Episode #491: JD Gardner – Bridging the Behavior Gap – Meb Faber Research

Episode #491: JD Gardner – Bridging the Behavior Gap

Guest: JD Gardner is the CIO & Founder of Aptus Capital Advisors, which provides risk-managed strategies designed to help clients stay invested through market cycles.

Date Recorded: 7/5/2023     |     Run-Time: 1:14:56

Summary: Today’s episode has an overarching theme that can be summarized by a quote from JD himself: “A strategy’s return is much less important than an investor’s return while exposed to the strategy.” JD explains how they provide solutions to help bridge the behavioral gap and use options provide investors with income and downside protection so investors don’t capitulate at the exact wrong time. JD also spends some time discussing the OCIO part of the business and lessons working with advisors in that capacity.

Sponsor: Future Proof, The World’s Largest Wealth Festival, is coming back to Huntington Beach on September 10-13th!  New in 2023 is Breakthru Meetings Program – which will be facilitating more than 10,000 1-on-1 meetings. Financial Advisors and LPs, get your ticket FREE plus a $750 reimbursement by applying for the hosted meetings program by the August 15th deadline.

Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

0:39 – Sponsor: Future Proof
2:05 – Intro
3:00 – Welcome our guest, JD Gardner
3:45 – The origin of JD’s company, Aptus, and embracing options and volatility as an asset class
18:10 – Prioritizing investor returns over strategy performance
21:50 – Challenging the 60/40 portfolio mindset
36:52 – Enhancing yield with option overlays for attractive risk-adjusted returns
31:17 – JUCY strategy generates additional yield through writing equity link notes
36:33 – DRSK provides downside protection and enhances portfolio performance with long vol
38:48 – ACIO is a collared strategy that aims to enhance the asymmetric risk profile
44:27 – JD’s favorite strategy; ADME
48:45 – Implementing a system with rules and guardrails
1:02:50 – One investing belief held by JD, not shared by majority of peers
1:10:49 – JD’s most memorable investment; Is It Time To Do A Templeton?
1:16:37 – Learn more about JD; Aptus Capital Advisors; Twitter @jdgardner251

Transcript:

Welcome Message:

Welcome to The Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer:

Meb Faber is the Co-Founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Sponsor Message:

Future Proof, the world’s largest wealth festival is coming back to Huntington Beach on September 10th to 13th. Over 3,000 finance professionals in every relevant company in FinTech, asset management, and wealth management will be there. It’s the one event that every wealth management professional must attend. New in 2023 is breakthrough meetings program, which will be facilitating more than 10,000 one-on-one meetings. Financial advisors and LPs, get your ticket free plus a $750 reimbursement by applying for the hosted meetings program by the August 15th deadline. You heard that right, a free ticket plus 750 bucks by applying for the hosted meetings program by August 15th. Get out of the hotel meeting rooms and conference halls. Instead, get into the sunshine on the beach. No suit or tie required. I was there last year and can’t wait to go back again soon. Get your ticket at a special discounted rate when you register at futureproof.advisorscircle.com/meb or click on the link in the show notes.

Before we get started today, I have a quick public service announcement. Cambria is currently soliciting a proxy vote from shareholders of our ETFs. Every vote is important and we would like to request any listeners who are also shareholders to please vote. If you have any questions related to the proxy or need assistance submitting your vote, please email us at info@cambriainvestments.com and someone from the Cambria team will assist.

Meb:

Welcome, everybody. We’ve got a fun show today. Our guest is JD Gardner, CIO and Founder of Aptus Capital Advisors, which provides risk managed strategies designed to help clients stay invested through the full market cycle. Today’s episode has an overarching theme that can be summarized by a quote from JD himself, “A strategy’s return is much less important than an investor’s return while exposed to the strategy.” JD explains how they provide solutions to help bridge the behavioral gap and use options providing investors with income and downside protection so investors don’t capitulate at the exactly wrong time. JD also spent some time discussing the OCIO part of the business and lessons working with advisors in that capacity.

Normally, I ask you to subscribe and review on the show on Apple and Spotify, but go give another show some love today. Give them a review and spread the love. Please enjoy this episode with JD Gardner.

Meb:

JD, welcome to the show.

JD:

Glad to be here, Meb. Thanks for having me.

Meb:

Where do we find you today?

JD:

I’m sitting in Lower Alabama, as I like to say, LA. So Fairhope, Alabama.

Meb:

What does that mean for people? I tell people from LA and my southern friends like to say Louisiana, but you, you got a new one, Lower Alabama. What does that mean?

JD:

So LA, we’re sitting … People may have heard of Orange Beach Gulf Shores, Alabama. We’re in between Pensacola, Florida and Mobile, Alabama. So actually, when people first come to visit here, I’m like, “Hey, it’s a really nice part of the world,” and then they come here and I think the perception of Alabama is not always the best until they come down here and they’re like, “Hey, this is a pretty nice area.”

Meb:

Well, cool. Look, you guys have been around for a bit with Aptus. You’ve splashed big on the scene, got a bunch of ETFs. We’ll get into some of your strategies today. Give us a little origin story of the firm, when you guys get started. You’re one of these rare mashups, CFA slash CMT. Am I right?

JD:

Correct.

Meb:

You got the two sides of the brain working. Give us a little origin story for you guys.

JD:

So the try to be not boring on this, but I came into the business in the financial crisis, so baptism by fire, feeling like I was educated, at least based on the books and the designations, and then all of a sudden you realize, “Hey, the real world is quite different from what my textbooks say.” So I came into the wirehouse space, got some great experience, spent some time as a research analyst and actually developed some trading strategies in the future space with, actually, I’ll get to this in a second, but somebody that connected us early, Meb, but really, the light bulb for us and for the origin of Aptus was the ETF structure back in ’09 really caught my eye just because of the tax efficiency and then a lot of the work that I was doing in the derivative side, some of the actual ground up work we were doing, building different systems.

I thought, “Man, this ETF wrapper can do a whole lot more than just track the S&P for five BPS. So what if we put some of this stuff inside of an ETF wrapper because I think that there’s a need for it?” and so we started Aptus. I do want to give you a shout out here, Meb, because I actually looked before we started. So we started Aptus in 2013, and I had this either dumb or smart, I did, depending on your angle, “Hey, we’re going to launch ETFs from Fairhope, Alabama,” and so I spent about two years searching for anybody in the space that knew something about the space and that was willing to say, “Hey, I’ll chat with you,” and John Romero, if you know that name, connected us. 2015 is our first email back and forth, Meb, and you were willing to say, “Yeah, let’s chat.” So we had a couple of conversations about exemptive relief and all of those different things.

Meb:

It sounds like a banger of a conversation. That’s all the boring nuts and bolts of ETF business, man. Well, it’s changed a lot. When we talk to people today, we’ve certainly done some podcasts with Wes Gray about how to start an ETF. 15 years ago, it used to cost a million dollars. I think it cost us half a million just to get the exemption or even the permission, listeners, to launch a fund, which is crazy. Now, ETF rule, it’s streamlined, it’s much simpler as the way it should be, which is great because it’s also opening up, I think, a lot of use cases that people we’ve talked about for a long time that you’re now starting to see, advisors, family offices, even charities, all these types of fringe use cases that were not the straight down the middle of the index ETF of 25 years ago. So it’s fun because there’s a lot of interesting ideas bubbling up and a lot of crazy ones too.

