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The Man Who Gutted the Ivy League
When Yale’s endowment fund was soaring, other Ivies rushed to copy the “alternative investment strategy” of chief investment officer David Swensen. Now those funds are a shadow of their former size—and it may be months before we know the full extent of the damage.
The “alternative investment strategy,” which this year has led many university endowment funds to the brink of ruination, was pioneered by David Swensen, Yale’s chief investment officer since 1985. A PhD in economics and lecturer in finance, Swensen achieved such consistently high returns for Yale’s endowment fund until 2009 that the strategy he outlined in his 2000 book Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, was widely imitated by other university endowment funds. Indeed, at the height of the market, it was difficult to find a major university that was not dancing to Swensen’s tune and, for all practical purposes, it not only replaced the traditional strategy of dividing a portfolio mainly between blue-chip bonds and equities, but also served as the new paradigm for university investment officers.
Despite a year of massive writedowns at private-equity houses, Yale will not know how it has done on two-thirds of its portfolio until June 30, 2009.
The heart of his strategy was to reduce drastically the allocation for bonds, equities, and cash, and substitute for them a portfolio of illiquid investments that included participation in leveraged buyouts, hedge funds, and stockpiles of physical assets. Swensen argued in his book that such illiquid investments carry less risk and more potential for high returns than stocks or bonds. His case was that because endowment funds did not have to concern themselves with withdrawals for taxes or redemptions to their investors, they did not need the liquidity of the major stock and bond markets and could therefore avoid losses from short-term fluctuations.
Swensen’s most persuasive point was his own remarkable performance at Yale. By 2000, he had put most of its endowment fund in illiquid investments. While high-flying U.S. stocks collapsed in the Internet bubble in 2000-01, Yale’s endowment fund made money as its assets rose in value, and it outperformed almost every other major endowment fund—many of which lost money—as its president, Richard Levin, pointed out. Following Swensen’s path, all of the Ivy League schools, including Harvard, with the world’s largest endowment, moved their portfolios into alternative investments.
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Lloyd Grove is editor at large for The Daily Beast. He is also a frequent contributor to New York magazine and was a contributing editor for Condé Nast Portfolio. He wrote a gossip column for the New York Daily News from 2003 to 2006. Prior to that, he wrote the Reliable Source column for the Washington Post, where he spent 23 years covering politics, the media, and other subjects.
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What this proves is that even guys with Ph.D.'s don't know what they are doing. The stock market has now crashed twice in less than a hundred years. There have also been various recessions that nearly toppled the market.
Why are we still investing in paper? Labor is what America was built on. Yale could have started a gold mine. They could have done any number of projects that would have turned a profit and also would have put people to work.
And the truth is you don't need to know anything about economics to realize it's a bad idea to invest in companies that send jobs overseas. It hurts the economy.
Down with the investor class. Up with the working class.
Nice job, Ed.
I see that my alma mater, Rice University (one of many schools claiming to be the Harvard of the South) is contemplating a merger with Baylor College of Medicine. I wonder if it's driven by a damaged investment portfolio at either institution.
I've had a squirrely thought niggling away in my head for a few months, now: if liquidity is simply being able to convert assets (real property, jewelry, stock certificates--and so on) into cash ($$$, euros, and so on), THEN illiquidity is the exact opposite! Illiquidity means that whatever a supposed asset is, THEN it simply cannot be converted into cash ($$$, euros, and so on). Can that be correct?? Someone: please confirm or deny that squirrely thought. Please!!
And the deeper problem -- when you have a liquidity call, you don't want to sell what's valuable, so you're forced to sell those assets that have been-devalued, thus wiping out vast amounts of equity.
Illiquid? Please go to UNIFIEDMARKETS.
I have an undergrad degree in painting; what most people call a waste of four years. So why do I know this is a ridiculously stupid way to invest money? Especially for a university.
Along with my "useless degree" I'm financially sound and didn't get scratched in this bust up disaster. I don't use the hip language, but I have plenty of ready money and plenty of usefull assets. And buying up more cheap.
Here's to you Yale, for not admitting me. I guess Southern rural brainpower isn't so pathetic after all.
Economics is a fuzzy math big guess anyway. Why would anybody let an economist actually handle money? Economists guess and teach for salary. Ever met a rich one? No. Wealthy people are reality based and deal in actual wealth producing assets. These kids with big cash flow went bust with Wall Street.
Giving economists actual cash is like giving a 15 year old whiskey and car keys.
"Giving economists actual cash is like giving a 15 year old whiskey and car keys."
Maybe you know my wife. She lost ~$10K on hot stock tips, which I argued against. She's an economics major, and my degree is English/photography, so I don't know anything. Every time she offers investment advice, I say "no thanks."
