What is the Mebane Faber Ivy portfolio?
An Ivy League education is a highly regarded accomplishment that comes with the promise of a rewarding, often high-paying career and a deeper understanding of the world around you. Unfortunately, only a small percentage of students ever have the opportunity to experience these prestigious schools.
But what if you didn’t have to go to one of these high-end schools to follow an Ivy-level investment strategy?
Scholars who manage the Havard and Yale endowment funds, and other investment funds for these top-level schools, often share their portfolio strategies with the public. One of the most popular of these is known as the Ivy portfolio.
What Is the Ivy Portfolio?
The investment style was developed by Mebane T. Faber, the co-founder and chief investment officer of Cambria Investments. He’s also the portfolio manager behind the Yale and Harvard endowment funds and the famed co-author of “The Ivy Portfolio: How to Invest Like Top Endowments and Avoid Bear Markets,” a book he partnered with Eric W. Richardson to develop.
All told, Meb Faber is somewhat of a Wall Street celebrity.
Faber developed this portfolio with diversification and tactical asset allocation at heart, making it possible for the average investor to mimic the investment decisions made by some of the foremost stock market experts with nothing more than a few low-cost index funds and exchange-traded funds (ETFs).
One in a large class of so-called “lazy portfolios,” this investment strategy is relatively simple to set up and manage, reducing the time commitment involved in the investing process.
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Portfolio Asset Allocation
If you choose to follow this portfolio strategy, your investment dollars will be spread evenly over five key assets — a 20% allocation apiece — each designed to bring balance to the next. Here’s how assets in the portfolio are allocated:
- U.S. Stocks. There are tons of total stock market ETFs out there. The important thing is to make sure that the one you choose has diversified exposure to the entire United States stock market and offers a low expense ratio.
- International Stocks. The portfolio puts heavy emphasis on international investing. When choosing an international ETF, look for one that invests across a wide range of regions, assets, and market caps for the most diverse exposure.
- Intermediate Bonds. Intermediate bonds make up the entire fixed-income allocation within this portfolio. Due to a relatively low allocation to bonds, it’s best to invest in Treasurys, because these are the most stable bond options.
- Commodities. The commodities you decide to invest in are completely up to you. Some of the most popular choices are precious metals, oil, or an ETF that provides diverse exposure to the commodities market as a whole.
- Real Estate. Finally, the portfolio comes with heavy exposure to the real estate sector, typically achieved by investing in real estate investment trusts (REITs).
The Investment Thesis Behind the Portfolio
Much like the All Weather Portfolio by Ray Dalio, this portfolio was designed to provide stability regardless of the cyclical nature of the economy and market as a whole.
By investing in assets that respond differently to different economic times, volatility risk is greatly reduced, but there’s a downside: With less risk comes less profit potential.
Nonetheless, for the risk-averse investor, this asset allocation strategy makes a lot of sense. Here’s the idea behind each of the assets in the portfolio:
U.S. stocks have long been regarded as the go-to for growth within a portfolio. As a developed nation and the largest economy in the world, there’s quite a bit of money to go around. Moreover, the opportunities for corporate growth in the United States are seldom seen around the world.
On the other hand, stocks in any region generally experience cycles. As the bears and bulls wage war on Wall Street, valuations will rise and fall. Although the overall trend is generally upward once everything is averaged out, buying on highs or selling on lows will lead to losses. That’s why it’s important to balance these assets out with safer investments.
International stocks are an important part of the portfolio because they are known to provide significant growth opportunities while providing a hedge against domestic political and economic risk.
For example, let’s say the U.S. housing market leads to domestic economic concerns, but other regions around the world aren’t experiencing the same issues. In this case, U.S. markets may fall, but international markets may continue to rise, helping to offset losses.
On the other hand, international markets — especially those in emerging economies — are known for volatile conditions, both politically and economically. These investments also come with risks that should be offset with safer asset classes.
Intermediate-term bonds are bonds that have a maturity of between three and 10 years. These offer increased yields compared to short-term bonds, but lower yields than long-term alternatives.
The bond market is often used as a tool to reduce drawdown risk because bonds provide a fixed return rate and are largely immune to the volatile nature of the market or the economy.
In this portfolio, bonds are relatively under-allocated, which is likely why it includes intermediate-term assets rather than short-term assets. However, due to the relatively modest allocation in this safe asset, it’s best to invest this portion of your portfolio in Treasury bonds rather than corporate bonds because they provide more stability. Some investors even go as far as switching the intermediate-term bond allocation for long-term bonds to provide even more stability.
The Ivy Portfolio uses commodities as an inflation hedge, which will generally reduce risk. If you’re going to follow this portfolio strategy to the letter, 20% of your investments will be in commodities.
Commodities have their part in many portfolios, but some argue that such a heavy allocation to these assets is a mistake. Inflation hedges aren’t big earners, and giving so much of the allocation to this category greatly limits your earnings potential.
Real Estate Investment Trusts (REITS)
Finally, REITs are an interesting play, especially when equally weighted with U.S. and international stocks.
