Show Us Your Portfolio: Andy Constan

[00:00:00] Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long term investor. Justin Carboneau and Jack Forehand are principals at Validia Capital Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital. Hey guys, this is Justin. In this episode of Excess Returns, Jack sits down with Dance

[00:00:28] Spring Advisors founder, Andy Constan, to discuss his personal portfolio and investment strategy. Andy's a prolific macro thinker and investor, so in this discussion we get into how the macro economy and outlook influences his personal investment strategy, the assets he holds, and the role the assets play in managing and growing his personal wealth over time. These show us your portfolio discussions allow investors to learn about investing methods and market views from those with experience in the markets such as Andy's. As always, thank you for listening. Please enjoy

[00:00:55] this discussion with Andy Constan of Damp Spring Advisors. Hey Andy, how are you today? I am well, thanks. How are you Jack? Good. Thank you for joining us. Last time you were on the podcast, we talked about macro and we talked, and I would highly recommend anyone take a look at that. It was called The Four Pillars of Macro with Andy Constan. I recommend anybody, maybe even before you listen to this, listen to that, because we really got into your entire framework around macro. And in this interview, we're going to talk more about your personal portfolio. And we're going to talk about how you

[00:01:23] translate that into managing your own money. Just before I get started too, I want to just congratulate you on what's going on with Damp Spring because you've built a really impressive thing there. And I saw one of my favorite Twitter followers, Jimmy Jude, just came on with you as well. So it's really cool. And I would definitely recommend anyone go check that out. Sure. Yeah. Jimmy's the best. I've been working with him off and on for a year at least. And we've been talking on the side and he wanted to join Damp Spring and we were glad to

[00:01:48] have him. And it's exciting for our members and for the quality of the product. So we're really excited about it. Yeah. It seems like you two balance each other out pretty well. You know, you come in markets from totally different directions and, you know, it probably creates a good thing in the middle. Yeah. Yeah. I mean, we're trying to really not have the opposite views. I hate that when one guy's saying buy and the other guy's saying sell, but you know, he understands my framework well, and he has this edge of understanding sort of

[00:02:16] short-term market moves, both technical and from his vast experience trading. And I'm focused more on a, you know, three month horizon. So it helps us get, um, that combination helps us get entry into the positions I want to hold for an extended period of time. Yeah. So it's nice. So when we start out with these portfolio episodes, we first like to talk about goals. So, you know, everybody has different goals for their portfolio. Some people are trying to fund retirement. Some people are trying to leave money to their heirs. Some people just want peace of mind. How do you think when you manage your own money, what do you think are your major overreaching

[00:02:45] goals? Yeah. So I hope to describe, so everyone makes mistakes in their investing and their personal investing. I hope to just give you a sense of what I think the right way to do it is. And I've made mistakes at times in doing it this way, but how I think the right way to do it is and how I'm doing it now. Um, and so goals are very important. So, you know, when I think about personal finance,

[00:03:11] the first thing I think about is that I always want to have enough cash available to meet, um, any type of sort of immediate cash need. And that could be very from, you know, my daughters, um, will, will expect a wedding one day. Um, that'll be a lump sum. And, uh, you know, I've just, I'm on the last month of, uh, last quarter of a semester, I guess of, um, college payment for my

[00:03:37] fourth kid. So, you know, that took some planning. So when you look back, it's all about planning for large expenditures with the right assets to have at the right time to fund those. As I look forward, you know, then it is into things like retirement and what, you know, having a lasting retirement. And, um, then you have to think about once your retirement is funded,

[00:04:06] you have to think about if you, what your view is on, um, providing for, uh, your family after you've passed your estate and things like, um, you know, what you'd like to give away from, for charity, uh, a portion of that estate. And that gets into some interesting and individual personal dynamics. You mentioned retirement. What are your views on retirement? You know, some people think they're going to go play golf and they're going to go, you know, do that for the rest of their lives. A lot of people think they're going to keep

[00:04:36] working, you know, how do you strike the balance there? I mean, do you think you'll ever retire? I mean, it seems like with damp spring, you've built something you could do for as long as you want to. How do you think about that? So I'm 59 and have retired twice, uh, and it didn't stick. Um, uh, I, I wake up in the morning and I think about markets. I go to sleep in the evening and I

[00:05:01] was thinking about markets. I, it's what I do. I don't, I, I certainly enjoy my life cooking and eating and wakeboarding and seeing my family and, you know, doing all the things I do, but, um, that's my life. And I can't imagine, um, if I'm able to make an impact,

[00:05:25] why I would stop doing it. And, uh, so in the next 10 years, I have no anticipation of stopping doing what I'm doing, but one day, you know, either, you know, assuming I keep my health, you know, that will be the tell, you know, if I'm no longer making an impact because, you know, I'm just too old to make an impact, I'll step aside. Yeah. One of the good things about working in markets is you can do it for a long time. You know, as long as your mental acuity stays there, you know, unless something weird changes and markets

