In an his “common sense column” James Stewart writes about the strong investment performance of the Harvard (and Yale ) endowments. Interestingly, he draws conclusions for individual investors that are quite different that those expressed in recent books by the managers of those endowments,
Harvard's Endowment Offers
An Education in Asset Allocation
By JAMES B. STEWART
September 3, 2008; Page D2
It's back-to-school week, so let's do some homework by studying the success of Harvard University's endowment.
Harvard Management Co., which runs the endowment, generated a return of between 7% and 9% for fiscal 2008, according to people familiar with the returns and cited by The Wall Street Journal in August. That's consistent with an estimate of 9% for the first 10 months of the fiscal year, which ended June 30, reported the Harvard Crimson in July. Given that the S&P 500-stock index fell about 15% during the same 12-month period, and that Harvard's returns were well above the rate of inflation, I'd award that performance an "A."
How did Harvard do it? The key is diversification, and not just by investing in a variety of stocks and bonds. Harvard invests in 11 noncash asset classes, only one of which is U.S. stocks. Like Yale and other large endowments, it counts on one or more of those to shine even when others are weak, achieving better long-term results than could be attained with fewer asset classes. It looks as though Harvard's 33% allocation to real assets, which include commodities and real estate, salvaged performance in what was otherwise a treacherous year.
(both endowments also include allocations to inflation protected bonds which they categorize as real assets)
Individual investors can emulate the principles, if not the exact returns, of Harvard's approach. True, Harvard's vast wealth -- $38 billion as of April -- gives it access to the best managers, the most sought-after private-equity and hedge funds, natural-resource partnerships that are closed to most, and even the ability to eliminate middlemen and fees and buy direct. (At one time Harvard was even the world's largest owner of timberland.) But you too can achieve similar -- maybe even better -- results by embracing a variety of asset classes.
(In fact David Swensen, the Yale Endowments manager in his book : UUnconventional Succes explicitly notes that individual should avoid the above assets, specifically because of the preferred access that the Yale Endowment has to these asset classes)
Like Harvard's, my results last year were strongly enhanced by the allocation I made to real assets, a result of more closely aligning my portfolio allocation with that of Harvard's and Yale's. That's why I recommended and bought stocks like BHP Billiton, Rio Tinto and Cia. Vale do Rio Doce, which are both commodity producers and foreign. As of June 30, the stocks were near their peaks after a spectacular multiyear run.
(There is often a significant divergence between stocks of commodity firms and the commodities themselves (the route chosen by Harvard and Yale), although direct investment in commodities is now easily accessible to individual investors through etfs and exchange traded notes (etns) Much of the recent runup for BHP and Rio Tinto has been because of a merger between the companies, not necessarily the move in the commodities markets)
Harvard hasn't yet released the official results for fiscal 2008, but its 2008 asset-allocation strategy is on its Web site. Despite the subprime, real-estate and credit crises, Harvard is staying the course, with even larger commitments to foreign equities and commodities than in 2007. U.S. equities constitute 12% of the portfolio; developed foreign equities are 12% and emerging market equities are 10%. Total foreign equities account for 22% of the portfolio, up from 19% in 2007, compared with 12% domestic. Real assets, including commodities, are 33%, up from 31%. Fixed income dropped to 9% from 13%.
(Contrary to Stewart’s assertion Mohamed el Arian recently departed ceo of Harvard Management in his new book When Markets Collide the allocation el Erian recommends for individuals is quite different than the Harvard allocation listed above. Here is his allocation for individuals (“midpoints” are listed)
US Equity 15%
Developed Intl Equity 15%
Emerging Market Equity 12%
Private Equity 8%
Real Assets:
Real Estate 6%
Commodities 11%
Inflation Protected Bonds 5%
Infrasturcture 5%
Nominal US Bonds 5%
Nominal non US Bonds 9%
Special Opportunities 8% )
(special opportunities defined as “new longer term trends supported by a secular hypothesis or shorter term activites that materialize due to sharp dislocations and significant overshoots”)
It's relatively easy for individual investors to duplicate these categories with individual stocks, sector mutual funds and exchange-traded funds. The good news is that for anyone trying to more closely align their portfolios with the Harvard model, foreign equities and real assets have recently sold off, making valuations far more attractive for anyone buying now. China stocks alone have lost about half their value year-to-date, and Russia and India are also experiencing significant corrections. Energy and commodities also have had a sharp selloff. A year ago, nearly all these asset classes seemed richly valued, if not overvalued; now bargains are showing up.
The hardest categories for individual investors to duplicate are private equity and hedge funds, which may be just as well, given their relatively weak recent performances. But in earlier years, they were critical to Harvard's success. A number of ETFs now approximate the returns of so-called long-short hedge funds by using quantitative strategies, without the exorbitant hedge-fund
(As noted David Swensen chief investment officer of the Yale Endowment in his recent book Unconventional Success and Mohamed el Arian up until recently CEO of the Harvard Management in his book When Markets Collide give their thoughts on the appropriate allocations for individual investors
With regard to hedge funds el Arian writes:
Either take comfort from the possibility that the hedge fund managers can “market time” the beta(market) exposures in a profitable way or worry that it is virtually impossible to know what the underlying market exposure is..”
on private equity:
Having a general exposure to private equity is neither a necessary nor sufficient condition for obtaining superior investment results you need to be in the right fund at the right time. The studies also show that it is difficult for new investors to get into the right funds. Why ? Because the individual performance difference among funds is rather stickyees. Harvard allocates 11% of its portfolio to private equity and 18% to hedge funds.)
David Swensen’s allocation for individuals differs even more radically from the Yale Endowment’s allocation listed in the 2007 annual report
h
Yale Individual
Absolute Return 23%
Fixed Income conventional 4% 15%
Inflation Protected Bonds 15%
US Equity 11% 30%
Foreign Equity 15% 20%
Private Equity 19%
Real Assets 28% 20%
(In sum it seems neither the Yale or Harvard endowment managers think it is “easy to replicate “their portfolios although of course they advocate broad diversification for individuals’ portfolios.
So it would be hard to disagree with this point made by Stewart)
Although I've been moving in the Harvard direction for some time, I still haven't gotten to as high a weighting in either foreign stocks or real assets. But the key is diversification. So far, it's benefited my portfolio just as it has Harvard's.
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