Retirement Wipeout; How To Protect Wealth Against Market's Biggest Shocks | Hal Ratner
Summary
Market Outlook: The podcast discusses the current state of the US equity market, highlighting concerns about overvaluation and economic uncertainty, particularly around trade policies and geopolitical developments.
Investment Strategy: Hal Ratner emphasizes the importance of a long-term investment horizon, focusing on retirement investing through automated portfolio construction algorithms that aim to maximize retirement income.
Asset Allocation: Ratner discusses a diversified approach to asset allocation, including a slight value bias in US equities, significant international exposure, and allocations to bonds and commodity futures, adjusted annually with a long-term perspective.
Technological Impact: The discussion touches on the profound impact of the AI revolution on society and investment strategies, suggesting that while AI may change societal structures, it does not yet necessitate a change in asset allocation models.
Retirement Planning: Ratner advises starting retirement planning early, recommending a savings rate of approximately 15% of income, and highlights the benefits of using 401k plans and managed accounts for efficient retirement saving.
Alternative Investments: The podcast explores the potential inclusion of private market investments and cryptocurrencies in retirement portfolios, noting the complexities and risks associated with these assets.
Risk Management: Ratner explains that risk is not solely defined by volatility but also by the quality of information available, emphasizing the importance of diversification and efficient portfolio management to mitigate risk.
Data Integrity Concerns: The podcast raises concerns about the potential impact of political interference on the integrity of economic data from institutions like the Bureau of Labor Statistics, which could affect market confidence and investment decisions.
Transcript
The US equity market is pretty overvalued. The US, we're the most powerful country in the world. We're the leading economic power in the world because of confidence in our institutions. And when things happen that underly that con that that confidence um it it it could bode poorly for the United States as a whole. So it it it's a potentially very big. >> How should investors navigate changing policy uh uncertainty surrounding trade as well as um fiscal policy? How should investors navigate volatility surrounding geopolitical uh developments? We'll be talking about asset allocation and portfolio management with our next guest Hal Ratner, global head of research at Morning Star Investment Management. We'll be talking about uh his views on proper diversification and the uh asset allocation that he prefers right now. Welcome to the show. How it's good to see you. I'm a big fan of Morning Star. I've been reading reports since I was a we lad. >> Great. Thanks. We appreciate that and uh thanks for uh thanks for the invitation. So I I think I wanted to start Go ahead. >> Yes. No. No, please. I I think I wanted to start off by just saying that um the primary focus of the group that I'm uh that I work with or my team is really revolves around uh retirement investing and using what's called an automatated portfolio construction algorithm and an online algorithm uh that's designed to allocate uh funds uh for individuals who were seeking to maximize their retirement income. So, for the most part, what we're looking at when we do our modeling is long-term estimates of asset allocation, you know, of asset classes, how they're going to perform, how they'll behave together. And um what we do look at what's currently going on in the market, that's not actually it's not usually something that we give a lot of credence to again because we're looking at investment horizons of like 40 years, 30 years in some cases. Now that said, in terms of, you know, how I view the market right now is I think by and I'm speaking, you know, uh, kind of for myself and kind of for Morning Star as a whole, but mostly probably for myself. Um, not that my views differ from Morning Stars that much, but that this is me talking in on Morning Star. So, I think by any traditional measure, you know, the US equity market is pretty overvalued. There's a lot of confusion and I think there's a lot of um there's reasons to be concerned because I do think the underlying economy is not doing terribly well right now. We saw the employment numbers come out recently that were quite poor. There's a lot of confusion uh coming out of the Trump administration right now in terms of you know what direction are we going to go um particularly around tariffs. It looks pretty negative at this point, but uh Trump does have the uh tendency to sort of change position on things relatively swiftly. Um that is good. I mean, the taco Trump always chickens out is meant to be an insult, but it's actually kind of a good thing because it implies that he's not um necessarily focused in or wed to some particular view. that has its negatives and its positives, but the positive is if things really start going south, there's some probability, we'll see a relaxation, I think, of some of those tariffs or at least a more intelligent implementation than what we're looking at right now. That confusion is a real problem, right? Because if you're, and I know this is, you know, if you're an employer, you don't know what to do about hiring necessarily. You don't know where inflation is going. Um and uh you know to kind of dovtail with another piece that David you had mentioned in our communications um you know his interference with the Bureau of Labor Statistics and the Fed are very potentially negative things for the market. So >> as an asset allocator whenever you see weakness in the economy like you mentioned payroll numbers for example and then you see uh the markets continuing to grind higher in other words somewhat of a disconnect what do you do with that? Well, I think that you kind of stick in in cases like so most asset allocators like us have something called sort of a policy portfolio. So this means that in the event that you have no particular view on the market, how do you position yourself and so in this particular market we would recommend essentially doing that. Um it's really difficult again to kind of predict where things are going right now. The market again does seem to be overvalued, but it also seems to be that people's risk appetites may be a little bit different than they've been in the past. And again, given all the I I think the lack of clarity right now and building out a coherent economic macroeconomic picture right now, um the view is to kind of stay where you are and not move um you know in anywhere uh and not to take any strong bets at this point. Particularly for our investors who again have very long horizons. Um, I do want to get to exactly what uh your asset allocation is in just one minute, but I want to first address uh this interesting article I read in the Financial Times this morning. It may have to do with what you're talking about in regards to your long-term uh outlook. Uh I'll just read these two paragraphs. Yeah, sure. >> So, there are better there are few better scholars to put AI in historical perspective than Carlo Perez, author of techn technological revolutions, financial capital, the dynamics of bubbles and golden ages. In her book, Perez identifies five great technological revolutions. The industrial revolution of the 18th century, the steam, coal, and railway revolution of the 1830s, the steel and heavy engineering revolution of the 1870s, the mass production age in the early 20th century, and the information technology revolution beginning in the 1970s. The author sees AI as an extension of that fifth technological revolution happening now. She also argues that these revolutions follow a fairly predictable cycle. An initial installation phase results in lots of lots of creative disruption and social disruption as industries and regions are appended. This is normally accompanied by overinvestment, financial mania, and stock market bubbles. I bring this up because um she identifies long-term cycles um over the course of the last 200 years. Do you agree with the last statement that we're currently perhaps seeing signs of overinvestment, financial media, and stock market bubbles that may last years during this fifth technological revolution that the author has quoted? >> Yeah. Yeah. I mean, I think that's a reasonable assertion. I I think one thing um that I would say this is these are all good points, is I do think the AI revolution is actually more profound than a lot of these other revolutions that she mentioned. So the a lot of a lot of the things like the industrial revolution really resulted in things like um you know changing the means of production right and shrinking time and space through improvements in travel and and efficiency and things like that. So there were really changes that impacted how we dealt with uh I want to necessarily get too like philosophical here but I do think this is important how we dealt with the terrestrial right and they were very disruptive and the whole like kind of schumpeder concept of creative destruction I think is you know like well taken in this case I do think with AI the change is that we're talking about a way that people perceive all aspects of reality and you know there are people right now that simply live, you know, you can live entirely in your house and just be on the internet all day. And if the information flow in your and the way that you think about things is entirely mediated by, you know, these algorithms out there, many of which are not, you know, you know, they're controlling themselves, you could begin to get somewhat disconnected from the terrestrial world. And the more people, I think, are um, you know, part of this, and we all are, right? I mean I was using this morning to do some research. Um the more there it kind of changes how we work and how we all like kind of you know how we think about like the labor market, how we think about um politics, how we think about the economy as a whole. So I think it's absolutely profound. And the other thing I would mention too is you do see through AI and things like chat gpt people sort of outsourcing their intellect to these engines, right? So you may remember where you were in school if you were writing research paper doing something you would maybe you'd use the internet to find literature that was relevant to the subject but then you'd kind of go to you know the you know uh an economic journal right to find an article that was written on that subject. Now people just kind of go to chat GPT. You get an abstract of what's going on and you kind of take that information away. And I think that process of not having to do the work to get that information, you know, and search for it may have some impact on how people think about things and also what the retention of of knowledge is. This may be going in a very different direction than you intended, but I think it's very profound. >> Well, just on I I like your line of uh line of thought uh H. So just on that so given that your your your your asset allocation approach is multi-deade and focuses on you know the endgame which is retirement how do you think this AI revolution that's currently happening is going to affect people entering retirement in the next coming decades how would it change you know fundamentally change society uh that is getting older in the next coming uh in the next coming decades and given these changes how would you distribute your asset allocation Well, I don't know that there are any at this point like clear enough signals to say that you would change, you know, what we would change what our asset allocation is. And again, our asset allocation changes as um, you know, people move through the retirement space. So, the way our product worked and the way typically retirement advisors work is there's something called a glide path. The glide path takes it says an investor is x years old you know 30 years old they should have asset allocation a as they move toward retirement that asset allocation should change and our model's a little bit more sophisticated than that in that we take into account a bunch of factors that would um lead to an ideal asset allocation such as how much money does somebody have much do they have saved how old are they what is their gender do they have outside assets all these other factors come and to determine what that asset allocation should be. And then um in terms of I think linking this back to AI or just technology, our entire business is based on the fact that the internet exists and you can deploy these models in real time. Um so I may not be exactly answering your question, but it's absolutely crucial to how we how we do things. So an entire a retiree an you know a retirement investor an individual in a um 401k plan doesn't need to necessarily sit down with an advisor to get some sort of modiccom of investment advice about how they should be investing. They can go literally to a URL that you know input the proper information or we can grab that information from their employer and then build a model of how they should actually invest. And I think going forward there's going to be more and more of that sort of investing in that information sharing online. It's a lot more efficient than um you know the way it was done let's say 15 20 years ago. >> What I was wondering if there are concrete lifestyle changes that we can observe that may influence the uh types of stocks uh or sectors that you may be overweight. For example, if let's say a few decades ago, uh primarily you would be looking at maybe consumer discretionaries or staples as long-term plays cuz everybody needs, you know, consumer staples even into their old age. Uh nowadays, people Uber eats their food. Maybe I I I don't remember the last time I bought groceries. I really don't. Um I, you know, a lot of my friends as well, um we're over we're becoming more and more reliant on big tech. So perhaps that, you know, that allocation would change for this current generation versus a few decades ago. I mean, one thing I would certainly look at would be things relating to longevity