David Swensen Insight

Archive for the ‘security selection’ Category

University endowments are important institutions. They play a critical role in maintaining the academic excellence of the universities that rely heavily on their income. Recently, these endowments have drawn much attention because of their superior investment returns compared to other institution investors, such as investment banks and insurance companies.

There is much diversity among university endowments. Ivy League endowments such as those of Yale and Harvard are well ahead of the pack in terms of investment returns.

Between 1994 and 2005, Ivy League endowments returned an average of 14.9% per year, compared to 11.7% for all university endowments and 9.7% for the S&P 500. Surprisingly, this high average return was achieved with less risk! The return volatility of Ivy League endowments was 8.8%, compared to 9% for all university endowments and 16.9% for the S&P 500. Clearly, these endowments have done something right!

Chart: Comparing the returns of Ivy League endowments, all university endowments and the S&P 500. “All Return” denotes the returns of all university endowments. “All Bench” denotes the returns of mimicking all university endowments using asset class indexes. “Ivy Return” denotes the returns of Ivy League university endowment. “All Bench” denotes the returns of mimicking Ivy League university endowment using asset class indexes.

ivy league endowments risk and returns

Data source: Lerner, Schoar and Wang, 2008, “Secrets of Academic: The Driver of University Endowment Success.”

Ivy League endowments derive their superior returns from two sources: asset allocation and investment selection. Ordinary investors can mimic their asset allocation, which is public information, to some extent. If investors buy each asset class index fund in proportion to the Ivy League endowment allocation, they may be able to achieve the Ivy Benchmark Return of 9.8% with 12.1% volatility. This is clearly superior to the S&P 500.

Ordinary investors, however, should not attempt to mimic Ivy League endowments’ investment selection. They do not have the knowledge, rigorous investment process, and access to highly-skilled investment managers to be successful.

Qualitatively, what ordinary investors can learn from these endowments is, in the words of David Swensen, to have a strong decision marking process. Do you have one?

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

David Swensen, Yale’s Chief Investment Officer and manager of the University’s endowment, discusses the tactics and tools that Yale and other endowments use to create long-term, positive investment returns. He emphasizes the importance of asset allocation and diversification and the limited effects of market timing and security selection.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

This is based on an interview David Swensen done on Fox News Network.

david swensen

David Swensen

1. Have a strong decision-marking process

Investing success requires sticking with decisions made uncomfortable by the variance of opinions. In his own words:

Think carefully how it is that you are gonna allocate your assets and stick with it. Too many individuals were excited about the equity market 18 months ago and were despairing 3 months ago. It should have been the other way around. They should have been concerned about valuation 18 months ago and excited about the opportunity to put money to work at lower prices 3 months ago.

2. Sell mania-induced excess, buy despair-driven value

On his favorite area of despair-driven value, David Swensen has this to say:

I think the most interesting area is the credit market. Bank loans are trading at extraordinary low value. High-grade corporate debts, below investment grade corporate debts associated with companies that are gonna survive this are extraordinarily cheap. It’s not the only place to find value, but that would be the top of my list.

3. Make decision based on thorough analysis

Know where you belong …

There are two ends of the continuum in the investment market. You should be in one extreme or the other. There is no room for success in the middle. At one end of the spectrum, you get investors who committed resources to do high quality jobs in active management … At the other end of the continuum are purely passive investment vehicles – index funds. The vast majority of players are in the middle and the vast majority of players end up failing. Be at one end or the other and almost all investors belong to the passive end.

4. Watch out for the “fee-ing frenzy”

This one should be obvious but ignored by many investors.


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