bizzXceleration: Performance, Value and Profit

What we're going to do is lay down a baseline courtesy of Davide Swensen, Yale's sui generii investing genius, who provides THE measuring rod here. But, given that he's smart, successful and wealthy, we're still going to argue at least a bit. Below is an excerpt from a recent NYT story and while you're reading it take a look at the accompanying table on returns for the SP500 based on Poltical Calculations tool.

Below the line we'll pick up some more arguments but our bottomline is that Swensen's right but doing it his way is going to be a very low return world for a long-time to come. Is there a way to take his basic approach and modify with some work and sweat ? We think/hope so. But before you start, and as you read, keep the table at right in mind (we'll discuss it later).

Keep It Simple, Says Yale’s Top Investor IT has been a time to worry even the savviest investors. The credit markets have been in a crisis, the domestic stock market has been shaky and overseas markets haven’t been much better. What should an individual investor do? Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals. That is the advice of David F. Swensen, who has run the Yale endowment since 1988, relying on a complex strategy that includes investments in hedge funds and other esoteric vehicles. For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult. For most individual investors, he said, copying the strategies of institutions like Yale is virtually impossible: big investors have access to fund managers and arcane strategies that are beyond the reach of most people. For most individual investors, he said, copying the strategies of institutions like Yale is virtually impossible: big investors have access to fund managers and arcane strategies that are beyond the reach of most people.

O.K. - sound advice from a great investor. Now take a careful look at the inflation adjusted returns, either with or without dividend re-investments. The period '95-'07 was o.k. but when you break it down that was all pretty much in the boom years. Returns in the '99-'07 period only virtue was they were positive, barely. Of course if you'd gone in '04 you'd have done reasonably well. And there's our arguments in a nutshell.

1. Long-term returns are likely to be flat for years to come; the old buy-n-hold strategy isn't going to work very well in an environment of low growth and poor earnings. In fact what the table shows is that they have been flat for the last nine years.
   
• Let's repeat that - stock market returns for nine years have been flat - worse than mediocre. Only by correctly assessting the trends and key themes has anyone made money.
  
2. But it is possible to understand the secular forces, business cycle trends and key themes, e.g. energy, developing world, etc. that are likely to get you off the baseline floor.
3. Getting off that floor will take some work. Perhaps not a lot but we're not talking a few hours and forget per year. We're talking a few hours per week in combination with on-going attention paid to economic, business and political news in general. You need to be doing that, IOHO, anyway just to improve your own security and well-being.
   

Now let's consider the chart at right, which please note, is from Mar04. We reproduce it here to illustrate the process, the approach AND to open ourselves up to some embarrassment if you think any of the observations in the table are questionable and/or wrong. Looking back on it it didn't strike us as too bad, but as incomplete and several things we didn't catch. On the other hand much of the longer-term trends are playing out pretty much as we indicated. Here's the real point though - it's hard to do a lot better so you need to work thru this little exercise in some detail periodically AND monitor it on a regular basis to see if it needs to be updated and/or refreshed. Think of this as a workbook not as the answer book.

If you take a look it's really a structured checklist. The columns are defined by timeframes and the major rows by asset classes. Notice that under "Economy" we have a multi-timeperiod outlook sketched out. What would be yours right now ? Feel free to cheat - in fact we encourage it - and go back to the blog. Now look at the comments for each of the asset classes - not to bad. Perhaps the most off was the Real Estate outlook. But was it off in the early Spring of '04 ? We'd argue not - and the Housing bubble really became a bubble in late '04 and definitely '05 but was also clearly topping in '06. Like Emerging Markets, Commodities and Energy those were all investment themes to play over that timeframe. Few of which are going to survive now - again in our opinion.

So how would you position your portfolio then or now ? And against what strategic evaluations ? Our attempts at answers are in the table at left where the first column is asset classes and the next our baseline. Not too different from Swensen's though perhaps a tad more aggressive. If however you're willing to be more active, that is work on this regularly and be disciplined, and take some more risk that will hopefully be mitigated by that work we have two other suggestions. And active allocation (Xbase) and a very active one (Xbase2).

A couple of things to note - under each Xbase we present allocations based on our notion of analyzing the trends so that Was is what was appropriate for, say '04-'06+ (in this scheme the jury is out on '07). And Is is the allocations for what we think is coming. BtW BOLD numbers indicate using leveraged funds or ETFs with Blue being long the market and Red short. 

Take a look and you'll see how we thought to play the big structural themes, e.g. Emerging Markets or Energy. And how we're suggesting both pulling back from those for now, emphasizing bonds and also shorting the markets more. All of which strikes us as consistent with our views of the outlooks for the economy and business performanc. One final note.

Another suggestion that floats around is the idea of splitting your investments into a Core and an Active portion, say 70/30. We think that's a very good idea - be conservative with the Core and more Aggressive with the Active portion. Only we'd suggest three categories: Base, Core & Active with the Active (perhaps we should say Aggressive investor) having a split of 15/35/50. But that's just an idea.

Anyway we hope that's a bunch of food for thought - hopefully it's useful and works with the prior posts on the economic outlook and the problems we see coming. And provides some useful things to think about and tools to start with. Good Luck !