risk, right? So, we have more people living longer right now. Um, they're uh declining. I mean, the amount of people like going forward, we're we're looking at an environment where people get are getting, you know, they're living for much longer periods of times, but they're also like very much in need of medical assistance and long-term care and assisted living and things of that nature. Now, that's pretty granular, but I do think that that's something that's going to have a meaningful impact on, you know, how you might want to one might want to invest their money. So, thinking in terms of a of a of an aging uh population uh and a population that lives for a really long time and needs the things that people who are old and and and feebled, you know, need is uh is I think that's that's a theme that is is undeniable at this point. I think that's a real trend. >> And what about the uh trend that um more and more people are going to become dependents in the future. For example, the dependency ratio of most developed countries is going to become closer to one. There's going to be for every working person, there's going to be a non- workinging age person. So the assumption here is that overall consumer spending may go down. Uh have you considered that and whether or not overall consumer spending in the future may change and ultimately what that does for you? >> Yeah, I mean that seems plausible to I don't know that I have a strong opinion on it, but but yeah, right. I mean, if more money is going away from discretionary spending and more toward, you know, um non-discretionary spending, which again would be supporting um you know, people who need additional care because of their age and their frailty that really will make uh that really could make a difference. I agree. >> All right. So, what's in your model right now? Let's start with large caps. How much of the uh allocation is given to the S&P for example? So our our model on the US side is pretty much close to market weighted. We have a slight value bias that we um I would say it's almost structural. It's started to disappear over the past couple of years or so, but we do definitely do have kind of a bias there as well. And we also have um we've had up until recently a bias towards small caps as well. Um internationally we're market weighted. Um we have about 30% of I'm sorry about um oh about 33% of all of our equity is in uh foreign uh stocks. So that would be the EPHA and um the emerging market index as well. We do have allocations on the bond side. Um it's also it it's also fairly close to what would you would say would be sort of an A type allocation with biases toward um tips uh particularly short tips. Um these are good uh vehicles to defease you know expenses and retirement. Um we h we we did have an allocation to long tips that we took out of the model um because uh long tips tend to respond more toward I mean they're very volatile and they respond more to changes in rates. They have very long durations as opposed to short tips. And um we have allocations to non-d bonds as well with a slight bias toward um I'm sorry non non- US bonds with a slight bias toward emerging market uh bonds as well. So, and these are fairly structural. They they move around a little bit from one period to the next. We have a commodity futures allocation as well, which is probably about 5% of equity on the on average. Um, and that kind of moves up and down depending on our view on how things are going to play out, let's say, over the next five years. >> How frequently do you adjust your application per year? >> We do. Yeah, we do it on an ann We only do it annually and we do it with a 5 to 20 year horizon. we will make changes if that something really big happens in the market and certainly if something structural would happen. So I don't know like the the you know the euro is you know goes out of existence and we revert to you know um native you like country specific currencies but it would have to be some really major event for us to go back and revisit everything. All right. And uh generally speaking, what uh criteria do you look at or consider when making asset allocation changes on an annual basis? >> Well, actually um one of the things is we don't want to move the allocations around too much from one year to the other. There are technical reasons for that, but it's also the case that again unless there's really really strong conviction convictions, we don't want to change things around that much. We're managing uh you or advising on about $150 billion dollars of assets and they're small pools of assets. So there's definitely an interest in not like you know moving portfolios around all that much. Um but the things we look at is current valuations and we have a forecast uh model that goes out uh 20 years and depending on the um you know what that forecast model looks like we'll make changes to our uh to the asset allocation model. But again, it's strategic. It's something that I would refer to as unconditional. Um, which means while we are taking into account current information, the amount of impact that has on the portfolios is actually relatively small. >> Okay. How would you describe this strategy versus simply a buy and hold of uh large caps or a 60/40 portfolio where you have large caps versus bonds and you just hold that for multiple decades? I mean what are the advantages of your of your strategy versus something that's just yeah >> our our model changes as a function of of where somebody is in their invest in the investment cycle. Okay. So for example here I'll I'll give you a good example. Um, so again, if you're 30 years old and you have a really long horizon, and I'm not going to take into account like any specific issues you may have with your investments, like you have a large position, let's say, in company stock, um, or assets you can't hold, which would have an impact on the solution. Let's just say that that doesn't exist. Um, by and large you're going to have a really heavy equity portfolio with a bias, you know, pretty well diversified across the, you know, across the board and a bias toward riskier assets, a bias toward emerging markets debt, a bias toward commodity futures and smaller cap stocks as well. And if we're talking about private equity, um, it would have a bias toward like a big bias comparatively uh toward private equity. Uh, these are assets that have, you know, long-term payoff potential. it makes sense for younger people to hold them. Okay, as you get older, uh we begin reducing the amount of risk assets you have and we also in you know the easiest way to think about that is you end up getting more bonds relative to stocks. But it's also the case that as you get closer to retirement, we change the asset allocation such that it aligns with the expected consumption basket of the typical retiree. So you move more into um dollar denominated assets and you move more into um you know kind of larger cap stocks and um you lo move away from particularly away from having much exposure any exposure to any kind of like currency risk that would be part of the part of the portfolio. And so the model we actually use is um is one essentially where we're trying to align the asset allocation with the expected consumption schedule and the composition of that consumption of the individual who's in retirement. If you have a very long retirement I a very long horizon until you retire that doesn't really matter and the portfolios kind of look like you know they're sort of meant to maximize risk and return in a standard way. But as you get closer to retirement, the portfolios converge on uh what's called a liabilitydriven model in which your optimization of the portfolios instead of you know optimizing risk and return or other aspects of the you know expected probability distribution. you're actually trying to minimize that um you know risk between what the liability composition of the liabilities are and again this is a consumption of people who are in the retirement space versus uh what the portfolio actually looks like >> at what point somebody's >> yeah please go ahead >> I was I I can if that's unclear or it doesn't make sense I'm more than happy to elaborate >> uh well I was just wondering at what point in somebody's life should they look into this kind of a portfolio like when should we start because G you mentioned it changes throughout somebody's life closer to retirement >> I think that in the for sure you know if you're not using a formal model like with when the draw down stage that idea of aligning the portfolio to some degree with your consumption schedule I think is a good thing people kind of naturally do it and then they naturally think of you know you want to you want to decrease risk in the portfolio um but also um ensuring again that the um you know that the amount of exposure you have to assets that are not necessarily representative in your consumption basket is a good thing to do. So again kind of minimizing currency risk is a good uh is a good thing to do. Minimizing exposure to small cap stocks and that kind of thing can be helpful. >> Okay. So just going back to my question at what point should we start looking into planning for retirement? So is it 25, 30 years old, 35, 40 is there a rule here? >> Yeah, I mean you should the idea is you should start thinking about retirement as soon as possible, you know. Um that doesn't mean you need a you know you don't necessarily need an LDI type portfolio, but the way that we look at it is that um you know the sooner you start planning for retirement and that includes things like how much are you saving and what are you investing in and what might you be investing in going forward is is super important, >> right? So, uh, is there a guideline for how much of our income should be set aside for savings and investments? So, let's say, let's use a nice round number. Let's say I'm pulling in $100,000 a year. That's my pre-tax salary. So, I'm, you know, spending on housing, food, clothing, basic necessities. Then, let's allocate some of that to a portfolio like yours, like roughly what's the percentage we should be looking at here? Um, I mean, I would say something along the lines of uh overall maybe something around 15%. Now, I'm including in there if you're in, you know, if you have a 401k plan, they typically have a company match. So, the amount that's actually coming out of pocket would be less than that. Um, so, you know, I but I think that probably makes the most sense. And the earlier again you start investing the greater probability you have of you know meet meeting that goal and even have the possibility if you get you know if you're particularly successful of reducing your savings rate as you approach retirement. >> What is your view on the 401k plan? Should employees actually subscribe to that plan or should they just opt out and manage their own money or hire a manager to manage their money or buy a fund outside of a 401k plan? Um, well, I I think that most employees should invest in their 401k plan if only because they're getting additional contributions to that plan from their advis I'm sorry, from their employer. Um, I would say that, you know, if there are target date funds in the plan, again, these are uh professionally managed as multi-asset class vehicles. Um, that's definitely way to go. And if you have a managed account type program like the one that we have, that's also definitely the way to go. Um I think there are very few investors who um you know are comfortable actually constructing their own portfolios using the uh investments that are available in their 401k. Um so that's my recommendation. I also think if you're going to I mean if you have a 401k plan I think going to an advisor to pay them to manage your retirement money unless the plan is particularly poor. I'm not and and and you don't have any and you don't have again any managed component of that plan like no target date fund and no managed account process then I'm not sure that's a really great use of one's money just if that's your only goal. I want to turn our attention now to some recent news surrounding um changes to policy. So this is from Morning Star. Uh you wrote this article actually private market investing coming to 41k. Here's what Trump's executive order convene for investors. I'll just sum up what happened here. So there was a recent executive order um that allowed the SEC uh Department of Labor and the Treasury to work on a framework that would allow for the inclusion of private market investments in define contribution plans. Um, further down, it also uh allows the inclusion of cryptos in 401ks. Um, are we going to see immediate changes to our 401k because of this new order? >> No, it's really unlikely. I you will see changes. I think in the long run uh these uh what uh the Trump administration is referring to as alternative assets are going to make it into a lot of plans. Um and I think that's a good thing, right? um but they're going to be mediated by some sort of advisor. So if there's a crypto ETF or crypto fund in your plan, the likelihood of you getting direct access to that is at this point like seems pretty much impossible. And um the way you would get access through it again would be through a target date fund or through a managed account solution. And the reason I don't think it's going to be the case that people will get direct access to these funds aside from the fact that there's general consensus that it's not a very good idea is that um again the original opinion letter that that you uh the uh uh Pantheon Ventures partners opinion letter um was very clear about the fact that there needed to be an adviser involved standing between the allocation and the end investor. It's also the case that uh Paul Atkins, who's the current head of the or a current head of the SEC, in his congressional uh testimony in his confirmation hearings expressed support for that original DO letter. And again, I assume that that framework will be carried through here. >> What about cryptos in a model like yours? Are you planning to change your model to incorporate cryptos at all? >> Yeah, we're probably not going to be incorporating cryptos. Uh we do have uh we do allow investors if they're holding crypto and they want to get invite uh in you know