David F. Swenson, the chief investment officer of Yale University’s endowment, says most endowments are on a fruitless search for market-beating returns and should abandon active management in favor of passive investments like index funds.

In an interview with Pro Publica, a nonprofit journalism site, Mr. Swenson says he is sticking with the diverse collection of actively managed equity-like investments that earned Yale such strong returns during the decade that ended last June. Yale earned 16.3 percent per year over that period, trouncing the returns provided by U.S. stocks by roughly 13 percentage points and raising the value of its endowment to $23-billion.

But since then, Mr. Swenson says, Yale’s endowment has dropped by roughly 25 percent.

The Yale model, spelled out in Mr. Swenson’s 2000 book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, focuses on holding a diverse group of equity-like investments. Yale has investments in private equity funds, real estate, hedge funds, timber, and U.S. and international stocks, but very little in high-quality bonds, like Treasury bills.

Mr. Swenson, who has been at Yale since 1985, says that during times of crisis, investors are sometimes willing to sell any risky asset to get into risk-free assets like Treasury bills. During such periods, the expected benefits of diversification across equity categories temporarily disappear.

“It would be nice if we could always have the benefit of diversification, but life doesn’t work that way,” Mr. Swenson tells Seth Hettena of Pro Publica.

Mr. Swenson thinks his strategy will work again when the credit crisis recedes, but he sees no sign of that happening soon. In the meantime, Yale’s managers are scouring the distressed-debt market for bargains. “The dysfunction in the credit markets is creating some extraordinary opportunities right now,” he says.

Yet he doesn’t think the vast majority of institutional investors should bother trying to exploit those opportunities. He argues that only a handful of institutions — he names Harvard, Princeton, and Stanford Universities, as well as Yale — have in-house investment professionals with the skill to outperform the broad indices over the long term. “There’s a vanishingly small number of such investors,” he says.

Mr. Swenson says that many endowments rely on consultants to structure their portfolios because it seems like “an easier, cheaper alternative” than hiring two or three high-quality investment professionals, but he believes that consultant-designed portfolios will ultimately produce mediocre returns and high fees. Those endowments, he argues, would be better off trying to mimic the equity and bond markets rather than beat them.

“Those on the passive end of the spectrum have figured out that they don’t know enough to be active,” Mr. Swenson says. “The passive group is not nearly as big as it should be. Almost everybody should be there.”

What do you think? Are the vast majority of endowments wasting their time trying to structure market-beating portfolios?