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csinvesting demons

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This is a great mental discipline. I had Thomas Jefferson over my bed at seven or eight. My family was into all that stuff, getting ahead through discipline, knowledge, and self-control. I think that you learn economics better if you make Adam Smith your friend. That sounds funny, making friends among the eminent dead, but if you go through life making friends with the eminent dead who had the right ideas, I think it will work better in life and work better in education. And if you take Warren Buffett, if you watched him with a time clock, I would say half of all the time that he spends is just sitting on his ass and reading.

And a big chunck of the rest of the time is spent talking one on one, either on the telephone or personally, with highly gifted people whom he trusts and who trust him. We want to get the facts, and then think. One is fluctuations in asset prices. We all know what that is. And a few months later, we forgot it. The other kind of risk is actually more profound, and it's the possibility that our general expectations for assets are wrong.

Going forward, it's pretty unlikely that they're going to do that over the next 20 or 30 years just because of the high prices. Even if economic growth were as rapid in the future as it was in the past, you want to pay less rather than more for the stocks.

So, right now, they're selling at a premium to their historical average. That conventional asset-allocation input of equities generate 6. We can't all earn alpha and earn a higher return, because the net alpha in the market is 0, so we would all be trying to take it away from somebody else.

We have to budget for lower returns. When you look at the bond market, it's even worse. That's much lower than the historical average, about half the historical average. Ptak: You got that right. It looks like real yields across the yield curve 49 to 99 basis points as of yesterday, which would be July 11, so a pretty paltry real yield.

I did want to, if I may, stick with the general topic of optimism and its nexus with investing, talk about that in the context of value investing. I sometimes wonder if value investing pays off because it's so repulsive over long stretches that it's almost impossible to be optimistic. That does, though, raise questions about the implications for its practical usability. For instance, if investors are likely to give up on it because they do find it so repulsive when it underperforms growth as it had done until relatively recently, they might miss out on some of that payoff, which can come in bunches.

Or do you think that's off base? Do you think that value investing really is usable, you just have to stick with it long enough? Siegel: I think that value investing is usable. But you shouldn't concentrate your whole portfolio in it. What we've seen is that the pendulum has swung between value and growth in very long cycles and large cycles where value does much better or much worse for the entire time that data are available.

Fama and French did this back to and you get these five- to year swings, which is so long that people give up on either value or growth at exactly the wrong time. So, in , value had outperformed massively, and it was a great time to buy growth stocks because we were just about to enter not a tech bubble but a period of tech innovation that produced huge returns for a decade and a half.

Anybody who went against the grain, anybody who went against the tide and overweighted growth stocks did much better than the market from until a year or two ago. Now people are saying, only growth works, so value is disgusting.

And the more disgusted you are, the more likely it is to work. I would overweight value right now, but not all the time. Benz: I wanted to ask about intuition. It's something that tends to be greatly valued in everyday life, but it can lead us astray when it comes to investing.

For example, in March , which you referenced earlier, few of us expected the great snap back in the markets because intuitively we knew the pandemic would be bad for humanity. Do you think intuition was a better model for investing before markets became so efficient or has it never really worked? Siegel: Well, informed intuition, if you've spent a lifetime in, let's say, engineering and you know something about the way that computers are put together or the internet is put together or something, you might have had the intuition that this was going to be a profound change in the way everybody did everything and you bought those stocks.

But the problem is that most people who bought the stocks in the first tech wave, in the s, bought them without knowing anything about the individual companies. They were right about the technology; they were wrong about the companies. So, you would now have a portfolio of AltaVista and Netscape and AOL and a bunch of other companies that had promised but they were just outcompeted by somebody else.

So, I would rather hang my hat on analysis than intuition unless you just happen to be one of those people with special inside knowledge but that is obtained legally. But most people who think they have inside knowledge don't. So, I would try to avoid relying on intuition too much.

You have a lot of experience assessing research proposals in that role. What are the best pieces of research have in common based on your experience? Siegel: Well, they draw heavily on theory to make practical recommendations that can be implemented in the short to medium term. And going back to Roger Ibbotson, we published a piece in on lifetime financial advice that came from Roger with several colleagues. We are about to publish, but have not yet received the manuscript, the second installment of that from Paul Kaplan, Tom Idzorek, and a third author whose name I forget, and that will come out later this year or early next year.

