7:59PM Dec 15, 2019
Charlie's the founder of Greenwich associates, author of 16 books on investing, and one of the most sought after industry advisors worldwide. He also believes deeply in the paradox of skill and his latest book, The index revolution why investors should join it now presents a compelling case for indexing for most investors. Charlie was an early guest on the show, and we reconvened to talk through the full case of indexing for individuals, and some of its constraints for institutions, our conversation covers the case for indexing smart beta, the retirement problem, investing in alternatives, private equity and indexing challenges in emerging markets. After we turned off the recording, Charlie proper that we offer a prize for anyone who can find.
Early to debate the issue. Before we get going, I'd like to invite you to join the capital allocators Think Tank, a premium content subscription service, where you can discuss each episode with me and the guests alongside allocators of sizable pools of capital. You'll also gain access to the library of transcripts of past episodes, visit capital allocators podcast.com, and click the premium content button to sign up for either a corporate or individual membership. Thanks for your support. Please enjoy my second conversation with Charlie Ellis.
Charlie, it is always wonderful to see you. Here's looking at you.
You've been talking recently about how the time has come for almost everybody to be indexing their assets. Right? What's the story
long lots of parts undeniable,
drop back 50 or 60 years,
early 1960s, I come into investment management business. There were no courses at the Harvard Business School on investment management. One other guy went to Wall Street, family, why in the world I go to the investment management business, it was an excellent. I was interviewing one of the smartest men I'd ever met, very obviously a substantially competent person. And found out during the first half hour the interviews that he was talking not about the Rockefeller Foundation, but the Rockefeller family's Investment Office. And by that time, I was absolutely sure if I could figure out what he was doing. I sure as the dickens could learn a lot by working for him. The next half an hour, I learned a lot about investment management as they were seeing it in those days. And at the end of that time, he said, Would you like to join us? And I said, Yes, he said, When would you like to come to And I said, Well, I'd like to take the summer off because my wife and I kind of thought we'd go west, because my brother's getting married. And so if it didn't make any difference to you, after Labor Day, he said, No, that's pretty. We don't do anything in the summer anyway.
Once you come in on Tuesday after Labor Day,
we shook hands, and he left. Then we had been interviewing in my apartment. So I went over to see my wife and she said, How to go. I said, Well, I got offered a job and I took it. That's terrific. What you're going to be doing Investment Management. Well, that sounds interesting. What are you going to get paid? Whoops, I forgot to ask. Those days you got paid the entry level with the Chase Manhattan Bank, which was the family bank, same as domestic servants. Everybody got paid $6,000 for the first two years,
those me and just for perspective, what's that in today's dollars, less
So I had a fabulous opportunity to be raised the very beginning. And the Rockefeller family through Lawrence had done some venture capital investing. One of them was with a brilliantly talented electrical engineer, named jack scan one who had invented a desktop device that if you punch down on the keypad, the stock exchange symbol of any stock, they would print out on each sensitive tape. What was the last price high for the day low for the day trading volume. And it was unbelievable. Up until that I had to pick up the phone and call a broker and say, what was the last price of IBM or General Motors or whatever. And it was the beginning, the very beginning of a technology transformation has been simply fabulous. And what I've been able to do is to witness that transformation. candidly, there isn't any doubt in my mind that that transformation has already taken place so forcefully. And for really good, understandable reasons. It's not going to reverse. And there is a sensible answer. There's a game or a process that can be played and we carry Goodman called it the money game when he wrote that wonderful book is Adam Smith. The money game was seeing if you could outdo the investment capabilities of the other people. And that game used to be good like stealing candy from children. 10% of trading at most was done by institutions and over the institutions. First Statewide branch chain was allowed but interstate branching was not allowed for banks. So every mid sized and larger city had two or three trust departments. They were most of it. The second group would be the major insurance companies in Hartford. There was a little bit of mutual fund activity up in Boston, a little bit New York and there might be some on the west. coast but nobody's paying much attention 90% of trading was done by individuals. And they were nice people who bought or sold once every year or two, usually an odd loss because that's how much money they had about half the time it was at&t. And they bought because they've been given a raise or a bonus or an inheritance. And they sold because they're sending kids off to college or buying a home or some other sensible purpose that had nothing to do with what's going on inside the market. And they didn't know very much, but that didn't matter. They were buying a few blue chip stocks that they read about in magazines and stuff like that, where they hard to beat, no way they were easy to beat and the secret to successful active investing is to have what's called it's a little bit nasty term but called willing losers. Or serial losers are repetitive, loser habitual live But there are fairly large numbers of people who just don't happen to have accurate measurements to see how well they're doing. Who, in their thinking, that looks like an interesting stock, I'm gonna buy some stocks going up and they go buy some more. That kind of thinking without reading good research and with a lot of without a lot of comparison shopping, makes them candidly easy targets to pick off and beat.
So one of the things we'll talk about later, is this question people have about how much indexing can come back then how did price discovery work? If 90% of the people were trading because of reasons exogenous to the
market, bought on the basis of what they had written the local newspaper, Business Week or whatever place or whatever they heard, they might be pretty active. Maybe 10% of people are pretty active sort of day traders, tied into that you call it broker Pay 40 cents per share commission, then buy some good stocks. If you want to do a little bit better from time to time trade stocks and try to do a little bit better than that. Or you might be it's early days for that sort of thing, but you might be investing in mutual funds, you find a mutual fund a really good investment results we buy in and hope that that good investment result would keep going
into we're at the trust departments that were doing
stock research. Cleveland trucks, for example, would have half a dozen analysts who were willing to spend time covering utilities or industrials or financials and 930 to 445 day job and they were reporting to a group of guys in their 60s who had come up through the chain of command that they work the Investment Committee and they met once or twice a month and they would approve additions or deletions from the approved list. And then the administrative officers working off that list would buy and sell What have you got to the list because your budget, you're going to be long term hold, because you want to avoid taxes on capital gains, good dividends, because you've got personal trust, and you've got capital beneficiaries and income beneficiaries and want to pay the income beneficiaries, well, there's the receivers, and then have some money left over maybe more than we go to the next generation. And one thing you didn't want to do is pay off taxes. So you buy things that you could hold forever.
