Fund flow data consistently shows that dollars have been moving from actively-managed funds to passively-managed funds over the past decade. Beyond seeing the data every quarter, the shift has been evident in the conversations that I have.
Ten years ago, most of the clients that I spoke to were skeptical of index mutual funds and ETFs. I’d have to explain the rationale and evidence supporting index funds.
Five years ago, it was a toss-up whether new client conversations would be spent explaining why we primarily used index funds or explaining why we also had exposure to some higher cost active funds.
These days, new clients are often quick to understand and accept the indexed parts of portfolio recommendations, but I have to explain why specific active funds make more sense for parts of a portfolio.
Although index funds are not always best and certainly not for all parts of a portfolio, they often are the best choice and rarely a terrible choice. Thus, I think greater investor awareness and acceptance of index funds is generally a good thing. It’s been interesting to watch the migration.
Seems like the NYT, WSJ, or WaPo broke a major news story every evening this week. Here’s some non-Trump/Russia/Comey reads for your weekend reading:
“On average, only people who make $150,000 a year or more say they value doing work that is important to them. Everyone else prioritizes an income that is stable and secure. Yet fewer than half of Americans earn a stable amount every month.” -Shift Commission
Findings of Shift: The Commission on Work, Workers, and Technology (Shift Commission)
State Unemployment Rates by Race and Ethnicity Show Recovery Expanding But Still Leaving Stubborn Pockets of High Unemployment (Economic Policy Institute)
How Homeownership Became the Engine of American Inequality (New York Times)
US Household Debt Surpasses Pre-Crisis Peak (Financial Times) VERSUS Are Household and Student Debt Exploding? (FRED blog)
Consumers Place Personal Loans Stop The Credit Mountain (Transunion)
Venezuelan Riot Police Seek Way Out (Wall Street Journal)
A Day in the Life of Americans (Flowing Data) (this page is way cooler on a non-phone screen)
Over the past few weeks, I have seen and heard evidence of increased competition in both public and private credit markets. As valuations rise and prospective returns decline, I think it wise to remember Thiel’s mantra of avoiding competition. Just as businesses do best in the absence of competitors, investors perform best when they do not have to compete for opportunities.
“Competition means no profits for anybody, no meaningful differentiation, and a struggle for survival. So why do people believe that competition is healthy? The answer is that competition is not just an economic concept or a simple inconvenience that individuals and companies must deal with in the marketplace. More than anything else, competition is an ideology—the ideology—that pervades our society and distorts our thinking. We preach competition, internalize its necessity, and enact its commandments; and as a result, we trap ourselves within it—even though the more we compete, the less we gain… If you can recognize competition as a destructive force instead of a sign of value, you’re already more sane than most.
-Peter Thiel, Zero to One
Just now catching up on highlights from last week’s Berkshire Hathaway annual meeting, which is always full of wit and wisdom from Buffett and Munger. The above quote is my favorite from this year’s meeting and is pretty consistent with what Munger and Buffett have been saying for years about the importance of intelligence versus sober thinking.
“You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.” -Warren Buffett (via Wiley)
“Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” -Warren Buffett (via Pensions & Investments Online)
“It is remarkable how much long-term advantage people like [Warren Buffett and myself] have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” – Charlie Munger (via 25iq)
Lastly, one of my favorite Munger stories (via WSJ):
“In the late 1980s, [Munger] recalled in a magazine interview, a guest at a dinner party asked him, “Tell me, what one quality accounts for your enormous success?”
Mr. Munger’s reply: “I’m rational. That’s the answer. I’m rational.”
Someone recently asked, “If rates are going up, why invest in bonds?”
The short answer is because the yield may more than compensate you for the interest rate risk that you are taking.
The longer answer is that the question itself is problematic:
- Firstly, this common question rarely indicates which rates are going up. Overnight rates (like the headline Fed Funds rate) or long-term rates (like the benchmark 10-year Treasury)?
- The question also pre-supposes that anyone knows whether rates are going up or down. If anyone knew the direction of specific rates with certainty, they could retire by tomorrow.
- Even if someone did know that a specific rate was going up, they wouldn’t know how much the rate was going to change or over what timeframe.
All of the above relate to simple Treasury bonds and do not even touch on any form of credit, the shape of the yield curve, or larger questions like asset allocation, diversification, or correlations.
Asset prices are high and fear is low these days. This situation may continue for days, weeks, months, or years; but markets move in cycles. Some day, asset prices will decline. Investors will panic and drive markets even lower. Fear will paralyze investors. Even the deep value investors will be hesitant to buy assets below their intrinsic value, due to market technicals. When prices are low, it is emotionally difficult to buy. So remember to stay calm and buy the f*cking dip.
Not only am I flying to Hawaii for free tomorrow, I am getting an extremely good price in mileage terms. Here’s how you can do it too:
1. I signed up for a Chase credit card and received Chase Ultimate Rewards points as a sign-up bonus. Currently, the bonuses are 100k for Sapphire Reserve, 80k for Business Ink, and 50k for Sapphire Preferred (and you can sign-up for multiple cards if you really want to rack up the points)
2. Also registered for an account with British Airways.
3. Then transferred points from my Chase account to my British Airways account.
4. Searched for flights from the West Coast (SJC in my case) to Honolulu on Alaska Airlines, which happens to be a partner of British Airways.
