Unconventional Success Quotes

“In fact, wealth-maximizing individuals compare the after-tax costs of debt with the after-tax returns from bonds, liquidating bond positions to pay off loans when the costs of debt exceed the returns from bonds. Rational investors consider liability positions when making asset allocations.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Supremely rational investors take the further step of acting against consensus, rebalancing to long-term portfolio targets by buying the out-of-favor and selling the in-vogue.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“When you look at the results on an after-fee, after-tax basis, over reasonably long periods of time, there's almost no chance that you end up beating the index fund.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Jeffrey and Arnott calculate the tax burden imposed by portfolio turnover. Using a 35 percent capital gains tax rate and a 6 percent pre-tax growth rate (roughly equivalent to the long-term capital appreciation of U.S. equities), the authors conclude that even modest levels of turnover create material costs. For example, as shown in Table 8.14, a turnover rate of 10 percent leads to a tax bill that reduces returns by more than a full percentage point, a steep price to pay relative to the 6 percent pre-tax rate of appreciation.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“In spite of strong similarities in the characteristics of the constituents of the S&P SmallCap and the Russell 2000, performance differs greatly. For the ten years ending December 31, 2003, the S&P SmallCap outdistanced the Russell 2000 by a margin of 11.6 percent to 9.5 percent. The surprisingly large performance differential results in large part from the games played by arbitrageurs during the reconstitution process. The arbitrage profits directly diminish the performance of the Russell benchmark, offering a free ride to managers evaluated against the Russell 2000.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Passive investors who select Russell style-based indices lose a substantial share of the transactions-cost benefits of index-fund investing.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Factors that drive turnover for the S&P 500 and Wilshire 5000 stem from market-related events. When a company exits the S&P 500 through merger, acquisition, or bankruptcy, a committee-chosen replacement takes the departing company’s place. The Wilshire 5000 passively accepts the ebb and flow of company creation and elimination, making as-frequent-as-necessary adjustments to the composition of the index. Bankrupt companies disappear, cash merger deals require redeployment of proceeds, and stock-for-stock transactions lead to elimination of the line item of the acquired company. Public offerings of securities force full-replication Wilshire 5000 index-fund managers to raise cash to acquire newly issued shares, while spinoffs simply require adding another line to the list of security holdings. In somewhat different fashion, both the S&P 500 and the Wilshire 5000 produce extremely low, investor-friendly levels of portfolio turnover.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Principal Management Corporation, the manager of the LargeCap Value Fund, actually provides no investment management services, focusing instead on “clerical, recordkeeping and bookkeeping services.” Responsibility for the day-in and day-out portfolio management rests with a subsidiary of Alliance Capital Management, Bernstein Investment Research and Management.17 The fee arrangement between Principal and Bernstein involves only a portion of Principal’s take from its investors. For the year ended December 31, 2003, Principal’s no-load Class B shares bore the burden of a 2.51 percent expense ratio, as detailed in Table 8.7. Investors paid a 12b-1 fee of 0.91 percent, other expenses of 0.85 percent and a management fee of 0.75 percent. Principal’s fees all but guarantee that investors will fail to generate satisfactory returns. The management fee arrangement between Principal and Bernstein provides clues to the economies of scale available in the money management industry. At asset levels below $10 million, of the 0.75 percent management fee, 0.60 percent goes to Bernstein and 0.15 percent goes to Principal. As assets under management increase, Bernstein’s fee share decreases and Principal’s fee share increases. At the final break point of $200 million in assets, of the scale-invariant 0.75 percent fee, Bernstein receives 0.20 percent and Principal receives 0.55 percent. The fee structure clearly illustrates scale economies in the investment management business. Bernstein, the party responsible for the heart of the portfolio management process, earns fees that diminish (with increases in assets under management) from 0.60 percent of assets to 0.20 percent of assets. Since Bernstein’s work changes not at all as asset levels increase, the reduction in marginal charges makes sense. It makes no sense that Principal’s mutual-fund clients accrue no benefits from economies of scale. Total expenses incurred by investors remain at 2.51 percent regardless of portfolio size. As Bernstein’s management fee declines, Principal’s management fee increases. For assets above $200 million Principal adds a management fee of 0.55 percent to other fees of 1.76 percent, bringing the egregious total to 2.31 percent for Principal and 0.20 percent for Bernstein. In this topsy-turvy world, Principal earns a marginal management fee of 0.55 percent for performing back-office functions, while Bernstein earns a marginal management fee of 0.20 percent for making security-selection decisions. As scale increases, Bernstein earns less while Principal takes more.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“The use of a fair benchmark assumes heightened importance when incentive fee arrangements fail to incorporate investor-friendly characteristics such as clawbacks and high-water marks. A clawback forces managers to disgorge past incentive fees when subsequent performance falls short of the benchmark. (In vivid imagery, taloned investors claw back previously paid fees.) In the absence of a clawback, investors face the ugly prospect of paying fees for performance that came and went. A high-water mark requires managers to fill performance deficits produced after having received incentive fees, prior to earning more incentive fees. In the absence of a high-water mark, investors face the unattractive possibility of paying fees on past gains without getting an offset for subsequent losses. Granum Value Fund investors benefit neither from a clawback nor from a high-water mark.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Certain performance-based fee schemes work to align the interests of fund managers and fund shareholders, encouraging fund managers to profit from performance excellence instead of asset gathering. Most incentive fee structures involve the combination of an asset-based fee and a performance-based fee. The asset-based fee covers reasonable overhead involved in running investment management operations. The performance-based fee rewards superior returns, defined by the amount by which the returns exceed an appropriate benchmark. For example, a large-capitalization equity fund manager might receive ten percent of the fund’s gains in excess of the return on the S&P 500. In such a dual fee structure, the asset-based fee covers costs and provides a fair income, while the incentive fee rewards managers for producing superior investment returns.