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The Long View
Mark Higgins: Financial History Is More Relevant Than People Think
00:51:30
The author and investment advisor on the danger of chronic deficits, the importance of central bank independence, warning signs in private credit, and why he’s still optimistic about America’s future.
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- [00:00]
Schwab/Ameritrade Announcer
Trading at Schwab is now powered by Ameritrade Unlocking the power of thinkorswim the award winning trading platforms loaded with features that let you dive deeper into the market. Visualize your trades in a new light on thinkorswim desktop with robust charting and analysis tools all while you uncover new opportunities with up to the minute market news and insights. ThinkOrSwim is available on desktop, web and mobile to meet you where you are. It's built by the trading obsessed to help you trade brilliantly. Learn more@schwab.com trading please stay tuned for.
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Disclosure Announcer
Important disclosure information at the conclusion of this episode.
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Amy Arnott
Hi and welcome to the Longview. I'm Amy Arnott, Portfolio Strategist for Morningstar.
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Christine Benz
And I'm Christine Benz, Director of Personal Finance and Retirement Planning for Morningstar.
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Amy Arnott
Our guest on the podcast today is Mark Higgins. Mark serves as Senior Vice President for IFA Institutional, where he specializes in providing advisory services to institutional plans such as endowments, foundations, pension plans, defined contribution plans, and various corporate plans. He's the author of Investing in US Financial Understanding the Past to Forecast the Future. Mark graduated from Georgetown University, Phi Beta Kappa and Magna Cum laude with a bachelor's degree in English and Psychology. He received an MBA from the Darden School of Business at the University of Virginia. He is a CFA Charter holder and CFP Professional. Mark, welcome to the Longview.
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Mark Higgins
Thank you for having me. Amy and Christine, excited to talk to you.
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Amy Arnott
Well, it's great to have you here. We wanted to focus most of the discussion on your book, Investing in US Financial History, but before that we wanted to talk a little bit about your background. And your main job is as an institutional investment advisor for index fund advisors, but you also serve as an editorial board member and guest curator for the Museum of American Finance. How did you first get involved with that organization?
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Mark Higgins
So I wrote a paper on Hetty Green, who we may get to this later, but as far as I'm concerned, she's the best investor in US Financial history from the Gilded Age. And I wrote a paper in April 2022. It was one of the first papers I wrote using the financial history research I was doing, and I posted it on a site called ssrn. And Kristin Aguilera, who is the editor of Financial History magazine, saw it and asked if we could convert it into an article for the magazine. We did, and I ended up writing several more articles over the years. They asked me to join the editorial board, I believe last year, maybe two years ago. I'm losing track a little. And then it's actually really exciting. They're creating a physical location in Boston. It's part of the Fidelity building in Boston, and it's going to be amazing. It opens next year in July. And they're using, I licensed the content for the book for one of the exhibits for $10 for, you know, the Hamilton kind of symbolism. And as part of that, I'm one of the guest curators with Dick Silla, who's a very well known economic historian. So they've been extremely supportive. I'm thrilled to help in any way I can with the magazine and with the museum that's opening. But it's been a great story.
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Christine Benz
So you mentioned Hetty Green, and we often hear her referred to as the Witch of Wall Street. But you argue, and you just said that she was actually one of the best investors in U.S. history. Since you mentioned her, can you quickly talk about why you think her story isn't widely known? And also what made her so successful as an investor?
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Mark Higgins
I mean, this would be a whole episode, but she was. If you could take every quality that she was maligned for to justify the term Witch of Wall street, it wasn't a vice, it was a virtue. They characterized her as a miser. She was very thrifty. She was a Quaker. And she learned that in the whaling industry, which is a lot like venture capital, where you have to wait a long time for your wealth to come back, if it comes back at all. She was also very charitable and a shout out to Bethany Bengson, who wrote an article in follow up to the initial article on Hetty Green that I wrote. She was also very charitable. She just did it very quietly. So those are just two things. Literally, I could go for an entire episode talking about what an exceptional investor and an exceptional person she was, but it's just completely misunderstood. She didn't fit the Times. But it wasn't because she was bad. It's because she was actually good.
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Amy Arnott
So it looks like you wrote that paper. Was it in 2022 when that first came out?
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Mark Higgins
The first one came out in 2022. And then Bethany and I did a follow up in, I believe it was late last year or early this year. I forget exactly when it came out. But she found the will of Sylvia Wilkes, who was the last heir of Hetty Green, and her entire fortune was distributed to 63 charities. And she found the will in a New York probate court. And we found the 63 organizations and published an article on that. It was really fun.
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Amy Arnott
It's fascinating. So it was Actually a couple years before that, right at the beginning of the pandemic, that you became convinced that you needed to start learning more about financial history. What was it about that moment in time that prompted you to start looking back at the earlier history of finance in the United States?
