Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Wednesday, April 11: Everyone
has different theories as to why they hold bonds. A friend has 30% of his portfolio
in bonds because he's "waiting for the next deal." He usually finds
awesome deals, but they come along infrequently. Several readers think I should
hold bonds as an insurance policy against the stock market crumbling. One reader
cited Jeremy Siegel, a finance professor at the Wharton School of the University
of Pennsylvania. In his famous book, "Stocks For The Long Run",
Siegel reports the percentage of time since 1802 in which stocks failed
to beat T-Bills. Not surprisingly, this percentage falls as holding period increases.
But what is surprising, at least to many of us, is that this holding period
has to grow to more than a decade to drop to below 10%.
time stocks didn't beat T-Bills,
to Professor Jeremy Siegel
Frankly, I don't
buy Professor Siegel's "statistics." And you'll see why below.
I'm still mulling
my bonds. Once I had a theory that I'd stick enough in bonds to earn sufficient
income to live on -- after all, I don't have a day job. But over the years as
I learned about investing, I realized that having money in bonds brings a huge
opportunity cost -- the opportunity of what you could earn elsewhere. As a result
my allocation to bonds has progressively dropped over the years. Presently only
6.1% of my net worth is in bonds (all New York State/City muni bonds).
not the only one to have figured this. (There are other geniuses out there.)
Take Yale, the University. They do a little better than I do. Here are their
latest incredible returns:
Annual Investment Returns
|Year to June
Read that again.
Yale earned 22.9% on a portfolio that started the year on July 1, 2005
at $15.2 billion. That's incredible. Downright phenomenal. Bloody amazing.
Any other words of praise you can think of. How was their portfolio allocated?
You'll note the
declining allocation to fixed income. Now for some excerpts from The Yale Endowment's
annual report. Read this stuff carefully. You'll learn more from reading how
Yale does it than from 1,000 investment books (and a thousand of my columns):
I'll write more tomorrow
about Yale. For now, you can read their 28-page annual report, "The
Yale Endowment 2006." Click
Over the past
two decades, Yale reduced dramatically the Endowments dependence on
domestic marketable securities by reallocating
assets to nontraditional asset classes. In 1986, 75 percent of the
Endowment was committed to U.S. stocks, bonds, and cash. Today, target allocations
call for 16 percent in domestic marketable securities, while the diversifying
assets of foreign equity, private equity, absolute return strategies, and
real assets dominate the Endowment, representing 84 percent of the
The heavy allocation to nontraditional asset classes stems from their return
potential and diversifying power. Todays actual and target
portfolios have significantly higher expected returns and lower volatility
than the 1986 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 Endowments long time horizon is well suited to exploiting illiquid,
less efficient markets such as venture capital, leveraged buyouts, oil and
gas, timber, and real estate.
six asset classes are defined by differences in their expected response to
economic conditions, such as price inflation or changes in interest rates,
and are weighted in the Endowment portfolio by considering risk adjusted returns
and correlations. The University combines these assets in such a way as to
provide the highest expected return for a given level of risk.
In July 1990, Yale became the first institutional investor to pursue absolute
return strategies as a distinct asset class, beginning with a target allocation
of 15.0 percent. Designed to provide significant diversification to the Endowment,
absolute return investments seek to generate high long-term real returns by
exploiting market inefficiencies. Approximately half of the portfolio is dedicated
to event-driven strategies, which rely on a very specific corporate event,
such as a merger, spin-off, or bankruptcy restructuring to achieve a target
price. The other half of the portfolio contains value-driven strategies, which
involve hedged positions in assets or securities that diverge from underlying
economic value. Today, the absolute return portfolio is targeted to be 25.0
percent of the Endowment, above the average educational institutions
allocation of 18.6 percent to such strategies. Absolute return strategies
are expected to generate real returns of 6.0 percent with risk levels of 10.0
percent for event-driven strategies and 15.0 percent for value-driven strategies.