JD:

When we started with our strategies, to get the tax efficiency, you had to have an index, and that’s the biggest thing. You can point to other things that the ETF rule did, but the biggest thing is now you can have an active ETF wrapper that doesn’t require an index to get the tax efficiency, so these crazy ideas and good ideas bubbling up. I think if there’s going to be issues with the traditional 60/40 portfolio and ETF’s liquid, transparent, easy to get in and out of, so if you can put some of these different exposures into an ETF wrapper and leverage the tax efficiency, that’s really where, going back to your original the origin of Aptus, I think that’s the path forward for us and that’s the space we’re trying to play in.

Meb:

Listeners, what JD is getting to there is that there’s a little too much inside baseball this early in the morning, but you used to really … The ETF rule was like a patchwork back in the day. It was an exemption. So some index funds had better tax treatment, but it wasn’t overall active funds. It was only some funds that got the exemption at certain years and then other years. So it’s just a huge mess. So we had actually had active and passive at various points, and this is always sends our due diligence teams down the rabbit hole. They’re like, “Well, why did this fund used to be indexed and now it’s active?” but thank goodness they swept clean the floor and fixed it so that everything has similar tax treatment.

However, this to me was the final bell ringing for the death of the mutual fund industry, which ETFs have been eating their lunch for a long time. We borrow Marc Andreessen’s phrase, we say, “ETFs are eating the asset management industry,” but finally they said, “Oh, actually, all ETFs have better tax treatment,” and yet some mutual funds have this massive disadvantage, which is why you’re seeing all the active conversions now. It’s just one after another hundreds of billions dollars.

JD:

They still own the 401(k) space. So that’s the standing bit for mutual funds.

Meb:

Yeah. Okay. So you got this crazy idea, as we like to say with entrepreneurs, this just very naive optimism that you’re going to start launching funds, compete with the big three who have trillions of assets. There’s tens of thousands of funds out there. What year on the timeline? When was the first fund?

JD:

First fund was ’16. So it took us a couple years.

Meb:

Well, you guys have certainly survived and one of the big mistakes you see a lot of, not just startups, but particularly in our world is not giving it a big enough runway, but also not just relying on one funder strategy, which, as you mentioned, any funder strategy could be out of favor for not just years, but certainly over a decade. So it’s hard to survive in that sort of environment, but tell us a little bit about y’all’s initial foray and you can pick which strategy you want to start with as a good overview of what you guys launched and then we can dig into all of them.

JD:

Probably the most interesting thing about what we’re doing is twofold, the types of strategies and then how we’re actually growing our distribution. So starting on the distribution front, we learned in ’16, and everybody and their mom was launching models. That’s the thing. It’s more efficient to have models, let’s launch models, and I would preface everything I’m about to say with our predominant relationship is a financial advisor, working with what we call the lifeblood of financial services. So these are folks that are advising on the wealth of the 500,000 to $5 million family. Sure, we work with bigger ones, we work with smaller ones, but that is what we call the lifeblood. So everything that I say is probably in the context of these conversations like the issues with that, what types of strategies are important, how can you compound those types of families’ wealth, but we learned in ’16 that everybody wants models, but there’s a big need for services around those models.

So we’ve got this whole OCIO side of our business where we really try to come alongside advisors and help them. I hate the word institutionalize, but that’s exactly what we try to do is institutionalize a process. So how do you diligence a fund? How do you put together a trade, rebalance rationale, all of those performance attribution? So the services side of our business, we spend a ton of time doing those things. Then on the product side, our thing is really vol is an asset class, vol to mitigate risk, vol to enhance yield. So everything that we’re building, there’s going to be derivatives, there’s going to be things like that wrapped up in a ’40s Act fund, an ETF wrapper, and what we’re doing is we want to be pioneers in the space of options-based ETFs.

Meb:

Let’s hang out here for a second on this OCIO model you’re talking about because I think particularly for advisors, this is a big value add. Can you talk a little bit more about what you guys actually do? Do you just hand them a playbook and say, “Look, this is best practices, these are the things you should be doing,” or are you sitting down with them with webinars or getting in their office and saying, “Look, this is how to really think about X, Y, Z”? What are the main levers? Just tell us a little more about it.

JD:

So I think scale is the most overused word in the financial services space. When we realized the opportunity in the OCIO space, it was, “Okay. Here’s what we’re doing for one advisor, and the question was always, “Well, how do you scale that?” My answer was always, “Well, if we’re building relationships because of these services and we’re doing services that they can’t and others won’t, if your average advisor has 400 or 500 million in assets, my Alabama math, it doesn’t take a lot for scale to add up.” So our OCIO business has gone crazy. Thankfully, we’ve got great partners on that side.

In terms of what we’re doing, this is a blanket statement for the advisor industry, but what we’ve found is, thanks to 2020, we’re not like, “Well, you must be in the southeast.” We get that a lot. Well, we actually have very few relationships in the southeast. We’re all over now. We found that, Meb, let’s say you’re the financial advisor in a relationship, we walk into your office. Typically, how well can you service 50 families or how well can you serve a hundred families? Well, your service is going to get watered down if there’s only one of you. So we found that to be true across the board is there’s typically one or a handful advisors in the places that we’re targeting, which is mainly independent space.

So what they need, there’s really not a ton of process around what they’re doing, and that’s where you can come in with a very low level detail work around how can we build a process and how can we be the team to help you operate that process versus the groups that are DIY, which is good up to a point or the groups that already outsource to somebody that maybe does what you just said, Meb, which is, “Hey, here’s the allocations. Go do it,” or, “Here’s your quarterly chart book.” We want to have a deeper relationship, and that does mean we’re not going to work with thousands of advisors. We understand that, but I think the right advisor is more important than the number of advisors.

Meb:

Was that a very subtle reference to JP Morgan’s quarterly chart book? They’ve been now copied and we get a few of those. Avantis has one. I don’t know who else does those. We thought about doing our little spin on it at one point, but they do a pretty good job. There’s some good charts in there and there’s also some charts in there where I’m like, “This is exceptionally misleading, JP Morgan,” but we love majority of their work there.

So for most of the advisors, what is the main thing where you come in and either you’re like, “Oh, man, here’s where we can help, guys. This is embarrassing almost,” or they’re like, “Look, we know we’re bad at X or we know we need some help with Y”? Is it across the board? Is there one particular area that seems to be you guys are particularly useful in?

JD:

So the thing, and we say this all the time, the thing that if we can help grow an advisor’s business, that that’s the trump card. So that’s the universal want, not necessarily the universal need, it’s the universal want of every advisor is, “How do I have bigger and better clients?” because the 80/20 rule in the advisory space is you’re going to have a small handful of clients or a subset of your overall book of business that generates the majority of wealth or the majority of revs for the advising practice. So it’s like, “How do I get more of that small handful?” I think if we can help with the things required to get that business in the door, every advisor wants that because I know a lot of your stuff, Meb, and hats off to what you’ve built, and like I said earlier, just given me the time of day eight years ago, I think, speaks volumes about you personally and I’ve never met anybody that doesn’t like you. So again, thanks for the opportunity to chat through some of this stuff, but-

Meb:

My DMs would disagree with you, but keep going.

