The Ivy Portfolio: Book Notes

The  following are my notes from the book: The Ivy Portfolio by Mebane Faber

Super-endowments(like Harvard and Yale) are tax-exempt, have long-term time horizons, and have few investment restrictions. They invest more in real assets and alternatives than in stocks and bonds. They have superior active management( market timing and security selection), relationships and pricing leverage. Hence they have had superior returns.

The question is:

Can an individual investor hope to replicate the fantastic results of the top endowments?

The answer given by Mohammed- el-Erian was:

It would be like advising my child to drop out of school to play basketball with the goal of becoming the next Michael Jordan.

But Mebane Faber thinks that we can be close.

Individual investors usually cannot get access to hedge funds and private equity. So we remove them from the list of asset classes.We have five asset classes now: Domestic stocks, Foreign stocks, Bonds, Real estate, Commodities.The Ivy portfolio, in its simplest form involves investing 20% of assets into the above asset classes.The annualised return of such a portfolio is 11.97%. The annualised return of a 60% stocks/40% bonds portfolio is 11.45%. Not much different at all.The Ivy portfolio invests 40% in real assets, just like the Super Endowments do.

So how do you actually carry out it real-time?

It is simple. Invest in the following.

Domestic stocks: 20%: Vanguard Total Stock Market ETF: VTI
Foreign stocks: 20%: Vanguard FTSE All World ex-US ETF: VEU
Bonds: 20%: Vanguard Total Bond Market ETF: BND
Real estate: 20%: Vanguard REIT ETF: VNQ
Commodities: 20%: Powershares DB Commodity Index Tracking ETF: DBC

This has given an annualised return of 11-12%(1985-2008) depending on whether you rebalance and how you rebalance.

Using 10 asset classes:

VTI, VB, VEU, VWO, BND, TIP, VNQ, RWX, DBC, GSG

Using 20 asset classes:

VTI, VO, VB, IWC, VEA, VWO, GWX, EWX, BND, TIP, BWX, ESD, VNQ, RWX, IGF, TREE.L, DBA, DBE, DBB, DBP

Then rebalance(monthly, yearly or five yearly)
If you need to take out money, take it from the asset class that has appreciated the most.
If you are investing money, add to the most lagging asset class.
Tax harvest by selling and re-investing in closely correlated ETFs. Like sell SPY and buy VTI.

If you want to improve upon the above performance, Faber suggests two options to time the market

1.  Quantitative system: For each asset class above, buy if above 10 month simple moving average. Go to cash if below 10 month simple moving average. The annualised returns for the Ivy portfolio timed this way is 11.79%(versus 9.79% for the untimed one) for the period 1973-2008. Using more or different asset classes, removing bonds and using high volatility asset classes might improve returns.

2. Rotation system: Each month the 3 month, 6 month and 12 month total returns for each asset class are recorded and then averaged. Then you invest in the top 1, top 2 or top 3 asset classes. Annualised returns for the period 1973-2008 are as follows: Top1(17.55%), Top 2(16.42%), Top 3(13.94%). Top 2 and Top 3 are better because you have less turnover, less drawdown and less volatility.

The biggest question for someone following a quantitative system is: Can you follow it?

  1. Can you persevere?
  2. Can you stop comparing?
  3. Can you accept underperformance when compared to the market?
  4. Can you accept that your system is imperfect?
  5. Can you ignore the media?
  6. Are you decisive?

3. Buy when blood is in the streets: After 2 or 3 down years, an asset class will do better. The best way to capitalise on this behaviour is rebalancing.

People often praise buy and hold and say if you miss the 10 best days your return comes down. If you miss the 10 worst days your returns increase dramatically and if you miss the 10 best and 10 worst days your returns are substantially higher than buy and hold.

Following the smart money.Another useful method is to  track the 10 largest holdings of institutional managers quarterly, equal weighting these holdings and rebalancing them quarterly. You can combine the top managers or invest in consensus holdings. Why reinvent the wheel?

In summary,

Invest in the Ivy portfolio.
Rebalance
Consider timing strategies.
Consider buying stocks held by top managers.

Then,

Enjoy life. And joy is after all, the end of life. We work and eat to live. We do not live to work and eat. That is what life means.

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