Yale’s investment chief shares some strategies

Yale’s investments are guarded by a Viking in gray slacks.

Tall and lanky, David Swensen GRD ’80, Yale’s chief investment officer, usually wields a pen rather than a battle axe. But those close to the University’s top money manager are quick to note personality traits he shares with his Scandinavian ancestors. A plain-spoken man with an easy, lopsided grin, Swensen, friends say, is fiercely competitive on the golf course, the squash court and, most especially, in the boardroom.

“He takes it all seriously,” said Andrew Golden SOM ’89, president of the Princeton Investment Company and one of Swensen’s proteges. “I’ll point out that I never lost a squash or tennis game with him, but then, I never found the courage to play a squash or tennis game with him.”

Dubbed the “Son of Sven” by his mentor — the late James Tobin, a Nobel laureate and Yale’s former Sterling Professor of Economics — Swensen has pursued revolutionary strategies while displaying a constant drive that has thrilled his employers and left most of his peers hard pressed to keep pace.

But critics say the CIO’s intense competitive streak, combined as it is with his equally intense demand for privacy, needs to be more closely and publicly watched. Investments Office decisions are made behind closed doors, and often the only Investments Office contests the public is informed of are the games of softball, squash, tennis and golf Swensen plays with office pals.

Swensen has been influential in investment circles for decades, but a strict policy of media silence has made it hard for outside observers to understand the thought process behind his decisions. In his 20 years at the helm of Yale’s Investments Office, Swensen’s managerial acumen and unorthodox investment policies have slowly revitalized the endowment — once a moribund discretionary fund with abysmal returns, it is now the backbone of the University’s operating budget.

Swensen’s decision to break his longstanding media silence in order to promote his new book comes at a time of escalating concern from some endowment watchers, who argue for increased disclosure of Investment Office activities in light of expected drop-offs in key areas of Yale’s portfolio and allegations of unethical recent ventures.

Swensen’s new book analyzes the pitfalls of personal investing in a market dominated by mutual funds, outlining an approach that sheds the conventional tools of his trade in favor of strategies he sees as more effective. Like his ancestors, he has discovered a new world, but this discovery is not without dangers.

Back against the Wall

A divorced father of three who lists Little League coaching as one of his primary passions, Swensen said he tries not to think about the markets when his work day is over.

“I spend my professional life managing Yale’s endowment. I like to do other things outside of the office,” he said.

But those who know Swensen said he seems to be constantly working to better diversify and improve the portfolio.

“He outworks everybody so that his course is carefully prepared,” said Charles Ellis ’59, a fellow of the Yale Corporation. “Anything he says in public is extremely carefully prepared. Like a champion athlete, he makes it look so easy, pretending you can do it yourself.”

Swensen arrived at Yale as a doctoral student in economics 30 years ago, when the endowment’s contribution to the operating budget was waning. At the time, 75 percent of Yale’s investments were located in traditional U.S. securities, like stocks and bonds, which meant that the market downturn of the 1970s crippled the endowment.

During this period, annual returns on investment rarely exceeded single digits, and the total value of the endowment fell by 45 percent between 1970 and 1978. The Yale Corporation was forced to freeze University spending midway through 1977.

The endowment began to rebound as the market turned more bullish in 1982, but then Provost Bill Brainard was still anxious to avoid a repeat of the previous decade’s investment failures. Brainard had offered guidance on Swensen’s doctoral dissertation along with Tobin, the Nobel laureate, and the three men were close, Swensen said.

Still, it was Tobin who first showed Swensen that spreading funds over a wide variety of asset classes could improve returns, and Swensen said his stewardship over the endowment remains a function of Tobin’s influence.

“Without Jim’s mentorship, there’s no way I would have completed my Ph.D. here,” Swensen said, noting that he sometimes spent more time at Berkeley College beer tastings than he did reading his textbooks. “It was fair to say that I lacked direction, so Jim kind of took me under his wing.”

After earning his doctorate, Swensen left Yale for Wall Street, but returned six years later at Brainard’s urging to become the University’s first chief investment officer. He and classmate-turned-coworker Dean Takahashi ’80 SOM ’83 then slowly began modernizing Yale’s portfolio.

