فصل 6 بخش 2

CHAPTER 6.2

DAVID SWENSEN: A $23.9 BILLION LABOR OF LOVE

Chief Investment Officer, Yale University, and Author of Unconventional Success: A Fundamental Approach to Personal Investment David Swensen is probably the best-known investor you’ve never heard of. He’s been described as the Warren Buffett of institutional investing. Over the course of his celebrated tenure as Yale’s chief investment officer, he’s turned $1 billion in assets into more than $23.9 billion, boasting 13.9% annual returns along the way—a record unmatched by many of the high-flying hedge funds that have tried to lure him away over the last 27 years.

As soon as you meet Swensen, you realize that he’s not in it for the money—he’s in it for the love of the game and a sense of service to a great university. And he’s got the paycheck to prove it: his worth in the private sector would be exponentially higher than what he earns at Yale.

At his core, Swensen is an inventor and a disruptor. His Yale model, also known as the endowment model, was developed with his colleague and former student Dean Takahashi, and is an application of modern portfolio theory. The idea is to divide a portfolio into five or six roughly equal parts and invest each in a different asset class. The Yale model is a long-term strategy that favors broad diversification and a bias toward equities, with less emphasis on lower-return asset classes such as bonds or commodities. Swensen’s position on liquidity has also been called revolutionary—he avoids rather than chases liquidity, arguing that it leads to lower returns on assets that could otherwise be invested more efficiently.

Before his days as the rock star of institutional investing, Swensen worked on Wall Street for bond powerhouse Salomon Brothers. Many credit him with structuring the world’s first currency swap, a trade between IBM and the World Bank, which in effect led to the creation of the interest rate and ultimately credit-default swap markets, representing over $1 trillion in assets today. But don’t hold that against him!

I had the privilege of sitting down with Swensen at his Yale office, and before I ventured up the hallowed halls of that storied institution, I did what any good student would do: I spent the night before cramming. Not wanting to be anything less than prepared, I absorbed 400 pages of Unconventional Success, Swensen’s manifesto on personal investing and diversification, before the meeting. What follows is an edited and abridged version of our nearly four-hour interview.

TR:

You work on behalf of one of the largest institutions in this country, yet you have a deep interest in and commitment to the individual investor. Talk to me about that.

DS:

I’m basically an optimistic person, but when it comes to the world that individual investors face, it’s a mess.

TR:

Why is that?

DS:

The fundamental reason that individuals don’t have the types of choices they should have is because of the profit orientation in the mutual fund industry. Don’t get me wrong, I’m a capitalist, and I believe in profits. But there’s a fundamental conflict between the profit motive and fiduciary responsibility—because the greater the profits for the service provider, the lower the returns for the investor.

TR:

When we’re talking about fiduciary responsibility, not all investors even know what that means. What we’re really talking about is: you have to put investors’ interests ahead of your own.

DS:

The problem is that the managers of the mutual funds make more money when they gather huge piles of assets and charge high fees. The high fees are in direct conflict with the goal of producing high returns. And so what happens over and over again is the profits win and the investor seeking returns loses. There are only two organizations where that conflict doesn’t exist, and they’re Vanguard and TIAA-CREF. Both operate on a not-for-profit basis—they’re looking out for the investors’ interests, and they’re strong fiduciaries. And fiduciary responsibility always wins.

TR:

Because mutual funds spectacularly underperform the market. I’ve read that from 1984 to 1998, only about 4% of funds [with over $100 million in assets under management (AUM)] beat the Vanguard 500. And that 4% isn’t the same every year—a more simple way of saying that is that 96% of all mutual funds fail to beat the market.

DS:

Those statistics are only the tip of the iceberg. The reality is even worse. When you look at past performance, you can only look at the funds in existence today.

TR:

Survivors.

DS:

Exactly. Those statistics suffer from survivorship bias. Over the last ten years, hundreds of mutual funds have gone out of business because they performed poorly. Of course, they don’t take the funds with great returns and merge them into funds with lousy returns. They take the funds with lousy returns and merge them into funds with great returns.

