you think that's implementable in the real world? Do you think there's value to that?
- [30:59]
Jack Forehand
No, I don't think that there, I have not seen a way in which someone could reliably and durably pick which hedge funds or hedge fund styles will outperform in the future. And I think there's actually pretty good evidence around this point, which is if you go look at fund of funds, right? Fund of funds, literally their only job is to pick managers, right? And you look at how they typically perform, what you see is that they typically not only charge fees, right? So you have index drag because there's fee drag, but you also see that there's index drag because of their picking. So typically, you know, if you look over the course of the last 20 years, the net of fees returns of the overall hedge fund index about five and a half percent. The net of fees returns of fund of funds is about 2.2%. Okay, well that, that what that tells you is there's 300 basis points of drag relative to the index net of their fees and their picking ability. And so that gives you a good sense like these people task, literally their whole job is to Pick hedge fund managers and they can't do it. And so I think what it comes down to from my perspective is that, is that, and this is there's always a key question that investors always face which is, you know, the benefits of diversification are relatively well known, right? They're not certain, but they're relatively well known. The benefits or the ability to pick asset classes or the ability to pick managers is highly uncertain. And so when you're thinking about that trade off, should you lean on diversification as a strategy or should you lean on concentration which is reflective of picking? Right. Many people turn to, to try to pick because they're overconfident in their ability. When the reality is the easy, it's much easier in terms of the work to choose diversification and the reliability of your outperformance when you choose diversification is much more consistent than when you choose. When you try and pick winners.
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Bob Elliot
Yeah, this seems to be a truth across like the investing industry in general, mutual funds, everything else like this, trying to pick winners doesn't seem to ever work out that well. Is there any truth though to this idea I mentioned at the beginning that there's this small group of hedge funds that produce most of the alpha and that they're consistent over time? Is there any truth to that at all or is it really. It changes a lot over time.
- [33:29]
Jack Forehand
It changes a ton over time. And I think that's one of the things, the outperformance persistence just doesn't really exist in the hedge fund industry. And I think a lot of times people will look back and there's good reason actually to, there's good reason to believe, fundamental reason to believe why there shouldn't be outperformance persistence in the hedge fund industry. And the primary reason why that is is because if you outperform as a hedge fund, then you will typically gain assets, right? And as you gain assets, you will typically not be able to engage in either as much diversification of your portfolio of views. Plus you will also start to incur increasing transactions costs. That's one of the key questions here, which is transactions costs are certain, alpha is uncertain, right? Transaction costs, you pay them, you will pay transaction spends, right? So that's why I say they're, they're, they're certain in terms of having to pay them versus your ability to generate alpha over time is, you know, is, is quite uncertain. And given that fact, what happens is as you get as money flows to these managers that are likely to be more skilled, right. Because they've demonstrated Outperformance on a forward looking basis, that flow starts to decay their alpha generation ability. And so you had. But, but the issue is you, the issue is that there's a lot of randomness in that, right? When exactly does that decay happen? And there's a lot of uncertainty in terms of when that decay happens. And so you kind of look at it and you say, well, the fundamental reasons for why I would expect there to be decay exist. There's also this randomness because, you know, managers, any one manager get things right, they can get things wrong. Who knows, the managers that have done well might just have gotten lucky, right? You don't know. You know, there's always got to be a top 1% manager, right? If you have 3,000 hedge funds, you know, 30 have to be great, right? It's just, there's just randomness to it, right. And so because of these two points, because of the fundamental point and the uncertainty about what's generating the returns, the idea that you're going to be able to pick on a forward looking basis is, is it's highly uncertain. It's highly uncertain. So what I'd say is have the humility to recognize that the benefits of diversification are relatively well known and your ability to pick is extremely uncertain. And given that trade off, pick diversification. Right? That's what we're doing. Have the humility to pick diversification.
- [36:19]
Bob Elliot
How would you think about this strategy in terms of an overall portfolio? I mean, would you look at it as sort of an absolute return type strategy that's pretty uncorrelated with stocks and bonds, so it creates a more efficient overall portfolio? Is that kind of how you look at it?
