A Not Terribly Bright Idea for Harvard

A group of 11 Harvard alumni has a plan to boost the university’s straggling endowment, but it’s not the magical fix the members imagine.

In an open letter to Harvard’s new president, Lawrence Bacow, the group recommends that the endowment move at least half its assets to a low-cost S&P 500 index fund. It’s a “radical new endowment strategy,” the alumni acknowledge. Harvard, along with other big university endowments, pioneered and still uses the so-called endowment model of investing, which calls for investments in high-priced hedge funds and private assets alongside traditional stocks and bonds.

A radical step is necessary, the alumni say, because Harvard faces a “fiscal crisis” from a new tax on wealthy university endowments. According to Bloomberg News, Harvard estimates that “the new 1.4 percent tax would have cost the endowment $43 million last year.” The group’s plan would use the money saved on well-compensated managers to pay the tax.

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Ray Dalio’s Short-Bet Puzzle Is Missing Some Pieces

Hedge fund titan Ray Dalio is famously enigmatic, but his latest wager may be the most puzzling yet.

Bloomberg News reported on Thursday that the fund Dalio founded, Bridgewater Associates, has made a $22 billion bet that many of Europe’s biggest companies in the blue-chip Euro Stoxx 50 Index are poised to decline.

Bridgewater didn’t respond to Bloomberg’s request for comment, so Dalio’s motivation is not entirely clear. But according to Bloomberg News’ Brandon Kochkodin, Dalio “has a checklist to identify the best time to sell stocks: a strong economy, close to full employment and rising interest rates.”

It’s an old idea. Economic fortunes are reliably cyclical, even if no one can precisely predict the turns. Booms tend to be followed by busts, and vice versa, and stock prices often go along for the ride.

By that measure, it seems like a precarious time for U.S. stocks. The U.S.’s real GDP has grown for eight consecutive years, by 2.2 percent annually from 2010 to 2017. Unemployment has declined to 4.1 percent from 10 percent in late 2009. And the yield on the 10-year U.S. Treasury is up to 2.9 percent from 2.1 percent in September — an increase of nearly 40 percent.

The problem with Dalio’s checklist, however, is that stock prices take their cue from companies’ fundamentals, not the economy. Yes, companies’ collective fortunes often reflect those of the broader economy, but not always. And when the two diverge, the relationship between economic results and stock prices breaks down, too.

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Not Everything Is Expensive If You Know Where to Look

Investors love to complain that asset prices are too high, but they have only themselves to blame.

Investors bid up the S&P 500’s price-to-earnings ratio to 26.8 at the end of 2017 from 11.1 when the 2008 financial crisis eased in February 2009, based on 10-year trailing average positive earnings from continuing operations.

They drove down yields on the Bloomberg Barclays US Corporate High Yield Bond Index to 5.6 percent at the end of 2017 from 16.1 percent in July 2009. They squashed the yield on the Bloomberg Barclays US Corporate Bond Index to just 2.7 percent from 7.2 percent in May 2009. And they did the same to real estate. The FTSE Nareit U.S. All REITs Index yielded 4.1 percent as of November, down from 11.1 percent in February 2009.

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Calpers Needs to Think a Few Moves Ahead

The largest U.S. pension fund, the California Public Employees’ Retirement System, is chasing investing’s holy grail: Buy low and sell high.

Calpers is considering whether to reduce its stock allocation to as little as 34 percent from 50 percent and discussed it at a board workshop on Nov. 13.

The temptation to lighten up on stocks is understandable. The MSCI ACWI IMI Index — a collection of large-, mid- and small-cap companies from around the world — is up 40.2 percent since its low in February 2016 through October, including dividends. That’s well above the index’s average 20-month return of 14.7 percent since inception in June 1994.

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Investing: A Random Talk With Malkiel

For decades, Burton Malkiel has been a leading advocate of the efficient market hypothesis and its logical extension, the low-cost, passive approach to investing — as outlined in his bestselling book, “A Random Walk Down Wall Street.” Dr. Malkiel is a Princeton economist and Chief Investment Officer of a robo-adviser, Wealthfront.

I had the opportunity to chat with Dr. Malkiel recently about smart beta, his Wealthfront portfolios, and how investors should think about rock-bottom interest rates.

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Does Buffett Really Love the S&P 500?

Warren Buffett crooned one of his greatest hits for groupies attending Berkshire Hathaway’s annual meeting in Omaha last weekend: “Just buy an S&P index fund and sit for the next 50 years.”

Buffett has a well-deserved reputation as a legendary investor, but if ordinary folks want to mimic the master, the last place they should be parking their funds is the S&P 500.

Buffett is a big fan of the S&P 500. He has already declared that 90 percent of the money he leaves to his wife will be invested in Vanguard’s S&P 500 index fund. He also wagered a million dollars that Vanguard’s S&P 500 index fund would beat a basket of hedge funds over ten years from 2008 to 2017. (The S&P 500 index fund is currently crushing the hedgies.)

