Krishna Memani on Wall Street's Very Expensive "Free Lunch"

Summary

Odd Lots Podcast Episode Summary

Title: Krishna Memani on Wall Street's Very Expensive "Free Lunch"
Host/Authors: Joe Weisenthal and Tracy Alloway
Guest: Krishna Mamani, Chief Investment Officer of Lafayette College Endowments
Release Date: May 30, 2025

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1. Introduction: Rethinking Diversification

In this episode of Odd Lots, hosts Joe Weisenthal and Tracy Alloway delve into the age-old investment principle of diversification. Challenging its efficacy, they converse with Krishna Mamani, a seasoned Chief Investment Officer, to explore why diversification, long touted as a "free lunch" in investment strategy, may no longer deliver the promised benefits.

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2. Diversification: The Traditional Mantra

Joe Weisenthal [02:07]:
"Tracy, this has come up a few times on the podcast over the years, but, you know, you really feel, you could really feel dumb as an investor over the last, I don't know, 15, 20 years, if you literally bought anything else besides big tech stocks."

Tracy Alloway [02:22]:
"Big US Tech stocks."

Discussion Highlights:

• Historical Context: For the past two decades, big U.S. tech stocks have significantly outperformed other sectors.
• Diversification Challenge: Despite the longstanding advice to diversify internationally and into small caps, these strategies have underperformed compared to concentrated investments in U.S. tech.

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3. Theoretical Foundations of Diversification

Krishna Mamani [05:40]:
"Diversification is the biggest free lunch available in the investment world. And I think from a longer term perspective that is absolutely true..."

Discussion Highlights:

• Origins: The principle of diversification stems from Modern Portfolio Theory and the Capital Asset Pricing Model (CAPM), pioneered by academics like William Sharpe in the 70s and 80s.
• Basic Premise: By spreading investments across various assets, investors can mitigate unsystematic risk without sacrificing expected returns.

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4. Why Diversification Has Fallen Short

Krishna Mamani [08:03]:
"...the fact that it hasn't worked out according to plan doesn't mean that the basic principle isn't invalidated. It just simply means that you have to think about it and acknowledge the fact that it hasn't worked out according to plan."

Discussion Highlights:

• Long-Term Underperformance: Over the past 30-40 years, diversified portfolios, especially those including international stocks and small caps, have not matched the performance of concentrated investments in U.S. tech giants.
• Benchmark Influence: Benchmark indices like MSCI All World Index compel investors to buy certain asset classes, often leading to suboptimal diversification.

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5. The Dominance of U.S. Tech Stocks

Krishna Mamani [10:36]:
"...the tech supremacy of The S&P 500 is certainly one of the drivers behind diversification's underperformance."

Discussion Highlights:

• Profitability and Growth: U.S. tech companies have maintained high profitability and growth, attracting significant investment flows.
• Low Interest Rates: Persistently low interest rates in the U.S. have favored growth stocks, particularly in the tech sector.
• Private Equity Influence: High multiples in private equity markets have further bolstered the performance of U.S. tech firms.

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6. The Role of Benchmark Index Providers

Krishna Mamani [18:46]:
"...benchmarks come in because otherwise it'll be free for all. As an asset allocator, if my returns were 10%, let's say I can always claim that I did a fabulous job and my benchmark outperformed by, you know, 1,000 basis points."

Discussion Highlights:

• Influence on Allocation: Benchmark providers like MSCI and S&P Global actively shape asset allocations by determining index compositions.
• Tyranny of Benchmarks: While benchmarks provide a framework for performance evaluation, they also constrain investment strategies, sometimes leading to herd behavior and concentrated investments.

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7. International vs. U.S. Market Performance

Joe Weisenthal [28:34]:
"Tracy, do you know how much without looking the dax Germany's benchmark index, do you know how much it's up in dollar terms this year?"

Tracy Alloway [28:42]:
"I do not. Although I will confess I have a chart of the MSCI All World versus the S&P 500. Almost."

Notable Quote: Joe Weisenthal [28:53]:
"The German stocks in dollar terms are up 32% this year. France up 17.5% in dollar terms, the Euro stocks up 22%. I mean, this is serious."

Discussion Highlights:

• Regional Outperformance: European and Latin American stocks have shown remarkable gains in the current year, diverging sharply from the flat performance of U.S. benchmarks.
• Flow Dynamics: Krishna attributes U.S. dominance to dollar-related global flows and the perceived strength of the U.S. economy, which have historically drawn investment into the U.S.
• Sustainability Concerns: While current international markets are performing well, there's skepticism about the longevity of these gains without structural economic changes.

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8. Career Risk and Investment Strategy

Joe Weisenthal [20:29]:
"Talk to us, though, about like your peers and career risk, et cetera..."

