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How I Invest with David Weisburd
E304: Neuberger Berman Co-CIO on Mistakes Smart Investors Make
00:44:57
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- [00:00]
A
Jeff, you're co cio of Neuberger Berman's roughly $550 billion asset manager. You work both at a large asset manager as well as at an endowment. Tell me about the difference between working at these two organizations.
- [00:13]
B
Yeah, there's a lot of differences in terms of the objectives as well as the scale of the assets that are, that are being invested. And other experiences I've had too. I worked at Cambridge Associates, I worked at Texas Teachers. So a lot of shapes and sizes of portfolios. The first thing is the larger you are. Texas Teachers, for example, that's 120 billion when I was there. I think they're over 200 billion now. It's like driving an aircraft carrier and a creek. The ability to fund niche managers or smaller strategies may be off the table in a lot of cases. And the way that you have to think about alpha and beta as building blocks, you just have to be very thoughtful and different. Not only that, there's times where you can move markets if you're involved in commodities or a certain sub asset class and fixed income. So when you trade and rebalance, it's very different at a Texas Teachers or a large mega $100 billion plan at an endowment or when I was at New York Presbyterian, which was only a few billion at the time, now that I think they're up to 7 or 8 billion, it allows you to be more agile. You can fund smaller managers, you can do co investments. And the endowment model I think is really where this came from. It's like we have this long term orientation but a smaller pool of capital that can be more targeted, more concentrated, smaller managers. And it allows you to, I think, therefore be more artistic. So the art and the science, you can say I'm just looking for high returns. If you're a very large $100 billion plus plan, you have to be more targeted and more quantified.
- [01:32]
A
So you worked under a previous guest, Britt Harris, who is the CEO and I believe CEO, CIO and CEO of Texas Teachers and also utemco. What was it like working with Brit?
- [01:43]
B
The thing I'll say about Britt is he had a knack for taking complex investment concepts and distilling them in a way that you could understand and process and to simplify the role in portfolio. And it allowed us to evaluate asset classes and managers in a way to say does this add value to the portfolio, the competition of capital? And I again I the simplification does not mean that we didn't understand the nuances. There's a Lot of complexity when you do due diligence and bring a strategy into the fold. But Brit had this very good way of marrying the role in the portfolio with the the overall return, risk objective and diversification. His whiteboarding sessions where he would take hundreds of investments and boil them down to just help me cluster them together. This is they serve role A, B and C. How much will we want to weight them? What do they do for each other? He just had this very good way of simplifying things and then being able to deliver that messaging to the governance to get it approved.
- [02:34]
A
For those that can't whiteboard a hundred investments, what are ways that they should formulate their portfolio? What are some good first principles for building an endowment like portfolio?
- [02:43]
B
And to put it in first principles I think to give a shout out to total portfolio approach tpa. What I love about TPA is that it defines very simplistically two different roles in the portfolio, growth and defensiveness. And that is the overarching barometer of when you have a 7030 portfolio, 70% equities, 30% bonds, or you have a 9010 portfolio, 90% equities, 10% bonds. Those are different risk profiles, but those are building blocks that you can understand. And by the way, if you don't have any edge, you don't have any ability to select managers or sub strategies and you need to have a passive vanguard approach to investments that is on the table for you to define and benchmark the success. So as a first principle, what I would say is it is important to just determine your risk profile appetite, measure it basically in passive equity bond blends. Size it appropriately, look at history, say if I had been invested in this way during the GFC, would would I be able to tolerate a 40% drawdown? And if the answer is no, then you know, you have to go back to the drawing board and resize them and be more conservative. I think it's just the more that you can simplify the objectives before you get into the nuances of how you invest, the better it will be.
- [03:51]
A
Said another way, at a high level you're optimizing returns with the constraint of what is your true tolerance for drawdown. So this is the most amount I could take in terms of drawdown. And now how do I maximize my returns with that constraint?
- [04:02]
B
Yeah, I, you know, this is, is to me the better way to define risk historically. Over the last 60 or 70 years, going back to Markowitz and all these things they teach you in business school, we learn about risk and return and we Often think of standard deviation as risk. Standard deviation is helpful if you have a trading book or you have to mark your equities to market or your portfolio to market for a given month. But as the time goes by, months and years, who really cares about standard deviation? In fact, a lot of investors, endowments don't care about standard deviation. But drawdown is something that's different. Drawdown is where you have a cumulative hit to your net wealth or your liquidity that may interfere with the ability to pay your bills, your plan participants, your retirement. That should inform the gut check what is the maximum risk I can take. And so I do think as a, as an industry allocators and managers, we should focus far more on drawdown risk and probably less on standard deviation.
- [04:52]
A
What's the difference between those two?