they want to get advice from us they want to have us manage their portfolios and they're holding it in some separate account we will model our allocations around that crypto allocation but at this point we're not comfortable uh making a recommendation to crypto largely because it's not it there's no real way to kind of estimate what the long-term returns on crypto would be. So >> uh I I think people make the distinction between let's say an altcoin in the crypto space versus Bitcoin. Not everybody makes that distinction but that distinction is being made a lot by a lot of people and certainly we're seeing Bitcoin treasury companies pop up um not crypto treasury companies pop up. So perhaps Bitcoin may have a role in a portfolio like yours alongside other alts like gold. I'm just speculating here. What do you think? crypto. Um, Bitcoin would be the most likely candidate, but uh, again, that's not something that at this point that we're really entertaining. >> When you're looking at alt, alternative assets besides traditional equities and bonds. Um, just maybe walk us through your decision-m criteria uh, and what metrics you look for. >> Sure. Um, well, first of all, we have an underlying kind of statistical model of how these asset how these different funds should be paid. So the thing we're looking for is you know essentially if you add a particular fund to a mix is it providing you know efficiency to the portfolio. So is it generating enough return and reducing the overall risk of the portfolio such that it's you know worth investing in. Um uh things like fees are important because again all all of our investments are implemented using uh you know mutual funds or ETFs or uh something called a um you like a separate account product which is like a mutual fund but is not publicly available and um uh so essentially uh that's what we're and then you know do we expect the vehicle to provide some level of alpha which means that there may or may not be additional return over above what our risk model would predict that it would return. >> What is your view on um some uh statistical asset allocation models like the optimal uh modern portfolio theory for example uh optimal asset allocation model based on uh sharp ratios and um volatility. Uh does that work in real life? >> These are all good. Yeah, these are fantastic tools. I mean I I would uh I don't think you want to use them in isolation. I think they're a good way to get an initial estimate of how you might want to be uh invested. But there are a lot of additional statistical tools you can you know you can bring to bear that help you know kind of enhance uh that modeling such as you can do you know simulations of different types of portfolios. Uh well you know one of the things we do is that again asset liability um optimization in which it's not you know it's similar to uh mean variance optimization or the sharp sharp ratio maximization that you referenced earlier but the idea is your benchmark is you have another sort of um asset that you're trying to uh optimize to get close to um I think all of these are great tools for an initial estimate of how you want to um invest but I also think it's important for you know to bring you know there's a lot of information that falls outside of these models and so I think to the degree that again you use them as a tool and not necessarily as the uh be all and end all that they're super they're super helpful. >> Okay. And then the other part of the um article that you wrote private uh market funds uh what exactly does that mean in the context of a retirement portfolio? >> Yeah that's a good question. So people are talking about so these are things like private equity and private credit. So these are investments that don't change that don't trade on an exchange. They're effectively illquid and they're priced uh via an appraisal method. So they're not priced on you know they're not priced by the market. Um what that means for uh their inclusion in portfolios is there there will never be like a pure sort of private equity fund in a retirement plan. What there will be will be something called a semi-liquid fund. What those are that would be a private market fund that's wrapped in an account that includes a bunch of um you know public market uh investments as well. So if for example I have a real property fund um you know the real property component is not liquid uh but let's say I have 75 I'm sorry I have 15% of that account is in REITs and REITs are obviously quite liquid um that would be how the account would be managed and that's how the investment manager and the manager you know like us who was managing the investment managers uh you know get money to and from those portfolios ensure there's sufficient liquid liquity uh to satisfy the needs of a retirement plan because the cash flow characteristics are very different than they are on the institutional side. >> All right. Um let's talk about uh the BLS situation regarding the firing of the uh commissioner of the BLS. Uh you wrote every time you reach into your pocket >> to use your credit card, you indirectly touch the BLS. >> Uh what do you mean by that statement and ultimately how does the change of the commissioner impact the financial lives of the regular person? Yeah, I mean I could talk about this forever so but I won't I'll answer your question. Um the every so virtually every business decision that's made is made directly using uh data from the BLS or indirectly using that that data. every time you touch your so for example interest rates right so interest rates the the fed funds rate is set by the Federal Reserve and what is one of the key metrics they use they use the personal consumption expenditure right that's how they help decide what they're going to uh set the Fed funds rate at if that number is believed to be corrupted by political interests it it's going to be very difficult for the Fed to feel comfortable making a um you know making some decision on the Fed funds rate and then anytime you know if you are you know uh uh you know if you're hiring people if you're renting property if you're you know whatever anytime you have to have an implicit contract or an explicit contract that incorporates the inflation rate and they all do know whether whether you do that or not um you're not going to be confident that that data is actually unbiased or at least that it's not biased by political interest. And so the importance of having a a a trustworthy um you know organization you know organ of the government that essentially is responsible for all this very very important macroeconomic data is potentially you know catastrophic. Now I don't think that it will necessarily have a bad outcome and two reasons for that is one of them is that the current um processes that the the um BLS uses are very very much sort of baked into the organization. It's not easy to change things. Um and it's very would be very hard for somebody who's heading up the BLS to like fudge you know the data himself. The other thing is I really don't think that the current uh nominee uh uh EJ Antony is I think the chance of him making it past confirmation hearings is actually fairly fairly low if only bec I know people have questions his his technical ability but I think that um the fact that he's such a obviously partisan and political person I think could be a real a real problem for him. So again, he was at the January 6 riots. He uh you know, he he's on podcasts of people who are very very very pro MAGA, like Super Pro MAGA. I think all of this is not going to go down very well. Um and it certainly will not go down well well with the market. >> Well, what does that mean for data independence? of let's say you have somebody who is in your view kind of partisan um we as investors and observers of the markets you know need reliable data at the at the end of the day. >> Yeah. So let me uh so the the first concern would be uh although I I actually don't know that that the first concern would be is that the data is that somehow he's able to put systems in place that biases the data to make the administration happy. I don't think that that's super likely. I think the the likelier scenario if somebody like him gets confirmed is that there will be this lingering sense out there at least for a period of time that the data is biased even even if it actually isn't. And that sense that belief that the data is biased I think is enough to cause problems uh in the market and cause problems just for the United States um you know when we go out to the rest of the world seeking you know financing for our debt and all that kind of stuff. So it's it's not it's not a good uh situation, but it may actually resolve itself and be okay. But it's all about confidence, right? The US, we're the leading country, like we're the most powerful country in the world. We're the leading economic power in the world because of confidence in our institutions. And when things happen that underly that const that that confidence, um it it it could bode poorly for the United States as all. So it it's a potentially very big deal. Okay. Uh just going back and finishing off on uh asset allocation on uh for retirees. Uh we haven't touched on real estate. Traditionally, most people have had their wealth tied in real estate and reads. How does that fit into your portfolio uh allocation? >> Well, we do in we do include REITs. Um and we also um and should and we do in many case in in cases where they're available include allocations to um uh to pro to non to non-re property as well. So any investment that I mean the the the beauty of uh you know property is that it gives off a pretty consistent yield right and when you're in the retirement phase being invested in assets that are income oriented and where the return profile is based on dividends as opposed to expected capital appreciation is always a good thing. uh property is good >> and that leads to your diversification principle or thesis if you will. I think you have a pretty interesting approach to this topic. It's a very widely studied academic topic. The topic of diversification. How many assets or securities does one need to hold to be fully diversified quote unquote? Uh you know what actually does it mean to be diversified? Do we even need diversification? Some asset managers argue we just need to be concentrated and right most of the time. Uh so you know how do you approach this subject? >> This was not a good question cuz I wrote about this pretty extensively about 10 years ago. So the question the number of assets or stocks you hold is not does not answer the diversification question. And in fact, what you care about as an investor is not diversification, but >> rather too, but um uh Okay, a lot of people do agree with you, but we were taught in school, I remember in business class at undergrad, 40 stocks means you're diversified. I don't know where that came from. That was just in a textbook. >> Okay. So, I've I've done this experiment, by the way. Um it can actually be fewer depending on what market you're talking about. The question is what is your definition of you know of diversification? So if you want to replicate the S&P 500, you actually don't need that many stocks to have the same performance characteristics of the S&P 500. It could be as low as 20. Sometimes it's 10 depending on what the breath is of the index. Um I think the number 40 and it changes depending on what criteria you're using um and what and whether you're trying to and what you're defining is a diversification. So if the goal is not to um so I'll give you an example. The goal is not to um essentially replicate a particular index with as um you know few stocks as possible. Diversification I you know I you can probably do less than than 40 stocks. I would say it's it could be something closer to 20 or you know even less than that if you want to do there. In this case, the way I'm defining diversification is the point of you get to uh risk that does not really change as you ask you add more stocks or standard deviation that doesn't change as you add more stocks. So in other words, the the experiment is I had one stock, what's my standard deviation? I add another stock, what's my standard dev? And I do that and at what point do I hit the standard deviation that I would have if I had a market weighted allocation to all of those stocks? And you can do it where you have an equal weighted allocation to all of those stocks and the number goes up obviously, but it doesn't really get that that big. So I'm sure that's a much longer answer than what you actually wanted, but you don't need that many stocks to be quote diversified, >> right? So, let's say, okay, I'm planning for retirement as as most people probably are, and I'm thinking, okay, what do I actually need to do to be, you know, I want some return, but I also want to be safe by the time I'm 70 years old and I'm retired. So, I I I own a home. I have a 401k. What else do I need is the answer. There's a question that I'm constantly asking myself in my head. you know, how many assets do I need to buy that are uncorrelated with the broad equities market such that I am properly diversified, quote unquote. >> So again, again, um this it's it's unfortunately it's not a very simple answer. Um because what you're really looking for, and this is I think this is a good way to think about it. You're not looking for quote diversification. You're looking for efficiency. And you'd mentioned the sharp ratio earlier. That's a good way to think about efficiency. I can be very very diverse if I don't have a portfolio that's really not going to perform very well at all. right? Uh I can what I want to do is I want to make sure that the diversification uh minimizes my overall risk or the overall expected variance of the portfolio and that the return that I get in the end is actually as good as it can possibly be. So one thing to do is like the question about how many stocks do I need is not it's not really the right question. The question is like what kind of stocks do I need to make sure that I'm divers diversified. So it's a question of making sure that the stocks you know the the the the elements that drive the performance of those stocks right or the the drive the revenues of the companies uh that the stocks