Successful investors know that building wealth in the market over the long run requires strict adherence to your investment strategy and strong portfolio management. But new investors often find it difficult to determine which strategy to use when it comes to managing their own portfolios.
One tried and true portfolio that has a history of outpacing average market returns is known as the David Swensen Portfolio.
The portfolio uses diversification across a wide range of assets to provide exposure to potentially high returns while limiting risk.
What Is the David Swensen Portfolio?
Yale University’s late chief investment officer and manager of the university’s endowment David Swensen developed this portfolio, also commonly known as the Yale Model. Swensen is also the author behind bestselling books like “Unconventional Success: A Fundamental Approach to Personal Investment” and “Pioneering Portfolio Management.”
Somewhat of a legend on Wall Street, Swensen was known for generating outsize returns while avoiding any undue risk and limiting volatility through the use of fixed-income securities and real estate investments.
His portfolio was designed to invest in a wide range of asset classes, not just in the United States, but around the world.
While the management style behind the portfolio is somewhat unorthodox as a result of its heavy allocation to real estate, it’s impossible to argue against his success in the market and the outsize returns people who’ve taken advantage of this portfolio have enjoyed.
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Portfolio Asset Allocation
The Swensen Portfolio was designed with diversification in mind, aimed at providing exposure to major opportunities while balancing out the risks through exposure to safer assets. Here’s how Swensen allocated Yale’s money:
- 30% in the Total U.S. Stock Market. 30% of assets held in the portfolio are invested in a highly diversified U.S. stock exchange-traded fund (ETF) with exposure to a wide range of sectors and stocks with various market caps.
- 15% in the International Stock Market. 15% of the portfolio’s assets are invested in an investment-grade fund that’s centered around international stocks across a variety of regions, sectors, and market caps.
- 5% in Emerging Markets. While investing in emerging markets can be risky, it can also be a source of significant growth. Swensen allocated 5% of the portfolio to these opportunities in order to tap into the profit potential without accepting too much risk across the portfolio as a whole.
- 20% in Real Estate. 20% of the portfolio is invested in real estate by way of a real estate investment trust (REIT). These funds attract funding from a large group of investors to purchase real estate like office buildings, apartment buildings, cell towers, and other infrastructure. When the owned real estate is leased, profits are divided among investors.
- 15% in Intermediate-Term Treasury Bonds. Getting into the fixed-income side of the portfolio, 15% of the portfolio’s assets are invested in intermediate-term Treasury debt securities. These are generally U.S. Treasury bonds with terms between three and 10 years.
- 15% in Treasury Inflation-Protected Securities. The final 15% of the portfolio’s assets are invested in Treasury inflation-protected securities (TIPS). TIPS generally increase with inflation and decrease with deflation, hence the term “inflation-protected.”
Important Note: While retail investors can get close to duplicating Swensen’s portfolio, the assets used will not be the same because Swensen — managing Yale’s multibillion-dollar endowment — was able to make somewhat exotic institutional investments that are unavailable to retail investors.
The Investment Thesis Behind the Portfolio
When it comes to so-called “lazy” buy-and-hold portfolios, the Swensen Portfolio is a bit unorthodox. Most of these types of portfolios include investments in gold or other precious metals, but Swensen avoided this concept.
For some time, the validity of precious metals as safe-haven investments has been called into question, and Swensen’s avoidance of this practice further serves to justify those concerns.
Instead of precious metals, Swensen uses TIPS — another unorthodox move for a lazy portfolio. Swensen had a strongly positive view of TIPS, and the performance of the portfolio suggests he was onto something.
With bonds only representing 15% of the portfolio, it was important not to use corporate bonds because Treasury bonds offer superior volatility protection. Because of such a small allocation to these investments, many investors choose to go with long-term maturities rather than intermediate terms for added stability.
The brunt of the portfolio’s growth has come from its mix of U.S., international, and emerging market stocks, as well as investments in REITs.
Pros and Cons of the David Swensen Portfolio
There are plenty of reasons to be interested in getting involved with this portfolio, but there are some drawbacks to consider before diving in.
