Book Review — “Unconventional Success — A Fundamental Approach to Personal Investment” by David Swensen
Investors have never had it so good: more and better information is available than ever before. With a little effort and a few clicks, most of what you need can be found on your screen while sitting on your couch.
Yet this unprecedented access is deceptive. Information overload makes choosing what to read — as well as who to trust — increasingly difficult.
Indeed, good, independent advice — like other forms of knowledge — is often hidden behind sales brochures and marketing literature. Further, much of the really important detail is often obscured by the fine print of legal disclosures.
Finding what you need sometimes requires a trip to the proverbial library, or Amazon. Fortunately, with time and effort the pieces will come together and reveal the bigger picture.
While I’ve read a lot of good books on investing, few have the same perspective as David Swensen’s “Unconventional Success — A Fundamental Approach to Personal Investment.” Now over a decade old, Swenson’s work may be one of the best, most approachable books for today’s modern investor.
In addition to the expected discussion of stocks, bonds and mutual funds, Swensen weighs in on private equity, hedge funds, mortgage-backed securities and others. Further, Swenson pulls no punches in his observations of Wall Street and the challenges faced by the individual investor.
However, unless you are in the financial services industry or managing a major endowment, you likely haven’t heard of Swensen. As the Chief Investment Officer for Yale University’s Endowment Fund, Swensen evaluates just about every aspect of institutional investing. [Swensen’s other book, Pioneering Portfolio Management, is practically required within institutional wealth management.].
Below are some of his thoughts contained in Unconventional Success for today’s modern investors. Further, I’ve largely quoted to share Swensen’s style and wit, as well as to retain the punch of his recommendations:
The mutual fund industry: “The mutual fund industry sits at the center of a massive market failure. The asymmetry between sophisticated institutional providers of investment management services and unsophisticated individual consumers results in a monumental transfer of wealth from individual to institution.”
While no secret in the industry, Swensen is the biggest name I’ve come across to label this disconnect a “massive market failure.” The knowledge gap between most investors and the investment industry means, for many customers, most of the financial markets returns are absorbed by industry fees, commissions and other expenses. What is left is then further reduced by taxes [see below].
Help may be on the way, however. Robo-advisors, mostly a mix of algorithms and call-center advisors, are attempting to bridge the knowledge gap, empowering unsophisticated investors for a reduced, market-friendly fee.
Active investment management: “Evidence points overwhelmingly to the conclusion that active management of assets fails to produce satisfactory results for individual investors. Two factors explain the individual’s predicament. The first problem stems from the investment choices available to the individuals. High costs and poor execution doom the vast majority of offerings. The second problem concerns responses by individuals to markets. Research shortcomings, rear-view mirror investing, and investor fickleness cripple most investment programs.”
As Dalbar, an investing data firm, captures in their annual investor performance report, we are often our own worst enemy when it comes to managing our investments. When combined with the active trading of professional managers, it is little surprising that most of us earn roughly half of the market’s annual returns for our accounts.
Alternative investments (“alts”), such as hedge funds and private equity: “Understanding the difficulty of identifying superior hedge fund, venture-capital, and leveraged-buyout investments leads to the conclusion that hurdles for casual investors stand insurmountably high. Even many well-equipped investors fail to clear the hurdles necessary to achieve consistent success in producing market-beating active management results…Trendy investors often pursue the cocktail-party-chatter benefits of commitments to the promise, seldom fulfilled, of actively managed alternatives.”
As I was instructed early in my career, we should avoid investing in things we don’t understand. However, social pressure (among many influences) causes us to pursue “wealth-destructive” behavior. Couple that with the difficulty of doing nothing, a counter-intuitive approach to investing, and we are primed to make more decisions than we should.
However, when it comes to investing, doing nothing (or, more accurately, very little) can be a much better approach, a strategy admittedly at odds with other aspects of life.
Financial product complexity: “Asset-backed securities involve a high degree of financial engineering. As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run. At times the creators and issuers of complex securities fail to understand how the securities might behave under various circumstances. What chance does the nonprofessional investor have?”
Swensen echoes what generations of writers before him have counseled against, as will many writers in the future.
This is not unlike the summary plan documents required of employer-sponsored retirement programs. Legal watchdogs determined the language required to describe the products — as well as protect those selling the financial products– stump nearly all of us. As a result the Department of Labor, following the Employer Retirement Income Security Act of 1974 (ERISA), mandates simpler, watered down description forms be periodically distributed to retirement plan participants.
