Yale CIO calls funds of funds a cancer in WSJ interview

Star investment manager David Swensen doesn’t mince words in a recent WSJ interview. The Yale University endowment chief investment officer keeps a stiff upper lip after a tough year (the fund is down 25%) and mainains his faith in alternative investing. But he says alternative investing works only if you have the resources to research the investments fully and if the managers  share the details of their portfolios.

The WSJ asks whether funds of funds or consultants can help those who don’t have the resources to conduct primary research. His answer is worth quoting in full:

Mr. Swensen: Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can’t make an intelligent decision about picking managers, how can he make an intelligent decision about picking a fund-of-funds manager who will be selecting hedge funds? There’s also more fees on top of existing fees. And the best managers don’t want fund-of-fund money because it is unreliable. You need to be in the top 10% of hedge funds to succeed. In a fund of funds, you will likely be excluded from the best managers. [Mr.] Madoff also relied enormously on these intermediaries. He wouldn’t have had nearly as much resources were it not for fund of funds.

Consultants make money by giving advice to as many people as possible. But you outperform by finding inefficiencies most of the market has not yet uncovered. So consultants ultimately end up doing a disservice to investors.

If l’affaire Madoff hasn’t already raised enough warning flags about funds of funds, let’s hope David Swensen’s caustic observations manage to steer unsophisticated investors away from alternative investing death traps.

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