When it comes to investing, Yale University has schooled its Ivy League rivals this year. The $25.5 billion endowment, run by chief investment officer David Swensen, led the pack with a 3.4 percent return for the fiscal year ended June 2016. That’s music to the ears of advocates of the so-called Yale model for endowment investing, which is known for large allocations to alternative investments such as private equity and hedge funds. But is Yale’s formula worth copying?
A new analysis by research firm Markov Processes International (MPI) tries to answer the question of whether other endowments have adopted the Yale model. Using a proprietary metric that it calls “common style,” the firm measured the overlap in asset allocation mixes among various portfolios, looking at a pool of 14 university endowments and calculating how closely they aligned with Yale’s investment strategy. The researchers found that Princeton University and the Massachusetts Institute of Technology showed the closest resemblance to Yale — and happened to be the only other endowments in the group to score positive returns.
Princeton and MIT reported returns of 0.8 percent for the fiscal year, and their asset allocation mixes overlapped with Yale’s by 78 percent and 77 percent, respectively. Perhaps it’s no coincidence that both endowments have David Swensen protégés at the helm. Andrew Golden, president of Princeton University Investment Co., trained under Swensen as an intern and worked as a portfolio manager from 1988 to 1993. Seth Alexander spent ten years at Yale’s endowment before taking over Massachusetts Institute of Technology Investment Management Co. in 2006. MIT’s and Princeton’s endowment strategies were an 82 percent match, according to MPI’s calculations.
Bringing up the rear were Duke University, Cornell University, and an average of the University of California endowments, with losses of 2.6 percent, 3.3 percent and 3.4 percent, respectively. The three employed asset allocation strategies that were among the least correlated to Yale’s of all the schools in the sample: Duke shared 50 percent of its asset allocation with Yale, compared with 40 percent for Cornell and 35 percent for the California schools.
“Only a few specific factor exposures were responsible for most of the gains this year,” Markov’s researchers wrote, citing private equity, real estate, and U.S. stocks and bonds. “More exposures drove losses.”
The data shows that endowments have not curbed their appetite for alternative investments since the financial crisis, despite the decision of some of their peers in the public pension community to flee from those assets in response to public pressure over the high fees charged by managers that produced years of less than stellar returns. The California Public Employees’ Retirement System turned heads in 2014 with a declaration that it planned to dump hedge funds from its portfolio, inspiring a number of other pensions to follow suit. In April the $51.2 billion New York City Employees’ Retirement system voted to cash out of hedge funds altogether, and the New Jersey State Investment Council in August revealed it would pare its $71.9 billion hedge fund portfolio from 12.5 percent to 6 percent.
Even the little guys are now saying bye-bye to hedge funds. The $7.6 billion Rhode Island State Investment Commission announced in September that it would slash its hedge fund portfolio by half, and the $14.9 billion Kentucky Retirement Systems decided in October to give hedge fund managers the ax.
Although Yale and Princeton had smaller weightings to hedge funds than their peers — in favor of private equity, venture capital, and real estate vehicles — Markov’s president Jeff Schwartz tells Institutional Investor that “amongst the large endowments that have access to these elite investment opportunities, their belief in alternatives has not been shaken by the backlash over fees and performance.”
Even though Yale takes top honors this year, Schwartz warns not to jump to conclusions. The merits of the Yale model have been the subject of a perennial debate that is sure to continue. “I don’t think one year is long enough to vindicate any investment strategy — not Yale’s or anybody else’s,” he says.