Now that pension plans are recovering from the market meltdown of 2008 and are reconsidering their longer term investment strategy, there are two alternative paths that they might consider—described here as the “Buffett” approach and the “Yale” approach.
Despite poor results during this period (a calendar year loss of 9.6% for Berkshire Hathaway (Buffett) for 2008 and a plunge of 24.6 % for the fiscal year ending June 2009 for the Yale Endowment Fund (Yale), these outcomes have to be considered within the context of even steeper marketwise declines. Over the longer term, the results remain quite spectacular. Berkshire Hathaway has delivered compound annual gains of 20.3 % since 1965 outperforming the S&P 500 by more than 11 %. Yale earned portfolio returns of 14.6 % for the period from 1985 to 2009, outperforming the S&P 500 by more than 4 % with significantly less volatility.
The Buffett approach takes a long-term value approach to investment management, although it is somewhat concentrated and subject to very few constraints. Buffett seeks out enduring businesses with long-term competitive advantage. Despite speaking out against complex trading strategies, having infamously referred to derivatives as weapons of mass destruction, Buffett does make forays into alternative investments on an opportunistic basis.
In contrast, the “Yale” approach has a heavy bias towards both equities and alternative investments. The emphasis is on preserving purchasing power relative to inflation and on portfolio diversification. Yale views alternative assets as being less efficiently priced, thus giving rise to the potential to add value through active management. Yale exploits these illiquid less efficient markets over a long-term time horizon.
Yale’s target portfolio mix is heavily geared towards these alternative assets and capital preservation assets; namely:
- Absolute Return Strategies 21 %
- Public Equities 25 %
- Private Equity 21 %
- Real Assets 29 %
- Fixed Income 4 %
So which approach makes more sense for a pension fund? Both share similarities—the willingness to take and hold contrarian views, a long-term focus and a disciplined approach to portfolio management. However the Buffett approach is focused on total asset return with no constraints due to short-term volatility and cash flow needs. By contrast, the Yale approach incorporates the concepts of risk allocation and reflects liabilities characteristics (in this case the needs of the endowment fund). The Yale approach has greater complexity and requires more extensive oversight.
As always, the selection of a portfolio approach depends on the circumstances. The following general observations capture investment beliefs from both Buffett and Yale:
• emphasize long-term value;
• consider absolute return and/or real return strategies to reflect pension obligations;
• concentrate the search for added value to areas where managers have established a record for skill and/ or markets are inefficient (in Buffett’s case, he applies this philosophy to the selection of management of firms); and
• align portfolio complexity with oversight capabilities.
Many funds may be driven by accounting or funding considerations or may have limited tolerance for risk in light of their 2008 outcomes. However for those who are still taking a long-term view to pension fund investing, one of these approaches may still reflect their beliefs and be the structure of choice.