Wise Money: Using the Endowment Investment Approach to Minimize Volatility and Increase Control (McGraw-Hill, 2012) by Daniel Wildermuth covers a lot of familiar ground. Think back, for instance, to Meb Faber’s The Ivy Portfolio (2009). But I suppose it’s worth going over this ground again.
Wildermuth, the founder and CEO of Kalos Capital and Kalos Management, describes “how the smart money invests”: in domestic and international equities, real assets, private equity, absolute return funds, and fixed income. His discussion of asset allocation is particularly apt for the high net worth individual, but investors with smaller portfolios can make the appropriate adjustments and still mimic the endowments.
One point that Wildermuth stresses and that, I think, merits some space here is the illiquidity advantage. “Liquid investments usually cost more and are worth more than similar illiquid investments because nearly all investors value liquidity.” But liquidity “introduces volatility, which most investors try to avoid. Nearly any asset that can be bought and sold on a daily basis prices according to current demand. Since demand for liquid investments can change markedly and quickly, prices can as well.”
“Liquidity premiums can only be approximated and vary across time and asset classes. As an example, a real estate holding that transitions from an illiquid structure to a readily tradable stock has historically increased in value a bit more than 10 percent. With stocks, the premium is usually much greater, oftentimes approaching or even exceeding 100 percent.” (p. 38)
Wildermuth claims that “a very common mistake made by most investors is assuming that their entire portfolio must be liquid.” In fact, since most people have investment time horizons closer to decades than months, “a completely liquid portfolio is usually undesirable for most individuals. The reasons are simple. Performance and diversification possibilities are missed, and the flip side of liquidity for investments with strong return possibilities is virtually always volatility.” (p. 41)
The author suggests that “a significant percentage of a portfolio, possibly even up to 40 to 50 percent, may be prudently invested in assets that have limited or unpredictable liquidity.” (p. 50) Investors with, let’s say, a $500,000 portfolio simply don’t need a supersized emergency fund.
For those investors who are unfamiliar with the endowment model Wise Money provides a good introduction—nothing revolutionary but useful nonetheless.