represent are coming from different places that the expected performance of these vehicles is going to be kind of sufficiently differentiated. you're, you know, you're in different sectors, uh, you have different names that, um, you know, you should see a muting of risk through that diversification. So, you, again, like I said, you can actually get a very diversified portfolio if you're just talking about stocks probably with 15 stocks out there if you want if you can do the work and you can do the calculations. Um, >> okay. So, what exactly do you mean by efficient? How do we how do we achieve this efficiency here? Uh so efficiency literally means in this case I'm defining it again as the sharp ratio or as simply the expected return over the risk of the portfolio and looking at it from the standpoint of both risk and return is really you know is critical. So again just getting a bunch of uncorrelated assets out there with any without any particular attention to how they might actually perform uh may get you a very low risk portfolio but it may not really return very much and you're investing because you want to make a return. So the act of putting together a portfolio that will have a high expected return for overall risk is again maybe this isn't a great answer. It's actually pretty complicated but there's methods of doing it and again um just sort of rule of thumb things are again looking for uh stocks that are in different areas of the market and where there's some expectation you know that they'll actually perform pretty well as well. I feel like I'm not really giving you the the answer you want. Unfortunately, it is very complicated. >> Well, let's just take a look at some maybe metrics that you may use. Uh this is from Morning Star, for example. I'm not sure. >> I'm not sure exactly what the security is. S&P 500 PR. Um what is PR? But anyway, uh this gives a sharp ratio of 70.71. Yeah. >> Okay. So, actually, so this is this is only the price return of the S&P 500. it doesn't it's actually the returns here would be lower than what you would actually get. >> Um so it it's interesting to look at but you would probably want the entire so the sharp ratio here is saying that like the price return the appreciation on the index on average is divided by the standard deviation of that index the variance of the index is you know uh 71 that that's what the the ratio is that you wind up with. The interesting thing here is that ver for a stock portfolio or any a stock index virtually all of your variance is coming from that price variance. So what this number would look like if you actually use the the total return index which says TR instead of PR um is that that sharp ratio would actually go up because your returns would go up a little bit. Um however the denominator that variance that standard deviation would barely change at all. You typically I think you want your sharp ratio to be as high as possible that absolutely you know maximize efficiency. So do you use the S&P as a benchmark and let's say well you got 71 therefore the portfolio you design should be more efficient than the S&P I should be at least 71. Is that something you do internally? >> Yeah I think so the the issue with sharp ratio is the mathematical fact is that you can have a very low yielding asset with a very low standard deviation and this comes back to that idea of efficiency. So cash for example like the one-mon tea bill has a really high sharp ratio right and actually now it has a really good return too but let's go back like 10 years when it had a really crummy return right you still had a really high sharp ratio so you need to be so the sharp ratio is a good metric but it needs to be again in the context of not only what is my sharp ratio but what is my expected return as well and what is my standard deviation as well in that portfolio >> I okay so I'm going to bring this up as an example Uh Bitcoin for example, uh a lot of Bitcoin proponents have highlighted the fact that over the entire course of Bitcoin's life, it's had a higher sharp ratio than any other major asset class despite its huge volatility. And that's because mathematically its returns have been astronomical relative to its uh standard deviation. And so um Fidelity has put together this research paper uh May dated May 1st, 2024. Um, and I think just skimming through the the the Bitcoin sharp ratio between 20 2000 and 2024, uh, sorry, 2000 and 2024 was about 0.9. So slightly higher than the S&P 500s. Um, and yet, you know, maybe as efficient as it is mathematically, it's not incorporated into a lot of retirement funds. Why not? >> Uh, well, I think there are a couple reasons for that. Um, one of I guess one of them is that it's just uh so first of all, Bitcoin also uh lost it had a a peak to trough draw down about a while ago of 75%. Um, so there's a lot of downside potential risk in the portfolio as well. It hasn't shown up that much. It only showed up really in one period significantly, but I think that that's something to be concerned about. The other thing is this is a new asset. It's not really under it seems to be uh uh priced largely by sentiment. There are no cash flows associated with this. So this really isn't it's not a security. It's not an investment in the sense that you invest in this and you expect some sort of like cash flow the way that you do in basically every other investment that you would invest in including commodities too which which have a have a you know uh they have a return like a cashbased return um as you're holding them or holding return as as you're holding those commodities. So, it's very very much sentiment driven and so I think it's scary for a lot of people. Um, I don't I'm not saying it's a bad investment. Obviously, it's turned out to be extraordinarily well over this time period, but there are a lot of reasons to to not go all in on this as well. I would also argue that at the moment I think because again we keep coming back to the current administration and I sound like I'm like a political pundant which I'm definitely not more than anything else but you know this desire to make the cryp the US the crypto capital of the world. the fact that the Trumps have a lot of financial interest in the crypto, you know, area are all things that are really contributing to the spectacular uh particularly more recent return in these in these um currencies. Um I think the technology is fascinating and that there will be a lot more use of more use of crypto and blockchain technology in the capital markets particularly, you know, the the public capital markets. Um but it's risky and um that's why I think the majority of advisers would not really put a big chunk uh into crypto although um again >> using it in a small amount does seem to be like a perfectly reasonable thing to do. >> It it is it is a relatively new asset class. You're right. It has had huge draw downs. You're right. Um I wonder if the same logic could be applied to the large cap uh stocks in the S&P that are tied to the tech sector. For example, this article that I have on my screen, it makes the comparison between Bitcoin and tech stocks, arguing here that Bitcoin over the last two years has been on par in terms of volatility to the largest MAG7 stocks. And so I I wonder how you feel about the Mag 7. >> This is not a good comparison. All right. So the MAG7 are actual companies, right? And you can analyze them and you can build out an earnings model >> and you can use tools that uh investors and you know analysts have been using for years to come up with a valuation model of what these stocks should be. That doesn't mean by any means that these models are right or that or that the market obeys them in any way, but there's a way to kind of get your hands around what one should expect, right? >> Crypto doesn't have any of that stuff. There's really no way of forecasting. uh certainly intermediate term returns all the models that I've seen and I'm not a crypto expert by any means but all the models I've seen are based on the time series that crypto has produced and there's not a lot of fundamental you know information that you can put in there so I think that makes it risky right and uh the the the example of the this the piece you shared I hadn't seen it before is actually really interesting because I think it points to the fact that you It points to the uh the risk of really using you know they say past performance is no predictor of the future and the fact that the information we have on Bitcoin is really limited if it's limited to fundamentally just the returns that the asset class has produced and there's not an ability to model it beyond that and and I don't think that there is right now um then that makes it just very very risky. So risk is not just variance and return. It's also um opacity of information or lack of information. >> Uh yeah question then. Yeah I mean no no no it makes sense. You earlier in the interview you stated that over the course of someone's life as they enter retirement they should be you'll allocate fewer risk assets to that individual. Okay. So then just philosophically speaking how do you define something that is a risk asset? Um certainly Bitcoin fits in that category, but then uh could one make the same argument with most of the S&P 500 stocks at this point? >> Oh yeah, definitely. So the way we define risk asset is actually pretty much everything that's not a a a pretty much everything that's not a bond. So stocks are risk assets, commodity futures are risk asset. Bitcoin, which is a lot closer to commodity, it's a currency uh would be a risk asset as well. Um and then non-risk assets would be um asset classes where the uh sort of the underlying fundamentals of how you get paid in the assets is not that risky. So a government bond a treasury bond is risky in the sense that um you know it's it has price variation right and if you have a long like a 30-year treasury then the ab you know that the price of that bond is going to move out a lot but you will definitely get paid you will definitely get your money. So risk assets though I think a good way to think about it is that as I move from if I think of of some entity that's collecting revenue to then pay through the security right the ultimate taxing authority and the ultimate you know uh uh king of all revenue collectors is the US government okay as you move down to let's say municipalities you're talking about m municipal bonds and then you move into individual companies and then you move from the debt of companies to the equity of companies, you know, you're moving down the capital structure, then the assets become more risky and they become more risky because there's more risk around whether you're actually going to get your money or you're going to get paid or not. >> The statement that risk is not just standard vol standard deviation in volatility, which is something you mentioned previously. That's something that's something uh some some other people have said as well. Is that true? >> Is that how do we look at risk? Yeah. So if you if you have to step back and say give me the broadest the definition of risk of what that is um risk is basically the is essentially the qual of the quality of your information. How good is your information and so the reason why and what is your ability to make some sort of assessment of how a particular asset might perform. So as my information gets poorer the risk essentially goes up right. So the reason why um you know stocks have higher standard deviation than bonds is because the certainty of me getting paid by a stock of me getting a dividend on that stock is actually lower than it would be for let's say a bond issued by the same institution um where the bond sits higher in the capital structure. Okay. So, my information um there's risk there because I actually don't know like what the company's revenues is go are going to be in like three years and maybe something bad will happen and they won't pay out a dividend and all that kind of stuff might happen. The likelihood my information that I'm not going to get paid out if I'm holding a bond, you know, it is is better because I know that I will get paid before the equity holders get paid. So, um, there's a lot of different ways to describe that, but risk is essentially the quality of your of your information and how you, you know, you know, your ability to synthesize that information into something that actually means something. >> Okay. Uh, very good. Thank you very much. Uh, how let's, uh, let's close off here and we can, uh, let people study your work in more detail. Where can we go to read more from you, How? >> Um, that's a good qu. Well, I have a few things right up on morningstar.com and I do have a new piece coming out that's going to be talking a little bit more about the um opinion letter from the do um that's going to be it's a short piece you pretty easy to read. You can read it in one one sitting but kind of focusing on the idea that like alts is not an asset class. Um the do letter talked about allowing alts, you know, into 401k plan. Again, we think that's generally a pretty good idea, but alts is not like, you know, it's a lot of stuff that everybody just kind of put under one umbrella. Bitcoin is an alt and private equity is an alt. And there no two investments that I can think of that are more different than each other than Bitcoin and alts, right? >> Uh Bitcoin, again, there's no capital. >> Private markets. >> Private markets. Yeah, I'm sorry. Um whereas private markets is kind of the most traditional type of investing out there. You know, you're investing in a company, you're lending to a company, you have a definite expected cash flow. Um again, it's not priced by the market, so you don't always know exactly what the valuations are. You always know exactly what what Bitcoin is trading at because it just traded. So, um they're really different from each other, and yet they're all being kind of considered uh you know, to be alt. So part of the piece that I'm talking about is sort of addressing that issue. >> Thanks again. We'll put the link down below to uh Morning Star and we'll uh we'll speak again. How take care for now. >> Yeah. Thanks a lot. Take care. Bye-bye. >> Thank you for watching. Don't forget to like and subscribe.
