Like religious devotees, acolytes of market finance are in constant pursuit of the next guru.
To stock traders, Warren Buffet is market messiah.
[img]667|left|||no_popup[/img]His annual letter to Berkshire Hathaway investors has been elevated to the status of the Holy Scriptures. With his track record, it sometimes appears Buffet is the divining rod of the market gods.
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Commodity disciples have followed the flame of former Investment biker and adventure capitalist Jim Rogers. From his ashram in Singapore, this expatriate American has preached the gospels of soybeans, crude oil and pork bellies. With the success of his Rogers International Commodities Index, adherents have hung on his every utterance.
For bond traders, Bill Gross of Pacific Investment Management Co. (Pimco), Newport Beach, is the keeper of celestial truth. At an estimated value of $840 billion, Gross oversees the largest, most successful bond portfolio on the planet. When Gross speaks, the pundits pause and the financial waters almost seem to part.
In recent years, the righteous seekers of market truth have flocked to study at the feet of David F. Swensen, Chief Investment Officer of the Yale University endowment. Since taking over in 1985, the once stodgy fund has grown at the average rate of 17 percent annually.
Singlehandedly, Swensen turned institutional investing on its head.
Swensen’s unprecedented success in the once conservative and hallowed halls of university finance has resulted in numerous books, lecture invitations and of course, imitators. Other major universities such as Harvard and Stanford have mimicked Swensen. But none has genuinely duplicated his remarkable achievements.
Swensen has closely followed the teachings of Nobel Economics Laureate Harry Markowitz, the father of Modern Portfolio Theory (MPT). MPT posits that rational investors will utilize asset diversification to minimize their portfolio risks and to control predicted value fluctuations.
Swensen's mantra has been to diversify away from holdings in U.S. stocks and bonds. In 1985, around the time Swensen took over, more than 80 percent of Yale's endowment was invested in domestic stocks and bonds. Today, that figure has dropped to less than 20 percent.
Over the years, Yale has invested its endowment into real assets, such as timber, oil and gas, and real estate, as well as into private equity and hedge funds. As of 2008, Yale had about 25 percent of its assets in hedge funds; 25 percent in hard assets including real estate, timber and energy; 17 percent in private equity; and about 31 percent in stocks.
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In fact, Yale only had about 15 percent of its assets in domestic U.S. stocks, with the rest of its stock allocation in high octane global markets. Not surprisingly, the allocations at Harvard and Stanford are similar.
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Contrast this with a typical U.S. pension fund that has 60 percent of its assets in U.S. stocks and 35 percent in U.S. bonds, maybe 5 percent in foreign stocks, and you start to see how Yale's unconventional allocation of assets has been the key to its extraordinary results.
Unfortunately, Swensen’s investment nirvana fell back to earth as the recession clamped its talons on the global markets. Although their fall from grace was not as precipitous as average investors-at-large, major university endowments like Harvard, Princeton, even Swensen’s own Yale fund, saw declines of 25 percent or more.
While diversity had been their savior through most of the decade, liquidity became the bane of their existence. The market nosedive revealed a colossal flaw in Swensen’s endowment model – to retain their flexibility, long-term investors need short-term liquidity.
Now many critics of Swensen’s approach have concluded that liquidity is a premium that must be built into any investment portfolio.
Historically, the retention of cash has been viewed as a drag on returns. With the cascading collapse triggered by the implosion of the credit markets, Swensen and his adherents were hampered by their own illiquidity. Because they were illiquid, they were unable to quickly reshape their portfolios in response to the tectonic shift in market conditions.
From the rubble of the Great Recession has emerged a new Phoenix – Mohamed El-Erian.
El-Erian previously headed the Harvard Management Co, a wholly-owned subsidiary of Harvard University charged with managing the school’s endowment, pension assets and working capital. El-Erian took over for the legendary Jack Meyer who led the fund until his retirement in 2005.
El-Erian now has left the world of academia and joined forces with bond holy man Bill Gross. To those lost in the desert of investment despair, the seaside haven of Newport Beach has become the New Goshen.
A former director of the International Monetary Fund (IMF), El-Erian says that he has learned the lessons of the Great Recession and is ready to adapt his investment strategies to the “new normal.” While he will adhere to the teachings of Markowitz and his chief apostle Swensen, El-Erian will bring the dimension of nimble liquidity to this new Pimco investment fund.
The desperate seeking the Promised Land are hoping that the combination of El-Erian and Gross will yield the true harmonic convergence.
Like the constancy of change, the flame of hope springs eternal in every investor.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
