Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.(Review)

Swensen, David F.

New York, NY: The Free Press (366 pp)

Pioneering Portfolio Management, written by Yale University's Chief Investment Officer, provides novel views on how to implement a long-term investment program and is sure to be of interest to pension administrators. By providing a step-by-step approach from conceptualization of the investment program to execution, it serves as a valuable how-to guide that would be useful to just about any long-term investor.

The book is organized in a linear fashion. The first three chapters assign considerable space to three steps that precede the asset allocation decision: 1) defining endowment purposes, 2) setting investment and spending goals, and 3) agreeing on a shared, enduring investment philosophy. Only then is asset allocation discussed.

In the chapter on asset allocation, the author provides a glimpse at how complex it is to define and describe the behavior of various asset classes. There are two reasons for this. First, investors have fluid views on what constitutes an asset class. For example, railroad bonds were commonly viewed as a distinct class, since they dominated the emerging market of the U.S. in the post-Civil War era. Second, historical data suggests that returns, and the variance of returns, follow a familiar statistical pattern (a bell-shaped curve), which is a precondition for modeling an efficient set of portfolios. However, Swensen cautions that the modeling of efficient portfolios (part of mean-variance optimization) is no science because of the extreme events that occur all too often in markets. Thus, he tells us that investment executives must make qualitative judgments as well--for example, discounting U.S. equity performance in the last 20 years to project the next 20 years.

The next chapter moves onto portfolio management. Here Swensen discusses implementation issues like rebalancing, which requires an investment manager to adjust a portfolio so that it complies with the original asset allocation target. Unlike many pension systems that do rebalancing as little as once per year within a range, he appears to come down on the side of continuous, daily rebalancing so that if the asset allocation is off by as little .01 percent of the allocation targets, trades are made to correct the balance. He argues that frequent rebalancing reduces portfolio risk and "market impact," since smaller more frequent sales have a smaller impact on market price than sales in large blocks.

Subsequent chapters delve into the implementation of a long-term investment portfolio, and two themes emerge. One is the need for continual vigilance to ensure that the interests of all the various investment professionals align with the interests of the plan sponsor.