Yale Model (Reading David Swensen) Part I
Demystifying Finance
Overview
“Yale Model” is an essay in two parts. It focuses on David Swensen’s 2000 book Pioneering Portfolio Management, taking it as a “philosophy of investment management” (a recurring description of it in both reviews and finance), one that imparts a worldview, and trying to understand what it includes and what it excludes, what holds it together. The first part introduces the so-called Yale Model and then turns to “Loser’s Game,” an essay from the mid-1970s by Charlie Ellis, a Yale trustee and former chair of the board’s endowment oversight committee. Ellis also wrote the introductions to Swensen’s book. Ellis’ description of the loser’s game sets up our exploration of the philosophy of investment.
The second section looks at the differentiation of institutional from retail investors, of the “long-term perspective” particular to the latter and the role quantitative risk management plays in structuring that perspective. Retail investors who play the stock market are embodied in the figure of the “market guru.” Swensen rejects the model, preferring to occupy the role of a professional or technocrat or, in some modes, the mystic of value creation.
The second part of “Yale Model” turns to the model itself, its returns, its risk-management methodology, and the asset classes investment in which define the model. It considers the importance of private finance and its social networks as well as a shared ideology of finance, organization, and resulting blindness best embodied in private equity’s business model.
Introduction
Today, most US college or university endowments with a portfolio valued at $1 billion or more manage their investments using one or another version of the “Yale Model.”[1] The name comes from the approach to investments developed at Yale from the mid-1980s by David Swensen, the endowment’s chief investment officer, and his associate Dean Takahashi. The model expands the range of asset types in which an endowment can invest beyond the traditional stocks and bonds to include alternative investments. Alternatives are primarily private equity and hedge funds, but the category also includes non-US listed assets, commodities, and so on. Alternatives promise elevated returns on investment—but elevated returns come with elevated risk exposures, and that risk has to be managed. Swensen and Takahashi’s main innovation was their development of heavily quantitative approach to risk management, the first direct application of modern portfolio theory, one that relied on computing to manage modern portfolio theory’s (MPT) complex mathematics.
In the decade before 2000, Yale--and a few other colleges and universities--used Swensen and Takahashi’s approach to achieve very good returns. That began to change with the publication of David Swenson’s book Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment[2]. In it, Swensen provides an overview of Yale’s approach: he explains in a general way his approach to quantitative risk management and the general characteristics of the asset types that comprise expanded field classes investment in which were enabled by it. He describes the process of asset-class definition and its fundamental importance to the quantitative machinery, whence the centrality of due diligence and the warnings of “don’t try this at home” to readers who manage endowments at institutions not willing to support it adequately. Running through these descriptions is an articulation of a worldview rooted in the cultivation of a “long-term perspective” appropriate for thinking strategically in the context of an endowment’s “time-horizon of centuries” and of a “contrarian thinking” to that perspective, of not reacting to price fluctuations or market turbulence, instead relying on the numbers to “rebalance” the portfolio’s contrary motion machinery to keep returns on target and risks contained. This worldview is one of the main topics of the two parts of this essay: what it is, what it includes and what it excludes, and what holds it together.
This worldview is basic to the book’s reception. Critics made Swensen’s book into a primer in the “new philosophy of investing,” one that provided the basis for a new self-conception for the emergent profession of active institutional investment management—of endowments, pension funds, mutual funds like private equity and hedge funds, and beyond. What he described seemed to be in the air at the time: one critic wrote that Swensen had “caught a shift in the zeitgeist of institutional asset management away from passive investment management.” The book sold very well—though the actual numbers are not available--and a revised second edition was published in 2009. It resonated widely as well. Proof lay in the number of institutions, colleges, universities, public and private pension funds, that adopted versions of Swensen’s approach and in the fact that, twenty years after its initial publication, Swensen’s book is considered a classic in financial-investment literature, which is characterized by rapid turnover and little sense of the past, and remains required reading for employees across a surprising range of financial service providers.
