Wesley Gray 05:49

Yeah, I would say the eloquence part is Toby. I went to a crappy California high school. So public high school. My English skills have been a work in progress.

Preston Pysh 06:04

But you can’t say that anymore because we did announce where you got your masters, your undergrad, and your doctorate from so…

Wesley Gray 06:10

Yeah, no, that’s true, but I knew how to write or do English because I managed to dodge as many as those classes as possible and just focus on STEM, finance, and math what have you. But over time, now I’m on my actually, I have a fourth book coming out here pretty quick. So clearly, I’ve gotten over my writer’s block.

Preston Pysh 06:33

Well, time to tell our audience about it. Let’s hear it.

Wesley Gray 06:36

Yeah, sure. So we did… So I wrote this book even before “Quantitative Value.” This book called “Embedded.” So it was book number one as about my time being embedded with Iraqis back in 2006. And then QV came out, “Quantitative Value,” which is basically a systematic deep dive into… If I wanted to capture the value premium in the most effective way possible, but pull out, the monkey brain we all have, how would I go about doing it? That’s basically what “Quantitative Value” is about.

And then this next book that’s actually coming out here in literally three or four weeks is called “DIY Financial Advisor.” And what that book is about is it’s not like investing for dummies book. iI’s certainly still a semi-pro level, maybe arguably a pro-level that there are more talks about the asset allocation piece. So if I were to put together a total global endowment or retirement portfolio, but I wanted to do in such a way that, I could explain this to normal people and we don’t have to talk about covariance matrices, getting inverted or whatever. That’s what that book is about.

And then the final book that we’re working on a manuscript right now is even though I’m personally obviously a huge fan of value, I’m also a huge fan of just what works over the long haul. And we like momentum a lot as well. And so this next book after… Or basically, the last book prize is called “Quantitative Momentum.” Same thesis as “Quantitative Value”: how are we going to design the most effective way to exploit the momentum premium? Again, by taking out Mr. Monkey Brain and trying to fully automate this. So that’s… And I’m probably done writing books for over the rest of my life after that.

Preston Pysh 08:34

Are those last two books your own writing or are you doing those with Toby or somebody else?

Wesley Gray 08:38

Yeah. So “DIY Financial Advisor,” it’s published by Wiley. That’s actually two of my business partners. Jack Bogle, he’s also a Ph.D. guy, actually one of my former Ph.D. students at Drexel. And then one of my other business partners, David Folk, he’s an MBA Warden guy. Really smart, eloquent. He’s the Toby in the relationship, in a sense that he’s the guy that’s actually a really good writer, really good communicator. And then, sometimes Ph.D. guys need some help with that. So he’s on there. He’s also obviously a really smart guy. And then “Quantitative Momentum” is Jack and me again. So we’re just grinding on that. We geeked out a little bit.

Preston Pysh 09:25

Just so Wes, the interview here, I’m going to be asking questions that are a lot more current market conditions based, and then Stig is going to be talking to you a lot more about what you do with your business and ETF. Just so the audience knows as we go through these questions. So I’m going to throw the first question here over to Stig. Fire away, buddy.

Stig Brodersen 09:44

First, I just want to say I love the expression of being Toby in the relationship. I don’t know. So, Wes, one of the reasons why I really like to talk about ETFs is because to me, they’re much more efficient than mutual funds, which is, and I guess they’re still more popular. But in the past, that is basically what people that are not picking individual stocks, they have been buying some mutual funds.

But there are some costs. There are a lot of processes involved with the mutual fund. Not only do they have to record who’s buying it, but clearly also has to buy, it has to sell it if the investor doesn’t want to invest in the mutual fund anymore then these two… I mean, there are new transactions that have to be done.

Now, the whole structure for an ETF is a bit different. And I think that’s also one of the reasons why it’s not as costly for the investor to invest in ETF. Could you perhaps explain the mechanism behind ETFs and why it might be more efficient?