So, even though they're 15 years apart, the Ibbotson people have an integrated theory of investing insurance, annuities—all these different tools in order to provide people with a lifetime income that's secure and yet has the room for adding value through either asset allocation or security selection alpha. So, that's the kind of research I like most.

We sometimes have also done pieces that step outside of the box of the Financial Analysts Journal or the Journal of Portfolio Management -type of research and look at a broader set of issues—for example, geopolitics, demography. There was a beautiful piece by David DeRosa on bubbles. He's against them. I don't know how he can be for or against bubbles. Either bubbles are or bubbles are not. But he takes the position that what we think are bubbles are mostly rational responses to circumstances and then when the circumstances change, the bubble bursts.

But it wasn't a bubble; it was rational at the time. So, these are the kinds of research I enjoy the most. I've also done some of my own research here. I'm not one of the famous people, but I know them all socially, so I was able to get them to come. And I edited it with a co-editor, Paul McCaffrey, who is producing a book on that as we speak.

It could come out in the next month. Ptak: I did want to ask you about what's become the new rage in investing research and portfolio management, which is combining quantitative and human-driven decisions. If you had to draw up a CFA curricula for a bot, how would it differ for the current human-based curricula?

And on the flip side, how do you think the current human curricula ought to be reshaped to account for the rise of things like machine learning? Is that something you've given any consideration? Siegel: A little bit. I'm writing a book review right now for Advisor Perspectives, which is an industry newsletter, a very good one.

I'm giving it a good review, so you can see where I'm going to come out. I believe that machine learning is a real thing. Machines can be programmed to learn, and that's a valuable tool in investment management. But when you step beyond that to the idea of artificial general intelligence, I think it's an illusion caused by very fast computers, very big data and very clever programmers who want to create that illusion.

So, we have had million years of evolution—not as human beings obviously but as animals—to develop a set of connections in our brains that actually are intelligent. Yet intelligence in the sense that we are talking about now didn't really emerge until the last , years. So, it is rare. It is fragile. And we don't know what it is. It's like Justice Potter Stewart said about pornography: We don't know what it is, but we know it when we see it.

And to imagine that we're, as human beings, of one level of intelligence, whatever we are, can build a machine in a few decades of those , years that's more intelligent than we are with all that evolutionary heritage is frankly ridiculous. These machines are going to do what we tell them to do.

But if we tell them using instructions that are crafted well enough, it will give the illusion of being intelligent. When I don't know how something works, like everybody else, I tend to think it's magic. I'm driving and there are two or three cars lined up at a red light, it immediately turns green and makes the other traffic stop because it's a smart red light, and all it's doing is counting the number of cars that are waiting for it to turn and changes the cycle, changes the frequency, according to the traffic instead of operating on a fixed time cycle.

It's just a technology that other people understand because they developed it, but we don't because we don't have the knowledge and so we feel like it's magic or intelligence, whichever you want to call it. Benz: There's been a lot written about the glut of skilled, highly trained professionals in the investing field. Can you talk about the level of competition you see now versus what you saw earlier in your career? Siegel: The industry has become way too big. Every stockbroker has become a financial advisor.

Ninety-six percent of them ought to tell people buy, hold, diversify, and rebalance and minimize taxes, and then they have to fill in that outline through implementation. In other words, somebody has to do it; their clients aren't qualified to do it.

But they should mostly be telling people to buy index funds and to use premixed asset-allocation decisions that conform to what somebody at the headquarters has decided is optimal. But telling them which securities to buy or micromanaging the list of mutual funds, to me, is a fool's errand for most people.

Inside the business, that's the public-facing side. And I think that competition has become more and more people fighting over fewer and fewer real alpha opportunities, and that's why the competition feels so fierce. It used to be an easy business. And it's not easy anymore because the market is more efficient, I guess. It's having one of its worst years ever.

Siegel: I think that it's a pretty good consensus outcome of people buying what's available in the market. But why do issuers produce that ratio? I think that the underlying reason is that for a very long period of history, bonds were a very good investment. And that period is roughly to It's a long time. Institutions bought fixed income to fund their pension plans.