- [04:54]
B
Yeah, drawdown to me is not only how far down does the portfolio go, how long does it stay down on the map. And we can use history to our advantage in this case. So I'll give you a couple of different examples. So the COVID drawdown was short lived because of the nature of the virus and the stimulus and the recovery. It happened so fast in the matter of weeks where we saw a 30% equity drawdown in the early part of 2020, turn around, invert and actually become a draw up. So that as a drawdown goes, it was severe in terms of magnitude, but duration, it was nothing, it was fleeting. But look at the dot com drawdown on the other hand. So the S and P fell, I think 45 to 50% in total return terms and it was down on the mat. So this is the knockout where two or three years go by and you're still plumbing the lows of the equity market. And it would took eight or 10 years before we set new highs in equities. That was a prolonged drawdown that should be scrutinized for investors. Because what it says is first of all, if your portfolio were 100% invested in stocks, could you sustain a 50% hit to your wealth and then survive if that lasted for three or four years before you get any recovery and eight to 10 years before you would completely claw back? And I think a lot of investors would say my organization would not survive that. And therefore that is the starting point of the first principles. You cannot be 100% in equities. You may not be able to be 50% in equities. That's how you define pain thresholds and the ability therefore to capitalize and rebalance and do the things you should be doing in Times of duress.
- [06:18]
A
There's a view out there that because of the way the incentives are in Congress and with the presidency, we're never going to have more than a two year drawdown in the stock market and that this U shaped recovery that takes three, four, five years is a thing of the past. What do you think about that?
- [06:34]
B
What I'd say is history rhymes even if it doesn't repeat. And that sounds like a similar mindset in the late 90s of the Greenspan put the idea that the Fed would be able to execute language or policy cuts or you're alluding to the fiscal side. Congress could get spending done such that equities can be bailed out. And that has been the experience. Buy the dip has worked really well the last 5, 10, 15 years until one day it won't. And I can't predict what it'll be that it causes the won't. But imagine this scenario. What if the Fed is perceived to have lost control of the balance between inflation and employment? What if treasury issuance is drowning the market because suddenly treasury investors are concerned the Congress is spending money and not raising enough revenue and therefore we see interest rates climb like they did in 2022. The balance between equities and bonds is thrown off. The Fed is far less powerful than it was. That put doesn't exist anymore. And I just think that we should always be vigilant. And yes, buy the dip has worked recently until one day it doesn't. And those are the types of regime changes deltas that can be very delicate and dangerous.
- [07:36]
A
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- [09:07]
B
One of the most perilous assumptions is the perception of low volatility. And we're seeing it right now with Vix at 14 interest rate volatility is near its lows the last 12 to 24 months. Low volume can encourage excessive risk taking, optionality, a lot of comfort until that volume profile changes. And that can have multiple derivative effects on the way assets are priced. And it could cause small disruptions, be it an earnings miss. So let's say suddenly gets hung on a debt issuance because they're now leveraging the balance sheet and the next debt issue they announced at a time of tumult becomes mispriced and widens. And that just feeds on itself throughout the entire credit complex. That to me is the risk like the volume being perpetually priced as a given of being under control. It's never that simple. And so you can't look at an options curve to extrapolate that. That's just what the market's telling you today. That shock that comes in where volume really rears of tech could be the biggest risk I worry about right now.
- [09:59]
A
In the last cycle, endowments leaned heavily into venture capital and private equity. Was that a mistake?
- [10:06]
B
Yeah, I think it was. I think the magnitude to which venture and growth equity became part of the menu got too far askew where it was dominating commitments. And let's first step back and assess why it was deemed to be such an attractive area to invest. Because over the long run, if you want to maximize your multiple and your internal rate of return, there is no doubt that venture capital and growth equity give you that highest threshold of returns if you select the right managers, if the DPS you are aligned with will execute. You can see 2 3, 4x in individual funds programs that will outpace a traditional buyout program portfolio if executed well. And in certain cycles it can even be more pronounced than that. So the the reason that this was such an attractive area was because endowments are seeking to maximize the returns. If you let an optimizer run wild, unconstrained it would just throw all this capital into growth equity and venture. If you're just trying to to juice the overall fund return. The challenge is that there's two elements to it. One, it is cyclical. And in 2020 and 2021 we have the benefit of hindsight to know now that that was a peak. We see plenty of moments like the dot com from really 2000 to 2008 or 2010. Venture capital was a nuclear waste land. It was the fallout of a lot of bad deals done in the late 90s, too high of multiples, assets that were not delivering the cash flows. A lot of funds that had below 1.0x the distributions took forever and that scarred a lot of allocators. And so venture capital commitments to new funds went away and fell off. And so this entire cycle played out until we got post. GFC venture was not really part of the gfc, right? It was, it was a quiet area. There was a lot of innovation, biotech, energy efficiency, technology. All of these areas started attracting new waves of capital. And then we had IPOs like Facebook and you know, it started to build a really compelling proposition again. So the cycle was on an upswing. But a lot of the allocators that had been wiped out in the late 90s were not really part of the ecosystem when you roll it 20 years forward. And so what I'd say is the cycle is the first key piece of it. You have to be mindful to to it and to have been going over allocated considering it was late cycle peak was a mistake. The second area that I'd say is a mistake for, for allocators was not balancing liquidity. So even in good times, if you are investing in venture and growth equity, it will take you over six to eight years before you get your capital back. It will take you 10 to 15 years before you get all of the capital back from a traditional venture fund. And the lack of liquidity became exacerbated in the interest rate spike of 2022. There are still a lot of venture capital funds that were raised five years ago that have yet to return a penny to their investors. And that was not the assumptions that were underwritten by these endowments. So what ended up happening is while these might be great funds, we might look at them five years from now and say, wow, as long as you were patient, you were going to get your money back. But in the interim, you have a lot of money that you've infused that's on the ground that you cannot touch and a lot of other opportunities and Volatilities have happened since then. You have a portfolio. If you put 50 to 60% of your portfolio in privates, you can't redeploy it into other liquid areas. So the lack of liquidity, I'd say the lack of balance has caused endowments to seize up. Their portfolios had a denominator effect initially where it grew to outsized proportion of their allocation and they were not able to rebalance into the areas that were really attractive in 2022.