Krishna Mamani [24:27]:
"So, Krishna Mamani. That seems like a really key point that as long as that's the benchmark, some institutional allocation will survive."

Discussion Highlights:

• Pressure on Asset Managers: Institutional investors face career risks if their diversified strategies underperform benchmarks, leading some to deviate from traditional diversification in pursuit of higher returns.
• Crowded Trades: Managers may flock to popular sectors like U.S. tech to outperform, risking reduced performance if these sectors falter.

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9. Diversification's Role in Tail Risk Protection

Tracy Alloway [31:12]:
"But if the argument is diversification is good for protecting you from tail risks, then what's been happening this year, and specifically in April, seems like a pretty big tail risk. And diversification worked in this case?"

Krishna Mamani [31:27]:
"Absolutely, diversification worked."

Discussion Highlights:

• Short-Term Benefits: Diversification can provide peace of mind during acute market stress by mitigating drastic losses.
• Long-Term Underperformance: Despite short-term benefits, over extended periods, diversified portfolios have lagged behind concentrated investments in high-performing sectors.

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10. Krishna Mamani’s Personal Approach to Diversification

Krishna Mamani [34:56]:
"I have constructed my portfolio in a very diversified way. It has worked out fine, but it could have worked a lot better for that."

Discussion Highlights:

• Acknowledgment of Limitations: While maintaining a diversified portfolio personally, Krishna recognizes that this approach has limited his potential gains.
• Valuation Context: He emphasizes the importance of considering valuation metrics and current economic environments when constructing diversified portfolios.

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11. Conclusion: Re-evaluating Diversification Strategies

Krishna Mamani [36:05]:
"I think ... when the opportunity comes back, we are kind of thinking about it the right way rather than just sticking to the mantra that we have thought about for the last 30 years."

Discussion Highlights:

• Need for Adaptation: The traditional approach to diversification may require reevaluation and adaptation in light of recent market dynamics.
• Future Research: There's a pressing need for research into the drivers behind diversification's underperformance and the development of new investment methodologies.
• Balanced Perspective: While diversification has its merits, especially for risk management, investors should critically assess its efficacy and remain open to alternative strategies.

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Key Takeaways

• Historical Context Matters: Traditional diversification strategies, heavily reliant on international and small-cap stocks, have underperformed compared to concentrated investments in U.S. tech over the past two decades.

• Benchmark Influence: Index providers play a significant role in shaping investment allocations, sometimes leading to concentrated holdings that may not always align with optimal diversification principles.

• Market Flows and Currency Impact: U.S. market dominance is partly driven by global investment flows favoring the strength of the dollar and the profitability of U.S. tech firms.

• Short-Term vs. Long-Term Benefits: Diversification offers valuable risk mitigation during market downturns but may limit returns during prolonged bull markets in concentrated sectors.

• Evolving Strategies Needed: Investors and asset managers must reassess and potentially innovate beyond traditional diversification to navigate the changing financial landscape effectively.

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For more insights and discussions on finance, markets, and economics, visit Bloomberg Odd Lots.

Transcript

[Krishna Mamani]

This is an Iheart podcast.

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[Joe Weisenthal]

Hello, Odd Lots listeners. I'm Joe Weisenthal.

[Tracy Alloway]

And I'm Tracy Alloway.

[Joe Weisenthal]

Tracy, we're doing another live show and it's right here in New York City.

[Tracy Alloway]

Yeah, this one should be our biggest yet. And we're gonna have a bunch of Odd Lots favorites and do something maybe a little different to some of our previous live podcast recordings when the guests are revealed.

[Joe Weisenthal]

The show is gonna sell out right away, so you should really just go get your T. It's June 26th. It's at Reckitt NYC and you can find a ticket link at bloomberg.comoddlots or bloombergevents.com oddlotsliveny we hope to see you there.

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[Joe Weisenthal]

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

[Tracy Alloway]

And I'm Tracy Alloway.

[Joe Weisenthal]

Tracy, this has come up a few times on the podcast over the years, but, you know, you really feel, you could really feel dumb as an investor over the last, I don't know, 15, 20 years, if you literally bought anything else besides big tech stocks.

[Tracy Alloway]

Big US Tech stocks.

[Joe Weisenthal]

Yeah, big US Tech stocks.

[Tracy Alloway]

Yeah, that's exactly right. And the funny thing is, investors have been encouraged to diversify, right? Like this is the mantra of markets is that you shouldn't put all your eggs in one basket, et cetera, et cetera. And so you've heard for the past 10 or 15 years that you should diversify into international stocks. You should diversify into small caps.

[Joe Weisenthal]

40. Yeah.

[Tracy Alloway]

60. 40. And a lot of those things have turned out to be duds. Or at least 6040 was a dud for like a couple of years, kind of.

[Joe Weisenthal]

I mean, it mostly did well, but like, yeah, it then had some, it had some rough years, particularly out of the pandemic.

