CHICAGO, Jan 25 (Reuters) – During a market crisis, when
everyone wants to jump off the ship in the same leaky lifeboats,
that doesn’t bode well for most individual investors, who simply
want to preserve capital.
The safeguard is to move against what behavioral finance
experts call the “bandwagon effect” — when so many investors
follow the same path that they disrupt the traditional
correlation of assets.
This is what has happened when Modern Portfolio Theory (MPT)
– a bedrock of investing that advocates diversifying your
portfolio to temper risk and boost returns — met big
institutional investors who employed the idea on steroids,
plowing money into alternative investments from leveraged hedge
funds to timber.
In his new ebook “Skating Where the Puck Was: The
Correlation Game in a Flat World,” William Bernstein, a money
manager and neurologist, credits the surge of going big with MPT
to David Swensen, the legendary manager of the Yale University
Endowment. His strategy of deploying more than half of the
college’s portfolio in alternative assets such as timber, hedge
funds, private equity and commodities produced a 15.6 percent
annualized return between July 1987 and June 2007, besting the
benchmark S&P 500 by nearly 5 percentage points.
At the time, Swensen’s success upended the ossified standard
practice of 60 percent stocks, 40 percent bond mixes. Seeing
that they could do better, money managers with significant
resources parroted Swensen’s allocations. By the mid-2000s, more
than 800 large endowments and pension funds were mimicking