You are who you read. Those who read Ben Carlson’s writing are better for it. He is honest, succinct, and full of insight for investors of all stripes. I’ve never interviewed anyone or published a guest post, but today I make an exception because this guy has become such a valuable resource for investors, and we need to spread the word.
Today, Ben’s book A Wealth of Common Sense hits shelves. I read an early copy and it is what you would expect from Ben: clean, engaging, and useful. It is a great book. Go buy it for yourself and for a few loved ones.
I sent Ben a list of questions, leaving out all that normal “why did you write this book” type stuff. I am sure he’s answered that question 50 times elsewhere. Here’s what he had to say:
What does your personal portfolio look like? How often do you rebalance or adjust it?
I utilize a barbell approach – my investment portfolio is all in stocks for long-term growth and then I have a liquid, online savings account for shorter-term goals. That will obviously change over time. My portfolio is full of index funds and ETFs and broadly diversified by geography, market cap and risk factors. I’m fairly slow to make changes. For example, for the past two years or so I’ve been slowly rebalancing from U.S. stocks to increase my foreign holdings because I probably had too much of a home bias in U.S. stocks. I don’t rebalance too often to allow short-term momentum to do its thing, but I will if certain investments get too far from their target weights.
How much exposure do you have to “factors” like value, momentum, and quality in your portfolio?
My portfolio is heavily tilted towards value stocks and I also like to diversify by market cap into small and mid caps. In some ways I view broad market indexes as something of a momentum play, but it’s obviously not a pure play. I’m a huge fan of the momentum factor, mainly for its diversification benefits. It’s also the least understood of the well-known risk factors. I’ve done a ton of work on momentum in my day job, but haven’t been too impressed with the retail products available. Most cost too much or they’re not tax efficient because it’s a higher turnover strategy. But some new ETFs should help take care of these problems, so I’ll be adding this factor to my portfolio in the future.
If you could design the perfect equity investment strategy, what would be its key features (or, if it already exists, what is it?)
I’ve given up looking for the perfect strategy because I’m not sure it exists. You can poke holes in every strategy out there based on historical data or potential future scenarios. I’ve learned to be wary of a perfect-looking back-test because the odds are that it would have been impossible to implement in real-time or too expensive based on the costs involved. The perfect strategy is the one you can live with over time without bailing out.
What financial technology company impresses you most and why?
I like what Betterment and Wealthfront are doing because they’ve made the onboarding process so simple for investors to sign up on their platforms. So many financial firms still make things much too difficult on their potential clients.
If you could recommend just one book that would be useful to investors at all levels of sophistication, what would it be and why?
Thinking, Fast & Slow by Daniel Kahneman. I feel one of the most important aspects of a sound investment approach is the ability to make good decisions. I don’t think it’s possible to make good decisions without an understanding of human psychology and this book gives the reader a master’s degree on human nature.
What is your biggest shortcoming as an investor?
I probably try to multi-task too often and pay attention to everything that’s going on. It’s amazing how going away for a week on a vacation makes you realize how pointless every headline or market development is, but when I’m sitting at my desk all day I can’t help myself.
What do you wish you were better at?
Predicting the future…
OK, based on my previous answer, I wish I was better at focusing my attention on a single task, instead of trying to pay attention to everything else that’s going on in the markets.
What do you think is the fairest fee structure for active managers? What do you think fees will look like in 10 years? Will it still be based on AUM? Can performance fees be justified?
I’ve thought a lot about this over the years and I’m not sure there is an optimal fee structure. You could look at every fee structure out there today and make a case that it creates a misalignment of interests. I think it all comes down how comfortable investors are with the firms they choose to work with and whether or not they will likely use poor judgement with the inherent incentives involved.
Professional investors have been clamoring for changes for a number of years now, but I wouldn’t be surprised if the fee structure looks fairly similar to the way it does today. It takes a long time to see changes in these things. Although there’s a good possibility expense ratios will be lower in 10 years. Performance fees can be justified in certain situations, but I’m not sure it makes sense when you combine it with a 2% management fee. I wouldn’t mind seeing active funds set up with index fund expense ratios but performance fees on top of that.
In your day job, you speak to many active managers. Two questions: what are you most sick of hearing? What is the most unique thing a manager has said to you?
“Here’s how we’re differentiated” gets said by nearly everyone. I liked the Peter Thiel quote from Zero to One where he said, “The most contrarian thing of all is not to oppose the crowd but to think for yourself.”
It’s nothing ground-breaking, but I’m always pleasantly surprised when a portfolio manager is willing to admit their flaws. The best investors are often humble and unassuming. Many firms try to promise their clients the world and then have to backtrack if and when things go wrong. Of course, many clients invite this on themselves in the due diligence process when they basically say, “We have the money…now impress us.” So I always find it unique when a manager is able to discuss their process in terms of reducing behavioral errors and which environments it does and does not work very well. These days it’s also unique when an investment firm refrains from mentioning the Fed.
Is it possible to identify the small group of active managers who will outperform in the future or is it just a fool’s game, the triumph of hope over experience?
It’s possible, but the key word here is small — the number of people or teams who can do it is small and as you increase the number of managers used you lower your chances of outperforming, so I don’t think it’s sustainable with a large number of managers or funds. The reason it’s so difficult is that career risk is ever present. Not only do you have to be able to identify a process that will work over the long-term, but you also have to give yourself a long enough runway to allow it to work. Very few investors are willing to sit through periods of underperformance without making a change, mainly because of outside pressure to hit short-term benchmarks.
There are teams who can do this, but the number of professionally-managed funds who are trying to outperform is much larger than the number who actually will outperform. The competition may be more intense now than it’s ever been.
If you could ask your ten favorite investors one question, what would it be?
What’s your secret to a happy life outside of the markets?