That's what the investor competition look like today,
hundred percent reversals, plus plus plus, instead of 90% of trading is done by individuals. It's now nine, nine, that is 99% of trading is done by computers. In a cash market derivatives markets added together derivatives markets a little bit bigger in the cash market, but 99% of trading. And that of course, in my mind is the final bellringer. So I want to explain some Some of the other things that go into it before you get to that, but 99% here's the final slammer. So there you are professional investor, you have noticed that you're getting better and better and better over the years because your skills keep getting better. You've got better tools to work with computers, like you wouldn't have dreamed of five years ago. They're terrific. I've got more power in my cell phone in my pocket than IBM 360 computer would have had. Holy crow. That's amazing. Yeah, it's just the beginning of the story. You have gained and gained engage. You have researched services like you've never had before. What I have it right now. You've got it through the internet. It's there all the time. Everybody gets it. So you're looking at yourself, you're saying, Ted, this is really terrific. I'm better than I used to be. I've got more source of information overhead. I get it very, very quickly, and I can act anytime I want to. There's only one Already, so can everybody else so Can everybody else. And if you happen to have, all of us are in mixture of skills and good luck, when the old days, good luck when all that important, the skills really made a big, big difference. But as more and more people get the same kind of computing power, the same kind of information, the same speed of access, more and more people get more and more equal to each other. And the skills that they might have diminished into their percentage or relative importance, because they've got these fabulous tools than this unbelievable supply. And it's that that makes them all increasingly equal. Even though they're getting better and better. They're getting less and less different. As they get less and less different. It's hard to beat the other guy. So if I'm playing bridge, and I get really better at bridge by quite a life, take lessons for five years. And I go out there and I find out everybody else's lessons to it, oh my gosh, I thought I would be way better I can't be. And then the last is, it's like playing bridge with all the cards faced up on the table. Because everybody knows everything that everybody else knows, you may manage it a little differently, may make some mistakes a little differently. You may do some smart things a little differently. But it's very hard to do significantly better than the other guys when they've got everything that you've got. And that's just the beginning of the problem. But it is an amazing reality. And everybody's sort of focused on their own personal experience. They know they're getting better. They know they got better tools. They know they got better information. They know their whiz bang compared to where they were five years ago or 10 years ago. Just easy to forget that everybody else was terrific, too. Right.
So let's talk a little bit about some of the implementation of that thesis that indexing is a winning strategy.
Well, just a couple of other things you might want to have. First. Number one, look at the information changes. Back in the 60s. wasn't all that long ago, were 70s or 80s. If you want to have a private meeting with senior management, all you had to do is show that you've done your homework that you were asking intelligent, probing questions, and that you had been coming back on a regular basis to this company, were serious investor, if you were, they'd be very glad to have you meet with 2345. How many? How many people would you like to me with because they'd like to be understood. So the pricing would be darn good. So, okay, that was rific you could get a competitive advantage. Secondly, you could be invited to a dinner where the senior executives would talk about what their plans are for the future of the company. You could get comparative advantage. Third, you could use your computer capability had one or slide rule, if you didn't have a computer to do some analysis, you could work through the SEC library down at the New York Stock Exchange where nobody went. But if you went, you can get filings to the logic to do some background digging, you could get a competitive advantage that was real.
First of all, the SEC now requires any publicly own company to use any useful information to any investor must simultaneously make a diligent effort to be sure everybody gets that statement information I give them no more private conversations with management. The second thing is, the number of people involved in active Investment Management best i can tell has gone from less than 5000 to more than 1 million over 56 years. A major securities firm might have had 10 or a dozen analysts back in 1962 or three. What were they doing They were looking for small cap stocks and interesting companies that might be interesting investment for the partners of the firm. Did they send anything out to their clients? No, not anything that Goldman Sachs didn't start sending things out until 64 or five, and there was just one of the salesman thought it might be interesting idea to put four sides of sheet of paper. Little information on four different possible investments he was doing it himself. Today, any self respecting security for has worldwide some in London, Hong Kong, Southern Singapore summit, Tokyo, some in Los Angeles 400 500, even 600 people trying to come up with insights, information, data that might be useful to clients, anything that might be useful stuff, demographers, economists, political strategists, portfolio strategist and every major industry team Working on that industry, every major company will have 10 1215 analysts really good covering that company. It's unbelievable what's been available as 600 or 500 per major firm. And of course, then if you go to the specialist firms, there are all kinds of people and then there are intermediaries, they were not a firm, we're just an intermediary. We've got access to all kinds of experts in any subject, you might like add, we've got 2000 experts. And anytime you want to talk to any one of them, just let us know glad to provide so unbelievable flourishing amount of information of all kinds, all of which is organized and distributed used as quickly as possible. instantaneously, everybody. And then you start going through these things. Well, I hear about the CFA program. How's that working out? Well, it's off to a pretty good start to get 135,000 people have passed the exams and another 250,000 people in the queue. Chief restrict before those people come from But still the biggest crowd is the US the second biggest crowd is China. third biggest crowd is India. Its global. Yeah, of course its global. It's all over the place people want in on the good thing. Then you know, you stay in Vegas they apply with that bait. Well, first of all, the investment world is probably the highest paid line of work. It's wide open to everybody. there's ever been certainly the highest paid line of work today for large numbers of people. Yeah, you don't just just a salary in the bonus. First of all, you have to retire at 65 or 70. You can keep going to 8085 1995 there guy said said look that one I'm going to stop working on a Saturday so so you stretch out longer. The second thing is anybody in the investment business knows once in a while, maybe once every 10 years, some unbelievably attractive opportunity, not really right for clients because it's too small to specialize. But some really attractive represent comes up and says I would like you to invest in me. And it doesn't