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Martin Leibowitz Failed Defense
of the Endowment Model
By Michael Edesess
July 20, 2010


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The authors don’t mention that various statistical studies cast grave doubt on the ability of the alternative asset classes to produce positive alphas on average – for example, among others, a 2005 study on private equity by Steven Kaplan and Antoinette Schoar in The Journal of Finance, and hedge fund studies by Mark Kritzman in Economics & Portfolio Strategy in 2009 and by Burton Malkiel and Atanu Saha in the Financial Analysts Journal in 2005.

The authors acknowledge that expected alphas of alternative asset classes will be reduced if these asset classes become more popular. They do not, however, explain why alternative alphas have not already been reduced by that phenomenon; but as I have already pointed out, the authors do not say anything at all about how the expected excess returns that are used as inputs to the model were arrived at, or even who created them.

There are not one but three chapters about stress betas – quite a lot for something for which the authors themselves admit there is weak evidence (a glance at their scattergrams purporting to show evidence reveals just how weak it is). It is hard not to suspect that this

is an attempt to explain away, and thus dismiss, the fact that alternative asset classes performed poorly in the meltdown.

In this book, the word “alpha” appears 1076 times and “beta” 1288 times. That’s a lot of mentions for two statistical distillates both of whose pragmatic relationships to anything enduring or prognosticative, or in short, useful, is in some doubt. But you’d never know that from the treatment in this book.

By contrast with all the mentions of alpha and beta, “costs” and “fees” are mentioned twice each, only briefly in passing – “costs” both times in the context of “transaction costs” – even though fees have been found by many researchers to be by far the best predictor of future relative performance. The authors don’t even tell us if the input assumptions – the expected returns – are gross or net of fees. If they are gross of fees, that changes all the end results, even if we accept the risibly weak foundation on which those results are already based. And of course, they don’t mention that fees for the management of “alternative” asset classes, even when “passive,” are in general much higher than for passive management of the so-called “swing” or standard asset classes.

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