Like the search for the perpetual motion machine, the money management business never ceases in its effort to invent what could be a perennial winner in both rising and falling markets. Not that long ago, a possible answer was the notion of a “go-anywhere” fund — a mutual fund that would make no pretense of representing a specific investment style (e.g. large cap value, small cap growth, etc.) nor would it confine itself to a specific industry or limit itself to just stocks without including bonds. In short, it would be free to invest anywhere with total discretion — offering no promise of direction — an acceptable approach when disclosed in the fund prospectus.
For investors, selecting one of these funds represents a leap of faith in the manager’s ability to time subsets of the investment universe.
At best, it represents a ride on an escalator leading to a steady climbing rise in asset values. For most, the experience is more like a roller-coaster, and at worst, a bumper car ride.
At the time the concept debuted 20 years ago as a “go anywhere” mutual fund, it was following the lead of some major college endowments and state pension funds that had bought into the concept to limited degrees. Soon, thanks to the fund industry, the opportunity was available to someone with just a few thousand dollars.
While the early version was pretty straightforward with investments sloshing around in recognizable equity and bond categories, the concept has morphed today into what is now termed “absolute return” funds. These are funds that profess to make money in up, down or sideways markets using arcane products like derivatives and short sales to make money in falling markets.
“Shorting a stock” means borrowing a share, selling it, holding the cash, buying the share back at a cheaper price later, returning what had been the borrowed share and keeping the difference between the initial cash received and what had to be spent to repurchase the share to be returned. Voila! The “short seller” just made money on a share that dropped in value.
“Derivatives” are more complicated in that they are fabricated investment products whose performance mirrors the performance of an underlying actual mix of shares like the S&P 500 index. A derivative doesn’t own shares directly like a fund. It just has a value based on share performance, and these “bets” on performance can be shaped in an infinite variety of ways.
As money managers go, one of the all-time greatest has been David Swensen who manages the Yale college endowment of $27 billion. I wrote about him back in 2005 when he had published his book, “Unconventional Success: A Fundamental Approach to Personal Investment.” Yale’s fund was at $16 billion at the time and has almost doubled since then even after paying out $500 million a year to support the college’s annual expenses. What I liked about the book was the three simple rules for individual investors: First, work with inexpensive not-for-profit mutual funds. Second, diversify investments over core asset classes, and third, rebalance periodically.
Today, at Yale anyway, that approach has been jettisoned. Fully 25 percent is invested in absolute return, 17 percent in venture capital, 15 percent in foreign equity, 14 percent in leveraged buyouts, 10 percent in real estate, 7 percent in bonds and cash, 7 percent in natural resources, and 4 percent in domestic equity.
Frankly, I find this to be destabilizing because it shakes my core belief regarding investment strategy. I was more comfortable with the David Swensen of the early 2000s. For what it may be worth, the flurry of new absolute return funds opened in 2009 and 2010 resulted in many subsequent closures of those failing to deliver, and the ones that survive have not met expectations. What this tells me is that Yale’s investment allocation reflects a tentative confidence in future stock market performance. For those of us not sitting on $27 billion, it could signal a segue toward more bonds and large dividend-paying stocks.