I’ve been a fan of Mike Dever and his firm, Brandywine Asset Management since I first began learning about mutual funds 20 years ago. Mike joins us today on Tradestreaming Radio to discuss his new book, Jackass Investing— a book with 30 years of hard-earned investment experience. Mike describes multiple myths investors (and the media!) have about investing — and then proceeds to bust them. In this podcast, you’ll learn:
Announcer: Live from the Internet, it’s Tradestreaming Radio with your host, Tradestreaming.com’s own Zack Miller.
Zack: Hey, this is Zack Miller and you’re joining us on Tradestreaming Radio, our place online where investors learn directly from experts, and today’s guest is Michael Dever, the founder of Brandywine Asset Management and the author of a new book, “Jackass Investing.” I’m looking forward to having Michael on the program today. He is a hero of mine, as I remember reading about Brandywine way back when I first started learning about mutual funds. Michael has a multi-decade history in the asset management field, pioneering use of new asset classes and new trading strategies. All of that is embedded in this book. I definitely recommend you read it.
The book is written as a series of myths, and they’re myth busting where basically he will set up what is considered standard, fair accepted wisdom in the investment industry and then he continues to poke holes in it. It does focus somewhat on trading strategies and not necessarily buy and hold. So if that’s not your thing, then you might not want to dig into this book, but I think it’s a great book with great research, lots of history embedded in the book, and Mike is obviously just a very interesting person to learn from.
I hope you enjoy it. You’re listening to Tradestreaming Radio. I’m Zack Miller your host. Tradestreaming is the place online where you want to go to learn from experts if you’re an investor. You can find this podcast on my website, TradeStreaming.com as well as on iTunes, where you’ll get all of our archives there as well. Come back to the website and check it out. We’ll also have a transcript up and any show notes. We always welcome to hear from you, so please let us know what we’re doing right and what you would like to see more of. We just want to make this a really, really useful service for you.
So without further ado, here is Michael Dever.
Can we start by first introducing yourself and tell me a little bit about you and your firm?
Michael: Sure. I’m Mike Dever. My firm is Brandywine Asset Management. I founded it in the early 1980s, and we’ve traded a variety of markets globally throughout the last 30 years, including futures, currencies, commodities, equities, long, short, market neutral equity, market timing, mutual fund timing, essentially anything where we think we can find some sort of an investment edge to take advantage of. Today our focus is solely on the managed futures component where we feel we can get broad global diversification across 100 markets within one instrument type.
Zack: Where are you based?
Michael: Outside of Philadelphia.
Zack: Okay. Did you start primarily as an equity shop? I remember reading about you in Worth magazine in the ’80s.
Michael: It goes way back, but no, not really. Our background has been more on the commodity and futures side.
Zack: So what prompted you to write this book?
Michael: Well, over the years I kept hearing people say things, repeating things that I felt were absolutely wrong and what I started cataloging as certain myths of the investment industry. In 1999 is when it really came to a head and I had some investors calling and saying that they were looking to putting their money into safe investments that could earn a steady 20% per year; and they were referring to technology stocks.
At that point, it just really popped in my head that I had to get a book out. It just took me the last ten years to put it together, the last two years especially to get the research in place. It was really the financial crisis that was the trigger for me when I saw people falling into the same traps that they fell into for the prior two decades. For the first 20 years of that, from ’80 through the end of the ’90s, they were rewarded by that behavior, which is a narrowly focused non-diversified portfolio. They got killed a couple of times in the 2000s, and I thought it was time to show them what I thought was the right way to diversify a portfolio.
Zack: So again, you sort of set out to bust some commonly held myths, and I think you focus on 20 of them in the book. Part of the problem with that, again, I feel like anyone who has dealt with a client is that clients sort of want to believe in the myths, right? Even if you can provide them results based evidence, they’d rather believe in that 20% return than to actually provide something a little more standard.
Michael: No question. Part of what you have is you’ve got that bias of people having done something, having invested in that either at the professional side – the financial planners, the wealth managers – and the individual side who has been told, well if you do this in your portfolio, over time it will work. They don’t want to feel that they’re jumping from one idea to the next idea. They want to try to settle into something and follow that, and they’ve been taught that that’s what they are supposed to do.
So there is definitely a certain ingrown resistance to change that’s always out there, but I think in today’s environment there are millions if not tens of millions of investors just in the U.S. who are sitting there saying, “I don’t believe what I have been taught. I am open to some new ideas.” So I think there will be some acceptance, but there will absolutely be people that get stuck in the old paradigm and want to stay with it.
Zack: But don’t you run the risk also as you sort of bust open myths to replace them with new myths?
