Three Pieces of Advice from the Chief Investment Officer of Yale University
It is not just individuals who must decide how and where to save for longer-term goals like house purchases, college tuition and retirement. Large organizations like university endowments, pension managers and not-for-profit boards need to balance today’s spending with future objectives, as well as decide where to put their savings. While their accounts are many times larger than individual budgets — millions of people rely on “institutional” money management teams to make the right financial decisions — these groups face a similar set of challenges, as well as different ones. Understanding their decision making process and how they save can make us a better investor.
All this is captured in David Swenson’s classic, “Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.” Swenson, the long time Chief Investment Officer at Yale University, has developed an international reputation by growing Yale’s endowment through smart investing strategies. Now, as many of the assets he discusses are available to consumers, Swenson’s perspective has only grown in importance over the years.
A handful of Swenson’s themes:
1. Investment framework. Know what you are trying to accomplish and stick to your plan. By identifying your goals and selecting the right investment strategy you are much more likely to reach them.
2. Agency issues. Often the interests of financial managers are not aligned with their customers (investors). This can cost significant amounts of money over time through unnecessary fees and expensive investment selections.
3. Passive management. Large, efficient markets like the S&P 500 are difficult environments for active managers to compete in and overcome their fees. Passive investing is generally the right approach in most over-analyzed, liquid markets.
Swenson offers a sobering assessment of market efficiency, writing “investors wishing to beat the market by actively managing portfolios face daunting obstacles.” The additional costs of management fees, transaction expenses, and, for very large investors anyway, market impact, make profitable “active” investing very difficult. His advice is to look for passive alternatives first.
Further complicating the picture, for both professional and amateur investor alike, is evaluating the “less-well-understood” risks an active manager takes to obtain their returns. By creating a concentrated portfolio in a handful of stocks, a fund manager has the opportunity to get lucky and outperform a particular benchmark. Swensen reminds us that volatility measurements are useful, but come with significant limitations. Financial theories explaining market performance are an imperfect science. As Warren Buffett is often quoted, “beware of geeks bearing formulas.”
Similarly, when it comes to asset allocation, Swenson suggests we should accept market diversification as inexact at best. He writes, “the tendency for markets to move together in times of crisis reduces the value of diversification, at least in the short run…[and] pose[s] serious challenges to quantitative modeling.” Continuing, the author also warns against picking too many active funds. While each may represent a diversified portfolio, when combined an investor may be left with what is essentially a high cost, high turnover index fund.
Despite all the evidence, Swenson warns investors often find ways to fool themselves. Playing the market “provides psychic rewards, generating grist for the mill of cocktail party conversations.” In today’s environment where consumers have an increasing supply of investment options, Swensen’s advice is more applicable now than ever, especially for those focused on achieving their long-term savings goals.
Thanks for reading. Comments and suggestions for other topics welcome.
Below are reviews of popular titles in the financial space:
· Ric Edelman, the founder of Edelman Financial, “The Truth About Money: Everything You Need to Know About Money” here.
· Lars Kroijer’s “Money Mavericks: Confessions of a Hedge Fund Manager” here.
Below are a few posts on my experience with money and the financial industry in general:
HSA Coach. Health is WealthTM