Fifteen years ago David Swensen authored Unconventional Success: A Fundamental Approach to Personal Investment. Swensen is well-known for his outstanding management of the Yale Endowment Fund. On pages 83 and 84 of his book, Swensen lays out the science of portfolio structure. Here is an outline of his arguments.
- Long-term investment portfolios will exhibit diversification and equity orientation.
- By equity orientation, Swensen constructs portfolios with a strong tilt toward equity securities such as VTI and VEU or VEA.
- Diversification requires each asset class to be large enough to contribute to the success of a portfolio. To accomplish this goal, limit the number of investment arrows in the investment quiver. We want each asset class to matter enough, but not too much.
- Swensen suggest a portfolio should hold six asset classes and they are as follows.
- U.S. Equities
- International Equities
- U.S. Real Estate
- Emerging Market Equities
- U.S. Treasury Bonds
- U.S. Treasury Inflation Protection Securities (Inflation is currently very low so another ETF might be used instead of TIP.)
- The portfolio should be divided between 5% and 30% for each asset class. In his book, Swensen lays out what percentage to carry in each asset class. If using the Kipling as a management aid, the percentages will vary from time to time depending on recommendations.
- The equity orientation will be carried by numbers 1 through 4 above.
- The portfolio will guard against either inflation or deflation.
- U.S. Inflation Protection Securities and U.S. Real Estate will provide inflation protection. Deflation protection comes from holding U.S. Treasury Bonds.
A portfolio holding the above six asset classes meets the requirements of equity orientation, mathematical diversification, while protecting the investor against inflation and deflation.
With these general requirements, what six ETFs might one use to populate a “Swensen portfolio” and how did it perform over the past 10 to 12 years?
One sample “Swensen Portfolio” includes these six ETFs: VB, VEA, VNQ, LQD, TLT, and PCY. Missing is Emerging Markets (VWO or EEM). I substituted LQD. How did such a portfolio perform over the past dozen years? Check out this link and experiment with your own ETFs or mutual funds.
Note that I selected only two asset classes at a time for inclusion in the portfolio.