The Six Most Controversial Takes from Excess Returns in 2024

[00:00:00] A lot of old time value investing has become dogma. Cannot do this, you should be doing this. You have to have a margin of safety. Says who?

[00:00:07] If we look across global stock markets on real returns over like 30 year rolling windows, like the first percentile is a negative 94% return. And the top percentile, that 99th percentile is a 70x. That's a massive dispersion.

[00:00:21] I think most people have is of the dream laying in bed. You're like, oh, I just can't wait till I get to Hawaii, sitting on the beach, drinking pina coladas, letting that sweet, sweet passive income roll in.

[00:00:33] Options are not a derivative. They are the underlying.

[00:00:39] Welcome to Two Quants and a Financial Planner, where we bridge the worlds of investing and financial planning to help investors achieve their long-term goals. Join Matt Zeigler, Jack Forehand and me, Justin Carbonneau, as we cover a wide range of investing and planning topics that impact all of us and discuss how we

[00:00:51] can apply them in the real world to achieve the best outcomes in our financial life.

[00:00:54] Jack Forehand is a principal at Validia Capital Management. Matt Zeigler is managing director at Sunpoint Investments. The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital or Sunpoint Investments.

[00:01:04] No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital or Sunpoint Investments.

[00:01:12] So Matt, I think a lot of the podcast listeners would probably see me as, you know, this nerdy quant guy. But as you know, behind the scenes, I am wildly controversial.

[00:01:19] You are Mr. Controversial Take. Let me tell you, I've been out to dinner with this guy. You can't take him anywhere. The whole room just falls apart, crash and burn. It's all chaos anytime you're hanging out with Jack Forehand.

[00:01:32] I think anybody listening knows that's an outright lie, but I wanted to go with it anyway because I've always had this dream of being controversial. So maybe this podcast is about as close as I'm ever going to get to it.

[00:01:42] Because what we decided to do is we've done a bunch of interviews so far in 2024. And as we get towards the end of the year, we're going to do some wrap up episodes where we put together some of our favorite clips, not necessarily from one person like we've been doing the other episodes, but around certain topics.

[00:01:55] And one of the things I wanted to do is like, what are the most controversial takes we've seen in the podcast so far this year? And I came up with six of them that I think are really cool. And I think will be, I think any good controversial take, you might look at it and say, like, this is the most insightful thing I've ever heard in my life.

[00:02:12] Or you might look at it and say, it's outright wrong. Like, and if you have that break, like whenever I put these on Twitter, you get that. If you have that whole range of it, it's probably a really good controversial take.

[00:02:21] And this is important. Like the controversial takes help us. These are so valuable. I know we're going to get through a bunch of these and you watching at home think about this too.

[00:02:32] These controversial takes are so helpful because they help find the boundaries or the parameters or how we think about stuff.

[00:02:39] I look at all these takes and in my brain, I'm like, this is how, this is how I understand stuff. I have to like turn it up to 11 and turn it all the way off and understand where the extremes are.

[00:02:48] And it's takes like this that help push that, that mode of thinking out all the way to the extreme. So agree or disagree or look for the nuance in between it, which I know you and I is both Mr.

[00:03:00] Non-controversial in so many ways, or just introduced or just interested in introducing this nuance to a broader category of people to go like, bring in, think about this stuff.

[00:03:09] It's really interesting on these terms. And we have some brilliant examples of this type of thinking.

[00:03:14] Right. But also it's so important to look at the other side and investing and what creates a controversial take usually is where a bunch of people think something very strongly.

[00:03:22] And that's a lot of the things we're going to do today. And that can be me at times.

[00:03:24] Like there's certain ones that we're going to talk about today that I probably feel very strongly about, but it's really important to look at the other side of that.

[00:03:29] Yeah. And by the way, just to plug your episode that came out today with Ben Hunt and Grant Williams, like you did something, you did something on a topic that is the most polarized thing in the world right now, which is you guys talk some politics, but they did a really good job of going down the middle on it.

[00:03:42] And that's something I think all of us can learn from. And hopefully that's something we're going to, we're going to do today as we dig through these.

[00:03:47] I've, and I think this is one of my favorite things about markets people. I think this is one of my favorite things about just getting to know, you know, the individual client work that you and I do with people.

[00:03:57] People are nuanced too. And especially with markets people who are used to when the facts change, I change my mind type of thinking.

[00:04:04] They tend to be some of the most philosophical thinkers that are kind of like in, I want to call it in pop culture, but that are available to us.

[00:04:12] These are really nuanced, disciplined thinkers who have ways of going here are the boundaries and here's how I can do this.

[00:04:18] And then coexist in a world that I default recognize doesn't always agree to agree with me when you have like, you know, Grant Williams saying, if I could have voted, I would have voted for Trump and Ben Hunt on the other side going like I'm a never Trumper.

[00:04:30] And now they sit down and have an hour long civil conversation about all the nuance in this and where this goes.

[00:04:36] That's a real lesson on how to exist in the world. So I'm excited for us to do our milder version of this today.

[00:04:43] And I'm pretty confident you and I can have an hour long civil conversation too. The fireworks won't break out here.

[00:04:48] I won't stab you. You're safe.

[00:04:50] Right.

[00:04:51] So this first one was our, this is our most viewed interview of the year by a good amount.

[00:04:55] And this take, this actually was also my most liked Twitter post of all time, which again, is not a very high standard, but it's, this was Aswalt DeModeren talking about why he doesn't go to the Berkshire annual meet.

[00:05:05] The place terrifies me.

[00:05:06] It's full of true believers who think they've found the, the, I mean, the three words that come to my mind when I think about old time value investment.

[00:05:16] I'm not, I'm not tarring Warren Buffett or Charlie Munger with this, is it's rigid.

[00:05:24] It's, it's ritualistic, right?

[00:05:28] There are certain things you're supposed to do as a value investor, including going to Omaha, reading Ben Graham's security.

[00:05:35] I'll wager for every hundred people who claim to have read Ben Graham's security analysis, maybe one actually read the book.

[00:05:42] I've actually read the book.

[00:05:43] It's a, I've written hideously boring books, but next to Ben Graham, my books are like, you know, Harry Potter to read.

[00:05:53] And you're supposed to follow those, those, those, it's, it's very ritualistic.

[00:05:59] It's very rigid and it's very righteous.

[00:06:01] The righteous part really bothers me, which is they believe that the, they're the chosen ones.

[00:06:07] You hang out with people who come to Omaha.

[00:06:09] They've been coming for what, 30, 35, 40 years.

[00:06:12] They think they've found the one pathway to successful investing.

[00:06:16] And I have no problem with all of that.

[00:06:18] But then they look down at the rest of the world as shallow and stupid and not quite there.

[00:06:26] And I think that's one of the most dangerous things you can do in investing is to view the rest of the investment world with contempt because you've done the right things.

[00:06:37] So I don't know.

[00:06:39] I don't feel any joy in hanging out with a crowd that's convinced that it's, I mean, because that's, it's, it's a really, it becomes almost a religion rather than, I have faith.

[00:06:49] I just, I tell people investing is about faith.

[00:06:52] I have faith, but I have no, I don't believe in dogma.

[00:06:55] And a lot of old time value investing has become dogma.

[00:06:59] Cannot do this.

[00:06:59] You should be doing this.

[00:07:01] You have to have a margin of safety.

[00:07:03] Says who?

[00:07:05] Right?

[00:07:06] So I think that that's what bothers me about old time value investing.

[00:07:10] And again, you know, I think that, you know, Warren Buffett is actually a much more flexible investor than many of the people who claim to follow Warren Buffett.

[00:07:21] But I think old time value investing has created these sets of rules that they believe everybody should follow.

[00:07:28] And to me, there is no one pathway to success.

[00:07:31] I love Peter Lynch.

[00:07:33] I love Warren Buffett.

[00:07:34] I like what some things that George Soros does.

[00:07:37] Because I think there's something to be learned by looking at great investors in every different, in every philosophy.

[00:07:45] And if you ask me what's the best philosophy for me, my advice is look inward.

