Ivy League Investors

Robert J. Shiller

Yale University, where I teach, has entrusted its endowment portfolio to one man, David Swensen, for over 20 years. During this period, the portfolio has grown from just over $1 billion to $18 billion – an average return of more than 16% a year, which appears to be the highest of any major university. And it shows no signs of diminishing: in the latest fiscal year ending in June, the return was 22.9%.

Presidents of Yale have come and gone, but Swensen stays on. He has done more for the university than any president, or anyone else. In a university, ideas count more than money, but $18 billion dollars can create an environment for many new ideas. With 11,500 students, that is more than $1.5 million per student (not including the university’s buildings and art collection, each worth many billions of dollars more).

How did this happen? How did Swensen make so much money? Everyone is wondering – not least those of us at Yale.

After all, many people here have been teaching the “efficient markets hypothesis” that financial markets around the world have become so competitive that it is impossible to make more than a normal return from investing. Anyone who beats the market must simply be lucky.

Studies seem to confirm this. For example, a 2004 study by Brad Barber and Terrance Odean of the University of California and Yi-Tsung Lee and Yiu-Jane Liu at National Chengchi University acquired trade-by-trade data on individual day traders on the Taiwan Stock Exchange. The study found that only the top 1% of day traders made a profit – after deducting trading costs – in two consecutive six-month periods, and the median profit was hardly worth the effort: only about US$4000.

It is easy to conclude that there is just no point in even trying to beat the market. But then one remembers people like Swensen. Can his consistent performance really be attributed to luck?

Robert Kiyosaki, author of the Rich Dad, Poor Dad series of popular investment books, bases his books’ titles and themes on a comparison of his own highly-educated father with his friend’s father, an eighth-grade dropout. According to Kiyosaki, his poor but scholarly dad tended to be pessimistic about one’s ability to achieve anything in the real world, so he discouraged his son from even trying. By contrast, the friend’s dad relished trying to achieve something big. Is it just a coincidence that he was rich?

Kiyosaki may try too hard to be inspirational, but I often think of him when I hear finance professors opine on the efficiency of markets and the futility of making money by trading in them. Maybe many academics find it difficult to take the initiative to achieve in the real world – I have yet to meet another professor who has mentioned having read Kiyosaki.

But Swensen is an academic, with a Ph.D. in economics. He is surrounded by academics. Somehow, all this talk about efficient markets has not discouraged him from trying, and succeeding.

There seems to be a pattern. Two similar universities, Harvard and Princeton, have had nearly the same success. The Harvard endowment, under Jack Meyer, earned a 15.2% average annual return over the last ten years, compared to Swensen’s 17.2% average, while the Princeton endowment, under Andrew Golden, earned an average of 15.6% per year. In fact, Golden worked under Swensen at Yale from 1988 until 1993.

Swensen has written two books about investing, one for professionals and one for the general public. I did not come away from reading them with a feeling that I know how to do what he did. But a couple of things stand out.

One is his long-term focus. Yale lets Swensen invest for the very long term, and does not bother him about quarterly performance. Maybe this allows him to focus more on long-term fundamentals – and thus to make investments that may not perform well in the short run. But, in fact, he has done consistently well in both the short term and the long term.

Part of the reason for Swensen’s success is “absolute return,” a term – now widely quoted in the investment community – that he coined for unusual investment strategies involving such things as merger arbitrage and distressed securities. He also has invested in non-traditional asset classes, including real estate, oil, timber, private equity, and venture capital and buyout firms. These assets are generally not followed by multiple analysts, and are not easily understood, giving him a greater advantage in applying his intellectual skills and the skills of others around him.

In these senses, Swensen is completely different from day traders, who are both investing for the short term and trying to beat the most crowded market – the market for exchange-listed securities.

But I also think that the phenomenal success of Swensen and others like him reflects the environment that Kiyosaki criticizes. The problem is a defeatist attitude, not scholarship.

When an analytical mind, a mind that is trained to search rigorously for the truth and as part of a community of such people is set free from self-doubt, it can do amazing things. Knowing David Swensen, I can attest that he is not a lonely day trader trying to beat the market. He is a good listener, is supportive of people he trusts, and is surrounded by a lot of good people with a wide array of skills. And he is certainly not a defeatist.