Portfolio Design: A Modern Approach to Asset Allocation

LESSONS ABOUT ALTERNATIVE INVESTMENTS LEARNED IN THE FINANCIAL CRISIS

Yale and other institutional investors suffered along with the rest of us when the financial crisis hit in 2007 to 2009. Yale’s portfolio suffered a loss of 24.6 percent in the fiscal year 2009 (from July 2008 to June 2009). Harvard’s portfolio was down 27.3 percent. The average return of NACUBO members was −18.7 percent. How do we explain these results? This section will examine how different types of alternatives fared during the crisis. Then it will examine Yale’s performance.

One important feature of investments during the crisis was that they varied widely in how accurately they reflected true economic values. Stocks are priced on organized exchanges—marked to market at every point in time. The same is true of REITS and the commodity futures contracts measured by the GSCI or DJ UBS commodity indexes. The same cannot be said of private equity or the NCREIF valuation-based index of real estate returns.

Consider first the damage inflicted on publicly traded equities during the crisis. The S&P 500 index reached a peak for this cycle on October 9, 2007. For the next 17 months it fell 56.8 percent until reaching a trough on March 9, 2009. Using monthly data for total returns on the S&P 500 (including dividends), the cumulative return on the S&P 500 was −46.7 percent from October 2007 through March 2009. Over the same 17 months, the return on the EAFE index was −53.6 percent and the return on the MSCI Emerging ...