- [36:30]
Jack Forehand
Yeah, I liken this question. Part of the inspiration actually of Unlimited was a fair amount of my time at Bridgewater. I got to work with some of the biggest, most sophisticated clients in the world, these big institutional asset managers. And one in particular was one of the most sophisticated, the Future Fund for Australia. They're one of the most sophisticated asset managers. They're big enough, they can basically do whatever they want in terms of invest in any manager in the world. And what I saw them do was build a portfolio which was about half traditional liquid securities and about half alternatives as you sort of described them. And within that alternative bucket, what they did is they invested about about 20% of their overall capital, so about 40% of that alts bucket in, in hedge funds. And the way they build that hedge fund portfolio is they invested in something like, you know, dozens of, of hedge funds. And because they were big enough, they were able to beat down fees. Right. And so what did they do? They basically built a diversified alpha portfolio hedge fund portfolio which represented about 20% of their overall portfolio at a much lower cost. And that was super beneficial, right? Strategy, diversified manager, diversified portfolio. And that 20% slot of their overall portfolio was, was very beneficial in navigating particularly challenging beta environments. And so I, I think that's basically how I would think about it. You know, unlimited is basically just that solution for the everyday investor, right? Instead of having to go find dozens and dozens of managers and beating fees down, we, you know, what we've tried to do is basically do the work for you, which is like buy an etf. It basically is strategy, diversified manager, diversified and lower cost than typical LP positions. And so that's what we're trying to do with, with, with our strategy. And so, and so, you know, but I go sort of goes back to like, if you look at the most sophisticated asset managers in the world, you sort of see 20, 20% allocation diversified alpha. That's the right sort of balance between the uncertainty of the alpha and the benefit to your portfolio composition from having an allocation to those alpha strategies.
- [38:48]
Bob Elliot
I want to shift and talk a little bit about the economy now, because that's actually where I originally found you. You have some really, really great insights on Twitter around some stuff.
- [38:56]
Jack Forehand
Thank you for reading. I'm still amazed anyone will read what I write since my whole, there's all these like marketing consultants and people like that, they're like, well, you gotta optimize all this stuff and in ways that you put stuff on Twitter. And I say, well, you know, and then they sort of like, they asked me, they say, how did you get 90 plus thousand followers? I said, well, I wake up in the morning and think about what's going on in markets and then I just write it on Twitter. And then I go about my day and when I think of something that's going on in markets, I write it on Twitter. And they are, it's like they're, they're, they can't, it blows their minds, right? These people who have spent their whole lives like optimizing people's accounts and they're like, so all you do is just write whatever comes to your mind and put it on Twitter. And I say, yes, that's what I do. What do you think?
- [39:43]
Bob Elliot
You need to start your own Twitter class now? Or you are the marketing consultant, you explain to these people, just go be yourself and write what comes to your mind. And I'll probably do okay.
- [39:51]
Justin Carboneau
It's about, yeah, it's about authenticity. I mean, that's what's coming through there. And, you know, that's how you shine on things like Twitter. It's not the canned marketing, you know, strategy, tweet, comment, do this, do that, you know, I mean, so I don't know, that's why you, you're at 97,000 and. And I'm at 2,000.
- [40:09]
Bob Elliot
But, but I mean, I'm kind of one of these macro, I guess, macro tourists, you'd call me like one of these people who thinks, oh, no, no, doesn't really know that much. So, like, that's why I really appreciate you is I'm trying to learn more about it. You know, I'm a quant factor investor, so this is like the furthest thing from what I do, but I've learned a lot about it. And, you know, we're in a period now where macro has become much more important. I mean, we're dealing with inflation for the first time in a really long time. We're dealing with a lot of stuff. I mean, people assumed, you know, for 40 years our stocks and our bonds did great for us and we don't have to really worry about it. And now we're kind of in a different world. So just to set the landscape, I'm wondering if you could just talk about where we are right now. I mean, obviously we had inflation that got really high. It's come down somewhat. At least the Fed is still hiking. You know, the market is expecting the Fed to be easing, I guess, by the end of the year. I'm wondering if you could just give us an overall view of where you think we are right now.
