Episode 114: How to do capital allocation & invest? Psychology of investing.
In today’s show, Pancham interviews Juan Carlos Herrera – founding partner of Quantor Capital and managing director of Inscription Capital – and together with Julio Cacho, founder and Chief Investment Officer of Quantor Capital and Inscription Capital.
Juan and Julio have the same investment philosophy: diversifying their portfolio accordingly to the market across multiple assets. With their same investment approach, they have built 2 investment firms, have been providing financial advice and are overseeing more than one billion dollars in assets!
In today’s episode, you’ll know more about diversification as they share its perks and the factors to consider when expanding your portfolio.
They’ll also share their principles, allocating your investments, and knowing your risk tolerance so you can invest to the fullest so this is definitely a don’t-miss episode!
Listen and enjoy the show!
Tune in to this show and enjoy!
- 2:36 – Pancham introduces Juan and Julio into the show
- 5:01 – How they met and built their investment model
- 9:42 – Why the asset prices are unpredictable
- 12:45 – Guide on how to heavily diversify your investments
- 22:14 – Breaking down your cash in 3 “buckets”
- 25:17 – Identifying your risk tolerance to know how much to invest
- 32:19 – How to overcome psychological hurdles in investing
- 37:18 – How their investment philosophy didn’t changed over time
- 44:02 – Taking the Leap Round
- 44:02 – Their 1st invested outside of Wall Street
- 45:13 – Overcoming their fear of doing everything the right way
- 46:11 – Lessons learned for their investments that didn’t end well
- 48:36 – Their lasting advice to investors
- 50:48 – Juan and Julio’s contact information
3 Key Points:
- Diversify and invest in as many assets classes as you can since no one knows what would be the best asset from now onwards.
- It will be very difficult to outperform the markets so the best solution is to simply replicate the market.
- By identifying your own risk tolerance, you can decide the type of portfolio you would want to have and can know your expected returns.
Get in Touch:
- Inscription Capital Website – https://inscriptioncapital.com
- Quantor Capital Website – https://www.quantorcapital.com
- Juan Carlos Herrera LinkedIn – https://www.linkedin.com/in/juan-carlos-herrera-253a8714/
- Julio Cacho Twitter – https://twitter.com/jcachodiaz
- Now Know This Podcast – https://www.audible.com/pd/Now-Know-This-Investments-Economics-Behavior-Podcast/B08K565KY1?qid=1617190287&sr=1-1&ref=a_search_c3_lProduct_1_1&pf_rd_p=83218cca-c308-412f-bfcf-90198b687a2f&pf_rd_r=XS5T9KKCSGD1B93XRDR3
- Watch The Gold Collar Investor Show #5 at https://thegoldcollarinvestor.com/show5/
- Pancham Gupta Email – email@example.com
Welcome to The Gold Collar Investor podcast with your host Pancham Gupta. This podcast is dedicated to helping the high-paid professionals to break out of the Wall Street investments and create multiple income streams. Here’s your host, Pancham Gupta.
Hi there, I’m Robert Helms host of The Real Estate Guys radio program and if you want to have better results in your life you gotta put better ideas in your mind. You’re in the right place. You’re at The Gold Collar Investor podcast.
Pancham Gupta: Welcome to The Gold Collar Investor Podcast. This is your host, Pancham. Really appreciate you for tuning in today. Let’s get into today’s show. When it comes to the topic of diversification, there are two schools of thought. Some believe diversification is a waste of time, while others think portfolios should be widely diversified. There is no correct answer to this question. Some investors might be happier with a concentrated portfolio; others may not be able to tolerate the volatility. However, whichever course of action you decide to take, it is essential to understand why you have taken this decision. The factors that have influenced your diversification plan. Warren Buffet has famously said that he is against diversification. His quote exactly is diversification is a protection against ignorance. It makes very little sense for those who know what they are doing. So the exact quote by Warren Buffet, what Warren is saying there is that if you really understand your investments, then you do not need to diversify, you go all in and you will do well. Warren Buffet has allocated as much as 40% of his portfolio to just one stock in the past. And in his case, you know, you can understand that because he gets involved with the management. He takes huge stakes in the company. He really understands the business and try to improve the business right. On the flip side, though, of this saying is that if you do not understand one particular asset class really well, then you should be hyper diversified, meaning that you do capital allocation to many, many different asset classes, since you do not understand any of them really, really well like Warren does. For equities, let’s say so, you know, I usually do not have financial advisors on the show, however, today, I have two of them. Juan Carlos and Julio Cacho. They fall in the second camp, that is do hyper diversification a bit about them before I bring them on. Julio Cacho is the Founder and Chief Investment Officer of Quantor Capital, as well as CIO of Encryption Capital, where he provides highly personalized advice to family offices, financial advisors, bankers, asset managers, institutions, and wealthy individuals on their investment portfolios and financial products and oversees more than $1 billion in assets. Previously, Julio was a Director of risk and performance at Zip Brothers Investments. A private multibillion-dollar family office in New York City. Julio has won the 2005 Citi Banamex research and economics prize and has published articles around optimal portfolio selection in peer-reviewed academic journals. And Juan, on the other side, is the Founding Partner of Quantor Capital and Managing Director of Inscription Capital. After graduating from the University of Texas in Austin, he began his financial career in Madrid, Spain, working for a boutique consulting firm. In 2006, he came back to the United States and joined Citigroup where he held positions in wealth management and private banking for affluent families. In 2008, he left the city to start quantitative hedge fund QL Capital Management. While at QL Capital Management, he helped design, develop, and create unique short-term trading strategies that invested in over 80 markets. In 2015. He sold QL Capital Management and started a private family office that later became Quantor Capital. Julio and Juan, welcome to the show.
