Unconventional Success by David Swensen

David Swensen is the Chief Investment Officer at Yale University who takes charge of the Yale Endowment Fund. He has made an average return of 11.8% per annum over 10 years. I shall summarise his ideas from his book, “Unconventional Success: A Fundamental Approach to Personal Investment“. I could identify 3 main parts in the book and it should help you get a good idea on what his message is.

Asset allocation is key to consistent profits

It can be seen that his method is heavily centralised on Modern Portfolio Theory and his principal investment concept is that asset allocation is key to consistent profits. In essence, he believes a well portfolio should consist of the following asset classes and in the specific percentage. He called it a well-diversified, equity-oriented portfolio and they are also known as core asset classes. Quote: “Diversification demands that each asset class receive a weighting large enough to matter, but small enough not to matter too much.”

• US Equities – 30%
• Foreign developed equity – 15%
• Emerging market equity – 5%
• Real estate – 20%
• US Treasury bonds – 15%
• US Treasury Inflation-Protected Securities (TIPS) – 15%

The portfolio is equity heavy because he believes stocks is the greatest source of returns over the long run and beats inflation. US treasury bonds are to provide a hedge against financial accidents and deflation. During unexpected inflation, TIPS would provide the best protection as there will be direct correspondence to inflationary changes. The foreign developed equities provides diversification when the correlation between foreign markets and US market breaks down. The emerging markets contain higher risk due to greater uncertainties and hence, constitute a smaller percentage in the portfolio. Real estate provides both income and potential capital appreciation. The returns are expected to be between equities and bonds.

Rebalancing and maintaining allocation generate steady returns

As some of the asset classes would outperform the rest, the percentage of the value of these asset classes will soar. Swensen believes a rational investor would pay a conscious effort to rebalance the portfolio. The advantage is that it tends to smooth the market cycles and deliver a consistent return. It seems like a double edged sword, on one hand it may cushion the portfolio on the downturn, but at the same time, it also limits the portfolio during a stock market bull run.

Retail investors should build portfolio with ETFs

As a fund manager, he is critical on the mutual fund industry and believes the management fee and sales cost are doing the investors injustice. Therefore, he thinks that the average retail investor should build his portfolio using low cost Exchange Traded Funds (ETFs). A word of caution was that with the proliferation of ETFs in the market, there tend to be black sheeps in the family and investors should do their due diligence to find out more before investing. In his book, he recommended 14 ETFs:

For US stocks:

• Vanguard Total Stock Market (VIPERs) [VTI]
• iShares Russell 3000 [IWV]
• iShares Dow Jones U.S. Total Market [IVY]
• iShares S&P 1500 [ISI]
• iShares S&P 500 [IVV]
• SPDR S&P 500 [SPY]

For Foreign developed market stocks:

• iShares MSCI Europe Australiasia and Far East [EFA]

For Emerging market stocks:

• iShares MSCI Emerging Markets Index [EEM]

For real estate:

• SPDR Wilshire REIT [RWR]
• iShares Cohen & Steers Realty Majors [ICF]

For US Bonds

• iShares Lehman 1 to 3 year Treasury [SHY]
• iShares Lehman 7-10 Yr Treasury [IEF]
• iShares Barclays 20+ Yr Treasury [TLT]

For TIPS

• iShares Barclays TIPS [TIP]

One thing I must comment was that the book was written in 2005 and he already warned about the dangers of mortgage-backed securities which proved to be the main culprit of the financial meltdown in 2008. To quote: “First, the credit risk may ultimately prove greater than market participants assume. Second, the Government-sponsored enterprises (e.g. Freddie Mac and Fannie Mae) induced investor complacency may mask significant risk of exposure to hard-to-understand options. Investors beware.” Another good advice: “As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run.”