The feedback to last week’s podcast with Ray Dalio was great; there were multiple requests for a transcript. We managed to turn that around pretty quickly, and it worked out well enough that I am going to try to make this a regular weekly feature of MiB.
You will find the transcript of our conversation with Jeffrey Sherman, Deputy Chief Investment Officer of Doubleline Capital, below. The audio can be found on Bloomberg, iTunes, Overcast, and Soundcloud. Our earlier podcasts can all be found on iTunes, Soundcloud, Overcast and Bloomberg. As always, your feedback is appreciated at “mibpodcastATbloombergDOTnet.”
ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast, I have a special guest and this was so much fun. His name is Jeffrey Sherman. He is the — I am going to make him CIO of DoubleLine and one of the people who came over from Trust Company of the West with Jeff Gundlach to help set up.
He actually is Deputy CIO, as well as sitting on a number of different executive management committees, fixed income financial allocation committee. He runs a number of Farm Funds as well as co-runs some funds with Jeff Gundlach and is as about as knowledgeable with Quant working in the fixed income and equity and commodity space as you’ll ever want to meet.
We really don’t go too deep into the weeds on the wonky Quant stuff, but it’s really a fascinating roll up your sleeve sort of conversation. He understands this as well as anybody out in finance. He also hosts his own podcast, which we’ll talk little bit about, so I found the conversation to be absolutely fascinating and intriguing and I think you will too.
So with no further ado, my conversation with DoubleLine’s other Jeff, Jeffrey Sherman.
My special guest today is Jeff Sherman of DoubleLine Capital where he serves as Deputy Chief Investment Officer. The CIO of DoubleLine is Jeff Gundlach, who coincidentally was the very first broadcast guest on Masters in Business.
Jeff Sherman previous to DoubleLine worked as a Senior VP at Trust Company of the West where he was a portfolio manager and Quant analyst focused on fixed income and real asset portfolios.
He has a BS in Applied Mathematics from the University of Pacific and a Masters’ Degree in Financial Engineering from Claremont Graduate University. He is also CFA charter holder, as well as a financial podcaster, Jeff Sherman, welcome to Bloomberg.
SHERMAN: Thanks for having me Barry.
RITHOLTZ: So I have to start with the education, Applied Mathematics and Financial Engineering — did you know you wanted to go into asset management earlier in your life?
SHERMAN: Not at all. Not whatsoever.
RITHOLTZ: Really? Because that would suggest — oh, here’s a path to Wall Street.
SHERMAN: That’s right and what happened is, naturally, I guess, I was more inclined towards mathematics along the way. I started off actually as a pure mathematician, which is a lot of abstract math and just trying to prove concepts, a little of logic really.
And although it was okay to me, it just didn’t really seem to have a long-term path. Obviously, you can be a professor —
SHERMAN: I mean talking about ring theory, group say — I mean, you’re already falling asleep.
RITHOLTZ: No, I love that stuff —
SHERMAN: Okay, good. So let’s talk deeper about that —
RITHOLTZ: Okay, everybody else will fall asleep.
SHERMAN: Oh there we go, so we’ll transition them, but the idea was the applications of mathematics. Typically, it’s applied to a lot of physics, right, and engineering concepts and I was always kind of curious by statistics.
You know, for some reason, I like the probability and statistics courses a little more and so I actually changed my major around the middle of my junior year to become an applied mathematician.
But unlike the traditional folks, I didn’t use the engineering and physics as the application. I actually used the stats and probability, so forgot to really apply for a job as I was going through my senior year —
SHERMAN: Yes, well, you know, you kind of get stuck in that academic lifestyle and so I decided to take the GREs and just try to keep going to school, so I ended up applying to grad school and ended up down in Florida State down in Tallahassee.
And interesting place. Didn’t have a lot application towards statistics and probability. As you might think of them, they’re pretty well-honed on the meteorological tilt. There’s these things called hurricanes that they study and they are well-known for that.
So my application got thrown out the window of statistic, not my application for grad school, but they said, “Everybody learns fluid mechanics here, and by the way, here’s fifth semester physics. Figure it out.”
And so, I was doing that along the way. It’s kind of late — like late 1999, early 2000, realizedthere were these Quant jobs on Walls Street and there were these programs that actually had a financial tilt and so, similar types of equations, kind of like thinking those areas and started taking simulation and things like that and ended up transferring back to Claremont, closer to home back in California and went from there.
RITHOLTZ: Financial engineering. Speaking of another mathematician, you were working at the Trust Company of the West with a gentleman named Jeff Gundlach.
RITHOLTZ: What was that like when you were there? Tell us about your relationship.
SHERMAN: Well, it was nonexistent when I started. I worked in a different department and I remember at the time, this is probably a story, a lot of people haven’t heard is Mr. Gundlach, we’d go around and put out puzzles of the month and they were always some quirky, very deep in thought puzzle and it was always, the rumor was if you could solve it within the month and turned in to him, you could get a job in his department.
I’m not here to tell you I solved one of those by the way, but it was always curious to me, you know, someone that’s kind of challenging folks in the workplace and obviously, as I was — I was working in the risk type group and kind of the middle office type analyzing things and just seeing kind of track record of the team and how the team had some autonomy was always something that I wanted to do.
And so, I just kind of started hanging around the folks in the team, trying to, you know, get my name known or something to try to get in the group.
RITHOLTZ: So you never solved one of his puzzles?
RITHOLTZ: And then he —
SHERMAN: I don’t know if he actually — for fairness, I am not sure if anyone ever did.
SHERMAN: I believe he probably did, but I’m not sure if anyone ever did and actually got rewarded with that, it could have just been a rumor, but the puzzles were available, I do know that.
RITHOLTZ: It’s an interesting crowdsourcing. They could be puzzles he couldn’t solve and said, “Let’s see if we can find someone else who can do the heavy lifting…”
SHERMAN: Again, I don’t know the answer to that, but again you have to ask him next time you see him.
RITHOLTZ: I will. So he leaves to launch DoubleLineon his own. How did you go about saying, “Hey, Jeff. I think you need another Jeff in the shop?”
SHERMAN: Right, well you know, I was on the team at that point in time. I had been with the team probably at least around five years — four to five years at the time, and it was a very quick kind of movement and a bunch of people on the desk were talking about you know, “What should we do?” And it was a pretty easy decision.
I was in my early 30s and I said, “You know, if there’s a risk to take. Now is the time to do it, one,” and you know, one of the most respected investors in the world, why wouldn’t you take a risk to join his personal new venture and so from that perspective, it’s almost one of the things people call a no-brainer.
Obviously, there’s a little bit of you know, strife and turmoil internally and again, I look back and the rest is history.
RITHOLTZ: You have a lot of different subject areas you cover. You’re Deputy CIO. You’re on the Executive Committee. You’re a fund manager. What takes the most of your time? What do you focus on the most?
SHERMAN: Well, I’ll clarify that. I don’t run the Executive Committee.
RITHOLTZ: You’re on —
SHERMAN: I am on it. Yes, yes.
RITHOLTZ: Did I say you ran it?
SHERMAN: It sounded like it to me.
RITHOLTZ: I tend to give people promotions.
SERHMAN: You know, hey, it’s good to be here. But that said, most of my day is spent between facing clients, you know, portfolio review, strategy reviews, giving outlooks and forecasts of how we’re thinking about the markets and obviously, you know, coming up with ideas for implementation.
So our team works on the asset allocation side, so were trying to kind of find relative valuation across various sectors of the bond market. Additionally, you know, we run our commodity strategy. I’ll quantitatively run it.
My team also helps run the equity products that we have on the — it’s kind of a blend of an index with some active fixed-income management and so again, it’s — every day is different, but that’s what makes it interesting, right.
You don’t come in and do the same thing day in day out, and I always view it as a problem-solving exercise, right. The ideas you are trying to find, you know, inefficiencies in the market, something that looks attractive. Perhaps something that people are missing in the puzzle and more importantly, trying to poke holes in what we own today, right.
So that’s a big part of it — it’s that, are we missing some risk out there? Obviously, the exogenous ones you can ever figure out until after the fact, but it’s also, are we getting lulled into an environment like today, which is complacent, low volatility, not much going on? Are we being lulled to sleep as well? And is or something we can do in our portfolios to help kind of offset that or to try to think about something that’s again somewhat exogenous to the process today.
