Friday, November 17, 2017

A Conversation with David Swensen?

Janet Lorin and Christine Harper of Bloomberg report, Yale's Swensen Sees Low Volatility as `Profoundly Troubling':
David Swensen, Yale University’s longtime chief investment officer, said the lack of market volatility in the current geopolitical environment is a major concern and warned that another crash is possible.

“When you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling,” Swensen, 63, said Tuesday during remarks at the Council on Foreign Relations in New York. That “makes me wonder if we’re not setting ourselves up for an ’87, or a ’98 or a 2008-2009,” he said, referring to previous market crises.

“The defining moments for portfolio management” came in those years, “and if you ignore that you’re not going to be able to manage your portfolio,” Swensen said.

The investment chief, who was interviewed by former U.S. Treasury Secretary Robert Rubin, also said he’s expecting lower returns for the university’s endowment, which he’s run for 32 years with a 13.5 percent average annual rate of return.

For the past 12 to 18 months, Swensen said he has been warning university officials to expect much lower returns in the future, as little as 5 percent annually, which would be down from previous assumptions of 8.25 percent.

“It’s not a very popular change,” he said. “We’re victims of our own success.”

‘Strategic Positions’

Swensen’s widely copied strategy of shifting away from U.S. stocks to alternatives including private equity has generated billions of dollars in gains for the school in New Haven, Connecticut. The fund reached a record of $27.2 billion as of midyear.

“We have to take strategic positions in the portfolio,” Swensen told an overflow crowd. “One of the most important metrics that we look at is the percentage of the portfolio that’s in what we call uncorrelated assets, and that’s a combination of absolute return, cash and short-term bonds. Those are the assets that would protect the endowment in the event of a market crisis.”

Asked why Yale’s uncorrelated assets are higher now than in 2008, he said, "I’m not worried about the economy so much, what I’m concerned about is valuation."
Janet Lorin of Bloomberg also reports that Mr. Swensen talked about China, quants, and manager selection:
Yale University chief investment officer David Swensen, in a rare public appearance, spoke Tuesday to former U.S. Treasury Secretary Robert Rubin at the Council on Foreign Relations.

During the hour-long session, Swensen, 63, disclosed that annualized returns over his 32-year tenure have been 13.5 percent, higher than the endowment’s assumption of 8.25 percent a year.

Swensen said he favors private equity and doesn’t like quants, and talked about his efforts to get university officials to lower expectations for future returns. The endowment has swelled to a record $27.2 billion, the second-largest in U.S. higher education.

During the interview, Swensen shared thoughts about investing and opportunities:
  • On where to invest: “The types of questions that you need to ask with respect to where you are investing are the bedrock for putting together your asset allocation. When I look around the world, there are places that we just won’t invest. Russia. If the rule of law does not follow, then do you know whether or not you own anything? And if you don’t know whether or not you own it, then why would you put your funds there? As we look around the world in spite of the problems we face in the United States, this is one of the best environments in which to invest. I think that the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
  • On China: His level of concern about China has been “pretty constant” over the past 12 or 18 months. “China is an area that makes me incredibly nervous, but at the same time, we’re heavily committed there. I’ve had great relationships with a handful of managers in China that have produced extraordinary returns. The party commitment to capitalism doesn’t seem as steadfast as I might have thought five or ten years ago.”
  • On private and public markets: Private equity “where you buy the company, you make the company better and then you sell the company is as a superior form of capitalism. I’m really concerned about what’s going on in our public markets. The short-termism is incredibly damaging. There’s this focus on quarter-to-quarter earnings. There’s this focus whether you are a penny short or a penny above the estimate. There’s this activist mentality that permeates the markets.”
  • On quants: “I’ve never been a big fan of quantitative approaches to investing and the fundamental reason is that I can’t understand what’s in the black box. And if don’t know what’s in the black box and there’s under-performance, I don’t know if the black box is broken or if it’s out of favor. If it’s broken you want to stop and if it’s out of favor, we want to increase exposure. And so, I’m an old-fashioned guy that wants to sit across the table from somebody who’s done the analysis and understand why they own the position.”
  • On manager selection: Swensen has long attributed much of his success to the selection of managers for their character and the quality of investment principles. The test for character is “subjective, a gut feeling.” He tries to spend time with prospective managers in a social setting when making evaluations. “Track records are really overrated,” Swensen said. “We would miss out on some incredible investment opportunities if we required three or five years of audited returns before backing somebody.”
I love that last part on manager selection, he's so right. David Swensen is a god in the endowment fund world, and for good reason. He holds the longest, most enviable track record among his peers and he has literally authored the book on pioneering portfolio management.

