C (4:24)

Depends on how you want to count. If the original manuscripts are 18 with three second editions. So that's 21.

B (4:32)

Okay. So the most recent one, Enrich youh Future, we'll get a chance to discuss a little bit today and we'll be talking about one of my favorites as well as it goes along with some of the subjects I wanted to cover today, which is all about alternative investments, which you've become quite an expert in over the years, along with the Various things you've done in your career, being a chief research officer and being a vice president at a mortgage firm. You've done all kinds of fun things in financial services since you came out of a business school years ago. What do you like to do besides working in finance and investing and educating investors about this other stuff?

C (5:16)

I have a pickleball court built on my driveway, so I'm out there most days. Not today because it's ice all and snow all over the ground. But I did play yesterday indoors until unfortunately I tore my right rotator cuff, so that's not letting me play tennis anymore. But still do a lot of. Even though I retired from Buckingham or Focus as the parent company, I'm still engaged doing writing, which I love to do research. So probably every day spend probably three or four hours reading the latest academic papers, writing them up. So in a way that the average reader can understand in simple terms what the research looked at, how, what it examined, what were their findings, and then most importantly, what are the key takeaways, the implications for investors. I publish now on four websites for Financial Advisor magazine, Wealth Management, Alpha Architect, which is really where the geeks hang out on more technical papers and Morningstar as well. And then last March I started my own column because I'm producing more stuff than the others are willing to take on in their budgets. So I now write at Substack as well and people can follow me either directly on Substack or on Twitter or LinkedIn. I publish links to all the pieces that I write, so that takes up a good part of the day. And my grandkids and my wife are the more important bigger rocks and they take up the other half of my time.

B (7:02)

Yeah, still sounds like you're pretty fully engaged to me.

C (7:05)

Yeah, I got very lucky in my career because of my position at Buckingham and then Focus. We were one of the largest RIAs in the country. When I retired it was over 70 billion and so all the investment firms wanted us to work with them. So I had that got me access to the leading minds in finance. So whenever I had a question or wanted to research a paper, I would contact Cliff Asness or Ken French and many others in the field and I wanted to keep up those contacts. So I'm still pen pals with all of them. And if I've accomplished anything, I think it's cause I was able to stand on the shoulders of giants.

B (7:56)

Absolutely, absolutely. And I just got done interviewing Christine Benz about an hour ago. Podcast listeners listened to her interview about two weeks ago. She Mentioned that you'd been writing for Morningstar as well, so she was thrilled to have you there.

C (8:09)

Yep, I started writing for them last year and usually two, sometimes three columns a month.

B (8:16)

Yeah. Okay. Well, let's turn to some investing topics. I know it's a subject that's near and dear to your heart. You know, when we look back over the last few years, 20, 23, 2024, US stocks have gone up 25%, 25%, another 15 or 16% year to date as we're recording this, three years that really haven't been equaled since the late 90s as far as US returns go, year after year after year, everyone's starting to call it the AI bubble, you know, the Mag 7 bubble. Is it a bubble? If it is, what should we do about it?

C (8:54)

Yeah, well, I think it's very hard to call it a bubble because we're not at levels that I think define a bubble. Eugene Fama, who's a lot smarter than I am, once he could not tell a bubble until after the fact. This is one case where I disagree with him. I think factually you can define a bubble. And when the broad market valuations are higher than the real return on tips, which are the riskless instrument because you have no credit risk and you have no duration or inflation risk, just hold it to maturity and guaranteed to get that real return that you paid for it. And so in the late 90s, we were at 40, call it on the Cape 10, the Shiller Index. So you invert that, you get an earnings yield. And that's the best predictor we have. It's not a great predictor and it's worthless in the very short term out to one, two, three years. But it's the best predictor we have of longer term returns like 10 years or longer. And that meant you had your real yield was two and a half or the inverse yield, two and a half. And that meant your real expected return to stocks if PE stayed the same would only be 2.5%. TIPS yields were 4. I was pounding on the table begging people to buy as longer term TIPS as they could. All of my retirement account money at that point was in long term tips, because I knew, at least in my mind, there was a bubble. It had a burst either by TIP yields falling, which could happen, and eventually did, or stock prices correcting from those valuations. We're not at those kind of levels at all today. The equity market is about 23, I think something like that. On the current Penn, if you look at the Cape 10, though, it is up in the 30s, but tip yields are about two and a quarter or something like that. So we're not at that. I would certainly say that equity valuations, when we're looking at broad market indices, are very high and therefore investor expectations for real return should be very low. But it doesn't mean it's a bubble. And I wouldn't do anything per se in certainly terms of trying to time it, because you can't do that successfully, if anything. What Cliff Asness used the term sin a little. So you're thinking you're 60, 40 is your portfolio. You think equity valuations are high. Maybe you go to 55% equities and trim it a little bit. But you have to be prepared. You could be wrong for years, as I was, Jim, in late 97, Greenspan declared a rational, exuberant market. I'm sure you remember that. And I thought he was right. The Cape 10 was already in the mid 20s, high 20s, and I thought that meant that equity valuations were pretty risky at elevated levels. But I noticed that value stocks, their valuations had been unchanged. So if you think about, let's say historically, to keep it simple, growth stocks are 20 pes, value stocks 12, market 16, roughly. Pes for the growth stocks went into 30s and 40s, but value stocks were trading at 12. So I went 100% value at that point from a much more diversified portfolio, and it turned out that I was dead wrong for two years and then I was dead right on because it was then the largest value premium in history for the next eight years. But a lot of people wouldn't be able to hang on because they don't have a strong enough belief system. But it shows you how difficult it is to try to time things. Valuations are only good predictors at the very long term, not the short term. Today, the same thing has happened. We have valuations stretched for the growth stocks, particularly technology differences. The companies are more profitable, but the valuations are very high. And one other thing I do want to touch on, but value stocks, they're trading lower than they were in the 90s. The PEs of them are typically in the 1011 kind of range. So they're really trading cheap. So it's hard to say the market's in a bubble. Certainly the large growth stocks that have dominated the market for it are highly valued. The last thing I'll comment on is this. There's some really good research which I've written up will get published in near future showing something that's very important that people may not be paying enough attention to. It's these high growth stocks used to be a lot of intellectual capital, a lot of off balance sheet assets if you will. They were intangible assets, not physical assets, high margins. So if Google made a fortune by creating good software add another client, their profit margin is infinite when they add that next client almost. So I had great scale. Now they've become because we're reading about all these big investments required in data centers, et cetera that they're becoming capital intensive companies having to spend huge amounts of cash. So their free cash flow that was driving the stock prices is not going to be there. And that raises the question will they be able to generate the profits to justify those high valuations? Nobody knows the answer. But we do know this. The evidence is that high asset heavy companies tend to have lower than market returns. And these companies have shifted their paradigm to where they're big spenders on Capex my crystal ball is always cloudy but I think that's where the risk of a bubble exists. Nobody knows if they'll pay off on those investments will arrive. We'll have to see.

