Meb Faber on the Big Bear Market in Diversification and Tactical Allocation

Episode Summary

Executive Summary: The episode argues that U.S. large-cap tech’s extraordinary run has made diversification look foolish, but that concentration is cyclical and valuation-driven. Meb Faber explains why global diversification, value tilts, and tax efficiency still matter, while highlighting new ETF structures—especially tax-deferral exchange funds and ETF conversions—that could help investors diversify without immediately realizing capital gains.

Main Topics: Why diversification has underperformed for a decade (Priority: 5/5): Tracy and Joe open by lamenting that diversified portfolios, international stocks, and bond-heavy allocation have lagged simple U.S. tech-heavy bets like QQQ, SPY, Apple, and the Magnificent 7. Meb Faber’s investment philosophy and Cambria’s niche (Priority: 4/5): Faber describes Cambria as an ETF shop focused on launching differentiated, research-backed products that are cheap, unusual, and worth owning personally. Global market portfolio and valuation cycles (Priority: 5/5): The conversation explains that long stretches of relative underperformance are often driven by valuation expansion and regime shifts, with the U.S. currently commanding a large share of global market cap and a high CAPE ratio. Indexing, flows, and concentration (Priority: 4/5): They discuss how market-cap indices mechanically favor winners, how flows drive performance, and why this has amplified U.S. and megacap tech outperformance. ETF tax efficiency and structure innovation (Priority: 5/5): Faber argues ETFs are more tax-efficient than mutual funds and highlights structural advantages like low fees, in-kind creation/redemption, and possible negative expense ratios from securities lending. Tax-managed diversification and 351 exchange funds (Priority: 5/5): A major focus is Cambria’s plan to use exchange-fund-like structures to let investors contribute highly appreciated stock positions into an ETF in exchange for a diversified, tax-deferred portfolio. Future of ETF product design (Priority: 3/5): The episode closes with discussion of how cheap and easy ETF creation has become, enabling white-label launches, mutual-fund conversions, taxable target-date ideas, and more personalized retirement products.

Key Arguments: Diversification has looked bad mainly because U.S. large-cap growth has enjoyed a rare and prolonged valuation tailwind since 2009, not because diversification is fundamentally broken. A global market portfolio is the best conceptual starting point because it reflects the world’s investable assets and naturally tilts toward the U.S. without being all-in on one country. The U.S. market’s CAPE ratio expansion from low-teens in 2009 to the mid-30s today explains much of the return gap versus foreign markets. Index construction and passive flows concentrate capital in what has already worked, reinforcing megacap and U.S. outperformance. ETFs’ real innovation is not indexing per se but low cost, tax efficiency, and flexible portfolio implementation. Investors with large embedded gains need tax-aware diversification tools; exchange funds and 351 exchanges may solve the problem of de-risking without immediate tax bills. Many asset-allocation debates matter less than fees and taxes for buy-and-hold investors, because long-run outcome differences are often smaller than investors assume. ETF product creation has become dramatically cheaper and faster, which should accelerate innovation and lower barriers for niche strategies.

Data Points: Episode length / product format: 5 minutes or less - Bloomberg’s Stock Movers promo describes short audio reports delivered throughout the day. Cambria assets under management: near $3 billion - Faber says Cambria has grown to roughly this size. Cambria ETF count: 16 ETFs - He notes the firm offers sixteen ETFs. Company launch timing: first ETF in 2013 - Faber says Cambria launched its first ETF over a decade ago. U.S. share of world market cap: roughly two-thirds - He says the U.S. now represents about two-thirds of global equity market capitalization. U.S. stocks since 2009: almost a ten-bagger - Faber cites a poll and says stocks are up about 10x since 2009. U.S. annualized return since 2009: about 15% per year - He characterizes the post-2009 U.S. stock market performance this way. CAPE ratio in 2009: low teens - Faber contrasts 2009 U.S. valuation with today’s higher level. CAPE ratio today: mid-30s - He says the U.S. is expensive but not bubble-level today. CAPE ratio historical extremes: as low as 5; as high as 45 - He references long-run U.S. valuation history and the 1999 bubble peak. Historical U.S. underperformance regime: 2000 to the financial crisis - He notes U.S. stocks were beaten by foreign stocks, REITs, gold, and emerging markets during this period. Global market portfolio underperformance stretch: 13 of 15 years - He says the global market portfolio underperformed SPY in this period by this margin. Best-performing stock of all time example: Kansas City Railroad / Altria examples - Faber references a Hakeem-like conversation about the power of long compounding and stock selection. Exchange fund holding period: 7 years - He says investors contributing appreciated assets must hold the exchange-fund structure for seven years. Tax efficiency advantage of ETFs: about 70 basis points after-tax benefit - Faber estimates ETFs’ tax advantage versus mutual funds on average. ETF startup cost: about $50,000 - He says new white-label ETF launches can be started relatively cheaply today. Annual fixed cost if an ETF has zero assets: about $250,000 per year - He warns a dead-on-arrival ETF can still incur ongoing expenses. Mutual fund/asset allocation fee assumption: 1.25% - Used in the illustration that fees can erase the advantage of the best historical allocation. Historical best-vs-worst allocation spread: within 1% to 2% per year - He says major asset-allocation styles clustered surprisingly closely over long periods.

Pivotal Quotes: "We always say the global market portfolio is the best starting point." — Meb Faber: Faber’s core framing for asset allocation and diversification. "The debate is really high fee, low fee." — Meb Faber: He paraphrases Bogle’s view that costs matter more than passive-versus-active labeling. "The bad news is like there’s a whole universe of absolutely awful gods. Awful, terrible." — Meb Faber: He warns that many ETF and fintech products are low-quality or gimmicky despite easy creation.

Implications: Listeners should expect more tax-aware ETF innovation, especially tools that let investors diversify concentrated winners without immediate realization of gains. The broader lesson is that today’s concentration winners may not stay winners forever, and fees/taxes can matter more than clever allocation.