Yale University recently released their 2017 annual report for the Yale Endowment, and while normally this would pass without much notice they appear to have made a few waves by continuing an ongoing feud with Warren Buffett. In his 2016 investor letter, Buffett criticized how university endowments pursue market-beating returns through active management and suggested they might be better off investing in index funds instead. Of course the CEO of Berkshire Hathaway follows none of that advice himself, but he has consistently said that most investors including his own wife would be better off with a low-fee S&P500 index fund rather than paying expensive active managers so it’s certainly not out of character. In any case, Yale appears to have taken that a little personally and they dedicated an entire section in their annual report to dispute his claim and promote their own success.
To support their belief in active management, Yale provides data that proves their managers have exceeded stock market returns for the past two decades. For example, over the past 20 years they posted an average return of 12.1% versus 7.5% for the total US stock market which gives them confidence to say they “crush the returns produced by US stocks”. Ending with a flourish, they conclude that “not only has the model worked for the past two decades, it will work for decades to come.”
That’s bold. And it caused a bit of a tizzy in the financial blogosphere with several stories on the topic. So are they right?
I went shoe shopping today for the first time in a while, and I forgot just how frustrating it can be. Finding a nice pair of shoes seems like it should be a pretty simple task these days, but the number of options makes it much more difficult than you’d think! It’s kinda surreal to walk through aisles and aisles of shoes and immediately dislike about 90% of them for one reason or another, and even the ones you like may not be that comfortable once you try them on. Buying shoes can be a real pain.
Well if you think about it, finding a good portfolio is a similar experience — there are lots of good options but very few easy answers. I do my best to curate some of the best options to avoid the cheap knockoffs likely to wear a hole in the sole on the first walk, but just like there’s no one pair of shoes for every person there’a also no single best portfolio for every investor. So you’ve gotta try them on for yourself.
I once knew a guy who was really into woodworking. One of the more fascinating things about him was that he not only made his own furniture but also was quite proud of his collection of hand-made woodworking tools. I once asked him why he preferred those tools to mass-produced alternatives. Among several reasons, “They do what I want”.
Some casual investors may wonder why I spend so much time investigating things like modeling mid caps and figuring out how to measure the error of older international bond data in backtesting calculations. While I certainly find this kind of information intellectually interesting, I admit that it sometimes becomes a chore and I can see why most people steer clear. The upside to all the groundwork, however, is that it expands my collection of tools and allows me to do what I want — explore interesting portfolios previously off limits simply due to lack of data.
Like, for example, the 7Twelve Portfolio.
In the late first century, a Latin poet named Juvenal described something thought to be unlikely as “a rare bird in the lands and very much like a black swan”. At the time, black swans were thought to not exist at all and the idea was preposterous. The clever turn of phrase was both memorable and descriptive, and by the 16th century “black swan” was a common expression in London to describe the idea of impossibility. Of course there was a looming problem with this saying, and in 1697 Dutch explorers discovered that black swans really do exist in western Australia. What once was used to describe something impossible quickly changed meaning to connote ideas thought to be impossible that are later discovered to be real.
One of the most influential authors in modern financial theory is a man named Dr. William Bernstein. His background is particularly unique, as one might be surprised to learn that his Doctor title was earned in medicine rather than finance. I personally believe it’s precisely this outside perspective, intelligent but abstract, that uniquely prepared him to explore portfolio theory in such interesting new directions. I’ve long admired his work.
Regular readers will certainly recognize his name, as the Bernstein Portfolio has been a staple on the site since the beginning. His writings on Efficient Frontiers are also an inspiration for the Portfolio Finder, and I’m sure he will continue to provoke new thought in the future.
While I’ve always taken great pride in spreading the word about the Bernstein Portfolio, the difficult thing about reducing his nuanced insight into a single portfolio is that it does not necessarily represent the full breadth of his ideas. While a staunch advocate of simple, low-cost index investing, Dr. Bernstein is also a pioneer in factor investing that explores how different types of indices can work together to improve the risk-adjusted returns of a portfolio. There’s more to his story than the simple Bernstein Portfolio.
So in the spirit of spreading the word about Dr. Bernstein and his work, I’ve added a new portfolio of his to the site — the Coward’s Portfolio.
Perhaps because of how prominently it features in the Portfolio Finder, I’ve noticed a great deal of questions and conversations about the Golden Butterfly portfolio of late. Rather than scatter my thoughts around the internet, I realized it might be best to provide a centralized synopsis of how and why it works so that everyone can benefit.
I love perusing message boards, and a recent conversation on the All Seasons portfolio mentioned in Tony Robbins’ recent book naturally piqued my interest. It’s based on the highly respected work of Ray Dalio (of Bridgewater All Weather Fund fame), but pared down to a form that a normal non-institutional investor can easily implement themselves.
With a focus on wide diversification and risk parity for a variety of economic climates, the fundamental theory behind the All Weather Fund has always appealed to me. So it was refreshing to find a simplified version endorsed by Dalio to compare against other lazy portfolio options.
I’m an unabashed proponent of portfolio diversification, and enjoy sharing examples of how thinking beyond over-simplified “stocks” and “bonds” can create an asset allocation greater than the sum of its parts. Like a wall built of many smaller bricks, it’s the strength of the big picture that truly counts and no one individual brick tells the full story.
What, then, would happen if one really took diversification to heart and just bought a little bit of every asset? Judging by the numbers of the Merriman Ultimate Buy-and-Hold portfolio (new in the Portfolios section), apparently you get a really great asset allocation!
One of the most common mental hurdles to overcome when researching asset allocation is the siren call of maximum returns. Nobody likes the feeling of leaving potential money on the table. Combine that with a bit of accurate but out-of-context historical data, misinterpretation of assumptions, and “common knowledge” that glosses over the details, and you naturally see a strong bias towards the stock market in most investment circles. Raise your hand if you’ve heard these before:
The stock market has the highest returns over the long run.
Higher risk, higher reward.
The implied conclusions are that diluting your portfolio with non-stocks must also dilute the return, and that the accompanying stock volatility is the unavoidable price to pay for better long-term returns.
Both are simply inaccurate.
I’d like to offer special thanks to several Bogleheads regulars who contacted me recently to help steer the portfolios section in the right direction. I make every effort to accurately represent each portfolio here, and greatly appreciate when people provide constructive feedback. As a result of said feedback, I’ve renamed one portfolio and added another.