Krishna Memani on Wall Street's Very Expensive "Free Lunch"

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0:45Amazon Business takes the buying experience you know and love from Amazon, plus tools that help you save costs and make insights-based decisions. Ready to bring your visions to life? Learn how at amazonbusiness.com. Hello, OddLots listeners. I'm Joe Weisenthal. And I'm Tracy Alloway. Tracy, we're doing another live show and it's right here in New York City. Yeah, this one should be our biggest yet. And we're going to have a bunch of Odd Lots favorites and do something maybe a little different to some of our previous live podcast recordings. When the guests are revealed, the show is going to sell out right away.

1:19So you should really just go get your ticket right now. It's June 26th. It's at ReketNYC, and you can find a ticket link at Bloomberg.com slash OddLots or BloombergEvents.com slash OddLotsLiveNY. We hope to see you there.

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1:51Hello and welcome to another episode of the Odd Lots podcast. I'm Jill Weisenthal. And I'm Tracy Alloway. Tracy, this has come up a few times on the podcast over the years. But, you know, you really feel dumb. You could really feel dumb as an investor over the last, I don't know, 15, 20 years. if you literally bought anything else besides big tech stocks. Big U.S. tech stocks. Yeah, big U.S. tech stocks. Yeah, that's exactly right. And the funny thing is, investors have been encouraged to diversify, right? Oh, yeah. Like, this is the mantra of markets is that you shouldn't put all your eggs in one basket, et cetera, et cetera.

2:27And so you've heard for the past 10 or 15 years that you should diversify into international stocks. You should diversify into small caps. 60-40. Yeah, 60-40. And a lot of those things. have turned out to be duds, or at least 60-40 was a dud for a couple years. Kind of. Kind of. I mean, it mostly did well, but it had some rough years, particularly out of the pandemic. But certainly, you would have been missing out on big gains if you put money into small caps or international stocks versus the big U.S. tech stocks. Right. And, you know, we've gotten a little bit, you know, when DeepSea came out, that raised some questions about big tech stocks.

3:07obviously with the policy volatility in the US, which is one way to put it. There have been some questions about, okay, is now the time to diversify abroad? Yeah. Okay. You could have bought money buying Rheinmetall or one of the beneficiaries of German defense spending. But so far, it's still not obvious that there's some other big moneymaker out there for investors besides big tech. But we may be at a juncture. Well, I think the other unappreciated aspect is the importance of the benchmarks in all of this. And I think investors tend to think of benchmark index providers as these very neutral entities that are like holding out a mirror to the market and just reflecting what's already there.

3:53But actually, a lot of their decisions are very active and have very, very big implications for investors. So, you know, if MSCI says that the all-world index is going to have small caps and big caps in it, then investors are, you know, they're forced to buy small cap exposure. That's totally correct. And this is core finance theory, that the optimal portfolio is more or less the global portfolio. We've talked about that with the dimensional guys. You really should have a weighted allocation somehow, if possible, to every bond, stock, and piece of real estate out there. And that's the best you can do.

4:28And that clearly has not been the best you can do for a long time. And so we want to talk about the tortured pain of the poor diversified allocator. And the tyranny of the benchmark index providers. Yeah, very Shakespearean. Anyway, I'm really excited. I think we do, in fact, have the perfect guest, someone who I've been a big fan of for a long time, Someone I've wanted to have on the show for a long time. He's probably one of my top five favorite posters on Twitter, although he's quieted down a little bit lately. But I think he's addicted like the rest of us. We're going to be speaking with Krishna Mamani.

5:02He is currently the chief investment officer of the Lafayette College Endowment. Previously, he was the CIO at the Oppenheimer Funds, which was bought by Invesco. So a long storied career. Someone who knows about all of this stuff. So Krishna, thank you so much for coming on the podcast. Thrilled we can finally make it happen. Thank you. Thanks for having me. Absolutely. What do they teach you in school about diversification? What is when they, you know, when you're training to be an investor, an asset allocator, what do they actually, what do they tell you? Diversification is the biggest free lunch available in the investment world.

5:37And I think from a longer term perspective, that is absolutely true and probably something that we ought to think about. But as you mentioned, the results over the last, it's not just last 15, 20 years, the results over the last 30 years, 40 years have been very, very, very, very different than what you would have expected if you had gone down this path. It doesn't mean that the basic principle isn't invalidated. It just simply means that you have to think about it and acknowledge the fact that it hasn't worked out according to plan. Where did the diversification thesis actually come from? Well, the diversification thesis basically says that if you have security-specific risks in individual securities, if you can find a way of diversifying that away, then that is something that you should do because it reduces your overall risk profile without sacrificing too much in return terms.

