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Faber: Why Market-Cap Weighting Falls Short

Cambria founder Mebane Faber talks to Morningstar’s Sam Lee about his fund’s global value strategies and what he is buying in his personal portfolio.

Samuel Lee, 06/24/2014

A version of this article was published in the June 2014 issue of Morningstar ETFInvestor. Download a complimentary copy here.

Mebane Faber should be no stranger to readers. He entered the exchange-traded fund business by partnering with AdvisorShares to launch AdvisorShares Cambria Global Tactical GTAA (AdvisorShares recently announced that it's proposing to GTAA's board of directors replacing Cambria with Morgan Creek Asset Management). Last year, Faber's firm Cambria Investments struck out on its own to launch Cambria Shareholder Yield SYLD and Cambria Foreign Shareholder Yield FYLD. Both funds invest in stocks with the highest total payout yields, defined as the sum of aggregate dividends, net share repurchases, and net debt reduction over total market capitalization. His firm followed up this year with Cambria Global Value GVAL, which focuses on value stocks in the most beaten-down, unloved countries. I think of it as a value strategy on steroids.

I interviewed Faber over email to get a greater understanding of how his funds work and his personal portfolio bets. Below is a lightly edited transcript.

Samuel Lee: You launched Cambria Foreign Shareholder Yield as an index fund, but Cambria Shareholder Yield as an actively managed fund. I assume this is to speed up your time to market. Can you explain the big differences in the implementations between the funds?

Mebane Faber: The filing process at the SEC makes it more difficult for foreign active funds than passive funds to get approved, but the SEC seems to be making great progress in these areas. It has no impact on how we implement the strategies.

Lee: Could you explain in detail how Cambria Global Value picks countries and the stocks within those countries?

Faber: Market-cap weighting results in returns an investor will receive from investing in the global portfolio based only on price, but does that really make any sense? It turns out historically market-cap weighting has been a very suboptimal way to invest as it overweights expensive markets and bubbles. A market-cap investor would have had 50% in Japan in the late 1980s in the biggest bubble we have ever seen (Japan is only 8% of world market cap now) and the majority of his assets in one of the most expensive markets in the world currently--the United States. While we don't think the U.S. is in a bubble, we do expect returns to be muted, perhaps 4% nominal per annum for the next 10 years. Most index investors are surprised to hear that at a minimum, even if they followed the Boglehead/indexing model, they should have half of their portfolio invested abroad, but none do, which is called home-country bias. It happens everywhere, and in the U.S. most allocate about 70% of their stock allocation to the U.S.

We talk about this in our new Global Value book a bit, and we believe it is more reasonable to weight markets and companies by value rather than price. It is just as important to avoid what is expensive as to invest in what is cheapest.

Samuel Lee is an ETF Analyst with Morningstar.

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