- [13:18]
A
Taking a step back, you're a co cio multi asset investing. How do you define what fits in that bucket at Neuberger Berman and what is your role and what is your mandate?
- [13:28]
B
So our role is in a multi asset construct. Anytime an investor comes to us and they want to have multiple asset classes to invest, so not just a pure fixed income mandate, they will give us parameters where we define a target asset allocation and we get to use bottom up strategies to add value. But importantly, we do top down asset allocation to tilt the portfolio in areas that are attractive. Now a lot of our clients, clients, in fact 2/3 of our mandates now allow us to use a blend of public and private investments. And that's really exciting for us. And so perhaps after we do the work, we work closely with our clients to determine the optimal asset allocation. If they determine we can put 20% in privates. What we can do is over the course of several years, starting from zero, working our way up to 20%, we can use a wide variety of private investment asset classes to build up and generate a robust return that is enhancing the overall portfolio. And what we will do is depending on the client's objectives, we'll use buyouts, co investments, secondaries, hybrids, like capital solutions that might be doing preferreds, real estate, even things like catastrophe bonds. All tools in our toolkit that we'll use to craft the optimal privates portfolio that is achieving high returns while providing reasonable cash flows in return to be able to balance in the overall hybrid of the portfolio.
- [14:45]
A
What tools are you using to know that have the right portfolio mix between public and private assets because they fundamentally have different systems, different accounting standards?
- [14:53]
B
Very good question. The first thing is we have to acknowledge the dual nature of the way you measure them. So we know the volatility of privates is artificially lower when you look at it on a bookkeeping basis. So there's a heavy lag in when it gets valued. It's often done on a quarterly basis for equity asset classes, but the underlying volatility, just given the leverage and the equity orientation of a lot of these investments is much higher. So we do dual modeling to show our clients what the economic underlying volatility and risk is the portfolio as well as what they will experience based on the way that it's measured. We do a lot of look throughs to understand sector allocation, the types of industries that we're involved in. But importantly, we also do a lot of stochastic modeling. So what that means is under a wide variety of economic regimes to stress test privates, not only in a base case or when the times are good, but assess periods where there will be a lack of liquidity or equity. Volatility is high because what ends up happening then is distributions, as we were just discussing, they'll slow down and so allow us to get comfort that if we commit capital over five years and we expect cash flow to come back at a certain rate over the next five years, but there's an economic shock understanding that it'll be a slower return backwards and how will that waterfall throughout the rest of the portfolio? It's a really a stress test on publics and privates, the interaction of them to make sure that we don't get over our skis and put too much money into privates relative to what they can deliver.
- [16:13]
A
Cliff Asness, previous guest and famous founder of aqr, coined this volatility laundering in that public books have to mark themselves up sometimes on a daily basis. Private books get to wait quarter by quarter. My whole argument would be so what if, if you're keeping the client from themselves or if, if the LP is keeping themselves from making bad decisions during stress tests, why does the fact that it maybe is technically volatility laundering, why should that matter to investor?
- [16:41]
B
Well, I agree with you. I think it gets back to drawdown being more important than volatility. Volatility is an interesting measure. We care about our cumulative returns that we earned on an investment. And so let me put it this way. Investment A and investment B, if we have investment A generates a cumulative annual return of 15% and it might be in this volatility protected concept that's being discussed in a private shell. And volatility B has full daily liquidity every day, but it gives you a cumulative return of 12%. I don't care what the assumptions are on how you marked A versus B. A lot of investors will say I want A because it's higher returning. And that is economically proven because when I invested in it day one, I gave this amount of money and now 15 years have gone by and I have 15% per year more to my name versus if I had done it in a liquid equity construct, I'd add 12% per year more to my name. Now let's say A and B are the same where they're both giving you 12% per year and A, you only get your capital back after 15 years. Goes by B and B, you can have it tomorrow. Of course I'll take investment B then. Right. Like I would rather have the transparent fully liquid investment if they give me identical returns. And I think that's where Cliff's point is fair. But the premise should be that privates are giving you a material multiple percentage point per year advantage in return that you should earn and that is measurable. So the volatility we don't really worry so much about, we measure cash on cash. We measure how over the lifetime of the private investments did it fair against a comparable public market equivalent a PME as we call it.
