Is it Time to Reevaluate the Status Quo?

Like all things in life, investing will continue to evolve as new products enter the market and new investment strategies uproot the status quo. Over the last 20 years, the disconnect between how individual investors allocate their assets and how professional investors—such as endowment funds, pension plans and sovereign wealth funds—allocate theirs has been widening.

Historically, both professional and individual investors almost exclusively invested in publicly traded equities and bonds. About two decades ago, however, institutional investors realized the advantages of having a diversified multi-asset class portfolio. For the 20-year period, which ended on June 30, 2016, U.S. Endowment Funds have gone from having negligible exposure to alternative assets to having on average 53% exposure to alternative assets, such as real estate, infrastructure assets and private equity.1 Over this same time period, the average individual investor has had less than 1% in alternatives.2

The rationale for investing across multiple asset classes is supported by modern portfolio theory. This theory shows that the risk-adjusted returns of a portfolio can be improved by diversification across assets with varied correlations. The theory is at the heart of the investment philosophy of most endowments and pension plans, and is the foundation upon which their portfolios are constructed.

By allocating a meaningful percentage of their assets to alternative asset classes, institutional investors like the Harvard and Yale Endowments have consistently achieved attractive annual returns and have significantly outperformed a typical retail portfolio. Over the last 20 years, these endowments have achieved annualized returns of roughly 52%, and 83% higher than the return a retail investor would achieve holding a traditional U.S. stock/bond portfolio (60/40) (Table 1).

Table 1
Harvard and Yale Endowment Funds Relative to a Traditional 60/40 Balanced Portfolio
June 30, 2017

Canadian Pension Plans have also significantly increased their investment in alternative assets, and as you can see from Graph 1, they have moved from just a 5% allocation in 1995 to 36% in 2017.6

Graph 1

By no means are we suggesting that investors should blindly follow the path of institutional investors and rush out to add a significant number of alternative investments to their portfolios. But, maybe individuals should stop to question their status quo investment methodology, and see if they could perhaps benefit from the investment evolution that has transpired in institutional investing.

  1. NACUBO – Common fund Study of Endowments, January 31, 2017
  2. American Association of Individual Investors, http://www.aaii.com/assetallocationsurvey, December 2017 results, accessed May 7, 2018.
  3. The Yale Investment Office. https://news.yale.edu/2017/10/10/investment-return-113-brings-yale-endowment-value-272-billion/, accessed May 7, 2018.
  4. Harvard University: www.hmc.harvard.edu/about-hmc/performance-history.html, accessed May 7, 2018
  5. Harvard Management Company, Inc.: Annual Endowment Report – September 2016, Page 1
  6. Pension Investment Association of Canada – Composite Average Asset Allocation, https://www.piacweb.org/publications/asset-mix-report.html and https://dougcronk.wordpress.com/, accessed May 7, 2018