Wesley Gray 10:50

Sure. I mean, that pretty much is why we got an ETF business. So there’s really three primary benefits of an ETF. And this will explain a lot about why at the face, an ETF seemed like the best thing since sliced bread. And yet all the hundred-pound gorillas, a lot of them are not doing ETFs, which you would think like, “We’ll wait for a second, this is client-friendly. It’s better for the consumer, what’s going on here?”

So the biggest reason, for us at least, is taxes. So when we’re out there managing money and managing accounts, doing whatever we can on the tax engineering front, we start learning about the whole ETF structure. And we’re like, “Holy cow, this is a eureka moment,” because we’re an active investor, which means we trade those securities in and out. Not all the time, but sometimes, and that is going to generate a huge performance fee from Uncle Sam. The more we can pump that out into the future, as Warren Buffett showed, the magic of deferred tax compounding is pretty incredible. So when we basically said, “Hey, this ETF structure, from a tax standpoint, we’re allowed to essentially do activity in the fun, but pump the capital gains out to the future and not have to distribute them on a 10-99. That’s incredible.” So that was a beneficial one.

12:20

Benefit two is going back to your discussion about mutual funds there. A mutual fund complex usually has to keep, let’s say 1%, 2%, maybe 3% cash on hand, because you need to have a liquidity buffer in case some client says, “Oh, give me my money back.” And you don’t feel like blowing out your portfolio. And why is that bad? Well, now I’m paying some idiot, a fee on 2 to 3% of the cash. He’s not deploying the money. He’s not actually doing anything on it. And it’s just an externality problem where even it’s trying to help the other investors. But meanwhile, it’s screwing the investors inside the fund.

Whereas an ETF, you don’t have to do that. You can buy and sell on the secondary market. Or for us, if you want to trade in big size and go through the primary market, you deliver us in kind shares and we deliver you out kind shares. So there’s no cash involved. There are no issues for fund investors. It is a much cleaner design.

13:21

And then the third one, which is the biggest reason why we think ETFs are a massive disrupter in the fund manager space is the way sales work. So going back to your point there about the convoluted way that one has to get into a mutual fund and get out of a mutual fund. It all works through what they call a transfer agent system. So for example, if I’m a sales guy, and I say, “Hey, Preston, dude, I got the greatest, cake on the planet. You should buy this thing.” And you say, “You know what, I’m going to buy this mutual fund.” And let’s say it is Stig’s mutual fund. Preston’s going to go over to Stig, fill out the paperwork, put 10K and Stig’s mutual fund, guess what I’m going to then do? I’m going to go to Stig and say, “Stig, hey, go on your transfer agent files and there’s this guy named Preston who gave you 10K, give me my cut, give me my trailer. Give me my fee or give me my kickback.” The whole mutual fund complex is based on that ability to cleanly and transparently intermediate, which means sales guys and vision guys are way more important to the process.

Now, let’s look at an ETF. An ETF transfer agent’s file consists of what they call authorized participants or the people we trade with, as which are banks. So the people I know who buy and sell our ETF are people like Deutsche Bank, JP Morgan, Goldman Sachs, etc. If Preston were to buy my ETF, I have no way of knowing that, unless he literally gives me a screenshot of like his, e-trade account or something, which means if I no longer have a way to basically pay people it lends its ETF structures, lend themselves to one of two things.

One, revolutionize sales culture. It’s got to be now become a commune salary-based sales force, that you just get paid to, like, sell the product, but we can’t pay to play because we don’t know if you sold a billion dollars or million dollars. So that’s one thing. Or two, disintermediate. Go directly to the consumer. So like you guys write blogs and podcasts and really good content. You own the client’s mindshare. That’s one way you can indirectly get sales without having to deal with like a massive Salesforce. And we do a similar model.

15:59

So the bottom line is the entire industry and most 800-pound gorillas and active management are not investment shops. They are sales intermediation shops, they don’t add value. They sell stuff. The minute you take that out of the equation, they’re going to sit back and be like, “Wait for a second, our whole business model has destroyed this whole ETF thing. We need to figure out what’s going on here.” So I think that’s what pretty much explains a lot of the dynamic in the industry right now.