[Tracy Alloway]

But when, but certainly you would have been missing out on big gains if you put money into small caps OR International stocks versus the big U.S. tech stocks.

[Joe Weisenthal]

Right. And, you know, we've gotten a little bit, you know, when Deepsea came out that raised some questions about big tech stocks. Obviously with the policy volatility in the US which is one way to put it, there have been some questions about. Okay, is now the time to diversify abroad? Yeah. Okay. You could have bought money buying Rheinmetall or one of the beneficiaries of German defense spending. But so far, you know, it's still not obvious that, like, there's some other big money maker out there for investors besides big tech. But this is. But we, we may be at a juncture.

[Tracy Alloway]

Well, I think the other unappreciated aspect is the importance of the benchmarks in all of this. And I think investors tend to think of benchmark index providers as these very neutral entities that are like, holding out a mirror to the market and just reflecting what's already there. But actually a lot of their decisions are very active and have very, very big implications for investors. So, you know, if MSCI says that the All World Index is going to have small caps and big caps in it, then investors are, you know, they're forced to buy small cap exposure.

[Joe Weisenthal]

That's totally correct. And this is core finance theory that the optimal portfolio is more or less the global portfolio. We've talked about that with the dimensional guys. You really should have a weighted allocation somehow, if possible, to every bond stock and piece of real estate out there. And that's the best you can do. And that clearly has not been the best you can do for a long time. And so we want to talk about the tortured pain of the poor diversified.

[Tracy Alloway]

Allocator and the tyranny of the benchmark index providers.

[Joe Weisenthal]

Yeah, very shake. Very Shakespearean. Anyway, I'm really excited. I think we do in fact have the perfect guest. Someone who I've been a big fan of for a long time. Someone I've wanted to have on the show for a long time. He's probably one of my top five favorite posters on Twitter, although he's quieted down a little bit lately. But I think he's addicted like the rest of us. We're gonna be speaking with Krishna Mamani. He is currently the Chief Investment Officer of the Lafayette College Endowments. Previously he was the CIO at the Oppenheimer Funds, which was bought by Invesco. So a long storied career, someone who knows about all of this stuff. So, Krishna, thank you so much for coming on the podcast. Thrilled we can finally make it happen.

[Krishna Mamani]

Thank you. Thanks for having me.

[Joe Weisenthal]

Absolutely. What do they teach you in school about diversification? When you're training to be an investor, an asset allocator, what do they tell you?

[Krishna Mamani]

Diversification is the biggest free lunch available in the investment world. And I think from a longer term perspective that is absolutely true and probably something that we ought to think about. But as you mentioned, the results over the it's not just last 15, 20 years. The results over the last 30 years, 40 years have been very, very, very, very different than what you would have expected if you had gone down this path. Doesn't mean that the basic principle isn't invalidated. It just simply means that you have to think about it and acknowledge the fact that it hasn't worked out according to plan.

[Tracy Alloway]

Where did the diversification thesis actually come from?

[Krishna Mamani]

Well, the diversification thesis basically says that if you have security specific risks in individual securities, if you can find a way of diversifying that away, then that is something that you should do because it reduces your overall risk profile without sacrificing too much in return terms. So that's what, that's where the theory comes from.

[Joe Weisenthal]

And no, no, no, but like, who.

[Tracy Alloway]

Propagated it, it must have had like, you know, an endorser or it must have made its way into the market in one way or another.

[Krishna Mamani]

I think it came from CAPM and William Sharp and you know, that coterie of academicians who basically did the pioneering research in this field in the, let's say, 70s, 80s and early 90s.

[Joe Weisenthal]

Yeah, in my 401k, I have like a very conservative diversified fund. It has not kept up with The S&P 500, I don't think, but every once in a while, such as the first couple weeks of April 2025 or the first couple of weeks of March 2020, I take a look at it and I'm like, oh, I pat myself on the back for those moments of diversification. Is it worthwhile just for those reasons? Every once in a while you're like, okay, you know what? This makes me feel good. I'm not going to panic less. I actually that 401k it actually stays close to all time highs. I keep allocating it a little bit. How much is that worth in terms of that comfort that I get for like 5 minutes every 20 years relative to the cost of underperforming a simple S&P 500.