B (15:52)

It's interesting though, over the last few years I've seen individual investors justify and use all kinds of good arguments to do it but justify, you know, limiting their investments to, you know, maybe the s and P500, sometimes just a growth stock index, sometimes just a tech stock index. And nobody seems to like small value stocks, nobody seems to like international stocks, nobody even seems to like bonds anymore. The difference in valuations between large growth stocks and small value stocks are now at historical highs. What do you think are investors, what do you say to these people that are saying you only need the s and P500? You should let simplicity be your guide and keep your costs low and just keep it there. What do you think? Do people still need to have small value and international and bonds in their portfolios?

C (16:46)

Well, as I said, my crystal ball is cloudy. It's very important that to avoid behavioral biases which destroy returns the investor's worst enemy is usually staring them in the mirror and they're overconfident of their knowledge and they're subject to recency bias. So they overweight recent returns and forget long term evidence. There's tons of studies demonstrating that those things lead to bad behaviors and bad outcomes. So one thing I've tried to impress on people is to always look at what led to the recent great returns right of causing people to only want to invest in S and P or these Other stocks that you mentioned, the high tech companies, the Max 7, whatever you call it, the S&P 500 or let's say it this way, growth stocks have far outperformed value stocks really since about 2016. So we got a decade. Okay. What people Forget is from 2007, no one would have wanted to own growth stocks. We had the biggest value premium in history. That's not that long ago. And why did that happen? Because valuations spreads had gone to record historic levels.

B (18:16)

So.

C (18:16)

So for example, I used that example earlier of a 20 pe for growth, 12 for value. And then we ended up with gross stocks. 40, 50 QQQ was trading, I think at 100 PE ratios. And that spread in valuations turns out to be the best predictor we have of the value premium. But again, you can't time. It just doesn't work. So you have to be patient for the long term. What's happened now? Growth stocks are far outperformed. So the question is, did that happen because of earnings growing much faster? Okay, well, the reason growth stocks traded at higher PEs with the PE, say at 20 and 12, because the market expects, say growth companies to grow earnings, say 2 or 3% a year faster. And they do. And that's what's happened. So how do we get outperformance much greater than that? Right. It was because PE expansion, not because earnings were much higher than expected. It was because of PE expansion. Trees don't grow to the sky. It's exactly what happened in 90s. I think there's certainly the risk it could be repeated. And then you have this other risk that I pointed out as well, that these companies now are morphing into an entirely different type of vehicle and we don't know if they'll be able to sustain those kind of profits. And I would just remind people that the same thing was true of international stocks. They dramatically underperformed in the late 90s. The next decade far outperformed US stocks, especially emerging markets, which nobody wants to own today because of recency bias. And investors missed out on those great returns if they didn't stay the course, simply rebalance their portfolio kind of the market global cap, which is what I recommend as a good starting point. And we see the same things today. But guess what? This year we got a reversal international. And by the way, Jim, this is something most people don't know because they only focus on US Stocks. And they say the value premium is dead. It's 10 years. Well, you know what, the value premium has been there internationally since the last decade. And international small value stocks, the fund I own, is up over 40% this year. And emerging market value stocks, the funds I own, are up over 25% this year. Will that continue? I don't know. But we do know that the outperformance in the US Again, while US earnings were faster than international stocks, most of something like 85% of the outperformance was due to multiple expansion, not earnings growth. And it was also we had a tailwind for US Stocks of a strong dollar. Well, the dollar is now significantly overvalued on a purchasing power parity basis. And that's provided a tailwind for international stocks this year, helping them dollars down. My memory serves about 10%, but the latest data from the IMF I just saw yesterday still shows the dollar's overvalued by about 15%. So we could see a paradigm shift here with the dollar falling. We also see a possible paradigm shift with Europe waking up to the fact that their excessive regulatory environments are killing their economy and allowing the US to grow faster. So you're starting to see noises about changes there and that could lead to faster growth in Europe. Time will tell. I don't know. But you're buying US stocks at valuations of like 23 times and international maybe 15 or something, and emerging markets at like 11 or 12, something like that. So you have a massive gap that's too large to be justified by any reasonable expectations. A faster U.S. growth, which is only about 1 or 2% a year, not a big gap that would justify the valuations that wide. So best thing I could tell you is remember your history and I'll close this part of it with this reminder. If you think 10 years is a long time, try these periods from 29 to 43. The S& P, which everyone wants to invest in now, underperformed t bills. That's 15 years. 66 to 82 is 17 years. The s and P underperformed T bills. And recently from 2012, it also underperformed. That's 13 years. That's 45 of the last 96 years. I think that's almost half the time. Which means if you abandon it after waiting 13, 15 or 17 years, you miss out on the spectacular returns that happen. So the best thing I tell people is have patience, stay disciplined. Good starting place, I think is a global market cap. And when valuations get unusually stretched, okay to sin a little. So two years ago I decided instead of owning 12 and a half percent or 1 8th emerging markets, I went to like 15%. I sinned a little and this year it's paid off. Same thing internationally. I sinned a little and I lowered my US to add a little international. But I won't make big bets like get out of U.S. stocks. And because it's impossible to time these things.

