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This is The Anderson Files on PodClips.
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The Anderson Files is a look at commerce, investment, economics and retirement issues that affect each and every one of you.
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Your host is Mike Anderson, Executive Vice President, Retirement Services and partner of Finestone Partners.
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Finestone Partners is an independent firm with securities offered through Four Point Capital.
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And now your host, Mike Anderson.
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Thank you, Mark.
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And my guest today is James Di Virgilio.
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James is CIMA certified and a CFP and is one of the country’s leading fiduciary investors and financial planners.
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He is co-founder of Chacon Diaz and Di Virgilio Wealth Management in Florida.
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James.
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Welcome.
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Oh, Mike, thanks for having me and an excellent job on getting all those difficult names right.
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I spent about 15 minutes this morning going over it and over it.
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So that’s the result of it done.
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You’ve done the best ever thus far.
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And I’ve been on a plethora of, a variety of different shows, so well done.
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I know that’s not easy.
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Thanks James for, you know, for today.
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You know, some, as far as our topic, some experts are saying the Coronavirus will bankrupt more people than it will kill.
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And your firm and the approach that you have as a fiduciary and financial expert, you’re using this method called Human Behavior Investment Portfolio Strategy.
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It, can you describe it a little bit, it looks like it’s a wise way to guide financial decisions.
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I see that, you know, most recently as the end of February that, you know, you were moving dollars from securities into us treasury bonds, which was very timely.
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But, you know, based on the method, the approach, could you describe how you manage the portfolios with this strategy, and in times of volatile times like this, how it how it will benefit investors in light of what we’re experiencing now? Well, sure, the portfolio is based upon momentum, momentum was first discovered in 1937, really around the same time that investors were learning that diversification or owning, you know, 30 or more stocks was better than just holding one, the idea of momentum or what we’re really calling human behavior.
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The idea that following crisis essentially indicates how people feel about an investment was sort of lost to time for a very long time.
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And the simple reason for that was that science thought that people were very rational, they would always make decisions in their own best interest.
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And we started to go through things like the Great Depression, a variety of World Wars.
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Really up until the 1980s, scientists kind of held on to this belief that people did rational things.
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And then finally they started to look at this with a more scientific lens and they discovered, in fact, well, this is precisely not true.
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In fact, people are highly irrational, especially during times of fear.
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I think everyone alive today, Mike, can really feel this.
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Now if you look at the toilet paper buying, or the run on goods and services in the US, it’s not rational, right? The amount of toilet paper each individual is purchasing is enough to last them a year.
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And so I think you see this in play and this certainly happens in markets as well across the world momentum or this, this idea of following human behavior is not just a US phenomenon, it’s a people phenomenon.
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It’s true of any culture, of any country, of any stock market, and using it in your portfolio, I think is very important, very impactful.
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The good news is, momentum has come a long way since we first observed it in 1937. We were able to combine everything we learned through the past 100 years of academic investing, and studying, you know, how people behave, how the markets behave, to put together a portfolio that’s based upon what I would consider to be the three pillars of portfolio management: diversification, correlation, as in paying attention between the differences of the investments in your portfolio, and then human behavior, really following what people were doing, that led us in our firm to be able to get out on February 27th and remain in treasury bonds, which is a safe haven during times like these.
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And we are still there today.
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Of course, we will reenter stocks again when the people sort of tell us to do so.
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But in a nutshell, that’s really what you’re using, is you’re using people to be the predominant gauge for what asset is best to invest in. For the human behavior aspect, what we see, you know, time and again, when markets are down 15%, 20%, 25%, 30%, is the tendency to, you know, sell at the bottom and buy at the top.
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Does this strategy help smooth out and kind of discount that that type of behavior? Absolutely.
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In fact, what it should do, if you imagine this is a wave, which we can all imagine this now, right, we have this high point.
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So we’re sort of on top of a wave, and this wave begins to come down, and it will come down over time.
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Sometimes, like in this case with Coronavirus, it’s come down very, very fast.
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You have like a 30 day crashing of the wave, most of the time it takes longer.
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But what a human behavior portfolio approach does, is that once that wave comes down far enough, it’s gonna tell you, you know what, the people have soured on these investments.
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You should pay attention to this.
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You should probably change your thinking, which is what we did.
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And then that wave kind of goes down, and down, and down.
