Introduction
This book was published in 2005, but it has become a “classic” in the world of personal investing. While the book is voluminous (400 pages) it is nevertheless an easy read. A main reason for this is the fact that much of what the book is reporting on is basically US-market specific and/or outdated. However, the book’s discussion of basic principles for personal investing are still as relevant today as when the book was first published. We shall review these slightly less relevant parts of the book in a rather cursory manner. But, before we start our review, let us give a brief biography of the author, David Svensen. He was the chief investment officer at Yale University for more than three decades and generated an annual return on Yale’s endowment of more than 16% per annum, having thereby gained the reputation as perhaps the most pre-eminent chief investment officer of not-for-profit institutional endowments. He passed away from cancer in spring 2021.
Mr. Svensen’s key advice is to create an investment portfolio that is:
Broadly diversified
Passively managed (i.e., draw on top notch professional investment managers within the various classes of investments that are pursued).
Try to build an equity-minded portfolio
Utilize where possible, good not-for-profit seeking managers
Pay close attention to tax considerations
Among the many conventions that tend to be widely and commonly accepted, which are attacked by Mr. Svensen, is the fallacy, in his view, of actively managed portfolios for most individual investors, and particularly so when it comes to relatively smaller ones. Mutual funds, in particular, may typically be biased in favor of large investors. And there are simply not enough good investment choices available to most investors. Truly attractive deals typically get funneled towards the largest investors, including big institutional ones. Also, Mr. Svensen points out that there tends to be a quite common extrapolatory tendency, a flock mentality, indicating that “good is expecting to continue virtually forever”, or vice versa, when it comes to downward trends. Thus, many independent investors end up being at the high end, for then to sell at the low end.
Mr. Svensen points out that developing an effective investment portfolio will have to be based on the following three principles:
The importance of equity ownership
The efficacy of portfolio diversification
The significance of tax sensitivity
He points out that one’s basic portfolio should ideally be relatively stable, and that high transaction costs might make it expensive to make changes in a fundamental portfolio. Dividends are always key, for stocks, bonds and sale of assets. Most investors depend on a certain amount of such current cash flows.
There seems to be three fundamental sources for generating a value-enhancing investment portfolio:
Asset allocation (for instance, in “my” investments portfolio there are five classes of assets: stocks/bonds, shipping, real estate, ventures, education).
Timing (in my words: in/out as well as long/short. The author does not consider the latter, however). Mr. Svensen thus does not discuss long/short. To come up with long term charter parties in shipping, rather than going short i.e., asset play, is a common consideration when it comes to managing this asset class, however. Long-short considerations are also quite common when it comes to commodity handling as well as when dealing with stocks.
Security selection (i.e., valuation, so as to buy low, sell high, with a good likelihood of value appreciation).
Among the various classes of equities, Mr. Svensen seems to prefer (high yield) equities (stocks), and real estate. He appears to be generally skeptical when it comes to bonds, however. Please note that this book was written in 2005, however, with a relatively low level of interest rates. In such circumstances, bonds may be relatively less attractive than with higher interest rates.
When discussing how to come up with which core asset classes to invest in, Mr. Svensen stresses that such assets must be able to produce basic differentiable characteristics. In this reviewer’s terminology this means as uncorrelated as possible! And such assets should fundamentally be driven by market characteristics, and not by having to put in a high degree of managerial efforts to create value in an asset. The availability of a well-functioning market is thus key! Mr. Svensen warns that many real estate deals, for instance, may involve too much work, indicating that fully effective market conditions might not be there!
Mr. Svensen also points out that it always seems to be advisable that a promoter of a particular “deal” might be an active investor in this given deal him/herself, i.e., to have “skin in the game”.
Mr. Svensen highlights that to develop one’s own investment portfolio might not only involve “science”, i.e., applying relatively objective criteria for an asset’s attractiveness, but also “art”, i.e., reflecting given investor’s preferences, such as in this reviewer’s case, shipping. In this reviewer’s opinions, learning is also an important benefit from the following of a relatively stable portfolio, and with not too many asset classes. Mr. Svensen does not discuss this. Svensen also points out that the overall “risk” imbedded in a portfolio might tend to become more and more diminished as one’s time horizon is shortened. It should be noted here that Mr. Svensen seems to be combining what now tends to be denoted risk and uncertainty here, i.e., the picking of undervalued assets (good risk propensities) and with relatively high upside potential (good uncertainty prospects).
Mr. Svensen appropriately postulates that the various asset classes in a given portfolio shall tend to have different expected returns, this being in contrast to the author’s portfolio, where an overall expectation of 10% for all asset classes seems to be the norm.
Now to Svensen’s discussion of what he considers non-core assets, such as high-yield bonds, tax-exempt bonds, asset-backed securities, foreign bonds, hedge funds and venture capital. While most of the discussions in this chapter (chapter 4) are either too US-centric and/or no longer up to date, it is worthwhile to notice Mr. Svensen’s skepticism when it comes to leveraged buyouts. He feels that the risk relative to the returns in many such situations would not be meritable. Also, fees often tend to be too high. And, as promoters typically tend to launch larger and larger rounds of new projects to the fee structure, get initially smaller projects and then the fees now becomes unreasonable. All of these issues seem to be as reasonable today as they were in 2005. In line with this, Mr. Svensen is also skeptical when it comes too much venture capital, but he points out that what he calls “fraction firms” might nevertheless be acceptable. This is indeed modern thinking!
Mr. Svensen seems to be critical to mutual funds while US legislation has since addressed many of the disfunctionalities that Mr. Svensen emphasizes, his caution about tech-based mutual funds may still have merit.
Rebalancing of a portfolio typically tends to be difficult, even “painful”, calling for the need to act against the crowd. Tax consequences must of course be central when it comes to expecting such changes.
Mr. Svensen shows that active thinking by individual investors typically does not work. To go for carefully selected mutual funds might therefore be viable. If you can’t beat them, join them, as the saying goes! However, to work with so-called non-profit market funds such as Vanguard, Fidelity, or State Street might be it. It should be noted that the above mutual funds should not be seen as non-profit in the strict sense, but that they are not primarily going for profit maximization, rather simply covering their costs plus a reasonable margin. Most mutual market funds seem to basically fail, however, because of:
Lack of consideration regarding tax
Outrageous fees
Excessive funding, earning the fund commission on each trade
Over-valued assets when it comes to assessing such firm’s safety margins
Kickbacks
Irresponsible re-distribution of capital
Instead, Mr. Svensen comes up with seven guidelines for how to work with mutual funds, i.e., all mutual funds, not only not for profit ones:
Have a clear long-term strategy
Follow a relatively concentrated portfolio; do not let a mutual fund invest in areas outside one’s portfolio
Stability in the client base, i.e., which mutual fund to work with
Negotiate fair fees
“Insist” on substantial co-investors by the mutual funds themselves, i.e., skin in the game
Limit the size of each deal
Demand good communication
All in all, Mr. Svensen, in this book, comes up with a set of investment principles that seems as relevant today as when they were written. While much of the specific discussions are no longer valid, due to emerging legislation and improved industry practices, the take home value of this book is indeed still high. This reviewer recommends this classic book highly!
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