Episode 104 – When Building Retirement Portfolios, How Big a Role Does Asset Allocation Play in Performance? with guest Roger Ibbotson, PhD

Episode: 104
Originally Aired: October 22, 2014
Topic: When Building Retirement Portfolios, How Big a Role Does Asset Allocation Play in Performance? with guest Dr. Roger Ibbotson, PhD

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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When Building Retirement Portfolios, How Big a Role Does Asset Allocation Play in Performance?
James Lange, CPA/Attorney
Guest: Roger Ibbotson, PhD
Episode 104

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  1.  Guest Introduction – Roger Ibbotson, PhD
  2.  Accurate Asset Allocation 
  3.  Bonds versus Annuities
  4.  Should stocks be part of your portfolio?
  5.  Index and Active Investing
  6.  Zebra Capital
  7.  What’s Next for Dr. Ibbotson

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1. Guest Introduction – Roger Ibbotson, PhD

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, with James Lange, CPA/Attorney, and author of two best-selling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again.  When it comes to building retirement portfolios, how big a role does asset allocation really play in performance?  To provide perspective and insight on that issue, we welcome another industry giant back to the show, Dr. Roger Ibbotson, long time Professor in the Practice Emeritus of Finance at Yale University’s School of Management.  Dr. Ibbotson is also chairman and CIO of Zeeba Capital Management, an equity investment and hedge fund manager.  Founder and former chairman of Ibbotson & Associates, now a Morningstar company, he also serves on numerous boards, including Dimensional Fund Advisors.  A prolific author, he’s written dozens of articles and books, including Stocks, Bonds, Bills and Inflation, which has become a standard reference for information about capital markets and returns.  Jim and Dr. Ibbotson will explore a variety of issues today and it’s sure to be an interesting and informative hour.  And listeners, since our show is live, you can join the conversation.  Call the KQV studios at (412) 333-9385 with your questions and comments.  And with that, I’ll say hello, Jim and welcome, Dr. Ibbotson.

Jim Lange:  Welcome, Roger.

Roger Ibbotson:  Well, I’m glad to be here.

Jim:  Well, first, I’m gonna start by saying that David’s introduction doesn’t really do justice…

David:  Oh, wait a minute!

Jim:  …to your reputation in both the academic and the financial world.  Some people, including me, would say that Roger is the most famous and well-known and knowledgeable expert on the subject of asset allocation in the world, and considering that asset allocation is probably…which we’re going to get into, how it is the most important part of your portfolio.  That makes you a pretty important guy.  Even outside the area of asset allocation, when/if you say, “According to Ibbotson,” that provides tremendous credibility for financial advisors all around the world.  And the famous “Ibbotson SBBI”, which is stocks, bonds, bills and inflation, which has both the charts, I give them out like candy.  I buy pads of them.  And then, of course, your annual book that comes out that is probably appropriate for advisors is just the great classic.  So, it is really a great honor to have you.

Roger:  Well, I hope to live up to that kind of introduction, but it’s certainly great to be here, yes.

2. Accurate Asset Allocation

Jim:  Well, one of the things that was a little bit shocking to me, that I’m hoping that you could shed some light on, is that all the studies that I had been familiar with that talked about the importance of asset allocation, or, to be more technical, the determinants of portfolio performance said that asset allocation accounted for roughly 91.5%, or, let’s round off and call it 90% of the determinants of portfolio performance, with security selection at 4.6%, and the rest to timing and other factors.  And I have seen that number 90% for many years, and I’ve even quoted it myself.  Now, as I understand it, you’re saying, “Wait a minute!  Maybe that’s not quite accurate.”  And, at the risk of being a little bit technical, which I think it okay because I think this information is so important, I wonder if you could expand on some of your thinking?  And I know that you have some pretty excellent articles on the subject, but I wonder if you could tell our listeners what your thinking o the importance of asset allocation is, and why the classic 90% number isn’t really what you think is the current, accurate number in determination of portfolio performance?

