The Wrong Way To Evaluate Performance
The CFA Institute posted a blog by Issac Presley about The Harvard Crimson, Harvard University’s student newspaper, which ran an editorial last month excoriating the university’s management of its endowment fund. To quote from the Crimson: “Harvard Management Company announced a $2 billion loss for fiscal year 2016. Let’s not mince words: this is unacceptable.” After ruminating about the importance of endowment growth, the editorial went on to add a helpful suggestion: “We also recognize that we are not investment advisors. College students have no business telling seasoned analysts and managers where to invest the endowment. Instead, we wish to urge the administration to prioritize endowment performance before Harvard falls further behind peer institutions.”
What’s wrong with this viewpoint? Basically it suffers from the implied premises that (1) short-term negative investment performance can somehow be avoided and (2) the most important measure of investment success is how well you’re doing relative to someone else.
Let’s address the latter first. Imagine you’re having a casual over-the-fence conversation with your neighbor. He gloats over the fact that he made 30% on his investment portfolio this year by putting it all into Apple stock. You’re standing there thinking that your portfolio only returned 5%. How would that make you feel? It’s natural to experience pangs of jealousy when someone else is doing better than you are, but what difference should it make to you how well (or poorly) your neighbor is doing with his investments? You should be investing for the purpose of growing your savings enough to fund everything you want to do for the rest of your life. That has nothing to do with your neighbor. For all you know he may be about to go bankrupt. The student journalists would have done better by researching the possible impact (if any) such an endowment loss might have on the university’s future goals, not on how well their investments performed relative to Yale or Princeton.
Which brings us to the first premise, namely that a yearly loss of some amount is “unacceptable.” It is not only acceptable, it is inevitable. Investing your money means putting it at (calculated) risk in order to grow it sufficiently for your needs. It is a fact that the more return you try to get, the more risk you have to take. If “prioritizing” performance, as the editors urge, means to stop the losses, then the only thing the university can do is reduce the level of risk and concomitant return. I could just imagine the headline next year: “Harvard Endowment Gains Only $500 Million.”
By investing his entire portfolio in Apple stock, your neighbor is gambling on that one firm to continue to enjoy its phenomenal success despite the increasing number and strength of its competitors. That’s taking on a lot of risk for a lot of gain. I can almost guarantee that he will suffer numerous future short-term losses regardless of how well Apple thrives as a company. You’ll know when the bad years arrive because he’ll avoid talking to you over the fence. And no company is immune to short-term losses. Take Walt Disney Co., one of the most successful stocks in history with a 128,000% return over 60 years. As I wrote in a previous post, despite its long-term success, during 30 of those 60 years the company’s stock price lost more than 20% of its value. If Harvard had invested in Disney, imagine how the Crimson editors might have reacted during those years!
It’s also helpful to put the loss in perspective. According to U.S. News, in 2015 Harvard’s endowment totaled $37.6 billion. A loss of two billion dollars therefore represents a return of minus 5.3%. Not good but a far cry from the 37% the S&P 500 lost in 2008. If the editors remain fixated on comparing Harvard’s performance with its peers, they should at least – given the size differences of the various endowments – measure performance in relative terms.
In short, investment performance is not something you can control directly. Your long-term investment success will be dictated by how well you manage the risk, cost, and taxation of your investment portfolio. And the strategy you follow should be designed to support your future, not anyone else’s.