Retirement Wipeout; How To Protect Wealth Against Market's Biggest Shocks | Hal Ratner
Summary
Transcript
The US equity market is pretty overvalued. The US, we're the most powerful country in the world. We're the leading economic power in the world because of confidence in our institutions. And when things happen that underly that con that that confidence um it it it could bode poorly for the United States as a whole. So it it it's a potentially very big. >> How should investors navigate changing policy uh uncertainty surrounding trade as well as um fiscal policy? How should investors navigate volatility surrounding geopolitical uh developments? We'll be talking about asset allocation and portfolio management with our next guest Hal Ratner, global head of research at Morning Star Investment Management. We'll be talking about uh his views on proper diversification and the uh asset allocation that he prefers right now. Welcome to the show. How it's good to see you. I'm a big fan of Morning Star. I've been reading reports since I was a we lad. >> Great. Thanks. We appreciate that and uh thanks for uh thanks for the invitation. So I I think I wanted to start Go ahead. >> Yes. No. No, please. I I think I wanted to start off by just saying that um the primary focus of the group that I'm uh that I work with or my team is really revolves around uh retirement investing and using what's called an automatated portfolio construction algorithm and an online algorithm uh that's designed to allocate uh funds uh for individuals who were seeking to maximize their retirement income. So, for the most part, what we're looking at when we do our modeling is long-term estimates of asset allocation, you know, of asset classes, how they're going to perform, how they'll behave together. And um what we do look at what's currently going on in the market, that's not actually it's not usually something that we give a lot of credence to again because we're looking at investment horizons of like 40 years, 30 years in some cases. Now that said, in terms of, you know, how I view the market right now is I think by and I'm speaking, you know, uh, kind of for myself and kind of for Morning Star as a whole, but mostly probably for myself. Um, not that my views differ from Morning Stars that much, but that this is me talking in on Morning Star. So, I think by any traditional measure, you know, the US equity market is pretty overvalued. There's a lot of confusion and I think there's a lot of um there's reasons to be concerned because I do think the underlying economy is not doing terribly well right now. We saw the employment numbers come out recently that were quite poor. There's a lot of confusion uh coming out of the Trump administration right now in terms of you know what direction are we going to go um particularly around tariffs. It looks pretty negative at this point, but uh Trump does have the uh tendency to sort of change position on things relatively swiftly. Um that is good. I mean, the taco Trump always chickens out is meant to be an insult, but it's actually kind of a good thing because it implies that he's not um necessarily focused in or wed to some particular view. that has its negatives and its positives, but the positive is if things really start going south, there's some probability, we'll see a relaxation, I think, of some of those tariffs or at least a more intelligent implementation than what we're looking at right now. That confusion is a real problem, right? Because if you're, and I know this is, you know, if you're an employer, you don't know what to do about hiring necessarily. You don't know where inflation is going. Um and uh you know to kind of dovtail with another piece that David you had mentioned in our communications um you know his interference with the Bureau of Labor Statistics and the Fed are very potentially negative things for the market. So >> as an asset allocator whenever you see weakness in the economy like you mentioned payroll numbers for example and then you see uh the markets continuing to grind higher in other words somewhat of a disconnect what do you do with that? Well, I think that you kind of stick in in cases like so most asset allocators like us have something called sort of a policy portfolio. So this means that in the event that you have no particular view on the market, how do you position yourself and so in this particular market we would recommend essentially doing that. Um it's really difficult again to kind of predict where things are going right now. The market again does seem to be overvalued, but it also seems to be that people's risk appetites may be a little bit different than they've been in the past. And again, given all the I I think the lack of clarity right now and building out a coherent economic macroeconomic picture right now, um the view is to kind of stay where you are and not move um you know in anywhere uh and not to take any strong bets at this point. Particularly for our investors who again have very long horizons. Um, I do want to get to exactly what uh your asset allocation is in just one minute, but I want to first address uh this interesting article I read in the Financial Times this morning. It may have to do with what you're talking about in regards to your long-term uh outlook. Uh I'll just read these two paragraphs. Yeah, sure. >> So, there are better there are few better scholars to put AI in historical perspective than Carlo Perez, author of techn technological revolutions, financial capital, the dynamics of bubbles and golden ages. In her book, Perez identifies five great technological revolutions. The industrial revolution of the 18th century, the steam, coal, and railway revolution of the 1830s, the steel and heavy engineering revolution of the 1870s, the mass production age in the early 20th century, and the information technology revolution beginning in the 1970s. The author sees AI as an extension of that fifth technological revolution happening now. She also argues that these revolutions follow a fairly predictable cycle. An initial installation phase results in lots of lots of creative disruption and social disruption as industries and regions are appended. This is normally accompanied by overinvestment, financial mania, and stock market bubbles. I bring this up because um she identifies long-term cycles um over the course of the last 200 years. Do you agree with the last statement that we're currently perhaps seeing signs of overinvestment, financial media, and stock market bubbles that may last years during this fifth technological revolution that the author has quoted? >> Yeah. Yeah. I mean, I think that's a reasonable assertion. I I think one thing um that I would say this is these are all good points, is I do think the AI revolution is actually more profound than a lot of these other revolutions that she mentioned. So the a lot of a lot of the things like the industrial revolution really resulted in things like um you know changing the means of production right and shrinking time and space through improvements in travel and and efficiency and things like that. So there were really changes that impacted how we dealt with uh I want to necessarily get too like philosophical here but I do think this is important how we dealt with the terrestrial right and they were very disruptive and the whole like kind of schumpeder concept of creative destruction I think is you know like well taken in this case I do think with AI the change is that we're talking about a way that people perceive all aspects of reality and you know there are people right now that simply live, you know, you can live entirely in your house and just be on the internet all day. And if the information flow in your and the way that you think about things is entirely mediated by, you know, these algorithms out there, many of which are not, you know, you know, they're controlling themselves, you could begin to get somewhat disconnected from the terrestrial world. And the more people, I think, are um, you know, part of this, and we all are, right? I mean I was using this morning to do some research. Um the more there it kind of changes how we work and how we all like kind of you know how we think about like the labor market, how we think about um politics, how we think about the economy as a whole. So I think it's absolutely profound. And the other thing I would mention too is you do see through AI and things like chat gpt people sort of outsourcing their intellect to these engines, right? So you may remember where you were in school if you were writing research paper doing something you would maybe you'd use the internet to find literature that was relevant to the subject but then you'd kind of go to you know the you know uh an economic journal right to find an article that was written on that subject. Now people just kind of go to chat GPT. You get an abstract of what's going on and you kind of take that information away. And I think that process of not having to do the work to get that information, you know, and search for it may have some impact on how people think about things and also what the retention of of knowledge is. This may be going in a very different direction than you intended, but I think it's very profound. >> Well, just on I I like your line of uh line of thought uh H. So just on that so given that your your your your asset allocation approach is multi-deade and focuses on you know the endgame which is retirement how do you think this AI revolution that's currently happening is going to affect people entering retirement in the next coming decades how would it change you know fundamentally change society uh that is getting older in the next coming uh in the next coming decades and given these changes how would you distribute your asset allocation Well, I don't know that there are any at this point like clear enough signals to say that you would change, you know, what we would change what our asset allocation is. And again, our asset allocation changes as um, you know, people move through the retirement space. So, the way our product worked and the way typically retirement advisors work is there's something called a glide path. The glide path takes it says an investor is x years old you know 30 years old they should have asset allocation a as they move toward retirement that asset allocation should change and our model's a little bit more sophisticated than that in that we take into account a bunch of factors that would um lead to an ideal asset allocation such as how much money does somebody have much do they have saved how old are they what is their gender do they have outside assets all these other factors come and to determine what that asset allocation should be. And then um in terms of I think linking this back to AI or just technology, our entire business is based on the fact that the internet exists and you can deploy these models in real time. Um so I may not be exactly answering your question, but it's absolutely crucial to how we how we do things. So an entire a retiree an you know a retirement investor an individual in a um 401k plan doesn't need to necessarily sit down with an advisor to get some sort of modiccom of investment advice about how they should be investing. They can go literally to a URL that you know input the proper information or we can grab that information from their employer and then build a model of how they should actually invest. And I think going forward there's going to be more and more of that sort of investing in that information sharing online. It's a lot more efficient than um you know the way it was done let's say 15 20 years ago. >> What I was wondering if there are concrete lifestyle changes that we can observe that may influence the uh types of stocks uh or sectors that you may be overweight. For example, if let's say a few decades ago, uh primarily you would be looking at maybe consumer discretionaries or staples as long-term plays cuz everybody needs, you know, consumer staples even into their old age. Uh nowadays, people Uber eats their food. Maybe I I I don't remember the last time I bought groceries. I really don't. Um I, you know, a lot of my friends as well, um we're over we're becoming more and more reliant on big tech. So perhaps that, you know, that allocation would change for this current generation versus a few decades ago. I mean, one thing I would certainly look at would be things relating to longevity risk, right? So, we have more people living longer right now. Um, they're uh declining. I mean, the amount of people like going forward, we're we're looking at an environment where people get are getting, you know, they're living for much longer periods of times, but they're also like very much in need of medical assistance and long-term care and assisted living and things of that nature. Now, that's pretty granular, but I do think that that's something that's going to have a meaningful impact on, you know, how you might want to one might want to invest their money. So, thinking in terms of a of a of an aging uh population uh and a population that lives for a really long time and needs the things that people who are old and and and feebled, you know, need is uh is I think that's that's a theme that is is undeniable at this point. I think that's a real trend. >> And what about the uh trend that um more and more people are going to become dependents in the future. For example, the dependency ratio of most developed countries is going to become closer to one. There's going to be for every working person, there's going to be a non- workinging age person. So the assumption here is that overall consumer spending may go down. Uh have you considered that and whether or not overall consumer spending in the future may change and ultimately what that does for you? >> Yeah, I mean that seems plausible