Roger:  I believe you’re right.  It’s actually not even close to an accurate number, and it’s actually one of the most misunderstood areas of asset allocation and, maybe, finance in general.  Let me start out with something simple, though, because this is what people basically say:  They say, “Well, what percentage of my return comes from my asset allocation policy?”  And that is a very interesting question.  They thought the answer was always 90%, but, in fact, that one, we can all think out together without even looking at data very carefully because it actually has a simple answer.  If I say, “Well, what are the portions of my return?”  There’s the return that comes from my asset allocation policy and then there’s a return from essentially trying to beat them, getting enough by stock selection, basically, our timing in some way, or in paying for the fees for it, some combination of things where you’re basically using active management.  So, my asset allocation is my stable part, my long-term policy, and the rest of it is trying to beat the market.  If you look at it that way, well, I think you probably have talked about it on your show before how the average person can’t beat the market.  On average, it’s actually a zero sum game.  It’s like a poker game where, on average, we don’t win at a poker game.  Maybe some people win and some people lose, but on average, you don’t win.  And in fact, with the cost of investing in the market, it’s actually a negative.  But it’s close to zero.  So, if you take two pieces, now, the asset allocation policy plus the other piece, which is close to zero, and if you ask what percentage of your performance, of your return, comes from your asset allocation, the answer’s gonna be 100% because it’s a hundred plus zero divided by a hundred.  It’s just 100%.  So actually, that’s the question most people actually ask, and then, well, I’m fortunate that I have a simple answer for: it’s all of it.  On average, for most people, all of your return comes from your asset allocation policy.  But actually, that’s not the question that the original 90% studies are trying to answer.  That’s just the way people interpreted what their answer was.

Jim:  All right.  So, let’s even simplify, and let’s take out active money management.  So, let’s say that you’re a Vanguard index investor, or you’re a Dimensional Fund advisor index investor.  So, let’s take out the element of active investing.  How important is asset allocation in that situation?  And then, maybe, if you could also say how important it would be if there was active management?

Roger:  Well, without active management, we’re still at the 100% answer.  But I want to stress one thing here: the original studies, which were done by Gary Benson and Randy Hood and some other authors, these studies were asking about the variation in returns, not the level of returns.  If you’re talking about the level of returns, the answer’s always going to be 100%, or perhaps even higher than 100% because the other piece might be negative after fees.  On the other hand, index funds with their low fees, we’re just at that 100% again.  But if you look at the variation returns, actually, there’s a much more interesting question, or a different question, anyway.  People want to know, “Why does my return differ from your return?  I have a different asset allocation policy and I have different stocks than you do.  What portion of the variation on returns comes from my asset allocation policy, and what portion comes from the fact that I have different stocks than you?”

Jim:  That seems like the more meaningful question to me.

Roger:  Yeah.  That’s not gonna have a trivial answer.  The only way we can really answer that is looking at a lot of data.  And we’ve done that, and I’ve looked at studies several times on this and participated in studies, and the answer is very sample dependent.  It depends on which group of investors you’re looking at, but on average, it turns out that it’s about equal.  It’s about half the reason that we have different returns.  It has to do with the fact that we have different asset allocations, and the other half of the difference in the returns between you and I is because we have different stocks and different fees and so forth in our portfolios.  And actually, I had a paper called “Does Asset Allocation Explain 40, 90 or 100% Returns?”  And the 40 is the 50 that I’ve just talked about.  Basically, sometimes it’s a 40, sometimes it’s a 50, sometimes it’s a 60, but the 40 is why our variation returns differ and the 100 is why at the level of our returns are all explained by our policies because there’s, on average, no return to active management.  The 90 is an answer to something, but we’d have to ask a very technical question that probably nobody would ask, I guess, to get that answer of 90%.  That’s the problem with 90%.  It’s an answer to a question that nobody really would ask.

Jim:  Well, I think that that’s really important information because many advisors, including myself, have been quoting the 90% number, and really, what you’re saying is in terms of accounting for variation that it’s really closer to 50%.