- [18:03]
A
I guess you should really ask the second order effects of volatility. You don't want volatility. A non controversial statement, but why two different answers. One is you don't want to take the wrong action at the exact wrong time. So I don't know many people that care about upwards volatility. When it goes up 70% they're not running, they're not giving a call and complaining. But when it does go down, do they take the exact wrong action, exact wrong time? Especially in the current market cycle where you have more of a V shaped recovery. So selling could cut off Your returns by 10, 20%. The second is, I guess there's this tail risk of a risk of ruin. If it's too volatile, it could literally go down to zero. That's another function of too much volatility is that it's, it's like crypto, it could go up 10x and then the next morning be down tax.
- [18:47]
B
Yeah. And by the way, if you're getting excessive volatility, some of it could be the underlying asset you own like equities or cycle of equities. A lot of it is probably leverage. And leverage is a different type of volatility ingredient that can be dangerous because it can take you to zero. Straight linear equities, unlevered. There's really very little evidence that if you bought it, even if it's a bubble or it might be overvalued and there might be a two year window where you regret it, there's not going to be a 20 year window where you regret it. Equities are anchored to economic growth. As long as it's diversified and sensibly managed and unlevered, you're going to be fine. But if you ramp up your volatility or your portfolio efficiency under these assumptions of introducing leverage, I think that's where you can get yourself in trouble. And that's where your point you're making about volatility. If you have a 10% volume asset class that you levered a 30% volume, there's scenarios where you can get wiped out pretty quickly.
- [19:37]
A
And oftentimes clients come to you with these constraints. Max drawdown. Maybe you mentioned 20% in privates. Let's say somebody came to you unconstrained single family office with no liquidity needs. I know it's unusual case, but what would be your ideal portfolio allocation today based on private and public markets then?
- [19:53]
B
That is an endowment like portfolio. I do think it should embrace equity orientation. So we will benchmark success of this portfolio. 80% equities, 20% bonds. And at 80% we have a lot to play with. But what I would probably do is 30% in privates and 50% in public equities, actively managed or a blend of active and passive. But we're going to be doing a lot to earn and maximize returns. And, but that will be a volatile portfolio. So for the other 20%, we're going to have uncorrelated liquid diversifiers of about 10% and then another 10% in T bills, cash and treasuries to keep it liquid to help us provide liquidity for rebalancing purposes going forward. I think that is a great overall framework. And of course the proof's in the pudding after that. So suddenly you hear, Oh, I have 30% of private equity to play with. I have 50% of public equities. That's where that you can roll up your sleeves and find a lot of interesting strategies and sub strategies.
- [20:43]
A
And is that behavioral? The 20% in the defenses that to keep people from their own worst enemies themselves. And again, selling in the worst time. Let's say the person goes into their. They're frozen, they're cryogenically frozen and they're going to wake up in 15 years. Would you still use that same portfolio?
- [20:57]
B
Yeah, I would. I mean I, I think the cryogenically frozen person could very well be in 100% in equity assets and be okay.
- [21:03]
A
Which is not realistic.
- [21:05]
B
Yeah, I would like to think that even with this 20%, and I would call kind of like the motor oil you're putting in the engine to lubricate the portfolio because there are going to be times in March 2020 you would have had a, that drawdown we were talking about. Equities fell 30 or 35%. Man, it would be great to rebalance toward target or go overweight equities at that point. If you're already 100% in equities, you don't, you can't rebalance by definition you're already in. So that's when you tap that 20% into equities at attractive values and then you take that money off the table at times of frothiness. And again, this part of the diversifiers in particular liquid un uncorrelated diversifiers that can generate high single digit returns with very little correlation to other markets. That adds a lot of value and balance to the portfolio too.
- [21:43]
A
And the key term there is liquid. If it has a quarterly gate or a yearly gate where you can't, you can't redeem it until the next quarter, then these, these market fluctuations, you can't be opportunistic.
- [21:52]
B
Yes, liquid and I would say uncorrelated is just as important a term. So it does you little good to have something that is a 04 beta to the S and P. That's not really a diversifier. But, but if you have something where independent of what's happening in rates or equities and it's still cranking out solid returns based on fundamentals, you know, we do have macro strategies that we, that we implement where we're agonizing over risk and managing it accordingly. In this strategy to make sure that while it's taking specific bets in currencies or rates or equities, it's hedged and stress tested to make in an aggregate it has no correlation to the equity market. And if that's capable of generating an 8 to 10% return, that is, that's where I would agree with Asmus. Again, like a low volatility strategy really in a diversifying construct can be quite valuable.
- [22:33]
A
Now we go on the 80%. You said 50% in publics, 30% in private equity. My intuition would be the exact opposite, which is 50%. You get the liquidity premium, you get all the, all the good stuff. I've had Professor Steve Kaplan that showed that 300 to 500 extra basis points of being in private equity and venture capital over a long enough period. Why not have more concentration in the private side versus on the public side?
- [22:57]
B
It's a great question and I think there is a fair amount of gap between 30 to 50. Maybe the right answer is somewhere in between. But let's take 50 plus and just talk about what goes wrong with that. And that's where. Imagine having that allocation at the end of 2021 and how it's gone. And I do think the denominator effects. You can go from 50 to 60 fairly quickly and you have a different portfolio, then you don't have a portfolio, you have a problem. You're now managing existing commitments, figuring out how to reach in the couch cushions to find the change to put in the machine to feed the commitment cycle. Because the majority of your portfolio you cannot control anymore. It is at the GP's control and it's being marked in a very different way. I just feel like you now have a portfolio that is not manageable. It is going to be anchored by commitments and decisions that you made possibly five to seven years ago. And you might be in a position where you have to make some difficult decisions about doing a secondary sell because you're just not able to manage the current economic environment accordingly. So my, my opinion is to have a private portfolio that is more than a majority of your overall asset allocation. A lot of endowments do try to do that, but if you talk to them right now, they're struggling with managing that. In a lot of cases, doing secondary sales because they feel like it's no longer optimal and it's become an outrust.
