...
Investing By Committee
If you think you have been having investment problems, pity the average endowment and pension fund. Their investments are run by committee, and they hire consultants to give them advice on how to allocate their investments. Typically, these consultants are rear view mirror advisors, with tons of charts and graphs showing how if you simply stick with your stocks for the long run, you will do just fine. They trot out the famous Ibbotson study to prove their point. They show what a "blend" of various stock indexes will do. You must stay in the markets at all times is their basic advice. They tinker with the blends from time to time, but rarely suggest anything but long only strategies. In many respects, they are like the typical broker you know, except they deal with larger numbers.
These endowments are pressed to give up more and more money for their causes, as the need is always great, yet the funds they manage have been shrinking. There are some shell-shocked trustees at this conference, and they are a little more wary of whose advice they take. Not surprisingly, consultants willing to think out of the box are being listened to more and more. There are advisors who can point to good results for their clients over the past years. If you are an endowment or pension fund, write me and I will suggest a few.
Take a Risk, You Get Fired
Mark Yusko from the University of North Carolina made some very interesting points about the consultant problem. First, he noted that most consultants and managers have a strong incentive to not take risks, where risk is defined as doing something different than the herd of other consultants. If you suggest something different and you are wrong, you lose your job. If you suggest sticking with the standard line, you can blame the market and point out that everybody else had problems as well. You keep you job.
This was perfectly illustrated by the story of Jeremy Grantham of GMO Advisors, whose presentation we will discuss at length in a moment. Grantham is a famous deep value investors. He was taking his clients out of stocks in 1998 and 1999 (and even earlier), as value, by his calculations of traditional stock portfolios, simply got out of line.
He told us he lost 40% of his accounts during this period, which is a staggering number, since he manages nearly $20 billion. His large pension fund investors demanded that he keep up with other managers, and he refused, based on his sense of value. Now, these funds wish they had stayed, as Grantham has beaten the socks off his competitors.
How painful it must have been to lose that much business. It is a testimony to his character that he stood by his belief in value even as his income went down. But the clients that stayed also need to be commended, as it is hard to sit out the dotcom bubble as your peers are participating. I remember the articles about how Warren Buffett just didn't get it.
There are some outstanding endowments and pension funds, as well as consultants, that have done well in this environment. They did not stick with the herd, took the risk of being more conservative, and today they have been rewarded. They are the exception, however.
The second point Yusko made that I found interesting was that 85% of portfolio performance came from asset allocation and only 15% from actual stock picking prowess. Intuitively this makes sense, but I had not seen any data prior to this.
What he means is that the more important decision for large (and small) investors to make about their portfolio is in which asset class to be positioned. How much in real estate? Gold? Bonds? Stocks? Hedge funds, etc.? Actual stock picking only improves portfolio performance marginally, as large funds must buy larger stocks more representative of the market in general.
While stock picking clearly could make a much bigger impact on smaller individual portfolios, the principal is the same. If you allocate a large portion of your portfolio to stocks, you are subject to the whims of the markets. If you have the bulk of your assets in stocks and they go up, you do well, but if you ride it down, you have the opposite result. Making the decision as to what percentage of your portfolio to devote to particular asset classes has a huge impact on your overall portfolio.
...
2000wave.com |
