The "Smart Money"

Harvard has begun exiting a large investment made six years ago in natural resources. Much of these investments were made outside the U.S. as in Central American teak forests, Australian cotton farms, a eucalyptus plantation in Uruguay, and timberland in Romania. The endowment thought they could take advantage of growing demand in scarce resources around the globe, particularly in emerging markets according to former head of Harvard’s endowment, Jane Mendillo, in a 2012 Bloomberg interview. In the past year the endowment has written down the value of its global natural resources portfolio by $1.1 billion. Over the past 10 years the fund has returned 4.4% on average. Contrast those returns with a simple buy and hold 60% stock and 40% bond index portfolio (rebalanced annually) that returned about 6.5% over the same time period.

Harvard’s mistake happens to many large pools of money periodically, not just individual investors; the fund decided it can identify superior traditional active managers that will outperform markets. Harvard paid these managers $242 million between 2010 and 2014. Mendillo’s successor, Stephen Blyth experimented with expanding the fund’s in-house team of stock traders which was followed by tens of millions of dollars in losses. Blyth stepped down in 2016. Why do these bright people continue to think they can outsmart everyone else in the markets? Because hope springs eternal. The issue is that we don’t know how much is luck and how much is skill when it comes to outsized returns. Clearly some investors have great skill but we can only reliably identify it ex-post. Those talented investors are increasingly rare as markets grow in efficiency over time.

According to the most recent SPIVA study (S&P index vs active returns) the index beats the active manager around 85% of the time over five and ten year rolling periods. This is true in most every asset class across equities and fixed income. Good luck finding those managers who make up the 15%. The players change yet the results stay the same. The answer is clear regardless of whether you are John Smith or Harvard’s endowment. Invest in a broadly diversified, low cost portfolio built around unbiased academic research and exercise patience.