Swensen and Takahashi shifted funds from cash and U.S. securities toward solid assets such as timber, fuel and real estate, earmarked more money for buyout funds, and added a new asset class that Swensen dubbed “absolute return.” This term is a euphemism for hedge funds, which seek to exploit market inefficiencies using large sums of money pooled from various institutional investors.

The change was gradual, but Swensen said that within about a decade, Yale’s portfolio assumed much of its modern form. More recently, Swensen has shifted additional resources toward hedge funds, which received approximately 26.1 percent of the allocated endowment funds last year versus 21 percent a decade ago, according to the 2004 and 1995 endowment reports.

Returns return

Trying to put Tobin’s theories of asset diversification into practice on an institutional scale was unheard of 20 years ago, but Swensen succeeded. During the past two decades, Yale’s endowment has returned an average of 16.1 percent per year, placing it in the top one percent of institutional funds. The S&P 500 index gained, by comparison, an average of 12.3 percent per year during that period.

The total value of the endowment has grown from approximately $1.07 billion to approximately $15.2 billion in that time, gaining $2.5 billion during the past year alone. Among other higher education institutions, only Harvard’s endowment is larger, totaling $22.6 billion at this time last year. Harvard Management Company President Jack Meyer has not announced this year’s returns figures yet, but Harvard posted an average annual return of 15.5 percent during the 20 year period ended June 30, 2004.

“I think David is the best in the business,” Meyer said. “He has a great eye for investment talent, and any year that we’re close to Yale, we’re happy.”

While the returns on the Yale and Harvard endowments are both among the top one percent in their class, the two investment management systems that govern those endowments have traditionally functioned almost as opposites of one another.

Since 1974, Harvard’s endowment has been run by the Harvard Management Corporation, which is separate from, but owned by, the university. This gives HMC managers the autonomy to set their own compensation rates. Yale, however, maintains complete control over its investments office. As such, Yale investment managers must have their compensation rates approved by University committees. Though his annual $1 million is no pittance, Swensen could be writing his own ticket on Wall Street, said John Griswold ’67, the executive director of the Commonfund Institute. Meyer made $7.2 million last year, prompting controversy over an inflated payroll for HMC money managers.

Concern for the University’s well-being is the top priority in the Yale Investments Office, Swensen said. Of his 20 internal managers, most are Yale alumni. But Ellis said Swensen is by far the most committed.

For his part, Swensen said Yale has more to offer him than his previous employers.

“I enjoyed my time on Wall Street, I learned a lot, and I still have a lot of friends there, but I never saw myself there long term, because when I looked at the senior guys there, that wasn’t the kind of life I wanted for myself,” Swensen said. “Here, I’m supporting one of the world’s great institutions.”

According to a 2003 study conducted by Harvard economics professor Josh Lerner, Yale’s superior returns during the past five years have primarily been a result of manager selection. While Harvard and the University of Texas system have traditionally been mostly internally managed, Yale and most large universities outsource the majority of their investment decisions to external management firms — pending Swensen’s approval in Yale’s case. With Meyer leaving HMC to start his own hedge fund, even Harvard’s management structure will likely resemble Yale’s more closely next year.

Across the university endowment community, as well as in pension funds and even in real estate investment trusts, Swensen’s tactics have been absorbed, adapted and sometimes taken to their logical extremes. Princeton’s managers are almost entirely drawn from outside the university, Golden — Princeton’s top money manager — said.

Golden, who worked as an intern and then a manager for Yale’s Investments Office from 1988 to 1993, said his management strategy has remained essentially unchanged from that of Swensen and Yale.

“I’ve stolen 85 to 90 percent of my good ideas from Yale, plus some undisclosed amount of my bad ideas,” Golden said, adding that his fundamental theory of endowment management focuses on “challenging conventionality.”

Hedging bets

Hedge funds have become a cornerstone of Swensen’s alternative investment policies, but federal regulators said the rapid expansion of such funds may be dangerous for Yale and other institutional investors.

With roughly 8,000 hedge funds in existence — collectively managing approximately $1 trillion, which accounts for 7.9 percent of all institutional investments, according to the Russell Survey on Alternative Investing — some funds are not living up to their reputation for double digit returns. In addition, hefty fees hack away at investor profits, and stories of corruption and graft have raised questions about fund reliability.