[00:05:55] operate completely differently than they have in the past, you know, it's something you can keep doing. Yeah. Well, I mean, I think the important part about that is, uh, and I think we've seen it in the last 40 years is let people rest on what happened in the last 40 years. And that's made, have them make mistakes in the last three. So to me, it's not about the, the, when I'll stop is when I think, um, there's no more to learn, not when I think I've run out of things to say, it's all about

[00:06:23] finding the next thing and constantly evolving and learning that keeps me interested. It just would not be that interesting at all to me to just pass along my history, so to speak. Yeah. And you know, what's, what's going on in the past 40 years is where I wanted to go next, because before we talk about your own portfolio, I mean, most people build their portfolios in a pretty simple way. They have an allocation between stocks and bonds. They probably have some sort of

[00:06:50] glide path as they approach retirement and they don't have much else in their portfolio. And I'm just wondering, do you think going forward, given what we've seen with inflation, I mean, do you think that's a legitimate way to build a long-term portfolio these days? Or do you think there's flaws in that now? Well, I'll say, I think it never was the way to build one. And it was never needed to be built that way and was flawed from the get-go and remains flawed. Nothing's changed. It's

[00:07:18] just equally flawed as to the way it's been. The only thing that's changed is that people realize now why that it was flawed. It's not that it wasn't flawed before and it is flawed now. It was flawed before. And this is the flaw that it exposed, a period of time in which both bonds and stocks fall. Yeah. I mean, we were lucky in that we saw a 40-year period that was not consistent with history. So if you had stocks and bonds, you were very lucky to be invested in stocks and bonds during that

[00:07:47] period. But people who've studied market history further back realize that's not the way it is all the time. But a lot of investors have seen nothing other than that. And it's hard, if you haven't seen anything other than that, it's hard to imagine it as a possibility. Exactly. It's a whole industry that services that they themselves believe. And so they tell their clients that and they position their clients in that way. There's a whole industry that grew up in this environment and knows nothing else.

[00:08:15] So if that approach is flawed, I want to kind of take a step back and start from first principles. Like when you build your personal portfolio, what are the key ideas? What are the key things you're thinking about in constructing a portfolio? Right. So, you know, I worked at Bridgewater and Bridgewater has the all-weather product. And, you know, I'm intimately familiar with how that all works. But it goes back to principles that others have. You go back to Harry Brown, who created something called the Permanent

[00:08:42] Portfolio, which was created in the late 70s and dealt with the flaw of the 60-40 portfolio back when it last had its bad experience in the 70s. And they all basically come around the same thing. All-weather has a great name. And for that reason, I think it's useful. The idea is the portfolio should be able to perform in all weather. And that means any type of environment,

[00:09:12] including ones that are inflationary. But, and this is the important thing. So let's just step back and say, I believe in that. I believe that if you are going to, that it pays over time to be long assets and you get the best risk adjusted return by being long a portfolio of assets that is more

[00:09:38] diversified than the 60-40, which includes things like commodities and gold and probably crypto in this day and age that provide balance to the 60-40 portfolio that it lacks. The problem is, and our weather didn't do particularly well in the last few years either, because there's an essential problem

[00:10:05] with owning assets in environments when money gets tight. And so we saw that during COVID when, or sorry, we saw that after COVID when quantitative tightening was announced in 2022, we saw both

[00:10:27] stocks and bonds and gold and commodities and all weather all fall. And that is, you know, that makes you think that just owning beta for the long term, even if it's more balanced than 60-40 is still not enough.

[00:10:49] So the thing about beta 60-40, or I think the preferred way. So let me step back for a second. The 60-40 portfolio over the last 40 years has done well. The all weather portfolio at the same level of risk has done better. Why is that? Because you've had been able to lever up the exposure

[00:11:15] because you were more diversified. And so for the same level of risk you've outperformed. Now that's a good thing. And so my allocation to passive long-term investments is uses that type of framework. But as I said, it's not enough. And so that means that you have to overlay something else

[00:11:41] to get diversification. And so I think that's the lesson of the last few years is that owning assets is just not enough. You have to have some other diversifier that performs when we have a significant monetary tighten. And how do you think about like incorporating that, that diversifier into your portfolio? So I consider that alpha, which means, so let's step back for a second. In this

[00:12:10] environment where assets are well, very well bid up, um, stocks and bonds, um, to me, it makes sense to trim your beta and hold more cash. So that's the first thing I've done in my portfolio is I've trimmed my long only portfolio, my beta portfolio and own until just very recently, the maximum amount

[00:12:38] of cash I'm willing to own, um, and the minimum amount of assets. Now that's an active strategy and has a market timing sense about it. So it's, you have to be very cautious about trying to market time. It's very, very hard, but at these levels, at the, at the high level, I think a high allocation to cash makes sense. And so I'm heavily allocated to cash. Now, the other type of investment is