- [40:56]
Jack Forehand
Yeah, I think, you know, one of the things, the challenges of, of, of a macro perspective, say, versus a factor investor's perspective, quant factor investor's perspective, is the sample size is just like so low relative to, you know, if you're a quant factor investor, right. You can invest in like 5,000 stocks on as frequent as, you know, like a daily basis for the last 30 years. Right. The sample size is just so high. When you think about the macro economy and the simplified macro economy, there's really, in the US there's been like 10 cycles over the last 10 data points over the course of the last 75ish years. And so I think part of what you have to do as a macro investor, you have to start to build the intuition about how these linkages work. And so if we think about where we are Today in the cycle, in a lot of ways, what we're experiencing right now is a very typical late cycle dynamic. And what I mean by that is we have unemployment or the labor markets are relatively tight. The outcome of that is elevated inflation. The central bank responded to that by tightening. The Fed responded, but also the ECB and the BOE and others responded by tightening. The way in which we got here was like a little abnormal in the sense of we had a relatively substantial fiscal stimulation coming out of a crisis period. But the conditions, the dynamics that we're in right now are very normal late cycle. And what I'd add is they're normal late cycle of a type of late cycle environment that is not similar to the late cycles that most of us have seen in our investing careers. Most of us have seen credit cycles, credit driven cycles.08 was a credit driven cycle, even to some extent, 2000 was a credit driven cycle. Earlier than that we saw credit driven cycles in the early 90s. What we see today is not a credit driven cycle, but an income driven cycle, a nominal income growth driven cycle. And I think that's a very important dynamic because the way in which those cycles end is a bit different than, and the sensitivity to tightening is a bit different than a typical credit cycle. Right. Typically what happens is you raise interest rates. People go from borrowing a lot to not borrowing. That shift in, in borrowing a lot to not borrowing is what ends up slowing the economy. Well, what we had here and combined with the fact that interest rates rise, which means that people spend more on interest payments, which means that they then, you know, have less money for consumption. What we're seeing right now is actually a very different story. We've been in what's described as the deleveraging for a long time, which is that households and businesses have been reducing the amount of debt relative to their income or relative to their expected profits or EBITDA for a long time. Right. Since really the financial crisis. And so what you have here is you have not. There wasn't that much credit growth coming into this late cycle. So the tightening that has occurred from the Fed hasn't mattered that much because the slowing of credit has been much less substantial than previous cycles. And then number two is the massive amount of liquidity that was in the system allowed basically all borrowers in the non financial sector, corporates and households to term out their borrowing at very low interest rates. And so that effect, which is like the typical impact on profits or on household spending that comes from rising interest rates, that hasn't occurred in this cycle. Right. Because if you're sitting on your 2% mortgage, you're paying a 2% mortgage. Right. Literally the Fed could raise interest rates to 1000% and you would pay a 2% mortgage. And that's the issue is that the sensitivity of the economy to the Fed tightening in this cycle is very low relative to the typical sensitivity that we've come to know, particularly like in the 08 period. And so the result is that, you know, we're seeing this late cycle dynamic, but it's moving glacially slow relative to what most of us have experienced in our careers. Right. If you had told people 14 months ago, hey, what's going to happen is the Fed is going to do, you know, almost 100 billion a month of Q T and they're going to tighten interest rates 500 basis points and growth was going to be 2% real and inflation was going to be 5% and employment was going to put up 2 to 300,000 jobs a month. I think people would have thought you were totally nuts. I certainly said that to me on the Internet when I suggested that could possibly happen. But that's the reality and that reflects the fact that the economy just is a lot less sensitive to the Feds policy than they ever than it has been in most of our experience.
- [45:55]
Bob Elliot
So yeah. Is the general idea here that this is going to be much more difficult to keep get inflation down and get it to stay down here? This is going to be a lot tougher than a lot of people think.
- [46:05]
Jack Forehand
Yeah, yeah. I think most people have never experienced inflation in their lives. Right. Like meaningful inflation. And so I think it's hard for people to fully appreciate how inflation works. I've described what's going on right now is there's a race, there's a race going on between the Fed tightening conditions enough to slow the economy, which is proving difficult against the pace at which inflation is becoming entrenched in the economy. And all the ways that inflation becomes entrenched, contracts, wage negotiations, frankly just people's simple expectations when they go to the grocery store or, you know, go get a plane or have some sort of service that they, they buy. And so we're in this, we're in this race and what's happening is that the Fed is not moving fast enough to slow the economy down fast enough to bring inflation down fast enough so that we're then seeing inflation signs of inflation entrenchment. It's why inflation entrenchment isn't some theoretical thing. It's why the Fed is so focused on the services ex. Housing component of the world, right? Because they, because that gives you a good sense as to whether that entrenchment happens. Because once inflation entrenchment happens every month that inflation remains elevated, it is harder and harder and harder to break the back of inflation. Right? It's harder and harder and harder to unwind those contracts, right. To slow the economy enough to reset the wage dynamics that are going on. And you know, people will object to the, to relating Today to the 70s, and I think in some ways they're right. From a magnitudes perspective, this is not the 70s. Inflation is not like well into the double digits, right? That's not true. But the dynamics, the mechanisms, the linkages are exactly the same, which is the longer that inflation remains in place, elevated inflation remains in place, the more depth of recession that needs to occur in order to bring that inflation durably down. And you know, right now it's not looking good. It's looking, you know, the Fed has not made any progress on inflation in six months. It's been core inflation's been 5% that whole time. The Fed has not made, you know, core PCE has, has not changed in six months. And that's really, if you're sitting in the Fed shoes, that's really a very scary environment where you're not making any progress.
