Horizontal Support (EP.22)

Episode Summary

Executive Summary: This episode covers how low rates and high valuations make investing harder, why companies often destroy value by overinvesting internally, and why buybacks, dividends, hedge funds, life insurance, momentum, and technical analysis all need to be understood with nuance rather than slogans. The hosts emphasize process, incentives, and empirical data over common investing narratives.

Main Topics: The challenge of investing in a low-rate world (Priority: 5/5): They contrast the 1990s, when institutions could meet return targets with bonds, with today’s environment where higher returns require taking more risk and accepting more volatility. This creates pressure on institutions and can encourage questionable promises from financial professionals. Buybacks versus dividends and capital allocation (Priority: 5/5): The discussion centers on whether buybacks are harmful or simply another way to return capital. They argue the empirical evidence suggests low-growth, lower-investment companies have outperformed, while many firms overinvest internally and destroy shareholder value. Hedge fund incentives, fees, and performance chasing (Priority: 4/5): The hosts discuss the emotional and operational strain on hedge fund managers, the tendency for investors to chase performance, and the oddity that some investors distrust fee structures designed to align incentives even when economics favor them. Why life insurance is underused and misunderstood (Priority: 4/5): They argue life insurance is a risk-management tool, not an investment, and criticize the idea of comparing it to index-fund returns. They stress that families with dependents often need coverage even if the expected 'return' looks poor. Momentum investing as a durable anomaly (Priority: 4/5): They discuss momentum as a behavioral phenomenon that works across economic regimes because people underreact and overreact. They note it is often mistaken for simplistic performance chasing, but there is a structured and evidence-based version of the factor. Markets, real estate, and technical levels (Priority: 3/5): They briefly touch on absurd Silicon Valley housing prices and give a simple technical-analysis explanation using Tesla’s repeated support around the $290-$300 range, illustrating how chart levels can break after repeated tests. Media and book recommendations (Priority: 2/5): The episode closes with cultural recommendations, including films, TV, podcasts, and a history book on the CIA, reinforcing the show’s casual, wide-ranging format.

Key Arguments: Institutions once could meet 7-8% return targets with bonds alone, but today they must accept volatility and risk to earn real returns. Buybacks are not obviously worse than dividends; both return capital to shareholders, and the data do not support a simple anti-buyback narrative. Many firms would create more shareholder value by not reinvesting excess capital into low-return internal projects. Hedge fund and advisor clients often chase recent performance despite short windows being poor indicators of skill. High fees do not necessarily imply better investing; in many cases, low-cost or no-frills approaches are superior. Life insurance should be evaluated as protection against catastrophic risk, not as an investment vehicle. Momentum persists because it captures investor behavior, not because it depends on economic growth. Repeated price tests can weaken technical support levels, making a break more likely once buyers fail to reappear.

Data Points: Institutional bond return target in 1995: 7.5% return target with 100% bonds - Used to show how much easier it was for institutions to meet goals in a higher-rate era Five-year Treasury performance in the 1990s: 7.2% annual return with 4.35% standard deviation - Illustrates why government bonds once satisfied many institutional return hurdles Low-asset-growth versus high-asset-growth premium: 20% per year return premium - Alpha Architect data cited for low asset growth stocks vs. high asset growth stocks over 40 years Equal-weighted low-growth vs. high-growth returns: 26% vs. 4% - Jack Vogel example comparing baskets of low-growth and high-growth firms GM capital spending versus equity value: $67 billion spent; $26 billion ending equity valuation - Example of a company that heavily invested while shareholder value lagged Toyota and Honda combined equity value in 1985: $21.5 billion - Used to highlight how much value GM could have acquired instead of overinvesting internally Households with life insurance in 2013: 60% - Federal Reserve Bank of Chicago report showing reduced coverage Households with life insurance in 1989: 77% - Comparison point for the decline in life insurance coverage Life insurance policies sold in 1965: 27 million - Peter Orszag data showing historical policy sales volume Life insurance policies sold in 2016: 27 million - Same policy count despite much larger population, implying lower per-capita uptake Population change by 2016: 50% larger than 1965 - Shows life insurance sales failed to keep pace with population growth GMO fund regional allocation to emerging markets: 63% - Used as an example of strong contrarian positioning GMO fund regional allocation to U.S.: 7% - Shows how underweight they are to the U.S. market GMO fund cash allocation: Almost 20% - Reflects their cautious, valuation-driven stance Fidelity Contra Fund outflows: $15 billion over the last 12 months - Despite strong recent performance, active funds still saw major outflows Legitimate outflows after share-class adjustment: About $10 billion - Adjustment mentioned to isolate true investor redemptions Palo Alto median home sale price: $3.1 million - Used to illustrate Silicon Valley housing extremes Palo Alto average down payment: 30% or close to $1 million - Shows the scale of capital required to buy in expensive markets Oakland median home sale price: $735,000 - Presented as a cheaper Bay Area alternative, though still expensive Oakland average down payment: 34% or about $250,000 - Highlights affordability issues even in less expensive Bay Area cities Oakland median household income: $57,000 - Used to underscore the disconnect between housing prices and incomes

Pivotal Quotes: "In an ironic twist, I always built my firm to survive the worst storm, but it was a nine-year bull market, complacency and sunshine that took me out." — Whitney Tilson (quoted in discussion): Reflecting on how a hedge fund built for crises struggled in a prolonged bull market "If you’re investing in GMO, you pretty much should know what you’re getting." — Ben Carlson: Explaining that a benchmark-free, contrarian fund requires investors to understand the mandate and accept the style "We fired the bank, moved that money to the robo-advisor, and have been satisfied since." — Guest/article quotation summarized by hosts: Illustrating that some clients prefer a less condescending, more automated advisory experience

Implications: Listeners should focus less on narratives and more on incentives, fees, and evidence. In a low-return world, capital allocation, risk management, and patience matter more, and flashy managers or simplistic anti-buyback/anti-insurance views can be misleading.