WEBVTT - Interview With Simon Lack: Masters in Business (Audio) 0:00:00.160 --> 0:00:03.040 Masters in Business is brought to you by proper Cloth, 0:00:03.440 --> 0:00:07.920 the leader in men's customs shirts, with proprietary smart sized 0:00:07.920 --> 0:00:12.319 technology and top rated customer service. Ordering a custom shirt 0:00:12.520 --> 0:00:16.680 has never been easier. Visit proper cloth dot com to 0:00:17.000 --> 0:00:23.360 order your first custom shirt today. This is Masters in 0:00:23.440 --> 0:00:29.000 Business with very Ridholts on Boomberg Radio. This week on 0:00:29.040 --> 0:00:32.080 the podcast, I have an extra special guest. It's somebody 0:00:32.120 --> 0:00:34.839 I've known for actually a good couple of years. His 0:00:34.960 --> 0:00:39.120 name is Simon Lack. He's probably best known for the 0:00:39.200 --> 0:00:43.360 book The Hedge Fund Mirage. He's written several others. Funny 0:00:43.440 --> 0:00:47.040 story which we talk about in the podcast portion I 0:00:47.120 --> 0:00:49.880 get invited to speak somewhere and I really don't want 0:00:49.880 --> 0:00:53.840 to talk to this group because they're annoying, and I 0:00:54.360 --> 0:00:57.560 decided to do a little counter programming. And I know 0:00:57.640 --> 0:01:01.920 they're very, very big and fairly hedge fund investors that 0:01:02.000 --> 0:01:04.399 can't figure out why the returns have been so terrible. 0:01:04.880 --> 0:01:07.440 They think it's something they're doing wrong, and so I 0:01:07.480 --> 0:01:11.720 create a presentation called romancing Alpha Forsaking Beta. And one 0:01:11.760 --> 0:01:14.720 of the big sources I used in the book was 0:01:14.760 --> 0:01:20.640 Simon's Hedge Fund Mirage. Based on the strength of that presentation, 0:01:20.800 --> 0:01:26.759 which was really me being um rude. I get invited 0:01:26.840 --> 0:01:33.560 to speak at UM the Kennedy School of Socially Responsible 0:01:33.600 --> 0:01:37.080 Investing a couple of years ago, and I make a 0:01:37.120 --> 0:01:42.160 presentation about why Beta for many institutional investors is better 0:01:42.200 --> 0:01:45.840 than Alpha. Who else is presenting at the same conference, 0:01:46.160 --> 0:01:48.760 but Simon Lack and we chatted up a conversation and 0:01:49.240 --> 0:01:52.760 ironically we each were citing each other's research. It was 0:01:52.800 --> 0:01:56.160 It was pretty funny. I strongly recommend the book. He 0:01:56.240 --> 0:02:01.200 pulls no punches, especially given what he did UH in 0:02:01.240 --> 0:02:03.760 his earlier career, which gave him a front row seat 0:02:03.800 --> 0:02:07.200 to what was going on in hedge funds. I could 0:02:07.200 --> 0:02:09.880 wax on for a much longer about this, but really 0:02:09.919 --> 0:02:12.400 he is so knowledgeable and full of so much information. 0:02:12.680 --> 0:02:15.840 Rather than me continuing to babble with no further ado 0:02:16.280 --> 0:02:23.079 my conversation with Simon Lack. This is Masters in Business 0:02:23.280 --> 0:02:28.280 with Barry Ridholts on Bloomberg Radio. I have a special 0:02:28.320 --> 0:02:31.720 guest today who I have been looking forward to sitting 0:02:31.760 --> 0:02:34.760 down and chatting with for a long time. His name 0:02:34.919 --> 0:02:38.919 is Simon Lack. He spent twenty three years with JP 0:02:39.120 --> 0:02:44.120 Morgan prior to founding sl advisors in two thousand and nine. 0:02:44.760 --> 0:02:48.200 His career JP Morgan was spent uh doing fixed income 0:02:48.240 --> 0:02:53.440 derivatives and forward FX trading before he ran the Investment 0:02:53.440 --> 0:02:57.320 Committee in charge of allocating over a billion dollars to 0:02:57.560 --> 0:03:00.800 hedge fund managers, as well as foul thing the JP 0:03:00.919 --> 0:03:05.200 Morgan incubator funds and a number of private equity vehicles 0:03:05.240 --> 0:03:10.880 that took economic stakes in emerging hedge fund managers. That 0:03:10.960 --> 0:03:15.080 experience led him to write the first of his three books, 0:03:15.520 --> 0:03:19.240 called The Hedge Fund Mirage, The Illusion of Big Money 0:03:19.280 --> 0:03:22.240 and Why It's Too Good to be True. His subsequent books, 0:03:22.400 --> 0:03:26.040 Bonds Are Not Forever and Wolf Street Potholes Are are 0:03:26.120 --> 0:03:29.400 both must reads. Simon Lack, Welcome to Bloomberg. Thank you 0:03:30.440 --> 0:03:33.120 so it's I've been looking forward to chatting with you, 0:03:33.200 --> 0:03:37.080 and I have so many things UM to go over 0:03:37.280 --> 0:03:40.440 with you. Let's let's start, given what's going on in 0:03:40.480 --> 0:03:43.200 the world to fixed income in the Federal Reserve, Let's 0:03:43.240 --> 0:03:45.680 start with your book on bonds and and talk a 0:03:45.760 --> 0:03:50.360 little bit about UM. Bonds. Interest rates go all the 0:03:50.400 --> 0:03:54.000 way back to eight hundred BC, that's about four thousand 0:03:54.080 --> 0:03:59.360 years ago. How important our interest rates for consumer spending? Credit? 0:03:59.480 --> 0:04:02.920 And the over all economy. I mean critical, right, I mean, 0:04:02.960 --> 0:04:06.040 maybe the most important economic variable out there is interest 0:04:06.120 --> 0:04:08.160 rates and people getting her favorites and on their money, 0:04:08.200 --> 0:04:11.040 and from the investment side, or from the consumer side, 0:04:11.080 --> 0:04:14.440 or both from the investment site, certainly, but obviously low 0:04:14.520 --> 0:04:17.640 rates stimulate demand, allow consumers to borrow money to buy 0:04:17.680 --> 0:04:20.080 things as well. So it's it's critical. I mean, it's 0:04:20.120 --> 0:04:23.240 probably the most important variable. So here in the United States, 0:04:23.720 --> 0:04:28.400 we as a nation have pretty much set rates for 0:04:28.600 --> 0:04:31.520 much of the globe. Taking rates down to such low 0:04:31.640 --> 0:04:34.919 levels in the early two thousands really helped set the 0:04:34.960 --> 0:04:39.080 table for a global financial crisis. Now, the US is 0:04:39.120 --> 0:04:42.800 a little out of step with Europe and Japan in 0:04:42.839 --> 0:04:47.080 that Qui is over, zerp is over. We're embarking on 0:04:47.120 --> 0:04:50.480 a reat raising regime. The rest of the world is 0:04:50.520 --> 0:04:53.680 still cutting, still doing their version of que Does the 0:04:53.800 --> 0:04:57.520 United States still set the interest rate for the world, 0:04:58.760 --> 0:05:01.919 I mean, to a large agree, certainly impacts the emerging 0:05:01.960 --> 0:05:04.760 world and clearly sets its own rates. And it's a 0:05:04.800 --> 0:05:07.640 great situation for the US to be because the financial 0:05:07.680 --> 0:05:11.279 crisis came about through too much debt, and the solution 0:05:11.480 --> 0:05:13.960 to too much debt is low rates. And I've often 0:05:14.000 --> 0:05:17.440 said to people that if Janet Yellen or Ben Banankey 0:05:17.560 --> 0:05:20.680 before her had got up and given a speech and said, hey, listen, 0:05:20.720 --> 0:05:22.880 here's the deal. We've borrowed too much money and we're 0:05:22.920 --> 0:05:25.640 just going to keep rates really low and transfer real 0:05:25.680 --> 0:05:29.080 wealth from savers to borrows. If they've given that speech, 0:05:29.320 --> 0:05:32.119 monetary policy would have been as it's been. They haven't 0:05:32.160 --> 0:05:34.880 given the speech, but you've had the outcome that's consistent 0:05:34.920 --> 0:05:37.040 with that low rates are in our self interest. Well, 0:05:37.080 --> 0:05:40.640 the political pushback to that explicit statement would have been 0:05:40.640 --> 0:05:44.800 pretty fierce. Absolutely absolutely. So I think that although you 0:05:44.839 --> 0:05:48.320 know in my book I'm negative on bonds, it's not 0:05:48.360 --> 0:05:50.680 because we think bond deals are going to go up sharply. 