Sunday, April 30, 2006

Hunt for the Holy Asset Class

I’ve come across a number of interesting articles lately discussing historical asset class returns. Extrapolating past returns into future performance seems to be getting dangerously close to a new national pastime.

Along those lines, Bill Miller makes a few interesting observations in the most recent letter to investors. With many commodities reaching astronomical levels, pension fund consultants find that now must be the best time to get in. Indeed, J. Sainsbury, the British grocery chain, has decided to increase its allocation to commodities.

From the letter:

Last month, J Sainsbury, the U.K. supermarket chain, said it planned to invest about 5% of its 3.2 billion pound ($5.5 bn, euro 4.6 bn) fund in commodities ...

The article went on to note how this move is being driven by pension consultants armed with data showing how well commodities have performed, how over 50 years they have performed about as well as equities, and how this was part of a move to "find surer ways" to fund long-term obligations than by investing in mainstream equity indices, those surer ways consisting of "alternative assets" such as private equity, hedge funds, commodities, and so on. These alternative assets are judged surer mostly because they have done so well the past five years, just as venture capital was so judged in 1999 and 2000 because of its stellar past returns, leading to a flood of money and a collapse in returns.

It is not an accident that despite the consultants being armed with data going back 50 years about how adding commodities to a portfolio can improve risk-adjusted rates of return, there was zero interest among pension plans and investors generally in owning them until very recently. "Two years ago it would have been hard to find any funds investing in commodities," says Stephen Woodcock, investment consultant.

Last week I came across an article in the NYT where Ben Stein summarized why he wouldn't invest in hedge funds (click here for the article, though you have to pay for it). Poor performance.

Burton Malkiel authored the study that evaluated historical returns for hedge funds. What’s noteworthy is that convertible arbitrage had one of the highest sharpe ratios – and this is at a time when people can’t wait to get out of the asset class.