5. Called British Airways and bought a round-trip Alaska Airlines flight for only 25k British Airways points.
The upside is that British Airways offers distance-based awards and most flights from the West Coast to Hawaii only cost 25,000 points (which is quite low for a $400-500 flight). The downside is that you can only purchase these over the phone, so you’ll also have to spend 60-90 minutes on hold before getting to speak to a British Airways rep. But I think its worth it, as even a family of four can fly to Hawaii for free simply by signing up for a credit card. Aloha!
Third and final post of a 3-part series. Read part 1 here and part 2 here. As a follow-up to this week’s mailbag question of whether China is buying up US real estate and debt, there is often an underlying fear (perpetuated by politicians running for office) that China has leverage over the US, because they can sell all of their US debt.
If China sells their US debt, they will have a lot of US Dollars (USD). Theoretically, I suppose they could just hold straight USD, but this is unlikely for a variety of reasons so let’s look at their realistic options:
- China could repatriate the cash, by exchanging USD for renminbi (RMB). But this would effectively be selling USD to buy RMB and would cause the USD to depreciate and the RMB to appreciate. If you’re an export-centric economy, why would you want your currency to appreciate against your main trading partner’s?
- China could exchange USD for other currencies, such as Euros (EUR), Yen (JPY), or Pounds (GBP). This would cause the USD to depreciate and those other currencies to appreciate. This is not an ideal outcome either though, since it would also drive the USD lower and the US is China’s largest trading partner. Presumably, the EUR, JPY, and GBP would strengthen and exports to those countries would do better though. However, I don’t see why these countries would buy USD just because China did not want it, especially if they had to increase their own money supply or buy more stuff from the US.
As you can see, China does not have a lot of options. Just as they’re more or less forced to buy US debt, they’re more or less forced to hold it. So the next time a politician starts warning about China owning and selling US debt, call BS!
Part 2 of 3 part series. Find part 1 here.
Today we’ll be looking at the second part of Matthew W’s question: Is China really buying up all our houses and debt and does it matter?
No, the Chinese do not buy all of our debt, but they do buy a lot of it. The below chart is a few years old, but I like how it illustrates the data and the percentages have not changed drastically (although Japan now holds slightly more US debt than China).
Before getting into the implications, let’s look at why China buys US debt.
The US buys a lot of stuff from China. A lot. Like the most stuff one country has ever bought from another.
When someone in the US buys something from someone in China, the American buyer sends US Dollars (USD) to the Chinese seller. The Chinese seller now has USD, which is not very useful in China. So the Chinese seller exchanges his USD for renminbi (RMB), with the government. Now, the government has a bunch of USD.
The Chinese government has trillions of USD, so they have a lot left over even after spending and investing hundreds of billions of it. Rather than holding over a trillion in cash, they buy US Treasuries, AKA US debt. There’s little else that you can do when you have that much cash. This, China is more or less forced to own a lot of US debt due to the trade surplus that they have with the US.
Every election cycle includes politicians railing against the fact that we’re indebted to China and they control us. But let’s look beyond the rhetoric and see if China’s lending to us matters at all, much less in a negative way. A few important points:
- There’s an old joke that if you owe the bank hundreds, that’s your problem. If you owe the bank millions, that’s their problem. In all seriousness, this is sovereign debt, not collateralized by anything. China does not have a claim on US assets or the right to repossess anything.
- US debt is owed in a currency that the US can print at will. Domestic politics may create situations where the US does not have the willingness to pay (a la the debt ceiling debacles in Congress), but it will always have the ability to pay.
- Given the above, having a large trade deficit where China holds our debt does not seem like a bad situation. We buy actual, physical goods with money…that we print. And they’re forced to buy our debt with it. We send paper and electronic currency and we get real things back.
- Lastly, the marginal demand for debt from China probably keeps US rates lower than they’d be otherwise.
The next and final post of this series will look at the question of whether China can or will sell their US debt and the possible implications. Stay tuned.
Question from Matthew W: Is China really buying up all our houses and debt and does it matter?
It is a common question and I’m going to break the answer into two posts, one on real estate and one on debt. Below are my thoughts on the the real estate part of the question:
The short answer is yes, a lot of US real estate is being bought by Chinese investors. See here, here, and here for details.
On to the second half of the question: does it matter? Whether it matters or not depends on where you sit and what you care about, but it certainly has an impact.
Houses and buildings take time to develop and build. Unlike stock or bonds, buildings cannot just be printed to meet increased demand. When there is increased demand for a limited supply, prices increase. It is impossible to know how much of the recent real estate price rally is attributable to Chinese buyers, but it is certainly a factor. So I would say, yes, Chinese are buying a lot of US real estate and it’s contributing to price appreciation.
Perhaps implied in the question is a fear that “the Chinese are taking over” by buying up US property, from trophy assets in “A markets” to residential homes. The same fears existed in the 1980s, except people were afraid of the Japanese. In that episode, Japanese investors bought at extremely high valuations and often lost money when the cycle turned. The future may not unfold like the past, but I am not too concerned about Chinese property purchases at this point.