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the same types of stocks, we keep those managers—we don’t fire for performance alone. As a result, we tend to have managers who have very clear styles, so it is easy to tell if they stray from the mandate. We have deep-value managers, for example, so if they pick Pets.com, you know something is wrong. Or our managers have concentrated portfolios. We tend to prefer those sorts of managers. JOI: Are there areas where index-based investing is not necessarily the way to go or isn’t appropriate? Maynard: It used to be that I had doubts about emerging markets and REITs because of the newness of the areas. Now, I think the markets are sufficiently mature, and we are starting to do index investing. But, clearly, bank loans, you can’t index. There are some niche markets pick the top quartile or top decile, it is worth it. I have no problem with people who go into that area if they are one of those types of funds who can’t handle market returns for one of two reasons—either because market returns are too volatile, or they need much-better-than-market returns. This traditional approach we use is fine as long as you can meet your liability with around 3 to 5 percent real returns above inflation. If your needs are significantly above that—if you are an endowment that has to make 8 percent real returns or you are so deep in the hole you’ve got to make 8 or 9 percent real returns—then picking the top-quartile active public equity manager doesn’t get you what you need, but picking the top-quartile or -decile hedge fund manager might. If you have to go into that market, you’d better be aware that the odds are 3-to-1 or 4-to-1 against you. We Hedge funds promise you equitylike returns with bondlike volatility. What they have given you is below-bond returns with equitylike volatility. I think everybody recognizes that the average institutional hedge fund or fund of funds isn’t worth it. where indexing is less appropriate, and I have concerns about index investing in some areas where you may be putting in a bias you don’t want if you index. For example, high-yield debt, you index according to market weightings. Or in emerging market debt, your assets will tend to go to those countries that are trying to borrow too much money. But other than that, for the big, major markets, U.S. large, mid and small; developed-market international; TIPS; REITs; emerging markets; general bond; the credit bond market; the government bond market—for all of those, I think index investing is fine. JOI: What sort of role do you see alternative investments playing in the PERSI portfolio? Maynard: We don’t see any role for those—I’m leaving out private real estate, private equity and the Idaho commercial mortgage program from that group. Those, oftentimes, are thrown into the alternative category. But we’re fine with some private equity. We’re fine with some private real estate. We’re fine with our local private commercial mortgage program. But beyond that, what is called the “hedge fund movement,” the letting 100 flowers bloom and diversifying into all these little areas like Sri Lankan distressed debt or whatever you like—that sort of stuff we don’t see a role for. A hedge fund from our standpoint is levered active management and very expensive. It’s doubling down on active management—and it hasn’t done its job. Hedge funds promise you equitylike returns with bondlike volatility. What they have given you is below-bond returns with equitylike volatility. I think everybody recognizes that the average institutional hedge fund or fund of funds isn’t worth it. What they say, though, is that if you don’t have to go there. We’re perfectly fine even with subpar market returns for a decade or two. But if we had to go there, if we had to make 8 percent real returns, then you’re in a different world. Then you’ve got to go into hedge funds and heavily into alternatives or do leveraged strategies, like risk parity. JOI: Do you use ETFs at all? Maynard: We have our passive index fund that’s cheaper than a Russell 3000 ETF because of our size, so there is no reason to use ETFs. Within our passive index funds, sometimes as money goes in or out, we may want an Indian exposure or a U.K. exposure. An ETF may be the cheapest way to do it temporarily, while we rebalance monies in and out, and our passive managers can use them. We just did a transition