to I don't know that I have a strong opinion on it, but but yeah, right. I mean, if more money is going away from discretionary spending and more toward, you know, um non-discretionary spending, which again would be supporting um you know, people who need additional care because of their age and their frailty that really will make uh that really could make a difference. I agree. >> All right. So, what's in your model right now? Let's start with large caps. How much of the uh allocation is given to the S&P for example? So our our model on the US side is pretty much close to market weighted. We have a slight value bias that we um I would say it's almost structural. It's started to disappear over the past couple of years or so, but we do definitely do have kind of a bias there as well. And we also have um we've had up until recently a bias towards small caps as well. Um internationally we're market weighted. Um we have about 30% of I'm sorry about um oh about 33% of all of our equity is in uh foreign uh stocks. So that would be the EPHA and um the emerging market index as well. We do have allocations on the bond side. Um it's also it it's also fairly close to what would you would say would be sort of an A type allocation with biases toward um tips uh particularly short tips. Um these are good uh vehicles to defease you know expenses and retirement. Um we h we we did have an allocation to long tips that we took out of the model um because uh long tips tend to respond more toward I mean they're very volatile and they respond more to changes in rates. They have very long durations as opposed to short tips. And um we have allocations to non-d bonds as well with a slight bias toward um I'm sorry non non- US bonds with a slight bias toward emerging market uh bonds as well. So, and these are fairly structural. They they move around a little bit from one period to the next. We have a commodity futures allocation as well, which is probably about 5% of equity on the on average. Um, and that kind of moves up and down depending on our view on how things are going to play out, let's say, over the next five years. >> How frequently do you adjust your application per year? >> We do. Yeah, we do it on an ann We only do it annually and we do it with a 5 to 20 year horizon. we will make changes if that something really big happens in the market and certainly if something structural would happen. So I don't know like the the you know the euro is you know goes out of existence and we revert to you know um native you like country specific currencies but it would have to be some really major event for us to go back and revisit everything. All right. And uh generally speaking, what uh criteria do you look at or consider when making asset allocation changes on an annual basis? >> Well, actually um one of the things is we don't want to move the allocations around too much from one year to the other. There are technical reasons for that, but it's also the case that again unless there's really really strong conviction convictions, we don't want to change things around that much. We're managing uh you or advising on about $150 billion dollars of assets and they're small pools of assets. So there's definitely an interest in not like you know moving portfolios around all that much. Um but the things we look at is current valuations and we have a forecast uh model that goes out uh 20 years and depending on the um you know what that forecast model looks like we'll make changes to our uh to the asset allocation model. But again, it's strategic. It's something that I would refer to as unconditional. Um, which means while we are taking into account current information, the amount of impact that has on the portfolios is actually relatively small. >> Okay. How would you describe this strategy versus simply a buy and hold of uh large caps or a 60/40 portfolio where you have large caps versus bonds and you just hold that for multiple decades? I mean what are the advantages of your of your strategy versus something that's just yeah >> our our model changes as a function of of where somebody is in their invest in the investment cycle. Okay. So for example here I'll I'll give you a good example. Um, so again, if you're 30 years old and you have a really long horizon, and I'm not going to take into account like any specific issues you may have with your investments, like you have a large position, let's say, in company stock, um, or assets you can't hold, which would have an impact on the solution. Let's just say that that doesn't exist. Um, by and large you're going to have a really heavy equity portfolio with a bias, you know, pretty well diversified across the, you know, across the board and a bias toward riskier assets, a bias toward emerging markets debt, a bias toward commodity futures and smaller cap stocks as well. And if we're talking about private equity, um, it would have a bias toward like a big bias comparatively uh toward private equity. Uh, these are assets that have, you know, long-term payoff potential. it makes sense for younger people to hold them. Okay, as you get older, uh we begin reducing the amount of risk assets you have and we also in you know the easiest way to think about that is you end up getting more bonds relative to stocks. But it's also the case that as you get closer to retirement, we change the asset allocation such that it aligns with the expected consumption basket of the typical retiree. So you move more into um dollar denominated assets and you move more into um you know kind of larger cap stocks and um you lo move away from particularly away from having much exposure any exposure to any kind of like currency risk that would be part of the part of the portfolio. And so the model we actually use is um is one essentially where we're trying to align the asset allocation with the expected consumption schedule and the composition of that consumption of the individual who's in retirement. If you have a very long retirement I a very long horizon until you retire that doesn't really matter and the portfolios kind of look like you know they're sort of meant to maximize risk and return in a standard way. But as you get closer to retirement, the portfolios converge on uh what's called a liabilitydriven model in which your optimization of the portfolios instead of you know optimizing risk and return or other aspects of the you know expected probability distribution. you're actually trying to minimize that um you know risk between what the liability composition of the liabilities are and again this is a consumption of people who are in the retirement space versus uh what the portfolio actually looks like >> at what point somebody's >> yeah please go ahead >> I was I I can if that's unclear or it doesn't make sense I'm more than happy to elaborate >> uh well I was just wondering at what point in somebody's life should they look into this kind of a portfolio like when should we start because G you mentioned it changes throughout somebody's life closer to retirement >> I think that in the for sure you know if you're not using a formal model like with when the draw down stage that idea of aligning the portfolio to some degree with your consumption schedule I think is a good thing people kind of naturally do it and then they naturally think of you know you want to you want to decrease risk in the portfolio um but also um ensuring again that the um you know that the amount of exposure you have to assets that are not necessarily representative in your consumption basket is a good thing to do. So again kind of minimizing currency risk is a good uh is a good thing to do. Minimizing exposure to small cap stocks and that kind of thing can be helpful. >> Okay. So just going back to my question at what point should we start looking into planning for retirement? So is it 25, 30 years old, 35, 40 is there a rule here? >> Yeah, I mean you should the idea is you should start thinking about retirement as soon as possible, you know. Um that doesn't mean you need a you know you don't necessarily need an LDI type portfolio, but the way that we look at it is that um you know the sooner you start planning for retirement and that includes things like how much are you saving and what are you investing in and what might you be investing in going forward is is super important, >> right? So, uh, is there a guideline for how much of our income should be set aside for savings and investments? So, let's say, let's use a nice round number. Let's say I'm pulling in $100,000 a year. That's my pre-tax salary. So, I'm, you know, spending on housing, food, clothing, basic necessities. Then, let's allocate some of that to a portfolio like yours, like roughly what's the percentage we should be looking at here? Um, I mean, I would say something along the lines of uh overall maybe something around 15%. Now, I'm including in there if you're in, you know, if you have a 401k plan, they typically have a company match. So, the amount that's actually coming out of pocket would be less than that. Um, so, you know, I but I think that probably makes the most sense. And the earlier again you start investing the greater probability you have of you know meet meeting that goal and even have the possibility if you get you know if you're particularly successful of reducing your savings rate as you approach retirement. >> What is your view on the 401k plan? Should employees actually subscribe to that plan or should they just opt out and manage their own money or hire a manager to manage their money or buy a fund outside of a 401k plan? Um, well, I I think that most employees should invest in their 401k plan if only because they're getting additional contributions to that plan from their advis I'm sorry, from their employer. Um, I would say that, you know, if there are target date funds in the plan, again, these are uh professionally managed as multi-asset class vehicles. Um, that's definitely way to go. And if you have a managed account type program like the one that we have, that's also definitely the way to go. Um I think there are very few investors who um you know are comfortable actually constructing their own portfolios using the uh investments that are available in their 401k. Um so that's my recommendation. I also think if you're going to I mean if you have a 401k plan I think going to an advisor to pay them to manage your retirement money unless the plan is particularly poor. I'm not and and and you don't have any and you don't have again any managed component of that plan like no target date fund and no managed account process then I'm not sure that's a really great use of one's money just if that's your only goal. I want to turn our attention now to some recent news surrounding um changes to policy. So this is from Morning Star. Uh you wrote this article actually private market investing coming to 41k. Here's what Trump's executive order convene for investors. I'll just sum up what happened here. So there was a recent executive order um that allowed the SEC uh Department of Labor and the Treasury to work on a framework that would allow for the inclusion of private market investments in define contribution plans. Um, further down, it also uh allows the inclusion of cryptos in 401ks. Um, are we going to see immediate changes to our 401k because of this new order? >> No, it's really unlikely. I you will see changes. I think in the long run uh these uh what uh the Trump administration is referring to as alternative assets are going to make it into a lot of plans. Um and I think that's a good thing, right? um but they're going to be mediated by some sort of advisor. So if there's a crypto ETF or crypto fund in your plan, the likelihood of you getting direct access to that is at this point like seems pretty much impossible. And um the way you would get access through it again would be through a target date fund or through a managed account solution. And the reason I don't think it's going to be the case that people will get direct access to these funds aside from the fact that there's general consensus that it's not a very good idea is that um again the original opinion letter that that you uh the uh uh Pantheon Ventures partners opinion letter um was very clear about the fact that there needed to be an adviser involved standing between the allocation and the end investor. It's also the case that uh Paul Atkins, who's the current head of the or a current head of the SEC, in his congressional uh testimony in his confirmation hearings expressed support for that original DO letter. And again, I assume that that framework will be carried through here. >> What about cryptos in a model like yours? Are you planning to change your model to incorporate cryptos at all? >> Yeah, we're probably not going to be incorporating cryptos. Uh we do have uh we do allow investors if they're holding crypto and they want to get invite uh in you know they want to get advice from us they want to have us manage their portfolios and they're holding it in some separate account we will model our allocations around that crypto allocation but at this point we're not comfortable uh making a recommendation to crypto largely because it's not it there's no real way to kind of estimate what the long-term returns on crypto would be. So >> uh I I think people make the distinction between let's say an altcoin in the crypto space versus Bitcoin. Not everybody makes that distinction but that distinction is being made a lot by a lot of people and certainly we're seeing Bitcoin treasury companies pop up um not crypto treasury companies pop up. So perhaps Bitcoin may have a role in a portfolio like yours alongside other alts like gold. I'm just speculating here. What do you think? crypto. Um, Bitcoin would be the most likely candidate, but uh, again, that's not something that at this point