Unlike traditional marketable securities, absolute return investments provide
returns largely independent of overall market moves. Over the past ten years,
the portfolio exceeded expectations, returning 12.9 percent per year with
essentially no correlation to domestic stock and bond markets. An important
attribute of Yales investment strategy concerns the alignment of interests
between investors and investment managers. To that end, absolute return accounts
are structured with performance related incentive fees, hurdle rates, and
clawback provisions. In addition, managers invest a significant portion of
their net worth alongside Yale, enabling the University to avoid many of the
pitfalls of the principal agent relationship.
Finance theory predicts that equity holdings will generate returns superior
to those of less risky assets such as bonds and cash. The predominant asset
class in most U.S. institutional portfolios, domestic equity, represents a
large, liquid, and heavily researched market. While the average educational
institution invests 29.1 percent of assets in domestic equities, Yale's target
allocation to this asset class is only 12.0 percent. The domestic equity portfolio
has an expected real return of 6.0 percent with a standard deviation of 20.0
percent. The Wilshire 5000 Index serves as the portfolio benchmark.
that the U.S. equity market is highly efficient, to pursue active management
strategies, aspiring to outperform the market index by a few percentage points
annually. Because superior stock selection provides the most consistent and
reliable opportunity for generating excess returns, the University favors
managers with exceptional bottom-up fundamental research capabilities. Managers
searching for out-of-favor securities often find stocks that are cheap in
relation to current fundamental measures such as book value, earnings, or
cash flow. Yale's managers tend to emphasize small-capitalization stocks,
as they are less efficiently priced and offer greater opportunities to add
value through active management. Recognizing the difficulty of outperforming
the market on a consistent basis, Yale searches for managers with high integrity,
sound investment philosophies, strong track organizations, and sustainable
assets generate stable flows of income, providing greater of nominal cash
flow than any other Endowment asset class. The bond portfolio exhibits a low
covariance with other asset classes and serves as a hedge against financial
accidents or periods of unanticipated deflation. While educational institutions
maintain a substantial allocation to fixed income instruments and cash, averaging
17.6 percent, Yale's target allocation to fixed income constitutes only 4.0
percent of the Endowment. Bonds have an expected real return of 2.0 percent
with risk of 10.0 percent. The Lehman Brothers U.S. Treasury Index serves
as the portfolio benchmark.
Yale is not
particularly attracted to fixed income assets, as they have the lowest historical
and expected returns of the six asset classes that make up the Endowment.
In addition, the government bond market is arguably the most efficiently priced
asset class, offering few opportunities to add significant value through active
management. Based on skepticism of active fixed income strategies and belief
in the efficacy of a highly structured approach to bond portfolio management,
the Investments Office chooses to manage Endowment bonds internally. In spite
of an aversion to market timing strategies, credit risk, and call options,
Yale manages to add value consistently in its management of the bond portfolio.
Willingness to accept illiquidity leads to superior investment results without
impairing the portfolio protection characteristics of high-quality fixed income.
in overseas markets give the Endowment exposure to the global economy, providing
substantial diversification along with opportunities to earn above-market
returns through active management. Emerging markets, with their rapidly growing
economies, are particularly intriguing, causing Yale to target more than one-half
of its foreign portfolio to developing countries. Yale's foreign equity target
allocation of 15.0 percent stands slightly below the average endowment's allocation
of 20.0 percent. Expected real returns for emerging equities are 8.0 percent
with a risk level of 25.0 percent, while developed equities are expected to
return 6.0 percent with risk of 20.0 percent. The portfolio is measured against
a composite benchmark of developed markets, measured by the Morgan Stanley
Capital International (MSCI) Europe, Australasia, and Far East Index, and
emerging markets, measured by the MSCI Emerging Markets Index.
approach to foreign equities emphasizes active management designed to uncover
attractive opportunities and exploit market inefficiencies. As in the domestic
equity portfolio, Yale favors managers with strong bottom-up fundamental research
capabilities. Capital allocation to individual managers takes into consideration
the country allocation of the foreign equity portfolio, the degree of confidence
Yale possesses in a manager, and the appropriate asset size for a particular
strategy. In addition, Yale attempts to exploit compelling undervaluations
in countries, sectors, and styles by allocating additional capital and, perhaps,
by hiring new managers to take advantage of the opportunities.
offers extremely attractive long-term risk-adjusted return stemming from the
University's strong stable of value-added managers that exploit market inefficiencies.