Roger:  And we can actually bring them back together.  We can take that 90% number…actually, the 50% is across investors, the 90% is your investment across time, but the reason why you get that high variation of 90% is because it has the market movement in there.  You have to take the market movement out.  So, for example, in a year like 2008, if you can remember the financial crisis then, we all lost money, and in a year like, frankly, 2009 and the last several years, most all of us made money because the stocks went up so much, they more than doubled over that period of time.  Well, if you take out the market movement, you get back to that 50%.  But if you put the market movement back in, then you could say that 90% of the return has to do with my asset allocation, which includes the market movement.  If you include the market movement, you get to that 90% again.  But it’s sort of a technical response and I don’t expect everybody to try to follow that, but again, the two questions you might ask are what percentage of my return comes from asset allocation, and why is my return different from yours?  And those two questions are really 100% and 50%.

Jim:  All right.  Well, I think that that’s very important information.  Just so we can be a little bit more precise with our definitions, when you say asset allocation, are you talking about percentage of equities and percentage of fixed income, or are you actually talking about specific asset classes, such as international small value and international small growth and etc., etc., that a well-diversified portfolio might have ten or fifteen asset classes in?  Are you talking about that, or are you just talking about stocks and bonds, or equities and fixed income?

Roger:  I’m actually…most of the studies have really just…stocks, or a couple different varieties of stocks, not a large variety of assets, and really, that gets at the crux of this.  Bond markets don’t move so much.  Stock markets move a lot, and if you look at what drives the return, it’s the proportion in equities versus the portion in, say, bonds or cash.  So, all the action is how much is the stocks bonds?  That’s the main driver of your asset allocation.  That’s not to say you can’t improve your asset allocation by putting in small caps or value stocks or…at Zebra Capital, we buy less popular stocks.  Or doing these sorts of things certainly can improve them, but they’re not going to…the dramatic difference between your asset allocation policy and mine is the difference in our equity portions.

Jim:  All right.  Is there any way to quantify the difference between, let’s say, somebody who has, for discussion’s sake, 50% in the S&P 500 and 50% in fixed income versus instead of having 50% in the S&P 500, they would have what you or I might consider the well-diversified portfolio that would have a certain percentage in large cap growth and large cap value and small cap growth and small cap value and real estate and international and emerging markets and emerging market value, etc., etc.

Roger:  Well, if you don’t mind me talking really roughly on this…

Jim:  No, no.  Please do.

Roger:  I pretty much have to because we have to specify numbers to do other than that, but think of it as well, it’s 50% of the reason why you and I are different is our policy and basically how much equity and fixed income we have, but it might be 60% when we start specifying the details of the fact that I’m in small caps, you’re in real estate equity and so forth, and I’m in value and you’re in international.  Those types of things will increase the importance of asset allocation as we actually more fine-tune the portfolios.

Jim:  All right.  Well, one question about asset allocation that clients often ask, and something that I would like to know, is some people, including Jonathan Clements, say that whatever asset allocation policy you decide on, you know, based on your risk tolerance and based on the number of years you need to have the money invested, etc., etc., that you should determine an asset allocation policy, and other than rebalancing, which is probably a separate question, more or less stick to that policy and don’t get all flustered at recent events.  Would you agree with that, or do you, and in your role at Zebra Capital, think, “No, no.  We can change asset allocation.”  I won’t say it will, but, at least, that we can make changes over time, not necessarily based on people getting older or, let’s say, more scared of the market, but just do you think it is more prudent to, in general, develop an asset allocation plan and stick with it?

Roger:  Well, for most of us, we should stick with it.  The problem here is there are differences.  We can project the returns of stocks that change over time.  But the problem is that when the stocks actually have the highest projection is when you least want to buy them.  For example, if you bought after…even models would basically say after the financial crisis, like in early 2009 when the world looked so chaotic, or actually in any recession.  If you could buy stocks in the middle of these recessions, that’s the best time to buy stocks.  But our tendency, of course, is to do just the opposite.  In fact, mutual fund flows, if you look at them, people have been getting out of equities ever since the financial crisis.  They rolled into the crisis with an equity position.  They lost money from their equities.  They never rebalanced to bring their equity position back in, and in fact, they even had negative flows out of equities they missed.  So, when stocks fell something like 50% in the financial crisis, and then when they more than doubled to come back from it, basically, too many of us essentially got out after the financial crisis and missed the rebound.  But that’s the typical behavior of people to actually go…in order to actually outperform the market, you have to go against the grain, but this is really hard for people to do.  So, I guess, at a first pass, I would say a stable asset allocation policy is far better than most of us are going to do because most of us are going to react the wrong way on this.