- [48:49]
Bob Elliot
So for those of us that are not experts, I mean, would wage growth be a really important thing to track going forward? Like in other words, if wage growth stays high, is there a way to get inflation back to 2% or is there really no way unless wage growth can be tackled as well?
- [49:00]
Jack Forehand
If wage growth remains elevated, inflation cannot come down. That's the simple reality. And the way to think about that is that wage growth, which typically is thought about in nominal terms, if you think about nominally, because people get paid nominally, they don't get paid in real terms, they get paid nominally. When you think about that, what you're doing is you're paying someone to produce a certain amount. And so what you want to think about, if you think about, let's just say wage growth is growing at 6% and your productive capacity, the productive capacity of the individual is, you know, they're earning a wage, they're also creating outcomes, right? Creating output, right? And so if, let's just say their output is zero, right. Actually, productivity has been negative 2, right? Negative 2 in terms of productivity growth over the course of the last year or two. That's probably, it's glee flukey. But productivity is low. In the economy right now. So you have 6% nominal wage growth, zero productivity. So now we got a gap, right? We're spending, you know, our spending growth is growing at 6%. The, the, the stuff we can spend on is growing at zero. How do we then, how do we close that gap? Well, there's two different ways to close it. One way to close it is by finding more productive capacity to meet that nominal demand. Demand which tightens economic conditions, right? We bring people out of retirement, we put them into the labor force and that creates increased productivity. Although there is the issue that even though you're bringing them into the labor market in order to create more productivity, you're also paying them. So it's not like a one for one dynamic. But by and large what we've seen is we've tightened the heck out of labor, right? You can't find good labor anywhere, right? And so then the remaining gap basically has to be met with changes in prices, right? Nominal. I have nominal spending power. I have a certain amount of productive capacity in the economy. The gap between those two has to be met, has to be resolved through prices, through price rises. And it's why we're seeing like, if you look at a number of different, a number of different, like I like looking at like the PNGs of the world, right? Because it's very concrete. Like you're selling, you know, ketchup. And what you see is that volume growth is relatively close to zero. But what you see is price growth is elevated, like high single digit price growth. And I think that's really reflective of this economy that we're in, which is, yeah, the real economy, real growth isn't that high because we've basically, we're basically fully employed. We're at productive capacity. We can't produce more on a real basis given our productivity and our, and our, the tightness of our labor markets. And so what is end. So what ends up happening, like real growth is actually kind of like confusing. Like what, what is reflective of the elevated economic output in our economy is the nominal growth. And nominal growth remains very, very elevated relative to what the Fed is trying to get done.
- [52:11]
Bob Elliot
Just one more for me before I turn it back to Justin. I want to ask you about some of the stuff that's out there. So people like me are hoping inflation's coming down, you know, can go to these sites on the web, you know, truflation and other places like that that are showing us things are coming down. The Fed's using lag data, but these sites have Real time data or something like that. And you had a thread on Twitter recently that kind of explained to me why I'm probably being an idiot using some of this stuff. So I'm just wondering if you could talk about those sites and what they're doing and if it adds any value in terms of what real inflation is out there.
