“Life is really simple, but we insist on making it complicated.”
This quote attributed to Confucius rings true if “life” is replaced with “investing.” Most investors and advisors feel compelled to continuously fine-tune a portfolio, overweighting various sectors, sprinkling in alternative asset classes, and experimenting with whatever form of “smart beta” is currently in style.
Investing is perhaps made most complex by large institutions such as pension funds and college endowments. The roster of external managers is constantly changing along with the composition of the portfolio, while various exotic investment strategies are on display.
In some instances, this sophistication generates excess returns. Harvard certainly has an impressive long-term track record to show for its efforts. But in many cases, complex investment strategies fall far short of simple ones. Below are two examples of massive funds that have lagged behind one of the simplest strategies available.
Ohio Public Employees Retirement System
The largest pension fund in Ohio covers more than 200,000 employees and manages close to $100 billion in assets. During the last 10 years, the fund has underperformed a hypothetical portfolio consisting of a 60 percent weighting to the S&P 500 SPDR (SPY) and 40 percent to the Barclays Capital U.S. Aggregate Bond Fund (AGG).
Put another way:
Ohio’s state pension fund would be better off today if it had fired its entire staff a decade ago, put its entire portfolio into a simple two ETF portfolio, and rebalanced once a year.
The obvious rebuttal here is that the 60/40 benchmark isn’t an appropriate point of comparison. But it doesn’t seem to be an excessively risky strategy that would explain the underperformance. OPERS lost almost 27 percent in 2008 when the hypothetical SPY-and-AGG portfolio would have been down about 20 percent, indicating that for at least that year, the pension fund was actually more aggressive.
OPERS has achieved this underwhelming performance at a significant dollar cost. In 2014 alone, the fund spent more than $350 million in fees to external managers. It spent another $26 million on commissions and paid its investment staff close to $15 million.
Many of the administrative fees — which totaled close to $75 million — wouldn’t go away if the strategy were simplified. This is, after all, a large pension fund serving hundreds of thousands of beneficiaries; there is certainly a significant staff needed to perform the core functions. But more than $400 million a year goes explicitly to pay for a strategy that underperforms a simple benchmark.
A 60/40 split between SPY and AGG would cost nine basis points annually. On an asset base of $92 billion, that works out to about $81 million.
University of Texas
The University of Texas maintains one of the largest endowments in the country, with more than $25 billion in assets. While the endowment has grown nicely over the past several years, the investment performance has been rather poor. The Texas portfolio gained about 5 percent annually during the seven-year period ended August 2014.
By comparison, SPY and AGG delivered annual returns of about 6.7 percent and 4.9 percent, respectively, over the same period. A simple 60 / 40 portfolio consisting of those two ETFs would have added 140 basis points in annual return to the Texas portfolio. Off the current asset base of about $25 billion, that translates into $350 million.
Put another way, every $1 billion invested by UT in August 2008 was worth about $1.41 billion in August 2014. Every $1 billion put into the hypothetical SPY-and-AGG portfolio was worth $1.54 billion.
Each year, investment fees reduce returns for the Texas endowment by 30 basis points or so. Applied to the asset base of about $25 billion, that implies $75 million or so in annual management fees — in order to underperform one of the simplest investment strategies available by about 1.4 percent annually. On top of that is a team of nearly 70 people and millions more in administrative fees.
That is a lot of money, going up in burnt orange smoke.
Disclosure: The author is an alumnus of the University of Notre Dame, whose football season opens against the University of Texas next week.