David:  Umm-hmm.  Do you wanna have time for a quick break right now?  When we do, we’ll come back and we’ll be talking to Dr. Roger Ibbotson and Jim Lange, and you can call the KQV studios at (412) 333-9385.


David:  And welcome back to the Lange Money Hour with Jim Lange and Dr. Roger Ibbotson, author of the classic book Stocks, Bonds, Bills and Inflation and Valuation Yearbook.  Both are available at Amazon.com.

3. Bonds versus Annuities

Jim:  Which are incredibly useful, mainly for financial advisors.  Roger, we have a question submitted from Mike Tillmans, and Mike’s question is, “For a 66-year old investor with modest investments, what is your advice regarding bonds?  I’m thinking to cash them in to purchase an immediate annuity to provide income that bonds are not providing now.”  Roger, how do you think you would answer Mike’s question?

Roger:  Well, I think the question has to do with how much money Mike needs in retirement.  If it’s gonna be tight, certainly, we all face longevity risk, and so we don’t know how long we’re gonna live, and he’s 66, I think he said, and his projection might be something like twenty years that he might live, and I don’t know what his spouse situation is and so forth.  But we have long horizons.  At one time, we used to think of 66 as old, but now, we think of it as quite young, I guess, and we have definitely a long, long way to go.  So, you would get a higher return with the annuity because, basically, it has a finite life and it pays while you are alive and then it stops paying.  And so, you’d get a higher return than you would from the straight bonds.  And. if you really have a tight financial need here that you can’t just draw it off from your stock and bond portfolios, annuities give you much more protection.  But if you put your whole portfolio into annuities, you would actually end up with exactly zero left at the end, which might be appropriate for some people, but a lot of other people would have sort of a bequest motive to leave something afterwards.

Jim:  Personally, I like the concept of immediate annuities.  And by the way, I’m distinguishing this from commercial annuities or tax-deferred annuities, which are a whole different beast.  We’re talking about immediate annuities where basically you give the insurance company a certain amount of money, and in return, they pay you a monthly income every month for the rest of your life, or perhaps, a monthly income with an inflation factor, which is something that Larry Kotlikoff is more of a fan of.  But do you think that, in Mike’s situation, that since immediate annuities are…and how much money Mike would get per month would be basically based on a) his life expectancy, and b) what the interest markets are paying right now.  Since the interest markets are very low right now, do you think it would be a reasonable strategy for Mike to, perhaps, wait a couple years or months or however long it takes for the interest markets to rise, and then purchase an immediate annuity?  Or do you think that he should do whatever is appropriate right now?

Roger:  Well, of course, the only way to lock it in is to do a little bit right now, but I do think the bond portfolio might be worse even if you’re comparing those two because that locks in the low interest rate, too, in the bond portfolio.  In general, I would be leery of the longer-term bonds right now, and of course, the longer-term annuities are effectively part of that, because usually I don’t have so strong of views on markets, but it’s hard to feel satisfied with the level of interest rates that we have in the markets.  They may stay low for the next several years, probably, with all the easy money programs that we’ve had.  I would think quantitative easing and things like that, we’ve had a very easy money policy.  And so, that keeps the interest rates low.  There’s some talk, of course, that Bernanke’s going to back off on that and these rates may rise, but it’s kind of unclear just how far they’re going to back off or when they’ll back off and so forth.  But, ultimately, these rates are probably too low.  They’re not likely to get lower.  They’re more likely to go up, and neither bonds nor annuities might be that attractive at this point in time.

