Most investors don't think about currency when they are investing. I think that is a mistake. Today Bespoke provided a perfect example of why currency matters . . . .
If you own all domestic stocks and bonds and the dollar drops consistently against a basket of other currencies your real currency weighted return is actually much lower. Ignoring currencies is not a smart decision.
Yale's David Swensen is a pioneer in multi-asset class investing. I've taken to reading Yale's annual reports to dissect Swensen's asset allocation and methodology. Something tells me I'm not the only one doing this. When Swensen inherited Yale's $1.5 billion endowment in 1985 their asset allocation was roughly two thirds stock and one third bonds. In the graph below, the first thing you will notice is how dramatically Yale's portfolio has changed over the years. Swensen has invested heavily in hedge funds, private equity, real estate, commodities and other alternatives. Today he has only 3.8% of Yale's portfolio in fixed income and just 11.8% in domestic stocks. I expect both of those figures to continue to trend lower. You can see in the graph below that Swensen has gotten progressively lighter on domestic equities over the past 10 years and recently he has gotten rid of most of his fixed income exposure:
Yale's $22.5 billion endowment is the second largest in the country behind Harvard's $34.9 billion endowment. But, Yale has been the top performing large (>$1billion) endowment over the last 22 years. This past year was no different as Harvard turned in a very respectable 22% return under Mohamed El-Erian and Yale put in a best of class 28% return:
It is absolutely amazing that David Swensen is still at Yale and not running his own fund. If their was ever a guy who could raise $5 billion on a whim and immediately cash in it is David. There must be something else that drives him to stay in the ivory tower . . . .
Hat Tip: WSJ
In a post from June 8th about Bill Gross I discussed the importance of commodity and TIPS exposure in a portfolio. Today's market provided a brilliant example of why commodities and TIPS work as diversifiers. In a day where most equity indexes were down over 1% two ETF's performed quite well: the Powershares DB Commodity Index (DBC) and iShares TIPS (TIP).
In the chart below I graphed the performance of 4 prominent Asian stock market indexes -- Japan, Malaysia, Hong Kong, Singapore -- and Australia over a 5 year period. If I had taken a survey to see if investors thought that the Asian countries or Australia was a better market to invest in over the past 5 years, I would bet that most retail investors would put their money on Asia. Here is the list from worst to best:
So what is the lesson here? Well, for starters proper asset allocation hopefully gave each of you exposure to these and other emerging markets in your portfolio. If you didn't have adequate exposure to this area your returns have probably lagged over the past 5 years. Today with companies like iShares offering more and more invidual country ETF's you can get more precise exposure to countries that are well positioned for growth over the next 5-10 years. Even though Australia (EWA), Singapore (EWS) and Malaysia (EWM) have all been hot for some time I believe that all three will continue to benefit from the explosive growth of China and India. The downside of course is the volatility. 
Eugene Fama, the ultimate random walker, has a video on the Dimensional Fund Advisors website in which he gives advice to investors. I encourage you to view the video in its entirety here. Here is a quote of the most important advice:
"The evidence is quite clear. If you do any systematic analysis of investment performance what you find is people basically get return for risk and then from that you subtract fees and expenses. It is the costs that basically determine deferentials in portfolio performance. Active managers charge more so they tend to do worse. But, that doesn't mean people will stop doing it. Especially MBA students, all the ones that want to be portfolio managers want to be active managers naturally since if they're lucky and they win they end up rich. And that is very, very attractive to them so lots of students in my class even end up being active portfolio managers. I don't know where they learn how to do it though. The evidence is also clear that what does matter in portfolio strategies is asset allocation. The choice of stocks versus bonds and within stocks a tilt toward value and a tilt towards small. Now those are basically the decisions you face, plus international diversification is another aspect of it."I agree with Eugene in large part, though I'm sure most Hedge Fund managers would watch this video and laugh all the way to the bank. I was a little bit disturbed by the fact that international diversification seems like such an afterthought to Gene as I feel it is such a pivotal part of portfolio construction. I also personally feel that utilizing other asset classes -- such as REITS and commodities -- can be very valuable in portfolio construction particularly as a means to dampen volatility and drive returns during prolonged market downturns. It would be interesting to ask Gene his opinion on that question in person. It might be a while before I get that opportunity . . .
I've had a lot of people ask me whether or not residential real estate is a smart investment. Of course the question is usually couched liked this: "I only invest in real estate because it is the best investment, don't you agree?" Because I'd rather not ruffle too many feathers I usually just respond "it depends." The bottom line is that we just experienced a decade long real estate boom. No one wants to listen to anyone say that residential real estate should just be a home, not a retirement plan and certainly not the place to keep your entire nest egg. Three years from now I suspect this will be an easier conversation.
Instead of giving you my own long winded thesis on home ownership I will just refer you to a couple of charts and a great article from David Crook. Mr. Crook (great name eh?) is the Editor of the Wall Street Journal Weekend Edition and is the author of a great book entitled "The Wall Street Journal Complete Real-Estate Investing Guidebook." He's a smart guy, I just wish more people would listen to what he has to say. You can and should read the article in its entirety here. To whet your appetite check out this graph from the article.
I always say why present a case with words when you can accomplish much more with numbers. Well below you will find two graphs. Click each one to enlarge.
This first graph shows the annualized rate of return to stocks and real estate over 5 years from 2001-2006. 
This second graph shows the annualized rate of return of stocks and real estate over thirty years from 1976-2006.
Remember, investing is about strategic asset allocation, rebalancing and time invested. The last time I checked most assets move in cycles. Over the past decade real estate has boomed, which tells me that real estate returns should revert to their longer term average over the next cycle. However since you live in your home it is hard to "rebalance" it as a part of your overall portfolio and perhaps even harder to make unemotional financial decisions about it. Therefore real estate should be a part of your investment strategy/retirement plan, but it probably shouldn't be your entire investment strategy/retirement plan. Remember diversification across asset classes works because we simply can't predict which asset class will outperform over the next 5-10 year period. If we knew that then we would sell all of our other investments and buy that one asset and hold it for 5-10 years.
I would love to hear comments or suggestions.