This essay is a reading of David Swensen’s book. It is broken into two parts. The first situates Swensen historically as articulating both a new professional identity particular to active institutional investment management, one rooted in usage of quantitatively-driven strategies. The need for such arose in the mid-1970s, in response to a breakdown of profitability in then-traditional approaches to active investment common to both institutional and retail investors, called “stock picking” (the monitoring fluctuations in share prices to determine when to buy and sell shares). By the mid-1970s, critics argued that such active investment strategies brought in mediocre returns that did not justify the additional expense of active management when compared with being in a passive index fund. One such critic was Charlie Ellis, later a Yale Trustee and head of the Board’s endowment oversight committee. Ellis also wrote introductions for both editions of Swenson’s book.
The first part of “Yale Model” uses Ellis to situate Swensen. In the mid-70s, Ellis argued that, among institutional investors in particular, the stock picking issue required a rethinking of active institutional investment management strategies. But as he argued at the time, managers were unable to see the profitability problem and still less to imagine alternative strategies because they were caught in what he called “the loser’s game.” We look at the loser’s game below as a way to put into motion a discussion of how ideology and practice intertwine to shape/delimit practitioners’ socio-cognitive horizons, one that we develop in the essay’s second part by way of the “long-term perspective” central to Swensen’s view of how endowments should be managed.
Ellis argued that institutional investment management should become more professionalized, and its procedures more quantitative. In what follows, we look at Ellis’ framing of the problem in the mid-1970s and then at how, in his introductions to PPM, he presents Swensen and his model as the solution to that problem. In the second part of this essay, we turn to that model and what holds it together. That piece is organized as three definitions of an endowment, which it may be helpful to rehearse here: an endowment is an organization; an endowment is a portfolio; and an endowment is a social network.
To anticipate: as Swensen was wont to say, by the time he took over at Yale in the early 1980s, stock markets were priced too efficiently; share prices too closely matched the value of the underlying assets; no-one was making any money. This “efficient pricing” was likely an effect of herding, of everyone looking at the same information and reacting to it in the same ways, in a context where there was little edge, little inside information, to be had. One effect of this efficient pricing was active investment strategies that may have been suited to earlier times no longer worked. Some other approach was required. Charlie Ellis, whose mid-70s essay “Loser’s Game” we analyze below, pin-pointed the problem, albeit without much explanation, and called for a new approach. But he had no real sense of what that approach might look like. In this respect, Ellis was a bit like the ancient Egyptians according to Hegel’s philosophy of history, who knew there was a riddle, but not what the riddle was.
If one continues with this narrative frame, Yale figures as Hegel’s Athenians, who worked out the riddle that was embedded in history, and proposed a solution for it. Yale’s solution entailed a sharp break with how endowments were managed. To that point, endowment management was prudent. Capital was to be preserved. The model had been extrapolated from John Maynard Keynes’ approach at Kings College, Cambridge during the 1930s. Portfolios held 60/40 stocks/bonds, with a preference for assets that were easily converted to cash. Economist Paul Samuelson approvingly described this approach as boring, “like watching paint dry or grass grow”: if you want excitement, he continued, "take $800 and go to Las Vegas." By contrast, Swensen argued that endowment mangers should seek to maximize returns on investment. To do this required that endowments move beyond stocks and bonds and consider an expanded range of asset classes - alternatives, hedge funds, and private equity chief among them. But strategies that maximize returns also increase risk exposure, and that risk must be managed. Swensen presents an image of his “means-variance” application of modern portfolio theory as an approach to managing risk adequate for the new strategy. By doing so, Swensen implicitly transposed the meaning of prudence from being risk-adverse to having an effective approach to risk management. Quantitative data was a defining characteristic of such an approach. Swensen was in this respect very much of his time: the centrality of “the numbers” converged with broader technocratic administrative trends, in ways that, as we will see in part two, are particularly bereft of feedback loops. The numbers are central to Swensen’s solution to the riddle that Ellis posed (though without being able to say what it was). But, like Hegel--albeit in different way--neither wondered whether Swensen proposed a solution for the same riddle that Ellis intuited. Nor did they wonder, as would the authors of the 2010 Tellus Institute report on the consequences of the financial crisis on the endowments of six New England colleges and universities that were invested on the model, whether Swensen had radically downplayed the risk entailed by adopting it.[3]
