David Swenson

IFA's Quote of the Week - 20 (David F. Swensen)

David Swenson
"When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there's almost no chance that you end up beating the index fund."
- David F. Swensen, Chief Investment Officer, Yale University Endowment, Economics Professor and author of Unconventional Success: A Fundamental Approach to Personal Investment, as quoted in: NPR, "Yale Money Whiz Shares Tips on Growing a Nest Egg"

David Swensen is an impressive investor. Since taking on the job of managing the Yale University Endowment back in 1985, he has generated net investment returns that average 16.8% a year, more than any university, foundation or pension fund.

Swensen is highly respected among his peers and aspiring investment managers, most of whom regard him as the gold standard for investment managers. In fact, former Harvard University Endowment investment manager, Jack Meyer, said in a 2005 interview, “I think David is the best in the business.”

Swensen’s reputation fast approaches legendary. In 1985, he took over the management of the Yale University Endowment with just $1.3 billion in the coffers, 45% less than it was worth previous to high inflation and poor stock market performance. At the time Swensen took the helm, spending was frozen, and the outside company formed by Yale to manage the endowment had been fired for poor management.

In an effort to bolster the endowment’s performance, Swensen looked no further than the lessons learned from his former economics professor and Nobel Prize winner James Tobin. Doing so, he quickly surmised that the fund suffered from a severe lack of diversification; more than 75% of the money was invested in U.S. stocks, bonds and cash. Swensen’s summary judgment was that the fund was “taking on too much risk and missing out on opportunities.”

Swensen set out to diversify the portfolio. In doing so, he grew the portfolio to more than $22 billion in assets as of April 2008. “Think of it this way:” states an article in the July/August 2005 issue of Yale Alumni Magazine, “a $10,000 gift made in 1985 would have grown by now [as of June 30, 2005] to $158,328, assuming none of it had been spent. That performance handily beats stock market returns of $95, 226, as measured by the S&P 500.”

Indeed, Swensen’s accomplishments are impressive. He is considered an unassuming hero to the New Haven campus, which is now pleasantly adorned with state of the art buildings, the result of $1 billion invested in facilities for science, engineering, and medicine, along with dramatic increases in financial aid. Quite simply, Swensen’s accomplishments have transformed the university. Certainly, there are plenty more improvements, additions and awards on the horizon as the endowment now spends annually 5.25% of the endowment’s value. This year, the allowable expenditures total roughly the same amount that the endowment was worth when Swensen came on board, an impressive irony.

Despite Swensen’s enormous success, there exists a cloak of secrecy surrounding the endowment’s investments. The tax status of the endowment allows for minimal tax-reporting disclosure, a privilege Swensen covets to the fullest. As a result, we have very little insight as to how Swensen achieved his exemplary returns. We do know, however, that the endowment invests in publicly traded companies; private equity, including timberland in Maine and Idaho, hotels and restaurants, and newly privatized companies in Russia and small companies in China—some of which are highly illiquid assets.

Academics have determined that over the long haul, returns from efficient markets are the result of risk, and they have identified a direct correlation between specific risk exposures and returns earned.

In contrast to the cloudy view we have of the Yale Endowment’s investments, index funds investing allows complete transparency and liquidity. Take, for example, IFA Index Portfolio 100, an index portfolio that invests in 11 indexes and carries 80 years of simulated risk and return data. The chart below shows a comparison of Yale’s Endowment, the S&P 500 Index and IFA Index Portfolio 100 for the 20-year period from 1985 to 2005 (the time period stated in the article, and assuming fiscal endowment year). As you can clearly see, you do not have to sacrifice transparency or liquidity to achieve those returns, you just have to buy a small value tilted all equity index portfolio that controls costs and turnover expenses.

Swensen himself is a vocal proponent of index investing, which he labels an “unconventional approach” because most investors follow active fund managers. He says they do so despite the fact that actively managed funds harbor an inherent conflict of interest that ultimately favors fund company profits over investor returns.

On numerous occasions, he has espoused the virtues of his unconventional approach that supports the buying, holding and rebalancing of a diversified index portfolio that keeps expenses and turnover low. An April 3, 2008 NPR article quotes Swensen, “’When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there's almost no chance that you end up beating an index fund,’ he says. The odds, he says, are 100 to 1.”

Finally, in his book A Fundamental Approach to Personal Investment, Swensen states, “Compelling data show that nearly certain disappointment awaits the mutual fund shareholder who hopes to generate market-beating returns”. Swenson continues, “the market contains a number of attractively structured, passively managed investment alternatives, affording investors the opportunity to create equity-oriented, broadly diversified portfolios.” And he concludes, “In spite of the massive failure of the mutual fund industry, investors willing to take an unconventional approach to portfolio management enjoy the opportunity to achieve financial success.”