It’s hard to gauge why Faber decided to put such a heavy allocation into these assets — historically they haven’t been great inflation hedges and don’t provide much by way of diversification benefit.
Nonetheless, there’s obviously something to having them in the portfolio that creates stability because this is one of the most stable portfolios out there, albeit a relatively low-performing one.
Pros and Cons of the Ivy Portfolio
The portfolio didn’t just rise in popularity because it gives the average investor the ability to invest like the Ivies; there are plenty of reasons investors follow this strategy. On the other hand, there are also drawbacks you should consider before deploying it.
Ivy Portfolio Pros
Here’s what investors like about this portfolio strategy:
- Stability. The portfolio is one of the most stable prebuilt portfolios available today. Throughout its history, it has experienced minimal drawdowns, even during market corrections and bear markets.
- Simplicity. Most portfolios have several assets, all with varying allocations. This particular portfolio has five assets, all being given a 20% allocation, ultimately simplifying the investing process. If you can divide by five, you can invest using this portfolio strategy.
- Income. Along with being a stable play, the portfolio is also a strong strategy for those looking for income from their investments. After all, 20% of the portfolio is invested in income assets while another 20% is REITs, another investment known for generating compelling income.
Ivy Portfolio Cons
While there are plenty of reasons to use this portfolio strategy, there are also some cons that should be seriously considered before you do so. They include:
- Minimal Annual Return. Sure, this is a stable, safe portfolio. On the other hand, you’re paying for that stability by giving up earnings potential. The portfolio isn’t known for the best annualized gains and has basically zero ability to outperform the S&P 500 index. If you’re looking for a competitive annual return, you’ll have to look elsewhere. With this portfolio, your returns are likely to track just ahead of inflation.
- Heavy Commodity Allocation. Commodities are a great asset when used at the right times and limited during others. A 20% allocation to commodities throughout the life of your portfolio is a bit much, likely playing a major role in the limited returns the portfolio generates on average.
- Heavy Real Estate Allocation. The real estate investments in the portfolio seem like they were thrown in there as a “let’s see” kind of move. When looking at the other four assets in the portfolio, all four economic cycles are covered. Then, for some reason, a fifth asset is thrown into the portfolio that’s not an inflation hedge and doesn’t provide much of a benefit for balancing out the other assets.
The good news is that two of these three cons can be taken out of the equation with a little bit of creative thinking during your portfolio’s setup.
If you’re interested in Ivy league-style investing but are looking for higher growth potential, consider the David Swensen Portfolio. Swensen managed the Yale endowment fund for years, and the portfolio he’s come up with takes a more aggressive approach that’s known for generating higher annualized gains than the Ivy portfolio.
Who Should Use the Ivy Portfolio?
There are two ways this question can be asked: “Who should use the traditional Ivy Portfolio?” and “who should use a different rendition of the portfolio?”
Who Should Use the Traditional Ivy Portfolio
The traditional Ivy Portfolio was designed to limit the effects of volatile price movements and provide a mix of stability and income, making it a perfect fit for retirees or investors with a short time horizon.
If you’re depending on your investment dollars to survive or make a near-term purchase, you can’t afford to take the risk of losses should the assets in your portfolio realize significant declines. These investors should work to make their portfolios as stable as possible, which is largely what the traditional Ivy Portfolio does.
Who Should Use a Revised Ivy Portfolio
The good news is it’s possible to revise the Ivy portfolio to generate larger returns while still protecting yourself from significant risk.
Depending on your investment strategy, it’s possible to make the model fit your needs by trading out one or more of the assets in the portfolio for other opportunities. More on these variations shortly.
How to Duplicate the Ivy Portfolio
Before you attempt to duplicate the portfolio, it’s important to note that the multibillion-dollar endowment funds of Ivy League schools like Harvard and Yale are institutional investors. These big-money investors are able to access somewhat exotic investment vehicles only available to institutions like hedge funds and private equity.
Unfortunately, for the individual investor, it’s not possible to copy these portfolios exactly. Nonetheless, with low-cost ETFs and index funds, you’ll be able to get pretty close. Here’s how:
The Traditional Ivy Portfolio
In the traditional version of the portfolio, the assets included are as follows:
- Vanguard Total Stock Market Index Fund ETF (VTI). The VTI fund invests in a wide range of U.S. stocks ranging in sectors and market caps, giving you overall exposure to the U.S. stock market.
- Vanguard Total International Stock Index Fund ETF (VXUS). The VXUS fund invests in stocks outside of the United States in both emerging and developed markets. The fund spreads investments across a wide range of regions, sectors, and market caps.
- Vanguard Intermediate-Term Treasury Index Fund ETF (VGIT). The VGIT fund invests in Treasury debt securities with maturities ranging from three to 10 years.
- Invesco Optimum Yield Diversified Commodity Strategy No. K-1 ETF (PDBC). The PDBC fund is an actively managed fund that invests in commodity-linked futures and other assets that provide broad exposure to the most actively traded commodities.
