YOGI BERRA and Modern Investing “If you don't set goals, you can't regret not reaching them.” NEED TO HAVE A CLEAR INVESTMENT APPROACH AND GOAL EXAMPLES OF THE CONVENTIONAL TRADITION Popular Works: Charles Ellis, “Winning the Loser’s Game” (Fifth Ed.) (McGraw-Hill 2009) John Bogle, “John Bogle on Investing: The First 50 Years” (McGraw-Hill 2001) Ellis and Makiel, “The Elements of Investing” (Wiley 2010) Larry E. Swedroe, “The Quest for Alpha” (Wiley 2011) Textbook 2012) Short Works Burton G. Malkiel, “A Random Walk Down Wall Street” (10th Ed.) (Norton Sharpe, Alexander, Bailey, “Investments” (6th Ed.) (Prentice-Hall 1999) Bodie, Kane, Marcus, “Investments” (9th Ed.) (McGraw-Hill 2011) Best Work David Swensen, “Unconventional Success” (Free Press 2005) 2011 Guest Lecture to Robert J. Shiller’s Econ 252: Financial Markets (Open Yale Courses) http://oyc.yale.edu/economics/econ-252-11/lecture6 "You've got to be careful if you don't know where you are going, because you might not get there." KNOW YOUR LIABILITIES AND INVEST FOR THOSE, NOT ABSOLUTE OR RELATIVE RETURNS TO PEERS “Baseball is 90% mental. The other half is physical.” A good strategy and plan is essential, but implementation is crucial “I never blame myself when I’m not hitting. I just blame the bat, and when it keeps up, I just change bats. After all, when I know it isn’t my fault that I’m not hitting, how can I get mad at myself?” Key to investment is to stick with an investment plan and don’t panic when it isn’t working "It's not too far, it just seems like it is." (Yogi giving directions to Yogi Berra's Hall of Fame Racquetball Club in Fairfield, New Jersey.) INVESTING WORKS IN THE “LONG TERM”, WHERE LONG TERM RETURN IS RELATED TO LONG TERM RISK RETURN GENERALLY FOLLOWS RISK 18% Small Stocks 16% RETURN (Arithmetic) 14% Large Stocks 12% 10% 8% 6% Int Gov 4% Long Corp Long Gov T-Bills 2% 0% 0% 5% 10% 15% 20% 25% 30% 35% RISK (Annual Volatility) Annual Returns Ibbotsen SBBI 2010 Classic Yearbook Expected vs Actual Frequency of Annual Returns Frequency 5 Year Rolling Returns 1871-2008 (log) 30% 30% 25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% -20% -15% Expected -10% -5% Actual 0% 5% 10% 15% 20% 25% 30% 35% 40% Annual Return (log) Source: Yale University Professor Robert Shiller’s website, as of 12/31/08 Past performance is not a guarantee of future results. Rolling periods represent a series of overlapping, smaller time periods within a single, longer-term time period. A hypothetical example is the 20-year time period from 12/31/82 through 12/31/02. This long-term period consists of 16 smaller five-year “rolling” segments. The first segment is the five-year period from 12/31/82 to 12/31/87. The next rolling segment is the five-year period from 12/31/83 to 12/31/88, and so on. 9 “When you come to a fork in the road, take it!” DIVERSIFY SUN RAIN TOTAL Suntan Lotion, Inc. 60% -40% -4% Umbrella, Inc. Combined (50-50) -50% 70% -15% 5% 15% 20.75% “It's tough to make predictions, especially about the future.” Jul-10 Apr-10 Jan-10 Oct-09 Jul-09 Apr-09 Jan-09 Oct-08 Jul-08 Apr-08 Jan-08 Oct-07 Jul-07 Apr-07 Jan-07 Oct-06 Jul-06 Apr-06 Jan-06 Oct-05 Jul-05 Apr-05 Jan-05 Oct-04 Jul-04 Apr-04 Jan-04 Oct-03 Jul-03 Apr-03 Jan-03 Oct-02 Jul-02 Apr-02 Jan-02 Daily Price Movement 10% Daily S&P Price Movements 2002-2010 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Monthly Returns 1926-2008 (log) 0.9% Average Return 7.8% Standard Deviation Frequency 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 Expected Actual 28 % 26 % 24 % 22 % 20 % 18 % 16 % 14 % 12 % 10 % 8% 6% 4% 2% 0% -2 % -4 % -6 % -8 % 0 -2 4% -2 2% -2 0% -1 8% -1 6% -1 4% -1 2% -1 0% 0 Monthly Return (log) Source: Actual returns from Ibbotson’s Stocks, Bonds Bills and Inflation, as of 12/31/08. Expected returns generated randomly using Ibbotson data. Past performance is not a guarantee of future results. 