TR:

So the 96% isn’t accurate?

DS:

It’s worse.

TR:

Wow.

DS:

There’s another reason the investor’s reality is worse than the numbers you cite, and that’s because of our own behavioral mistakes we make as individual investors. Individuals tend to buy funds that have good performance. And they chase returns. And then when funds perform poorly, they sell. And so they end up buying high and selling low. And that’s a bad way to make money.

TR:

What’s the reality of chasing returns?

DS:

A lot of it has to do with marketing. Nobody wants to say, “I own a bunch of one- and two-star funds.” They want to own four-star funds. And five-star funds. And brag about it at the office.

TR:

Of course.

DS:

But the four- and five-star funds are the ones that have performed well, not the ones that will perform well. If you systematically buy the ones that have performed well and sell the ones that have performed poorly, you’re going to end up underperforming. So add to your statistics that more than 90% of funds fail to match the market, and then add in the way people behave—they further depress their returns below the market.

TR:

So chasing returns is a guaranteed way to have a lower return or lose money?

DS:

Those factors that randomly cause something to perform well are just as likely to reverse themselves and cause what had performed well to perform poorly—it’s called reversion to the mean.

TR:

Okay, so what can investors do to help their cause?

DS:

There are only three tools, or levers, that investors have to [increase] returns. The first is asset allocation: What assets are you going to hold in your portfolio? And in which proportions are you going to hold them? The second is market timing. Are you going to try to bet on whether one asset class is going to perform better in the short run relative to the other asset classes you hold?

TR:

Are you going to be in bonds, or stocks, or real estate?

DS:

Yes, those short-term market-timing bets. And the third tool is security selection. How are you going to structure your bond portfolio or stock portfolio? And that’s it. Those are the only three tools we have. The overwhelmingly most important [as you figured out] is asset allocation.

TR:

I read that in your book, and it blew me away.

DS:

One of the things I love teaching my students at Yale is that asset allocation actually explains more than 100% of returns in investing! How can that be true? The reason is, when you engage in market timing, it costs you money; it’s not something you can play for free. Every time you buy or sell, you pay a broker. So there’s a leakage in fees and commissions paid—which reduces overall returns. And the same is true for security selection.

TR:

So this takes us back to index funds and a passive approach to investing.

DS:

Right. The active managers charge higher fees with promises of beating the market, but we’ve seen it’s a false promise more often than not. You can take a passive approach and own the whole market. And you can buy the entire market for a very, very low fee.

TR:

How low?

DS:

Less than 20 basis points. And you can get it through a mutual fund offered by Vanguard. So if you can implement your investment with low-cost, passively managed indexed funds, you’re going to be a winner.

TR:

You’re not paying fees, and you’re not trying to beat the market.

DS:

Plus, you get another benefit: your tax bill is going to be lower. This is huge. One of the most serious problems in the mutual fund industry, which is full of serious problems, is that almost all mutual fund managers behave as if taxes don’t matter. But taxes matter. Taxes matter a lot.

TR:

Is there any bigger bill we face in our lives?

DS:

No. And this speaks to the importance of taking advantage of every tax-advantaged investment opportunity that you can. You should maximize your contributions if you’ve got a 401(k), or a 403(b) if you work for a nonprofit. You should take every opportunity to invest in a tax-deferred way.

TR:

How do we set up the most efficient asset allocation?

DS:

Anybody who’s taken freshman economics has probably heard “There ain’t no such thing as a free lunch.” But Harry Markowitz, whom people call the father of modern portfolio theory, says that “diversification is a free lunch.” TR:

Why is that?

DS:

Because for any given level of return, if you diversify, you can generate that return with a lower risk; or for any given level of risk, if you diversify, you can generate a higher return. So it’s a free lunch. Diversification makes your portfolio better.

TR:

What’s the minimum diversification you need?