[00:07:50] Now figure out what makes you tick.

[00:07:52] Because that's going to tell you what the right philosophy for you is.

[00:07:55] It's not what worked for Warren Buffett.

[00:07:56] It's what's going to work for you.

[00:07:58] Yeah.

[00:07:58] So I think this is one of those cases where people kind of entrench themselves in this.

[00:08:01] And I think the answer is the gray area in between.

[00:08:05] Oswath is right that a lot of value investors get stuck in their ways.

[00:08:09] They feel like value investing is the only way to invest.

[00:08:13] They feel like a certain way to value invest is the only way to do value investing.

[00:08:16] And if you get trapped in that, you end up not seeing the other side.

[00:08:20] And so I think he's right from that perspective that people get trapped in that.

[00:08:24] And there are definitely people who go to the Berkshire Annual Meeting who would fall into that camp.

[00:08:28] But the side I would disagree with is I know a bunch of people who go to the Berkshire Annual Meeting.

[00:08:32] And these are the types of people that do look at the other side, that do say value investing is not the only way.

[00:08:38] Like our friend Tobias Parle is a great example.

[00:08:39] Like people who are very open to other approaches.

[00:08:42] So I think Oswath is right about this, but he's also not right about this.

[00:08:46] I mean, obviously, as a value investor, I tend to – anytime anybody comes after us, I tend to want to defend us.

[00:08:51] But I think the bigger point here is you've got to be – you don't want to be, as he described in the video, you don't want to be rigid no matter what your investment style is.

[00:08:58] You don't want to be ritualistic.

[00:09:00] You want to be open to other ideas.

[00:09:02] You want to be open to other processes.

[00:09:04] Do you remember or were you ever a fan of Little Rascals?

[00:09:07] I do remember it.

[00:09:08] It's like so long ago though.

[00:09:10] I can't tell you any details.

[00:09:13] This is the hazy, more probably like the 90s movie version than the original, but I'm pretty sure it was in both.

[00:09:19] The no girls allowed sign on the clubhouse.

[00:09:24] Do you share this weird cultural memory?

[00:09:27] This is kind of the point on the Berkshire.

[00:09:29] Berkshire is like a weird value investors club and like why not to go there meeting?

[00:09:33] And I think this is my interpretation of – my bad interpretation of Professor Devin Durant's comment.

[00:09:40] I see this as the boys club with the no girls allowed sign.

[00:09:43] We were like, that's cute that you've created this like church to value investing with your, you know, pope and whatever up there on the pulpit.

[00:09:52] But like the reality is – and this is where I think like a Toby or somebody else coming there fits in.

[00:09:58] It's really not a no girls allowed thing.

[00:10:00] Like there's plenty of smart people.

[00:10:02] There's plenty of people who'd be like, nope, no girls allowed.

[00:10:04] That's the way it goes.

[00:10:05] We're this funny little boys club in the woods.

[00:10:07] But I think in reality, most of the people who go there understand this is not the way the real world functions.

[00:10:13] And we might have something that we believe in, but we understand this like we don't exist in a vacuum.

[00:10:20] You know, you're going to see your favorite band play.

[00:10:22] It's like if you love Slayer, what are you doing at a Dave Matthews band concert and vice versa?

[00:10:26] Like I don't begrudge the people who go there.

[00:10:28] It's not exactly my thing and I'm not dying to go there.

[00:10:31] But hey, if I could have gone in, I don't know, 10 or 20 years ago, I probably should have.

[00:10:36] It would have been fun to see Charlie and to say, hey, just like I saw the Rolling Stones, I could say, hey, I saw, you know, Charlie and Warren in their day.

[00:10:43] I don't see any problem with that.

[00:10:45] And to your point, it's not for everyone and it's not for him.

[00:10:47] Like, yeah, the key is I think if you're doing anything like that, if you're doing anything where you're surrounding yourself with a bunch of people who agree with you,

[00:10:54] you've got to be careful that it doesn't affect your way of view the world.

[00:10:58] You don't come out of that thinking.

[00:11:00] And as he pointed out in the clip, Warren Buffett is not like this.

[00:11:03] Like Warren Buffett gathers all these value investors together, but he still is very open minded about the way he manages money.

[00:11:09] And so are many people who go there.

[00:11:10] So I think that's the key.

[00:11:12] And it's not just about the Berkshire meeting.

[00:11:13] It's about anything you do is like if you surround yourself with a bunch of, you know, growth investors, you could get trapped into thinking like this is the only way to invest.

[00:11:20] So the more you can surround yourself with people who disagree with you or the more when you do surround yourself with people who agree with you, you can realize, you know, that's not the only way the way the world works.

[00:11:29] I think you're OK.

[00:11:31] Yeah.

[00:11:31] What new thing am I going to get out of this?

[00:11:33] How is this going to help me grow?

[00:11:35] And I think his perspective is I go to this thing.

[00:11:37] It's just I can stand around patting myself on the back for a couple of days or whatever versus going to something that's actually going to push your attention forward.

[00:11:44] And, you know, I'll be the first one to say, like, last time I saw the Rolling Stones was Bridges of Babylon tour in the 90s.

[00:11:50] And they were they were they were wonderful.

[00:11:51] And I wanted to hear the old hits and I didn't need anything new from that concert.

[00:11:55] And if that serves a role in your life, that's fine, too.

[00:11:58] But always challenge yourself.

[00:11:59] Love that clip.

[00:12:00] Love that idea.

[00:12:01] So this next one is our good friend Jason Buck.

[00:12:04] And this is my opportunity.

[00:12:05] I always wanted to do a podcast cover that says Now Do Japan.

[00:12:08] And so when we had Jason on, I was like, I saw the topic.

[00:12:11] I'm like, I'm putting Now Do Japan on the podcast cover.

[00:12:13] Surprisingly, it didn't work as well, given that I sometimes overrate my podcast skills or my podcast cover skills.

[00:12:20] The actual cover of the episode actually did phenomenally well.

[00:12:23] But the cover did not get the click through rate I thought it would.

[00:12:25] So maybe my whole Now Do Japan idea wasn't as good as possible.

[00:12:28] But here's Jason talking about we're talking about the idea of stocks for the long run and whether it makes sense.

[00:12:35] So I think the rule of thumb I always like to use because everybody, unfortunately, will use different bookends for their time horizons.

[00:12:41] Right.

[00:12:41] Like you'll hear a hundred year return.

[00:12:42] And that's really like 1916 to 2016 or, you know, like 1920 to 2020.

[00:12:49] And it's like everybody's using kind of different bookends, which gives you a little bit different numbers.

[00:12:53] But the easiest one to think about long term.

[00:12:55] I think Meb Faber has done great publications on this.

[00:12:57] And I think some of it comes from the triumph of the optimist.

[00:12:59] But over the long, whether you want to use 100 years, 120, 180 years that we'll talk about later.

[00:13:04] The idea is the real returns.

[00:13:07] The rough heuristic I use is stock markets about six and a half percent.

[00:13:11] Let's call it seven percent because some some of those windows will say seven percent.

[00:13:13] So let's be optimistic.

[00:13:14] Let's say the real returns of the U.S. stock market are seven percent.

[00:13:17] The real returns of global developed stock markets are about five percent.

[00:13:21] Interestingly enough, the 60-40 portfolio over the really long term is about five percent real.

[00:13:26] Commodity trend followers do about four percent real compounded.

[00:13:30] Bonds, two percent.

[00:13:31] And, you know, bills are about a half to one percent over time.

[00:13:35] So that's the kind of rough heuristics we use is I think about as like seven, five, four, two, one gives you a rough idea.

[00:13:41] So inside of that global number, there's there's a big amount of dispersion with all these other countries.

[00:13:45] So what did you find when you looked at that?

[00:13:47] Because one of the things I've always wanted to say in a podcast is now do Japan.

[00:13:50] And so this is your opportunity to now do Japan.

[00:13:53] Yeah. So what we were looking at is, you know, there's a great book by Jeremy Siegel called Stocks for the Long Run.

