Posted: February 28, 2014
Nobel Prize-winning investments?
Lessons from a $450 endowmentJames Osborne
Every year, the Nobel Prize is awarded to leaders in the fields of physics, chemistry, medicine, literature, peace and economics. Along with the honor of the award is a cash prize of about $1.2 million. These cash prizes are funded by the Nobel Foundation, an investment pool that was the result of Alfred Nobel's desire to create a legacy and reward advances in these fields.
At the end of 2012, the Nobel Foundation was valued at about $450 million. The foundation has a stated goal for a 3.5 percent real (after inflation) return on assets, which is in line with the spending policy of the foundation, a 3-4 percent annual target. These are very reasonable assumptions, and not too dissimilar than what many retirees would want from an investment portfolio: a growing stream of income, sustainable withdrawals that can keep pace with inflation.
I'd say it is safe to assume that a portfolio valued at $450 million has access to some pretty good resources, hopefully world-class investment consultants and institutional level asset managers. Maybe they would even take input from some Nobel Prize winners? Reports are that the Nobel Foundation pays 0.60 percent in annual asset management fees. With names in the portfolio like T. Rowe Price, Aberdeen, RAFI and Carlyle, (not to mention numerous hedge funds and private equity funds surely charging more than 0.60 percent) this seems at least believable.
Surely if any portfolio can outperform a passive investment strategy, it's a $450 million endowment that provides awards to some of the world's best and brightest. Right? And 0.60 percent of $450 million is a staggering $2.7 million. Hopefully, they are getting some good advice and stock picking for $2.7 million.
The Nobel Foundation has a stated investment policy of 20 percent fixed income, 55 percent equities and 25 percent "alternatives." A 50-55 percent allocation to equities would be considered prudent with most and in line with research supporting endowment-style perpetual distributions, so this is perfectly reasonable.
Unfortunately, it appears that the managers of the Nobel Foundation fall prey to many of the mistakes of individual investors. The most obvious of these is a backwards-looking, knee-jerk reaction to market volatility.
In 2007, according to the Foundation's 2011 annual report, the portfolio had a 12 percent allocation to alternative investments, including private equity and hedge funds. Through and after the bear market in 2008 and 2009 the foundation increased this allocation from 12 percent to 24 percent, 28 percent, and finally 33 percent, reducing the portfolio's exposure to stocks as you will see in the chart below. These were not simply market value changes – in 2011 the target allocation to alternatives was 30 percent. So, like many individual investors and their advisors, the Foundation committee ran way from volatile markets after a market decline.
And how did this work out? From 2009 to 2013, the global equity markets rallied, coming off of generational lows. At the same time, the Nobel Foundation investment committee was moving money out of stocks after a decline and into alternative investments, the same fear trade so many individuals gave into. Here's how the foundation performed from 2008 through 2012.
(From the 2012 Annual Report)
Not great. What else could they have done at the Foundation? What if they simply owned a portfolio that was 50 percent a global stock market index fund, and instead of putting money in alternatives, they put the remaining 50 percent into a bond index fund. Here's how that stacks up against a passive portfolio of 50 percent global stocks and 50 percent US bonds.
The Foundation portfolio underperformed this simple passive mix of Vanguard Investor-class mutual funds every year. From 2008 to 2012, the annual under performance was 0.14 percent, 8.10 percent, 4.87 percent, 3.19 percent and 2.23 percent, respectively. The Foundation underperformed in the down markets of 2008 and 2011 and failed to keep up with the recovery in 2009 and 2012.
We can't say exactly where this performance came from, as the Nobel Foundation is private and releases only a spattering of information in their annual report. But it is safe to say that changing the endowment's asset allocation in the middle of a bear market and paying up for expensive, poor-performing hedge funds are certainly not adding to results.
Individual investors can learn a lot from the missteps of a $450 million endowment. Bear markets are painful, but not nearly as painful as the consequences of selling at the bottom in search of some kind of magic bullet investment strategy.
Simple is often more successful than complex, and it can be much easier to control your behavior with a relatively simple portfolio than with a complex one. Costs and fees matter a great deal. Your behavior matters a great deal. Access to institutional investment managers, consultants, private equity firms and hedge funds appears to not matter one bit.
James Osborne is a Certified Financial Planner ® professional and President of Bason Asset Management, a Lakewood-based Registered Investment Advisor. He has spent his career in the investment management industry, helping clients manage their portfolios and plan for retirement, legacy and lifetime goals. In addition to the CFP ® professional designation, he has an MBA in Investment Management from the University of Colorado. James has previously instructed CPE courses for the Colorado Society of CPAs. Contact James at firstname.lastname@example.org and learn more at http://www.basonasset.com.