The Swensen Portfolio Has No Shot Of Outperforming

Tweaking a sophisticated asset allocation strategy.

The Value Stock Geek blog took a look at the well known David Swensen asset allocation model outlined in Swensen's book Unconventional Success. The allocation as follows;

  • US Equities 30%
  • Foreign Developed Equities 15%
  • Emerging Market Equities 5%
  • REITs 20%
  • US Treasury Bonds 15%
  • US Treasury Inflation Protected Securities 15%

Presumably the missing 5% is in cash.

Obviously, it can outperform but that is not the point. The point is about asset allocation and at a higher level, this asset allocation is about smoothing out the ride of the course of an entire stock market cycle. We cover this ground frequently. An adequate savings rate combined with a reasonable asset allocation and the avoidance of truly stupid investment behaviors should be enough to get most people to where they need to be financially. That has nothing to do with outperforming anything, it is far more about participating or going along for the ride which, repeated for emphasis, can get the job done.

Relative to other similar broad asset allocation strategies, Swensen's may or may not be relatively successful but it is very unlikely to hurt anyone even if turns out to have not been the absolute best.

Anyone wishing to mimic this mix can do so very cheaply with ETFs (there are quite a few different ETFs out there for each of the market segments Swensen targeted) or Vanguard mutual funds.

Swensen believes that investors should not have more than 30% in any single big market segment. Something as broad as domestic equities or treasuries, 30% or even 40% is probably fine but I think REITs are a little too narrow to get as much as 20%. The book that this portfolio is published in came out in 2005. The chart shows an iShares REIT ETF, IYR, versus the S&P 500 since late 2004.

That IYR has lagged so far behind the S&P 500 isn't necessarily a problem. From Swensen's view point it is meant to buffer equity market volatility but when you needed IYR most, during the financial crisis, its correlation seemed to tighten and went down more than the stock market in lock step with the stock market.

I've talked before about not wanting too much in things like gold, MLPs and yes, REITs. Before the financial crisis there was plenty of content advising 15-20% allocations to these types of diversifiers and this example with IYR tells you why it is too much. Gold during this decade is an other example, MLPs got destroyed a couple of years ago when oil went down to $30, remember that they were thought to be immune to crude price volatility because they only transport it, they don't drill it. I tend to think more in terms of 5% allocations to these types of diversifiers for the above reasons. That idea that something works until it doesn't rings very true with me, especially with narrower exposures, I think of these three as narrow.

In trying to apply a Swensen-like idea to my portfolio I would probably want to be a little more tactical than simply mapping something out and sticking to it forever save for rebalancing.

I might lay something out though in line with Swensen's portfolio as follows;

  • US Equities 40%
  • Foreign Equity (developed and emerging) 15%
  • Shorter Term Treasuries (individual issues) 15%
  • TIPS 10%
  • Merger Arbitrage 5%
  • Gold 5%
  • Bank Loan (a little riskier) 5%
  • Cash 5%

This not something I implement anywhere but is an example of how I view asset allocation which is favor smaller weightings. Things go wrong and usually they cannot be predicted which is why 20% in something narrow is a pretty bad idea for my money.

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