B (24:33)

Good advice and you know, one of your favorite, one of my favorite books of yours is the only guide to alternative investments you'll ever need. You took a whole long list of alternative investments, divided them into the good, the flawed, the bad, and the ugly. But I wanted to talk a little bit today about some of the various alternative investments. People are thinking about these because they worry about, you know, a bubble in US Stocks in particular, but also they just become sexy sometimes and people become interested in, you know, looking at what else is out there. Probably the first alternative asset class that any investor considers is real estate. And there's a whole spectrum I've taught about a real estate that goes all the way from just investing in publicly traded REITs to directly investing in rental properties, buying the properties down the street and renting them out. And obviously there's some things in between, between turnkey properties and syndications, private real estate funds, those sorts of things. Given real estate has not been super popular since everything tanked when interest rates went up 4% in 2022. But given stock performance the last three years, what are your thoughts on real estate these days?

C (25:48)

Well, first let me just comment on that book which I wrote. I really had a stretch, as you might remember, to even find some good ones in order to have some good alternatives. I included things like emerging market stocks, which today I think most people would not think of as an alternative investment. But the world has changed dramatically. So let me just touch on that and then I'll turn to your real estate question. The reason alternatives like hedge funds or private real estate, private equity, private credit, reinsurance, all of these things that people look to because they either have low or no correlation with the economic cycle risk of stocks and, or the economic cycle risk and the inflation risk of bonds. The problem with them is not the concept itself. These asset classes do bring diversification benefits for obvious reasons, which we can go into if we have time. The problem was that the sponsors were taking all of the benefits in their fee structure by charging typically 2 and 20 or more so 2% annual fees, 20% profit sharing, if you will. And on worse, many of these were what I'll call capital call investments. So you might commit a million dollars and they would call it maybe every three months you'd get a call for 100,000. Another three months later, you get another capital call for another 100,000. As they found investments, the problem was they were charging the 2% on the million, and you only got right away the first hundred thousand was invested. So they were chewing up all the returns. And a simple math example can demonstrate that. Let's say U.S. stocks got 10%, and you could invest in a hedge fund, private equity, whatever you want. Investing in equities that could beat the market by 5%. That's huge, right? You're a legend if you could do that. So you get 15, but 2%, you got 2% fees, and 20% of 15 is 3. You're paying total costs of 5%. And then some of them added other expenses on top of that. You ended up with a return of less than 10 and you had total illiquidity. So I recommended avoiding all of these at that time. Then around 2013, several years after my book came out, AQR was the first real hedge fund to try to democratize some of the assets. They said some of the strategies we do in hedge funds are really in niche markets. We can't manage more than a billion or two because then we would arbitrage all the profits away. The cost of trading would be too high. So we're gonna keep them private and we can charge their 2 and 20. However, there are other assets where the marketplace is huge and we could bring it to the public. And they did. Bringing long short factor strategies which go long, where the evidence shows value, momentum, carry, and quality, or what they call defensive. And they came out with a fund that they thought would deliver 4% to 5% premium over T bills with about a volatility of about 10%. And here you had a totally uncorrelated asset to anything and no exposure to inflation. So if you knew you could get that five, which of course was not a guarantee, you. You would kill for that investment. And every model portfolio would load up on it. Turns out 12 years later, the fund is delivered virtually on that, and they only charge 1.3%. And I'll put quotation marks around that. And then a firm called Stoneridge came out with a reinsurance vehicle. Now, we know hurricanes don't cause bear markets and earthquakes don't either, and vice versa. So we know naturally insurance companies are in the business to make money. They charge for profits. Why didn't I recommend it then? Because again, their sponsors were taking the big fees. Stoneridge came out with a product with no carry, something a little bit more than a 2% fee guess was it would return about 5% premium. It's over the last 10, 12 years, whatever, since it's been out, pretty much has done that. But both of those strategies, I'll point out, experienced really bad runs for three years. Both of them had drawdowns of about 35 to 40%, which is typical of equity types of risks. Right. We see that quite often with equities even much worse. But as an example, AQR's fund the last four years, I think is average over something like 25% a year. And Stoneridge's fund the last three years, reinsurance funds up like 135% if you stayed the course. So the world has changed. And I Now have literally 57% of my assets and alternatives because there is a big illiquidity premium there, which is natural if you can afford to give up liquidity. That premium generally averages depending upon the asset and how illiquid. Somewhere between 1.5 to 3% a year and sometimes more. So I could give a good example for people who are looking for higher yields. You could buy a private credit vehicle. It's a public cigarette. It's called broadly syndicated Loans offered as BKLN or SRLN delivered pretty decent returns. The private version of virtually the same assets has outperformed by 4 or 5% a year. Why would you give that up, in fact, when the credit profile is actually even slightly better on the private vehicle? But people say, oh, I don't want to pay 1.3% or 1.5%. The other vehicle is 50 or 60 basis points. They're not looking at the problem properly. You care about value added. Now let's come down to the real estate. Real estate is certainly a diversifier. However, it does have fairly high correlation to the economic cycle risk of stocks, not perfectly high. It also can have correlation with bonds. You get bond yields rising and real estate can get hit like it did in 2022, which is, by the way, also true of equities, which is why people look to other alternatives because they want to avoid a 2022 when both stocks and safe Treasuries lost double digits, large double digits, and that was not the first time it had happened. I think there are five evidences, at least three, and maybe five where that's happened before. Which is why I want to add other alternatives because I believe there are big risks because of our budget deficit problems and the high valuations. We have risk of inflation because of those deficits. So real estate is okay. I would only do it if I was investing in a broad sort of on the market type of public portfolio like a Vanguard REIT or dimensional fund advisor REITs. The problem is that's a very tax inefficient way to do it. You can do it very cheaply. If you do it in private vehicles, you can own the same types of assets. And now the return becomes much more tax efficient because it's treated as return of capital, not a ordinary dividend, something like Blackstone's product. Blackstone was the first to come out with a product that wasn't 2 in 20. It was, I think their fee is 1.3 and 12.5%. Not cheap. But the fund is outperformed public markets by, I can't remember, 2% or 3% a year since inception. That's because of the illiquidity premium is there. And now there you're getting some active management. But I think that Blackstone has demonstrated throughout time that they could deliver if you will. We don't have time to go into it, but I think there are some advantages that Blackstone has in their databases. They're actually the largest employer in the United States and they cost multiple businesses in the PE and credit and other businesses, real estate. So they have great databases to see what's happening. Wages, profits, other things where people are moving, where rents are going. And so I invested with them as well. So I would include real estate in a portfolio, but I only own private. It's turned out to be a big advantage and I recently added an infrastructure fund run by a firm called Hamilton Lane. Again here, even lower fees, now 1.4%, no carry at all. And infrastructure is a better diversifier, much lower economic cycle risk than real estate in general because they tend to be very long term contracts tied to inflation like triple net leases and price escalators, et cetera. So I have now, I would say between real estate and infrastructure, something like 15% of my portfolio in that broad category.

