A Comparison of Retail and Institutional Investment Strategies
When it comes to investing, there are essentially two possible approaches available:
1. Retail – used by most individual investors utilizing the services of a retail brokerage firm, such as Merrill Lynch, Morgan Stanley, etc.
2. Institutional – methodology employed by virtually all large pension funds, trusts, and endowments.
Over the last fifty years, there have been many advances made in the investment arena. Most of these advances were the result of academic research. A brief history of these strides would include:
1950 - the conventional wisdom was that once you obtain competency, one should invest in three or four securities. Broad diversification was considered undesirable.
1952- Harry Markowitz (Nobel Prize in Economics, 1990) concluded that diversification reduces risk and that one should focus on the risk of the overall portfolio.
1964 – William Sharpe (Nobel Prize in Economics, 1990) developed the Single-Factor Asset Pricing Risk/Return Model, which is used for evaluating the risk and expected return of securities and portfolios.
1965 – Paul Samuelson (Nobel Prize in Economics, 1970) in his paper on the behavior of securities prices, concluded that market prices are the best estimates of value and that future stock prices are unpredictable.
1966 – Eugene Fama (Univ. of Chicago) based on extensive research on stock price patterns developed the “Efficient Markets Hypothesis”. He found that stock prices quickly change based on new information and that investors cannot identify superior stocks using fundamental information or price patterns.
1968 – Michael Jensen completed the first major study of mutual funds and concluded that investment professionals fail to outperform market indexes.
1990- Nobel Prize recognizes the economists who shaped the way that we invest. William Sharpe for the Capital Asset Pricing model and Harry Markowitz for the theory of portfolio choice.
1992 – Eugene Fama and Kenneth French develop the three-factor asset pricing model, an invaluable asset allocation and portfolio analysis tool. Revolutionizes the way we construct and analyze portfolios by identifying independent sources of risk and return.
The volume of academic research over the last fifty years is quite impressive. The institutional investors that manage the large, multi-million dollar pension plans have embraced these advances in the science of portfolio management. At the same time, most of these advances have been all but ignored by the brokerage firms that sell to the individual investor.
Some of the services that institutions expect and demand include:
1. An individually designed investment program tailored to their needs.
2. Objective advice focused on the best interests of the pension plan.
3. Full disclosure of any potential conflicts of interest.
4. Advisors that are experienced, professional, and competent.
5. A portfolio management strategy that is academically sound.
6. A consistent and disciplined execution of the agreed upon strategy.
7. Continuous supervision of each investment account.
8. Stringent cost control in order to achieve low cost, effective management.
9. Detailed reporting to include performance relative to benchmarks and consolidated tax reporting.
10. Responsive service and access to the principals that are making account decisions.
The large pension plans are managing multi-billion dollar portfolios based on the latest academic research available to them. At the same time, the retail investment industry continues to use the investment strategies that were the conventional wisdom of the 1950’s. Can you think of any other industry in the United States that is still based on the technology of the 1950’s? Which approach do you think the “smart money” is using?
The typical retail investor is trying to beat the market by investing in stocks that are recommended by the research department of the local brokerage firm. The ability of these research departments to pick winnings stocks has long been debatable and recently even their objectiveness has been completely indicted.
Retirement Planning Advisors is dedicated to bringing economical and effective institutional quality investment management services to middle-income families and retirement plans. Let us know if you’d like to learn more about our approach to portfolio management.
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