JD:

Well, I think the biggest need is really versions of performance chasing. If you look at advisors, I can’t remember who was on the podcast with you that I was listening to and it was like trying to strip everything away and focus on the process. Well, that may be the case when you’re coming into a strategy, but it’s never the case when you’re exiting the strategy. So what we try to do is to build a process around, without saying this explicitly to all relationships, is we want to make sure we ring your system of performance chasing, and that’s nearly impossible to do.

So one example because I know you love trend. I love trend. We started with a trend following strategy. We pivoted to now we’re in this world where it’s like beta plus these convex payoffs like, “How can I just give you the beta exposure knowing that there’s a potential payoff that can allow me to take risks?” but getting back to my trend example, trend could be the best … We’ve got the best trend strategy in the world. Let’s just hypothetically assume that. Well, it’s going to go through periods where it works and where it doesn’t work, and when do you think it’s bought and when do you think it’s sold.

That’s where it’s even the extreme would be Cathie Wood’s Ark back in … Everybody wanted it. Every conversation we had is like, “Well, should we have a 5% allocation? Should we have a 10% allocation?” It’s like, “Well, why do you want that allocation?” “Well, this thing’s up 200%. This thing’s up 100%.” It’s like, “All right. Well, let’s look at what they own and try to justify this,” and I’m not picking on them. It’s just an example of the most extreme version of performance chasing that we’ve seen. So the want is growth, the need is an actual process that can be far enough away from it to recognize when you’re performance chasing and when you’re not.

Meb:

I think it’s fair to pick on someone who claims their stocks are going to do 50% a year for the next five years, which is now up to … It’s got to be 80% a year because two years have gone by. Anyway, so you have a great quote that says, “Strategy’s return is much less important than an investor’s return while exposed to the strategy,” which really just summarizes what you talked about so succinctly. We’ve mentioned this in the last few podcasts, and I think we got to print some out with some Cambria logo on it, but in a nonjudgmental way sending this very brief checklist to an investor just to help them walk through the thinking of partnering, quote, with our fund management ideas, but really applies to everything. It was what you mentioned. First one is like, “Why did I buy this fund or strategy?” Two, “Will I rebalance, and if so, what’s the criteria? How long do I plan on holding it? Is it time-based? Is it forever?” whatever, and then lastly is when it comes time to sell, “What criteria will I use?”

It’s not trying to shame them, but I think even for me personally, having that note card in reviewing it and then being like, “Well, here’s why we’re going to sell it,” and then does it have any of the criteria that we talked about? It’s like, “No, it’s down. That’s why we got to sell it. It’s down,” whatever it is. I don’t know if that would incent better behavior, but it would make me feel better.

JD:

In terms of the convictions that I’ve gained over the last 10 years of doing this, one of them is I almost don’t think style tilts, factor tilts active management. I think a lot of that stuff is you have to be so convicted in that process because everything’s a trade-off. My wife gets upset with me because I view the world in terms of what’s my risk on this and what’s my reward and it better be asymmetric. So if you have high active share and you get it right, it’s like, “Hey, good job.” If you have high active share and you get it wrong, you’re cut, you’re out. So there’s an asymmetric payoff. So we think about it a lot in the OCIO work where an outsourced chief investment officer, hopefully I started with that, but what are we adding into the portfolio and what is the level of conviction not from our side, but more from the advisor side? Do they understand the process? Have we helped them understand the process? What are the issues? When should it work? When won’t it work? Do we know all these things going into it because do you think everybody owned dividend payers and value in 2021 or do you think they bought them in 2022?

It’s been this glaring example, 2022 was, where it’s like, “Well, Q3 and Q4, well we want to allocate into this, this, and this.” It’s like, “Well, okay. Well, let’s talk through that.” Well, guess what? Now starting July in 2023, all of those things they wanted to allocate into are the things that are plus one on the year when the S&P’s plus 15. So now those things are out of favor and they want to be sold. It’s that behavior where just give me the beta. That’s my point is we have this whole more stocks, less bonds for a lot of reasons, how can you make that shift without injecting too much risk in the traditional risk level mindset? You only do that through convexity, but the nice part about beta is I don’t have to worry about factor tilts or style tilts coming in and out of favor.

Meb:

Let’s dig in there. I figured this is a good jumping off point, start talking about the investing side. Let’s say you go into an advisor’s office up the road in Birmingham and that you sit down and they say, “JD, all right, here’s my portfolio. 60% mark cap weight US stocks, 40% 10-year treasuries.” What are you going to tell them? What’s the first words out of your mouth in this conversation and then where does it go? He says, “I’m totally open-minded. I want to hear what you got. We’re open to partnering with you guys. Lead me down the road.”

JD:

First thing we’re going to talk through is the issues with what has worked in the past. So everybody, that’s an exaggeration, but a lot of people own some version of a Vanguard or a BlackRock 60/40. It’s embedded in the financial world, the issue with that, and we’ve been talking more and more about this is what gets overlooked is the 40. Well, this has worked for the last 30 years. Take out 2022 and this has worked perfectly. Well, why has it worked? It’s worked, one, because you’ve had this correlation benefit where you’ve been structurally negatively correlated between equities and fixed, but you’ve also had fixed deliver substantial returns, substantial real returns because inflation’s dropping rates are dropping and bonds are producing. So now, we would argue that 2022 was a slap in the face that this negative correlation where bonds have not only acted like a good diversifier but also a good hedge.

The difference between a diversifier and a hedge is correlation risk. Hedge has none, diversifier has some. So bonds have been this positive carry, significantly positive carry hedge. Now, everybody has grown accustomed to this portfolio that should work. So we would talk through … The first thing is say, “Hey, what happens if stocks and bonds are actually positively correlated, and what happens if your real returns from bonds real, not nominal, real returns are going to be minuscule? What do you do then? How do you combat that?” So we would highlight the issues. Our solution would be-

Meb:

First of all, how do people respond to that because we posted a great Twitter table? Listeners, we’ll put it in the show note links, but basically, it was showing bond returns during the worst S&P drawdowns or really bad months for the past 120 years, but everyone assumes bonds will hedge during stock drawdown, and then, obviously, 60/40 got smashed last year, but for the better part of the early part of the 20th century, bonds often didn’t hedge, not only didn’t help, but they, in some cases, were also down. So the assumptions that you’re talking about, so much of our world is because of everyone’s individualized experience, what they grew up in or their prime learning earning career part, and bonds for many places around the world, but particularly in the US, are not always the savior that they’ve come to be seen as.

JD:

I think it’s an easier conversation with younger folks. Going back to the lifeblood that I mentioned earlier, I think most of those … The cookie cutter client is the, and I understand this is not like everybody, but it’s somebody that worked for 30, 35 years, saved in a 401(k) and they retired with a couple million bucks, and most of that is the lifeblood, that type of trajectory. Well, it’s like, well, this hasn’t worked, and advisors are in that age, most of them, I don’t have the exact stats, I can just tell you from firsthand experience, are people that their livelihoods have benefited from this 60/40 mindset.

So coming in and saying, “Hey, historically, this has not been the case,” their reference point is, “Well, in my history it has been the case.” So I think that the only way that you can have that conversation is through performance, is to be able to show if you’re in a 60/40 traditional mindset and we are able to get you to say an 80/20, can we produce better upside, but can we give you similar risk metrics? If you can show that, I think that’s the way that you can get somebody to get out of the 60/40 mindset and being handcuffed to the correlation benefits being there and the return drivers being there, which we think both of those things probably are not there.

