Sunday, May 3, 2015

The Differences Between Endowment and Legacy Portfolios


As I have previously stated, I want to learn every single day. In the last four days I was in meetings with a university investment committee, portfolio managers at Wasatch Advisors and Berkshire Hathaway's annual shareholders’ gathering. In each meeting I learned a great deal about the many institutional applications of my Timespan Fund Portfolios, particularly the Endowment and Legacy Portfolios.  Each has its place. The real difference is that the Endowment Portfolio is designed to fulfill the funding needs during the account-holder’s lifetime, while the grantors of the Legacy Portfolios are looking way beyond their own lifetimes, possibly for multiple generations.

Investment Committee tenures might determine policies

During this period of extraordinary low interest rates and its heightened demand for high quality, non-correlated bonds of lengthy maturities, an intense discussion as to the opportunity to issue long-term bonds is occurring. Some see this as a lost opportunity to issue a large amount of bonds with maturities of up to125 years to match the demographic changes expected, especially the growth in longevity recognized by leading life insurance companies.  

The case for a larger and lengthier bond issue is akin to a legacy portfolio designed to provide strategic capital for yet unidentified  needs. Having survived and prospered from the 2008 crisis in the financial community, I was appreciative of the value of  rapidly deployable large amounts of excess capital. The very fast acquisitions of Bear Stearns and Merrill Lynch are two headline examples of the swift use of strategic capital. A week or so before the expedited closing of these deals by JP Morgan Chase and Bank of America neither bank had an idea that such an opportunity might soon exist. This development  has not yet happened in the academic and scientific communities, but based on some present terms I don't rule it out. (One of my concerns about the future structure of the financial community is that due to the various capital constraints placed on large financial institutions there has been a shrinkage of truly excess capital that can be mobilized in crisis/opportunities.)

The bottom line for those of us who deal with the financial construction for various organizations: it is important to take into consideration the weighted
average tenure of the political leaders.

My other two days were spent with investments that could play a role in Legacy Portfolios.

A Visit to Salt Lake City

Please do not take the following discussion as a recommendation to purchase any Wasatch mutual fund, which should only be considered in the light of your account and what else you own.

Most of Wasatch Advisors funds can be grouped into small market capitalization stock, domestically-oriented funds and similar funds invested in international, emerging, and frontier stock funds. The focus of my visit to this group of fundamentally driven portfolio managers and analysts was to determine whether these funds could be used in legacy-oriented portfolios.

One of the concerns in using small caps in a long-term Legacy Portfolio is the expected market declines; i.e., how much worse would these actively managed small cap funds do in market declines? To answer these concerns they measured the performance of the Wasatch Small Cap Core Growth Fund vs. the Russell 2000 Growth Index for the 100 worst performing days between 12/31/2012 and 3/31/2015. According to their data, in 92% of the worst days the fund performed better than the index. This finding suggests that there is not additional risk in using this fund for long periods which would be typical in legacy accounts.

The other attractive capability in the shop is in an actively managed Emerging Markets Select Fund. This 30-40 stock portfolio is managed flexibly with a bottoms-up approach where selectivity has produced better results than using sectors or country matrices. In general they invest primarily in companies providing goods and services to be consumed in the country or region produced. One of the guiding principles for my Legacy Portfolios is to invest in long lasting, positive to exploding trends beyond the current market cycle. On this basis, the
Emerging Markets Select Fund is one of the types of funds that should be found in a Legacy Portfolio.

The Institutionalization of Berkshire Hathaway

I also attended the annual meeting of Berkshire Hathaway*. In the always amusing and occasionally instructive Warren and Charlie Show, many of the answers to questions asked brought out the following comments by Mr. Buffett or Mr. Munger:

1.  They don't make acquisitions primarily due to macroeconomic factors, they intend to own the acquired companies for a hundred years. They are running the company by making decisions with a one hundred year outlook.

2.  They believe that corporate culture starts at the top; institutionalized integrity is what they are all about.

3.  Warren and Charlie are looking for Berkshire to be an institution that will live and grow well beyond their lives.

Berkshire Hathaway in portfolios

Berkshire could easily fit in both Endowment and Legacy Portfolios. For the Endowment Portfolio,  Berkshire has the potential to produce continuity and broad diversification based on the 80 separate businesses which it owns, an actively managed securities portfolio, and a new aggressively managed private equity partnership of substance.

From a Legacy Portfolio’s standpoint, the current management of Warren and Charlie are future-oriented, demonstrated by their ability to create a direct writing workmen’s compensation insurance company from scratch, major tax subsidized solar and wind based utility revenues, and increased investments that will benefit from the remarkable growth in China.  Berkshire Hathaway is building on to the long-term future.

* Shares of Berkshire Hathaway are owned in our Financial Services Fund and personally.

Question of the week: Do you have elements in your portfolio that would fit in either the Endowment or Legacy Portfolios, or possibly both?

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