Yale foresees private equity to lead in performance, volatility

Yale University, New Haven, Conn., expects private equity to be the highest-returning and most-volatile asset class in the long term in the $19.35 billion endowment's portfolio, according to its update report.

Yale's private equity portfolio is expected to have real returns of 10.5% and risk of 26.8%. Emerging markets equity was the asset class with the second-highest expected real return with 7.5%. Risk is projected to be 22.5%.

Several asset classes were projected to have a real return around 6%, including natural resources, domestic equity, developed non-U.S. equity and real estate. Projected risk of the asset classes was around 19%.

The report also said the endowment's target asset allocation mix “produces an expected real (after inflation) long-term growth rate of 6.3% with a risk (standard deviation of returns) of 15.2%.”

Absolute return had the best risk-reward trade-off with an expected real return of 5.25% and expected risk of 12.5%.

Bonds continued to be the asset class with the lowest expected real return. The asset class has the worst risk-return trade-off, according to a Pensions & Investments analysis of the report. The expected real return is 2% with a risk of 10%.

In May, Yale's investment committee raised the endowment's target allocation to private equity to 35% from 34%, absolute return increased to 18% from 17% and real estate increased to 22% from 20%. Funding will come from cutting the targets of domestic and international equity one percentage point each to 6% and 8%, respectively, and a two-percentage-point decrease in natural resources to 7%. Fixed income and cash remained unchanged at 4% and zero, respectively.

The endowment fund's current actual allocation is 35.3% private equity, 21.7% real estate, 14.5% absolute return, 8.3% natural resources, 7.8% foreign equity, 5.8% domestic equity, 3.9% fixed income and 2.7% cash.

Ten-year annualized returns were 10.6% as of June 30, 2012, while absolute return returned 10%; domestic equity, 9.8%; fixed income, 4.5%; foreign equity, 16.6%; natural resources, 16.2%; private equity, 13.2%; and real estate, 7.3%. All asset classes outperformed their active benchmarks.

Yale's 10-year track record ranked first in the Cambridge Associates universe in nine of the last 10 years.

For the 20-year period ended June 30, 2012, Yale's annualized return was 13.7%. Its selection of active managers accounted for 4.1% of the return while its unique asset allocation added 1.1% of the total.

The $19.35 billion in total endowment assets as of June 30, 2012, represents a decrease of 0.1% from $19.37 billion a year earlier. Returns for the fiscal year were 4.7%.