Situating Swensen
Meet Charlie Ellis
Both editions of Pioneering Portfolio Management (PPM) begin with introductions by Charles D. Ellis. The book does not provide much information about him apart from what he himself includes in the introductions. He is warmly described in Swensen’s acknowledgements. But Charlie Ellis was an interesting figure. He was a Yale undergraduate who majored in History. He went on to get a Harvard MBA, a process that he called “transformational,” and then held down a job with the Rockefeller family office (a private trust) while getting a Ph.D. in economics from NYU. In 1972, he founded Greenwich Associates, an investment consultancy that provided--and still provides---research reports to investment managers. He retired in 2000.[4]
A prominent figure in finance and a Yale alum, it is not surprising that Charlie Ellis would be appointed a university trustee. Boards of Trustees are charged with stewardship or overarching governance of a college or university. They work at a remove from the institution’s day-to-day administration. They control the underlying compacts that set out relations among professional bodies (trustees, administration, faculty, students, staff), set overall policy frames and objectives. Financial stewardship is one of the most important functions of any board of trustees. For example, boards approve their institution’s budgets. Boards operate via subcommittee. One such subcommittee oversees a college or university’s endowment. Ellis chaired Yale’s Investment Committee from 1997 through 2008.[5] He worked closely with Swensen and his team. They were friends. They had similar backgrounds and moved in a common milieu. Few would be better positioned than Ellis to evaluate the Yale endowment and its performance, Swensen’s management and his book.
In addition to being himself a successful advisor to institutional investors, Ellis was the author of a book of advice for investment managers that was well-known at the time. In its range of topics, Ellis’ Winning the Loser’s Game has clear affinities with PPM.[6] Beyond that, as we will see below, Ellis was instrumental in the professionalization of institutional investment management. Obviously, the choice of Charlie Ellis to write the introductions for PPM was far from neutral. His texts provide Swensen legitimation: they affirm his status in an informal guild of investment managers, emphasize his bona fides (those splendid returns), and pass on the torch of generations
The Loser’s Game
Greenwich Associates provided Charlie Ellis a good vantage-point from which to assess transformations in finance of the 1970s. Ellis tried to formalize and think about some of them in an essay called “Loser’s Game” that appeared in the Certified Financial Accountant Institute’s in-house publication, Financial Analysts Journal in 1975.[7] Two years later, the article won the CFA Institute’s Graham Dodd Award for excellence in research and financial writing.[8] The award cemented Ellis’ reputation as a finance writer, and “Loser’s Game” was a touchstone for his later work. This section tries to unpack “Loser’s Game” and the perspective from which it is written.
The narrative vantagepoint from which “Loser’s Game” is written could be that of a consultant or an anthropologist. Both think in terms of a people interacting in a particular context or cultural space, one that can be understood as condensing onto a situation at any given point in time, and are interested in observing how people react---or don’t---when that situation changes. But Ellis’s explanations for the varying responses he observed are more rooted in a mechanistic psychology than in any cultural materialism.
The context for “Loser’s Game” is the stock market. The situation at the time Ellis was writing is that, among players in the stock market, the investment strategies that had worked fine for decades now seemed exhausted. The market landscape had changed: it was now difficult to “beat the market” by picking stocks, that is, for making investment decisions by using the movements of share prices as primary data. Returns were consistently down: the expense of active management could no longer be justified. Managers could not adapt, Ellis argues: they did not---and could not---see that their strategies had been rendered obsolete. They were psychologically unable to do so. They were stuck in routines shaped by strategies that were familiar but which no longer functioned as if there were no alternatives. Only returns-on-investment (ROI) showed there was a Problem.
But Ellis was also of this time, observing the situation as if from a remove, recognizing a systemic problem, without a ready-made alternative to offer. Nonetheless, he argues, something, somehow, has to change.
Ellis does not offer much explanation for the situation he describes. The most likely explanation is the one adduced earlier, that pricing had become “efficient” as an effect of herding, of everybody looking at the same information about the same objects and reacting to that information in the same way, because they all used the same strategy.
