Should the Yale Model be ditched? Jennie Wang The Yale Model was developed in 1985 by David Swensen and Dean Takahashi, and it is core to investment strategies that asset allocators, commonly endowments and foundations, often follow. The model calls on allocators to diversify their portfolio amongst five to seven asset classes, focusing more on equities. It additionally emphasizes the importance of rebalancing regularly, and that the goal of the exercise should be to bring the asset classes back to their target portfolio weightings. Finally, the model states that in the absence of confidence in a specific strategy, the portfolio should look to ETFs and index funds. Since 1985, the model has been adopted by many other endowments and foundations, to the point where it is also known as the Endowment model. Fund of funds, looking to achieve the same impressive 11.0% return per annum (net of fees) as the Yale Endowment has over the last decade, have also adopted the Endowment model as an investment strategy. In light of the financial crisis of 2008-2009, though, criticism on the Yale Model has not been scarce. In one example, an endowment dropped 30% in the fiscal year ending June 2009, prompting a critic to declare that, “the endowment model of investing is broken.”[1] Many endowments found themselves unable to satisfy their cash needs and turned to selling their interest in commitment-based funds on the secondary market. Rather than offering adjustments to the model, critics continue to advise endowments to ditch the Yale model altogether. There are three additionally critical pieces about the model that are important to note but often forgotten or ignored. First, the investment office must recognize the importance of establishing and maintaining strong relationships with managers. The first commitment is almost never expected to be the last, and being a strong supporter of a manager can have a huge impact on their particular sector (the Yale Endowment’s influence on real estate is a prime example). If an investment office does not develop strong ties with primary dealmakers and attempt to sustain these relationships, that sector’s eco system has a lower chance for success at survival. Second, endowments have long time horizons – they should not plan for the end, which distinguishes them from an individual who is saving for retirement. This allows endowments to concentrate on long-term, illiquid holdings, satisfying the importance of institutional investors concentrating their portfolios in assets that are not traded in public markets. There is a premium to liquidity, of which endowments simply need a lower amount. William Jarvis of the Commonfund
Institute has said, “the game is a 20-year game or even longer,” and that “over time, more diversified portfolios should generate top returns.”[2] Lastly, the investment office must understand that active management in alternative assets can most decidedly expose market weaknesses. Many endowments assume that active management, including rebalancing, should occur at a minimum, annually. David Swensen has admitted that the staff at the Yale Endowment’s investment office rebalanced at a much higher frequency, often daily.[3] In this final component, having the proper rebalancing tools are essential to facilitate the process, tools such as those in the InvestCloud offerings. Not only should this tool have the capacity to show a target allocation, it should have the ability to retain these targets over time. After all, the Yale Model has been around for 30 years. Additionally, the rebalancing tool should provide the ability to report on these target changes over time, address the performance at an aggregated level and provide comparator benchmarks for analyses. InvestCloud satisfies each of these requirements. Without confirming that a portfolio has in fact followed all facets of the endowment model, it is premature to call the model “broken.” What relationships has the investment office built with its managers? What rebalancing tools has the investment office utilized in its analyses? How frequently is the portfolio rebalanced? We should not so quickly ditch a model when it has proven itself over three decades to sustain profitability long term. The numbers cannot be ignored. The Yale Endowment achieved an 11.0% annualized return over the last decade, well over the 7.8% that would have been earned had the assets been allocated directly to the S&P 500.[4] As Mark Yusko of Morgan Creek Capital Management, LLC so elegantly put it, “one year where endowments did not outperform but rather ‘tied everyone else’ does not break the endowment model.”[5] With proper preparation for extreme events and careful analysis on their portfolio’s diversification, the Yale Endowment keeps good company with the likes of Harvard and Princeton in their long-term strategies. Find out more information on how InvestCloud can help manage endowments and foundations by contacting us at 888-800-0188 or visit us at www.investcloud.com. Jennie Wang, Vice President of Business Development at InvestCloud, started her career in the financial services industry in 2008. She served on the Fund Administration team at Vastardis Fund Services, focusing on private equity and asset allocator clients, where she was responsible for a team administering over $10 billion in assets. She then moved to join the Product Development team at Envisor Technologies in 2012. Jennie has been a part of the InvestCloud team
since 2015. She holds a bachelor of Science in Biomedical Engineering from the Johns Hopkins University.
[1] Humpreys, Joshua. "Educational Endowments and the Financial Crisis."Educational Endowments and the Financial Crisis (2010): 3-6. 27 May 2010. Web. 2 June 2015. [2] McDonald, Michael. "Yale Says 'Alpha Is Not Dead' as It Defends Investment Model." Yale Says ‘Alpha Is Not Dead’ as It Defends Investment Model. Bloomberg, 27 Feb. 2014. Web. 02 June 2015. <http://www.bloomberg.com/news/articles/2014-02-27/yale-says-alpha-is-notdead-as-it-stands-by-investment-model>. [3] "P David Swensen Yale Individual Investor Portfolio Annual Rebalancing." Advanced Strategies. MyPlanIQ, n.d. Web. 02 June 2015. [4] Brown, Dennis. "Notre Dame Endowment Returns 19.7 Percent for Fiscal Year 2014." Notre Dame News. University of Notre Dame, 23 Sept. 2014. Web. 02 June 2015. [5] Opalesque, TV. "Mark Yusko: The Endowment Model Isn't Broken." YouTube. YouTube, 19 May 2010. Web. 02 June 2015.