always work out. But sometimes it does what it does, it can be beautiful. So, you know, the person benefits around the edges that are quite nice as well. The other thing is, you hang out with the nicest most interesting people in the world. There are just a terrifically interesting, capable group of people playing the largest competitive game anybody ever found. So if you get your energy up, but competing a golf or tennis, this is that's nothing can be done. When you get up with the really interesting game, which is multi dimensional, complicated, only the best can win, but they all get to win. And how many times do you hear somebody who used to be in the investment business and get tossed out? It's very, very small, very small. So there are a lot of really nice characteristics and everybody goes to any business school studies, investment management, at least a couple courses. Then they offer you how you go about doing things and then lots of people offering jobs and now know this recently been some diminution. But But go that big a deal when you look at it and Mr. Terrific employment. So what else is going on? Well, trading back in the early 60s might be 3 million shares a day or the New York Stock Exchange. And today, it's
probably somewhere between four and 5 billion, that's more thousand times, actually, more than 1000 times, but that's right. Unbelievable. So you got volume change, and proportion change in the numbers at all, is every time you want to buy or sell, you have to buy from guys, you know, everything that you know, you have to sell to people will everything that you know, and if you think the markets going to average a return of seven or 8%, which may be a little bit on the high side. You think Well, let's see. It's a 1% of operating costs. Not every day every trade, but over a year. Maybe half 1%. Maybe one percent and phase half of 1% 1% to one and a half percent. You know, that's right. And that up, it's somewhere around 2% has to be recovered, just to keep up with the market. So 10% of 8% is 25%. You have to beat the competition by 25%. And they know everything, you know, as soon as you know, and you can only buy from them and you only sell to them. how good a chance do you have of having this whole workout? And the answer is not very good. Then you say, well, that's the explanation. And I understand that. Everybody's got a Bloomberg terminal and everybody's got internet. And everybody's got all that information. Is there any data that would suggest because I read the newspapers, it looks pretty damn good. I, four out of our funds were in the top 10% or 20%. Now Yeah, how many funds do they actually have? Right? 76? Oh, so it's a small fraction or in the topia, is that equal to random? no drama is not equal to random. It's a little bit less than what you get with random. So take, Steve is now putting out the data, takes the funds that were in existence 10 years ago, and bring it all of them for it, including the ones that were merged out or terminated. What fraction of them could not keep up with the index that they chose? That's their benchmark. The answer is answers. 84% can keep up with 84%. That's an enormous number, or fraction. What does that mean? To me, it means very simple. If you would like to be sure that you're a top quartile manager djoser. What he has to do is choose index funds and the chances are, you'll be The top half of the top quarter mile, be sure to be in the top quarter long run. You do have to hang on but long run. That didn't sound bad. doesn't sound bad at all. Sounds like a pretty easy shot. It's two inch. But
basically, it's a two inch bike tonight.
Never to keep things simple as possible, but no simpler.
If we assume that index things the right strategy, but take it to the next level and walk through. Okay, how does someone pick the index? Depends how
clever you think you are. And what's your temperament or risk tolerances. easiest thing in the world is to buy a total market index. So you know diversified across all economies, all markets worldwide, and virtually every major company is there. That's one second right now. American and I want to stay within the United States. You can do the total US market or you can do the s&p 500 or whatever generic broad based you want. Actually, I've got a strong opinion. I've got enough time so that I can make a long term policy decision. I believe that small cap companies long long term or a better place to be invested. Where I believe Long, long term, emerging markets are more attractive than people think they are just priceless are dominated by short to intermediate term thinking over the long term, I think they'll do better and I've got the stamina, the nerve cool to be able to go through turbulence ups and downs by know in the long run that's going to work on worrying say, and do some of that, but not too much intensity, might overweight, emerging markets by 1020 30% of your portfolio or overweight small cap stocks by 1020 30% of your portfolio, but the main thing is fees are huge. And if you're talking about taxable funds, then taxes are really important. And costs are there and real, sidestepping those turns out to be the secret to long term success given where we are today. And we've got an unbelievably skilled dominated market where everybody knows all this stuff all the time immediately.
And what's your take on the lower cost is sort of, quote unquote smart beta strategies, different ways than just calculating getting at an index like exposure?
Well, first of all is the best naming that is the second best naming the very best naming was went to Scott's agree that they were going to shift the name of death insurance over to like the smart beta is just it's brilliant. You may have noticed you can now buy a bottle of sparkling water that's selling well. Joe Let's come back to this question on smart beta, if you are really knowledgeable in understanding the factors, that is factor investing that you're really talking about. So low cost, and momentum. These things do have real merit over the long, long, long term. But if you think about it for a minute, when will sales organizations ramp up their selling effort the most? And when will nice people who haven't thought about it as carefully as they might be most tempted to say, let's go with it, of course, is after a very good period of rising prices. So if value has been working very, very well, the demand for interest in buying into and the supply interest in selling people on value factor investment will rise to a crescendo at the top and then people get disappointed. We really have courage that didn't work out. I'm really not doing Oh, Well at all, now they're looking at my numbers. I don't have to give out of them. Goodness, something will work. But I'm sure there is a merit there somewhere. I believe that the guys who have for years specialized in factor investing are going to find they can't make as good a profit from doing it as they used to, because of the crowd. But they'll still probably do a pretty good job for themselves and for their investors, those who are in it because it's a good commercial opportunity. intermediaries are in it because they think hey, this is a new way to beat the market are going to create a self disappointing experience and it's a shame but you know, we're all human beings do that all the time is
a performance chasing dynamic in factor investing is kind of an interesting debate. I think it's Cliff Asness, Rob are not that go back and forth on whether you should be able to time factors and the data hasn't supported it in the same way it has with asset classes. So if you the notion is right, right that when a factor performs gets sold well, people will come in at the wrong time. It's just classic performance chasing history actually suggests that it's hard to time the factors.