Ellis was particularly concerned by the effects of efficient pricing on actively managed institutional investors: mutual funds; money managers; insurance companies, investment banks and commercial trusts. Ellis does not mention this, but in the mid-1970s the geography of institutional investors was starting to change. In 1974, the Employee Retirement Income Security Act ERISA act allowed pension funds to join their ranks, with certain provisos.[9] Like endowments, pension funds operate with a much longer time horizon than do other types of institutional investors, which, in retrospect, militates for quantitative, long-term-oriented investment strategies that did not yet exist in 1975.[10]
In 1975, modern index funds entered the space when Jack Bogle opened Vanguard, the first index fund.[11] From that point, investors had available a material choice between active and passive management. Passive strategies track a stock-market index like the Dow-Jones Industrial Average, the S&P 500 or Russell 1000. They’re cheap (no human interaction), they provide diversification for investor portfolios, and the returns have been good, particularly in recent years (thanks in no small measure to stock buybacks). The expense of active management gets continuously compared to that of index funds, so it’s no surprise that active managers hate them. In 2016, one active manager famously referred to index funds “even worse than Marxism.”[12]
In 1975 the investment landscape was changing, but the effects of these changes were not immediate. They do not figure in “Loser’s Game.”
Ellis describes institutional investment managers using active strategies to trade on public exchanges. They monitor price movements: buy low; sell high, with a preference for liquidity (assets that could be quickly converted to cash). Institutional investor strategies were the same as those used by retail (individual) investors.[13] But that was not in itself the problem. Rather, the strategy no longer worked. Ellis writes:
The investment management business (it should be a profession but is not) is built upon a simple and basic belief: professional money managers can beat the market. That premise appears to be false.
In Ellis’ view there were two problems: how to recognize that the strategies no longer work, and how to figure out what might replace them. With respect to the latter, Ellis would later call for the “professionalization” of institutional investment management, a process that would distinguish it from retail investments. Institutional investors operate with far long timeframes than do retail investors. To occupy that timeframe would require a different type of primary data, one that would replace share prices and their movement. Eventually this “professionalization” would be associated with an increased quantification of portfolio management.[14] But 1975, finance was not yet professionalized in this sense. Rather, it was in the process of professionalizing. The CFAA award given to “Loser’s Game” reflects an aspect of that process. The CFA Institute is a professional organization that set professional standards for certified financial accountants. It also evaluates, assigns value to, research and other written work, policing genre boundaries on the one hand, awarding prizes on the other. These activities work to define the profession’s domain of legitimate knowledge. The reception of “Loser’s Game” is a moment in the process Ellis advocates. But to see in Ellis a call for increased quantification just so presupposes knowledge of the longer-term effects of the transitions that Ellis was describing in 1975, effects that neither he, nor the money managers whose plight he describes, could have known.
What was clear for Ellis at the time was that active strategies no longer worked and that, because index funds there were cheaper, passive alternatives for investors to go passive, active managers had to justify their expense and they couldn’t do it. The game had changed:
The belief that active managers can beat the market is based on two assumptions: (1) liquidity offered in the stock market is an advantage, and (2) institutional investing is a Winner's Game.
The unhappy thesis of this article can be briefly stated: Owing to important changes in the past ten years, these basic assumptions are no longer true. On the contrary, market liquidity is a liability rather than an asset, and institutional investors will, over the long term, underperform the market because money management has become a Loser's Game. (p. 1)
Market liquidity refers to the extent to which a given asset can be bought or sold without affecting its underlying price. The term also refers to the speed with which an asset can be converted to cash. That attribute is valued because stock-picking as a strategy works with an exceedingly short time-frame. There is no longer an advantage to that. In fact, liquidity and the time-horizon of a piece with it had become liabilities. If new strategies for institutional investors are to be developed, they would have to work on a different basis beginning with time-frame.
But the main point lay in the distinction between types of game, winner from loser. Ellis explains the distinction by way of examples: golf, tennis, and war. It is an odd grouping unless war is understood as something like maps of battles from the past set into motion or on the model of chess. All three are amenable to the strategy: each presents participants with chains of shifting situations in which in what is immediately given (the anecdotal) and what is likely to happen should one do x or y (the probabilistic) are in a sense superimposed. But each level involves a particular relation to time: the present as over against the near-future; reactive and proactive relations. Ellis is interested in how, in such situations, a participant’s viewpoint can change when she recalibrates her relational understanding in order to foreground the probabilistic. In war (or, better perhaps, chess) such a shift enables a player to think several moves ahead and to anticipate the opponent’s reactions. But there is something similar in golf (with shot placement the balancing of how ambient conditions might affect it and how one compensates) as well as tennis (this is more obvious). Strategy is a matter of familiarity and practice, of immersion in a game. Ellis chooses them for a perverse reason, in order to think about what might happen when someone accustomed to one game, and possessed of skills fitted that game, abruptly finds him or herself in a different one.
