Index Funds vs. Ivy League

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And so I've famously applied for the CalPERS CIO job 3 times, and I say publicly, say, look, I'm going to fire almost everyone. I'm going to put this in a bunch of low-cost ETFs. We'll have a meeting once a year. We'll rebalance, we'll drink some beers, we'll watch Seinfeld, talk about it, and then guess what? We'll check out for another year. You can sell that big shiny office on and on. And they won't take me up on it.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Meb Faber, and he's not really looking for a job. He's the CIO and founder of Cambria Investment Management. He's talking about CalPERS. That's the California Public Employees Retirement System. It's a big institutional money manager, and Meb has a new white paper out on Yale's endowment fund. In a moment, we're gonna hear from him on a few topics, really. When you hear about those wonderful past returns from institutional money managers, should you feel like they're getting something you're not? Should you feel like you're missing out? Can you invest as well as Yale? I think you'll be encouraged to hear the answer. That's coming up. First, we'll say a few words about big foods, Big Florida splash. Listening in is our audio producer Jackson. Hi, Jackson.

Big Florida splash.

I oversold it.

Is that like a saying?

No, it's not something that anyone is saying.

No, I'm talking about CAGNY. That is the Consumer Analyst Group of New York. And they have a big February meeting every year in, of course, Florida, because it's February. Usually it's in Boca Raton, but this year they moved it right next to Disney World near Orlando. It's not quite as winterproof as Boca Raton, but it is more inspirational when it comes to the topic of overcharging for overeating. So if you're an investor and you enjoy slide presentations about the packaged food industry, then there's nothing like CAGNY each year to really get your Orville Redenbacher and your Duncan Hines. What I like is the week after the CAGNY conference. That's when all the analysts come back from it and then they publish their reports about all the slide presentations and they try to come up with common themes. What's going on in big food? What is big food saying as a group? What are we hearing right now? One thing you're hearing quite loudly if you're an investor in this group is that your shares are underperforming. Just about all the big ones are down over the past year. Kraft Heinz, General Mills, ConAgra, J.M. Smucker, Mondelez International, Hershey, PepsiCo. This is at a time when the S&P 500 is up close to 20% over the past year. Big food is supposed to be a staple. It's supposed to be something that keeps making money in good times and bad. So why are food stocks slumping? Jackson, you got guesses?

Maybe shrinkflation got too out of hand and consumers can't take it anymore.

I think inflation is one of the keys. There was a pickup in the overall inflation rate, a slight acceleration recently. Eggs are out of control. What's the cost of a dozen eggs near where you are?

I just stopped buying eggs. I've just given up.

I don't know if you have these. I'm in the suburbs. Some people have chicken coops in their backyards. It's a nice thing where you can have fresh eggs and you can teach your kids about raising chickens. These people are swaggering around like Bitcoin billionaires right now because everyone, everyone else is getting jammed up for $15 a dozen at the grocery store. These people are living large. I think inflation is part of the explanation. I'll explain why in a moment. There has been a drop in consumer confidence. The Confidence Board says it, quote, dropped sharply in February. Wall Street is also worried about trade wars. And no one's quite sure how obesity drugs will affect the long-term cookie monsterization of American eating habits, world eating habits, really. There is one big food company that's doing just fine right now, McCormick. That's the spice seller. That stock was recently up 19% in a year. So it's really keeping up with the broad stock market. On an earnings report, their CEO said, we do not compete for calories. We flavor them. He's pointing out that his company is differentiated at a time when big food is trying to figure out how to get growing again. What does it mean for investors? Let me run through a few summaries from Wall Street. JP Morgan had maybe the most methodical approach here. It used what it describes as proprietary data tools to analyze what the food company CEOs were saying during the CAGNY week. And it found that versus last year, companies were talking more about consumer sentiment and inflation and pricing and value. And elasticity, which I'm gonna assume is a reference to demand rather than pants, and cash flow. JP Morgan points out the snacking industry has been in a deep slump for over a year, but there was a lot of talk about health and wellness. One of the other reports pointed out that everyone is talking about protein right now. Jackson, have you seen that? They're ramming protein into everything. What, what have you seen in the snack aisle lately?

I literally just was at Costco and I got sold from the free sample lady on, on protein Cheerios.

And so you bought some, you tried it, protein Cheerios. Can you taste the protein? Does it taste like a sugary kid cereal and they're making you think it's good for you? What's happening here?

Yeah, it tastes like regular cereal and you can talk to your doctor about whether or not it's good for you.

Oh, we're not on speaking terms.