Thank you. Thank you for having us.
Thank you for the invitation.
No, thank you for your time here. I’m super excited for the show today. It’s rare that we have financial advisors on the show, and I’m absolutely looking forward to the show today. A lot going on in the economy. We just have $1.9 trillion bill passed in the Senate. So a lot to talk about. So before we get in into the show, are you ready to fire up my listeners break out of Wall Street Investments?
Pancham Gupta: Let’s go. Great. Great. So Juan and Julio, like, please tell our listeners about your background and how you two got into the space that you are in and actually came together to start your company and, you know, be part of Inscription Capital.
Juan: So I think our story is pretty interesting. We come from different backgrounds, but met in this investment world that we’re all in. And myself, I was born in Houston, Texas, went to school at the University of Texas in Austin, and got my job right out of college at a boutique consulting firm in Spain, which then brought me back to the States. About two years after that, to work for Citigroup. I worked at Citigroup for a while. And then, in 2007, I started a hedge fund, left Citigroup, and started a hedge fund with a lifelong friend of mine. And we ran that fund for about eight years. In 2015, we had a sale of the fund and was then at that time trying to go on to my next the next chapter of my life, which was, I was consulting a lot of high net worth families on what to do with their investments, which led to the creation of an investment advisory firm. And then I met Julio, as I was kind of putting the pieces together of this, you know, towards the last year of my hedge fund adventure, I met him in New York City, when I tried to take my hedge fund to try to sell it to his former employer, who used to work with the Ziff Brothers Investments in New York, which is one of the most prominent investment shops in the country. And I’ll let him explain a bit more about what he did there. But then after that, we got to know each other, they never really invested in my fund, but we became good friends. Julio randomly move to Houston as I’m creating this, and kind of start picking his brain as to what the investment philosophy looked like for this very wealthy family in New York City. And he started to share with me all the things that they did and how they approached investing wealth for the family, which I found to be very fascinating. And we basically build our entire investment model around that. So that’s how we kind of came together. And I’ll let Julio maybe talk a little bit about his background.
Julio: Sure. So I am originally from Mexico, and then I moved to the US because I want a scholarship to study for a PhD at Princeton University. So I did my PhD in economics, I specialized in portfolio theory. So All my publications are in that area, and what is the optimal portfolio, way to, to invest. So after, after I finished a PhD, then I was lucky to get an offer to work at Ziff Brothers Investments. I didn’t know who they were actually back then but learning more about them, I really was very excited. It’s basically where some private asset manage, I will say asset management firm. So like a private hedge fund and they did many interesting things. So then I decided to take to take the job that I work as in the risk and performance department, doing research and monitoring the risk. So I became Director of the Department and then I decided to move to Houston because this was in New York, this Ziff Brothers said, say to move to Houston, because I wanted to be closer to Mexico, and better weather and other things. So when I move, so then I quit. I moved to Houston. And then I started teaching at Rice University and is when , when Juan Carlos and I met again, as he as he said. He had this idea of becoming a multifamily office, and then I have this idea of educating people to learn so that they knew more about what, what were my findings in my professional life, but also merging those findings with the academic findings, right. So just to try to see or to try to show people what would be like the scientific way to invest, that will say, following the scientific method, and that’s how I see myself currently as an educator, right, educating people, what’s the best way to invest a correlate to science,
Pancham Gupta: Great -inaudible- We are going to get into some of that now. So let’s talk about this. Thank you for sharing your backgrounds. There is a lot going on in the economy today. In the last one year, we are coming up for the anniversary of Coronavirus lockdowns, right? Some unprecedented things have happened, starting with the onset of Coronavirus lockdowns, stimulus packages, moratoriums, you know, presidential elections, etc, etc, right? It’s has been a roller coaster ride. At this point, the asset price inflation, if you want to call it that, you can call it whatever you want. Basically the asset prices are rising and it’s rising at a record pace, be it stocks be it the crypto market, be it real estate, right or any sector if it was not negatively impacted by the Coronavirus, like hotel industry, for example. It’s been fueled all of this asset price rise has been fueled by a never ending, you know, fiscal and monetary policy. The federal government is on your side. So with this new $1.9 trillion stimulus bill passed, you know, passed in Senate, many believe that we are in the forever bull cycle. At what point do you guys think that it would change if at all?
Juan: You know that ,it’s a hard question to answer because, you know, predicting the future in financial markets is a very daunting task. There are so many variables that go into analyzing this professional person that dedicate their lives to trying to figure out what’s going to happen next or have very bad track records at this. And it’s for the reason that it’s very hard, right, the variables that go into this is extremely difficult. Whether this $2 trillion, is going to create a lot of inflation or not, whether modern monetary policy is going to be the new thing with a lot of government intervention in the central banks of the world will pay off or not, is up for debate. So there’s all these debates are being had right now, especially by policymakers on the fiscal and monetary side. I think for the average investor, though, the best thing that they could do is to make sure that they’re diversified across as many asset classes as possible, not just equities, I think a lot of people look at diversification and only maybe try to diversify their equity portfolios. And sometimes even I know this is very common in the tech industry, the diversification is, is being thought of as well I’ll invest more in private equity, not so much in public equity, but they don’t realize that it’s still equity. The difference is really that one in the private markets, you don’t see the mark to market, you don’t see the price fluctuations as you do in the public markets. But I can guarantee you that if there is a we are in fact in a bubble and it does pop, you will feel the pain in both. It doesn’t, you know, private equity is not going to diversify you away from any risks in public equities. They’re going to go hand in hand.