Due to widespread concerns about reliability, the SEC issued a mandate last year ordering hedge fund advisors to register with the commission by next Feb. 1.

“The growth in hedge funds has been accompanied by a substantial and troubling growth in the number of our hedge fund fraud enforcement cases,” the SEC release said. “In the last five years, the Commission has brought 51 cases in which we have asserted that hedge fund advisers have defrauded hedge fund investors or used the fund to defraud others in amounts our staff estimates to exceed $1.1 billion.”

Swensen said Yale has not been defrauded by an investment partner during his tenure, but he said such a betrayal remains his greatest fear as a CIO.

“I was once asked what keeps me up at night, and that’s at the top of the list,” he said, wincing at the mention of Enron. “It’s a risk that we would like to push to an irreducible risk, but it’ll always be a risk.”

Still, Swensen said he has confidence in his staff’s research and his own screening process, attributing hedge fund horror stories to the widening spectrum of competence among hedge fund managers.

“I wouldn’t say that I have faith in hedge funds per se, but I have reasonable faith in our ability to discriminately select high-quality partners,” Swensen said. “You’re seeing a lot of hedge fund problems now because there’s such mindless enthusiasm on the part of the public. A lot of the entrants are low-quality, and you’ve got a lot of people crashing around doing dumb things.”

‘X’ marks the endowment

While some disclosure advocates said they worry about the risks corrupt funds may pose to institutional finances, student activists said they are more concerned with Yale’s activities across the globe. Yale’s direct ownership of public stock, which once comprised the majority of the portfolio, has declined precipitously, now accounting for only 2 percent of Yale’s investments. All other endowment holdings are in externally managed, and therefore private, investment funds.

Quarterly SEC filings offer a small hint of what is actually in Yale’s portfolio, but there is no way for the community to truly know where most of the University’s money is being invested on a daily basis. Student and union activists have pushed for greater disclosure from both Swensen and Levin, but they said the conversation has been one-sided.

“We’ve really made very little progress with them on disclosure,” Phoebe Rounds ’07 said. “We’re going to keep working on it, but it can’t all come from us.”

Rounds is a member of the Undergraduate Organizing Committee and the UnFarallon Coalition, both of which have occasionally petitioned Yale to divest from controversial investments or projects. During the past year, their members and other students voiced concerns regarding a series of Yale investments in energy companies whose policies they allege to be environmentally irresponsible or dangerous to nearby communities.

While he declined to comment on case specifics, Swensen said he feels unfairly portrayed by disclosure advocacy groups.

“It’s part of my job to manage the investments in an ethical fashion,” he said. “They’re trying to create this public impression that all I want to do is generate returns regardless of moral and ethical issues.”

But Rounds said criticism of Yale’s lack of transparency is not an implicit criticism of the CIO’s priorities.

“David Swensen has done a great job making money for this University, but the University has to be ethical,” she said. “There just needs to be a clear standard, and Yale needs to adhere to it.”

The most controversial of Yale’s recent investments concerns Talisman Energy, a Canadian corporation operating in the Sudan. A 2002 U.S. State Department report implicated Yale’s investment vehicle Tercentennial Energy Partners in a scandal involving Talisman, alleging that the company’s 25 percent stake in Sudan’s largest oil concession has contributed to a “scorched-earth policy” designed to isolate the area’s oil production facilities.

Swensen said Talisman has divested from those funds, and Yale’s Advisory Committee on Investor Responsibility is preparing a broader policy recommendation on similar investments, committee chair Geert Rouwenhorst said.

The ACIR, an eight-person panel composed of students, alumni, faculty and staff, does not make any direct policy decisions, but drafts recommendations to the Yale Corporation’s Committee on Investor Responsibility. Like most of the Yale community, the ACIR is not privy to the makeup of Yale’s investments.

Rounds expressed frustration that the ACIR has no direct influence on or knowledge of Yale’s portfolio, but Rouwenhorst said the existence or lack of Sudanese investments should not prevent the committee from suggesting a policy on the subject.

Historically, South African corporations served as test cases for divestment based on ACIR recommendations. During the period of South African apartheid, Yale adopted a framework that mandated divestment from 17 offending companies, a policy that Levin said still continues. Within the past decade, the ACIR has also passed resolutions asking that Yale push cigarette manufacturers to better regulate their own marketing to minors, but the University has not entirely divested from tobacco interests.

