With Yale’s $23.9 billion endowment at a historic nominal high, the University continues to project strong growth rates, according to the annual report released late last week by the Yale Investments Office.
In the 28-page document, the Investments Office detailed both the guiding principles of its investment strategy and predicted how shifting asset allocations would affect growth in the coming years. Though the $4 billion investment gain during fiscal 2014 — a 20.2 percent return — was announced in September, the full report justified the composition of the University’s current holdings and detailed the investment policy for the longer term.
The report also outlined the University’s continued reliance on the endowment as a source of revenue for funding operations. During fiscal 2014, the endowment was responsible for subsidizing nearly 33 percent of the University’s $3.1 billion income. Over the last decade, spending from the endowment has continued to rise at an annual growth rate of roughly 8 percent, nearly doubling from $502 million to roughly $1 billion.
Chief Investment Officer David Swensen declined to comment, but investment experts said the University’s endowment structure — from its heavy allocation to nontraditional assets, including venture capital, real estate and natural resources, to its increase of foreign equity targets — has allowed Yale to consistently rank in the top tier of institutional investors.
“Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management,” the report stated. “The Endowment’s long time horizon is well suited to exploit illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber and real estate.”
The report stated that the endowment’s target mix of assets projects an inflation-adjusted long-term growth rate of 6.3 percent with a risk level of 15 percent. Last year, Yale’s target mix of assets under management produced a portfolio expected to grow at 6.3 percent with risk of 14.8 percent. Yale’s equity risk premium — the excess return that equities provide over a risk-free rate — has been around six percent for more than a decade. To many investors, the goal is to attain that kind of long-term equity risk premium without the volatility of investing in a pure equity portfolio.
Massachusetts Institute of Technology finance professor Andrew Lo ’80 said Yale’s long-term horizon for investments allows the University to employ tactics that are not easily replicated for individual investors.
“Yale is making full use of their endowment status because they are really investing for all the future generations of faculty, staff and students,” Lo said. “So that gives them an advantage that many shorter term investors don’t have when they look at all the potential opportunities over the course of say a 10 or 20 year horizon.”
One of the most notable shifts in the endowment structure during fiscal 2014 was its increase in foreign equity from 11 to 13 percent of Yale’s portfolio, a rise that was offset by a two percentage point decrease in real estate targets, the report stated. However, Yale’s investment in the foreign market remains well below the average endowment allocation to this asset class among large endowments. According to the NACUBO-Commonfund Study of Endowments — the most comprehensive annual report on higher education endowments — large endowments, on average, have 18 percent in foreign equity.
According to the report, this type of foreign equity — which includes 5 percent in foreign developed markets, 3 percent in emerging markets and 5 percent to “opportunistic foreign positions” in China, India and Brazil — allows the University’s endowment to become more diversified and earn strong returns through active management.
“There are opportunities that are being created by all these global, geopolitical events, so … I think focusing just on the U.S. is doing a disservice to the investors,” Lo said. “When you focus on international markets, it requires much broader expertise and that is really where Yale’s investment staff have really shown they are able to demonstrate that kind of expertise in a variety of markets and in different countries.”
Although Yale increased its holdings in foreign equities, Lo acknowledged that the University’s investment strategy is distinguished by its heavy asset allocation towards other alternative assets.
The increased investment in foreign equities is part of a larger trend of Yale’s endowment shifting away from fixed income classes, such as bonds, and targeting 95 percent of the funds for investments in assets expected to produce equity-like returns, which include domestic securities, absolute return strategies, real estate, natural resources and private equity.
Current economic conditions make this type of equity bias even more strategic for the Investments Office, School of Management Professor Roger Ibbotson said.
“There are very few opportunities in the fixed income space because … if you think interest rates will rise in the future — which is possible that it might with quantitative easing ending — longer-term bonds are a poor investment and shorter term bonds have smaller yield,” Ibbotson said. “You don’t get much yield for going out there [in the bond market], if interest rates rise those prices will drop.”
Instead, it appears the University will continue its large-scale investments in the field of private equity, such as investments in venture capital and leveraged buyout partnerships. Not only is Yale’s 33 percent allocation to private equity the largest among its eight assets classes, but it is also far greater than the average educational institution’s 10 percent allocation to this type of investment.
Lo said Yale’s large investment in the private equity market is part of a strategy pioneered under Swensen’s leadership and has led peer institutions to emulate Yale’s strategy to varying degrees of success.
“Yale was certainly among the first to get into private equity in a big way, so the Investments Office has established a long track record of these kinds of investments,” he said. “So I think they are following their nose to see where the best opportunities are, and it happens to be in many case to be in private equity markets.”
Over the past two decades, Yale’s private equity investments have earned 36.1 percent per year.