MONEY Master the Game: 7 Simple Steps to Financial Freedom (78 page)

KB:

So if the Japanese bonds move up 150 basis points to 200 basis points [1.5% to 2%], it’s over. The whole system detonates, in my opinion.

TR:

Wow.

KB:

But my theory is, I have always said to our investors, “If it moves two hundred basis points, it’s going to move fifteen hundred.”

TR:

Right.

KB:

It’s either going to sit still and do nothing, or it’s going to blow apart.

TR:

This all plays into your idea of “tail risk.” Tell me what tail risk is; not many investors focus on it.

KB:

If you look at what I’m doing, I’m spending three or four basis points a year on Japan. That’s four-hundredths of 1%, okay? If I’m right about the binary nature of the potential outcome of the situation there, these bonds are going to trade at 20% yields or higher. So I’m paying four-tenths of 1% for an option that could be worth 2,000%!
Tony, there has never been a more missed-price option that’s existed in the world’s history.
Now, that’s my opinion. I could be wrong. So far I am, by the way.

TR:

You’re wrong on timing.

KB:

I’ll tell you what. I can be wrong for ten years, and if I’m right ten years from now, it was still 100% odds on that to be there before it happened. And people say to me, “How you can bet on that, because it’s never happened before?” And I say, “Well, how can you be a prudent fiduciary if I give you the scenario I just laid out, and not do this? Forget whether you think I’m right or wrong. When I show you the cost, how do you not do that? If your home is in an area that is prone to fire, and 200 years ago there was a big fire that wiped everything out, how do you not pay for home owner’s insurance?”

TR:

Got it, that’s awesome. So let me ask you this: Do you consider yourself to be a significant risk taker?

KB:

No.

TR:

I didn’t think so; that’s why I asked. Why do you say you’re not a risk taker?

KB:

Let me rephrase that. Significant risk taker means we can lose all of our money. I never set myself up for the knockout punch.

TR:

Tell me this: If you could not pass on any of your money to your children, but you can only pass on a portfolio and a set of rules, what would that look like for your kids?

KB:

I’d give them a couple hundred million dollars’ worth of nickels because then they wouldn’t have to worry about anything.

TR:

They’re done, their investment portfolio is done. Oh my God, that’s wild. What gives you the most joy in life?

KB:

I have my kids.

TR:

That’s awesome!

KB:

A hundred percent.

TR:

Kyle, thank you. I so enjoyed this, and I learned a lot!

TR:

What would you say are the three biggest investment lies that are still promoted in the world today?

MF:

Well, I think everything is a lie! It’s always very simple! But, I mean, look: I’ve met a lot of very honest people and so forth, but unfortunately, in your lifetime, you will come across more salesman-type financial advisors. You should really have people that are very honest. But I can tell you this from experience: everybody will always sell your dream investments, and my experience has been, being the chairman of many different investment funds, usually the clients make very little money. But the managers of the fund and the promoters, they all walk away with a lot of money. All of them.

TR:

Where should investors turn?

MF:

There are different theories in the investment world. There are essentially the efficient-market theory proponents. They say that markets are efficient. In other words, when you invest, the best is just to buy an index. And the individual selection of securities is basically useless. But I can tell you, I know many fund managers that have actually significantly outperformed the markets over time, significantly. I believe that some people have some skills at analyzing companies because they’re either good accountants or they have skills.

TR:

What do you think of the markets these days?

MF:

I think there’s still risk in the emerging world, and it’s still too early to buy their currencies and stocks—and it’s too late to buy the US. I don’t want to buy the S&P index after it reaches 1,800. I don’t see any value. So best is to go drinking and dancing and do nothing! Do you understand? It was Jesse Livermore [a famous early-20th-century trader] who said, “The most money made is by doing nothing, sitting tight.” Sitting tight means you have cash.

In your life, the important thing is not to lose money. If you don’t see really good opportunities, why take big risks? Some great opportunities will occur every three, four, or five years, and then you want to have money. There was a huge opportunity in US housing prices at the end of 2011. Actually, I wrote about this. I went to Atlanta to look at homes, and then Phoenix. I don’t want to live there, but there was an opportunity. But the opportunity closed very quickly, and the individuals were at a disadvantage because the hedge funds came in [with cash]—the private equity guys, they just bought thousands of homes away.

TR:

Do you see deflation or inflation coming?

MF:

The inflation-deflation debate is misplaced, in my view, in the sense that inflation should be defined as an increase in the quantity of money. If the money in circulation increases, as a result credit increases, we have monetary inflation. This is the important point: monetary inflation. Then we have the symptoms of this monetary inflation, and these symptoms can be very diverse. It can be an increase in consumer prices, it can be an increase in wages, but again, it’s not as simple as that because in the US, we have, in many sectors actually, a decline in wages in real terms over the last 20 or 30 years already, inflation adjusted. But what about the wages in Vietnam and in China? In China, wages have been going up at the rate of something like 20% or 25% per annum and also elsewhere in emerging economies.

