With some smaller, less highly managed endowments outperforming Yale in 2014, debate over the University’s reliance on alternative investments has once again surfaced.
Over the past three decades, the Yale Investments Office has pioneered an investment strategy characterized by its emphasis on alternative, illiquid assets — such as private equity and hedge funds — over traditional investments such as stocks and bonds. However, with the strong stock market performance of 2014, endowment allocations to alternative assets have dropped 4 percent among wealthiest institutions since 2012, according to the NACUBO-Commonfund Study of Endowments released last month.
According to the study, small endowments such as Villanova University, Babson College and the University of La Verne — to name a few — beat Yale’s 15 percent rise in market value. However, they amount to less than a twentieth of Yale’s endowment size.
Though some experts see a trend among endowments of shifting towards more liquid assets, others cautioned Yale against chasing year-to-year fluctuations in the market.
“More traditional asset classes had solid performance last year while alternative asset classes lagged,” said Rick Ferri, founder of Portfolio Solutions LLC. “Hence, smaller endowments that had higher allocations to traditional index exposures performed well.”
Ferri said the movement away from alternative assets towards traditional stocks and bonds may be a reflection of “performance chasing,” in which endowments officers try to adopt successful practices from other institutions. In recent years, the trend has been towards index tracking — investing in funds that track a broad market index — since the stock market has performed strongly.
During the 2014 fiscal year, the S&P 500 rose 24.6 percent. Further, domestic equities, which include stocks and bonds, rose 22.8 percent, generating the highest returns among the five main asset classes surveyed by the study.
Still, the Yale Investments Office only placed 6 percent of its $24 billion in this category of investments — 7 percent below the average among endowments of comparable size.
“I am shocked that Yale’s domestic equity asset allocation was just 6 percent,” said George Papadopoulos, a wealth manager and WSJ wealth management expert. “I think it is obscenely low.”
Papadopoulos added, however, that abandoning an asset class just because another asset class did better is not the best strategy for long term investments.
Three experts interviewed said that though many institutions have mirrored Yale’s strategy of investing in alternative asset classes, some schools have begun to pare down these investments due to fees and growing competition.
“A couple of things are working against so-called alternative investments at this point,” said Tom Brakke, a consultant and investment adviser at TJB Research. “First is the high fees: Fees erode returns; high fees erode them more quickly.”
He added that as more money has been placed into alternative investments, the additional capital and expertise now being devoted to this area may weigh on returns.
Still, others defended Yale’s investment strategy and said it is too soon to argue the Yale model should be revised.
Provost Benjamin Polak said that though last year was very strong for domestic equities, in particular the S&P and other index funds, it is important that Yale remains diversified so if equities go down, Yale’s portfolio will not be too heavily correlated.
“The standard thing one tells every young investor; stock markets go up but they also go down,” Polak said.
William Jarvis ’77, managing director of the Commonfund Institute, similarly emphasized the benefits of Yale’s investment strategy, especially when weighed in the long-term. He said that though less-diversified portfolios performed strongly in 2014, diversified portfolios did better over a 10-year period.
Massachusetts Institute of Technology Finance professor Andrew Lo ’80 cautioned investors against chasing year-to-year performances, adding Yale is ultimately concerned with its long-term growth.
“One of the greater strengths for a college endowment is investing in illiquid assets, so it may do well in one year and tank the other year,” Lo said. “But long term perspective allows university to enjoy these risk premiums.”