0:05:50.839 --> 0:05:52.640 I think you're going to see rates lower than they 0:05:52.640 --> 0:05:55.440 should be from an investor standpoint for a long time. 0:05:55.480 --> 0:05:58.359 I mean, the return on bonds is just inadequate to 0:05:58.440 --> 0:06:01.599 justify putting money into them. So I want to I 0:06:01.640 --> 0:06:04.360 want to stick with the concept of of the US 0:06:04.680 --> 0:06:09.000 Federal Reserve Bank setting rates for the world. In your book, 0:06:09.040 --> 0:06:11.800 you actually right, and I guess this is a little 0:06:11.839 --> 0:06:14.960 bit of a forecast, or certainly is looking forward a 0:06:15.040 --> 0:06:19.160 number of years ultimately, the United States may find that 0:06:19.200 --> 0:06:22.719 it can no longer set its own interest rates. Explain, 0:06:23.040 --> 0:06:25.839 it's possible, it's possible. We have a you know, a 0:06:26.000 --> 0:06:30.200 very bad indebted position, and under most forecasts, it's only 0:06:30.240 --> 0:06:33.560 going to get worse. And eventually it's quite possible that 0:06:33.640 --> 0:06:36.640 other countries will decide what rates the lender's money at. 0:06:37.160 --> 0:06:39.640 But I think it's actually, although that's a possibility and 0:06:39.680 --> 0:06:42.240 it's something you worried about, I think it's more likely 0:06:42.560 --> 0:06:44.560 that we will continue to set rates, and will continue 0:06:44.560 --> 0:06:47.880 to set rates lower than they really should be for 0:06:47.920 --> 0:06:50.360 the interests of the lenders. And and you know, I 0:06:50.400 --> 0:06:52.760 have trust of the lenders, meaning to avoid default and 0:06:52.800 --> 0:06:55.120 make sure lenders get to get a fair return. And 0:06:55.160 --> 0:06:58.840 so I explore this idea of populism in the Bond Book, 0:06:58.839 --> 0:07:01.880 and a couple of years the books of the Way, 0:07:02.040 --> 0:07:04.800 hopefully ahead of the curve. And here's the thing, right, 0:07:04.880 --> 0:07:08.359 we've had this transfer of wealth from one generation to 0:07:08.400 --> 0:07:10.520 the next. The baby boomers have basically brought a lot 0:07:10.560 --> 0:07:13.680 of money to pay entitlements, and the next generation is 0:07:13.680 --> 0:07:15.680 going to be left to pay for that. So now, 0:07:16.120 --> 0:07:19.320 just so we've got a new president, and just suppose 0:07:19.680 --> 0:07:23.080 interest rates went to ten. Just suppose the Chinese and 0:07:23.160 --> 0:07:27.280 Japanese who added selling bonds. What do you suppose President 0:07:27.280 --> 0:07:30.280 Trump would say to those guys. And I think he'd say, hey, listen, 0:07:30.280 --> 0:07:31.840 if you want to keep selling bonds, I'm just going 0:07:31.880 --> 0:07:33.360 to cut the interest rate in half on what we 0:07:33.440 --> 0:07:37.160 pay you as weaponized fixed income instruments. Is that it's 0:07:37.240 --> 0:07:39.440 you know what I mean, it's it's not something that's 0:07:39.480 --> 0:07:41.400 at all on the horizons to day. But my point 0:07:41.560 --> 0:07:45.920 is that the moral obligation to repay what's been borrowed 0:07:46.320 --> 0:07:49.040 with fair value is going to become more and more 0:07:49.080 --> 0:07:52.320 tenuous over time because the people who are repaying the 0:07:52.320 --> 0:07:54.560 dead are not the ones who made the decision to borrow. 0:07:55.000 --> 0:07:57.480 And I think you're going to see that connection weaken, 0:07:57.960 --> 0:07:59.880 and it's going to be at the expense of the 0:08:00.040 --> 0:08:02.200 people who own the debt. Let me push back a 0:08:02.280 --> 0:08:06.200 little bit on this and and just observe there is 0:08:06.240 --> 0:08:12.480 a global shortage of high quality sovereign paper like US treasuries. 0:08:13.040 --> 0:08:16.440 We haven't been doing the sort of tax and spend 0:08:16.520 --> 0:08:19.120 or tax and borrow like we used to. We haven't 0:08:19.120 --> 0:08:24.400 been doing the big infrastructure projects. It seems that demand 0:08:24.600 --> 0:08:30.080 for quality paper absolutely overwhelms the supply. If the Japanese 0:08:30.200 --> 0:08:34.200 or the Chinese or other holders of US treasuries decide 0:08:34.240 --> 0:08:37.320 to suddenly hit the bit at once, how hard is 0:08:37.320 --> 0:08:39.640 it to imagine that all the paper just gets sucked 0:08:39.720 --> 0:08:43.080 up by foundations, pension funds and everybody else who could 0:08:43.160 --> 0:08:44.920 be I mean, you know, they've each got over a 0:08:44.960 --> 0:08:47.640 trillion dollars, and as a practical matter, it's hard to 0:08:47.640 --> 0:08:49.720 see how you could sell that sort of amount in 0:08:49.720 --> 0:08:51.760 a short period of time. But the Chinese, of course, 0:08:51.760 --> 0:08:55.199 have been reducing their holdings recently. I think part of 0:08:55.320 --> 0:08:58.920 without much impact to letting things roll off, and they'n not, 0:08:59.120 --> 0:09:00.960 you know, opening at all trans the way they were, 0:09:01.080 --> 0:09:04.960 so it hasn't caused really any discernible disruption to this point. 