6:34So that's where the theory comes from. No, no, no, but who propagated it? It must have had an endorser or it must have made its way into the market in one way or another. I think it came from Cap M and William Sharpe and that coterie of academicians who basically did the pioneering research in this field in the, let's say, 70s, 80s and early 90s. In my 401k, I have a very conservative, diversified fund. It has not kept up with the S &P 500, I don't think. But every once in a while, such as the first couple weeks of April 2025 or the first couple of weeks of March 2020, I take a look at it and I'm like, oh, I pat myself on the back for those moments of diversification.

7:25Is it worthwhile just for those reasons? Every once in a while, you're like, okay, you know what? This makes me feel good. I'm not going to panic less. That 401k, it actually stays close to all-time highs. I keep allocating it a little bit. How much is that worth in terms of that comfort that I get for like five minutes every 20 years relative to the cost of underperforming a simple S &P 500? Paying a price for peace of mind. Yeah. Well, so again, my argument isn't that diversification is a bad thing. I think from economic principles, from financial principles, diversification is a good thing.

8:06And if you can find a way of diverse or mitigating your overall security specific risk, you are to do that. The point I'm trying to, I would like to make is the fact that it hasn't worked. And therefore, kind of relying on 30 years or 40 years or 100 years of history to come to some sort of investment principles that people follow very religiously, you know, hasn't worked. So shouldn't we kind of think about that and try to delve into what are the drivers? And it opens up a new research field because I would argue that the overall research in financial kind of investing is basically hasn't evolved a lot since the 90s.

8:50It's basically redoing the same papers with a little bit of changes here and there. But the core thinking, CAPM related core thinking really has not changed. So I think the right way to use this period of underperformance, whether it'll sustain itself or whether, you know, 2025 changes the paradigm altogether or not is kind of irrelevant. The key point is, let's kind of look at this period. Let's look at it in a little bit more detail rather than being extraordinarily doctrinaire about things. which is anytime you post on Twitter that, well, my international funds haven't really worked for me, I get schooled by all sorts of people.

9:34But the fact is they haven't worked for me. And I continue to do that. I have a very diversified portfolio and I will probably stick with it. But I think it is also fair to recognize that it hasn't worked. And therefore, we should look at it in a little bit more detail and kind of not take the mantra of diversification as religion, which is what it is right now. So in your opinion, what are the drivers or the reasons why it hasn't worked? Because I imagine, you know, you could tell a story that the big tech stocks in the US have just been phenomenal companies that continue to throw off cash. You could maybe tell a story about the benchmark indices, which we spoke about in the intro.

10:20You could tell a story about flows and investors crowding into stocks. Why hasn't diversification worked? Well, so again, let's just kind of narrow it down. When we are talking about this level of diversification, what we are talking about is U.S. stocks not working or U.S. stocks doing better than international stocks. So that's what we are talking about. I think there are several drivers. I think the kind of the tech supremacy of S &P 500 is certainly one of them. The profitability of the tech franchise is another one. Low interest rates in the U.S. where growth was higher than interest rates certainly was a factor in driving returns.

10:58And kind of the existence of private equity, which got multiples high. So there are a plethora of reasons as to why things haven't performed. and therefore, you know, it is worthwhile spending a little, you know, these are speculations on my part, but this is worthwhile spending a little bit of time figuring this out in a little bit more rigorous way than we have done so far because, you know, right now, again, if anybody puts up a notion that diversification is bad, they'll get schooled. But I think given the length of time that it hasn't worked and given the length of the magnitude of how it hasn't worked, I think it is worthwhile spending a little bit of research focus to analyze what the drivers were, as you say, and see if there are some other things that we can divine out of this 30-year episode.

11:54So I totally appreciate the need for additional research, and I would agree with you on that. But is saying that diversification hasn't worked the same as saying that investors should only buy winners and avoid all the losers? Well, so I think there's an element of that for sure. That is, international markets have done poorly relative to US markets. One anecdote here. I used to be the spokesperson for Oppenheimer Funds with respect to globalize your thinking in 2011 when the campaign came out. So you were a messenger. I was the messenger of this thing. And I kind of diversified my portfolio based on that thinking.

