On October 5, I led a live discussion with Charles D. Ellis, the pioneer and evangelist for passive investing in equities and author of Winning the Loser’s Game on the Terminal. As he made clear in the discussion, he is very, very dubious about the wisdom of investing in bonds, and suspects that the best chance to profit from investing in venture capital or private equity has now passed.
He also provided some fascinating new insights on just how David Swensen, who died earlier this year after a spectacularly successful career at the head of Yale University’s endowment, found managers of private assets who could outperform for him. It wasn’t easy.
Here is the transcript.
10/05 10:37 ET
Welcome to Authers Notes, TOPLive’s blog-based discussion of some of the most influential books about investing, finance and economics hosted by Bloomberg columnist John Authers. This time around, John’s guest is Charles D. Ellis, founder of Greenwich Associates and author of Winning the Loser’s Game. Now in its eighth edition, Ellis’s work has informed the thinking of countless investors and investment professionals in the decades since it was first published.
Andrew Dunn, TOPLive Editor
10/05 11:33 ET
Hello and welcome to our discussion of Winning the Loser’s Game, an investment classic that has been required reading for budding CFAs for decades, and this year reached its eighth edition.
We’re very grateful to Charley Ellis for giving us the time to talk about this, and also to the many readers who have submitted questions in advance.
The opinions expressed by the panelists are their own.
John Authers, Bloomberg Opinion, New York
10/05 11:35 ET
In brief, “Winning the Loser’s Game” offers the classic case for indexing as opposed to active management. With more and more money managed professionally, and with institutions devoting ever more resources to looking for the best performing stocks and bonds, the market becomes ever more prohibitively difficult to beat.
The title comes from an analogy with tennis. Roger Federer, Serena Williams and the greats play a “winner’s game” in which they come up with just the right shot that touches the line but stays in, and win their points; most of us play a “loser’s game” in which the winner is the one who makes fewer mistakes, and we are best advised just to try to make sure that we can get the ball back over the net.
Similarly, Charley argues, investing is now a game of avoiding mistakes—and that means a steady asset allocation and using indexation to minimize fees, rather than make any active attempt to beat the market.
John Authers, Bloomberg Opinion, New York
10/05 11:37 ET
Beyond the argument for indexing, however, the book also leads to arguments for a very active approach in private markets, where there is more of a chance that an investor can find an edge.
The founder of Greenwich Associates, Ellis worked with some of the most influential investors of their generation—including Jack Bogle, the founder of Vanguard, and David Swensen, who died earlier this year after several decades of spectacular success running Yale University’s endowment. While there, he pioneered investing in alternative assets such as venture capital, hedge funds, and even forestry.
This live blog gives us a chance to talk both about how private investors should manage their money using indexes, and how big institutions with long time horizons can venture into much more esoteric territory.
John Authers, Bloomberg Opinion, New York
10/05 11:39 ET
Joining our discussion today is Bloomberg’s Janet Lorin.
Janet has been writing about various aspects of higher-education finance, including college endowments, for almost 14 years at Bloomberg. She and a colleague shared a George Polk award for national reporting for a series about student debt.
Andrew Dunn, TOPLive Editor
10/05 11:40 ET
Now for the questions....
One reader asks the following, which strikes to the heart of current complaints about indexing:
“If one invested in a World or All-World equity index at present, one would get a strong representation of U.S. shares, which have an exceptionally high CAPE, and within that a strong representation of the S&P 500 and of the rather few shares which dominate the S&P 500. Some respected commentators, notably Jeremy Grantham and Rob Arnott, would not recommend such an allocation. Is it really a good idea?
Put differently, indexing means accepting the market’s judgment about the appropriate valuation to put on companies. If the market is already overpricing a company, does this not help to create bubbles? And is there an argument for “Smart Beta” or “Fundamental Indexing,” (as Arnott calls it) which weights stocks by a measure other than their market cap?
John Authers, Bloomberg Opinion, New York
10/05 11:41 ET
This is a wonderful question.
Like any great question, it’ll require considerable thinking over a long period of time, and we won’t know the answer until we get to the end and look backwards. And then we’ll all know exactly the right answer.
So that leaves us with the only choice, which is to make sensible estimates. Jeremy Grantham and Rob Arnott are two brilliant and independent thinkers, so we should all listen to them very carefully when making our own judgments.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:42 ET
My own view, and this is not an expert opinion, is that wide-range indexing global markets makes good sense for everyone.
The secret to real success in indexing is always going to be taking a long-, long-, long-term view, and I’m comfortable taking market capitalization as the basis for the long-term view knowing that this will put me into stocks that I would otherwise have not gotten into and leave me in stocks that would make me uncomfortable.