[00:13:08] uncorrelated absolute return. People call that alpha. And that's also very hard to find. Most people don't have it. Um, and they charge a lot for you to invest in that way. Hedge funds, some you don't even have access to that charge very high fees. And so looking for alpha, um, there are a number of

[00:13:34] players out there that are trying to create alpha at lower fees. Um, there was a period of time recently where, um, a lot of money fled, flooded into, um, CTA funds, which have that sort of uncorrelated diversification, absolute return. Um, and so that's a tricky thing, but if you are able

[00:13:59] to do it, I think that's what a portfolio needs. So that's what I have. I have a passive long position in assets diversified in a all weathered like way. I have a large cash holdings relative to my long-term average. And I have a fair, for me, because I actually specialize in generating alpha, I have a fairly heavy allocation to my alpha portfolio. How do you think less sophisticated

[00:14:27] investors should think about this problem? Because it is kind of an issue, you know, less sophisticated investors typically have this buy and hold thing in their 401k with stocks and bonds. Now it has changed a little bit because you are starting to see ETFs with, with strategies like this that are coming out, but how do you think they should think about that if they can't, you know, they don't understand the complexity, but they want to deal with this world where maybe stocks and bonds aren't going to work as well. Yeah, it's very hard. What the number one easiest thing to do is take less risk in an environment in which, uh, risks are high. The easiest thing is

[00:14:57] to hold more cat. And the best thing is it pays five, you know, half percent. And so that's the first step is to minimize your holding of assets. The question is, you know, are you susceptible to FOMO? Like, are you going to say, I'm going to sell assets today? And then you do. And then they rally 20%. If you then go buy them back, you know, that's the worst possible outcome you could have. Um,

[00:15:26] so you have to understand yourself in which, you know, it's very hard and your broker is not going to be interested in having you be in cash because he probably isn't going to get a paid a fee for your cash holdings. Um, and so there's a lot of FOMO that is going to kick in and you have to know yourself. So that's the number one thing that people have to be is, are they going to be susceptible to

[00:15:50] chasing once they've gone into cash? Um, at the same time, you also don't want to panic into cash when the market's cratering. Uh, that's the worst time to sell, to sell assets when the market's already down. So the number one thing I would say is know yourself, add cash in a sensible way. Yeah. And I think that gets to the idea of having a systematic process, which, which to me,

[00:16:18] I think you can disagree, but I think it's very important that it doesn't have to be a quantitative process, but if you're going to be adding and removing cash, some sort of rules that govern that you can stick to. Because like you said, when, when a human emotion gets involved in this, it can turn into a complete mess of making the wrong changes at the wrong time all the time. Yeah. And, but I really think that's mostly the know yourself thing, like rules that you don't believe in. You're not going to, you're unless somebody else executes them for you,

[00:16:45] you're not going to do them. So you have to really understand, you know, what your goals are. Are you comfortable compounding your wealth double in 12 years? If so, there's an investment for you, that has no risk. If you need it to be six years, you're going to have to take some risk.

[00:17:12] And so trying to understand yourself, that's, and getting someone, preferably your advisor, but again, they may not be working fully in your interest. Um, getting someone to really push you to your edge in terms of your risk tolerance is by far the most valuable thing you can do as an investor. The choosing of what you invest versus what your goal is and what you personally are like

[00:17:42] and making sure people, you know, expose that both to yourself and to them is more important than any of this stuff. Yeah. That's so important to do. And it's so hard to do, like knowing the edge of your risk tolerance before you get there is very, very tricky. You know, we run quantitative strategies and, you know, so if you're running a value strategy for someone, you've kind of got two issues you can run into. One is when the market goes down, they're going to panic. The other is when value underperforms, they're going to panic. And so you have to kind of know the edge of the risk tolerance on both of those areas to get someone in the right strategy.

[00:18:11] Because to your point, if someone invested in a value strategy and they don't believe in value when it's not working, they're done. Like they're much better off than just the S&P 500 or something. Absolutely. So many bad decisions are made by people who have, those expectations and reality are, and, and, and who they are as a person are in conflict. So understanding yourself, getting somebody to help you understand yourself and getting your advisor to understand you is critical. So, so your core portfolio is kind of an all

[00:18:41] weather risk parity type approach where you're going to own all the assets all the time and you're not moving in and out of them. Is that right? Let me, let me be specific. Um, 10% of my, so the all weather portfolio that I have, I call it DS beta. It's, it's roughly like, um, what's the, uh, R par or any of the other commercially available, uh, risk parity like

[00:19:04] structures. It happens to have about a 10% annual standard deviation or risk. Um, and so I put money in that money in that so that I, my AUM, my personal, the money I put aside for investing. As I mentioned, there are other money that you put aside to meet other goals, but for my investing

[00:19:31] dollars, I put all of that into all weather. And so now I have a portfolio that has a 10% volatility over time and should generate 6% excess of cash. So 11% in this day and age over time annualized. I then lever that with a, well, firstly now, so now I say what my basic position is.