- Vanguard Real Estate ETF (VNQ). The VNQ fund invests in a long list of REITs, providing exposure to various types of real estate across several subsectors of the industry.
Pro tip: You don’t have to build this portfolio in your brokerage account yourself. If you use M1 Finance, you can simply load the Ivy Portfolio prebuilt expert pie to gain access to a curated allocation of securities that follows this strategy.
As mentioned above, the traditional Ivy Portfolio is designed for safety and stability. However, if you’re willing to take on a little risk, returns can be greatly expanded with a few small changes. The following renditions of the portfolio are ways to do just that.
The Emerging Market Ivy Portfolio
While emerging markets increase risk, they also have the potential to greatly increase your profitability. To build an Ivy Portfolio more focused on emerging markets, you’ll want to trade out two of the assets.
First, such a heavy allocation to REITs is far from necessary. Instead, trade your 20% holdings in the VNQ fund for 20% in a diversified emerging markets ETF like the Vanguard FTSE Emerging Markets ETF (VWO). VWO invests in a mix of stocks in emerging economies like China, Brazil, and South Africa. The companies in the portfolio range widely by sector and market cap.
Due to the increased risk investing in emerging markets brings to the table, you’ll want to trade the commodity holdings for something even less volatile that will offset this risk.
So, instead of the PDBC fund, you might allocate an additional 20% of the portfolio to intermediate-term Treasury bonds, bringing the total allocation in the VGIT to 40%.
The Small-Cap Ivy Portfolio
Historically, small-cap stocks are known for outperforming their large-cap counterparts. By adding exposure to small-caps, you have the potential to greatly increase the portfolio’s returns.
In order to adjust for small-cap exposure, simply replace the holdings in VNQ and allocate that 20% of the portfolio to the Vanguard Small-Cap Value ETF (VBR). The VBR fund invests in a long list of companies with small market caps that display strong value characteristics.
The Growth Ivy Portfolio
The growth strategy is another common one among investors. Investing in growth stocks gives you access to companies that are showing strong growth in revenue, earnings, and share prices.
When adjusting your portfolio for exposure to growth, you’ll want to replace the VNQ fund and the VTI fund for more focus on growth stocks. When it comes to replacing them, you’ll have two options:
Option #1: Stable Growth
The first option is for investors who would prefer to invest in large-cap, stable growth companies.
In this case, the entire 40% of your portfolio freed up by getting rid of the VTI and VNQ funds can be invested in the Vanguard Growth Index Fund ETF (VUG). The fund is highly diversified and invests primarily in large-cap companies that have strong growth characteristics.
Option #2: Increased Growth
As mentioned above, while small-cap stocks are known for increased risk, they also tend to outperform their large-cap counterparts over the long term. To increase your earnings potential in the growth category, invest 20% in the VUG for large-cap growth exposure and 20% in the Vanguard Small-Cap Growth Index Fund (VSGAX).
The VSGAX is a small-cap growth fund focused on investing in smaller domestic companies that display growth characteristics. These investments are diversified across a wide range of sectors.
The Value Ivy Portfolio
Finally, the value investing strategy is another common option among the investing community. The strategy involves looking for stocks that are trading at a discount based on valuation criteria, buying those stocks, and enjoying the growth while the stocks rise to or above fair market value.
To center the portfolio around the value strategy, you’ll want to get rid of the VTI and the VNQ funds, and once again you have two approaches you can use to replace them:
Option #1: Stable Value
For stability in your value holdings, you’ll want to invest in blue chip companies that have large market caps and have displayed dominance in their categories. To do so, replace the 40% allocation that’s been freed up with the Vanguard Value Index Fund ETF (VTV).
The fund invests in U.S.-based companies that trade with large market caps and are believed to be undervalued when compared to their peers.
Option #2: Increased Potential
Not only do small-cap stocks tend to outperform large-caps over time, value stocks have a history of outperforming growth in the long run. One of the best ways to increase the earnings potential of your portfolio using value stocks is to mix in some small-cap value.
To do so, swap out the VNQ fund for the Vanguard Small-Cap Value ETF (VBR). This 20% of your portfolio will be made up of domestic small-cap companies that are believed to be undervalued based on a range of valuation metrics.
Maintain Balance in Your Portfolio
Regardless of which rendition of the portfolio you choose to use, it’s important to maintain balance when you invest. Over time, some assets will rise or fall in value faster than others, leading to the allocations across your portfolio coming out of balance.
This portfolio won’t require weekly or monthly rebalancing, but you’ll want to make sure to take the time to rebalance at least once quarterly. Doing so will make sure your portfolio stays in line with your strategy.
While the Ivy Portfolio comes with its share of benefits for retirees and short-term investors, it’s definitely not the best fit for everyone based on its traditional allocation.
However, you have options with these portfolios. You can invest in them as they stand or customize them to make them your own. Some minor adjustments in the strategy have the potential to greatly increase your growth potential.
Whether you invest in the strategy as it stands or you decide to make a few tweaks, remember to take the time to do your research. The more educated you are about the assets you purchase, the more likely you are to make profitable decisions in the market that align with your goals.