Me too - I have a useless degree, from a small college. Ha!
Hey everyone. Here's some advice from an English major: Put your retirement money in municipal bonds, and live off the interest. Reading this guy's strategy gave me goose bumps.
Wonder if he still lectures? Probably. Like "in Cramer we trust", who I heard proclaim BearSterns sound as a dollar a week before it went bust, he has no shame and will have a ready alibi.
I feel that this article is a misrepresentation of Swensen's proposal. Keep in mind that in Unconventional Success, a more recent book, Swensen recommends 55% of your money in stocks and 45% in bonds (and he goes on to break things down after that), recommending only 5% of the total for real estate based investments. This is a far cry from what others were recommending at the time and would have been a safer investment overall than most, one that plans for long term growth. Furthermore, Swensen goes on to argue that mutual funds and other fee based systems take advantage of the average investor. To vilify someone who frankly was looking out for the average investor to such a great degree is inappropriate. Shedding tears over collegiate funds getting reduced is also silly as these institutions have been price gouging the middle class for 30 years with some of the fund directors taking home double digit millions for raising the endowments.
Having attended a third rate State "at" school, I was somehow able to take a company public and sell it some years later for a tidy profit. During that time, I cannot tell you how many times I met with Ivy League trained Hedge Fund managers who owned my stock and had to listen to them tell me what my company was doing wrong. When I sold, my Ivy League Goldman broker recommended I give most of my dough to these same hedge friend guys to manage. Having seen how little they knew first hand, I passed and put it into bonds. A few years later, an Ivy League private equity manager threw down a check for $200 million and said to go out and buy a company in my former field. The $200 would be leveraged to buy the target company. Some days I just sit an wonder how it would be to be leveraged to the gills in a land of zero credit? Maybe the Ivy Leaguers only appear to be the smartest guys in the world because they won't hire anyone else. But, then they are snappy dressers.
I understand that Yale faculty have a pay freeze in effect, and layoffs of support people are in the cards. But the rockstar salary of Yale's President presumably will not be touched.
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"Ah, the circle of predatory capitalist life is complete."
Marx published his Manifesto in 1848. 160 years later he was vindicated. Read Michael Harrinton's "The Twilight of Capitalism."
Creative finance is about redistribution of $$ with a worthless instrument. What is hard about that? Our economy runs on advertising and PR and that is to set a value not intrinsic to the product. We have lived this way without complaint. Coke dealers seldom are addicted. It is when they play with their wares that the trouble begins. Now the Ivy League is learning a valuable lesson on creating worthless instruments of exchange and buying into their own hype.
So he told colleges illiquid assets had higher returns; and they DID have higher returns and they were ILLIQUID. They made a lot of money. But illiquid returns are, duh, illiquid. If the colleges put too much in those returns, their bad. Is the strategy flawed? Come back in 20 years. It's the LONG run results that he predicted and the only money tied up should have been long term money. Doyle Brunson said it best regarding poker and it's unpredictability: "That's why it's called gambling." Investment returns are variable, "That's why it's called investing (not saving)".
Give Swensen his due. He saved Yale. In the early 1980s, just before he arrived, Yale was in such financial dire straits that people legitimately wondered whether it was declining into another Lehigh or Bucknell, two good but far from great schools that appealed to kids with sub-Ivy credentials. New Haven was (is) a dump. The campus was surrounded by a ghetto. Yale had never been strong in the sciences and could not afford new labs to keep its biologists and physicists. Even worse, its physical plant needed a billion dollars of maintenance.
Swensen reversed all that. His investment prowess enabled Yale to survive, rebuild, and prosper. Everything Yale did to save itself as a world-class university, is first and last because of Swensen.
Yeah, illiquid investments in private equity and hedge funds are now taking a bite out of Yale's endowment. But a 25% or even a 33% haircut come June 30 can't erase his mind-boggling gains.
Yale will be back. (Not sure about the copycat schools, however, other than the big ones.) And probably sooner than anyone realizes. I'll bet Yale will be a big player in Geithner's plan to allow private investors to use taxpayer funds to buy toxic bank debt. Swensen's always been good at making seed investments in smart Yalies. I doubt he's lost his touch.
Stressing his poor performance this year while ignoring what he's delivered for Yale since 1985 misses how incredibly good he is.
No, I'm not a Yalie and I don't know Swensen.
This is what I come to the Daily Beast for-- the delicious, delicious, schadenfreude.
Mua ha ha ha ha!
Ken Lay got hisself a PhD in economics and he turned out pretty good, 'cept it caused him an early suicide.
Thank you.
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