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Don’t Let McKinney Scare You Millenials

Poor millennials. Up to their ears in student debt. Facing stagnant wages. Beset by obscene housing costs in the big cities where they are most likely to land a job – if they can land a job, that is.

And now a high-profile consulting firm, McKinsey & Co., is adding to millennials’ woes with a Debbie Downer report that warns that millennials will have to work seven years longer or save twice as much in order to live as well in retirement as their parents. The reason, according to McKinsey, is that returns for U.S. and Western European stocks and bonds will be far lower over the next 20 years than they were over the previous 30 years.

Well, take heart Millennial Investors. Your futures are better than McKinsey would have you believe.

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Go Ahead and Hedge the Dollar, Silly

Despite its recent stumbles, the dollar has had the hot hand for much of the last two years. The U.S. Dollar Index, which measures the value of the dollar relative to a basket of foreign developed market currencies, has advanced 18 percent since April 2014.

Conventional wisdom suggests that the dollar isn’t done yet. The Federal Reserve is looking for any excuse to raise interest rates, while Europe and Japan are desperately trying to reboot their economies — a recipe for a stronger dollar.

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Where to Hide In Brutal Markets

You know what you do with your portfolio when the stock market behaves badly? You move to those timeless stores of value: cash, gold and real estate.

Or at least that’s what some investment strategists are suggesting in response to market malaise. They certainly aren’t not alone. Just search on Google for advice about the wisdom of investing in cash, gold or real estate and you’ll find a chorus of voices singing the praises of those traditional safe havens.

Despite such popularity, my guess is that few sophisticated portfolio managers actually attempt to sidestep the market’s vagaries by hiding in cash, gold or real estate — and for good reason.

Consider that the simplest 60/40 diversified portfolio made up of the S&P 500 Index and long-term government bonds has returned 9.9 percent annually from 1972 to 2015 (the longest period for which data is available for all investments referenced in this column; those returns include dividends).

Cash, as represented by 30-day Treasuries, returned 4.9 percent annually over the same period. Gold returned 7.5 percent annually over the same period. And real estate, as represented by the FTSE NAREIT U.S. Real Estate Index, returned 9.7 percent annually over the same period.


On a risk-adjusted basis, gold and real estate fared even worse. The 60/40 portfolio has a Sharpe Ratio of 0.48, whereas gold and real estate have Sharpe Ratios of 0.13 and 0.27, respectively. (The Sharpe Ratio gauges risk-adjusted returns, with a higher ratio indicating that investors are more adequately compensated for volatility. The Sharpe Ratio of cash is zero because the Sharpe Ratio measures the excess risk-adjusted return over cash.)

So cash, gold and real estate have been no match for a simple diversified portfolio over the long haul. But here’s the more crucial twist: They also haven’t even been a sure-fire hiding place during market routs.

There were four ugly multi-year episodes for U.S. stocks between 1972 and 2015, as measured by changes in the value of the S&P 500. The first episode was the Nifty Fifty crash of the early 1970s. The 60/40 portfolio declined 29.6 percent from December 1972 to September 1974, but real estate investors were less fortunate, suffering a decline of 52.6 percent over the same period.

The second episode was the stagflation recession of the early 1980s. The 60/40 portfolio declined 3.7 percent from November 1980 to July 1982, but this time it was gold investors’ turn to get hammered with a decline of 44.7 percent over the same period.

The third episode was the post-tech bubble collapse of the early 2000s. The 60/40 portfolio declined 21.2 percent from August 2000 to September 2002, and this time investors got what they came for – cash, gold and real estate all appreciated in value.

The fourth and most recent episode, of course, was the 2008 financial crisis. The 60/40 portfolio declined 29.7 percent from October 2007 to February 2009, but real estate investors were left poorer yet again, suffering a decline of 63.2 percent over the same period.


Given that cash, gold and real estate appear to be less than perfectly correlated, you may be wondering whether a combination of the three would have been the silver bullet. No dice there either. An equally weighted portfolio of the three would have declined in two of the four bear markets – by 8.5 percent from November 1980 to July 1982, and by 20 percent from October 2007 to February 2009.

All of this means that investors who are hell-bent on sidestepping bear markets have a near-impossible mission. For starters, they have to time their market exit and re-entry to near perfection, which is famously difficult to do.

But that’s just the beginning. Investors also then have to predict which of their desired ports of call –- cash, gold or real estate –- will actually hold up in a storm. Granted, cash should always hold up (and if it doesn’t, heaven help us all), but it also inflicts the most severe penalty for mistiming the market, as it will fall farthest behind over time.

So investors shouldn’t look longingly at cash, gold or real estate right now, even if their portfolios seem shaky. They should just stay the course, because sometimes a port in the storm is much more dangerous than it appears to be.

Source: Bloomberg Gadfly, https://bloom.bg/2gMGqpP

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