0:09:05.000 --> 0:09:08.000 So I think that's true. I'm Barry Hults. You're listening 0:09:08.040 --> 0:09:11.360 to Masters in Business on Bloomberg Radio. My guest today 0:09:11.400 --> 0:09:14.800 is Simon Lack. He is the author of the hedge 0:09:14.800 --> 0:09:17.600 Fund Mirage, The Illusion of Big Money and Wow, it's 0:09:17.600 --> 0:09:21.679 too good to be true. And I have to reiterate 0:09:21.840 --> 0:09:25.800 for listeners that you spent twenty three years at JP Morgan. 0:09:25.960 --> 0:09:30.199 Part of that time was you sitting on an investment 0:09:30.200 --> 0:09:34.320 committee that was responsible for allocating over a billion dollars 0:09:34.840 --> 0:09:38.800 in hedge in money to hedge funds and emerging market 0:09:39.160 --> 0:09:44.079 emerging managers, and you had a front row seat to 0:09:44.800 --> 0:09:48.600 really the emergence of hedge funds as a major set 0:09:48.600 --> 0:09:50.679 of players in the market. I mean, it was so 0:09:50.720 --> 0:09:52.840 cool because in the early nineties, that's when I first 0:09:52.880 --> 0:09:55.840 started investing in hedge funds, sitting on that committee, and 0:09:55.880 --> 0:09:58.880 it was a very obscure backwater and you'd go and 0:09:58.920 --> 0:10:02.880 see these very talented people in a small office with 0:10:03.040 --> 0:10:07.520 very complex strategies, with leverage and Cayman vehicle, and it 0:10:07.600 --> 0:10:10.000 all sounded quite risk and banks we're not doing that. 0:10:10.160 --> 0:10:12.440 I mean, we were really sort of pioneers in terms 0:10:12.480 --> 0:10:16.240 of allocating proprietary capital to that. And it was so cool. 0:10:16.280 --> 0:10:18.760 I mean, there's never a boring meeting with their hedge 0:10:18.760 --> 0:10:20.920 fund manager. Each one of them is interesting in their 0:10:20.920 --> 0:10:24.400 own way. And of course the industry just completely took off. 0:10:24.400 --> 0:10:26.160 And in the early nineties when we were doing that, 0:10:26.679 --> 0:10:29.400 the markets were very inefficient and you could make some 0:10:29.559 --> 0:10:33.000 very very attractive returns, and as in most things in investment, 0:10:33.040 --> 0:10:35.720 you know, popularity is eventually going to kill it, and 0:10:35.760 --> 0:10:38.120 that's what happened over the last ten or fifteen years. 0:10:38.200 --> 0:10:40.720 Let me put a little flesh on the bones. And 0:10:40.840 --> 0:10:45.240 this comes right from the hedge fund mirage. A m 0:10:45.440 --> 0:10:48.040 for all of hedge funds was a hundred and eighteen 0:10:48.120 --> 0:10:52.080 billion dollars ten years later, by two thousand and seven 0:10:52.120 --> 0:10:55.880 it was two point one trillion, and last year we 0:10:56.000 --> 0:10:59.840 just crossed three trillion. So despite all the talk about 0:11:00.280 --> 0:11:02.640 this is the end the hedge funds, they've been under performing. 0:11:02.640 --> 0:11:06.160 Everybody knows the fees are too high. They continue to 0:11:06.200 --> 0:11:11.160 accumulate massive amounts of capital, and it's an extraordinary disconnect 0:11:11.200 --> 0:11:14.200 by generally public pension plans. I mean, those are the 0:11:14.600 --> 0:11:17.319 those are the big source of capital today for hedge funds, 0:11:17.320 --> 0:11:20.280 not so much high net worth investors. And they what 0:11:20.320 --> 0:11:24.400 they do is generally investors will understand that small hedge 0:11:24.400 --> 0:11:26.320 funds are better than big ones. I mean it can 0:11:26.360 --> 0:11:28.480 be expensive to have a portfolio of small hedge funds. 