David Swensen Portfolio Pros
The Swensen Portfolio has become so popular for the following reasons.
- Strong Returns. The portfolio is known for a history of compelling annual returns. In fact, the portfolio has outperformed the S&P 500 index more often than it has underperformed. While the portfolio is somewhat aggressive in terms of risk, the returns have been hard to ignore.
- Heavily Diversified. The portfolio is known for heavy diversification. It includes the use of three stock index funds and ETFs that are all significantly diversified in their own right, then adds in REITs to further diversify. Although the fund’s allocation to safe havens is relatively small, this diversified mix of asset classes adds a level of protection.
- Easy Management. The Swensen Portfolio is one of many in a category known as lazy portfolios. It’s designed to be a set-it-and-forget-it style option. While occasional rebalancing is necessary, you won’t find yourself adjusting your investments daily, weekly, or even monthly in most cases.
David Swensen Portfolio Cons
With relatively simple management, diversified holdings, and a history of strong returns, the portfolio is attractive. On the other hand, every rose has its thorns. Here are the potential sources of pain associated with investing using this portfolio strategy:
- Aggressive Exposure to Risk. Sure, the portfolio offsets some risk through its diversified exposure to assets around the world and a small investment in safe havens. However, if you’re a risk-averse investor, the declines experienced during tough economic and market times will likely be a turn-off. As such, if you don’t at least have a moderate appetite for risk, this strategy isn’t one for you.
- Real Estate Exposure. Exposure to the real estate industry is a positive for most portfolios, but the Swensen portfolio exposes 20% of your assets to the category. As such, the portfolio may be too heavily weighted to this category, and some adjustments could be made to produce either larger gains or better volatility protection.
- International Exposure. International stocks are a great addition to any investment portfolio, but as with other high-return assets, they often come with high levels of risk. Many investors aren’t comfortable with investing 20% of their money abroad and may need to adjust these holdings.
Who Should Use the David Swensen Portfolio?
The David Swensen Portfolio is an aggressive buy-and-hold strategy, which helps to outline who should be using it. The best candidates for use of this strategy include:
With only 30% of the portfolio invested in TIPS and bonds, there’s not much protection from volatility, which is fine for younger investors. After all, younger investors with long time horizons can afford to take on increased risk because they have plenty of time to recover should something go wrong.
On the other hand, retirees and investors nearing retirement age should stay away from the strategy. Ultimately, the risk of drawdowns that could take place in bear markets isn’t worth the increased potential benefit of such an aggressive strategy.
Many experts suggest using your age to inform your asset allocation, with your age representing your allocation to bonds and other safe havens. Considering this, anyone over 30 years old might think twice about this strategy, as the aggressive exposure to stocks and real estate could result in a higher level of risk than you’re willing to accept.
Those Interested in Real Estate
The portfolio’s heavy exposure to real estate may be a turn-off for traditional investors. However, there’s a large population of investors who view real estate as the go-to investing opportunity.
If you’re interested in investing in real estate but don’t have enough funds to purchase a property of your own, REITs can provide the exposure you’re looking for. Also, by using this strategy to gain that exposure, you’ll also hold a wide range of equities while balancing your risks out somewhat with some safe havens.
How to Duplicate the Portfolio
Unfortunately, duplicating the exact portfolio used in Yale’s Endowment Fund is impossible for most people because it is an institutional investor. Like hedge funds, private equity firms, and venture capitalists, large institutional investors have access to exotic asset types that aren’t available to the general public of individual investors.
Nonetheless, the performance of the portfolio can be closely duplicated using a mix of low-cost ETFs, index funds, and REITs. It’s also worth mentioning that there are several renditions of the portfolio. Here’s how some of these look:
The Traditional Swensen Portfolio
The best way to set up the traditional Swensen Portfolio is to use the following allocation:
- 30% in Vanguard Total Stock Market Index Fund ETF (VTI). The VTI fund offers a heavily diversified group of domestic stocks. These stocks cover all sectors and market caps.
- 15% in Vanguard Total International Stock Index Fund ETF (VXUS). VXUS is an ex-U.S. investment fund that consists of a diversified group of international stocks in emerging and developed markets. These stocks also span various sectors and market caps. With 30% of the portfolio already invested in U.S. stocks, it’s important to make sure that the fund you choose is an ex-U.S. fund — meaning it is solely focused on opportunities abroad — in a wide range of regions, sectors, and market caps to ensure widespread international exposure.
- 5% in Vanguard Emerging Markets Index Fund ETF (VWO). The VWO fund invests in a wide range of sectors and market caps in emerging economies around the world. The majority of holdings in the fund are companies in China, Brazil, Taiwan, and South Africa.
- 15% in Vanguard Intermediate-Term Treasury Index Fund ETF (VGIT). The VGIT fund offers a diversified list of intermediate-term Treasury debt securities. These are generally bonds with maturities ranging from three to 10 years.
- 15% in Schwab U.S. TIPS ETF (SCHP). The SCHP fund provides investors with exposure to a diversified group of TIPS.
- 20% in Vanguard Real Estate Index Fund ETF (VNQ). Finally, the VNQ fund invests in a diversified group of REITs, working to mix holdings between companies that buy different types of properties in different regions.
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The Long-Term Bond Swensen Portfolio
As mentioned above, due to the minimal holdings of bonds in the portfolio, many investors choose to swap intermediate-term Treasurys for long-term Treasurys in order to create added stability.
To do so, simply replace the VGIT holdings in the portfolio with the Vanguard Long-Term Treasury Index Fund ETF (VGLT). As its name suggests, this ETF provides diversified exposure to long-term Treasury debt securities, generally ranging in maturities from 10 to 30 years.
The Domestic Swensen Portfolio
Some investors would prefer to keep their money invested in domestic companies. If that’s you, there are a few ways to adjust the portfolio.
If you’d like 100% of your equity holdings to be invested in domestic companies, simply scrap the VXUS and VWO holdings, and invest the additional allocation in the VTI fund.
This would mean that 50% of your allocation would be invested in the VTI fund that tracks the total U.S. stock market. However, doing this may leave you more heavily invested in domestic stocks than you would like, given the growth opportunities international stocks offer.
Investors generally feel comfortable with a 10% allocation to international plays. If that sounds like you, allocate 7.5% to the VXUS fund and 2.5% of your portfolio to the VWO fund. The remaining stock holdings — or 40% of the portfolio’s allocation — would be invested in the VTI fund representing domestic investments.
The Small-Cap Swensen ex-REIT Portfolio
Small-cap stocks tend to be volatile but have a history of outperforming their large-cap counterparts over the long term. Moreover, value stocks have a history of outperforming growth plays over time. So, small-cap value gives you exposure to some of the most compelling opportunities on the market.
To take this approach, simply trade your 20% holdings in the VNQ fund for the Vanguard Small-Cap Value Index Fund ETF (VBR), which invests in a diverse list of domestic small-cap stocks that display strong value metrics.
Keep Your Portfolio Balanced
Keeping the Swensen Portfolio in balance is important. After all, the strategy was designed based on the value of specific allocations to specific types of assets. If those allocations fall out of balance, the results could be vastly different from what you expect.
The good news is that the Swensen Portfolio is one in a long line of lazy portfolios, meaning there’s not much work involved in maintenance. You won’t need to take part in weekly or monthly rebalancing. However, it is best to make sure you rebalance your portfolio on at least a quarterly basis.
To rebalance, simply open your portfolio and calculate the percentages of your total portfolio’s value that are invested in each asset. If those percentages don’t match up with the plan outlined above, make adjustments as necessary by selling shares of over-vested assets and buying shares of under-vested assets.
For the young investor, the David Swensen Portfolio may be one of the most appealing in the lazy portfolio category. It offers access to significant growth and the potential to beat overall market averages.
On the other hand, it does come with increased risk compared to other lazy portfolio options. As such, if you’re a retiree or an investor with a short time horizon, you may be better served using a safer portfolio strategy, such as the Ray Dalio All Weather Portfolio or the Golden Butterfly Portfolio.