- [52:39]
Jack Forehand
Well, the first thing you do is to say, I think in a lot of ways we've got to get to a 2% inflation rate. How will we get there? Well, one of the ways to think about it is we've got to solve it from the top down, which is our wage growth relative or income growth relative to productivity has to be in such a way that can result in aggregate result in a 2% inflation rate. Right? So that's sort of the top down. Right. So you have to bring the, the wages down, the nominal wage growth down relative to the productivity. The opposite way to look at this is also from a bottoms up perspective, which is when you look at the prices of all this stuff, it has to all add up to the 2%. Right. And I think that's important because if there is deflation in certain areas or disinflation in certain areas, which then leads people to have more income, nominal income, they can then spend it on other stuff. Like the very classic thing is like gas prices go down, but then hotel prices go up. And why? Well, it's cheaper to drive your car to the hotel, but you have more free cash flow so you can spend more money on your hotel once you get there. Right, that's, and that's kind of the, the dynamic. And so in some cases, so it's very important when you're looking at these things to make sure that you have a comprehensive understanding of the overall economy, not a limited understanding of the overall economy because it's aggregate prices that the Fed cares about, not a subset of prices. And so sometimes when you're looking at certain things, there are certain areas what I describe as are a lot easier to track. It's a lot easier to track car prices than it is to track the cost of, you know, getting your nails done. Right, or getting a haircut. Because car prices are posted on websites, right. And you know, goods prices are posted on Amazon. Right. So you can, you get a very real time sense of that. But how much it costs to go get the services and how those menu prices are changing are a lot harder for various people to see. And so I think there's been a lot of focus on these various sites and these Various methodologies that are focused on are overweight towards goods prices or overweighed towards the prices that they can see and not weighing the prices that they can't see. And so truflation as an example, is overweight a variety of different observable prices. And then another big piece of what it's overweight is it's overweight or it's typically using asking rent prices. Well, 90% or something like that of rental. 90%, sorry about that. 90% of, of new rent costs are not, are not. You don't go out and get a new apartment, right. You stay in the, in the house that you're in, right. And you get a bump, right, in terms of your rental costs. Right. A rental reset that takes a long time to flow through and things like that. But you can't see contract rent prices changing, right, because they're sitting in a document on a bilateral basis. And so the problem is you're observing something which is not reflective of the actual, the actual real inflation that people are experiencing. And that is much more slow moving than what asking rent prices are, because asking rent prices are the marginal cost, not the median cost of renting an apartment.
- [56:08]
Justin Carboneau
I'm trying just to think about this tactically here. So if you have inflation entrenchment that's here and it's entrenched and the Fed stays or has to stay higher for longer or maybe even has to start to raise more, then it would seem to me, I'm trying to think about asset classes and positioning. It would seem to me, I'm just going to sort of outline these. It would seem like value over growth. It would seem like short versus long in terms of fixed income, gold maybe and commodities. It would seem like, you know, housing supply is still going to remain tight because, you know, people, to your point earlier, you know, a lot of, there's been 10 years of, you know, 2 to 3 and 4% interest rates. No one wants to borrow at a 6 or 7% mortgage. I'm thinking like US debt service is going to be a lot higher now and in the future. So I'm just trying to think, I mean, what do you think about asset classes and positioning? I know this isn't the way you're managing the etf, obviously we already talked about that. But just in terms of tactically positioning a portfolio, what would you say to just this overall idea that I'm getting at?
- [57:18]
Jack Forehand
Yeah, well, I think the, the, the biggest. There's two things to think about. First of all, you know, where do we have to go in order to get this inflation problem solved. And what we have to do is we have to have enough of a tightening of financial conditions to create enough of a slowing of spending to create enough of a hit in earnings to create a slowing of hiring or weakness in the labor market, which then will create a slowing of incomes and a durable slowing of nominal demand. Right? So that's the path we have to go down. And then I think what you see in the markets today is you have to compare. That's the path we're going on. Like, to be clear, unambiguously, we're going down that path. And then because it's the only. It is the only solution, right? So there is no soft landing. The soft landing will never happen because you can't have the inflation come down in the way the Fed needs with the soft landing. Right. And so how do we solve this problem? Well, so that's the path we're on. And then I think what's really important to recognize when you're thinking about trading assets is, is you don't just trade assets based upon what's happening with economic momentum. What you have to trade assets on is economic momentum or your future view of what will likely transpire compared to what's priced in. And so that's actually, I think one of the most interesting things about this cycle is most of us learned over the last 15 years, up until the recent period, I mean, really up until this year, that trend is your friend, right? There's momentum in the economy. Follow the trend. Stocks are going up by buy stocks, stocks are going down, sell stocks. Like trend is awesome in terms, and probably the riskier the trend that you take, the better. What we have today is we have so much uncertainty in terms of what's going on in the market and so much desire to call the turn that what we're getting is the macro economy is like a tanker ship slowly slowing down. It is boring. If all we did was we looked at the macroeconomic stats every day, no financial markets, just the macro stats, you would be bored to tears, Right? Fintwit would be a lot more boring if we didn't actually have the markets to be looking at every day. Right. But instead we have these markets where expectations are wildly whipping around. So, like, just think about this year. We went from soft landing, which is a cut in interest rates, to higher for longer until March 8, right? Which was interest rates, you know, short rates to 6% to deflationary depression. 150 basis points of cuts in the next six months to today, where we're getting back to at least flat and maybe higher. Well, the reality of the macro economy has not changed like that. But to trade the markets, you had to at each one of the points in time, look at the extremity, essentially fade the extreme views in one direction or another. And I think that's really what we're seeing, which is that because people don't realize that the macroeconomy moves so slowly, what they're doing is they're over interpreting each one of these incremental pieces of information, expectations are wildly moving around. And despite the fact that we sort of learned that trend is your friend over the last 15 years actually fading extremes around the central thesis of modest glacial slowing is actually the best way to navigate through this environment.