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Eventually, it comes back up, and then on the upside, you know, at some point in time after it comes up enough, it will say, hey, the people are feeling good about this investment again and you’ll get in now.
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It’s not, there’s no magical, you know, like put your finger in the water and see how people feel.
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It’s not, it’s nothing like that.
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You’re really using price changes.
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And there’s a variety of data you can incorporate into your analysis to kind of reveal what people think about any given market at any time.
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And that’s where you’re utilizing the simplest way to look at this. It’s what they discovered in 1937.
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They wanted to know why the Great Depression was the way that it was, and why things fell so fast, and why they fell so far.
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And so their thesis was pretty simple.
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They said, let’s just look back at the past year of prices and let’s take a look at investment A versus Investment B, and we’re going to choose whichever investment has done better over the past year.
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And we’re going to see if that portfolio makes any sense.
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If people are in fact influencing prices, then you would expect the portfolio that’s kind of just selecting which investment to hold based upon the past year of prices to be better.
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And that’s exactly what they found; that finding has held true to this day.
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There’s been thousands of studies – Stanford, Harvard, Yale, Princeton, et cetera – that will corroborate
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this. People drive these bear and bull markets to a certain extent.
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Now it’s not perfect,
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Mike, you can’t always get this exactly right.
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But what we know in the long run, is, using these bear and bull cycles following prices,
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you know, ie, human behavior, to smooth out
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as you just mentioned, these environments tremendously and I’ll give you some real world examples. In 2008, you’d have gone down about 10 to 12% following human behavior first, going down 53.
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you know, when you look at today, obviously, we went down, you know, 3% where the market is now down about 27.
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And so it does work very, very well in bear markets.
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That’s really what it’s still to do is protect you when the market does experience these bear cycles. Is the the application of the strategy, is it a combination of a programmed strategy together with human decision making? Is it a combination of the two or one or the other? That’s a great question.
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I’m, I’m a huge believer in non-emotional, systematic thinking.
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So I think even in life, if you study like gut reaction, if we say, Mike, let’s look at the decisions you make and base that on your gut reaction, you know, we know psychologically that’s really your gut reaction is really a product of all the experiences that you’ve had.
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And actually the better you train yourself becomes less emotional and more systematic.
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Our strategy is entirely that way.
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In fact, there’s no emotion whatsoever.
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It doesn’t matter what my opinions are on Keynesian economics and where world governments are going.
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None of that factors in.
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There are some very mathematical or quant based components that tell you when human behavior triggers this, you get in, when it triggers this, you get out, and we follow those you know, to, a T.
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So there is no really allowance for gut feel, gut feel almost always gets you in trouble when you’re talking about trading investments.
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And so we avoid that at all costs. To back up
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one step.
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A lot is made of algorithmic trading.
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And the reality is any algorithm is built by human thinking and a human system.
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So you don’t arrive at these set of rules unless you’ve really spent a lot of time studying them to make sure you have good data, to make sure they make sense, to make sure they’ve been tested.
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So it’s rules that you’re creating yourself, you know, with the human brain, with the human mind.
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But hopefully, if your system is good, it does not allow for a ton of, you know, human guessing, so to speak, because that will slow you down.
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Give you the wrong answer at the wrong time and you tend to induce panic and anxiety.
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You just don’t want that when you’re trading assets, when you get to the point where the program is saying to leave bonds, reallocate back into stocks, into equities.
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Once that occurs, and if I could ask, that hasn’t occurred yet, you’re not getting a a buy signal or reallocation signal yet?
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No, we’re not.
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And this is interesting. One thing that, that a human behavior portfolio does not do, it does not attempt to exactly hit the bottom of any bear market again because it’s reactive, not predictive, you have to react to what’s happening.
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And that means the only way that you’re going to get back into stocks is to react or lag when people are getting back into stocks. Right now, we’re quite a bit a ways from that happening that it would take several, you know, convicted up days to sort of put that in range where you would say, OK, now we’re getting pretty close to where the people are feeling good about the market.
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And that would also make sense with historical data that says that, you know, the fastest exit from the bear market is about 50 days.
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On average, it’s 680 days, right? So it probably takes a minute or two to get back in.
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But you’re not bottom fishing, you really are comfortable catching that wave when it’s already a bit on the upswing.
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And this makes sense for a really simple mathematical example.
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Imagine you start at zero and in the human behavior portfolio, you go down 5% but the market goes down 30.