[Tracy Alloway]

Paying a price for peace of mind.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

Well, so again, my argument isn't that diversification is a bad thing. I think from economic principles, from financial principles, diversification is a good thing. And if you can find a way of mitigating your overall security specific risk, you ought to do that. The point I'm trying to, I would like to make is the fact that it hasn't worked.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

And, and therefore kind of relying on 30 years or 40 years or 100 years of history to come to some sort of investment principles that people follow very religiously hasn't worked. So shouldn't we kind of think about that and try to delve into what are the drivers and it opens up a new research field? Because I would argue that the overall research and financial kind of investing is basically hasn't evolved a lot since the 90s. It's basically redoing the same papers with little bit of changes here and there, but the core thinking, CAPM related core thinking really has not changed. So I think the right way to use this period of underperformance, whether it'll sustain itself or whether 2025 changes the paradigm altogether or not, is kind of irrelevant. The key point is let's kind of look at this period. Let's look at it in a little bit more detail rather than being extraordinarily doctrinaire about things, which is anytime you post on Twitter that well, my international funds haven't really worked for me, I get schooled by all sorts of people. But the fact is they haven't worked for me and I continue to do that. I have a very diversified portfolio and I will probably stick with it. But I think it is also fair to recognize that it hasn't worked and therefore we should look at it in little more detail and kind of not take the mantra of diversification as religion, which is what it is right now.

[Tracy Alloway]

So in your opinion, what are the drivers or the reasons why it hasn't worked? Because I imagine you could tell a story that the big tech stocks in the US have just been phenomenal companies that continue to throw off cash. You could maybe tell a story about the benchmark indices which we spoke about in the intro. You could tell a story about flows and investors crowding into stocks. Why hasn't diversification worked well.

[Krishna Mamani]

So again, let's just kind of narrow it down. When we are talking about this level of diversification, what we are talking about is US Stocks not working or US stocks doing better than international stocks. So that's what we are talking about. I think there are several drivers. I think the kind of the tech supremacy of The S&P 500 is certainly one of them. The profitability of the tech franchise is another one. Low interest rates in the US where growth was higher than interest rates, certainly was a factor in driving returns and kind of the existence of private equity which got multiples high. So there are a plethora of reasons as to why things haven't performed. And therefore it is worthwhile spending a little, you know, these are speculations on my part, but this is worthwhile spending a little bit of time figuring this out in a little bit more rigorous way than we have done so far. Because you know, right now, again, if anybody puts up a notion that diversification is bad, they'll get schooled. But I think given the length of time that it hasn't worked and given the length of or the magnitude of how it hasn't worked, I think it is worthwhile spending a little bit of research focus to analyze what the drivers were, as you say, and see if there are some other things that we can divine out of this 30 year episode.

[Tracy Alloway]

So I totally appreciate the need for additional research and I would agree with you on that. But is saying that diversification hasn't worked the same as saying that investors should only buy winners and avoid all the losers?

[Krishna Mamani]

Well, so I think there's an element of that for sure that is international markets have done poorly relative to US markets. One anecdote here. I used to be the spokesperson for Oppenheimer Funds with respect to globalize your thinking in 2011 when the campaign came out.

[Tracy Alloway]

Oh, so you are a messenger.

[Krishna Mamani]

I was the messenger of this thing and I kind of diversified my portfolio based on that thinking. The idea about portfolio construction with respect to diversification isn't that diversification is a bad thing. I think that's a right approach. I think given the history over the last 30, 40 years, we ought to think a bit more about are there other drivers? Rather than just simply believing in the historical track record and the volatility context of that historical track record.

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[Joe Weisenthal]

To the idea that a big part of the story is the unique profitability of large tech companies in the us. But that is clearly not the only story, because it's not just that global stocks have underperformed in many instances, they've just performed badly against anything. I'm looking at a chart of EWZ, a popular ETF to have exposure to Brazil. It's basically flat for 20 years. I assume the Brazilian economy has grown quite a bit in the last 20 years, but it has not redounded, apparently to the benefit of an American shareholder investing in Brazilian stocks at all. So obviously this can't be the entire story that it's just about US outperformance. It's actually that global stocks have done bad. What's going on? Why? Why in a world in which the economy is generally, you know, more or less growing elsewhere, have international equities actually just done bad on an objective basis?

[Krishna Mamani]

The old adage is the economy is not the equity market. Yeah, yeah. And that is, that is absolutely true. I think the period from, let's say 2010 onwards in the US is especially galling. And I think if I had to come up with a reason as to why that has kind of worked out, the way it has worked out is basically because of dollar related global flows.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

That is, I think the profitability basically attracted a whole lot of things that were going to come to or a whole lot of flows that were going to come to the US because of the perceived strength of the dollar during that period. Because, as I said before, growth was higher than interest rates in the US So it was a natural kind of place for those flows to kind of arrive at.

[Joe Weisenthal]

But like, again, another one, Mexico, it's just flat for 20 years. So in your story, it's not quite flat for. Yeah, it's where it was in 2007. So, like, flat for, like, 18 years. Like, there's a big. The flows are a big part of the story for the fact that these stocks can't deliver anything over a decade's time horizon.

