Beware of the Sophisticated Approach: It Isn’t Better; It’s Different
Among investors, there’s an ongoing debate about the relative efficacy of the traditional investment model versus the endowment model. The traditional model of roughly 60% stocks and 40% bonds works extremely well in bull markets, but subjects investors to a bumpy ride under less favorable conditions. The endowment model draws from a wider array of investments, including private equity, various hedge fund strategies, and natural resources. It produces more consistent returns, although it is prone to collapse under extremely stressful financial conditions
In the past decade, the endowment model appears to have beaten the traditional model rather handily, as the largest university endowments chocked up 9.5% to 10% returns, and pension plans returned 6% to 7%. The conclusions seem obvious. First, we should all be clamoring to invest using the endowment model. Second, sophisticated investing is superior to pedestrian investing. Third, the folks running endowment funds and the money managers they employ must be smarter than the people relegated to operating in the traditional world of stocks and bonds.
|Screwing Up (1996)|
Unfortunately, all too many people from individual investors to state treasurers have drawn these conclusions. They’ve moved toward the endowment model because those trailing 10% returns look so darn tempting. Alas, you can’t invest in prior returns. You only get what your investments earn in the future, and I’m pretty sure the two models will not produce as large a gap in the next ten years. Moreover, I don’t think the gap – 10% for the endowment model versus 6.5% for the traditional model – is as large as it appears.