RITHOLTZ: Here’s a rumor that I just love. Bob Schiller visits DoubleLine’s Los Angeles office and more or less starts pitching CAPE as a way to manage equities more safely and then somehow, this becomes a portfolio. How exaggerated is that?
SHERMAN: There’s some truth in it. The facts are — we don’t want fake news, right. We want facts, right?
The facts are that Professor Schiller was in his office and Professor Schiller was talking about his CAPE Index Family of the products he had partnered with Barclays to work on and I don’t know if he pitches in a more safeway or that he was actually there truly pitching the product because that’s not really Professor Schiller’s style.
He’s a very humble and he likes to talk about ideas, but I don’t believe it was a full-blown pitch. The bankers with them, well —
RITHOLTZ: That’s a different story.
SHERMAN: I think perhaps they were pitching and the question became, “Okay, this is great. We run a lot of fixed income assets. We have a macro fund and we have a hedge fund that we do things where we could buy these types of products,” but, “So do you want us to just trade this or what’s the idea here?”
So from there, what we ended up doing was taking a look at the family indices and thinking about is there any merit here? And at first, looking at it, cursory glance, thinking you know, just another value product. You know, so okay, great good job.
RITHOLTZ: So using PE? Using 10-year PE?
SHERMAN: Yes, using like a CAPE ratio which is a 10-year price ranged ratio because the longer time, you’ve got inflation-adjusted of course.
RITHOLTZ: You get a full cycle, blah-blah-blah —
SHERMAN: Well, who knows if it’s a full cycle anymore? Well, while you’re eight — you know, can we —
RITHOLTZ: — off of the —
SHERMAN: — off of the low. I know you’re pet peeve about that.
RITHOLTZ: You know my peeve about that.
SHERMAN: Right, and the bull market starts with a new high, I get it. But that being said, I have ever read enough and heard enough about it, but what we did is started to do some kind of statistical work on it.
Like a kind of factor decomposition and things and I get — the story I like to tell is that, the first blush through I just said, “This is wrong. These proposals make no sense. You still have like residual return alpha in there after this process of adjusting for factors.”
RITHOLTZ: So in other words, you’ve been saying there’s something to this and when you it’s wrong, “Hey this is identifying an inefficiency that you hadn’t previously considered.”
SHERMAN: However you don’t know me well enough, Barry. The first thing I said, “That has got to be wrong. It has got to be wrong.” And so, cranked through it again and then the next step after we see it again, go from monthly to daily. Started looking at different time periods. I go, “Now, give me the data set. I want to make sure — let me look through how you’re doing it.”
And yes, you’re absolutely correct. It’s that there seems to be something beyond what’s in the factors. There’s nothing wrong with factor decomposition or factor portfolios. They’re great, but if everybody can deliver to you and it is commoditized, what’s my edge? Right?
So what we ended finding out there is that this excess return seemed to exist and we started going through regime changes and looking at different rate environments and different growth and recessionary areas. And what we found is, it seems to be relatively robust.
And so now, the big question becomes, we have this equity index that we’ve seen that appears to deliver something different in the value space or even just in core large-cap equity in the US, what do you with it?
Right, DoubleLine historically has been known for being more fixed-income — we’re in it. So what we do with it?
And so the first thing I think about is, why not do it as an overlay? Right? So an overlay means that you can get this exposure through derivative like a swap and you can put that on top of let’s say, a treasury portfolio. Now that’ll replicate the total return and you can deliver that, but that’s no fun. That’s just an index business.
And if you’re not familiar, we run about $117 billion of actively managed product. So from the standpoint of what to do with it, why not be a little active with that treasury portfolio? And why not run things beyond treasuries? Why not do what we do well and try to build a diversified, kind of lower risk fixed-income product? Don’t look like the traditional intermediate term bond funds, but run something that will take a little bit of interest rate risk, take a little bit of credit risk and use our macro forecasting to blend that together for the right environment?
And if you do it right, you can add, let’s call it a couple hundred basis points here over the index, so if you have a good product and a process that you believe in from the equity side, which really resonated with us.
RITHOLTZ: So you by the four cheapest S&P 500 sectors as measured by the 10-year CAPE?
SHERMAN: Not precisely, so there’s a couple of things different there. One is, instead of using just the CAPE ratio to identify the value, think about like for instance, the technology sector and think about utilities.
Historically, utilities have always truly traded a lower multiple in technology, right? And then there’s reasons for that vol — you know, highly regulated industries versus highflying growth of these stocks —
RITHOLTZ: Dividend blah-blah-blah.
SHERMAN: Yes, all the traditional kind of metrics you would think for that. So if you just use the CAPE ratio, you would always buy utilities for instance.
RITHOLTZ: Oh really?
SHERMAN: Because it would be one of those lower valuation sectors, at least in a historical context and that would introduce bias to the portfolio.
So to normalize this or to try to standardize it, what you do is you compare each sector’s CAPE ratio to its own historical average.
So if you think about it, it is normalizing it for its own trading range.
SHERMAN: Now, you have a basis to compare them —
RITHOLTZ: So in other words, you’re picking the four least expensive sectors relative to their own history?
SHERMAN: You’re almost there.
RITHOLTZ: Getting closer.
SHERMAN: You’re getting closer, thus far that’s all the information you have. That is correct.
SHERMAN: So you rank these each month and you’re going to pick the bottom five, and then of those five which are the cheapest because it’s valuation, you want to avoid value drops, cheap getting cheaper, right, falling knife, all those sexy adages we’ve put to that process. What you do is apply momentum.
So of the five sectors whichever one is the worst performer, you throw it away. So think about your city in 2014. Energy is extremely cheap on a on a multiple basis, especially relative to its own history on this CAPE basis, and all of a sudden, oil starts declining, middle of the second half of 14 and by a couple of months, because of such negative performance in the equities, it kicks it out of the index. So you’re left with the other four.
Well, this actually would’ve saved you if you’d just only focused on the five, it saves you approximately 600 basis points per annum over the next couple of years.
RITHOLTZ: That’s huge.
SHERMAN: Right, so that’s —
RITHOLTZ: So is CAPE plus a factor?
SHERMAN: Plus a factor, but you’re not trying to emphasize the factor, right? So I like to say that we’re not factor investors. The factors are the result of the process.
RITHOLTZ: And who came up with this really interesting way to use CAPE as a basis of creating an equity-like product?
SHERMAN: Not me, first of all.
SHERMAN: I am not going to take credit for that even though you want to give me a promotion on it. No, no. I am not going to do that. But this was a joint effort between Professor Schiller and the folks at Barclays.
So after — I think it was in early 2010, they started getting together working on this project to try to use the CAPE ratio to do something divestible.
You know, there’s all of these critics out there about the CAPE ratio, “Oh, it doesn’t work.” Right? It’s been above average for long period of time.
RITHOLTZ: Well, you can’t just use it as a buy or sell decision by face value, that’s why people say it doesn’t work, but they’re really not looking at it correctly.
SHERMAN: I would agree with that and I would agree that — what is CAPE? It is a valuation metric. What do valuation metrics say? They don’t tell you when to time the market. They tell you how to think about prospective returns.
And that’s exactly what the CAPE ratio does. When it’s above average, it says, you should expect below average returns. Wow. That’s not very hard, but people want to say, “Oh, it’s at this level. The market hasn’t crashed. It’s stupid.” Right?
But if you look at any valuation metric today, they are in — and I am going to imply it to the US equity market, at least as many as I’m aware of, they all say, “The market is overvalued.” But it doesn’t say it’s going to crash, but for some reason, people get that fascinated by this CAPE ratio and just want to attack it.
And again, it does have some good credibility of talking about forward-looking returns. In fact, it has one of the highest R squared of the metrics out there. However, it doesn’t say when to get out of the market.
RITHOLTZ: I’m fond of reminding people that stocks were cheap in the 70s and they did poorly and they were expensive in the 90s and they did really well.
SHERMAN: Right, well — and you know, the level we see on the CAPE ratio at the US equity market, the large cap had — this is the third time we’ve been here and both times, once it’s hit this level, at some point, it would collapse.
You had the great depression, which we lost that 80 percent. No big deal. You know, whatever.
RITHOLTZ: What’s 80 percent between friends?
