October 12, 2009

Financial Times, By Chrystia Freeland

For almost one-quarter of a century, David Swensen, head of Yale University's $16bn endowment, has been one of the most influential figures in US finance. Because of his extraordinary success in managing the Yale fund, Swensen has been described as the biggest "donor" in Yale's history.

The 55-year-old divorced father of three arrives for lunch with the FT precisely on time. He has chosen Bentara, an airy Asian restaurant in Yale's hometown of New Haven, Connecticut. As he approaches our table in the near-empty room, he looks more like a college professor than a Master of the Universe. Tall, slender, with an angular face, close-cropped hair and even, white teeth, he wears khaki trousers and a blue shirt, with a Patagonia vest under his black leather jacket to ward off the New England winter chill.

Yet Swensen commands more financial firepower than most of the more gilded combatants on Wall Street, just a 90- minute train ride away. In the 10 years to June 30 2008, Yale's endowment fund posted average annual gains of 16.3 per cent, including banner returns of 41 per cent in 2000 and 28 per cent in 2007. It is a performance that has had fund managers clamouring to look after Yale's money (like most big endowments, Yale entrusts most of its wealth to outside money managers). A Swensen investment became one of Wall Street's most coveted seals of approval.

Swensen's approach transformed the management of university endowments and other big public funds, inspiring them to follow his strategy of shifting from putting all their money into traditional investments in shares and fixed-income bonds, and instead moving partly into so-called alternative investments such as private equity or real estate. His investment style is so well-known - perhaps second only to the "value investing" approach of Warren Buffett - that it is often simply called the "Yale model" or the "Swensen model".

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Another nod to Swensen's prominence was his appointment this year to President Barack Obama's newly formed economic recovery advisory board, chaired by former Federal Reserve chairman Paul Volcker, and including such heavyweight chief executives as General Electric's Jeff Immelt.

The financial crisis and the sharp public censure that it provoked of Wall Street's culture of excess and instant gratification was, in some ways, a vindication of Swensen's Lutheran ethos of self-restraint and his philosophy of investing for the long-term. But the crash brought pain to Yale, too: in the fiscal year ending June 30 2009, its endowment was down 24.6 per cent, a wrenching $5.6bn investment loss for the university and an unprecedented setback for Swensen.

Swensen traces the origins of his career back to a precocious interest in capital. He remembers being captivated by the corn futures report on the car radio on the drive home from school in River Falls, Wisconsin, with his chemistry professor father. "I've been fascinated with markets ever since I was a child," he says. "It was the idea that every day these prices would change. What caused that?"

The intellectual attraction of finance - which Swensen likes to think he could have inherited from a great-grandfather who ran a small-town bank in Iowa - was so strong that as a 12- or 13-year-old boy he pooled his money from odd jobs and Christmas and birthday gifts into his first equity investment: shares in Eastman Kodak. It was an enthusiasm that led him to Yale's economics department, where in 1980 he wrote his PhD dissertation on the valuation of corporate bonds.

Graduation brought a professional choice: Swensen planned either to go to Amherst College, because teaching undergraduates appealed to him, or to work at the Bank of Canada, "because if I were going to do research, I wanted it to apply to a real world problem". He also thought Canada would be "my kind of place", thanks to the "cross-country skiing and real cold weather". A later discussion of taxation, healthcare and social safety nets makes me think that Canada's greater commitment to social welfare might also have appealed.

As it turned out, he went no further than Wall Street. In the mid-1970s, Salomon Brothers had more and better information on the bond market than any other investment bank, and Swensen had been working with a Salomon team to collect data for his dissertation. When he told his banker contacts about his two career options, one of the senior partners stepped out of the room and returned 10 minutes later with a job offer.

The speed of that transaction - especially compared with the bureaucratic hurdles the Bank of Canada had to clear to justify hiring a foreigner - lured Swensen to Salomon: "I thought it would be great to work for a place that could make a decision in five minutes as opposed to a place that would make a decision in five months."

Swensen loved Salomon Brothers. "It was great," he says, as his kari ayam, or chicken curry, and my two-soy chicken arrive and we both dive in with relish.

"I love competition and obviously Wall Street is an incredibly competitive environment," he says. "It was a time when Wall Street was more open to change than it had been in decades, so investment banks could come up with new ideas and clients were willing to try out these new ideas, so it was an incredibly exciting time."

He remembers with particular pleasure structuring the first-ever swap transaction, an "amazing" deal, concluded in 1981, between IBM and the World Bank that allowed the technology company to hedge its Swiss franc and German Deutsch-mark obligations. The next year, in 1982, he was poached by Lehman Brothers, to run the firm's swap group, a three-year stint that he describes as "way cool".

But Swensen had also kept up his ties to Yale, commuting to New Haven one evening a week to teach an undergraduate seminar. After three years at Lehman, Swensen got a call asking him to return to Yale full-time to run the university's endowment. He did so in 1985.