[Krishna Mamani]

Well, so I think domestic flows relative to international flows are really very important in determining the state of the equity market.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

And the best example, counterpoint to what you're talking about that I can give you is really India.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

So India used to be a market that was supported entirely by foreign flows.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

And foreign flows. And when there was a panic in New York, all sorts of money would leave India and come here and the stock market would crater over the last, let's say, 10 years, as the Indian economy took off and financialization and the saving vehicles in India changed, and the equity market, as opposed to land and property, became the primary source of savings and deployment of those savings. I think the characteristics.

[Joe Weisenthal]

The capital depth.

[Krishna Mamani]

Yes, capital depth, financialization of the economy, and right now, the drivers in the Indian equity market, at least for the last five years, really has been the domestic investors as opposed to foreign investors. So I think that is really the. From a flow standpoint, that is the difference.

[Tracy Alloway]

Yeah. And if you look at the MSCI India index, it's like the exact opposite.

[Joe Weisenthal]

And actually, it looks like it's done well.

[Tracy Alloway]

Mexico and Brazil. Joe, you know what I always say.

[Joe Weisenthal]

I do, but I'll let you say it.

[Tracy Alloway]

Are you going to say it? No, I want you to say it.

[Joe Weisenthal]

Flows before pros.

[Tracy Alloway]

Yeah, he did it. All right. That makes me happy.

[Joe Weisenthal]

By the way, I stole Tracy's joke in the intro. She's not happy about that. I said that thing about how Shakespearean. Tracy said that right before we went on air. I want to give her credit.

[Tracy Alloway]

Oh, thank you, Joe. But now I feel petty. I didn't expect you to do that. Okay, going back to the conversation, I'm.

[Joe Weisenthal]

Trying to make you feel petty. You made me feel bad, so now I'm trying to make you feel petty.

[Tracy Alloway]

All right, all right. Fair. Going back to the conversation, can you Talk a little bit more about the role of the benchmark index providers in all of this.

[Krishna Mamani]

The thinking in this world is always benchmarks are terrible, but they are, they're terrible, but better than anything else that we have. So I think there is a role for benchmarks, and benchmark providers are important participants in the market. And, you know, the market capitalization of companies like MSCI and S and P Global kind of tell you as to how valuable that those franchises are. The way as an investor, if you are an asset manager or if you are kind of an asset allocator, how you are doing has to be evaluated in some sort of a rigorous framework. And that's where benchmarks come in. And that's why we need benchmarks, because otherwise it'll be free for all. As an asset allocator, if my returns were 10%, let's say I can always claim that I did a fabulous job and my benchmark outperformed by, you know, 1,000 basis points. So it's a, you know, there is tyranny of benchmark, but this is a necessary tool that we need. I think a separate question is the, the extent of the kind of, the diversification of the, of the benchmarks. So you talked about MSCI, ACWI and even things like Russell 3000 or things like that. So there are issues with diversification. I think S&P 500, on the other hand, for the large cap US market is a very, very solid benchmark. I mean, there are peculiarities with respect to additions and taking out of the index, but I think that is to be expected in a dynamic market. And I think for the most part it has worked out reasonably well.

[Joe Weisenthal]

You are an employed person. You have had a career. Despite imbibing the gospel of diversification, you have had a successful career in the markets. Talk to us, though, about like your peers and career risk, et cetera, because, you know, at some point, like you keep making less money than you could have by buying us. What does that do? And what have you seen? You know, when you look across the industry, do you see an evolution whereby people who were taught the same thing as you about diversification have increasingly felt pressured to not be diversification or to disguise their diversification in some way that they could tell their investment committee, we're diversified, but actually we just found a way to go extra long?

[Krishna Mamani]

Nvidia I think in the institutional world, as opposed to retail world, I think diversification is still the matter. And again to emphasize it is the right thing to do.

[Joe Weisenthal]

But why do you keep saying that?

[Krishna Mamani]

If you think about it in statistical terms, yeah, you know, there is a way to diversify the tail risk. But what I'm saying is we need to evaluate that and see or reevaluate that and see if there are some other techniques and methodologies that we can use where this doesn't become the only way for you to mitigate your overall risk in the portfolio.

[Tracy Alloway]

So what would be another technique or.

[Krishna Mamani]

Methodology evaluating from a track record standpoint, let's say, or from a performance standpoint, let's say does adding emerging markets to a globally diversified portfolio, does that really add a lot of value to the process? Does just let's say developed market index, both US and Europe and perhaps Japan, can that deliver some level of correlation to the overall index without you being stuck in places like China for a long period of time or Brazil or Mexico for, for, for that matter? So I haven't found the solution. If I had found the solution, I would have implemented that in my personal portfolio. My point is we ought to think about that and we don't really think about it because diversification on a global basis has been the mantra and the accepted doctrine forever.