- [24:06]
A
So if you have to make that secondary sale, let's say even you get a 10% discount once every five years, you're now giving up that 200 basis points. You might have gained 300. Now you have 200 and you have a headache.
- [24:16]
B
That's right. And by the way, in venture and growth equity, I'm not sure a 10% discount is realistic. I think it could be 20 or 30%, which makes the math even harder. So a secondary sale, which we like, secondaries growing as a market, we think GP led, LP led, these are all compelling areas when you want more.
- [24:30]
A
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- [25:45]
B
It helps lubricate the private system. So we're believers in that space. But if you're using secondaries as a seller perpetually to manage your portfolio because it got misallocated, the headwind that you will encounter from performance adversity in that will be substantial. And by the way, a lot of secondary sales, interestingly, are initiated when there's a new regime. When a new chief investment officer comes in, they look at what they call the quote unquote legacy privates. They get to kind of take the hit because it wasn't their doing, move on. They want the ability to redeploy the portfolio. But I think that speaks to the fact that a secondary for a lot of endowments and other investors like pensions, is a tool of last resort because it can be so problematic.
- [26:22]
A
And it's not just ego. They want to make their own mark on their portfolio. The incentives are so misaligned because if they start with a lower mark for the entire portfolio and they're getting a percentage of the offside, they're actually almost incentivized to sell at a discount.
- [26:35]
B
That's right, they are. It's kind of like, you know, I mean, we see the same thing in public equities with management teams. There's a new management team. Is it not surprising that the, the write offs happen in the first year of the new management? I mean, that's natural. And by the way, it's probably fair. I mean, a new CIO should be empowered to put their mark on, on the portfolio. But secondary sales do come at great cost if you're not careful. And hopefully we're talking about a fairly small port part of the portfolio. And in most cases that's what we see. We don't see endowments out there selling half of their privates in the secondary market, they're doing more targeted exposures that they're trying to really peel off. But that's why when I say if I craft this perfect unconstrained portfolio, it's a lot easier to work with privates when they're 30 to 35% of your portfolio, not 50, 60 or 70%.
- [27:12]
A
So there's almost a volatility of the strategy, if not literally in the portfolio, but from having this illiquid investment on the books, there's many different things that could happen to it that could hurt the overall portfolio.
- [27:23]
B
That's right.
- [27:24]
A
So continuing with this unconstrained portfolio, let's say it came with $10 billion cash. So either a new endowment or a high net worth individual getting, getting a very large liquidity. How would you practically go implementing this 8020 portfolio?
- [27:38]
B
That's an interesting question because there's a lot of discussion about ramp up. If this, this is a new portfolio that has not benefited at all from the prior strength of the inequities we've seen over the last 10, 20 years. And so the worst case that this new family with their wealth would think about is that you put it all into equities tomorrow and that's when we get that the bear market finally comes. So I do think a phased implementation is appropriate. If you're coming from cash and you're going into a risky portfolio, balancing the entry is appropriate. And we do see often a progressive asset allocation target done in advance, though that's what I'd say is like, let's make clear, get the committee or whoever's in charge to say, look, we think rounding it in over three years gradually is appropriate for liquidity purposes, for equity entry purposes. That would be a fair way to do it. And a lot of our clients too, if they're only now getting involved in a meaningful equity allocation, we do see a gradual ramp up or in privates by necessity, because privates take years to build up. You have to have kind of a interim asset allocation before you get to your permanent asset allocation.
- [28:41]
A
To play devil's advocate, isn't that a principal agent thing in that if the expected value every day in the market is 0.1%, you want to be invested in the market? Yes, to your point, it might go down 20% the day after, but on average it's going to go up 0.1% and being invested overall is smarter than not?
- [28:58]
B
Well, let's look at it another way, which is you could have easily made this decision in April of 2000, and I worry about the down on the mat for three years. I mean, that would look like a very dumb portfolio for three years where it's going to be underwater on equities by 40 or 50%, people staring at it and this, I mean, look, the way I think about it this way, if I were involved in the equity market in 95 through 2005, I had three or four years of just unbelievable equity gains, 30 or 40% per year. And then I had three years of difficulty and then two years of kind of more sideways markets. But when I look at that 10 year period, I would feel more than happy with the way that result went. Whereas if I got involved in 2000-2010 and I put all, you know, I was sitting in cash watching everyone else make money for five years before suddenly I decided to not only dip my toe, but throw every dollar I have into a huge equity risk portfolio, just put it in. I would have five to eight years of a lot of just asking questions like what the hell have we done here? I just, I think going from cash to equities, phasing it in is a natural and logical way to do it. And by the way, with our 401ks, we as individual investors, what's great about having 6% of your paycheck put in every month is this is the true dollar cost averaging where you get a methodical, gradual ramp up in your wealth into equities. I think it's a very different. There's just a lot more entry risk if you do something from cash to equities at a given point in time. But even if you do that, then 10, 15, 20 years from now, it'll still be a good decision. Let's just make that first five years a lot easier.