Pancham Gupta: Right? Right. So you know, you’re absolutely right, there’s no question about that. It’s very hard to predict. And people have dedicated their lives to predict and if failed horribly in in many cases. So given what’s going on right now, like, you know, what do you suggest people do with their hard earned money? I know, you mentioned that they should really heavily diversify. And you talked about, it’s not just equity. So what would you say that, you know, if there is a person that sells listening, and is working in a tech company, let’s say Facebook, or Apple, and they’re making good salary, and they’ve invested in stock market, because the company pays them bonus and as stocks and they’ve invested in other tech companies and some other utility companies are, like completely diversify its equity portfolio? What would you suggest to them?
Julio: As we said, the principle here is to diversify as much as you can, because that’s the only real free lunch that we have. I mean, at least, that’s the only free lunch that has been proven scientifically. Okay, we have data to back up to back up that claim. And so that’s basically the main thing to do now, how do you diversify? So, investing is in as many assets as you can. Use in principle, you will want to invest in most of the companies in the world that you can, when you will try to do is to invest in most of the bonds that are out there different governments, different companies, and also commodities, right? So you need to invest in every single asset. And the main reason is because we don’t we can just one Carlos was saying we cannot predict which is going to be the best asset going forward, right? We don’t know which one is going to go up higher.
Pancham Gupta: So when you say every single asset, just to clarify, you mean every single asset class, or are you talking about, like all assets within the asset class?
Julio: Both, both all asset classes, okay, but also within each asset class, try to invest in every single asset. So, for example, if you’re investing commodities, try to have exposure in all the commodities not only one not only to if you’re investing in companies, try to invest in most of the companies. Of course, there are some companies that you cannot invest some private companies that maybe you cannot invest but all the public’s you can You should try to invest in all these public. And there’s different ways to do this, right? One simple way is to use ETFs. Right, you can use ETFs or index funds to have exposure to most of the companies in the world. In bonds, you can do something similar, right? You want to invest in sovereign bonds, but also you want to invest in corporate bonds, you also want to invest in municipal bonds. So in as many assets because, remember, diversification, the key is that you want to capture the flow of money from one asset to another. The thing is that we don’t know, which is going to be the asset that is going to get more flows, we don’t know or more trading. So because of that, you want to invest in every single in every single asset, because we cannot predict which one is going to be if we were able to predict, then the prices, we will already reflect those expectations.
Pancham Gupta: So let me ask you this, like, you know, this, when he says every single asset within the each asset class, that sounds like very daunting task as compared to, you know, picking stuff out, because, you know, if you’re in the traditional equity markets, yes, you can pick ETFs, like you said, For bonds and for commodities also, but what about the private alternative space? Like, you know, how would you do that, for example, for real estate, or let’s say, you know, real estate is one, let’s say crypto is another asset class, right? How would you suggest for all the asset classes, which are outside of your traditional equity markets?
Julio: I mean, of course, as I was telling you, it is not easy, or probably even not possible to invest in every single asset. Right, right. Yeah, we need to try to invest in most of them, just by investing in the public once, for example, you are going to capture a big chunk, for example, of companies, maybe 80% of the capital will be in public companies, right? Probably, compared to private. So even for example, Bitcoin, Bitcoin is just a small part of the whole pie, right? It’s a tiny, tiny one. So it depends on your size of your portfolio, if you have a lot of money, then maybe you should have maybe a small part of your portfolio in Bitcoin, but it’s going to be the point, maybe 01 percent of your portfolio. So yes, we want to try to invest in most asset classes. But if you cannot invest in all of them, because also because of costs, right? Because also, the more difficult is to invest them, the higher fees you’re going to pay, or the higher the costs. So you need to take that into account, because maybe it’s not worth it, to invest in a private fund that charge two and 20. That is gonna eat all the benefits of that diversification.
Juan: Yeah, so one of the findings that he’s talking about is, you know, it’s very difficult to outperform the market. Now, when we say the market, we were referring to the equity market, the bond market, the real estate market. So because of this, this is like a debate that has pretty much been settled that it is very, very hard, most people will not outperform the market in the long run. Therefore, the best thing to do is to replicate the market. And so what Julio says invest in everything, he’s referring to invest in everything, according to the size of the market, that’s why he was referring to Bitcoin being only a small percentage of the whole pie. Because if Bitcoin grows, if it takes market share away from say, gold, it becomes a bigger, bigger, bigger alternative investment product or currency or whatever it ends up becoming, will then be yeah, of course, you know, you will have a bigger percentage of Bitcoin in your portfolio. So it’s the same thing that how the S&P 500 is created, right? The S&P 500 is a market-cap-weighted index that gives more weight to say right now Apple, Amazon, and Facebook, some people might argue and say, well, that’s why I should not invest in the S&P because it has too much risk in those companies. But that’s not the S&P doesn’t have too much risk in those companies. That’s just the size. That’s just that’s just what it is. That’s the size of the market, right? 10 years ago, the top 10 companies were GE, IBM, at&t, and so it rotates, right? So you know, 10 years from now, maybe they’re new companies that are in that in the top 10 that we have never heard of maybe right so, but by owning the market cap index, you no longer have to worry about choosing the winners and losers. Basically, you’re just hoping the market. And now we’re taking that one idea, but now expanding it to all asset classes, not just the S&P 500
Pancham Gupta: Got it. Got it. Yeah, for a normal investor. For them to be able to do this. It’s actually extremely hard, right? Like, you know, creating an S&P whosoever, that S&P, S&P company, right. There are people who are working full time just managing that index, right or people at Vanguard who are replicating the fund. They are spending so much time but as an average investor who is trying to really replicate not just the equities, maybe bonds, and crypto and all that and trying to replicate that in their own portfolio so that it reflects the overall market, right, which is presented by many different asset classes. It’s a daunting task. And many people don’t even have the financial know how to how to even do it. And also like who you mentioned, it can be prohibitively expensive too, right, depending on how much capital you want to allocate. So what is your advice to those people who are, who want to do this, but it’s very, like, it’s just hard.
