From the April 01, 2010 issue of Futures Magazine • Subscribe!

The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets

The Ivy Portfolio: How To Invest Like the Top Endowments and Avoid Bear Markets
By Mebane T. Faber and Eric W. Richardson
John Wiley & Sons, Inc.
$49.95, 228 pages

The author begins his discussion with the workings of Yale and Harvard’s endowment funds, as they have produced superior returns over their life spans. However, even these experienced fund managers were hit hard by the latest bear market, as they experienced a drop in their endowment’s value of between 30% in their last reporting period tarnishing a previously stellar performance record. The book’s focus is to provide investors with insight into how to build a diversified portfolio by using a tactical asset allocation approach. This process should be able to provide stable returns, no matter what the financial or economic environment. The book provides investors with practical investing advice using ETFs that the can be put to immediate use.

Faber points out the growth in the largest endowment funds since 1950 and the benefit of not having to pay taxes provides more funds for compounding of returns. Also, these funds have long time horizons, as they expect to exist in perpetuity so they are able to hold some illiquid vehicles. The university’s financial health and ability to offer scholarships, build new facilities, maintain academic posts, and fund research are heavily dependent on their endowment fund’s performance. Not surprisingly, the largest endowment funds have fewer stocks and bonds, but more real and alternative assets (hedge funds, private equity, and venture capital).

As far as when to enter and exit the market, Faber proposes using a 10-month simple moving average on the ETF or index invested in. He even tested this approach on the foreign market and found that in all cases this approach beat buy-and-hold from 1973-2008 on a risk-adjusted basis with less volatility and drawdown. A test of the S&P 500 Index from 1900-2008 produced an annual return of 9.21% for buy-and-hold and 10.85% for the 10-month moving average approach.

The authors believe that investors can mimic the investing style of the leading endowments on a risk-adjusted basis using ETFs. The basic “Ivy” portfolio consists of a 20% allocation to a domestic stocks, foreign stocks, bonds, real estate and commodities represented by the following ETFs: VTI, VEU, BND, VNQ, and DBC, respectively, and rebalanced annually. From 1985- 2008 (June 30) this portfolio had an 11.97% annualized return compared to 15.95% for the combination of Harvard and Yale. The only negative years for this portfolio were 2001 and 2002 with an annual loss of 1.5% a year.

Faber further analyzed a “rotation” system using the Ivy portfolio components. Each month the 3-, 6-, and 12-month return of each asset was averaged. He then invested in the top performing ETF of the five ETF portfolios for that month. This process was repeated every month going forward. From 1973-2008, this strategy averaged 17.55% compared to only 9.79% from the standard non-rotating “Ivy” portfolio. Although the volatility of the rotated portfolio doubled from the basic portfolio, the maximum drawdown was slightly less.

The author then compares the rotation strategy using the two strongest performing ETFs from the group of five for the period 1985-2008 to that of Harvard and Yale. He found that this approach produced equivalent performance with a 15.81% average annual return and a similar 10.25% volatility with a correlation of about 80% to both endowment funds.

One interesting way for the investor to obtain investment ideas for his/her portfolio is to follow the 13F filings of the best funds managers who are required to report their holdings quarterly to the SEC. Although the data is available 45 days after the filing date, it is still usable. (Note: Investors can go to TickerSpy.com to obtain this information for free for the top funds.) Faber recommends that investors consider investing in a few of the top holdings from a group of the best managers, at the right time based on the 10-month moving average. By using this approach, Faber believes that investors can obtain similar performance to hedge funds.

In summary, the “Ivy” portfolio using the 10-month moving average, as the market timing mechanism, provides equity-like returns with bond-like volatility with 36 years of positive returns. This simple investing approach can be used successfully by the average investor to outperform the typical mutual fund at lower cost and with better risk-adjusted returns. Faber provides the evidence and explanation as to how investors can benefit from using a timing approach with a group of diversified ETFs. Each chapter contains a brief summary of the main points which is a useful way to emphasize the key points that investors need to keep in mind. He also provides insight into the workings of private equity and hedge funds in separate chapters.

Leslie N. Masonson is the author of “All About Market Timing” and “Day Trading on the Edge.” Reach him at lesmasonson@yahoo.com

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