Let's continue to get acquainted with the legends of Yale University, and concurrently with the legends of the economic/investment world. After Bob Schiller, let's move on to his guest during the recording of the cycle. lectures on finance – David Svensen.
Mr. Svensen manages Yale University's investments with 1985 of the year, systematically stagning S&P 500 with less volatility. (although alas, I have never understood how to compare with stupid, Excuse me, dynamics S&P, for such a comparison does not contain any logical load. at least just because, that shares — it's only part of the portfolio).
Basically, it was he who created the approach/process of managing pension funds and other similar, and his Pioneering Portfolio Management стала библией среди управляющих. Generally, if Warren Buffett is an image of a pop guru, then Svensen is a guru for professionals. A little later, Svensen's book was published. Unconventional Success: A Fundamental Approach to Personal Investment for individual investors, but we won't get to it (in prinitzpe the main salt in the main book).
Several reservations at once. You are as a private investor or a small professional (up to several billion.), just can't follow Svensen's full ideas. For) you don't have 30 Yards, in) you have taxes, from) your horizon is not infinity.
And another series of flaps. An unsophisticated reader may have an incorrect idea of active/passive management and the risk that endowment funds take.. Actually, the same Svanson is very active in managing the portfolio, it's just that this activity is not in the field of catching a weekly makimum on S&P. AND, just in case, don't forget, that period under review — it's the greatest bull market, and the share of shares and leverage in the portfolio is much higher, than it seems at first glance. Plus do not forget, that is illiquid (alternative asset classes) "держится" better in times of crisis (here the greater illiquid, all the better, because illiquid so-so can fall on 100%, and illiquid that is not traded can not).
David Svensen: interview 2009 of the year, Yule Endowment 2010
Concept. Agency problem. Active management.
2. Instrumental tasks.
Independence. The Story of Yuel. Examples are successful and not very good.
Stability. Examples of.
Additional income provides an advantage in the quality of education.
3. Investment and current objectives.
Since the endowment must perform two functions — to preserve/increase funds for the future and at the same time serve as one of the sources of funds for financing current operating activities, contradictions often arise. How much to spend, how much to invest. This is decided by the investment policy. Generally, the chapter is intuitive, but it is worth reading as many people know about the nuances of the financial life of universities. for example, the usual CPI for the endowment is irrelevant, the university has a different cost structure, отсюда и необходимость обганять свой собственный CPI.
4. Investment philosophy.
1) asset classes (asset allocation)
2) market timing (timing)
3) selection of specific tools (selection)
Timing here is perceived as a short-term deviation from long-term targets for asset allocation. Hence the non-perception of this fragment seriously. By Prinytspu — more harm, what is useful. Wherein, both items No. 2 and No. 3 constitute the active part of the management (although again, and the asset allocation process itself — it's that passive control?)). And then he is born., IMHO, extremely sound thought — active management is useful on inefficient (alternative asset classes) markets and harmful in effective (stock).
And a very incessant chat is about rebalancing.. That's what I understood., that they rebalance every day. Everyone. Rebalancing has pros and cons, but it is one of the main means of risk management. For sale then, that has grown (since the share of this instrument has grown), bought then, that has decreased or increased at a slower pace. With individual stocks, it would be suicide on the principle of selling good., buy bad. But with asset classes, the idea is very sound..
5. Asset Allocation.
Description of asset classes, in substance and style.
Assets Mix and Mean-Variance Optimization. Testing.
6. Asset Allocation Management.
Rebalancing, Leverage, sad examples.
7. Traditional Asset Classes.
8. Alternatives to asset classes.
9. Asset Class Management.
Stories and examples, that active management is wrong (hitting Jim Kramer, what's on the avatar)). Useful as stories, and a little bit in terms of applying logic to facts. Plus examples of the organization of investment structures.
10. Investment process.
About that, how to structure the process (Invetition Committees, organizational structure, etc.). Also about the decision-making process itself, what it should be aimed at and what will interfere with its purity.
Absolute must read for managers. A very interesting mix of abstraction and specificity.
Necessary for the emergence of their own thoughts in the first place.
More excerpts (tagged by me).
Why exactly they are now impossible to establish.
