The stewards of the University’s endowment stood by their investment strategy in an annual report released Tuesday.
The report on the endowment, published yearly in the spring, provides a comprehensive account of how Yale’s endowment was invested during fiscal year 2008. Because of the current economic turmoil, the report includes an unprecedented update on the endowment’s performance through the end of calendar year 2008. The report also gave Chief Investment Officer David Swensen a platform to defend his investment strategy in the face of criticism of the fund’s estimated 25 percent plunge.
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“While the decline in Endowment value in the current financial crisis caused some observers to question the tenets of Yale’s investment strategy, when evaluated with a time horizon appropriate for a long-term investor, the University’s equity-oriented, well-diversified portfolio continues to provide the best foundation for future investment success,” the report states. “After the financial trauma recedes, Yale will once again benefit from the prospect of superior returns generated with prudent levels of risk.”
After four consecutive years of double-digit growth in the endowment’s value — including gains of 41 and 28 percent in 2000 and 2007, respectively — it should not be surprising that the endowment could suffer a double-digit loss in a single year as well, the report says.
The report also placed Yale’s 25 percent plunge in the context of even steeper marketwide declines. For the six months ending Dec. 31, U.S. stocks fell nearly 30 percent, stocks in developed foreign countries fell more than 36 percent, and equities in emerging markets dropped more than 47 percent. Only U.S. Treasury bonds yielded positive returns.
For that reason, most investors fled risky assets and bought treasuries. But Swensen remains uninterested in fixed-income assets because he is focused on the long term.
“Equity orientation makes sense for investors with long time horizons,” the report says. “In the midst of financial crises, some argue for higher allocations to risk-free assets, no doubt wishing after-the-fact for the now unattainable before-the-fact protection.”
The report stressed the long-run opportunity cost of bonds, which have lower returns that stocks. As other investors flock to bonds, the value of all risky assets have plummeted, leaving even a diversified portfolio like Yale’s with nowhere to hide. But when the current crisis passes, Swensen said, Yale will “reap the benefits of a well-diversified portfolio.”
Yale’s endowment is invested in six different kinds of assets, divvied up into a fixed distribution based on statistical analysis of risk and expected return. As the market fluctuates, Yale must buy or sell in order to maintain its distribution targets for each asset class.
At the June 2008 meeting of the Yale Corporation, the Investments Committee increased the target for private equity from 19 percent to 21 percent because assets in that category were appreciating. For the same reason, the committee increased the allocation of real assets — such as oil, timber and real estate — from 28 to 29 percent.
As market conditions moved Yale’s holdings away from the targets, the portfolio ended up on June 30, 2008, with 3.9 percent in borrowed cash. Yale’s managers aim for zero cash, but they sometimes have to borrow money to temporarily bridge a gap between payments, as was the case last June.
Such debt is unusual for Swensen, who shuns leverage as a matter of policy. By contrast, his counterparts at Harvard use leverage as part of their investment strategy, which stuck them with a liquidity crunch — one that Yale was able to largely avoid — when the financial crisis hit, Swensen said in a recent interview.
Yale’s underlying investment strategy has not changed despite the financial crisis, Swensen said in a recent interview. The Investments Office has had to buy and sell assets to stick to its policy targets. But while other investors flocked to the safety of Treasury bonds, Swensen slightly raised Yale’s holdings in illiquid assets, a move he says will pay off in the long run.
“Over long periods of time the illiquid assets are less efficiently priced and they generally promise higher prospective rates of return,” he told the News in January. “Some people lose sight of that in the midst of a market trauma.”
The glossy pages of the endowment report were interspersed with features touting the residential college system. The report was written before the Yale Corporation met two weeks ago and decided, in large part because of the endowment’s decline, to postpone the two new residential colleges.