Preston Pysh 16:31

That was fantastic. And you know what, if you call any of these major companies and they’re trying to push a mutual fund, and they’re telling you, “Oh, yeah, the market could go higher, even though it’s August of 2015.” And, it’s like, you described that in great detail, and I think that it illuminates a lot that’s hidden behind the curtain for a lot of people and they don’t really see that side of basically the affiliate marketing side of investing.

Wesley Gray 17:00

Just real quick to emphasize that point because a lot of people don’t see it, but we get hit up by people all the time. They want to figure out how to quote-unquote, monetize us because we’re a great sell because we got all these PhDs and all these great things. And they walk in the door. And they’re like, they don’t even know about the ETF structure, really how and why it works. And they’re like, “Wait a second. So what you’re telling me is we can’t get paid?” And I’m like, “Yeah, you can’t get paid, get the hell out of my office.” And the more people understand that financial services are all about the middleman, and all about distribution, the more they learn how skeezy this industry is. And the more they want to go towards, disintermediate solutions. So, I just want to emphasize that.

Preston Pysh 17:47

Here’s an idea, you actually have to create the asset to make money?

Wesley Gray 17:51

Yeah, yeah. You actually have to create value. You can’t just be like some like a huckster in the middle. How about that for a business model.

Preston Pysh 18:01

Alright, so I want to change gears and talk a little bit about the current market conditions and as we said, this is August of 2015. So a lot of our audiences from the future when they’re listening to this stuff, so just to give you some context of where we’re at. So right now I’m of the opinion that we’re starting to see the deflationary pressures take over and I’m really excited to talk to you because I know you’ve had all these hardcore classes you understand macro where a lot of people were just micro investors. So I think the deflationary pressures are starting to take over. I also think that the Fed is going to actually raise rates before the end of the year. I actually believe them which I think there’s a lot of people out there that don’t.

Wesley Gray 18:35

Yeah.

Preston Pysh 18:36

So if they do that, that’s going to only increase these deflationary pressures. Additionally, you got the dollar, is getting stronger by the day, which is increasing those deflationary pressures beyond that. You got the American trade gap is getting deeper, which is making those deflationary pressures even stronger. So with all that said, do you agree with my opinion and if so, what are some of the triggers people really need to pay close attention to moving forward? And we all know that Carl Icahn, billionaire Carl Icahn, billionaire Bill Gross. All these guys saying that the bubble here is the junk bond market. Do you agree with my very bearish position? And if not, what aspects are you looking at?

Wesley Gray 19:15

Well, so a lot of thoughts just came over my head. So first off, I haven’t been going last year’s basically got to Graham’s Interest Rate Observer Conference. But every time I went to that, from 2009, 2010, 2011, 2012, I heard stories about how the world is going to blow up. How bonds are the worst thing on the planet, gold’s going to go to infinity. And these are from insanely smart people that have insanely well thought out theses and stories. And guess what? All of it was bull, and none of it worked.

Now, that said, with everything you just said personally, intuitively, I all agree with. But I have moved beyond that when it comes to market timing on basing things on subjective thought processing, because I can’t find any evidence that any expert who actually thinks they know what they’re talking about can actually predict anything when it comes to macro, whether we’re inflation, deflation, etc.

Now, we work for a billionaire. And I’ve been talking to him actually about this very thing a few years ago, and I’m not going to give you the full debrief on the email. But the email starts off with this line: “Hocus Pocus my ass.” And he’s speaking in reference to my diatribe hate email of why he would want to use long term trend following rules. Like, I literally just look at asset prices and current prices, a relative assault that asset sets long term trend, and using that simple stupid rule as a way to basically see the time, how you get in and out of different areas of the marketplace, whether it’s commodities bonds, what have you. I just went off on the guy and said, “This is stupid.” And he literally responds, “Hocus Pocus my ass.” And he has like this 20 laundry list of names of people that said this was going to happen, it didn’t happen.

21:26

So here’s where I would say, I agree with anything, everything you mentioned, having reconciled and investigated our billionaire buddies. The idea here basically is to focus on trend falling, which is again also antithesis to like every gut reaction of every value investor on the planet. The bottom line is that if you focused on evidence-based, robust, minimally complex, which again leads those robust ways to time markets. I highly recommend people follow trends. So if as long… Even though it’s not intuitive, so as long as a market is trending and above some long term base rate, you just hold the thing. The minute it goes below that long term trend, get out of it.