[00:19:58] Um, and then in this environment, I deliver it by 30%, meaning I take 30% and put it in cash and only have 70% in that beta because I don't like assets right now. I think cash is a more favorable and that's an alpha. That's a market timing decision. Then I take the a hundred dollars of assets that I

[00:20:27] have invested $70 in, in the beta, $30 in cash. And I use that to, to execute my alpha strategy. And my alpha strategy also has a 10% annualized volatility. And it is structured with options spreads

[00:20:50] that at no time. So let's just say I have a call option on the S and P that I paid 10% for. If it goes to zero, I lose 10%. Now I, it's much more diversified than that. My bets are more concentrated, not, not, not as concentrated. Um, the idea is that I have at any point in time over the course

[00:21:20] of this year, I can lose 10% on my alpha portfolio. That means I'll now only have 90%. You know, I'll have a negative 10% return. My beta hopefully will offset that diversify that. And so that's my, I didn't do a great job explaining it, but that's my basic thing. I basically have the same amount of risk on my beta portfolio as I do my alpha portfolio. And they have been diversifiers over

[00:21:50] the years. And so on the, on the beta portfolio, are you owning the underlying assets like ETFs or using something like futures? How are you building that? So for me, I happen to use, I like the, so there's a variety of things. The all weather has a big, and my portfolio has a, uh, an exposure to things that you can't lever easily with futures. So for instance, the number one thing

[00:22:18] is, um, uh, is, um, inflation link bonds. You just can't buy any, you know, you can buy an ETF. They're a little expensive. So I tend to look at physical bonds. And so you got to pay cash for those. You can't, you could, if I was an institution, I could repo them, but I get no leverage from them. So I have to use leverage for some of my things. So, you know, I'll use S and P futures for the equity

[00:22:43] piece. I'll use bond futures for the bond piece, but TLT, you know, there's, I'm not levering up the portfolio significantly enough that a regular margin account could do what I do, um, using ETFs. I just prefer to use futures and prefer to have the cash around because some of the ETFs and some of the margin that you get, if you're an individual, you just don't get good rates, interest rates on your

[00:23:13] margin. So for an individual, if they're comfortable using futures and don't use it for leverage, but use it for financing, you know, that would be a better way to implement than using ETFs by and large. So I have a mix. So the bottom line is I have a mix of those things for things. I can lever cheaply with futures. I'll use futures for things. I can't lever at all. I'll use physical assets in inflation

[00:23:40] like bond for things that are cuspy. Like, do I prefer to use gold futures versus GLD ETF? It's sort of cuspy, which I'll use. And so it depends on what I'm going for in that portfolio. But in general, you're trying to get exposure to the broad asset classes, right? You're not trying to have active management in there or factors or anything like that. You're trying to get broad exposure.

[00:24:05] Right. It's beta. It has, if I'm going to have alpha now, I trade macro, so I don't pick single stocks and single bonds and things like that. I'm always looking at asset class allocation. In the beta portfolio, I'm trying to be as passive as I can and just broad asset class exposures. The alpha portfolio, I don't happen to trade single stocks, but if you did trade single stocks, that would be appropriate for an alpha portfolio if you think you can outperform,

[00:24:34] if you can generate uncorrelated alpha trading single stocks, have at it. I'm just curious, how has this evolved over time? I mean, when you were younger, were you more of a buy and hold type investor? And then I know you've worked at Brevin Howard, you've worked at Bridgewater, you kind of learned and evolved over time, or is this something you've been doing for a really long time? Well, I think my investing philosophy was pretty straightforward. Do as well as I could on my

[00:25:00] salary, try to sell as much of the stock they would hand me for compensation as soon as I could trade and not really trade or invest at all. It was probably dumb, but if you've worked at an investment bank, certainly over the last, you know, and the regulations got stricter and stricter and a major hedge fund, you know that you don't, you can't trade.

[00:25:25] Right. So, um, it's really been since I've been, so my investment philosophy has been since I've been at Bridgewater to codify the way I describe my investing and how I actually invest, but even still at Bridgewater, I couldn't do it. And at Brevin, I couldn't do it. So that's what I'm saying. My personal experience is sort of irrelevant. I'm describing a philosophy that I literally could

[00:25:55] not put in place because of compliance for most of my career. Yeah. That's something I think a lot of people miss about the asset management industry is you don't realize, you know, you can't totally translate what people are doing in their personal portfolios because everyone in the asset management industry is under some degree of restrictions in terms of what they can trade and how they can trade it. And so they're probably not building the optimal portfolio they would without that, you know, inside of what they're doing. And if they worked on the sell side, they're way over concentrated in, you know, Goldman Sachs

