Miles on money: Many paths to success
Friday, April 26, 2013 7:00 AM
When I enter a destination into my car’s GPS, I am always offered three routes of travel from which to choose. The standard route uses major highways, but I’m also shown alternates that may be quicker or shorter.
When it comes to investing, however, people often seem to be looking for a singular answer: the one best path. And investment advisers are often all too eager to oblige.
A useful caution can be found in the 2012 NACUBO-Commonfund Study of Endowments, which gathered data on the investment strategies and performance of 831 U.S. colleges and universities. How colleges invest their endowments is instructive, because universities rely on their endowment returns to pay operating expenses, while at the same time trying to preserve the purchasing power of their assets into perpetuity. So they take investing very seriously.
Given the relative similarity of their objectives, you might expect that foundation investment strategies would coalesce around a single “best way.” Not so. Let’s start with the largest endowments, those over $1 billion. In 2012, they allocated their investments this way: 12 percent to domestic equities, 9 percent to fixed income, 15 percent to international equities, 3 percent to short-term/cash/other, and – here’s the kicker – 61 percent to what are known as “alternative strategies.”
Alternative strategies include such things as private equity (i.e., leveraged buyout funds and other investments in private companies), hedge funds of various stripes, venture capital, privately owned real estate, energy and natural resources, and distressed debt.
By contrast, the smallest endowments (those under $25 million) invested 39 percent in U.S. equities, 29 percent in fixed income, 14 percent in international equities, 7 percent in “other” and a mere 11 percent in alternative strategies. The asset allocations of small endowments more closely mirror typical individual retirement accounts, which in 2010 were allocated 52 percent to equities (U.S. and foreign), 20 percent to fixed income, 9 percent to cash and certificates of deposit, and 15 percent to “other.”
Given the disparity in investment approaches between the largest and smallest endowments, you may find the similarity of their returns surprising. In 2012, endowment returns averaged -0.3 percent overall, while the largest foundations returned on average 0.8 percent and the smallest averaged 0.3 percent. Three-year returns averaged 10.6 percent and 10.4 percent, respectively.
In fairness, over time, the largest foundations have been able to use their greater scale and access to premier managers to achieve, on average, higher returns, but not without exception. One small foundation I know well has outperformed even the largest endowments over many years without investing a single dollar in alternative investment strategies. And, in a recent posting on the site www.pragcap.com, Robert Seawright illustrated that an indexed portfolio invested 60 percent in equities and 40 percent in bonds -- note, that means 0 percent in alternative strategies – outperformed even the largest endowments over the one-, three- and five-year periods.
My point is that there are many paths to investment success. An occupational hazard for investment managers is to conclude that we have found the one best way. Having managed money for a number of institutions, as well as serving on the investment committees of a number of foundations over the years, I have concluded that investment success is less about the search for a single Holy Grail of investing, and more about what works for each client’s unique needs.
To be sure, our analysis leads us to favor certain asset allocation strategies over others, but the caution here is to not be misled by tales of new, “more sophisticated” investment approaches.
The question should not be “Am I on the one best path?” but rather, “Am I on the right path for me – one that I understand and can stick with over time?”
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