The passing last year of investment great David Swensen was very sad news. We are fortunate that he was a generous sharer of his insight. But we need to be careful to focus on the right lessons from his success.
Swensen achieved excellent investment outcomes over his 35-year stewardship of Yale’s Endowment. He generated returns of 13.1% per annum through 30 June 2020, significantly outperforming his peers and a traditional 60% stock/40% fixed income portfolio.
He rethought how institutions should invest. His most famous book is the hugely influential Pioneering Portfolio Management, An Unconventional Approach to Institutional Management.
At the heart of his approach was an emphasis on diversification into illiquid and alternative assets. He believed in asset allocation rather than stock selection. Allocating to alternatives provided the returns required alongside significant diversification from long-only equity exposure. And he recognised that the endowment’s long-term investment horizons so they could invest in private markets and benefit from an illiquidity premium.
So Yale endowment took large exposures to hedge funds, venture capital, leveraged buyouts, natural resources – and real estate.
Swensen was a pioneer. Witnessing his success, many others followed and over time allocations to real estate have increased.
Many see Yale’s allocation to alternatives, including real estate, as Swensen’s key insight. This is a mistake.
“When an unconventional asset class becomes conventional, the investment proposition can change fundamentally”
Yale’s Endowment did well in these sectors because they were immature and other institutions were not investing in them. As capital has flowed into real estate, competition for the best managers, strategies and assets increased. When an unconventional asset class becomes conventional, the investment proposition can change fundamentally.
To understand Swensen’s key lessons, we should listen to those who knew him well and worked with him closely. They do not see investment brilliance as the key to Swensen’s success. They did not believe it was what he invested in, but rather how he invested that set him apart. They stress organisational and cultural aspects of Swensen’s approach.
