He said that when he first got to Yale the typical endowment had 50% in US stocks, 40% in US fixed income and 10% in alternatives and that mix made no sense to him. He said that diversification is a great thing. It was a great thing then and it is a great thing now. Endowments may have thought they were diversified but he said there is no way you can argue that having 90% of your assets in US marketable securities represents diversification.
If you have a long investment horizon you should have an equity orientation because over long periods of time equities should produce superior returns and if they don't, Swensen said, then it means capitalism isn't working. He also echoed a sentiment mentioned by many which is that after a decade long decline for stocks and more than a decade of big gains for bonds, stocks now are likely to outperform and bonds underperfom.
Roger chiming in: Despite the emotion that exists today this is a logical way to think of things.
Back to Swensen who noted that diversification isn't going to help in the middle of a financial crisis. It "failed" in 1987, 1998 and now. During a crisis people rush to treasuries which causes them to go up in price and everything else to drop in price.
To him this crisis reminded him the people pay too much for illiquid investments like hedge funds. Too much in terms of the extra return they provide.
He thinks that the things that are important about diversification for endowments are just as important as for individuals but the path to that point means different types of products. He noted disappointment in not being able to replicate the Yale endowment for individuals with ETPs . He said the type of active management needed for all the asset classes is not available for individuals. Investors need to be either very active or completely passive. Individuals are probably better off being completely passive because he believes the quality of the management in the mutual fund industry is not high but it is very expensive.
He spelled out some of his model portfolio for individuals and has made two tweaks from the book. He reduced his REIT allocation from 20% to 15% and increased emerging market equity exposure from 5% to 10%.
30% US stocks
15% treasury bonds
15% TIPS
now 15% REITs
15% foreign developed equities
now 10% emerging markets
Ok, all done paraphrasing Swensen.
I have been critical of his model portfolio mostly because of the 20% in REITs. Even the new 15% is way more than I would ever want. When people talk about correlations going to 1 during the crisis REITs are the first thing I think of. I had one REIT targeted at a 2-3% weight toward the end of the bull market but I sold it early on. REITs will be a fine hold again at some point but I no longer trust them in terms of being a diversifier.
On a brighter note I believe it has gotten much easier to build a portfolio with the type of diversification that Swensen seems to be looking for. Private equity remains elusive but I am not really a fan of that anyway. Certain types of hedge fund strategies are available but not the ones that go up 500% thanks to shorting all the stuff that dropped 90% in 2007 and 2008 (or whatever the equivalent of that type of trade will be in the future).
Long time readers will know that I find what the endowments do to be fascinating. They provide a great opportunity to learn but not emulate. That people have learned a lot of things about their own tolerance for volatility from the double bear market of this decade is a good thing, that it might send them to a portfolio of 30% equities, 30% bonds and 40% "diversifiers" would probably be a bad thing especially for people younger than 60.
If something more like 15% in diversifiers for someone with a low to middling tolerance for volatility is right then I think the investment product landscape offers a lot of choice with more choices to come.
One thing that Swensen addresses (along with many other people) that I try to emulate is to not let the conversation get too far away from logic and how markets tend to work. The point above he makes about stocks having a good chance to outperform bonds after how the chips have fallen over the last 20 years or so is very logical. An asset class has a good chance to outperform if it has lagged for a meaningful period of time. The sentiment guarantees nothing but it puts the odds in the favor of equities.
This is not a conversation about where or when the bottom is but looking out over some number of years the odds are that stocks will outperform. That is not an emotional statement it is a logical statement about probabilities.
On an unrelated note last June I went to
19 comments:
Thank you for a really meaty post today, Roger. Lots to think about.
For clarification, is your point about limiting diversifiers because they smooth out volatility but reduce expected return? Better for retirees but not younger investors who are still growing their portfolios and can better tolerate the volatility of more equities?
It's interesting to me that Swensen argues against a porfolio of US stocks and bonds as being non-diversified, but then only recommends 25% in foreign/emerging markets for individuals. Maybe he'll adjust that on the fly as the world economy stabilizes?
Now that you and Swenson are so down on REITs, I think they will become a great part of my portfolio in the future. Not yet, as I think the real estate bubble has a ways to go. But 1 to 4 years from now REITs will likely be better than bonds for those of us over 50.
Just my contrary 2 cents
anon 5:59 two answers, the time to go heavy (if there is ever a time) would not be after the stock market cuts in half. If global equities have gains anywhere close to what they did after the 1930s and 1970s (ten baggers over 20-25 years) I would expect many types of diversifiers that get left in the dust.
anon 6:07 the way I see it 30% in domestic equities and 25% in foreign which works out to 45% of the equity portion. I would also not that the allocation in the endowment looks much different.
anon 6:09 before you get too carried away I have been saying the same thing about REITs since 2007 when I sold my one REIT so your use of the word now is not accurate. Further do really take Swensen's 15% as bearish?