[00:26:22] or Morgan Stanley, or in my case, Citigroup and Solomon before that. I will say that Solomon Brothers was the, during my career, was the worst performing stock in all of the S&P 500. Wow. And I kept, they just kept giving me stock. Well, your move to get rid of it was a good move then. Well, you tried. I never got rid of enough. And certainly those who worked at Lehman and

[00:26:47] Bear Stearns never got to implement their investment strategy as their stocks went to zero. You don't use these in your personal portfolio, but I'm just curious your view on them. Like a lot of people will use active management. They'll use factors. They'll use some way to try to outperform the market. What is your general view on those types of things? I think alpha exists and it's very hard to find. And if you find it, it usually comes at a high fee, which may be worth paying. But here's what I would say about alpha and why I'm so focused on

[00:27:17] telling my two graybeards clients who are working with their financial advisors to better understand this new environment. Alpha is so hard to get, which might be stock picking. It might be sectors. It might be depending on an asset manager or all of the things you need to decide whether you can

[00:27:41] market time or the same things you need to decide if a manager you give me money to can market time. I just don't think it's something that's realistic for a long-term, you know, person who pays, you know, maybe 20 minutes a week up on their investment. If that to be able to identify alpha and

[00:28:08] pay and, and successfully. So it just keeps, you know, a Jack Bogle guy at heart, passive low fees diversified. How about value momentum factors like that? I mean, those can usually be accessed at a fairly low cost. I mean, do you think those add any value or do you think those are, you know, those are also challenging for investors to use? I think momentum is a reliable long-term factor.

[00:28:36] I'm not sure about value. I think so. But I know momentum works. And the question is, are you deciding to go into momentum in the spring, the fall of 2022 after momentum has worked for six months and you flood into the momentum strategy and then you get liquidated on the CPI day in November of

[00:29:01] 2022 when all of these CTAs got just destroyed? If you're FOMO-ing into anything because that's where the money has been, you're likely to fail. However, a little bit in momentum strategy, I believe the momentum strategy is a persistent source of alpha. And so, you know, every few months, if you want to put a little

[00:29:29] bit more assets, diversify, go from your beta to a little bit more of, of momentum strategies. Broadly, I'd endorse that. You mentioned Bobel. What do you think about international exposure? You know, he was a big proponent of, you know, you can get everything you need in the U.S. on your equity portfolio. You don't really need international exposure. I think it sounds like you're using U.S. stuff as well. Like, what do you think about that? Do you think international diversification adds value?

[00:29:54] Yes. But I think you have to also be very conscious. For the U.S., it's less of an issue. For international investors investing in smaller markets that are their home country, I think it's essential. But for the U.S. investor, the U.S. investor does get both a deeply liquid local market and their, that is consistent with their future life liabilities. And so, you know, the diversification

[00:30:21] is a benefit, but it comes at a cost of convenience, of complexity, et cetera. Now, let me step back a little bit and say that one of the important factors for investing internationally is that your market has what I would call balance, meaning the U.S. has treasury bonds

[00:30:48] that if interest rates fall because growth falls, you'll make some capital return. And so they diversify against stocks, which are likely to be falling in that case. And so there's a nice balance between stocks and bonds that exists in the U.S. Until very recently, well, in Japan, it doesn't exist. So if you're going to invest in Japan as a diversifier, all you're doing is buying Japanese

[00:31:16] equities because you can't buy Japanese bonds. They're just, you know, they won't provide anything for you in the case of a falling Japanese economy where your long stock position is. So I consider Japan to have no balance. And so any allocation I would give to Japan would be very, very small. Um, and I think that's, what's happening to some extent regarding the yen because international

[00:31:39] investors can't get balance there. Um, Europe is better, but it's still not obvious that there is strong balance. Interest rates have risen a lot, but they came from zero and now they're still quite a bit lower than the U S. And so I think you can get some balance in Europe. Emerging markets, that's, that's like buying a tech stock or buying anything else. You're just, I'd prefer to lever an

[00:32:08] S and P position than by a levered beta investment that comes prepackaged in the form of an emerging market equity or a, um, single or a NASDAQ stock or, uh, you know, any particular high flyer just for me in terms of the way it responds. Um, but I would say one thing is that when you're getting into emerging market diversification, I think you're doing some of the same things that you're doing.

[00:32:37] Um, when you choose high beta U S stocks as a diversifier, um, I'm just not sure you're getting much value there versus doing that. So I guess the high level thing is I still want diversification, low cost, low complexity, uh, low fee, and it's available internationally, but I, you know, I would

[00:33:02] caution that there are places where it would make sense at places where it's just a different bet. Yeah. And to your original point, I mean, U S investors can probably get away with less international diversification than anybody else. Um, you know, a lot of other countries, if you put all your money in your home country, you've got a much, much bigger risk than if you do here. I mean, I was just thinking back to Japan in the eighties. Like, I mean, people who put all their money in Japan and the eighties got just completely destroyed. Um, and that's a pretty developed country. And in some other countries you could really get killed. Yeah. Yep.

