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Do as I say, not as I do

The so-called endowment model of investing garnered a great deal of attention prior to the credit crisis and economic recession.  As practiced by David Swensen at the Yale University endowment it was viewed as the state-of-the-art model for institutional investing.   However in light of its surprisingly poor performance during the crisis it has come into disrepute.

Gillian Tett at the Financial Times today notes how the image of the endowment model is now in a state of disrepair and some investors are not looking elsewhere for investment thought leadership.  Tett writes:

But these days, the names of Harvard and Yale – like so many American financial brands – are looking somewhat tarnished in places such as Asia. Or as Tony Tan, deputy chairman of the GIC explains: “The whole idea of the endowment model has been very influential [before]. But any reasonable investor would [now] want to take another look at this.” Or, more specifically, about whether to copy it.

It may be the case that the Yale model never really was replicable outside the confines of New Have and the mind of CIO David Swensen.  Justin Fox at the Harvard Business Review argues that the true Yale model had little to do with the actual portfolio management process of emphasizing diversification into (and across) alternative investments.  Indeed it was more the marrying of a long-term approach with a smart money manager.  Fox writes:

The real Yale model, then, involves more than just an investing approach. It requires finding a very smart, capable person not motivated chiefly by money (Swensen could have made vastly more on Wall Street than he has at Yale) who is willing to stick with the same job for decades. And it involves an institution that puts enough trust in that person to weather a bad year or two without lots of second guessing. (Tellingly, there are echoes here of the way things work at Warren Buffett’s Berkshire Hathaway.)

Some might argue, like James Picerno at the Capital Spectator, that the idea of trying to select outstanding managers of alternative assets like hedge funds and private equity is at best, “devilishly” difficult.  Picerno notes that trying to assess any investment model based on a few observations is short-sighted at best.

If trying to generate alpha in this way is outside the reach of the vast majority of investors what is left for the rest of us?  Picerno writes:

That means that for most investors, and perhaps most institutions, focusing on conventional betas is the only game in town. Fortunately, there’s enough action here to keep investors of all types happy. Depending on how you choose to slice and dice the conventional markets of stocks, bonds, commodities and REITs, there are at least half dozen basic choices or as many as 20 to 30.

Maybe it shouldn’t be all that surprising that we end up back at this point.  It was David Swensen himself who in his book Unconventional Success, which was geared towards individual investors, discussed the futility of selecting fund managers and emphasized low cost, indexed investments.  At the time of its release it seemed like a discordant message when the Yale endowment was riding high both in its returns and reputation.

Like most ideas in the investment world, the idea of the endowment model was taken to the extreme.  The endowment model was copied by investors who neither understood what was involved nor had the institutional fortitude to implement it through an entire cycle.  So the next time some one like David Swensen advises investors to “do as I say, not as I do” take heed.

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