Meb:

All right. Well, let’s hear the punchline. How does one wave the wand and do that? I want to hear where the magic happens. What does one do because this would be a retort everyone would say and say, “Well, yeah, 60/40 was bad last year, but, man, it’s doing just fine this year. JD, what you talking about? I’m just going to do that or maybe I’ll just hang out in 5% T-Bills. What am I missing?”

JD:

So nothing’s perfect. Let’s get that out of the gate, but our whole thing is if you have something embedded in portfolios … So we talk a lot about actual hedge protection, so convexity associated with hedges, and I know a lot of people have started … More and more and more people have started talking about this, but all returns come from yield and growth or multiples expanding. So you can make that more complicated, but we always revert back to a yield plus growth framework where the yield’s easy to understand, growth is harder but not that harder to understand, and then multiples expanding is the third driver. We say if you go decade by decade, and I can pop you with this chart, it’s a good one to show, some decades multiples expanding is beneficial, other decades it’s not. An aggregate, it’s a goose egg.

So if yield and growth are the drivers, and we’re building portfolios. Like that quote that you said, that’s front and center of our minds when we’re building portfolios. How can we build something that somebody can stick with? Well, if we can take vol and view it as an asset class, use it to enhance yield, which we’ve got a whole suite of funds now that’s designed specifically for that. So here’s your beta with some yield, if we can juice the yield and we can give you exposure to more of the G … So own more stocks, less bonds because we always make the point. Your 5% government bond, the government’s never going to come out and say, “Hey, Meb, we’re going to pay you a little bit more interest this year.” You’re going to get what the coupon is.

Think about the outcome. If I’m giving you beta, but I’m giving you 80/20 rather than 60/40, in a 2023, who’s mad at you? Nobody. In a 2022, if your convexity is actually there to protect against drawdowns, it’s not going to be a great year because convexity especially, especially low delta stuff didn’t pay out, but higher delta stuff did. So if you have the right blend of convexity that you actually mitigate some of that risk and have similar risk metrics than a 60/40, actually, I think you’re going to long-term compound wealth at a faster rate and do it in a way that’s behaviorally more digestible from the advisor.

Meb:

Let’s make this tangible. Give us an example. You guys have, how many, seven funds now, eight? Give us an example of what this would illustrate. Walk us through one of the strategies. You got some good tickers, man. By the way, if you learned anything from our first chat 10 years ago or whenever it was, you guys have some good tickers. Listeners, we got ACIO, DRSK for de-risk, DUBS, IDUB, JUCY. We’ll dig into them, but give us an example. Which one should we start with?

JD:

The easiest one to start with is juicy. So this is a-

Meb:

J-U-C-Y, listeners.

JD:

J-U-C-Y, yes. So this is something that you mentioned 5% T-Bills. We absolutely love that. So where we see a huge opportunity in the market and why we launched this is because we felt like if the market for T-Bills is 5% right now, let’s just put 85% of the portfolio in T-Bills and then let’s put an option overlay on the other 15%, and I’m like, “The guys will make fun of me.” I’m anti short vol. I’m never a fan of short vol, but the way that you enhance yield is through being short vol, but we have a cap on how we’re doing it. There’s other like Franklin Income Fund has been using the same types of overlay for many years. There’s other funds doing things like this, but the point of JUCY was to say, if I can give you something that’s 85% T-Bills with an option overlay to juice the yield, and if we can do that without getting your face ripped off, I’m giving you cash beta with this additional yield. I think that’s attractive.

Then DUBS is the same thing for S&P like domestic equities, and IDUB is the same thing for international equities. So we view those as building blocks. That’s our opinion, better beta. It’s just beta because you’re going to get significant portions of the beta with more yield.

Meb:

Well, let’s hang out on JUCY for a minute. This thing has got what looks like maybe perhaps around 8% yield is what it’s showing, and we’re recording this around July 4th, but walk through what does the strategy actually do to the extent you can give away a little more of if the advisor says, “Okay, I’m interested, but tell me a little more.”

JD:

So the nice part about JUCY is we are writing ELNs, so equity link notes. So JUCY is 85% treasuries and then 15, these are all rough estimates, not exact, 15% ELNs. So these ELNs, we’re structuring the payoff of certain things in the market with counterparties. So we’re going to shortfall. Most people think of covered calls as that’s a way to receive some incomes from the option premium or selling puts to receive premium. We’re doing a version of call writing in these ELNs to generate that additional yield. The nice part is each of these ELNs, there’s path dependency and options. Anytime you’re going to talk about options, you’re going to have path dependency risk. So you can reduce path dependency by frequency. So we’re frequently writing these ELNs. We’re doing it with multiple counterparties. It’s a short vol strategy that can benefit from rising volatility because of that frequency that I mentioned. In a perfect world, JUCY can be a staple in portfolios and viewed as a more conservative allocation to help juice the Y and the Y plus G framework.

Meb:

So for the investor looking to add this, and by the way, listeners, this has only been around for not even a couple years now and well over, I think, 400 million. So congrats. The advisors that are using this, where does this fit in for them? Are they taking out part of something else? Are they putting it in the alts bucket? How do they slot this in? What’s the narrative?

JD:

So the initial adoption that we saw was mainly a cash bucket. So we joke around the launch of JUCY. We viewed it as a tool to say, “Hey, Meb. Do you have X cash sitting at your bank account that’s paying you nothing, your checking account, your savings account?” So we felt like it was a good tool to go offer something, “Hey, this is going to be more income than your money market, more income than your deposits at your bank.” We like to joke that the timing of some of these cash sweeps was the same timing as some of the bank issues that were out there. So we like to say we had a part to play in that, which is obviously not true, but we saw initially as a cash-like vehicle that that was how it was viewed. There’s obviously other risks associated with it that’s not associated with cash.

Then when it comes to the overall allocation, we see it mainly as a fixed income. We don’t see many advisors thinking of it as an alt. It’s viewed more as, “Hey, if we’re going to allocate to fixed income, it’s going to have less duration than a ag type benchmark.” So it’s going to be used as to either lower duration and enhance yield, which is a good combo.

Meb:

First question probably out of the advisor’s mouth, “All right, JD. You’re telling me 8%, 10%, 12% yields. What’s the catch? Where’s the big risk? When does this fund get walled up? When will it likely struggle or what’s the big swan risk for this type of fund?”

JD:

We’ve heard that question you’re asking worded differently, but worst case scenario for a JUCY is a market that’s an S&P 500 that’s up 10% each month, up 10, up 10, up 10 because anytime that there’s a version of covered calls being used … A covered call is selling a call, so you’re selling away the upside. If the underlying goes through your strike and realizes that upside, that’s obviously going to cost you money. I do think as a side note, that’s one thing that’s misunderstood. A lot of people get mesmerized by, “Hey, I just sold 10 grand of premium of calls in Nvidia.” It’s like, “That’s great. It’s going to hurt when you buy back that 10 grand for 50 grand.” So in JUCY, the worst case scenario is a market that’s just ripping higher and higher.

Meb:

Which by the way, seems like the market the last couple months and it doesn’t look like the fund has really suffered from it.

JD:

Yes. So there’s some nuance in the way that we’re structuring the ELNs that allow us to mitigate some of that risk where it would have to be literally a straight up market because if we’re separating when we write these notes, you get the benefit of, “Hey, a 6% rip in the market may affect one of the ELNs,” which is going to be a very small slice of the overall pie, but it’s not going to be detrimental to the ones on either side of it. So if you’re just constantly recycling these ELN payoffs, that’s where you can get the benefit of this yield without really stepping in front of any landmines.