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Mark Higgins
Yeah, so I was an investment consultant working with institutions at the time. And like everybody, in March 2020, when the pandemic hit, I was caught flat footed. I felt like, you know, nothing like this had ever happened even remotely similar. Essentially the entire world economy just almost shutting down unexpectedly. But, you know, I had plenty of time on my hands. You couldn't go out and do anything. So I started reading financial history books. And the more I read, the more realized that it actually wasn't unprecedented, that the March 2020 panic almost looked identical to the July 1914 panic. World War I, most people don't know. It really came out of nowhere and similar effects. The entire world just kind of shut down and went to a total war bearing. I also, this was later on, but was reading about the inflation that followed the great influenza. The second wave, which is the deadliest, ended in the end of 1918, simultaneously with World War I, which ended on November 11, 1918. And the inflation that followed it was not transitory. It required aggressive monetary action. It looked a lot like post Covid. So the more I was reading, the more I realized that we're so focused on what's around us, not just daily, but maybe people look back 10 years at most and they miss really, really important patterns, that if you paid attention to them, you could invest better and you could create much better monetary and fiscal policies.
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Amy Arnott
Yeah, I'm embarrassed to say that before I read this book, my investment knowledge kind of started in 1926, which is with the SBBi indexes. So it was really helpful to go back much, much earlier than that.
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Mark Higgins
And it's more relevant than people think. People think. And I did too, by the way. I mean, before I started doing this research, it was the most educational thing I ever did. They think that human behavior evolves and it doesn't. The conditions evolve, but the human behaviors are the same. So it makes it easy to dismiss things that happened 100, 200 years ago, 300, 400 years ago, when they're actually really relevant to today. And it's a big blind spot.
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Christine Benz
As part of your research for the book, you toured the west coast by train with your family. What were some of the highlights of that trip?
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Mark Higgins
You know, you're the first. You read the intro to the book. I Think I mentioned this in, like, a sentence and in the acknowledgments. You're the first person to ask this, and I'm glad you did because it was one of the highlights. And, you know, so I went on this trip with my son Jack, who is at Penn State Altoona in the railroad engineering program. And, you know, he. From a very early age, from age like 2, he was really passionate about trains. And his entire life, he's just been building that passion, and now he's building it into a care. And it was really cool when the stories of the development of the railroads, which was a huge theme in the late 1800s, kind of overlapped with his passion. And we decided to do a trip to see some of the famous sites like the Transcontary Summit, where the transcontinental railroads met. And it was just. It was a great highlight. Now, the most memorable thing about it was when my son convinced my father, and my father and my mother went on the trip with us, convinced us to eat this ridiculously spicy beef jerky while we were driving through Utah. That was the most memorable. But really, I talked to Jack about this last night and asked him what was most memorable. And it was just, you know, he said, just being with you and being with my grandparents, I'll never forget it. And it was a really cool moment where our passions, which we're both very passionate about, overlapped, and we were able to bond on that. I'll never forget that.
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Amy Arnott
That's amazing. So we wanted to get into the book, and I think each chapter of the book starts with a quote from some figure in financial history. And I noticed the first and last chapters of the book both start with quotes from Alexander Hamilton. And I'm wondering if you could talk about what made him such a pivotal figure in the financial history of the United States.
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Mark Higgins
I always tell people there are really two people that stand out. Hetty Green stands out as, in my opinion, the best investor. And then the most versatile and brilliant financial mind would be Alexander Hamilton. And it is uncanny how much he foresaw in terms of the development and the challenges of this nation more than well over 200 years ago. And the most lasting thing is repairing the US debt. We were basically bankrupt in 1790, and he basically repaired it by consolidating all the state and federal debts, modestly raising tariffs to ensure there's revenue, there's no income tax back then, and really solidifying the credit of the United States, which we would need over the next 230 years. The other thing is he established the first central bank. And I remember reading most people don't know this, but the Federal Reserve is the third central bank. The first one was established by Alexander Hamilton. It was chartered in 1791. Only a 20 year charter disappeared for about five years. Then the second bank came and disappeared in the mid-1830s. So he was brilliant in that regard too. We may talk about this later. Some of the challenges for the US right now. But one of the things that really struck me about Alexander Hamilton is when he repaired the debt, he established two principles. One was the debt should be used primarily in times of emergency, public dangers, mainly foreign war. And then once the danger subsides, we should pay it back with budget surpluses. We actually did this. The War of 1812 hit, we ran up debt, paid it back. The Civil War hit, ran up debt, paid it back. World War I, same thing. And then World War II hit and we stopped doing it. And there are reasons for that. We were very wealthy. We thought that would continue. We were generating more wealth because the whole world was destroyed and we had the reserve currency. So this is becoming a very relevant issue today. And it's another example. Most people don't realize that chronic deficits are not normal in this country. They're normal over the last 70 years, but they're not normal in the broader history.