- [30:26]
A
There's a behavioral aspect too. If you're literally starting a family office or an endowment, you, you don't want the institutional baggage of being too much in privates and being maybe 40 to 50% privates early on. You catch a bad year and now you're like, we don't do privates. There's these downstream behavioral consequences to being overweighted versus if you're 30 to 35%, it dips by 10%. There's not this institutional baggage that develops internally.
- [30:46]
B
Yeah, it's a sequence of returns. Just even though we know given we're very mathematical, in the long run it shouldn't matter. The sequence of returns does matter.
- [30:54]
A
We're still humans. Tactically, when you have this $10 billion and you want to enter the market sequentially Are you literally keeping these in Treasuries or is it a hyper diversified portfolio? What's the best practice when it comes to having money that's on the sideline that's not yet deployed optimally?
- [31:08]
B
There are, there are other options in terms of lower risk, lower equity orientation strategies driven more by yield as well as liquid diversifiers that can give you returns that exceed Treasuries where you can study the interaction of these, understand their risks because they're not without risk, but they have a different type of risk than equity risk. And you can diversify these exposures in a way where you can earn a return superior to Treasuries. I do think treasury should still be a key component of it. But yeah, I mean there's, this should not be a plain vanilla treasury ladder portfolio day one. You can do other things that are lower equity risk but still decent returning strategies.
- [31:43]
A
Double click on that. Purely simplistically, it seems like money in Treasuries is lost returns. Why is that not true?
- [31:51]
B
Well, yeah, that's why I think that you want to keep some Treasuries for liquidity purposes. But I do agree with you. I think that you would want to be doing some other yield enhancement strategies to try to beat Treasuries. I do think Treasuries as a allocation by themselves, they are doomed to underperform inflation. They're not going to give you a very good return. Yes, real yields are higher now than they have been from five or six years ago, but it's still a tough starting point. So yeah, I agree with you. I think that in this hypothetical $10 billion and let's say that we've made the determination we're going to put one third of the money to work in equities. So we've got 600 million or so to play with that we want to be more stable, but we still want to be earning a decent return. Let's keep 100 million or a billion of it in Treasuries and high grade credit liquidity assets that we know will be very cash like, will be that stability and put the rest of it in a diversified portfolio of interest enhanced strategies, liquid diversifiers, macro hedge funds. I mean there, there's, there are a lot of things you can do to, in a diversified way that you could have a decent confidence that you could get a 7% return.
- [32:52]
A
Not financial advice. These, these are very sophisticated instruments that you want to, you want to hire a professional in terms of this is, it's Q1, 20, 26. What asset classes today are overvalued. And which asset classes are undervalued in your opinion?
- [33:06]
B
Well, I'm going to start with undervalued because I'm an optimist at heart. And then I'll come back to the overvalued. And to make clear, we are leaning into risk assets. We upgraded equities about a year ago. We think that when you look at what is going right, there's a lot going right. We have the Fed easing, we have earnings growing in the low teens. We have a capital cycle that's only getting started, GDP growth that has navigated tariff uncertainty accelerating. So we see top line revenue growth ahead. We see bottom line growth, earnings growth ahead and valuations while elevated. We don't worry about evaluation evaluations as much when we're aligning with growth. And so because of that, we like equities, especially outside the US and we think that leaning into private equity, private real estate, public equity, these are all overweights in the portfolio. The area that's more challenge to us that can help fund some of these overweights is in fixed income, more importantly in US Fixed income. So we have tight credit spreads. We have interest rates that are, you know, they're higher than they were three years ago, but lower than a year ago, particularly on the front end. So we would be, by leaning into risk assets, we think you could probably go underweight your fixed income allocation a bit to fund some of those overweights.
- [34:16]
A
And you look at a lot of these asset classes and first principles from the outside, it seems to me that fixed income and private credit are in ways related or serve similar purposes. To what extent is that true and to what extent are they truly different asset classes?
- [34:29]
B
While fixed income and private credit have the same overarching exposure of being creditors, so you're ultimately owning an obligation. I think they're dramatically different in terms of how they should fit in your portfolio. So private credit, we do measure it relative to traditional fixed income. But when you invest in private credit, you should not be thinking of this at all as a liquid asset class. And your expectations should be geared accordingly around that. But you should expect to earn 9, 10, 11% returns. So this is an example of something that might be of interest to our new family office. They may want to put a decent amount, day one into private credit because that's going to give them some really interesting returns and they have the illiquidity tolerance to handle that. But if I compare that to the role that traditional fixed income should serve, those are night and day in two ways. One, the traditional fixed income is ready for me by the end of the day if I need it for a capital call or to pay a bill that comes in. It is readily liquid, tradable and it settles T plus 1. And private credit will never be able to do that. The other thing that traditional fixed income will do is if you go into a recessionary trade or a deflationary economic cycle, traditional fixed income that's tied to high quality debt, particularly Treasuries, has the ability to go up in value 10 or 20% depending on the duration or interest rate sensitivity you've bought. Private credit could be having its own challenges in that environment. It may push out the liquidity when you'll get it back, and it may have an impairment in the credit quality of the companies. So, you know, look, I do think a lot of investors that have the ability to take on less than liquidity, like pensions and insurance companies and some endowments, I think it's appropriate that they're shifting money into private credit. But they're still doing a lot of work to make sure they have the liquidity they need and still keep some decent amount of traditional fixed income to serve that valuable role in the portfolio.