1. The first theme centers on the importance of taking actions within the context of an analytically rigorous framework, implemented with discipline and under-girded with thorough analysis of specific opportunities. In dealing with the entire range of investment decisions from broad-based asset allocation to issue-specific security selection, investment success requires sticking with positions made uncomfortable by their variance with popular opinion. Casual commitments invite casual reversal, exposing portfolio managers to the damaging whipsaw of buying high and selling low. Only with the confidence created by a strong decision-making process can investors sell mania-induced excess and buy despair-driven value.
2. A second theme concerns the prevalence of agency issues that interfere with the successful pursuit of institutional goals.
3. The third theme relates to the difficulties of managing investment portfolios to exploit asset mispricings. Both market timers and security selectors face intensely competitive environments in which the majority of participants fail.
4. University of Bridgeport In the early 1990s, severe financial distress caused the University of Bridgeport to lose its independence after a desperate fight to survive. From a peak of more than 9,000 students in the 1970s to fewer than 4,000 in 1991, declining enrollment created budgetary trauma, forcing the school to consider radical measures. In spite of the institution’s dire straits, in October 1991, the University of Bridgeport rejected an offer of $50 million from the Professors World Peace Academy, an arm of the Reverend Sun Myung Moon’s Unification Church. Preferring to pursue independent policies, the institution’s trustees elected to take the drastic step of eliminating nearly one-third of its ninety degree programs, while petitioning a judge to dip into restricted endowment funds to meet payroll costs. After running out of options in April 1992, the trustees of the university reversed course, ceding control to the Professors World Peace Academy in exchange for an infusion of more than $50 million over five years. As board members associated with the Unification Church took control, the sixty-five-year-old institution received a new mission:—to serve as “the foundation of a worldwide network of universities striving for international harmony and understanding.”
5. Simply accumulating a portfolio of Treasury Inflation Protected Securities (TIPS) allows investors to generate inflation-sensitive returns guaranteed by the government. Unfortunately, the excess of university inflation over general price inflation may well consume any incremental returns from TIPS, providing almost no real return to the institution. Such single-minded focus on asset preservation fails to meet institutional needs, as merely accumulating a portfolio of assets with stable purchasing power provides little, if any, benefit to the academic enterprise.
6. In an August 2, 1998 New York Times interview, Hansmann suggests that “a stranger from Mars who looks at private universities would probably say they are institutions whose business is to run large pools of investment assets and that they run educational institutions on the side that can expand and contract to act as buffers for investment pools.”
7. Investment returns stem from decisions regarding three tools of portfolio management: asset allocation, market timing, and security selection. Investor behavior determines the relative importance of each aspect of portfolio management, with careful investors consciously constructing portfolios to reflect the expected contribution of each portfolio management tool.
8. Many investors believe that a law of finance dictates that policy allocation decisions dominate portfolio returns, relegating market timing and security selection actions to secondary status. In a 2000 study, Roger Ibbotson and Paul Kaplan survey a number of articles on the contribution of asset allocation to investment returns. The authors note that “[o]n average, policy accounted for a little more than all of total return,” implying that security selection and market timing make no material contribution to returns.1 In another nod to the centrality of the asset-allocation decision, Ibbotson and Kaplan conclude that “…approximately 90 percent of the variability of a fund’s return across time is explained by the variability of policy returns.”
9. An inverse relationship exists between efficiency in asset pricing and appropriate degree of active management. Passive management strategies suit highly efficient markets, such as U.S. Treasury bonds, where market returns drive results and active management adds little or nothing. Active management strategies fit inefficient markets, such as private equity, where market returns contribute very little to ultimate results and investment selection provides the fundamental source of
10. The sense of the skepticism with which investors viewed stocks in the 1930s runs through Robert Lovett’s “Gilt-Edged Insecurity,” which appeared in the April 3, 1937 edition of The Saturday Evening Post. Lovett begins his examination of historical market returns by suggesting that his readers “[c]onsider the absurdity of applying the word security to a bond or a stock.” Lovett’s analysis showed that an investor buying “100 shares of each of the more popular stocks” at the turn of the century would have turned nearly $295,000 into just $180,000 by the end of 1936. He concludes by warning his readers to remember: “(1) that corporations…die easily and frequently; (2) to be extra careful when everything begins to look good; (3) that you are buying risks and not securities; (4) that governments break promises just as businesses do; and (5) that no investments worth having are permanent.” 6 Lovett’s commentary vividly illustrates why so few investors came up with the dime to invest in small stocks in June of 1932.