B (35:58)

But you're only interested in these big diversified portfolios. You don't have much interest in building your own little empire of short term rentals or something.

C (36:08)

No, I don't want to be in that business of being a landlord. And the headaches I also actually prefer. I'll mention this while we're on it, let me talk about it this way. In private credit, okay? You can invest with some good firms like Aries or Blackstone. These are what I would call closed architecture. They have their own proprietary loans they make and you can invest in their funds. I chose to invest with a firm called Clifforder, who has a private credit vehicle that they have partnered with based upon their track record as a consultant to some of the largest pension plans, endowments in the world for like 30 years. They know who the best performers are. And unlike in public markets, Jim, where there's no evidence of persistence of performance of active management, in private markets, there is clear evidence of some persistence of performance and there are papers to explain why. If you're interested, we could talk a bit about that. So Clifford knows which firms have the best track record. They have the relationships, and they're now a $40 billion player that all the big boys want to partner with. So if you invest with Clifforder, you get loans from Aries and Blue Owl and Blackstone, you know, and all these other names you and I would not know. So you have a much more diversified portfolio by manager, you have a much more diversified portfolio by lender, type by sector, industry, geography, et cetera. So I want that. I'm trying to capture, if you will, as much as possible, the beta of that asset class, like a total stock market fund will do. But at the same time, I think you can capture a little bit of alpha by sticking with the best managers there. And private markets obviously are not as transparent as public ones, so there is some advantage there as well. So I would not have invested in Blackstone today if Clifford had a real estate fund. There are no ones that I see today of comparable with lower costs in real estate. That is open architecture.

B (38:27)

You know, when I talk to people about alternative investments today, the one they bring up that you know, wasn't necessarily in your book years ago, but probably the most commonly one mentioned is some sort of crypto, whether it's a cryptocurrency or some other type of crypto asset a few years ago is NFTs, although they're not very popular at all right now after recent performance. Do you see a place for these in a portfolio? And if so, what is that place?

C (38:53)

No.

B (38:55)

No, none of them. Nothing? No Bitcoin? No Ether? No. Nothing?

C (38:58)

No, no, no. Here's the logic. I've written some pieces. You can just type in Bitcoin+Swedro and Google search for those interested. Let me first say that I'm perfectly willing to admit I could be wrong and have been wrong if you want to look at the valuation. But I don't judge a strategy by the outcome. That's a fool's errand. You should judge a strategy by the quality of decision making, not the outcome. In other words, Jim, if you took all of your IRA money and bought a lottery ticket and you happened to win, I still think you were pretty dumb doing it. It was not a good strategy. So you can make lots of good strategies, decisions and bad outcomes happen and you lose money. Doesn't mean the decisions are wrong. You can also make bad decisions and get good outcomes. Doesn't mean they were good decisions. In the long run, a series of good decisions is much more likely to get you good outcomes. So here's what I think on Bitcoin. What you hear all these arguments that are is about the technology of blockchain and everything that has nothing to do with Bitcoin or any of these things. It's a technology. And the argument that there's a limited supply of Bitcoin is specious. There's an unlimited supply of things that could do exactly the same thing. And if you have an unlimited supply of something, what should the price be? Asymptotically close to zero. My personal opinion, which I feel good because two of the smartest people I think I know have the most respect for, John Cochran was president of the American Financial association. And he I think is our leading financial economist. And Gene Fama, I'm sure everyone knows his name, both think this is sort of the biggest scam perpetrated if you will, ever. But we could be wrong. Something is worth what somebody is willing to pay for it. I mean there's lots of artwork that trades for sells for tens of millions of dollars. To me it looks like my grandkids finger paintings. I think they're worthless. But there is no logic at all in my opinion. None. And any argument that I've read for anyone to invest in Bitcoin or any other cryptocurrencies, None. And if Cochrane and Fama see the same thing, I feel good about my rationale thinking about it.