So to answer your question, in a system, we can have deflation in certain things, and assets and goods and prices and even services and inflation in others. It’s very seldom that in the world everything will go up in price at the same rate or everything will collapse in price at the same rate. Usually, if you especially have a fiat currency system, those who can print money, and what you will have is the money doesn’t really disappear. It just goes into something else. What can disappear is credit—that’s why you could have an overall price level that would be declining.

But for us investors, we essentially want to know which prices will go up. Like, “Is the price of oil going to go up or down?” Because if it goes up, then maybe I want to own some oil shares; and if it goes down, I may want to own something else.

TR:

What would you suggest would be the asset allocation to take advantage of in the environment we’re in right now and to protect yourself?

MF:

Well, my asset allocation used to be 25% shares [stocks], 25% gold, 25% cash and bonds, and 25% real estate. Now I have reduced my stock positions as a percentage of the total assets. I have more cash than I would normally have. I increased the real estate in Vietnam, and I increased the equity portfolio in Vietnam.

TR:

So what might that look like today then, percentage-wise, out of curiosity?

MF:

Well, I mean, it’s difficult to tell because it’s so big.

TR:

Are you talking about portfolio or something else?

MF:

[
Laughs.
] No, the thing is this: I don’t know! I mean, I’m not counting everything every day.

TR:

Well, what would it look like roughly?

MF:

Roughly, I think bonds and cash would be now something like 30%, 35%. And then stocks maybe 20%; then real estate, I don’t know, 30%; and gold 25%. It’s more than 100%, but who cares? I’m the US Treasury!

TR:

We know why you like cash. What about bonds, when many people are afraid they’re at the lowest level they can be?

MF:

The bonds I traditionally hold are emerging-market bonds. The corporate bonds are also mostly in dollars and euros. But I want to explain this very clearly. These emerging-market bonds have a very high equity character. If the stock markets go down, the value of these bonds also decline. Like, in 2008, they tumbled like junk bonds. So they’re more like equities than Treasuries. I own some of these. That’s why when I say I’ve a low equity exposure of 20%, my equity exposure through these bonds is probably more than 20%—maybe 30%.

I think sometimes as an investor, we make a mistake that we have too much confidence in our view, because my view is irrelevant for the whole marketplace, do you understand? The market will move independently of my view, so I may not be optimistic about Treasuries, but I could see a condition under which Treasuries would actually be quite a good investment even for a few years. You will only earn your 2.5% or 3%. But that may be a higher return in a world where asset prices go down. Do you understand? If the stock market goes down for the next three years by, say, 5% per annum or 10% per annum, and you have this yield of 2.5% to 3%, then you’ll be the king.

TR:

What about other asset classes?

MF:

There’s a lot of speculation for high-end real estate; high-end real estate is at an incredibly inflated level. I believe all these inflated levels—I’m not saying they can’t go any higher, but I am suggesting that one day they’ll come down meaningfully. And that in that condition, you want to have something that is a hedge.

TR:

You have a quarter of your assets in gold. Why?

MF:

Actually, what is interesting is when I told this to audiences before 2011 [when prices started dropping], people said, “Marc, if you’re so positive about gold, why would you only have 25% of your money in gold?” I said, “Well, maybe I’m wrong, and I want to be diversified because the gold price has already had a big move and is due for consolidation.” Gold is probably to some extent a hedge, but not a perfect hedge in an asset-deflation scenario if you have it in physical form. But it’s probably a better investment than a lot of other illiquid assets. It will probably also go down in price, but less than other stuff. Treasury bonds, for a few years at least, should do okay in a deflation scenario for asset prices—at least until the government goes bankrupt!

TR:

Last question. If you couldn’t pass on money to your kids, only a set of principles to build a portfolio, what would they be?

MF:

I think the most important lesson I would give a child or anyone is: it’s not important what you buy; it’s the price at which you pay for something. You have to be very careful about buying things at a high price. Because then they drop, and you’re discouraged. You have to keep cool and have money when your neighbors and everybody else is depressed. You don’t want to have money when everybody else has money, because then everybody else also competes for assets, and they are expensive.

I would also say, look, I personally think we have in general no clue about what will happen in five or ten minutes’ time, let alone in a year’s time or ten years’ time. We can make certain assumptions, and sometimes they look fine and sometimes they’re bad and so forth, but we really don’t know for sure. That’s why as an investor, I would say you should be diversified.

Now, not every investor can do that because some investors, they invest in their own business. If I have a business like I’m Bill Gates, then I put all my money in Microsoft—and that was, for a while, at least, a very good investment. Probably for most people, the best is to have their own business and to invest in something where they have a special edge compared with the rest of the market; where they have an insider’s knowledge. That’s what I would do. Or give money to a portfolio manager. If you’re very lucky, he will not lose your money, but you have to be very lucky.