The Investment Scientist

Posts Tagged ‘david swensen

“They are the cancer of the institutional investment world.” – David Swensen

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.

Read the rest of this entry »

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.

Sign up for The Investment Fiduciary monthly newsletter.

“Avoid the fee-ing frenzy,” says David Swensen. financial-advisor

Marion banks at Wachovia. When she 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.

Read the rest of this entry »

The financial crisis has sparked a debate about the Yale model, 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.

Absolute Return is a class of investment that seeks to generate long-term returns not correlated with the market.It does this by exploiting market inefficiencies. There are two basic strategies: event-driven and value driven. Event driven strategies rely on specific corporate events such as mergers, spin-offs or bankruptcy restructuring. Value driven strategies rely on buying under-valued assets while at the same time short-selling over-value assets. Don’t try this at home! You might just be the inefficiency being exploited.

Private Equity is a class of investment that participates in leverage-buyout (“LBO”) and venture capital. Venture capital is money that funded Google. However, it also funded thousands of failed ventures. LBO partnerships engage in the exercise of buying badly run businesses, reforming them, and then reselling them for a profit. Good private equity funds are generally close to individual investors. However, many below-average funds (often with exorbitant fees) are being aggressively marketed by Merrill Lynch and the like to unsuspecting high-net-worth individuals.

Real Assets include real estate and commodities. They are tangible (as opposed to paper assets) and they’re a good hedge to inflationary forces. This asset class is accessible to individual investors through Exchange Traded Funds (ETFs) and physical property such as the houses they live in.

Fixed Income is an asset class that produces a stable flow of income. It provides greater certainty than other asset classes. Fixed-income investments will perform badly in an inflationary environment, with the exception of treasury inflation protected bonds or TIPS. This asset class is readily accessible to individual investors.

Foreign Equity includes both matured market equity and emerging market equity. With US economy becoming an ever smaller slice of the global pie. This asset class provides a great way to participate in foreign growth. However, their diversification benefit is over-rated. With the exception of China, foreign stock markets highly correlate with the US market. Foreign equity is very accessible to individual investors.

Domestic Equity needs no additional explanation.

By all mean let David Swensen enlighten you, but don’t fall all over yourself trying to mimic him. What is good for Yale is not necessarily good for you. This is an advice coming from none other than Swensen himself.

Sign up for The Investment Fiduciary monthly newsletter.

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.

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.

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

David Swensen discusses the current state of the market and derivative trading >>>

Yale’s Swensen sees “Extraordinary” opportunity to snap up debts >>>

David Swensen discusses the ups and downs of Yale Endowment >>>

Jack Bogle, father of index funds, likes David Swensen and Warren Buffet >>>

I wrote this article in early December 2008. Amazingly, it is one of the least read in my blog. Hadwealth-preservation someone read it and followed it, he would have earned 10% return so far in 2009.

– Michael Zhuang 3/10/2009

At the moment of writing this, SPY, the exchange traded fund (ETF) for the S&P 500 index, is trading at $85.95 and the near at-the-money call option (with strike 86 and only eight days until expiration) is trading at $3.45! (A call option is the right to buy the underlying stock at the strike price. At-the-money means the option strike price is equal to the price of the underlying stock.)

The at-the-money call premium is a full 4% of the underlying index price! Historically, that number has been in the 1% to 2% range.

What does 4% premium imply?

Read the rest of this entry »

Don’t give up on financial innovation” by William Watson is more about Robert Shiller’s view. David Swensen did get a cusory mention.

The Economist has a piece “All bets are off” that is highly skeptical about David Swensen’s multiple asset class approach. It argues that all asset classes were driven (higher) by two factors: low interest rate and healthy global growth.

Princeton’s endowment, managed by David Swensen’s disciple Andrew Golden, earned 5.6% in 2008 (fiscal year ended in June). The performance was attributable to “non-marketable exposures and independent return managers.”

Yale Daily News: David Swensen got a raise. Now he makes $2 million dollar a year.

David Swensen derides securities lending as “make a little, make a little, make a little, lost a lot.”

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.

Read the rest of this entry »

Yale Endowment, as an institution investor, has to disclose to SEC its public equity holdings every quarter. This allows us to get a glimpse of David Swensen’s direct stock investments. Since Yale Endowment does not have to disclose its private equity investments and its allocations to money managers, this is not the complete picture of its asset allocation.