that we're really entertaining. >> When you're looking at alt, alternative assets besides traditional equities and bonds. Um, just maybe walk us through your decision-m criteria uh, and what metrics you look for. >> Sure. Um, well, first of all, we have an underlying kind of statistical model of how these asset how these different funds should be paid. So the thing we're looking for is you know essentially if you add a particular fund to a mix is it providing you know efficiency to the portfolio. So is it generating enough return and reducing the overall risk of the portfolio such that it's you know worth investing in. Um uh things like fees are important because again all all of our investments are implemented using uh you know mutual funds or ETFs or uh something called a um you like a separate account product which is like a mutual fund but is not publicly available and um uh so essentially uh that's what we're and then you know do we expect the vehicle to provide some level of alpha which means that there may or may not be additional return over above what our risk model would predict that it would return. >> What is your view on um some uh statistical asset allocation models like the optimal uh modern portfolio theory for example uh optimal asset allocation model based on uh sharp ratios and um volatility. Uh does that work in real life? >> These are all good. Yeah, these are fantastic tools. I mean I I would uh I don't think you want to use them in isolation. I think they're a good way to get an initial estimate of how you might want to be uh invested. But there are a lot of additional statistical tools you can you know you can bring to bear that help you know kind of enhance uh that modeling such as you can do you know simulations of different types of portfolios. Uh well you know one of the things we do is that again asset liability um optimization in which it's not you know it's similar to uh mean variance optimization or the sharp sharp ratio maximization that you referenced earlier but the idea is your benchmark is you have another sort of um asset that you're trying to uh optimize to get close to um I think all of these are great tools for an initial estimate of how you want to um invest but I also think it's important for you know to bring you know there's a lot of information that falls outside of these models and so I think to the degree that again you use them as a tool and not necessarily as the uh be all and end all that they're super they're super helpful. >> Okay. And then the other part of the um article that you wrote private uh market funds uh what exactly does that mean in the context of a retirement portfolio? >> Yeah that's a good question. So people are talking about so these are things like private equity and private credit. So these are investments that don't change that don't trade on an exchange. They're effectively illquid and they're priced uh via an appraisal method. So they're not priced on you know they're not priced by the market. Um what that means for uh their inclusion in portfolios is there there will never be like a pure sort of private equity fund in a retirement plan. What there will be will be something called a semi-liquid fund. What those are that would be a private market fund that's wrapped in an account that includes a bunch of um you know public market uh investments as well. So if for example I have a real property fund um you know the real property component is not liquid uh but let's say I have 75 I'm sorry I have 15% of that account is in REITs and REITs are obviously quite liquid um that would be how the account would be managed and that's how the investment manager and the manager you know like us who was managing the investment managers uh you know get money to and from those portfolios ensure there's sufficient liquid liquity uh to satisfy the needs of a retirement plan because the cash flow characteristics are very different than they are on the institutional side. >> All right. Um let's talk about uh the BLS situation regarding the firing of the uh commissioner of the BLS. Uh you wrote every time you reach into your pocket >> to use your credit card, you indirectly touch the BLS. >> Uh what do you mean by that statement and ultimately how does the change of the commissioner impact the financial lives of the regular person? Yeah, I mean I could talk about this forever so but I won't I'll answer your question. Um the every so virtually every business decision that's made is made directly using uh data from the BLS or indirectly using that that data. every time you touch your so for example interest rates right so interest rates the the fed funds rate is set by the Federal Reserve and what is one of the key metrics they use they use the personal consumption expenditure right that's how they help decide what they're going to uh set the Fed funds rate at if that number is believed to be corrupted by political interests it it's going to be very difficult for the Fed to feel comfortable making a um you know making some decision on the Fed funds rate and then anytime you know if you are you know uh uh you know if you're hiring people if you're renting property if you're you know whatever anytime you have to have an implicit contract or an explicit contract that incorporates the inflation rate and they all do know whether whether you do that or not um you're not going to be confident that that data is actually unbiased or at least that it's not biased by political interest. And so the importance of having a a a trustworthy um you know organization you know organ of the government that essentially is responsible for all this very very important macroeconomic data is potentially you know catastrophic. Now I don't think that it will necessarily have a bad outcome and two reasons for that is one of them is that the current um processes that the the um BLS uses are very very much sort of baked into the organization. It's not easy to change things. Um and it's very would be very hard for somebody who's heading up the BLS to like fudge you know the data himself. The other thing is I really don't think that the current uh nominee uh uh EJ Antony is I think the chance of him making it past confirmation hearings is actually fairly fairly low if only bec I know people have questions his his technical ability but I think that um the fact that he's such a obviously partisan and political person I think could be a real a real problem for him. So again, he was at the January 6 riots. He uh you know, he he's on podcasts of people who are very very very pro MAGA, like Super Pro MAGA. I think all of this is not going to go down very well. Um and it certainly will not go down well well with the market. >> Well, what does that mean for data independence? of let's say you have somebody who is in your view kind of partisan um we as investors and observers of the markets you know need reliable data at the at the end of the day. >> Yeah. So let me uh so the the first concern would be uh although I I actually don't know that that the first concern would be is that the data is that somehow he's able to put systems in place that biases the data to make the administration happy. I don't think that that's super likely. I think the the likelier scenario if somebody like him gets confirmed is that there will be this lingering sense out there at least for a period of time that the data is biased even even if it actually isn't. And that sense that belief that the data is biased I think is enough to cause problems uh in the market and cause problems just for the United States um you know when we go out to the rest of the world seeking you know financing for our debt and all that kind of stuff. So it's it's not it's not a good uh situation, but it may actually resolve itself and be okay. But it's all about confidence, right? The US, we're the leading country, like we're the most powerful country in the world. We're the leading economic power in the world because of confidence in our institutions. And when things happen that underly that const that that confidence, um it it it could bode poorly for the United States as all. So it it's a potentially very big deal. Okay. Uh just going back and finishing off on uh asset allocation on uh for retirees. Uh we haven't touched on real estate. Traditionally, most people have had their wealth tied in real estate and reads. How does that fit into your portfolio uh allocation? >> Well, we do in we do include REITs. Um and we also um and should and we do in many case in in cases where they're available include allocations to um uh to pro to non to non-re property as well. So any investment that I mean the the the beauty of uh you know property is that it gives off a pretty consistent yield right and when you're in the retirement phase being invested in assets that are income oriented and where the return profile is based on dividends as opposed to expected capital appreciation is always a good thing. uh property is good >> and that leads to your diversification principle or thesis if you will. I think you have a pretty interesting approach to this topic. It's a very widely studied academic topic. The topic of diversification. How many assets or securities does one need to hold to be fully diversified quote unquote? Uh you know what actually does it mean to be diversified? Do we even need diversification? Some asset managers argue we just need to be concentrated and right most of the time. Uh so you know how do you approach this subject? >> This was not a good question cuz I wrote about this pretty extensively about 10 years ago. So the question the number of assets or stocks you hold is not does not answer the diversification question. And in fact, what you care about as an investor is not diversification, but >> rather too, but um uh Okay, a lot of people do agree with you, but we were taught in school, I remember in business class at undergrad, 40 stocks means you're diversified. I don't know where that came from. That was just in a textbook. >> Okay. So, I've I've done this experiment, by the way. Um it can actually be fewer depending on what market you're talking about. The question is what is your definition of you know of diversification? So if you want to replicate the S&P 500, you actually don't need that many stocks to have the same performance characteristics of the S&P 500. It could be as low as 20. Sometimes it's 10 depending on what the breath is of the index. Um I think the number 40 and it changes depending on what criteria you're using um and what and whether you're trying to and what you're defining is a diversification. So if the goal is not to um so I'll give you an example. The goal is not to um essentially replicate a particular index with as um you know few stocks as possible. Diversification I you know I you can probably do less than than 40 stocks. I would say it's it could be something closer to 20 or you know even less than that if you want to do there. In this case, the way I'm defining diversification is the point of you get to uh risk that does not really change as you ask you add more stocks or standard deviation that doesn't change as you add more stocks. So in other words, the the experiment is I had one stock, what's my standard deviation? I add another stock, what's my standard dev? And I do that and at what point do I hit the standard deviation that I would have if I had a market weighted allocation to all of those stocks? And you can do it where you have an equal weighted allocation to all of those stocks and the number goes up obviously, but it doesn't really get that that big. So I'm sure that's a much longer answer than what you actually wanted, but you don't need that many stocks to be quote diversified, >> right? So, let's say, okay, I'm planning for retirement as as most people probably are, and I'm thinking, okay, what do I actually need to do to be, you know, I want some return, but I also want to be safe by the time I'm 70 years old and I'm retired. So, I I I own a home. I have a 401k. What else do I need is the answer. There's a question that I'm constantly asking myself in my head. you know, how many assets do I need to buy that are uncorrelated with the broad equities market such that I am properly diversified, quote unquote. >> So again, again, um this it's it's unfortunately it's not a very simple answer. Um because what you're really looking for, and this is I think this is a good way to think about it. You're not looking for quote diversification. You're looking for efficiency. And you'd mentioned the sharp ratio earlier. That's a good way to think about efficiency. I can be very very diverse if I don't have a portfolio that's really not going to perform very well at all. right? Uh I can what I want to do is I want to make sure that the diversification uh minimizes my overall risk or the overall expected variance of the portfolio and that the return that I get in the end is actually as good as it can possibly be. So one thing to do is like the question about how many stocks do I need is not it's not really the right question. The question is like what kind of stocks do I need to make sure that I'm divers diversified. So it's a question of making sure that the stocks you know the the the the elements that drive the performance of those stocks right or the the drive the revenues of the companies uh that the stocks represent are coming from different places that the expected performance of these vehicles is going to be kind of sufficiently differentiated. you're, you know, you're in different sectors, uh, you have different names that, um, you know, you should see a muting of risk through that diversification. So, you, again, like I said, you can actually get a very diversified portfolio if you're just talking about stocks probably with 15 stocks out there if you want if you