11. Market timing, defined as a short-term bet against long-term policy targets, requires being right in the short run about factors that are impossible to predict in the short run.
12. A modern, somewhat more sophisticated version of the 1950s relative yield game, tactical asset allocation (TAA), moves assets above and below policy weights based on recommendations of a sophisticated quantitative model.
13. In the 1950s, many investors played a market timing game with stock and bond yields, based on “…practically an article of faith that good stocks must yield more income than good bonds…”9 When dividend yields on stocks exceeded bond yields by a fair margin, investors viewed stocks as attractive, overweighting equities relative to bonds. Conversely, when bond yields neared stock yields, investors favored bonds. History provided a solid foundation for the strategy. “Only for short periods in 1929, 1930, and 1933 [had] stocks yielded less than government bonds.” 10 This valuation-based technique worked well until 1958, when stock yields last exceeded bond yields. In the late 1950s and early 1960s, as the yield advantage of bonds increased relative to stocks, market timers became more invested in fixed income and less invested in stocks. Of course, investors incurred significant opportunity losses while futilely waiting for stock yields to signal a buying opportunity. Ultimately, the failure of the relative yield market timing technique forced its practitioners to identify an alternative form of
14. The fundamental purpose of rebalancing lies in controlling risk, not enhancing return.
15. As a matter of course, at the beginning of every trading day Yale estimates the value of each of the components of the endowment. When marketable securities asset classes (domestic equity, foreign developed equity, emerging market equity, and fixed income) deviate from target allocation levels, the university’s investments office takes steps to restore allocations to target levels. In fiscal year 2003, Yale executed approximately $3.8 billion in domestic equity rebalancing trades, roughly evenly split between purchases and sales. Net profits from rebalancing amounted to approximately $26 million, representing a 1.6 percent incremental return on the $1.6 billion domestic equity portfolio.
16. The fundamental purpose of rebalancing lies in controlling risk, not enhancing return. Rebalancing trades keep portfolios at long-term policy targets by reversing deviations resulting from asset class performance differentials. Disciplined rebalancing activity requires a strong stomach and serious staying power. Conducted in a significant bear market, rebalancing appears to be a losing strategy as investors commit funds to assets showing continuing relative price weakness.
17. The alternative of not rebalancing to policy targets causes portfolio managers to engage in a peculiar trend-following market timing strategy.
18. In contrast, active managers in less efficient markets exhibit greater variability in returns. In fact, many private markets lack benchmarks for managers to “hug,” eliminating the problem of closet indexing. Inefficiencies in pricing allow managers with great skill to achieve great success, while unskilled managers post commensurately poor results. Hard work and intelligence reap rich rewards in an environment where superior information and deal flow provide an edge.
19. In an ironic twist, survivorship bias causes active managers to appear less successful relative to peers than reality would indicate. Consider the U.S. equity manager that preserves capital in 2000. According to results reported in 2000, as shown in Table 4.6, a zero percent return handily beats the -3.1 percent median result. As survivorship issues inexorably alter the landscape, by 2005 the 2000 median return morphs into a gain of 1.2 percent. As time passed, the erstwhile median-beating zero percent return moves from the respectable second quartile to the not-so-respectable third quartile. Survivorship bias darkens the relative performance picture.
20. In the least efficient private markets, no passive alternative exists. Even were a passive alternative available, market-like results would likely disappoint.
21. John Maynard Keynes argues in The General Theory that “[o]f the maxims of orthodox finance none, surely, is more antisocial than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole.”
22. John Maynard Keynes in The General Theory articulated this concept of value: “…there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off…at an immediate profit.” 18 James Tobin and William Brainard formalized this concept as “q,” the ratio of market value to replacement
23. Historically, naïve value strategies have delivered superior rates of return, while exposing investors to relatively high levels of fundamental risk.20 Jeremy Grantham of Grantham Mayo Van Otterloo warns of the “sixty year flood” that may wipe out years of gains garnered by simply purchasing the cheapest stocks. True value can be acquired by purchasing assets at prices below fair value, a forward-looking concept that considers anticipated cash flows with adjustment for the level of
24. The asset classes from which investors construct portfolios change over time. Snapshots of Yale’s portfolio throughout the past 150 years provide an impression of the evolution of portfolio structure. Real estate constituted nearly half of the 1850 portfolio, with “bonds and notes mostly secured by mortgages” and stocks making up the remainder.