SHERMAN: Yes, especially if we compounded. It doesn’t take much, but 500 percent to get back to breakeven that is and then get in your bull markets as you like to say, right?
SHERMAN: But then the second time, it was in the technology kind of boom and it went up like another 75 percent or 80 percent before it ultimately did crash.
SHERMAN: We’re putting this all together, there’s nothing that says — you know, we have two data points. Not very robust statistically —
RITHOLTZ: Right, not a good set.
SHERMAN: Right, but it does strike some fear, but if you want to get bullish, I mean, just think of the Japanese stocks in late 80s. I mean, they traded with a high 90 CAPE multiple.
SHERMAN: So I mean, look, we’ve gotten a couple hundred percent to run without even earnings growing if you believe in the Japanese model.
RITHOLTZ: Let’s talk a little about the two Jeffs which is how you and the other Jeff, Jeff Gundlach is known.
He has a pretty wild origin story. He is a board drummer in a hair band watching the television show Lifestyles of the Rich and Famous when he decides, he’s tired of being broke and takes a phonebook and just literally starts reaching out to finance companies. More or less some, something along those lines —
SHERMAN: He looked up the words “investment banker” I think.
RITHOLTZ: That’s right. That’s right.
SHERMAN: And it was in the Yellow Pages.
RITHOLTZ: It was not in the Yellow Pages. What was your origin story like?
SHERMAN: Nothing dramatic like that. After — I was in grad school and obviously, one of the things you have to do is an internship, to get some hands on experience and I did my internship at a place called Trust Company of the West.
And so, as an intern there, I accepted a full-time position while I finished up the last piece of my graduate work. So unfortunately, nothing really sexy like using the phone book at the time. I guess, if you could — if you want to get nostalgic. The way I got the internship I actually had accepted an internship back at Florida Power & Light down in West Palm Beach. I knew some people there from my Florida stay days, and so looking for internship, I tried some local companies, but I didn’t get any calls back.
And I drove my Ford Ranger pickup, you know, the two-seater, not the extended cab —
SHERMAN: And you can see — I’m me about 6 feet 3 inches, not the most comfortable ride cross-country —
SHERMAN: — in that four-cylinder beast that I had there and drove to a West Palm Beach to —
RITHOLTZ: From California?
SHERMAN: From California. Yes, I was —
RITHOLTZ: So like a week driving cross country —
SHERMAN: Four days. I mean, there’s not a lot of money to go around. Internship, you get there as soon as you can. Those motels are expensive across the country. That’s like 30 bucks a night.
So anyway, I get there and why I say it’s a little nostalgic is, I get a call from my roommate back in LA who says, “Hey, there’s a guy from TCW who left you a voicemail…” you know, ” — on the answering machine.” Right? This isn’t cell phone days, and so, “They’re talking about interviewing you for an internship.” So I said, “Great, I’ll call them.”
I ended up actually calling them, did the interview and at the end of it, it’s like, you know, kind of what’s your timeframe? “A couple of weeks or something like that.” I said, “I start a job in like four days, but if you guys can offer me the internship, I’ll come back.” So I had to meet with someone else and fortunately, they did and I made the trek back three days this time because again, no funds are coming in too, so those were like 14 to 15-hour days, but that’s how I came back to start my internship.
RITHOLTZ: That’s a pretty good origin story. That’s not terrible. That’s an interesting cross-country and back in a week essentially.
SHERMAN: Yes, I mean essentially, like 5,000 miles over the course of a week, a week and a half, not the most pleasant experience. There was a lot of pit stops along the way. I think I was doing — because of my legs aching no more than like 90 minutes, I was getting up, getting a quarter tank of gas each time just to do something.
SHERMAN: That’s — you’ve got to have a good playlist on your CDs.
RITHOLTZ: So the other Jeff, which is what people used to call you, the primary Jeff is Gundlach, what’s it like working with a guy who is a force of nature like him?
SHERMAN: It’s what I now. You know, this is the team I’ve worked with the majority of my career. I’ve been around this team, you know, in my entire formidable years as being an investor and so, you now, he is human like anybody else. We collaborate. We all work together. He fosters a very great environment.
If you think about the amount of talent we have surrounding from our emerging markets team, our loan team, our high-yield folks, our mortgage people. I mean, we span the entire universe and he provides folks with a lot of autonomy. You know, foster growth, constructive criticism when necessary, but I think one thing that should be noted is he is a very good listener.
You know, if there are ideas, there’s different ways to do something, he’s always open to them, but if they’re wrong, he’ll tell you. So it’s a fair relationship and I think that’s why you see very limited turnover in the investment staff because it’s a good environment.
RITHOLTZ: What do you think when he goes on TV and says, “Sell everything.” How do you guys respond to that? Do clients call or what happens?
SHERMAN: Well my team’s office, we don’t sit on the training desk with everybody else. We’re kind of removed. I kind of like that little close knit with my team, but our team is right outside the media room. So we’re going, “That’s happening right there, right now.” Now, sell everything, you know, I’m not going to say that he’s always hyperbolic but I think, he’s trying to get a point across.
And what he is saying is that, at the time, this was right around Brexit, where everyone is telling you — it is right prior to Brexitthat this inflation is taking over. GDP is collapsing. We’re going to be stuck in this highly levered economy with no growth. I mean, it was just very negative time.
And idea was that, we can’t break really new lows on the 10-year. These markets aren’t responding in a way that’s consistent with the message and to sell everything is that, if you feel that you have too much risk on and you’re nervous by the phrase, “sell everything,” Barry, what that means is, you probably own too much risk.
And that was really the message behind it. Again, clients don’t take it as, “Well…” They’re like, “Should I just sell everything?” But it’s like, you’d tell people when you have a great market going on like we have in the equity market, people get extremely nervous and they want to sell everything, sell a piece.
Monetize something, but you’ve got to get back in the game to some — the “sell everything” mantra, I think I am not going to call it hyperbolic, but it’s meant to be there to try to drive a message home and it’s that, “Look, there’s a lot of risk out there you’re not seeing.”
RITHOLTZ: Reduce your risk levels and anytime you sell something you have to have a line in the sand to get back in, I assume.
SHERMAN: That’s exactly right and we were really focused on the bond market and the thing wasn’t just sell everything. You know, it was really related to an art piece too where it was, sell the house, sell the wife, sell the kids.
And so I think, he used that and he said, “Just sell everything.” And I think he used it in the Webcast a few days earlier and you know, we heard him saying it around the office, didn’t think it’d really go on TV, and said — but he did and you know, look he was right at the time.
I mean, there was a lot of risk brewing specifically in the bond market and yields shot up pretty quickly post Brexit and so, there was the entry point — we weren’t really doing a lot of trading at that time. We just hated the price levels and so it was time to start putting things back to work.
So it’s being patient too. Making sure that you don’t stray — don’t let the central bankers force you into the box, into positions you’re not comfortable with. Don’t have the full mode if you’re missing out with everybody else and you know, make sure you’re investing for your philosophy and what you’re trying to achieve and that’s really what it is. It’s that people have gotten accustomed to taking a lot of risk that’s really not in their normal zones, I would say.
RITHOLTZ: Let’s talk a little bit about stocks and bonds and commodities, which is telling us where we are in the financial cycle?
SHERMAN: Well, I think each of those three sectors of the market, those asset classes have a different time perspective and I think of the bond market as be more contemporaneous. It’s digesting macro data as it comes through. It tells us essentially where we are currently.
The equity market, obviously, the forward discounting mechanism, you think about when we’re in the midst of a recession, equity prices tend to be rising somewhat. When you’re in the middle to the backend of the recession as it’s think about the prospects looking forward and then I would call commodities are the more of the laggard. They actually tell you what has happened and the reason for the commodities being on that kind of backward looking thing is because, you’re talking about — or you already have consuming — or you already have consumed the commodity itself and so you kind of see this forward-looking thing, the supply and demand imbalance gets out of whack.
And so, they all tell you different things except — or they have different time horizons. Except right now, you’re getting a little contradictory afferents between these markets and in fact, with the commodity story, what you’ve seen is it’s been based on a lot of growth. Specifically industrial metals, very, very strong this year.
RITHOLTZ: So let me push back on you, the immediate response on commodities, I hear from traders all the time, “Oh, it’s weak dollar story.”