- [60:54]
Justin Carboneau
I wanted to just.
- [60:56]
Jack Forehand
And that's hard.
- [60:57]
Justin Carboneau
That is hard for sure.
- [60:59]
Jack Forehand
Right. It takes a lot of discipline to fade that. Given that we've all sort of learned this like follow the trend, follow the noise. Right. To then fade the noise is a whole different mindset than basically any of us have dealt with in our entire, you know, over the last 15 years. That, that very art.
- [61:21]
Justin Carboneau
Well, as investors you're always going to be biased to your own experience. And so that's why I think kind of being open minded, learning from history, listening to other perspectives, especially people you don't necessarily agree with, I think can be important for a lot of investors. And certainly those people listening to our podcast know that that's where we're sort of at with our thinking. I wanted to switch gears a little bit and ask you about the debt ceiling. So. And I don't have my hands on all the numbers here, but you know, I think that the federal government stopped issuing debt kind of going into the debt ceiling negotiation and the talks and you know, without knowing if we were going to actually pass it. But as a result of that, I think there's going to be a lot more debt now issued for the rest of the year. And I'm just wondering if you've thought through any of the possible negative implications on that in terms of liquidity, draining out of the market or any other sort of risks that could happen.
- [62:27]
Jack Forehand
Yeah, I think this post debt ceiling situation is like the quintessential challenge with fintwit commentary today. So you've got a set of people who are like, well a lot of the issuance is going to be in, in bills. And you know, bills are essentially a cash like instrument. And so if people take cash out of, you know, our RRP and, and, and put it into bills. It doesn't really matter, right? You know, so they'll sort of sit there and they'll say doesn't matter, right? And then there's other people who will talk about a trillion dollars of TGA needs to get, get refunded. And this is a massive amount of, and the world is going to come to an end and asset prices are going to fall apart. And this is the bare moment. And the reality is it's kind of in between that, which is that the Fed is going to issue, or the Fed, the Treasury is going to issue a fair amount of new debt. A lot of it is going to be in the form of bills. Those bills aren't really going to matter much. It'll probably, you know, draw down cash in other locations and have it flow into T bills. But, you know, because it's cash for cash like dynamics, it won't really matter for asset prices or anything like that. It'll just be like people shifting between cash assets and not really selling risky assets. At the same time, there's going to be a relatively significant amount of duration sales which add to, added to the continued quantitative tightening which like, you know, we all like forget, you know, 100, almost $100 billion, you know, a month of quantitative tightening just keeps coming, right? Or at least as high as that amount. You know, it just keeps coming into the market. And so each, each month, basically you've got to find people to buy those incremental bonds and, and also you have to find people who are going to buy those bonds that the, the Fed is selling. And you know, that's, those people are going to have to find, typically take money out of risky assets in order to do so. And so that's going to be, that's like a, a sagging weight on asset prices. And so the answer is like not quite as extreme as the, you know, the people who say it doesn't really matter, not quite as extreme as the trillion dollar TGA people say, but this like, sagging weight on asset prices that we're likely to see in the second half of the year, which is probably going to intersect interestingly with some of the fiscal tightening that we'll see coming out of the debt ceiling dynamic and some of the, you know, monetary policy, the economy is glacially slowing as well. And so, you know, that might all sort of like, you know, we might wake up November 1st and say like the economy is now, you know, slowed enough to be a more meaningful, you know, to be meaningful at that Point.