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So, you know, you’ve got a net gain of 25 there.
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Then as the market turns back up, it goes up maybe 10, 15%.
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So it’s at minus 20 you get back in.
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So, although you missed the beginning of that 10% run up, you know, you’ve netted yourself on both sides by reacting to what’s going on.
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So you always go down a little bit with it and then you wait a while until you go back up with it.
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And I know right now there’s no no buy signal being triggered and it’s not, you know, technically close either from a quantitative perspective, I see.
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And from identifying a convictive up day in the market, is based on the algorithm based on the program that would be based on volume percentage of the markets that are up, advanced decline?
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What would identify a day in the market that would be considered a conviction day up or down?
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It’s a good question.
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It’s important to also state that our strategy is primarily buy and hold.
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So one of the main lenses is to have as few trades as possible.
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And I think that’s why the more trades you make, the less you make, that tends to be true across any strategy you choose.
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So efficiency tends to be fewer trades when possible.
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So you’re waiting for a lot of conviction.
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So right now, for example, there couldn’t be a single day that would be large enough, given market history, that would tell you get in tomorrow, you know, if the market goes up 15% tomorrow, for example, we would still not get back in it.
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And that’s kind of how the system works.
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You have to have real conviction, and conviction takes more than just one day.
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This is also not an uncommon practice.
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I’m sure,
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as some of your listeners know, a lot of traders who trade in the very short term, in fact, will wait for two days before they would get back in, that’s kind of an old school trading mantra and that’s for short-term traders.
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So for us, you’re looking at something probably a little bit longer than that, for it to build up.
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But there are mathematical, you know, hurdles to hit.
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And one of them you mentioned, of course, volume is really important.
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You know, if you’re looking at trading any portfolio, the conviction behind the direction of where things are going has a lot to do with volume.
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You could have big price moves with very little volume.
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That’s not a human behavior or people that move.
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In fact, you largely ignore those sort of moves.
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But when you see heavy volume and heavy price change, now you’ve got a signal that the people are telling you something; you should pay attention.
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Isn’t holding on to stocks though, the best way to get even with the bear market?
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So if you look at at all the bear markets that we’ve had, and you say, what is the best strategy? Is it a all stock portfolio? Is it a 60/40 stock and bond portfolio? Is it a multiple asset class portfolio? We’re gonna wind up holding stocks bonds, real estate and commodities or other assets or is it something where you follow human behavior? And, you know, without a doubt, you can study something like absolute momentum, you know, and if you want to want to check that out, that’s a good way to look at what happens during a bear market following the people is the best downside protector during a bear market.
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In fact, the worst thing to do is just to hold on to your stocks the entire time.
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You’d much rather have a stock bond portfolio or a stock bond real estate commodities portfolio.
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And you know, there’s good reasons for that, that probably goes beyond the scope of being able to discuss that just over the spoken word today.
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But the truth in what you’re saying is still true.
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If you were to hold on to your stocks indefinitely and you have enough time at some point in time, the US stock market will make you high as this always happens.
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But sometimes that can be a long time.
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Like, and you’re familiar with this period of time.
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If you look at 1999 and 2009, the S & P 500 made nothing.
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You had a 0% return.
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You went to the dot com crash, you went through an easy money period, you went through the great recession, you had no money, you had no gain, 10 years of investing.
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Another aspect of the efficiency of the strategy in, as you know, the investment management world, we measure upside what we call upside capture and downside capture.
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Could you describe that a little bit? And for listeners, the upside capture is how much of an up market does a portfolio capture in the return when the market is up? And how much of the downside is captured in a portfolio when the market is down? Could could you describe how the portfolio strategy has fared in this area? Absolutely.
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And that’s everything, right.
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The question you’ve just asked is the foundational bedrock of a professional investors mindset.
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And of course, you being one that that’s where we live, that, that space we’re in.
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Let’s start with something that’s been very well studied for a long time, an all stock portfolio versus stock and bond portfolio.
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And if you look over the past 50, 60 years and all stock portfolio will net you 10, 10.5% per year on average return.
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Now, we should stop for a second and say that that’s on average, that really trips people up.
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In fact, you rarely actually get 10% during any one year.
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You know, it’s all over the place.
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It’s up 20, it’s down five.
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But on average, you make 10, your worst case scenario or what you’re talking about your downside capture ratio, right? But let’s let’s categorize this by the worst result, is to go down minus 50%.