B (41:30)

Yeah. When I Google Swedrow and Bitcoin, a recent article from Morningstar pops up where you argue that Bitcoin versus gold is a safe haven asset, that Bitcoin really doesn't stand up to gold even in a terrible economic time when people are fleeing to safe assets.

C (41:50)

Yeah, exactly. And gold can be a safe haven at times, but it doesn't always work. So gold, I tell people I don't own it. I wouldn't own it. Gold tends to go through very short periods of explosive returns and then long periods of sleepy returns. And the one thing I know most investors can't stay 20 years of underperformance and rebalance and stay the Cost. And anyone who thinks gold is an inflation hedge has to explain this. In 1980, gold was at 850 2002, it was 270 and inflation averaged over 4% a year. So you lost 86% of your money in real terms. It is literally impossible intelligently to say gold is an inflation hedge over any normal investment horizon over 100 years. Yes, it's worked. You know, when Jesus walked the earth, an ounce of gold bought a centurion's uniform. Today it'll buy a nice suit for a Goldman Sachs executive. So you got no real return for, you know, 25, 22,000 years. To me, there are better alternatives out there. However, gold has tended to do really well. And when governments got fiscally and monetary loose policies combining the two of them, which we certainly did under the Biden administration, we're not doing any better under this administration. And same thing happened around the globe. And so that's what spurred gold I think. And there's risk that that could get worse. So gold could continue to do well. I think there are better investments like reinsurance, like private credit. Both have high double digit or sorry, double digit returns. And reinsurance next year, in a normal year should return something in the order of 20% after being up 136% the last three years. By the way, I'll just touch on that. Reinsurance is such a logical investment, right? We have 150 years of it, more of insurance, reinsurance company data. They make money, you can invest in it in either a cat bond, a catastrophe bond, which is daily liquid. So I don't do that because I want the illiquidity premium and that's had a nice return over T bills, something on the area of 5% a year, totally uncorrelated to anything. And I think it's only had, here's the interesting thing, one year a loss in the last 15 or 20 years and yet nobody wants to own it. And the fees part of the reason why there's something like one and a half percent a year, something like that. So there are a lot of advisors. If it's not a vanguard like fee, they ignore it. But they're costing their clients great opportunities to add a good diversifier. 2022 reinsurance of all kinds did fine, certainly didn't lose double digits. But if you own what is called quota shares, which are one year type of contracts, more diversified today. Well, let me go back 2018 through 2020, three really bad years in a row, lost something like 35%. But there's a self healing mechanism in all risk assets. What do I mean by that? So Jim, I'll ask you what happens? Where do you live?

B (45:29)

I'm in Utah.

C (45:30)

Utah. So let's imagine you lived in California or Florida. What happened to homeowners insurance premiums after the fires in California?

B (45:41)

They went crazy. People are having a hard time getting it.

C (45:44)

Yeah, like 60%. And what happened to the other underwriting standards? Well, they went through the roof. Meaning if you wanted insurance and you lived in a prone area to fires, you can't have a house within a tree within 30ft of your house and no two trees within 30ft. And all the brush has to be cleared. And in Florida, if you want hurricane insurance, your roof has to be able to withstand and windows 140 mile an hour winds. It's got to be concrete or whatever. So the risk went down because the tighter underwriting, the deductibles went way up. So maybe a $5 billion hurricane would have that caused out losses, would have hit these reinsurance programs. Now it might not until losses got to 10 billion and the premiums went up 30, 40, 50, 60% in some cases. So what happened in 23? The fund I invested in, Stoneridge's reinsurance fund made 44.5% but 80% of the money was gone. Naive retail investors panicked and sold. I bought more like Warren Buffett. I run to where the fire is because the premiums are higher, the risk is less, and I'm getting a much higher expected return for taking less risk. Next year was up like 33% and last year, this year it's going to be up like 23. And next year it's a little early because the contracts aren't in. But the talk in the industry I would expect in a normal year to make about 20%. And by the way, this year the Fund's up over 20% despite the big losses from the Altadena fire, which cost $10 billion in losses. If that hadn't happened and that was easily preventable, the fund would have returned over 30% this year. But that risk showed up. So I think every investor should own reinsurance. It should be 10% or so. Five at a minimum. I own about 15% of my portfolios in reinsurance.

B (47:59)

Can it be done cheaper or does it just cost that much to do it that they got to charge 1.5% or whatever?