They bought fixed income to fund if there were insurance companies. The big money was in fixed income and equities were this gravy—you sold some stocks to some rich people. And so, you've got what I call the standard model. The allocators picked from a list of active managers in each asset class, usually buy way too many of them, didn't have access to index funds or didn't want to buy them.

And so, they compared the performance of their active managers to benchmarks, fired the underperforming ones, gave more money to the outperforming ones, and since these things tend to run in cycles, generally underperform the market. Stocks are risky. We're all human, and we do what we see the person next to us doing. You have to buy what's out there. And if we all decided to increase our allocation to equities, we couldn't. But we would just be buying them from each other.

This is a point Cliff Asness made. He can usually be counted on for very good thinking. Benz: Our research has found that fund investors tend to do a really poor job of utilizing so-called liquid alternative funds. If you take the illiquidity and gates away from alternatives, do you think they can still work for individual investors in the form of liquid alternatives? Siegel: Well, the term liquid alternatives has changed over time. When I started hearing about liquid alternatives in the early to mids, it meant hedge funds and to some extent managed-futures funds because the stuff they were buying was liquid, and then the illiquid alternatives were venture capital and private equity.

Over time, liquid alternatives have come to mean liquid to the investor. And when you securitize an alternative investment, you've removed—so that you can trade it like a stock—you've removed the one thing that has tended to give alternative investments better returns, which is the lockup. If you can lock up somebody's money for a long time, you can take risks that don't necessarily pay off in the short run, but that may pay off in the long run.

If you take that away, I would rather just invest in liquid nonalternatives, stocks, bonds, and some real estate. Although some people call real estate an alternative. It's the oldest asset class, so I'm reluctant to put it in the alternatives bucket. Ptak: Wanted to shift and talk about endowments. You spent a good chunk of your career in the endowment world. And as you know, a lot of ink has been spilled concerning debates over the endowment model.

Some decried it as costly and complex, others defend it as path-breaking. What are the lessons an advisor or an individual investor should take away from the success of the endowment approach? And conversely, what are the lessons they need to unlearn, so to speak?

Siegel: I'll start with the last one because it's so easy. The lesson they need to unlearn is that if David Swensen can do it, so can I. He and the people at other big endowments and foundations have access to the best funds because they come to you, you don't have to go ferret them out.

The best people they can afford to hire, outstanding analysts and other chief investment officers who can make millions. And if they do lose money, they have this capability of withstanding some pain. Of course, they do care because it's always better to have more money to give away than less. Endowments are a little trickier because the liabilities are not so flexible.

If you start paying your professors less, they will just go to another place that doesn't pay less. Students will do the same thing. But these institutions also have a lot of reserve in their fundraising ability. An ordinary individual investor doesn't have any of this backstop. If I want to raise funds, I have to work harder. I'm already working as hard as I can. And I don't have the option to reduce my liabilities by saying I'm just not going to pay them.

So, individuals have to be inherently more conservative. You get older, life becomes a race against diminishing capabilities and your risk level has to go down as you get older. So, there's a lifecycle effect that institutions don't experience. So, I would say that's the main lesson is, endowments and foundations have generally done well, but they have some structural advantages over individuals. Unless you have a rich uncle—a university has a rich uncle—which is the alumni and yet that's not an unlimited resource any more than your rich uncle is.

But it is a backstop for bad performance. Benz: One investing paradox is that success demands humility, but humility is a tough sell. What's the humblest thing an investor can do to boost their odds of success while also attracting clients? Is it to have a long time horizon?

Siegel: Well, the humblest thing an investor can do is buy index funds. It says to the client, I don't know what stocks are going to do best, but other people collectively as a market make pretty good decisions, so I'm just going to trust them to say the prices are roughly right. And when you buy an index fund, you're making a bet that the prices are roughly right. They're obviously not exactly right. In terms of having a long time horizon, it can be humility, or it could be hubris. I can claim to have a long time horizon, but I don't know what liabilities I'm going to face tomorrow, so I better have a short time horizon with some of my investments and I could also live 30 more years, so I need to have a long time horizon with other parts of my portfolio.