Juan: I mean, let me go through two scenarios for that. Most people, maybe, if you’re an employee, and you have a 401k, let’s say, the best thing to do is look at your 401k. And make sure that you have a choice of the most broad based index fund that you can find. So for example, Vanguard. Vanguard is going to have a lot of options in there probably, hopefully, Vanguard or I share products are in your 401k. And if they are, don’t fill it up with a bunch of different sector ETFs, or whatnot, find the broadest one. The broadest one, like a Vanguard total stock market index fund that does the market cap waiting for you. Right, that encompasses everything, there’s a there’s a Vanguard total world stock market index fund as well, right there, well, that’s actually a better choice, because you’re diversifying throughout the whole world, not just concentrating in the US. Because again, a lot of people will go with the notion of they’ll look at their 401k’s. And they’ll see that the US stock market has returned better than the international ones. So they’ll put more money in the US. But that’s based off of past performance, which is no, you know, it’s funny, every fund manager at the bottom says past performance is no guarantee of future performance. And that’s true, right? And so that’s why, what you want to do is you want to make sure that you’re diversified enough to where you’re not going to just go and put your money on what’s been hot lately, you want to make sure that you capture the risk-adjusted returns that you want going forward in time not looking at the past. So it’s more important to know why you’re investing in something going forward than just investing in something because of this fear of missing out because this one asset class has been going up a lot lately.
Pancham Gupta: Right? Right. So actually, I want to talk about what types of risks exist when it comes to investing in, like, if you have an investing philosophy of what you are discussing, I want to talk about that. And then I also want to ask you about, I know you said you can’t predict the future, but in terms of your outlook towards what’s going to come down and what you think that will happen. Given all the things that are happening today. I would like you to expand on that as well.
Juan: So I’ll let Julio talk a little in a little bit about the risks part, the two main risks that people should be aware of, in terms of what’s going on right now and how to position your portfolio. I think people should have and should, should bucket out their money into three buckets. Okay, meaning, how much money do you need for, say, six months in case you lose your job? Right, if you lose your job, you should calculate how much expenses you have. And make sure that you keep at least six months, you know, have cash ready to go in case a pandemic hits again, and you’re at work or, you know, the last thing you want to do is go into a recession, get out of a job and then going having to sell your investments, right having a forced liquidation. Right? So have enough cash on hand that can cover its basic expenses for, say, six months, okay, then you’re left with two portfolios. So you’re going to divvy up your money into two more buckets. The second bucket is going to be your sleep well at night portfolio, which is what Julio was talking about, which is this diversify as much as you possibly can invest in every asset class, okay? And it’s very simple to create a proxy of this right in, say, your 401k, or in your normal account, you don’t have to get it exactly right. If you want to get it exactly right, then give us a call, we can help. That’s what we do. That’s our specialty. But you know, for the average person, I would say, as long as you can get a very broad based, you know, world equity index, and then combine that with a broad based bond index, okay? However much you decide to divvy up between the two is going to depend on your risk tolerance. So I would say that that’s how I would have my sleep well, at night portfolio should only probably be three or four ETFs, maybe, again, get the lowest cost CTS get the ones that are broadly diversified. Okay, market cap weighting is very important. Make sure that market-cap-weighted, and that’s your sleep well at night portfolio, right, that’s going to keep up with inflation, you’re not going to have to worry about that portfolio for the long run. And then the third portfolio should be where your risk is, then that’s all and only put money in that portfolio that you know for sure, with a high degree of confidence, you’re not going to need for say 15-20 years, right? That could be your private equity investments, that could be your 100 that could be 100% equity portfolio. Or it could even be that you decide to increase the safe portfolio, the portfolio to and you could use leverage To increase your risk-return with that. So those are there’s a lot of ways to increase your risk, but only invest in the more volatile or in the more riskier investments with money that you’re for sure confident you’re not going to need for a long time to let those investments go through and do their thing.
Pancham Gupta: Got it. So how would you allocate percentage wise, between the second and the third portfolio you talked about? I know, it’s very different for different people, people who, a person who is at 40 years versus 30 years versus 60 versus 70. But do you have any kind of formula for that? Like how people should think about it?
