On WealthTrack with Consuelo Mack, Yale endowment guru David Swensen discusses his thoughts on how individual investors should structure their portfolios, where the markets are headed, and why you should steer clear of mutual funds.
According to Swensen, who as manager of Yale’s endowment has grown the university’s portfolio from $1 billion to about $17 billion during his 24-year tenure, says that long-term individual investors should focus on equities — especially now. “With a long time horizon you should have an equity orientation, because over longer periods of time, equities are going to deliver better results,” he says. “If they don’t, then capitalism isn’t working. And we could well be at a point where investments in equities are going to produce returns going forward that are higher than what we’ve seen in the past five or ten years, and we could well be in a position where bonds are priced to produce lower returns. When you see Treasuries with coupons of 2% or 2.5% or 3 %, that doesn’t really bode well for prospective returns.” Swensen says it’s impossible to predict future returns, but adds, “I would say with today as a starting point you could expect, over reasonable periods of time, to be rewarded for equity exposure.”
While he says individuals should focus on equities, Swensen has and continues to be a big advocate of diversification, the benefits of which become clear over time, he says. He recommends that investors have 30% of their funds in U.S. stocks, 15% in Treasury bonds, 15% in Treasury Inflation-Protected Securities, 15% in Real Estate Investment Trusts, 15% in foreign developed market equities, and 10% in emerging market equities. As investors get older, they should keep this type of allotment for a portion of their portfolio but begin to decrease the size of that portion, putting part of their portfolios into less risky assets like cash or Treasuries.
One place Swensen doesn’t advise looking for good returns: the mutual fund industry. While the size of Yale’s portfolio allows him and his team to find an array of successful managers, individual investors usually can only get access to a broad swath of managers by investing in mutual funds — and their results aren’t good. “The problem is that the quality of the management in the mutual fund industry is not particularly high, and you pay an extraordinarily high price for that not-very-good management,” he says. Swensen cites one study performed by Rob Arnott that measured mutual fund performance over a two-decade period. The study found that you’d have had a 15% chance of beating market after fees and taxes by investing in mutual funds — and that includes only funds that were around for the entire period; many other weaker funds didn’t last, meaning the results have a survivorship bias.
Taxes and fees are the big culprits, Swensen says: “Why are the tax bills so high? Because turnover’s too high. The mutual fund managers are trading the portfolios as if taxes don’t matter, and taxes do matter. And they’re trading the portfolios as if transactions cost and market impact don’t matter, and they do matter. And as they trade the portfolios, basically what’s happening is Wall Street is siphoning off its slice of the pie … and that’s at the expense of the investor.
“But even if you end up finding that needle in a haystack, that mutual fund that is going to outperform over a long period of time,” Swensen continues, “you as an investor — and I’m not just talking about individuals, this, unfortunately, is true of institutions as well — are likely to be motivated not by kind of pure, analytical, rational calculus, but by fear and by greed.” Individuals and institutions who buy mutual funds “take this mutual fund industry which produces a bunch of products that are not great to start with, and then they screw it up by chasing hot performance and selling after things turn cold.”
Asked what the one recommendation he has right now for investors is, Swensen cited TIPS. “We’ve had this massive fiscal stimulus, massive monetary stimulus, and it’s hard to see how that doesn’t translate into pretty substantial inflation, or at least pretty substantial risk of inflation … down the road at some point,” he said.