To illustrate the point, Ellis dwells on tennis, citing Simon Ramo who was quite an interesting fellow. Ramo based his distinction between winner’s and loser’s games on differences observed between those that involve professional, highly-skilled players and those that involve amateur, unskilled players. Not surprisingly, professional players reliably put the ball where they want it to go. They win games because they win more points than their opponent. Games of amateurs are:
…almost entirely different. Brilliant shots, long and exciting rallies and seemingly miraculous recoveries are few and far between. On the other hand, the ball is fairly often hit into the net or out of bounds, and double faults at service are not uncommon. The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points. (p. 3)
But what would be the situation of players accustomed to the winner’s game who abruptly found themselves in a loser’s game? Ellis argues adapting to such a change would be psychologically taxing and that the difficulty of doing so would increase with the player’s level of skill, which Ellis equates with intelligence. Because of changes in the relations among the continuities or forces that shaped the tennis he knew--possibly air pressure, for example, or maybe gravity---a tennis player accustomed to dropping shots with precision now finds his accuracy no different from that of an unskilled player. Imagine the incredulity: vary it by changing the player’s underlying sense of personal entitlement, altering the player’s class position. Make the player a narcissist to generate responses that flow from incredulity to denial to rage.[15]
What would explain such a situation among portfolio managers? Consider the difficulty a market player might have in understanding the effects of herding. On the one side arrange all the assumptions about homo economicus as rational actor and the power of incentives, about markets and their objectivity. How is someone equipped with such assumptions to understand the effects of herding in effecting not just prices of individual stocks but the behavior of entire markets? For that to be possible, “the market” cannot be located “out there” as a kind of object that exists independently of the actions of market actors. For that to hold, actions of players “in the market” are also actions “on the market” that can--and do---change those markets. Donald Mackenzie describes such a situation in the late 70s-early 80s. Developments in computing converged with new models for pricing options (Black-Scholes-Merton in particular). The models made it possible to generate “correct” pricing trajectories into the future: the movements of actual prices with reference to that created space for arbitrage. Taking advantage of these pricing variations required the equations (in the form of a software package) and a fast computer. The hedge fund Long Term Capital Management made a huge amount of money in this way until competitors figured out the approach and adopted it. Then everyone adopted it. Soon everyone everywhere was using the same strategies to exploit the same information—and that eliminated the price discrepancies the strategy was meant to exploit.[16]
Ellis recommends that active institutional managers confront that they are now in a different game and either adapt to being in a loser’s game or go passive. That advice is echoed in his introduction to Swensen from 2000:
(…) concentrate on your defenses. Almost all of the information in the investment management business is oriented toward purchase decisions. The competition in making purchase decisions is too good. It's too hard to outperform the other fellow in buying. Concentrate on selling instead. In a Winner's Game, 90 per cent of all research effort should be spent on making purchase decisions; in a Loser's Game, most researchers should spend most of their time making sell decisions. Almost all of the really big trouble that you're going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the Loser's Game. (p.7)
In other words, switch into the longer time-horizon afforded by managing an institutional investment vehicle and focus on portfolio diversification and risk management. This entails a different approach to research, a different sense of when to buy or sell (rebalance) informed by a contrarian streak in the manager’s thinking. Gone are the days of following individual share price movements hoping to find the best moment to sell.
In his 2009 introduction to PPM, Ellis makes a similar point with respect to Swenson’s approach, here emphasizing the endowment’s risk management:
As innovative and successful as Yale’s many investment initiatives have been—and Yale’s extraordinary achievement in superior long-term results quite naturally attracts all the attention---close observers know that the real secret to Yale’s investment success is not the profoundly pleasing performance produced over the last five, ten and twenty years. Just as the secret to real estate is “location, location, location,” the real secret to Yale’s remarkable continuing success is defense, defense, defense.