SHERMAN: Well, you know the dollar has been weak but if 80 percent is going to spike industrial metals’ prices 30 percent, I think there’s a little disconnect there. So the strength of the dollar is not going to pull if we rallied back to you know, early 2017 levels, I don’t think it’s going to pull down, you know, industrial metal prices — copper and nickel, specifically in that manner to reset those prices.
So it’s a good story, but we’ll keep it as a narrative that’s not necessarily factually correct.
RITHOLTZ: What about the flattening yield curve? I keep hearing people say, “You know, this yield curve is flattening and that suggests a recession is not that far off.”
SHERMAN: That’s right, but they — when they pull you the chart out, they start either in 2017 or they go back to really December of 2013 at the end of the taper tantrum. Remember the taper tantrum, although not December, if you go back time to peak, when that 10-year kind of closed at 302 and what were (twos) at that time, like 30 basis points, right?
I mean, massively steep curve, but if you actually pull the data set back, respect history, what you’d see is the average experience is in kind of the high 90 basis points, like 96 or 97 basis point average kind of using monthly data to shape this —
RITHOLTZ: Roughly, between two and ten.
SHERMAN: Two and tens, yes. It’s actually the difference between 10 and the two, we call it twos ten. But today, yes, you’re sitting in the mid-70s, but that’s not a recession indicator. In fact, we have some charts we use in a lot of our Webcast that we show that this is endemic of a Fed tightening cycle.
And so when the Fed tightens, the yield curve tends to flatten. What people get fearful is that if the yield curve inverts —
RITHOLTZ: At the end of that —
SHERMAN: Right and so I hear — I read a lot about, “Oh this is portending recession. Recession…” but it’s barely below average. To see a little bit of this flattening could take place but, what about the gross story, Barry? What about the idea that you know, we’re growing on a nominal basis in the four handles, right?
A real GDP is about 2.3 percent on a year-over-year basis. We’ve been growing in the low twos since the financial crisis, and you have this inflation print and if commodities actually puts you on the verge of getting a little more inflation system, perhaps that yield curve actually does steepen a little bit.
So we’ll have to see kind of on the inflation side, because the back end of the curve is very price closer to nominal GDP, and we haven’t even talked about the Feds unwinding their balance sheet.
RITHOLTZ: So let’s talk a little about the Fed unwinding their balance sheet. I keep — by the way, every time I reference, “They said, I hear trading…” you know the rumors that bounce around desks. One of the things we hear is, “Hey, you know, the Fed is behind the curve. They should have tightened much further already.” What are your thoughts on that?
SHERMAN: Well, if you want a recession, yes they should have tightened sooner, but the behind the curve is garbage. I mean, the fact that we can’t print a two-handle inflation consistently, the fact that we can’t print a two-handle inflation print consistently really does destroys that thesis.
Yes, unemployment is low, but there’s no wage inflation behind it. People use the hurricane spike at the, you know the 2.9 percent average hourly growth a couple months back, the month post the hurricane that it was, “Oh my gosh. Here it comes. Here it comes.” That’s revised then a little bit. The next print is 25. We’re back in the in the middle of the range.
And so the idea that the Fed is behind the curve, I think once again, it’s just a myth. The Fed has pushed this year. I mean they’ve raised rates twice. Their on their to third — the third hike and what you’ve seen though is because it’s put pressure on the front of the curve, which — you know, the Fed fund ties into LIBOR prime, all those rates, what you’ve actually done is constrict some parts of the consumer when they talk about credit cards, loans that are tied on the front end of the curve.
Almost everything outside of housing is tied to LIBOR, right? Or some derivative of buy at prime rate. So you’ve actually seen some constriction in consumer spending, so it’s a little bit strange. The bond market, you know, if you talk about term financing to corporate America, yields are lower today than they were at the beginning of the year, but the consumer is paying 50 plus basis points higher.
So for consumer driven economy, they have to be very careful. If 70 percent of GDP is coming from the consumer, we’ve got to be careful of like tightening that spigot too quickly and so, I don’t buy the idea that the Fed is behind the curve. In fact, they’re doing a double dose of tightening for the fact that they’re going to raise rates. They’re in the process of a hiking regime. That’s undeniable.
SHERMAN: And they’re reducing their balance sheet. They’ve already started last month. In October they started taking off $10 billion a month out of the balance sheet by the lack of reinvestment.
RITHOLTZ: Stop there because I’ve been discussing this with people and you get that thousand yard stare when it starts. Explain what it means for them not to roll over paper they have. How their balance sheet shrinks by them doing nothing?
SHERMAN: Right, so they have — there is maturity wall. Each month there’s securities that mature. Prior to October 17, they reinvested those proceeds at some point along the curve, both through treasuries and agency mortgages — government guaranteed mortgages. So by them not reinvesting the securities that means those securities and so they’re being held in what I would call a price taker hand that the Fed buys blindly, does not care what the yield is, right?
It now gets put out in the float of the market. So from an equity perspective, if we draw that parallel, imagine insiders putting securities out in the marketplace. So those bonds need to be digested by price discrimination or people who are price discriminatory when it comes to the price and yield of those securities.
RITHOLTZ: I suppose, it’s the Fed that buys it at any price, I would guess.
SHERMAN: Blindly, so you can think at the ECB EUR60 billion still a month that they’re doing until the end of the year, so by the Fed putting these securities out supply in the market, it needs to be digested by investors and so that means there’s a net supply of new bonds in the marketplace without even discussing the budget, discussing the shortfall there.
She deficit neutral $1.5 trillion that the new tax plan is going to cost every 10 years, so at the margin, it is not much on their balance sheet. It’s only $10 billion. You know, some firms get that in a month in terms of bond flow, so —
But the plan is —
RITHOLTZ: Or a day if you’re Vanguard.
SHERMAN: Yes, yes. Right. That’s the elephant in the room, right?
RITHOLTZ: But what we’re saying about the Fed is, don’t take that money and roll it into a new bond, which means that bond is now those — what would’ve been purchased and put back on the Fed balance sheet is now out in the marketplace.
SHERMAN: It’s out in the market, one. So the market has to digestive it. But don’t forget, it goes from 10 billion a month and in January, it’s on schedule to go to 20 billion a month and then in April 30 billion a month and then July 40 billion and in October 50 billion —
RITHOLTZ: So this isn’t them selling. This is simply them not renewing, not rolling over bonds that mature in order to shrink their balance sheet.
SHERMAN: That’s correct and so that has stated today. Remember the game plan can change.
SHERMAN: So what that means is, is that these securities were set to mature anyway and if you actually look at the Feds balance sheet and the maturity schedule, it always is above this threshold, so they will be barring any changes in the plan, putting these securities out in the marketplace effectively; however, they do have a little thing and they’d say, “Up to…” It doesn’t say exactly and there are a few months which — I can’t recall off the top of my head if there’s one month in 18 or if it starts in 19 where there’s not enough to actually dump the 50 billion a month.
So we’ll have to see how that plays out, but let’s talk about what happens if the Fed continues to press rates because there behind the curve? And we’re putting more of these bonds in the marketplace, we just feel that it has to be at the margin negative for yields, meaning, they should go up.
SHERMAN: Because there’s more float in the market —
RITHOLTZ: And yet, yields have not really picked up all that much. How you explain that up to this point late in 2017?
SHERMAN: Right, I think I am going to call it Super Mario now and I’m referring to the ECB President and you know, Draghi, he’s really got himself a conundrum. He’s got nominal GDP similar to ours. He’s got German Boones, the ten-year trading sub-40 basis points, you know where we’re sitting, we’re closer to 240 basis points. And so — and he’s got overnight lending rates negative 40 basis points, you know, we’re talking today at like one and three-eighths here in the US, so what is the disconnect between their economy which is growing. They have margins expanding. You know, they never had this recession and they’re continuing to grow similar rates. Why are their yields so —
RITHOLTZ: They (inaudible) they never had this recession. They had a bad couple of years and they certainly suffered during the great recession —
SHERMAN: Sure, but also, we did too really in profitability in the US. It was highly correlated to energy, right? It impacted the entire world, but I mean, we had a proper recession here in the US, which I’ll define as declining corporate profits consecutively. So it was approximately five quarters. We staved that off, right?
And really they did too, right? They never had the true economic recession that is typically associated with that and it’s one of the first times in history you’ve actually seen, even the US, go through the proper recession not leading to a true economic recession.