There was a lot of talk about algorithms, which is always the case with big food companies. Jackson, have you heard that?

Like, it's not the first thing that comes to mind, honestly.

Well, they use it in the context of like it's their growth. There's something about food companies where they don't like to come out and say, hey, we're really growing nicely. But they say and said, yeah, our growth algorithm is this much revenue growth with this much earnings growth. And so then they talk about we're either hitting our algorithm or we're not at our algorithm. Anyhow, B of A writes this about a lot of companies. General Mills, it writes fiscal 2025 outlook not reaffirmed and fiscal 2026 sales expected to be below algo. Coca-Cola focused on achieving its long-term algorithm. Okay. Kraft Heinz Company 2026 signal is return to growth, but no algo until 2027. Hershey, they write, focus on path back to on-algorithm growth or above in 2026. Okay, we'll see if that happens. One of the big factors there has been a wild swing in cocoa prices. Okay, so some companies have algo, but a lot of them don't right now.

I just can't believe they just can't say like growth target.

I don't know why. I don't know why.

The way they're using it, it sounds like, like Riz or like he's totally hitting algo.

Yeah, I think because if you're selling cookies and chips to a population that is just demonstrably overcooked and chipped on every level, that I think you have to maybe come up with other words than growth. I don't really know. That's just my speculation. Oppenheimer, I guess, sums things up for all of them when it writes, as we look forward, a higher interest rate backdrop, limited pricing power for a number of players, GLP-1 risks for food names, in other words, obesity drugs, FX headwinds, that's foreign exchange, tariff risks, and a still significant focus from leading retailers on private label suggest that a difficult backdrop is likely to continue. This is something to watch. I don't really have all the answers now. It's another example of a consumer staple group that is not looking quite as stable as it is supposed to look. We'll see if big food can come up with any of those innovations to start winning back some growth. I'll tell you about one more innovation, and that is, um, Milk-Bone. Now we're getting into pet food, sort of. Milk-Bone Soft and Chewy Peanut Buttery Bites. Made with Jif peanut butter. Now hang on, the J.M. Smucker Company, you know, the jams and jellies and also peanut butter, Jif peanut butter, they are the owner of Milk-Bone. And they talk about the humanization of pets and they say this is the first time that they're putting real human food in pet food. Although if you've ever dropped scraps off the dinner table, you've probably been a part of the humanization pet food movement all along.

I, I didn't even think of pets.

I'm keeping an eye out for Kibble and Slim Jim, but there haven't been any announcements on that front yet. And that is Big Food and the CAGNY splash. Coming up next, we'll hear from Meb Faber about institutional investing and whether you can match the returns of the pros. That's after this quick break.

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Welcome back, Jackson. We're done with food, but give us your bok choy story. Go ahead. You were buying bok choy.

I ran out to get a side last night. There's a grocery store about 2 blocks away. I had 3 baby bok choys in my cart and I went over to the self-checkout line and the employee there who is helping folks out there walks up to me and he goes, wow, you just got bok choy. And I said, yeah. And he said, what are you eating tonight? And I just said, bok choy.

I like that story because it starts nowhere and then stays stays nowhere. I thought that the ending of that story—

I was sure that the ending was going to be that he was asking you about your baby bok choy just for an excuse to say, I guess you want your baby bok, baby bok, baby bok.

I'm sure.

Oh man, that'd be so good.

Meb Faber, founder and CIO of Cambria. He put out a white paper recently called Can We All Invest Like Yale? And this is a topic I know that Meb has written about in the past. So this was an updated look with some fresh returns, and it caught my attention for a couple of reasons. First of all, the Yale endowment has had this wonderful return over decades, and it's done that partly by investing in strategies that most investors don't go into, like private equity. And so that leaves people thinking, if I want to be a sophisticated investor like Yale, I'd better buy into private equity one way or the other. And that can come with high fees. In this latest analysis, Meb points out that the returns for the Yale endowment since 2010, more recently, aren't really so great. They're not as good as returns for an S&P 500 fund. If you're in a cheap index fund, you've done better. He raises the question of whether Yale was just in on the golden age of private equity, which makes me wonder, What age are we in now if it's not the golden one? He also touches on other subjects like what the hedge fund manager Cliff Asness has called volatility laundering, or the fact that private equity looks like it has low volatility, but really what it has is just a lot less trading than regular stocks. He also mentions CalPERS and Bridgewater and some other big institutional money managers, and he asked whether they wouldn't be better off just putting money into cheap index funds. I'm interested in all of those topics, so I reached out to Meb for a chat. Let's hear part of that now. I want to say that I like this setup just because, you know, these names Harvard and Yale, they're also just kind of synonymous with smart. You know, somebody tells me stand on your head, I say no thanks. They say, well, Harvard researchers say you should stand on your head. I say, okay, help me up here.

