Archives for September 2008

The last book I reviewed was Financial Armageddon. Then I saw the title of this book: When Markets Collide. I almost stopped right there, as I was not at all in the mood for yet more doomsday talk.

However, I saw that the author, Mohamed El-Erian, ran the Harvard University Endowment for nearly two years, and is now the co-CEO of the huge bond investment company PIMCO. Throw in the fact that the tagline of this book is “Investment Strategies for the Age of Global Economic Change”, and perhaps this would be an insightful book about investing like David Swensen’s Unconventional Success. (Swensen ran the Yale University Endowment.)

Ease of Reading / Target Audience
The first I noticed about this book was that it was very difficult to read. The author tried to write this book for both experienced economic policymakers and the average investor. Not an easy feat. I felt that he came off as one of those guys who is just “too smart” and can’t simplify things for the rest of us. Here is an example of this high-level writing from the book:

The challenge of how to deal with consequential and volatile endogenous liquidity relates to another policy issue that I will discuss in Chapter 7: how to refine the traditional instruments of monetary control and ensure more meaningful and sophisticated supervision on a range of activities, with volatile leverage, that have been enabled by the ongoing structural transformations and yet are outside meaningful oversight.

Quick Summary: My Interpretation
The relationships between the economies of the world are changing. Emerging markets, which used to either be debtor nations or those who would only buy the safest thing available (US Treasuries), are growing fast and will start to invest their considerable wealth elsewhere, including equities. The U.S. can’t rely on other countries to buy our debt forever, just as the other countries can’t rely on U.S. consumers to prop up the world’s economy. This is where the “markets collide”. Throw in complicated structured investments like derivatives which nobody perfectly understands, and we are only in the beginning of a very bumpy road ahead.

Model Asset Allocation
So what is a U.S.-based individual investor to do? El-Erian states the three basic steps of portfolio management are: “choosing the right asset allocation, finding the best implementation vehicles, and conducting risk management.” Accordingly, here is his model asset allocation, with midrange percentages.

Equities (49% total)
15% United States
15% Other advanced economies
12% Emerging economies
7% Private

Bonds (14% total)
5% U.S.
9% International

Real Assets (27% total)
6% Real estate
11% Commodities
5% Inflation protected bonds
5% Infrastructure

Special Opportunities
8%

This adds up to 98%, but the way I read the book, the rest should be in cash. As a comparison, here is the asset allocation from Unconventional Success.

El-Erian doesn’t like home-bias and is believes strongly in being “globally-diversified”. You can see that only about 1/3rd of the equity allocation is to U.S. stocks. If an investor does have access to private equity, then you can redistribute that back into the other equities. In my opinion, he cops out in the active manager vs. passive index debate. He simply states that it’s really hard to find a good active manager, but if you can you should go with them. Of course, no further hints are given. 😛

As for bonds, he believes that bonds are overall a good portfolio diversifier to manage volatility. He also advocates a big portion of international bonds, which he believes are mature enough to be considered right beside domestic bonds. (He was also was an emerging bonds analyst for many years.)

Inflation is another big concern due to huge global growth, and thus there is a sizable allocation to real assets – commodities, real estate, inflation-protected bonds, and infrastructure (publicly traded equity and debt securities of utilities, airports, ports, roads, hospitals, etc.). Special Opportunities could mean speculative plays such as distressed debt or long-term environmental gambles like carbon credits.

In general, this is pretty different mix from many other model asset allocations I’ve read about.

Summary
When Markets Collide is mainly a macro-economics book as opposed to a how-to-invest book, but it does give some interesting insights about the future that might influence my personal investing strategies. For example, I agree that activities from non-U.S. countries will be increasingly important and their equities should be a significant part of one’s portfolio. I am not so sure (or educated) about the rest. I could only give a very superficial review here, so if this perspective sounds interesting and you want more details than I have given, I would read the book. If futuristic projections aren’t your thing, then I’d probably skip it.