A 7% real investment return over the long-term is in my opinion, highly aggressive. World real GDP growth from 1960 through 2019 is 3.5%. Since the proposed fund expects to invest over “centuries or millennia,” any growth rate faster than GDP eventually takes over the world. Piketty’s r > g can’t work if wealth remains concentrated in a fund with no regular distributions.
Even in the shorter run, it’s unrealistic to expect the fund to implement a leveraged equity-only strategy (or analogous VC strategy):
1) A leveraged approach may not survive (e.g. will experience −100% returns). Even if the chance is small over a given year, this will be increasingly likely over a longer horizon. Dynamic leverage strategies can be implemented to reduce this risk but this likely reduce returns too.
2) A high-risk strategy will result in extremely painful drawdowns. In bad times, any fiduciary running the fund will face enormous pressure to shift to a more conservative strategy. During the Great Depression, US equities declined by nearly 90% during the course of just 3 years, even without leverage. Sticking to the same approach in the face of a potentially worse decline is nearly unimaginable.
Indeed, the proposed fund may actually have to be quite conservative for it to survive over time (through broad diversification even into low-return assets) and be accepted by the world (to avoid scrutiny or excess taxation). In my opinion, when investing over centuries with an unprecedented strategy, I would characterize a 2-4% real return (broad asset class diversification that keeps up with world GDP) as reasonable, and a 5%+ real return (all equity with or without leverage) as aggressive.
I agree risks of expropriation and costs of market impact rise as a fund gets large relative to reference classes like foundation assets (eliciting regulatory reaction) let alone global market capitalization. However, each year a fund gets to reassess conditions and adjust its behavior in light of those changing parameters, i.e. growing fast while this is all things considered attractive, and upping spending/reducing exposure as the threat of expropriation rises. And there is room for funds to grow manyfold over a long time before even becoming as large as the Bill and Melinda Gates Foundation, let alone being a significant portion of global markets. A pool of $100B, far larger than current EA financial assets, invested in broad indexes and borrowing with margin loans or foundation bonds would not importantly change global equity valuations or interest rates.
Regarding extreme drawdowns, they are the flipside of increased gains, so are a question of whether investors have the courage of their convictions regarding the altruistic returns curve for funds to set risk-aversion. Historically, Kelly criterion leverage on a high-Sharpe portfolio could have provided some reassurance with being ahead of a standard portfolio over very long time periods, even with great local swings.
A 7% real investment return over the long-term is in my opinion, highly aggressive. World real GDP growth from 1960 through 2019 is 3.5%. Since the proposed fund expects to invest over “centuries or millennia,” any growth rate faster than GDP eventually takes over the world. Piketty’s r > g can’t work if wealth remains concentrated in a fund with no regular distributions.
Even in the shorter run, it’s unrealistic to expect the fund to implement a leveraged equity-only strategy (or analogous VC strategy):
1) A leveraged approach may not survive (e.g. will experience −100% returns). Even if the chance is small over a given year, this will be increasingly likely over a longer horizon. Dynamic leverage strategies can be implemented to reduce this risk but this likely reduce returns too.
2) A high-risk strategy will result in extremely painful drawdowns. In bad times, any fiduciary running the fund will face enormous pressure to shift to a more conservative strategy. During the Great Depression, US equities declined by nearly 90% during the course of just 3 years, even without leverage. Sticking to the same approach in the face of a potentially worse decline is nearly unimaginable.
3) A consistently leveraged portfolio approach has never been done before over long investment periods. Foundation/university endowments are probably in the most analogous position and few apply leverage. Harvard tried a modest 5% leverage during the 2000’s, and it blew up during the Financial Crisis.
4) Any successful strategy will be mimicked and thus face increasing competition and declining returns. If the fund grows to any significant size, it will start facing competition from itself. For example, Yale’s legendary endowment has seen declining returns from a ~9.5% real rate over the past 20 years to a ~5.5% one over the past decade. Similarly, given Berkshire Hathaway’s large size, it’s now increasingly difficult for Warren Buffet to beat the stock market.
Indeed, the proposed fund may actually have to be quite conservative for it to survive over time (through broad diversification even into low-return assets) and be accepted by the world (to avoid scrutiny or excess taxation). In my opinion, when investing over centuries with an unprecedented strategy, I would characterize a 2-4% real return (broad asset class diversification that keeps up with world GDP) as reasonable, and a 5%+ real return (all equity with or without leverage) as aggressive.
I agree risks of expropriation and costs of market impact rise as a fund gets large relative to reference classes like foundation assets (eliciting regulatory reaction) let alone global market capitalization. However, each year a fund gets to reassess conditions and adjust its behavior in light of those changing parameters, i.e. growing fast while this is all things considered attractive, and upping spending/reducing exposure as the threat of expropriation rises. And there is room for funds to grow manyfold over a long time before even becoming as large as the Bill and Melinda Gates Foundation, let alone being a significant portion of global markets. A pool of $100B, far larger than current EA financial assets, invested in broad indexes and borrowing with margin loans or foundation bonds would not importantly change global equity valuations or interest rates.
Regarding extreme drawdowns, they are the flipside of increased gains, so are a question of whether investors have the courage of their convictions regarding the altruistic returns curve for funds to set risk-aversion. Historically, Kelly criterion leverage on a high-Sharpe portfolio could have provided some reassurance with being ahead of a standard portfolio over very long time periods, even with great local swings.