Meb:

Interesting. Give me something else if we’re done talking about this one or if there’s anything else we want to touch on this one.

JD:

I’m a big fan of long vol. So this goes back to a lot of what you’ve … Some of the content that you put out is great stuff. I think my real world experience of when you’re talking about factor tilts, when you’re talking about trend, when you’re talking about different things to portfolio construction, it’s where those things are needed and valuable without a doubt, but where we see less behavioral issues is when we can just say, “Hey, here’s the beta.”

On the yield side, we’ve covered JUCY, DUBS, and IDUB or similar story, but on the long vol piece, DRSK to us, it was our flagship fund, really still is. It’s supposed to be a bond replacement, but it is inherently long vol. So if markets rip higher, that should benefit DRSK. If markets rip lower, that should benefit DRSK. I think when you think of true long vol exposure, this is a concept, Meb, that I think is fascinating and probably few people want to chat as much as I do about it, but where say you’re capturing 50% to 75% of a rising market and less than 50% of a falling market, can that be beneficial to the overall allocation?

Well, if you’re benchmark’s 60/40, we think it can be. Let’s just own more of the equities and let’s give away some of the upside with that additional exposure if we know protection is there in the downside, and I think that’s our thesis across the board is, “Hey, can we improve the yield of a portfolio and can we take this negative returning thing that the presence of its potential payoff, just the presence of it, allows us to take more risk?” That’s going to do wonders for our ability to compound capital over a longer period of time.

Meb:

So of those two, DRSK and ACIO, which one you want to dig in a little deeper into? Which one do you want to lead with?

JD:

So ACIO is a take on a collared strategy.

Meb:

For the listeners, what does that mean?

JD:

A collared strategy is three components, long equities, short calls, long puts, so different variations of that. I think the overwhelming covered call collared exposures you can get are going to be some form of beta on the underlying and then they’re going to be short calls on the index, long puts on the index. So what we talk a lot about is let’s assume you’re long on the S&P or whatever it is. If you short calls on the S&P and buy puts, well, puts are more expensive than calls. So remember, where you sell calls, that’s your ceiling. So let’s say you want to take the premium that you sell. So the upside that you sell away, you’re going to receive premium. Let’s absorb that premium and pay for protection. Well, if your goal is to be neutral on let’s just use what we collect as what we spend, well, you’re going to have your underlying equity, you’re going to have a ceiling, I’m making these numbers up, but it’s going to be somewhat close. You’re going to have a ceiling that’s plus three with a floor that’s minus eight, so plus three minus eight. That’s asymmetric, but it’s in the wrong direction.

So what we do in ACIO that’s different, the big differentiator is we’re going to sell underlying equity calls. So those Nvidia calls are going to be at 70, 80, 90 implied vol. The S&P’s not going to be at that. So there’s no arbitrage. There’s a reason Nvidia’s priced differently than the S&P, but the structure of the collar strategy in general, we think we can bump the ceiling to plus seven, plus eight, plus 10 and we can actually keep floors that are somewhat minus five or tighter. That’s the goal of the strategy.

Meb:

You may have mentioned it, but how do they traditionally use it? Is it more like an equity swap, they take out the part of the stocks?

JD:

It depends on how portfolios are constructed. We’ve seen ACIO used as a low vol swap. So if people have allocated to some type of low vol in the past, it makes sense that or it could make sense. We’ve also seen it on the more sketchy credit spectrum. So if there’s some high yield type exposure, we’ve seen ACIO used there, and we’ve also seen it as just a core equity knowing that there’s going to be a lower beta associated with it, which really filters into our more stocks, less bonds mantra.

Meb:

We’ll get to this in a minute. I was going to say I want to hear how you would … If someone’s like, “You know what, JD? I love you, guys. I want to put all y’all’s funds in a …” What is Bridgewater call, their combination of all weather and pure alpha? It’s called optimum strategy or optimal allocation or something. Anyway, we’ll hear about that in a minute, but first, I want to hear about … Let’s hop over to DRSK, and you can tell us a little more about that one and what’s the difference there.

JD:

DRSK has a benefit right now that we’ve never had, which is actual yield on the underlying bonds. So DRSK is going to be majority in investment grade bond ladder. Then what we do, so call that 90% to 95%, and then with the remaining 500 to a thousand BPS, 5% to 10%, we’re going to own call options on the S&P and the individuals. So it’s a almost a form of dispersion where we’re buying the underlying, but we’re going to pair that with puts.

This is like, “Why does that matter?” Full transparency here, DRSK has had a crappy 2023. That’s really the first five months of 2023 is the only period that we would say, “Hey, DRSK has looked like it just hadn’t played out we’d hoped.” This is one of the things that’s assumed in the option space that I think is assumed incorrectly. If you have 500 BPS in call options, it expire between six, seven, eight months out. The market sells off 20% quick. It’s like, “Well, what happens with that? Well, prices fall, but vols rise.

So if you think about the pricing of an option, yeah, you’re your nearness to the money is really important factor, but so is implied vols. So if you’ve got 500 BPS in calls, the market sells off, your calls go from people that … Well, it’s zero. You’re going to lose that money. Well, you’re actually going to lose less than you think because you’ve got time to maturity, to expiration, and you’ve got the buoy of rising vols across the board. So we try to pair that with puts whose timed expiration is much closer. So you get the ability, this gamma, the ability for delta to move on your puts much faster than it does on your calls.

So you have a fourth quarter of 18 is a perfect example of you lose money on the calls but you make more money on your puts faster. So we view DRSK, its use in the portfolio is to say, again, all this is in the more stocks, less bonds, but to say, “Hey, we’re going to own X percent slug in DRSK knowing that of that X percent it’s like the whole capital efficient mantra, you’re going to get more equity exposure embedded into the allocation because of DRSK presence.”

Meb:

So as we’re thinking about this, have people behaved? Do you know what we’re going back to at the beginning of our conversation, the end investor’s timing strategies, timing allocations? Has your audience been pretty good? You want to slap them on the wrist a little bit? Are they following the flows, chasing performance? What’s the review?

JD:

So two ways to answer that. One way is I think this new ELN suite, so the enhanced yield suite, will really help with performance chasing just because DUBS, IDUB, and JUCY are just beta and that goes along … We’re not taking a whole bunch of risk. For the other funds, there’s always going to be some type of performance chasing. We try hard internally to ring our process of performance chasing because it is really hard, especially when you’re held not only for the strategies performance, but you’re held accountable for the model performance. I’ll bring this up and, hopefully, this will resonate with you, Meb, but my favorite strategy, and I’m fine to picking your favorite kid, I love all my kids equally, but my strategies, I love them differently, our tail strategy. So ADME is my absolute favorite.

Meb:

Oh, boy. Okay. Well, it’s-

JD:

It is the most hated that we have.

Meb:

I was going to say it’s your fourth biggest fund, so it’s not the most popular. Let’s hit that one while we’re here. I want to hear your favorite. What’s the deal? Is this favorite for all the time or favorite right now?

