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My Two Cents

David Swensen’s A+ at Yale

Chris Farrell Sep 27, 2007

Who said, “Individual investors lose. Mutual fund managers win.” Consumer advocate Ralph Nader? Crusading New York State attorney general Eliott Spitzer? No, it was David Swensen.

Don’t worry if your reaction is “David who?” The chief investment officer for Yale University’s endowment fund isn’t a household name. But he should be.

In the past year, for the 12 months ending June 30th, the fund generated a 28% return, the highest in seven years. Over the past decade, Swensen earned an average annual return of nearly 18%, and Yale’s endowment nearly tripled to $25.5 billion. That’s not all. Over the past two decades, Yale’s endowment has averaged a nearly 16% average annual return vs 10% for the average endowment fund. “David Swensen has had the best record at any established investment institution in the world over the past 20 years,” says Barton Biggs, managing partner at hedge fund Traxton Partners in New York.

The performance is stunning. And several years ago, Swensen set out to impart his investment knowledge to individual investors. The book he came out with is called Unconventional Success: A Fundamental Approach to Personal Investment. It’s a book that should be on every investors bookshelf.

The title is misleading, however. Swensen’s reputation is that he is a Wall Street rarity–a true investment contrarian. Most endowments invest the bulk of their portfolio in domestic stocks and bonds. Swensen commits substantial sums to alternative, often highly illiquid investments, such as private equity, foreign stocks, and timber.

Yet he recommends individuals shun his approach as too impractical, too costly, and too time-consuming. Instead, he preaches the virtues of diversification, investing for the long haul, owning index funds, and keeping fees low. Swensen may make an unusually strong case for these investment verities, but it’s hardly unconventional advice.

The book should have been called “The Great Fund Rip-Off” or something along that line. For Swensen is scathing in his criticism of for-profit mutual funds. He believes the standard advice that individuals fare best when they turn over their money to the mutual fund managers is wrong. It’s a bromide guaranteed to lose individuals money. Worse yet, American workers are saving for retirement through for-profit mutual funds in their 401(K)s, 403(b)s, 457s, and the like. If he’s right in his dismal judgment–and I think he’s disturbingly on targe–then the retirement security of millions of Americans is at risk to a rapacious mutual fund industry.

Now, this is an uncompromising, unconventional argument for an investment professional. In essence, Swensen believes the fundamental conflict of interest between for-profit mutual fund managers and their shareholders is irreconcilable. Management will always choose lining their own pockets over their customers’ interests through outrageous fees, opaque charges, excessive trading, and other financial shenanigans. “When a sophisticated provider of financial services stands toe to toe with a naive consumer, the all-too-predictable conclusion resembles the results of a fight between a heavyweight champion and a ninety-eight-pound weakling,” he writes. “The individual investor loses in the first round knockout.”

Swensen supports his dark take with plenty of detail and examples. Among the more intriguing sections is a history of the industry. Scandals have a long pedigree in the mutual fund industry. For instance, in the 1920s and 1930s Wall Street dealers took advantage of their shareholders through a two-tier pricing system. In the ’40s, ’50s, and ’60s large investors routinely took advantage of old prices to reap extra profits. The same goes for the mutual fund scandals of the early 2000s. “The abuses have existed decade after decade,” says Swensen.

Of course, there have been reforms over the years. But Swensen isn’t buying any optimistic future, though. “Regulatory authorities prove no match for profit seeking charlatans,” he says.

What is an individual investor to do? For now, Swensen recommends buying index funds, preferably through low-fee not-for-profit fund companies like Vanguard and TIAA-CREF. Unconventional Success should be required reading for every graduating senior in college before they start investing for their retirement. It should also be required reading for Congress and in executive suites. America’s retirees deserve better than the system they have now.

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