0:11:28.520 --> 0:11:30.840 You need a lot of them. They also know that 0:11:30.920 --> 0:11:32.920 any big hedge fund they look at was better when 0:11:32.920 --> 0:11:34.960 it was smaller. That's why it's big today. There are 0:11:35.000 --> 0:11:39.800 inefficiencies that can only be mortified. You can't put twenty 0:11:39.800 --> 0:11:42.880 billion dollars into it, and so they missed the obvious 0:11:42.960 --> 0:11:45.360 third step, which is that a small hedge fund industry 0:11:45.720 --> 0:11:47.920 was better than a big one. And I would challenge 0:11:48.000 --> 0:11:52.400 any institutional investment hedge funds today to ask themselves what's 0:11:52.400 --> 0:11:56.840 the optimal size of the hedge fund industry? And generally 0:11:56.880 --> 0:11:59.559 those investors don't even contemplate the question. They don't think 0:11:59.600 --> 0:12:01.959 of it in terms of any sort of finite pool 0:12:02.480 --> 0:12:05.800 of arbitrage type profits to be exploited. And it's a 0:12:05.960 --> 0:12:09.320 huge disconnect. It's a huge error, and they're getting the 0:12:09.360 --> 0:12:13.400 results that they deserve for such shallow analysis. The themed 0:12:13.600 --> 0:12:18.040 short seller Jim Chanos, who himself runs hedge fund Kinnicoast Associates, 0:12:18.040 --> 0:12:20.640 was a guest on the show and he said when 0:12:20.679 --> 0:12:23.040 he launched his hedge fund, and I think it was 0:12:23.120 --> 0:12:25.960 sometime in the eighties, because there was a couple of 0:12:26.000 --> 0:12:30.160 hundred guys, they all generated alpha. Now there's eleven thousand 0:12:30.280 --> 0:12:33.880 hedge funds, those same two or three hundred guys are 0:12:33.920 --> 0:12:37.800 the ones generating the alpha. That's a little bit of exaggeration, 0:12:38.000 --> 0:12:39.720 but not a whole lot, is it. I mean, the 0:12:39.760 --> 0:12:42.320 problem is that it's very hard to forecast who's going 0:12:42.360 --> 0:12:45.000 to do well, you know ahead of time. So there's 0:12:45.000 --> 0:12:46.880 always going to be happy class and there's always gonna 0:12:46.880 --> 0:12:49.840 be hedge funds that do well. But hedge fund performances 0:12:49.920 --> 0:12:53.000 mean reverting, and so you have a set of investors 0:12:53.040 --> 0:12:55.839 who very largely look at performance to decide where to invest. 0:12:55.880 --> 0:12:57.680 I mean, I sat in so many meetings with hedge 0:12:57.679 --> 0:13:01.440 fund managers and you have the whole discussion about security 0:13:01.480 --> 0:13:05.240 selection of portfolio construction. So one manager leaves your caucus 0:13:05.559 --> 0:13:07.320 and we talk about it, and then somebody says, you 0:13:07.400 --> 0:13:09.400 know what, he was up fifty last year. Yeah he's 0:13:09.400 --> 0:13:11.320 pretty good. Yeah, I like him. He's pretty good as 0:13:11.360 --> 0:13:15.640 opposed tone you want to take your money off of that, Yeah, 0:13:15.840 --> 0:13:18.240 so hege. So you've got this the way hedge fund 0:13:18.280 --> 0:13:24.480 investors are helplessly momentum driven hedge funds are mean reverting investments. 0:13:24.640 --> 0:13:27.120 This is never going to be a good combination. They're 0:13:27.160 --> 0:13:30.439 always buying what worked yesterday and it's actually less likely 0:13:30.520 --> 0:13:34.200 to work tomorrow. But they're generally institutional investors in hedge 0:13:34.200 --> 0:13:36.600 funds are not that sophisticated. In my experience, my head 0:13:36.600 --> 0:13:40.439 of research gave me a little tidbit which I found fascinating. 0:13:40.920 --> 0:13:45.199 In America today, there are more hedge funds than taco bells. Amazing. 0:13:45.440 --> 0:13:48.839 Do we have either too many hedge funds or none 0:13:48.920 --> 0:13:51.719 enough taco bells. What's the takeaway? I think you get 0:13:51.760 --> 0:13:54.480 better value for money taco bell. There's no question about that. 0:13:54.559 --> 0:13:56.880 Given the choice, I'd picked the Taco Bell. So here's 0:13:56.920 --> 0:14:00.199 the fascinating anything about this. There are a small all 0:14:00.280 --> 0:14:03.800 group of of the alpha generators that chainos referred to. 0:14:04.440 --> 0:14:07.360 And whether it's Jim Simons or Cliff ast Nests or 0:14:08.200 --> 0:14:11.120 d Shore or Steve Cohen or go down the list, 0:14:11.720 --> 0:14:18.760 the concept of the significantly outperforming manager seems to keep 0:14:18.800 --> 0:14:22.480 everybody else in pursuit of