DS:

There are two levels of diversification. One is related to security selection. If you decide to buy an index fund, you are diversified to the maximum extent possible because you own the whole market. That’s one of the beauties of the index fund, and it’s one of the wonderful things Jack Bogle did for investors in America. He gave them the opportunity in a low-cost way to buy the whole market. But from an asset-allocation perspective, when we talk about diversification, we’re talking about investing in multiple asset classes. There are six that I think are really important and they are US stocks, US Treasury bonds, US Treasury inflation-protected securities [TIPS], foreign developed equities, foreign emerging-market equities, and real estate investment trusts [REITs].

TR:

Why do you pick those six versus others? And what’s your portfolio allocation?

DS:

Equities are the core for portfolios that have a long time horizon. Equities are obviously riskier than bonds. If the world works the way it’s supposed to work, equities will produce superior returns. It’s not true day in and day out, or week in and week out, or even year in and year out, but over reasonably long periods of time, equities should generate higher returns. I have a straw-man portfolio in my book, and 70% of the assets in there are equities [or equity-like], and 30% are fixed income.

TR:

Let’s start with the equity side of the portfolio: the 70%. One of your rules for diversification is to never have anything weighted more than 30%, is that correct?

DS:

Yes.

TR:

And so you put the first 30% where?

DS:

US stocks. One of the things I think that’s really important is we should never underestimate the resilience of the US economy. It’s very powerful. And no matter how much the politicians try and screw it up, there’s an underlying strength there. And I never want to bet against that.

TR:

And that’s why you’re so heavily weighted, 70%, toward growth. Not just in the US economy but in overall business around the world.

DS:

And then I probably put 10% in emerging markets, 15% in foreign development, and 15% in real estate investment trusts.

TR:

Tell me about the 30% fixed-income securities.

DS:

I’ve got all of them in Treasury securities. Half of them are traditional bonds. The other half are in inflation-protected TIPS. If you buy regular Treasury bonds, and inflation takes off, you’re going to end up with losses.

TR:

People get confused by that, unfortunately.

DS:

When I first started on Wall Street, I remember going to my first client meetings and whispering to myself over and over again, “Interest rates up, prices down.” I didn’t want to get that wrong. That would have been really embarrassing.

TR:

Can an individual investor make money in today’s market?

DS:

That’s the beauty of having a long-term buy-and-hold strategy. That’s why you diversify. I’m not smart enough to know where the markets are going to go. In the late ’90s, people said, “Why did you take all this trouble to diversify your portfolio? All you needed to do was own the S&P 500.” And what they were doing was, they were looking at the best asset class, and it just happened to be our equity market. And they said, “Everything you did was a waste of time.” But that was the American experience. And that’s not the only experience in the world. And if, at the beginning of the 1990s, you were a Japanese investor who put all your money in the Japanese market, at the end of the ’90s, you’d be miserable. You’re never going to have the return that’s equal to the best individual asset class return, and you never know what that asset class is going to be before the fact.

TR:

What do you say to the baby boomers out there, the ones who are facing retirement in the not-too-distant future?

DS:

Unfortunately, I think most individuals don’t have any idea how much money they need to save for their retirement. I really worry that a lot of people will look at their 401(k) account and say, “I have fifty thousand dollars or a hundred thousand—that’s a lot of money.” But if you’re talking about financing a retirement, it’s not a lot of money.

TR:

A lot of people aren’t going to be able to retire when they want to retire.

DS:

The only way people can get to the right place is to educate themselves. And I’m thrilled you’re trying to help people get the knowledge that they need in order to make intelligent decisions.

TR:

I understand that you went through a tough health time. What’s next for you?

DS:

About a year ago, I was diagnosed with cancer. I didn’t have a bucket list. I didn’t want to quit and travel around the world. I wanted to keep on doing what I could to support the university. Manage Yale’s portfolio as long as I could do it. And that’s what I’m doing. I love my job.

TR:

That’s awesome.

DS:

I think Yale is one of the world’s great institutions. And if I can do anything to make it a stronger place and a better place, then maybe I will have made a difference.

TR:

David, thank you, this has been extraordinary. I feel like I went to Yale and took a class on portfolio construction.

DS:

Well, you did.