[Joe Weisenthal]

But say more about the career risk, okay, at the institutional level they're fine. It's like oh yeah, diversification. But you know, for example, I'm always a big fan of reading the bank of America fund manager survey every month. And these are discretionary fund managers that could do everything and for like 10 years with a few exceptions in there they say long tech stocks is the most crowded trade, but also it's the trade that continues to work. Talk about this effect, this sort of the anti diversification success on the sort of thinking of a fund manager who probably doesn't love being in a crowded trade but also doesn't want to underperform well.

[Krishna Mamani]

So I think an active manager is kind of caught in a way, right? On the one hand you have to outperform your peers. On the other you have to outperform the benchmark. And that is a challenge. And that challenge leads to the sort of things that you are talking about. That is, well, they may do very well relative to the benchmark without crowding into the most crowded trades. But if their competitors are crowded in there and do much better than them, that's an issue for them. So that's their way of solving that particular challenge. I think the crowded trades have been there for a long period of time, but I think the way I would evaluate that is how much of a portfolio manager's performance is really Driven by, you know, the core views that they express as to what their edge is. Right.

[Joe Weisenthal]

I don't understand.

[Krishna Mamani]

So what that, you know, every portfolio manager will tell you that their strategy is we look at ROIC and that's what we focus on. And therefore that's how we kind of structure our portfolio to pick companies individually.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

Now if they say that thing and they are kind of focused on and that's how I hired them.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

And instead they focus on getting into, let's say crowded trades because they are going up, then that's really a red flag from an allocated perspective.

[Joe Weisenthal]

Got it.

[Tracy Alloway]

So Joe alluded to this in the intro, but you know, if you were diversified into international stocks, there was. Well, there were a couple moments this year where you actually looked really smart and you did get a little bit of peace of mind as The S&P 500 was selling off. You know, European equities were surging earlier in the year. But what do you need to see for a durable change in international versus US stocks and specifically US tech stocks?

[Krishna Mamani]

Well, so I think the underlying economic environment has to change for that dynamic. Actually, underlying economic and industrial environment has to change dramatically for that to kind of play out. So if you look at the world from a capitalization standpoint, what we are talking about is us on one side and Europe, Japan, India, China, Brazil, those are really the places that we are talking about. So structurally, US economy has done better. The dollar is the reserve currency and the growth outlook over the last 10 years have been much better in the US than it has been. So flows coming into the US ought not to be a surprise in that environment. And for flows to go the other way, basically the fiscal expansion in Europe has to get going in a massive way. And that fiscal expansion has to lead to companies and institutions that can take advantage of that fiscal expansion and therefore deliver superior returns to their shareholders. And therefore, I'd be interested in buying those companies.

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[Joe Weisenthal]

Tracy, do you know how much without looking the dax Germany's benchmark index, do you know how much it's up in dollar terms this year?

[Tracy Alloway]

I do not. Although I will confess I have a chart of the MSCI All World versus the S&P 500. Almost.

[Joe Weisenthal]

Yeah, but just take a guess. Take a guess.

[Tracy Alloway]

I have no idea. Tell me.

[Joe Weisenthal]

32%.

[Tracy Alloway]

Wow.

[Joe Weisenthal]

The German stocks in dollar terms are up 32% this year. France up 17.5% in dollar terms, the Euro stocks 50, up 22%. I mean, this is serious. And this is like, these are numbers that we're really not used to seeing in me and Tracy's entire career, this kind of divergence. Because as of the time we're talking about, the US Benchmarks are actually flat on the air, which is pretty impressive actually, given where they were a month ago. Like, at what point you're like, this is a sea change. What would it take? Not from a economic standpoint, but like, you know, what does it take for the other fund managers around the world to like, oh, I believe in. I mean, I don't start with is this the sea change here or not in your view?

[Krishna Mamani]

Well, so, you know, again, these are spectacular returns and definitely spectacular relative returns.

[Joe Weisenthal]

Yeah, it looks like there's some spectacular objective returns. It's only May.

[Krishna Mamani]

Yes.

[Joe Weisenthal]

But anyway, keep going.

[Krishna Mamani]

And you know, a lot of these returns are dollar driven as well.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

So a significant portion is really the this thing and a lot of it is because of the upcoming fiscal expansion in Germany.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

Okay. So for this to be sustainable in the long run, I think the economic picture for the continent has to change.

[Joe Weisenthal]

Meaning, you know, by the way, just the Bovespa, the Brazilian stock market is up 25% in dollar terms Chilean stocks, which I've never looked at, but it's right here when I go to the Wei page on the terminal. That's up 32%. It's not even. I actually hadn't quite realized this. It's not even just a Europe story. Latam too is actually, in dollar terms, having a phenomenal year.

[Krishna Mamani]

The confluence of dollar weakness, tariffs, those are really the things that have kind of had an impact on dollarized returns. If they remain sustainable, then it will be worthwhile looking into those markets and the thesis would be proven. But we have also had episodes where we have had these types of moves, false dogs. And pretty soon, in six months, a couple years, you give back all of these spectacular relative returns.