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If instead you hold a stock and bond portfolio, 60% stocks, 40% bonds, you get a 9.9% return.
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So you have a small reduction in return, but your worst case scenario goes down to around minus 25%.
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So you cut that worst case scenario in half and that’s exactly what you’re alluding to.
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And of course, we can create a ratio for this, but that tells you that the stock-bond investor is getting a lot of the upside, maybe as much as 80, 85% of the stock market’s upside, but it’s getting half of that downside and that’s what leads to that result that’s really good.
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It’s a reason why there’s a Nobel Prize for the guy who discovered the 60/40 portfolio, Mr Markowitz out of the University of Chicago.
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That’s what made that so profound, human behavior, the portfolio we’re utilizing just takes that one step further.
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In bull markets, you tend to actually get about the same or even better than what the US stock market would get.
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However, that can vary wildly.
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No, two bull markets are the same.
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Sometimes you might get less, you might get a much, a much lower upside capture ratio.
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But consistently on the downside, you get a much, much better or much lower downside capture ratio.
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And to give you an example of the average, a bear market takes you down about 37%.
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If you look at a human behavior portfolio, you’re actually positive 4% during those periods, it’s a ginormous swing.
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And that’s again, what makes it a better risk reducer? And so if you put all your portfolios together on the table, the story of investing is, can I capture as much upside as possible while protecting my downside? And then that begins really the beginning of using a, you know, a mathematical strategy, is to analyze what’s my risk reward and what’s the most, you know, probability based way to make money when, when the, the quant program was developed.
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Did you do this with a group of colleagues? Did you hire people from you know, Caltech, MIT, to come in and say, hey, this is the program we’d like you to build based on this human behavior approach to portfolio management?
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How did you put your program together? Sure.
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Yeah, the origin story was that we were multiple asset class investors, we’re asset allocators, we believe that was the best way to go.
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That’s still a very good way to invest.
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You know, some people call that the endowment strategy.
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And I was at a session at Warden for my CIMA on, you know, advanced investment principles and momentum came up.
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And this is about five years ago.
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And really, there was a shift that was beginning where it used to be a momentum is an anomaly.
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Don’t worry about human behavior, don’t worry about these things, they’re unquantifiable.
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And all of a sudden it was like there’s, there’s something here, you know, we’re kind of rediscovering this and we’re looking into it.
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So that kind of got us going.
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And we began our journey.
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We came across a book called Dual Momentum by Gary Antonacci, a Harvard MBA who had been studying the same thing, a trader for a long time, we read that began to really pour into it and then decided that we felt like we had some ideas that could further improve that methodology.
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And that’s where we contacted a code writer, began working in Python to kind of test out our our theories and what’s probably really important to say to any investor out there is it’s really, really crucial to have a scientific study done.
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So you have to have a period of time you’re testing your in sample data and then a period of time to test your out sample data, to make sure that your thesis is in fact verified.
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And so we spent about a year and a half doing that three years total and then arrived at the portfolio we have today.
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So really we stood on the shoulders of others to take their learnings.
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And then we crafted maybe a small end piece to get our actual strategy today.
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This is the Anderson files with Mike Anderson.
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And my guest is James Di Virgilio. James, to continue, for the types of securities that the portfolio that the strategy can allocate to.
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Is it restricted to stocks, bonds and cash? Do you get into real estate? Do you get into commodities, hedge funds? What’s the spectrum of what can be allocated to? In theory, you could use the framework to invest in anything you wanted, you could have a variety of assets.
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So I think what we’ve learned and what we know is that it’s best to use a high volume large index.
00:21:38.41 – 00:21:48.689
So we use exchange traded funds and you can use something like the US stock market, the foreign market you can use the aggregate bond, the Treasury bond, you can add in things like real estate and commodities if you want.
00:21:49.0 – 00:21:59.989
I think the reality is if you look at the risk return profile of things, especially like commodities, they tend not to make a lot of sense, especially in a human behavior portfolio.
00:22:00.0 – 00:22:01.589
They’re noisy, they’re not consistent.
00:22:01.81 – 00:22:06.43
So like Occam’s razor states, oftentimes the simplest solution is the truest and best.
00:22:06.439 – 00:22:18.819
And I think that’s very true when it comes to human behavior, the asset classes themselves, it’s important to just have a big broad asset class of the ones that we know are different and then be able to utilize the movements between them.
