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Yale rebuts Buffett, defends performance of alternative investments

  • Net returns justify fees charged by alternatives managers
  • Long-term manager relationships to align interests
  • Leveraged buyouts crossed target allocation for 2017

Yale University’s endowment has defended the high fees that come with alternative investments by pointing to their strong returns.

Yale’s defense, included in its just-released 2017 annual report, marked a rebuttal to billionaire investor Warren Buffett’s 2016 investor letter.

In it, Buffett suggested that endowments and other institutions might do better by heeding his advice to invest in an index fund replicating the S&P 500. Instead, they “depart to listen to the siren song of a high-fee manager,” Buffett said.

In fact, “the top performers clearly overcame the fee burden to post extraordinary results,” the Yale endowment report said.

Alternative investments, within which Yale includes LBOs, venture capital, natural resources and real estate, provide “not only diversification benefits, but also abundant opportunities for astute managers to add value in the investment process,” the report said.

Alternative assets account for nearly half of asset allocation in Yale’s $27.17 billion endowment.

Yale CIO David Swensen has been a long-term proponent of alternatives. Through portfolio diversification and astute manager selection, Yale endowment has returned 12.1 percent over the 20 years ended June 30, 2017.

Swensen’s strategy of investing in alternatives became a 1995 Harvard Business School case study, “Yale University Investments Office,” and has been influential in strategies developed by other college endowments.

The Yale endowment separated its PE asset class into leveraged buyouts and VC in 2015, revealing the importance of buyouts to its overall portfolio.

The following year the university reduced its target allocation to LBOs to 15 percent from 16 percent. It currently stands at 14 percent.

Still, the actual asset allocation surpassed the target and was 14.2 percent for LBOs in 2017.

“Leveraged buyouts offer extremely attractive long-term risk-adjusted returns, stemming from the University’s strong stable of managers that exploit market efficiencies,” the report said.

Yale expects leveraged buyouts to return 10 percent in 2018, the report said.

Generating an annualized return of 8.8 percent for a decade, the asset class has outperformed the passive benchmark by 2.7 percentage points per year and performed in line with the Cambridge PE Composite Index for 2017.

The passive benchmark is a blend of the Russell 2000 and MSCI ACWI ex-U.S. and Small-Cap Index.

The leveraged buyout program earned 12.6 percent per year over the past 20 years, the report said.

Yale endowment returned 11.3 percent net of fees in 2017.

Among its peers, Dartmouth College returned 14.6 percent, Princeton University 12.5 percent and Columbia University 13.7 percent in 2017.

Swensen has been the endowment’s chief investment officer since 1985. Timothy Sullivan oversees the endowment’s LBO and VC portfolios.