Yale and You

It's generally well-known -- and famous among asset allocators -- that Yale University's endowment has crushed the benchmarks in the past 22 years since David Swensen has been running it. Swensen is up 16.1% versus the S&P 500's 12.3% during the period, and he his volatility has been much lower.

First I'll transmit a few nuggets on how they do it (see the report), then I'll quote a terrific article by Geoff Considine on how individual investors might try to imitate.

• Read about how Swensen's team does it, here in the Yale Endowment 2007 report. Its 6/30/07 asset allocations were: 23.3% Absolute Return (vs 19.5% Educational Institution Mean), Domestic Equity 11.0% (vs 26.3% EIM), 4% Fixed Income (vs 12.7% EIM), 14.1% Foreign Equity (vs 22.1% EIM), 18.7% Private Equity (vs 7.0% EIM), 27.1% Real Assets (vs 10.1% EIM), and 1.9% cash (vs 2.3% EIM). A few nuggets from the report: In all its investing, Yale goes to great lengths to seek investments managers whose interests are aligned with their investors. Alpha comes largely from security selection. Intelligent diversification is crucial. Absolute Return: actively managed funds, half event-driven, half value-driven, involving hedges that make these funds essentially no correlation to domestic stock and bond markets. Domestic Equity: underweight because it's a highly efficient market, and hard to find what they're looking for: investment managers "with exceptional bottom-up fundamental research capabilities....with high integrity, sound investment philosophies, strong track records, superior organizations, and sustainable competitive advantages. Fixed Income: underweight because "they have the lowest historical and expected returns of the six asset classes that make up the Endowment." Foreign Equity: similar comment to Domestic Equity. Private Equity: overweight "stemming from the University's strong stable of value-added managers that exploit market inefficiencies (not ones that simply add financial leverage to their acquisitions). Real Assets: (Real estate, oil and gas, timberland) sensitivity to inflationary forces, high and visible cash flow, and opportunity to exploit market inefficiencies owing partly to Yale's long-term partnerships with managers.

Next, from Considine's article, on helping retail investors translate Yale's approach to their own portfolios. [Considine runs Quantext (portfolio management software, highlighted below), and his SeekingAlpha articles can be found here.]

• Swensen discusses what he thinks individual investors should be doing. notably, he does not suggest that retail investors take on non-equity assets like timber that have made Yale's performance so strong. Instead, he proposes a plain vanilla portfolio that did not look all that great to my eye (below)
• 

• ....When I ran this portfolio through our forward-looking portfolio management software, Quantext Portfolio Planner (QPP), the results were essentially what I expected. QPP projects that this portfolio will match the expected return of the S&P 500 on a going forward basis (8.2% per year) , with less risk (the projected standard deviation is 11.8% vs. 15% for the S&P 500). This is okay, but far from spectacular -- and, notably, far below the 1-to-1 ratio between expected return and standard deviation that Mr. Swensen is planning for with the Yale endowment.
• Mr. Swensen is famous for seeking out asset classes with low correlation to broad equity indices, such as a range of commodities, timberland and other real assets. Where are these in the retail portfolio? Mr. Swensen only has 12% of Yale's portfolio in domestic equities but he is proposing that retail investors put 30% of their assets in domestic equities. Whilte it is true that Mr. Swensen has access to private equity and other assets that the average retail investor cannot easily include in his/her portfolio, it is certainly possible to get a lot closer to the Yale model.
• To broadly replicate the kind of performance that Mr. Swensen has engineered for Yale in the retail portfolio, I replaced all the Vanguard funds with ETFs and then added commodities (via DJP), a timber REIT (PCL), a very large electrical utility (EXC) and a large oil company (COP). The idea here is to provide a significant exposure to commodities and real assets. I have also ditched the short-term bond fund. our New model portfolio looks like this:
  
• 

Here I'd note that substituting individual securities for asset classes significantly diminishes diversification, but I'll continue to quote Considine below because ETFs can be easily substituted for the individual companies he has chosen. Considine adds:

• Quantext Portfolio Planner projects that this portfolio has an expected return of 10.1% per year, with a standard deviation of 11.6% per year -- almost exactly what Mr. Swensen says that he has targeted for the Yale portfolio.

He concludes:

• Forward-looking models (like Quantext Portfolio Planner) are the standard of practice in institutional money management, and the technology is gradually making its presence known among retail investors and their advisors (as shown by the Stein-DeMuth book [called Yes, You Can Supercharge Your Portfolio]. What would your portfolio look like in one of these forward-looking models?