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David Swensen
has made better returns for Yale than any portfolio manager at any university.
He has a word of advice: don't try this at home. . Last spring, Yale president Richard C. Levin
'74PhD held a cocktail reception for David F. Swensen '80PhD, who was
celebrating his 20th year as Yale's chief investment officer. Inside the
president's official residence, posters and news clippings mounted on easels
tracked the growth of Yale's endowment from $1.3 billion to $14 billion under
Swensen's stewardship. The display culminated in a
bar chart titled "Value of Key Contributors to
No one has named a Yale building after David Swensen -- not
yet, anyway -- and it's a safe bet that most students and alumni do not know
who he is. Yet Swensen, an unassuming 51-year-old Midwesterner who did his
undergraduate work at the University of Wisconsin in River Falls, has
arguably made as much of a contribution to Yale as anyone in recent times.
That $7.8 billion figure is the difference between the value
of Yale's endowment today, after 20 years of Swensen's
portfolio management, and what its value would be had the money grown at an
average rate of return for all college and university endowments. When Yale
is measured against its peers, a group of universities with
multibillion-dollar endowments that includes Harvard, Since Swensen's arrival in 1985,
Yale's endowment has generated net investment returns that average 16.1
percent per year. "For the last 20 years, no educational institution has
a better performance record than Yale," Swensen says, matter-of-factly.
By comparison, Harvard's endowment has grown by a still very impressive 14.9
percent a year. Jack Meyer, the outgoing head of the Harvard Management Co.,
which manages Harvard's money, says, "I think David is the best in the
business." Think of it this way: a $10,000 gift to Yale made in 1985 would
have grown by now to $158,328, assuming none of it had been spent. That
performance handily beats stock market returns of $95,226, as measured by the
S&P 500, and bond market returns of $44,722, as measured by a Lehman
Brothers index. (It does not, however, approach the record of Berkshire
Hathaway, the company run by the legendary investor Warren Buffett, in which a $10,000 investment would have grown
to $413,721.) What makes Swensen's record more
noteworthy is that Yale's returns have been generated by a portfolio with
less risk than the one he inherited and less volatility than an investment in
stocks. That is an investor's dream -- less risk and higher return. Swensen's thinking has reshaped the
way other large-scale institutional endowments are managed; Harvard,
Princeton, and Stanford would be poorer institutions had their portfolio
managers not followed his lead, and people he helped train at Yale now manage
money at the Rockefeller Foundation, the Carnegie Corporation, and Bowdoin College. In 2000, Swensen wrote the definitive
book on institutional investing, called Pioneering Portfolio Management:
An Unconventional Approach to Institutional Investment. In August, the Free Press will publish his second book, a guide
for individual investors called Unconventional Success: A Fundamental
Approach to Personal Investment. Books offering investment advice are
plentiful, but this one is likely to make waves, for a couple of reasons. The
first is that Swensen's track record as an investor
lends him authority, and the second is that he is so clearly troubled about
what he sees as the immorality -- there's no other word for it -- of the
American investment business as it's practiced today. His most pointed
criticism is directed at the mutual fund industry, which, as he shows, has
been no friend to investors. "Overwhelmingly," Swensen writes,
"mutual funds extract enormous sums from investors in exchange for
providing a shocking disservice." That is, mutual funds charge their
investors big fees and usually fail to deliver returns that beat the market. While mutual fund managers are his favorite target, Swensen is
also bothered by other businesspeople who do not share his unyielding moral
sense. General Electric's former CEO, Jack Welch, with his retirement perks;
Merrill Lynch analysts who tout the stocks of their own investment-banking
clients; and Charles Schwab fund marketers who encourage investors to chase
hot performance -- all come under fire in the book. So does the Bush
administration's proposal to create personal Social Security accounts, which
Swensen views as irresponsible. Perhaps because Swensen prides himself on his integrity, he bristles
when critics come after him. Student activists have accused Yale of investing