So when you actually look at kind of the spread and everything, I do believe if you look at yields, there’s been such correlation in global bond yields that the reason you have some of this kind of — I won’t call it a ceiling, but the fact that you have yields in the US a little too low relative to historical standards as measured by GDP, I think a lot of it stems from the fact that you had this compression because they continue to buy bonds.
It’s not just that they won’t hike rates; negative 40 basis points in overnight lending, but they also are buying EUR60 billion, so Draghi cut 30 billion of that out in January. That’s 30 less that — EUR30 billion left he’s buying and the Feds dumping more into the market.
RITHOLTZ: So we could see an increase in rates in 2018?
SHERMAN: Yes, and that’s kind of our stance at this point is that yield should push higher from these levels and historically, long bonds and you know, trade around nominal GDP. So that says, you know, maybe there are about 100 basis points to Rich today and Lawnbomb (ph) being the 30.
RITHOLTZ: We have been speaking with Jeff Sherman. He is the deputy CIO at DoubleLine Capital. If you enjoy this conversation, we love your comments, feedback and suggestions. Write to us at MIBpodcast@Bloomberg.net. You can check out my daily column on Bloombergview.com or follow me on Twitter @Ritholtz.
Be sure and check out our podcast extras where we keep the tape rolling and continue discussing all things bonds, commodities and equities. You can find those podcast extras wherever you find where podcasts are sold, Apple iTunes, Overcast, Sound Cloud and Bloomberg.com. I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio.
Welcome to the podcast. Thank you Jeff for doing this. I had so much fun on your podcast earlier this year and I knew I wanted to have you here for a while. Let’s talk about a few things we didn’t get to some questions I wanted to ask you during the regular broadcast portion and then we’ll jump into some more fun stuff.
So you mentioned Super Mario. We were talking about the Fed. We left out the third player in Central Bank —
SHERMAN: Kuroda San.
RITHOLTZ: Yes, what do you think about Abe (inaudible) and what’s going on in Japan and can you ever recall a period where the US, Japan and Europe were so out of phase with their recoveries and/or economic stimuli?
SHERMAN: Yes, that’s a lot to digest there. So essentially I don’t know how the BOJ gets out of there policy. I mean, they own so many equities. I mean, the data we see like 60 percent of the equity market, roughly the same with their ETF market —
RITHOLTZ: Like you can let you bonds just mature and roll off. You can’t do that with equities.
SHERMAN: Right and the other thing is that they’re supposedly targeting a rate, the rate isn’t the rate they’re targeting. I mean it’s flat out trying to manipulate the curve, but you know, the thing is, is that they believe it’s working. Abe got reelected got the majority which —
RITHOLTZ: The economy isn’t bad.
SHERMAN: The economy isn’t bad and they think they’re going to get their inflation, so we’ll have to see, but I think they’re the ones that are on cruise control. They’re not going to appeal this back until they get their desired effect.
RITHOLTZ: How do we explain that of all the major economies, they’re the ones that’s the most problematic in terms of their balance sheets, their demographics, their heavily export dependent economy and yet what is the 10-year in Japan now?
SHERMAN: It’s roughly — it’s usually in the single-digit basis points now.
RITHOLTZ: It’s amazing. So how do you explain that? Is Japan more creditworthy than Germany or the US? Or is something else going on?
SHERMAN: I think it’s something else going on too. I mean, it’s the home of the carry trade. It has been for so long. It turns into the flight to quality asset when there is crisis because as Japanese based investors, they have to invest overseas to get any semblance of a return, right?
And so what you find as when things go bad, they repatriate the money back home, get the strength in the yen. So I think the dynamics have changed over time, but I think what we should learn from it, it’s a precursor of things to come in the developed world and Europe is on that track, the US is on that track.
When you look at birth rates, we’re barely at replacement rates here in the US —
RITHOLTZ: We’re way ahead of Japan though. I mean, the US may be the best birth rate of industrialized democracy.
SHERMAN: Right that’s why I say, Europe is going to have the problem next.
RITHOLTZ: For sure.
SHERMAN: Right? And there’s one way to cure the birth rate, have kids one. Or then how do you — immigration is another thing that —
RITHOLTZ: Right —
SHERMAN: You need workers. It’s not necessarily having children, because that takes a while, even if we start tonight, Barry, it’s going to take, you know, 18 to 20 years to get that thing going.
So immigration is a good stopgap to for that time, but you look at things like Saudi Arabia, I mean, their workforce and prime working age is like 80 percent of their area has the prime working age, so I think what you see in to Japan, it goes to Europe next and then the US without changing its ways, ultimately we go that direction, but you talking decades, many decades down the road, but again we shouldn’t just turn a blind eye to what’s going on in Japan and that’s what happens when you have a closed off immigration system.
SHERMAN: And you don’t have the birthrate and again, the demography is horrible, you know —
RITHOLTZ: And yet they continue just puttering along. It’s —
SHERMAN: It’s good to control your own printing press.
RITHOLTZ: Well, to say the least. I have to push back against something you said or I may have misheard previously. You had said, this is the only profit recession we’ve seen where there wasn’t a subsequent economic recession.
SHERMAN: I believe that to be true, but —
RITHOLTZ: Is that the US? Or is that Europe?
SHERMAN: US, I was talking about.
RITHOLTZ: So US unemployment doubled from 5 percent to 10 percent, GDP dropped to zero. How is that not a —
SHERMAN: I’m talking recently —
RITHOLTZ: Oh recently —
SHERMAN: In recent quarters —
RITHOLTZ: Oh so you’re not referring to the financial crisis —
SHERMAN: Not ever, no. Okay, come on, Barry.
RITHOLTZ: All right, I misunderstood.
SHERMAN: I’ve been around at least that long.
RITHOLTZ: So you used 2016, 2014 —
SHERMAN: No, I am using 14 and 15, right? So that’s really when the —
RITHOLTZ: So you had to drop in profits —
SHERMAN: — drop in profits throughout most of 15, early 16 and then you started to see the recovery, so those are the five quarters I am referring to.
RITHOLTZ: Got it. So that —
SHERMAN: So you can fact check it later too, but —
RITHOLTZ: A number of — I think it was I am trying to remember who — (Acree) was forecasting that as a recession and it never showed up as a recession.
SHERMAN: It never materialized and if you look at the conference board leading indicator which is a great indicator of a recession, what you had in 15 is we got close, when we rolled over early 16, we got almost zero on that and the negative area, it tends to be recessionary. Not always, but again it’s one point in that rebound there, so that indicator still looks pretty good.
RITHOLTZ: That is the Reinhart and Rogoff explanation is filing financial crises, you get a very subpar GDP, very subpar employment and wage gains and it looks like you’re perennially on the verge of a recession, but you just slowly recovering and there is no credit available to push you away from that sub-1 percent GDP. Very little credit I should say.
SHERMAN: Then there’s two things that I kind of gleaned from that one is, it’s that you also have this high debt burden, right? And that’s the other part of the Reinhart and Rogoff Study is that essentially, when you hit certain debt to GDP ratios, you can just never recover.
And the second point I was trying to make too is that ultimately — or historically, I should say, when you had a nominal GDP sub-five in the US — that led to a recession and we’ve been perennially there’s —
RITHOLTZ: Sub —
SHERMAN: Sub 5 percent nominal, not real —
RITHOLTZ: Okay —
SHERMAN: Yes, sorry I wasn’t clear there, so include inflation, but that has to be tossed out. We’ve been sub-five for a long period of time, so I think it’s consistent with the Reinhart and Rogoff Study as well —
RITHOLTZ: And then the other thing I wanted to ask you about that I didn’t get to while we were doing the broadcast portion was on the Schiller (Kate) portfolio, there are a handful of questions. First, this model, you guys at DoubleLine are now running $1 billion or so? Is that right?
SHERMAN: It’s a little more than that. That’s about $6 billion today —
RITHOLTZ: Six billion, wow. And who is the fund manager of that?
SHERMAN: That myself and Jeffrey Gundlach.
RITHOLTZ: That would be you and Jeff, all right, so the two Jeff’s are running this is a $6 billion portfolio. You have — the original version was US, I understand there is a European version of this.
SHERMAN: Yes, that’s correct. So —
RITHOLTZ: The same basic model?
