This is another in my series of posts on fixed asset allocation portfolios (AKA lazy portfolios.) You can read about the other ones here.
David F. Swensen is perhaps the most successful university endowment manager of all time. He began at Yale in 1985 and compiled such a great record that many other universities began copying his methods. He wrote Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, the bible for these managers. In 2005, he published a book called Unconventional Success: A Fundamental Approach to Personal Investment. As he initially planned it, this was going to be a book that took the approach he used at Yale and taught an individual investor how to do it in their own portfolio. As he prepared the book, he realized that what he did at Yale COULDN'T be done successfully by the individual investor. But he did see a way through which the individual investor could find investing success. The book explains the method. Here's what he says about it in the preface:
As I gathered information for my new book, the data clearly pointed to the failure of active management by profit-seeking mutual fund managers to produce satisfactory results for individual investors. Following the evidence, I concluded that individuals fare best by constructing equity-oriented, broadly diversified portfolios without the active management component. Instead of pursuing ephemeral promises of market-beating strategies, individuals benefit from adopting the ironclad reality of market-mimicking portfolios managed by not-for-profit investment organizations.
The Yale Portfolio Allocation
| Domestic Equity | 30% |
| Foreign Developed Equity | 15% |
| Emerging Market Equity | 5% |
| Real Estate (REITS) | 20% |
| US Nominal Treasury Bonds | 15% |
| TIPS | 15% |
I like this portfolio a great deal. Aggressive, but not too aggressive. It adopts the philosophy that you should take your risk on the equity side by using only very safe treasury bonds in the portfolio. It adopts a total market philosophy, which keeps costs down and ensures the investor will beat the average stock investor in that asset class. It takes advantage of relatively low correlation between its major assets. It has a good chunk of international stocks, certainly within the range of what I consider prudent. I also like the 50/50 split between nominal and inflation-protected bonds. I think a typical physician investor who adopts this portfolio, sticks with it, and saves an adequate amount will reach his investing goals over the long run.
Downsides of the Yale Portfolio
I dislike two things about the portfolio. First, I think 20% REITs is way too high. In 2005, when the book was published, REITs had been on a ten year tear. The conventional thinking in the 90s was that they were LOWER risk than the overall stock market. The last 5 years have convinced me otherwise. As a sector of the overall stock market I find REITs to be a fairly high risk asset class. I think 20% of your overall portfolio (and 29% of your equity) is far too much for this narrow sector. I do believe REITs can have a place in your portfolio (my own has 7.5% of the portfolio, 10% of my equity), but 20% is too big of a bet IMHO. If you need convincing take a look at the Vanguard REIT Index Fund performance from 2007 to 2009. I watched the REITs I owned lose 75% of their value. That's a risky asset class by any definition.
Second, the portfolio gives nary a nod to the research published by Fama and French. Historically, small and value stocks have had higher returns than the overall stock market. Some think this is a free lunch. Others think it is because they are riskier assets to hold. Perhaps it was just a statistical anomaly due to a limited data set. But I think at least a small bet in this direction is worthwhile to the investor who can tolerate the tracking error and additional complexity.
Yale Portfolio Performance
Performance of this portfolio (using appropriate low cost index funds or ETFs) is tracked regularly by MarketWatch in their lazy portfolio section. Returns over the last ten years (current on 10/7/11) were 6.78% per year versus the S&P 500 returns of 2.82%. It also compares favorably to the Coffee House Portfolio, whose returns over that same time period were 5.66% (although with a bit more risk as it is 60/40 instead of 70/30).
If you're still trying to design your own lazy portfolio, I suggest you give Swensen's book a read. You could certainly do much worse.
The Yale Endowment does not pay income or estate taxes, has no withdrawal phase and is not exposed to lawsuits.
Otherwise, as an investment strategy it is quite good.
For a individual investor, I would argue ,their personal home should be considered as a exposure to real-estate asset class ( although a highly non-liquid investment and not to be used as a collateral to finance consumer goods). For rmost people their home is their biggest investment ( atleast at the very beginning stages of their career).
So why add more real-estate exposure? I would suggest zero REIT exposure ( I understand it is commercial real-estate, but real-estate nonetheless)
Any thoughts on this ?
A personal home with a mortgage is a consumer item, not an investment. How do you re-balance your Home? I consider my mortgage as a negative bond. Holding a mortgage reduces my bond exposure.
