- Taking advantage of alternatives
- School considered closed-lipped
- Cutting its absolute return portfolio
Yale University’s endowment makes more money than most in the infrequently traded and illiquid world of alternative assets by picking the most skillful of managers, sister news service Reuters reported. The Yale endowment, which reached $19.3 billion in assets, fiscal-year ending June 30, 2012, has been one of the most secret and most successful in the past two decades partly because the quality of its active managers, according to its annual Endowment Update.
In its fiscal 2012 Yale’s endowment generated an investment gain of $913 million, or 4.7 percent, compared with a 21.9 percent return in the previous year.
U.S. college and university endowments lost an average of 0.3 percent for fiscal 2012, down sharply from a gain of 19.2 percent a year earlier, pressured by volatile international markets, according to data gathered from 463 institutions by Commonfund Institute and the National Association of College and University Business Officers.
Over the past 10 years, the Yale endowment grew from $10.5 billion to $19.3 billion as a result of disciplined and diversified asset allocation policies and strong active management results, the report said. Yale, considered by many fund managers to be a secretive and closed-lipped organization, publishes its Endowment Update once a year, allowing the public a glance of its investment strategy.
In fiscal 2012, the endowment cut its absolute return portfolio to 14.5 percent, from 17.5 percent, which was below the average educational institution’s allocation of 23.8 percent to such strategies. Yet over the past decade, the absolute return portfolio returned 10 percent per year with low correlation to domestic stock and bond markets, according to the report.
Absolute return investments are designed to provide diversification to the endowment by exploiting market inefficiencies. The portfolio is invested in strategies such as mergers, spin-offs or bankruptcy restructurings, as well as strategies that involve hedged positions in assets or securities with prices that diverge from their underlying economic value.
According to the report, Yale has beaten the median endowment, as measured by Cambridge Associates, by 5.2 percentage points per year over the past two decades. During that same period, nearly 80 percent of Yale’s success relative to the average endowment was attributable to the value added by the university’s active managers, while only 20 percent was the result of its asset allocation.
The university’s strategy is to place skilled active managers in less efficient markets to add value to their investment and reap greater variability in return. For the endowment, placing active management in U.S. Treasury securities is inefficient and not that profitable, “as the spread between top and bottom quartile results for active bond managers measures an astonishingly small 0.8 percent per annum for the decade,” the report said.
Emerging markets, which tend to be less efficiently priced than the U.S. markets because of their thinner liquidity, present greater opportunity for stock selection and manager performance. Yet illiquid alternative investment managers “succeed or fail by dint of their skills and abilities, not by the action (positive or negative) of the market,” according to the report.
Before hiring those skillful managers, Yale goes through relentless evaluations of the group’s investment acumen, strategy, character and ethics, as well as its bottom-up research capabilities. Yale also looks for managers who can execute concentrated portfolios by focusing on bottom-up, security-specific investments and on companies with earnings driven by factors that can be forecast, such as production, costs, distribution and pricing.
Yale focuses on long-term partnerships as a crucial part of its investment strategy, and “targets employee-owned firms to ensure that incentive compensation appropriately benefits the investment team.” Yale often develops close relationships with firms early in their life cycle as their assets under management are limited, which allows flexibility, and managers tend to be more motivated and capable of earning substantial returns.