'Diworsification': the perils of diversifying across asset classes

published 12 October 2006

One of the investment world's great heroes is David Swensen, the man who has managed Yale University's endowment money since 1987. What makes him a hero? The fact that in all the years since he took over he has averaged a return of 16 per cent to 17 per cent a year with not one single down year.

That's something almost nobody else can lay claim to: there are managers knocking about who can say they've made similar average returns but they have usually resulted from performance extremes losing a lot some years but making much more in others.

The secret of Swensen's success is, he says, relatively simple diversification across asset classes. Instead of just investing most of the Yale portfolio in equities and bonds, his strategy (now known as the Yale Model) is to chop the money up into five or six equal parts and invest each in a separate asset class with as little correlation between them as possible. This means putting money into hedge funds, private equity, venture capital and property as well as into the big stock markets.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

It isn't normal for everything to keep going up and we know that a great many markets are beginning to look a bit iffy. Commercial property yields are at rock bottom (in the City they are as low as 4 per cent) yet supply is still being expanded at speed; the residential property market has moved so far beyond any kind of common sense I barely dare comment on it any more; the blow-up at Amaranth a few weeks ago (where the hedge fund managed to lose $6 billion in a month thanks to a bad bet on natural gas) has sounded a warning about the level of borrowing such schemes use; and the private equity and venture capital businesses will suffer as interest rates rise.

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.