[00:13:59] That is one of the bestselling books of all times in finance and investing.

[00:14:03] And more recently, Arnark Kilova et al. in the Journal of Financial Economics did kind of a takedown of that paper.

[00:14:10] Not necessarily a takedown, but they want to look at like developed economies globally going from, you know, 1841 to 2019.

[00:14:17] So there's like 180 year study of kind of global stock markets and thinking, you know, about real returns over those global stock markets or even nominal returns.

[00:14:24] It doesn't really matter.

[00:14:25] But like you're pointing out the dispersion, you know, 19 in using 30 year rolling windows, 1990 to 2020 for Japan is negative 20 percent, one percent real return total.

[00:14:35] So you had a 30 year period of being underwater in Japan.

[00:14:38] And it's interesting, like you said, that's usually the anomaly that people point to.

[00:14:42] And I wonder, you know, we like to throw it out there as anomaly because people don't want to deal with it.

[00:14:46] Like you said, now do Japan and people's brains kind of break because they're like, well, it just doesn't you can't count Japan.

[00:14:50] And so I always wonder why or how that happened.

[00:14:53] I really don't know the answer other than I really wonder if if I'm being compassionate towards my MMT friends.

[00:14:59] I wonder if that's the first time we really had that developed economy, have that underwater period, you know, post going off the fixed rate exchanges.

[00:15:06] And so maybe Japan is the leader.

[00:15:07] Maybe some of these other developed countries are going to see something that's, you know, similar to that in the future.

[00:15:12] But then you're talking about what is the actual dispersion of those returns.

[00:15:15] If we look across global stock markets on real returns over like 30 year rolling windows, like the first percentile is a negative 94% return.

[00:15:24] And the top percentile of that 99th percentile is a 70x.

[00:15:27] That's a massive dispersion in returns that gets you to an average of 7% CAGR on real terms.

[00:15:33] So like that's the kind of dispersion we're talking about from negative 94 all the way up to 70x.

[00:15:38] And then what they tout in the media is that your average is 7% CAGR.

[00:15:42] And we'll get to this is like, are you likely to be average?

[00:15:45] I'm not so certain of that.

[00:15:46] So, yeah, I think this is one of those things that it's an important thing to think about.

[00:15:51] And I don't even think even Jason is challenging the idea that stocks over a very long period do well.

[00:15:57] But also a lot of this is about how you define the long run and how an individual investor defines the long run.

[00:16:03] And for an investor in Japan, you know, I would think any investor defines 30 years as the long run.

[00:16:08] And there were investors in Japan who didn't get any return for 30 years.

[00:16:12] And so a lot of this is about expectations and understanding that, you know, just because we've had this really, really great outcome in the stock market in the United States, maybe we won't have a Japan type outcome.

[00:16:23] But it doesn't mean we can't have and we did.

[00:16:25] And we had with, you know, the last decade.

[00:16:27] It doesn't mean we can't have these extended periods where stocks don't give you any return.

[00:16:33] This just and that's it.

[00:16:35] Like if all you remember is that part, none of this is guaranteed to you, which we all say all the time.

[00:16:40] We know it's obvious, but none of this is guaranteed to you.

[00:16:43] And weird stuff happens.

[00:16:45] The the weird thing that always happens.

[00:16:48] I'm thinking about home country bias.

[00:16:49] I start thinking about I don't know if we're going to keep going down a weird dated pop culture reference this year or not.

[00:16:56] But this is just where my brain apparently is.

[00:16:58] My Fair Lady.

[00:16:59] Remember My Fair Lady fan?

[00:17:00] Is that at all on your radar?

[00:17:02] No, I know.

[00:17:04] Classic Broadway musicals.

[00:17:06] So this wonderful song.

[00:17:07] The character Freddie sings it about Eliza Doolittle on the street where you live.

[00:17:11] And it's this whole thing.

[00:17:12] You have this kind of like rags to riches social experiment thing going on.

[00:17:16] On one hand, we have this this woman from like, you know, the dumps, the ghetto basically getting like brought into high society and the person in high society like wandering around looking for it.

[00:17:25] But everybody comes into the table with these biases and these biases are going to mismatch and weird stuff is going to happen.

[00:17:33] Remembering Japan and I applaud your cover.

[00:17:35] Now do Japan like remembering there is a scenario.

[00:17:38] There's a way this plays out where you don't get at all what you're expecting.

[00:17:43] And Jason's point and how he lays this out here is just be careful with your assumptions because you might get horribly disappointed and you should have a way to do it.

[00:17:52] Bonus shout out like people who ran businesses in Japan, like lots of people survived just not from the stock market during that period.

[00:17:59] And that feels like a really important reminder here and now too.

[00:18:04] Yeah, and I think like challenging the idea of stocks for the long run doesn't necessarily mean he doesn't mean like you shouldn't be invested in stocks for the long run.

[00:18:11] I think what it means is a lot of people have this idea.

[00:18:15] I'm going to get my 8 to 10 percent in stocks.

[00:18:18] And if I extend my time frame as long as, you know, 10 years, that's a really long time frame.

[00:18:22] Like I'm pretty much guaranteed to get my 8 or 10 percent.

[00:18:24] And that's the problem is people have to realize that the time frame under which you can not only not get the 8 to 10 percent, but get something close to zero is longer than you think probably in the stock market.

[00:18:35] And that doesn't mean you don't invest in the stock market.

[00:18:37] It means you just invest understanding that.

[00:18:39] And that sort of leads into the way Jason manages money, which is he has a bunch of other stuff.

[00:18:43] And he talked in that clip about the different returns of different asset classes and managed futures and things like that.

[00:18:47] But he's a believer that, you know, given that reality, it might be better to invest a lot more broadly than just stocks.

[00:18:54] And that's sensible for some people and maybe not for others.

[00:18:56] But I think that's the bigger point here.

[00:18:59] It makes me think, too, about the Colin Roche point about the duration of different types of assets and this idea of having even just a diversified basket of very long duration assets.

[00:19:10] You know, you have your stocks, you might have your stocks in multiple countries and multiple currencies and have that alongside of perhaps your real estate or your crypto or whatever else.

[00:19:19] And understanding that philosophy of this is a long duration asset.

[00:19:23] There are some wacky outcomes.

[00:19:24] And am I diversifying amongst those wacky outcomes for the time when I might need to convert this back into money?

[00:19:29] Which, I mean, that's one of Jason's great big dominating ideas.

[00:19:33] And once you hear, you're not going to shake out of your brain.

[00:19:35] Like know what you need this for and when and then do everything you can to take as much of that risk off the table so you can live your life.

[00:19:44] So this next one is beyond my pay grade.

[00:19:46] So you and me both.

[00:19:48] This one terrified me when you said we were doing this.

[00:19:51] Options are not a derivative.

[00:19:54] They are the underlying.

[00:19:57] When people refer to options and all the volume increases and wow, the phrase that everybody uses, it's wow, the tail is starting to wag the dog.

[00:20:09] I'm here to tell you that options are the dog.

[00:20:13] What do I mean by that?

[00:20:14] Well, pretty simple.

[00:20:16] If you look at a stock or a bond or any asset, right?

[00:20:20] But people, it's two dimensions.

[00:20:22] Either goes up or down.

[00:20:23] What if I gave you two stocks, white label, no name on it, same market cap, same industry, same everything.

[00:20:31] You would say, well, those are the same stock.

[00:20:33] What if I peel back that option train and show you that one is incredibly right distributed with a left tail.

[00:20:39] The time at which that distribution is completely different and the growth trajectories are different.

[00:20:45] Whereas on the other one, it's the exact opposite.

[00:20:47] You know, very much a value stock, maybe left distributed, right fat tail in case they come up with a solution.

[00:20:54] Completely different stocks.

[00:20:56] The actual option.

[00:20:57] They're giving you nodes and probability across the full distribution of what this thing looks like.

[00:21:03] At the end of the day, that asset, whether it's a stock or bond, has a full three-dimensional picture of its characteristics of what the asset is.

[00:21:11] The asset itself is the thing.

