The October 3, 2005 issue of Fortune magazine carries a “wall street: special report” called “The Money Game” by Marcia Vickers. This details the investment strategies of David F. Swensen and Jack R. Meyer, who managed the endowments of Yale and Harvard, respectively. While most mutual funds that pick stocks underperform indices, both schools have consistently earned a much better return than the stock indices. How did they do it? Below are their allocations.
Note that Harvard’s total is 105 percent because of leverage, i.e., situations in which they’ve borrowed money to purchase investments. Conspicuously absent from these portfolios are heavy investments in American companies run by Harvard and Yale graduates. “Domestic Equity” are publicly traded stocks such as GE and Microsoft. Harvard and Yale have faith that their graduates will make a lot of money for themselves, but no faith that they will make money for their shareholders.
| Harvard | Yale | |
|---|---|---|
| Domestic Equity | 15% | 14% |
| Foreign Equity | 15% | 14% |
| Private Equity | 13% | 17% |
| Fixed Income (bonds) | 27% | 5% |
| Real Assets | 23% | 25% |
| Absolute Return (hedge funds) | 12% | 25% |
I guess I don’t follow the logic here. Both schools invest identical percentages in domestic and foreign equities. There is no data here to suggest that either school’s managers look at U.S. companies as more risky than foreign companies.
Jim: A traditional portfolio for an American investor with a long-term investment goal would be 80% domestic equities. Harvard and Yale have around 15%. That is a tremendous vote of “no-confidence” in U.S. public companies.
Ben Stein just wrote in NYT about this very subject. He wonders whether or not his donations to Yale make a difference anymore given the high returns they earn on the money they already have.
http://www.nytimes.com/2005/10/23/business/yourmoney/23every.html?ex=1287720000&en=711d580317f18bcc&ei=5090&partner=rssuserland&emc=rss
Maybe they could lower their tuition a bit? It seems they can afford it.
Looks more like a vote of “no-confidence” in the valuation of US public companies by the stockmarket, rather than the way they are run. Obviously long-term, they see the market as performing poorly.
Philip, I think 80% in equities would be considered by many investment advisers to be extremely high for someone investing for long term preservation of capital. Its not like these colleges are going to retire in 30 years. Their time horizon is more like centuries.
And of course the fact that both institutions allocate identical percentages in both domestic and foreign equities shows they have no anti-domestic bias in selecting investments.
Like most long term investors they both have a lot in bonds. It would be interesting to know the constituents of their bond portfolios. I bet there are a lot of U.S. Goverment and private sector bonds in those portfolios.
The way these funds make greater than average returns is by diversifying across asset classes, which gets them a lower risk without reducing their return. Then they raise the risk back to a “normal” level of risk by leveraging, i.e., borrowing on margin or using options, which increases the risk back but provides a higher rate of return. It’s a fairly common portfolio strategy.
Anyway, Harvard and Yale are already overexposed to the success of their graduates in the alum giving arena.
Jim: You would have made a great endowment manager in the 1950s, when bonds were indeed the rage! And I’m not sure why you say “they both have a lot in bonds”; Yale has only 5% of its endowment in bonds, according to Fortune (look at the table again). The longer-term the investment horizon, professional money managers put MORE into equities and less into bonds. http://flagship2.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0306&FundIntExt=INT shows the Vanguard fund for people who expect to retire in 2045. It is 88 percent equities, 12 percent stocks. By contrast, http://flagship2.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0304&FundIntExt=INT shows that the fund for folks who are going to retire in 2025 (shorter horizon), holds 42 percent bonds and the rest in stocks. Bonds are less volatile than stocks but don’t provide protection against inflation.
Vanguard’s managers have more faith in domestic equities than Harvard and Yale. The fund for 2045 retirees holds about a 4:1 ratio of domestic:foreign stocks, rather than the 1:1 ratio of Harvard and Yale.
Given that Harvard and Yale incur their expenses in the domestic economy (salaries, construction and maintenance of buildings), it is a strong statement about their beliefs when they hold just as many foreign equities as domestic.
