David Swensen has been the investment manager of Yale's Endowment since 1985 and is known as one of the best investors of our time. He recently was a guest lecturer at one of Yale's economics classes and the lecture is posted online.

Our investment process is largely based on the "Yale Model" of investing and I believe you will find his thoughts reassuring and educational.

Click here to watch Swensen's lecture at Yale.

Tags: Greg, Universities, Asset Class

How can retirees meet their income needs and manage current market risks?
A Barbell portfolio is comprised of 50% very safe assets and 50% very risky assets. It did surprisingly well during the 1929 crash and also during the recovery from the 1974 crash. While it's had mediocre long-term performance, it does provide substantial benefits to retirees during extreme market environments like the ones we are seeing today.

What if we're halfway through a 1929 crash?
As you can see, changing to a Barbell portfolio in the middle of the 1929 crash safely funded an annual $50,000 distribution and still exposed the portfolio to enough equity risk so that it was able to recover when the markets rebounded.


The portfolio illustrated is constructed out of three indexes. 10% 90 day treasuries, 40% intermediate government bonds and 50% small cap stocks. It assumes a $1,000,000 initial investment, is rebalanced annually, includes our maximum fee of 1.50% and an annual withdrawal of $50,000.

What if it's 1974 and we're about to recover?
The Barbell portfolio still did surprisingly well during the recovery period after the 1974 crash. It even outpaced the S&P 500 shown by the light blue line above.


The portfolio illustrated is constructed out of three indexes. 10% 90 day treasuries, 40% intermediate government bonds and 50% small cap stocks. It assumes a $1,000,000 initial investment, is rebalanced annually, includes our maximum fee of 1.50% and an annual withdrawal of $50,000.



Why did this portfolio do so well in tough times?
There are two main reasons this portfolio has performed well during extreme market conditions:

• First, the government bonds were able fund the income distributions.
• Second, the small cap stock exposure provides a high level of market risk. Fortunately small cap investors have historically been rewarded for this risk.

During these times we believe it is important to fund your liabilities (income needs), while keeping as much market exposure as possible. A Barbell portfolio may provide retirees with a way to accomplish this goal.

Tags: Greg, Asset Class

Asset Class	Ticker	5 Day Return
Alternative
Gold	GLD	17.64%
Commodities	GSG	-1.54%
Natural Resources	IGE	6.87%
130/30 Funds	JFT	1.69%
Hedge Funds	GARTX	3.10%
Master Limited Partnerships	BSR	-7.88%
Private Equity
US Private Equity	PSP	6.00%
Intl Private Equity	PFP	0.70%
Real Estate
US Real Estate	RWR	3.98%
Intl Real Estate	RWX	-1.74%
US Stocks
US All Stocks	VTI	0.00%
US Small Cap	VB	3.36%
US Micro Cap	FDM	6.03%
International Stocks
Intl All Stocks	VEU	0.90%
Intl Small Cap	GWX	3.75%
Emerging Market Stocks
Emerging Market Stocks	VWO	5.34%
Emerging Markets Small Cap	DGS	-4.44%
Frontier Markets Stocks	FRN	-3.52%
US Fixed Income
US Treasuries	ITE	-0.66%
Inflation Protected Securities	TIP	-0.99%
Tax-Free Muni Bonds	MUB	-3.77%
US Corp Bonds	AGG	-0.17%
US High Yield Corp Bonds	JNK	-2.87%
US Preferred Stock	PFF	-2.67%
International Fixed Income
Intl Treasuries	BWX	0.23%
Intl. Inflation Linked Treasuries	WIP	-1.89%
Emerging Market Treasuries	EMB	-6.30%

Tags: Greg, Asset Class

Retail investors’ behavior is not reflective of the current global landscape. According to Hewitt Associates’ 401k data for 2007, retail investors were only allocating 14% of their equity portfolios to international investments. This contrasts starkly with the current US portion of global market cap and global GDP. Unlike retail investors, institutional investment activity clearly reflects awareness of the rapid expansion occurring outside the US.



I heard Paul Wolfowitz, former head of the World Bank, lecture on this topic several years ago. At the time, Mr. Wolfowitz pointed out that in 25 years the US portion of global market cap would shrink from roughly 50% to 25%. He also outlined that this trend began to accelerate in the 1970s (at that time US markets made up 66% of global market cap). What troubles me is that institutional investors like Harvard and CalPERS have increasingly moved their equity allocations in line with this global market cap shift. Unfortunately, individual investors who are increasingly more responsible for their own investment decisions (as DC plans overtake DB plans) are showing no signs of adjusting to this trend. This could prove to be a costly mistake.