But the time horizon issue I don't see so much as humility versus hubris, but it's a planning tool that a lot of people don't use effectively. Ptak: One of your more popular pieces of writing in recent years was an article you wrote on investing myths. If I'm not mistaken, I think you've updated it a few times to this point, the most recent being in Why'd you write it, and how would you change it if you were to update the piece yet again today?

Siegel: I wrote it because somebody in Brazil paid me to come down there and give a talk on Siegel's Nine Myths of Investing. So, when that gave me an outline I had to fill in. Most of the myths have changed over time. I've updated it every two to five years. And what would I change now? Well, first of all, you'd have to go back and look at what the myths are. I don't really think I have time to go over all of them. But the one that I would change today is that stocks and bonds are always negatively correlated, so each is a good hedge against the other.

It's not true. It runs in cycles. So, with stock market down, the bond market is also down, and people say, "Diversification doesn't work. Diversification within the bond market works in the sense of holding some less-volatile, shorter-term securities. They sacrifice some yield in order to get that safety. Secondly, stocks and bonds will again be uncorrelated or negatively correlated someday. But this is not that day. And there are other assets.

The one that comes to mind is the original alternative investment: cash. But, on average, over time cash has paid a percent or so over the inflation rate. And then the other one is real estate. I keep coming back to real estate because it has become the unloved stepchild in the investment world. And other than their house, nobody has any.

The last time I heard somebody talking about real estate as an investment was probably in the decade of the s, and probably it was going up a lot. Then there was a crash. And the crash stuck in people's minds while real estate itself turned around and went up again. And there may yet be another crash, but it's just another asset class that should probably be in your toolkit.

Other myths—I kind of went out on a limb in the last version of that article and started talking more about social and political issues. One is that we can transition to entirely green energy without disrupting the entire world economy. We can't. We either have to transition slowly, which may not be good enough, but I actually happen to think it is, because energy transitions have taken a half century or so—wood, coal, coal to oil, oil to natural gas, and so forth—and the next transition is not going to be all solar and wind.

Nuclear power is going to be a vital and probably the most important part of it. So, if the myth that you're subscribing to is the, let's call it the European version, although that's not quite fair because they have plenty of nuclear power in Europe. It's not going to happen, but we're going to need all the energy we've got, because the world is getting richer fast.

That's still huge. Indonesia is higher than that, and it's a country of million people that most Americans couldn't find on a map. The energy demands are going to be huge from all these different parts of the world that are growing and becoming middle class. And so that myth is something I spent a little time on in the article and I would write more about it next time. Benz: You more or less predicted the spate of inflation we would have before it happened.

In fact, one of the myths you wrote about in was that the government could borrow all it wanted without sparking inflation. What did you see then and what do you think people should be monitoring to assess how long high inflation will persist into the future? Siegel: My forecast at the time was based on basic economic history from the and s, which is that when the government borrows more money than it can pay back, it's going to pay it back anyway but in cheaper dollars.

And the way that you get cheaper dollars is to have inflation. Inflation is a transfer of resources, of real resources, from savers who are bondholders and cash holders, to borrowers, which in this case is the government itself. So, it's tax. So, when you have a budget—that's how government budgets, it's out of balance by a lot for a long time— you're going to have a lot of inflation, because it's the only way the government is going to be able to make those payments on the bonds.

I didn't see anything in the economy other than the budget deficits. And it was so early that you could say, I was wrong. There's not much difference between being a decade and a half early and being outright wrong. So, I'll say I was wrong. So, when you get a supply shock like the one we've just been through, prices are going to rise, and you don't even need an unbalanced government budget, you don't need budget deficits for prices to rise when there are shortages of things because by ships not being able to dock and workers not coming to work, we just have never seen anything like this.

Ptak: What role do you think top-down macro should play in an allocation and investing process? Obviously, it's hard to correctly make a macro bet, though we've just talked about one you did correctly make, but it's even harder to translate that into a successful investment. So, should most people just avoid macro and diversify and call it a day?

Siegel: If you mean macro bets to guide your general asset-allocation philosophy, I think you should.

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