4. Should stocks be part of your portfolio?

Jim:  All right, well, that leads us to stocks, and if Mike were here or on the line, he might say something like this, and frankly, I hear this a lot.  From the Republicans, I hear that Obama has no idea what he’s doing and he’s wrecking the country and we’re all gonna go to hell in a hand basket.  From the Democrats, I hear, “Oh, wait.  Congress is so dysfunctional that the country’s going down.”  And then, you hear, even people like John Bogle, questioning some of the institutions that we have grown to trust, whether it’s the Fed, whether it’s the SEC, whether it’s the auditors, whether it’s the agents, and he has a whole list.  Do you feel that stocks are still viable, and it’s still reasonable to have, particularly for somebody who is 66, to have at least a portion of their portfolio in stocks?

Roger:  Absolutely.  I will say, you know, people thought after the financial crisis, things looked a lot worse than they do now, of course, and people wanted to get out of stocks because they thought there was no future in the stock market.  But, in fact, the stock market, and earnings, I will say to go along with it, went right up, and companies actually do adapt and maybe the environment is not the same as it was ten years ago or twenty years ago, but companies have adapted and their profits increased, and markets have actually doubled, more than doubled, in the last four years, and even while that’s happened, price earnings ratios are not especially high at this point.  I think that you’ve got to invest in stocks.  You’ve gotta actually take the risk if you actually want to get returns here in the markets.  There’s no way to avoid it.  If you won’t get it in the bond market, you’ve got to get it in the stock market.  Maybe there are different forms of equities you can get in, but basically, you’ve got to be in equities to get these long run returns.

David:  How much of that market growth do you think has been dependent upon low interest rates?

Roger:  Well, that’s certainly been an impetus.  I mean, sometimes it is exactly tied to the economy.  Starting in ’09, I mean, we can also talk about Republicans and Democrats, but actually, this is a period after the financial crisis, but Obama’s been in there that whole time and actually been the recipient of a huge bull market here ultimately.  Now, it’s true.  It was a company with low interest rates, and a lot of the low interest rates were caused by the fact that we had a financial crisis, so we had to have low interest rates in order to try to bring the country back, and some of those low interest rates can’t always continue.  Certainly won’t.  I wouldn’t even recommend that they continue this long that we’re now four years beyond the financial crisis, or five years beyond it.  And so, I wouldn’t say that we should continue these kinds of policies forever.  Basically, the economy has to stand on its own at some point.  But still, yes, we will have rising interest rates.  That’s why I suggest you don’t load up too much on longer-term bonds anyway.  However, I think that ultimately the stock market is tied to the earning power of corporations, which doesn’t seem to be over yet.

Jim:  Let me ask you a tougher question, if I could, and I didn’t give you any preparation for this one, so I’m sorry if this is too tough for off the cuff, but it’s something that I think about.  Let’s assume, for discussion’s sake, that there is some type of significant terrorist event, either a 9/11 or even worse than 9/11.  Maybe a dirty bomb or something that maybe isn’t totally catastrophic that wipes out entire cities or portions of the country, but something that is major and, let’s say, maybe more than one building or two buildings and 3,000 people.  What do you think the impact of that would be on the stock market, and should that have any bearing on people’s investing?

Roger:  Such a thing would, of course, have a very negative immediate impact on the stock market.  The stock market would drop commensurate with how serious the event was.  However, after it happened, just like after the financial crisis, which was a breakdown of the whole financial system almost, or we did have a 9/11.  The 9/11 was, sort of, actually, in the middle of parts of a recession.  We did have that, and, of course, it makes things a lot worse when that happens.  But it doesn’t mean we don’t recover, and ultimately, we can’t predict when those things will happen.  When they do happen, our markets are gonna drop abruptly, but it doesn’t mean you get out afterwards.  After the crisis, basically, that’s the best time to buy stocks.  Now, nobody will want to do it, I know.  So, I can give you that advice, but if we bring ourselves back to early 2009, after the crisis was sort of settling, and it looked like the economy wasn’t gonna totally collapse, but things were in really bad shape, telling somebody to buy stocks at that time would be anathema.  It would be very hard to convince somebody to do it, but actually, those are the best times to buy stocks.

Jim:  I always found it interesting that being a good investor is doing exactly the opposite of what our human instincts are.  Usually, if there’s danger, we run.  If there’s things that are good, we seek more of it.  But in actual investment policy, that’s probably the worst thing that you could do.