JD:

Favorite right now, for sure, not all the time, but you just own beta. So the underlying is beta. We have the ability to sell some calls to reduce the cost of tail exposure and then we carry tails. So we carry tails at all times. So I always point to, and we had a … I should say this. We had a strategy change. ADME changed in basically 2019. I believe November of ’19 was the strategy changed. So that was actually, ADME was our original fund and we converted it into the tail fund.

So 2020 was a first great test and, obviously, if you had one or two deltas, you know this as well as anybody, 2020 was a great year to have tail exposure. We ended up the year right in line with the market with much less drawdown. 2021 was fine. We trailed. We had drag from the tails, but we’re not there to capture a hundred plus percent of the market. Then 2022 happened and everybody hated it because convexity … When I say convexity, that sounds like a fancy word, but this is important. We’re obviously big options based. We believe you fix portfolio construction, I think you can fix portfolio construction with options exposure and you can do it by taking more beta instead of taking different factor tilts and things like that.

What does 50 delta mean? 50 delta means that for every 1% move in the underlying, you’re going to move 50 cents. So a dollar up, you’re going to move 50 cents. A dollar down, you’re going to move 50 cents. Well, a 50 delta option is going to be much more expensive than a one delta option. So in a market that’s falling, that’s free falling like a Q1 of 2020, your 50 delta options are going to help, but your one delta options are going to go bonkers. With VIX going to 80, with markets free falling, there’s convexity embedded in those tails that’s massive. Why is it massive? It’s because you’re probably protecting over a hundred percent notional easily. To get a hundred percent notional protection on a 50 delta option, you’d have to spend an arm and a leg. The different strategies we have like ACIO has higher deltas. ADME has lower deltas. So we try to blend those in allocations where you’re going to get some benefits from convexity, but it might not be optimal at the individual strategy level. So ADME is a perfect example. Tails in general is a perfect example of convexity just didn’t pay you in 2022, and obviously, that’s not good for flows.

Meb:

You mentioned thinking about strategy changes, thinking about the funds. How do you think about that? Is that something that most of these … Are they entirely rules-based? Are they mostly rules-based? Is it discretion? How do you guys tell the story around what your funds do?

JD:

So we’re big on having a system in place. We view the system as not the end all be all. It’s the guardrails of the discretion. This is how I like to describe it. Eight years ago, if I had an investment idea, I would go to your website and see if you had anything. I’d go to a bunch of different people’s website and see what I could find and try to read up on it. Now if I have an idea, I can just roll backwards and say, “Hey, will you take a look at this? What do you think about this?” So having a team that has the experience and the knowhow to think creatively and to think well about some of these things has done a ton for us and for our overall business to be able to say, “Hey, let’s launch options-based strategy that have system, that’s the discretion’s guardrails, and then let’s have folks that know what they’re doing making the decisions.” That’s where, I think, we do have, I’d put our team up against anybody just in terms of their experience and expertise in these areas.

Meb:

Talk to me a little bit about putting these all together. Is there a way that you sit down with advisors and say, “Hey, look, I hear you. You do the 60/40 thing, but over here is our model. What we really like is if you were to go all in on us or just you really think about putting these Legos into a box.” Do you do that at all, going back to the Bridgewater analogy or is it more just like, “No, these are rifle solutions to where we’re pinpointing where you may only need one or two of them”? How do you talk about that?

JD:

I would point to any success that we’ve had in terms of building relationships and gaining assets is come from experience. So if you think about our first two funds that we launched, one was concentrated momentum with a trend overlay. The other one was concentrated value with a tail overlay, and they were built to mesh together. I don’t want to spend any time on that, but our first basically three years, two years, two and a half years of existence was those funds were built if one was doing well, the other was not and vice versa. We would come in and say, “Hey, Meb, if you’re going to allocate X percent, do half of X here and half of X here.” The typical response was, “Well, that one’s done a whole lot better. I want to own that one. That one hadn’t done well, I’m not going to touch that one.”

So that experience collided with, “Hey, let’s launch these end models and let’s show, let’s illustrate how we would use them in a total portfolio context.” So now, every new fund idea that we have and that we want to bring to the table, we want to make sure that there’s some type of fit within our model framework, and then we have to have the resources, the technology, and services that we’ve built internally to be able to deal with an advisor that has different exposures. How do we incorporate what we are doing? If we can be aligned on the investment front, how can that alignment manifest itself in the end exposures based on where they are now and where we think they should be? So long-winded way of saying we think about them in the total portfolio context without a doubt.

Meb:

So as you look to the horizon, it’s summer 2023, have you guys got any more hair-brained ideas on the docket? Anything you can talk about that you think you’re thinking about or that you think is missing from the playbook?

JD:

The biggest thing that we’re rolling out is we’ve spent the last four years on some internal technology that we’re using with a lot of our OCIO, and I think that we’ve really dug in the last few years to get that to a point where we can actually roll it out to the rest of the world. I think that that’s going to do a lot. That’s the biggest thing that we’re working on is once we roll that out.

Meb:

Give us a preview, man. You can’t just mention that and not say what it is. Broadly speaking, what are some of the things you’re thinking about there?

JD:

The high level stuff is really not the hardest stuff in the world. It’s the low level stuff that is the grind. I’m talking about operating an advisor’s business. So what are the single account issues, tax transitions, concentrated holdings, how to protect them, legacy issues, all of these things. We’ve built internal systems to where we can track, and we’ve been doing this … So this first time I’m mentioning it really. We’ve been doing all this watching the whole direct indexing, how much money that’s raising, and how different people are talking about it, but our whole thesis is if Meb has a hundred million in assets, he’s going to have 20 million that can be modeled out immediately. He’s going to have 80 million that need help, and so we need a system in place that helps.

This is the last thing I’ll say on this. I think if you build a piece of technology, and this goes back to my either dumb or smart depends on your perspective, but if you build a piece of technology that can scale, I believe it is really hard to take a scalable solution and shrink it down to the needs of an advisor at the count level on a day-to-day basis. Where we had the benefit is we were willing to do that work manually for the first few years and then figure out ways. Now, we’ve got a full blown tech team now, which is obviously helpful at saying, “Hey, it would be really nice if I could do this and not have to press 18 buttons to do this and to go to these four different screens.” So that’s really what we’ve been doing for the last three, four years, which has been probably the biggest learning experience and definitely the biggest test of patience that I’ve ever gone through business-wise.

Meb:

We talk a lot about the business and money management versus money management and asset management. There’s so much sludge and slog involved in everything, not just with compliance, but dealing just with a lot of the things you mentioned, but that also can be what differentiates certainly advisors and makes the practice ability to scale, which you talked about earlier, but that’s cool, and particularly if you can get a great deal of that automated and systematic, it makes life a lot easier too. So fun. I’m excited to see it. Give me a sneak peek when you guys are ready to roll.

So the way you’ve built it is I think a very thoughtful approach to the asset management business and, hopefully, it creates longer lasting relationships. As you think about marketing and getting the word out there, how do you guys think about it? I hear you got some good schwag. I haven’t seen it, but what do you guys do? Are you going to conferences, playing golf? How do you publish in articles? Is it mostly through the website? How do you think about that world?

JD:

So I got mixed feelings on this, on just the best way to approach it. So I’m not a huge … I don’t do a ton of stuff on social media and all that stuff, and this is the type of format, and I’m not blowing smoke here, but this is the most helpful type of format for us in terms of … The interview, the sound bites and stuff like that aren’t great for really driving home points and things like that. So this type of stuff is-

Meb:

Right, but y’all’s strategies, it’s not the headline level, “Hey, I’m buying the hack ETF,” where it’s like the title gives everyone, “You probably should read the Aptus Prospectus,” and it’s like you guys are doing what you’re doing is a little more, and I say this in a good way, a little more involved, complicated, deliberate than just buying, say, a biotech ETF or something, index-based.