in oil and timber operations that are environmentally irresponsible. Others,
including a Wall Street money managers suffer no such indignities. They
also earn much more than Swensen does. In 2002-2003, the last year for which
public records are available, he was paid about $1 million, making him Yale's
highest-paid employee. But his counterparts at Harvard, which has outsourced
its portfolio management to a private company, earn $15 million to $20
million a year. And hedge fund managers in the private sector earn even more
-- typically, 20 percent of their investment returns, which can net the best
of them $100 million or more in a good year. So it's no wonder that, when
Swensen spoke to alumni in What is wrong with David Swensen? "A genetic
defect," he says, smiling. He is only half-joking. The oldest of six
children, Swensen comes from a family of academics. His father and
grandfather were chemistry professors. His father was also dean of the
college of arts and sciences at the University of Wisconsin-River Falls. His
mother became a Lutheran minister after raising their children. His parents
organized international cultural exchanges and helped resettle more than 100
foreign refugees in rural Instead, Swensen came to Yale in 1975 as a graduate student in
economics and fell in love with the place. "I'd never met so many smart
people who loved ideas, who loved to engage in intellectual debate," he
says. As a freshman counselor, he began a lifelong friendship with a As a grad student, Swensen studied with two gifted economists
who would help shape his life. James Tobin, a Nobel Prize winner with a
modest mien and a deep moral sensibility, became his mentor and good friend
until Tobin's death in 2002. William Brainard, the
Arthur Okun Professor of Economics, advised him,
first on his dissertation and later on work in the investments office. Swensen's dissertation, "A Model for the Valuation
of Corporate Bonds," led him to Wall Street, where he spent six years in
corporate finance at Lehman Brothers and Salomon Brothers. "I liked the
competitive aspects of Wall Street," he says, "but -- and I'm not
making a value judgment here -- it wasn't the right place for me because the
end result is that people are trying to make lots of money for themselves.
That just doesn't suit me." When Yale needed a new endowment manager in 1985, Brainard, then the university provost, recommended Swensen.
He was an unorthodox hire. Only 31, he had never managed an institutional
portfolio. But he was smart, and analytical, and willing to challenge
conventional wisdom. Recalls Brainard: "It
might have looked like an odd choice, but I didn't have any anxieties about
it." The endowment had been poorly managed for some time. From 1968
to 1979, a period of high inflation and poor stock market performance, its
purchasing power declined by 45 percent. Spending had been frozen, and an
outside company formed by Yale to manage the endowment had been fired. Here, a word about how the endowment works. The $14 billion
investment pool is actually an amalgam of thousands of funds donated for a
wide variety of purposes. These funds support the 28 Sterling Professors, underwrite
scholarships, and finance so many graduation prizes that they cannot all be
given out in one day. They also pay for upkeep of the bells in Schools with the biggest endowments get richer because both
their relative and absolute returns tend to be better. So the gap that
separates Harvard, Yale, and Every endowment manager has two goals. "If you are going
to be a good steward of endowment assets," Swensen explains, "you
need to care both about preserving the purchasing power of the portfolio and
about providing as much for the operating budget as you possibly can."
Yale uses a complex formula to calculate how much it can spend from the
endowment each year; the rate, which is set by the Yale Corporation, has
increased from 4.5 percent in 1982 to 5.25 percent today, reflecting
confidence that the endowment will continue to grow at a healthy pace. The heart of the endowment manager's job is to allocate assets
to different classes of investments. In the early 1980s, Yale held more than
three-quarters of its money in How diversified have Yale's holdings become? Over the years,
the endowment has invested in public companies like the cable giant Comcast
and the insurance firm UnitedHealthcare, startups
like Cisco, Yahoo, and Amazon before they went public, newly privatized firms
in Russia and small companies in China, high-end office buildings such as the
John Hancock Center in Chicago, timberland in Maine and Idaho, even a resort
in Tucson. (The women's golf team got to practice there for free one year.)