[00:33:30] But just one more on your liquid portfolio before we move on, I wanted to ask you about leverage because you, you mentioned before that you've got your beta portfolio de-levered right now. And at other times you're applying leverage. And I'm just wondering if you could talk about the thought process you go through when you think about the optimal amount of leverage you have. Yeah. So leverage is a complicated word for people. Um, it, for one, it has a stigma of risk that is you know, worries people for another, there's a practical issue, which it both has a cost

[00:33:56] in terms of your borrowing money, which costs money to fund. And it has a risk that you could be forced to pay back your loan, a margin call prematurely. And so that's what financial leverage carries with it. But I think people misunderstand, um,

[00:34:19] what that really means at a basic level. So for instance, if I bought a, the S and P 500, I'm going to experience 15% annualized volatility. If I bought the magnificent seven, I may, you know, the stocks that are the leaders in the S and P 500, um, I may experience a 30%

[00:34:46] annualized volatility in that less diversified portfolio. And so for the same hundred dollars of investment, I have completely different risks. And so that's leverage. For instance, I could simply have the same portfolio, but instead of buying a hundred dollars of this highly volatile basket,

[00:35:16] I buy $200 of this less volatile basket. And then I have the same risk absent this financial cost and, um, uh, margin call risk. So I think it's important to understand what you own and its riskiness before you think about whether you're levered or not, because what matters is if you lose a bunch of

[00:35:42] money, are you going to liquidate your portfolio? And if you're invested in a bunch of risky stocks, the chances of you having that drawdown that causes you to liquidate are higher than if you don't have a bunch of risky stocks and you're just in an index. And so what I'm saying is that leverage comes with, is, is about risk. It's not about, it's also about financial leverage, but first and foremost,

[00:36:10] it's about risk. So the best way to take, to lever up your portfolio is to replace, for instance, 10 year bonds with 30 year bonds. They're the same thing. You're going to get your money back, but one's going to be more volatile than the other. Now you didn't spend it. You didn't borrow any money or take any leverage, but all of a sudden just by asset allocation,

[00:36:33] you increase the risk of your portfolio, you levered up. And so that's what the way I think about it. And then there's the financial leverage part. So you decide that you're going to financially lever your lower risk asset portfolio to match your, the higher risk asset of volatility that you're willing to take. So you'll lever up this portfolio. If you lever it up on margin and the market

[00:37:02] falls, you're going to have a margin call. And so you have to determine how you're going to fund that margin call and where that margin call will kick in before you invest on margin. And so that's a complicated thing. I'd love to, I've written a bunch of things on it. Maybe I'll post them with you guys,

[00:37:26] but it's a combination of what you own and how much you're borrowing that should be considered when you're thinking about leverage. In addition, there are a bunch of assets that contain leverage themselves like levered ETFs or certain stocks. Like if you want to buy Bitcoin, you can buy master,

[00:37:50] which is a super levered call option on Bitcoin. It's just a stock. So it seems like it's not levered, but it's really levered. And so what I'm saying is evaluate what you own, what its riskiness is, what its internal leverage is, and then whether you want to use borrowing or margin or futures or options

[00:38:18] to take on leverage, to own more assets. Yeah. To your point, I mean, that's something I've definitely come around a lot in my career is like leverage is a tool and it depends how you use that tool. I mean, you see a lot of people who very intelligently use leverage and they can use leverage and de-risk their portfolio rather than adding risk to a portfolio. It really just comes down to what you're doing with it and you've got to be really smart about it. But just in and of itself, it doesn't add risk to a portfolio. Yeah. I mean, well, if you take one portfolio and you buy more

[00:38:46] assets on borrowed money, inherently you're taking on more risks. But if you buy diversifying assets that have an opposite risk return than the assets you own, so you're hedging, that margin actually reduces that spending of more money than you have, reduces your exposure. So it matters what your portfolio exposure is. I want to ask you about a couple of things outside of the standard

[00:39:16] asset classes. Do you do anything with private equity, venture capital, anything like that, real estate investing? Back in the internet day, there was a big trend around getting partners at investment banks. Goldman Sachs was minting money with its private equity stakes and venture stakes that it gave to it, access to its partners. So every investment bank started doing

[00:39:41] the same. And I got in a number of private internet-related venture funds. I've done some individual venture investing. I haven't done anything in private credit. I don't have any interest in doing anything in private credit. I haven't done anything in real estate. Yeah, I've done a bit. You know, it's dabbled to understand more so than a major commitment to an asset class.

[00:40:11] So most of your money is managed with your liquid portfolio. As I said, if you look over history, most of my money has been sitting in cash or other firms or my firm's equity. But now my assets are largely in diversified assets. How about crypto? Have you done anything there? Just to fool around and no longer. I don't have any problem with crypto. In fact, I think Bitcoin is

[00:40:36] becoming so low volatility that it's actually achieving one of its features of digital gold. But yeah, I keep close enough to know, but I have no investment in it and haven't made an investment investment in it in a few years. Before we ask our closing questions, I just wanted to ask you about your macro views. Last time you were on the podcast, you were a big fan of Higher for Longer.

