Why I Love David Swensen

This post stands in direct contrast to my earlier missive Why I Hate Jim Cramer. I have long admired David Swensen; his focus on asset allocation, his low-key, humble nature and his intellectual prowess impress me greatly. The catalyst for this post was a piece in today's Financial Times penned by John Authers, who heard David speak at the recent Yale commencement. Some of David's comments included:

“Investment management is a simple business,” he said. It came down to two principles. First, equities are best for the long run (as proved by many surveys). “With a portfolio like Yale’s, with a time horizon measured in centuries, everyone would come to the same conclusion: it’s far better to have equities in your portfolio than bonds or cash.” By equity, he means any asset where there is a potential upside that can be taken by the investor.

His second principle is simpler: “Diversification is important.”

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What of security selection? CAPM suggests this is a mug’s game. If prices adjust to include all known information, good stock-picking can be done only by luck.

His solution was to buy assets outside the public markets that are not so efficient. Assets such as private equity and timber have the added advantage that they are uncorrelated.

Is this something you should try at home? Swensen thinks not. “I know it’s necessary to be humble,” he told the gathered alumni, “but I think Yale is set up to make high-quality active management decisions.” It has a staff of 20, and its time horizon means it can buy illiquid investments such as forestry.

Alternatively, he says, “you are in the category in which most investors find themselves, where they aren’t set up to make quality active asset allocation decisions. They should manage their portfolio passively, through low-cost index funds.”

David Swenson, for me, is an investment deity. He simply speaks the truth - period. Where David speaks softly and carries a big stick, Jim shouts loudly and carries a pencil behind his ear. David speaks of long time horizons, the importance of asset allocation and the over-emphasis on market timing. Jim speaks of "get in now," single stock positions and places extreme emphasis on market timing. David understands the limitations of individual investors and counsels them to focus on low-cost index funds and passive investing, whereas Jim "empowers" people to make decisions which they are largely unqualified to make, leading to a sharp divergence between perceived skill and actual results. And this is both dangerous and a shame. The kind of investment advice David proffers isn't sexy and doesn't lead to bragging rights, at least until it comes time to retire. At that point Swensen devotees will be bragging all the way to the bank. And Jim's acolytes? Well, they might be bragging on the golf course today, but as to the future, I'm not so sure.

Comments

[dan]

Great post...I also agree that Timber stocks are a real strong asset protection tool especially for diversification of portfolio's. I would recommend this report to everyone on here.

http://www.whiskeyandgunpowder.com/Report/TimberStockReport.html

-Cheers!

[Kris Tuttle]

This post really captures the facts behind investing and the issues facing the individual (part-time) investor.

The success of the Cramer style is just a symptom of base human nature. It's the same reason millions buy new diet books every year. They don't want to face the fact that healthy eating and moderate exercise over their lifetime is all they need to do. That takes time and discipline. It's easier to insist that they just haven't purchased the right diet book yet and eventually their no-effort dream will come true.

Investors who follow Cramer and his ilk believe that he will bestow instant stock ideas and BAM! I'll be rich. No different than lottery tickets which hard working people spend millions on every day as well.

I would say however that there are some individual investors who can make long-term stock investments in the public markets if they have the passion and training to do so. But the other 90% would be much better off with the passive approach advocated by Swensen.

[Stuart]

We should thank Jim Cramer. Without his sort of there would be fewer noise traders and fewer inefficencies for Hedge Funds to exploit. Where would the endowment Hedge Fund allocation go then?

[Bond investor]

The problem with following David Swensen's advice is that most of us individuals need liquidity and transparency. We don't have a 100-year time horizon or a full-time staff of 20 to research forestry assets for us. We can't afford to say the 40% bond allocation that Swensen inherited in 1985 "made no sense." Indeed, most of us are quite happy with bonds bought in 1985 that are still held today.

For those of us who want liquidity and current income, bonds are an important part of the portfolio.

Bond allocations are also important to pensions with known liabilities. Swensen's fancy alternatives are poor duration matches.

Thankfully, Swensen is pretty humble, and his books acknowledge the need for different investors to have different asset allocations.

[Roger]

Yaser, I hear you but I am unconvinced. As you say, Jim is a "facilitator" - so is a drug dealer. I think you need to look at what he is facilitating and to assess whether it is good or not. In my humble opinion, not.

Wren, yes I read the article and yes, great point. To me it boils down like this: if you are picking single stocks, then yes, the information content of "old boy" networks are very powerful and very valuable. If, however, you game is more finding great managers and making smart, tactical and strategic asset allocation decisions, such information content ceases to drive much value. This is where I perceive Yale Endowment to be. Is there some of the old boy stuff going on, I'd guess, but is this a key determinant of Yale's outperformance? I'd say not.

[wren]

Roger: Of course you saw the recent study that said that money managers make above market returns on stock picks from companies managed by their school chums? Do you think some of Jimmy Cramer's success as a hedge fund manager can be ascribed to advice, tips and inside information from his Harvard and GS buds? I think so. He's a smart, diligent guy but so are lots of folks on the Street. He's as much as admitted it on his website. If you don't have the inside scoop you're probably struggling to beat the averages. Like most funds these days. That said how do Harvard, Yale and Princeton manage to put up the big numbers year after year? Patience? Astute asset allocation? Or are they tapped into the best single source of market insight -- their alumni?

[Yaser Anwar]

Sir:

I'm afraid I have to respectfully disagree w/ regards to Jim Cramer.

Jim often purports intelligent active asset allocation- in his books he even dispels how to go about it. Often in his show he will talk about the important of diversification- that's why there is a segment called "Am I Diversified?". Everytime he recommends a stock he tells everyone to do their research, and in his book 'Watch Tv Get Rich' he talks about what stocks he talks on air are for what people.

You have to be cognizant that most people who watch Jim's show are already actively trading, or come close to it. Jim's Mad Money didn't exist before 2005, and there were still millions upon millions of individual investors who traded actively.

What Jim does is facilitate the process. His audience has, would and will be making trades when he is off air.

He brings a certain passion and aura to the show that is unmatched. Not only that, he is quite thorough and knows what he is talking about.

Is every pick a winner? Definitely not. What he suffers from is law of large #s- talking about 1000s of stocks in a quarter- so his Win/Loss ratio suffers.

I've said this before, if one knows how to utilize Jim's prowess they can do quite well. Out of all the stocks he mentions, see which one fits the bill according to one's own portfolio style and risk tolerance.

I think readers will also be interested in this article on Mohamed El-Erian.

http://money.cnn.com/2007/05/31/magazines/fortune/global_guru_erian.fortune/index.htm?source=yahoo_quote