Oh, boy, yes. Wonderful down the story that ends with a guy saying and I know every rock in his habit, you know, every rock and us have a huge crash with a whole bunch of everybody on the boat gets jammed around. And he says he knows one now. Let me give you the big positive pitch on indexing. Number one is that long term. And that's key because short term is what attracts your attention long term, you will have at least top quartile investment returns. Very good change will have top decile given how the markets tightened up. That'd be wonderful. Other things in addition to top decile, yes. Other things that really matter. What would that be? Well lower taxes if you're talking about personal account That'd be nice. What else? actually lower interest, lower compelling interest, lower chances that you're gonna say, Oh my god,
or, gee, that's terrific as our interest on interest, no
interest yet or electrical interesting. Boring is really helpful to stay with something hey I'm getting your own way and most of the mistakes that most of us have made and most of us will make our mistakes where we see Mr. market out there, that marvelous gigolo pain, all kinds of tricks trying to get our attention. So we'll do something and he doesn't give a darn what we do. He just wants us to do something and he wants us to do it when we're not paying too much attention. So Mr. Morgan's out there scaring us sometimes and delighting us sometimes we make the same mistake we make otherwise, because we're real people because we're naturally emotional because we have simplifying ways that we do things. If you haven't read the book. condiments wonderful book Thinking Fast thinking Slow, slow down. Think fast read that book, because it's a catalog of the ways in which as human beings are not perfectly rational. And once you get used to the fact that none of us are perfectly rational, then you can behave the way you want to, which is reduce the chances of being stimulated, provoked or scared into doing something that might not be in your best interest. And the less you do, the more you benefit is the reality about investing. Because usually what you do is you make mistakes. So if you makes your mistakes that are often a little bit like driving cars want to be a really good driver, don't get into accidents and your your friends and neighbors will tell you, you're really good driver. So it really great opportunity of indexing is it's boring. And because it's boring, you don't get interested in doing something about incentives, nothing to do about it. You stand kind of inadvertently for the long term, and wonderful things happen to you if you stay in for the long term. We've all seen charts the dead I love them because they all say, Gosh, that's interesting over the last 50 years, if you missed 2% of the best trading days, you missed the whole 50 years. And that's, that's a part of why is boring is helpful, because you don't get excited and get off to the sidelines. So you do have the positive years come for you. It's also true that the worst days come free, but over time, you will do substantially better just by being there. We're talking about this at a moment in time, where we've had an incredibly strong run in both equity and bond markets for a long time.
Do you get concerned at all that even if indexing can be the active management community vesting in the indexes, won't get retirement plans for their objectives won't get the pension plans that are underfunded.
It is but it's an important one
crucial. If you look at what are the biggest problems we as a nation have in the investments world, it's easy to summarize pensions or retirement security. You can see it easily in the state and city funds that are seriously underfunded, even if there are so many as seven seven a half percent rate of return which they're not going to get because they've got 25% in two and a half 3% bonds. They're just not going to get it. The same thing. If you look at individuals, we've got half the population does not have a retirement plan. Private Sector the good social security but no retirement plan. Those that do 401k is increasingly dominant, taking over from defined benefit system. The average person approaching age 63 and a half which is operational and retirement age in this country is making a terrible mistake in two different ways. One is that they look at their account and they say, Ted This is absolutely wonderful I got more money in my name than I ever dreamed I would have. I've got 165,000 smackers in my account why my wife and I are good again Florida meet up for those young people and play some golf, some tennis, have some fun, we're gonna have great years we've earned it been a long long working run, but we've earned it it's going to work out just fine. And anybody with any knowledge about investing knows right away. Hundred $65,000 if you take money out, take money out take money out from 63 or four Until 8689 90, in a zone, you're not going to have anywhere near enough per year, cobbled together with social security make anything like a decent connection. So what are you gonna say? You're gonna say stuff. God damn it. I worked hard all my life I played by the game rules as everybody laid them out. And I was supposed to be able to retire at a decent age and enjoy retirement. That's part of the deal. The answer is Jim, sorry, but nobody else understands that to be the part of the deal. And you're on your own. But if I'm on my own, I can promise you this. I'm angry. I'm focused, and I'm going to do something about it. And if you think we've had vices politics in the past, imagine what it would be if you had millions of people and their relatives. It's all saying it isn't fair. It isn't right. These guys got screwed. And I think we're going to have a terrible societal problem, political problem. If we don't recognize that we've got a deep misunderstanding on retirement, then you go back. Do you mind if I take a few minutes just to gloss over the key factors? We're at 65 come from? What came from social security? 1935. Yeah. But where did come from before the book came from the Railroad Retirement act in 1923. were to come from before that, what came from Churchill and Chamberlain jointly put forward in the United Kingdom to retirement at 70. And then somebody said, You can't do it Winston because 70 would put us at a disadvantage compared to the Germans, the Germans who got retirement 65 Okay, we'll revise it will put forward 65 deployments that was before 1920. So where did the Germans get say? 65 that's easy in the early 1880s. Baron von Bismarck was trying to prove that combining all the different principalities in Germany together into a German nation, led by pressure, his home country would be a great thing. So he tried to prove that aggregating was a terrific thing, then you want to get technology on a side. So we had two different devices to prove it. One was the telegraph. The Telegraph was allowed was combined with the postal service. So you could send letters to be picked up. Any Porter in any major city could be picked up in the morning be delivered that afternoon. Pretty good service. In the Telegraph, you can have instantaneous communication anywhere in Germany.