He continues:
But how, you may ask, can defense be so important to Yale’s remarkably positive results? Starting with those great truisms of long-term investing---“If you lose 50% it will take a 100% win just to get even” or “If investors could just delete their few large losses, the good results will take care of themselves”—all experienced investors will gladly remind us of the great advantages of staying out of trouble. Delete a few disasters and compounding takes care of everything.[17]
In PPM, Swensen has some words about managers who keep at Ellis’s “loser’s game.” These comments provided Swensen the chance to contrast the figure of the stock picker or “market guru” with his self-understanding as an understated technocrat of institutional investment management. That’s what we turn to next. Part 1 of this essay ends with a brief consideration of whether institutional investment strategies based on the Yale Model now find themselves in a new version of the problem that occupied Charlie Ellis. Part 2 of this essay looks at the Yale Model itself.
Reading Swensen I
I am not a market guru
Roughly in the middle of PPM, Swensen includes a series of critical takes on investment advice books and authors. In it, Swensen is basically saying: “I am not a market guru. This is not a book on how to pick investments.” In fact, he takes exception to market gurus and stock pickers, sees them as cringe-atavistic, and contrasts them with how he sees himself in his role as an up-to-date institutional investment manager. This section can be taken as Swensen providing instruction to the reader on how not to read PPM as well. “I am not a market guru. This is not a book on how to pick investments.” The appeal of such books leans on and repeats mythologies that interpenetrate finance and “the investment process” that a secret lay hidden behind the apparent chaos of asset prices and their movement and that some members of the priesthood of finance know that secret and, further, that within that priesthood one may take time out from becoming exceedingly rich to write that secret down. Swensen represents a different way of imagining investment managers like himself as low-keyed technocrats, as people with gravitas who serve a higher purpose in their search for excellent returns on investment. This way of seeing himself formalized a change in the finance industry’s repertoire of imaginary projections about itself (finance cannot be understood as practices and objects that are separate from the myths about finance).
Swensen contrasts the old and new ways of understanding “the active investor”:
The thrill of the chase clouds objectivity in assessing active management opportunities. Playing the game provides psychic rewards, generating grist for the mill of cocktail party conversation. (…) The willingness to believe that superior performance comes from intelligent hard work clouds clear judgment. The investment world worships success, deifying the market seer du jour. Instead of wondering whether a manager at the top of his profession made a series of lucky picks, observers presume that good results follow from skill. Conversely, in public perception, poor results follow from lack of ability. Market participants rarely wonder whether high returns come from accepting greater than market risk. The investment community’s lack of curiosity about the source and character of superior returns causes strange characters to be elevated to market guru status. (pp. 246-7)
Swensen follows with discussions of three “market gurus”: Joe Granville; the Beardstown Ladies, and Jim Cramer. These people have in common that they were/are still mired in Charlie Ellis’ loser’s game but have been nonetheless at different times taken seriously by investors/audiences to whom they provide specific investment advice (stock picks) that turned out to be consistently wrong. Swensen has particular contempt for Cramer, who, he notes, was “educated at Harvard College and Harvard Law,” and so, presumably, should know better. Swensen presents Cramer as a charlatan given to formulating “inane rules designed to help average investors beat the market” but which never do. Cramer was “wrong about tech stocks during the dot-com bubble (249), wrong about “value investing”, wrong about Cisco and Yahoo” (250). Swensen characterizes Cramer’s television persona on CNBC’s Mad Money, as “a mockery of the investment process, throwing chairs, shoving toy bears into meat grinders and decapitating bobble-headed dolls made in his own likeness.” He continues: “Betwixt and between his sophomoric antics, Cramer throws out hundreds of stock recommendations.” Over a 6-month period of 2007, Cramer recommended “an astonishing 3458 stocks.” Swensen cites the conclusion reached by an unnamed writer for Barron’s, the source for the 3458 number: “The credible evidence suggests that the tele-stockmeister’s picks aren’t beating the market. Did you really expect more from a call-in host who makes 7,000 stock picks a year?”
