Yale’s endowment fund has performed exceptionally well under David Swensen, returning an average of 10% per year since 2005, beating all major stock indexes and all but 2 of Morningstar’s mutual fund categories. Morningstar’s John Rekenthaler suggests that this outperformance comes from Swensen’s unconventional choices, but quickly quickly parrots Swensen’s advice to individual investors: “don’t try this at home.” So what can we learn from Yale’s success?
Rekenthaler identifies a few possible lessons from Yale’s success:
- Illiquid assets can be more profitable;
- Reduce or eliminate bond holdings, if possible;
- Invest with funds run by successful active managers.
Each of these possible lessons, however, comes with a set of caveats that may be the equivalent of “don’t try this at home.” Illiquid assets are hard to identify and invest in as an individual, and funds have not had much success attempting to emulate Swensen’s approach on this point. Fixed-income is a maintstay of a balanced portfolio and finding an alternative is risky. Although Swensen has profited from active managers, he has much better information and access than the individual investor. As Renkenthaler puts it, integrating these ideas is “most appropriate for portfolios with long time horizons, owned by investors who have a relatively high risk tolerance.” He also notes that current market trends may make this a particularly bad time for attempting to apply ideas gleaned from Yale’s success.
A recent article by Cliff Asness and colleagues from AQR Capital Management challenges the academic finance recommendation to avoid attempts to time the market. “Sinning a little,” Asness and colleagues suggest, can boost returns. Among other things, they suggested trimming exposure to stocks in October 2015, as the article went to print, by holding more cash.
The article uses two core factors – valuation, measured by the cyclically adjusted PE (CAPE) factor made known by Rober Shiller, and momentum. Drawing on 115-year data, they found meaningful advantages to timing the market in moderation. The article cautions against extremes, but moderately applying the value-plus-momentum strategy to an equity strategy yielded a “1.2 percentage point increase annually over a buy-and-hold portfolio” over a 115-year period and an annualized 0.8% return for a portfolio of 50/50 in stocks in bonds over that same time frame. In both tests, the strategy also materially reduced risk by lowering the max drawdown results.
Bonnie Baha, head of global developed credit at DoubleLine Capital LP, said “I think there is a high probability of an accident” if the Fed raises rates in 2015. She said that a rate hike would be “like putting your foot on the brake when there’s no gas in the car to begin with,” suggesting it could trigger a “tightening cycle” and the Fed might then have to backtrack.
DoubleLine has a strong record, with its flagship fund beating 97% of peers over one, three, and five years.
Baha said she expects “more of the same but worse” for corporate bond investors in 2016. She said companies are borrowing too much and pointed to energy as particularly problematic. “Right now, to step into this, you’d be catching a falling knife,” she opined. “With oil at $40 a barrel, these people can’t make it . . . At some point there are going to be some bargains out there, but we’re not stepping into that now.” She pointed to closed-end bond funds as a good alternative.
The Sequoia Fund, managed by proteges of Warren Buffett, highlights the risks of focusing on just a few stocks. Although it has one of the best long-term records of any actively managed mutual fund, two of its directors recently retired because a big bet on just one stock, Valent Pharaceuticals, turned out poorly.
The tradition of an “under-diversified” portfolio, however, includes some big wins. Benjamin Graham’s investment in Geico in the mid-1970s is an example. Warren Buffett has defended the approach as appropriate for “know something” investors, whereas “know nothing” investors should have widely diversified portfolios. Academic work supports the assertion that less-diversified mutual funds had better performance, on average, than the most diversified actively managed funds.
However, as Mark Hulbert points out in reporting on this topic for Marketwatch, “it’s human nature for each of us to think we’re above average.” Thus, he suggests, “our default assumption should be that we don’t know how to pick stocks, and that therefore we should invest in an index fund.” Nonetheless, “it would be going too far to conclude that no one has stock-picking abilities.”
Yale professor Roger Ibbotson and Research Affiliates founder Rob Arnott debated the challenges and opportunities of timing the market at the 2015 Schwab IMPACT conference. As reported by Financial Advisor, the two speakers generally agreed that “the stocks that are the most popular will do the worst, as Ibbotson said, or, as Arnott put it, “you just have to find the flows and do the opposite.” But Arnott argued for focusing on underlying valuation and that “we should weigh companies based on their macroeconomic footprint. . . Use the size of a business to contratrade against the markets’ bets.” While Ibbotson didn’t necessarily disagree, he added a major caveat: “If you go against what everybody else is doing, you can do well . . . [but] people can’t really follow that kind of advice.”
It’s extremely common to hear investment commentators talk about “growth” and “value” as though they are polar opposites. But Validea CEO John Reese says not to buy that false notion.
“When it comes to investing’s great ‘either/or’ – that is, the growth or value debate – you can have your cake and eat it, too,” Reese writes for Canada’s Globe and Mail. “That’s because the great growth versus value debate is, in fact, a false choice. … Confining yourself to either value stocks or growth stocks is only limiting your portfolio’s potential. At certain times, you’ll be able to find more attractive growth-type picks; at other times, the market will be offering more value-type plays. Having a portfolio of growth-focused and value-focused stocks can also help smooth your returns over the long haul, since the two styles take turns leading the market.”
Reese says the “fallacy of the growth-versus-value notion goes even deeper. … That’s because implicit in the debate is the idea that any given stock is either a value stock or a growth stock, and that’s just not true.” He highlights a pair of stocks that currently get approval from the growth strategy he bases on the writings of renowned quantitative investor James O’Shaughnessy — and a separate value strategy he bases on O’Shaughnessy’s writings. One of them: AXA, a Paris-based financial company that’s involved in life insurance, property and casualty insurance, asset management and banking.
Jim Rogers, known for the 4,200% gain he and partner George Soros secured over a decade in the 1970s, told a Barron’s interviewer that he sees a significant bear market coming.
“In America we’ve had economic setbacks every 4 to 7 years since the beginning of the Republic and chances are that we’re certainly getting closer to being due . . . and the next bear market is going to be worse than most of us have experienced because the debt is so much higher.” He also noted that right now “is the first time in recorded history that you’ve had all the major central banks printing staggering amounts of money.””
When asked about recommendations for commodities investments, Rogers was very positive on agriculture: “It has been a nightmare industry for a long time and that’s got to change. I would certainly buy agriculture.” After discussing other possibilities, he summarized: “I would buy agriculture with both feet, energy with a toe, and watch the others.”” Regarding currency investments, he noted “my largest currency is the U.S. dollar,” continuing, “I expect some problems going forward in the world financial markets . . . as the turmoil comes, the U.S. dollar will go higher and higher.”