[00:21:15] Not the stock price.

[00:21:17] Not the asset value.

[00:21:18] The asset value is just a summary of that full distribution.

[00:21:22] By arbitrage, every node on that distribution that represents this asset is summarized by one price,

[00:21:30] which is the asset price, the stock value, the bond value.

[00:21:35] Everybody started in that asset value, that very simple two-dimensional world.

[00:21:38] And derivatives are new, so we call them derivatives because they're derived from this thing.

[00:21:42] But the reality is they're not a derivation.

[00:21:45] It's a better technology.

[00:21:46] It's a better way to full.

[00:21:48] We're going from a two-dimensional sheet to, you know, a hologram.

[00:21:52] You're seeing the whole thing in its full essence.

[00:21:55] And the reason it hasn't been used more until more recently, but again, we've seen secular growth since I've been in the business for 25 years, and it's been exponential.

[00:22:04] But the reason is, is because of network effects.

[00:22:06] Much like a technology, even if it's a better idea, you need to build infrastructure for, and you need more volume,

[00:22:14] and you need more participants for it to be an act of it to become the core thing that people, everybody uses.

[00:22:21] What have we had in the last 25 years since I started in the business?

[00:22:23] When I started in 1998, we had one quarterly expiration in the S&P 500, and options were priced at every 3% to 5% in the market.

[00:22:36] That's it.

[00:22:37] Now we have every day.

[00:22:39] And by the way, the multipliers were 250.

[00:22:41] We have every day expiration.

[00:22:42] We have every five points in the S&P.

[00:22:44] We have options for every single major equity and every single asset across the world.

[00:22:52] We have more education.

[00:22:53] We have access through brokerage and regulation has thinned out to allow much more access.

[00:23:01] Not to mention we've gone from 250 multiplier to 100 to 50 to 10 to 1 to now 0.1.

[00:23:07] It is incredibly available now, and people are beginning to get educated, understand.

[00:23:12] But the reality is, we're still at the tip of the iceberg.

[00:23:15] It is a superior way to position based on information that you have on any asset.

[00:23:21] You can express any point without the same taking the full risk of the whole asset at any point in time or moneyness on that asset.

[00:23:30] And that is just a superior way to express information.

[00:23:34] So my view is that the world is going to options, and that option will be the primary way to invest in the future.

[00:23:43] And whereas even though notionally there's more trading volume, realistically, it's still 1% of total investment that happens in the market.

[00:23:51] And my belief is that if you look forward in 20 years, 40 years even, we will be in a completely different world where options sit at the core of investing.

[00:24:01] Awesome.

[00:24:02] We've never done this before.

[00:24:03] I mean, we try to, although we may not have informed opinions all the time, we try to have an opinion on everything on this podcast.

[00:24:07] But in this case, I think I might use one of my lifelines.

[00:24:10] Let's use a lifeline.

[00:24:11] I want to, who wants to be a millionaire, this one right here with you, because I don't want to try to answer this question.

[00:24:16] Who are we calling today, Jack?

[00:24:18] I think I am going to phone a friend here.

[00:24:20] And, you know, usually I guess on the show, what do they usually phone their dad or something like that?

[00:24:22] Like, unfortunately, my dad's not going to be helpful on this one.

[00:24:25] Neither of our dads are qualified for this call.

[00:24:30] So we're going to go ahead and phone our good friend Brent Kachuba, who is the founder of Spot Gamma and is definitely more qualified than us to talk about options.

[00:24:37] So, Brent, are you with us?

[00:24:40] Hello.

[00:24:40] Hey, Jack.

[00:24:41] What's happening, man?

[00:24:43] Not too much.

[00:24:44] Thank you for bailing me out here, because this one, this whole Jim Garcon quote is beyond my pay grade.

[00:24:48] I'm not really sure what to make of it.

[00:24:50] I mean, I know when I put it out on Twitter, I probably got like 600 likes, which for you is probably a standard Tuesday on Twitter.

[00:24:55] But for me is about as good as it gets.

[00:25:00] It continues both ways on this.

[00:25:01] I got basically, this is the most insightful thing I've ever seen in my whole life.

[00:25:04] And then I got like, this is out completely wrong.

[00:25:07] So what do you think about this idea that options are not a derivative, they are the underlying?

[00:25:12] Yeah.

[00:25:13] So the idea here is that as the Optus market grows, it changes the distribution of price.

[00:25:19] And so the idea is that when you have a lot of people buying call options or buying put options, that actually changes the underlying distribution via hedging flows.

[00:25:28] And so we just saw that happen in Tesla, I would argue, where Tesla was up 25, 30% in just the course of a few days.

[00:25:34] And at that same timeframe, we saw record call volume in Tesla.

[00:25:38] Last Friday, we traded 4.8 million contracts, call contracts.

[00:25:43] And so you can see that it's via these hedging flows in this options demand, that volatility starts to really increase.

[00:25:49] And I think associated with that is that the amount of underlying liquidity, in my view, is starting to decrease.

[00:25:55] So if you look at how many ETFs there are for like an NVIDIA or a Tesla, levered ETFs, the increase in sort of passive indexing, the size of passive indexing, that is gobbling up shares, right?

[00:26:08] Corporate buyback, that's all gobbling up the underlying shares.

[00:26:12] And so what happens is there's less underlying liquidity, and then you have more options, right?

[00:26:16] More derivatives, and that demands more hedging flows.

[00:26:19] And I think that really starts to move the amount, again, the underlying price distribution in ways that people aren't accustomed to.

[00:26:26] And so I obviously am an options person, so I tend to sort of side with gem members.

[00:26:31] And I think some people say, hey, on a macro basis, I don't quite buy into this yet.

[00:26:36] But you can definitely see these idiosyncratic examples like Tesla last week, and even NVIDIA really earlier this year,

[00:26:43] where those individual names also start to drive the underlying index.

[00:26:47] And then you see those big options positions driving the names that are driving the index.

[00:26:51] And so that is why I think that was such an interesting and arguably controversial take that gem had.

[00:26:57] Do you think, Wannery, the other point he made there is this idea that he thinks 10, 20 years from now,

[00:27:03] like way, way, way more people are going to be using options.

[00:27:05] Like it's going to be something like your everyday investor might do.

[00:27:08] I kind of have both sides of that.

[00:27:10] One is I think he's right, and I think you can make better bets on the distribution with options.

[00:27:14] But the other side of it is I always think about Ken Griffin and his yacht, and I'm like,

[00:27:17] or everyday investors do that in bulk, are they going to lose?

[00:27:21] So how do you think about that?

[00:27:23] Yeah.

[00:27:24] I mean, when you start to learn options, then you can learn about the different payout structures that you can set up.

[00:27:30] And also the defined risk-reward is so interesting.

[00:27:32] And so I think that for anybody that doesn't have, say, a one-year-plus view, then you start to say,

[00:27:38] hey, let's be like Nancy Pelosi and buy these weeps instead of buying stock.

[00:27:42] Because you have fixed risk, but also you can start to bet on the volatility of the underlying instrument

[00:27:47] in a more direct way, which I think is interesting.

[00:27:49] And I also think that we've seen the options grow, right?

[00:27:53] Volumes continue to grow.

[00:27:54] There's better offering.

[00:27:55] There's better access.

[00:27:56] And so it's a smarter investing public that's out there, and people are really starting to learn to use opt-ins in a variety of different ways.

[00:28:05] And I would just say, too, like with the Tesla example, we saw a lot of stock replacement trades, right?

[00:28:08] People who had made a bunch of money in Tesla stock, they want to keep a bullish position on it, but they want to take them off their table.

[00:28:15] So what do they do?

[00:28:15] They sell a bunch of their underlying stock position.

[00:28:17] They buy some calls, and they can still participate in the upside with fixed risk.

[00:28:22] And I think those types of setups are really advantageous for a lot of traders and investors.

[00:28:26] So, yeah, I'm happy Brent was able to do this because we couldn't.

[00:28:30] This is one, and I mentioned this with him, this is one of those things that it's like, it could be the most insightful thing of all time,

[00:28:36] or it could be something that's not right, and I can't really figure out the middle ground here with it.