Juan: Yeah. So if you think about it, I’ll use a very simple logistic example, let’s just say that your portfolio is three is 100%, equity portfolio. Okay. And let’s say your portfolio is this global portfolio. And let’s assume that you’re going to try to, you know, target to make 3-5% returns in the safe portfolio, and about 10% returns in the aggressive portfolio. Okay, so let’s also then take the volatility, the risk, so the 100% equity portfolio, more or less is going to have about 20 to 15% volatility, okay, and the same portfolio, we’re probably have about 5%, volatility, five or six. So that gives you the fluctuations of how much is going to move. Okay. So how do you split the money up between those two? Again, it’s going to come down to not your age, but your risk tolerance, right? So if you’re someone who’s very risk-averse, okay, that cannot tolerate risk at all. Then forget about portfolio three, put everything in 142 and call it a day. Okay. Right. And that’s the one concept that people need to understand that risk and reward are tied and joined by the hip. There’s no way around it, right? If someone offers you an investment that has 15 -20% returns, and they say there’s no risk, they’re not necessarily maybe lying to you, they just don’t know the risks. And we’ll get into those risks in a second. But there’s, there’s no free lunch, meaning like if there’s someone that’s offering you a 15% return, when the risk free rate of return is 0.11. Yeah, there’s risk, you just, they might not be aware of it, or you might not be aware of it, but there is risk, or else everyone would do that investment, right. And the market would do it. So, you know, risk and return are joined by the hip. So if you’re someone that wants to take more risk, then you could put more money into portfolio three, but just know, right? Using the stock market example, if that’s all your investment, if your portfolio three is 100% equity portfolio, you better be okay being down 50%. Meaning if you’re down 50%, at some point, it’s kind of the fee, you’re going to pay overtime to compound 10% returns, okay, I think about as a mental psychological fee, okay, because if you’re invested in broadly based market-cap-weighted index throughout the whole world, and it’s down 50%, trust me, any private equity investment you have might be bankrupt, right? Because it’s gonna go by the hip again, right? In the long run, you know, that if you invest in the whole market, right, and even if it’s down to 50%, you have a higher probability of getting out of that 50% drawdown and then going forward and in growing with the economy, you don’t have to we don’t have to move it around. You don’t have to sell it and then buy it again. And that’s another thing I would say, make sure you get your risk tolerance, right. And then always be invested, when I get a lot of questions are is, well, what do I you know, is now a good time to invest? Should I wait for the market to pull back? Right, right? This is very hard to know, I don’t know, the market could go up another 10%. This year, another 20% next year before it crashes, if it does crash at all, right? I don’t know. So it’s better to always be invested, but be invested in according to how much risk you can tolerate, right? And then if you can tolerate more risk, put more money in bucket three, if you can’t tolerate more risks, then leave it more in bucket two, and then did that’s how you really can simplify how you can decide how much risk you can take. And then I’ll kind of let Julio go into what those two main risks that you need to be aware of, though.
Pancham Gupta: Sure.
Julio: Okay. So I mean, just to summarize, a little bit. So there are some facts, right, that we know, the facts, which are based on empirical evidence, is that it’s very unlikely for even for a professional investor to outperform a market. Okay, so that’s kind of or its benchmark, it’s very unlikely, actually Fama and French have a paper that they published in 2010. That actually they estimate that only 3% of the mutual funds outperform in the long run, right? And those 3% are not consistent because in a given period of time, they are not the same outperformance, right. So that’s one fact. Given that, then what we found is that the best thing to do for an investor is to replicate the market, right? Because given that fact, otherwise, you have a 97% probability of ending up worse. So in terms of risk-return, it’s better to replicate the market. Now, when you replicate a market, you are going to get a combination of expected return and risk. That’s a combination of these two right. Now, every investor has a different risk tolerance, right? There is no one optimal portfolio for everybody. There is none, it depends on your risk tolerance. Now, once as Michael was saying once you decide the risk tolerance, then you can decide what type of portfolio you want, right based on risk. Now, this expected return is given by your exposure to one type of risk, not all the risks are the same. Risks are multidimensional, multi dimensional, but you can classify risks in two big groups. One is systematic risk, and the other is idiosyncratic risk. The idiosyncratic risk is a risk that you can diversify, right. It’s like, for example, if you invest in a company, and it turns out that the CEO makes a bad decision, right. So that’s idiosyncratic risk. Systematic risk is when you are diverse, fully diversified. And maybe there’s a Coronavirus or a recession that’s going to basically affect all the assets. Okay? It’s very difficult to diversify that part very, very, very difficult. So investors get compensated for systematic risk for taking systematic risk, not idiosyncratic, because if you’re syncretic, you can diversify only systematic. Therefore, if you want to choose what expected return, you need to you want to get, then you need to study what exposure to systematic risk, you have to get. That’s the key, measuring how much exposure to systematic risk you want, because that’s gonna give you your expected return. So that’s kind of the idea.
Pancham Gupta: Got it? Got it. Yeah, this reminds me of the paper that you mentioned about Fama French, I remember reading that long time back, and also, this systematic risk and the idiosyncratic risks that you’re talking about. It reminds me of like, I once model that, you know, in the equation, given the, you know, portfolio, right, yeah, it makes sense, a lot of sense. The thing is that, in theory, it sounds, we understand what you know, what needs to be done, but in practice, to replicate that it’s very, very hard sometimes, you know, as an individual investor. So you really have to see emotions come into play, right, like this. Systematic, and idiosyncratic is very, you know, technical, very scientific. But when you combine that with the psychology and the emotional behavior of people how they come about, it’s, it kind of makes it very hard. Do you have anything to say to that? Like, how to kind of, you know, like behavioral finance versus like, how people react to these different things? And how can you like, getaway? Or be wary of it?