- [36:09]
A
What's one key philosophy you've changed over the last 12 months?
- [36:14]
B
I'll give you one over the last 12 months and then I might give you one over the last 12 years. A philosophy that I go back to was don't undersell the ability of economic incentives and humanity to navigate a challenge. And I'm talking 12 months ago. It was nine months ago, we had Liberation Day. And when President Trump held the posters that showed the new punitive tariffs that if we took literally that would have raised the average tariff rate in the US to over 20%. And you did the math on that, it would result in an immediate recession, a contraction in profits, inflation skyrocketing to 5%. All of these assumptions that. And we know that there was negotiation to come. But even so, I think our initial reaction, and my own reaction was, wow, this is a pretty dire scenario. And you know, it could really cause a growth shock until you start to see the response, the fact that negotiations are available, replacement onshoring or just inventory management, and ultimately to be able to grow through that crash. I do think it's informed the resilience of industries to be able to manage manufacturing and services in a complex global economy. And so I think it's just a reminder that when you do the math of a shock, apply a fair amount of Judgment to the human impulse do better than the adversity would suggest. The the lesson I would say over the last 12 years is I. If we were having this podcast in the year 2013, I would have told you I was a value investor, that I like price earnings ratios to be cheap in my portfolios. And over the next five to 10 years I did become more of a core investor which is paying equal attention to growth and value because you get what you pay for. I think that, you know, I've been an allocator for over 25 years and when you look at the ability of a cheap priced book company to outperform Google, they're not really the same investments. They both can serve a valuable role in your portfolio. But I think a lot of us have had to learn that a value investor is going to be challenged. If you don't have high quality businesses that are capable of growing, and if you have high quality businesses that are capable of growing, they're probably not value businesses anymore. The market will have an increasing awareness of that. Discover it and buy it. So I think you have to look through valuation. There's only one tool. Look at growth, look at quality of earnings, look at return on equity. There's a lot of other metrics you need to look at. Be a quality investor.
- [38:33]
A
How do you continue to evolve your investment philosophy and stay cutting edge in your approach to investing?
- [38:38]
B
An exercise I try to do having been an equity analyst and a credit analyst early in my career. So having those skills where you can take a complicated portfolio and drill down from a forest to one tree, I think this is a good exercise for any allocator. If you have access to a Bloomberg or a FactSet or Aladdin, whatever your tool is, take the s and P500 and look at the composition of it. We know the magnificent seven is 40% of it. Maybe you can pick one of those companies, maybe find like a. You know, I've been looking at Paramount because it's in the news for, you know, mergers, discussions and it might be buying the assets of Warner Brothers. So you double click on Paramount and you'll see what sector does that roll up into? How much is it weighted in the index? And you kind of quantify it that way. Look at the historical price. How has it done over the last two or three years? But then what I would encourage investors to do is look at the financials, look at the last three or five years. How much money does it make? Not in earnings per share, but like in billions of dollars. How much debt and Equity does it have, it has an enterprise value. How has that evolved? And you kind of study this one small company, see what's driven it up or down and the way that that is rolling up into a sector, it rolls up into a country, it rolls up into an index. It, The S&P 500 is not just this blanket thing that we all look at and invest and allocate towards. It's a dynamic, living, breathing index of 500 companies. And you go outside the US it's even more complicated than that. Understand bottom up, what drives the top down. It's going to make you a better investor. It'll help you ask intelligent questions of your managers when they have their positions. And I think it'll keep you relevant and help you understand five years from now the types of sectors or trends and the pricing, how that will all work its way into a portfolio and keep you from being rusty to be what I'd call a lazy alligator that just kind of looks at betas top down.
- [40:18]
A
Benjamin Graham, who is Warren Buffett's mentor, said that the stock market in the short term is a voting machine and a long term is a weighing machine. Have you found that to be true and when is that not true?
