David Swensen: Yale’s Financial Wizard, guest lecture and interview

You can view (or just listen) to a great guest lecture by David Swensen, in Bob Shiller’s Financial Markets course. The whole course is on iTunes U, but you can grab this lecture directly at Academic Earth, or at iTunes U (audio) which is what we wanted for our iPod hiking.

The ProPublica interview with David Swensen was Feb 18, 2009. I would like to see a repeat of the interview today and again year-end 2010. I liked Swensen’s reply to this challenge:

(…) I’m sure you’ve heard that the financial crisis has sparked a debate about the Yale model, that it doesn’t work as advertised in the current market. What’s your response?

The first thing I’d say is it’s too short a time period over which to judge. If you want to have a fair assessment of any investment strategy, get through the crisis and then look back and see how things performed.

If you look back 10 years from June 30, 2008, Yale’s performance was 16.3 percent per annum. Bonds were 5 percent plus or minus, and stocks were 3 percent plus or minus. So what are you going to do? You’re going to give up that kind of performance to hold a lot of bonds to protect against the financial crisis? Where’s the alternative that performs so much better? 100 percent government bonds? Is that the alternative? Well, then what would have happened if you had held that the decade before? I don’t get it.

They’re not thinking about what happened the 10 years before and they’re not giving us time to get through this crisis and see how it plays out for the Yale model against a more traditional portfolio. That’s one of the really interesting things in these articles that have been critical of the Yale model and sometimes of me personally: Where’s the alternative? What’s the option? Yeah, the model fails. Well, relative to what?

And, regarding “diversification didn’t work this time”:

Have you been able to draw any lessons from this crisis? Were you prepared or was there something that you missed and should have seen?

It’s a very provocative question. One of the criticisms of the Yale model that I’ve seen in the press is that diversification didn’t work. First of all, measuring over a six-month or a nine-month or a 12-month time horizon is measuring over an inappropriately short time horizon. But I think probably the more interesting take on the question is that in times of financial crisis, one of the overriding factors in the market is a flight to quality. And we saw that on October 19, 1987, when stock markets all over the world declined by more than 20 percent. You saw a big rally in Treasury bonds. We saw it again in 1998 around the collapse of (the highly leveraged hedge fund) Long Term Capital Management. You saw an even more pervasive decline in risky assets, and perhaps even a stronger flight to the safety of Treasury bonds. And now today, you’re seeing what you saw in ’87 and ’98, except you’re seeing it even more pervasively and even more intensely than in those two previous crises. When you have this overriding phenomenon of investors selling any type of risk asset to buy the risk-free asset, that overwhelms all the other economic drivers of return. For the period during which we’re in the crisis, the hoped-for benefits of diversification disappear. But once the crisis passes, then the fact that these different asset classes are driven by fundamentally different factors will reassert itself, and you’ll get the benefits of diversification. It would be nice if we could always have the benefit of diversification, but life doesn’t work that way.

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