where we allowed the transition manager, in order to keep our exposure in the market, to buy ETFs. As a marginal, transactional tool, sure. But as a base exposure, we can get that exposure cheaper directly. JOI: How much of a concern is the fact that the markets are more volatile? Maynard: Recently, for the last year, markets have been extremely well-behaved; in fact, much less volatile than normal. What we saw in the last decade or two is actually what was predicted for annual volatility. Even 2008-2009, that was maybe a two-standard deviation when looked at on a monthly or a yearly basis. People were fooled by how calm the ’90s were, leading them to say that’s normal volatility. What we’ve seen in the last 20 years is actually fairly well within the range of what was expected. Remember, our numbers that we 24 March / April 2013
www.journalofindexes.com have been basing modern portfolio theory on go back now to the Civil War. That includes all the stuff that happened in the late 1800s and the Great Depression. There’s this idea that modern portfolio theory and that the expectations of people when they put these numbers together were wildly off—but no, they were pretty much right on. In 1996—about the time Greenspan spoke about irrational exuberance—our estimated volatility of the funds back then was 12 percent annual standard deviation. The standard deviation of our funds, since 1996—through the supposedly most volatile time since the Great Depression—has been 11. If you could just not react on a day-to-day basis or a month-to-month basis, the annual volatility has been well within that predicted range, I think for pretty much everybody. But what happened is that people didn’t recognize what those numbers actually meant when they experienced them on a day-to-day basis or a month-to-month basis. Remember: Modern portfolio theory doesn’t work if you wake up in under five years. If you wake up once every five years, it works perfectly. JOI: What would induce you to make significant changes in the portfolio or your overall approach? Maynard: I’d have to be able to see someone implement an approach that is describable and repeatable. Most of my time is spent looking at new stuff coming in: We would make a change if there was an opening of a new, basic capital market—like when they opened up REITs and TIPS in the late ’90s—with a clear portfolio benefit. When TIPS were launched, they went from 3 up to 4.2 percent real yield. None of my bond managers would buy it because they were getting crushed by it, but in a portfolio like ours, it’s a beautiful instrument. And so we had to go in and put 10 percent of our portfolio into TIPS because our active bond managers weren’t doing it. It’s that sort of opening of a new capital market that has clear benefits and can be easily accessed that would cause us to change. We’re a fund that does basic equity or fixed-income investing with five or six special things that we think have clear, describable portfolio benefits. If they opened up a new capital market, that’s the type of thing we do—but we haven’t seen that this decade. The other part of this, too, is if you aren’t willing to put 5 to 10 percent of your total fund into it, it doesn’t make a difference on the risk level. It just doesn’t move the needle. Adding a lot of little things isn’t going to do it. JOI: Are there any particular asset classes that you see as driving returns or dragging them down in the future? Maynard: I’m not going to put my fund at risk because I have particular ideas. The way I manage is if I get a bright idea, I go to a dark room, lay down and wait for the feeling to pass. But for cocktail party conversation, I like the equity markets. People assume that this “new normal” means that equities won’t return what they have returned in the past in terms of real returns. I think they do. I think the equity markets are nicely set up to do so— I’m not talking “spectacular.” But the idea that equities can get you 5 to 7 percent real returns, like they have over the last 200 years, I think is fine. Bonds are likely to be dead money for a while, but you never rely on bonds to get you the returns anyway. They’re the Armageddon asset class. You’ve got to have something to rebalance from if everything else goes down, like in 2008-2009. They did their job just fine there. I think Europe probably is going to be fine as an equity investment, because we invest in companies; we don’t invest in countries. I think leveraged strategies could run into a period of difficulty, but I thought that last year, and last year they turned out to be the best strategies in the world. Why advertise in the Journal of Indexes? SERIOUS IDEAS FOR SERIOUS INVESTORS the bogle issue March / April 2012 defining alternatives May / June 2012 commodities beta? July / August 2012 big ideas September / October 2012 emerging emerging January / February 2013 The Economic Role Of The Investment Company John Bogle Managed Futures Strategies Jeremy Schwartz and Chris Jabara Commodities Sectors And The Business Cycle Geetesh Bhardwaj and Adam Dunsby Determining Market-Capitalization Breakpoints Andrew Clark The Next Emerging Markets Amy Schioldager and Heather Apperson The Bogle Impact: A Roundtable Featuring Gus Sauter, William Bernstein, Burton Malkiel, Don Phillips, Ted Aronson and more! Benchmarking Tail Risk Management Vineer Bhansali Commodities In A Portfolio Sal Gilbertie Index Variation And Portfolio Performance Craig Israelsen The Man Who Invented ‘BRIC’ Weighs In An Interview with Jim O’Neill Lessons From SPIVA Srikant Dash Indexed Approaches To Long/Short Investing Peter Little and Greg King Keeping Current With Commodities Featuring Jim Rogers, Victor Sperandeo, Shonda Warner, Jodie Gunzberg and more Sectors And Style Paul Baiocchi and Paul Britt Better Beta Robert Holderith The Case For Indexing Christopher Philips Market-Neutral Factor Investing Kishore Karunakaran Better Beta In Commodities Indexing Jonathan Guyer Dynamic Correlations Christopher Philips, David Walker and Francis Kinniry Jr. Exploring Emerging Market Debt Rick Harper and Bradley Krom Plus an excerpt from Bogle’s forthcoming book and an interview with the man himself, as well as thoughts on indexes and investing from Agather and Blitzer Plus an interview with Morgan Creek’s Yusko, thoughts on hedge fund indexes from Bruno & Whitelaw and columns by Vogelzang, Blitzer and Krein Plus Mulvey on managed commodities futures, Kaplan on capturing long/short strategies, and S&P’s Blitzer, DJI’s Krein & Prestbo ... and more! Plus an interview with John Prestbo, David Blitzer on the next big thing, Guido Giese on adding risk control to index methodologies, and more! Plus Blitzer on the ‘great moderation,’ WRS’ Johnson on pension fund management, S&P DJI’s Orzano and Banerjee on targeted approaches to EM, Russell’s Goodwin, JoI’s Bell ... and more! JOURNAL OF INDEXES ADVERTISING INFORMATION AT WWW.JOURNALOFINDEXES.COM/ADVERTISE IndexUniverse LLC, 353 Sacramento St., Suite 1520, San Francisco, CA 94111 • Advertising and Reprints Inquiries: 415.659.9004 www.journalofindexes.com March / April 2013 25
Page 1 and 2: Plus an interview with Robert Mayna
Page 3 and 4: www.journalofndexes.com Vol. 16 No.
Page 5 and 6: McGRAW-HILL You can never have too
Page 7 and 8: ©2013 Morningstar, Inc. All rights
Page 9 and 10: THE POWERSHARES DB COMMODITY INDEX
Page 11 and 12: InsideIndexing risk, return & inDex
Page 13 and 14: kets and currencies—as particular
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Page 19 and 20: Over 70 years ago, Benjamin Graham
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Page 23 and 24: the U.K.), but most of the other co
Page 25: JOI: But PERSI’s strategy does se
Page 29 and 30: Figure 1 Main Index Providers And R
Page 31 and 32: Figure 5 Five Key Issues With Equit
Page 33 and 34: Figure 8 Important Issues When Sele
Page 35 and 36: indexes that do not rely on a buy-a
Page 37 and 38: Figure 13 Relative Risk of Alternat
Page 39 and 40: For example, in a recent paper, we
Page 41 and 42: value of the Maximum Diversificatio
Page 43 and 44: Despite high t-statistics, statisti
Page 45 and 46: There is a growing body of research
Page 47 and 48: olling annual correlation to the re
Page 49 and 50: Interest rates go up. And down. And
Page 51 and 52: Figure 4 Impact Of Worst-Case Bond
Page 53 and 54: conference schedule the world’s b
Page 55 and 56: While the global financial crisis t
Page 57 and 58: [Kapadia & Szado, 2007] and reached
Page 59 and 60: tic, we found it prudent to test th
Page 61 and 62: Morningstar Index Funds U.S. Style
Page 63 and 64: Exchange-Traded Dow Jones U.S. Indu
Page 65 and 66: News continued from page 15 Malkiel
Page 67 and 68: ETF Analytics There are over 1,000

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