C (48:06)

Well, yeah, it could be done cheaper as a cat bond. I'm surprised that no one's come up yet. There's, I know there's One firm that came up with a little lower fees like 150. The other funds, the one Stoneridge I think is like 170. Pioneer runs one. I think that's a very good fund, 160. But I wouldn't want to own an index here and that would be the cheap way to do it. And the reason is the issuer of the bond has asymmetric knowledge of the buyer. So they may say, hey, this is not the best deal, let's get rid of it and dump it on the public and it'll be there. And if you're an index fund, you'll own it. I want a more equal. I know. So I want an active manager there who's got lots of experience in doing that. However, the quota shares, they're really running a reinsurance company for you literally. But without the regulatory environment, infrastructure, you don't have all these salespeople and whole stuff. You can run it with a small team to do that. And so when you're paying about 2% or so to manage that, that does seem expensive and I wish it was cheaper. But the return on investment for the insurance contracts you're buying are very similar to the return the insurance companies get because they have all those other expenses of dealing with all the regulators and capital rules, etc. So like I said, hard for me to see why today someone wouldn't want to invest in a reinsurance vehicle that's expected return is about 20% and has no correlation to any other asset. Why would if you could give up the liquidity? Now I'll add one other important thing. My experience in my 30 years in this business advising thousands and thousands of clients is one thing investors vastly overvalue is liquidity. Having worked at a firm with 70 billion assets, we had over 10,000 clients. I never met one. And I asked our we had hundreds of advisors. I asked how many of your clients take more than their RMD who are withdrawing? And I never got one who said they were. Now at age 90, your RMD is not even 10%. These illiquid assets today on what are called interval funds, most of them offer 5% every quarter, so 20% a year at a minimum. So if you're not taking 10%, why couldn't you have some portion of your portfolio in an illiquid asset? Not all of it, of course, but all of my assets in my IRA or Tax advantage accounts are in illiquid assets. For that reason I can capture a large illiquidity premium. And most of these are Tax inefficient investments as well. So I do want to hold up in tax advantaged accounts.

B (51:22)

Now, the typical mantra with investing is high returns come with high risk. What I mean, if you're expecting 20 or 30% returns out of this sort of an asset class, long term, what is the risk?

C (51:37)

Yeah. So first of all, I'm not expecting 20% long term. I'm telling you what's happened now because capital flew out when I first started investing the no loss return. So the premiums collected was about 15. The expected losses average, a median of a bell curve was about 8. So the fund, after expenses would have expected to return 7. Okay. And T bills were 2. So nice 5% premium. If I could guarantee that I take it all day, I'd get out of equities altogether. But of course that's not true. That median means you could have in a one in say 25 years, lose 30, 40%. One in 50 years lose 50 or 60%. And one in 100 years, you get wiped out totally. Same kind of thing with the stock market, which is why you don't put 100% of your money and in reinsurance and why I have call it 15% of my money there, not 30 or 50 or 100% of my money there. You always have that tail risk there. And today I would expect. Well, what happened is I told you the first few years the fund generated about that 5% return. Real. Then it had three horrible years. The fund was at $5 billion at the end of 17. Three years later it was down to 1 billion. Now, about a third of that drop was due to the losses. The other two thirds was due to investors fleeing. So now it's down to 1 billion. And what happened as we talked about, the premiums went way up and the expected, sorry, the no loss return was in the 30s. If you applied a normal, say 8 or 10% loss, you would have expected 23. Some good circumstances happened. The fund did even better than anyone would have expected. Today I expect the no loss to return to be about 30. No one expects no losses, although that's possible.

B (53:54)

Right.

C (53:55)

But it's highly unlikely. The median return would be about, let's call it a 8 or a 10% loss. And then you got the tail risk where you could get hurt back. The risks are there and you're illiquid. That should be worth in the insurance market, that's worth 1.5% to 2% depending upon circumstances. Those are regime shifting. It could be more, sometimes could be less. So that's a free lunch for me because I don't need the liquidity.

B (54:27)

Now the other asset class you've talked a lot about lately is credit credit in the private market. And I've invested there in several different ways. Years ago I was investing in some peer to peer loans and you get such high yields on them that even with pretty high default rates you still come out with a pretty good return. And more recently I've invested on the credit side of real estate essentially in funds that sit there and loan money to developers but are in first lien position on the properties where they can foreclose. When you're talking about investing in these sorts of private credit vehicles, what are you talking about actually investing in?

C (55:04)

Yeah, so I invest in two funds, both run by a firm called Cliffwater. One is private credit, which is middle market to smaller companies, typically companies with ebitdas between say 50 and 150, 200 million. Okay. The average LTV is only about 40%, the average default. These are all loans by the way, that are senior secured by real assets and sponsored by private equity. So if bad things happen, doesn't guarantee that the private equity firm will jump in and throw more capital to save their investment. But it means the odds are pretty good it could happen because if there is a default, the lender seizes all the assets and the private equity firm can get wiped out. These types of loans clifforder publishes every quarter an index called the Cliffwater Direct Lending Index. And they publish both a broad one and the senior loans. The credit default history on the direct loans is 1% losses on the senior secured sponsored, it's only 25 basis points today the yield is 10% on that fund. No duration risk. Now you tell me why you think you should own say a 5 or 10 year treasury yielding 4. You have duration risk when we have big budget deficits. Inflation risk, I can get 10. I don't have liquidity at least minimum of 20% a year. But maybe I can get it all out. Depends on how many people get it. And a default history through cycles, call it 1% a year. Doesn't mean it can't have losses, but that's a huge premium of 6%. And I have a much less risky portfolio from one perspective, which is inflation risk. So I am taking credit risk. That's true, that's economic cycle risk. But the structures of the deals are good enough that the history is even in a really bad environment like in 08, I would expect the fund to only lose high single digits. That's the nature of that investment, I invest in another fund, but it's a little too technical, run by Flatrock, that invests in what are called double B pieces. A little too complex here. But that fund, that double Bs have had virtually not zero, but virtually no credit losses. And that fund is probably yielding over 11%. I've owned that for several years as well. So they're generating big returns. They were all 20, 22, did fine, provided strong returns. So they're a big print. They're non. They do have risks, but the downside risks are tiny compared to the downside risk of equities. And all of them have equity, like expected returns right now.

