by Timothy D. Carkin, CAIA, CMT
Senior Vice President
In 1985, 31-year-old David Swensen took over Yale University’s endowment. The young manager convinced the investment board to adopt a new asset allocation focused on high-returning asset classes and limit low-returning ones, like fixed income. Liquidity was perceived as a cost to the portfolio, not a benefit, which led to significant weightings to private equity and real estate. Over the next few decades Yale’s endowment thrived, growing to $30.3 billion, at which the university contemplated funding incoming student’s tuition in perpetuity. Most major universities, particularly Ivy Leagues, have since adopted similar strategies which are referred to as the “Yale Model” or “Endowment Model.”
The books are now closed on the 2019 fiscal year for Ivy League endowments. For the fifth time in the last 16 years, they lost to a 60/40 portfolio (60 percent S&P 500 + 40 percent Barclays Aggregate). The Ivy League recorded a less-than-elite 6.7 percent return on average, with Brown winning the day with a 12.4-percent return and Columbia’s 3.8 percent bringing up the rear. By comparison, a passive 60/40 portfolio returned almost 10 percent. To add further insult, the endowment model also experienced more volatility than the 60/40 allocation last year.
Source: MPI Analytics
What Makes Ivy Grow?
The ability to have access to capital for personal expenses or paying taxes is important to most investors. A fundamental attribute of the endowment model is a limited provision for liquidity. The following chart portrays the most recent target asset allocation for Yale’s endowment. Notable is the minimal 3-percent allocation to U.S. equities. In place of a larger allocation, leveraged buyout and venture funds fill the void. The same is true for bonds as absolute return (hedge funds) outweigh fixed income by a large margin. These private funds sacrifice liquidity for potential higher returns. Unfortunately, the last few years they have exhibited higher volatility, higher fees and muted returns. As the financial crisis hit full swing in 2009, there were plenty of articles written calling for the death of the “Endowment Model.” Managers simply could not reallocate or sell due to the large weight in private investments. For our clients, we believe a much more moderate allocation to private investments is prudent.
Additionally, international stocks outweigh domestic by five times in Yale’s portfolio. Historically, this has been a bad call, but the allure of growth in foreign markets continues to entice endowment managers. We have watched as many of our peers have significantly increased their international allocations looking for the same potential. At Ferguson Wellman, we haven’t followed suit, which to date has been to our clients’ benefit.
Source: Yale Endowment Fund
Many investors watch the performance of Ivy League endowments because they use a different playbook. We do as well. The investment landscape is always changing and private markets are becoming more accessible. As we review potential new investments, it is important to consider the value of liquidity and its place in our asset allocation.
Week in Review and Our Takeaways
The S&P 500 rallied over half a percent. Continuation of the same headlines: slowing growth, Brexit and impeachment proceedings appear to be overshadowing any conviction investors may have in market fundamentals
Our underweight to international stocks and hedge funds relative to large endowments continues to benefit our clients