Unconventional Success

I just finished reading Unconventional Success by David F. Swensen, a fascinating, and ultimately, disturbing book. Swensen details the utter horrors visited upon the personal investor by Wall Street, the mutual fund industry, and the SEC. Any investor not using Vanguard index funds is doomed to have his/her wealth steadily transferred, by hook or by crook (literally) into the pockets of Wall Street. "Buyer beware" indeed.

The portion of the book I wish to memorialize here deals with portfolio construction and asset allocation. Swensen emphasizes that investors need to understand the "why" behind asset selection - to understand the investment attributes provided by a particular asset class. He identifies six core asset classes:

1. domestic equities
2. foreign developed market equities
3. foreign emerging market equities
4. real estate
5. US Treasury bonds
6. inflation-indexed bonds (TIPS)

The characteristics contributed by core asset classes include:

• substantial expected returns (equities)
• correlation with inflation (TIPS, real estate, and equities)
• protection against financial crisis (government bonds)

Swensen includes an entire chapter on non-core asset classes, explaining why each is not a good choice for inclusion in a portfolio. Of significant interest is the rejection of any kind of bond other than US Treasury bonds, with the sole possible exception of municipal money market funds. Non US Treasury bonds contain characteristics that make them a lose-lose situation for the investor - they have a zero upside with lots of down side.

Swensen does not include a discussion of asset styles such as growth/value or small cap/large cap in the chapters on core and non-core asset classes. The reader is left wondering whether such investments are worthy of inclusion in a portfolio. Swensen mentions styles only when discussing the importance that indexes be well designed - defined as an index that does not undergo undue changes in composition. He rejects style classes for the sole reason that the indexes themselves are poorly constructed (i.e. constructed in a manner that result in too much turnover and provide opportunities at time of index adjustment for market arbitrage - all at the investor's expense).