But if these “market gurus” are always wrong, what explains their appeal? The interpenetration, even among market players, of finance and mythologies about finance in which the mythologies frequently predominate. Swensen noted some of these earlier: the assumption that individuals are the primary actors; that outward success can be equated with inward skill or other virtues and outward failure with their inner absence; the equation of money, success and power, the erotic charges attributed to all three; how being associated with them makes one “interesting” in the glittering theater of a cocktail party.
Despite a record of providing vast amounts of specific investment advice most of which would have provided his audience the unique experience of losing money together, had they followed it, Cramer is also a kind of mythological residue. He is a figure of “the trader.” For people of a certain age, or who have seen movies that capture something of the recent past, the term “financial markets” may still conjure images in which the main trading infrastructures (the exchanges) were centralized physical spaces, usually quite large and of an open design, outfitted with various technologies for the communication of prices populated during trading hours by people engaged in what appeared to outsiders as continuous clamor as they jostled for position while shouting or signaling orders (in the Chicago commodity exchanges traders used a system of hand signals called arb).[18] These were shouty, sweaty, largely male environments in which the whole of time was compressed onto now this present moment, now this. These days, the physical spaces where trading used to happen are mostly, but not entirely, symbolic. Most trades happen online; settling and clearing are mostly automated and depopulated. In the middle of the last decade, regulators were concerned that the ever-increasing centrality of networked computing would result in the fragmentation of financial markets—but, instead, increased globalization of capital flows, of transactions, and financial information, has enabled a remarkable concentration of ownership of the electronic infrastructures that enable contemporary finance. Figures like Cramer traffic in nostalgia: his rolled-up shirt sleeves and shouty demeanor are those of an old-school “open-outcry” trader. On screen, Cramer’s schtick is to perform variations on how old-school traders used to appear from a distance, framed with chyrons in the form of electronic ticker ribbons through which courses a continuous flow of share prices that call to mind their early electronic forms at the NYSE or the CBOE. Swensen was undoubtedly correct about Cramer as a useless source of investment guidance—but that doesn’t seem to matter. Cramer is an entertainer who, like so many others these days, works a grift, the legitimation of which lay with ratings, which function for television as returns do for endowments. He need serve no other public good. But who watches Mad Money?
In the same paragraph quoted earlier that set the shredding of Cramer into motion, Swensen presents himself as a new type of (specifically institutional) investor. As over against the superficiality and lack of curiosity he ascribes to the market gurus, he presents himself as having an intimate understanding of how returns are acquired. He is an explorer of risk and its quantitative management, which informs portfolio diversification and its balance asset classes. The ruckus of the trading floor has been long since been disappeared in favor the individual staring at terminals and, in some places, the hum of servers. The new active managers are more technocrat than the adrenaline-jazzed lax bro “big swinging dicks” of the mega-trade, and that appears to suit Swensen not least because he is in the game for Yale, a name that carries with it a certain gravitas. But Swensen’s break with the older imaginary investment manager goes further than that. Institutional investment management is not centered on the individual. As Swensen puts it: just as for real-estate the key is said to be “location, location, location” for active investment management, the key is “people, people, people.” (251). The new active investment management is a collective process, undertaken with serenity, without histrionics, in particular (private) social environments in which the boundary that separates inside the endowment from outside is blurry, the access to which is most unevenly distributed.
These claims to superior, more intimate knowledge of how returns on investment are generated based on a turn away from price toward risk as the primary datum, and the reconfiguration of the imagined role of the active institutional investment manager are basic to PPM’s appeal, and to that of the Yale Model. Readers in a position to imitate Swensen’s approach, who managed pension funds and larger endowments, did so. The result was that crazy amounts of money flowed into alternative investments starting around 2000, so much that, by 2006, the asset classes broke. This outcome was the exact opposite of Swensen’s stated intentions. He extols the virtues of contrarian thinking and worries over how being-a-contrarian, in an endowment context, might complicate the matter of trustee oversight. But what happens when everyone is the same kind of contrarian?[19] Swensen’s refrain of “Don’t try this at home” and warnings of the dangers to which a fund exposes itself where due diligence is not adequately carried out went largely unheeded. “The Yale Model” is the result of a misreading of Swensen’s book by people involved with institutional investment or oversight and other forms of asset management. Yet the model, as presented in PPM, is what sold the book and created the Yale Model: the allure of those returns; the seductiveness of being let in on intimate and secret information previously unrecognized; the flattery of associating the risking of institutional money in large amounts on risky, illiquid and opaque and eye-wateringly expensive investment vehicles[20] with some higher purpose or calling all turned out to be more compelling than Swensen seems to have anticipated. Short of never publishing the book, it is hard to know what more he might have done to counter such mis-readings.