Let me—

let's give it a shot. Like, we think of these, these people as just, if there's a way to do it, surely the business minds at Harvard and Yale have figured it out. And Yale has had some great success in the past.

They were really the smartest money on the street, meaning asset allocation, and particularly David Swensen, who sadly passed away a few years ago. I would consider him to be the GOAT, right? As far as asset allocators, you put him on the Mount Rushmore. But the endowments are unique, right? So if you think about a traditional college endowment, Harvard, Yale, increasingly other Colleges like Texas have been ascendant, but we're talking big pool capital, $50 billion, right? But they have somewhat of an infinite time horizon. So it's not like you or I were like, hey man, I got to buy that house, pay those bills, put the kids through college. They're thinking in terms of decades, if not centuries. Second is they're not taxed. So that's a big one. They can think in terms of tax only on risk-adjusted returns. Absolute returns. And on top of that, they've done an amazing job. Really, in the 20th century, Harvard was the big name, and then kind of more recently in the last few years, it's been Yale. But if you look at what defines the endowment model, and we can be more specific about the Yale model in a minute, it's an equity-like focus. So majority of the portfolio is equity-like investments. So think stocks, But also things kind of like stocks that happen to be private, like private equity, venture capital, which have been defining characteristics of Yale, things you and I normally don't have access to, like Sequoia and all these other great VC firms, KKR on the PE side, etc. Second is they lean heavy into alternatives or active management when they think they can add value. So if you pull up Yale's recent asset allocation, Listeners would be like, what, they only have 2% in US stocks? That's crazy. Well, when you sort of normalize the equity exposure in general, it's obviously much, much higher. So anyway, in our first book, The IV Portfolio, we tried to distill, hey, let's pretend we don't have access to private equity, VC, hedge funds, which are 3 big portions. And let's say we only have access to public investments. So ETFs, for example. Could we distill a portfolio that looks sort of like Yale and Harvard? And in the book we did, you know, and then interestingly enough, David Swensen actually published his own recommendation to individual investors, and they're incredibly similar. So if you just normalize the exposure and say, hey, let's just count private equity and VC as stocks, we'll exclude the hedge funds. And basically here's Swensen's recommendation: 20% US stocks, 20% foreign stocks, 10% emerging markets, 20% REITs, so real estate investment trusts, 15% US bonds, and 15% TIPS, Treasury Inflation Protected Securities. Very, very similar to what we looked at in our book, which was roughly 50% stocks, 15% fixed income, 35% real assets. And REITs and TIPS are sort of in that bucket, commodities, commodity equities. And so we compared it, and this paper will walk it forward 'cause we got an even longer period since 1985, which is when Swensen took the helm. The interesting takeaway is, is the average endowment over this period did just fine. Almost 9% a year. 9% is great. You'll make a lot of money compounding 9% per year. Reasonable volatility, manageable drawdowns. The S&P did almost 12%. So incredible period, by the way. But a lot of that driven by the last 15 years. This replication portfolio, you call it Swensen, did 9.5%. So it did a great job, but Yale did 13%. Okay. So the average endowment, 60/40 asset allocation, all of these did just fine, but Yale was head and shoulders above, which—

And this was the longest time period. Do I understand that right? 1985 all the way through last year, 2024? Correct.

And the fun thing about markets is you can chop these up into different regimes, and there's times when certain allocations look better than others. We wrote a piece last year called The Bear Market and Diversification, and this period since the bottom in 2009 has been one of the best periods ever for U.S. stocks. So if you look at— they've done 15% per year for over a decade. That's only happened 4 times in history, and they all have names: the Roaring Twenties, Nifty Fifty, Internet bubble, and then whatever we're calling this. COVID meme stock mania. But it's been an exceptional period for US stocks. But a diversified allocation, it's arguably been the worst. Now, not in terms of return. You did probably 8, 9% a year. No problem. The problem is your neighbor did 15. So if your neighbor did 15, just dollar cost averaging into SPY in terms of magnitude of underperformance, but more importantly, years in a row. So no matter your buy and hold allocation, you probably underperformed him 14 out of 15 years, an exceptional drubbing.

The smartest person on Wall Street, not counting the one who got the right meme coin of the day, is just that person who plunked all of their money in a cheap S&P 500 index fund and held it for a long time, 'cause that thing's done really well. And how's that compare with the endowments?