So when Swensen speaks, you'd better listen and listen carefully. Do I agree with everything he says? Of course not, my name is Leo Kolivakis and I've got my own opinions on markets and the economy but I agree with a lot of the points he raises:
  • On low volatility: Since the summer, I've been warning you the silence of the VIX won't last forever, and when vol picks up, many traders jumping on the short global vol trade are going to be screaming like lambs to the slaughter. When volatility spikes and stays high, it will crush many unsuspecting fools who keep buying exchange-trade products betting that volatility will sink lower. Now is not the time to be picking up dimes in front of a steamroller. 
  • On public versus private markets: Swensen loves private equity and I don't blame him. It has been a great asset class for Yale and other institutional investors but I'm much more tempered in my enthusiasm and have taken on those who defend the industry at all cost, stating much of the outperformance in private equity is due to leveraged asset-stripping. In public markets, I share Swensen's concerns on short-termism but I'm also concerned on valuations as euphoria keeps creeping into these markets, no thanks to the universal shift into passive investing and global central banks who refuse to let markets go down. I've been warning my readers that markets are on the edge of a cliff, it's as good as it gets for stocks and if credit markets keep deteriorating and a crisis develops, we are going to experience the worst bear market ever. This won't bode well for public or private markets.
  • On China: Unlike Swensen, I'm very worried about deflation headed for the US and what will happen when the bubble economy bursts. Importantly, I don't see any "baffling" inflation-deflation mystery, think deflation remains the clear and present danger, and I'm dismayed at smart people who think a major reversal in inflation is upon us. As such, I'm short emerging market stocks (EEM) and Chinese shares (FXI). Because of deflation, I'm also short oil (USO), energy (XLE), metals and mining (XME) and financials (XLF) and remain long and strong good old boring US bonds (TLT), the ultimate diversifier in these insane markets. 
  • On quants and manager selection: I understand Swensen's healthy skepticism on quants taking over the world but there's no denying this trend has been going on for a while and will likely persist. Just because you can't understand the black box, it doesn't mean you can't invest in it. Maybe put them on a managed account platform and monitor and control the risk more carefully. As far as manager selection, he's spot on, you need to look way past track record, get a gut feeling for a potential manager and run with it. You won't always be right but so what, it's an art, not science.
Speaking of art, I had to chuckle this week when I learned Leonardo Da Vinci's Salvator Mundi smashed an auction record, selling for $450 million (click on image):


Too much money, with too few brains chasing too few deals. I didn't say it first, Trump's friend did when he sold his real estate holdings way before the 2008 meltdown. He might have gotten out too early but he had the sense to get out.

And that's the moral of the story. Markets can keep setting records and they can stay irrational longer than you or I can stay solvent, but at one point the music will stop and it will hurt a generation of investors.

Are there intelligent risks to take? Sure, you can track what top funds are buying and selling but that's not going to guarantee you great returns because the more risk you take, the more volatility you will need to endure and it's fun when liquidity is plentiful but not so much when it dries up.

Nevertheless, it's Friday and US Thanksgiving is next week, so let me share with you some stocks that moved up nicely on my watch list today, and they're not just biotechs (click on image):


You can track more of my investment ideas on StockTwits here but to be honest, I don't have the time to post every stock I'm looking at.

I also want to let my readers know that I updated my comment on CalPERS doubling its bond allocation to include Monday's Investment Committee clips and earlier today, I spoke with OPTrust's President and CEO, Hugh O'Reilly, on that pension's decision to divest from big tobacco. You can read his comments at the end of that comment in an update here.

As a reminder, I don't get paid for sharing my wisdom on pensions and investments. In fact, I'm grossly underpaid for all the work that goes into this blog so I kindly remind everyone regularly reading my comments to please take the time to donate via PayPal on the top right-hand side under my picture (view web version on your smartphone).

I want to sincerely thank all of you who financially support my efforts, it's truly appreciated.

Below, a conversation with David Swensen. Take the time to listen to him, Yale and Harvard weren't the top-performing endowment funds last fiscal year but he's a very wise man who had one of my favorite economists, James Tobin, as his mentor.

I particularly like his bleak assessment of America’s looming retirement crisis around minute 40 and how he then slams US public pensions who justify a discount rate of 7.5 percent when he thinks they should be using the 10-year bond yield plus 50 basis points (roughly 3 percent).

I guess he's unaware the Mother of all US pension bailouts is in the works right now which makes the debate on discount rates obsolete.

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