Yale's Investment Manager: Don't Try to Do What We Do

Coinciding with the release of the new edition of his book Pioneering Portfolio Management, Yale Endowment CIO David Swensen gave an interesting interview to the WSJ

my bolds, my comments in italics


* JANUARY 13, 2009

Yale's Investor Keeps Playbook
In Line for First Loss Since '88, Mr. Swensen Still Champions 'Alternatives'



By CRAIG KARMIN

He isn't a household name. But as the Yale University's endowment's chief investment officer for two decades, David Swensen has earned a reputation as one of the world's savviest and most successful investors.

He pioneered an approach that de-emphasized stocks and bonds while embracing less-traditional fare like hedge funds, private equity, and oil and gas. During his tenure, Yale has had an average annual return of 16% for the past 10 years through June, compared with a 2% average for the Standard & Poor's 500-stock index. Yale's assets more than tripled over that period to $23 billion, trailing only Harvard University's in size.

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David Swensen
Joe Fornabaio/The Wall Street Journal

David Swensen, investment chief for Yale University's endowment, says institutional investors should be built for growth, not to withstand stock-market downturns.
David Swensen
David Swensen

Yet even Yale hasn't escaped the financial crisis.

The university estimated late last month that the endowment had lost 25% of its value since the end of June. That is expected to lead to budget cuts and puts Mr. Swensen in line for his first negative fiscal year since 1988. Other endowments that have set out to follow the strategy he has advocated are also suffering.

Nonetheless, Mr. Swensen is sticking to the same investment approach that he's used in the past. He describes that process in detail in his book, "Pioneering Portfolio Management," which he revised and which was reissued this month....



Wall Street Journal: As you revised your book, first published in 2000, did any sections strike you as dated?

David Swensen: It was more in the other direction. The book talked about an approach to investing that has succeeded over the past decade. In the '90s, all you had to do was put your money in the S&P 500. In the ensuing decade, a diversified strategy just crushed the S&P. The book talks about a sensible approach that was also profitable."


WSJ: Yet, other endowments have attempted a Yale-like approach, usually with less success. What goes wrong?

Mr. Swensen: A lot of institutional investors think they are emulating Yale, but they are not. Most endowments use fund of funds and consultants, rather than making their own well-informed decisions. You can divide institutional investors into two camps: those who can hire high-quality, active-management investors and those who can't. If you are going to invest in alternatives, you should be all in, and do it the way Yale does it -- with 20 to 25 investment professionals who devote their careers to looking for investment opportunities. Or you belong at the other end, with a portfolio exclusively in index funds with low fees. If you're not going to put together a team that can make high-quality decisions, your best alternative is passive investing. With a casual attempt to beat the market, you're going to fail.

If someone looked at what we're doing superficially and made superficial attempts to copy us, then I have little sympathy for them. It's a much more complicated process than that, and I explain it in detail in the book. If someone read my book and failed, I'd have some sympathy.

WSJ: What about fund of funds and consultants? Can they be a solution?

Mr. Swensen: 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.

Consultants make money by giving advice to as many people as possible. But you outperform by finding inefficiencies most of the market has not yet uncovered. So consultants ultimately end up doing a disservice to investors.....



WSJ: With hedge funds suffering their worst year on record, will institutional investors have more power to demand lower fees?

Mr. Swensen: Put that in the category of wishful thinking. It would be nice if fees were not so onerous. But you still have investors who are happy to pay a high price in hopes of getting the holy grail of extraordinary returns.

WSJ: Many hedge funds share little information with investors beyond their general strategy. Is that acceptable?

Mr. Swensen: We require complete transparency. We either know every position, or we don't invest. I have access to every position in every hedge fund in which we're invested. If they won't trust us with that information, why should we trust them with our money?