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Christine Benz
We'd like to follow up on some of those points, Mark, but wanted to stick with central banks for the moment. The first central bank in the US closed in 1811 when the US House of Representatives narrowly voted to reject the proposal to renew its charter. Why was the idea of a central bank controversial back then?
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Mark Higgins
You know, it's been controversial for a long time in U.S. history. And there are a lot of reasons. I would say the most powerful one is particularly around 1811, there was just a lot of fear of centralized power under the federal government. The colonies had rebelled against Great Britain and there was just a lot of fear of consolidation. It also the banks banking tended to benefit the northern states, the merchant class, the financiers more than the farmers. They're the ones taking out the loans. So it was really fear of centralized power and just kind of aversion mainly with more agricultural states to banks.
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Amy Arnott
Another great example of current events that have really interesting historical parallels is the whole topic of central central bank independence. And Alexander Hamilton was a strong believer that a central bank had to operate independently without political interference. And we did see under the Johnson and Nixon presidencies, there was a lot of political pressure applied to the Federal Reserve. Which was one of the reasons inflation spiraled out of control in that era. That's a reason. And I'm curious, you know, now we're again seeing the President trying to threaten the Fed's independence. How worried should investors be about that?
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Mark Higgins
So I am worried about it. It's not the first time it's happened. The worst was actually Andrew Jackson. He actually got rid of the central bank, the second bank in the United States, but it was pretty bad in the 60s and 70s. And you're right, that was a big cause of the great inflation was that they couldn't keep. The Fed had so much political pressure on them and they succumbed to it. And they failed on really three occasions to tighten rates sufficiently to tame inflation. So it's not a good thing. I'm absolutely against what's going on, but what is missing from the conversation is, and I'm actually pretty surprised about this, there were really two mistakes that the Fed made after post Covid inflation started picking up in 2021. The first was, I don't know if they ignored or discounted the lessons from the inflation after the last pandemic. The great influenza and World War I ended simultaneously. It was not transitory. It lasted about two years. It required aggressive action. The Fed was late, so they kind of missed that. And the less excusable one was when they pivoted last year, over a year ago. Now, if there's one lesson from the great inflation, and it's very clear, it's very well documented, is that when inflation emerges and persists, you need to tame it, you need to extinguish it decisively. That's why recessions usually follow events like this, because you need to overcorrect. And that's rarely talked about. And the price of not doing that is it allows inflation. First of all, their miss of The World War I great influenza precedent allowed inflation to really ramp up and persist. And then their premature pivot allowed it to last. And that actually leads to a lot of civil discontent, first of all, which is going to make political pressure seem more rewarding. And now you have that situation. So this is going to sound harsh, but I really believe it. I think the Fed made two material errors. The first one, maybe it's excusable. You had a precedent that happened 100 years earlier. The second one, it's hard to excuse it. The great inflation is well documented in books. It's well documented in Fed speeches like the Anguish of Central Banking, which burns delivered in September 1979. It's well documented in an article, the Origins of Inflation by Alan Meltzer. It's just they really missed it, and that's rarely talked about. And I think we're going to pay a price for it.
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Christine Benz
We already are sticking with historical precedent for the current environment. I wanted to ask you about Charles Merrill, who you talk about in the book. He founded Merrill lynch in 1914, and he thought stocks were overvalued in 1928 and early 1929, but was ridiculed and criticized when stocks continued to post gains to the extent that he had to meet a psychiatrist to reassure himself that he wasn't losing his mind. So why is it so hard to go against the crowd as an investor, even if you're convinced that you're right?
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Mark Higgins
It is hard. And the irony is it is really hard to outperform markets. Can some people do it? Yes, but it's very, very hard. But if you're going to do it, the only way you can do it is to be different from the crowd. Because if you're going with the crowd, really the only way it makes sense is to index and reduce your costs because you're not going to beat them. And I don't know, I think people, you get ridiculed if you're wrong. I mean, Charles Merrill experienced that. People made fun of him in the newspapers. His colleagues made fun of him. And you risk being ridiculed and ostracized. Now, I think the risk is less than people think. I don't think there's any shame in making a prediction based on sound logic being wrong, learning from it, admitting it, and moving on. I mean, I've been wrong. You just kind of admit it, figure out what you did wrong and move on. So I think people underestimate the costs involved psychologically. Now, if you're making a bad bet investment wise and you make a huge bet, there's financial costs to it, but psychological costs. I think as long as you have sound logic and you learn from your mistakes, I don't see the downside to being different as much as most people think.