According to the MSCI Blue Book, in 1970 the US public equity markets made up of 66% of global market cap. We recently ran a simulation using S&P 500 (SPY), MSCI EAFE (EFA) and MSCI EM (EM) Indexes to test how investors would fair if they had kept pace with globalization. We began the simulation in 1970 with 60% invested in the S&P 500 and 40% in the MSCI EAFA index. In 1988 we shifted the portfolio to be 40% the S&P 500, 40% MSCI EAFA and 20% the MSCI EM index to reflect the shrinking global landscape. Rebalancing annually, this global portfolio averaged a return of 11.71% vs. 10.50% for the S&P 500 over the same period.





The case for retail investors to move to a global portfolio is a case for improving their returns. Since 1970 the rate of real GDP growth has slowed in the US. This is also reflected by a US public equity market that has seen its growth rate slow post-1970. This is exactly why institutions are increasingly moving toward global equity mandates. The risk to US retail investors is that they may see investment returns significantly below previous generations. This does not bode well for those investing for retirement today.

Disclosure: The author’s firm has positions in SPY, EFA, and EEM.

Tags: Asset Class, Pension Funds, Greg

What asset classes are winning in 2008 as of Wednesday, August 13th?
1) +15.45% - Biotechnology (XBI)
2) +14.77% - Commodities (GSG)
3) -0.66% - Domestic Real Estate Investment Trusts (RWR)

What asset classes are losing in 2008 as of Wednesday, August 13th?
1) -21.16% International Real Estate (RWX)
2) -20.73% Domestic Listed Private Equity (PSP)
3) -19.39% Emerging Markets (EEM)

How are the broad markets as of Wednesday, August 13th?
Domestic: Stocks (SPY): -12.06% and Bonds (AGG): -1.22%
International: Stocks (EFA): -18.69% and Bonds (BWX): +0.20%
Emerging Market: Stocks (EEM): -19.39% and Bonds (PCY): -7.75%

Our Comments: An interesting trend has emerged within the markets in the last few weeks. We're finally seeing some strength from the dollar and weakness in commodities. This trend change is matched by a strengthening of domestic stocks and a dramatic decline of the foreign stock markets.

Most importantly in our minds we have seen great strength from Micro Cap. This may be signaling that the US markets are out of the woods. We are well aware that things are looking better for the domestic markets.

While the US economy is facing significant challenges in some industries not all is doom and gloom. We must always remember that the markets are a leading indicator and they seem to be indicating things will begin to improve.

Tags: Greg, Asset Class

Well, everything (except real estate) has been getting a lot more expensive and it looks like it’s not going to get any better. Consumer prices increased by 1.1% month over month in June. This was a lot higher than the consensus forecast and it’s the biggest monthly rise since Hurricane Katrina. The annual inflation rate jumped to a 17 year high of 5%.



So what does this mean for you and your portfolio? For discussion purposes let me highlight some of the techniques used by universities to hedge against inflation.

Often in managing their endowments, universities construct portfolios that include several hedges against inflation. To begin with, Treasury Inflation Protected Securities (TIPS) is an allocation that universities often use. These are bonds that typically go up when the consumer prices go up. David Swensen, the former head of the Yale Endowment, believes TIPS are an important component to a portfolio. Universities often allocate to commodities, precious metals and natural resources as well. On a sad note, usually real estate is a good inflation hedge, but unfortunately the deleveraging of the credit markets will likely prevent an appreciation in real estate in the near term. Important Disclosure

Tags: Greg, Asset Class, Universities

What asset classes are winning in 2008 as of Tuesday, June 10?

1) +33.24% - Commodities (GSG)
2) +11.89% - Natural Resources (IGE)
2) +3.10% - Domestic Real Estate Investment Trusts (RWR)


What asset classes are losing in 2008 as of Tuesday, June 10?

1) -10.97% International Real Estate (RWX)
2) -10.64% International Listed Private Equity (PFP)
3) -9.31% Domestic Listed Private Equity (PSP)


How are the broad markets as of Tuesday, June 10?

Domestic Stocks (SPY): -7.00%
Domestic Bonds (AGG): -1.22%

International Stocks (EFA): -7.01%
International Bonds (BWX): +0.82%

Emerging Market Stocks (EEM): -6.17%
Emerging Market Bonds (PCY): -0.32%


Our Comments: In the last 30 days we have seen the return of volatility to the markets. Oddly enough, there has been strength from micro cap (FDM). Since our last email it's only down -0.24% and considering the S&P 500 (SPY) has fallen -4.62% during this same period, that's quite remarkable. Historically micro cap and small cap has led us out of recessions, so if we are in a recession those are the asset classes that may signal a recovery.

If you go back 10 years (June 6th 1998) and take a look at the S&P 500 (SPY), the market appreciation is only 24%. That's an average annual return of 1.89% over that 10 year period. With S&P 500 having a long term annualized return of 10% to 12%, we've got a significant deviation from the mean return. So what does this mean? We feel that US stocks are due for a rally in the next few years.

