Would the Founding Fathers Stay With Their Stock Portfolio?

“These are the times that try men’s souls.”

Thomas Paine

This simple quotation from Founding Father, Thomas Paine’s “The Crisis”, not only describes the beginning of the American Revolution, but also our life in the stock and bond market. Look at numbers from the past seven years as compared to the previous twenty:

How are professional investors handling this downturn in both the stock and bond markets? Professional investors know something that most of us don’t.

Benjamin Franklin is famous for stating “An investment in knowledge always pays the best interest. “ ¹ Lets go to two of the best sources of knowledge in our United States, Yale and Harvard. How do they invest their $20 Billion Endowment Funds? Are they silently waiting out the stock and bond markets? The answer is partially yes, but as you can see in the graph below, they have drastically changed their model from the traditional Stock/Bond mix to Stock/Bond/Alternatives.

That is not a misprint. Yale and Harvard, according to their annual endowment reports have an average of 65% of their investment assets in an asset class that is neither stocks nor bonds.

Alternative asset classes are defined as uncorrelated assets that do not move in the same direction at the same time as traditional asset classes. An alternative asset class can benefit investors during various market cycles by providing a higher level of diversification and potentially reducing risk.

Examples of alternative assets are market neutral funds such as long-short funds that buy stocks like the traditional mutual fund but also shorts (sells) stocks that it does not like within the same portfolio. Other categories are real estate, natural resources, gold, commodities such as livestock and timber, treasury inflation protected securities (TIPS) and emerging market stocks and bonds.

Founding father, John Adams, was guided by this belief: “Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.” ²

The evidence of our asset allocation models suggests that we can benefit from diversifying alternative assets into our portfolios. If we used a sample portfolio of 15% Commodities, 20% Global Real Estate, 20% Market Neutral, 20% TIPS, 10% Emerging Market Stock, 10% Emerging Market Bond and 5% Gold and Precious Metal from September 30, 1997 to September 30, 2007, an average annualized rate of return for the ten year period of 10.9% was produced versus 6.6% for the S&P 500. More importantly, during the bear market the cumulative return of the portfolio was 18.6% versus the S&P 500 at -43.1% ^3.

Even Thomas Jefferson knew the value of real assets as alternative investments. He was able to make the Louisiana Purchase happen in 1803. The United States paid $15 million dollars for over 800,000 square miles of land. The land area of America nearly doubled with this one transaction. The Louisiana Purchase contained vast amounts of natural resources, commodities and the land itself.

As individual investors we have different liquidity issues than Yale and Harvard. We also do not have access to the same investment managers, although the amount of top notch alternative investment managers keeps increasing each year. It is interesting to see quality companies who used to cater only to institutions like Yale and Harvard begin packaging their services to the individual investor.

What is important to understand is that we can take these lessons and apply some real strategies to our portfolio to help us create less volatile portfolios while hopefully increasing our returns. See your investment advisor for information on which of these asset classes might make sense in your portfolio.

NOTE 1 (http://www.quotationspage.com/quotes/Benjamin_Franklin/

NOTE 2 http://www.quotationspage.com/quotes/Thomas Jefferson/)

NOTE 3