- [65:27]
Justin Carboneau
You know, and it seems like you're sort of making an argument for maybe a longer term, sort of challenging market, I guess, you know, I think a lot of investors, if you started Investing anytime since 2003, I mean the financial crisis was painful, but you know, it wasn't that it started in maybe late, well mid 07 to late 07, the cracks. But then we bottomed in March of 09 and then the COVID thing wasn't. It was like a one month downturn. So I think a lot of investors are sort of used to this quick bounce back and I think what you might be articulating here is that we might have some heavy wood to chop going forward.
- [66:11]
Jack Forehand
Yeah, I mean the main, I think it's reflective an inflationary dynamic does not totally changes the reaction function of the central bank. Right. That's I think a thing that folks have a hard time seeing. Like if you go back to the 60s and the 70s, again, the levels were different. I'm not saying we're back to the 60s and 70s in terms of levels. So let's talk about the linkages. What you see for instance is that the Fed typically kept interest rates elevated and only cut like halfway into the recession. Right. Rather than if you look at the, you know, 2000 or 08 or Covid, I mean, which is so short it's hard to even remember, it was so quick. But the basic idea is that growth, in those cases, growth slowed down and then the Fed cut. Right. They basically saw the recession start and the Fed started to cut and then began to cut more and more aggressively as conditions got worse. And so that's the thing is like that's a very different dynamic. Like what happens if the unemployment rate is 5% and the Fed isn't cutting? What does that picture look like for asset price? Right. And not just stocks, what does it mean for bonds? Right. We've all sort of learned that bonds are the way to go. Right. You just buy your bonds. But if the Fed is holding up the short rate, maybe bonds don't rally in the way that we all expect. Right. Certainly all those people with their bets on a deflationary depression coming out of SVB have been burned. What happens if the Fed doesn't ease when growth starts to slow? That's the question that investors, strategic investors should be really asking themselves right now. What happens in that case? How do you navigate that circumstance? Where do you find diversification under those conditions? That's the really challenging situation that investors could face over the next 12 to 24 months.
- [68:13]
Justin Carboneau
So I need to make a hard pivot here and go to what we consider is our standard closing question, which is, and we like to ask this of all of our guests, but based on your experience in the markets, if you could teach one lesson to your average investor, what would that be?
- [68:28]
Jack Forehand
Diversification. It's that simple. Diversification is the ticket to building durable wealth over time. I emphasize that diversification. I don't mean stocks and bonds are not diversification. It's better than holding an all stock portfolio. It's better than holding one stock. But true diversification means diversifying your asset class exposures and diversifying your strategy exposure, your alpha strategy exposures in order to generate that consistent return. And that I think a lot of people have really, over the last 40 years have become immune to what diversification or desensitized to what diversification really means because they've only seen assets work in one way. But talk to people who invested in the 70s and the 60s and talk to them about how they survived those dynamics without, you know, facing huge painful drawdowns in, particularly in real terms in their wealth. And the way that they did that was by holding a lot of different assets. Gold, commodities, inflation index bonds. I mean, they didn't exist then, but the effective exposure of inflation index bonds, real assets in various kinds, that's how they survived that period during a period when stocks and bonds didn't do well. And that's what you have to face. What does a high interest rate environment look like with elevated inflation? It's something you've never seen before and so open your mind to the diversification possibilities that are out there.
- [70:17]
Justin Carboneau
Bob, thank you very much for coming on, spending so much time with us. I definitely would see, hopefully you will come back on with us in the future. This has been great. Good luck with the ETF and thank you very much. We appreciate it.
- [70:30]
Jack Forehand
Thanks so much for having me. It was great.
- [70:33]
Bob Elliot
Thank you.
- [70:33]
Justin Carboneau
This is Justin. Again, thanks so much for tuning in to this episode of Excess Returns. You can follow Jack on Twitter racticalquant and follow me on Twitter @jcarbono. If you found this discussion interesting and valuable, please subscribe in either itunes or on YouTube or leave a review or a comment.
- [70:52]
Jack Forehand
We appreciate Justin Carboneau and Jack Forehand.
- [70:54]
Bob Elliot
Are principals at Bolivia Capital Management.
- [70:56]
Jack Forehand
The opinions expressed in this podcast do.
- [70:57]
Bob Elliot
Not necessarily reflect the opinions of Olivia Capital.
- [71:00]
Jack Forehand
No information on this podcast should be construed as investment advice.
- [71:03]
Bob Elliot
Securities discussed in the podcast may be holdings of clients of Olivia Capital.