But it’s my experience that being uncomfortable and accepting that indexing works better than trying to outsmart indexing.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:43 ET
A number of readers say that they get the argument for indexing, but that it only raises the issue of which index to choose. And as the book makes clear, it makes the issue of asset allocation all the more important.
This question is typical:
“Whilst most will agree equities will outperform bonds in the long term, is it right to take as given previous market performance, albeit over 100 years. Shouldn’t we hedge against future poor equity performance if the world/ U.S. changes?
Is there some sensible rule that people can adopt for asset allocation without falling into the traps of over-trading, or believing that they can beat the market?
John Authers, Bloomberg Opinion, New York
10/05 11:45 ET
Asset allocation is terribly important and almost always conventional advice is dead wrong. My favorite target is “invest your age in bonds” (so presumably if you’re 30 years old, you should invest 30% in bonds). So this rule is nuts.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:46 ET
Imagine the typical 30-year-old who is a serious investor. Let’s assume for a minute that she did an MBA and is working in a fairly high-income career? What is her most valuable asset?
It’s not her securities portfolio; it is her ability to earn substantial income in the many years ahead. Likely she would not retire until well after 70 -- that’s a long, long time. And the present value of her earning and saving power is huge.
In addition, she may already own a home. She will be receiving Social Security benefits, and those are are more like bonds than other investments you can think of. They are stable assets. So this woman is actually heavily invested in stable assets, and the last thing she needs is to do more by buying bonds.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:47 ET
Jump to the other end of life: I’m 84, and I own zero bonds. I am receiving required minimum distribution, I am receiving Social Security, I do own my home, and being an art history major in college, I own some paintings. The conventional advice would be that I should have 84% of my securities in bonds. I have zero.
Why? Because I’m still able to earn enough to cover our expenses, so my objective is to provide financial confidence to my grandchildren. Their average age is 15. They won’t be spending the money that I’ll give them for years and years. So the sensible investment is all equities, and that’s what I’m doing.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:49 ET
Having rejected the conventional wisdom of investor age in bonds, a clear-cut challenge for me and any other person is to figure out what’s right for me in my particular situation.
As investors, each of us is unique just as much as my fingerprint is unique or the iris of my eye is unique or my DNA is unique. In similar way, we differ in wealth, we differ in income, we differ in saving capacity, we differ in risk tolerance, we differ in interest in investing, and we differ in skills in investing.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:50 ET
If each of us were to take all those factors and think seriously about ourselves, we would realize that we are unique as investors. The best thing any investor can do is to figure out what’s really right for her or for him for the long, long term in portfolio structure.
Put that plan in writing, and stay with that plan until either we change a lot, or the world changes a lot. Chances are high most of us should be investing even more than we do in equity investments.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:52 ET
Charley, as chairman of Yale’s investment committee, you spent a lot of time working with David Swensen, the endowment’s legendary CIO, who passed away this year. We’re about to see enormous gains by endowments because of venture capital.
Can you talk about the long-term strategy of institutional investors and how it differs from everyone else?
Janet Lorin Investing Reporter
10/05 11:56 ET
I really like to give a very long answer to this question. The Yale endowment under David Swensen was marvelous!
An appropriate investment strategy for an institution like Yale is very, very different from individual investors or institutions that don’t have the unusual skills that Yale developed as an investment-management organization.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:57 ET
Over the long term, “venture capital investing” has been a disappointment. Returns have been significantly less than the equity market. The risk has been greater, and basically it has not been a good idea.
Charles D. Ellis, Greenwich Associates Founder
10/05 11:58 ET
Venture capital is not about the money; it’s about the people. And 10 or a dozen great success makers in venture investing concentrate substantially on
knowing all the people who might be terrific in a new organization and assemble the very best teams to create great success. And they succeed.
As a result, everybody who wants to be successful as builders of new technology companies wants to work with those very best investors. So demand exceeds supply, and the best investors know that they have limited capacity from dollars’ point of view, so they limit their investors to those who truly understand venture investing and are long-term investors and will be repeating long-term investors.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:00 ET
As we all know, life itself is unfair, and it turns out that only 10 or a dozen organizations are really successful at venture investing, and that means everybody wants to be investing with them or have them invest in their companies.
Usually 90% of the great successes in venture investing go back to those same 10 or dozen organizations. And success breeds success, which breeds success. So you’re either one of the favorite investors, or you shouldn’t consider venture investing, because you will not succeed.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:02 ET
Yale this year has more than 25% in venture capital and will likely see gains like it hasn’t seen since 2000’s 41% return. U.S. stocks also performed well during the year ended June 30, with the S&P 500 returning 41%, including reinvested dividends. Who did better with less risk?