SHERMAN: The same model. Instead of using the S&P 500 decomposing its sectors, take the MSCI Europe and decompose it into its sectors —
RITHOLTZ: So if you are MSCI Europe, could you do the same thing for MSCI emerging markets or Asia or what have you?
SHERMAN: You are correct and there are other versions. There is a Japanese version. We do not have a product on that today. There is an Asia ex-Japan version as well and most people, the first question is what about emerging markets? And so remember, we’re using earnings data to build a CAPE ratio, so how do you think earnings 10 years ago looked in the emerging market? What’s the credibility and so although we’ve tried to gravitate to these international standards, you know, I am skeptical of the data set and actually how good the data is.
So perhaps at sometime, someone will be able to create a standard methodology for that, but again I think it’s too early to apply this in its form as it exists today.
RITHOLTZ: So that’s a really interesting product that that you helped to create based on Bob Schiller’s work. What is the process like for thinking about developing and rolling out new models, new funds, new what have you?
SHERMAN: I have a whiteboard in the office, you know, typically when people have ideas, our team looks at it. What’s the targeted market? What’s our edge? What differentiates us from other things?
And so although, we have probably 17 strategies that we offer out to the public today, when you look across them, they are different, but they’re all consistent, they are macro consistent. They are the same thinkers, so the same portfolio management. It’s a different risk profile.
And so what I like to say is it answers the question I get whenever I give a talk in front of an audience. If you had $100.00, Barry, how would you allocate it across your funds? And so instead of doing that —
RITHOLTZ: That’s a good question.
SHERMAN: It is a great question and so my response now is, tell me your risk profile what kind of drawdown do you like? What’s your objective here? And we can give you probably a strategy that’s a one-stop shop for it? Right?
And so the idea is that, if we find new things, we’re happy to get involved with them, but again we don’t want to saturate the market with products that we don’t think has some different edge than something currently exist, and so we’ve rolled out ETFs over the years where we self-advised them, different channels. We built a Use-It complex starting last year. It’s starting to take hold of the European markets and so, right now, we are looking at kind of that horizontal type of distribution. We’re trying to bring our services to more people, right?
And not necessarily we’ve got to have new products to do that.
RITHOLTZ: So that the biggest theme in in the world of investing for the past I don’t know, year, decade, fill in the blank has been the shift towards passive investing on the equity side versus active stock picking, but I think a lot of people make the assumption that the same is true on the bond side and from what most of the academic data shows is that active investing on bonds actually generates alpha.
Tell us about why active on bonds is so much more effective than active on equities?
SHERMAN: I mean —
RITHOLTZ: Small little question, tiny topic.
SHERMAN: Yes, small topic —
RITHOLTZ: It should take you 30 seconds.
SHERMAN: How much time do you have left for the rest of the day? I think what is amazing about it is, the bond indices first of all, historically have been kind of poorly constructed and what they did is —
RITHOLTZ: Over inclusive regardless of quality and regardless off —
SHERMAN: It’s not necessarily overly inclusive, what I would argue is — it’s the thesis behind it. The fact that they used market value of debt to index it, so the more you borrow, the larger position you are in the index. So they’re trying to bring that market capitalization idea from the equity market and turning the market value and fixed income and so it doesn’t makes sense.
So Barry, as you borrow more money for me, more investors should give you more money and put a higher allocation because you’re more creditworthy. No, you’re absolutely less creditworthy, so it’s actually inherently incorrect the way that the traditional indices have looked at that and obviously there’s other people trying to build new models behind that, but I think if you look across the universe, there’s a lot of S&P data that shows active fixed income management tends to outperform the indices over very long periods of time.
RITHOLTZ: It just is such a different set of data versus equities. It’s incomparable.
SHERMAN: Well, look at the ETF world. The passive ETFs, not the active ones, but the passive ones relative to active managed, either ETFs or funds. It’s the same thing that is true there.
RITHOLTZ: I am not saying that people are picking off the ETF investors, but there — you know what they’re going to buy. When the big new issue comes up, you don’t want to participate in it because you know they’re going to gobble it down and they’re price takers once again just like the Fed.
SHERMAN: And so you can move the bond price a lot more than you can probably the equity prices. That said this fervor for indexation on the equity side, there’s got to be a limit to it. Obviously, the whole world can’t be indexed.
RITHOLTZ: We’re at 35 percent in the US and if you listen to Bill McNabb or Tim Buckley, the incoming CEO, they point out that globally, it’s 5 percent.
SHERMAN: Right, that’s fair.
RITHOLTZ: So wherever that limit is, we’re still fairly early days here.
SHERMAN: Agreed, I also think back to how the product sold. The product isn’t sold, buy and hold cheap. A lot of people — I know you profess that your team, people say that, but a lot of people are saying active management doesn’t work.
So what the corollary is they’re telling people that indexing outperforms active management, so what happens when it doesn’t? Are the people still going to stay there, one? Secondly, we take this idea that if you index, you’re going to be buy-and-hold, you’re going to be. Now your job as an adviser is to help people stay invested, but let’s be honest. A market correction, a legit 20 percent, kind of drawdown, people are going to run for the hills too —
RITHOLTZ: Yes but, here’s the push back, so first I don’t disagree with anything you’re saying except the way it’s best phrased is, hey, active equity stock picking and/or market timing can beat indexing.
However, it’s expensive and net of fees and costs, there a bogey to overcome and what makes you think that you’re going find Bill Miller in 1989, not Bill Miller in 07, so those are the challenges.
SHERMAN: Right, but I think that’s also —
RITHOLTZ: That’s a different argument though.
SHERMAN: It is and the thing about it is, maybe what it is, is maybe there’s too many poor managers, maybe there’s to me people hugging the index —
RITHOLTZ: Bill Miller is still — Bill Miller actually comes out and says —
SHERMAN: I think that’s true —
RITHOLTZ: Hey, why are you paying up for clause and index?
SHERMAN: Right, and I think those people should be exposed and they are —
RITHOLTZ: They’re slowly are.
SHERMAN: You know what, got upset about the DOL Rule, but maybe we have too many bad advisers too that are flipping things and going this stuff.
RITHOLTZ: There’s no doubt.
SHERMAN: Right. So we’re cleaning all of these things up and if you’re getting an index product, pay index fees. I’m with you there, but I do think there are good stock pickers. I’m probably not one of them at this stage of the game, but there are people that you should reward there, and the activists, and you know, people have targeted niches. Those people will always be able to generate alpha, it’s just you have to identify them, yes —
RITHOLTZ: In advance.
SHERMAN: Right, in advance —
RITHOLTZ: When they’re small size —
SHERMAN: Not when they have — before they get too big —
RITHOLTZ: $55 billion hedge fund —
SHERMAN: You know that you have to pay four and 44 to get in, but —
RITHOLTZ: And they won’t even take you.
SHERMAN: And they won’t take you. They’ll close down and only run their own money, but —
RITHOLTZ: Not to mention any names —
SHERMAN: I don’t know anyone that has done that, so —
RITHOLTZ: Maybe one, maybe one —
SHERMAN: Yes, but —
RITHOLTZ: So let’s talk about podcasting a little bit. Active-passively beaten to death over the years everywhere. So by the way, for those of you listening Jeff has a podcast which is misnamed “The Sherman Show.” I have internally renamed That Sherman Says —
SHERMAN: Okay, great —
RITHOLTZ: Which is what it should be called and when you do — when you are privileged to be invited on Jeff’s podcast, they — he has this word association and that segment is called Sherman Says and your job in word association is to come up with a one word response, which I actually think I was pretty, pretty true to, but —
SHERMAN: Yes, you were one of the successful people in only using one word —
RITHOLTZ: But when I’ve listened to other people’s answers, they are like paragraph long, how is his word association if you giving me a storyline on it? So I did not want to do word association with you because that’s your thing —
RITHOLTZ: But I did something, I am going to name drop here, at a recent conference, I did something with Cliff Asmus (ph) who is always amusing and fascinating and invariably —
SHERMAN: Very sharp tongue and witty —
RITHOLTZ: Right, not only a math guy, but like a really funny right side of the brain as well.
SHERMAN: And his work is phenomenal —
RITHOLTZ: Absolutely —
SHERMAN: Definitely, a big fan.