can do the work and you can do the calculations. Um, >> okay. So, what exactly do you mean by efficient? How do we how do we achieve this efficiency here? Uh so efficiency literally means in this case I'm defining it again as the sharp ratio or as simply the expected return over the risk of the portfolio and looking at it from the standpoint of both risk and return is really you know is critical. So again just getting a bunch of uncorrelated assets out there with any without any particular attention to how they might actually perform uh may get you a very low risk portfolio but it may not really return very much and you're investing because you want to make a return. So the act of putting together a portfolio that will have a high expected return for overall risk is again maybe this isn't a great answer. It's actually pretty complicated but there's methods of doing it and again um just sort of rule of thumb things are again looking for uh stocks that are in different areas of the market and where there's some expectation you know that they'll actually perform pretty well as well. I feel like I'm not really giving you the the answer you want. Unfortunately, it is very complicated. >> Well, let's just take a look at some maybe metrics that you may use. Uh this is from Morning Star, for example. I'm not sure. >> I'm not sure exactly what the security is. S&P 500 PR. Um what is PR? But anyway, uh this gives a sharp ratio of 70.71. Yeah. >> Okay. So, actually, so this is this is only the price return of the S&P 500. it doesn't it's actually the returns here would be lower than what you would actually get. >> Um so it it's interesting to look at but you would probably want the entire so the sharp ratio here is saying that like the price return the appreciation on the index on average is divided by the standard deviation of that index the variance of the index is you know uh 71 that that's what the the ratio is that you wind up with. The interesting thing here is that ver for a stock portfolio or any a stock index virtually all of your variance is coming from that price variance. So what this number would look like if you actually use the the total return index which says TR instead of PR um is that that sharp ratio would actually go up because your returns would go up a little bit. Um however the denominator that variance that standard deviation would barely change at all. You typically I think you want your sharp ratio to be as high as possible that absolutely you know maximize efficiency. So do you use the S&P as a benchmark and let's say well you got 71 therefore the portfolio you design should be more efficient than the S&P I should be at least 71. Is that something you do internally? >> Yeah I think so the the issue with sharp ratio is the mathematical fact is that you can have a very low yielding asset with a very low standard deviation and this comes back to that idea of efficiency. So cash for example like the one-mon tea bill has a really high sharp ratio right and actually now it has a really good return too but let's go back like 10 years when it had a really crummy return right you still had a really high sharp ratio so you need to be so the sharp ratio is a good metric but it needs to be again in the context of not only what is my sharp ratio but what is my expected return as well and what is my standard deviation as well in that portfolio >> I okay so I'm going to bring this up as an example Uh Bitcoin for example, uh a lot of Bitcoin proponents have highlighted the fact that over the entire course of Bitcoin's life, it's had a higher sharp ratio than any other major asset class despite its huge volatility. And that's because mathematically its returns have been astronomical relative to its uh standard deviation. And so um Fidelity has put together this research paper uh May dated May 1st, 2024. Um, and I think just skimming through the the the Bitcoin sharp ratio between 20 2000 and 2024, uh, sorry, 2000 and 2024 was about 0.9. So slightly higher than the S&P 500s. Um, and yet, you know, maybe as efficient as it is mathematically, it's not incorporated into a lot of retirement funds. Why not? >> Uh, well, I think there are a couple reasons for that. Um, one of I guess one of them is that it's just uh so first of all, Bitcoin also uh lost it had a a peak to trough draw down about a while ago of 75%. Um, so there's a lot of downside potential risk in the portfolio as well. It hasn't shown up that much. It only showed up really in one period significantly, but I think that that's something to be concerned about. The other thing is this is a new asset. It's not really under it seems to be uh uh priced largely by sentiment. There are no cash flows associated with this. So this really isn't it's not a security. It's not an investment in the sense that you invest in this and you expect some sort of like cash flow the way that you do in basically every other investment that you would invest in including commodities too which which have a have a you know uh they have a return like a cashbased return um as you're holding them or holding return as as you're holding those commodities. So, it's very very much sentiment driven and so I think it's scary for a lot of people. Um, I don't I'm not saying it's a bad investment. Obviously, it's turned out to be extraordinarily well over this time period, but there are a lot of reasons to to not go all in on this as well. I would also argue that at the moment I think because again we keep coming back to the current administration and I sound like I'm like a political pundant which I'm definitely not more than anything else but you know this desire to make the cryp the US the crypto capital of the world. the fact that the Trumps have a lot of financial interest in the crypto, you know, area are all things that are really contributing to the spectacular uh particularly more recent return in these in these um currencies. Um I think the technology is fascinating and that there will be a lot more use of more use of crypto and blockchain technology in the capital markets particularly, you know, the the public capital markets. Um but it's risky and um that's why I think the majority of advisers would not really put a big chunk uh into crypto although um again >> using it in a small amount does seem to be like a perfectly reasonable thing to do. >> It it is it is a relatively new asset class. You're right. It has had huge draw downs. You're right. Um I wonder if the same logic could be applied to the large cap uh stocks in the S&P that are tied to the tech sector. For example, this article that I have on my screen, it makes the comparison between Bitcoin and tech stocks, arguing here that Bitcoin over the last two years has been on par in terms of volatility to the largest MAG7 stocks. And so I I wonder how you feel about the Mag 7. >> This is not a good comparison. All right. So the MAG7 are actual companies, right? And you can analyze them and you can build out an earnings model >> and you can use tools that uh investors and you know analysts have been using for years to come up with a valuation model of what these stocks should be. That doesn't mean by any means that these models are right or that or that the market obeys them in any way, but there's a way to kind of get your hands around what one should expect, right? >> Crypto doesn't have any of that stuff. There's really no way of forecasting. uh certainly intermediate term returns all the models that I've seen and I'm not a crypto expert by any means but all the models I've seen are based on the time series that crypto has produced and there's not a lot of fundamental you know information that you can put in there so I think that makes it risky right and uh the the the example of the this the piece you shared I hadn't seen it before is actually really interesting because I think it points to the fact that you It points to the uh the risk of really using you know they say past performance is no predictor of the future and the fact that the information we have on Bitcoin is really limited if it's limited to fundamentally just the returns that the asset class has produced and there's not an ability to model it beyond that and and I don't think that there is right now um then that makes it just very very risky. So risk is not just variance and return. It's also um opacity of information or lack of information. >> Uh yeah question then. Yeah I mean no no no it makes sense. You earlier in the interview you stated that over the course of someone's life as they enter retirement they should be you'll allocate fewer risk assets to that individual. Okay. So then just philosophically speaking how do you define something that is a risk asset? Um certainly Bitcoin fits in that category, but then uh could one make the same argument with most of the S&P 500 stocks at this point? >> Oh yeah, definitely. So the way we define risk asset is actually pretty much everything that's not a a a pretty much everything that's not a bond. So stocks are risk assets, commodity futures are risk asset. Bitcoin, which is a lot closer to commodity, it's a currency uh would be a risk asset as well. Um and then non-risk assets would be um asset classes where the uh sort of the underlying fundamentals of how you get paid in the assets is not that risky. So a government bond a treasury bond is risky in the sense that um you know it's it has price variation right and if you have a long like a 30-year treasury then the ab you know that the price of that bond is going to move out a lot but you will definitely get paid you will definitely get your money. So risk assets though I think a good way to think about it is that as I move from if I think of of some entity that's collecting revenue to then pay through the security right the ultimate taxing authority and the ultimate you know uh uh king of all revenue collectors is the US government okay as you move down to let's say municipalities you're talking about m municipal bonds and then you move into individual companies and then you move from the debt of companies to the equity of companies, you know, you're moving down the capital structure, then the assets become more risky and they become more risky because there's more risk around whether you're actually going to get your money or you're going to get paid or not. >> The statement that risk is not just standard vol standard deviation in volatility, which is something you mentioned previously. That's something that's something uh some some other people have said as well. Is that true? >> Is that how do we look at risk? Yeah. So if you if you have to step back and say give me the broadest the definition of risk of what that is um risk is basically the is essentially the qual of the quality of your information. How good is your information and so the reason why and what is your ability to make some sort of assessment of how a particular asset might perform. So as my information gets poorer the risk essentially goes up right. So the reason why um you know stocks have higher standard deviation than bonds is because the certainty of me getting paid by a stock of me getting a dividend on that stock is actually lower than it would be for let's say a bond issued by the same institution um where the bond sits higher in the capital structure. Okay. So, my information um there's risk there because I actually don't know like what the company's revenues is go are going to be in like three years and maybe something bad will happen and they won't pay out a dividend and all that kind of stuff might happen. The likelihood my information that I'm not going to get paid out if I'm holding a bond, you know, it is is better because I know that I will get paid before the equity holders get paid. So, um, there's a lot of different ways to describe that, but risk is essentially the quality of your of your information and how you, you know, you know, your ability to synthesize that information into something that actually means something. >> Okay. Uh, very good. Thank you very much. Uh, how let's, uh, let's close off here and we can, uh, let people study your work in more detail. Where can we go to read more from you, How? >> Um, that's a good qu. Well, I have a few things right up on morningstar.com and I do have a new piece coming out that's going to be talking a little bit more about the um opinion letter from the do um that's going to be it's a short piece you pretty easy to read. You can read it in one one sitting but kind of focusing on the idea that like alts is not an asset class. Um the do letter talked about allowing alts, you know, into 401k plan. Again, we think that's generally a pretty good idea, but alts is not like, you know, it's a lot of stuff that everybody just kind of put under one umbrella. Bitcoin is an alt and private equity is an alt. And there no two investments that I can think of that are more different than each other than Bitcoin and alts, right? >> Uh Bitcoin, again, there's no capital. >> Private markets. >> Private markets. Yeah, I'm sorry. Um whereas private markets is kind of the most traditional type of investing out there. You know, you're investing in a company, you're lending to a company, you have a definite expected cash flow. Um again, it's not priced by the market, so you don't always know exactly what the valuations are. You always know exactly what what Bitcoin is trading at because it just traded. So, um they're really different from each other, and yet they're all being kind of considered uh you know, to be alt. So part of the piece that I'm talking about is sort of addressing that issue. >> Thanks again. We'll put the link down below to uh Morning Star and we'll uh we'll speak again. How take care for now. >> Yeah. Thanks a lot. Take care. Bye-bye. >> Thank you for watching. Don't forget to like and subscribe.