By James Saft
March 12 The Yale Endowment's heavy emphasis on
illiquid and alternative investments like hedge funds and
private equity in its endowment is working like a charm.
You, however, are not Yale and neither, likely, is your
pension fund, university endowment or personal portfolio.
Understanding why what is good for the goose underperforms
for the gander is key to not just Yale's fantastic performance,
but improving your own.
Called the Yale Model, the endowment's philosophy has been
to be long on private equity, real estate, natural resources and
hedge funds employing absolute return strategies. As a result
Yale has thus been underweight traditional traded securities, be
it fixed income or domestic and international equity.
The results have been fantastic, though flight to safety
during the great financial crisis led to a serious
underperformance due to a lack of fixed income and extremely
high correlations in risk markets. In nine of the last 10 years,
however, 10-year returns for the Yale Endowment have stood at
the top of the league tables of similar funds compiled by
Cambridge Associates, according to Yale, which last week
released its annual review of the endowment's performance. ()
And to compare it to a more traditional pension fund model,
had Yale followed a 60/40 equity/bond split since 1988 the value
of the fund would stand at just $9.11 billion today, as compared
to its current value of $20.78 billion.
So should other long-term investors or even individuals try
to turn themselves into mini-Yales? Almost certainly not.
Many other long-term investors have markedly increased their
exposure to illiquid and alternative assets in recent years,
notably many public sector pension funds which are facing
unpleasant choices between reneging on commitments or cutting
services and raising taxes. How nice instead to just beat the
That probably isn't going to work, and to understand why,
you first have to understand Yale's relatively unusual
investment horizon, which is essentially infinite, and secondly
the positional advantage it has thus far maintained.
As a huge institution which intends to be around forever,
Yale has the ability not only to suffer what would be disastrous
swings in markets, but also to accept the limitations of having
about 75 percent of its assets in alternative investments, most
of which can't be liquidated as market assets can.
GO PASSIVE, LITTLE MAN
But it is not as simple as just earning a stream of income
from taking liquidity risk, as nice as it would be if that were
Yale, in its own opinion, outperforms because it is good at
choosing managers, most of whom won't answer your phone calls,
and because it is good at negotiating advantageous terms.
"Yale has never viewed the mean return for alternative
assets as particularly compelling," it said in the review.
"While alpha is not dead, opportunities to access it may not
be available to all investors."
Yale cites figures which show a huge gap between the mean
returns of top- and bottom-quartile managers in venture capital,
leveraged buyouts, natural resources and real estate. In all
four areas the best have outperformed the worst by more than 15
percentage points annually between 2003-12. Interestingly those
dispersions are, if anything, lower than they were in the decade
before, perhaps indicating that some of the advantages of going
into illiquid assets are being arbitraged away by trend
The clear implication is that your chances of beating what
are the often pedestrian (and expensive) returns to be had in
alternatives are not great. That's absolutely true if you are an
individual, and very likely true of even the largest
I personally also am quite scared by the movement of public
sector pension funds into alternatives, as has been so notable
in South Carolina, New Jersey and Rhode Island, among others.
Not only does this trend smack of wishful allocating, it
seems ripe with potential for malfeasance. It is all too easy to
see scenarios in which politicians, public sector employees or
consultants engage in corrupt, or at the least, self-serving
Even putting that aside, the big reason everybody can't
outperform is that this isn't Lake Wobegon and we, and our
investment managers, aren't all above average.
"The most important distinction in the investment world does
not separate individuals and institutions; the most important
distinction divides those investors with the ability to make
high-quality active management decisions from those without
active management expertise," Yale writes.
"No middle ground exists. Low-cost passive strategies suit
the overwhelming number of individual and institutional
That, as we know, won't stop many investors from trying, but
it bears repeating.