If you haven't heard of David Swensen, maybe it's time you did. He's been at the helm of Yale University's endowment fund for 20 years, racking up a very respectable performance record. Lest you think we're talking small potatoes here, get this: The Yale endowment fund's size is $15 billion, larger than the market caps of modest little firms such as ConAgra, Marriott, International Paper, Southwest Airlines, and Harley-Davidson. The endowment's average annual gain in the past two decades: 16%.
Swensen isn't eager to divulge his holdings, but according to some SEC filings and old articles I ran across, some of Yale's recent holdings have included FelCorLodging Trust
I think the first time (or one of the first times) Swensen was covered here in Fooldom was back in 2000, when Brian Graney wrote: "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."
Swensen has been in the news recently in several regards. For one thing, as Harvard University is undergoing a turnover in its endowment management, Yale's longtime management is offered up as a counterexample. (Though, to be sure, departing Harvard manager Jack Meyer hung around a while, turning $4.7 billion in 1990 into a recently reported $25.9 billion. For context, that sum is greater than the market caps of General Dynamics or Nike.)
Then there's Swensen's new book, Unconventional Success: A Fundamental Approach to Personal Investment.
A pox on funds
In his book, Swensen is rather critical of mutual funds today. This is another regard in which he's rather Foolish. As the folks at Booklist summarized:
Soft money, 12b-1 fees, overtrading, market timing, and other management practices lower performance and virtually guarantee that most mutual fund returns will fall short of their benchmark, such as the S&P 500. Furthermore, for-profit mutual fund companies have a fiduciary obligation to their stockholders, not to their investors, and this relationship "inevitably resolves in favor of the bottom line." Swensen is also highly critical of the Morningstar rating system, which only causes investors to chase hot performing funds and managers.
Ouch. These kinds of criticisms are not new to readers of The Motley Fool. We've detailed problems with mutual funds many times:
Losers disappear
In an interview with The Wall Street Journal, Swensen offered a critical point about frequently published statistics on the mutual fund universe. The Journal asked, "So if you look at the regular data on fund performance, you're not seeing the whole story?" Swensen replied:
You're not seeing the losers that disappear. They could disappear because they go out of business or because cynical managers of mutual funds will take poorly performing funds and merge them into better-performing funds, and so the record of the poor performer disappears. The picture that you get if you just look at the survivors is dominated by the winners -- but of course investor dollars were invested with the losers that disappeared.
And the picture gets worse. Swensen continued:
And if you look at the aggregate results of the mutual fund industry on an after-fee, after-tax basis and adjust it for survivorship bias, the probability that you are going to end up with market-beating returns is de minimis. . The 10-year after-tax shortfall for mutual funds is 4.5% per year relative to what you would have gotten if you had put your money in an index fund.
Hedging it
So what should Fools do, if mutual funds are problematic? Well, index funds are an obvious and attractive option. They offer average market returns and tend to sport low fees. Swensen also likes index-based exchange-traded funds (otherwise known as ETFs, which you can learn all about in our ETF Center), and nonprofit fund families, such as Vanguard. He also encourages investors to be more informed and more involved, rather than simply leaving it all to the professionals.
Swensen has invested the Yale endowment heavily in hedge funds, as many other endowments have done. Does this mean you should look into hedge funds for yourself? Well, you can look, and it's always good to learn, but odds are, you aren't rich enough to invest in one, and many are not so hot, too. (See Hedge Funds Explained.)
Be better than average
For us small investors, some ETFs make good sense. So do index funds. But index funds will just get you to average. If you want to aim higher, seek out the relatively few outstanding mutual funds out there. They do exist. And their superiority can turbocharge your portfolio.
Consider this: If you plunk $10,000 in an index fund that grows at the market's average annual rate of 10% per year for 25 years, you'll end up with around $108,000. If that $10,000 were invested in a mutual fund that averaged 13% growth annually (let's say 12%, adjusting for management fees), your end result would be closer to $170,000. That's a difference of more than $60,000, or a 57% premium on top of the $108,000 base amount.
You'll find outstanding mutual funds profiled here in Fooldom and elsewhere in the financial press. (Just be a savvy and wary consumer of fund information -- our Mutual Fund Center can help you learn how to evaluate funds.) I also encourage you to give our Motley Fool Champion Funds newsletter a whirl -- for free. Try it out and you'll be able to access all past issues and see all the recommended funds. Last time I checked, the average return for the group of recommended funds was 13.42%, versus 6.77% for the S&P 500 over the same period.
Selena Maranjian's favorite discussion boards include Book Club, Eclectic Library , and Card & Board Games. She owns shares of Amazon.com. For more about Selena, view her bio and her profile. You might also be interested in these books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . Amazon.com is a Motley Fool Stock Advisor recommendation. First Data is a Motley Fool Inside Value recommendation. The Motley Fool isFools writing for Fools.