B (58:16)

So you're essentially loaning money to private companies.

C (58:20)

Yep.

B (58:20)

Secured by the company's assets.

C (58:22)

Yeah. And something like 90% of companies are private. So, you know, just because you're in the public markets doesn't mean you're as diverse as. And all these are profitable, highly profitable companies, at least in the structure that I'm recommending. Again, open architecture, broad diversification, of course, industry sectors, geographies, managers. So in Clifford's case, unlike if you're with a big BDC or business development company, they might have 8 or 10% in their biggest loan. Cliff Waters is under 1%. I think it's 0.6% is the largest loan. So even if there is a default, not going to really hurt the portfolio very much.

B (59:10)

So hundreds of loans in the fund.

C (59:13)

Thousands. Thousands of loans.

B (59:16)

Very interesting. And why do you think that people are passing on these? Is it liquidity risk that you think they fear? Is it a combination of that plus the higher expense ratios on these funds? What's keeping people out of it? Just that it's not traditional, hasn't been popular. I mean, typically when people. Things have great returns like these, have people chase them and, you know, I hear very few people besides you talking about these.

C (59:45)

Yep. I want to keep it that way. Although I'm trying to educate people and take advantage. I don't want money flooding in because that's how you ruin an asset. Money flows in, gets crowded, and spreads come down. That certainly can happen. So first of all, these spaces, the companies who I would invest with, most of them, because these are complex products with big illiquidity issues. They want to make sure that there's an advisor, someone like yourself or myself, who's sitting down with the client, explaining the risk, walking them through in great detail, showing them the tail risks with hurricane losses, all this stuff, not just saying, here, buy this, it's in My model portfolio that also allows them to keep their expenses down because they don't have to have hundreds of people and manning call centers, et cetera. They won't take money directly from investors. Aqr, Cliffwater, Stoneridge, none of them takes money directly. So that's one issue. Second is there are lots of advisors who I think are short sighted. They tend to look at only the expense and not the value added and the benefits. It's like say well you know, I'm going to take my wife out on her anniversary to McDonald's instead of a nice restaurant because it's cheaper. You only go for something cheap if it's a commodity. An S&P 500 fund should choose the cheapest one because they're all virtually identical in this space. That's not true. And there are way significant value adds here and you're getting illiquidity premiums and you want access to the best management because there is clear evidence of persistence of performance as well there. So you have the price issues or the cost issues, you have the illiquidity and then you have advisors telling clients don't invest. And the last thing is the average investor who's do it yourself, which many are, that's their choice. Of course they don't have the time, the skill, the access to do a proper due diligence. When I was at Buckingham we took three years to get to know the people at Stoneridge before we would invest and I had access to them. We had dozen meetings or more over the years getting to know the character, the people, et cetera. Almost no individual investors are going to have access to due, proper due diligence. So you really should be working I think with an advisor if you're going to invest in these things. So that's where the limits are. You have a lot of people who just say I want to be a dyi, don't want to pay an advisor so they're not going to get access. That's their choice. But they're missing out on I think some significant opportunities that they can't access on their own.

B (62:53)

Now this was a little bit of the DFA model for years and you know, up until the folks left DFA and started Avantis and started offering this sort of, you know, fund management techniques that they used at DFA in an ETF model. You know, DFA then of course had to follow suit and start offering ETFs directly to individual investors. Do you see that sort of a thing happening with these asset classes?

C (63:22)

I don't Think that's the case? Because again, this is the illiquid nature. And if you can't make them liquid, there are firms that are trying to do it. Like putting private credit into a daily liquid asset. I'd avoid them like the plague. It to me shows a complete lack of risk management skills. You don't put an illiquid asset into a daily liquid investment. And what you're doing, if you do that right now, you're going to hold a certain amount of illiquid assets in a daily liquid etf. That means you better have a lot of liquid assets right there. So now you're not capturing the illiquidity premium anyway with those other assets. So I don't want to own the fund anyway. That's the real problem. You're mixing things that don't belong and you could end up with blow ups in a bear market. Everyone starts to panic and now they're even forced to sell that illiquid asset at the worst time. And the buyers will say, sure, I'll buy 30 cents on the dollar, 50 cents on the dollar, whatever. I'd avoid anything that looks like that's trying to mix those two assets, except in very minor ways, maybe would own 10 or 15% or something like that.

B (64:43)

Now the criticism of this style of investing, right, these multi asset classes, some liquid, some illiquid, is you end up with a pretty complex portfolio. And among individual investors, you know, in the personal finance and investing space, there's this constant debate between optimizing and satisficing. Now I've always had the impression that you kind of lean toward the more complex side, the optimizing kind of side. At what point do you think it's not worth managing a portfolio with all these sorts of little bit more complicated, little more illiquid assets just because you don't need to. And simplicity has its value.

C (65:28)

Yeah, Well, I think the biggest mistake here made is overstating the simplicity issue. For example, we know you certainly can invest whether you want to tilt like I do to small value stocks or not. You can own just two or three funds and you're globally diversified sector diversified, etc. Right. You can own a Vanguard Total US and a Vanguard Total International fund. Or you could own three DFA funds or Avantis funds and you got all your equities. Then you could own three or four alternatives, say 10% each. You could own a reinsurance fund, a private credit real estate that maybe incorporates infrastructure as well and maybe aqr, and you got four funds. You mean to Tell me the average person that seven funds is way too complex and hard to deal with. To me, that's ridiculous is the right word. You know, there's nothing complex except you have to understand some of the products. I would tell people if you don't understand the product or don't have an advisor you trust 100%. So don't invest in the AQR long short factor strategy, which goes long copper and short zinc and all these other currency hedges, all this stuff. So now you got three funds, but everyone can understand private credit. It's very simple. Reinsurance is very simple. And real estate, so you own 10% of each. You got three funds, three domestic funds, and you own a TIPS or a Treasury for your liquid daily to help rebalance and stuff. I find it hard to believe somebody really makes a case that that's too complex. So that's my view. I don't own 50 funds. You know, I've got a small number of funds.

