The achievements of the Yale Endowment are significant and well documented.
Their achievements can largely be attributed to the successful and bold management of their Endowment Funds.
They have been pioneers in Investment Management. Many US Universities and global institutions have followed suit or implemented a variation of the Yale’s “Endowment Model”.
Without a shadow of a doubt, those involved with Endowments, Foundations, Charities, and saving for retirement can learn some valuable investment lessons by reviewing the investment approach undertaken by Yale.
I think these learnings are particularly relevant given where we are currently in the economic cycle and the outlook for returns from the traditional asset classes of cash, fixed income, and selected equity markets.
A growing Endowment
In fiscal 2019 the Yale Endowment provided $1.4 billion, or 32%, of the University’s $4.2 billion operating income.
To put this into context, the Yale Endowment 2019 Annual Report notes that the other major sources of revenues for the University were medical services of $1.1 billion (26%); grants and contracts of $824 million (20%); net tuition, room and board of $392 million (9%); gifts of $162 million (4%); and other income and transfers of $368 million (9%).
Spending from the Endowment has grown during the last decade from $1.2 billion to $1.4 billion, an annual growth rate of 1.5%.
The Endowment Fund’s payments have gone far and wide, including scholarships, Professorships, maintenance, and books.
Yale’s spending and investment policies provide substantial levels of cash flow to the operating budget for current scholars, while preserving Endowment purchasing power for future generations.
What a wonderful contribution to society, just think of the social good the Yale Endowment has delivered.
Yale’s Investment Policy
As highlighted in their 2019 Annual Report:
- Over the past ten years the Endowment grew from $16.3 billion to $30.3 billion;
- The Fund has generated annual returns of 11.1% during the ten-year period; and
- The Endowment’s performance exceeded its benchmark and outpaced institutional fund indices.
In relation to Investment Objectives the Endowment Funds seek to provide resources for current operations and preserving purchasing power (generating returns greater than the rate of inflation).
This dictates the Endowment has a bias toward equity like investments. Yale note:
“The University’s vulnerability to inflation further directs the Endowment away from fixed income and toward equity instruments. Hence, more than 90% of the Endowment is targeted for investment in assets expected to produce equity-like returns, through holdings of domestic and international equities, absolute return strategies, real estate, natural resources, leveraged buyouts and venture capital.”
Accordingly, Yale seeks to allocate over the longer term approximately one-half of the portfolio to illiquid asset classes of leverage buyouts, venture capital, real estate, and natural resources.
This is very evident in the Table below, which presents Yale’s asset allocation as at 30 June 2019 and the US Educational Institutional Mean allocation.
This Table appeared in the 2019 Yale Annual Report, I added the last column Yale vs the Educational Institutional Mean.
|Yale University||Educational Institution Mean||Yale vs Mean|
|Cash and Fixed Income||8.4%||11.9%||-3.5%|
The Annual Report provides a comment on each asset class and their expected risk and return profile, an overview of how Yale manage the asset classes, historical performance, and future longer-term risk and return outlook.
High Allocation to Non-Traditional Assets
As can be seen in the Table above Yale has a very low allocation to traditional asset classes (domestic equities, foreign equities, cash and fixed income), and a very high allocation to non-traditional assets classes, absolute returns, leverage buyouts, venture capital, real estate, and natural resources.
This is true not only in an absolute sense, but also relative to other US Educational Institutions. Who in their own right have a high allocation to non-traditional asset classes, 45.4%, but almost 30% lower than Yale.
“Over the last 30 years Yale has reduced their dependence on domestic markable securities by relocating assets to non-traditional assets classes. In 1989 65% of investments were in US equities and fixed income, this compares to 9.8% today.”
By way of comparison, NZ Kiwi Saver Funds on average have less than 5% of their assets invested in non-traditional asset classes.
A cursory view of NZ university’s endowments also highlights a very low allocations to non-traditional asset classes.
