What Buffett Would Say About Harvard’s Portfolio

Investing guru Warren Buffett doesn’t think much of diversification . In his view, it’s for investors who don’t really know what they’re doing. Those who do can actually lessen risk by betting big on a few investments they thoroughly understand, Buffett asserts, and will earn the greatest returns in the long run.

Harvard Management, which oversees Harvard University’s $27 billion endowment, has apparently taken that advice to heart. Based on its latest disclosure of U.S.-listed equity holdings to the SEC, Harvard prefers to invest internationally and allocates about 90% of its stock purchases to foreign countries, mainly emerging markets.

Of course, the disclosure filing only reveals investments worth 5% of the endowment‘s total value, about $1.5 billion as of September 30th. So we’re just getting a small taste of Harvard’s overall investment strategy. But if the filing’s any indication, Harvard thinks emerging markets are the way to go. [Click here to have a look]

The top five holdings in the disclosure filing make up more than half the $1.5 billion portfolio, and all are large bets on emerging markets, as the table below shows. The top 10 account for 67%, and all but two — Pebblebrook Hotel Trust (NYSE: PEB) and NewAlliance Bancshares (NYSE: NAL) — are in emerging markets.

Such a strategy is easy to justify. Developing countries like the ones in Harvard’s top-10 list have much faster-growing economies than the United States and other developed nations — a trend that’s likely to continue.

Next year, for example, economists expect GDP growth in China, South Africa, Brazil, South Korea and Mexico of +9%, +7%, +4.6%, +3.9%, and +3.6%, respectively, compared with +2.8% for the United States and +1.3% for Western Europe. Plus, many developing countries are in much better financial shape than the United States and Europe right now, making their superior economic growth more apt to persist well into the future.

Such growth has translated to mouth-watering long-term investment returns. Harvard’s top two holdings — IShares MSCI Brazil (NYSE: EWZ) and IShares FTSE/Xinhua China (NYSE: FXI) — provide excellent examples of that.

The former is an exchange-traded fund (ETF) that closely tracks Brazil’s benchmark Bovespa Index, which is tilted heavily toward commodities. As of October 31st, the fund’s three largest sector weightings were materials (27%), energy (27%) and financials (19%). Its top holdings at that time included names like Petroleo Brasileiro (NYSE: PBR), Itau Unibanco (NYSE: ITUB) and OGX Petroleo (OTC: OGXPF). The fund is up +4% this year compared with more than +9% for the S&P 500. But its five and 10-year average annual returns are +22% and +21%, compared with only +1% and 0% for the S&P.
The China ETF in Harvard’s portfolio, up +7% year-to-date, has also handily beaten the S&P over time, posting an average return of +19% a year for the past five years. The fund’s only been around since 2005, so it doesn’t have a 10-year record.

It outperformed by mirroring the FTSE/Xinhua China 25 index of the 25 largest Chinese stocks. Like the index, the fund had half its assets in financials as of October 31st. At that time, its two other biggest sector weightings were telecoms (20%) and energy (14%), and its top holdings included China Mobile (NYSE: CHL), Bank of China (OTC: BACHF) and PetroChina (NYSE: PTR).

The two domestic stocks in Harvard’s top 10 are odd selections. Pebblebrook, a new small-cap real estate investment trust (REIT) that acquires upscale coastal hotels, only has an 11-month trading history, 10 employees and no analyst coverage. Small-cap banking firm NewAlliance is a more fathomable pick. It has at least some analyst coverage and a five-year trading history. But I can’t find anything to suggest that either company is a candidate for overweighting.

Action to Take –> I applaud Harvard for having the conviction to bet big like Buffett, but I wouldn’t rush to replicate the investment strategy in this portion of its endowment. Though gusty, the strategy pretty much ignores another Buffett mantra: “Believe in America.”

That mantra is especially relevant now. There are currently many high-quality, attractively valued domestic stocks every bit as capable as emerging markets of generating high-powered returns. And they can do it with substantially less currency, political and other types of risk associated with emerging markets.

For the emerging markets fanatic, I’d therefore suggest allocating more like 40% to 60% of equities to emerging markets funds and reserving at least 40% for individual U.S. stocks. That way, you can make bold, profitable bets both here and abroad.

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