WASHINGTON - Many of the nation's best and brightest finance professors are a boring bunch investment-wise, keeping their own portfolios invested largely in stocks through index funds that seek to match, rather than outperform, the broad market's returns.
For the most part, they shun active management, subscribing instead to the efficient-markets theory that stock prices are based on all relevant publicly available information and investor expectations, making it impossible for investors to consistently best the market over the long run.
And while some spoke openly about their personal investments, others shied away from the subject, claiming a discussion of their personal finances would prejudice their investment clients.
Not surprisingly, Eugene F. Fama, who developed the efficient-markets theory more than 30 years ago, is a true-blooded passive investor. Others of his ilk include Andrew Lo, founder and chief scientific officer of AlphaSimplex Group LLC, a Cambridge, Mass.-based investment advisory firm, who is on leave from the Massachusetts Institute of Technology; Robert F. Whitelaw, an associate professor of finance at the Leonard N. Stern School of Business at New York University; and Kent D. Daniel, an associate finance professor at the J.L. Kellogg School of Management at Northwestern University in Evanston, Ill.
"There is nothing to be gained from active management or very little, and not enough to compensate for the money you have to pay for it," Mr. Whitelaw said, explaining why he and so many of his colleagues choose to keep their savings in passive strategies.
"I am largely unwilling to pay any active manager. My impression is that in most cases, it is not worth it," Mr. Daniel said.
Until about six months ago, Mr. Fama, who has been teaching finance at the University of Chicago since the early 1960s, had his entire holdings in a passive portfolio, mostly in the Wilshire 5000 index, but a small portion in other stock index funds as well, including small cap, international and small cap value index funds. About 20% of his stock portfolio has a value tilt, he said. Now he has 10% in short-term high grade corporate bonds.
"I do believe in stocks for the long run," Mr. Fama said, adding he has no intention of moving out of stocks, even though he plans to retire within five years.
Mr. Lo also has 100% of his savings in equities, with about 90% in an S&P 500 index fund and 10% in more risky, private equity investments in startup companies. Over the next year or so, however, Mr. Lo plans to begin moving his money into his investment company. Mr. Lo anticipates that he would move his personal wealth into a quantitative strategy such as market-neutral investing, where managers aim to beat the market by not only picking winning stocks, but also shorting losers.
"I view the stock market as a good investment for the long term, and given my risk profile, I put (my investments) in a very low-cost index fund," he said. Mr. Lo describes himself as a fairly risk-tolerant investor in for the long haul. Mr. Whitelaw, who also advises corporations and financial institutions on risk management and equity trading, has about 90% of his savings in stocks, in both domestic and international index funds, and 10% in short-term securities such as money market funds and bonds. "I do no active management. I don't tinker with it at all."
Notwithstanding the stock market's recent decline, he has no plans to change his asset allocation for at least a decade.
His 403(b) plan account is invested in the Vanguard Total Stock Market Index Fund and the Vanguard Total International Stock Index Fund, and his fixed-income investments include the Vanguard Inflation-Protected Securities Fund, the Vanguard High-Yield Corporate Fund and the Vanguard Total Bond Market Index Fund.
Mr. Daniel also has a fair bit of inflation-indexed bonds in his portfolio - as much as 40% - through a TIAA-CREF fund that he views as an opportunistic investment. The rest of his money is in equity index funds, but with a value tilt. "I've avoided Internet and high-tech stocks for a long time," he noted.
He said he does not have more of his investments in the stock market because salaries of finance professors appear to be linked to the stock market's fortunes.
Edwin T. Burton III, an economics professor at the University of Virginia and, until recently, chairman of the $37.5 billion Virginia Retirement System, has about 50% of his portfolio in equities, the bulk of which is in index funds. At VRS, he advocated the pension fund keep most of its assets in passive portfolios, and the system has approximately 70% of its equity investments in passive investments, he said. The other half of his portfolio is split between real estate and fixed income, although he confessed he was not entirely sure of his asset allocation. "An individual's situation is very different from a pension fund. I've got children who have trust funds. Do I count their assets or not?"
But all finance professors are not indexers.
Some who are involved with active money management firms have actively managed portfolios that dovetail with the investment styles they espouse.
For example, Josef Lakonishok, co-founder of LSV Asset Management, a Chicago-based money management firm with $7.5 billion under management, and finance professor at the University of Illinois at Urbana-Champaign, said his personal investment portfolio mirrors that of the style he advocates. A true active investor, Mr. Lakonishok's research has questioned the notion of completely efficient markets and believes investors can exploit pricing inefficiencies. LSV is a deep-value firm and invests in fundamentally sound but beaten-down stocks whose outlook is expected to improve.
Mr. Lakonishok's portfolio also includes some hedge fund investments, as well as international equities, both in developed and emerging markets, he said.
"I have a big exposure to equities through my money management company, but I don't tinker with the asset allocation. I am a patient investor," he said.
On the other hand, Richard H. Thaler, a behavioral economics and finance professor at the University of Chicago and a principal at Fuller & Thaler Asset Management, San Mateo, Calif., altered his asset allocation about a year ago when inflation-indexed bonds were offering an attractive 4%-plus real return. Ten-year inflation-indexed bonds now are returning around 33/8%.
At the time, he had his entire portfolio in stocks; he moved half into bonds, mostly into an inflation-indexed bond fund offered through TIAA-CREF. Mr. Fuller declined to say how much of his personal wealth is invested in portfolios offered by Fuller & Thaler.
Russ Wermers, an assistant finance professor at the Robert H. Smith School of Business at the University of Maryland, stands out in the crowd.
He has between 85% and 90% of his investments in cash, with the small balance in stocks, he said. Mr. Wermers began retreating from the stock market in 1999, when he had about 80% of his investments in stocks, and by the end of the first quarter of 2000 had only about 25% invested in stocks.
Most of his stock investments were in Fidelity Investments' Magellan Fund, one of the largest mutual funds, which practically mimics the market.
The Dow Jones industrial average would have to drop to 7000 or 8000, or rally for six months to a year, before he would be willing to plunge back in, he said.
Although at 42 he still has decades before he contemplates retirement, Mr. Wermers admits to being risk-averse: "I don't want to risk my retirement savings in this market."