Unconventional Success is a brilliant book by David Swensen, a legend among institutional investors — the Yale Endowment Fund (the fund report is worth checking out) that he manages has consistently outperformed rivals at other Universities and comparable benchmarks by wide margins. The fund achieved these returns by diversifying into real estate, oil and gas, timber, private equity, hedge funds etc. and active management. You would think that a guy who a record that most money managers can only dream about would counsel individual investors to follow his footsteps. Instead, he has a simple message for average investors: don’t try this at home.
As an investor, I find the first half of the book in which Mr. Swensen discusses asset classes to be invaluable reference source. While noting that market timing and security selection can generate investment returns, the author makes a convincing case that retail investors should instead focus on intelligent asset allocation. He classifies asset classes into core (domestic equities, treasury bonds, inflation-linked bonds, foreign developed equity, emerging markets equity, real estate domestic, foreign and emerging markets, bonds, TIPS and REITs) and non-core (domestic corporate bonds, high-yield bonds, tax-exempt bonds, asset-backed securities, foreign bonds, hedge funds, leveraged buyouts, and venture capital), explains the reasons why investors should favour the former and stay clear of the latter. If you follow the news of the current financial turmoil, Mr. Swensen’s reasons for classifying asset-backed securities as non-core would sound familiar:
Asset-backed securities involve a high degree of financial engineering. As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run. At times, the creators and issuers of complex securities fail to understand how the securities might behave under various circumstances. What chance does the nonprofessional investor have?
It is interesting that Mr. Swensen chose to title the book after Keynes’ quote that “worldly wisdom teaches us that it is better for the reputation to fail conventionally than to succeed unconventionally”. As the vast majority of investors choose the conventional route of active management through mutual funds (the second half of the book is a stinging critique of the shortcomings of active management), the author says that constructing a well-diversified, equity-oriented, passive portfolio is an unconventional investment strategy but provides the best chance of success.