[00:41:01] You know, you talked about your islands, Recession Island, Soft Landing Island, and Higher for Longer Island. And you've been pretty solidly in Higher for Longer Island. So I was wondering if you could give us an update on where you think we are and, you know, with respect to those islands and kind of where you think we're going, going forward. Sure. So I wrote a script that I posted on my highlight section of my Damp Spring Twitter feed. That script is titled The Way to Kill Inflation. And it basically,

[00:41:31] the first act of that was the Fed raising interest rates, consistently raising interest rates, really the higher for longer case, where equities continued to do well because the economy was still not restricted by monetary policy and nominal GDP was strong. And so stocks did well, bonds did and short term bonds did really badly because the Fed kept hiking.

[00:42:00] Right. Act two is when we get what is called a bear steepener, where long term interest rates finally go to rates that are restrictive on the economy. And that needs a catalyst. For six months or so,

[00:42:21] the issuance by the US Treasury has been kept down because of the debt ceiling. And that all changed when the debt ceiling was was resolved. And over the last three months, they've built up their checking account using bills issuance. But what really makes a difference and what gets us to act two of this play

[00:42:48] is a supply catalyst that pushes up long term interest rates. And that happened when on July 31st and August 2nd, I was on CNBC fast money on August 1st and said what was going to happen, which is the Treasury was going to finally increase the amount of long term treasury bonds that it was going to issue.

[00:43:17] And they did that in a sort of astounding size. And that really has turned the market, both equity market and bond market to a market in which the two year note is about fairly priced, but 30 year bonds and equities are starting to fall. And in that act, you start to see, and the following act is when equities sort of

[00:43:45] catch up to the fact that bond yields have risen. In those two acts, you start to see the wealth effect hurting consumption. At that point, companies, and this is probably first quarter of next year, companies start seeing this demand destruction and find that their earnings are coming down.

[00:44:10] And so their stock had been falling as multiples contracted a little bit. And then their earnings start coming in as demand gets cut. And so then they start firing people. And that's how inflation ultimately gets killed. Yields up, demand assets down, demand down, earnings down, unemployment rate up,

[00:44:39] inflation dead. And that's the sequence that I see the next nine months playing through. And it really just began on August 2nd. Yeah. So in the over the intermediate term, it doesn't sound like you're positive on any of the major assets right now, or at least not stocks and bonds. I'm getting there on two year notes where I think you can actually make a levered bet on two year notes. They're finally pricing cheap enough, but still not there. And yes, I'm bearish on stocks and bonds. Actually,

[00:45:07] I'm okay on commodities and gold sort of in the middle. But yeah, I'm bearish stocks and bonds, quite bearish long term bonds. I think stocks will catch up, but it might take a few months before they really start coming in, but really bearish on stocks, on bonds. We have a few questions we always ask when we close these up. And the first relates to leaving money to children. It's something I think about a lot. You certainly, we all want to pay for our, or most of us want to pay for our

[00:45:35] kids' education. We maybe want to leave them some money, but we also want to leave them so much money that they, you know, that it affects their ability to become who they're going to become. So I'm just wondering if you have any thoughts on that. I know you have kids, so if you have any ideas around that that you think about. So our goal was always to pay for our kids' college and then have them so that they don't have any college debt. Though I guess that was a bad trade. But pay for

[00:46:03] their college and we've done that. And, you know, then there's, that was the big thing. And so now that we've done that, they're pretty baked, these kids. You know, they grew up in Scarsdale. I think they've developed in a wonderful way, not spoiled, but listen, they grew up in Scarsdale, New York, in, you know,

[00:46:28] one of the wealthiest communities in the world. And that's not good. They got a lot of advantages, but I think they've really gotten through it pretty well in a pretty well-rounded way. Anyway, so more to the point, my father passed recently. And, you know,

[00:46:53] his investment is investing is allowed my mom to not be worried about money. And I think that's important that, um, certainly for your spouse, that you have enough so that when that, if that were to happen, you, uh, your spouse is, is, um, protected the next generation. I prefer to give it away, but,

[00:47:17] um, with that caveat, which is depends, depends on how your kids are developing. Um, it's a complicated thing. Yeah, no, it is. And there's, there's certainly no right answer. Um, you know, we, we have Rob Arnaud on the podcast, you know, he was talking about, he had set up trust for his kids, you know, and he, he maybe felt like he regretted to some degree how much he'd put in theirs. But then we had, you know, we had Daniel Crosby on the podcast and he was talking to us about like, well, what if your kid wants to be an artist? You know, what if they want to be something

