[0:05]David Swensen, thank you so much for joining us on Wealthtrack once again. You and I had talked earlier about the fact that you are a bottoms up guy and in this particular period of time you've got to be a top down guy. So what is your take on what has caused the financial crisis that we've been through? Did did you see this coming or was it inevitable? You know, in some ways you could say that that that we saw this coming. I mean in the end of 2007, you know, we took all of Yale's cash and put it into Treasury's. Right. Why? What what was it that that you saw that that you were concerned about? Well, we were just concerned about the viability of any of a number of issuers of commercial paper. So we didn't want to have our our money in these institutional money market funds. But maybe we didn't pay enough attention to what it was that we were doing on the on the cash management side and the implications for the overall portfolio because we certainly didn't sidestep the the the the carnage that that that that resulted from the, you know, total collapse of the, or the near total collapse of our of our financial system. So there so there were signs.
[1:38]Um and you know, maybe with hindsight uh I wish that I would have paid more more attention to them. So uh now where are we? You know, what what's your assessment of of how far we've we've gone in repairing the financial system? Well, actually you you you asked I guess first uh how it was that that that we got here. And you know, I think that uh Jack Bogel gave a fascinating uh speech a few months ago where he talked about moving from the ownership society to an agency society and about the need to move from the agency society to a fiduciary society. And I it really resonated with me. If you if you look at the investment banking world that I joined in 1979, I spent six years on Wall Street before uh I went to Yale. Um I spent three years at Lehman Brothers, three years at Solomon Brothers, they were private partnerships. The partners sat on the trading floor and knew what the exposures were because they owned the companies. So that was that was Jack Bogel's ownership society. And then you look at the absolutely insane capital structures that evolved in the intervening years. You saw way, way too much leverage in the financial system. Investment banks were the worst, but commercial banks were over leveraged as well.
[3:17]And you looked at the at the character and quality of the assets and the assets, I think by and large were there on their way to some place else, but of course when the music stops, they don't get to go some place else so they're there. Right. Right. And it was other people's money because these were publicly traded entities, right? And and so it was heads I win, tails you lose in terms of compensation for the individuals at these financial institutions. And the trick is getting away from this agency society, this set of financial institutions that are dealing with other people's money. Right? With no skin in the game. Yeah, no skin or inadequate skin in the game. And then move to a fiduciary society. Uh I I I think I agree with Jack, you can't put the genie back in the bottle, you can't require that all investment banks be private partnerships. Um so we have to figure out a way to to to move from this agency society, not back to the ownership society, but forward to a fiduciary society. So how do we do that? I mean, I think it's uh it's a very, very difficult question. But if you think about commercial banking for example, I think that it would be great if we ended up with um a set of very simple deposit gathering balance sheet lenders. And the deal would be that if you get government insurance on the on the deposits, you have to accept a high degree of regulation.
[5:01]And as part of the as part of the deal, it could be that when you generate loans and they and and these highly regulated deposit gathering balance sheet lending uh banks would only provide basic financial services. Are these like the old S and L's of or well, actually, yeah, like the Bailey Brothers Savings and Loan in It's a Wonderful Life. That's exactly what they're like. And and you could require that they keep a large part of what it is that they originate on their balance sheet. Doesn't mean you can't have some securitization, you can't have some syndication, but you have to eat your own cooking. You have to live with uh the consequences of of your actions. Is is that a possibility? Well, sure. I mean do you see it happening? I mean, you know, you're you are now advising uh President Obama. Is is that something that's that's you're going to talk about and that will be talked about in Washington? I think it's uh it's one of the ideas that's on the table and even if that particular idea uh isn't one that that's adopted. I I I think that there are are are ways in which we can um to to behave more as principles and less as agents. What about regulation? Because you you have some actually pretty big ideas about needing a much a more broader, comprehensive sort of regulation. So so what is it? Well, I mean, one of the causes of the of the problems that we find our our our self-facing is that there was this religion of deregulation or this cultish belief that the that the market was always going to get you to the to to the right solution. Right, self-governing, right. And and and Alan Greenspan was right at the top of the list of those who are advocating uh that position, that that that general attitude.