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Amy Arnott
You mentioned how difficult it is for active managers to beat the market. And I thought one interesting thing that you mentioned in the book is that even if you go way back to the 1920s and 30s, there was a lot of evidence that active management consistently failed to beat a relevant market index. And this is something that Ben Graham also wrote about back in 1963. So why do you think it took so long for passive management to gain broad acceptance?
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Mark Higgins
I think it's the as it usually is it's the incentives. So first of all, people did know that it was very difficult to beat the market, intuitively. So the way you beat the market in the Gilded age in early 1920s was to manipulate it. And there are these things called stock pools where you would get pool capital, there'd be a pool manager, and then they would buy off newspapers, buy off journalists, spread rumors, do wash sales, do all kinds of nonsense to manipulate the market and basically fleece the public. And in 1934, during the pecker hearings a couple of years earlier, people got sufficiently disgusted with that that they passed the securities act of 1933, which required disclosure, and then the securities Exchange act of 1934, which outlawed market manipulation and insider trading. And once that happened, the only game in town was to beat the market through securities analysis. And that was really the birth of the security analyst profession. So I think it almost arose out of default. People kind of intuitively knew that it was hard to beat the market. There was an SEC study in 1940 that shows the same things that Morningstar's studies show that most funds underperform. But that was really the last thing that Wall street had. And that's what they invested in. And it's not. You mentioned Ben Graham. It's not a coincidence that securities analysis was such a hit in 1934. That was the last game in town. Ben Graham was a rarity, and he wasn't manipulating the market. He was analyzing securities, and that's why it took off.
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Christine Benz
Then you write that the Federal Reserve's failure to contain growth in the money supply was the root cause of the great inflation in the 60s and 70s. Should people be concerned about all of the money printing that has happened more recently?
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Mark Higgins
I mean, yeah, absolutely. And Ray Dalio recently came out, I think yesterday and said this is like the early 1970s. I agree with him. I think that's the best comparable for what we're going through right now. It was a lot of spending on social programs associated with the great. You know, started with a great society in the 1960s. You had the Vietnam War. But more importantly, and this is really what drives inflation, you had a Federal Reserve that was too accommodative. And it's actually been surprising to me. I wrote probably three years ago a paper saying that this was unlikely to be a great inflation level event because the lessons were too recent. The Fed knows what happened in 1965-19. They know that Volcker had to turn the screws like never before in order to prevent it. They're not going to repeat that error and I'm beginning to think I was wrong. I think they have repeated the error and it's very concerning.
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Amy Arnott
Another topic you wrote about was the danger of policymakers being less sensitive to the federal debt and the consequences of running unsustainable budget deficits. And you also think that the next major financial crisis might happen after foreign countries start abandoning the US dollar as a reserve currency. Is that something that investors should be worried about now that we have started to see a lot of countries de dollarizing their reserve assets?
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Mark Higgins
Yeah, I mean, this is by far the biggest concern that I have because it is a true anomaly. Ever since Hamilton repaired the debt in 1790, we have not had debt at this levels at all. We're now above World War II peak levels, which, you know, we had a global two front war to fight and we're not in a crisis. So this is very, very anomalous. And the real anomaly is not necessarily the response to the global financial crisis and Covid, although I do think Covid went too far. It's running all those deficits in the peaceful years where we should have been running surpluses. And I would probably reverse what you said in terms of this causing a financial crisis where past dominant reserve currencies have lost their status is because there was a crisis that bankrupted them. So the Dutch lost to the British in the Fourth Anglo Dutch War in the 1700s and that's when Great Britain took over. The pound sterling became the dominant reserve currency. World War I and definitely World War II bankrupted Great Britain and that's when the dollar replaced it. So it's more. It goes all the way back to Hamilton. So Hamilton knew that it was critical to have abundant borrowing capacity and sterling credit to deal with emergencies, not just to fund continuous deficits for the government. And what worries me is we are eroding our debt capacity. There will be some unforeseen crisis. What is it? I don't know. Maybe there's some type of war that we didn't anticipate. Maybe there's some type of cataclysmic natural disaster. It's impossible to predict what it is and when it'll occur. But if it does occur and we have insufficient debt capacity, well, we're just going to have to deal with the consequences. And that's what worries me the most.
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Christine Benz
The book details shadow banking and how it contributed to the global financial crisis. Could you discuss first what are shadow banks and what are some of the major problems with them?
