| The best-laid plans often go awry. My plan was for Points of Return to take the week off. But the sad news of the passing of David Swensen, at only 67, is impossible to ignore. I hope you enjoy this tribute to one of the greatest investors in history. Normal service resumes next week. Have a good weekend. David Swensen, who ran Yale University's endowment since 1985 and transformed the world of investing in the process, died of cancer on Wednesday at the age of 67. Always dedicated to his alma mater, where he received a doctorate in economics, he taught his last class on Monday. When Swensen took over the Yale endowment, it was worth a little over $1 billion. It grew under his watch to $32 billion, even as it made regular disbursements of cash that allowed the university to transform its campus. Had he put the entire endowment into an S&P 500 tracker fund when he started and made no disbursements — during a period when U.S. stocks enjoyed two of the longest bull markets in history — it would only have reached $24 billion. That says a lot about his prowess. But he was famous less for his spectacular returns than for the unconventional way in which he earned them. In 1985, he inherited a portfolio that was 40% invested in bonds, with more than half in U.S. stocks. This was a classic "60/40" portfolio of stocks and bonds, mostly actively managed. By last year, only 2.5% of its holdings were in U.S. equities, while bonds and cash accounted for 7.5%. Instead, the portfolio was dominated by absolute return hedge funds (23.5%), venture capital (also 23.5%) and leveraged buyout or private equity funds (17.5%). In the intervening years he had also made pioneering forays into extremely illiquid real assets such as forestry. Such strategies are now commonplace. Hedge funds and private equity make up a huge share of large university endowments' investments, and pension funds have followed them. Such vehicles were still esoteric opportunities when Swensen first started to put Yale's money into them. They have now become institutionalized asset classes in their own right. It is no exaggeration to say that Swensen deserved more credit for this huge shift in the investment landscape than any other single individual. With the sole exception of Warren Buffett, Swensen's actions at Yale were more closely watched than any other investor's. Unlike Buffett, or many far less influential investors operating in Wall Street or Greenwich, Connecticut, Swensen achieved this without joining the ranks of the plutocratically rich. He was Yale's best-paid employee, receiving a base salary of about $850,00 and typically pulling in a bonus of a few million dollars more, but happily eschewed the chance to be far richer. The close-knit team of young investors who worked with him in New Haven spread his influence, with former Swensen employees now running the endowments of top-tier schools from the Massachusetts Institute of Technology to the University of Pennsylvania, Stanford and Princeton. For all his influence, however, there may now be some dispute over his legacy. Allocations to deeply illiquid investments made life tough for the big endowments during the global financial crisis, and many of them (including Yale) were forced to borrow to tide themselves through. Yale's own students even joined Harvard's in interrupting the last Harvard-Yale football game to protest that both universities' endowments still held oil, coal and gas assets, as well as Puerto Rican debt. Meanwhile, disenchantment with hedge funds is growing. Their returns have lagged ever further behind simple indexed investments in the S&P 500 in the decade-plus since the crisis. Having held sway for a generation, Swensen's passing came just as his Yale model was receiving its first serious reappraisal. But even if we should be more cautious of hedge funds and private equity, that does not mean there was anything wrong with Swensen's model. Always infectiously curious, Swensen had no particular allegiance or affection for hedge funds. The key to his success, he always said, was his disciplined following of two key insights he had gained from his academic research in economics. He made them sound disarmingly simple. The first was that equities were indubitably better than bonds or cash for the longer term — and that "equities" should not be restricted merely to shares traded on public stock exchanges, but should include any investment with a non-guaranteed upside for the investor. His second was that diversification was important. James Tobin, the Nobel prize-winning economist who had taught him at Yale, was one of the developers of the Capital Asset Pricing Model (CAPM), which showed that it was possible to improve risk-adjusted returns by adding uncorrelated assets to a portfolio. Or as Swensen put it: "For a given level of return, if you diversify you can get that return at lower risk. For a given level of risk, if you diversify you can get a higher return. That's pretty cool! Free lunch!" Led by Tobin's ideas, he stressed asset allocation rather than stock picking, or attempts to time the market — beyond the mechanical market timing that came with his policy of regularly rebalancing Yale's portfolio. At the margin, that entailed buying more of assets that had done badly and selling some of those that had done well. This led to occasional moves that looked like great timing, such as buying equities in the wake of the October 1987 stock market crash. These principles don't necessarily mean entrusting private equity and hedge funds with pots of money. What they do imply, however, is a disciplined opportunism, combined with a grasp of what he and his team at Yale could and could not do. With the public markets deeply liquid and exhaustively researched, there was no point in trying to beat them. But private markets were less efficient, and he could reasonably hope to find bargains, if his team was smart enough. "I know it's necessary to be humble," he told alumni at Yale's 2007 reunion weekend, "but I think Yale is set up to make high-quality active management decisions." Swensen's investment discipline allowed Yale to enjoy a huge "first-mover advantage" as it built relationships with the pioneers of alternative assets using strategies that were still nowhere near reaching their capacity. He sent his team of brilliant youngsters to explore opportunities that were ideally not correlated with each other, and they found hedge funds and private equity at a time when financiers had barely started to exploit the opportunities available. In need of capital, these investment vehicles were not yet demanding the kind of excessive fees for which they were to become infamous. It is not at all clear that if he were starting again today his discipline would have led him to the same place. He regularly attacked excessive fees in his later years. If his team couldn't find any place where Yale's long-term horizon might give them a chance to beat the market, he might even have left money in index funds. This was the course he encouraged in his book for retail investors who did not have Yale's ability to scope out esoteric investments. The logic that guided the Yale endowment to forestry and hedge funds also guided individual investors to exchange-traded funds. We will never now know how Swensen would have responded to the challenge of the current climate, where both stocks and bonds look historically expensive, and alternatives are out of ideas. But the chances are that if he had had the chance to apply his well-practiced principles to the situation, he would have come up with a way for Yale to keep making money. Like Bloomberg's Points of Return? Subscribe for unlimited access to trusted, data-based journalism in 120 countries around the world and gain expert analysis from exclusive daily newsletters, The Bloomberg Open and The Bloomberg Close. | 
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