About the high real estate exposure, I asked the question why on the Bogleheads forum. The response I got was that Swensen had been successful in alternative investing, and real estate was the only alternative that a retail investor could easily access. In a later recommendation, I believe that he recommends a lower real estate exposure. Also, IIRC, the original 20% recommendation was to real estate, not REITs.
In Mr. Swensen’s book the rationale he provides for REIT exposure is to protect against inflation. He uses TIPS and REITS (35% of portfolio) to protect against inflation. He uses Treasury Bonds (15%) to protect against deflation. Mr. Swensen believes in, “Protection against unanticipated changes in economic conditions”. It is important to note that Mr. Swensen was just providing the framework for a portfolio and that he believes each investor should tailor their portfolio to their circumstances, preferences, and skills. The focus of his framework portfolio is on equity orientation, mathematical diversification, and functional diversification.
About increased exposure to small and value stocks, I do it myself. However, I have noticed the following. Those public figures who do advocate increased exposure to small and value stocks have a self interest in such tilting, usually by their association with DFA. Those public figures who do not have a self interest in such tilting (Bogle, Ellis, Malkiel, Swensen) don’t advocate it.
Mark,
my post was to draw attention to the similarity between owning a home and owning a REIT, ie exposure to real-estate. Why own both ?.
One produces income and is generally liquid as long as you have not purchased a non-traded REIT. The other is an asset which hypothetically grows in value while you pay for it with dollars that are worth less each year. REITS can be good investments when purchased at a good price. Like all good investments, you should trim them back if the price per share grows substantially faster than the underlying value of the real estate in the portfolio. REITS generate steady income through dividends. REITS can also allow you to diversify your real estate risk/ holdings with properties in different regions, type (ie healthcare properties), and terms of the lease agreements.
I see little or no similarity between a REIT and a personal home. REITs are diversified geographically and economically. REITs are purchased for income. REITs can be re-balanced. The investor cannot be foreclosed on, pays no maintenance fees and doesn’t have to mow the grass.
A personal home is like investing in a single stock.
David Swensen has actuall revised his allocation in 2009 to lower reit percentage and increase emerging market.
So now its:
30% in U.S. Stock index funds (VTI), (IYY)
15% in Foreign Developed stocks (EFA), (VEA)
10% In Emerging Market stocks (VWO), (EEM)
15% in Real Estate index funds (VNQ), (ICF)
15% in U.S. Treasury bonds (SHY), (IEF)
15% in U.S. Treasury Inflation Protected Securities (TIP), (IPE)
http://seekingalpha.com/article/146731-david-swensen-changes-his-portfolio-allocations
I wanted to see the latest allocation Swenson advises & found this from April 2014:
http://www.bogleheads.org/blog/david-swensens-portfolio-from-unconventional-success/
The blog got moved to here:
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=137826
US equity: 30%
Foreign developed equity: 15%
Emerging market equity: 5%
US REITS: 20%
US Treasury bonds: 15%
US TIPS: 15%
Which is the same as 2011.
I’m new to all this so feel free to chime in.
Does Swenson update his percentages each year or only some years? That is how you go & rebalance or is rebalancing something quite different?
Any of you guys have a Yale Portfolio?
I will go & look at some other portfolios WCI mentions.
I am interested in designing a portfolio along the lines of the kinds WCI mentions because it seems like less work. I’m familiar with how to trade stocks but never got into these “funds” so I’m new to it so don’t anyone hesitate to make suggestions the best way to learn it all. I know it depends on my age, risk tolerance etc.
Thanks
You saw this post here, right?
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
Rebalancing isn’t looking up what Swensen recommends now, so much as realigning your portfolio with its goal asset allocation, whatever that might be. It’s enforced selling high and buying low.
Hi James! Great site! Going through multiple pages of your fixed asset allocation book reviews, I see your advice about sticking to a plan and not market timing. With the fed signaling that they will increase interest rates, would I then hold off on purchasing TIPS and bonds?… Is that market timing? If so, I guess I’ll just jump right in and follow the plan to the grave.
Yes, that’s market timing. Just jump in. Rates have “had nowhere to go but up” for 8 years now. Besides, the hit short and intermediate term bonds take with a 1-2% raise doesn’t take long to overcome with the new higher rates. It’ll actually be better for you in the long run if rates do go up!