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Mark Higgins
Yeah, I mean shadow banks are Basically bank like entities that are operating outside of the purview and support ultimately of the Federal Reserve System. And it was a problem in 2008 and 2009. I mean, it's a bit complex and you can read about in the book, but there was big bank like entities mainly with the investment banks and what they were doing with securitizing mortgages. And the problem with a situation where you have a large banking system operating in the shadows is when you're borrowing short and buying long term assets. If everyone wants their money back at the same time, you can't give it to them. And one of the key functions of the Federal Reserve is being a lender of last resort. So what they can do is when you have a situation like that, you can, you know, buy assets or lend to them to provide the funds that they need to apply to depositors who are demanding it. And just the knowledge that they can do that is often sufficient to prevent a run. And when you have a shadow banking system that doesn't have access to that, when there's a run, which there was in 2008 and 2009, the Fed is impaired in what they can do to help. And that's essentially what happened.
- [26:06]
Schwab/Ameritrade Announcer
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- [26:39]
Amy Arnott
Spend a bit of time talking about the current market environment. You've written about the dangers of of unrealistic return expectations. And that's something that really hurt institutional investors going back to the 2010s because they overloaded on asset classes like hedge funds and private equity. Do you see any similar issues brewing with those asset classes today?
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Mark Higgins
I think it's worse. So this goes all the way back. You have to go all the way back to the early 1980s when alternative investments like venture capital, which was desperately needed back then to fund the computing age and buyout funds, they had a lot of tailwinds at their back back then because of declining inflation and interest rates and rising equity valuations. So they got monster returns. That's When Yale. David Swenson came to Yale in 1985, he got in on that early and he generated amazing returns for the Yale University endowment. And then he published a book in 2000 called Pioneering Portfolio Management. And he didn't say this, but a lot of people interpreted the book as if I just allocate to private equity and hedge funds and now private credit and venture capital, I can get Yale like returns. But they dismissed the fact that he was, and his organization was uniquely talented early and had. He's a great teacher and had great access. And so it really started ramping up in 2000. And now you're to the point where, I mean, there are trillions and trillions of dollars allocated to these asset classes. And there are clear signs that it's over allocated. The distributions have dried up. There's an article in the Wall Street Journal that I think it was about 30,000 companies awaiting exit. And now you have this push the institutions are getting out. A lot of them are selling assets in the secondary market, including Yale, by the way. I don't know if they've executed the sale, but they were looking into it. And now it's being marketed to retail investors and 401k plans and defined contribution plans. And what people don't realize is that this is not the beginning of a cycle. This is the end of the cycle. And what is typical of the end of the cycle is retail investors are the targets. And that's what's going on now. And it's very concerning.
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Christine Benz
You've been particularly skeptical about the return prospects for private credit. So maybe you can talk about what are some of the warning signs that you see there?
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Mark Higgins
You know, it's just that if there's one thing I can put my finger on, it's the lack of fear. And you have seen some fear pick up a little after the bankruptcy of First Brands. But there's just this general perception that there's free money to be had here. And what happens in these situations, which has definitely happened here, is you have some kind of false narrative that you hear all the time. Well, there's so much private lending needed because of the aftermath of the 2008, 2009 global financial crisis. Well, that happened 16 years ago. I mean, that was legitimate in the early years. It's not. I don't buy it now. And it's just a herd instinct. People make monster returns at a time where it made sense. There was a legitimate gap in the market, which there was after the global financial crisis. And then the herds descend, yields Decline, people start underestimating risk and it breaks. And look, if I'm wrong, I will be the first to admit it, but I don't see how we're not near the end of this cycle. Much closer to the end of the cycle rather than the beginning. And can I put my finger on specific data that indicates this? Well, I can, but it will take a little longer. And a lot of this is with financial history. You see big patterns. You don't necessarily see one data point that is fatal. It's the pattern. And that's the pattern I see.
- [30:40]
Amy Arnott
And with private credit, I think people look at the yields available on some of those funds and I don't know if they realize that the default rate is actually pretty high. I think I was reading something this morning where the default rate on private credit is something like 10%. So hopefully the first brand's bankruptcy will be a bit of a wake up call. But it seems like people are just focused on the return potential and kind of turning a blind eye to the risk side.
- [31:17]
Mark Higgins
Yeah, I think it'll break, but we'll see.
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Amy Arnott
So you were talking about patterns. And another thing you discuss in the book is the six different phases of an asset bubble. And I think if you look at the market right now as we're taping this toward the beginning of October, you could point to a bunch of different areas that, that might seem a bit bubbly. US stocks, bitcoin, gold, artificial intelligence. Are there any asset classes that you think people should be especially worried about at the moment?
