The days may be numbered on the rocketing growth of Yale’s endowment.
The University’s investment portfolio — valued at $15.2 billion in June of 2005 — grew 22.9 percent to $18 billion this year, marking the second straight year Chief Investment Officer David Swensen and his team have posted returns above 20 percent. In the last decade, the endowment has averaged over 17 percent yearly returns, growing by $13 billion. But while the University’s investment team may continue performing above average, experts and administrators said they do not expect such steep growth to continue.
“One would never prudently count on returns of this magnitude,” Yale President Richard Levin said in an e-mail Wednesday night.
Unlike many other universities with large endowments, such as Harvard and Stanford universities, Yale leaves most of the hands-on investing to external managers. Swensen has been hailed as a pioneer of this method, reducing risk and maximizing returns by using sophisticated strategies to choose managers. One of the most significant portions of the endowment is entrusted to hedge funds — lightly-regulated portfolios catering to sophisticated investors — which have been a source of much of the endowment’s success over the last 16 years.
But hedge fund experts warn that they cannot be profitable forever.
“Hedge funds have a very rough road ahead of them,” fund manager Peter Collery ’81 said. “You have billions and billions of dollars managed by guys trying to beat the market. Pretty soon they will become the market.”
Despite this threat, Levin said the University chooses its managers very carefully and does not plan to change its winning strategy. Yale’s careful manager selection is one of the reasons it has exhibited superior performance to its peers, he said.
The facts make clear that Yale has, at least in recent history, outperformed its peers. Yale’s more than 17 percent average through the last decade beats those of rivals Harvard and Stanford, whose returns have averaged around 15 percent during the same period. When compared to the 8.7 percent 10-year return of the median institutional fund, as measured by the Trust Universe Comparison Service, Yale does even better.
Some attribute this superior performance to both skill and luck.
“Yale’s returns recently have been so good, I think it reflects both talent and luck,” Collery said. “While the talent may be sustainable, the luck is less likely to be so.”
The endowment’s rapid growth has made it a target of some who criticize the University for being too conservative in its spending habits. Local 35 president Bob Proto said Yale could loosen some of its own spending restrictions to increase funding for some routine operations and to give back to the community.
“There’s a self-imposed spending rule that the University has, and I think it absolutely needs to rethink its investment in its operations as it relates to providing service to the faculty and undergraduates,” he said.
The administration determines how much of the endowment to spend by using a “smoothing” formula to take into account how much it spent the previous year in order to mitigate the effect of market fluctuations on the endowment’s portion of the yearly operating budget. Last year the University spent about 4.5 percent of its endowment.
The University has defended its spending habits in the past by arguing that it needs to preserve the purchasing power of the endowment for future generations. One endowment expert, Donald Basch, a professor of economics at Simmons College, said Yale’s spending policies — and the smoothing mechanism in particular — have been wise in their conservatism.
“We know now that, given the strong investment performance over the last 15 years, Yale has used a smaller percentage than what is necessary to preserve the endowment,” he said. “But the growth of the endowment … is partly due to that conservative policy.”
Basch said that despite his appreciation for Yale’s money management, he doubts that the University’s endowment growth will sustain its current rate 20 years into the future.
“I am in awe of Yale’s investment performance,” he said. “We can have this conversation 20 years from now, and we will see whether I am still in awe.”
In the past 20 years, the endowment’s contribution to the yearly operating costs of the University has grown from 11 percent to 32 percent.