Financial Markets: Lecture 9 Transcript
February 13, 2008
Professor David Swensen:
Let me start out by putting what I think is a relatively controversial proposition
on the table and that's that this investment management business, when stripped down to its bare essentials, is
really quite simple. Now, why do I say that? Well, I think if we took the group here today and divided you up
into smaller groups of four, or five, or six and asked you to talk about what's really important in managing a
portfolio that has a very long time horizon, I think that almost all the groups would come to very similar
conclusions. If you're investing with a long time horizon, having an equity bias makes sense; stocks go up in
the long run. Bob Shiller's friend, Jeremy Siegel, wrote a book that has the very simple title,
Stocks For The
. Well, the book is assigned; you all know it.
The other thing that I think would come out of the discussions is that diversification is important. Anybody
whose read a basic finance text, as a matter of fact, I think anybody who thinks about investments in a
common sense fashion knows that diversification is an important fundamental tenet of portfolio management.
As a matter of fact, Harry Markowitz called diversification a "free lunch." We spend all our time in intro.
econ. figuring out there is no such thing as a free lunch but Markowitz tells us that diversification is a free
lunch. For any given level of return, you can reduce--For any given level of risk, you can increase the return;
sounds pretty good. That's pretty simple, right? Two tenets, an equity bias for portfolios with a long time
horizon and diversification.
Bob mentioned in his introduction that I showed up at Yale in 1985, after having spent six years on Wall
Street, and I was totally unencumbered by any portfolio management experience. I thought that was pretty
neat. Here I was, back at Yale, with a billion dollar portfolio--it seemed like a lot of money at the time--no
portfolio management experience. What do I do? Well, one of the things I think is a sensible thing to do in
life is look around at what others are doing, so I looked at what colleges and universities had done in terms of
asset allocation. Turns out that 50% of endowment assets in the mid-1980s were invested in common stocks,
40% of endowment assets were in U.S. bonds and U.S. cash, and 10% in a smattering of alternatives. Well, I
looked at that and I thought, this doesn't really make a lot of sense. You have half of your assets in one single
asset class: U.S. common stocks. You've got another 40% of your assets in U.S. bonds and cash. So 90% of
your portfolio is in domestic marketable securities and only 10% is invested in things like real estate or
venture capital or private equity--hardly enough to make a difference in terms of the portfolios returns.
Unencumbered by, I guess, the conventional wisdom, we started out at Yale on a path that I think is--