Most recently, according to the Wall Street Journal, Yale took a big
stake in the Kimpton Hotel and Restaurant Group, a
fast-growing chain of hip boutique hotels, many of which operate under the
Hotel Monaco brand. By diversifying beyond In retrospect, Swensen's approach
sounds sensible, but at the time it was revolutionary. "No institutions
were managing money in accordance with what finance theory would tell
us," he says. "It just wasn't done." Len Baker '64, a Asset allocation is driven mostly by quantitative analysis. But
the second major job of an endowment manager is picking the right asset
managers -- a matter of judgment, more art than science. Swensen has a
demonstrable gift for both. Remarkably, Yale's outside managers outperform
the benchmarks in each of the asset classes. It's famously difficult, for
example, for active managers of Before hiring an outside manager, Swensen does lots of due
diligence. "People I went to junior high school with had been contacted
by Yale," jokes Doug Shorenstein, chair and chief executive of the
Shorenstein Company, a real estate firm that invests for Yale. Swensen
accompanies investment managers when they visit companies, and he will call
CEOs to see which investors they think best understand their business.
"You want people of high integrity, high energy, high intellect, people
who are obsessed with the market," he says. "You like to see
independence, a modestly strong contrarian bent." He also wants Yale's
outside managers to have their own money in the funds they manage for their
clients, and he prefers those who specialize. One manager focuses on small
energy companies in Over the past ten years, Yale's domestic equity managers as a
group have outperformed the Wilshire 5000, a broad gauge of publicly traded
stocks, by 5.5 percent a year. Yale's managers have also outperformed their
benchmarks in the categories of absolute return, fixed-income bonds, real
assets, and the biggest winner of all, private equity, which earned Yale a
whopping 37.6 percent annual return over the past ten years. This included
Yale's single most profitable investment to date, a stake in a
telecommunications company called Cerent. Yale
bought its stake for $400,000 and collected $130 million when the company was
sold to Cisco in 1999. By investing with Because it was diversified, the endowment also held up well
after the bubble burst and the public markets collapsed. In 2002, a year when
most endowments suffered heavy losses, Yale's portfolio gained a respectable
0.7 percent. "The endowment growth," says Rick Levin,
"is by far the most important single financial contributor to what we
have been able to accomplish over the last decade." When Swensen became
chief investment officer in 1985, Yale could safely spend just $46 million of
endowment money a year, representing about 10 percent of its operating
budget. Last year, the university spent $502 million from the endowment,
about 31 percent of its budget. The difference amounts to well over $1
million a day, and its impact is tangible: renovated campus buildings, a $1
billion investment in facilities for science, engineering, and medicine,
dramatic increases in financial aid for low-income and international
students, and new global initiatives. Charles Ellis '59, a member of the Yale
Corporation and chair of its investment committee, says, "Can you
imagine Rick Levin doing anything like the great job he's done if he didn't
have the discretionary resources to do it?" Or, as a rival portfolio manager said when the Chronicle of
Higher Education asked him about Swensen: "He's too damn good for
the rest of us." Last spring, as students in a class in Yale's David Swensen teaches this class on institutional portfolio
management every year, along with a There is no way for anyone but Swensen and his team to know
whether Yale profits from sweatshops (even if we could agree on how to define
the term), because the endowment customarily does not identify its holdings
or disclose the names of its investment managers. Only a limited amount of
data is released as part of Yale's IRS filings. Transparency has become a
watchword in corporate Ethical investing has been debated at Yale for more than 30
years. Swensen's mentors, Tobin and Brainard, led a seminar on the issue in 1969. Three years
later, law professor John Simon '53LLB and two graduate students wrote The
Ethical Investor: Universities and Corporate Responsibility, the first
book on the topic. In 1972, Yale also became "the first major university
to resolve this issue by abandoning the role of passive institutional
investor," according to the New York Times. It formed an Advisory
Committee on Investor Responsibility (ACIR) made up of students, faculty, and
alumni. Between 1978 and 1994, at the committee's urging, Yale divested
shares of 17 companies doing business in Other universities are more open, and some have gone further
than Yale, when it comes to ethical investing. Harvard divested tobacco
stocks; Yale has not, though Swensen says there were no tobacco holdings as