There can be good reasons why other investment portfolios may not have such high allocations to non-traditional asset classes, including liquidity requirements (which are less of an issue for an Endowment, Charity, or Foundation) and investment objectives.
Rationale for High Allocation to Non-Traditional Assets
Although it is well known that Yale has high allocations to non-traditional assets, the rationale for this approach is less well known.
The 2019 Yale Annual Report provides insights as to the rationale of the investment approach.
Three specific comments capture Yale’s rationale:
“The higher allocation to non-traditional asset classes stems from their return potential and diversifying power”
Yale is active in the management of their portfolios and they allocate to those asset classes they believe offer the best long-term value. Yale determine the mix to asset class based on their expected return outcomes and diversification benefits to the Endowment Funds.
“Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management.”
Yale invest in asset classes they see offering greater opportunities to add value. For example, they see greater opportunity to add value in the alternative asset classes rather than in Cash and Fixed Income.
“The Endowment’s long time horizon is well suited to exploit illiquid and the less efficient markets such as real estate, natural resources, leveraged buyouts, and venture capital.”
This is often cited as the reason for their higher allocation to non-traditional assets. As an endowment, with a longer-term investment horizon, they can undertake greater allocations to less liquid asset classes.
Sovereign wealth Funds, such as the New Zealand Super Fund, often highlight the benefit of their endowment characteristics and how this is critical in shaping their investment policy.
Given their longer-term nature Endowments are able to invest in less liquid investment opportunities. They will likely benefit from these allocations over the longer-term.
Nevertheless, other investment funds, such as the Australian Superannuation Funds, have material allocations to less liquid asset classes.
Therefore, an endowment is not a necessary condition to invest in non-traditional and less liquid asset classes, the acknowledgement of the return potential and diversification benefits are sufficient reasons to allocate to alternatives and less liquid asset classes.
In relation to the return outlook, the Yale 2019 Annual report commented the “Today’s actual and target portfolios have significantly higher expected returns than the 1989 portfolio with similar volatility.”
Smaller Endowments and Foundations are following Yale
In the US smaller Endowments and Foundations are adopting the investment strategies of the Yale Endowment model.
They have adopted an investment strategy that is more align with an endowment more than twice their size.
Portfolio size should not be an impediment to investing in more advanced and diversified investment strategies.
There is the opportunity to capture the key benefits of the Endowment model, including less risk being taken, by implementing a more diversified investment strategy. Thus, delivering a more stable return profile.
This is attractive to donors.
The adoption of a more diversified portfolio not only makes sense on a longer-term basis, but also given where we are in the economic and market cycle.
The value is in implementation and sourcing appropriate investment strategies.
In this Post, I outline how The Orange County Community Foundation (OCCF) runs its $400m investments portfolio like a multi-billion-dollar Endowment.
Diversification and Its Long-Term Benefits
For those interested, the annual report has an in-depth section on portfolio diversification.
This section makes the following key following points while discussing the benefits of diversification in a historical context:
- “Portfolio diversification can be painful in the midst of a bull market. When investing in a single asset class produces great returns, market observers wonder about the benefits of creating a well-structured portfolio.”
- “The fact that diversification among a variety of equity-oriented alternative investments sometimes fails to protect portfolios in the short run does not negate the value of diversification in the long run.”
- “The University’s discipline of sticking with a diversified portfolio has contributed to the Endowment’s market leading long-term record. For the thirty years ending June 30, 2019, Yale’s portfolio generated an annualized return of 12.6% with a standard deviation of 6.8%. Over the same period, the undiversified institutional standard of 60% stocks and 40% bonds produced an annualized return of 8.7% with a standard deviation of 9.0%. “
- “Yale’s diversified portfolio produced significantly higher returns with lower risk.”
There are also sections on Spending Policy and Investment Performance.
Lastly, I have previously discussed the “Endowment Model” in relation to the fee debate, for those interested please see this Post: Investment Fees and Investing like an Endowment – Part 2
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