Juan: Absolutely. I mean, I think, look, I think I think investing is a lot like dieting, right? Where the correct way. And what’s going to give you the highest probability of achieving your goals is kind of common knowledge and investing, right? Kind of like dieting, where if you want to lose weight, we’ll just eat less and exercise more, you don’t have to go buy a bunch of books to really read about it and investing, it’s kind of like, pay low fees, get the fees down as much as you can, and invest in as a broadly diversified index as you can get, because that’s going to give you the highest probabilities. Now the problem is, is that an investing just like dieting, we have a lot of temptations, the temptations are all over the place, right? It’s all over the news and investing it’s all over the Wall Street Journal’s it’s everywhere, right? and invest in this new thing. And this new thing, and this is going to be the next Bitcoin, and this is going to be the next Facebook. And so what ends up happening as our psychologies overwhelmed, right, with all these different things going on, and having to constantly do something with your portfolio, Oh, I should sell this now and buy this and buy that. And so at the end, what we decided to do to try to combat this psychological thing is these three, these three buckets that I told you separating your money into these three buckets, because at the end of the day, if you think about it optimally, you don’t need that second bucket. And an optimal portfolio, you only need how much money do you need to live with? Right? How much money do you need to buy groceries, and then everything else should be optimized in a portfolio that’s invested in every asset class in the world with a bunch of which as much leverage as you possibly can get without incurring anything? That’s it, right? That’s that should be your two portfolios, right? The introduction of this three portfolio thing having this bucket two, which is the safe portfolio, to counter your bucket three is a psychological thing, right? It’s meant for behavioral, it’s meant for people to understand, hey, if I only put if I’m someone who’s medium, risk-tolerant, and I only put, let’s say have a million dollars, and I put $200,000 dollars in my bucket three. Okay, and now my bucket three is down 50%? Well, maybe I can tolerate that psychologically a little bit better, because my $200,000 is worth now 100. But it’s not my million going down to 500,000. You see, I’m saying, yeah. And so that’s where the psychology kind of plays a role really, into deciding how when you decide how do you split up your buckets, it’s really a psychological test. Because optimally speaking, you shouldn’t have a portfolio to use, you try to achieve the most returns you possibly can, right? and optimize that and just have enough cash on hand to do whatever you want to do. Spending wise. That’s the trick, right? And there’s a lot of, there’s a lot of things that we try to tell people like, you know, there’s a big psychological hurdle of this FOMO fear of missing out this big psychological hurdle of also, should I or shouldn’t I be in the market, like I talked about, right? People don’t realize that it’s actually worse than if you’re waiting to get in the market, and you’re not making money, it’s actually going to hurt you more than being in the market, and the market goes down. Over the long run, it’s actually going to penalize you more. And there’s countless studies on this that showed this, right? That it’s interesting. And so it’s actually going to penalize you more for not being in, right and deciding year after year that, okay, I’m waiting for the crash and waiting for the crash and waiting for the crash and the crash, maybe it does come maybe five years later, or three years later. And by the time you do get in, right all those three years before that of not earning anything is going to cost you a lot more than if you just experienced a 40% drawdown in March of last year, and then you recovered in six months, right or in 2008 experienced 60% 50% drawdown. And then two years later recovered. So it’s actually it’s a it’s a mental thing. Because when you see the statistics, it’s actually that’s why I always say it’s better to be in the market. And if you’re someone who’s very risk-averse, then just don’t have as much money and say, like the riskier asset classes. There’s one more thing I wanted to say about the real estate, you’ve commented about real estate, there’s there is already exposure to real estate, once you invest in a broad based equity index, all the rates are already included inside the indexes themselves. So you already get exposure to real estate. And if you really think about it, real estate is made up of two main components equity and debt. Right? So if you own real estate, are you an equity owner of real estate? Or are you lending money like a bank to, to a company and you hold the debt of the of the of the real estate prime? Right, right, you can actually accomplish owning real estate by owning, you know, the equity side of the components and also say, the mortgage-backed securities or the debit side of the components, right. So you can actually own the records to have a direct exposure to the real estate that way.
Pancham Gupta: Got it. Got it. Cool. Thank you. So, you know, I want to ask you guys one more question. Like before we move on to the next section of the show. My question is, given the COVID pandemic happened in the March of last year, how has your investment philosophy changed? And where are you investing personally? Your answer? Broadly,
Julio: I mean, it hasn’t changed our view on how to invest. I mean, our principle continues to be the same, right, which is diversified accordingly to the market across multiple assets. And that’s basically the basic principle. Why because it’s extremely hard, or actually extremely unlikely to predict the future, and extremely likely to outperform the market, therefore, I mean, the three message, nothing changed. Nothing has changed. So that under continuous being our philosophy, that’s still our, our philosophy, and we personally, I mean, I can talk about me, I personally invest in that way. I mean, the fully diversified – inaudible- act only to the market across assets. But I use leverage to have higher respective features. If you think in terms of the efficient frontier, right? I mean, we were talking about the theory in that you told me that you already did some studies about this. So we’re going to try to do is to move up in the efficient frontier, how you move up, is using leverage, right? You borrow to invest more in this global market, right? Me personally, I am, I am risk-tolerant in this investment in these investments. So I replicate the market with leverage, not what I do, personally.
