Q&A with Harvard’s El-Erian

The full article can be found here.

Q: Could you give us some specific pointers as to how you do that [focus on the long term]?

A: Absolutely. We feel that there are four distinct, albeit inter-related, issues that long-term investors need to take into account – and they’re what we think of when constructing and managing the Harvard portfolio. They’re factors we believe will play out in the market for several years to come.

First, it’s important to have a diversified and internationalized portfolio. For the average investor, this may mean shifting part of the domestic equity exposure into international equities and introducing some commodities. We believe that long-term global forces are in play. For example, we’re looking for a growth slow-down in the United States. Yet emerging economies, as well as Japan and Europe, are experiencing higher growth.

Commodities also serve as great diversifiers, and they provide some downside protection against a geo-political shock emanating in the Middle East. A good idea is to purchase a diversified commodities mutual fund or an ETF (exchange-traded commodities fund).

Second, within domestic equity exposures, we’re looking for a handoff from small-cap and mid-cap to larger-cap companies. This has to do with the growing influence of the private equity. We believe that large cap companies will be next to benefit from the large influx of private equity capital buying up companies. Private equity companies are now targeting larger capitalization companies. As an example, think of the recent news on Cerberus Capital Management, the private equity firm, buying Chrysler for some $7 billion.

Third, it’s a good idea to have some inflation protection in the portfolio. The world has benefited in the last few years from two major dis-inflationary forces that will likely diminish in importance going forward: increased U.S. productivity and the entry of low cost workers in the global workforce, particularly in China and India.

As these forces diminish, inflationary pressures will pick up, making securities such as TIPs (Treasury Inflation-Protected securities) a good addition to portfolios. The fourth theme may distant to the average investor, but it’s of enormous importance. Suddenly more central banks in the world will be reconsidering how to deploy their capital. The numbers are large. For example, China has over $1 trillion of reserves, Russia over $250 billion and Brazil over $120 billion. To date, most of these funds have been invested in U.S. bonds, and Treasurys in particular. Over time, they’ll adjust the allocations to other parts of the world.