The Ignorant Investor

The Economist's Buttonwood points out some questions regarding the approach taken by Yale's David Swenson in managing Yale's endowment. I liked Swenson's book for the individual investor. Very common sense in that he points out that what he does at Yale can't be replicated by the individual investor because he has access to money managers and asset deals that cost to much for Joe Average to access. Buttonwood wonders whether Swenson's approach to using non-correlated asset classes hasn't proven as effective as people initially thought:

Another problem is that diversification means more than simply a willingness to invest across a wide range of asset classes. It also requires taking a separate stance from the herd. Some asset classes (particularly illiquid ones) can be subject to a “rowing boat” effect. Mortgage-backed securities were a classic example. Everyone rushes into them, so the price rises sharply and investors pat themselves on the back for their shrewdness. Then something happens to change sentiment. As everyone tries to rush out of the asset, the boat capsizes. The additional returns achieved during the boom turn out to be illusory.

Martin Leibowitz of Morgan Stanley has analysed the characteristics of endowment portfolios over the past ten years. He looked at three portfolios: a classic 60/40 US equity/Treasury bonds split; a Yale-like portfolio with seven separate asset classes; and a portfolio with international diversification but without the illiquid private-equity, hedge-fund and real-estate portions. What is remarkable about these portfolios is how closely correlated they all are with the S&P 500. Even the Yale-like portfolio had a correlation of more than 0.9 (where 1 is a perfect fit).

This story is directed more at professional money managers than me, but I am intrigued by the idea that the simplistic two-asset class mix are correlated to more complex portfolios.