Yale investment wizard David Swensen says passive, index-fund investing may be boring but that the diminishing number of high quality active investment management teams makes it mandatory for most people.
"Those on the passive end of the (investing) spectrum have figured out that they don't know enough to be active," Swensen said in an interview with propublica.com.
"The passive group is not nearly as big as it should be. Almost everybody should be there."
Swensen, who was recently named to President Obama's Economic Recovery Advisory Board, grew Yale’s portfolio from $1 billion in 1985 to more than $23 billion last year by creating a widely diversified portfolio that included private equity funds, real estate, and hedge funds.
Swensen says one of the criticisms of his investment model he frequently hears is that diversification doesn’t work in times of financial crisis.
“For the period during which we’re in the crisis, the hoped-for benefits of diversification disappear,” Swensen says.
“Once the crisis passes, then the fact that these different asset classes are driven by fundamentally different factors will reassert itself, and you’ll get the benefits of diversification.”
Diversification becomes temporarily less important in times of market panic, but those times don't last forever, observes Morningstar’s David Kathman.
“A diversified portfolio is less risky than one that's concentrated in one area of the market because different parts of the portfolio will tend to do well at different times, thus smoothing returns over time,” Kathman writes.
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