RITHOLTZ: So for a live Q&A I did with him, I came up with a lightning round, which was you can answer these long or short, you could do one word, you could do a sentence, but the idea here is, whatever comes into your head quick answer.
SHERMAN: All right.
RITHOLTZ: All right, you ready? For the lightning round with Jeff Sherman, two-year or 10?
SHERMAN: For what?
RITHOLTZ: For anything?
SHERMAN: Two is higher, 10 is higher, spread relatively similar.
RITHOLTZ: Star Trek or Star Wars.
SHERMAN: Star Wars.
RITHOLTZ: Europe or emerging markets?
SHERMAN: Emerging markets. Dollar will continue some weakness and I think that’s very supportive.
RITHOLTZ: LA Lakers, Golden State Warriors.
SHERMAN: I am a Lakers fan.
RITHOLTZ: All right, I just wanted to give you an opportunity to —
SHERMAN: I like everything else Bay Area. I am a San Francisco Giant, San Francisco 69ers, But I grew up watching the Lake Show, you know, with the Magic and so and so —
RITHOLTZ: You and me both.
SHERMAN: Look, I do root for Golden State in the playoffs because the Lakers can’t ever make it anymore and so again, maybe one day with Lonza, we can get it back together.
RITHOLTZ: Smart data or factor investing?
SHERMAN: Factor investing.
RITHOLTZ: I knew you were going to go that way. Taco or burrito?
SHERMAN: Taco. I’m a big taco fan.
RITHOLTZ: Bill Miller or Peter Lynch?
SHERMAN: Peter Lynch.
RITHOLTZ: That’s interesting. I am surprised you said that. Tesla P100 BMW i8?
SHERMAN: I am a beamer guy.
RITHOLTZ: Okay, I see you’re in California, so I didn’t know which way you were going to.
SHERMAN: Yes, yes, I don’t feel it’s still that much of pollution in there, so —
RITHOLTZ: Tax reform or infrastructure spending?
SHERMAN: Infrastructure spending. If you’re going to do $1.5 trillion, at least let’s put it to work.
RITHOLTZ: Let’s get some paved roads and some reliable —
SHERMAN: If you’re going to drive that i8 or that Tesla, you don’t want to bounce down the alley —
RITHOLTZ: Let me tell you, they both have tight suspensions. What is your favorite pet peeve?
SHERMAN: When people just state things as facts with no evidence behind them and so I needed evidence-based investing conference and I’m a big fan of that. We hear so many rumors. We talked about the flattening of the yield curve among other things today and people just say with blatant fact —
RITHOLTZ: With a lot of confidence too —
SHERMAN: That is why it’s called the con game, right? It’s a confidence game. You’ve got to come across sharp, so again, sometimes, we misstate facts, but I’m always willing to retract the statement if that’s indeed the case, but at least if you are going to spread something around, let’s try to make it somewhat factual.
RITHOLTZ: And our last lightning round, give us words to live by or your favorite motto. It’s tough to pull that out loud.
SHERMAN: Wow. I mean you should at least prep me on that one.
RITHOLTZ: I prepped you on the next section. This one I wanted — I wanted this to be surprise, as you do.
SHERMAN: Yes, I mean I think, simply honesty is the best policy. We’re in the business of being fiduciaries and when — we see these things where people are conning clients and things, it makes our jobs harder. We’re trying to come out factual, we’re trying to give things, so you know, maybe it’s the golden rule, do unto others as you want them to do you.
RITHOLTZ: There you go, that’s a winner.
SHERMAN: It sounds kind of corny, but —
RITHOLTZ: It’s a compliance friendly answer to say the least.
SHERMAN: That’s right, so there we go.
RITHOLTZ: Let’s jump to our longer form favorite questions that we ask all of our guests. Tell us the most important thing that people don’t know about your background?
SHERMAN: The most important thing about the background, you know that I had no intention of getting in this business you know, I mean I was just a lost teenager into a young adult and is looking for something to do and —
RITHOLTZ: And that was grad school —
SHERMAN: That was — grad school, I found it. And actually at Florida State, I really found it because I started to really — kind of all the math really started to click finally. People talk about their a-ha, or eureka moment and I finally had it where these subjects kind of started tying together all of a sudden and I felt like, “Okay, now it all makes sense.”
Perhaps, I was teaching too, I was a teaching assistant which I taught calculus and the likes and I think that really helped too trying to explain to people not just, do they have to be visual or oral? What kind of learner are you? And trying to get different perspectives, so again and I think that’s what helps with this job is you know we are narrators at times, right, we’re giving out ideas. We’re trying to explain why we’re thinking what we’re thinking and you know, if you to go back to the pet peeves question that you asked earlier, you know, I hate when people say, we were just talking about your book.
The answer is, you’re absolutely right talking our book, why? Because we did a lot of analysis to position that book —
RITHOLTZ: We believe in the book —
SHERMAN: And here’s the data. You’re absolute right, I am telling you why —
RITHOLTZ: But it’s a chicken and egg thing, you’re not talking to your book. They just go out and sell it. The book exists because of the underlying philosophy and the data behind it.
SHERMAN: Absolutely, right and take it or leave it. If you like the way we think, then maybe you should invest with us. If you don’t, it’s fine. Other people may.
RITHOLTZ: So who are some of your early mentors?
SHERMAN: Yes, I mean from a financial perspective, I had the various layers of bosses too over time, obviously I admire Jeffrey Gundlach, you know, being there. I worked for one of his guys named, Claude Erb (ph) for a while. Taught me how to read a lot of financial literature —
RITHOLTZ: He’s written a lot of stuff —
SHERMAN: He’s written a lot. He’s won like a (gram) dot award. He’s run some scrolls over the years too. Good researcher and really taught me to think about every single asset class and don’t trust the data, keep grinding through it. Good lessons there.
And you know, there’s the people that I’ve read like — I don’t even say like, one guy I have only met once in person, Cliff Asmus (ph) reading materials from him, and so spend a lot of time on SSRN, you know, checking out what’s the new stuff out there and so there’s a lot of people that I’m forgetting right now, but you know, again they probably don’t even know who the heck I am. But I have been big fans of their work and what they put out.
RITHOLTZ: So you referenced Cliff Asmus (ph) tell me some other investors who influenced your approach to investing.
SHERMAN: I think, you know you’ve got a pull Rob Arnaud (ph) in there too with what he’s done in kind of valuation. I mean, before the factor stuff, you know, all of his stuff on valuation I think was very, very groundbreaking at the time too —
RITHOLTZ: This is pre-smart beta?
SHERMAN: Pre-smart beta. So if you go back to the 80s, I mean he was always talking about multiples and really how those of driving — sorry, how those drove returns over years. Like if you don’t think about it, it’s all dividend discount model. They don’t think about the valuation component and he’s tried to apply that too, smart beta factors too —
You know, there’s the big debate between him and Asmus (ph) today about you know, well, really if the basket turn overs significantly, is it really a valuation expansion?
RITHOLTZ: According to Cliff (ph), the debate is over —
SHERMAN: I think in the last piece, Cliff (ph) said it’s over —
RITHOLTZ: Yes, unless you want more —
SHERMAN: But again, there’s been a lot of just kind of academic work like the studies like from the (Ebetten) and (Sinkfield) and things like that. I was just kind of a student of history of the financial markets to because I think there’s a lot to be gleaned there. It’s not this cutting-edge piece that really gives you the most information, it’s respecting other periods that have similarities and no two crises look the same, so don’t expect the last one to hit in the next time.
RITHOLTZ: So speaking of history, let’s talk about some of your favorite books. What do you read for fun? Be it finance or non-finance? Fiction or nonfiction?
SHERMAN: Yes, I think one of the best books early on in my career I was trying to read all these financial literature, you know, so we start with the Michael Lewis and like Monkey Business and all of these things, one of the ones that really got a hold of me was Peter Bernstein’s book, Against the Gods —
RITHOLTZ: Man, is that an amazing book —
SHERMAN: It is and the prospectus I think is what it is. What really struck me was in it and when you’re talking about, well 500,000 of years ago, people just blamed the gods. There is no risk, right. It’s the gods fault and man, I kind of think that today almost, right, there’s some people out there that still say, “It’s not me that did something wrong, let’s blame someone else.”
And the evolution of probability theory and you know, again it is funny how it’s always gambling that starts the conversation and probabilities there, but trying to quantify things and understand it and if you’re going to get in the financial business or the investment management business, I mean, this is — thinking about risk is imperative and again, it leaves you with a cliffhanger at the end of the day.
