Meb Faber: Fees & Taxes Trump Allocation

March 10, 2015

Meb Faber is a widely respected voice in the investment world thanks to his research-driven quantitative perspective on what works for investors. He is also the brains behind a growing roster of Cambria ETFs.


His latest book, “Global Asset Allocation: A Survey Of The World’s Top Investment Strategies” looks at a dozen or so asset allocation portfolios from some of the most-well-known investors out there. His findings, which he shared with, are surprising. Your latest book looks at asset allocation portfolios. What about this theme sent you looking for answers?


Meb Faber: We've been writing about allocation strategies and market returns for a long time, mostly from the lens of the best investors in the world. Our first book was on some of the endowment allocations, and a lot of my work focuses on the active and tactical side of the equation.


But going back to the first book, we said, “Look, if you're going to do a buy-and-hold allocation, you should be paying as little as possible for this, because by definition you're not really doing anything. You're buying a portfolio and holding it, and maybe rebalancing once every year, two years, or whenever.”


What I failed to grasp is that the vast majority of investors still want buy-and-hold allocations, but the allocations are often suboptimal and, in general, they pay way too much for it.


So, in the book, we wanted to show that investors spend probably 90 percent of their time obsessing over the allocation—how much to put in stocks; should they own gold; how much in XYZ—as do professionals.


But—and this was actually surprising to me—all the most famous guru-style strategies had vastly different exposures: some 25 percent in gold, some zero and the end result ended up being very similar, with the exception of permanent portfolios. The spread between these 15-odd portfolios we looked at was less than 1 percent a year.


The point we made in the book is that while most people spend 90 percent of the time thinking about allocation, what they should be spending 90 percent of the time on—if they're doing buy-and-hold—is minimizing fees and minimizing taxes. Would ETFs change that equation if the best-performing portfolio were allocated primarily to low-cost ETFs?


Faber: If you went back to 1972, and picked the best possible allocation in this book, but you implemented it through your average mutual fund—which is 1.25 percent, and/or the average advisor who didn't invest in the average mutual fund—this is what would happen: You would take what would have been the best-performing buy-and-hold strategy and make it worse than the actual worst-performing strategy in the book. To me, that was a very telling example of how much fees matter in this case.


The average ETF cost is down around 0.6 percent, so it's half the cost of the average mutual fund. That's a little bit unfair, because some index mutual funds, like the Vanguard runs, will be lower cost, of course, and some active ETFs will be more expensive. But yes, the average ETF helps. And if you can get the really cheap ETFs, that helps even more. To talk about asset allocation, you use in the book the traditional 60/40 portfolio as the benchmark. In your view, in what ways does a 60/40 asset allocation fall short?


Faber: Historically, 60/40 has been great. I tend to agree with Bogle on that. However, I think 60/40 is terrible right now. We've done a lot of research with valuations, and U.S. stocks right now are one of the most expensive markets in the world. Now, it's not a raging bubble and it's not horrific, in my mind, but there are much, much better opportunities elsewhere.


So, at a minimum, if you're going to do 60/40, half of the 60/40 should be in foreign stocks and bonds. The problem with the 60/40—and we haven't seen it for 30 years—is the inflationary 1970s environment that can be really tough for bonds, and for other investments, too.


You need to have some real assets in there like TIPS or commodities. That can help a lot. What we've seen in the past 30 years is certainly unlikely to be seen going forward, with bond yields globally at 2 percent and under. If 60/40 is flawed for today’s environment, but a look at vastly different asset allocation portfolios showed that, over time, performance varied little, what exactly is an investor choosing between here? Doesn’t the outcomes all turn out about the same?


Faber: I think you're making a great case for our ETF, GAA [the Cambria Global Asset Allocation ETF (GAA)]. Yes, if you're going to do something and you put together all of the best ideas into one wrapper, it's the lowest-cost ETF out there. It allocates to 29 underlying funds that have that rough allocation—40 percent stocks, 40 percent bonds, 20 percent real assets.


It doesn't have home-country bias, so half of the allocation's in foreign securities. And it tilts toward value and momentum, and it rebalances for you. But I’m preaching my own book.


By far, the biggest benefit of an investment advisor or an automated investment solution is that it keeps you from getting in your own way and it keeps you from doing really dumb things.


So ultimately, having something like an asset allocation portfolio and sticking to it is a wonderful option. But therein lies the challenge of being an investor, right? When you're in a drawdown, will you be able to say: “Yeah, I'll just allocate more to this fund. That's boring and not very exciting, but it’s probably the right thing to do.” Other than from a valuation perspective, what is so bad about having a home-country bias? The U.S. stock market has been leading in gains for the last five years or so.


Faber: That's a great reason. The U.S. has been outperforming everything else for the past five years. Historically, U.S. stocks outperforming international stocks is really a coin flip, it's 50/50.


If you go back to the last 114 years, the U.S. is one of the top-performing equity markets in the world, with some countries like Austria essentially having no real return on stocks.


But there's no reason to concentrate. We live in a global world where the U.S.' percentage of GDP is only about 20 percent, and half of world market cap. At a minimum, in my mind, you should be half foreign.


The valuation is the biggest argument, by far, right now. Because of valuation and because of the way the world is probably moving over the next 50 years, I think a 60/40 with strong home-country bias is suboptimal. Other than the impact of fees on outcome, did anything surprise you when you looked under the hood at what these big money managers are doing when it comes to asset allocation?


Faber: Some of the allocations surprised me, particularly in the more consistent style portfolios, where the allocations are a little more surprising and atypical—like Marc Faber's portfolio: one of the most consistent and low-volatility portfolios in every decade. El-Erian's was positive in every decade, but a little more volatile due to higher equity exposure.


Think of the impact of including gold during the '70s, for example, which was obviously a huge benefit to a lot of the strategies that utilized it. Marc Faber's is a good example. He only has 25 percent in gold. You're not going to find many investment advisors or individuals with an allocation like that. But it was one of the most consistent portfolios we reviewed. What do you hope investors will take away from your research on asset allocation?


Faber: If you're going to do buy-and-hold, pay as little as possible and understand your disposition. If you're like me and you have plenty of behavioral biases, come up with a systematic way to implement it.


That could mean your advisor, as long as they're a low cost advisor. It could mean an automated investment solution like Schwab or that Wealthfront's putting out, or an allocation ETF like GAA. Just buy it and don't worry about it, and go focus on the rest of your life.


It's hard to do, of course. Investing is a very emotional topic, but it's probably the best advice.


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