14 Frequency vs Action in Monthly Returns 1926-2008 (log) 12% 12% 2% of m onths gives 10% of action 5% of m onths gives 20% of action 10% of m onths gives 33% of action 10% Action Actual M or e 16 % 14 % 12 % 10 % 8% 6% 0% 4% 0% 2% 2% 0% 2% -2 % 4% -4 % 4% -6 % 6% -8 % 6% -1 0% 8% -1 2% 8% -1 4% Frequency 10% Monthly Return (log) Source: Actual returns from Ibbotson’s Stocks, Bonds Bills and Inflation, as of 12/31/08. Expected returns generated randomly using Ibbotson data. Past performance is not a guarantee of future results. 15 SHAPE OF ROLLING DOW jONES DISTRIBUTIONS 1928-2010 (Log) Daily 184 49 0 Expected 3Y 6Y “The wind always seems to blow against the catchers as they are running” Winds, particularly in the form of transaction costs, are against use of complicated strategies THE SWENSEN “J” CURVE RESULTS SIMPLE COMPLEX “Few institutions and even fewer individuals exhibit the ability and commit the resources to produce risk-adjusted excess returns. . . .. No middle ground exists. Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high-quality active management decisions. The framework of the Yale model applies to only a small number of investors with the resources and temperament to pursue the grail of risk-adjusted excess returns.” Dr. David Swensen The Yale Endowment 2013 Annual Report at p. 15 (emphasis added) "It gets late early out there.” (Yogi's comment on the glare of the sun in left field at Yankee Stadium during the 1961 World Series against the Reds.) Markets forecast expected market returns and levels early " It ain't over 'til it's over " (Commenting on the 1973 National League Pennant Race) Don’t make radical moves in anticipation of end “HALF THE LIES THEY TELL ME AREN’T TRUE." HEDGE FUND CLAIMS Good returns at low standard deviation Claim: “Equity Returns with Bond Risk” Actual Experience – Less than Bond Returns with Equity Risk Good diversifier for portfolio – low correlations with standard asset classes Claim: Decreases portfolio dependence on market risk Actual Experience - Doubles down on existing standard bets Better and Safer Returns in Tough Times Claim: “Absolute” Returns Actual Experience – Negative returns worse than standard portfolios “Slump? I ain't in a slump ... I just ain't hitting." “If you don’t know where you are going, you will wind up somewhere else” Excess Returns to 55-15-30 150% HFR Excess S&P Excess 100% 50% S&P Excess 37% 0% -50% -100% HFR Excess -100% 1 0 9 8 7 6 5 4 3 2 1 0 9 8 7 6 5 4 2 Ja n1 Ja n1 Ja n1 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n0 Ja n9 Ja n9 Ja n9 Ja n9 Ja n9 Ja n9 Ja n9 3 -150% “Third base ain't so bad if nothing is hit to you." $1.30 GROWTH OF $1 OVER PAST FIVE YEARS HFRXGL PERSI HFRXM HFRXAR HFRXEH $1.20 $1.10 PERSI $1.08 $1.00 HFRXM $0.94 $0.90 HFRXGL, $0.86 HFRXAR $0.83 $0.80 HFRXEH $0.76 $0.70 $0.60 Ju n07 Se p07 D ec -0 7 M ar -0 8 Ju n08 Se p08 D ec -0 8 M ar -0 9 Ju n09 Se p09 D ec -0 9 M ar -1 0 Ju n10 Se p10 D ec -1 0 M ar -1 1 Ju n11 Se p11 D ec -1 1 M ar -1 2 $0.50 OTHER ISSUES WITH HEDGE FUNDS “If you can’t imitate