Roger:  And, in fact, by the way, at Zebra Capital, we do this not to tie markets, but really to buy which stocks.  You buy the stocks that are less popular.  We look at the stocks that are less traded, and so forth.  It turns out the hot stocks that maybe Jim Kramer might be talking about or something, those kinds of stocks that are in the news and exciting right at the moment, those kinds of stocks actually do the worst, and the stocks that are kind of off the market in fact have far better returns, and we’ve done lots of studies to show that.  So, it applies both at the overall stock market level.  The best time to buy is when times look bad.  It’s also the case when the less popular stocks, in general, are the stocks that actually have the highest returns, for example: value stocks.  Now, the evidence is pretty strong that value stocks have higher returns than growth stocks.  Well, if you look at the companies that are value companies, there’s something wrong with those companies.  Every one of them.  Usually, they’re distressed in some way.  But it turns out that buying distressed companies, bad companies, you might say, actually is a better strategy than buying good companies.  Bad companies may be good stocks, and good companies may be bad stocks after you look and see how they’re priced.

Jim:  It sounds like Zebra Capital is a little bit like the ugly house market.  I don’t know if that’s fair, but…

Roger:  Well, if you have an ugly house in a great location that can be renovated and made nice, you get a big payoff for that sort of thing.

David:  Well, are you suggesting now that the stock market is high that this is the time to get out?

Roger:  Well, I might be leaning more that way, except if you look at price earnings ratios and so forth, it’s not that high.  But definitely, it has doubled.  But people are still sort of pessimistic.  That makes me more optimistic.

David:  Well, at this point, let’s take another break because it’s a good idea and it’s a good place, so we’ll come back and continue the conversation.


David:  And welcome back to the Lange Money Hour with Dr. Roger Ibbotson and Jim Lange.

Jim:   And again, Roger’s books, which I think are classics, especially for financial advisors, Stocks, Bonds, Bills & Inflation, that comes out every year, and the Valuation books are an invaluable resource, as well as the charts available at Ibbotson & Associates.  The books are available at www.amazon.com.

Roger:  I should say you can also get them directly through Morningstar because Morningstar’s the publisher of the books, now that I’ve sold Ibbotson & Associates to Morningstar back in 2006.

Jim:  All right, and that’s corporate.morningstar.com.  Is that correct?

Roger:  Well, I think you can just go morningstar.com and find it…certainly, if you go on the internet and just say ‘Morningstar,’ you’ll find Morningstar all over the place, but as far as the site to buy it, I think it’s just morningstar.com.

5. Index and Active Investing

Jim:  Okay, and that would probably be more direct, and there might be other benefits of buying it through them.  I imagine you’d get on a newsletter that would provide useful information.  So, one of the questions that you alluded to earlier when you talked about the poker game, and things that you have discussed in the past, is the issue of index investing versus active investing, and I know Zebra, to some extent, is an active investor, or active investments, because you are actually…well, going back to the ugly house analogy, but trying to pick stocks that are out of favor, so you’re actively trying to beat the market versus, say, a Vanguard or a Dimensional Fund Advisor approach of just being the market.  Do you have some thoughts on which is better, or are they just different and it’s a matter of style, or what wisdom can you give our readers for the general question of active versus passive?

Roger:  Well, of course, Vanguard, which I have some investments myself in, these are index funds meant to match the market.  Dimensional is a little bit different.  Dimensional Fund Advisors, I’m on their board, and I’ve been on their board for thirty years, and in fact, original co-author Rex Sinquefield of Stocks, Bonds, Bills & Inflation, he’s retired from Dimensional, but he was with Dimensional for all that time, and even, by the way, David Booth was a roommate of mine back in the 1970s at the University of Chicago.  So, I’ve been involved with Dimensional from the start.  They don’t exactly think of themselves as index funds, though, because they’re interested in a strategy.  They make this distinction because they’re not trying to match an index.  They think, in fact, it might be sometimes expensive just to do the trading to match the index.  So, they wouldn’t call themselves an index, or even an enhanced index, but certainly, you can think of them as a passive manager where they’re effectively saying, “We think prices are fair.  The prices are efficient.  We’re just trying to participate in the market in a low-cost way.”  So, they would fit into those categories, yes, not the extreme indexation that you get out of Vanguard.