Further, for those who think complexity is a problem for amateurs, I recommend reading “When Genius Failed: The Rise and Fall of Long-Term Capital Management.” Another, more recent example of complexity stumping the experts, one many of us are likely familiar with, is the sub-prime mortgage collapse of the preceding decade.
Be wary of complexity.
Market timing: “Active market timers usually fail. Market timing requires taking relatively few, generally undiversifiable positions. Timing decisions involve the large questions of asset-class valuation, forcing short-term asset allocators to develop views on an impossibly broad range of factors. Even if the market timer overcomes the odds by making a correct call, notoriously fickle markets may fail to resolve valuation discrepancies in the short run. Serious investors avoid entering the market-timing morass.”
As others have written, in few endeavors do novices expect to take on hardened, industry professionals and win. The vast majority of investments are bought and sold by financial industry veterans who are paid handsomely when they make the right call, and paid better than most even when the don’t. As Swensen writes, “individual investors possess neither the time nor the resources to succeed in active management of marketable securities portfolios.”
Charles Schwab, Morningstar and the Broker Community: “Schwab’s advice…simply encourages readers to allocate assets in security types that have done well…[Schwab’s] rearview-mirror orientation further comes through in the boast that it offers ‘most 4 and 5-star Morningstar-rated bond funds,’ touting a rating system that utilizes only backward-looking analysis.”
The logic of investing is counterintuitive: buy when times are bad and sell when times are good. Unfortunately, we tend to trust in the familiar and recently successful. Instead we should beware last year’s winners.
As Yogi Berra said, “it’s tough to make predictions, especially about the future.”
Industry compensation and mutual fund distribution payments. “Pay to play represents yet another reason for sensible investors to avoid broker-marketed mutual funds.”
Many investors do not realize that many of the funds their advisor selects pay a commission to the advisor. True, an advisor’s compensation must now be disclosed, but it is generally behind legal language that obscures the incentives. One need not have a degree in human behavior to assume these cash payments may influence the advice an an advisor provides.
Retirement savings management: “Instead of looking forward to a promised benefit supported by a variety of safety nets, employees face a future determined by their usually ill-considered decisions regarding savings levels and their frequently ill-informed actions regarding investment alternatives.”
Much has been written about the dangers created by moving employee retirement savings from a defined benefit pension scheme to a defined contribution, largely self-directed account (such as a 401(k) and 403(b)). Swensen believes this introduces extraordinary risk to the average American, imposing a burden of investment management few will handle. We, as a society, will end up facing the consequences.
Taxes and Investing: “In an industry guilty of many crimes against investors, ignoring the tax consequences of portfolio transactions ranks among the most grievous…lack of tax sensitivity by the mutual-fund community imposes huge costs on investors.”
“From a tax perspective, index funds once again provide a significantly better option. Even though passive replication of a market index falls short of total tax efficiency, the low turnover of an index fund produces aftertax results superior to nearly all actively managed portfolios.”
This is by no means new, but worth repeating: taxes are the silent drain on your investing. While the financial services industry reports fund performance in gross, top line performance, what individual investors actually take home can be far different. There is a reason the fine print always says “consult your tax advisor.”
Conclusion: Despite his significant technical expertise - or perhaps because of it - Swensen recognizes emotions and human behavior drive much of the investing market. Overcoming the barriers of investor knowledge, industry structure (fees, commissions, excessive expenses, lack of individual investor tax sensitivity, etc.), and behavior are non-trivial, requiring effort and continued diligence.
However, this is attainable. The decision then, as with so much in life, comes down to where and how you want to spend your (cool and unemotional) time.
Final Word — If these topics are not your passion or an area you see yourself dedicating time to, then you will likely want to explore hiring the services of a financial advisor, preferably one who has obtained a CFP designation. A CFP must pass an exam testing knowledge not only of investments and taxes, but also basic budgeting, insurance and estate planning, to name a few areas. Similar to other professional fields, a CFP must then maintain their license through continuing professional education requirements.
More Books: Other books in this category worth a read are:
“Winning the Losers Game: Timeless Strategies for Successful Investing” by Charles Ellis (my review here)
“A Random Walk Down Wall Street” by Burton Malkiel (my review here)
“The Clash of Cultures: Investment vs. Speculation” by John Bogle (my review here)
“Investment: A History” by Reamer and Downing (my review here)
“Empire of the Fund: The Way We Save Now” by Birdthistle
“Where are the Customers’ Yachts: or A Good Hard Look at Wall Street” by Fred Schwed
“Against the Gods: The Remarkable Story of Risk” by Peter Bernstein
