Swensen: Unconventional Success: A fundamental approach to personal investment

David F. Swensen, the Chief Investment Officer at Yale University, wrote books as instructions for the average investor. Swensen's investment strategy rests on Tobin's construct for understanding stock prices. Tobin's "q" a "means of understanding stock prices . . . compares the replacement cost of corporate assets to the market value of those assets. In equilibrium, Tobin argued, the ratio of replacement cost to market value, which he named "q", should equal one" (pp. 40-41).

Swensen's book, Unconventional success: A fundamental approach to personal investment, described three activities of portfolio management, asset allocation, market timing, and security selection. Asset allocation, Swensen defined as "the long-term decision regarding the proportion of assets that an investor chooses to place in particular investments" (p.11). Investors divide investments into six classes, such as domestic and foreign equities, emerging market securities, inflation-indexed bonds, conventional bonds, and real estate. Investors compare the returns from these classes against benchmarks to determine results.

Market timing, Swensen explained, "represents a purposeful attempt to generate short-term superior returns based on insights regarding relative asset class valuations" (p. 12). Security selection "refers to the method of construction of the individual asset classes, beginning with the choice of a passive or active management" (p. 12). Passive management mirrors results of indices, such as the S&P 500, Russell 3000, and others. Active management "involves making bets against the market with the investor attempting to overweight attractively priced stocks and underweight expensively priced stocks" (p. 12). Research, Swensen attested, attributed to asset allocation 90 percent of the variability of returns. The other two investment tools have a 10 percent impact.

Within the context of asset allocation, three principles shape a well-structured portfolio, "equity bias . . . substantial diversification . . . tax considerations" (p. 17). Equity bias acknowledges that equities outperform other asset classes. Research of Ibbotson and Siegel support this proposition. Substantial diversification assumes a sufficient number of investments to distribute risk. Swensen perceived that current market risk "required a portfolio of fifty securities" (p.22).
Swensen advocated the following breakdown of asset classes in a typical portfolio:
Domestic equities 30%
Foreign developed equities 15%
Emerging markets 5%
Real Estate 20%
US Treasury Bonds 15%
US TIPS 15%
Deviations to this portfolio would result from investment time horizons, the level of commitment to an equity orientation, and personal circumstances.

To minimize risk, Swensen pointed to US Treasury bonds and US Treasury Inflation Protected Securities (TIPS). However, investors should understand of the relationship between these government instruments and inflation. Similarly, when rebalancing a portfolio, investors should consider the tax ramifications of their actions.

Although Swensen castigated mutual funds generally, as "performance deficit" (p. 208), he mentioned some mutual fund managers that exhibited traits that promoted the investors interests: owning a significant stake in their fund, have a passion for superior returns, engaging in relentlessly research in the companies they follow, shunning a herd mentality about the market, and demonstrating the courage of their convictions. Under the headings of "Principal orientation . . . clear strategy . . . long-term focus . . . portfolio concentration . . . stable client base . . . fair fee arrangements . . . substantial co-investment . . . limits on assets under management . . . shareholder communication" (pp. 303-310), Swensen explored traits on good mutual fund managers. For the active investor, Swensen examined exchange traded funds (ETFs) as an investment option. An costly vehicle for small investors who trade in small increments, they offer investors who make larger trades a more cost effective choice than mutual funds. Swensen cautioned investors to watch the fees. Unfortunately, some ETF managers have mimicked the mutual fund market.

Swensen, D. F. (2005). Unconventional success: A fundamental approach to personal investment. New York: Free Press.