Pancham Gupta: Got it
Juan: And I do the same thing. So it’s basically I have money that I need for, like I said, a rainy day, you know, in cash. And then the rest of the money is invested in a global market portfolio constructed in a way where it’s fully diversified and as much in as many asset classes I can get my hands on. And obviously, you know, the one thing that I want to remind people on the show, right is I know that the drawback on diversification for a lot of people is that you’re going to get lower returns. Yeah. And so people say well, diversify, diversify and not going to become like a Warren Buffett. I’m not going to get these high returns and I want well, that’s easy. That that problem is easily solved through the use of leverage. Right? So even Warren Buffett, right, got 20% returns through the use of leverage, because what he would do is he would he would, he would use leverage in the form of the he would buy insurance companies, right. And with the float, he would actually that those are like those, that’s money he has to pay back in the future, but he would finance that, to use his purchases of stocks companies, right? Yeah. So he would buy very safe assets, and then lever them. Right. So this is the same concept. But normally, you’re not doing it with stocks, you’re doing it with all the assets in the world. So you’re technically taking the safest portfolio you could possibly construct. Because you’re investing in every single asset in the world, okay, you’re balancing those asset classes due to their sizes, okay. And then, if you are someone who wants higher returns, you have two options, right? You have option one, which is the classical option, which is you can skew your portfolio and put more money into the riskier asset classes like equities, right, or venture capital or private equity, which is what most people do. Or you could just use leverage and leave the asset allocation in the exact same proportions. So you could leave the asset allocation, the exact same proportions, and then just lever the portfolio to your risk tolerance. It’s very similar to real estate when people buy, you know, say, a multi-family, you know, construction project, or whatever real estate property you want to buy, right, the more financing you get on that real estate property, the more risk you’re taking, the higher the expected returns are going to be. Right for that real estate property. Now, why do people use debt and leverage in real estate a lot, because it’s, they tend to be a safe asset, right? So someone takes the safe asset and puts leverage on it, then they invite their investor buddies, and they can then tell them they’re going to make 15 to 20% returns on this real estate deal. But you have to remember, you’re only making 15 to 20% returns on the real estate because it’s using leverage, right? Because based on banks, giving them 60%. Finance. So this is the same concept, right? You’re taking a very, you’re taking a safe, much safer portfolio, much safer investment than just one real estate asset. you’re investing in everything.
Pancham Gupta: So how would you suggest levering up in the stock portfolio? Is it through margin accounts? Like for an average investor who doesn’t have a lot?
Juan: There are many ways to do it. The most optimal way to do it, and the most cost effective way to do it is to use futures contracts. Okay? So instead of investing, bet investing and say the s S&P 500 index fund, you would buy the S&P e mini futures contract, and then you would roll that. I would say, don’t try to do this on your own. Yeah. For this art, you would probably need professionals that are you know, that know how to do this. This is a small commercial for us. But that’s that is our bread and butter. That’s what we can help do. It really comes down to finding a professional that really knows what they’re doing right with futures and leverage. Because the moment you do start using leverage, you want to be very careful, exactly know what you’re doing.
Pancham Gupta: Yeah absolutely. That’s great. And we will talk towards the end how people can connect with you. So thank you, Julio, and Juan. We will be back after this message… Have you ever wondered why the rich keep getting richer? What is the secret that they know? But you do not? What if I told you that wealthy people make their money work for them in two different places? Yes, the same dollars invested into different places and working hard for them while they sleep. They utilize these special accounts that have been in existence for more than 100 years. Do you want to learn more about these accounts, then you are in the right place? Listen to the episode number five by going to thegoldcollarinvestorbanking.com/banking show, I repeat, thegoldcollarinvestor banking.com/banking show or visit thegoldcollarinvestorbanking.com… So we are moving to the second round of the show, which I call taking the leap down, ask these four questions to every guest on my show. So Julio, and Juan, my first question for you is, when was the first time you guys invested outside of Wall Street? If you have a debt? Anyone have you can go if you didn’t, that’s fine.
Julio: So outside of Wall Street, you mean like, I mean, exactly. What do you mean, outside of?
Pancham Gupta: What I mean by that is like non traditional, like non stock, like Stock Exchange-listed funds, like you know, in alternative investments, whether it’s, you know, let’s say physical gold would be one or real estate or, you know, crypto anything, which is not kind of on the traditional stock exchanges,
Julio: like futures, you will say, also, I that’s one of the change. So I don’t know if
Pancham Gupta: Yeah, I mean, futures Yeah, future would count depending on where but yeah, no, that’s fine. So futures like when was the
Julio: Futures was many years ago. I mean, probably 15 years ago that I started trading with futures Got it and for you, Juan?
Juan: First investment outside of Wall Street. I haven’t done many; I think it would be my house.
Pancham Gupta: Cool. My second question for you, what fears did you have to overcome? Like when you first invested Julio in the futures? Or one when you got your house? Did you have any fears
Juan: for my house? No, you know, I think I think like everyone, we all need a place to live. So right, there was no big fear. I don’t know you Julio with futures. I’m sure there were fears there.
Julio: I mean, my major, your fear was like in anything, right? I mean, that you make sure that you are doing it correctly, that you’re not making mistakes, etc., etc. I mean, that’s, that was really the, the main fear right? Not make a mistake.
Pancham Gupta: Got it. Got it?Is that the Bloomberg screen behind your back?
Julio: No, that’s not. That’s not Bloomberg. No, Bloomberg, actually in this machine. In the front.
Pancham Gupta: It looks like Bloomberg because I actually worked at Bloomberg for many years. So okay, cool. So, my third question for you is, can you share with us one investment that did not go as expected.
