Drink Up! 20% Returns Are on the House!

Ashby Monk

It seems everywhere I look these days, large institutional investors are putting up investment returns above 20%. For example,

  • CalSTRS just notched the highest return they’ve had in 25 years with a 23.1% return.
  • CalPERS also registered 21% return, which is its best performance in over 14 years.
  • UTIMCO’s five endowments were collectively up 20% in the year ended June 30.
  • And the NZSF had a 23% return for the last nine (!) months.

But before you have a conniption at these returns — which would be understandable — I should note that these funds did not quadruple their exposure to exotic hedge fund strategies. No, these returns were “on the house”: global financial markets have been in quite a good mood lately, giving out returns in equity benchmarks of over 30% in some cases. In other words, these institutional investors were simply drinking what was freely available at the bar of global financial markets. (Caution: Beware of hangover.)

Still, I’ve got a few thoughts on these astounding numbers:

  1. This is why long-term investors really have to be long-term investors. (Are you listening politicians?) Institutional investors should not (and really cannot) be in the business of trying to time all of these things. So if you want to play the game, you have to play for the long-term.
  2. There’s big upside for investors that can patiently ride out down years with appropriate rebalancing strategies in the troughs. Imagine how well you would have done had you started buying equities in order to maintain your target equity allocation in late 2008? (Note: Norway doesn’t have to imagine anything; that’s what it did.)
  3. Portfolio and asset manager compensation has to be smoothed over time. There have to be “clawbacks” if performance really starts to suffer. And all performance bonuses have to be based on sensible benchmarks. Example: CalSTRS may have just knocked the leather of the ball with annual returns over 23%, but the fund still only has a three-year return of 1.2%. That’s nothing to write home about.
  4. What’s going on with risk factor allocations? It seems to me that the motive underpinning this big push towards risk factors was about avoiding this kind of volatility in portfolios. Granted, it was really about avoiding downside volatility, but if you can be up 23% in a year, then you can still be down that much, right?

Final thought: Let’s keep our heads here. All the stakeholders at these funds need to remember that these returns were “on the house”. These funds were simply riding the waves of the increasingly volatile financial markets. As such, increasing benefits or giving big bonuses or canceling plans for governance upgrades based on these returns alone would be universally silly. Mean reversion works both ways; which way do you think it’ll be heading next?

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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