The author is president of MZ Capital, a RIA serving DC/MD/VA. Get his monthly newsletter in your mailbox or get to the directory of his past articles.

Table: David Swensen’s stock portfolio

Ticker % weight of portfolio Name
OEF 1.24% iShares S&P 100 Index
INFN 0.12% Infinera Corp
EFA 13.82% iShares MSCI EAFE Index
EEM 37.42% iShares MSCI Emerging Market Index
AKR 7.12% Acadia Realty Trust
XTXI 1.39% Crosstex Energy Inc.
WWW 0.07% Wolverine World Wide
CELG 0.05% Celgene Corp
DEI 29.47% Douglous Emmett Inc.
CXO 8.39% Concho Resources Inc
SPY 0.9% SPDR S&P 500 Index


In a recent ABC news piece, Dr. David Swensen, manager of $34 billion Yale Endowment had this to say about Jim Cramer:

On ‘Mad Money,’ Cramer promotes a mindless short-term approach to markets by encouraging frenetic trading of individual stocks. Such a high-cost, tax-inefficient strategy almost guarantees failure.

In the same article, my view on Jim Cramer was also mentioned:

Zhuang is no fan of Cramer. Like Swensen and Ehrenberg, he argues against frequent trades and says Cramer may be influencing investors to overreact to financial news.

(For Swensen’s stellar track record, click here.)

This post was written at the depth of the financial crisis. If you stuck to the Swensen Model through out the crisis, you would be ahead now. See our model portfolio.

– Michael Zhuang

Wall Street Journal headline: “Harvard Endowment Returned 8.6%”

In light of the events of the last few weeks when financial companies collapsed in rapid succession, an all-weather portfolio is what all of us need. Yale and Harvard University endowments have portfolios that do well in both good and bad times. You’d expect these smart people to know what they are doing. They do!

In any one fiscal year (ending in June) since 2000, The Yale Endowment has never had a loss. Don’t you wish you had a portfolio that could do so well? Sadly, your record is likely to be worse than that of S&P 500. Harvard’s endowment portfolio had only two years with small losses. The worst was in 2001. That was when it suffered a loss of 2.7%. Here are the details:

Table 1: Comparison of returns for Yale, Harvard, and the S&P 500

    Year Economic Cycle Yale Harvard S&P 500
    2000 Tech bubble 41% 32% 7%
    2001 Tech bubble bust 9.2% -2.7% -14.83%
    2002 Tech bubble bust 0.7% -0.5% -17.99%
    2003 8.8% 12.5% 0.25%
    2004 19.4% 21.1% 19.11%
    2005 RE bubble 22.3% 19.2% 6.32%
    2006 RE bubble 22.9% 16.7% 8.63%
    2007 RE bubble bust 28% 23% 21%
    2008 RE bubble bust 4% 8.6% -14.8%
    Average Return 17.8% 14.4% 1.6%
    Volatility 12.4% 11.3% 14.6%

How did Yale and Harvard achieve such return stability through two major cycles of boom and bust?

The answer lies in their unconventional asset allocation. The typical US investor allocates 60% to domestic equity, primarily in large-cap growth stocks, and 40% to fixed income assets. In contrast, the endowments allocate to six non-cash asset classes that have low correlation with each other. In particular, domestic equity and fixed income make up only a small percentage of the overall portfolio: see Table 2 below. This broad diversification across weakly correlated asset classes is the primary reason why the endowment portfolios did well in both boom and bust times. (I will discuss secondary reasons in the future.)

Table 2: Asset allocations of Yale and Harvard endowments

Asset Classes Domestic Equity Absolute Return Foreign Equity Private Equity Real Assets Fixed Income Cash
Yale 11% 23.3% 14.1% 18.7% 27.1% 4% 1.9%
Harvard 12% 18% 22.% 11% 26% 16% -5%

Both endowments allocate over 25% to real assets, such as real estate and basic materials. This allocation seeks to protect against the double threat of a weak dollar and inflation.

Chart: Evolution of Yale Endowment asset allocation

As the chart above shows, Yale Endowment significantly increased its exposure to real assets in the last three years. Average investors like you and me would be well-served to heed the unspoken message of these intelligently-managed endowments. And now for your take-home lesson:

1. Broadly diversify

2. Hedge against inflation and the weak dollar.

Get The Investment Fiduciary monthly newsletter in your mailbox.


Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

Error: Please make sure the Twitter account is public.

Archives

%d bloggers like this: