A review of The Ivy Portfolio by Mebane T. Faber and Eric W. Richardson
April 6, 2009
A regular feature of this website is the monthly update on a simple market timing strategy with moving averages. Those updates have included a link to Mebane Faber's excellent article A Quantitative Approach to Tactical Asset Allocation, published by the Journal of Wealth Management, and available in PDF format here. Well, that article is no longer my top recommendation for market timing. That honor now belongs to Faber's new book, The Ivy Portfolio, written in collaboration with Eric Richardson.
The significance of the title is revealed in the post-colonic surge, How to Invest Like the Top Endowments and Avoid Bear Markets. Part one of the book's three-part structure gives an overview of the Yale and Harvard Endowments — how they originated, how they invest, and how an individual investor can incorporate some of their most effective techniques. In a section headed Implementing Your Portfolio, the authors identify three sample Ivy Portfolios utilizing ETFs: a simple portfolio of five ETFs and more complex alternatives with 10 and 20 ETFs.
These portfolios will be familiar to investors who've studied Modern Portfolio Theory (MPT), the approach to diversification that won Harry Markowitz the Nobel Prize in economics. The Ivy Portfolio departs somewhat from traditional implementations of MPT by including commodities as an asset class for 20% of the holdings.
Part two of the book consists of a chapter each on private equity and hedge funds. Both are seen, with perhaps an inference of hesitation, as optional supplements to an investment strategy.
The core of the book, and the reason it gets my "Top of the Class" designation, is Part Three, entitled Active Management. Here Faber's JWM article is expanded and supported with an impressive array of charts and tables. The use of market timing with monthly moving averages is introduced as a risk management strategy, Winning by Not Losing, a heading that surely must resonate with the buy-and-hold crowd. The book acknowledges the stigma attached to timing — one that has evolved alongside the "stocks for the long run" bias that dominated financial planning since the early 1980s.
The concise description of the timing strategy (aka The Quantitative System) with a 10-month simple moving average consists of two rules — one for buying and one for selling — expressed in fewer than two dozen words. The performance of the strategy from the end of 1971 through 2008 is then extensively illustrated with the five asset classes of the simple Ivy Portfolio defined in part one. We see the annualized return, volatility, Sharpe ratio (risk premium), and maximum drawdown for the timing strategy as compared to buy-and-hold for five indexes:
For those who aspire to an even more active investment strategy than following moving averages, the book includes Following the Smart Money, a chapter on the use of 13F filings of institutional fund managers to inform investment decisions.
The book concludes with a succinct chapter on developing a seven-step action plan for implementing your own Ivy Portfolio. I won't enumerate all the steps here. But I can't resist mentioning step 7: Enjoy Your Life.
Of the many books I've read on investment strategies over the past decade, I put this book at the top of the class.