Michael: No, I’m actually keeping the same philosophy that’s been in place for decades, which is broad strategy and market diversification. I think people need to have a broadly diversified portfolio.
So I have what I consider to be a different way of viewing that. I think that most people start, even though they say they’re going to have a diversified portfolio, by boxing themselves in to a very narrow portfolio and then say within that small box I’m going to diversify. What I do out of the gate is say open up your box, not necessarily playing outside of the box, but just really expand it and incorporate a variety of new strategies and markets into your portfolio that really will provide you with true portfolio diversification.
So the philosophy is the same. It’s just my belief is that the way people have been taught to do it is absolutely wrong and there’s a better way to diversify a portfolio.
Zack: So is it truthful to say that you are sort of taking aim at buy and hold in particular?
Michael: Certainly. Well, it’s certainly one of the myths that’s out there. I break everything down into trading strategies. A trading strategy is comprised of a return driver, something that is going to make a power return and a market. It’s coupled with a market.
A buy and hold strategy in U.S. equities for example is simply one strategy, which is a strategy of buying and holding in one market type, U.S. equities. I show in the book that that’s a very narrowly diversified approach. You have very little diversification value in a buy and hold approach. So while it may be a valid strategy, it’s not a valid portfolio. But it is not a terribly bad thing to have as one component in a portfolio.
Zack: I really like how you defined the investment process. Could you talk about that going from return driver to trading strategy? You sort of just hit on that now. Just to block that out a little bit.
Michael: Everything has to be broken down to what the ultimate underlying return driver is. So any investment you’re looking at you need understand that. That is what I do throughout the book, and once you have a return driver, you try to select which markets it is most applicable to. For example, looking at stocks, my first myth is stocks provide intrinsic return, well, there’s no magic return that is provided by stocks. In the long term, the return from stocks is driven by corporate earnings growth. If a company grows and their earnings grow, the stock will become more valuable and ultimately price higher.
But in the short term, and by short term I mean less than 20 years when we do these studies, the dominant return driver for a stock position has to do with the enthusiasm or lack thereof of the investor crowd. It is really the P/E ratio. The expansion of the P/E ratio contributed more than half of the gains of the stock market bull market from 1980 through 2000, and the contraction of it is what really held the stock market flat through the 2000s even though you had corporate earnings growth through that decade.
So it is understanding what the return drivers are, what markets it is applicable to, and then you can put a portfolio together that is made up of disparate and uncorrelated return drivers.
Zack: I think what you did was combine, people who buy the book if you don’t know, if you go to Jackass Investing, there is a way to log in. There is an action section there that not only takes your myth busting that you get in the book but then provides you an actual strategy to capture that. So can you tell us a little bit about the strategy to address this myth number one that you talked about?
Michael: Sure. In myth number one, there is not a problem with . . . I believe it is a valid return driver. I don’t believe that you can sit there and say that over time it is a God given right to earn money in stocks and that there’s an intrinsic return, but I do believe in capitalism and I do believe that there will be corporate growth over time and that that can be captured with a long stock position.
We capture that with exchange trade funds and mutual funds in this model portfolio that I put together. But overall, long stock positions make up maybe a quarter of the portfolio. So we don’t want to be totally dependent on that driving and dominating our portfolio performance. But we capture it in equal weighted ETFs for example rather than capitalization weighted ETFs. We capture that in dividend ETFs that are looking for higher dividend models. We are looking for it in stocks that meet or exceed analysts’ estimates. So there is different mutual funds and ETFs that are out there that follow different strategies to capture that long stock component using slightly different return drivers. Then that is what we incorporate into this portfolio as a portion of it.
Zack: So does that require a lot more work on the individual investor?
Michael: It doesn’t, because what I did is I created two different types of portfolios as a model portfolio. One that is essentially a passive portfolio . . .
Zack: These are the free lunch portfolios that you describe in the book?
Michael: That is correct. In myth number 20, there is no free lunch, I lay out in that myth the performance of what I call the free lunch portfolios, the ability of earning both higher returns and having lower risk than the conventional wisdom portfolio, which is essentially long stocks, bonds, maybe some real estate, and a little bit of cash. The numbers are absolutely true. You can do a lot better because you’ve simply opened the box up as we’ve talked about in the beginning, you’ve exposed the portfolio to disparate return drivers, uncorrelated from each other, to provide a truly diversified portfolio rather than one that is narrowly diversified like a stocks and bonds portfolio.
In the free lunch portfolios, I have two different options. One that is very passive. It just invests in long only and ETFs and mutual funds. I say long only because it is buying those, but those mutual funds and ETFs themselves are employing trading strategies that were described in the book. So somebody else is doing the actual trading. That is the simplified free lunch portfolio.