Now, Zebra Capital, yes, we are more active here, where we are trying to outperform the market, and you can think of it as the poker game, and who should play the poker game, basically?  Well, we shouldn’t all be in the poker game, of course.  Basically, the only people who should be playing the poker game are, I think, people who really have a good chance of winning in the poker game.  We think the way to win is to go against the grain because there’s so many people that actually do the wrong things, and you have to go against them.  These people shouldn’t be in the poker game, though, but they are.  They may even be professional managers, and often they are, where they’re just systematically going after the most popular stocks.  They go after the exciting stories rather than the fundamentals that really matter.  So, yes, in general, the poker game’s going to be a zero sum game.  There’s going to be winners and losers.  We think we can be a winner, and we think actually we’re subsidized by a big horde of investors who fall for the popular wisdom all the time.

6. Zebra Capital

Jim:  Who would be an appropriate person to be a client of Zebra Capital?  Would this be other money managers, individuals?  What kind of clients are you looking for?

Roger:  Well, not necessarily the people listening to this broadcast, I don’t think, because we typically have a million dollar minimum investment.  We have high net worth investors, probably, but most of our investors are, in fact, they’re global.  We’re a global firm, and our investors are institutional investors, for the most part, although we do take, of course, some high net worth investors.  So, I mean, it’s possible that some of the people listening could be potential prospects for us, or clients for us, but I’m not speaking to our target audience here, certainly.

Jim:  Umm-hmm.  Whereas, I guess, in disclosure, as you probably know, I do believe that there are some active money managers.  I haven’t studied Zebra’s results, but I would imagine Zebra…I also work with an active money manager called Fort Pitt Capital Group that I feel very good about.  But most of the new business that I am doing in the money management field is actually with Dimensional Fund Advisors where we have a local DFA, or Dimensional Fund Advisor, money manager who actually manages the money, does the asset allocation, does the cash projections, does all the good things and even more than the vast majority of money managers, and then our firm actually does things like Roth IRA conversions, when you should take Social Security, tax planning, estate planning, etc., and then we combine our services and just charge one percent or less.  So, that might be a little bit more appropriate for some of the local folks, but I know, very frankly, we have a lot of advisors, and we have people from all over the country, maybe not the world, but the country where Zebra Capital might be a good fit also.

Roger:  Yeah.  I will say, and I don’t want to speak for Dimensional in this regard, a lot of investors really are better off…not that I believe markets are efficient.  In the poker game, if the poker game were totally efficient, it’d be just random who won and who lost the poker games, and I don’t think that’s quite the case.  On the other hand, if you act as if markets are efficient, if you’re one of the people who are, in fact, probably going to lose in the poker game, you shouldn’t be getting into that poker game, especially after costs.  A lot of us should not be getting into the game, and Dimensional’s actually offering, basically, products that…not exactly, they don’t try to match markets, but, basically. they participate in the market.  They keep the cost down.  They try to do work with them not even on asset allocation fronts.  They try to do the things that really matter to investors, rather than just trying to beat the market.  Now, ultimately, that’s a big part of investing, and Dimensional fills that role.

Jim:  Is it fair to say that if you didn’t want to participate in the poker game. that it would make sense, if you’re a do-it-yourselfer, to perhaps try to develop a well-diversified portfolio within Vanguard?  That’s for the do-it-yourselfer.  But if you’re not a do-it-yourselfer, to perhaps find a Dimensional Fund Advisor and develop a well-diversified portfolio using some combination of Dimensional funds, which, let’s say, if aren’t technically enhanced index funds, at least use a passive approach.  Would that be a fair piece of advice?  And then, if you do want to participate in the poker game, then look for companies, you know, such as Zebra or Fort Pitt or other active managers.  Is that fair?

