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Five Quotes from Financial History to Guide Trustees

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February 27, 2024, Investing in US financial history The publication of The Great Monetary Program of the United States concludes my exhaustive four-year effort to document the financial history of the United States. The book begins with Alexander Hamilton’s Great Monetary Program in 1790 and ends with post-COVID-19 inflation in 2023. With the promotion of the book drawing to a close, I am returning to my second passion: my work as an advisor to institutional investment plan fiduciaries.

This blog post is based on several chapters from my book and over 12 years of experience as an investment consultant. It is structured around five quotes related to trustees fulfilling their fiduciary duties.

If you serve as a trustee for an institutional investment plan, these citations may help guide you as you make decisions for the benefit of those who depend on your stewardship.

Quote 1: “A trustee may incur only those expenses that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the trustee’s skill…It is imprudent to waste the beneficiaries’ money.” Uniform Prudent Investor Act (1994)

The scarcest asset of fiduciaries is rarely present in the portfolios they manage. In fact, the scarcest asset is time. Trustees typically meet for a few hours every quarter and are forced to rely heavily on advice provided by investment consultants, professional staff, and asset managers. Over the past few decades, these advisors have encouraged trustees to add actively managed funds and expensive alternative asset classes.

The Uniform Prudent Investor Act (UPIA) requires fiduciaries to evaluate whether these incrementally higher costs are worth it, but few stop to think about their obligation to make such a judgment. Perhaps reciting this quote before every decision (especially one that will result in significantly higher fees) might be a cheap and powerful hedge against unintentional financial overspending.

Quote 2: “In many cases (unfortunately), the conclusions can only be justified by assuming that the laws of arithmetic are suspended in favor of those who choose to pursue careers in active management.” — Nobel Prize winner William Sharpe (1991)

Investment consultants and investment staff often recommend the heavy use of active management without considering the overwhelming evidence that active management is highly unlikely to add value. Skeptics of this approach need only look at the outperformance of active management. Nevada Public Employees Retirement System (PERS) To validate their concerns.

Nevada PERS employs only two staff members and allocates about 85% of its portfolio to index funds, yet its 10-, 15-, and 20-year returns exceed those of about 90% of public pension plans with more than $1 billion in assets.When presented with such exceptional results, consultants and staff may deny the reality of the basic mathematical principles underlying them or claim that they are anomalies.

Meanwhile, trustees often accept such explanations at face value, even though the claims are rarely backed up by a credible track record. A good rule of thumb is that if a consultant or staff member cannot convincingly demonstrate why they are uniquely capable of picking the best fund managers repeatedly and consistently over the coming decades, the most prudent course of action is to assume that they are not.

Quote 3: “You don’t want to be average. It’s worthless and serves no purpose. In fact, average is lower than the market. The question is, ‘How do I get to the first quartile?’ If you can’t do that, it doesn’t matter what the optimizer says about your asset allocation.” Alan S. Buffard, former Treasurer, Massachusetts Institute of Technology (2008)

the year of 2000, David SwensenFormer CIO of the Yale University Investment Office Pioneering Portfolio Management. The book details many of the techniques he used to generate profits far exceeding those of his peers.

The keys to Yale’s success were a highly accomplished CIO, stable, prudent governance, and a unique learning culture that allowed team members to replicate Swensen’s talents. Investing in US financial history The title is “Pioneering Human Resource Management.”

Using this rare ecosystem, Yale has repeatedly selected the best fund managers, focusing on alternative asset classes such as venture capital, buyout funds and absolute return funds. Pioneering Portfolio ManagementRather than concluding that the Yale ecosystem was incredibly rare and difficult to replicate, investment staff, consultants, and OCIOs mistakenly assumed that access to alternative asset classes alone would ensure Yale-like returns.

The problem with this assumption is that it was established even 15 years ago that Yale’s returns depend on the consistent and sustainable selection of top quartile fund managers. Without an ecosystem like Yale’s, this feat is nearly impossible to achieve in the risky and expensive realm of alternative asset classes, and failure to generate top quartile returns will produce mediocre results or even worse.

So before establishing or continuing an allocation to alternative asset classes, fiduciaries should ask themselves whether they or their advisors are Yale-capable. In most cases, the honest answer is no.

Quote 4: “Either a passive strategy that wins most of the time, or a very active strategy that beats the market. For almost every institution and every individual, the simple approach is best.” – David Swensen, former CIO of the Yale University Office of Investments (2012)

No one understands better than Swensen how difficult it is to outperform highly efficient markets and dangerously opaque alternative asset classes, which is why he concludes that nearly all institutional and individual investors would do better long-term by investing entirely in low-cost index funds.

Unfortunately, the main reason this message never reaches board or investment committee meetings is because those who advise fiduciaries are constantly plagued by a deep-seated fear that it will make them obsolete.One of the greatest tragedies is that the opposite is true.

If advisors could let go of the hopes and dreams that they are part of the tiny minority of investment professionals who can outwit the market’s ruthless efficiency, they could refocus trustees’ valuable time on addressing real, often-ignored financial challenges.

Quote 5: “Nothing weakens your financial judgment more than seeing your neighbors get rich.” —J. Pierpont Morgan, financier

Trustees are often hesitant to change their portfolios to differ significantly from their peers, and even those who subscribe to the belief that low-cost index funds are the wisest approach often succumb to fears that peers will underperform in the short term.

One of the great ironies of financial history is that trust companies often view large allocations to low-cost index funds as a risky proposition, when in fact quite the opposite is true. At the root of this misconception is an old adage uttered by a great Gilded Age financier: J. Pierpont MorganOvercoming the instinctive jealousy that comes from seeing one’s neighbors get rich is an emotional obstacle that trustees must overcome if they want to be wise stewards of capital.

We hope these quotations will guide future decisions of fiduciaries in whom taxpayers and beneficiaries place their trust. Acquiring these principles requires no monetary expense and little investment of a fiduciary’s most valuable asset: time. But applying these principles repeatedly and with confidence can help fiduciaries reduce costs, minimize unnecessary complexity in their portfolios, and reallocate time to solving previously ignored financial challenges. In so doing, fiduciaries can move further down the path to fulfilling their fiduciary responsibilities.

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