that alpha. They're willing to 0:14:22.560 --> 0:14:26.080 forsake beta in order to chase alpha. Is it just 0:14:26.240 --> 0:14:29.360 that simple. It's a problem with the accounting treatment that 0:14:29.440 --> 0:14:31.800 public pension plans use, and it's a little bit of 0:14:31.760 --> 0:14:35.560 an obscure issue, but basically, with a pension fund, normally 0:14:35.680 --> 0:14:37.600 use a corporate bond rate to figure out what your 0:14:37.600 --> 0:14:41.480 liabilities are. Pension plans used the expected return on their 0:14:41.520 --> 0:14:45.520 investment portfolio, which is a made up number. It's yes, 0:14:45.560 --> 0:14:48.120 it's an estimate, right, And that's the account of standards 0:14:48.200 --> 0:14:51.280 that government entities have to use. And the result is 0:14:51.320 --> 0:14:55.720 it biases them towards hedge funds because of their historic performance. 0:14:55.800 --> 0:14:57.720 Let's let's put more flesh on this. So if you're 0:14:57.760 --> 0:15:01.160 a public pension fund that let's use Jersey is an example, 0:15:01.200 --> 0:15:04.240 because there's such a mess anyway. So the New Jersey 0:15:04.280 --> 0:15:07.920 pension funds sets up what they're expected returns are, and 0:15:07.960 --> 0:15:11.440 they create that number by saying, here's the historical returns 0:15:11.480 --> 0:15:14.880 of stocks, here's restored historical returns of bonds. And oh 0:15:15.040 --> 0:15:20.600 look how giant there are expected returns are for hedge funds. 0:15:20.680 --> 0:15:24.200 And that means that New Jersey has a smaller tax 0:15:24.240 --> 0:15:28.600 obligation to put money into the state pension. That's entirely correct, 0:15:28.640 --> 0:15:32.360 and so taking hedge funds out would cause their unfunded 0:15:32.400 --> 0:15:35.880 position to be worse and put more pressure on the 0:15:35.960 --> 0:15:38.800 governor to add, you know, to raise taxes. Even though 0:15:38.800 --> 0:15:41.560 hedge funds have been as a group, have been significantly 0:15:41.640 --> 0:15:47.040 underperforming mutual funds and certainly underperforming the index. Aren't we 0:15:47.080 --> 0:15:51.200 just creating a giant, bigger problem down the road. Aren't 0:15:51.200 --> 0:15:53.440 we just kicking the can? Yeah? The can is totally wrong. 0:15:53.480 --> 0:15:55.440 And in fact, the other end of that is if 0:15:55.640 --> 0:15:58.280 if a pension fund own treasury bills, which they wouldn't, 0:15:58.320 --> 0:16:00.680 but if they did, and they pay what quarter percent, 0:16:01.560 --> 0:16:04.480 and that affects they're expected return and the discover rate 0:16:04.560 --> 0:16:07.720 on their liabilities. If they burned the cash that was 0:16:07.720 --> 0:16:10.840 in those trosury bills as opposed to keeping them, if 0:16:10.840 --> 0:16:13.200 they literally if they burned on my fire, it would 0:16:13.280 --> 0:16:16.200 drive up their expected return because cash is a drag, 0:16:16.600 --> 0:16:19.720 and that higher expected return would translate into a lower 0:16:19.760 --> 0:16:22.920 present value of their obligations. And so that actually look 0:16:22.960 --> 0:16:25.520 as if they're in better shape even after destroying some 0:16:25.600 --> 0:16:28.000 of the assets that they would use to meet those obligations. 0:16:28.000 --> 0:16:31.400 And it's obviously, you know, an unrealistic example, but the 0:16:31.480 --> 0:16:34.160 math is what it is. You put in an asset 0:16:34.160 --> 0:16:37.040 with a high expected return, it makes your funny position 0:16:37.080 --> 0:16:40.960 look better regardless of how those assets do. And so 0:16:41.080 --> 0:16:43.920 it's a huge problem and it's unlikely to be a 0:16:43.960 --> 0:16:47.160 crisis because it unfolds over time, but it's to the 0:16:47.320 --> 0:16:51.520 cost of taxpayers in any state, including New Jersey where 0:16:51.560 --> 0:16:55.040 I live, who have that. I'm very ritolts. You're listening 0:16:55.120 --> 0:16:58.400 to Master's in Business on Bloomberg Radio. My special guest 0:16:58.440 --> 0:17:02.760 today is Simon lack of sl Advisors. He previously spent 0:17:02.800 --> 0:17:06.199 twenty three years with JP Morgan, where he spent a 