Yale's private equity investments include participations in venture capital
and leveraged buyout partnerships. The University's target allocation to private
equity of 17.0 percent far exceeds the 6.4 percent actual allocation of the
average educational institution. In aggregate, the private equity portfolio
is expected to generate real returns of 11.4 percent with risk of 29.0 percent.
equity program, one of the first of its kind, is regarded as among the best
in the institutional investment community. The University is frequently cited
as a role model by other investors pursuing this asset class. Since inception,
private equity investments have generated a 30.6 percent annualized
return to the University. The success of Yale's program led to a 1995 Harvard
Business School case study- "Yale University Investments Office"-by
Professors Josh Lerner and Jay Light. The popular case study was updated in
1997, 2000, and 2003.
equity assets concentrate on partnerships with firms that emphasize a value-added
approach to investing. Such firms work closely with portfolio companies to
create fundamentally more valuable entities, relying only secondarily on financial
engineering to generate returns. Investments are made with an eye toward long-term
relationships -- generally, a commitment is expected to be the first of several
-- and toward the close alignment of the interests of general and limited
partners. Yale avoids funds sponsored by financial institutions because of
the conflicts of interest and staff instability inherent in such situations.
oil and gas, and timberland share common characteristics: sensitivity to inflationary
forces, high and visible current cash flow, and opportunity to exploit inefficiencies.
Real assets investments provide attractive return prospects, excellent portfolio
diversification, and a hedge against unanticipated inflation. Yale's 27.0
percent long-term policy allocation significantly exceeds the average endowment's
commitment of 8.4 percent. Expected real returns are 6.0 percent with risk
of 15.0 percent.
The real assets
portfolio plays a meaningful role in the Endowment as a powerful diversifying
tool and a generator of strong returns. Real assets provide relative stability
to the Endowment during periods of public market turmoil, at the price of
an inability to keep pace during bull markets. Pricing inefficiencies in the
asset class and opportunities to add value allow superior managers to generate
excess returns over a market cycle. Since inception in 1978 the portfolio
has returned 17.4 percent per annum.
nature of real assets combined with the expensive and time-consuming process
of completing transactions create a high hurdle for casual investors. Real
assets provide talented investment groups with the opportunity to generate
strong returns through savvy acquisitions and managerial expertise. A critical
component of Yale's investment strategy is to create strong, long-term partnerships
between the Investments Office and its investment managers. In the last decade
Yale played a critical role in the development and growth of more than a dozen
organizations involved in the management of real assets.
Don't say I didn't tell you. Australia is BOOMING: From
Dollar Near a 17-Year High as Metals Prices Increase By David McIntyre
April 11 (Bloomberg)
-- The Australian dollar traded near a 17-year high as prices rose for metals
the country exports, improving the outlook for economic growth.
is the world's biggest gainer in the past month as traders raised bets the
Reserve Bank of Australia will increase interest rates from a six-year high
of 6.25 percent. A measure of six metals climbed to a record on the London
Metal Exchange. Raw materials exports account for about 14 percent of the
economy, with China the second-biggest market after Japan.
for base metals, which the Australian dollar is significantly leveraged to,
remains firm, keeping sentiment high towards the currency,'' said Sue Trinh,
a foreign- exchange strategist at RBC Capital Markets in Sydney. ``The data
is printing firmly, underpinning rate-hike expectations.''