[7:14]And it turns out that that was an incredibly naive approach because what the what the deregulation led to was this huge over leveraging and this incredible lack of of quality control. uh among our our our large our large financial institutions. I think it's absolutely obvious that hedge funds need to be regulated.
[8:26]Long-term capital. 1998, $5 billion of equity, $150 billion of positions on the balance sheet. 1.2 trillion dollars of derivatives positions. That was one institution that could have brought the system down. Could have brought the system down. Why is it that here we are more than 10 years later. We haven't come to the conclusion that we need to regulate entities that could pose a threat to the system. I think it's it's it's absolutely obvious that any institution that could pose a threat to the system should be under the regulatory umbrella. You know, you've talked about the new reality and and Pimco refers to it as the new normal. So what what does the new reality is that that we that we're living in now as as far as the investment climate, the economic climate. looking at the that the big picture what what's what do you think the new reality is that we should expect? Well, I I I I think that at least for the for the near term, we have to have more modest expectations uh about what it is that our investment portfolios are are are going to generate for us. So, for instance, what's more modest versus what Yale delivered? I mean 16.3% returns in the Yale Endowment over a 10-year period. That was a pretty good run.
[10:08]That was a terrific run. And and I think stocks over that period were up a little bit more than 3% per annum and bonds, you know, somewhere between 4 and 5% per annum. So there was just a a huge gap between what it was that the portfolio produced and and what you could have generated from from marketable securities. I mean if if we think that, you know, equities over long periods of time might produce 11% annually. 11% supposedly. Yeah, 10, 11, 12% returns, those that's that's exactly the number I was going to come up with. I think, you know, we have uh just gone through a a period where um the economy uh took a more substantial hit than I think any of us anticipated. And I guess then we have in like 50 years. Right. And we're still in a a position where the financial markets, which were broken, uh a few months ago, have yet to have yet to heal completely.
[11:20]And so I I I would say that uh at least for the intermediate term, you you have to have lower lower expectations with respect to uh equities and maybe all other uh financial assets. I mean, bonds, you know, starting out with the, you know, three, three and a half, 4% uh coupon on on treasuries, that's a that's a very, very, very low starting point. Now now you're not uh correct me if I'm if I'm wrong. corporate bonds, we we've had several guests on who were investing in corporate bonds and they just said that they the returns are pretty exceptional.
[12:08]You know, are you at all attracted to the distressed bond market or you at all attracted to, you know, the the corporate bonds are high yield, you know, junk bonds? Those kind of securities or So it depends on what hat I'm wearing. If I'm wearing my my Yale hat, I think there are some extraordinary opportunities in the credit markets. If I'm wearing my individual investor hat, I don't think that there are high quality vehicles that individuals can can tap into. Because you don't want individuals to lose money in other words. You you don't think individuals should take the kind of risk that you're you can take at Yale or Well, I I I I think if the right investment vehicle were there. Then, you know, I could I could recommend that an individual uh take those kind of risks. Because one of the things that uh has come out of these broken credit markets are some very attractive risk adjusted opportunities. But the but the corporate bond market is very, very tough. I mean, you need to have the same kind of analytical capabilities that you have to analyze equities. And you you on top of that, you have to understand call provisions. Uh it's it's it's incredibly complicated. And the mutual funds that specialize in this area generally are are are high cost and and do a poor job of of dealing with these incredibly complicated issues. You know, there are some hedge fund managers who have come out with mutual funds and we've we've had a couple on our show, Cliff Asness from AQR and Andy Low, who you probably know from MIT as well. Uh, you know, for individual investors and it's it's again, it's uh in the in the spirit of portfolio diversification. They're they're giving an individual an opportunity to invest in, you know, uh in arbitrage or or to replicate some hedge fund returns. What do you think about those kind of options for individuals that that I'm sure we're going to see more of in the years ahead? So I I I believe that there are a handful of high quality managers. And, you know, I think Cliff Asness and Andy Low are really impressive guys and there there there are also some impressive guys on the equity side in the in the mutual fund world. But it's a handful among the thousands of mutual funds. And individuals by and large aren't well equipped to separate the the the wheat from the chaff. Right. And and when the probabilities are overwhelming that they'll end up with the not so good managers or the bad managers or the terrible managers as opposed to this tiny handful of high quality managers. I think the only reasonable advice that I can give is to stay on the passive end of the spectrum. Put together a portfolio that you can implement uh using index funds. And again, asset allocation being being the key, the proper asset allocation, well diversified by asset class. And, you know, fairly equity oriented. So it seems so unfair. Yeah.