[00:28:42] But I think it's interesting, and I think one thing that's absolutely right is people are using options more and more.

[00:28:48] And also, options do represent, I mean, stocks are like a two-dimensional thing.

[00:28:53] They go up or they go down.

[00:28:54] Options are more three-dimensional.

[00:28:55] I mean, they give you the ability to bet on certain outcomes, certain parts of distributions.

[00:29:00] So I think that is important to think about.

[00:29:02] And I don't know whether, I mean, you know, they believe stock options will become more widely used.

[00:29:08] And so far, they've obviously been incredibly right.

[00:29:10] I mean, I don't know if you've seen the chart about options usage, but it's going up and up and up.

[00:29:13] And maybe just like, I was thinking about this idea, because we talked about Ken Griffin and the idea that, like, when you use options, you just benefit Ken Griffin.

[00:29:19] But maybe something we haven't seen coming in terms of, like, we always thought, like, investing in index funds has come way, way, way down from what it was.

[00:29:27] So maybe at some point, you know, if people start to use options more and more and more, like, the cost of using these options is going to go way, way down.

[00:29:33] And maybe they're going to be more usable for the average investor.

[00:29:36] It's really interesting, because on one hand, I hear what Brent is saying about maybe more and more people will use this.

[00:29:43] And I'm still hung up on that whole, like, dog, tail wagging, dog, dog wagging tail.

[00:29:48] Is the dog Cujo in this scenario?

[00:29:50] Like, I'm so confused by that.

[00:29:51] But this idea of, and this is, I'm torn on this too, because I see this going up, but I see this going up less for hedging and more for speculating and use.

[00:30:02] It feels like more of the demand is for speculating and granted, like, the big players need it for hedging because it's the way you control around flows when where the flow is happening is changing.

[00:30:12] I want to say, I'm pretty sure Grant Williams brought this up in the conversation I just did with him and Ben Hunt.

[00:30:17] Grant was like, in 10 years, do we actually find out, like, zero DTE options were a terrible idea?

[00:30:23] And we just have gotten rid of them.

[00:30:25] And this is where I'm somewhere in the middle on this.

[00:30:28] I don't know what societal good or what with capital formation any of these things is doing that actually benefits corporations, society, the world at large.

[00:30:40] I see the speculation side.

[00:30:42] I don't fully understand the other side of this business.

[00:30:44] Do you have any thought on that or any insight?

[00:30:46] Yeah, well, I mean, I think you're right.

[00:30:47] I mean, the one thing we have to say is, like, you know, buying GameStop call options, if that ends up being what people are using the options for, we've got major problems on our hands.

[00:30:55] Right.

[00:30:55] That's not good.

[00:30:56] The question is, as part of, like, a sensible investment strategy.

[00:30:59] So, like, for instance, like, our friends at Simplify have an ETF that is, like, long the S&P 500 but buys some out of the money puts to hedge.

[00:31:05] Like, are there things, you know, if the cost of options go down, are there things like a sensible investor who's buying, you know, major indices and not betting on crazy meme stocks?

[00:31:15] Like, are there things they'll be able to be doing in 10 years from now in their portfolios that they're not doing now, maybe using these options in a sensible way and not in the crazy way that a lot of people are using them?

[00:31:25] As we record here, you know, the Tesla squeeze has been going on and there's been some craziness in options.

[00:31:30] But will there be more sensible ways people use them?

[00:31:32] I mean, I don't have the answer.

[00:31:34] And that's why we brought in Brent, because Brent and Jim are both much smarter than I am.

[00:31:37] Yeah, I'm fascinated with this, especially with my, you know, the planning and allocator hat on, because whether it's some of the, you know, the call writing strategies, whether it's some of the risk hedging strategies, some of this stuff and what's available in ETF wrappers in the last couple of years alone.

[00:31:52] So it's pretty staggering how cool and how useful they are.

[00:31:57] I just can't tell where it's going.

[00:31:59] And that's why people like Brent are just indisposable to me for helping just think through this stuff, because it's fascinating.

[00:32:05] And I will say, especially coming out of coming into the end of 2024 here, some of those products and some of those vehicles have just been really incredibly useful tools.

[00:32:15] And without a deeper option market, I don't think they could have existed.

[00:32:19] So this next one is another thing that people, going back to Asuas, rigid and ritualistic.

[00:32:24] This next one is one that people tend to get rigid and ritualistic about as well.

[00:32:28] And if there was an annual meeting of dividend investors, it would probably be far, far more extreme than anything going on at the Berkshire annual meeting.

[00:32:37] But this next one is from Meb Faber.

[00:32:39] And we had a whole episode.

[00:32:40] We could have used anything from the Meb Faber interview on this, because we talked about things that Meb believes that 75% of investors would disagree with.

[00:32:46] So we could have put all kinds of takes from that in this thing.

[00:32:48] But we chose this one, which is Meb talking about why dividends alone are not a good way to invest.

[00:32:53] So, you know, we wrote a book a decade ago called Shareholder Yield, A Better Approach to Dividend Investing.

[00:33:00] And that's a pretty ballsy subtitle, right?

[00:33:04] Because Morningstar did a recent report where they outlined they were looking at dividend funds and there's over 300 of them managing over a trillion dollars, right?

[00:33:13] So you're kind of coming at one of the most beloved brands and narratives of the past 100 years, right?

[00:33:21] And so we're updating this book, listener, so hopefully it'll be out before year end.

[00:33:26] But you can download the last version free online.

[00:33:29] But in the beginning, we demonstrate.

[00:33:30] We say, hey, look, you know, here's your return if you only had price return of U.S. stocks for the past 100 years.

[00:33:39] And here it is if you had reinvested the dividends.

[00:33:42] Now, the key phrase in all of this is reinvested dividends.

[00:33:45] And I've been combing through a lot of the academic literature.

[00:33:49] And the consensus seems to be that most people don't reinvest their dividends, at least in the same proportion of what they invested in.

[00:33:57] And the fantasy I think most people have is of the dream, laying in bed.

[00:34:03] You're like, oh, I just can't wait till I get to Hawaii, sitting on the beach, drinking piña coladas, letting that sweet, sweet passive income roll in, right?

[00:34:12] And so there's nothing wrong with dividends.

[00:34:15] They are very much a part of the investing stream.

[00:34:18] But if you live in a high tax state like I do in California, the last thing in the world you want is dividends and high dividends.

[00:34:27] And so do dividends outperform historically, meaning high dividend yield?

[00:34:31] Yes, they do.

[00:34:32] Now, that factor, as we all call them, tends to put you in a little bit junkier companies, right?

[00:34:38] But it gives you this value tilt, which, in my opinion, is really what you're looking to get, right?

[00:34:43] You want to have that value tilt.

[00:34:46] But if you're going to do value, my opinion is always just do value.

[00:34:50] Don't do a cousin of value, dividend yield.

[00:34:53] And so there's a million different ways you could do this offshoot where, you know, we wrote probably our least downloaded or read paper was one that was targeting no yielding stocks.

[00:35:06] And we said, hey, if you did a value tilt and targeted no yielding or low yielding stocks, you ended up with a higher after-tax return and a taxable count than if you invested in high dividend yield or the broad market.

[00:35:21] You know, so there's all sorts of different ways you can go to this.

[00:35:24] But the whole key being that I think, you know, the analogy we use in the book update that's an old blog post is we liken it to the old Coke, Pepsi taste test.

[00:35:34] You guys remember that?

[00:35:36] So for the young listeners under here who don't know what this is, you know, everyone prefers Coke.

[00:35:43] And if you do a blind taste test, most people prefer Pepsi.

[00:35:48] But then you reveal it, most people go back to Coke.

[00:35:50] And a lot of this has to do with branding, I don't know, commercials, marketing, what your parents, maybe you just like Warren Buffett, big Coca-Cola drinker.

[00:35:59] Anyway, I think it's the same thing was true with dividends.

[00:36:01] They have a great narrative, a great story.