Swensen worried that he wasn't qualified for the job: "I was sceptical because I had no portfolio management experience ... I remember wondering, even after I got to Yale, whether they were really serious about putting me in charge of this billion-dollar portfolio, because it seemed like an enormous amount of money and a big responsibility, and I'm not quite sure why it is they would have chosen me to do it."

So, I suggest, you shared your misgivings with the hiring committee and they reassured you? Swensen is a thoughtful conversationalist, pausing before many of his answers and preferring not to respond at all if he feels he doesn't know enough about an issue, but with this question he breaks into his only outright laugh of our encounter: "I never asked anybody. That was a private thought that I didn't share."

He was also concerned about the 80 per cent pay cut he would have to accept to return to Yale. It is an eye-popping drop but, says Swensen, to his surprise he has "never" missed the money, "never once".

That may be because Swensen took to the role at Yale with a passion that this otherwise reserved man isn't shy about declaring: "I love it! I love it! ... I was talking to somebody the other day who characterised endowment investing as the purest form of investing ... I think that notion underpins why it is that I, or one of the reasons why I love my job as much as I do."

This happy moment seems to be a good time to ask Swensen about the financial crash and the severe bite it has taken out of his beloved endowment. Does Swensen feel he anticipated the crisis?

"Late in 2007, Yale took all of its operating cash and moved it out of money market funds and put it into Treasury bills, so we were absolutely aware of potential issues. And that was months before Bear Sterns," he says. "But, that said, we weren't prepared for the magnitude of the crisis, or its duration."

This mild assertion of prescience in late 2007 makes me wonder whether the crisis has prompted Swensen to reconsider his big idea - investing in illiquid assets. If more of Yale's assets had been easier to cash in at that time, surely Swensen would have moved more money into T-bills [ultra-secure US government bonds] and hence suffered a smaller loss? (Partly thanks to doing just that, the University of Pennsylvania's endowment reported one of the smallest losses in the year to June 30 2009, and fell by 15.7 per cent.)

Swensen has a monosyllabic reply to this speculation: "No." I try again. Swensen is still terse: "No, we never would have done that." I try a third time, but it isn't until the fourth version of the question that Swensen offers a more expansive response: "There have been some articles that have criticised the Yale model and my role in managing the endowment. And I think that's odd ... What's the alternative? Aside from the heroic impossible alternative of being 100 per cent in T-bills?" Over the longer run, he says, Yale's diversified strategy handily beats a classic 70/30 allocation in stocks and bonds.

The larger point, Swensen believes, is that even though moments of radical disruption, such as the 2007 financial crisis, reward investors who make a big bet on major change, "ultimately, market timing is an exercise in futility. When you've got dramatic movements in the markets you can identify after the fact a handful of investors that succeeded in the short run. But making big, aggressive asset allocation moves isn't a strategy that's likely to prove successful in the long run."

Years of steady, exceptional performance have made Swensen an investing legend among the cognoscenti and largely insulated him against questions, such as these, about his investing approach. We pause, with some relief, to finish our curries and comment on how tasty they are.

Then, as we sip cups of tea, we return to Swensen's favourite themes of money and markets. He says the crisis has reinforced his view that the most important investing advice is "you should invest only in things that you understand. That should be the starting point and the finishing point."

For most investors the practical application of this axiom is to invest in index funds (low-fee investments that aim to mirror the performance of a particular stock market index). "The overwhelming number of investors, individual and institutional, should be completely in low-cost index funds because that's easy to understand."

Even after the battering of 2007 and 2008, Swensen is not optimistic that many will follow his advice: "The investment community is hopeful - hopeful's probably too weak a word - wildly optimistic about their particular chances ... Never underestimate the gullibility of large pools of money."

Swensen says his criteria for selecting outside money managers are simple: "The most important thing is character and the quality of people. That's also the second most important thing and the third most important thing. It's everything." Assessing character involves such deep background checks that, says Swensen, "Some of our managers will tease us about having tracked down their high school geometry teacher."

Such basic research would have protected investors from the convicted fraudster Bernie Madoff, Swensen says: "If you sat down and had a conversation with him about his investment activities and couldn't figure out that he was being evasive, shame on you."

Swensen used to say he could imagine no higher calling than to represent Wisconsin in the US Senate. With his seat on Obama's economic recovery advisory board, he now has a formal entrée into the White House. He has begun to speak out about public policy issues, earlier this year writing an opinion column in The New York Times arguing that a not-for-profit endowment model would rescue America's imperilled newspapers.

Money has never been able to entice him away from New Haven - by contrast, the two previous heads of the Harvard endowment left for the private sector - but I wonder if public service might. "It's impossible to prise me away from Yale," he says. "I love Yale. I've been here almost 24 years. I do love higher education, but I particularly love Yale."

I ask if he can name one special thing about Yale that he particularly loves, expecting perhaps a shout-out to the undergraduates he still teaches, or to the intellectually stimulating company of the Yale faculty, or even a paean to the grand civilising mission of one of the world's great universities. Instead, Swensen tells me: "This year, it's the hockey team."