Janet Lorin Investing Reporter
10/05 12:03 ET
This is clearly a very clever question. The obvious answer is: Doing well in the S&P 500 (as good as or better than in venture investing) is much less risky.
The second answer would be to borrow from Marty Leibowitz’s book “Inside the Yield Book.” It all depends on what your investing is going to be for the next year.
In the case of a large endowment like Yale, one or two years is way too short a time period to get a good fix on risk.
Ten years might be long enough; 25 years is almost surely long enough. But one year is way too short.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:05 ET
This is a very specific question from a reader, but it raises the very broad point that rebalancing at present would appear to mean buying bonds. Is this really a good idea? Here’s the question:
“I’m on the board of a well-endowed private school. Our consultant advises upping our risk to compensate for the skimpy income we’re earning on our portfolio in order to maintain the endowment’s roughly 4% annual support of school operations. Doesn’t rebalancing (winning the loser’s game) call for doing just the opposite, namely, selling equities and using the proceeds to augment the portfolio’s skimpy income as needed to fund operations?
“Asked differently, shouldn’t an endowment’s allocation be maintained independent of the cash support it is called upon to provide?”
John Authers, Bloomberg Opinion, New York
10/05 12:06 ET
For an endowment that’s large relative to its mission, asset allocation should be optimized quite independently from the determination from an appropriate annual draw. This is a wonderfully thoughtful question.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:07 ET
With the Federal Reserve driving interest rates down and inflation verging on 3%, maybe more, conventional wisdom from the past on stock-bond ratios really needs to be reconsidered carefully.
These are, as Abraham Lincoln would have said, unusual times, so our strategy should be comparatively unusual, or at least unconventional.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:08 ET
Inigo Fraser Jenkins of AllianceBernstein famously calls passive investing “communist-style” investing.
What do you have to say about that? Is it more Xi Jinping than Warren Buffett?”
John Authers, Bloomberg Opinion, New York
10/05 12:10 ET
What a wonderful attack! The best I can say is that it’s nonsense.
First of all, “passive investing” is a great misnomer. It was invented by a couple of guys who were electrical engineers, and everyone who’s in electrical engineering knows that, to connect an appliance to the power source, you plug the active end, which has two or three prongs, into a passive end, which has two or three holes. It has no emotional impact of any kind.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:11 ET
Take that same terminology and apply it to investment management, and it takes on great power. Who would like to be introduced by his or her spouse as, “she or he, is passive”? Or: “Tom Brady may be a good quarterback, but our quarterback is excellent. Our quarterback is passive.”
None of us wants to be passive. But if you go past the mudslinging and insult-generation, indexing has a lot going for it.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:12 ET
Over a reasonable time period, like 15 years, indexing will beat 90% of active managers, partly because it has lower cost of operation, partly because it has lower fees, and for individual investors of course it has lower taxes.
If our objective is to be in the top quartile, indexing assures us of success over a reasonably long time period.
What’s not to like about winning with so little effort?
Charles D. Ellis, Greenwich Associates Founder
10/05 12:12 ET
Besides, with the time freed up by not focusing on detailed operational questions, each investor can focus on the really important questions like asset mix over the long term.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:13 ET
Now turn the question around: If you were now indexing, would you be willing to change to “active” investing, knowing the odds are 90% against your keeping up with your market index, knowing that your taxes would be higher and knowing that the chances of falling short are not only high but painful because they are much larger than the benefits of those few who outperform?
Charles D. Ellis, Greenwich Associates Founder
10/05 12:15 ET
As passive grows in share of total, are there limits of passive as share of total where the cost might be increased market instability? Who can take the other side if, say, passive was 80% of the total?
John Authers, Bloomberg Opinion, New York
10/05 12:18 ET
This is a fascinating question. Many people think it’s the share of the total equity market that is indexed that really matters.
I don’t think so. Markets are made by people with different opinions, and so long as the number of people continues to be very high, and they are active in expressing their opinions, a very small percentage of the market not being indexed would be plenty.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:19 ET
Over the last 50 years, we’ve gone from roughly 5,000 people engaged in active investing to comfortably over 1 million people engaged in active investing. If that were to drop down to half as many as today, it might make some difference. But the reality is, more people join on the active investing side every year than withdraw or go away.
And candidly, the Darwinian process has been upgrading the talent pool year after year after year, and the extraordinary increases in the tools with which people engage in active investing -- think of the magnitude of change in computing power, the wide range of analytical models of various kinds, the power of the internet, the 330,000 Bloomberg terminals, the SEC regulation FD for fair disclosure, the increased number of CFAs.