[Tracy Alloway]

But if the argument is diversification is good for protecting you from tail risks, then what's been happening this year, and specifically in April, seems like a pretty big tail risk. And diversification worked in this case?

[Krishna Mamani]

Absolutely, diversification worked. The question is, is the diversification or the relative performance of European markets and the rest of the world, is it all concentrated in a very short period of time? What do I mean by that? I think if the expectation is that the US because of tariffs and all sorts of policy responses, the things that drove the dollar and the flows into the US go away on a sustained basis, the trend will probably persist. I would posit that that probably isn't, or at least that probably isn't a very realistic scenario at this point.

[Tracy Alloway]

What timeframe should you be judging diversification success on?

[Krishna Mamani]

Actually, that's a really good question. So success of diversification from my mind, has to be evaluated over a reasonably long period of time. So five, 10 years, even 20, 30 years. I think those are the time frames that you have to evaluate it on so that everything that has, you know, everything economically has had an opportunity to play itself out. And all we are talking about is the security specific volatility for individual securities that benefits from this diversification. So I think it has to be evaluated over a long period of time. And that's why, when it hasn't really performed for as long period as it has not, despite their recent performance. The point I would make is let's kind of think about that a little bit and look at why that has been the case.

[Joe Weisenthal]

Wait, I want to make a counter argument. Why shouldn't we evaluate a tail risk hedge, which implicitly is what diversification seems to offer in just very short term. Because like in March 2020, there was a possibility, you know, the economy could have unraveled further. I could have lost my job. I would have been on the hook for paying for my own health insurance and so forth. I was very excited in that moment that rates went to zero and the bond portion of my 401k or whatever shot up. Right. That actually helped me. In an acute moment, there's obvious, you know, we haven't hit a recession yet in the US in those acute moments where there's suddenly a risk and you're sort of your career is correlated to your portfolio, can't it be enough for diversification just to pay off in the short term?

[Krishna Mamani]

Okay, so let's kind of make sure that we are talking about the same diversification.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

So you know, diversification between equities and bonds.

[Joe Weisenthal]

Yeah, yeah.

[Krishna Mamani]

I think that from a risk management perspective, because of different volatility characteristics of the two instruments, I.e. still very much valid.

[Joe Weisenthal]

Okay.

[Krishna Mamani]

You know, one has, you know, double digit volatility, the other has 5, 6% and they react in, you know, in different economic environments, you know, very, very differently.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

Okay, so that is, that is valid. I think what we are talking about is really international diversification.

[Joe Weisenthal]

Yeah. All right, fair enough.

[Krishna Mamani]

And if you look at the correlations of international equities relative to U.S. domestic equities, correlation is very, very high. So it's giving you some diversification benefit, but it is not giving you the level of diversification benefit that you think you are getting.

[Tracy Alloway]

Have you done anything in your own portfolios to take into account some of these thoughts over diversification?

[Krishna Mamani]

I have been a victim of this diversification because I constructed my portfolio and have posted this on on Twitter for everyone to see, which is I have bought international small cap and I bought US Small cap and I bought developing markets. So I have constructed a portfolio in a very diversified way. It has worked out fine, but it could have worked out lot better for that. Am I doing something relative to that? I think the thinking with respect to that has to be about some valuation context in the environment. So if you are going after sticking with it for 30 years, if you were going to flip that switch, doing it when US markets are the most expensive probably isn't the right thing to do. But that doesn't take away us thinking about what the drivers of that when that is not the case.

[Tracy Alloway]

I see. Yeah.

[Krishna Mamani]

So that when the opportunity comes back, we are kind of thinking about it the right way rather than just sticking to the mantra that we have thought about for the last 30 years.

[Joe Weisenthal]

If you flip and suddenly you're like, you know what everything I was taught, I was wrong and I'm going to lean more heavily into the U.S. will you let everyone know so that then we can then diversify exposure? Will you put out that alert? I finally caved. I finally caved. I finally don't believe anything I learned in school because maybe the rest of us can use that as an opportunity to go heavy into eem.

[Krishna Mamani]

Sounds like a good idea. I'll be, I'll be again, as I said, school in, in, in. On whichever platform. I kind of put that out. This, you know, as an investor who has kind of stuck with this for almost 40 years. Yeah, it has been a challenge. And what I am doing is acknowledging that challenge. That is the lack of correlation that we were expecting from international equities hasn't worked out. That's it.

[Joe Weisenthal]

But just on this point, and you've been in a few different seats, how do you, you know, what do you have to do career wise to maintain that discipline? Because this is a big thing, right? Career risk in any seat. And there are different, you know, some people are on a very short leash at a big institution that has longevity of over a century. Maybe you have a long leash, et cetera. What is, you know, how does career risk and career longevity play into this type of thinking?

