Former analyst Brian Sozzi, now at The Street, got my attention last month with his headline “Investors Have Learned Squat 10 Years After the Lehman Brothers Bankruptcy.”
We can agree that opinions are like belly buttons, everybody has one. But you and I prefer to listen and learn from those with informed opinions, and Sozzi is certainly well qualified.
It was four years into his Wall Street analyst job on Sept. 15, 2008 when Sozzi reflected, “I only thought deep down days in the market were buying opportunities. After all, the old B.S. line on Wall Street for years has been ‘buy low, sell high.’ Selling dominated my trading screens, high-stakes drama was playing out on business news networks and behind the scenes in Washington, and an entire generation of investors were being wiped out — houses, stocks, you name it. But thinking back to that time and today’s environment, I can confidently say most investors have learned nothing 10 years since the Lehman bust.”
Sozzi went on to say what may sound very familiar to too many investors, “People are simply riding momentum because everyone else is and they don’t know how to read a cash flow statement. Some continue to hold Lehman lessons dear, but it’s my view the majority have moved on without revisiting that time every quarter, as they should. It’s sad and it will come back to bite investors — again — within the next five years.”
First, let’s look at the smart money as represented by the Yale Endowment, June 2017 annual return (net of fees) 11.3 percent (See accompanying graph).
This isn’t your typical 60 percent stocks and 40 percent bond portfolio. The Asset Allocation report reads “Over the past 30 years, Yale dramatically reduced the endowment’s dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1985, over four-fifths of the endowment was committed to U.S. stocks, bonds and cash. Today, domestic marketable securities account for approximately one-tenth of the portfolio, while foreign equity, private equity, absolute return strategies and real assets represent nearly nine-tenths of the endowment,” according to Yale Investments Office.
Further, “The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power. Today’s actual and target portfolios have significantly higher expected returns and lower volatility than the 1985 portfolio. Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management. The endowment’s long time horizon is well suited to exploiting less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber and real estate.”
In closing, “In 1985, when alternative asset classes accounted for only 12 percent of the endowment, Yale faced a 21 percent chance of a disruptive spending drop, in which real spending drops by 10 percent over two years, and a 36 percent chance of purchasing power impairment, in which real endowment values fall by 50 percent over 50 years. By 2016, when absolute return, private equity and real assets accounted for approximately 74 percent of the endowment, disruptive spending drop risk fell to 8 percent and purchasing power impairment risk declined to 10 percent.”
There is no recommendation in my article here for investors to try and follow Yale’s model. But if it is the case that success leaves clues, as I believe it does, there may be some things we can learn from some of the best and the brightest.
Yale observed, “The rigor required in conducting mean-variance analysis brings an important element of discipline to the asset allocation process.”
What I find encouraging is that Yale is doing exceptional work. I am inspired to follow their lead. As opposed to a two-asset class composition of 60 percent stocks and 40 percent bonds (or vice versa), please do notice Yale holds eight asset classes outside of cash. Please pay particular attention to their holdings by percentage in U.S. equity and fixed income.
It is my opinion that to be better prepared for the good, the bad, and the unforeseen, savvy investors will diversify unlike they have ever diversified in the past.
Allow me to confess that my peers and I accept responsibility for failing to help investors see how their portfolios may be any better prepared for the approaching storm. Perhaps this work will help right our ship before the next disaster reaches your life savings.
John L. Grace is president of Investor’s Advantage Corp, a Los Angeles-area financial planning firm that has been helping investors manage wealth and prepare for a more prosperous future since 1979. His On the Money column runs monthly in The Wave.