Unbelievable benefit commercial interest, family interests, all kinds of different reasons. What else do you do? Well, your face technology was railroads. We're going to bring coal and iron ore from the ruler and other areas to where the steel mills are and we're going to build steel mills and have tremendous industry. And then we're going to do, railroads are going to be able to bring people from the cities out to the countryside for weekends, vacations to can be normal, and will bring from the countryside, fresh fruit, fresh vegetables, all kinds of wonderful things that people establish good eat, it's going to make everything terrific. That's great. But where are you going to get the workers to work on the railroad? I'm going to offer them lifetime employment. That's interesting. You get them to come off the forest because they can work lifetime employment. That's terrific. What do you call that? That's guaranteed. This is a commitment. It's the honor of Germany. Okay. Let's go. Well, what goes on? Well, after go on for a couple of years or accidents on the railroads. Good Lord, what happened to that accident? Well, it was two trains ran into each other and a couple people were killed and there was big newspaper how glow and the Reichstag is really upset about it. thing about passing legislation and your political momentum is being broken up pretty badly. Very, you really got to do something about this? Well, let's send a study group and find out what the heck is going on, which is another excellent. Find out what's going on with these accidents. Well, we found out what the answer is in work parties, playing tiles, lifting heavy ties, brailles, shoveling coal, all kinds of heavy work. They're saying to the older guys, you know, the guys are in their late 50s 60s, your tool for this kind of work, you take the easy job, you'll be in charge of the switches. So the switches are being made by guys in their early 60s. So beautiful summer's day and the no trains coming in for the next couple of hours and they can, why not take a little nap? And they're just taking a nap when they forgot to wake up, and the accident happened. So we gotta stop this one. How can we start this you guarantees and paid for life. So once you pay them not to work Not to work. That's interesting. We'll do that. But I don't want to spend a lot of money on it. So find the many max where it costs not too much to solve most of the problem. And the answer was 65. Most people don't live to 65 in those days in Germany, but those who are really doddering, so 65 will pay not to work the only last for another couple years after that anyway. So that's where Germany, England, and that's why England went to 65. And that's why railroads went from 65 because they studied the German railroads before best in the act in the States. And then that's where social security came from. Then what's happened since 1883? Where's that goes that mean? They're working look, no, no. All that time goes into retirement. So retirement years has been expanded, expanding, expanding, and the balance between work years and retirement years has changed profoundly. And of course, the last part is in retirement. Don't forget it's 6566 67 little argument about the exact number of Something over 65% of your life time health expenses are spent in your life six months. So what happens that? Well, that's where half the bank for personal bankruptcies come from all kinds of trauma that goes with that cheevers assisted living is expensive and dementia is a serious problem and all those guys into difficulties. So we're going to have a real problem with old age, retirement security. And we could deal with it in a couple of ways. If you don't mind take just one more minute Emelianenko instead of people claiming Social Security when they could, which is 62. Most people don't know that there's a big difference between claiming Social Security 62 and 70 and a half when you have to do you know no have no most people don't know this is a bet it's a lot bigger. If you wait that long up. It's at least 25% more. Well, yes, certainly at least 25 it's actually 76% Hire every day for the rest of your life, inflation protected.
benefits, Social Security if you wait, why? Because the trade off. If you wait, you have fewer years in retirement, so they're willing to give you a larger amount. But what could you do with those who call it eight years? Nine years, you could during the same time period, if you got a 401k you're 60. So the easiest years to save money. So you can ramp up your savings, dump it into the 401k as fast as you could. The second thing is, you'd be invested in the 401k. And that's pretty good. The third thing is you're not taking money out of your 401k takes those three factors not taking money out, keeping put any more money in rate of return, you would easily double your 401k they've been tripling depending on which nine years yeah. So does that change things? Well, the senior Social Security goes up by 76% I love that because it's the spirit of 76 in this country, and your 401k goes up by at least, maybe more, and put those together. And your chances of being in serious financial trouble in retirement go from awful to not too bad. So if we act stone, we could make a big, big difference in what could otherwise be one of the worst problems our society has ever faced,
and what are the challenges of getting that message out, so that people understand it and act on it?
nobody's paying attention to it. It's too late. It's the big problem. The second is, Congress is not doing it because why? Well, they've got all the other things that they're dealing with in those sort of politically urgent issues that they've got to be prepared to run on. that nobody's thinking about, Hey, you know, be really good for America. If we all agreed to move retirement age from 63 or four up to 70. The company should have to adjust individuals would have to adjust. But that would make a huge positive difference. That if we encourage people not to take their social security until they're 70 and a half, and if we encourage people to keep working, is the best thing people can do. And I left here, I'm now just past 80 years of age, then I'm having a wonderful time working. I'm lucky, I'm in a line of work that I enjoy and love. I'm not a coal miner, and I'm not the ditch digger. And it's not tedious and boring. It's interesting, but it does keep you alive and well to keep going.
Yes, I want I want to bring these two together. So we have this retirement issue, and particularly true underfunded pensions as well for the old defined benefit plans. And we have this strong belief you have an indexing. And I mostly agree with you about indexing. I think the story is right. Get in the weeds have been exposed to certain people that I like, pretty much everybody else feels like maybe they're in a exception, but that's okay. That's my own fault.
You're gonna give me a break? Where could you disagree with what I've said, I haven't seen any flies.
Green, the issue I have is that it doesn't strike me today, going forward for the next 10 or 20 years, the indexing will get people what they need. They
certainly won't. So let's
talk a little bit about what some of the sophisticated institutions have done. So our beloved alma mater, Yale University has next to no money in public equities or bonds. Now I get that not everybody can do that. But for those who can, what's your take on it? Yes, indexing is important in those markets where you can index but the more interesting opportunities over the next stretch might be in private equity or venture capital or direct real estate or real assets, not financial asset
talk to you shouldn't be talking that way.
I've used myself as an example. I have probably this good network of friends in the investments world is anybody
particularly in the active
management world? Yep. Huge. And I know, because of service on the whole bunch of different philanthropic investment committees, I happen to know an awful lot of guys who are really talented at picking talented people. And I meet with them on a regular basis. So you think, hey, Charlie, you are probably as good a position as anybody to be able to pick and choose terrific active managers. What do you do with your own investing? I've got two kinds of investment. One is index funds, which I'm so happy with just really comfortable with. And the second is an index fund equivalent in many ways, Berkshire Hathaway. Now why do in Berkshire Hathaway because I bought into it and they were early mid 70s No more than this person. I don't want ever to meet him at all. Why is this a drought here? You sold out. Just I'm grateful to what he's done for me and other investors. And I'm very, very comfortable. I know they haven't done as well as indexed in the last couple of years. But that didn't bother me. I'm very comfortable staying with an investment. Why don't I go do some of the clever things that can be done? easy answer. I'm not good enough. I don't know enough. There are some ways that you could do it. Let's Let's be candid. You and I both have tremendous admiration for David Swensen, that you should David be indexing it. You know, why? He's got all kinds of competitive advantage. Everybody loves David Swensen. Everybody loves the idea of working for Yale. He's got the best team on his side, picking working with managers anybody ever had, if you have a relationship with Yale, you know, it's going to be a long term relationship average 10 years their mentor relationship, something like 14 years. That's the average, even though they usually invest with people at day one or before day one that they get into business. If you look at a list of their investment managers, you say, geez, I don't recognize most of those names. That's right. Nobody else does either. So very unusual kind of investing. Guts ball, intellectually precision, and they do slightly better on asset mix. Half of 1%, maybe slightly better on manager selection, half of 1%, maybe got a team of 30 guys who are working to be sure they keep it up. And they got a network of friends and admirers all over the world, leading feeding any kind of that they possibly can see who gets first called they do, who gets the best call, they do all kinds of vendors. So there are organizations like that, and they're not very many of them, but there are okay, who else? Well find a small investment management organization. That is really good and what tour specialist in their industries and the industry's fit together fairly well. So you got half a dozen more stellar analysts, they've got their own money in a couple of principles to get their money in, and then taking in a few outside investors as well. A couple billion dollars to help cover costs. That would be a very attractive opportunity. What else? If you find a group of let's say, 100 mathematicians who were unbelievably proficient at working with data, and they are doing things that none of the rest of us understand? And if you saw their performance compared to the performance of others, it makes no sense to me at all. They're up another guys are down there down with other guys are up. It's all over the place and they go to show ups and then not so much. I don't think I could have the stomach to live through that fine, but that's what they're doing some something nobody else is doing. They have no real competition. And they're doing fine on average over the long term. Okay, so destiny reality Okay, so what are you talking about? I'm talking about, if you are really an exception, in the waiting room fast, you don't have to index you can do something really different. But you have to be really good at your exceptional way of doing things. And you have to be not very widely followed or copied, because you got to be almost alone doing it.
