Bob Maynard on The Challenges of Complex Investing
/While many institutional investors have flocked to alternative assets, few have been able to translate these allocations into successful performance. Allocating is easy, performing is hard.
Bob Maynard, CIO of the Idaho Public Employees Retirement System, illustrates the difficulty of executing on alternative strategies:
All of these additional areas add complexity and require time for Boards and staffs, and are often not worth the extra effort unless there is a clear organizational commitment or belief in a certain additional approach that can survive changing Boards and staffs over the years that may occur before the extra efforts pay off. One of the most valuable resources of an investment organization is not the assets in the portfolio, but the time required of the Board and staff. After the basics have been accomplished, additional investment efforts in more complex areas have to expressly trade off the requirement of additional resources and time compared to the often problematic longer-term return benefits.1
Bob Maynard has been the CIO of Idaho’s Public Employee Retirement System since 1992.2 He has overseen a remarkable comeback for the Idaho plan and advocates for a simple, boring approach to pension management.
While most investors gravitate to the promise of alpha and uncorrelated strategies, Maynard highlights the often-failed task of building the organizational support necessary to allow an alternatives allocation to succeed. Staff/board turnover and strategy ignorance destroys the ability of the investment team to build and sustain an alternatives portfolio. It’s easy when things go well. But when the markets turn, many organizations lack the fortitude and capability to manage through a down cycle, especially with illiquid, leveraged, and high-fee strategies.
Turnover breaks any continuity in investment strategies. New employees, board members, or consultants want to leave their mark on the plan and demand change. It’s an easy trap to fall into, as the pressure to jettison strategies recommended by the prior team is overwhelming. Sure, some strategies may need to go. But constant change creates the expectation to invest with a short time horizon. This lack of consistency makes it impossible to see through times of underperformance, which will happen eventually.
Time commitment is another issue. Allocations to complex strategies leave other strategies neglected. There’s only so much time in a day. Focusing on one thing means neglecting something else. There’s no way around it. You will miss opportunities the more time you allocate to complex strategies. This time cost is largely ignored because it’s not evident on any given day. We all believe we can do more in the future, so we add to our commitments, managers, and strategies. But over time, this lack of focus will flow through as subpar returns with higher risk. Investors treat time as one of the least precious resources – more responsibilities are added, with more effort needed in the attempt to “do it all.” But trying to do it all means doing nothing at all, since attention is scattered, and expertise is never fully developed.
Maynard shares a useful graphic called the Swenson J Curve. Maynard describes it below:
Dr. David Swensen, the CIO of Yale and godfather (or direct father) of the “Endowment Model”, in fact, cautions the vast majority of institutional and private investors NOT to attempt to reach for most of these extra returns because of the problems of insufficient resources, extra fees, transaction costs, and other barriers.1
Investors incrementally add complexity, not realizing the expanding complications inside their portfolio. Make a choice – take the simple route using traditional strategies or go all in with alternatives by adding the talent, resources, and attention to make it a complete effort. There is no room in the middle. Dabbling in any of the private asset classes isn’t going to work. Outsourcing isn’t the answer given the extra fees and propensity to chase what everyone else is doing.
Making the commitment doesn’t have to be instantaneous. People and resources can be added over time but there needs to be absolute buy-in from the team and board. Either you’ve 100% sold your team and board that you can invest in alternatives or you hold off until you secure that commitment. Anything less fuels hesitation, skepticism, and doubt. Every investment team must have compelling answers to the following questions: what is your edge? What can you do that is rarely done by others? What inefficiencies can you really find? What’s unique about your manager selection process? And so on… If any of these questions are answered with vague, generalized responses, it’s a no-go. “We want to invest with good managers” doesn’t cut it. You either need to be on the level of a David Swenson (or at least close) or not do it all. It’s hard for organizations to admit they can’t replicate what others have done.
Maynard emphasizes Swenson’s advice to pick one strategy – either simple or complex, but don’t choose something in-between. And if you choose complex, you better be good:
Dr. Swensen believes that simple conventional portfolios can perform quite well and successfully. He also believes that very complex “endowment portfolios”, if done extremely well, can outperform basic conventional investing. But, he cautions against the assumption that if one simply adds complexity a bit at a time, the performance will improve linearly. In fact, he asserts it is only the very, very excellent and well-resourced practitioners of endowment investing – the investing “1%” – that can actually do better: Few institutions and even fewer individuals exhibit the ability and commit the resources to produce risk-adjusted excess returns. … No middle ground exists. Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high quality active management decisions. The framework of the Yale model applies to only a small number of investors with the resources and temperament to pursue the grail of risk-adjusted excess returns.1
Maynard then advises:
Everyone else, including almost all professional institutional investment organizations, will do much worse for their entry into more complex investing, and that for that vast majority, the more complex the portfolio, the worse the result.1
Building and maintaining a simple investment strategy is much more difficult than it seems. Investment organizations get bored with traditional strategies (and are envious of other funds doing interesting strategies) and when combined with overconfident egos, end up seeking out complicated strategies. The challenge is not getting your organization to invest in alternatives, but to stay out of trouble by not getting caught up in strategies in which your team lacks the talent to execute or the organizational commitment to see it through to the end.
The problem isn’t building expertise, but actually admitting when the resources don’t exist to successfully execute a strategy. This is an essential Charlie Munger principle – understanding your circle of competence and not deviating from it.
It’s hard to admit you won’t be the next Yale, but you have to know you’re limits. It’s not fun conceding when everyone else is doing more and more. Successful leaders must be disciplined.
Remember, we don’t get paid to do exciting things. We get paid to deliver real returns to our beneficiaries.
Sources
1. Idaho Portfolio Narrative – 12-12-2020. https://www.persi.idaho.gov/docs/investments/Portfolio-Narratives-2020-12-12.pdf
2. https://www.ai-cio.com/news/veteran-series-bob-maynard-turned-persi-around/