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“To the extent that size impedes performance, increases in assets lead to lower returns for fund shareholders.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“In an extraordinarily offensive maneuver, a number of mutual-fund companies continued to charge 12b-1 fees even after the management company closed funds to new investors.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Larger portfolios impede investment advisor efforts to manage assets actively”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“In 1980, the Securities and Exchange Commission caused considerable damage to mutual-fund shareholder interests by permitting mutual funds to pay for marketing and distribution expenses directly from fund assets.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Within the realm of active equity management, investors inhabit a perverse world where higher fees correspond to lower returns. In the broader universe that includes active and passive management, index funds exhibit a dramatic cost advantage over their actively managed counterparts. Well-informed investors recognize that fund fees matter.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“The dollar-weighted and equal-weighted Lipper data indicate that in recent years, investors drank one of two poisons: the burden of higher fees or the drag of larger portfolios.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“While astute mutual-fund investors avoid loads, all holders of mutual funds pay management fees.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“On initial investment, investors frequently pay a load, or sales charge, to acquire shares. Loads range up to 8.5 percent, sometimes varying with the size of investment and length of holding period. Funds without sales charges carry the no-load designation.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Aside from the unusual circumstances in which agents exhibit principal-like behavior, investors face the challenge of dealing with an adversarial agent who profits at the investor’s expense.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Sensible taxable investors reach an obvious conclusion: invest in low-turnover, passively managed index funds.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Well-constructed academic studies confirm the theoretical premise. Robert Arnott’s 2000 examination of U.S. equity mutual-fund returns shows a twenty-year pre-tax deficit of 2.1 percent per year relative to the result achieved by investors in Vanguard’s 500 Index Fund. Nearly 80 percent of actively managed funds failed to reach Vanguard’s market-mimicking return.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Finance theory teaches that active management of marketable securities constitutes a negative-sum game, as the aggregate of active security-selection efforts must fall short of the passive alternative by the amount of the fees, commissions, and market impact that it costs to play the game.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Evidence suggests that individuals face a high likelihood of disappointing retirement incomes, based on low savings rates, poor investment choices, and inferior portfolio execution.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“The management of taxable mutual-fund assets without considering the tax consequences of trading activity represents a highly visible, yet little considered scandal. A serious fiduciary with responsibility for taxable assets recognizes that only extraordinary circumstances justify deviation from a simple strategy of selling losers and holding winners.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“In spite of its limitations as a tax-efficient investing vehicle, on an after-tax basis over the two decades of the Arnott study, the Vanguard 500 Index Fund bests the average mutual fund by 2.8 percent per year. Only 14 percent of funds, as shown in Table 7.6, post superior after-tax results, winning by an average margin of only 1.3 percent per year. Losers, much larger in number than winners, lose by a greater margin, posting a 3.2 percent per annum after-tax deficit.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Fifteen-year results show a scant 5 percent probability of picking a winner, making active manager selection akin to backing a long shot at the race track. In a cruel twist of fate, for those skilled (or lucky) enough to identify a mutual-fund winner, the gain proves far more mediocre than the race track’s long-shot payoff, as the average winnings amount to a scant 1.1 percent per year. Fully 95 percent of active investors lose to the passive alternative, dropping 3.8 percent per annum to the Vanguard 500 Index Fund results.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Equity mutual-fund returns in recent decades provide a textbook example of the negative-sum game of active management. Recall that active managers as a group must underperform the market by a margin equal to the cost of trading (market impact and commissions) and the burden of fees. The theoretical possibility exists that mutual funds as a group might exhibit superior performance, with other market players producing shortfalls sufficient to counterbalance the superior mutual-fund results. Unfortunately for the mutual-fund investor, U.S. equity markets contain insufficient numbers of mullets for fund managers to exploit for active management gains. In fact, mutual-fund managers and other sophisticated market participants control such a large portion of the aggregate market capitalization that they dominate the trading of securities and the price-setting mechanism. Because well-informed institutions define the market, would-be market-beating investors as a group face the unwelcome prospect of losing to the market by the amount that it costs to play the active management game.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“Chapter 8, Obvious Sources of Mutual-Fund Failure, concludes that, in the highly efficient securities markets, mutual-fund managers lose by the amount that it costs to play the game.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“The aggregate of the compensation paid to mutual-fund managers virtually guarantees that investors fail to achieve market-beating results.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment

“The mutual-fund industry consistently fails to meet the basic active management goal of providing market-beating returns. A well-constructed academic study conservatively puts the pre-tax failure rate at 78 percent to 95 percent for periods ranging from ten to twenty years. The same study places the after-tax failure rate at 86 percent to 96 percent.1 The omission of the impact of vanished firms, also known as survivorship bias, colors the results with another shade of pessimism. Sales charges imposed by Wall Street further reduce the chances of success. Churning of mutual-fund holdings by investors adds an additional odds-lengthening factor to the equation. At the end of the day, as described in Chapter 7, The Performance Deficit of Mutual Funds, investors cannot win the active management game.”
― David F. Swensen, Unconventional Success: A Fundamental Approach to Personal Investment