Yale’s CIO Swensen explains his approach in his book “Unconventional Success”. It’s about asset diversification. That’s why he doesn’t have “heavy investments in American companies”. He doesn’t have “heavy investments” in anything.
Yes, he advises avoiding altogether certain rip-off markets and investment vehicles. He cites actively managed mutual funds, through which most individual investors get into the US public equity market, as particularly silly but that’s not a comment on US public equities.
I agree: US public companies are too often piggy banks for officers and bankers. Are things better at foreign public companies? Salaries and equity awards might generally be more reasonable in foreign public companies but corruption is generally worse. Nevertheless, add up the first two lines of your table and see that public equities are still where Harvard and Yale make big bets.
There’s enough evidence that US public equity markets are seriously flawed without having to divine it in Harvard’s and Yale’s investment strategies.
I don’t think foreign public corporations are any better. Their management is adopting the “american model”. The CEOs of German companies used to get much less than their american counterparts. Not anymore…
The Motley Fool radio show on NPR featured Swenson recently. I think it was a podcast. I thought it was interesting. Also, about companies started by graduates — this is a dilemma for some investors or donors or whatever you want to call them. The question is whether to give money to a private venture firm or incubator, or to a university to invest in startups. But this kind of investor is really more of a donor, a “patron” of technology and/or business innovation, and not as concerned with returns as whether their money will be put to good use. One of my clients, basically an incubator, is “competing” for money that would otherwise go to universities.
Philip, I don’t believe that the investment allocations are a commentary on the people running American companies. They simply reflect the reality that the international market is increasingly important to the world economy. The United States has seen its share of the global equity market decline from 68% in 1970 to 46% in 2004. Therefore, if you wanted to construct a total world stock market index portfolio today, you could devote 46% of your portfolio to the Vanguard Total Stock Market Index Fund and 54% to the Vanguard Total International Stock Index Fund. For more fine grained control, in lieu of the Total International Stock Index, you could split the international part of the portfolio between the Vanguard Developed Market Index Fund and Emerging Markets Index Fund; in his book “Global Bargain Hunting”, Burton Malkiel wrote, “Over an eleven year period ending in 1995, the mix that provided the highest return available with the least risk was 61% U.S stocks, 26% developed country stocks, and 13% emerging market stocks.” Viewed in the light of U.S companies currently holding less than half of the total world stock market value, one might even make the argument that the Harvard and Yale managers are overweighting US stocks in their portfolios.
Swensen has written one book for institutional investors and a more recent one for individual investors. What interests me is how different his recommended portfolios are for institutional and individual investors. In his book for individual investors, “Unconventional Success”, Swensen suggests the following reference portfolio for investors to consider (and to tweak to suit their individual circumstances):
U.S. Stocks 30%
International Developed Markets Stocks 15%
International Emerging Markets Stocks 5%
U.S. Government Bonds 15%
Inflation-Indexed Bonds (TIPS) 15%
Real Estate 20%
Compare this portfolio to the Yale endowment portfolio you showed in your post (close to 2/3 of the investments in the form of private equity, hedge funds, and real assets are not recommended for your average small fry investor; well, maybe you could mimic the returns of the real assets class somewhat by buying REITs or energy funds but Swensen’s real assets also include things like direct investment in timber properties.
Overall, I thought Swensen’s book had many valuable insights for individual investors. An individual can mimic his reference portfolio on the cheap by buying Vanguard index funds for the six core asset categories:
Total Stock Market Index Fund (5-Year return: -0.59%)
Developed Market Index Fund (5-Year return: 2.92%)
Emerging Markets Index Fun (5-Year return: 14.27%)
Intermediate-Term Treasuries (5-Year return: 6.5%)
Inflation-Protected Securities (5-Year return: 8.79%)
REIT Index Fund (5-Year return: 14.09%)
His reference portfolio would have provided a return of about 7.1% over the last five years, which is a much better performance then the S&P 500 over that period (5-Year return: -1.85%) with a lot less risk.