A Harvard-educated Dane, Lars Kroijer worked for HBK Investments and Lazard Frères before co-founding the London based hedge fund Holte Capital. He’s written two books; the first is “Money Mavericks: Confessions of a Hedge Fund Manager” and the second, “Investing Demystified: How to Invest Without Speculation and Sleepless Nights”, which advocates for a simple, low cost, highly diversified investment philosophy. We caught up with Lars and asked him a few questions on passive investing. If you prefer to listen to the interview, click play above.
Great to speak with you today Lars. I just provided you with a short intro, but tell me about yourself and how you fell into the finance world.
Hi, thanks. Thanks for having me.
I don’t know how I fell into it. I graduated university with a pile of debt and got a job offer on Wall Street. And I guess one thing led to the next and it’s now been 25 years since I made that decision. I guess I’ve always found finance and investing really, really interesting. Both theoretically, but also practically speaking. It’s been a while now, but it’s certainly something I’ve enjoyed.
And many of our listeners actually may not know what a hedge fund is or have a preconceived idea of the world of finance based on films like The Wolf of Wall Street. Could you describe what a hedge fund is and how it works?
Hedge funds are actually many things. It’s an investment vehicle. It’s an investment fund. Now, what the investment fund does is really, really varied. I’d say yes, implied by the name the very first hedge fund, they actually sold something called the hedge. In other words, something that guarded against market declines. So people “hedged” against market declines.
And often the term “hedge funds” becomes synonymous with crazy risk-taking or even fraud or a lot of bad things, which is I think very far from what it is in actuality. But of the 10,000 hedge funds in existence in the world today. you can find pretty much a variation of anything and funds that do a variety. Mutual funds usually invest in equities. You can find people that do various kinds of statistical arbitrage in government bonds or commodities or what have you. So it’s an incredibly varied concept. I’d say where they are different from mutual funds is that most often they can hedge against, and they do hedge in some form against market movements. Markets could mean many things.
And the second is that they’re typically not open to retail investors. So your mum can’t put a thousand euros into it. The minimum is typically a hundred thousand euros. You also have to prove that you’re a high net worth individual and a sophisticated investor. So it’s a slightly higher bar to invest in these vehicles. Not sure that this answers the question but it gives a bit of an overview.
You were really successful in running one. And you mentioned actually in the later stages of your first book, “Money Mavericks”, the case of Mrs. Shaw. And you kind of touched upon it in your answer there. But why do you think hedge funds are not good investments for the average person who is Mrs. Shaw? And what’s the story there?
Well, Shaw is actually many people. But I think the first question that investors have to ask themselves is, who are you? Who are you as an investor, are you able to outperform the financial markets yourself? Or are you able to pick someone who can outperform the financials markets for you?
And in my view, the overwhelming majority of people, if they’re being truthful, will have to answer that question with an emphatic no, I can’t beat the markets. And also, I can’t pick among the many, many offerings out there, the ones that actually will beat the markets consistently over time, certainly after fees and expenses.
And this is obviously something that has very profound implications for most investors, even if they don’t realize it.
I felt when writing the second book, I was in a very good position to tell that story. Because first of all, I have a lot of theoretical background with having studied optimal portfolio theory, and I have a lot of familiarity with various financial products. But also, I have myself operated in the financial markets for many years and can appreciate how incredibly hard it is to beat the market, even if you have amazing access to company management technology and have the ability to hire the best brains in the industry. Even then, it’s incredibly hard.
And so, you know, what are the chances that someone sitting in their bedroom with very little access to anything other than the internet can outperform the combined trillions of dollars of money moving around the financial system and allocating ascribing prices to assets in a very, very efficient way? The chances that you can do that better are minuscule.
And again, what I’m advocating is that people should come to understand and embrace that, and then they should act on the basis of that premise.
You touched on it there in “Investing Demystified”. You really push for a diversified portfolio and very low risk. And you talk about not being an expert to be an investor. You actually recommend investing in index funds. So why should we invest in index funds?
