Legendary investor David Swensen died of cancer earlier this month at age 67. Mr. Swensen revolutionized institutional money management as the developer of the Yale Model – an investment approach characterized by low bond holdings and extreme levels of diversification everywhere else.
Nick Maggiulli’s Of Dollars and Data website drew investor lessons from the manager’s highly successful career in 4 Investing Lessons from David Swensen. The four lessons are: “Asset allocation is everything,” “If you want growth, increase your equity exposure,” “Diversification works … in the long run” and “Our time horizon might be shorter than we think.”
Mr. Swensen believed that 90 per cent of the variability in portfolio returns were determined by asset allocation. This is because asset selection is, in aggregate, a negative return strategy – for every buyer there’s a seller and for every loser there’s a winner. Add in fees, and the overall returns are negative.
The Yale Model involved far more regional diversification than most U.S. institutional funds. As Mr. Maggiulli recounts, Mr. Swensen proposed a base allocation in his book, Unconventional Success: A Fundamental Approach to Personal Investment, that featured only a 30-per-cent weighting in U.S. equities, 15 per cent in ex-U.S. developed markets, 5 per cent in emerging markets, 20 per cent in U.S. real estate, 15 per cent in Treasuries and 15 per cent in Treasury Inflation Protected Securities.
The hefty allocation to real estate underscored the manager’s belief in replacing bond exposure with equity assets that offer both income and outperformance.
For Canadian investors, applying Mr. Swensen’s diversification lessons is not entirely straightforward. Domestic portfolios routinely feature regional diversification through U.S. equities and the benefits of further equity weightings in other G20 countries are debatable.
To further complicate things, the S&P/TSX Composite index has a very high correlation with the MSCI Emerging Markets index once currency is factored in, so the diversification advantages are dubious.
Canadian investors should, however, be searching for means of diversification. As the third lesson emphasizes, diversification is effective over the long term even if there are shorter periods where it looks counterproductive.
In terms of shorter-than-expected time horizons, Mr. Maggiulli points to Mr. Swensen’s tragic untimely death. We don’t, however, need to be that macabre to recognize that unforeseeable circumstances can lead to the need for funds well ahead of schedule.
-- Scott Barlow, Globe and Mail market strategist
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