Roger:  Yeah, I think that’s fair.  Of course, you can’t, as an individual, go to Dimensional and invest with them.  Dimensional won’t accept individual investors.  They only accept accredited advisors who they’ve actually trained to work with their philosophy, which I imagine you’re part of.  So, if you’re going to be a pure do-it-yourselfer and want to be in the game in a passive way, Vanguard is the natural way to do that, or some of the other index funds.  Dimensional will not take you as a direct client like that.  And again, if you’re going to be active as a do-it-yourselfer, you probably can’t just go to Zebra either unless you have sufficient money to invest.  So, a lot of the avenues for, maybe, the great potential returns may be sort of closed off to you.  You have to go to the conventional mutual funds, and so forth.

Jim:  Can I ask you a question about Zebra?  Let’s say that somebody had one or two million dollars.  Is Zebra kind of an all-in-one that you could do everything?  Or would it be the kind of thing that they would put a certain amount with Zebra and then have other investments elsewhere?

Roger:  No, we wouldn’t be all-in-one.  No, we’d only be a part of somebody’s investments, and that’s why we’re pretty much talking about ten million dollar-plus net worth individuals because only that kind of a person would want to put one million, say, in our funds, I think.  So, we’re not going to take the people who have two million dollars and, say, put half of it in our funds.  I don’t think that would be appropriate for people.

Jim:  Okay.  Well, that is helpful, whereas I suspect that Vanguard or the Dimensional Fund Advisor-type potential clients would be able to achieve a well-diversified portfolio of all the major asset classes even with a one million dollar, or even smaller, portfolio.  Is that fair also?

Roger:  Yes, I’m sure these things can be accomplished.  Not through us at Zebra, but through, basically, your financial advisors or do-it-yourself in some way with the mutual index funds.

7. What’s Next for Dr. Ibbotson

Jim:  You know, we only have a couple minutes left, but the last time you were on, you kind of gave a surprising answer to this question, and I’m going to throw out this question again.

Roger:  To see if it’s the same answer, right?

Jim:  Well, I don’t know, but the question is, “What are you up to lately?”  And I know that you…you know, you’re so prolific.  You keep coming out with articles.  I have three in front of me.  The most recent one that I found was June 27th, “Risk and Return Within the Stock Market: What Works Best.”

David:  Of this year, yeah.

Jim:  Can you give us a little bit of idea of what you are doing now and what is next for Roger Ibbotson?

Roger:  Well, I’m glad you asked that question.  You even pointed out the article, because this is the most recent article we have out there, and we have it on ZebraCapital.com.  We have it there.  It’s a newly released article.  We haven’t even broadly put it out yet, but the article has some pretty phenomenal findings, frankly.

In general, we wanted to see whether how you compare how value works compared to buying lower turnover stocks or liquidity in different ways, or momentum measures, all of those kinds of things.  We wanted to see which works best.  But, in general, there’s a very strong pattern that, in fact, of course, across asset classes, stocks beat bonds, but within the stock market, you actually get a lot of perverse effects here where the lower risk assets do much better than the higher risk assets.  Even something as broad as low beta beats high beta, or low volatility assets beat high volatility assets, and the stocks with the less popular lower turnover turn out to be much lower risk and much higher return.  So, we found a phenomenal deck of surprising results in this paper and some of them were known in the literature before that, of course, but some of them are brand new and this is just really exciting work for us.  So, I’ll probably get involved back in asset allocations to some extent just because I had to be out of it after a non compete for five years, but so many of these results actually apply to asset allocation, as well.  How to put together stock portfolios, bond portfolios and so forth.  So, it’s dramatically exciting work.

David:  We’re coming to the end here, so let me say thanks to Dr. Roger Ibbotson, and thanks to Dan Weinberg, our in-studio producer, and Amanda Cassady-Schweinsberg, Lange Financial Group’s program coordinator.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning here on KQV, and you can always access the audio archive of past shows, including written transcripts, at the Lange Financial Group website, www.paytaxeslater.com.  You can also call Lange directly at (412) 521-2732.  Finally, please join us for the next edition of the Lange Money Hour on Wednesday, August 7th at 7:05 when we’ll welcome Seymour Goldberg, attorney and expert on the finer points of Social Security law, to the show.




jim_photo_smJames Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans.  Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.