Good for you go for it. You think about private equity. And let me give you two answers. One is in this world where more and more money is moving to indexing in the public markets, private equity still has extremely high fees and access to me and the other hand, structurally and David said, it's sort of the purest form of capitalism, because all of these behavioral issues disappear. If you give your money somebody for 10 years and then go buy businesses and picks them up. Where do you come out on thinking about private equity for the institutions that you work with, that have the appropriate resources to beating trying to find those exceptional managers,
those who are skilled at being good customers and understand the real competition today is not by the investment managers to get your investment money. It's by the people who've got money to get access to the best investment managers. And that's been true for the last decade and venture capitalist have clearly true in private equity. And that's a really important differentiation. Most of the guys grew up thinking that competing for the girls and funds turns out to the girls for paying attention to over the guys. And actually the big competition might be the other way around. So it's worth keeping in mind that there's a big change. The other thing that's really important, is I don't think there's any very large pool of capital that has not addressed the following question. We have a commitment to a higher rate of return than we're now getting. What can we do to increase our rate of return? Answer? Private equity. Great, so why don't we put Not 10%, but 20 or 30%, don't go to 40%. That's a little high. But let's say 33% into private equity. And we'll do it in a very imaginative way. We'll have a couple of specialists who work on selecting the private equity funds employed by US, Canada, we can't pay very high salaries because our fund structure doesn't allow us to do that. But we'll do the best we can. And we're going to be a major commitment to private equity. Fine. So you do and I do and they do and they do and the other students, so does everybody else make a major commitment to private equity? jump over to talking to private equity firms today? What would they say? We've got more money than we really would like to have. In fact, we've got a cash balance that we can use yet. We're competing with other guys with a lot of money too. So the entry price for private equity has been going up and up and up. The excellent price can't keep going up a lot if some stock markets on the relatively high side. But I recognize that that's probably as good as we can anticipate. cheevers is getting harder and harder to get those returns, then we go into different directions. Some people say, so we're not going to raise more money, we're going to stay small as we can, we're going to specialize in our particular niche, then we're not going to take new accounts. So that takes them out of the equation. There's another group say, Well, you know, if everybody wants us, we'll have to be opening up more capacity. We'll just take the money. Let's see if we can find a way to invest it as we go along. But might be difficult, but we're gonna try and you know, it's always worked so far. Well, you could have a huge flood of cash going into private equity and you can run anything by raising the entry price, which is happening
today for sure. So there's no easy road.
What do you think about with the Instead of indexing and the challenges and some of the other assets, longer term themes that might inform where you put your capital. So let's just say China's an example, where it's not hard to have a thesis that investment in China in the growth of economies is going to be a lot stronger than it will be in the US or other developed markets over the next 20 years. And for sure, some institutions have deployed a bunch of money in different ways in China. How do you think about that in the context of an asset allocation strategy?
Well, I just spent a week in Beijing. So
I'm sort of timely just
loaded up. First thing you notice right away, is the air is not too bad change. heavy industry has been pushed out of Beijing. Second thing is here, they're actually planning to do even more than that. That's a sister city going to be built, but uninfected kilometers from Beijing and a fair fraction of the people in Beijing. are going to be moved there. And it's going to be a dream come true ideal High Tech City. And it could be really interesting. Third thing is the middle class, or upper middle class in China is larger than the US population, as far as keeping in mind 350 million people here, Mrs. million people there. The number of really, really bright people. It's about proportionate, maybe a little bit on the higher side, in the mix in China, then there's a lot of dynamic, a lot of excitement and having to have a fairly stable government. For many people is a positive factor. The old communist ideas have been pretty carefully put aside by dang and others who said, Why don't we release the energies of dynamic group of people and that's exactly what's going on. If you look around and say to you know, a lot of these buildings, I don't remember them when I was here last. That's right. You don't because they weren't here last, but more coming. They're going to be more of them. And there's a certain amount of excitement above, hey, you know, if you work hard you can do really well. And all kinds of the energies that we think of and they say, well, it's not just China. Vietnam is pretty exciting place to get 120 million people and we got a high commitment to education and they've got strong work ethic and they don't borrow money and they live with their parents until they're in their early 30s. And then they move to a new place and then they bring it parents and it's a lot of dynamics to say we must have won that war because it really is all American and so many wonderfully exciting ways and it's interesting used to be that you see mustard oil bicycle and then every once in a while the motor scooter and then once in a while, an automobile. Now, every once in a while you've got those motor scooters all over the place. Quite a few automobiles and everybody's talking about building in the new Hanoi the wider highway So So, so the dynamics in the countries that are really dynamic or exciting, then if you think, gosh, you know, longer wavelength is this likely to be a big power? The answer is absolutely yes.