In 2022, are the followers of the Yale Model in a new loser’s game?
End of Part I.
© Pattern Recognition: A Research Collective, 2023
[1] Markov Processes’ recent “2022 Endowment Saga: How The Mighty Have Fallen” gives a good sense of what is meant by “one or another version.” Consultants and funds also refer to the Yale Model as “the endowment model,” BlackRock for example.
[2] . The author used the revised edition appeared in 2009 for this piece.
[3] We look at this in the Balance Sheet that concludes this collection of texts.
[4] In a press release announcing CRISL’s purchase of Greenwich, the latter was described as “a leading provider of proprietary benchmarking data, analytics and qualitative, actionable insights that helps financial services firms worldwide measure and improve business performance.” The company’s website is here.:
[5] See 1/4/2021 Commonfund blog, Board of Trustees and Investment Committees Roles and Responsibilities.
[6] A review is available here.
[7] A pdf of Ellis’ “Loser’s Game” can be accessed here.
[8] CFA Institute page for the Graham-Dodd Prize.
[9] A discussion of pension funds as institutional investors is important to have, but it would pull us afield here, so we defer it to another time.
[10] Janette Rutterford and Dimitris P. Sotiropoulos, “Financial diversification before modern portfolio theory: UK financial advice documents in the late nineteenth and the beginning of the twentieth century” in Euro. J. History of Economic Thought, 2016 Vol. 23, No. 6.
[11] See 1/9/2019, Fox Business, “Vanguard Index Funds: A History of their evolution for investors” The report is mostly a chapter from Jack Bogle’s autobiography Stay the Course which is, perhaps surprisingly, quite interesting. See also: 9/21/2021, Elizabeth Gravier, “Index Funds are among the easiest ways to invest—here’s how they work” at CNBC. But they are not all created equal. See the 2009 interview “David Swensen’s Guide to Sleeping Soundly” in Yale Alumni Magazine and, more broadly, Swensen’s 2005 book for individual investors, Unconventional Success: A Fundamental Approach to Personal Investment.
[12]. A search on the title will show that the comment is a recurring favorite of finance journalists.
[13] “Retail vs. Institutional Investors: What’s the difference?” in Investopedia.
[14] One might wonder what exactly constitutes “a profession”—we consider this later on---but note here that a professional organization that sets professional standards & selects/rewards important work is important for defining a profession. Ellis’ essay was published by and, later, singled out and rewarded by The Certified Financial Accountants Association. In 1975, then, investment management might be seen as having been in the process of professionalization.
[15] In part 2 of this essay, we return to, and expand on, the motif from “Loser’s Game” of practice embedding people in a particular milieu to the exclusion of problems and of any sense of alternatives.
[16] Donald MacKenzie, A Motor not a Camera: How Financial Models Shape Markets (Cambridge: MIT Press, 2006).
[17] Ellis, Foreword to the 2009 edition, p. xi.
[18] See the undated footage of NYMEX Floor Trading with commentary by Robert Downey Jr posted to Youtube. More generally, see James Allen Smith’s 2009 documentary film “Floored” about the impact of the digital trading revolution on some of the last people working open-outcry in the Chicago futures exchanges (for hogs and cattle). A short review is here. The film itself can be viewed here. Smith provides a good sense of the visceral experience of “open-outcry” trading in the pit. See also this on open-outcry and the CME Group, which owns these futures exchanges.
[19] For example, Ludovic Phalappou and Jeffrey Hooke (among others) have shown that private equity returns haven’t beat the market since 2006.
[20] Private equity and hedge funds in particular. We will return to the question with which this paragraph ends after we’ve established some more information about these asset classes.