0:17:06.240 --> 0:17:09.840 good part of his time allocating money to hedge funds 0:17:09.880 --> 0:17:14.720 and other alternative investments. Let's talk a little bit about 0:17:15.160 --> 0:17:17.439 something that has come up in one of your books, 0:17:17.440 --> 0:17:23.080 Wall Street Potholes, about what is now called the fiduciary rule. 0:17:23.440 --> 0:17:27.000 When when we look at people like your attorney, or 0:17:27.040 --> 0:17:31.240 your accountant, or even your doctor, they're all obligated by 0:17:31.359 --> 0:17:36.119 law to serve your interests. Why shouldn't financial advisors have 0:17:36.240 --> 0:17:38.840 that same obligation. Yeah, I mean it's a fair question. 0:17:39.119 --> 0:17:42.320 I think that a lot of investors think they aren't 0:17:42.359 --> 0:17:45.600 dealing with the fiduciary when they're really not. And I 0:17:45.680 --> 0:17:49.040 think that the easiest solution is to just ensure fair 0:17:49.080 --> 0:17:51.879 disclosure that if you're not a fiducier, that your business 0:17:51.880 --> 0:17:54.520 card says I'm not a fiduciary. Because there's also a 0:17:54.520 --> 0:17:57.760 big segment of the investor market who perceives that dinner 0:17:58.000 --> 0:18:00.960 with the fiduciary is more expensive because the fiduciary is 0:18:00.960 --> 0:18:04.080 going to charge an asset fee and there's a lot 0:18:04.119 --> 0:18:05.639 of ass who say, look, I don't want to just 0:18:05.760 --> 0:18:07.760 pay you a fee every quarter just for my money 0:18:07.800 --> 0:18:09.440 sitting now. I want to pay you a fee when 0:18:09.440 --> 0:18:12.520 I do a transaction, which is the non fiduciary model. 0:18:12.560 --> 0:18:15.680 And I think that the regulations should be flexible enough 0:18:15.840 --> 0:18:19.240 to allow both of those to exist. But I certainly 0:18:19.240 --> 0:18:21.680 think it should be disclosed. People should know whether they're 0:18:21.680 --> 0:18:23.960 dealing with a fiduciary or not. What what about twelve 0:18:24.000 --> 0:18:28.080 B one fees? Where advisors and and and we you know, 0:18:28.119 --> 0:18:34.080 we run into a nomenclature title issue when we have brokers, advisors, 0:18:34.160 --> 0:18:38.200 registered representatives, go down the list of names. Not all 0:18:38.240 --> 0:18:41.280 of these people are fiduciaries. And some of these people 0:18:41.920 --> 0:18:45.679 are both brokers and fiduciaries depending on what had they 0:18:45.680 --> 0:18:49.760 happen to be wearing at that moment. It's still relatively complicated, 0:18:49.840 --> 0:18:52.600 isn't it. It's complicated for people don't understand and and 0:18:52.640 --> 0:18:57.040 so it's a very very highly regulated industry barriers, you know, 0:18:57.240 --> 0:18:59.840 and it's hard for me to believe that even more regulations, 0:18:59.880 --> 0:19:03.159 the answer it should be just explained clearly to people. 0:19:03.280 --> 0:19:06.679 So you're in favor of transparency and disclosure, not full 0:19:06.760 --> 0:19:11.200 on fiduciary obligation. Right, But disclosure doesn't mean that it's 0:19:11.200 --> 0:19:15.320 buried in a document. Disclosure means it's on your business card. Really, 0:19:15.480 --> 0:19:18.440 I mean, really it should be really. So if I'm so, 0:19:18.520 --> 0:19:22.239 I've I've previously had a Series seven, which I gave up, 0:19:22.280 --> 0:19:25.720 and I've also had a sixty five. The series seven 0:19:25.800 --> 0:19:29.280 is the brokerage license. The sixty five is the advisory license, 0:19:29.840 --> 0:19:34.720 and I found complying with all of the rules as 0:19:34.720 --> 0:19:40.480 an advisor. The fiduciary standard is incredibly simple. The governing 0:19:40.560 --> 0:19:43.359 question is what's in the client's best interest. You have 0:19:43.440 --> 0:19:45.639 a lot more room as a broker to do things, 0:19:46.080 --> 0:19:49.359 but the compliance is much more complex, absolutely right. And 0:19:49.440 --> 0:19:52.359 in my business, I'm a fiduciary, and it's dead simple. 