My inaccuracies on your multitude of positions aside (your hard to keep track of)
My comment on REITs is that the negative comments make them look more desirable. Remember I do not think they a ripe yet, I said 1 to 4 years.
But yes I do think REITs will become a very desirable income generating place to invest that will keep pace with inflation so better than bonds. However I think another shoe could drop first. Still I will keep them on my Radar.
Those changes to Swenson's model make sense. Probably still a tad underweight foreign but oh well.
Hmm. Swenson must have announced this change to his portfolio in the past; I already have a tracking portfolio set up this way.
Despite all of Swensens' criticism of stock-heavy portfolios, the last time I checked REITS were stocks... and hedge funds and "alternative investments" are often largely stocks... am I missing something?
Ajw
many view REITs as a distinct asset class that happens to be exchange traded. maybe an eye of the beholder thing?
personally I would say that a long short product that happens to use stocks should act differently than an index fund.
Swensen is one of those who I'd like to hear more detail from. He's somewhat of a legend and obviously intelligent. Yet I have some "Why..." questions for his allocation to REITs, omission of commodity index products, and the increase from 5 to 10% EM.
I'd also like to hear his allocation to small caps and his take on fundamental indexing. I feel like REITs are just small-cap high-yield stocks, and maybe his purpose for the excessive allocation there is to move the portfolio cap size down and yield up with a low ER.
I respect Swensen a lot, but his criticisms of active management for the masses seems based on the problem of performance chasing, which can just as easily be done with passive vehicles... in his book he goes into length about the Longleaf shop and how it is an example of excellent active management available to mutual fund investors... but he seems to have abandonded that view lately...
I agree that long/short and other strategies that truly go against the grain of the underlying asset classes are useful diversifiers, Roger... but the idea that REITS are a distinct asset class just doesnt make sense to me... to me they are still common stocks which are simply concentrated in one sector, which has historically had some disconnection with the overall market... but you could say that about any sector stock fund...
Ajw
Why should you assume that just because stocks are cheap, it is probable that they will outperform in the future? Are you saying that because that is the way it has always worked? I doubt that your theory would hold up in front of a panel of experts in probability theory.
Roger,
I am not a Sox fan, but I saw a game at Fenway in 92 or 93, which was one of the best games I had ever witnessed - Clemens vs. Saberhagen (when Saberhagen was solid - KC days).Final score was KC 1 - Boston 0. Both pitchers threw a complete game. Even better, I got in free since I was a cadet at the Academy then.
Anyway, I tend to think REITs will again be a solid diversifier for a portfolio. Like other assets, it correlates with stocks during panics, but as time progresses we should see the variation re-emerge. Correlations are not static, as we all know, but I do believe that the low correlation will hold over the ensuing years.
For investors who are truly long term, REITs don't look too bad here. The yield is around 9%. Sure, it will probably be cut as commercial real estate drops, but this is a healthy yield compared to the 10 year Treasury. Usually, the spread is 2-3%. Right now, it is more like 6%. Again, the investor must be long term as there will be massive swings in the price of REITs over the coming years, but one has to believe that 10 years from now the price should be, at least, where it is today, which would make it a better investment than a 10 year bond.
Kirk, you are very close to joining the nation, i can feel it.
Anon 3:22
you are going against buy low, sell hi.
I disagree with Roger all the time, hopefully respectfully most of the time. What I try not to do is ever disagree with logic like buy low, sell hi
roger, when you have results approaching swenson's, let us know...his yale endowment results are stellar over the long haul...what are yours like???
sure, its easy to pick on the short term troubles in reits, but you really miss the larger point by nit-picking him...
fair enough but your comment implies that we should not try to learn from mistakes made by the heavyweights. We can learn from what they get right and what they get wrong, ignoring one because of the his reputation or whatever seems like a missed opportunity to me.
roger, have you even read swenson's books? your comment suggests ignorance of his investment philosophy and strategy. he doesn't need to pick individual asset class winners or losers (like reits), he needs to choose a mix of asset classes that over time reduces volatility, and optimizes total return. he openly admits that individual asset classes in his mix will have down periods...its not a "mistake"....
I have read Swensen. If it wasn't a mistake then why did he reduce REITs from 20% to 15%? He learned something about them he didn't know and made a change as a result of his mistake. 20% was too much (a point I made before the bear market), he learned that and reacted. It does not detract from him because everyone makes mistakes.
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