[00:36:04] Don't even get me started on buybacks because that's the next 50 minutes of this discussion.

[00:36:09] I'm trying to keep these short because we got 20 of these.

[00:36:13] But if you do the whole column list of things that are horrific, terrible, no good, very bad ideas, and the other list is things that are probably totally fine.

[00:36:24] Look, dividend investing is totally fine.

[00:36:26] It's not the worst thing in the world.

[00:36:27] But if you get me into the is this optimal question and why are there better choices, there's certainly, I think, better choices and better ways to do it.

[00:36:38] My first take on this is I actually do prefer the taste of Coke over Pepsi.

[00:36:42] And I don't think it's just because it's Coke.

[00:36:44] I actually do.

[00:36:45] I think I prefer the taste.

[00:36:46] I mean, maybe I've been programmed by the marketing, but I do think that's the case.

[00:36:50] Well, you know, if the nice people at Pepsi want to send out the vintage thing, Ray Charles can sing it to you, Beyonce can hand it to you, and then we'll see what you think in that blind taste test.

[00:37:03] But this idea about dividends, and I think his point was a good one, and this goes back to the whole black and white and no gray area thing, is like people who are favored dividends will listen to that and be like,

[00:37:13] Meb is saying that under no circumstances should dividends be part of an investment strategy.

[00:37:17] And he's not saying that.

[00:37:18] What he's saying is dividends alone are probably, you know, are probably not a great thing to use.

[00:37:25] And there's probably better ways, if you're focusing in dividends as your primary criteria, there's probably better ways to accomplish what you're trying to accomplish.

[00:37:33] If you're trying to buy cheap stocks via dividends, you can probably use other value metrics and get not only better returns, but probably more tax-efficient returns.

[00:37:41] If you're trying to get money out of your portfolio and you believe like dividends are some sort of magic thing, you might be better off using a synthetic dividend where you can create the dividend on your own.

[00:37:50] So I think that's the bigger thing is it's not a black and white thing.

[00:37:53] Dividends are great or dividends are horrible.

[00:37:54] It's that maybe dividends should not be the only thing you use in selecting stocks for your portfolio.

[00:38:00] It's whatever, whatever vehicles you're choosing to invest in, whether it's a stock or a fund or whatever else, if it's going to distribute money in any way, shape or form, you as the investor have to ask the question.

[00:38:12] Does this, does this distribution work for me?

[00:38:15] How am I being taxed on this thing?

[00:38:17] And that's such an integral part of all of being a long-term investor or doing any type of planning, especially if you need to spend down some of the money.

[00:38:25] There's lots of ways to do this efficiently and inefficiently.

[00:38:28] Meb's point stuck with me a long time on this since he wrote that initial, you know, paper or blog post about this because it's just, it's so obvious.

[00:38:36] People who get hung up on, oh, I got to have dividends.

[00:38:39] I never want to spend principal or whatever else, but then just rack up all this income that then gets reduced by the tax rate.

[00:38:44] It's if you take five minutes and write it down on a piece of paper and get the calculator out and, you know, do this.

[00:38:52] Most of these people will go like, whoa, that's an insane amount of drag.

[00:38:55] I am self-imposing on myself by doing it this way.

[00:38:59] Just forcing people to get this question out onto the table.

[00:39:02] I applaud Meb every day for making this comment.

[00:39:05] It's so smart.

[00:39:07] What's interesting too is Meb is putting his money where his mouth is a little bit because I believe his, his new dividend or his new ETF tax that's coming out.

[00:39:14] I believe the underlying strategy is going to be value with no dividends.

[00:39:18] So that's an interesting like extension of this is, well, if, if dividends are tax inefficient and there's better ways to do value, you can just do pure value and not worry about dividends.

[00:39:27] But you also could do pure value and say like, to make this more tax efficient, I'm going to get rid of the stocks that pay high dividends and the dividend people must really hate that.

[00:39:34] Yeah.

[00:39:35] Yeah.

[00:39:36] There's definitely some stuff where you're going in and you're just, you know, yelling profanities in the church on some of this stuff, but the logic stands and you have to force that conversation in with, with, you know, look, if you love dividends, like we're not here to convert you.

[00:39:52] But the reality is you're paying tax on these distributions.

[00:39:55] If paying that tax shoots you wonderful.

[00:39:58] If it doesn't, there's lots of other options.

[00:40:01] And that's why points like the one Meb is making here is just, it's just profoundly useful for people to hear.

[00:40:08] So this, that we have two more to go here.

[00:40:10] And this, this one is maybe more controversial in my world.

[00:40:12] Your average person may not be that concerned about this, but I'm very concerned about it, which is we had Alejandro Lopez-Lear and Andrew Chen on the podcast.

[00:40:20] And all of us who follow factors, whether it's value or momentum, we're trained that if you're going to follow these factors, there's got, you have to be able to explain why they work.

[00:40:29] And we, we usually have two different explanations.

[00:40:31] We have like a risk-based explanation.

[00:40:33] So I get outperformance from value stocks because they're riskier, or we have a behavioral explanation, which would be like people are overestimating the problems of these value stocks.

[00:40:41] And if they do that across a wide number of stocks, I can buy a basket of stocks and I can benefit as they realize that all the problems aren't really that bad.

[00:40:48] So we have these two explanations, but an interesting thing could be, what if I take financial statement data?

[00:40:54] And what if instead of having these explanations, what if I just start dividing numbers by other numbers?

[00:40:59] And then I'll have these factors that basically have no explanation and see how they work.

[00:41:04] So here's them talking about their paper where they did this.

[00:41:06] So you could think of, there's four, at least four ways to come up with an anomaly or trading strategy with unusual returns.

[00:41:15] One, one is to think about risk and try to think about the sources of risk and then to identify exposure to that risk.

[00:41:21] Another one is to think about mispricing and behavioral biases and think about which stocks will be underpriced and overpriced.

[00:41:28] Another one is to kind of do a combination of both.

[00:41:32] You're not really sure which it is, but you do a robust enough job that you can get published in a top finance journal, which is, you know, very sought after in my community.

[00:41:40] And the fourth thing you could do is you can just mindlessly search accounting data and look for trading strategies.

[00:41:46] Just look for anything that worked well in the past.

[00:41:48] Just naively backtest like everything that you have.

[00:41:52] And you would think based off of just the difficulty of these things, it's so easy to naively backtest compared to come up with a risk-based theory that you publish in a top journal.

[00:42:01] You'd think that going through all those bells and whistles, adding all those bells and whistles, jumping through all those hoops would get you something in terms of how the performance of that strategy looks after your original sample.

[00:42:15] You know, so we're going to compare what we do is we take these four different ways of making anomalies and we compare like the in-sample period.

[00:42:22] Like so for Fama French's famous papers in 1992, we'll compare the data from 1963 to 1990 to the anomaly returns after 1990 until today.

[00:42:35] And you would think that if you do all that work, you would get better out-of-sample performance.

[00:42:40] But it turns out that the answer is no.

[00:42:43] It's about the same no matter what you, all those four different approaches lead to about the same kind of out-of-sample performance.

[00:42:51] Yeah, perfectly well said.

[00:42:53] I would say the other, Andrew has a very nice thought experiment.

[00:42:57] I'm going to change it a little bit so it resonates more with the audience.

[00:42:59] But suppose you have an analyst that comes to you and tells you, well, hey, you know, I found this strategy that has like a very high T-stat, like a very high statistical significance, like above like three.

[00:43:09] Right.

[00:43:10] And it has a very, you know, good average return.

[00:43:13] And then you ask like, okay, how did you come up with it?

[00:43:16] Right.

[00:43:17] And the expectation is that if the analyst tells you, well, I just, you know, I actually have like this theory about how this type of firms should be underpriced because, you know, it's just hard to value this specific metric.

[00:43:29] You would normally expect that strategy to perform differently.

[00:43:32] That if your analyst just tells you, well, I just tested 10,000 strategies and this one was that had like the highest, you know, one of the highest average return and one of the highest T-stat.

