FOOL ON THE HILL: An Investment Opinion
Pioneering Portfolio Management

One of the central themes of Pioneering Portfolio Management, a recent book by Yale's chief investment officer David Swensen, is the importance of investing with discipline. However, Swensen's view of discipline may seem at odds with approaches supported by other investors, such as focused investing. However, it is still possible for investors to integrate both discipline and concentration when creating a successful stock portfolio.

By Brian Graney (TMF Panic)
September 19, 2000

Recently, while sniffing around the Web for the latest nuggets of available investment-related information, I stumbled upon the semi-annual report from the Sequoia Fund. For those unacquainted with it, Sequoia is an investment fund co-managed by a fellow named Bill Ruane, who is a long-time chum of famed investor Warren Buffett from back in the days when the two studied together under the legendary Ben Graham at Columbia.

Given the similarities between Ruane and Buffett's fundamental investing philosophies, most readers can probably guess what the report said. The bulk of it stressed the importance of patience and other issues related to long-term investing, with a few digs about the "recent speculative frenzy in the dot-com sector" and the superior performance of cash relative to the major stock market indices this year thrown in for good measure.

However, what really caught my eye was the book recommendation that came at the end of the report. Figuring that Ruane and his comrades at Sequoia really had no reason to plug a book outside of being helpful to their fund's shareholders, I took a chance and picked up a copy on their advice.

For the most part, I'm thankful to Ruane and company for the tip.

The book that was recommended is Pioneering Portfolio Management by David Swensen, who is the chief investment officer for Yale University. From the get-go, it's obvious that the intended audience is the endowment and institutional investment business in which Swensen works, which at first prompted me to fear that I may have done my part in boosting Amazon.com's (Nasdaq: AMZN) quarterly revenues by picking up a snooze-fest of academic ramblings. Thankfully, though, there are enough compelling insights sprinkled between the book's covers to keep just about any individual investor with an open mind turning the pages.

Judging from the returns referenced in the book, Swensen has done fairly well managing Yale's investment money over the past 15 years and the book is largely an explanation of his disciplined, yet unconventional, approach. Disciplined investing, much like long-term investing, is one of those vague phrases that gets kicked around a lot and is open to all kinds of interpretations. It really depends on how you choose to define the term. After all, an investor whose philosophy is to buy a stock the day before a previously announced stock split becomes effective and sell it the following week might be considered to be "disciplined" in a certain way, although calling such an individual an "investor" would be wholly inaccurate.

Coincidentally, the issue of investing discipline was an indirect theme of a speech about institutional investment management given a few years ago by another old pal of Buffett, Berkshire Hathaway (NYSE: BRK.A) vice-chairman Charlie Munger. In it, Munger singled out Yale's investment philosophy as an example of what institutional managers should avoid doing, taking particular exception to the complexity that has moved the university's endowment toward becoming an institutional version of the so-called "fund of funds" investment model.

Without a doubt, Yale's investments run the gamut. Swensen's unconventional approach has given rise to a portfolio that depends much less on domestic stocks and bonds compared to most other colleges and universities. Instead, Swensen advocates a greater reliance on investments in less liquid private assets, including real estate and venture capital and leveraged buyout funds. In this regard, Swensen may not correlate 100% with Foolishness, but he has his moments. Anyone who refers to technical analysis as "quackery," as Swensen does at one point in his book, gets my thumbs-up.

And clearly, Swensen's ideas have had some pull in the rather radius-constrained circle of endowment management. Just last week, The Wall Street Journal published a story on Notre Dame's recent market-beating investment returns, which have come as the university has ratcheted up its investments in illiquid private assets to some 40% of the endowment. According to the Journal, that figure represents twice the percentage the school has allocated to stocks and more than six times its allocation to bonds.

Such a model appears to be in direct conflict with the focused investing viewpoint set forth by Munger, who at one point in his speech makes a case for why it might be "a rational choice, in some situations, for a family or foundation to remain 90% concentrated in one equity." According to Swensen, such a policy is too risky for a perpetual institution like Yale, which has a responsibility through its investment policies to both its current and future students. As a cautionary tale, he relates in his book the unfortunate experience of Boston University, which funneled an outsized percentage of its endowment money into a single, unknown biotech company in the 1980s and 1990s and suffered a loss of more than 90% on cost by the time all was said and done.

But while based on their printed words Swensen and Munger might appear to be polar opposites on the issue of investing discipline in general, there is some common ground. In fact, Swensen supports the idea of concentration in the chapter of his book that deals with traditional asset classes (read: stocks and bonds.) "Portfolio concentration increases the likelihood of beating the market," he admits. "Instead of following the maxim, 'Don't put all your eggs in one basket,' fiduciaries ought to hire managers who put all of their eggs in one basket, and watch that basket very carefully." The last part of that quote is so frequently attributed to Buffett and Munger that it's probably tattooed on their bodies somewhere.

For individual investors, the ideas of investing discipline and portfolio concentration don't necessarily need to be mutually exclusive. As a matter of course, Munger's qualified suggestion of a single-stock approach would require a different kind of investing discipline from that espoused by Swensen in his book -- and a whole lot of it to boot. Yet as the Sequoia Fund's rather concentrated yet still disciplined portfolio of about a dozen stocks (along with some U.S. Treasury securities) illustrates fairly well, there can be a middle of the road. Individual investors can successfully structure their own retirement and child education "endowments" with both principles in mind.

Here's a link to Pioneering Portfolio Management at Amazon.com, but you can, of course, buy it elsewhere. If you do click the link above and buy the book, the Fool gets a commission on the sale, just to let you know what the relationship is.

Related Links:

  • Sequoia Fund SEC filings at freeedgar.com
  • Address by Charlie Munger on foundation investment