[00:47:44] that may, may not be that fruitful financially? You know, doesn't it make sense to give them some money so that they can do something and pursue their passion? So I can see both sides of all this stuff. Maybe, but it also might be useful to have them have the consequences of living with those choices. Yeah. So ultimately, good. I don't know the answer. I mean, that's a deeply philosophical, philosophical and personal one. And I will say for sure, there are no right answers and you have to,

[00:48:14] the one thing I have learned, and I think my wife was most focused on this is these four kids that I have are all very different. And you deal with the one that's in front of you, not the one you hope for, not the one you hope the person becomes or just who they are. And if you do that, you're going to make better decisions than having some preconceived notion of who they are to become and what money

[00:48:42] they will need to become that thing. You know, that's a great point. You know, it's great for me to be on this side. I like asking the questions that don't have answers versus having to answer the questions that don't have answers. So that's one of the benefits of being a podcast host, I guess. Just two more as we wrap up. I wanted to ask you, is there anything in your life that you spend money on, not as an investment, but something you get great joy in? Like, so for instance, I have a racing sailboat and, you know, I race my sailboat in Long Island Sound and it's not the greatest investment. It certainly requires upkeep and it loses money. But, you know, on Wednesday nights, I go out there

[00:49:12] with my friends and we race around the buoys and we'll have a couple of beers and it adds a lot of value to my life. And I'm just wondering, is there anything like that for you? I dumped a lot of money into my family's house to make it the way we wanted it to be during the time

[00:49:30] and gotten a negative return on that. I've done a frame off restoration of a $30,000 car, a 1952 MGTD that's been in the family, my in-laws, father-in-laws car. That's now my son's car.

[00:49:54] And put $150,000 in it and it's still worth $30,000, but it's gorgeous. Yeah. Yeah. Um, and, uh, you know, I've done, I, I, I bought 2,500 bottles of wine when I was a wine collector and realized I don't drink much. So sold $2,400, 2,400 bottles of wine. And I actually made money on that deal. Um, yeah, wine's actually been a very good investment. I guess recently people have done

[00:50:24] very well with wine. Um, right now I, um, I dumped a few thousand dollars a year into, uh, Pokemon go. Oh, interesting. Which is an, a phone video game, a phone game that I've been playing since the day it came out. And, uh, man, I'm really, I got a killer Pokemon go game, like beyond belief. Are you into boating, sailing or power boating or anything? I know you live right in

[00:50:53] the water there. Um, yeah, we have a, I throw a, uh, Hobie on the beach. I live on the beach, um, on the South, the South side of the North fork. I have a, put a Hobie on the beach and a, you know, all the paddle boards and canoes and things like that. Uh, and a motorboat in the board out there that I, if I have somebody that dry can drive me, which is right now my brother's

[00:51:19] actually here. So I'm going to get him to, I've been water skiing, skateboarding, surfing, weight boarding all my life. And so that's probably my greatest passion besides cooking, which is definitely my greatest passion. Um, but yeah, I mean, you can throw money. Well, if you have a boat, you're throwing money at a boat because there's no other way. Um,

[00:51:41] and I think the next thing I buy is going to be one of those, um, um, the hell's it called? E, um, it's not a surfboard, but it's, um, and it's got a wing in the bottom, but it like a hydrofoil. Yeah. I know exactly what you're talking about. I'm going to get one. I see those things flying

[00:52:08] around sometimes on the sound. They're like, they're like 10 grand and battery operated and, but they look like a ton of fun. So that's probably my next totally ridiculous purchase. Yeah. One of the things I've found, you know, people always say it's better to spend money on experiences over assets. And I think that's true to a large extent, but I've also found like buying assets that generate experiences, it ends up being a really good thing. So, you know, to your point of the boat, like renovating your house and then you're living in there all the time, you know, you generate great experiences with that, like putting in a pool, having a sailboat,

[00:52:38] like, I think those things that can generate like recurring experiences actually end up being pretty good investments from that perspective. Yeah. And you know, that's why I spent a lot of time on, um, cooking and teaching and helping others because that's how you interact with people. So I don't want to keep you too long because I know you're about to go out to the water. Um, but we have one standard closing question we always ask in these interviews, which is if you could impart one lesson you learned from building your portfolio to the average investor,

[00:53:05] what would it be? I mean, the most important one is alpha is very, very hard for anybody to get. You probably don't have it. No, that actually is a great one because you still see so many people out there pursuing alpha, even though, you know, most of them probably won't, won't get it. Um, well, thank you so much for joining us. If people want to find out more about you, about what you're doing at damp spring, where can they go? At damp spring on Twitter or damp spring.com.

[00:53:33] Well, thank you very much for joining us and, you know, go enjoy yourself on the water. All right. Thanks Jack. You too. All right. This is Justin again. Thanks so much for tuning into this episode of excess returns. You can follow Jack on Twitter at practical quant and follow me on Twitter at JJ Carboneau. If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment. We appreciate it. Justin Carboneau and Jack Forehand are principals at Validia Capital Management.

[00:54:00] The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.