12:35The idea about portfolio construction with respect to diversification isn't that diversification is a bad thing. I think that's a right approach. I think given the history over the last 30, 40 years, we are to think a bit more about are there other drivers rather than just simply believing in the historical track record and the volatility context of that historical track record.

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14:01In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. So I am very partial to the idea that a big part of the story is the unique profitability of large tech companies in the U.S. But that is clearly not the only story because it's not just that global stocks have underperformed. In many instances, they've just performed badly against anything.

14:40I'm looking at a chart of EWZ, a popular ETF to exposure to Brazil. it's basically flat for 20 years. I assume the Brazilian economy has grown quite a bit in the last 20 years, but it has not redounded apparently to the benefit of an American shareholder investing in Brazilian stocks at all. So obviously this can't be the entire story that it's just about U.S. outperformance. It's actually that global stocks have done bad. What's going on? Why in a world in which the economy is generally more or less growing elsewhere, have international equities actually just done bad on an objective basis? The old adage is the economy is not the equity market.

15:21Yeah, yeah. And that is absolutely true. I think the period from, let's say, 2010 onwards in the US is especially galling. And I think if I had to come up with a reason as to why that has kind of worked out the way it has worked out, is basically because of dollar-related global flows. Okay. That is, I think, the profitability basically attracted a whole lot of things that were going to come to, or a whole lot of flows that were going to come to the U.S. because of the perceived strength of the dollar during that period. Because as I said before, growth was higher than interest rates in the U.S.

16:01So it was a natural kind of place for those flows to kind of arrive at. But like, again, another one, Mexico, it's just flat for 20 years. So in your story, it's not quite flat for 20 years. Yeah, it's where it was in 2007. So like flat for like 18 years. Like the flows are a big part of the story for the fact that these stocks can't deliver anything over a decade's time horizon. Well, so I think domestic flows relative to international flows are really very important in determining the state of the equity market. Okay. And the best example counterpoint to what you're talking about that I can give you is really India.

16:40Okay. So India used to be a market that was supported entirely by foreign flows. Okay. And foreign flows, and when there was a panic in New York, all sorts of money would leave India and come here, and the stock market would crater. Over the last, let's say, 10 years, as the Indian economy took off, and financialization and the saving vehicles in India changed, and the equity market, as opposed to land and property became the primary source of savings and deployment of those savings. I think the characteristics - So capital depth. Yes, capital depth, financialization of the economy. And right now, the drivers in the Indian equity market, at least for the last five years, really has been the domestic investors as opposed to foreign investors.

17:27So I think that is really, from a flow standpoint, that is the difference. Yeah. And if you look at the MSCI India index, it's like the exact opposite. That actually looks like it's done well. Oh, Mexico and Brazil. Joe, you know what I always say? I do, but I'll let you say it. Are you going to say it? No, I want you to say it. Flows before prose. Yeah, he did it. All right, that makes me happy. By the way, I stole Tracy's joke in the intro. She's not happy about that. I said that thing about how Shakespearean. Tracy said that right before we went on air. I want to give her credit. Aw, thank you, Joe.

18:01But now I feel petty. I didn't expect you to do that. Okay, going back to the conversation. I'm trying to make you feel petty. You made me feel bad, so now I'm trying to make you feel petty. All right. All right. Fair. Going back to the conversation. Can you talk a little bit more about the role of the benchmark index providers in all of this? The thinking in this world is always benchmarks are terrible, but they are terrible, but better than anything else that we have. So I think there is a role for benchmarks and benchmark providers are important participants in the market. And, you know, the market capitalization of companies like MSCI and S &T Global kind of tell you as to how valuable those franchises are.

18:43The way as an investor, if you are an asset manager or if you are kind of an asset allocator, how you are doing has to be evaluated in some sort of a rigorous framework. And that's where benchmarks come in. And that's why we need benchmarks, because otherwise it'll be free for all. You know, I can, as an asset allocator, I can, you know, if my returns were 10%, let's say, I can always claim that I did a fabulous job and my benchmark outperformed by, you know, 1 ,000 basis points. So it's a, you know, there is tyranny of benchmark, but this is a necessary tool that we need. I think a separate question is the extent of the kind of the diversification of the benchmark.