That stupid simple concept is, is basically not that simple, but pretty dang close is how we think about market timing now. And in fact, I just don’t… I don’t even try to think about macro anymore. I’ve been smoked too many times and heard too many smart people just say something like, “I’ve got to do this.” And then they’re 180% wrong.

Preston Pysh 22:43

So based on that statement, okay, we’ve seen the trend since 2015 is not a good one. So what would your opinions be on that? And I totally agree with you on the market timing. And I am really curious to see your book as you’re talking about asset allocation because that’s what all these big guys say, “Hey, you can’t time the market, but you can change your asset allocation.” So based on that trend, and based on your firm understanding of asset allocation, what do you have to say for the audience?

Wesley Gray 23:11

Sure, yeah. So commodities have not been good for, six, seven months now and they’re still not good. So commodities, until those trickle back, don’t be in that. S&P, I mean, it keeps going higher. And every time I hear someone say the cape ratio is at 99 percentile, get out, which I’ve been saying for three years now. I say, hey, the trend is strong. Until that trend really breaks, it hasn’t we’ve had like small short term vol. domestic equity is still on-trend. International equity, however, it basically fell out of bed last year early. It’s been chopping around, you could argue it’s close to being back on-trend. In many metrics, it actually is, I mean, we’re long in it right now. Bonds have again been hit or miss as well.

But yeah, I’d say so domestic equity long and strong until the trend says otherwise. International also tend to be long. Commodities out. Bonds, it’s been hit or miss. Real estate, hit or miss.

Preston Pysh 24:19

I guess I see it differently on the trend for the domestic equities. I mean, it’s off. I made a video back and I want to say March of 2015, sending out warnings that, “Hey, this is not looking good.” And since that video came out when the market was at 18-3, it’s down to what 17-3 now. So it’s 1000 points off of that. So I don’t necessarily see the trend is still increasing at this.

Wesley Gray 24:42

I’m sure the long term trend is what matters. Short term trends don’t tend to be effective. It’s all about long term trends. And to give you the most extreme example, long term trend falling helped you in, for example, Greece, right? It got you out of that bedlam. Now, if you look at China, it got you into China. And you’ve also written a 30% drawdown. But you’re still in that market because of the long term trend, the current market price is still above that long term trend. So you’re still sticking with it. So just because you do trend falling as a market time and device, it’s not in the business of preventing you from 10-20% drawdowns. It’s in the business of preventing you from the 50% drawdowns which is why it’s just… You’d still be long SMP, even though you’re exactly right. You made a good short term call. I just can’t find ways to systematically do that, that I have confidence in.

Stig Brodersen 25:40

Cool. Spoken like a real value guy. I like that. Okay, so Wes, I gotta forward a question. The reason why I’m saying I’m forwarding is that I get this question a lot. And this question is about how to value an ETF? Because whenever you look up an ETF online, you simply get bombarded with different key ratios. So if I was to value an ETF, which ratio? So how should I approach estimate the intrinsic value from that?

Wesley Gray 26:12

Sure, well… So I mean, in general, if you remember, ETF is just a holding for a bunch of underlying securities that all have different intrinsic values that obviously we’re trying to front-run. What I would say is when investigating whether I’d want to own an ETF, there are two elements. One, focus on that person’s process and then focus on how that portfolio is formed.

So for example, let’s take a value process. Let’s pretend that someone actually had a good value investing based process that’s trying to identify let’s say, the DCF of a firm and compare that to the true intrinsic value of the firm. And whenever the stock is way less intrinsic value, you buy. Whenever it’s way above, you sell.

27:00

Okay, so the process, we argue is good. We are fundamentally buying securities that are undervalued, and then it comes back to the formation. So if you look at the marketplace and this is not just the case for ETFs, but across the world, a lot of people suffer from what we call diversification. So you may have the greatest process in the world to identify said undervalued securities, but if you hold 300 stocks in the portfolio, it’s like Monger says, the diversification element, it’s become madness now. Like focus on your edge, own up to the tracking error, and the fact that you’re going to be not beating the index and beating the index in the short run. And you don’t follow that model.

