While technology hasn’t exactly leveled the playing field between regular-Joe investors and ultrahigh net worth and institutional investors, it has shown all the little people where the playing field is.
Just look online and you’ll see that we may all be in the same ballpark, but we’re playing different games entirely.
However, individual investors have at their disposal many of the same strategies and investments available to the richest institutional investors in the world.
In many ways, individual investors can try to emulate the basic asset allocation strategies followed by the heavyweights.
But should they?
Institutional investors — those that run big pension funds or endowments — have many advantages over individual investors. They have billions of dollars to invest, plus an unlimited investing time horizon. Those two factors put them in a different league.
Certainty of expenses
Pension funds know their cash flows with greater certainty than individuals.
“Typically, they might be required to spend 4 percent a year or have a target of a certain amount of dollars,” says Larry Swedroe, lead director at Buckingham Family of Financial Services in St. Louis.
For example, pension funds pay out health care and pension benefits to retirees through their lifetimes. Actuaries determine how big these funds have to be to meet their ongoing and future obligations.
“None of us on the planet are able to plan with that kind of certainty. We have liquidity needs,” says Swedroe, author of “The Only Guide to Alternative Investments You’ll Ever Need.”
Long time horizon, lots of money
Because of their long time horizon, pension plans can put lots of money into extremely illiquid investments such as private equity and timberlands — things that might not pay off for 10 or 20 years.
And then there is the influence that comes with having more money than the GDP of some small countries. Besides having access to some esoteric alternative asset classes, pension funds can buy into the top-level performers in those areas.
The alternative asset category comprises a broad swath of nontraditional investments, such as currencies and futures; real assets like farmland and commercial real estate; precious metals and other commodities; and private equity.
Access to private equity
A major component of institutions’ strategies is investment in private equity, which means equity that is not publicly traded.
The term covers many different styles of investing into private enterprises, including venture capital, leveraged buyouts, mezzanine capital or debt.
In general, it is a realm of investments that is not accessible to individual investors due to sky-high minimum investments and the long time that the money is invested.
Usually, though, only a fraction of a pension fund’s total portfolio is devoted to private equity investments.
“The average over-$1-billion-in-assets endowment puts about 13 percent in private equity,” says Albert Chu, chief investment officer for WealthStone in Columbus, Ohio. Most of the minimums to get into a private equity fund start around $500,000. The typical investor would have to be extremely affluent to have the correct mix.
As examples, let’s look at the private equity holdings of two gigantic public pension funds in California. As of Dec. 31, 2014, California Public Employees’ Retirement System, or CalPERS, the largest pension fund in the U.S., manages $295.8 billion, with about 10.3 percent of that allocated to private equity. Another behemoth, the California State Teachers’ Retirement System, or CalSTRS, runs about $190.8 billion as of February 2015, with a 10.4 percent allocation.
Even if individuals were able and inclined to invest in private equity, they probably shouldn’t. Only the cream of the crop really pays off.
“Private equity is an institutional game and all the outperformance is created by the top 20 percent of funds,” says Mebane T. Faber, author “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.”
While those kinds of strategies will only be available to accredited investors, or investors with investable assets of at least $1 million, individuals can still mimic the style of pension or endowment fund investing.
What individuals can do
Some experts believe individual investors can benefit by following these strategies:
- Follow a broad asset allocation strategy based on your own investment objectives and risk tolerance.
- Consider passive investing.
- Write an investing plan, follow it and rebalance your investments.
Asset allocation strategies
If you follow a broad asset allocation strategy using noncorrelating asset classes, you’re emulating exactly what institutional investors do. Rather than investing in only one type of mutual fund — for instance, large-cap value — investors should spread their investing dollars over all domestic market capitalizations to decrease the volatility in their portfolio.
“The big endowments have been the best investors over the past quarter century,” says Faber.
“That means very broad diversification not just focusing on domestic assets but foreign assets, and of course paying as little for investment management as possible.”
Consider passive investing
Pension funds, in particular, focus on passive investing strategies. For instance, a large portion of CalPERS’ allocation to equity is spread over passive investments, such as index funds or ETFs.
“Today, only maybe 15 percent of individuals adopt passive investing versus about 40 percent of institutional money,” says Swedroe.
Individuals looking to save money on fees and expenses might consider putting the bulk of their money into a range of index funds comprising separate asset classes rather than paying for actively managed mutual funds.
“The fees investors are paying can easily erode a third to half of their account over time,” says Mitch Tuchman, CEO of MarketRiders, an online investment services company. “If you understand what indexing is and you understand how to put together a portfolio and take away the expense of trying to beat the market, anyone can manage their own portfolio and do that at very low cost.”
Risk is that uncertainty that investors must deal with to get potentially higher rewards. Diversifying your portfolio lowers risk. Rather than putting everything into one technology stock, investing in a technology sector fund will provide the same possible returns without the inherent risk.
“My line is that in a sea of uncertainty, diversification is the safest port,” says Swedroe.
“Markets don’t reward you for higher expected returns for owning a single stock. That is more akin to speculating than investing. Instead of owning one or two stocks, you’re better off owning 8,000 stocks,” he says.
Plan and follow through
Pension funds and endowments also follow an investing plan and rebalance their allocations when their portfolios veer from their target percentage.
“Yale rebalances part of its allocation every day,” says Tuchman of MarketRiders.
Arriving at the exact asset allocation for your portfolio will take some soul searching and investigation into the various asset classes. The process involves assessing your objectives and risk tolerance.
Research and write an investment plan and then stick to it for the long term.
“That is one thing institutional investors are very good at — they don’t let their emotions get in the way. They don’t panic and sell in bear markets,” says Swedroe.
Selling low is a losing strategy, but institutional investors do the reverse by selling asset classes that have done well to move back to their target allocation.
Investors who come up with a solid plan and adhere to it are almost always better off in the long run than those who experiment among various strategies.
“Why do people begin investing without an investment plan? They need to identify their goals and risk tolerance and write up an asset allocation plan and establish what their minimum and maximum targets are for each asset class,” Swedroe says.
The most important distinction between the professionals and everyone else is that they have the ability to shut off their emotions and invest only with their brains.
If individuals want to emulate the big guys, divorcing the emotional issues from their money — prudently — will help them realize the same investing success.