David Swensen Insight

Archive for the ‘asset allocation’ Category

Harvard University Endowment significantly increased its holding of Market Vector Russia, iShare Mexico and iPath India in third quarter of 2009.

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

Rank Names 9/30/09 (x1000sh) 6/30/09 (x1000sh) Change
1 iShares E. Mkt 10298 9712 +586
2 iShares Brazil 3355 3294 +61
3 iShares China 4962 4178 784
4 iShares S. Korea 4127 4349 -222
5 iPath India 1882 1388 +494
6 iShares S. Africa 1624 1595 +29
7 iShares Taiwan 7297 6836 +461
8 Mkt vector Russia 2596 882 +1714
9 iShares Mexico 1639 570 +1069
10 Vanguard E. Mkt 1568 1758 -190

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On his anticipation of the crisis

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.

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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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The Yale model is under intense criticism that it doesn’t work as advertised in the current market condition. Here is David Swensen‘s response in an interview with Seth Hettena, Special to ProPublica.

The first thing I’d say is it’s too short a time period over which to judge. If you want to have a fair assessment of any investment strategy, get through the crisis and then look back and see how things performed.

If you look back 10 years from June 30, 2008, Yale’s performance was 16.3 percent per annum. Bonds were 5 percent plus or minus, and stocks were 3 percent plus or minus. So what are you going to do? You’re going to give up that kind of performance to hold a lot of bonds to protect against the financial crisis? Where’s the alternative that performs so much better? 100 percent government bonds? Is that the alternative? Well, then what would have happened if you had held that the decade before? I don’t get it.

They’re not thinking about what happened the 10 years before and they’re not giving us time to get through this crisis and see how it plays out for the Yale model against a more traditional portfolio. That’s one of the really interesting things in these articles that have been critical of the Yale model and sometimes of me personally: Where’s the alternative? What’s the option? Yeah, the model fails. Well, relative to what?

Here is the source.

Once upon a time, the Yale University Endowment invested like the rest of us, in just two asset classes: US equity and fixed income. After taking over the reins in 1987, David Swensen, the chief investment officer of Yale Endowment, moved aggressively into non-traditional and often illiquid asset classes like foreign equity, absolute return, real assets and private equity.

Chart: The Yale Model asset allocation
[enable picture display to see this chart]
Picture credit: thedividendguyblog.com

His unconventional approach produced a 20-year unbroken record of positive returns, resulting in stellar growth of the endowment from $1b to $17b. No wonder rival school Harvard University studies him closely. Other institutional money managers trip over themselves trying to mimic him.

Yale’s six asset classes are defined by their different expected response to economic conditions, such as inflation, growth and interest rate. Here is my own simplified explanation and cautionary note about these asset classes in relation to us as individual investors. Read the rest of this entry »

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.

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