So I think for an ETF specifically, because all it’s doing is buying underlying securities, it’s really important that you understand the managers’ approach to how they go about it because that’s going to be his approach. It’s going to be reflected in how and why he buys securities. And then obviously look at how and why he forms his portfolio as he does. And in the end, the intrinsic value of an ETF is the NAV. I mean, they basically trade plus or minus, 20-30 pips around a nav. So that is the intrinsic value. The real question, I think you’re asking me about the underlying securities, then?

Stig Brodersen 28:27

Yeah, yes and no, because I think that if I look at an ETF, and I might be looking at I’m not saying S&P 500 because that might be easy, but let’s just say S&P 500. You might say, okay, so the intrinsic value is just the assets. And that’s basically what I’m buying. It might be a small premium discount with basic… That is what I’m buying. Then we’ll have like hardcore value guys like me and Preston, and you’re saying, “Well, that’s not the value. The market is overvalued. So that’s not the value.” How do I estimate the intrinsic value of that? And what we would usually say is, “Well, you need to if you have a stock. You need to discount all the future cash flows to give them a price.” Then you have, like, “I can do that to Coca Cola but what if I have 500?”

Wesley Gray 29:10

Gotcha, gotcha, gotcha. I’m tracking. So one of the things that we’ve done a ton of research on is on what we call valuation base timing. So can you look at fundamentals, not at the individual stocks stock level, but at the macro market level, they help you make call`s on the market, right? Like as you want to, because we all know I’m sure you guys are aware, the old Chillers research where if you just look at, current valuations, they predict very highly future returns, which makes sense if prices are really high.

By construction, expected returns should be low. Similarly, if prices are really low, expected returns should be really high. It’s almost like mechanical and finance. So the issue though is that when you look at that evidence, you’re like, “Okay, great.” So, the markets insanely expensive right now. So I guess I’m going to sit on my hands for 10 years and wait for it to blow up, the reality of it is that’s not how the world works. So we’ve asked the question, how can we tactically use these valuation fundamental market-wide metrics to help us be more effective at timing market exposure? And we’ve looked at things like extreme valuations.

For example, if the market ever goes above the 95th percentile, go to cash or some, some derivative. That doesn’t work. We’ve also looked at things where we say, “Well, what if we look at, the valuation on the market, like say, earnings yield, so like PE but inverted, minus, say, 10-year rates, because that’s your cost of capital. You could argue might be like your 10-year treasury rate.

So if stocks are really expensive But the 10 year is 2% and the earnings yield is 5%. Even though 5% an absolute basis might be insanely expensive, on a relative basis, maybe it’s a good deal. Okay, that doesn’t work either like again, going back to buy and hold. It seems more effective and going to trend following the beats this stuff, big time.

The only way that we’ve found where fundamental seemed to work. But of course, it requires a little bit of data torture, is if you take market-wide valuations, create an earnings yield version of it, like inverted. So it’s like E over P and minus off realized inflation. That spread is actually pretty dang good. As far as like as a tactical way to identify when this is going to be effective or not.

Preston Pysh 31:53

So the inverse PE for the Shiller ratio?

Wesley Gray 31:56

Any. You can use any evaluation metric. You just want to make sure it’s like a yield format. And you compare that to the realized inflation. Like just use CPI. That spread is actually pretty dang effective relative to buy and hold or other things, as far as knowing when to time just overall in the see.

Preston Pysh 32:17

That’s awesome because that’s what we’ve really been promoting to our audience through all the episodes of our podcast. Go ahead, Stig.

Stig Brodersen 32:23

Yeah. So another question that I’m asked is, if you look up in the financial database, you would see the price to earnings and you will also see what the price to the free cash flow is. Now, very often, those two numbers are different. And I also know that you were specifically looking at stocks, where you’re filtering out what you call earnings manipulators. So it seems to be that earnings are a lot easier to manipulate than cash. Cash is just hard to do that with. So how do you look at when you value an ETF, looking at a price to earnings or price to free cash flow?