25. Traditional fixed income assets respond to unanticipated inflation by declining in price, as the future stream of fixed payments becomes worth less. In contrast, inflation-indexed bonds respond to unexpected price increases by providing a higher return. When two assets respond in opposite fashion to the same critically important variable, those assets belong in different asset classes.
26. After specifying expected returns, risks, and correlations for the set of investable asset classes, the search for efficient portfolios begins. Starting with a given risk level, the model examines portfolio after portfolio, ultimately leading to identification of a combination of assets that produces the highest return. The superior portfolio takes a place on the efficient frontier. The process then continues by identifying the highest return portfolio for a range of risk levels, with the resulting combination of superior portfolios defining the efficient frontier.
27. Care must be taken, however, to avoid using asset class constraints simply to fashion a reasonable-looking portfolio. Taken to an extreme, placing too many constraints on the optimization process causes the model to do nothing other than to reflect the investor’s original biases, resulting in the GIGO (garbage-in/garbage-out) phenomenon well known to computer scientists.
28. Richard Bookstaber, author of A Demon of Our Own Design, states that a “general rule of thumb is that every financial market experiences one or more daily price moves of four standard deviations or more each year. And in any year, there is usually at least one market that has a daily move that is greater than ten standard deviations.” 3
29. Historical capital markets data require adjustment. Mean-reverting behavior in security prices implies that periods of abnormally high returns follow periods of abnormally low returns, and vice versa. Jeremy Grantham, a prominent money manager, believes reversion to the mean constitutes the most powerful force in financial markets.
30. The spring 1988 Journal of Portfolio Management study by Paul Firstenberg, Stephen Ross, and Randall Zisler, “Real Estate: The Whole Story” concluded that institutional allocations to real estate should be increased dramatically from the then current average of under 4 percent of portfolio assets. The authors based their conclusions on data showing government bonds with returns of 7.9 percent and risk (standard deviation) of 11.5 percent, common stocks with returns of 9.7 percent and risk of 15.4 percent, and real estate with returns of 13.9 percent and risk of 2.6 percent. Although, for purposes of their study, the authors increased real estate risk levels from historical levels to more reasonable levels, their mean variance results were anything but sensible. Efficient portfolio mixes included between 0 and 40 percent in government bonds, between 0 and 20 percent in stocks, and between 49 and 100 percent in real estate. Fortunately, the authors tempered their enthusiasm in taking the “pragmatic perspective…that pension funds should seek initial real estate allocations of between 15 to 20 percent.” 8
31. For many investors, defining the efficient frontier represents the ultimate goal of quantitative portfolio analysis. Choosing from the set of portfolios on the frontier ensures that, given the underlying assumptions, no superior portfolio exists. Unfortunately, mean-variance optimization provides little useful guidance in choosing a particular point on the efficient frontier. Academics suggest specifying a utility function and choosing the portfolio at the point of tangency with the efficient frontier. Such advice proves useful only in the unlikely event that investors find it possible to articulate a utility function in which utility relates solely to the mean and variance of expected returns. Identifying a set of a mean-variance-efficient portfolios fails to finish the task at hand. After defining the efficient frontier, investors must determine which combination of assets best meets the goals articulated for the endowment fund. Successful portfolios must satisfy the two goals of endowment management: preservation of purchasing power and provision of substantial, sustainable support for operations. To assess the ability of a portfolio to meet these goals, creative modelers fashion quantifiable tests.
32. In fact, the world of commerce (as opposed to the world of investment) generally rewards following the trend. Feeding winners and killing losers leads to commercial successes. Executives who hyper-charge winners produce attractive results. Managers who starve losers conserve scarce resources. In the Darwinian world of business, success breeds success. In the world of investments, failure sows the seeds of future success. The attractively priced, out-of-favor strategy provides much better prospective returns than the highly valued, of-the-moment alternative. The discount applied to unloved assets enhances expected returns, even as the premium assigned to favored assets reduces anticipated results. Most investors find mainstream positions comfortable, in part because of the feeling of safety in numbers. The attitudes and activities of the majority create the consensus. By definition, only a minority of investors find themselves in the uncomfortable position of operating outside of the mainstream. Once a majority of players adopts a heretofore contrarian position, the minority view becomes the widely held perspective. Only an unusual few consistently take positions truly at odds with conventional wisdom.