B (67:31)

Now. Our time's getting short, but I wanted to spend just a moment on your latest book. Enrich your future. Who should buy it and what are they going to learn?

C (67:40)

So that book is a collection of stories that I've developed over the years to help people understand difficult concepts. When I wrote my first book, I was lucky enough to have as an agent an English professor named Sam Fleischman at Columbia University. So, Larry, you got a good book here, but we need to inject a way to make it much more readable for the average reader because you're trying to convey difficult concepts. And he taught me to use analogies to cooking and gardening and sports and movies and history that make difficult concepts easy to understand. So the most important chapter in the book is analogy to sports betting. We all know if, say, if you're a college basketball fan, Duke is playing army, which they do every year because Mike Shashefsky was the famous coach of Duke, was an Army West Point grad and a coach that army play him every year. They've never even come close to winning a game and likely never will. But you can't make money betting on Duke just because they're a better team, because everyone knows it. And the point spread works to equalize the odds of people winning, which is why we don't know people who get rich betting on sports, or it's highly unlikely we do. The people who get rich betting on sports are the bookies. And so I use that analogy that the point spread is the PE ratio. So it's easy to tell if you take Say Google and General Motors. Which one is Duke and which one is Armiger?

B (69:24)

Yeah, that one's not hard. I think pretty much everyone would say that Google would be Duke, Right?

C (69:30)

Exactly. So why do you think you can pick Google as a better investment than General Motors when everyone knows that it's in the price already? And so I use stories like that throughout the book to make difficult concepts easy to understand. Like, my wife is a great baker, and what she taught me was, if you want to make cookies sweeter, you add a little bit of salt, not sugar. Well, same thing applies in investing. You can add a risky asset to a portfolio like reinsurance, and by adding it, you actually reduce the risk of the portfolio because it's uncorrelated the way it mixes with other assets. So the book is really filled with 40, I think, terrific stories. It's got great reviews. Anyone can look up on it. I have lots of people who've given it to their children and grandkids for them to learn how to read. So you don't have to be a math professor or quant or even a DYI investor. If you want to learn how markets really work and what the winning strategy is, I think you'll find it a very valuable book. I'll just add this one last thing. One of the things I've always done is made myself available. Anyone who reads my book and has any questions about it can always reach out to me on LinkedIn or X or my Substack account, and I'm happy to answer any questions. I never go to bed at night without checking emails and answering questions, so you get that as a bonus in reading the book.

B (71:06)

All right. Well, we've been chatting with Larry Swedrow, author, columnist, advisor, investor, and we appreciate your time and all the work you put in on the behalf of individual investors and their advisors.

C (71:21)

My pleasure. Hopefully they found this helpful and you can subscribe to my columns at Substack.

B (71:28)

Okay. I hope you enjoyed that. As promised, we got into the weeds as we usually do. Anytime I talk to Larry and give you some things to think about when it comes to investing. If you incorporate alternatives into your portfolio, consider ways to keep the portfolio still reasonably simple, that it can be dealt with not only by you if you have diminished capacity, but by your heirs, your spouse, possibly perhaps children, that you're leaving money and assets to. Keep these things in mind as you build your portfolio. If it requires an investing advisor to invest in it, you're also putting that heir in with that investment advisor. So make sure you're going the right way. When you do that, don't forget about our contract review partners. You can go to whitecoatinvestor.com contract review and please have your contracts reviewed. This is like one of those few no brainers, right? If you're paying off your student loans, it's a no brainer to refinance them. If you're going to sign a contract, it's a no brainer to have it reviewed by somebody that reviews these all the time. The likelihood that you will not save more than that fee is practically zero, right? Almost every contract can be improved. If nothing else, you'll be told exactly what you're worth using the most current data available out there. As I mentioned at the beginning of the podcast, SOFI could help medical residents like you save thousands of dollars with exclusive rates and flexible terms for refinancing your student loans. Visit sofi.comwhitecoatinvestor to see all the promotions and offers they've got waiting for you. One more time, that's sofi.com whitecoatinvestor Sofi student loans are originated by Sofi Bank NA member FDIC. Additional terms and conditions apply. NMLS 696891 thanks for those of you telling your friends about the podcast, thanks. For those of you leaving 5 star reviews, a recent one came in Life changing. I'm an attorney, not a doctor. This podcast has been a life changer for me and my family. I've learned so much good, effective and powerful advice. I have my kids listening to this as well. Five stars. Those poor kids. Hopefully we'll get something entertaining for the kids out there. I'm not that entertaining of a person to start with, so asking me to entertain your children as well is asking a bit much. For those of you kids out there that your parents are making you listen to this, I hope you're learning something useful. If not, I apologize but the podcast is now over. Hopefully you can now listen to something you want to listen to. For the rest of you, keep your head up and shoulders back. You've got this. We're here to help you stick around with the White Coat Investor community and we'll all achieve our goals together.

A (74:08)

The White Coat Investor Podcast is for your entertainment and information only and should not be considered financial, legal, tax or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.