Wesley Gray 32:59

So this is a great question because Jack and I actually have published papers on this where we just say, you know what? There are great stories for why free cash flow may make more sense. There are great stories for why the price to earnings makes more sense, maybe enterprise multiples. We’re going to literally just data mined and use a supercomputer to look at every perturbation evaluation metric that one can even fathom. And just see in the sample or during this period, what actually works and what actually doesn’t work, at least over the past 40-50 years, we have data.

Well, it turns out and this is surprising until you dig into it, is that price to free cash flow is actually horrific. The reason being is cutbacks are so noisy on firms, it’s too noisy to actually give you an appropriate signal. So a lot of times it moves you one way or the other. It’s just ineffective. It’s not bad. It’s better than just say, buying the S&P 500, but buying cheap firms on price free cash flow is definitely not ideal.

And now we say, “Well, what about things like price to earnings? Or, we like enterprise multiples” I think Toby calls it the Acquirers’ Multiple or what have you. You could use book-to-mark and all these other things. It turns out that when you’re being intellectually honest, trying to look for what’s robust, what tends to work through thick and thin, maybe not all the time, but on average, enterprise multiples seem to be the most effective. And I would argue the reason for that is because that is the most businesslike way of looking at a firm, right? We’re looking at, I gotta buy the whole damn thing. The debt, the equity, payoff, minority interest, I got to put the cashback of my hand, and I get this, general operating income, that I can split between debt and equity. And we think that’s how private equity guys view the world. We think that’s how business guys view the world. And it just turns out that is the most effective way to sort quote-unquote value.

Preston Pysh 35:07

I’ve got a question for you, Wes. So Stig and I have been studying Ray Dalio a lot. And I’m sure you’re familiar with Ray there. And he’s a macro guy. And he’s been able to sidestep all these major downturns and what he says that he’s using in order to really understand that is he’s using really two main variables. He’s looking at the inflation and where that’s at. And then he’s looking at the GDP growth. And whenever he sees a country, let’s call the US, when he sees that the inflation is completely flat or decreasing significantly, and he sees the GDP decreasing significantly. That’s where he’s moving his money into more of a cash position because he’s getting ready to basically change locations on that four-piece quadrant. When you take those two variables, it turns into a quadrant of four, and he’s getting ready to move into a different quadrant where equities aren’t going to be nearly as good. And so when you look at the current conditions, have you guys… I guess I’m curious if you guys studied using those two variables and trying to understand the way that he’s going about moving his assets around based on those variables.

Wesley Gray 36:16

Sure. So we know a lot about that guy’s process because they’re all based on what they call risk parity, right? And so if you look at the past… Let me just tell you a little dirty secret about Bridgewater.

Preston Pysh 36:29

Tell us all.

Wesley Gray 36:31

And that’s not to mean that’s not what they’re going to do and afford. But historically, they’ve been focused on a very effective concept, just a really high level like an intellectual. It’s called risk parity. The idea being if you guys are unfamiliar, the audience is unfamiliar, real simply, is if I run a traditional 60-40, portfolio, 60 stocks 40 bonds. The problem is stocks are way the hell more volatile than bonds. So from a risk standpoint, my portfolio is getting say, let’s just make this up, 80% of the risk from the stocks, and only 20% from the bonds. So we can use some math to try to balance that out. We’re maybe from a risk parity structure, we should be owning 80% bonds, 20% stocks because now on a portfolio basis, 50% of my portfolio risk comes from stocks, 50% comes from bonds.

Now, let’s think about what asset over the past 30 years has looked like more than any asset class out there. 30-year treasury bond. If you started doing risk parity concepts in 1980, you’re going to basically have a portfolio that is going to be leveraged treasury bonds and have small exposures to equity and other assets. You can take a brain dead portfolio that is leverage treasury bonds, mixed with a little bit of equity, and essentially replicate the track record of Bridgewater.

So now we got to ask yourself, is that track record because those guys are actually smart and know what the heck they’re doing? Or do they haven’t run upon a golden goose called the 30-year treasury bond levered that laid the golden egg?

