David Swensen Insight

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Quoted from David Swensen’s interview with WJS …

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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“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.

Read the rest of this entry »

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.

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

David Swensen:

Avoid the fee-ing frenzy!

A woman banks at Wachovia. Let’s call her Marion. When Marion needs to rollover her 401(k) into an IRA account, she naturally asks a Wachovia financial advisor for help. He helps her open an account and recommends she buy the Evergreen Asset Allocation Fund (EAAFX). Is there anything wrong with this picture? Plenty!

First, the fund has a sales charge (front-end load) of 5.75%. Her 401(k) balance is $100,000. This means, the advisor takes $5,750 just for the act of opening the account for her.

Second, the fund has an expense ratio of 1.27%. This expense ratio includes a 12b-1 fee of 0.25%. This means the advisor will continue to collect about $250 every year for as long as Marion is invested in the fund. The fund manager will collect $1,020- every year!

Third, the fund is actually a fund of funds. Money in the fund is simply divided up and invested in a numbers of other funds, each of which has another layer of managers and fees ranging from 0.39% to 1.02%.

In fact, there are superb funds that don’t charge front-end load and have low expense ratios. But financial advisors who work on commission may never tell you about what’s a better choice for you. No wonder Jack Bogle, founder of the Vanguard Group laments, “Too much salesmanship and too little stewardship.”

Ninety percent of financial advisors are ‘product pushers’ on commission. Conflict of interest runs rampant. How can people like Marion, and people like you, protect themselves against what David Swensen calls a fee-ing frenzy? The answer is, by going with a fee-only advisor.

What is fee-only?

Fee-only means the advisor doesn’t take commissions, product incentives, or third-party payments as hidden compensation.

Why fee-only?

Just because someone is a fee-only advisor doesn’t make him or her automatically trustworthy. But fee-only advisors are more likely to be trustworthy and transparent in their dealings because they avoid conflict of interest. 

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.

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.

In his book “Unconventional Success: A Fundamental Approach to Personal Investing,” David Swensen prescribes for retail investors an asset allocation markedly different from his management of Yale Endowment.

  • Domestic Equity (30 percent) – Stocks in U.S.-based companies listed on U.S. exchanges.
  • Emerging Market Equity (5 percent) – Stocks from emerging markets across the globe. Brazil, Russia, India, China, etc.
  • Foreign Developed Equity (15 percent) – Stocks listed on major foreign markets in developed countries, such as the UK, Germany, France, and Japan.
  • REITs or Real Estate Investment Trusts (20 percent) – Stocks of companies that invest directly in real estate through ownership of property.
  • U.S. Treasury Notes and Bonds (15 percent) – These are fixed-interest U.S. government debt securities that mature in more than one year. Notes and bonds pay interest semi-annually. The income is only taxed at the federal level.
  • TIPs or U.S. Treasury Inflation-Protection Securities (15 percent) – These are special types of Treasury notes that offer protection from inflation, as measured by the Consumer Price Index. They pay interest every six months and the principal when the security matures.

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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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