0:19:52.440 --> 0:19:54.560 You just do what's right for the clan. As you say, 0:19:55.080 --> 0:19:57.480 the broker dealer model, where you're not where you have 0:19:57.520 --> 0:20:00.560 the lower standard, there's so much potential for conflicts. So 0:20:00.600 --> 0:20:03.440 there's so many more rules and regulations. So let's let's 0:20:03.440 --> 0:20:06.240 talk about that a little bit. How if you want 0:20:06.280 --> 0:20:10.240 to have a disclosure obligation on non fiduciaries, do you 0:20:10.280 --> 0:20:13.520 simply want their business card to include the word non fiduciary. 0:20:13.640 --> 0:20:15.840 Is it that simple? I mean, maybe it would say, 0:20:15.920 --> 0:20:18.159 you know, my responsibility is to act as an agent 0:20:18.200 --> 0:20:21.480 of the company I work for. Some wording non fiduciary 0:20:21.560 --> 0:20:23.560 might be you're telling me that wouldn't be in six 0:20:23.640 --> 0:20:27.720 point tiny text. They can regularly sec regulation fund size 0:20:27.760 --> 0:20:30.840 as we do. So I'm thinking about things like twelve 0:20:30.920 --> 0:20:35.040 B one rules where mutual funds and this goes way 0:20:35.040 --> 0:20:39.000 back to two when this wasn't an especial lucrative business. 0:20:39.680 --> 0:20:44.880 Um mutual funds were paying brokerage firms for carrying their 0:20:44.880 --> 0:20:48.760 product line, just like various food companies pay for shelf 0:20:48.800 --> 0:20:51.359 space in a supermarket. Hey, you want to be eye level, 0:20:51.359 --> 0:20:53.280 You want to be at the end of the row. 0:20:53.359 --> 0:20:55.280 You don't want to be on the bottom shelf in 0:20:55.280 --> 0:20:58.200 the middle of your lost So various fun families would 0:20:58.280 --> 0:21:03.640 pay these fees, and it really wasn't well understood, and 0:21:03.720 --> 0:21:07.959 whatever disclosure there was, we're buried in pages and pages 0:21:07.960 --> 0:21:11.080 of fine print. Nobody really understood that, And so the 0:21:11.160 --> 0:21:15.879 disclosure can always be better. But also investors have a 0:21:15.920 --> 0:21:19.960 responsibility to invest the time to understand that. I mean, 0:21:20.400 --> 0:21:22.800 it doesn't have to be that expensive to invest money 0:21:22.840 --> 0:21:25.000 and you don't have to be paying twelve B one 0:21:25.080 --> 0:21:27.400 fees or loads. You know, we run a mutual fund 0:21:27.440 --> 0:21:29.560 in my business, and you can access it very cheaply 0:21:29.640 --> 0:21:33.000 through SHOUB and Fidelity with I shares with no upfront fees, 0:21:33.359 --> 0:21:35.840 or you can access it for a financial advisor, where 0:21:35.840 --> 0:21:37.960 there will be some fees. And so it really is 0:21:38.040 --> 0:21:40.679 up to the investor to decide do I want to 0:21:40.720 --> 0:21:43.080 go into this fund through an advisor and pay for 0:21:43.119 --> 0:21:45.720 him for the advice and that may be justified, or 0:21:45.760 --> 0:21:48.200 am I happy doing my own research? And I think 0:21:48.240 --> 0:21:51.600 that that, you know, the vast majority of retail investors 0:21:51.640 --> 0:21:55.240 don't do enough hard work and research on who's going 0:21:55.280 --> 0:21:57.919 to be investing the money and how and the economics 0:21:57.960 --> 0:22:01.200 around that. They're so focused on warching an individual stock 0:22:01.680 --> 0:22:06.359 they forget that there's alpha creation outside of just assets. 0:22:06.400 --> 0:22:09.639 So we call that organizational alpha. It's absolutely right. I 0:22:09.680 --> 0:22:12.159 mean a case in point is, you know, we we 0:22:12.240 --> 0:22:16.119 specialize in energy infrastructure, and there's fifty billion dollars of 0:22:16.200 --> 0:22:20.080 mutual funds and ETFs that are taxed as corporations, and 0:22:20.200 --> 0:22:23.160 so only sixty of the return on those assets goes 0:22:23.200 --> 0:22:26.480 to the class MLP or something like that. That's I mean, 0:22:26.640 --> 0:22:29.800 so investors are paying, they're investing in funds where only 0:22:29.880 --> 0:22:32.920 two thirds of the return goes back to them, and 0:22:33.080 --> 0:22:35.639 I can tell you the vast majority don't even realize 0:22:35.840 --> 0:22:38.119 that they're subject of this tax, and it just shows 0:22:38.160 --> 0:22:41.160 that they don't read the prospectuses. I'm very redults. You're 0:22:41.200 --> 0:22:44.480