But don't pay any heed to the eggheads in the economics department. Instead, watch the guys who run the colleges' money. America's top two Ivy League universities of Harvard and Yale have made consistently high returns on their endowment funds over the past couple of decades, while running very modest risks.
Between 1985 and 2008, Yale clocked up annualised returns of 16.6 per cent each year, while Harvard made 15.2 per cent a year. Not only were these portfolio performances far better than the return achieved by the period's best-performing major asset class - equities - they were also achieved with the sort of low volatility more typical of safe US government bonds.
Yale's worst yearly return over the whole 23-year period was a tiny loss of 0.2 per cent - not bad considering this timeframe includes the 2000-02 equity meltdown.
The Ivy League schools' stunning success is typically put down to a combination of factors. First, they hold lots of 'alternative' investments, such as hedge funds, private equity, real estate, and natural resources such as farmland.
They also employ clever tactical asset allocation - market timing - in order to skew holdings towards likely winners at the expense of more probable losers. They are also great at picking the best managers in each asset class, and then getting access to them. That's because many of the relevant personnel are Harvard and Yale old-boys and are often keen to help out their alma mater.
The accompanying chart shows Yale University's mix of assets as of 2012. Aside from the spread of holdings beyond just stocks and bonds, notice how the three biggest alternative assets make up more than three-quarters of the portfolio.
Inspired by Harvard and Yale's approach, Mebane Faber - a top US fund manager - has looked into the principles behind their success. In his book The Ivy Portfolio, he finds that a combination of stocks, bonds, commodities and real estate can produce better risk-adjusted returns than a bog-standard 60:40 portfolio split between stocks and bonds.
Specifically, he suggests the following equally-weighted portfolio, rebalanced once a year:
■ 20% - US equities (S&P 500),
■ 20% - Overseas equities (MSCI EAFE),
■ 20% - Real estate (FTSE NAREIT),
■ 20% - Commodities (GSCI),
■ 20% - Bonds (US 10-year notes).
The beauty of this allocation is that it demands little management and can be easily implemented wholly using low-cost exchanged traded products.
Looking at the 1985-2008 period, Faber's 'Ivy Portfolio' delivered 11.97 per cent a year - quite a bit less than the 15.9 per cent achieved by the Ivy League schools, but ahead of the 11.4 per cent of a 'bog-standard' 60:40 split between stocks and bonds, and with less volatility to boot.
Using Mebane Faber's basic model, I've put together an 'Ivy Portfolio' for UK investors. My proposed set-up is:
■ 20% - UK equities (FTSE All-Share),
■ 20% - Overseas equities (MSCI World ex-UK, £),
■ 20% - Real estate (FTSE NAREIT, £),
■ 20% - Commodities (GSCI, £),
■ 20% - Bonds (FTSE All-Stock Gilt index).
I've taken the study back to 1980 and have brought it right up to mid-2013.
Performances compared
| 'Ivy UK' portfolio | 60:40 UK equities:bonds | |
|---|---|---|
| Annualised return (%) | 12.2 | 11.1 |
| Volatility (%) | 11.9 | 10.8 |
| Worst drawdown (%) | -37 | -22.8 |
| Sharpe ratio | 0.6 | 0.56 |
| Sortino ratio | 0.76 | 0.76 |
| MAR | 0.33 | 0.49 |
| Source: Thomson Datastream | ||
Between 1980 and 2013, my UK version of Faber's 'Ivy Portfolio' produced a total annualised total return in the UK of 12.2 per cent a year, which was better than the return for a typical 60:40 equity:bond split. Adjusting for the risks run, the UK Ivy Portfolio also did better than the 60:40 split, although the portfolio suffered a bigger worst peak-to-trough decline.
While the results of applying Faber's basic 'Ivy' approach to the UK are decent enough, I believe they can be bettered.
First of all, adding more alternative investments - such as private equity and other real-estate holdings - has the potential to boost returns and lower risk.
My research also suggests that using methodical tactical asset allocation could do the same job. In the follow up to this article, I will be looking for specific ways of boosting the returns by changing the mix of assets and doing some tactical asset allocation.