In the standard free lunch portfolio, there are some trading strategies individuals can employ on their own, trading stocks, trading ETFs, using strategies that have a sound logical basis for providing a positive, inherent return, but they do take a little more work on the part of the investor. But it’s not necessary. They could employ the simplified free lunch portfolio.
Zack: I like your discussion about a diversified global ETF portfolio using some type of timing mechanism on top of it, sort of like tactical asset allocation. Can you talk a little bit about your philosophy there?
Michael: That one is more momentum driven that’s in that. Well, there are two myths that kind of touch on the momentum part of investing – buy low and sell high as a myth and it’s bad to chase performance. In both of those, it shows that momentum investing is a viable practice. There’s a return driver there that’s derived from the fact that trends exceed the normal distribution expectation, and when people jump on a trend and it goes their direction, they are rewarded for that behavior and it perpetuates the trends. So that behavior can be used for timing ETFs or mutual funds as well.
You don’t want to be timing them in and out on a fast basis, and you don’t want to be timing them from the seat of the pants. You have to have a systematic process in place for doing that. But what it does is systematically move you in and out of the stronger performing in the U.S. portion of the portfolio, U.S. sectors, and in the international different countries.
Zack: One other strategy that you talk about is actually I devote a whole chapter in my book to it was the insider trading strategy. It is one that, at least from the research, seems so clear that by following certain corporate insiders, you’re going to make money doing it and so infrequently used. What do you attribute that to?
Michael: I don’t know why people ignore certain opportunities. To answer that question, I think that some of it is they like to do what other people are doing. There are a lot of things that are out in the public domain as far as trading strategies that are valid trading strategies that are under exploited, which is great.
Zack: Leaves the opportunity for us.
Michael: Exactly. You and I can exploit those and the people who read our books can exploit those. I don’t know why people don’t follow that kind of path. But if you’re going to follow anybody, follow the guys who really know about the company. It is a great valid return driver.
Zack: I think people use it as an input into idea generation, meaning they’ll look and see if there is insider buying. I think the hard part to get individual investors in general on board with all these things is getting them to stick to a quantitative model. Joel Greenblatt said this in his book, when he published the magic formula. People asked him in an interview, “Are you afraid by publishing this stuff, all the arbitrage opportunities are going to go away and your formula is going to start to work?” He said, “I have no fear of that at all because people can’t stick to these systems.”
Michael: And that is absolutely true. The human nature is to think they can do better than the system, and if they’ve got some input that is coming in during the day and their system says they should stay long a certain stock but they have more insight into it that they don’t think their model is picking up yet systematically, they might sell that stock. That is the data from the [inaudible 16:09] studies, which is in my book as well in myth number three. It really shows that people cannot make those decisions on a day-to-day basis properly. They lose money by doing that but they will still keep trying to do it.
There is another section I have on expert opinion, essentially showing that you cannot rely on experts, just reiterates that whole concept that people who are committed to a certain philosophy and start preaching it to the public as an expert become even more locked into it and become even more wrong than the experts who are less followed.
Zack: That is a great point. So as you are saying that I am thinking in some way in my own investment and what I preach to my clients is I do a lot of that leg work for them. Not necessarily the stock picking, but enforcing the systems, and it’s easy to do because I’m sort of a dispassionate outsider. When people start managing their own money as you describe, they lack stick-to-it-ness, particularly in what is happening in the ETF space. We are seeing a lot of new strategies coming on board, and my first inclination was, and you mentioned one of them, which is the Guggenheim Sabrient Insider Index. Now, Wall Street is packaging them and there goes that opportunity. But in some way they’re making it a lot easier. It is a lot easier for me to outsource that to them even if I could probably do better on my own theoretically. At least someone else is managing the money and enforcing that stick-to-it-ness in some way.
Michael: Right. What made my book and actually the action section that is over on the JackassInvesting.com website possible was the ability for individual investors to gain access to these trading strategies without having to trade them themselves. The fact that you’ve got the Guggenheim Fund and a number of other ETFs that are employing strategies that are providing uncorrelated returns or less correlated returns at least, that gives these individual investors access that they otherwise would not have had.
Otherwise they would have had to essentially make it their profession and develop strategies and follow those strategies on a daily basis. Now they can put a passive investment in place in an ETF that is making those active trading decisions on their behalf.
Zack: What is jackass about this process? Is jackass referring to the previous way we’ve done it, or are you sort of just saying let’s buck the system?