[00:43:43] Normally, Andrew tells it with a PhD student, but I guess it's more clear with the analyst.

[00:43:47] And, you know, it's actually an empirical question whether these two strategies would perform different.

[00:43:53] Right.

[00:43:53] We would really expect that the theory one should do better, but it's something that we're trying to test in the paper.

[00:44:00] So, yeah, we actually should do a whole episode on this at some point because we've gotten a lot of takes from our various guests and interviews about this.

[00:44:07] And we've gotten a wide variety of takes.

[00:44:09] But you and I did an episode with Cliff Assness that's coming out a few days after this episode.

[00:44:14] And I was kind of surprised to get his take on this because a lot of the people we get their takes on this have been, this is just wrong.

[00:44:21] Like we've all been trained again, going back to what we talked about before.

[00:44:24] It's been ingrained in us.

[00:44:25] Like if these factors aren't intuitive, you can't use them.

[00:44:28] But Cliff was very, very open to this paper.

[00:44:30] He was very complimentary of this paper.

[00:44:32] And he kind of said, although I still believe in the intuitive thing, like what we're doing at AQR is slowly moving to this idea that maybe my factors don't have to make sense.

[00:44:41] If they hold up in the data, if they hold up out of sample after the testing, maybe I can use some of these factors, even if I'm not exactly sure why they work.

[00:44:51] So I'm with you.

[00:44:52] When Cliff said that to us, it was one of those things where I believed everything that I heard when I read this paper and you guys had them on and did this interview.

[00:45:02] But hearing somebody like Cliff has to say at our firm, we're slowly moving the needle more towards stuff like this.

[00:45:08] So this rhymes with the reality as I'm experiencing and what I can do.

[00:45:11] And I still can't wrap my bread, my brain all the way around it because I feel like there still must be.

[00:45:17] I don't know if you feel like this too.

[00:45:18] There must be some intuitive explanation for this.

[00:45:20] There must be the risk-based or the behavioral-based thing behind this.

[00:45:24] But I almost wonder if this is ways to tease out stuff that you can't quite understand.

[00:45:29] Like you can't quite understand that second or third thing.

[00:45:31] So it doesn't make sense that the S&P goes up when there's more Nick Cage movies or something like that.

[00:45:37] And I know that's not what they're testing.

[00:45:38] But this idea that there are just knock-on effects and other weird things that are happening that you can use math to tease out those correlations.

[00:45:47] And there's some actual single there.

[00:45:48] They're not just spurious.

[00:45:51] It almost feels like this has to exist.

[00:45:53] And I'm happy that they're proving it and forcing this conversation.

[00:45:56] I'm fascinated.

[00:45:56] What do you think?

[00:45:57] Well, they basically covered in the episode exactly what you're saying, which is you can probably go after the fact.

[00:46:03] Like if I'm dividing cost of goods sold by accounts receivable or something, that's my factor.

[00:46:08] So on the surface, like why would I do that?

[00:46:10] That doesn't seem to make any sense.

[00:46:11] But let's say that's one of the ones, and it might be one of the ones, they found that actually continued to work out a sample.

[00:46:17] So there's probably a way to go back after the fact and explain why that works.

[00:46:22] There probably is.

[00:46:23] And they kind of said, like we could have done a lightning round with them in the podcast and we could have come up with these random factors.

[00:46:28] And they probably could have come up with an explanation.

[00:46:30] So it's not necessarily that an explanation doesn't exist.

[00:46:33] There might be an explanation that exists.

[00:46:35] But these were factors that were not tested in these.

[00:46:37] They started with test factors that were tested in other people's papers where other people had come up with the explanations.

[00:46:42] And they just found these themselves.

[00:46:44] And so they were arguing like maybe I could come up with an explanation.

[00:46:47] So I think that maybe is part of it.

[00:46:49] Maybe there is some explanation behind the surface that is explaining what's going on here.

[00:46:53] We just don't know what it is.

[00:46:54] And does it matter?

[00:46:56] Like do we have to have, and this is, I get the sense this is what Cliff's talking about when he's talking about how they're harnessing this.

[00:47:03] Does it actually matter that you understand the intuitive thing up front or that you even ever figure it out on the back end if it works?

[00:47:11] Because like if it works, so long as it's not working against you in some way, shape, or form,

[00:47:16] they're not doing this to go, ha ha, we proved a new physical reality and here's, you know, the 13th dimension of time, space, whatever.

[00:47:24] Like they're literally just going, this is something that makes sense and is repeatable.

[00:47:28] This is something that makes sense and is producing it.

[00:47:31] That point you made is the key point.

[00:47:33] Right.

[00:47:33] Which is, so I don't know if you, there was a quote from Robert Mercer, I believe it's Robert Mercer, of Renaissance,

[00:47:37] who basically said something along the lines of like our factors that work best make absolutely zero sense.

[00:47:42] Um, and so at Renaissance and they're obviously short-term stuff, they're not doing what long-term investors are doing.

[00:47:48] They don't care whether it makes sense.

[00:47:49] If it holds up in the data, they do it.

[00:47:52] And that might be, especially with machine learning coming out and Cliff touching this a little bit,

[00:47:56] that might be the way all of us are going here a little bit.

[00:47:58] If we have, you know, if we have the data to back up what we're doing,

[00:48:02] but we can't necessarily explain exactly why it's working.

[00:48:06] I think all of us are probably going to be using that kind of stuff more and more going forward.

[00:48:10] And we're going to be relying a little less on this idea that it has to be intuitive.

[00:48:16] That it doesn't have to be intuitive that we can, we still have to trust, but verify.

[00:48:22] And we still have to call out stuff that's, that's BS.

[00:48:25] Cause there's still going to be stuff that BS, but that should be stuff that you could immediately test and ask.

[00:48:31] You're familiar with the whole, um, um, like, you know what it's called?

[00:48:34] Uh, the, the whole thing about like 50,000 as like, as one of these like mystery numbers that just like shows up over and over again.

[00:48:42] It's the ultimate.

[00:48:44] It's not too small and it's not too big.

[00:48:46] Like if you said this happened to 200 people, people will go like, ah, that's, that's too small.

[00:48:50] I don't care.

[00:48:51] But if you say it happens to 10 million people, then people are like, whoa, where'd you get that number?

[00:48:54] So you can say 50,000 about a lot of things.

[00:48:56] And people will be like, yeah, that checks out.

[00:48:58] So in like the eighties, they were like the Satanists, they're kidnapping and murdering children, like 50,000 a year.

[00:49:04] And you're like, oh my God, that's terrifying.

[00:49:06] Doesn't sound too big.

[00:49:07] Doesn't sound too small.

[00:49:08] So it just permeates everything.

[00:49:10] It ends up all the way like Chris Hansen and like the, to catch a predator stuff.

[00:49:13] And, uh, it's just a, it's a death magnet for like weird stuff that they couldn't explain.

[00:49:18] But then as soon as you peel back the layer a little bit more, you go like, oh, uh, you know, you can't have 50,000 deaths by Satanists when there's only 20,000 homicides in the country and stuff like that.

[00:49:29] So the amazing thing here is they're, they're lasering on in on a trend and they're saying, we see this stuff in the data, but we actually have proof that it's working.

[00:49:36] It's not a BS claim.

[00:49:38] It's a verifiable thing.

[00:49:40] It's okay.

[00:49:41] If we don't understand why there's, there's actually some public good in this too.

[00:49:46] And that's part of why I'm so excited.

[00:49:47] I'm still just so excited about this paper.

[00:49:49] I love something that does not seem to cause harm, but gives us new information about the world we operate in.

[00:49:56] So this last one is we're going back to Asolat the Motor.

[00:49:58] And we could have probably played like most of his episode in this song because there were all kinds of takes that people would probably consider controversial.

[00:50:04] But this is him talking about why he's okay not beating the market.

[00:50:07] I invest actively because I enjoy investing.

[00:50:10] I invest actively not because I want to beat the market, but because I enjoy investing.

[00:50:16] Which means that when I invest, the one thing I have to do is remember the Hippocratic cult, which is do no harm.

