Yale's fund outperforms as it has better access to different assets.
A few years ago, David Swensen, the portfolio manager of Yale University's giant endowment fund, graduated from obscure Ivy League institutional investor to guru for the common people.
His book Unconventional Success, which was published in 2005, quickly became an investing bestseller.
A guide for 'the little man'
Swensen had grown Yale's endowment fund 18-fold in the 20 years since 1985. The average annual return was 16% -- way ahead of the S&P 500 and achieved with lower volatility.
Unconventional Success was Swensen's guide for 'the little man' on how best to build up a pot for retirement.
Swensen recommended a 'well-diversified, equity-oriented portfolio,' with the following asset allocations:
- US equity (30%);
- foreign developed markets equity (15%);
- emerging markets equity (5%);
- real estate (20%);
- US treasury bonds (15%); and
- US treasury inflation-protected securities (15%).
Swensen laid into the actively managed fund industry with a vengeance and urged individual investors to use index trackers to construct their portfolios.
Today, you'll find countless 'Swensen model portfolios' on the web (including adaptions for UK investors), with suggestions for appropriate tracker funds.
Let's have a look at the performance of a US model portfolio in the five years since the publication of Swensen's book, and compare it to the Yale Endowment Fund.
The figures in the table below are discrete annual returns coinciding with the endowment fund's fiscal year, which ends on 30 June.
|VTSMX domestic equity (30%)||+6||+8||+18||-14||-28|
|VDMIX developed equity (15%)||+11||+24||+24||-13||-34|
|VEIEX emerging equity (5%)||+33||+31||+41||+2||-32|
|VGSIX real estate (20%)||+25||+13||+7||-18||-47|
|VUSTX treasury bonds (15%)||+9||-12||0||+7||-1|
|VIPSX inflation protected (15%)||+3||-7||-1||+10||-4|
|Yale endowment fund||+22||+23||+28||+5||-25|
As you can see, the Yale Endowment Fund has out-performed the little man's tracker portfolio.
Why Yale wins
Looking at the endowment fund's asset allocation, it's not hard to see where its out-performance comes from.
According to its annual report (pdf file) for the year ended 30 June 2009, the fund had less than 20% in domestic and foreign equities, and less than 5% in fixed income.
Around a quarter of the fund was allocated to 'Absolute Return', another quarter to 'Private Equity', whilst the largest allocation, nearly a third of the portfolio, was to 'Real Assets'.
- Absolute Return: Yale became the first institutional investor to pursue absolute return strategies as a distinct asset class in 1990. Since then, it has achieved an average 11.4% annual return.
- Private Equity: Yale's private equity investments include participations in venture capital and leveraged buyout partnerships. Since inception these investments have generated a 30.4% annualised return.
- Real Assets: Yale invests directly in such things as real estate, oil and gas, and timberland (over three million acres, roughly equivalent to the size of Connecticut). Real assets have delivered an average 14.3% annual return since inception.
Why the little man lags
Relatively illiquid and less efficient markets are well-suited to Yale's long-term, multi-generational horizon. Furthermore, it has the considerable funds required to invest in these markets.
In contrast, small private investors simply don't have the wherewithal to invest directly in private equity and real assets.
Indirect participation is possible, of course, through intermediary investment vehicles that tap into these markets. But only a fraction of the real return trickles down to the little man on the bottom floor.
To be fair to Swensen, he never claimed that the performance of his individual-investor portfolio would mirror that of the Yale Endowment Fund. Rather, it's the proliferation of 'Swensen model portfolios' by others, accompanied by casual mention of his Yale-fund record, which may have led some investors to over-estimate the level of return they might expect.
The latest from Swensen
In an interview in the March/April 2009 edition of the Yale Alumni Magazine, Swensen revised his asset allocation recommendation for individual investors, due to 'economic conditions'. He advised lowering real estate investment trust exposure from 20% to 15% and raising emerging markets equity exposure from 5% to 10%.
Of course, the bumper returns from direct investment in private equity and real assets remain something most small investors can only dream of.
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