of his last yearly review. This spring Harvard divested from PetroChina, a company tied to the Sudanese government. Robert A. G. Monks, a prominent shareholder advocate, says
universities are obliged to become more responsible owners. He argues that
active institutional owners could help to steer business in ethical
directions on issues ranging from CEO pay to global warming. "By their
silence, the great universities have allowed shareholder advocacy to be
marginalized," Monks says. "If Harvard and Yale were to say, 'We're
owners and we've got to take responsibility,' then everyone would follow that
norm." Swensen responds that Yale has committed to managing its timber
holdings sustainably, and the investment managers
he hires do speak up about the corporations in which they hold stakes. (Glenn
Greenberg publicly objected when Comcast tried to merge with Disney.) Swensen
also says that he welcomes the campus debate, now unfolding under the auspices
of ACIR, over the university's holdings in companies doing business in Swensen argues that disclosing Yale's holdings would erode the
university's competitive edge. "To the extent that there's value in the
information that an active manager gathers, you dissipate that value in
making the information public," Swensen says. Disclosure might also
bring unwanted attention to asset managers. "If people discover that one
of our managers is investing for Yale, that becomes
a Good Housekeeping Seal of Approval, and the manager comes under pressure to
take more money." Nor, he says, would it be practical for him to take on
the task of setting social and environmental policy for all of Yale's
investment managers, let alone for the companies they invest in. "I
don't want to be in a position where I'm trying to figure out the right
social consequences and the right environmental consequences and then try to
engineer the portfolio to achieve those," he says. "That's not my
job." Swensen chose to write his new book for individual investors
because, he says, "It's very, very difficult for investors to get good
advice. Most providers have an ax to grind." Brokers want people to
trade stocks, insurance agents want to push their products, and the mutual
fund industry and its vast network of distributors -- well, don't get Swensen
going on that. Swensen's critique of the for-profit
mutual fund industry is devastating. He argues persuasively that most mutual
funds and their managers benefit from high fees, sales commissions, portfolio
turnover, and, above all, amassing more assets. Those actions all run counter
to the interests of individual investors. Moreover, most funds fail even to
achieve their basic goal of beating market returns. They are charging a lot
of money for lousy results. "Overwhelming evidence," writes Swensen, "proves the failure of the for-profit
mutual-fund industry." Consider just one problem he identifies -- the so-called 12b-1
fees, which mutual funds charge to their investors to pay for marketing and
distribution costs. The fees pay for, among other things, those full-page ads
touting the latest hot funds that appear in newspapers and magazines. Their
purpose, of course, is to bring in new investors, who make the fund company
more profitable. But as funds grow bigger, managers inevitably find it
difficult to buy bigger stakes in their existing investments without driving
up the cost. "There's an inverse relationship between size and
performance. Period," Swensen says. The SEC has permitted 12b-1 fees
even though they are clearly not in the interests of investors. Swensen
writes: "Shame on the SEC for allowing 12b-1 fees, shame on the [fund]
directors for approving them, and shame on the mutual funds for assessing
them." Brokers, who charge sales commissions for the mutual funds they
offer, only stack the deck further against their unsophisticated clients.
"Sensible investors avoid the brokerage community," he writes. None of this will win Swensen friends on Wall Street. Several
Yale Corporation members and members of its investment committee have close
ties to the fund and brokerage businesses. So be it, Swensen says. "I
don't want to make people feel badly about what they do, but I just think
that the entire mutual fund industry has failed," he says. "The
clients lost, and the people who run the mutual funds made a lot of money.
That's scandalous. It's a failure of the system. I know at times that I sound
intemperate, but I feel so passionately about this." Swensen's book could also thrust him
into the debate over privatizing Social Security accounts. In Unconventional
Success, he shows that most individual investors fail to follow the most
basic investment precepts. Most trade too much, buy high, sell low, chase
past performance, and fritter away money on excessive fees and sales charges.
Given that, it's tough to argue that giving individuals more control over
their retirement accounts is sound policy. "You're asking people to take
responsibility for an activity in which they've demonstrated failure,"
Swensen says. As for Swensen's own future, his hope
is to keep doing what he's doing. A divorced father of three, he has carved
out a good life for himself in |