The challenges in some of the emerging markets with indexes are they get highly concentrated in just a few names. In fact, you lose what you're trying to get access to, which is a exposure to China, where today if you wanted a Chinese index, you probably only own banks and tech companies. Hashtag somebody think about a less diversified stock market index exposure
carefully. Let me put myself in the horns of a dilemma. The Chinese market is anybody who spends any time with it knows is still dominated by retail investors prices particularly. So unless you are good at understanding retail investors and how they track past price performance and project future price performance. Interesting may not be all that useful and might actually be a mistake, because you might find yourself being indexed with foolishness rather than index with rigorous professional expertise. So I don't want to put too much of a pressure on indexing emerging markets as well, and particularly China, because there's an unusual,
different dynamic, but then the 70s in the US, but if you have a bunch of retail, you know, and there's certainly a gambling ethos in China, and maybe that they're saying that there isn't that kind of a better opportunity for active management than there is in the US,
obviously. So if you really understood what you were doing, at the really right context, and so on, I think it'd be very interesting.
And what do you think about Europe in that context? Is that closer to the US and yeah, let's talk about some of the common debates about indexing, particularly in the us today. There's this question of Vanguards going like crazy Black Rock ETFs In addition to the traditional index funds, how big do you think indexing can get? Before you lose this someone to price discovery?
Well, let me look at it the way I look at it and see if you find this makes sense. First, if you have 30% of the value of the market index, that's not 30% of the trading activity, it's a much smaller fracture. So what you have to do is have enough assets indexed to reduce the trading activity enough. So that enough of that million plus people who are making their living as active investors comes down and down and down to a level where your call Where do you think then the markets start to become less carefully priced in information starts to get a little choppy? Mike Bloomberg terminals are going to stay out there, but maybe Stop adding to them. The SEC is not going to change its rules. That's sort of a fixed formula. You might have hedge funds reduce their volume of activity, so maybe some of that, but computers are rising and AI is guaranteed to come as a more and more and more powerful phenomena. So maybe all those things kind of cancel out. And it doesn't make an awful lot of difference, but find a way to have enough participants in the pricing determination. Decide to I've looked at it very carefully, and I've decided I'm quitting the business. I'm going into medicine, law, farming, ranching, what is it that people are going to go into that they think they're going to find a more satisfying than man, you know, honestly, it's not as good as it was, but it's still the best game in town. Yes. So it's gonna be very hard to get people to give up on going into active investing. If they do You cut back a lot, how much do you have to cut back? And the answer is you have to cut back and cut back and cut back a lot. So that you don't have a residual group of people who are pretty pretty darn good at price determination. And I don't know what it would be, but it's certainly more than half the big one have to quit. Yeah, we're a long way, probably more than three quarters and have to quit. And my own guess would be somewhere around 85% would have to quit, just because it doesn't make sense anymore.
And the combination of the interests of the people who are active managers and not quitting, and the behavior of individuals who want to do better than average, would make it sound like but that's not gonna happen for
a long time. It's my own field. But if it does happen, give me a call because I'll come out of whatever, then say, let's go.
Try it again.
What advice would you give someone who's early in their career and has discovered This great passion for investing. And they've also discovered this truth that you might never be able to win.
Well, I think the obvious answer is think about it very carefully, if you're doing it because you love it. Personally, I think there's some real merit to that as a way of making a decision of what you want to be doing. When young people say I want to go with my passion bothers me, because passion to me is an irrational, powerful emotion. And I'm not sure if passion is the right thing to guide somebody, but she said, No, I really enjoyed the nature of the work, and I'm really, really attracted to it, then I think you probably be able to find ways of making a decent living and would enjoy it. But if you're in you have to be candid with yourself. Are you going to it because you think it pays so very well? Be prepared. It's not going to pay someone if you think you're going to because it's fun. everybody's having a great good time. candidly, be careful because the party may be closing down and maybe the punch balls Going to be disappearing and maybe all the most fun people will have decided to invite go home a little on the early side. I just, it's been an absolutely glorious place to be. I am so grateful that the world was organized in such a way that that's where I happened to be. And I recognized it was all good luck. Just a truly wonderful, wonderful time. And it's not protective or jealousy of other people having a wonderful time too. I just be careful. So if you were
young, starting your career today, and you can't whisper plastics in someone's ear anymore. So what's the whisper? If you know now that if you're at the early part of a certain industry and can kind of capture a long wave of growth, you can have a very rich career.
Where would you head today
won't give you the right answer. I give you a different, this maybe person Personally, I know what I would do is I would look for mid sized groups, hundred to 500 people where I could provide a quality of leadership that they would find really, really exciting, positive affirming, and what I call servant leadership where you're helping the organization get better and better and better what it's doing. And that's the kind of work I've done with investment committees. And that's the kind of work I've done in my philanthropic work. And candidly, that's the kind of work I did a grinchy Associates and that's me. And I love doing that kind of work. And it's fairly portable, and is profoundly enjoyable. But it's a little bit like barony, you have to be for the long term, because moment to moment, it can be kind of frustrating, but if you're in it for the long term, deeply satisfying.
All right, Charlie, I want to turn to some closing questions that we didn't get to the first time we sat down for the podcast. What's your biggest investment pet peeve
about investment management as a profession and business or investing it's too much of a business, not a Enough of a profession. And that means people are not going to tell the real straightforward story that active Investment Management no longer earns the fees and costs it incurs. And that we shouldn't be telling everybody would be a good idea if you would go ahead and index because you'll be better off doing that. Probably. pet peeve, most profound concern is obviously retirement security. It is a dreadful, dreadful problem, particularly for democracy. And if we don't deal with it fairly soon, it's going to be very hard to deal with it then if we get behind the curve when that when we're really going to suffer.
Yeah, I know you're also very fond of the term passive investing.
No, we don't like passive
passive investing. You know, you think about it. did pass it. Investing is a term come from easy, guys to put together the concept. We're all electrical engineers. So plug with three prongs or two prongs is the active part than the passive part. is plugged this got two or three holes. So accident past and neither one has a pejorative connotation. But can you imagine anybody saying, I'd like you to meet Ted, he's passive? How you would feel about it? Or if you heard people rumery you know, Ted, I think he's kind of passive. You wouldn't like that. Then you wouldn't want to vote for somebody who is identified as past. past and Mr. negative word, we're all taught to be active, take charge, do something. And it's a shame that nominal terminology has put an enormous negative right on top of a very sensible way
of doing it. What's the riskiest thing you've ever done?
