Book Review: Unconventional Success

Today I’m reviewing the book Unconventional Success by David Swensen.

David Swensen is the celebrated Chief Investment Officer of Yale University. By allocating a large percentage of Yale’s endowment to unconventional assets like private equity funds, absolute return hedge funds and real assets, Mr. Swensen got the Yale Endowment an average return of 18% per year for the last 10 years, which everybody else envies. When I first got the book from the library, I thought the book was about how he did it at Yale. But it’s not. The unconventional success he refers to in the title of the book is rather conventional — invest in a diversified allocation of stock index funds and treasury bonds through investor-friendly outfits.

So the title is a misnomer. There is nothing unconventional about investing in index funds. We already know that from many other books, like John Bogle’s The Little Book of Common Sense Investing and Burton Malkiel’s The Random Walk Guide To Investing. While it gives advice on asset class selection, Swensen’s book gives no guidance on asset allocation, which is often said to be the most important decision one makes in investing. The book showed one generic 70/30 model portfolio without going into details who should adopt an allocation like that. Is it for young people just starting out or people who already retired? The book doesn’t say. It says you have to personalize it but it doesn’t tell you how.

It’s not in the book but Mr. Swensen suffers from “do as I say not as I do.” The Yale Endowment’s 2007 annual report (PDF) shows that it uses active management as opposed to indexing even for its domestic equity investments. The report contradicts what Mr. Swensen advocated in this book. For example, the report says on page 7:

“Despite recognizing that the U.S. equity market is highly efficient, Yale elects to pursue active management strategies, aspiring to outperform the market index by a few percentage points annually. Because superior stock selection provides the most consistent and reliable opportunity for generating excess returns, the University favors managers with exceptional bottom-up fundamental research capabilities. Managers searching for out-of-favor securities often find stocks that are cheap in relation to current fundamental measures such as book value, earnings, or cash flow.”

And again on page 10,

“Yale’s investment approach to foreign equities emphasizes active management designed to uncover attractive opportunities and exploit market inefficiencies. As in the domestic equity portfolio, Yale favors managers with strong bottom-up fundamental research capabilities.”

Translation: I will try to beat the market, but you should buy index funds.

I like the book’s analysis on “alignment of interests.” It is a major theme of the book. Mr. Swensen believes that investors should be keenly aware of the conflict of interests in investing. Some asset classes present inherent conflict of interests problems. Mr. Swensen didn’t like all other bonds except treasury bonds and TIPS. He also didn’t like hedge funds, leveraged buyouts, and venture capital, although retail investors usually don’t get to invest in those. Mr. Swensen showed that for-profit mutual funds are often a bad deal for investors because of conflict of interests. This is similar to what John Bogle wrote in his book The Battle for the Soul of Capitalism. Mr. Swensen recommended investing through not-for-profit organizations, namely Vanguard and TIAA-CREF, and institutional ETF managers Barclays and State Street.

Overall this is a good book about the conflict of interests in investing. It is not a guide book because it lacks practical guidance on what to do after you know you are supposed to invest in index funds with Vanguard. I don’t think it’s good enough to get on my recommended reading list, but you will definitely learn something.

Rating: ****

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Comments

  1. Anonymous says

    While at Yale, I got to have dinner with Swenson. He is a very interesting, and brilliant, man. As to Yale’s strategy, he would admit your issue about active management and defend it on the grounds that the endowment’s size gives him opportunities you/I don’t have.

  2. says

    It’s true the endowment’s size gives it opportunities retail investors don’t have. But the endowment, especially its domestic and foreign equity portion, isn’t that much larger than a large mutual fund. If you look at Yale’s annual report, the performance gap above passive benchmark is huge, many times over the cost difference between what an investment manager charges the endowment versus what a retail mutual fund charges. So he’s saying he can find top quartile active managers but retail investors can’t. It raises the question why.

  3. Anonymous says

    I don’t agree that the book lacks “practical” advice. The chapter on exchange traded funds, for example, suggests specific funds for the various sectors of the market that are recommended earlier in the book. For investors thinking about ETFs as an alternative to traditional funds or individual stocks, there is a lot of food for thought there. Indeed, I thought that Swensen’s emphasis on low-cost broad-index ETFs was second only to “alignment of interests” as a focus of the book.
    Herb
    Brooklyn, NY

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