Yale’s recently released annual endowment report reveals a shift, perhaps the largest in 10 years, in the way Yale allocates its investments.

Yale Chief Investment Officer David Swensen readjusted the Yale endowment’s asset class allocations for the first time in four years, according to the 2001-02 fiscal year report. Most significantly, Swensen decreased the target for private equity from 25 percent of holdings to 17.5 percent. The new asset allocation targets are expected to produce a real annual growth rate of 6.2 percent for the $10.5 billion endowment.

The Yale endowment’s assets are divided into six asset classes, including domestic equity, fixed income, foreign equity, absolute return, private equity and real assets.

In compensation for the change in private equity targets, real assets targets increased from 17.5 percent to 20 percent, absolute return targets increased from 22.5 percent to 25 percent and foreign equity targets increased from 10 percent to 12.5 percent.

The asset class targets provide a framework the Investment Office uses to manage Yale’s portfolio. Ultimately the goal is to create a portfolio that can provide a steady stream of income each year but can also maintain the purchasing power of the endowment over a much longer period of time. The asset allocation targets are reviewed annually.

Initial concerns

Swensen spoke of a possible shift in asset class targets at the European Venture Capital Association’s investor conference in Geneva, Switzerland, in March 2002. At the time, Swensen recommended a decrease in the private equity target allocation from 25 percent to 20 percent for Yale.

Private equity “is not nearly as attractive as it was five, 10 or 15 years ago,” Swensen said at the conference.

Swensen also said that while public equity in Yale’s portfolio had showed 15 percent growth, private equity yielded a negative return in the 2000-01 fiscal year.

But in previous years, Yale’s private equity portfolio generated a 30 percent rate of return, leading to a 41 percent return on investments in the 1999-2000 fiscal year — the largest return in the past decade.

Larry Goldstein, a senior fellow at the National Association of College and University Business Officers, said he was not surprised Yale was reconsidering its investment targets.

“My guess is that most endowment managers today — are looking at asset classes more closely,” Goldstein said.

The recent decrease in private equity allocation is a departure from the trends of the past 15 years, in which Swensen has steadily increased Yale’s reliance on such holdings. In his 2000 book, “Pioneering Portfolio Management,” Swensen advocated a move away from liquid assets like stocks and bonds toward investments in private assets.

But Swensen also wrote that some investors might be overestimating the potential gains from private equity, explaining that such funds have often “failed to live up to expectations.”

The changes in investment practices are less significant than those made between 1985 and 1995, when Swensen revamped Yale’s portfolio. In 1985, approximately 65 percent of the portfolio was held in domestic equity, but by 1995, the figure was down to 25 percent.

Individual approaches

Goldstein said the struggling national economy has created an atmosphere in which investors must approach their portfolios more carefully.

“You’ve got people who are finding it an appropriate time to reconsider all investments,” Goldstein said. “Nothing’s performing to meet expectations.”

He also said decisions about investment targets largely depend on an institution’s access to certain managers and funds.

“It’s so much an individual campus decision and where your exposure is,” Goldstein said.

According to the Stanford Management Company’s endowment report issued in November, Stanford targets private equity at 10 percent, with a target of 40 percent in public equity. The Harvard Management Company reported a 9 percent holding in private equity in June, down from 10.6 percent in 2001.

According to the Harvard endowment report, private equity returns were “disappointing” in both the 2000-2001 and 2001-2002 fiscal years, though they were “extremely rewarding” in the three prior years. Stanford reported a negative 30.5 percent return on private equity for the 2001-02 fiscal year.

Lyn Hutton, chief investment officer of Commonfund — a nonprofit company that manages funds for educational and nonprofit institutions — said smaller endowments “have tended to be a little more conservative” in considering private equity allocations, with a 10 to 12 percent target being much more common.

Future possibilities

Though the decrease in private equity targets was significant, Yale’s holdings in that asset class still remains significantly above the educational institutional holding average of 5.5 percent, according to the Yale report.

The report also emphasizes that the current holding in private equity of 14.4 percent remains below the target of 17.5 percent, which suggests that “Yale expresses a desire for deliberate growth in private equity exposure over the next few years.”

But while private equity has often provided significant returns, it is also less liquid than bonds and stocks, which are easily bought and sold. Private equity is also often associated with significant risk — particularly during periods such as the Internet bubble of the late 1990s.

Hutton said technology and telecommunications venture capital performed especially poorly in recent years.

“[The Yale Investment Office] did some very important work on whether the return was commensurate with the risk,” Hutton said.

A May 2002 article in The Private Equity Analyst, an industry publication, speculated that other institutions might follow Yale’s lead in withdrawing from private equity investments following Swensen’s speech.

But Hutton said while institutions often reconsider their strategies, she has not seen much change in policy.

“We have not found evidence that institutions are changing their asset classes,” Hutton said.

Hutton said that while private equity funds have fared poorly in the last few years, the economy is such that public equities have not performed well either.

The 2002 NACUBO Endowment Study — as yet unreleased — shows endowments struggling again in the 2001-02 fiscal year, Goldstein said.

But Goldstein said Yale’s investment return of 0.7 percent in 2001-02 is still significantly better than that at many other institutions.

“[Yale] is one of a very few [universities] that didn’t have negative returns,” Goldstein said. “So David [Swensen]’s doing something right.”