A couple of changes to the target portfolio. There are really two target portfolios. One is our desired asset allocation and the other is the benchmark portfolio I compare performance to each month and year.
The first change applies to the benchmark portfolio. Up till now, I have used the FTSE DSC venture and buyout indices as the proxy for venture capital and buyout PE. But these indices track gross performance before investment fees. Investment fees are very high for these asset classes and it is unrealistic to assume I could match the gross performance. By contrast, the HFRI index I use for hedge funds is net performance after fees. So, I am applying the standard 2 and 20 investment fee structure to the returns of these indices. 2 refers to the 2% annual management fee and 20 refers to the carried interest or performance fee - 20% of the profits. There is big difference between hedge funds and private equity in how these fees are applied. Hedge funds would charge 2% of NAV each year and 20% of the profit above a hurdle rate. If gross profits are in a drawdown - below the previous "high water mark" - no performance fee would be charged. Private equity charges 2% of the original investment and only charges carried interest when an investment is realised but usually there is no hurdle rate. I am deducting 2%/12 of NAV each month and 20% of profits above the high water mark are also deducted. I implement this by computing the gross index and then a high water mark index - the maximum of the gross index in all previous months. If the gross index at the end of the month is above the the high water mark, 20% of the percentage increase relative to the high water mark is deducted from returns. So this exaggerates likely fees. On the other hand, I don't take into account the dilution that often happens to early stage venture investors.
Venture returns are reduced from 1.67% per month gross since January 2008 to 1.22% net and buyout returns fall from 1.29% to 0.93%. These returns are still better than any other asset class.
I have also tweaked the allocations to give 20% to each of long public equity, hedge funds, and private equity. I have also increased the credit allocation to 10%. So, the benchmark portfolio consists of:
MSCI All Country World Index Gross 9%
ASX 200 Total Return Index 11%
HFRI Fund Weighted Hedge Fund Index 20%
Net FTSE Venture Index 10%
Net FTSE Buyout Index 10%
Gold Spot Price USD 10%
TIAA Real Estate Fund 12%
CREF Bond Fund 10%
Winton Global Alpha Fund 5%
Australian Dollar Cash 3%
Short Australian Dollar Futures 31%
The index is effectively rebalanced monthly.
The 31% short Australian Dollar position is half the total position in hedge funds, private equity, real estate, and bonds. The indices or funds for each of these is in US Dollars. This hedge implies that half of the allocation to these assets is in Australian Dollar denominated funds and half in US Dollar denominated funds.
Our target allocation for investment is close to this. We split the Australian stock allocation into 7% large cap and 4% small cap. Real assets, credit, and futures categories are also broader than the specific funds listed here.
I won't bother deducting fees from the long stocks allocation as you could use ETFs with very low fees to track these indices.
Here is a graph of the simulated performance of the benchmark since September 1996:
