Image Credit: Edvard Munch, “The Sun” (1911-12), The Munch Museum, Oslo, via Wikimedia Commons
By Jason Zweig | March 8, 2013 12:01 p.m. ET
Unless you’ve somehow kept your wealth a secret, your financial adviser has probably already urged you to “add alternatives” to your portfolio, or simply “invest like Yale.” But here’s a comeback to use next time this topic comes up: Tell the professional you’ve recently studied the Norway model — which will be true once you’ve finished reading this column.
There’s certainly much to be said for Yale’s investing approach. The university’s $19 billion endowment focuses almost exclusively on alternative assets, such as hedge funds, timber, oil and gas, real estate and private-equity funds that invest in corporate buyouts. It generally shuns stocks and bonds. Yale’s reasoning: As an institution with a perpetual time horizon and extensive resources, it can capitalize on the extra return alternative assets should offer because they can’t be easily traded like stocks and bonds.
Note that this is not a market-timing strategy. Yale did not forecast a poor future for stocks and bonds when its chief investment officer, David Swensen, began investing in alternative assets in 1990. Rather, the university believed its approach made sense because a large endowment was a perfect vehicle for holding and managing illiquid investments. Indeed, the strategy has worked as hoped: From 2000 through 2012, Yale’s endowment returned about 12 percent annually.
That’s a very respectable performance during any time frame. But it was especially impressive then because U.S. stocks averaged a paltry 2 percent return annually for that period. Meanwhile, as interest rates fell, the yields available on bonds dried up. As a result, Yale got a lot of attention — and it was also widely imitated. Whereas Swensen once had the field of alternative assets almost all to himself, a recent study of institutions that together oversee a total of more than $100 billion found they had moved 43 percent of their holdings into alternative assets, such as venture capital and hedge funds — double the level of a decade earlier.
It isn’t just the professional managers of giant pension funds and university endowments that rushed to copy Yale. Rob Martorana, an analyst for Financial Research Corp. of Boston, estimates that the total assets of mutual funds and exchange-traded funds investing in alternatives have doubled since the end of 2008, to more than $314 billion. Alternatives became the new mainstream.
Now, let’s turn to Norway. Its huge Government Pension Fund Global keeps roughly 60 percent of its assets in publicly traded stocks (half in the U.S.), 35 percent in bonds and up to 5 percent in real estate. How much does the Norwegian portfolio hold in hedge funds? Nothing. Venture capital? Nada. Commodities? Zip. Private-equity funds? Zero.
“The Yale model would not work for us,” says Norwegian spokeswoman Bunny Nooryani, because “the fund is too large to implement that type of strategy.” With two-thirds of $1 trillion to invest, building a meaningful portfolio of non-liquid assets would be far too cumbersome and costly. And yet the Norwegian fund has fared quite well. It has gained an annual average of 4 percent since 2000, or double the return on U.S. stocks. Since 2009, it has earned 4 percent annually, while Yale earned an average of just 1 percent a year.
The Norway portfolio is “diversified in everything,” says Antti Ilmanen, an analyst at AQR Capital Management in Greenwich, Conn., who serves on the fund’s advisory board. It owns shares in nearly 9,000 companies and holds approximately 1 percent of every significant stock on earth.
The Norwegian fund has another advantage, says Elroy Dimson, a finance professor at London Business School who also is on its advisory board. “Norway is willing to suffer a lot and do worse than other major investors when markets are going down,” he says. The giant fund loads up on smaller stocks and on so-called value stocks, which trade at lower prices in the short term. When markets fall, these companies tend to fall even farther — but that sets them up for higher performance in the long run, according to decades of research by Dimson and other experts.
Norway is mechanically disciplined. When stocks decline, the fund buys enough of them to get its holdings back to the 60 percent target; conversely, it buys bonds whenever their proportion of the portfolio falls below 40 percent. The fund “rebalances” this way to eliminate emotion from its decisions. Instead of selling in fear during falling markets and buying euphorically when markets rise, the Norwegian fund trades only when one asset has shrunk in relation to the other. That effectively compels the fund to buy low and sell high — rather than the opposite, which is all too typical.
So, which do you like, Yale or Norway? Before answering that question, you might want to read what Swensen has to say about his strategy at Yale. His first book, Pioneering Portfolio Management, explains how Yale earned such high returns on its alternative strategies. His second, Unconventional Success, warns that such returns are available only to those who can do original research and who can identify opportunities well before the investment crowd arrives.
That time passed years ago for alternative investing, says William Bernstein, an investment manager at Efficient Frontier Advisors in Eastford, Conn. Now that hundreds of billions of dollars have swarmed into alternatives from institutional and individual investors alike, says Bernstein, “it’s somewhere between highly probable and certain that you will underperform [a stock portfolio] if you are being sold commodities, hedge funds and private equity right now.”
Think of it like this, he says: “The first person to the buffet table gets the lobster. The people who come a little later get the hamburger. And the ones who come at the end get whatever happens to be stuck to the tablecloth.”
Source: WSJ.Money magazine, https://www.wsj.com/articles/SB10001424127887323884304578324471643163046
For further reading:
David Chambers, Elroy Dimson, and Antti Ilmanen, “The Norway Model”
Definition of ENDOWMENT in The Devil’s Financial Dictionary
David Swensen, Pioneering Portfolio Management
David Swensen, Unconventional Success