Just as the emerging markets quietly started their charge towards the tail-end of the dot com boom, we feel that towards the tail-end of this commodity boom US stocks will start their next upward move. In the last week, almost every asset class has gotten killed. However, there has been surprising relative strength from the S&P 500, which is a rare occurrence. We'll be watching for a consistent trend change.

What do we do with this information? For one, we don't try to anticipate what's going to happen in the short run. Our firm studies very long-term trends and tries to build portfolios that do well through them all. Currently, our average University Endowment Styled Portfolio is up in 2008 (0.84% after fees). Our portfolios are generally globally diversified so we just need one of the markets to improve for performance to kick up. We are constantly researching how to make our portfolios more stable without sacrificing return. Our historical research is designed to help us understand how to make those improvements.

Important Disclosure

Tags: Greg, Asset Class

We follow about 25 asset classes. Of those, here is what we're seeing in 2008:

What asset classes are winning in 2008 as of Friday, May 16?

1) +28.86% - Commodities (GSG)
2) +14.58% - Natural Resources (IGE)
2) +10.85% - Domestic Real Estate Investment Trusts (VNQ)


What asset classes are losing in 2008 as of Friday, May 16?

1) -4.76% Domestic Listed Private Equity (PSP)
2) -4.12% Domestic Micro Cap Stocks (FDM)
3) -3.46% International Listed Private Equity (PFP)


What about the broad markets?

Domestic Stocks (SPY): -2.17%
Domestic Bonds (AGG): +2.05%

International Stocks (EFA): +1.08%
International Bonds (BWX): +6.39%

Emerging Market Stocks (EEM): +3.19%
Emerging Market Bonds (PCY): +0.94%


Our Comments: Predicting the short term movement of any asset class is similar to predicting the weather, but over the long run we can be quite certain of their return. Therefore, the historic performance of an asset class gives us the best guidance for long term future returns.

We know that the long term returns of commidities are about 10%. When they outperform this rate for a period of years we should remind ourselves that they will have to eventually go through a severe correction to revert to their mean returns.

While we often include an allocation to commodities in clients' portfolios, we are well aware that the odds of a severe downward correction are increasing. Earlier this year we were rebalancing into real estate and domesitc stocks (at the time they were underperforming); now we are evaluating reblancing into underperforming classes like private equity and micro cap. This helps us manage the risk of our portfolios and ensures that we are selling high and buying low.

Important Disclosure

Tags: Asset Class, Greg

While venture capital fundraising is off this year (down to 18.8 form 21.3 billion), private equity money keeps pouring in from the institutions. With major players Apollo and Carlyle able to build funds around 10 billion in size, funds raised for private equity have reached $199 billion. This is $35 billion more than the same time last year.

Looks like a good time to be a business owner trying to sell to private equity. It also reminds me of the tech bubble where the greatest cash inflows came in the four months before the crash.

Tags: Greg, Asset Class

While retail investors are selling out of their REIT's and watching the value of their homes decline, the smart money on Wall Street is gearing up to buy everything on sale. The S&P Homebuilders index (ETF: XHB) peaked in July of 2005 and has fallen 68% since then. The real estate bust has sent individual investors running for the hills, while veteran investors like Warren Buffet, Bill Miller and The Carlyle Group have rolled up their sleeves and started buying into the weakness.

They have proven to be a bit early, but listen to what Bill Miller had to say in his recent letter to investors: "The headlines today are all about this being the worst housing market since the early 1990’s. Had you bought housing stocks during that previous period of duress, you would have made many times your money and handily outperformed the market over the subsequent decade."

While Buffet and Miller have focused on the homebuilders, other institutions are not shying from buying hard assets. Carlyle just finished raising $3 billion for a private equity fund and it plans to put it to work in a relative value strategy. The leverage will be low, they will only borrow $4 billion, giving them a total of $7 billion to invest. One thing's for sure, a weak dollar is making U.S. assets like real estate look more attractive to foreign investors and over the next few years their appetite for these discounted assets may be the stabilizing factor for the sector.

In 2005 the homebuilders index signaled the eventual real estate slow down. It acted as a leading indicator falling before other housing related stocks and as a result it is likely to be the first real estate sector to turn around. While the average individual investor is thinking, "real estate is just getting worse!" and the average institutional investor is saying, "I can't buy them because I need to make next month's numbers," investors with a longer time horizon, like Warren Buffet and Bill Miller, are likely to be well rewarded. Most people are calling for the real estate slowdown to continue into 2009 and 2010. If that prediction is true, it's likely that housing related stocks, and XHB, will bottom well before that time.

Tags: Asset Class, ETF, Greg