Michael: No, it’s really referring to the previous. To me jackass investing is the fact that conventional investment wisdom teaches people to take unnecessary risks with their money. Any time you take an unnecessary risk, that is behaving like a jackass. It is avoidable, but people are taught over and over buy and hold, concentrate your portfolio on stocks and bonds. Okay, diversify it, but you are still long only, which is driven within a 20 year period primarily by the enthusiasm of other investors. Your investment decisions are really being relegated to the population, and if they like stocks, the stocks you held long are going to go up. If they don’t, they are going to go down. To me that is jackass investing – taking unnecessary risks.
Zack: They asked Jack Bogle once about yearly rebalancing, which is very much part and parcel of a buy and hold strategy, at least the kind that Vanguard promotes. He admitted that he doesn’t necessarily do it every year. Do you employ a lot of these techniques in your own firm’s investing?
Michael: Our firm, we trade across a hundred global markets using a few dozen independent but separate return drivers in the trading strategies.
Zack: But all of those strategies are comingled?
Michael: They are. Just like somebody would comingle these different investments into a single portfolio. So we end up with a portfolio that’s deriving its returns from thousands of different market return driver combinations. That’s what we want to see is something that is diversified to that extent.
Zack: So does it correlate to any of the free lunch portfolios that you describe in the book more closely than one?
Michael: It does not, because the free lunch portfolios tend to have a larger long component. We’re just a subset in our firm. We essentially specialize in about one-third of the free lunch portfolio’s composition as a subset. That’s what we do. We are not taking on right now the insider trading strategy or the investor sentiment strategies. We’re using our trading to trade the global diversified portfolio which is about a third allocation to the free lunch portfolios.
Zack: I think you were being a little modest in your introduction to yourself and your firm. I think I read somewhere that you have a master trading story of your own, don’t you?
Michael: In what way do you refer to?
Zack: In the sense that you took some capital and built it into something much bigger.
Michael: Yeah, absolutely. I started out in 1979, like any individual investor. I had some money at that time, $5,000, and an interest in learning how to invest that. I started trading with that money and got involved in a variety of commodity contracts, got into equities, and really learned through the ’80s what didn’t work, but I also had some investments with some great traders, Paul Tudor Jones, John Henry, that have gone on to fame and baseball teams.
I got a good close-up view on what they did with their trading and developed my approach, which really we launched in the early 1990s, which is a systematic, multi-strategy, broadly diversified approach to trading.
Zack: Interesting. There was one quote from somebody who reviewed the book on Amazon I thought was awesome. It said, “Everyone knows that Wall Street is packaging products that are feature rich, so we buy them, but are not full of the features that will make you rich from investing.” I think your book sort of gets right at the heart of that.
Michael: Yeah, I thought that was a great line when I read that.
Zack: Yeah, I had to use that one.
Michael: Yeah, it was excellent. But that is exactly true. What I’m trying to do in the book is show people what they can do to create a truly diversified portfolio. It requires discipline to adhere to it, a systematic process. You can’t be sitting there day to day and jumping on a stock because your brother-in-law mentioned it at dinner the prior night. You really need a disciplined, diversified, systematic approach to investing your money.
Zack: Awesome. Given your approach, one thing I ask all participants, the last question on the program, is where do you go for investment research? How do you stay on top of your game? Whether online or offline, are there certain periodicals or something that you go back to that help make you better at what you do?
Michael: We’ve used the historical databases, because what we do is develop strategies that have stood the test of time and then applied them systematically in real time trading. On equity side, we’ve used a company in the past called Charter Oak. It is more of a professional focused organization that provides the Compustat type data and the software to go with that.
The commodities and the futures side comes from a variety of sources for us. We get fundamental data from the reports that the U.S. government produces and some of the world organizations and we get pricing data.
Zack: But where do you come up with the strategies? Are you reading academic research, or are you just developing those all in- house?
Michael: Definitely I’ll steal ideas anywhere I can get them. So no question, if we see something in academic literature that makes sense – most of it doesn’t – we’ll try to apply that in a systematic fashion and see if it does work. But just through the 30 years of trading, I’ve cataloged hundreds and hundreds of different ideas, really more observations. We just systematically go through that list and test out the different ideas to find out what really is effective.
Zack: So sort of like an in-house laboratory in that sense?
Michael: It is. Through the ’90s we had, and it was really set up that way, more of a research organization like a scientific organization where you had 15 programmers whose job was simply to test ideas. That really helped put the base in place for what we are doing today.
Zack: Amazing. Mike, thanks for your time. Not only is the book an excellent read, you get a sense that it was those ten years in incubation. There is a lifetime of investment wisdom in there and it was a great read. I appreciate your time on the call today.
Michael: Thank you, Zack. Appreciate it.