The Investment Scientist

Yale Endowment asset classes

Posted on: February 6, 2009

Once upon a time, the Yale University Endowment invested like the rest of us, in just two asset classes: US equity and fixed income. After taking over the reins in 1987, David Swensen, the chief investment officer of Yale Endowment, moved aggressively into non-traditional and often illiquid asset classes like foreign equity, absolute return, real assets and private equity.

Chart: The Yale Model asset allocation
[enable picture display to see this chart]
Picture credit: thedividendguyblog.com

His unconventional approach produced a 20-year unbroken record of positive returns, resulting in stellar growth of the endowment from $1b to $17b. No wonder rival school Harvard University studies him closely. Other institutional money managers trip over themselves trying to mimic him.

Yale’s six asset classes are defined by their different expected response to economic conditions, such as inflation, growth and interest rate. Here is my own simplified explanation and cautionary note about these asset classes in relation to us as individual investors.

Absolute Return is a class of investment that seeks to generate long-term returns not correlated with the market.It does this by exploiting market inefficiencies. There are two basic strategies: event-driven and value driven. Event driven strategies rely on specific corporate events such as mergers, spin-offs or bankruptcy restructuring. Value driven strategies rely on buying under-valued assets while at the same time short-selling over-value assets. Don’t try this at home! You might just be the inefficiency being exploited.

Private Equity is a class of investment that participates in leverage-buyout (“LBO”) and venture capital. Venture capital is money that funded Google. However, it also funded thousands of failed ventures. LBO partnerships engage in the exercise of buying badly run businesses, reforming them, and then reselling them for a profit. Good private equity funds are generally close to individual investors. However, many below-average funds (often with exorbitant fees) are being aggressively marketed by Merrill Lynch and the like to unsuspecting high-net-worth individuals.

Real Assets include real estate and commodities. They are tangible (as opposed to paper assets) and they’re a good hedge to inflationary forces. This asset class is accessible to individual investors through Exchange Traded Funds (ETFs) and physical property such as the houses they live in.

Fixed Income is an asset class that produces a stable flow of income. It provides greater certainty than other asset classes. Fixed-income investments will perform badly in an inflationary environment, with the exception of treasury inflation protected bonds or TIPS. This asset class is readily accessible to individual investors.

Foreign Equity includes both matured market equity and emerging market equity. With US economy becoming an ever smaller slice of the global pie. This asset class provides a great way to participate in foreign growth. However, their diversification benefit is over-rated. With the exception of China, foreign stock markets highly correlate with the US market. Foreign equity is very accessible to individual investors.

Domestic Equity needs no additional explanation.

By all mean let David Swensen enlighten you, but don’t fall all over yourself trying to mimic him. What is good for Yale is not necessarily good for you. This is an advice coming from none other than Swensen himself.

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9 Responses to "Yale Endowment asset classes"

Hi,

Great post. Also, thank you for constantly delivering great content . I enjoy linking to your blog in my nightly investment links. Have a great weekend & take care.

Best Regards,

Miguel Barbosa
Founder of SimoleonSense.com

I am searching all theories and cases about asset allocation.
Iam a owner of financial advisor ofiice in Brasil.
Thank you for the material.
Claudia Kodja PHD

Claudia,

It’s my pleasure. Feel free to contact me if you have any questions: mzhuang@mzcap.com.

I have heard Yale & Harvard own oil and gas royalties in their endowments, can you verify ?

James,

I will see if I can.

Michael

We are trying to use the Yale Endowment data in a white paper we are writing. You state that the Yale Endowment grewt from $1b to $17b. Do you know how much of that was due to donor contributions and how much can be atrributed to investment performance?

Andy,

I don’t have the number, but if you go read their annual reports, you maybe able to find out.

http://www.yale.edu/investments/

[…] domestic equity, primarily in large-cap growth stocks, and 40% to fixed income assets. In contrast, the endowments allocate to six non-cash asset classes that have low correlation with each other. In particular, domestic equity and fixed income make up […]

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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