Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can’t make an intelligent decision about picking managers, how can he make an intelligent decision about picking a fund-of-funds manager who will be selecting hedge funds? There’s also more fees on top of existing fees. And the best managers don’t want fund-of-fund money because it is unreliable. You need to be in the top 10% of hedge funds to succeed. In a fund of funds, you will likely be excluded from the best managers. [Mr.] Madoff also relied enormously on these intermediaries. He wouldn’t have had nearly as much resources were it not for fund of funds.

What do you think? Is it too strong a statement? Or is it right on target? Please share your thought.

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Watch David Swensen’s lecture here.

Table: Top 10 holdings in Harvard University Endowment’s public portfolio

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We were absolutely aware of potential issues. And that was months before Bear Stearns. That said, we weren’t prepared for the magnitude of the crisis, or its duration.

On changing the Yale Model

There have been some articles that have criticised the Yale model and my role in managing the endowment. And I think that’s odd … What’s the alternative? Aside from the heroic impossible alternative of being 100 per cent in T-bills?

On market timing

Ultimately, market timing is an exercise in futility.  When you’ve got dramatic movements in the markets you can identify after the fact a handful of investors that succeeded in the short run. But making big, aggressive asset allocation moves isn’t a strategy that’s likely to prove successful in the long run.

On his most important advice

You should invest only in things that you understand. That should be the starting point and the finishing point… The overwhelming number of investors, individual and institutional, should be completely in low-cost index funds because that’s easy to understand.

The orginal interview is here.

Pimco mimicking Yale

Here is the second paragraph of the Bloomberg report:

“The richest colleges beat market indexes in the decade through June 2008 by loading up on hard-to-sell assets such as private equity and real estate, while cutting stocks and bonds, a style pioneered by Yale University’s David Swensen. Pimco is refining the model to appeal to investors who want more flexibility to sell assets quickly to raise cash.”

Students of David Swensen understand that the Master avoids liquid assets because “market players routinely overpay for liquidity.” Serious investors benefit by avoiding overpriced liquid securities. Instead, they locate bargains in less liquid markets. This wisdom is borne out by his track record over the last two decades.

Further more, the Master teaches that liquidity is never there when you need it. All these armchair quarterbacks are speaking as if cash strain could have been avoided if only the endowment investments had been in liquid assets. Not long ago, liquid assets were selling at 50% discount or more!

Cash strain isn’t a problem of the Yale model. It’s the result of the extraordinary financial meltdown we experienced during the last two years. Let’s put things into context. Fabled Wall Street powerhouses melted like a snow cone on a hot day, when the crisis hit! So big deal cash strain.

So now Pimco is out to fix a non-existent problem. And somehow, their “refined” model is able to generate endowment-sized outperformance—without illiquid assets?

I think this is just a marketing gimmick by Pimco, purveyed willingly by a non-critical press. What do you think? I’d like to hear you.

“The mutual fund industry in not an investment management industry, it’s a marketing industry.” I didn’t say that, David Swensen did.

Investment success requires sticking with positions made uncomfortable by the variance with popular opinion. Casual commitments invite casual reversal, exposing portfolio managers to the damaging whipsaw of buying high and selling low. Only with confidence created by a strong decision-marking process can investors sell mania-induced excess and buy despair-driven value.

A rich understanding of human psychology, a reasonable appreciation of financial theory, a deep awareness of history, and a broad exposure to current events all contribute to development of well-informed portfolio strategies.

Would you consider forming a partnership with someone you don’t know, in which you would contribute the money and that someone would conduct a business that you don’t understand, and do the accounting as well?

Most business owners would respond with a resounding “No!” The reason is obvious: such an arrangement is the surest way to lose money.

Yet, many of these same business owners would jump at the opportunity when presented with an “exclusive” offer to invest in a hedge fund that promises to make money in good times and bad through a magic “black box” formula.

They should know better. A hedge fund is a private investment partnership unregulated by the Securities and Exchange Commission (SEC). The hedge fund (unlike a mutual fund) does not have to register as an investment company, or the fund manager as an investment advisor. As a result, they are not required by the SEC to report their performance. If they make their performance public, it is often to attract investors. So, they can always “cut and paste” to create a more attractive performance.

Hedge funds are just like any other business: 90% don’t last more than three years, 9% survive, and 1% do exceptionally well. They are not bad things per se. As a matter of fact, the highly successful Harvard and Yale endowments put close to 20% of their money in hedge funds.

The key to the success of the Harvard and Yale endowments, however, is that they approach each hedge fund as a business venture. They usually know the hedge fund managers personally, they understand the formulas, they have rigorous due diligence before investment, and they hire their own accountants to audit the performance afterward.

Just because Bill Gates made a lot of money starting Microsoft does not mean we should all go out and start a software company. Likewise, just because Harvard and Yale make a lot of money investing in hedge funds does not mean the rest of us can or should do the same.

Unfortunately, there are organizations out there that thrive on attracting money for the bottom 90% of hedge funds from unsophisticated investors. (The top 1% of hedge funds don’t need help.) These organizations include the so-called funds of hedge funds, some multi-family offices, and some big Wall Street firms’ wealth management arms. Without them, Bernie Madoff wouldn’t have been able to made off $65 billion (no punt intended.) No wonder David Swensen called these organizations the cancer of the institutional investment world.

TIPS (Treasurey inflation-protected securities)  should be in everyone’s portfolio … We got this massive fiscal and monetary stimulus, it is hard to see how that does not translate in to substantial inflation … down the road.

Much of the 22 minute interview is about Swensen’s (well-known) investment philosophy, his outlook about inflation appears in the last two minutes.