dollar bought 82.43 U.S. cents at 4:15 p.m. in Sydney and reached 82.67 cents,
the highest since October 1990. It traded at 82.39 cents late in Asia yesterday.
pared an advance as some investors said a 5.7 percent gain over the past month
was too much.
dollar over 82.40 cents is overbought so I have no interest in buying it over
that level,'' said Peter Pontikis, treasury strategist at Suncorp-Metway Ltd.
in Brisbane, Australia.
dollar's 14-day relative strength index against its U.S. counterpart rose
as high as 75.9 today, from 52.4 a month earlier, approaching a threshold
that signals the rally may be too rapid. A level above 70 flags a reversal.
Hard for Exporters
Peter Costello, speaking in London yesterday, said the currency's record level
made it hard for exporters. At the same time, the currency would help prevent
inflation from accelerating because imports would be cheaper.
The chance of
a quarter-percentage point rate increase rose to 54 percent from zero over
the past month, according to a Credit Suisse index. Sharada Selvanathan, a
currency strategist at BNP Paribas SA in Singapore, said data over the next
few weeks, including tomorrow's employment report, would be a crucial influence
on those expectations.
``In the very
short term, the Australian dollar is going to retain support, and I wouldn't
be surprised to see it above 83 cents,'' she said.
also said the currency may reach 83 cents this week after data such as job-vacancy
advertisements, which climbed to an all-time high in March, according to an
Australia & New Zealand Banking Group Ltd. report yesterday. Home-loan
approvals rose 0.3 percent in February, as expected by economists, a government
report showed today.
dollar advanced to a decade-high against the yen as a bigger-than-expected
drop in Japanese machinery orders suggested the country's 5.75 percent rate
advantage is more likely to widen than narrow.
dollar is quite strong not only against the yen, but also against the dollar,
due to growing prospects of widening interest-rate differentials between Australia
and other countries,'' said Daisaku Ueno, a senior economist and currency
analyst in Tokyo at Nomura Securities, Japan's largest brokerage. ``Australia's
central bank will raise rates in May or June.''
dollar was at 98.29 yen compared with 98.19 yen in late Asian trading yesterday.
It reached 98.50 yen, the highest since May 1997.
The yield on
the Australian government two-year bond rose 1 basis point to 6.31 percent.
A basis point is 0.01 percentage point. The price of the 8.75 percent security
maturing in August 2008 fell 0.031, or A$0.31 per A$1,000 face amount, to
103.064. Bond yields move inversely to price.
The spread with
Japan's two-year notes was 5.50 percentage points, close to the 5.53 percentage
points on April 3, the widest in two months.
To contact the
reporter on this story: David McIntyre in Sydney at firstname.lastname@example.org
Fred met a woman while on vacation in the Keys and fell madly in love with her.
On the last night of his vacation, the two of them went to dinner at the Ocean
View and had a serious talk about how they would continue the relationship.
"It's only fair to warn you, I'm a total golf nut," Fred said to his lady friend.
"I eat, sleep and breathe golf, so if that's a problem, you'd better say so now."
"Well, if we're being honest with each other, here goes," she replied. "I'm a
"I see," Fred replied, and was quiet for a moment. Then he said, "You know, it's
probably because you're not keeping your wrists straight when you tee off."
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely available
for three reasons: Writing is good for sorting things out in my brain. Second,
the column is research for a book I'm writing called "In Search of the
Perfect Investment." Third, I encourage my readers to send me their
ideas, concerns and experiences. That way we can all learn together. My email
address is .
You can't click on my email address. You have to re-type it . This protects
me from software scanning the Internet for email addresses to spam. I have no
role in choosing the Google ads. Thus I cannot endorse any, though some look
mighty interesting. If you click on a link, Google may send me money. Please
note I'm not suggesting you do. That money, if there is any, may help pay Claire's
law school tuition. Read more about Google AdSense, click
here and here.