JD:

For sure. I think that the hack reference just lets me know you’ve been in the ETF world for at least 10 years, but-

Meb:

They got new owners that I just saw.

JD:

I saw that.

Meb:

All right. Well, keep going. So marketing schwag.

JD:

I think we really lean on our network that we have now for when somebody comes across us. We’ll do a conference or two. We’ve got a couple partners that at least we view as really solid partners that help us get in front of the types of advisors that we need. Then once we make a contact, we really lean on our network to speak for us because obviously if you say if you’re a prospective advisor trying to use us and you ask us if we’re any good, we’re probably going to tell you that we think we’re pretty good. So it’s really done wonders for us to have a growing network of folks that are willing to say, “Yeah, give them my number and let us chat about just the ins and outs of their business and our business and how we interact and things like that.”

Meb:

So I want to hear about this juicy schwag. What are you guys passing out? Are you going to send us some? What do you got?

JD:

Well, so that’s a joke in the office when somebody asked what schwag do we need to get for JUCY, and the answer was sweatpants. So we’ll have to-

Meb:

Oh, man.

JD:

We’ll have to figure that out.

Meb:

That’s funny. It’s 4th of July here for … I forget why they canceled the fireworks show, but there was a reason, but they did a drone show and I was like, “What does a drone show cost? Is it like $10,000? Is it like a hundred?” I was like, “We could do some drone shows here with some ETFs at some of these properties.” So I need to look into it. My guess is it’s more expensive than I would expect, but-

JD:

Without a doubt. I meant to start with this, Meb, but we’ve been chatting for however long we have. So I had to go up to Denver. This is, whatever it was, a month, maybe not a month ago. On Sunday before I had to go to Denver, the Nugs had the Timberwolves game four about to sweep them and I told my wife, I said, “Hey, if the … We’re Timberwolves fans today because if the Nuggets lose, they have to play game five at home and I’m going to bring you to Denver.” So I went to my first NBA playoff game, game five when they beat the Timberwolves and wife’s now a Denver Nuggets fan. So we had a blast.

Meb:

I have a pretty funny story where my brother and I went to game two of the finals and, A, being a quant, B, being a cheap bastard, I knew that, generally for every event in history, the prices go down right around until the game starts. So if you can just hold out emotionally, you’ll probably get tickets for a lot cheaper. So, we went to … Denver has an in-stadium Breckenridge pub that’s got grizzly bears and mountain lions. It’s just a very western themed, but they open it up early. We wait till right before game time, buy some tickets, and because of the flood of the app, basically, the purchase went through but never got the tickets. Long story short, we end up sitting in the pub for the entire game, so we never got to go. They refunded us and actually gave me a giant credit, which was good because I actually got to go to game five and see the final.

However, I had to take the last flight out of Denver because I was told under no circumstances was I going to miss kindergarten graduation. So the morning flight was too risky to me. I was like, “I can’t take the morning flight. They get delayed all the time,” yada, yada. Sure enough, my last flight out of Denver on Southwest, they did the rolling 30-minute delay. So I get to the airport, it’s like, “Your flight’s at 11:00.” 11:30, 12:00, 12:30, 1:00, 2:00, 2:30, they finally go, “Flight’s canceled,” and I’m panicking because I really want to be at this graduation and I feel guilty, but they moved it to 6:00 AM, but I’m also this psychopath at the airport because I flew for 24 hours with no bags. So no laptop, no AirPods, no jacket, no nothing. It looked like a crazy person, but I’m also at the airport freezing and there’s nothing to do because it’s 2:30 in the morning. So there’s no TVs, there’s no restaurants open. I can’t go to sleep because it’s too cold. So I must’ve taken 50,000 steps. I just walked for four hours. I’m like, “There’s nothing else to do.”

Anyway, there was a drone show after game two that said Nuggets in Five,” and I was like, “Oh, perfect. They nailed it,” but I’m like, “Who’s sponsoring that drone show? Why don’t you just go to the drone owner? It can’t be the Nuggets.” I’m like, “What a strange …” Anyway, long-winded story. So the flight is at 6:00 AM, I’m on board. I’m still wearing all my Nuggets clothing. We pull out of the gate and they’re like, “Hold on. One of our wings are loaded incorrectly,” and I’m just head in hand. I’m like, “Oh, my God. I can’t believe it.” We’re on the way out. Anyway, we fixed it, we get home. I made it with two minutes to spare. Didn’t shower. I did brush my teeth, but I made it and well worth it, but it was a really fun game. Fun time.

Talk to me a little bit about … As we’re talking about a lot of y’all’s ideas, the question we love asking people is, what is one investing belief do you hold that the vast majority of your investing peers do not share professionals? So two-thirds, 75% would say, “JD, I don’t agree with what you just said.” Is there any one or you probably got a few, but what are some that come to mind?

JD:

There’s probably a few that maybe not 75% would disagree, but I think the whole idea of, and maybe I’m wrong on this. I’d love to hear what you think, but if you were to separate out the … I’m not going to use an insurance analogy because that’s too easy, but if you were to separate out the premium that you spend on the potential payoff of protection and equity sell-offs, I think a lot of people focus on the standalone, “That’s ugly. I don’t want that. That’s negative.”

I’m growing in conviction that somehow there’s got to be a better way to communicate. This negative thing is a standalone basis. Its presence in the portfolio is what allows an investor to compound wealth on a real basis more effectively than a 60/40 mindset where you’re dependent on bonds and I think that’s … I do go back and forth, Meb. I haven’t shared this with my team yet, so we might need to edit this one out, but most investors, I can only … Can you think of any other goal other than to compound wealth or income off the portfolio? Maybe there’s other objectives of an investment portfolio that I’m not thinking of for-

Meb:

There’s some fringe stuff where there’s the bragging rights, there’s people that want to be able to say, “You know what? I bought Nvidia. You know what? I bought …” They like the bragging rights, and this, probably in the angel investing world too, “Hey, I was in on Google when they were just in a garage,” but other than that, as far as traditional portfolio, if you’re not a braggart, there’s not really much. There’s the people that get siloed, “Hey, my portfolio yields 6%. What is yours?” Weird, but it’s rarely outside of, “I just want to brag about it,” type of goals.

JD:

So if the goal is either income or compounding wealth, let’s just take away the income for a second, if the goal’s compounding wealth, I don’t know how important a conservative, a moderate, a growth. Should we just build the portfolio that we are most convicted that could compound at the highest rate? Sometimes that’s going to be a more aggressive portfolio by traditional measures, and sometimes it’s going to be more conservative. So that’s not a well-thought out argument, but I think that the whole risk base, and we operate in this framework too so I’m pointing at ourselves here, but I don’t know how much, don’t know if that’s the right way to go about it is to say, “Well, Meb, you’re this old and you have this much money, therefore, boom, here’s where you default to.” I think the goal should be like, “Hey, what portfolio is going to compound wealth at the highest rate and can I stomach it?”