If you just looked at Yale versus some of the benchmarks since 2010, and these guys report in the summer, so June 30th fiscal year, so it's slightly different. Average endowment, 8%. Yale almost 11%. So you still have that 3% delta that's better. But guess what? S&P 15%. The point being is that there's periods where, uh, any one asset can look amazing. And then if you did the decade prior with S&P 2000, 2010 decade, not so hot. But so the takeaway from all this is, is there something in the water up in New Haven? Are they simply better. And so we kind of walk through in this paper, you know, clearly we can't replicate it with just market cap index beta, but what if, and we're using hindsight here, we acknowledge that in the paper. What if we say we tilt towards things like value? We love shareholder yield. You've written so much about factors over the years. We tilt towards value, small cap momentum that adds some returns, still doesn't get you to Yale, And then we said, well, it's not quite fair either because implicitly or explicitly these endowments use leverage. So whether it's through hedge funds, whether it's through private equity, if you buy stocks, they're levered anyway, on and on. You have a lot of ability to use leverage. So what if we leverage this portfolio by half? So total exposure of 150%. Now the cool part is that gets you up pretty close to Yale. So 1985, 2024, you can do 13% a year. The volatility is still reasonable, so 18% per year, and the worst year, you know, not fun. And one of the things about only reporting once a year, the nice thing is, of course, you only have to look once a year. You and I get to look every day. So usually the maximum drawdown is roughly twice the worst year statistic. So Yale lost a quarter in that sort of GFC, but in reality it was probably down half at one point.

That issue of the volatility, you know, just for people who haven't looked into this, with the stock investor, I mean, it is what it is. They live with it every day, the swings in the stock market. With the investor who's locking money up in these less liquid things, you know, you're not quite sure because you only find out how wildly something is swinging in price when there's a trade, when there's a price. And with some of these things, you don't get prices all the time.

You know, it's like your house pre-Zillow where you say, look, I, you know, I got to sell this. I don't know. Here's roughly what I think it is valued at. But you can't value it every day. The jiggles in private equity, one of the benefits, and it's kind of a wink-wink nod, is they know the equity is in line with the stock market, but because they only mention it once a year, it often gets smooth and drives people crazy. Like our buddy Cliff Asness, who calls this volatility laundering. But really it smooths out the returns a bit, which You know, again, I used to joke we should just buy a bunch of ETFs, put it in a fund, but only allow investors to look once a year. Now, there's the fun part about these types of studies and things that we write is that almost anyone can come up with a different takeaway from this paper. So we have a, we have a quote in this paper, an old Wall Street quote says, one of the funny things about the stock market is every time one person buys, Another person sells, and they both think they're astute. And the same thing is takeaway from this paper. So some people will read this and be like, you know what, my takeaway is 60/40 is just fine. Other people will go along with Swensen and say, you know what, I think I should diversify globally. Other people like myself, who has a large longstanding rivalry with CalPERS, we've written a lot about these big institutions. And circling back to the beginning of this discussion, most people assume that if you have the best resources in the world, infinite pools of capital, in case CalPERS, hundreds of billions of dollars under management, you get to talk to any single investment fund in the world you have access to, you would assume that would result in outperformance, but historically it doesn't.

In the white paper, you mentioned kind of in passing that, you know, you were considering some possibilities of why Yale had done so well in the initial part of the study period. And you said, something along the lines of maybe they were just in on a golden period for private equity, which made me wonder, is the golden— what made it the golden period? And is the golden period over for those investors out there who are being pitched on something having to do with private equity and who are wondering, hey, is the getting still good, or is there something better over there that I'm not getting in the stock market? What do you mean by that golden period for private equity? Where do you think we are now?

If you look at the late, great Charlie Munger, he used to talk about going fishing where the other fishermen aren't, you know. And so the alpha, which we wrote about in the Ivy Portfolio of Harvard in the 20th century, is they were early into things like Timberland, right, when no one else is investing in Timberland. They're early into hedge funds. And then Yale, early into private equity, early into venture capital when there wasn't much competition. Now every single MBA coming out of school, what do they want to do? They want to go work for VC in Silicon Valley, on and on and on. These massive private equity firms that have just been growing and sloughing off enormous amounts of fees. So let's be very clear. Part of the alpha of Swensen and Yale and Harvard back in the day, not so much recently for Harvard, was that they made these decisions at the time. You know, so they said, hey, look, let's move into these inefficient markets. Let's move into these strategies, whatever it may be. When no one else is doing it, when we see these opportunities. And fast forward to 2025, a lot of that former what you would call alpha has been commoditized. And we've seen this in the ETF markets too. You got an ETF for almost everything. I saw a cat bond was coming out the other day, merger arbitrage, all sorts of managed futures. You know, you can get a global portfolio for about 5 basis points, 0.05%. Best time ever to be an investor.