him, don’t copy him” Resources required are huge and complex Anecdotal reports of success "We don't throw at .200 hitters." To impact total fund, need to make a large commitment to area – at least 10%-15% Returns have been moderate, at best “It ain’t the heat, it’s the humility”. Hedge funds ultimately a zero sum game, and have to find the top future quartile performer in advance Odds 3:1 against “The future ain't what it used to be” Records of past success often disappear upon implementation or hire “Even Napoleon had his Watergate.” "He's a big clog in their machine.“ For every Julian Robertson, there’s a Julian Robertson For every John Meriweather, there’s a John Meriweather For every John Paulson, there’s a John Paulson "Nobody goes there anymore. It's too crowded." A working strategy becomes known and popular Yogi's opinion of Rugerio's, a popular St. Louis restaurant where he had once worked as headwaiter. “YEAH, BUT MOST OF HIS HOME RUNS WERE HIT ON ARTIFICIAL TURF.” When asked why Johnny Bench hit more home runs than he did. Strategies that worked with small amounts often can’t scale or incur bigger transaction costs “In theory there is no difference between theory and practice. In practice there is.” New strategies that work on paper blow up when implemented "We're lost. But we are making good time." Hedge funds make a portfolio exceedingly complex and difficult to track, with lots of activity "A nickel ain't worth a dime anymore." Costs of hedge funds are outrageous “It was hard to have a conversation with anyone – there were too many people talking.” Too many claims, rationales, and approaches marketed under the rubric of “hedge funds” Switching Benchmarks or Comparables “Libor +” when cash enhancement was easy S&P 500 when was worst capital market Now bond potential returns when S&P outperforms “You better make it 8, I’m feeling really hungry.” Responding to a waitress when asked into how many slices she should cut his pizza Claimed Diversification that worked only when you didn’t need it “Correlations going to 1”. All equity acts alike in a crisis. “It's deja vu all over again” Old failed approaches under new wrappings. E.g. “Macro”, “Multi-Strat” Managers or firms with purported speculative genius: E.g. “Equity Long/Short” and “Absolute Return” Old: Asian infrastructure in the 90s, Specialty fixed income and derivatives in the early 90s and 2000s, Portfolio Insurance, VAR New: Risk factors, Risk Sleeves, Volatility trading, Tail risk insurance, minimum variance Investments at the tail end of fads or reactions to recent trends Old: Jacob Barker, Jacob Little, Anthony Morse, Jesse Livermore, Gerald Tsai, Elaine Garzarelli, Abby Joseph Cohen, Salomon Brothers, Long Term Capital, Bear Stearns New: “130/30”, Taleb, John Paulson, High Frequency Trading, “Fast Money” New untested approaches with theory but no sustained track record Old: Tactical Asset Allocation, Balanced funds and Bank Trust Depts in the 70s and 80s New: Strategic Partners, external CIOs Old: VC after the 90s, Death of value investing in 2001, Internet fad New: Commodities, Real Assets, Leverage (“risk parity”), non-S&P 500 Industry incented to support – “Where are the customer’s yachts?” “2 and 20” fees – Best business people in world, but business isn’t to beat the market Consultants have a reason for existence and better fee CIO’s and staff can reach for brass ring - The “public fund MBA” Boards get more interesting meetings, lunches and dinners