When I graduated from Harvard Business School, there were no courses investment management. Now there are two dozen.
On top of that, investing has gone global.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:22 ET
We have one slightly different question, about David Swensen, which also has much broader implications for asset management:
“There’s a story nobody seems to have written following David Swensen’s passing. While everyone covered his shift to illiquid investments, few, if any, wrote about his focus on aligning interests between clients and money managers. He did not like firms with more than one product or any form of outside ownership (especially publicly traded asset managers). These are lessons being forgotten by many allocators today; could Charley comment on this, please?”
Specifically, beyond these concerns about an investor’s structure and corporate governance, how important are fees -- not just as a lead weight that detracts from performance, but also as perhaps giving the investment manager different interests from the client’s?
Janet Lorin Investing Reporter
10/05 12:24 ET
These are two really wonderful questions. Starting first, David Swensen took a very straightforward view. He was focused on the mission of serving Yale University and therefore serving the students who come to the university over many, many years. That centrality of mission or purpose governed every aspect of what he did.
And of course that mission or purpose was very, very long term. David thought carefully about how to be the best client for an investment manager. And if you look at the behavioral characteristics, you get the message.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:24 ET
First, you’re very quick to make a decision. Within days of making a presentation, you would know if you were going to be a Yale manager or not.
You would get some stern “Dutch uncle” advice on how to make your case stronger, and implicitly you would get David’s affirmation, which would help you with other prospective clients.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:25 ET
In exchange for those characteristics, David was looking for a very long-term relationship. Even though many of the managers chosen by Yale endowment were not well-known, the average duration of a manager relationship with Yale was over 14 years.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:26 ET
Let me give one example of how David differentiated Yale from other investments. Once a year Yale would host a weekend with Swensen, inviting investment managers to come and play Yale’s famous golf course with members or recent alumni of Yale’s varsity team and the coaches of the varsity team. The second day would be playing tennis with professional women tennis players in rapid rotation, so everybody got to play everybody.
With those two sporting events, a dinner at which the president and senior officers of the university came to say thank you to those investment managers -- thank you for doing great work, thanks for enabling us to do our great work -- and a nice talk by the president showing his appreciation.
And then some entertainment and then some swag bags filled with all kinds of Yale memorabilia.
But the direction of affirmation was the reverse of norms. How many institutional investors make a big deal of celebrating how wonderful their investment managers really are? Yale went all out to get that message across:
Thank you, thank you, thank you.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:30 ET
And that was just one of many different ways in which Yale made itself an ideal client, and expected ideal managers in response.
Take another example. New Haven is an interesting city but not a giant center of investment management. You’re David Swensen and you want to put together a really outstanding team of talented people as an investment organization. And there you are in New Haven, with competition from Boston and New York, which are already certified outstanding investment-management centers.
How do you build a great investment team in New Haven? Start with: Every year, more than 1,000 talented young people come to study. If among them you can get two dozen outstanding candidates, you have something going. If you create a to-die-for course on investing, and carefully screen the 200-300 applicants for the 25 most promising; of that 25 you choose one, two or three to intern for the summer in the Yale investment office; and of those interns, one or two get invited to come and stay for two or three years. They are the best of the best of the best of the best, and those that fit in really well with team-playing are invited to stay for a longer period of time.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:33 ET
Now you treat that group of people with great respect and include them in all major decisions, so they are always learning, learning and learning. And presto! You have the makings of a great investment organization in New Haven, because you took advantage of the Yale talent pool to find the best of the best inside that talent pool.
And the same thing was done with investing committee, the same thing was done with investment policies, the same thing was done with every aspect of Yale’s management organization.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:35 ET
The one thing I always like to emphasize: Everybody likes to talk about the terrific long-term success that Yale had.
The return of investment was very high. Even better than that was the rigorous management of risk on every dimension.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:36 ET
As bonds evidently look dangerous at present, where does that leave cash? Does it at least have value for the optionality it gives you to dive in to situations when they arise?
John Authers, Bloomberg Opinion, New York
10/05 12:37 ET
The question answers itself. For those who value optionality, having optionality has real value. I have spent so many years learning that market timing tends to fail that I would be looking for an investment opportunity other than cash.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:39 ET
So you are advising your grandchildren at age 15 to put money in equities instead of index funds? The word “compounding” comes to mind.
(Selfish interest here: My 13-year-old son just celebrated his bar mitzvah and he’s asking what to do with the generous gifts people gave him.)
