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Alaska's Fund Diversifies -- So Should You

The Alaska Permanent Fund is the closest the U.S. has to a sovereign wealth fund, and investors can learn from it.

Do-it-yourself investors can't mimic large endowments or sovereign wealth funds, but they can learn about asset allocation from them.

Today's example is the Alaska Permanent Fund, which was established in 1976 to pay a royalty (or dividend) to the residents of Alaska out of the tax collected from the movement of oil. It's the closest the U.S. comes to having a sovereign wealth fund. The fund is managed like an endowment with various investments.

The fund's Web site provides transparency in terms of asset allocation and performance, and offers investors the chance to see what went right and to benefit from its mistakes.

Each segment of the equity allocation is a combination of active and passive management, each with its own benchmark. To clear up one item of confusion, the global equity allocation is benchmarked against the MSCI World Index, which includes the U.S., and the non-domestic equity component is benchmarked against the MSCI EAFE Index, which only contains foreign stocks.

Like most diversified investors, the Permanent Fund has had a very rough year. According to the

Anchorage Daily News

, the fund has lost 25% of its value over the past year, including 10% in October alone.

While 25% sounds like a big number, it would have been worse if the fund had only invested in equities. Losses on stocks exceeded 20% in the nine months through September, the absolute return category was down 10.2% and fixed income was essentially flat. The results for its private equity and infrastructure investments aren't included in the report, but it is possible those results are down as well because those classes rely on complex financing.

The goal of the fund is to achieve a 5% real return. That is, 5% plus the rate of inflation. As depicted in the chart, the fund uses nine asset classes to pursue that goal and maintains a schedule of how much it can deviate from those targets.

For example, the target for the total equity allocation is 53%, plus or minus 10%. As of Sept. 30, equities had fallen to 38.8% of the fund. (The equity weighting was 52% on June 30.)

It appears as though the fund has no plan in place for defensive action in case the equity market deteriorates. Indeed, I entered several search queries about defense or exit strategies in the 2008 annual report but received no results. The nature of endowment investing makes it very difficult to raise cash and sit on the sidelines. It would be reasonable for a manager hired by an endowment fund to believe he has been given a mandate to remain fully invested.

Where I think do-it-yourselfers can learn is the allocation choices. There are a few important ideas contained within and several that are clearly missing. I think absolute return is becoming an important asset class as normal equity returns remain elusive. Infrastructure would seem to benefit from a coming stimulus package that will involve creating new and improving the country's old electrical grid, bridges and the like.

Missing from the mix are emerging markets, inflation-protected securities (which would seem to be important given the goal of 5% returns after inflation) and commodities.

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Commodities may be omitted by design due to the source of the Permanent Fund, but, given how well the space has done this decade -- emerging markets, too, for that matter -- I find it odd that these asset classes aren't specifically targeted. Over the course of the five-year bull market that started at the beginning of the second quarter of 2003,

iShares MSCI EAFE Index Fund

(EFA) - Get Report

was up 150%, badly lagging the

iShares MSCI Emerging Market Index Fund

(EEM) - Get Report

, which rocketed 350%.

Do-it-yourselfers can learn from the basic asset classes that appear to be missing and also are not restricted from taking a defensive posture based on some sort of exit strategy, such as when the broad market going below its 200-day moving average (or DMA) or the 50 DMA crossing below the 200 DMA or any other strategy with a track record for success.

At the time of publication, Nusbaum had no positions in any securities mentioned in the story, although they may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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