I think there's a uranium ETF out there. I mean, there's everything.

That's pretty narrow.

Yeah.

So, you know, I think the challenge that we all have to ask ourselves is, am I buying alpha or am I buying beta? And so our belief is we can replicate, and I think most of the academic literature points to this, you can replicate private equity and VC through the public markets through things like smaller cap exposure tilts towards certain sectors and of course a value approach. So most of private equity— our buddy Dan Rasmussen wrote about this years ago— said the vast majority of the returns from private equity come from simply investing in cheap companies. And they love the metric enterprise value to EBITDA. And he's like, you invest in the cheap ones, you can do it in the stock market and you get pretty darn close. We've actually started to see a bunch of private equity replication ETFs too. Now, I wouldn't want to launch them at this point in the cycle, however, but, but it's an interesting idea. And so I think, I think the question is and has always been, am I buying beta? Am I buying just exposure to something or am I buying true alpha? And that's a hard question to ask and answer.

In other words, outperformance of the index or buying just, you know, riding the index, which, you know, has been pretty darn good for a long time. Let me open it up to anything that you want to add and just tell us before we let you go, What do you think? Do you have any idea what investors are in for, what they're headed for? It doesn't have to be this year, this year, but just someone putting money to work right now. What should their expectation be for the future?

I'll give you two ideas real quick. One is I think you got to move away from market cap weight US. So it's no question which valuation metric you use that market cap weight is expensive. Now it's sort of a yellow flashing light, It doesn't really matter until it rolls over. So we're big trend followers. We're the biggest outlier here. And I think the entire country, as far as our firm Cambria, where we say the average investor, if they want to diversify to a trend following type of strategy or manage futures, could be up to half. So anyway, for the buy-and-hold crowd, look, move away from market cap. There's things like value is a great opportunity, foreign value, emerging markets value, which has been tossed into the dustbin. We all spend all of our time talking about investments, what looks good, how much I put in gold, what's the Fed doing, what's Trump doing, on and on and on, where are interest rates going. And the reality is the biggest way most of us can generate alpha is through fees and taxes. So lowering fees, the average ETF compared to the average active equity mutual fund, Bank of America says it's over a percent per year benefit through fees and taxes. But taxes, the problem is most investors in the US have highly appreciated gains over the past 15 years. So maybe you used to have 60/40 or something like that. Well, now you probably got 80/20 or 90/10, and it's all U.S. And the things that have gone up the most are now the most expensive. So think the Mag 7 tech stocks, the Qs, on and on. We actually have an opportunity now where we've come up with this idea that allows you to seed our ETFs before they launch in a tax-deferred or tax-free transaction. It doesn't wipe the taxes, you merely defer them. It's like a 1031 for stocks. So you can contribute a portfolio. Stocks or ETFs. It's called a 351 transaction, which no one's heard of, but there's over 100 of these that have been done. We just did one in December. But it's a cool idea if you're stuck in Nvidia and Apple and Microsoft, whatever you, you have, and you say, man, I want to sell these, but the IRS is going to kill me. You could contribute those and get a diversified portfolio like this endowment-style ETF in return, which we think is pretty cool. You know, it's a solution not too dissimilar from the exchange funds of days of yore. You're going to hear a lot more about it this year. We actually said we thought it would be a bigger story than crypto ETFs were last year, and they were a big story. You know, they raised $100 billion. So we think this 351 idea, as always, people don't think as much about taxes until they have to pay them. But we think this is a fun idea for the future.

Thank you, Meb, and thank all of you for listening. We've answered some questions here. We've raised some others. What are those? What Milk Bones with Jif peanut butter taste like. Jackson, you got to take one for the team here, buddy.

I think they're human grade. They've got to be, right?

Our lawyers are asking that we don't commit on that statement.

Jackson Cantrell is our producer. Alexis Moore is helping out with production, listening in on the podcast. You haven't heard from her yet, but you will soon. Let's hear one syllable, Alexis. Hey.

The reviews are pouring in already and people love your hay.

You're gassing me up. Thanks, Jack.

You can subscribe to the podcast on Apple Podcasts, Spotify, wherever you listen. Thanks and have a great week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you.

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Where data speaks.