Continuing a trend that began more than two decades ago, the Yale Investment Committee approved a slight increase in the endowment’s exposure to private equity for the 2013 fiscal year, according to a December report.
At its May 2012 meeting, the committee — a group that meets four times a year to review the University’s investment strategy — set the target asset allocation for private equity at 35 percent, compared with 34 percent during the last fiscal year, and also raised the absolute return target from 17 percent to 18 percent of the endowment and the real estate target from 20 percent to 22 percent. In the report, the Investments Office said the endowment is biased toward equity because “the need to provide resources for current operations as well as to preserve the purchasing power of assets dictates investing for high returns.”
Finance and investment experts interviewed said the alterations to the University’s asset allocation are consistent with the demonstrated preference for alternative asset classes that Yale has demonstrated since David Swensen took the reins as chief investment officer in 1985.
“Yale’s endowment with Swensen at the helm has always been known to be creative and at the forefront of its peers with respect to alternative investments like private equity, absolute return (hedge funds) and real estate,” said Andrew Karolyi, a professor of finance at Cornell University, in a Sunday email. “It has paid off very well for them.”
Since 2008, Yale has increased its allocation toward private equity by almost 15 percentage points. Private equity investments have produced a 30 percent annualized return to the University since 1973, and the Investments Office estimated that Yale’s private equity portfolio will generate real returns of 10.5 percent with a risk of 26.8 percent, which is the chance the return will differ significantly from the predicted return.
William Jarvis’77, managing director of the Wilton, Conn. investment firm the Commonfund Institute, said Yale’s target allocations suggest that the University expects private equity investments to yield slightly greater returns than other asset classes with similar risk levels this fiscal year.
Though the committee slightly increased the target allocation to absolute return this year, the trend since the onset of the nationwide economic recession has gone the opposite direction. The current 18 percent target allocation is significantly lower than the 25.1 percent of the endowment Yale allocated toward absolute return in fiscal year 2008.
It is difficult for absolute return managers to generate returns that exceed current interest rates by a margin great enough to justify the fees the managers charge for their services, said Scott Clemons, chief investment strategist of New York-based investment bank Brown Brothers Harriman.
Yale continues to direct only a small proportion of its endowment toward fixed income — a decision the report attributes in part to the University’s vulnerability to inflation.
Fixed income, which has the lowest-expected returns of the seven asset classes that make up the endowment, is the least attractive asset for the Yale endowment, the report said. Similarly, Yale decreased its exposure to domestic equity this year by 1 percent. Jarvis said the decrease is a logical move for Yale, since U.S. stocks are very efficiently priced, meaning that their price reflects the value of the asset, so even the best managers have few opportunities to achieve outperformance.
The report stressed the importance of hiring active managers who can identify and exploit market inefficiencies. In the context of private equity, good managers are able to add their expertise to the management of companies, helping to grow the value of businesses as opposed to just predicting their performance, the report said, adding that private equity also demands high manager fees and less liquidity, making for a riskier investment.
Nearly 80 percent of Yale’s outperformance relative to the average university endowment in the past two decades reported by Cambridge Associates was attributable to the value added by Yale’s active managers, while only 20 percent was the result of Yale’s asset allocation, the report said.
Though the Yale endowment saw a 4.7 percent return in the fiscal year that ended June 30, 2012, it still has yet to recover fully from the financial downturn. It remains 15 percent below its level at the end of the 2008 fiscal year, according to the report. Considering the inflation that has occurred since then, the purchasing power of the endowment remains well below where it was five years ago.
In fiscal year 2009, the endowment was able to provide 46 percent of the University budget, whereas in 2012 it provided less than 35 percent, the report said. The decline in endowment spending amounts to $181 million.
Correction: Jan. 18
A previous version of this article mistakenly reported that Yale has increased its allocation toward private equity by almost 15 percent since 2008. In fact, Yale has increased its allocation by almost 15 percentage points.