- [40:28]
B
I totally find it to be true. And another thing I've learned over the last, I'd say five to 10 years is not to question an individual stock that appears to be on fire and, and is increasing 10 times or 20 times. And I'm talking about Nvidia. I did not question Nvidia five years ago when it was beginning its ascent, because I thought, well, investors are smart. They're pricing in something about its future pipeline of revenue streams and why we will watch, we're going to scrutinize it. And the standard is high because when a stock does this well, if it fails to clear a barometer, it's going to get punished. But if you think about it, Nvidia, when it was hitting a $1 trillion capitalization, 2 trillion, 3 trillion, you could look at the revenue and see that it was delivering the exponential growth that was promised. And that's, I mean, we all make that assessment now. I think that's why we're, we're looking so closely at the AI capital cycle. It's going to get quite challenging when we're talking about trillions of capex being deployed. But this was the ultimate weighing machine. If someone wanted to be rolling their eyes at Nvidia just because it went up so much or like, I don't know what that thing is it's worth 2 trillion. I really question it. Well, they look, they look kind of silly now because it did prove out via the earnings. It gets back to my point. Double click. Understand the earnings. See the revenue. Is it growing? Is it proving the economics that validated such a dramatic equity move? And equity investors are smart. They're going to price this two years in advance. I mean, that's why when you see something like that happen, watch it closely. We're looking a lot at what's happening in Korea equities because Korea is up 80% this year and we're going to have to see the validation. Will we see an 80% increase in earnings? Possibly. But investors are leading indicators and they're smart. Those that are gravitating towards the growth and, and trying to see the earnings are validated.
- [42:01]
A
You mentioned AI and a lot of people look at the AI stocks, which we could talk, talk at length at. But one of the things that's perplexing to me is internally in my business we're using AI all the time. We're getting economies of scale on every employee. We're using it from anything from CRM to production to hiring to everything. And for some reason that AI efficiency, both today, but also just the increasing speed of AI efficiency doesn't seem to be priced into the stock market. Is that a naive outlook? Or like, what are your thoughts on this?
- [42:33]
B
I don't think it's naive. I think that if we talk about the key measures of AI efficiency and integration, we're still trying to discover that. And at Neuberger we have the benefit of 30 dedicated equity analysts and we get to hear every week about manufacturing sectors, industrials that are adopting and implementing AI and the use cases and the test cases. But I do think it's still early days. I think a year from now we're going to have a much better sense and see that priced in. But a lot of it is we need to see verifiable margin enhancement or cost savings from these tools. And it's probably just too soon. But I'm with you. It's changing quickly. Every day that I use AI in my workflows, the improvements are pretty notable.
- [43:12]
A
It seems like one of these beliefs that GDP could only grow 3% or whatever, but it doesn't seem to survive this first principle. Whereas if you're using AI to cut costs and also to accelerate revenue, you're seeing in startups. So if you think of startups as a leading indicator to more mature companies, to me it's like, why Aren't equity markets up more? Or maybe this is the priced in. Maybe that's why we're having this bull run.
- [43:33]
B
Yeah. And you know, the GDP data our view is, and it's one of our key themes for 2026 is that yeah, AI will be a double edged sword. There's going to be some losers along with the winners. But it is a very real productivity boom that will be driving enhanced GDP growth and revenue growth. So, you know, we see it in the macro data, not as much in micro, but over time I do think that we expect to see a meaningful uplift, probably about 2% of incremental EPS growth from AI after we look back at this year.
- [43:59]
A
What is one piece of timeless advice you would go back to when you started your career 25 years ago that would have either helped you accelerate your career, helped you avoid cost of mistakes.
- [44:07]
B
I had a tendency and I suspect a lot of people listening to this feel the same where you have a dream job or you put a position on a pedestal. And when you achieve that, sometimes it's not what you expected. And maybe if you would have focused more on the journey and not the destination, you would have felt maybe you would have made better decisions along the road. But you know, one job I put on a pedestal quite early in my career was I want to be a Wall street equity analyst. That's all I want to do. And I did that for two years. I'm grateful for what it gave me in terms of skill sets, but I realized it was quite in the weeds on a certain set of five stocks. It was not macroeconomic at all. It was not very driven. I had friends that asked me what I thought about the stock market and I said, I have no idea. I could tell you about beverages if you care. And they didn't care. They didn't really care what soda was doing that year.
- [44:55]
A
It doesn't keep 99% of people from opinion on this.
- [44:57]
B
No, that's true. But I realized I spent several years trying to interview, I got rejected, I got the job, I put my head down and then one day I was kind of walking to work. I'm like, I don't love this. I don't think this was what I made it out to be. And I started to migrate into the buy side or fixed income and macro and other things. And that's just a, you know, I think I would have probably made some better decisions about how I spent my time and what I was focused on if I had not gotten so anchored and put a certain role on a, on a pistol. So that's what I would suggest is it's a journey, it's not the destination. And you should always be re underwriting what you define as your dream job. Or don't even put in those terms. What is your dream day like? How do you want to spend your time? What is out of it?
- [45:32]
A
Yeah, it kind of goes back to this principle that you're saying that a stock is not just a ticker with just like, look at the quality of the earnings, look at what the business does, look at the day to day performance of the business situation with any career path. Okay, it might be a nice title. Maybe there's something with a worse title but much more interesting and much more fulfilling.
- [45:47]
B
Absolutely. That's well said.
- [45:49]
A
Well, Jeff, this has been an absolute masterclass. Thanks so much for jumping on the podcast. Looking forward to continuing this conversation live.
- [45:54]
B
Really enjoyed it.
- [45:54]
A
David, that's it for today's episode of How I Invest. If this conversation gave you new insights or ideas, do me a quick favor. Share with one person in your network who'd find it valuable or leave a short review wherever you listen. This helps more investors discover the show and keeps us bringing you these conversations week after week. Thank you for your continued support.