David Swensen Insight

Archive for March 2009

In his book Unconventional Success: A Fundamental Approach to Personal Investment, Swensen recommends the following allocations, for individual investors who want a “well-diversified, equity-oriented portfolio”:

30% Domestic stock funds

20% Real estate investment trusts

15% U.S. Treasury bonds

15% U.S. Treasury inflation-protected securities

15% Foreign developed-market stock funds

5% Emerging-market stock funds

In an interview with Yale magazine, Swensen said, economic conditions might call for a modest revision. He now recommends that investors have 15 percent of their assets in real estate investment trusts, and raise their investment in emerging-market stock funds to 10 percent.

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The following illustrates an implementation of the Swensen allocation with a strong small and value tilt. Despite having only 70% in equity, it has outperformed the benchmark S&P 500.

icarra chart

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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?

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm applying David Swensen's insights for clients. He is also a regular contributor to Morningstar Advisor. To use his wealth management services, schedule a discovery meeting (phone call) with him.

You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights.

@mzhuang

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