JEALOUSY IS a terrible thing—and often unjustified. Our apparently self-assured coworker may be racked by self-doubt. Our rich neighbor may be far less happy than we imagine. And those institutional investors, who can buy all kinds of exotic investments that we can only lust after, may be clocking returns that are notably unimpressive.
This last thought was driven home by Ben Carlson’s short, engaging new book, Organizational Alpha: How to Add Value in Institutional Asset Management. My only criticism is the title: Individual investors might imagine that Organizational Alpha isn’t for them—and yet it’s a great, insightful read, whether you have $1,000 to invest or $100 million. Organizational Alpha illustrates how too much meddling and too many supposedly sophisticated investments can drag down performance—and how investing is often best when it is simplest.
“The majority of institutional investors are constantly looking for ways to make things more complicated,” writes Carlson, who cites four reasons: It makes life more interesting, institutional investors think it’s their job to outperform the markets, they assume complex must be better, and they believe that sophistication will impress others.
Institutional investors often devote big chunks of their portfolios to hedge funds, private equity funds, venture capital funds and other alternative investments. But this is treacherous territory where diversification isn’t necessarily the answer. Carlson notes that, while a diversified stock portfolio can generate better returns with less risk, a diversified portfolio of alternative investments is often a recipe for mediocrity.
Take hedge funds. The best of these funds can overcome their hefty expenses and deliver dazzling results. Problem is, if you pick the wrong hedge funds, you could suffer steep losses. Nervous institutional investors respond by buying a broad array of hedge funds—and almost inevitably end up with lackluster results, as the bad funds offset the good. The upshot: Unless you have the confidence and insight needed to invest with a few great managers, you’re probably better off skipping hedge funds entirely.
“As a baseline assumption, most institutional investors have to realize that it’s difficult to beat a low-cost, low-turnover, long-term oriented approach to investing,” Carlson says. If that’s true for institutional investors, it’s doubly true for individuals. Index funds may not give you bragging rights at the neighborhood barbeque. But you’re probably the only person there who isn’t lying about their investment performance.