00:22:18.829 – 00:22:20.479
And so that’s what our portfolio looks like.
00:22:20.489 – 00:22:28.27
It’s all exchange traded based and it’s very, you know, simple and low cost to operate and that’s very helpful to the strategy itself.
00:22:28.28 – 00:22:40.51
So you’re not dealing with a lot of trading costs or a lot of other factors that would influence your net return. You know, and here we are today, the world’s dealing with the Coronavirus.
00:22:40.52 – 00:22:46.56
We have a collapse in oil prices and, you know, life goes on.
00:22:46.569 – 00:23:06.13
People retire, people are approaching retirement and you know, we all know the baby boomers, but 10,000 a day reach retirement age, what would you suggest that retirees do in this environment? Yeah, that’s another great question.
00:23:06.67 – 00:23:10.099
I think it’s really important to have an investment strategy.
00:23:10.109 – 00:23:15.189
And you know, if you’re a client of our firm, of course, we have that strategy and there’s two things that we believe in.
00:23:15.199 – 00:23:17.14
One is a total return strategy.
00:23:17.38 – 00:23:25.359
So we believe that you need to be invested in an investment strategy much like you would if you were 25, the only thing is now you may scale down the risk.
00:23:25.369 – 00:23:29.3
So with any investment strategy, you know, we utilize in our practices.
00:23:29.31 – 00:23:33.099
Mike, if you want to scale the risk down, you just hold a permanent position in bonds.
00:23:33.43 – 00:23:38.26
So for example, at our firm, all of our clients have the same framework portfolio.
00:23:38.5 – 00:23:46.079
But if you have a lower risk portfolio, you’re gonna always hold a 50% in bonds, which just really narrows the range of your return.
00:23:46.089 – 00:23:49.0
And then sometimes, like now, you’re holding 100% in bonds.
00:23:49.01 – 00:23:51.3
So that’s one is having an investment strategy.
00:23:51.39 – 00:23:56.359
You don’t want to be invested in all bonds, you don’t want to be invested in all cash, those are not good long term options.
00:23:56.449 – 00:23:59.05
You’re not going to wind up making enough to outlive your money.
00:23:59.53 – 00:24:02.239
And then secondarily, you have to have a spending plan.
00:24:02.53 – 00:24:16.79
So you know, what’s your budget, how much can you afford to live on? What’s going to allow your money to last? And then is it going to be able to handle a 20, 30, 40% downturn? So it’s really important to model that, you know, a lot of times we’ll look at modeling and we’ll say, well, look, this is gonna be great.
00:24:16.8 – 00:24:17.42
It’s gonna work out.
00:24:17.43 – 00:24:29.8
But what happens in the first five years of your retirement, if the market goes down 30%, that’s really going to affect compounding, will you have enough money to live off of? Will you be able to reduce your spending? There’s a lot of important questions that need to get answered.
00:24:29.81 – 00:24:36.959
And I think that’s why it is so important to see a fiduciary financial planner and investor because you don’t want to leave those at the chance.
00:24:36.969 – 00:24:41.109
There are good answers to those questions and having them is going to to really help you.
00:24:41.189 – 00:24:47.849
So you know, to sum that up, have an investment strategy, do not just be invested in income-oriented bonds or cash.
00:24:47.859 – 00:24:58.229
You really need to be a total return investor, pulling money from your portfolio on a monthly or bimonthly basis to make sure that you’re on a systematic sort of withdrawal period.
00:24:58.63 – 00:24:59.4
James.
00:24:59.41 – 00:25:00.77
Thank you very much.
00:25:00.78 – 00:25:05.43
Could you share your web address with everyone? Sure.
00:25:05.439 – 00:25:11.609
It’s cddwealth.com, cddwealth.com.
00:25:11.619 – 00:25:16.589
And there’s a plethora of articles and videos on a lot of the topics we talked about today, Mike.
00:25:16.599 – 00:25:19.06
So you can certainly get more information there, James.
00:25:19.069 – 00:25:19.77
Thanks so much.
00:25:19.78 – 00:25:22.25
We hope to have you back in the future.
00:25:22.31 – 00:25:26.17
I’m Mike Anderson with The Anderson Files.
00:25:26.18 – 00:25:27.39
On PodClips.
00:25:27.4 – 00:25:28.53
See you next time.