Oh, I think that's got to be skydiving. I would not do that I was at risk but I was at risk to be skydiving with two sons who were early mid teens and they went first. Based on the plane, I will have to tell you Watching that plane and watching my two beloved sons, I knew they were safe because when you skydive first time, you're wired with a cable to the guy who's an expert. You can't have any trouble. But it still gave me the heebie jeebies. When I went up, I also had Heebie Jeebies, but nowhere near as intensive. And then when I landed and realized he had just landed on my feet, hey, this is kind of fun. Let's go again. And my two sons running Dad, can we go again? Can we go again? I really do. Okay. It was just an emotional reaction. What teaching from
your parents as most aid with you?
I think probably an affection for America in the long run
would be the biggest one. They had grown up
in college, and then went right into the depression. And then the Second World War, the Cold War and they really believed in America. Sort of why? I'm awfully glad I do. You know, I've had an enormous privilege and traveled all over the place. And there is no place that I would rather live or have my family live, or my great grandchildren live than in America. I think we're going through a miserable moment right now. But it won't last forever. And we've gone through terrible times. Justin McCarthy did exist, and he was right here in America. And Father kosslyn didn't exist. And he was right here in America. And we've had some truly dreadful here and there and another place, but the long run the goodness of the American people in the goodness to the values we strive to keep coming back and we're lucky to have an economic system that works really, really well. And we're large scale, large number of harbors which turns out to be great to see more traffic, large number rivers turns out to be great, large number of really good agricultural soil turns out to be great We've been very lucky people and all we have to do is
stay lucky. What's the biggest mistake you've made?
I knew a very bright guy
I knew he was exceptionally bright and not a particularly agreeable person. But he was deeply involved in some venture investment. And I thought being able to invest with him might be a terrific opportunity and small proportions. He said,
you know, I'd really like to work with you. You've
got a good manager real background, you could go on the board of a couple of these companies and really help us a lot. Then sold I bought into it, then fortunately, didn't put up a lot of money but enough so that that was a mistake. So I guess that would be one. The second is back in the early mid 70s. I had a wonderful conversation over lunch with a terrific investor named Sandy goddess when Sandy ran a firm called first Manhattan. And he stepped in and said Mr. Guzman would like to see you and they'd like to have lunch with you. And I was kind of surprised because the year before, they'd been clients and Greenwich associates and I'd been able to show I thought pretty clearly that they really shouldn't be in the securities business, because they didn't want to put up capital for black trading. And they didn't organize their research by industry. They were organized around really creative ideas, then institutions were really ready to pick up that they liked what they were doing, but they couldn't understand how to work with it themselves. And they were really good at Investment Management. But they were missing the market that we were covering. We were covering large corporate pension funds thousand largest and they were gone for the second or third largest total stadium think we've got anything Rafi I think you ought to not use our services. Because I'd like to see as your assistant so I went in and see Andy's happens to be a beautiful lesson in gentleman class act. He said to me, Charlie, it's very nice to see that you told us last year, we've agreed with you. We shouldn't be using your services. But I wanted to tell you personally so it's always think that's the right way to tell somebody not going to use their service. Another separate head to say, it's kind of like but you're here for lunch and I'd like to have lunch too. And I know you're a good guy. So why don't we go up and have lunch and talk about anything you want to talk about? So the elevator going up on fundamental point in the world is anything guys wanna but the funniest, we sat down? He said, Well, we want to talk about is it Sandy? You're probably a good investor is I will ever know. Do me a favor. I'm a young guy. Teach me some lessons about investing. What would you recommend for somebody my age for investing easy. It's easy Berkshire I said you mean Warren Buffett's
But tell me all about it. For the next 40 minutes. Sandy Gunderson, who was chairman of Berkshire Hathaway told me one after know that there's different factors that caused him to believe that one really was a superb investor. So I went back to my partners, entrenched associates, and we had a reserve fund that I said, you know, the markets way down. It can't go down a lot more than this. And that happened to be true in the early 70s. That's a safe, insane investment. I think we would be smart to invest this money into safe and sane Berkshire Hathaway. So as a defensive move, we bought some Berkshire Hathaway, and candidly, it's worked out beautifully. But if what I wish has gone up 300 times from where we bought it. What I wish obviously, is we bought more. That's probably the biggest mistake.
opportunity costs. Yeah. What information do you read that you get a lot out of
that other people might not
know about? Well, I'm an art history major. So I enjoy reading about artists. Then you learn a lot by reading about artists, first of all, like investing.
It's not easy.
And very few artists are really successful financially. Then, fame comes and goes, if you look over the great, absolute short, greatest artists in the 1920s, most of them nobody has ever heard of. You go back earlier, you say, Yeah, that's right. The impressionists did not sell well. Did they know they did not sell well, but they're been very popular since then. Yeah. but different. So fashion is a very important. So that helps you with investing. And then connectivity and people is turns out that artists who were successful, hugely new artists who were successful and they learned a lot from you Whether in their art but they also helped each other get sales. And in Canada, the Group of Seven organize themselves to see if they couldn't get more promotions. And so they collectively promoted the Group of Seven is the Canadian artists who are capturing the essence of Canada then out today, their art is all over the place and wonderfully admired because they taught each other some skills and techniques that made them more or less comparable, but the concept of an all Canadian art really took off. So you learn something that way so that's me.
All right. Last one, what life lesson Have you learned that you wish you knew a lot earlier in life?
It is all about people, whatever it is, is all about people. Then people have great character, never lose it. And people do not have great character, never get it. And if you could just take that one, one lesson Stay with it but help you enormously in your family life, in your social life, in your business life, in your professional life, and in your personal just inside yourself life. And anything you could do to drift closer and closer to good character will pay off many times over. Charlie you have and always
will be one of those great characters. Thank you for this time. And
thank you for being you. It's a pleasure.
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