19:31So you talked about MSCI Acqui and even things like Russell 3000 or things like that. So there are issues with diversification. I think S &P 500, on the other hand, for the large cap U.S. market is a very, very solid benchmark. I mean, there are peculiarities with respect to additions and taking out of the index, but I think that is to be expected in a dynamic market. And I think for the most part, it has worked out reasonably well. You are an employed person. You have had a career despite imbibing the gospel of diversification. You have had a successful career in the markets. Talk to us, though, about like your peers and career risk, etc.

20:16Because, you know, at some point, like you keep making less money than you could have by buying the U.S. What does that do? And what have you seen? When you look across the industry, do you see an evolution whereby people who were taught the same thing as you about diversification have increasingly felt pressured to not be diversification? Or did it disguise their diversification in some way that they could tell their investment committee, we're diversified, but actually we just found a way to go extra long in Vidya? I think in the institutional world as opposed to retail world, I think diversification is still the matter.

20:52And again, to emphasize, it is the right thing to do. But why do you keep saying that? If you think about it in statistical terms, there is a way to diversify the tail risk. But what I'm saying is we need to evaluate that and see or reevaluate that and see if there are some other techniques and methodologies that we can use where this doesn't become the only way for you to mitigate your overall risk in the portfolio. So what would be another technique or methodology? Evaluating from a track record standpoint, let's say, or from a performance standpoint, let's say, does adding emerging markets to a globally diversified portfolio, does that really add a lot of value to the process?

21:38Does a just, let's say, developed market index, both the US and Europe and perhaps Japan, can that deliver some level of correlation to the overall index without you being stuck in places like China for a long period of time or Brazil or Mexico for that matter? So I haven't found the solution. If I had found the solution, I would have implemented that in my personal portfolio. My point is we ought to think about that and we don't really think about it because diversification on a global basis has been the mantra and the accepted doctrine forever. But say more about the career risk. Okay, at the institutional level, they're fine.

22:21It's like, oh, yeah, diversification. But, you know, for example, I'm always a big fan of reading the Bank of America fund manager survey every month. And these are discretionary fund managers that can do everything. And for like 10 years, with a few exceptions in there, they say long tech stocks is the most crowded trade. But also it's the trade that continues to work. Talk about this effect, this sort of the anti-diversification success on the sort of thinking of a fund manager who probably doesn't love being in a crowded trade but also doesn't want to underperform. Well, so I think an active manager is kind of caught in a way, right?

23:04On the one hand, you have to outperform your peers. On the other, you have to outperform the benchmark. Okay. And that is a challenge. And that challenge leads to the sort of things that you are talking about. That is, well, they may do very well relative to the benchmark without crowding into the most crowded trades. But if their competitors are crowded in there and do much better than them, that's an issue for them. So, you know, that's their way of solving that particular challenge. I think the crowded trades have been there for a long period of time. But I think the way I would evaluate that is how much of a portfolio manager's performance is really driven by the core views that they express as to what their edge is.

23:58Right? I don't understand that. So what that, you know, every portfolio manager would tell you that their strategy is we look at ROIC and that's what we focus on. And therefore, that's how we kind of structure our portfolio to pick companies individually. Yeah. Now, if they say that thing and they are kind of focused on and that's how I hired them. Yeah. And instead, they focus on getting into, let's say, crowded trades because they are going up. Then that's really a red flag from an allocated horseback. Got it. So Joe alluded to this in the intro, but if you were diversified into international stocks, there were a couple moments this year where you actually looked really smart.

24:44And you did get a little bit of peace of mind as the S &P 500 was selling off. European equities were surging earlier in the year. But what do you need to see for a durable change in international versus U.S. stocks and specifically U.S. tech stocks? So I think the underlying economic environment has to change for that dynamic. Actually, underlying economic and industrial environment has to change dramatically for that to kind of play out. So if you look at the world from a capitalization standpoint, what we are talking about is U.S. on one side and Europe, Japan, India, China, Brazil, those are really the places that we are talking about.

25:33So structurally, U.S. economy has done better. The dollar is the reserve currency. And the growth outlook over the last 10 years have been much better in the U.S. than it has been. So flows coming into the U.S. ought not to be a surprise in that environment. Okay. Right? And for flows to go the other way, basically, the fiscal expansion in Europe has to get going in a massive way. And that fiscal expansion has to lead to companies and institutions that can take advantage of that fiscal expansion and therefore deliver superior returns to their shareholders. And therefore, I'd be interested in buying those companies.

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