Juan: So, I started actually trading futures back in my hedge fund days on my on my own outside of the investment philosophy, because we did trade futures at the former hedge fund that I was with. And the fund manager actually told me to do it. So, I could learn more about futures, right, he said, the best way to learn futures is for you to start doing it on your own. So, I did. And I ended up at first making a lot of money and then blowing my account up. And there was a lesson learned because it didn’t go my way. Because I really didn’t know, I didn’t invest in a way where I had a good sound theory as to why it should have made money. It mainly was based off of no trend, following technical analysis, just reading charts, and had no fundamental reason as to why I think in the future, this should make money other than just signals. And I think the lesson learned there was that you could do all the technical analysis, you can do all the chart reading you want. The most important thing I think, to make money in the future, or having a good investment philosophy or a good trade is, is truly understanding why it should make money going forward. And it could be you could be wrong about that, right? I’m just saying, but the reasoning should be, why is this investment going to make money going forward, and not catch yourself in the typical trend-following momentum game that most people play, which is I’m going to invest in Amazon because it went up a lot, or Tesla, because it’s been going up a lot, or a Bitcoin? Because it’s been going up a lot. It’s more about fundamentally, are you buying this asset or what you think is a good value right now, and what are your reasonings for this to keep going up in the future?
Pancham Gupta: Got it. Cool.
Julio: And for me, was, for example, last year, right. Last year, in March, I will have expected maybe many asset classes to be down by the end of the year, right? expecting that I, however, all the asset classes went up last year. So, my expectation was maybe the same or even down. That was my personal my personal expectation, but all of them were, what up? Right. Okay.
Pancham Gupta: So, my final question for you is, what is one piece of advice would you give to people who are thinking of you know, diversifying right now, and, you know, getting in the market?
Juan: I would say, first of all, make sure that you understand your own risk tolerance, right? Diversify across as many asset classes as you possibly can. If you’re worried all about the economy, don’t get out of the markets, make sure you’re still fully invested. But just don’t take on more unnecessary risks, right? Always be fully invested, I think. And if you are worried about the economy or something, it’s okay. I’d rather people I think, decrease their risk tolerance. If you have any exposure to, say, a portfolio three that has more risk, right, bring it more down to portfolio two, that’s always an option, much better option than to take them to completely be out of the market. But the main takeaway, I think, is, make sure your risk tolerance is right. Make sure you understand that clearly. And know that look, the difference between the public markets and the private markets because I get this question a lot by clients. equity is equity. debt is debt if you’re an owner of debt, or if you’re an owner of equity, whether it’s private or public, you know that the instruments you’re owning is the same thing. The only difference is one you can see the price of every day and the other one you can’t
Pancham Gupta: That’s right. Thank you. What about you Julio, similar or anything different?
Julio: Yes. I’m just gonna advise. So, make sure you are very well diversified, right? That you’re replicating the markets at a really low cost. Costs are really important. So very low costs, make sure about all the fees that you’re paying, pay attention to all the fees. That’s also because they compound over time, they compound and they can eat a lot of your performance, right to make your investment as tax efficient as possible, also. And that’s what kind of said, I mean, understand your risk tolerance, and understand exactly what you are investing in. If you don’t understand the instrument, or if you know, understand the philosophy, don’t invest.
Pancham Gupta: Got it. Cool. Thank you so much, Juan and Julia, for sharing your knowledge and your time here. So how can listeners connect with you if they want to reach out and, you know, find out more about your company and the services that you provide?
Juan: So, you can reach us at inscriptioncapital.com also at quantorcapital.com. You can find me Juan Carlos Herrera on LinkedIn and Julio; I think you got a good Twitter handle.
Julio: Yes, in Twitter. I am Julio Cacho, so you can find me on Twitter.
Juan: And then lastly, we also started a podcast called Now Know This. It’s an it’s up. It’s been up and running now for about three months. It’s myself and another partner of ours at the firm, Cole Conklin and we do a lot of educational things on the markets and investing in these risks things and a lot of these topics that that we talked about today. So if you’re all interested in that the podcast is called Now Know This.
Pancham Gupta: Sure. You have it. That’s great. Actually, I will put that in the show notes. And, you know, Julio, your Twitter handle is jcachodias, right?
Julio: With a Z. Yes, correct.
Pancham Gupta: Sorry. Yeah, Twitter. So we’ll put that in the show notes as well. Thank you, Julio, and thank you Juan for your time here.
Julio: Thank you.
Juan: Thank you so much for having us. It’s a pleasure.
Pancham Gupta: Thank you for listening today. You know, I don’t know which camp do you fall in? Do you fall in the camp of hyper diversification or you no hyper focused in one asset class. I’ll tell you for me, I am kind of like a hybrid. I’m really, really focused, hyper focused in multifamily real estate because I really understand or you know, trying to learn everyday but really understand that asset class quite well. But at the same time, I also diversify across different asset classes. Do tell me what you ,what your preferences, what you focus on. With that, I would say that if you have any questions, please reach out to me at p@thegoldcollarInvestor.com. That’s p as in Paul @thegoldcollarinvestor.com. This is Pancham, signing off. Until next time, take care.
Thank you for listening to The Gold Collar Investor Podcast. If you love what you’ve heard and you want more of Pancham Gupta, visit us at www.thegoldcollar investor.com and follow us on Facebook@thegoldcollarinvestor. The information on this podcast are opinions as always, please consult your own financial team before investing.