Well, look, let me start by saying I don’t necessarily say you shouldn’t have low risk or you should have low risk. Risk is a very individual thing that depends on your circumstances and stage in life and so forth. You know, if you’re a young person, and all else equal, you’re likely to be able to afford more risk than if you’re an old person, although again, it’s highly individual.
The reason you should invest in an index tracking product is (which, by the way, is different from an index fund) because that way you’re not paying anyone to be clever on your behalf. You’re simply buying the market according to the values that the market has ascribed to the various securities. So if you take for example the most famous index, which I guess is the S&P500. There, you’re simply buying those 500 stocks in the proportions of the market caps relative to each other. Now, you know, that’s numbingly simple to do. So you’re paying tiny, tiny amounts of money for someone to do that for you. And if you don’t think you can outperform that market yourself or indeed pay someone to outperform it on your behalf, then that’s a very efficient and cheap way to create a diversified portfolio. Now, then you say, well, why the S&P 500? And I’m saying, you shouldn’t do just the S&P 500. You should do the broadest, cheapest index tracker you can get your hands on. If we stick to equities for a second, you should do some sort of a global tracker, a global index. For instance MSCI World, but there are many out there and you should make sure you’re optimizing for tax.
And that’s really it. A broad, cheap, tax-optimized equity index tracker for the global equities market. For the vast majority of the people, that’s all you have to do for equities. It’s really that simple. And you will likely end up better off in the long run and than if you do what most people do now, which is themselves either picking stocks, trading in and out of markets or paying a higher paid financial manager to essentially pick stocks on your behalf.
You speak about the example of a London Underground driver. In “Investing Demystified”, you mention this use case and more generally why people should not try and beat the market. Do you want to walk us through it?
So the example I used is, as you know, someone who drives a train on the London Underground. Let’s just say for argument’s sake that they get paid £50,000 a year on average over their lifetime and that they put 10 percent of their income away in equities every year. Let’s say there are two of them:
- One puts it in an actively managed fund or a mutual fund
- The other puts it in an index tracker that tracks the same market
There are some basic assumptions. We’re ignoring tax and let’s say their income goes up with inflation. Also, we look at the period from the age of 25 to 65 and we assume that the markets do as well in the future as they have in the past, which is 4.5% to 5% above inflation. At retirement, the train driver who put his money in an index tracker will be better off to the tune of seven Porsche cars, since the value of seven Porsche cars is the amount of fees that the person who invested in an actively managed fund on average will have paid in excess of the person who just bought index trackers. So this is this is someone who drives a train for the London Underground and they are probably not gonna be able to afford a Porsche. Who will pay that amount of money over their lifetime?
To say that this doesn’t matter is just crazy talk. It matters hugely. And it leaves people with the ability to put themselves in a far better financial situation than they otherwise would be. And essentially retire richer than they otherwise would. So this is important stuff. And I think it’s too easy to ignore by people. There is too much conventional wisdom or vested interest in having you still trying to outperform the markets by actively picking stocks. But what I’m saying is that’s actually not in the interest of most people.
You spent a big part of your career trying to beat the market. So why is it so hard to actually beat it? And, you know, picking stocks, why is it so difficult?
Am I just a hypocrite? I’m a hedge fund manager who says you shouldn’t try to beat the market. So it’s important to understand that I’m not saying markets can’t be beaten. I’m not saying that at all. I’m just saying that you have to make clear who you are as an investor and whether you’re able to do it now.
Because I ran a hedge fund and I have access to incredible information technology, news, smart people, management and whoever I wanted to talk to, I could probably appreciate better than a lot of people that even if you have the best exposure or best access, it’s still incredibly hard to beat the market.
So what if you didn’t have any of that and you didn’t even have a background in finance? It’s very hard to even argue that you consistently should beat the markets.
Now, there are a lot of reasons why people still believe that, and part of it is because we tend to remember our winners. So when you’ve done better than the markets over a certain period of time, you’ll never think that it’s because you were lucky. And even if you haven’t, we tend to remember our performance as better than it actually was. There are lots of reasons. Plus we’re constantly bombarded with ways that we should be smarter than the market or try to make money or somehow be astute or clever. So there’s a, you know, this sort of taking a step back and saying, “No, I can’t outperform the market and I appreciate and embrace that”. What you should do on the basis of that premise almost feels to a lot of people like cheap surrender or even boring. But it’s likely that that will make it far better off in the long run.
