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Monday, October 12, 2009

Dr. Swensen Speaks and His Bottom Line: Don't Try to "Be Like Yale"

David Swensen, head of Yale Investments gave an extensive interview to the Financial Times He certainly displayed no remorse over his investment strategy. Yet at the same time he advised (as he has done before) that most investors both individual and institutional are far better off pursuing an investment strategy utilizing liquid,transparent index funds and etfs.
My bolds and italics.

Lunch with the FT: David Swensen
By Chrystia Freeland
Published: October 8 2009 18:50 | Last updated: October 12 2009 17:18

For almost one-quarter of a century, David Swensen, head of Yale University’s $16bn endowment, has been one of the most influential figures in US finance. Because of his extraordinary success in managing the Yale fund, Swensen has been described as the biggest “donor” in Yale’s history.

...Swensen commands more financial firepower than most of the more gilded combatants on Wall Street, just a 90- minute train ride away. In the 10 years to June 30 2008, Yale’s endowment fund posted average annual gains of 16.3 per cent, including banner returns of 41 per cent in 2000 and 28 per cent in 2007. It is a performance that has had fund managers clamouring to look after Yale’s money (like most big endowments, Yale entrusts most of its wealth to outside money managers). A Swensen investment became one of Wall Street’s most coveted seals of approval.
Swensen’s approach transformed the management of university endowments and other big public funds, inspiring them to follow his strategy of shifting from putting all their money into traditional investments in shares and fixed-income bonds, and instead moving partly into so-called alternative investments such as private equity or real estate. His investment style is so well-known – perhaps second only to the “value investing” approach of Warren Buffett – that it is often simply called the “Yale model” or the “Swensen model”....

The financial crisis and the sharp public censure that it provoked of Wall Street’s culture of excess and instant gratification was, in some ways, a vindication of Swensen’s Lutheran ethos of self-restraint and his philosophy of investing for the long-term. But the crash brought pain to Yale, too: in the fiscal year ending June 30 2009, its endowment was down 24.6 per cent, a wrenching $5.6bn investment loss for the university and an unprecedented setback for Swensen.
Swensen traces the origins of his career back to a precocious interest in capital. ..
Does Swensen feel he anticipated the crisis?

“Late in 2007, Yale took all of its operating cash and moved it out of money market funds and put it into Treasury bills, so we were absolutely aware of potential issues. And that was months before Bear Sterns,” he says. “But, that said, we weren’t prepared for the magnitude of the crisis, or its duration.”
This mild assertion of prescience in late 2007 makes me wonder whether the crisis has prompted Swensen to reconsider his big idea – investing in illiquid assets. If more of Yale’s assets had been easier to cash in at that time, surely Swensen would have moved more money into T-bills [ultra-secure US government bonds] and hence suffered a smaller loss? (Partly thanks to doing just that, the University of Pennsylvania’s endowment reported one of the smallest losses in the year to June 30 2009, and fell by 15.7 per cent.)
Swensen has a monosyllabic reply to this speculation: “No.” I try again. Swensen is still terse: “No, we never would have done that.”
I try a third time, but it isn’t until the fourth version of the question that Swensen offers a more expansive response: “There have been some articles that have criticised the Yale model and my role in managing the endowment. And I think that’s odd ... What’s the alternative? Aside from the heroic impossible alternative of being 100 per cent in T-bills?” Over the longer run, he says, Yale’s diversified strategy handily beats a classic 70/30 allocation in stocks and bonds.
The larger point, Swensen believes, is that even though moments of radical disruption, such as the 2007 financial crisis, reward investors who make a big bet on major change, “ultimately, market timing is an exercise in futility. When you’ve got dramatic movements in the markets you can identify after the fact a handful of investors that succeeded in the short run. But making big, aggressive asset allocation moves isn’t a strategy that’s likely to prove successful in the long run.”
Years of steady, exceptional performance have made Swensen an investing legend among the cognoscenti and largely insulated him against questions, such as these, about his investing approach. ...

Dr. Swensen is a far wiser and more experienced than I am but I am not sure the questions or the answer really probed the more important issues related to the Yale model. Those would include the issues of liquidity, leverage and transparency related to the alternative investment vehicles. After accounting for those additional risks was the portfolio adequately compensated relative to a portfolio of more liquid transparent instruments with no leverage ? Wouldn't a proper alternative (pun intended) portfolio to the Yale model be one that holds allocations of global stocks, commodities, and various types of fixed income through liquid and transparent vehicles such as etfs combined with a cash cushion to meet liquidity needs ? Dr. Swensen seems to acknowledge that such a strategy is probably best for most investors and he seems to argue that the best thing to learn from the Yale investment experience is how difficult if not impossible it is to replicate :

....He says the crisis has reinforced his view that the most important investing advice is “you should invest only in things that you understand. That should be the starting point and the finishing point.”
For most investors the practical application of this axiom is to invest in index funds (low-fee investments that aim to mirror the performance of a particular stock market index). “The overwhelming number of investors, individual and institutional, should be completely in low-cost index funds because that’s easy to understand.”
Even after the battering of 2007 and 2008, Swensen is not optimistic that many will follow his advice: “The investment community is hopeful – hopeful’s probably too weak a word – wildly optimistic about their particular chances ... Never underestimate the gullibility of large pools of money.”

Swensen says his criteria for selecting outside money managers are simple: “The most important thing is character and the quality of people. That’s also the second most important thing and the third most important thing. It’s everything.” Assessing character involves such deep background checks that, says Swensen, “Some of our managers will tease us about having tracked down their high school geometry teacher.”
Such basic research would have protected investors from the convicted fraudster Bernie Madoff, Swensen says: “If you sat down and had a conversation with him about his investment activities and couldn’t figure out that he was being evasive, shame on you.”

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