Revisiting The “Swensen Six” Portfolio

Investors looking for a well-diversified and basic portfolio need look no further than the “Swensen Six.”  Both HedgeHunter and I’ve written about David Swensen’s simple portfolio before.  More references can be found by searching for Swensen on this blog.  Here is the “Swensen Six” portfolio in its most basic form where only six ETFs are used to cover the investing world.

• U.S. Equities – VTI – 30%
• Developed International Equities – VEA – 10%.  This was originally 15%, but was later reduced to 10% with the 5% excess now allocated to VWO.
• Emerging Markets – VWO – 10%.  This was originally 5%.
• U.S. Real Estate – VNQ – 20%
• U.S. Treasury Bonds – TLT – 15%
• U.S. Treasury Inflation Protected Securities – TIP – 15%

What is Swensen’s reasoning behind this portfolio?  While he does not specify the precise ETF tickers shown above, his asset allocation divisions are clearly spelled out in his book, Unconventional Success.  Here is his logic.  I am paraphrasing and the quoted material comes directly from Swensen’s book.

1. “Basic financial principles require that long-term investment portfolios exhibit diversification and equity orientation.”
   • The above six ETFs accomplish both the goal of diversification and equity orientation.  VTI, VEA, VWO, and VNQ are all equity oriented ETFs.  Within the above six ETFs we are invested in hundreds of individual stocks from all over the globe.  Now that is diversification.
2. “Diversification demands that each asset class receive a weighting large enough to matter, but small enough not to matter too much.”
   • The recommended percentages accomplish the weighting requirements.  A 30% weight is not so large as to matter too much and a 5% or 10% weight is sufficiently high to contribute to the portfolio well-being.
3.  “Equity orientation requires that high expected return asset classes dominate the portfolio.”
   • VTI, VEA, and VWO accomplish this requirement as these equity ETFs are the principle drivers of portfolio return.
4. “Investors give up expected return to defend portfolios against unanticipated inflationary or deflationary economic conditions.  U.S. Treasure Inflation-Protected Securities (TIP) protect against inflation with certainty, while real estate holdings guard against inflation with reasonable assurance.  … domestic equities add in the inflation-hedging characteristics of a portfolio, but in the short run domestic equities prove notoriously unreliable as inflation hedges.”

Just as Swensen altered the weights assigned to VEA and VWO in a paper published after his book was released, are there other tweaks one might introduce to the “Swensen Six?”  Yes, and here are two possible adjustments.

While Swensen recommends a 20% allocation to U.S. Real Estate (VNQ), one could further diversify by lowering the percentage to 15% and placing the remaining 5% in International Real Estate (RWX).  This keeps the percentage in REITs, but diversifies the portfolio even further.

The other minor change would be switch out TIP for a bond ETF, BIV or assign 10% to BIV and keep 5% in the TIPs.  BIV provides more income than TIP.

What is missing from this simple portfolio?  The one missing ingredient is not tied to the asset allocation model, but rather there is little protection in a down market as we experienced in 2008 and early 2009.  This requires the introduction of something like the momentum or ITA Risk Reduction models.