David Swensen Insight

This week in WealthTrack’s series on Great Investors, Consuelo Mack features the never-before-aired portions of her wide-ranging interview with Yale’s renowned endowment chief, David Swensen. Among the topics covered are Swensen’s assessment of the new investment reality and where he is investing his and his family’s money. See the portion aired in May here.

“They are the cancer of the institutional investment world.” – David Swensen, Yale endowment CIO

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.

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In an interview on WealthTrack, David Swensen said:

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.

David Swensen told German newspaper Frankfurter Allgemeine Sonntagszeitung in an interview published on Sunday:

Now is a better time to buy equities than six months ago, one year ago or five years ago. One thing is certain: If I now had government bonds, I would consider selling them and invest the money in everything else.

In a recent interview with Yale Alumni Magazine, David Swenen had this dialog with the reporter.

Yale Magazine: Unconventional Success delivered a scathing critique of the mutual-fund industry. You rightly pointed out that the vast majority of mutual funds charge high fees, trade too frequently, and under-perform the markets. How did the industry react?

Swensen: I’ve heard stories of people in the fund management business being irate about the book. That’s not surprising. The mutual fund industry is not an investment management industry. It’s a marketing industry. And if somebody interferes with your marketing, you’re not going to like that. So I was pleased to hear that there were senior people in the industry who were very, very unhappy with me and my book.

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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.

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

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

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

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.

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