- [31:56]
Mark Higgins
The one that worries me the most is private markets. And I've written about this recently. I'm converting a newsletter that I did on Evergreen funds that are basically investing in private markets. And you know, I laugh about this, but it's actually not funny. It'll be funny in like 30 years or something. But it's amazing what they're doing. So what they're doing, and you know, now there's a big push to go into defined contribution plans to hit the retail market, which is that in and of itself is a red flag. And what these funds are doing is they are investing in, you know, secondary positions that a lot of the institutions are selling for reasons that we discussed earlier, that there's too much capital there and not enough opportunities. And the Evergreen funds are buying secondary positions. And then there's this obscure accounting rule that was established in 2009 when secondaries were a very, very small market and the market was legitimately distressed because of the global financial crisis. So there's this Thing called a practical extension expedient that was really just for reporting purposes. When you buy a secondary position and the general partner is reporting an NAV that differs from what you paid for the secondary position, just, you know, at a convenience for to make reporting easier, you're allowed to literally in one day mark it up to the nav. So what a lot of these funds are doing is they're starting by buying some direct investments, but buying a lot of secondaries immediately, marking them up, using this practical expedient and reporting these very big returns. And I mean, it doesn't take a genius to figure out the problem with this. There are a lot of problems with it, but the biggest problem is the only way to maintain your returns is to keep buying bigger and bigger slugs of secondary so you can get those one day markups. And a lot of people, it's surprising, but a lot of people just don't know that this is happening. That not only are these returns potentially, I would argue that likely are not real because people are getting rid of them for a reason. A lot of them have multiple bids now. There's evidence they're overpaying for them. And then on top of that, they're marking them up to levels that may never be realized. And some of the funds are even. Well, a lot of them actually are paying themselves based on the markup. They're paying themselves incentive fees based on the markup. And there's a recent article in the Wall Street Journal by Jason Zweig on the practices at Hamilton Lane, the Hamilton Lane Private Assets Fund. And they are distributing massive amounts of money on returns that are shaped by various degrees depending on the fund. But a lot of it's coming from these accounting markups, and it's really disturbing. I feel like I've seen a lot of interesting ways to take advantage of loopholes that probably shouldn't exist. And I've seen worse than this. But this one's pretty bad.
- [34:54]
Christine Benz
So AI is often pointed to as potentially another bubbly area in the market. I wanted to ask about the CFA charter. There were more than 190,000 CFA charter holders globally as of March 2023. And passing the CFA exam has historically been one of the best ways for people to get ahead early in their careers. You're a CFA charter holder, as is Amy, but we recently saw a news report that chat can easily pass the Level 3 CFA exam. So are advances in artificial intelligence an existential threat for investment analysts, in your view?
- [35:35]
Mark Higgins
Yeah, I mean, I don't know. I'm not Surprised that it was able to do it. I mean, they're mostly multiple choice, but it is really, really impressive that it was able to do that. That's one. I just, I don't know how that's going to play out. No, I will say that I always looked at the cfa, like when I see people have passed the three levels of the cfa, I mean, it may not be what they intend, but I look at it as somebody who's pretty darn dedicated and a hard worker. So I don't think it reduces that signal value. But in terms of, you know, I talk about like the educational things and I'm probably going to offend people here and I apologize, but it's just, you know, my, my impression, I look at four educational things that I did over the past 25 years and by far it's not even close. By far the most valuable was the reading and research that I did independently to write my book. Second is probably a tie between the CFA and cfp. The CFP was a little more practical in terms of how you can help people. The CFA was just kind of deeper on the investment stuff, so it's probably a tie there. And then my apologies to Darden, but MBA is last on the list. And the funny thing about it is it's inversely correlated to the cost. So the cheapest thing was buying books and reading. A lot of stuff was free. CFA and CFP were pretty cheap too. I'm just talking about financial expense. Obviously it was a big time investment and then by far the most costly was the mba. So I don't know how this plays out in terms of value proposition, but I think some of the things particularly showing commitment. I don't know if it's the most time efficient way of showing it, but I think there's value there, but I don't know how it plays out.
- [37:24]
Christine Benz
Mark, you referenced how valuable steeping yourself in financial history was if you were to recommend a couple of books for people. Obviously your book is incredibly comprehensive. But what were the ones that you found just so useful and eye opening?
- [37:40]
Mark Higgins
Yeah, I mean, some of it is time sensitive. So I think the most important book for people to read right now is a book by Robert J. Samuelson. It's called the Great Inflation. I forget exactly the subtitle, but it's called the Great Inflation. Just because I think we are going through a lot of the same issues right now. There's one I just have an attachment to just because it was the first one I read. It was called the Big Board and it's on the history of the New York Stock Exchange. It stops, I think, in 1960, 1970, but I don't know if I'd recommend that. But it was a really interesting book. I'd have to think about some others I haven't really thought about lower down the list. But the number one I would recommend right now is the Robert J. Samuelson book.
- [38:27]
Amy Arnott
I also wanted to touch on the topic of tariffs, and a lot of tariff proponents point to William McKinley, who is a Republican president who championed tariffs, and Congress passed several tariff bills back in the 1890s. But I haven't heard a lot about the trade policies in the 1930s, which did not work out well. Do you see any parallels with the recently enacted tariffs, or do you think the situation is different this time?
