Yale investing guru Swensen missed problems with his advice

Posted by: Aaron Pressman on March 17, 2009

The brutal bear market has been less than kind to almost everyone who ever gave investing advice. In some cases, the press has picked up on it but not in every case. Exhibit A today is the continued praise showered on David Swensen, head of Yale’s endowment and author of the 2005 book, Unconventional Success: A Fundamental Approach to Personal Investment. In the book, Swensen lays out a simple asset allocation strategy relying on inexpensive index funds. Sock away 30% of your assets in U.S. stocks, 20% in real estate investment trusts, 15% in U.S. Treasury bonds, 15% in U.S. Inflation Protected Securities, 15% in foreign, developed stocks and 5% emerging market stocks. That’s it. That’s the magic formula.

In an interview in the March/April issue of the Yale Alumni magazine that went online the other day, Swensen says the magic formula is still the way to go:

Q: 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?

A: 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.

Of course, there’s one big problem with Swensen’s answer. His magic formula didn’t do so well during the crisis. If you take a simple mix of exchange-traded funds, allocate per Swensen’s book and look at the results over the past year, the bottom line is pretty ugly: -32%. (I used funds with the symbols IWV, TLT, TIP, EEM, IYR and EFA). That beats the S&P 500, but it’s much worse than a simple mix of say 70% U.S. stocks and 30% bonds, which lost only 25%. A 60/40 mix dropped 19%.

And a year-end rebalancing wouldn’t have helped — at least not yet. If you set Swensen’s allocations up at the beginning of 2008 (and lost 23%) and then rebalanced at the beginning of 2009, you’d be down 17% so far this year. But if you let your winners ride, so to speak, and went with the portfolio as it stood, you’d only be down 12%.

There are any number of reasons why Swensen’s magic formula wasn’t so magical of late. The main reason is that most of the various asset classes involved started to mirror each other’s performance more and more as the bear market grew more severe. Thus, the benefits of diversification shrank. It’s a predictable effect, the increasing correlation of different asset classes in volatile markets that’s been identified in numerous academic studies. One asset that would have helped improve results is gold, but Swensen’s not much of a commodity fan, at least in his book.

So what do you think? Should Swensen have his investing guru credentials repealed or is his advice still worth following?

[UPDATE: We’ve started a new thread about Swensen with more data and more arguments here.]

Reader Comments

Timothy Sykes

March 17, 2009 2:14 PM

I suggest you look at my strategy of short selling hyped up manipulated stocks, up 250% in the last 1.5 years, http://www.timothysykes.com/tim lists all my trades and they're much better than any of these other pretend gurus who might work well for institutions, but they suck for the averae investor/trader

Swensen Fan

March 17, 2009 4:54 PM

In his own words, from, Bloomberg Jan 2, 2009 Interview with Swensen:
“There isn’t an investment strategy that can produce the kind of long-term results we’ve generated at Yale that isn’t going to post the occasional negative return,” Swensen said in the Dec. 30 interview. “I don’t think people should disregard the book because of the market trauma of the last few months. We’re not even done with the current fiscal year. Judging a long-term investment strategy based on the results of a five- to six-month period is foolish beyond words.”

I Like Swensen But

March 18, 2009 2:14 PM

"Don't touch any commodities whatsoever with a ten-foot pole" is just terrible advice, especially from a diversification uber alles guru who ought to know better.

MSS

March 18, 2009 8:07 PM

Is it really fair just to look at his allocation's performance over one year. I have not read his book, but I would bet that he is measuring this performance over 10, 20 or 30 years.

ignorance arbitrage

March 19, 2009 3:23 PM

This is a singularly idiotic post.

This is a long term investment strategy (as he points out again and again in his book), judging it in 15 minute increments is just incredibly bad investment analysis.

Rather than asking, "Should Swensen have his investing guru credentials repealed or is his advice still worth following?" we should ask, "Should Aaron Pressman be allowed to write an investment column?"

Lawrence Weinman

March 20, 2009 7:33 PM

based on aaron pressman's methodology for evaluating investment strategists, the investment strategist that advocated putting all ones money in tbills would be the best qualified investment strategist since he his strategy outperformed all others last year.

Yale fan

March 21, 2009 3:38 PM

People who follow Swensen need to realize the endowment time frame is measured in decades and multi-decades versus a few years for the average shmuck investor, so he can deal with the bad years here and there. Also, with over 70% in "alternatives" and private equity, much of the great returns that beefed up the portfolio came with private equity deals such as Google, well before the IPO and other tech darlings in the infancy stages.

He is a great investor, but the average Joe can't touch his results even if they try. He can get great managers and early entry at low fees, we can't.

Stu

April 23, 2009 5:46 PM

Kudos to the person who posted this:

"This is a singularly idiotic post.

This is a long term investment strategy (as he points out again and again in his book), judging it in 15 minute increments is just incredibly bad investment analysis.