Levin said he values recommendations from the ACIR, but generally not those of disclosure advocates, since, he said, revealing any pieces of Yale’s portfolio would compromise the University’s investment strategies.

“If the committee were to tell us, ‘don’t invest in South Africa, don’t invest in Burma, don’t invest in Sudan,’ we won’t invest there,” Levin said. “Disclosing thousands of investments isn’t particularly helpful.”

Beyond Yale, though, the push for disclosure of university investments is slowly gaining strength. This past year, the exposure of ties to the repressive Sudanese government forced Harvard and Stanford universities to sell their respective stakes in PetroChina, another energy conglomerate.

“It’s important for Yale to take steps forward with its peers right now,” Rounds said. “There’s a lot more they could be doing.”

UnFarallon, the UOC and the Graduate Employees and Students Organization have also highlighted drilling projects in Bangladesh and Calgary as Yale financial interests with questionable policies. The most recent of these cases involved Niko, a Canadian natural gas company whose drilling projects in the Tengratila fields of Bangladesh exploded in January and again in June.

Tercentennial owns a reported 1.35 million shares of Niko — worth roughly $63 million, according to the Internal Revenue Service. Student activists have pushed for Yale to subsidize medical assistance to the villagers wounded in the Niko explosions, but Rounds said University officials have been unresponsive to that suggestion.

In Calgary, Compton Petroleum’s proposal to deplete natural gas deposits near the city limits prompted some concern from city residents and members of Alberta’s New Democrat Party about the possibility of a similar explosion. Through Centennial and Tercentennial, Yale is Compton’s largest investor.

Arguing that the foreign press covering these cases is unreliable, Swensen said most of the petitions and complaints he has received are without substance, adding that he does not respect arguments made by some of the activist member groups.

“I think what the people at GESO are doing is antithetical to everything that Yale stands for,” Swensen said. “They’re just slinging mud.”

The yellow brick road

“A young Viking, a badger called Dave

Determined poor Eli to save.

First, he’d be

A Ph.D.

And then make those markets behave.”

Tobin, the late Nobel prize-winning economist, wrote this limerick for Swensen five years ago. The verse was delivered at a dinner — hosted by Levin — dedicated to celebrating the endowment’s first year at $10 billion. Now at $15.2 billion and growing, Yale’s endowment is once again a prime mover for University projects.

This year, the endowment contributed approximately 31 percent of Yale’s operating budget, for a total of about $610 million. During Swensen’s first year on the job, the endowment provided approximately about 10 percent of the operating budget, a comparably diminutive $39.8 million.

With Yale’s budget narrowly balanced after two years of deficits on its operating budget, finance officials said Swensen’s consistently stellar performance is a key factor in their annual planning sessions.

“He came in at the high end of what we expected, so it wasn’t a huge surprise, but we could not accommodate a great many of our projects without the contributions of David Swensen and his team,” Vice President for Finance and Administration John Pepper said.

Funds drawn from the endowment are limited on an annual basis by a fixed spending cap. Though exceptional returns have allowed the Yale Corporation to raise the cap three times since the beginning of Swensen’s tenure — from 4.5 to 5.25 percent of the total endowment funds — Swensen said the cap should not increase beyond the current level for the foreseeable future.

Specifically, Swensen said the endowment should grow with Yale, rather than being used to address immediate budgetary concerns.

“Spending should not react to short term needs,” he said. “We’ve tried to keep the spending at a level that is sustainable.”

It is unlikely that endowment returns will remain as consistently high as they have been in recent years, Swensen said, noting that performance must decrease as portfolio size increases. But in spite of his influence on the investment world, he said it is unlikely that his contrarian investment strategies will be rendered ineffective by copycats.

“I wish I had some new, interesting, attractively priced new opportunity, but everything seems priced too expensive,” he said. “I’m not too worried, though. These techniques aren’t getting too crowded.”

David Swensen, the University’s chief investment officer, is the guardian of Yale’s endowment.
Esther Quintana
David Swensen, the University’s chief investment officer, is the guardian of Yale’s endowment.

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