And in terms of diversification, why is that so important?
It’s important because you don’t, if you can, put all your eggs in one basket. So if you take the example of someone who lives in London, was educated in London, has their job in London, has their pension, their insurance in London. They may own a flat or a house in the city. They may inherit money from their parents that also live in London. And on top of that, they had an investment portfolio and they put it in London real estate. As a result of all this, they’re incredibly exposed to the London economy. And by diversifying away from that, they’re spreading their risks. And in a way, it’s almost irresponsible not to do that.
Now, in the past, for all sorts of practical reasons, that was actually very hard to do. It wasn’t easy to buy international stocks. But today you can pretty much buy stocks from all over the world, online, in seconds, and at very low cost. And you should absolutely try to diversify away from this kind of concentration risk that a lot of people have, sometimes even without thinking about it.
The greatest asset that most people have is their house or their apartment, but also their future earnings stream. And both of those things are typically tied to the local economy. So a lot of people simply already have a lot of exposure to the local economy, either through their current job or job prospects, but also through the place they live in. Having their investment portfolio diversified away from that is a good idea.
I’d really love to know actually what your thoughts are on finance education. It was a big gap in my schooling and we weren’t really taught about financial literacy. So I’d love to know how you approach the subject with your kids.
I have 14 year-old twin girls so we’re not really on the investing stage yet. It’s more at the stage of “don’t spend all your money on sweets and stupid stuff”.
I think ultimately the way you teach people about this is to address questions in their own lives. What I said before about not having all your eggs in one basket, just sort of makes sense to people. I used the example before because it’s actually based on a real person. Most people in that situation, being very exposed to the London economy, would sit back with the feeling that, well, I really hope the London economy doesn’t go in the gutter, because that would be really, really bad news for me. And you would be left with this sort of “pit in your stomach” feeling.
That’s probably a super unsophisticated, super unmathematical sign that there’s something that you should try to do differently. I think it’s similar to questions around risk. A lot of cases come down to, how do you feel about it? You can get very mathematical about a lot of these things. But also mentally, if you sit back and you’re sort of feeling, well, this doesn’t feel good, this doesn’t feel right. Then that’s probably a good indicator that there’s something wrong. For a lot of people, that’s a very good and first natural step to then taking that feeling and trying to educate them on how they could potentially use investments to make the feelings go away or feel better about their overall financial situation. I don’t think that teaching them why they should buy Facebook shares as opposed to Apple shares, or how to do this kind of cash flow analysis, or big Excel spreadsheets, is the way to teach most people about the best way of investing, because that’s not relevant to most people’s lives.
What would you tell a 25 year old Lars? What would you tell him now with the kind of knowledge and hindsight that you have.
Twenty five years old… That’s twenty years ago. I’d tell him to go buy some Apple shares, I guess.
I’d probably tell him that Denmark will not win the world championship in football. In terms of investing, I would certainly tell him that you should think very long and hard about: can you beat the market? And if you can’t, then don’t try.
Not only will that probably make you wealthy in the long run, but you’re also going to save a ton of time. Time that you don’t need to spend, that you’re not getting paid for to try to outperform or try to be better than the market. I’d say, spend that time to go do stuff that you love. And then if you do stuff that you love, you’re probably going to be better at it. You’re probably going to make more money doing that than you will trying to figure out whether Apple is going to outperform Facebook, not that those existed 25 years ago.
I’d say that’s a much better use of your time than sitting in front of the computer screen and trying to day-trade or trying to pick one mutual fund over another fund or be lured into spending too much time and money on financial advisors, to which I say “just don’t do it”.
Keep it super simple, super cheap and don’t trade a lot and put money aside over time. And the compounding of that money will probably leave you much better off in the long run than you otherwise could imagine.