33. Investors debate the frequency with which portfolios should be rebalanced. Some follow the calendar, transacting monthly, quarterly, or annually. Others attempt to control transactions costs, setting broad limits and trading only when allocations exceed specified ranges. A small number pursue continuous rebalancing, a strategy that provides greater risk control with potentially lower costs than either the calendar or trading range approaches. Continuous rebalancing requires daily valuation of portfolio assets. If asset class values deviate by as much as one or two tenths of a percent from target values, managers trade securities to achieve targeted levels. Trades tend to be small and accommodating to the market. Since rebalancing requires sale of assets experiencing relative price strength and purchase of assets experiencing relative price weakness, the immediacy of continuous rebalancing causes managers to sell what others are buying and buy what others are selling, thereby providing liquidity to the market. In contrast, rebalancing strategies not as responsive to the market require larger and less accommodating transactions, increasing market impact and transactions costs.
34. Leverage appears in portfolios explicitly and implicitly.
35. Placing asset allocation targets at the center of the portfolio management process increases the likelihood of investment success. Disciplined rebalancing techniques produce portfolios that reflect articulated risk and return characteristics.
36. Traditional asset classes rely fundamentally on market-generated returns, providing reasonable certainty that various portfolio constituents fulfill their appointed missions. In those cases where active management proves essential to the success of a particular asset class, the investor relies on unusual ability or good fortune to produce results. If an active manager exhibits poor skill or experiences bad luck, the investor suffers as the asset class fails to achieve its goals. Because traditional asset classes depend on market-driven returns, investors need not rely on serendipity or the supposed expertise of market players.
37. The equity risk premium, defined as the incremental return to equity holders for accepting risk above the level inherent in bond investments, represents one of the investment world’s most critically important variables. Like all forward-looking metrics, the expected risk premium stands shrouded in the uncertainties of the future. To obtain clues about what tomorrow may have in store, thoughtful investors examine the characteristics of the past.
38. Yale School of Management Professor Roger Ibbotson produces a widely used set of capital market statistics that reflect an eighty-year stock-and-bond return differential of 5.7 percent per annum.1 Wharton Professor Jeremy Siegel’s 203 years of data show a risk premium of 3.0 percent per annum.2 Regardless of the precise number, historical risk premia indicate that equity owners enjoyed a substantial return advantage over bondholders.
39. Market participants rarely wonder whether high returns came from accepting greater than market risk, or whether low returns resulted from lower than market risk. The investment community’s lack of skepticism regarding the source and character of superior returns causes strange characters to be elevated to market guru status.
40. Of all the individuals who moved markets with their predictions, Joe Granville may be among the strangest. In the late 1970s and early 1980s, the technical analyst made a series of “on the money” predictions.
41. In the early 1990s, the Beardstown Ladies captured the investing public’s attention.
42. Joe Granville, the Beardstown Ladies, and Jim Cramer provide compelling evidence that market participants frequently and uncritically accept simple prominence as proof of sound underlying investment strategy. The falls from grace suffered by Joe Granville and the Beardstown Ladies (and perhaps a future fall from grace for Jim Cramer) should encourage investors to adopt skeptical attitudes when evaluating active management opportunities.
43. Structuring a portfolio consistent with fundamental investment tenets requires a governance process that produces an appropriate policy portfolio, avoids counterproductive market timing, and identifies effective investment management relationships.
44. John Maynard Keynes, in The General Theory, describes the difficulties inherent in group investment decision making: “Finally it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is the essence of his behavior that he should be eccentric, unconventional, and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” 1
45. Certain asset classes require active management skills if the investor hopes to realize an attractive risk-adjusted outcome: absolute return, real assets, and private equity. In each case, no market exists for the investor to buy; active management proves critical to producing acceptable results.
46. In his wonderful book, Winning the Loser’s Game, Ellis bemoans the fact that decision makers spend too much time on relatively exciting trading and tactical decisions at the expense of the more powerful, yet more mundane, policy decisions.6
47. Charley Ellis describes a useful framework for categorizing various portfolio management decisions. Policy decisions concern long-term issues that inform the basic structural framework of the investment process. Strategic decisions represent intermediate-term moves designed to adapt longer term policies to immediate market opportunities and institutional realities. Trading and tactical decisions involve short-term implementation of strategies and policies.