[Front Cover of Unconventional Success]

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.

This article has 9 comments

  1. While the book does critique the vast majority of active management provided to retail investors, Swenson brilliantly outlines outline in one chapter how to “Win the active management game”.

    While his a great book for all investors, anyone choosing to forego a passive index investing and instead invest all or a portion of one’s money into actively managed mutual funds (this would not be the CC, of course), would be well advised to read this particular chapter.

    I have never read a better summary of the key characteristics required to win with mutual funds. Using his criteria (which applies to about 1% of funds out there), investors can quickly eliminate the vast majority of weak funds out out there and focus firmly on the few good ones.

    It may also be worthwhile to show this chapter to your investment advisor (if you use one) and ask him/her to (as objectively as possible) critique the funds he/she has recommended using Swenson’s criteria.

  2. When it comes to individual investors, one the things that I find fascinating is that many focus almost exclusively on the returns generated by the great managers of the world (Peter Lynch, Warren Buffett, etc…) and then ignore the actual advice they provide to the average investor.

    On numerouse occassions Buffett and Lynch have counselled that individuals should manage their portfolios passively, using low-cost index funds. In fact, Buffett is so confident in the S&P 500 index that he bet $1,000,000 against the founders of Protege Partners that the S&P500 will outperform a fund of hedge funds picked by Protege. More info on the bet is available here:

    http://www.pwlcapital.com/Advisor/Ottawa/Andrew-Baechler/Advisor-Insight/Andrew-Baechler/July-2008/Warren-Buffett-likes-the-S-P-500-vs–a-Fund-of-Hed

    Rather than follow Buffett and Lynch’s advice, most individual investors instead turn to the Jim Cramer’s of the world in the hope that his short-term “get it now!” advice will earn them above average Lynch and Buffett like returns.

  3. Didn’t Cramer say that Lehman was a buy just before it imploded?? :)

    CC – thanks for the great review – I will be getting this one out of the library for sure.

    Mike

  4. Rob: Good point and it’s a great idea for a future post.

    Andrew: Actually, apparently even Cramer thinks that most individuals should index most of their portfolio (I haven’t read his book but a MoneySense review noted the irony).

    Mike: I first read this book when it first came out but I found myself referring it many times that I purchased my own copy.

  5. I am a stock market book junkie and this is the best of the bunch. It is very well written and gives great insight into the need to index most of your portfolio.

  6. If you are going to read only one investment book in your entire life, it should be Swensen’s.

    But then, my fear is that the people who will invest time & energy to read 500 pages on asset classes, portfolio structure and the many ways retail investors are being separated from their dollars, probably don’t need Swensen’s advice.

    For me personally, his book made me realize that it took those 500 pages to give me the deep conviction to follow a passive, “do-nothing” approach. This is probably where most people struggle, because an active approach seems so much “smarter” at first glance.

  7. But isn’t there some controversy about the Yale’s endowment fund being invested mainly in illiquid assets for which a day to day price might be difficult to find.
    Also most of those illiquid assets ( like timber) have pretty high entry investment minimums to start with, which are not suitable for the usual middle class investor.

    Anyways, buying and holding a diversified portfolio of index funds sounds like a good idea for the long run.

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