Janet Lorin Investing Reporter
10/05 12:40 ET
To me, putting money equities means putting money into equity-indexed funds. I don’t know how it will work out over the next five years, but I do know how it’ll work out over the next 25 or 50 years.
And for a 13-year-old, 50 years may be too little, so maybe you ought to be thinking about 75 years. And the easy answer is equity-indexed funds.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:41 ET
One fascinating further follow-up on Janet’s question is that it’s hard to teach financial responsibility to youngsters when savings accounts pay no interest at all!
Fidelity is even offering special brokerage accounts for teenagers, which Bloomberg Opinion’s Brian Chappatta wrote about here: Fidelity Lets Teens Trade Stocks? It’s Not Daft: Brian Chappatta
How exactly do we get people to think responsibly when no risk means no reward?
John Authers, Bloomberg Opinion, New York
10/05 12:42 ET
Teaching financial responsibility to youngsters is always difficult, and it’s surely harder now than it’s ever been. My own focus would be on explaining how dreadful credit-card debt is and the power of compounding.
For example, helping people understand the rule of 72 can help people who are young think the right way about the longer term and the value of the snowball.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:43 ET
Endowments did well this year—once-in-a-generation well. Just like when an investor has a good run, the question is what to do with the money?
Washington University in St. Louis just announced that it will spend $1 billion of its $6 billion gains on financial aid.
How should schools be spending these extraordinary gains?
Janet Lorin Investing Reporter
10/05 12:44 ET
Each institution should make its own decision, but it would be hard to beat investing substantially in scholarships that would enable more young, talented people to get a great education.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:45 ET
With inflation rising, is it safe for a recent retiree to even think about long-term index investing?
John Authers, Bloomberg Opinion, New York
10/05 12:45 ET
Of course my answer would be that each individual should have or soon develop an explicit plan in writing what they’re investing, focused entirely on what’s really right for them, and this would include their way of thinking about risk and their capacity to live with inflation.
Getting the right answer to this important question is certainly not easy. But avoiding a major mistake is worth the time and effort that it takes.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:46 ET
Final question, from a reader:
“Is it possible we are at a moment in time for another one of those 18-year flat real return periods?”
And I’ll add—as it’s obvious that’s possible, could Charley kindly call the market for us and put some kind of probability on this?
John Authers, Bloomberg Opinion, New York
10/05 12:47 ET
There have been times in the past when there was really no return for investors over a fairly long period of time. The idea of not having any return of consequence for 18 years seems dreadfully grim, but it is possible.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:48 ET
The easiest way to talk about the future given the high levels of valuations put on stocks today and bonds, largely driven by the Federal Reserve doing the right thing for the economy as a whole, which was to increase employment, securities investors have gotten an unbelievable benefit in high returns.
None of us should be surprised if future returns are clearly modest by historical standards. Certainly we should not be anticipating a repeat of the kind of favorable experience that we’ve had for the last few years. It will not happen.
As returns regress to the mean, un-wonderful results must be expected.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:49 ET
Any final thoughts before we wrap up?
John Authers, Bloomberg Opinion, New York
10/05 12:50 ET
There’s one area that I would like to focus attention on, and that’s when to claim Social Security. Broadly speaking, Americans claim Social Security at 63 or 64. “Full retirement” is at 65. And you must claim Social Security by 70½.
I am a big advocate of re-thinking that set of numbers. If 65 was the right age to retire in 1935, when Social Security was made the law of the land, health-care improvements would shift that fulcrum from 65 to probably at least 70, or maybe 71 or even 72.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:51 ET
If you don’t claim Social Security, each year that you put it off, you get an 8% increase in your long-term benefits.
And if you wait not until 65, but until 70½, you get 76% more from Social Security every year for the rest of your life, adjusted for inflation.
If you continue to work during that period, you get to add more money into your 401(k) plan, you do not take money out of your 401(k) plan, and you add market returns, the 401(k) would shift substantially upward.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:52 ET
The combination of more Social Security and more 401(k) payouts would shift millions of American workers from too little to enough, and would be the best investment each individual could make for their own happiness.
All of us in the investment world should be championing this investment decision with everyone that we know, with every Congress-person and every senator every chance we get.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:54 ET
That concludes our live blog for today. We need to thank Charley from the bottom of our hearts for giving us his time, and offering some fascinating answers. It was also great to attract so many questions in advance.
I’m arranging the next book to discuss now. I aim to share the title in the Points of Return newsletter tonight or tomorrow—and please join us for the book club blog next month.
John Authers, Bloomberg Opinion, New York
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of The Fearful Rise of Markets and other books.