Tuesday, April 28, 2009

The Ivy Portfolio II

As promised (YAIO April 15), I read The Ivy Portfolio.  I have to say that I started with a negative bias.  Although the Harvard and Yale endowments have produced superior investment returns for the past 23 years (generally a very good period for any equity investor), they lost roughly a quarter of their assets-- $5 to $10 Billion-- in the current bear market.  My first impression of the book is that the authors began the project  well before the debacle of late 2008 and rushed to publish before their conclusions were completely discredited.  It's worth noting that both Harvard and Yale endowments operate with a June fiscal year end, so their 2008 annual reports don't include information about the damage suffered in July to December.  

To be fair, the authors do note in passing that 2008 was a bad year.  However, the book is peppered with statistics based on periods ending before 6/30/08.  For example, consider this: 

 "The worst years for Harvard and Yale were -2.7% and -0.2%, respectively--pedestrian compared to the -17.99% experienced by the S&P 500 in 2002 and the stunning drawdowns of 2008..." 

That's a joke given what we know about their current performance.

However, I did find plenty of value in the book.  Let's cut to the bottom line first.  The fundamental conclusion is that a traditional stocks/bonds/cash portfolio allocation is inferior to one which includes alternative assets such as private equity, venture capital, hedge funds, and commodities.  To simplify things for the individual investor, the book recommends an allocation of equal parts domestic stocks, foreign stocks, bonds, commodities, and real estate, rebalanced regularly.  

On the positive side,   there's a good discussion of some of the behavioral biases that hurt investment performance.  For example, quoting Philip Fisher:

"None of us likes to admit to himself that he has been wrong... More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason."     

Or Warren Buffett on "anchoring":

"When I bought something at X and it went up to X and 1/8th, I sometimes stopped buying , perhaps hoping that it would come back down.  We've missed billions when I've gotten anchored.  It cost us about $10 billion (by not buying enough Wal-Mart)."                                                                                                              
Also some good sections about trend-following and avoiding losses. 

However, I disagree with much of the advice about portfolio diversification through the use of funds.  The outperformance of the Harvard and Yale endowments certainly was due in large measure to timely investments in alternative asset classes like hedge funds, commodities, and private equity.  But that doesn't mean that it will work for you, or even that it could have worked for you.  The authors are quick to acknowledge that the endowments had access to some of the very best funds and partnerships--ones closed to most investors.  The average individual investor risks being put into a basket of very average (or worse) alternatives.  

And finally, here's a more balanced view of Yale's portfolio management from Portfolio.com: Cash Me If You Can.


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