Yale's Alumni Magazine for March/April 2009, features Marc Gunther's interview with Yale Endowment's Super-Investor, David Swensen, and details some of Swensen's key advice to investors about portfolio management. It is a must read. Here is an excerpt.
In just under a quarter-century as Yale's chief investment officer, David Swensen '80PhD has generated Bernard Madoff-like returns -- except that Swensen made his money honestly. Under his leadership, Yale's endowment has generated an astonishing 20 consecutive years of positive returns, from 1988 to 2008.
Yale Alumni Magazine: Has it been a difficult time for you?
Swensen: In some ways, yes. I absolutely love the idea of producing ever-increasing levels of support for Yale. Looking ahead to the next few years, that's not going to be in the cards. That's a difficult reality to deal with.
But in terms of the day-to-day work, managing through this economic and financial crisis is absolutely fascinating. It's exhausting, but fascinating.
Y: It may be fascinating to you, but it's discouraging for those of us who have watched our 401(k) values plummet. Given all the turmoil and uncertainty, what should individual investors do?
S: If an individual investor followed the program I outlined in Unconventional Success [see box], they probably did reasonably well, through the crisis, thus far. They'd have 15 percent of their assets in U.S. Treasury bonds. They'd have another 15 percent in U.S. Treasury inflation-protected securities. Those two asset classes have performed well.
Of course, the other 70 percent of assets are in equities, which have not done well. With all assets, I recommend that people invest in index funds because they're transparent, understandable, and low-cost. So, the equity holdings have gone down step-by-step with the declines in the market.
I recommend that investors rebalance.
But I also recommend that investors rebalance. Rebalancing is even more important amidst these huge declines in the stock market because it presents a great opportunity. People can sell the Treasury securities that have appreciated dramatically to bring their allocation to the 15 percent target, and they can redeploy those funds into domestic equities and foreign equities and emerging market equities and real estate investment trusts, all of which are now much cheaper, and therefore have higher prospective returns.
Y: Explain this idea of asset allocation, please.
S: Asset allocation is the tool that you use to determine the risk and return characteristics of your portfolio. It's overwhelmingly important in terms of the results you achieve. In fact, studies show that asset allocation is responsible for more than 100 percent of the positive returns generated by investors.
Y: How can that be?
S: It's because the other two factors, security selection and market timing, are a net negative. That's not surprising. They're what economists would call zero-sum games. If somebody wins by buying Microsoft, then there has to be a loser on the other side who sold Microsoft. If it were free to trade Microsoft, the amount by which the winner wins would equal the amount by which the loser loses. But it's not free. It costs money. It costs money in the form of market impact and commissions if you're trading for your own account, and it costs money in terms of paying fancy fees if you are relying upon an investment advisor or mutual fund to make these security-specific decisions. For the community as a whole, all those fees are a drag on returns.
That's why the most sensible approach is to come up with specific asset allocation targets that you can implement with low-cost, passively managed index funds and rebalance regularly. You'll end up beating the overwhelming majority of participants in the financial markets.
Y: So people should not be afraid of stocks now?
S: Not only should they not be afraid, they should be enthusiastic. One of the great ironies is that if you had talked to the average investor 18 months ago, he or she would have thought it was a pretty good idea to buy stocks. In recent months, the same investors despair about their portfolio and are fearful about putting money into the equity market.
That's 180 degrees wrong. They should have been cautious 18 months ago, when prices were much higher than they are now. They should be enthusiastic today.
Y: That runs counter to human nature.
S: That's one of the really tricky things about the investment world. It's very different from a lot of things we deal with, day in and day out. If you talk to a businessman, a businessman is going to feed the winners and kill the losers. But in the investment world, when you've got a winner you should be suspicious about what's next. And if you've got a loser, you should be hopeful -- although not naively hopeful.
To read the whole interview, plus the additional material, click here. (make sure you read the items highlighted in blue on the right hand side)