It does never give you the answer, but I think that’s the right answer to risk management is that there is no perfect answer. We have all of these models. Everybody has all these great data points and we are over fitted, right? We don’t know what the next thing is. Most people aren’t predicting the crash when it happens. You’re always going to get someone who’s —
RITHOLTZ: Randomly finds it.
SHERMAN: Right —
RITHOLTZ: So Against the Gods, that’s great. By the way, I never read his other — one of his other books called The Power of Gold, that’s literally sitting next up in my queue —
SHERMAN: I’ll take it as a recommendation. I like Bookstaber’s book on A Demon of Our Own Design —
RITHOLTZ: Sure. That was really interesting —
SHERMAN: That was a really good one too and again, that was trying to quantify things more so, the parallels here are kind of the risk side —
RITHOLTZ: The effect of derivatives and how completely unanticipated the average investor — unaware of the average investor was —
SHERMAN: Unaware, yes, and so, you know, I don’t read a lot of fiction, you know, I spend more time as I said kind of on the SSRN and things, but those are kind of two things that really resonated well.
The recent financial books that I’ve read recently —
RITHOLTZ: Give me one more. We have to have a third book —
SHERMAN: I didn’t know we have to have three —
RITHOLTZ: Well, I’ve just made that rule now.
SHERMAN: Okay, well if we’re going to go three, I’ll go back to — I’ll take Michael Lewis’s Moneyballthough —
RITHOLTZ: God I love that —
SHERMAN: Yes, but I am a baseball guy, so you know, from the standpoint, I like the stats. There’s just something about it, so —
RITHOLTZ: It’s fantastic and then he —
SHERMAN: I actually have never seen the movie —
RITHOLTZ: The movies is great. Strongly recommended. Lewis says that he missed the major point of Moneyball which Richard Thalerand, Cass Sunsteen (ph) reminded him was, “Hey, you’re using all this work from AmusDoverski (ph) and Danny Connoman (ph) —
SHERMAN: Which is what led him to the most —
RITHOLTZ: The Undoing Project, which is really, if you haven’t read that —
SHERMAN: I have read that when — it didn’t really —
RITHOLTZ: It’s different. It’s very different.
SHERMAN: It didn’t resonate as much with me, but I do like the Thaler’s (ph) school of thought too —
RITHOLTZ: No doubt about that —
SHERMAN: They’re talking more and more to Professor Schiller, love the behavioral side too and —
RITHOLTZ: Did you speak — but speaking of Lewis, did you ever read the Blind Side?
SHERMAN: I did.
RITHOLTZ: What did you think of it?
SHERMAN: I did like it, except that you know, the opening scene, it didn’t resonate well with me as a 49ers fan, you know what the LT taking out the career of Montana, so I got through that and that I thought it was a good book. Again not a movie — I never watched the movie though —
RITHOLTZ: So I only have you for a few more minutes. Let me jump through my last favorite questions. Tell us about a time you failed and what you learned from the experience?
SHERMAN: Well, you know, the failure stuff is hard to recognize, but you know —
RITHOLTZ: — the fact —
SHERMAN: No, I mean, I think it’s the best you did learn, but you know as an investor too, just again starting with the personal accounts, just getting over confident, as a young trader, you think you know everything, I love the options market because you don’t have much money so it’s a great way to leverage your bet and you find the undoing of things and how other people can corner you in positions.
Think about, kind of during the financial crisis — people stepped in and backed companies too and probably should’ve been playing around with some of those trades too, but you know, personal life too, I mean I’ve been moderately successful, never was the top student and things and so I guess, probably one the biggest failings to was when I was in the peer — abstract math are pure mathematics, there were some just tough times there where your brain doesn’t click. You just don’t get it. There’s no examples. You’re talking about proving these delta epsilon proofs, which everybody is already asleep by now, but just you really, just getting my teeth kicked in in that stuff and bouncing back.
And so has some of it is hard work as all the sports athletes take adversity, I don’t think any game is adversity by way. I think it’s a little overused there —
RITHOLTZ: But there is something to be said from failing and learning from it and picking up and brushing yourself off —
SHERMAN: Yes, and you have to do that and so again, and then just recognizing that, look you can’t be an expert at everything, right? There are certain things — you can only — there’s only so much time, there’s only so much brain capacity we have, unless maybe you are Cliff (ph) that you can absorb all these topics and so you dedicate yourself to something and I think I’ve tried sports some I am not good at and you know, I am never going to try them again —
RITHOLTZ: So speaking of that, what do you do to stay mentally and physically fit outside of the office? What do you do —
SHERMAN: Well, I’ve got a cold right now as you are aware —
RITHOLTZ: Well, outside of the bubonic plague, when you’re not Typhoid Mary, what do you do to relax out of the office?
SHERMAN: Yes, I just — you know, I do some reading here and there. I just — I live in Santa Monica, just kind of kickback enjoy kind of lifestyle there and signs check out —
RITHOLTZ: Are you out surfing — are you just enjoying?
SHERMAN: No, I don’t know how to surf. It’s embarrassing.
RITHOLTZ: You’re right by Meb (ph). You should have met the guy —
SHERMAN: I know, he did offer. He did offer to —
RITHOLTZ: I heard on the podcast —
SHERMAN: Yes, and I don’t know if he wants to see me. The only thing I am really good at is sinking, so I have been doing some scuba diving lately, but the thing about the scuba diving is I am still just getting familiar with the environment.
You want to talk about something scary is watching those things just move around in their own environment so quickly —
RITHOLTZ: Which things?
SHERMAN: Anything. I’m saving a sea turtle. These big sea turtles, probably the most feared I ever been scuba diving. It’s not these little sharks. It’s the 100-pound or 150-pound sea turtle with the turbo jet going by you buzzing the tower so — and I feel helpless, so at least I won’t call it a failure.
Yes, I was a wooze (ph) at the time and I’m better now. You’ve got to put yourself in some of those environments.
RITHOLTZ: And then our last two questions, what sort of advice would you give a millennial who is interested in a career in finance?
SHERMAN: Yes, you’ve got to be good. It’s highly competitive now. There’s a lot of consolidation in the industry. Be well read in history especially political events, financial history is extremely important. So one great thing about grad school and then you learn history of subjects too, I think that’s very pertinent and you know, be open and listen. You know, I think there’s a lot of good people in the industry around you. Be the sponge. Make sure you kind of absorb that and you know, read scholarly articles.
You may not understand everything, but just press through and the best thing to do, when you find something you like, you find (inaudible) like, look of the footnotes. Education is the key here —
RITHOLTZ: And our final question, what is it that you know about investing today that you wish you knew 20 years ago?
SHERMAN: That you’re never going to know it all, one. Mathematical models are not perfect. They are tools. They are not the all-be-it end game to everything and there’s going to be things that behave outside of your control.
So that can be the security you bought that just tanks. It can be the thesis you have and you realize, all your bets are correlated. They’re all the same thesis. That’s something very important. I see a lot of them on this top 10 list (inaudible). I know you have your what I did right and wrong kind of stuff or just wrong —
RITHOLTZ: Yes, do the mea culpa —
SHERMAN: Right, the mea culpa, and so understand that you know, you have got to have that diversity there and that’s very important too because sometimes you think — you talk to yourself with this idea that you have all of these trades on, but they’re all just being on the dollar, right, when you really break them down or something like. So make sure that you actually have those different exposure in portfolio and again, I think the best thing is you come out cocky, you study all of this math, I’ve got the perfect model for this. No way.
No such thing, so —
RITHOLTZ: Thank you, Jeff for being so generous with your time.
SHERMAN: Appreciate it, Barry, thanks.
RITHOLTZ: We have been speaking with Jeff Sherman. He is the Deputy Chief Investment Officer at DoubleLine Capital. If you like this conversation, be sure to look it up (inaudible) on Apple iTunes, Overcast, Sound Cloud, Bloomberg wherever finer podcasts are sold and you could see any of the other 165 or so such podcast that we’ve done previously. We love your comments, feedback and suggestions. Write to us at firstname.lastname@example.org, Medina Parwanis our producer and audio engineer. Taylor Riggs is our booker. Michael Batnickis our head of research. I am Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.