[Krishna Mamani]

Well, so, you know, again, you have to distinguish between the type of investor you are.

[Joe Weisenthal]

Yeah.

[Krishna Mamani]

So if you are an asset class investor and your mandate is international investing, international may not have done well relative to domestic investing, but somebody allocated money to you and they're looking for you to do better than international benchmarks and your peers in doing the same thing. So there the career risk is really not direct. The career risk is in terms of flows. That is if you had a global mandate or international mandate, you know, so.

[Joe Weisenthal]

It'S not like you're getting fired for underperforming. It's just that no one allocates to you.

[Krishna Mamani]

No one allocates to you.

[Joe Weisenthal]

Got it.

[Krishna Mamani]

If you are an allocator, then, you know, it's kind of the performance is relative to your benchmark and your benchmark, that's how you are evaluated. And your benchmark is for most institutional portfolios, it's still very much msci acqui for the equity component.

[Joe Weisenthal]

Krishna Mamani. That seems like a really key point that as long as that's the benchmark, some institutional allocation will survive. Really appreciate you coming on odd lots. We're all going to be looking out for that tweet when you decide to go into Mag 7.

[Krishna Mamani]

Okay, sounds good.

[Joe Weisenthal]

You know what, I really appreciate Krishna is probably the only person on social media.

[Tracy Alloway]

I knew you were going to say.

[Joe Weisenthal]

This, who admit that they didn't time the market perfectly and weren't all in on tech stocks over the last 10 years. Everybody else timed them. Oh, I went to cash, you know, blah, blah, oh, you know, whatever. I'm glad someone admits the truth, which is that most people have just been, at least in recent years, overly diversified.

[Tracy Alloway]

Well, it's also interesting to me to see a big institutional investor tweet at all.

[Joe Weisenthal]

Yeah, well, that's true.

[Tracy Alloway]

All right, so that was really interesting. One thing I am coming to really appreciate is that peace of mind point and the idea that there is a price to pay for peace of mind. It's not necessarily free, but every once in a while, maybe it does actually help you in acute moments of stress.

[Joe Weisenthal]

Well, totally. And look, if the markets are going down, if you're, let's say you're employed in America and you have a lot of. This is something I think about a lot. If you're employed at an American company and you have a heavily exposed American index when markets are tanking, that is often associated with recession.

[Tracy Alloway]

Right.

[Joe Weisenthal]

And that is associated with an increased probability of losing your job. And an increased probability of losing your job is associated with having to sell your investments, maybe even take a tax hit at a time when you can least afford to pay it. Sell your investments to literally continue your life. Which is sort of like the worst correlation you could, you know, the worst confluence events. So the idea that like, okay, like if you lose your job and you have to dig into your savings, at least you're not selling at a local bottom in the market. That seems like one benefit to diversified allocation.

[Tracy Alloway]

Yeah. So you're not so invested in basically America Squared. Right.

[Joe Weisenthal]

And you won't panic. I mean, this is the other thing, right? Like people were all, we're animals and you see the line go down and you sell and so forth. Perhaps if the line is a little bit more stable than, you know, your overall top line, then you don't, you know, then you don't make rash emotional decisions as quickly, which I think there's a lot of benefit to not doing.

[Tracy Alloway]

Do you think there's a difference between how much diversification helps the retail investor versus big institutional investors?

[Joe Weisenthal]

That's a really good question. I mean, the nice thing about the big institutions, right, is they have longevity themselves. And yeah, it's a good question, but I don't think any American retail investors diversify anymore. I think that, you know, most. It seems like retail investors in America. Like, you know, it's not enough to go long MAG7. You have to sell puts on MAG7, right?

[Tracy Alloway]

That's right.

[Joe Weisenthal]

Like, like hyper. Hyper. Whatever the opposite of diversification is.

[Tracy Alloway]

Hyper concentration.

[Joe Weisenthal]

Hyper concentration. Yeah.

[Tracy Alloway]

All right. Shall we leave it there?

[Joe Weisenthal]

Let's leave it there.

[Tracy Alloway]

This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

[Joe Weisenthal]

And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our guest Krishna Mamani. He's at Krishnamani. Follow our producers Carmen Rodriguez at CarmenArman, Dash O' Bennett at DashBot and Kalebrooks at Kalebrooks. For more Odd lots content, go to bloomberg.com oddlots where we have a daily newsletter and all of our episodes and you can chat about all of these topics, including investing, diversification, market, so forth in our Discord, Discord, GG Oddlots.

[Tracy Alloway]

And if you enjoy Odd Lots, if you like it when we talk about the downsides of diversification, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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[Krishna Mamani]

This is an iHeart podcast.