- [38:59]
Mark Higgins
Initially, I was very concerned, and especially when Trump came out with the wildly inflated tariff levels. There are two concerns. One, it just seems unrealistically and damagingly high. They've since backed off that. The bigger concern, though, was if this turns into a tit for tat trade war with everyone throughout the world. That actually was a pretty important contributor to World War II. Well, it's actually more important in Japan in terms of the rise of militarists in Japan. I write about this in the book the Depression was sufficient to allow the rise of the Nazis. So I was concerned about that. We haven't seen that yet. So the way I would describe it is it's very risky. Some of those risks have not come to fruition yet, but it's risky. I'm relieved that the Trump administration has backed down on just the level of tariffs and that there isn't a tit for tat response, because it's the tit for tat response that gets really concerning.
- [40:07]
Christine Benz
One of the things you've been critical about is some of the agency conflicts in investment consulting. Can you unpack what the main conflicts are and what types of negative outcomes they've led to?
- [40:21]
Mark Higgins
Yeah, and this is a frustrating one because it's tough to balance. I feel like it's an important message to get through, but I don't want to alienate people either, because I was part of this from quite some time. And this came from the research. When I got to the 1960s and 1970s and really 1980s, I started seeing where the investment consulting industry came from, and it's actually a really interesting history. So it really started in the 1970s with computing, and consultants essentially revealed that the bank asset management departments, which were managing institutional money, were not Performing well and they're charging a lot of fees. And this was revealed with their performance reports. And the consulting firms essentially emerged as performance reporters. And then as they moved the trustees away from the bank asset management departments, they started doing manager searches. And then they started, you know, offering asset allocation services. And by 2000 they started getting into alternatives. And then the OCIO concept came. And the funny thing is, is you saw over several decades, a lot of these consulting firms became exactly what they replaced. And you know, like there's this assumption, and this is my conversion when I was at an investment consulting firm, there's this assumption that being a little different in terms of your asset allocation, picking and hiring and firing active managers and adding alternative asset classes to portfolios is adding value. But there's a lot of evidence, and I would say my personal experience as well, that it isn't. It's detracting value and they're focusing on the wrong things. There are institutions that need a lot of help in terms of managing their finances and, you know, simplifying their portfolios at this point and reducing costs. And instead, consultants are just so wedded to business models that are dependent on things that are not adding value in aggregate. I mean, can it, you know, can you get lucky or can somebody have extraordinary skill? Yes, but the odds are against them. And there's plentiful evidence. And I think one of the best pieces of evidence is an article I wrote for the Museum of American Finance. I did a case study on the Nevada purs, which has over 60 billion in assets for 20 years, more than 20 years now. But at the time I think it was, I think the period was ending in March. I may not get this time exactly right, but about a year ago, and for 20 years they had outperformed. And this is before fees are taken into account. They have much lower fee levels. They had outperformed between 89% and 98% of their peers depending on the timeframe. And the evidence is overwhelming that consultants should be moving institutions and trustees to less complex, lower cost portfolios. And they're going in the opposite direction. I think it's just institutional inertia.
- [43:19]
Amy Arnott
Yeah, I think we've seen a lot of evidence on the retail side as well that simplicity can actually lead to much better results for individual investors. And Things like the 6040 portfolio or target date funds for 401k plans tend to end up with pretty good results in terms of risk adjusted returns. But also behaviorally, people tend to stick with them.
- [43:48]
Mark Higgins
Absolutely.
- [43:48]
Amy Arnott
Which is another main driver behind getting Better results over time.
- [43:55]
Mark Higgins
It's not rocket science. And sometimes I feel. I saw this article the other day, it was like the new 6040 is the 50, 30, 20. And I was like, I know what the 20 is. It's alternative investments.
- [44:06]
Amy Arnott
Exactly.
- [44:07]
Mark Higgins
And sometimes I feel like it's a. So now it's 50% equity, 30% high quality fixed income, 20%, some esoteric stuff that you don't need. Some combination of the previous two, and really big fees. That's the cynic in me. But that to me is roughly what's going on.
- [44:29]
Amy Arnott
Yeah. And you can see a lot of proponents of that type of asset mix will point to projected returns on alternative assets, but there's no guarantee that you're actually going to get those returns. And as you point out, in the meantime, you are guaranteed that you're going to be paying higher costs no matter what.