Meb:

I think the struggle for most people is they don’t know what the answer to that is. So they would say … I think people just disagree on what the opportunity set is. There’s the efficient market crowd, so then it’s just a question of stocks, bonds, other things. There’s the people who take a much more strategic view, “Hey, foreign stocks are cheaper. Small caps or value looks better now than in other times,” whatever it may be. Commodities have been terrible maybe. So I feel like it’s not as simple as if the answer was known ahead of time.

So I think there’s two parts of that is if you could even guess … In the longer timeframe, the answer gets clear to me, but I think people definitely struggle with that, and then that uncertainty informs them saying, “Oh, shit. Maybe I don’t know what I’m doing. Maybe it is US stocks forever and foreign stocks are terrible and why would anyone invest in them? It’s been 10 years now,” whatever it may be. I don’t know.

JD:

If you’re building a portfolio today, right now said, “Hey, here’s 10 million bucks,” what percentage of that portfolio is going into private investments?

Meb:

Are you asking me are that question?

JD:

I’m asking you question that.

Meb:

Man, is this for me or is this for just someone? Because the feature bug of the private liquidity part that I think has been well-documented, in some cases it’s great, in other cases it’s not great. If you look at what’s going on with BREIT and investors getting stuck in something that they weren’t really … I don’t think they really believed they would get stuck in it. There’s things where people think, “You tell me it’s illiquid, but it’s not really. Oh, it actually is illiquid. Oh, shit. I didn’t actually expect you to be serious when you said that. The chances I thought were slim,” but I think on the public side, I love the concept of designing it ahead of time, putting it into practice and going away for a decade so that the funds and strategies will react to what’s going on in the world, and that’s my goal.

I don’t want to pay any attention to the public stuff. Just set it up, check it in 10 minutes a year. The private, the same thing, but you better be really certain on the private side on the buy decision because you’re stuck. There is no … So really, it’s a question of, to me, at that point of then cash flows and needs and do you need this money and what’s the purpose of it. So I think it totally varies for people, and mine sounds more scientific than probably it was and is, but it’s also getting blurry on the private side. There’s a lot of what it means to be private. Sorry, this is a long-winded rambling answer, but anyway, you had a input on the-

JD:

We’ve just had exposure, more exposure recently than we’ve ever had to different things that are interesting that aren’t, “Hey, here’s some type of platform where you can go get them,” this true … Some of them, it really makes you scratch your head on how much of this stuff is real and if it is real, what percentage of the portfolio should go there. We’re not recommending any of this to advisors. This is just more of if you had a $10 million family walk in the door and say, “Hey, I’ve got these interesting opportunities and here’s … What is reasonable for, to take that illiquid and the risk that you can’t see your statement on a monthly basis and know what’s going on, how much of the portfolio goes there?”

Meb:

Is this going to keep cousin or nephew, Eddie, from mucking around with a portfolio and spending it all on Bugatti’s or whatever else? Then maybe it does all need to be private. I was thinking in my head as you’re talking about. I’m like, “There’s some areas that I definitely would love to see a public illiquid variant like a farmland interval fund, I think, would be a perfect solution for that world that’s not in existence,” but I think it comes a lot down to are you trying to keep someone else or yourself from mucking around with it then having those safeguards. We’ve talked for a long time on this podcast the concept of the forever fund, where you allocate and you get penalized for redeeming early, but the rewards go to shareholders. That to me is a really cool idea.

JD:

It’s a great idea.

Meb:

It has to exist in the mutual fund. Oh, you say it’s a great idea and I agree with you, but I don’t think anyone would actually invest in it. I think people would say, “Ah, that’s brilliant, smart, but I’m logical, so I would never do something like that. So I’m not going to …” I don’t know. I also think I’d get sued, but when we get big enough, I think we’ll give it a go. What’s your most memorable investment? Anything come to mind?

JD:

Easy answer there. I don’t know if this is a good thing to say out loud or bad. I know I’ve shared it before, but when I was in college, I was in grad school … Actually, I believe it was my senior year going into grad school. I bought a penny stock. So I had my e-trade account doing my thing. You’re not talking about much money here, but we had practice. I played basketball and I had to get to the gym. So I placed a trade, went to the gym, practiced, and showered up. This is not that long ago, but it’s long ago enough that everybody didn’t have laptops. You had your desktops in the study room area. So I’m like, “All right. Before we head out, I’m going to go check my e-trade account.” The thing-

Meb:

What year was this?

JD:

This was probably ’08. So this is in the middle of some vol.

Meb:

Things are going nuts. Things are going nuts.

JD:

Yes. So I paid some crazy low whatever, and I checked and the thing was up. It had gone from a cent to two bucks and 40 cents. It was-

Meb:

You’re the Reddit meme stockers before it was cool.

JD:

So what I did with … The reason why I remember that is because I literally cashed that out and bought a ring for my wife. That’s the penny stock trade right there. That was my most memorable by far.

Meb:

Hopefully, you stayed away from them afterwards. There’s an old blog post we did. Listeners, who I’m sure no one remembers at this point, I’m going to search it real quick. It was called Is It Time To Do A Templeton? and there was a quote. It’s funny to look back at my blog from 15, 20 years ago because all the formatting got jacked up, but it says, “In 1939 with Hitler’s Germany ravaging Europe, John Templeton bought a hundred dollars of every stock trading below $1 on the New York and American stock exchanges. The trade got him a junk pile of some 104 companies, 34 of which were bankrupt for a total investment of roughly $10,400. Four years later, he sold these stocks for more than 40 grand.” So whatever that is, a three bagger. I did this, nice timing on my post, but it was March 2009. I said, “Is it time to do a Templeton?” I said, “If you ran the screen today, it returns about 300 stocks from a list of about 2,500. If you then …” For some unknown reason, I sorted them by number of insider buys to narrow it down and then you can go back and actually look at the names and I said, “There’s some truly nauseating charts in there.” A lot of these are tiny micro caps. They’re in five to 150 million range, and it absolutely smoked it over the next year or two.

JD:

I bet.

Meb:

I didn’t buy any, of course, because it reminds me there was an old idea that we talked about that was thinking about market neutral. People love to think about some of these ideas like market neutral and our buddy Wes Gray talks about even God would get fired as an active manager because even if you were perfect, there’s just times when the strategy goes inverted and backwards and you lose on both sides, but market neutral, when the market really goes down a lot, so 50% plus, it doesn’t make as much sense to me to be shorting at that point.

The big loss has already happened, and so thinking about removing that short exposure because a lot of those things that have gone down, particularly in the individual securities, 90%, 95%, like you mentioned, there’s a point where it’s just kindling and they just go nuclear the upside. We haven’t had that many markets like this in a long time. Most of these markets go down 20% and rip right back up, but at some point I imagine it’ll be healthy and nice to have a nice normal bear market once again.

JD:

It’ll happen at some point.

Meb:

At some point. JD, this has been a lot of fun. Where do people go if they want to find out more about your funds, they want you to ring them up, come visit them and walk through your CIO process? What’s the best place?

JD:

So just our website, Aptus Capital Advisors, best place to find us, and we actually put a ton of content out. We’ve got a content hub, so feel free to sign up for that. We’re usually putting something out a couple times a week and it’ll be more if there’s big macro events happening, but that’s the website. Meb, really, thank you for having me. This has been a lot of fun.

Meb:

Well, listeners, we’ll put the links in the show notes. JD, it’s been a blast. Thanks for joining us.

JD:

Thank you.

Meb:

Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.