We’ve looked at risk parity and asset allocation contacts. And the minute you pull out treasury bond exposure, there’s no evidence in our opinion that it’s actually effective. So what happens in the asset management business? Well, you build a track record doing something, you became a brand, you get hundreds of billions of dollars. Do you guys really think that someone managing hundreds of billions of dollars can continue to provide outsized performance in a relatively competitive market with charging two and 20 fees or whatever it is? I say there’s no win.

So, I love what those guys do. It’s a great brand, great business. They all made billions of dollars. But frankly, I think everything you just mentioned there about their little two by two matrix is a great story. It sells a lot of pension funds and endowments and consultants because it sounds great. I don’t know of any empirical evidence that it actually works, period.

Preston Pysh 39:16

So you’re basically saying that because interest rates have continued to go down since 1980, whenever this 75-year cycle basically hit its culmination peak and has gone down, is the reason that they’ve been able to… because they’ve levered it, they’ve been able to do so well?

Wesley Gray 39:32

Yeah.

Preston Pysh 39:32

So now that we’re at the bottom of that, or at least we think we are, you’re saying that the next 20 to 30 years could be a real challenge for them because?

Wesley Gray 39:42

What I’m saying is the falling anyone, not just Bridgewater, but anyone in any strategy, we need an investigator over the past 30 years in control for leverage bond exposure, and then ascertain whether this person’s process is based on the fact that they just had exposure to leverage treasury bonds? Or is it based on some underlying intellectual edge that is going to allow them to perform at a sample?

Now, I’m not saying that’s not the case with Bridgewater. I’m just saying that is and due diligence point that one would want to investigate very clearly. And then these stories that they’re throwing out there about their two by two matrix, I would want to get clear empirical evidence that it’s not a story. It’s actually something that in theory could work in reality, because you don’t want to invest in stories. You want to invest in things that actually have evidence behind them.

Preston Pysh 40:41

So my understanding, with a little bit of research that I’ve done is that he breaks up let’s say the portfolio of 100% of whatever cash is in that portfolio. 25% is put into a growing inflated environment. 25% of the portfolio is putting into a deflationary GDP growing environment. So he’s basically splitting 25% into each one of those four quadrants. So for me, I guess when I look at that, there’s only a small portion of his portfolio over this assuming that the story matches what they’re actually doing, which I would tend to believe that it is. I wouldn’t necessarily say that he’s been highly leveraged on a 30-year treasury then that would have encompassed his entire portfolio. In fact, he talks about how he has diversified the funds of his company, worldwide, where only a small portion call it maybe 12.5% percent to 30% of all the money that he’s managing is even domestically in the United States. That is his holy grail to investing is being able to distribute all of that money worldwide, but I think we’re getting off.

Wesley Gray 41:52

I’ll do a recap on it. Totally agree. But you got to look at track records early and late and now the question is out of sample because their construct is very good. That’s a very, very sensible way to diversify a portfolio. Don’t diversify based on some covariance matrix. It is totally noisy. based on somewhere you got some allocation, the different states of the world, no matter what the state of the world ends up being. That’s true diversification.

My question to something like Bridgewater is, can they beat a simple passive allocation to say, some domestic equities, some international equities, some reads, some bonds and some commodities with a simple trend-following rule on it? And it’s not that they’re not good and smart. My question is more now out of sample, with all the IQs and all the brain powers and all the assets that they’ve been endowed with, can they really add value above that? And I’m going to argue no, but we’ll see. We got now a sample test and we’ll compare their performance against, some passive or diversified portfolio that has trend-following rules on it.

Preston Pysh 43:01

All right, I guess we’re just going to have to short the 30-year treasury leverage for the next 30 years and will be set.

Wesley Gray 43:11

I didn’t say that either. I said to think about it because we could go to Japan to ride the wave. But if it spikes against you, you might want to, try something else.

Preston Pysh 43:21

Wes, I’m just teasing you. So that concludes our first part interview with Wesley Gray. And we’re really looking forward to playing the rest of our interview with him next week. So make sure you guys tune in next week to hear that. So thanks for listening.

Outro 45:28

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