David Swensen

David Swensen and the Reality of Past Performance

Posted by Mike McLaughlin on Aug 15, 2011, in Thoughts , tagged with , , , , ,

If you read our blog, by now you’ve probably also read David Swensen’s op-ed from the Saturday New York Times. There’s a lot in there worthy of discussion, but one paragraph in particular got a strong reaction from me:

Mutual fund companies, retail brokers and financial advisers aggressively market funds awarded four stars and five stars by Morningstar … But the rating system merely identifies funds that performed well in the past; it provides no help in finding future winners. Nevertheless, investors respond to industry come-ons and load up on the most “stellar” offerings.

Let’s all say it together: past performance is not predictive of future results. True in investing? Yes. In life? No.

The reason David Swensen gets to write an op-ed for the New York Times and lead the Yale endowment is because of what he’s done in the past. Looking at the track record of anything is the most intuitive evaluation barometer we have. Ignoring it is neither natural nor logical.

This doesn’t mean the issue Swensen raises – investors unsuccessfully chasing performance – isn’t real. I just think he’s angrily, unfairly, and incorrectly casting blanket blame on mutual fund marketers and financial advisors, who generally believe in what they’re doing and try to do right by their customers and themselves.

The real enemy here for Swensen is human nature. It’s in our nature to be emotional and overconfident, and compensating for these realities will require a lot more than broad-stroke, ham-handed criticisms of an entire industry.

Does Everyone Really Understand the Complexity of Index Investments?

Posted by Mike McLaughlin on Feb 18, 2011, in Thoughts , tagged with , , , , ,

Third in a series of posts on the sales and marketing implications of the ongoing debate between active and passive management.  Read the first and second posts.

Back the spring of 2009, David Swensen, who oversees Yale’s endowment, gave an interview about his investment principles.  A frequently-repeated quote from the interview is:

With all assets, I recommend that people invest in index funds because they’re transparent, understandable, and low-cost.

The word that jumps out to me is understandable.  I think most investors and financial advisors would reflexively agree that index vehicles are exactly that – a tribute to the way they have been described and marketed.

But there is a variable involved in index investing that makes me wonder if everyone understands index products as well as they believe they do:  the underlying indices.  We spent some time digging into a variety of investment indices, leading us to two conclusions:

  1. Indices are Complex: An index is an easy concept in the abstract, but not so in practice.  For example, to fully digest the methodology behind the creation/maintenance of MSCI indices, you’re going to need to read 119 pages of information.  And consider how different theories have emerged on how indices can be best constructed.

  2. Indices can be Volatile: The components of indices vary regularly, and sometimes significantly.  For example, almost 700 securities were added / removed from the MSCI Small Cap indices at the end of last year.  Even the US Large Cap 300 index had 5% turnover in November 2010.

In addition, index updates sometimes occur as infrequently as every six months.  2008 did a lot to remind everyone how much can change in six months.

In the marketing of investment vehicles, index investments are presented as the simplest, most straightforward option.  As Mr. Swensen stated, they’re understandable.  But as we talk with advisors, they typically get indices conceptually but not in great detail. Data like that presented above catches many by surprise.

For firms positioning themselves and their products against index investments, this represents a way for marketing and sales teams to potentially change the conversation.