HedgeWorld: A Flawed Model or Modeler?

However, the problem with hedge fund investing may not be with the industry or managers in general, but with the approach to using alternative investments in general. At least that’s one of the arguments made by David Swensen in an interview on January 13 with Craig Karmin in The Wall Street Journal. Swensen has been the Yale University endowment’s chief investment officer since 1988, delivering an average annual return of 16% for the 10 years through June 2008, the end of Yale’s fiscal year. While in mid-December Yale’s president said the endowment had lost 25% of its value since June, Swensen has stuck to his investing guns, especially the use of alternative investments, including hedge funds, as he says in his recently reissued 2000 book, “Pioneering Portfolio Management.”

In his fascinating interview with Kamin, Swensen argues that while many institutions say they are emulating the Yale model, “they are not. Most endowments use fund of funds and consultants, rather than making their own well-informed decisions. You can divide institutional investors into two camps: those who can hire high-quality, active-management investors and those who can’t. If you are going to invest in alternatives, you should be all in, and do it the way Yale does it–with 20 to 25 investment professionals who devote their careers to looking for investment opportunities. Or you belong at the other end, with a portfolio exclusively in index funds with low fees. If you’re not going to put together a team that can make high-quality decisions, your best alternative is passive investing. With a casual attempt to beat the market, you’re going to fail.”

Part of that approach to beating the market is demanding to know every position in every hedge fund that Swensen considers. “If they won’t trust us with that information,” Swensen argues, “why should we trust them with our money?”