[15:24]But but so you think that individuals are are always going to be at a essentially at a disadvantage. And so the best that we can hope for is to to have market returns and and to have a balanced I mean a portfolio that that has some non-correlated assets. I mean, is that Yeah, it I mean it seems unfair in a sense, but most everybody as, you know, something that they do with their lives other than studying financial markets. Right. Right. And and I know how hard it is to to beat the markets. They're actually uh quite efficient. And so I've gotten incredibly highly qualified, you know, wonderfully motivated group of colleagues at at Yale. And, you know, we work really, really hard to to to put together these market beating portfolios. And and the market beating portfolios are our viewers should know are are you're not investing the money yourself, you're investing with you outsource. Yeah, without with outside managers. So you're choosing right, outsource. So so how do you is is there, you know, one or two things that you insist upon in in choosing a manager? I mean, what are the things that you look for in choosing a a good investment manager? So if we talked about this 20 years ago, I probably would have come up with a, you know, list of objective criteria. And now I just say it's it's all about the people. Uh you want to have really high quality people, great integrity, uh very intelligent, hard working, uh they people that have found an edge that they can exploit. In their particular niche. In their particular niche. Uh and I would say it's people first, people second, people third. You just want to be partners with great people. But size counts too, right? You you don't like to invest with with funds that get too big. Size is the enemy of performance. And so the people that we invest with, uh I like to say have a have a screw loose because they don't define winning by amassing as large a pool of assets as they possibly can. Because if they did that, they would invariably make more money. Right, because they they they have asset based fees and they sometimes get uh a carry on the performance. So the bigger the pile of money, the more money they're going to make. And that's that's one of the huge problems with the mutual fund industry. It's not about creating great investment returns, it's about amassing these huge piles of assets because that's the way that the fund companies generate greater profits. But the managers that that that we're with are actually being good fiduciaries to the university because almost uh invariably, they'll limit the size of assets under management so they can produce great investment returns. And they define winning by having a great investment record as opposed to the greatest degree of fee income that they could possibly generate. Assets under management. Well, speak speaking of having a screw loose, you can be making a lot more money if you were working for one of these investment funds yourself. So so why 24 years ago, I mean I all right, so you've had 24 years to figure this out. Haven't you been tempted, I mean to to leave Yale and and the not-for-profit sector and make more than a paltry couple million a year. Well, I I I get paid incredibly well for for what I do and I've loved being part of an academic community.
[19:13]teaching, uh since 1980, even longer than I've been working at Yale. I love the students, uh I I I I like the idea that I'm supporting one of the world's great institutions. So this is something you want to continue to do. You're as long as they'll have me. I'm sure they're going to have you for a long time. I should end it there but I'm not going to. What about your kids' portfolios? How how do you invest I mean I've got a 21-year-old son and you've got three children. So how are you investing their portfolios? So, um, I've got a a combination of index funds and and some close-end funds trading at a discount. I guess that's uh um and the one asterisk that I would put by the uh, you know, purely passive approach. You know, I love what Jack Bogel's written, I love what Charlie Ellis has written, I love what Bert Malkiel's written, they're all fans of index funds.
[20:46]What is loser's game or or enough or Jack's Bogel has written a lot of books. I might add your books, unconventional success and And and you just got to take control of your financial destiny and not believe that you can pass responsibility off to a trained professional and that you'll end up with a good outcome. Unfortunately, um that that that just isn't the way that the world works. Well, I have a suggestion for you, David Swensen, and that is you should start a mutual fund and uh you know, take your fiduciary responsibility and make it accessible to the rest of us.
[25:15]Anyway, that's that's a dream, I'm sure. But thank you so much for being with us on Wealthtrack, spending so much time with us. It was just great for us. It really was. This was fun. Thank you.