Rather than asking, "Should Swensen have his investing guru credentials repealed or is his advice still worth following?" we should ask, "Should Aaron Pressman be allowed to write an investment column?""

Yale Fan

May 15, 2009 6:27 PM

Pressman acknowledges that Swensen's strategy beat the S&P 500 and that during a severe bear market, asset classes begin to mirror each other. However, he doesn't give him enough credit. Because of Swensen's ideals, he works for less at a university, shares his advice with the masses and institutional investors (and the President),and is a vocal critic of the underhandedness in the mutual fund industry. Furthermore, his endowment has outperformed every other university for the last two decades.

Swensen is The Guru of investing.

ignorance arbitrage

June 1, 2009 10:49 PM

Thanks, Stu.

I'm trying my hand at blogging, where I have a post on Harvard v. Yale discussions... ignorancearbitrage.blogspot.com

Finn

June 16, 2009 4:36 PM

This is a worringly ignorant article - others have pointed out that saying a long-term strategy underperformed in one 12 month period is just stupid beyond words. However, to be more specific, Mr. Pressman is ill-advised because the 60/40 mix he suggests will dramatically underperform when the recovery comes. he clearly does not understand the notion of an efficient frontier and gaining the maximum return for a given risk. We have to understand that Swensen's model portfolio is a Beta-reliant portfolio - that is, its returns come from risk premia. It is designed to be pretty close at the efficient frontier, according to MPT, and assumes the investor knows nothing about the future beyond past risk-return and correlation numbers for the different asset classes. Oh, and to the person who advocates using Gold as a hedge against inflation - go get a long-term chart of Gold returns (pre-1970). I think it averages about 0.1% p.a. over 200 years - why not use Treasuries and TIPS for your inflation/deflation stabilisers and get a risk premium for doing so?

Aaron Pressman

June 17, 2009 9:55 AM

Thanks for all the comments, folks. I thought I'd jump in to address some of the points raised by Swensen defenders.

1. It was Swensen, in an interview with Yale's alumni magazine, who made an assertion -- one which was categorically false -- about the short-term performance of his magic formula. The magic formula did not do "reasonably well" for various reasons outlined in the original post.

2. There's a huge and misleading disconnect between how Swensen has run the Yale endowment to produce such amazing results and the magic formula he recommends for ordinary investors. Yale uses active managers, has nothing like 30% of its assets in US stocks and frequently reallocates among a wide array of asset classes, many of which aren't easily accessed by individuals. Plenty of investors turned on by Yale's results looked to Swensen for advice but the advice they received has no connection to the endowment's superior results. Those commenters who cite Swensen's Yale track record as evidence that his magic formula is a good idea have fallen into the same trap.

3. Until he wrote a book for individual investors, Swensen regularly admitted that individual investors could not follow Yale's investing program. I suspect he got tired of giving that non-answer and, to paraphrase Woody Allen in the great flick "Manhattan," let's face it, he wanted to sell some books here.

4. Some commenters make reference to modern portfolio theory, the efficient frontier and the benefits of diversification. These are excellent theories but they're constructed on top of numerous simplifying assumptions about how the world works. I'd suggest taking a look at some of the more recent research about how MPT has failed of late. Particularly, Nassim Nicholas Taleb. Here's a quote from a recent interview:

"The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world.

All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that. In the 1920s, the German mark went from three marks to a dollar to three trillion to a dollar in no time.

That’s why portfolio theory simply doesn’t work. It uses metrics like variance to describe risk, while most real risk comes from a single observation, so variance is a volatility that doesn’t really describe the risk. It’s very foolish to use variance."


(For more see http://www.mckinseyquarterly.com/Corporate_Finance/Performance/Taking_improbable_events_seriously_An_interview_with_the_author_of_The_Black_Swan_2267)

Aaron Pressman

June 17, 2009 11:38 AM

I expanded the above reply into a new blog post so feel free to check out the expanded version over at
and post comments there if you'd like.

American in Paris

June 23, 2009 1:42 PM

I just want to see Mr. Pressman do better. Whining about the fact that 2008 was a bad year except for someone 100% in cash is not productive. And of course, anyone 100% in cash would have experienced negative returns during the last ten years due to inflation and taxes.

Aaron Pressman

June 23, 2009 2:21 PM

Rod, Businessweek reporter and blogger Aaron Pressman here.

Thanks for your comments. But I don't think many would agree that the correct analytical approach to investing is to throw up one's hands and conclude that every strategy lost money over the last year and stop there. For one, Faber's did not. Further, the addition of asset classes Swensen excludes but others include (like gold) would have improved returns. Or look at an asset allocation fund like First Eagle Global (SGENX) which has a substantially better record over that past five-ish year span I cited above than Swensen's formula.

The point that cash would have lost money because of taxes and inflation applies to any strategy (not that anyone here was pushing an all-cash strategy). The return of Swensen's magic formula would have been even lower if you adjusted for inflation, taxes on the interest and dividends from the ETFs etc.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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