Furthermore, wealthy families may not share Yale's major advantages in private asset investing. The model may indeed be advisable for individuals or families with an extended time horizon, those who are diversified enough to ride out market illiquidity. It might also be appropriate if they are not overly levered in their own businesses or properties or if they are in the right sectors at the right time. Equally important, they must recognize that Yale can do things they can't. Otherwise, these investors are better off seeking other strategies.
Many harness themselves to a traditional 60/40 or 50/50 asset allocation because of the historic performance of markets and asset classes. But past performance represents the average of all data points measured. Few years are average; most years are above or below, sometimes greatly so. If investors use the past performance of traditional asset classes (stocks and bonds) to project future returns, the only thing they can be reasonably sure of is that the "average" performance won't happen. Markets tend to move in "long waves," in secular trends and in shorter-term cycles, and investors who do not account for that in their asset allocation face disastrous results.
The accumulation period for most individuals is 15 to 20 years, the time between their peak earning years, when they are able to save and invest meaningfully, and their retirement, when they expect to live on the income from their investments. Secular markets (longer-term structural shifts), however, have historically lasted 17 years, plus or minus a couple of years. That means the duration of an entire secular bull and bear market cycle can last approximately 34 years!
Consider a couple in their late 40s or early 50s with a 60/40 asset allocation at the beginning of the secular bear market in the year 2000. That couple today may well be in deep financial distress. Certainly, their retirement plans have taken a stomach punch. A similar couple implementing the same policy in 1982 fortuitously caught the start of the nation's greatest secular boom market and simply rode the surge to a secure retirement, even if their investment managers were mediocre or relatively poor. The only difference between these two couples may have been the years of their birth-a happenstance. Depending on when someone is born, his or her 20-year window may occur during the best or worst of times.
The role timing plays in the success or failure of traditional asset allocation strategy is enormous, and arbitrarily applying an investment policy that lacks the flexibility to adjust to secular or cyclical considerations reduces portfolio performance to little more than a coin flip.
The careers of financial professionals often parallel those of the investment portfolios they manage. Advisors and managers had to do little more than hang on to the reins during the two decades from 1981 through 2000. Since then, it has been anything but easy. Performance has ebbed, no matter how hard managers rowed upstream. Many have considered themselves successful during the past decade if they simply suffered less bad performance than others.
As a member of the investment committee for the City of Hope, I concern myself with the investment needs of an entity expected to continue indefinitely. With luck, the organization will be making medical breakthroughs to help humanity combat the worst diseases long after I am gone. Because the endowment has this limitless time horizon, we aren't overly concerned about year-to-year market conditions. We can ride out economic cycles and short-term market movements, whereas few individual investors have that advantage. Instead, their investment policies must account for these secular markets and cyclical movements.
Alternatives
Because the asset allocation strategy used by Yale and other endowments may not be practical or appropriate for most investors, and since traditional rebalanced "policy portfolios" are at the mercy of long and short market cycles, what strategies should be considered for those who are not Yale?
Portfolio management has become increasingly difficult in recent years as the capital markets have become dominated by hedge funds, the proprietary trading desks of large banks and professional "fast money" traders. These market players have several things in common. They frequently use volatile, short-term trading strategies, magnify their returns and their effect on the market through the use of leverage, and follow market technicals (such as momentum), leading to speculative bets that can be divorced from underlying fundamentals. Increasingly, these strategies are dominated by "quants," who manage money largely via computer models. Perhaps the most daunting aspect of this is that these players frequently race to be the first into the most speculative (highest beta) trades they can find when they believe market technicals support them.
The goal of these quants is not to be the first in but, as the momentum clearly begins to change, to jump in quickly to maximize the surge that follows. When the momentum begins to stall, they jump out and the rally collapses. Because so many strategies, particularly those used by quant managers, rely on similar technical indicators, billions of dollars can pile into and out of the same trades almost instantaneously, causing a roller-coaster ride of market volatility for the rest of the investment community.
How does this affect the average investor? Those lacking endowment-size portfolios are typically left staring at a harsh reality and a difficult set of choices. The reality that the capital markets have been largely co-opted by short-term speculators leaves investors three main options, in my judgment.