- [44:52]
Mark Higgins
Yeah. And it depends on the study. But a lot of those assumptions are suspect for two reasons. Some of it is just the methodology. I saw a study the other day, I can't say who the organization was, but it assumed that you were going to get several hundred basis points of alpha from those allocations. That's a big assumption, that you're going to be much better than average. And that study is being used to justify broad allocations to alternatives which by definition can apply. Are there small segments that might outperform? Sure. But if you're using an assumption of alpha and applying it to everybody, that's impossible. It can't happen. So there's flaws there. And this is where history comes into play. Just because something worked in the past, it worked under a different set of conditions. And what you've seen over the past 45 years. First of all, the returns aren't what a lot of these studies are saying, that they're not as attractive as people think. There's a lot of evidence of that. But even if they are, that was in the run up, that was in the early stage of the cycle. We're in the late stage of the cycle. Those rules don't apply anymore. And people rarely consider that.
- [46:02]
Amy Arnott
So for our last question, we wanted to kind of zoom out and look at things from a big picture perspective. And you spent about three and a half years working on the book and you wrote at the very end that at the beginning of that process you were pessimistic about America's future, but now you feel more confident. What made you change your mind there?
- [46:26]
Mark Higgins
Yeah, so this was. I was pessimistic because when you're Caught in the present, everything looks like a disaster. And the way I wrote this book, and I can't say this was a methodology, it just kind of happened this way is I started. I actually started before 1790, but I started the book in 1790, and I just, over three and a half years, gradually read myself to the present. That meant reading books on, you know, I don't know how many. 100, 200, something like that, Reading studies, reading newspapers. So around major events, I would literally sit on the couch and Katie would. My wife would be like, what are you reading? I'm like, oh, I'm reading a newspaper from 1850. And I would sample newspapers from, like, one a week around major events to see what it was like to live then. And, you know, one thing you pick up on is, first of all, we've had some really bad. I mean, can you imagine living in the 1930s where average unemployment was roughly 20% for 10 years? And by the way, after that, you had 100 million people died in the World War. That was really bad. And I also watched war movies, and I tried to. I developed a real appreciation for the sacrifices that soldiers make. I watched the most brutal, gruesome war movies, read the most brutal, gruesome memoirs just to get a taste of what it must be like to be in a war. And it's horrible. But anyway, by the time I got to the 2000s, I said to Katie, I was like, you know, this actually isn't that bad. And that's what gave me the hope. It's seeing that every generation thinks the whole world's going to fall apart after they leave. I mean, you read the newspapers. That's where you pick that up. And this country has seen. We've seen horrible depressions. And the Great Depression wasn't the only one. The 1840s was probably just as bad. We've seen horrible wars, pandemics, natural disasters. We had civil war. That's civil unrest. We've had everything. And there's something about this country that our institutions and our people are more resilient than people often think. Sometimes it's suppressed, sometimes it goes dormant. But I really believe in this country. I think we have a great culture. I think we have stronger institutions than people think. I think we have people that are better than people often appreciate. And we are innovative. We're not scared of failure. And I think we have a really good formula. And will it end someday? Sure. I don't think it's close now. I always couch that. And there's a lot of this in history. It's cognitive dissonance. You got to hold two things simultaneously. That does not mean we don't have problems. The debt is a big problem. The monetary failures are a big problem. Political divisiveness is a big problem. I just think we'll get through it. And a 230 year track record is not something to take lightly and sneeze at. I think it will continue.
- [49:22]
Amy Arnott
Well, Mark, thank you so much. It's been great talking with you and I really enjoyed reading the book and I think anyone who is an analyst or financial advisor or individual investor should definitely read it. I think it's a great foundation for understanding, you know, what's happened in the past and what that might mean for things that are happening now.
- [49:48]
Mark Higgins
Well, thank you so much to both of you, Christine and Amy. This has been a really fun interview and thank you for having me.
- [49:55]
Christine Benz
Thanks so much Mark.
- [50:02]
Amy Arnott
Thank you for joining us on the Long View. If you could please take a moment to subscribe to and rate the podcast on Apple, Spotify or wherever you get your podcasts, you could follow me on social media, AmyArnot on LinkedIn and hristinebenz.
- [50:18]
Christine Benz
On X or Christine Benz on LinkedIn.
- [50:22]
Amy Arnott
George Cassidy is our engineer for the podcast and Cary Grant produces the show Notes each week. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us@thelongviewstar.com until next time. Thanks for joining us.
- [50:43]
Disclosure Announcer
This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording and are set subject to change without notice. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. And its affiliates, which together we refer to as Morningstar. Morningstar is not affiliated with guests or their business affiliates. Unless otherwise stated. Morningstar does not guarantee the accuracy or the completeness of the data presented herein. This recording is for informational purposes only and the information, data analysis, analysis or opinion it includes or their use should not be considered investment or tax advice and therefore is not an offer to buy or sell a security. Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analyses or opinions for their use. Past performance is not a guarantee of future results. All investments are subject to to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile. Before making any investment decision, please consult a tax and or financial professional for advice specific to your individual circumstances.
- [52:10]
Mark Higgins
It.