[00:50:23] Don't do things in your portfolio that could cause you calamitous costs.

[00:50:31] For instance, I diversify.

[00:50:34] I hold 40 plus stocks in my portfolio.

[00:50:37] That would be a no-no with old-time value investing where you said concentrate.

[00:50:41] No.

[00:50:42] Why not?

[00:50:43] Now people say, don't you feel confident enough in your big winners?

[00:50:47] No, I don't.

[00:50:48] You might, I don't.

[00:50:50] Because I know how many things I don't control.

[00:50:54] Imagine buying Marriott in December of 2019 because you felt confident it was undervalued.

[00:51:01] You might have been right.

[00:51:02] But two months later, COVID hit and there goes your rightness.

[00:51:06] There are too many things I don't control.

[00:51:09] It's hubris to think that you pick the five best companies in the market.

[00:51:14] So I diversify.

[00:51:17] I try to buy undervalued companies.

[00:51:21] But here's the bottom line, though.

[00:51:23] If I get to be 85 and you came to me on my deathbed and said, you know what?

[00:51:28] You could have made 50 basis points more or 25 basis points more a year by investing in index funds

[00:51:35] instead of doing what you did, value companies and buy cheap companies.

[00:51:38] And you ask me, are you okay with that?

[00:51:41] My answer is yes.

[00:51:43] I'm okay with not beating the market.

[00:51:47] And that, I think, is critical.

[00:51:48] Because if you keep telling yourself, I did the right thing, therefore I should beat the market,

[00:51:53] therein lie the seeds for being righteous, for being indignant, for getting angry.

[00:51:58] I mean, when you get angry at markets, nothing good comes out of it.

[00:52:03] And if you think about it, there are a lot of people out there very angry at markets, very angry at other investors.

[00:52:09] They're very angry at what other people do.

[00:52:11] And my response is, you're wasting your time and your energy, and it's sucking up what you should be doing on your own investments.

[00:52:20] So, if I end up underperforming the market, I'm perfectly okay with that.

[00:52:24] And I think this is great.

[00:52:26] I think this might not be applicable to everybody, but I think to him or to someone like him, I think this is great.

[00:52:32] I mean, he gets a lot of joy out of doing his valuations, picking the stocks for his portfolio.

[00:52:38] If he underperforms the market by a half a percent or something over the course of his life, it's not going to change his life that much.

[00:52:46] He's getting benefit personally from doing it.

[00:52:48] Now, I think where you run into a little bit of danger is if you carry this to your average person who doesn't care that much about the stock market,

[00:52:54] that person should probably be buying index funds.

[00:52:56] That person should probably not be saying, I'm okay underperforming by half a percent, even though I don't really like building this portfolio.

[00:53:02] I think this is sort of unique to people like him and like me who enjoy this stuff and get a lot of benefit out of doing it.

[00:53:10] There's this weird thing, and he says it right at the beginning with the first do no harm and this Hippocratic Oath.

[00:53:17] I think we talk a lot about, especially in a fiduciary world and everything else, we talk about this like Hippocratic Oath or taking care of others and first do no harm.

[00:53:25] We don't often enough talk about the Hippocratic Oath to ourselves to first do no harm to ourselves.

[00:53:32] If you love investing, if you love value investing and whatever else, and this is part of your own identity and what brings you joy and happiness in the world,

[00:53:39] so long as you're not doing harm to yourself, so long as you're not just doing like reckless gambling or something that's damaging to you,

[00:53:46] if you want to go out and evaluate, you know, like Uber pre-IPO and run a bunch of regressions on figuring out the history of this stuff like Aswatt does, amazing.

[00:53:55] First, do no harm to yourself.

[00:53:56] Likewise, if you hate this stuff, you shouldn't torture yourself and try to think you have to understand all the facts and numbers and everything else.

[00:54:03] You can just go buy an index fund.

[00:54:04] It's okay.

[00:54:05] Do no harm to others, but also do no harm to yourself and lean all the way into that because if you really enjoy this, you don't have to beat the market because you can actually make yourself happy by doing this thing.

[00:54:17] Like, it's a downright poetic piece from the professor there.

[00:54:21] And that's a really important point because if I get an incredible amount of joy out of buying GameStop call options, I still shouldn't do it.

[00:54:28] Because there's a level of, you know, this is, he's talking about, well, if I'm 50 basis points behind the market over the long term, like if you're doing that, you're not going to be 50 basis points behind the market long term.

[00:54:38] You're probably going to be broke.

[00:54:39] And so there's obviously levels to this.

[00:54:41] Like what he's saying is if you really love doing this and you're producing something close to the market returns.

[00:54:46] And also, by the way, Oswalt has probably a very large portfolio.

[00:54:50] He's probably not worried about like how he's going to get by in retirement.

[00:54:53] Like somebody who is very worried about how they're going to get by in retirement, like half a percent a year over their lifetime might be a huge deal.

[00:55:00] Like for them, they may not be able to do that.

[00:55:02] But what he's saying is for someone in his specific situation, someone who loves doing it, someone who's got enough money that it's not going to kill them, he's not going to regret it if he underperforms.

[00:55:10] And I think that's important because I think everybody, some people will say like if you underperform, it's a catastrophe no matter what.

[00:55:15] And I think, again, going back to this idea we've talked about with the gray area, nothing's black and white.

[00:55:20] You've got to look at the circumstances.

[00:55:21] And for him and people like him and people like me, you can accept if you underperform, if you like doing it.

[00:55:27] You wouldn't take your whole paycheck every single week and just go to the store and buy, you know, scratchy lottoes.

[00:55:32] You wouldn't take your whole savings account, break the piggy bank, empty out the 401k and go buy, again, like scratchy lottoes.

[00:55:40] Pick the most ridiculous, egregious thing.

[00:55:41] All this is saying is like find a healthy behavior that guides yourself forward and then be nice to yourself about what you like.

[00:55:49] Get the returns you need to get and the way you want to get them.

[00:55:52] But if, you know, if you do all that stuff first and then you get that pleasure out of day trading the GameStop call options, like God bless you do with a small amount of money.

[00:56:01] Just the same way, you know, somebody else goes off and buys their scratchy lottoes.

[00:56:05] It's OK.

[00:56:06] Just don't hurt yourself.

[00:56:08] So I guess that's something good to wrap up on.

[00:56:11] This is about as wildly controversial as I'm ever going to get.

[00:56:13] So for people who are like, that's not possible.

[00:56:15] It is.

[00:56:16] This is basically the wildest you're going to get out of me.

[00:56:19] Wild man Jack Forehand unleashed.

[00:56:24] Excessive returns.

[00:56:25] That's what these are.

[00:56:26] We should put it on the YouTube cover, Jack Forehand unleashed.

[00:56:29] That could be the lowest click the rate of any cover.

[00:56:31] Tearing the shirt off.

[00:56:33] Tearing the shirt off.

[00:56:34] Literally not one person will click on the cover.

[00:56:35] Sorry.

[00:56:36] I'll click on it.

[00:56:37] That's for you.

[00:56:38] Don't worry.

[00:56:38] Well, thank you.

[00:56:39] Maybe my dad or something, even though he'll be like, why are you doing this?

[00:56:41] I literally did.

[00:56:43] So anyway, anybody, thank you for joining us.

[00:56:46] We'll see you next time.

[00:56:47] Hi, guys.

[00:56:47] This is Justin again.

[00:56:48] Thanks so much for tuning into this episode.

[00:56:51] You can follow Jack on Twitter at Practical Quant.

[00:56:54] You can follow me on Twitter at JJ Carbono and follow Matt on Twitter at Cultish Creative.

[00:57:00] If you found this discussion interesting and valuable, please subscribe in either iTunes

[00:57:05] or on YouTube or leave a review or a comment.

[00:57:08] Also, if you have any ideas for topics you'd like us to cover in the future, please email

[00:57:12] us at excessreturnspod at gmail.com.

[00:57:15] We would like this to be a listener-driven podcast and would appreciate any suggestions.

[00:57:19] Thank you.

[00:57:20] Thank you.