NEW HAVEN, Conn. - While the U.S. stock market has broken record after record, the $4.6 billion Yale University endowment has been quietly slicing its domestic stock holdings and moving assets to private markets from public ones.
The fund cut its U.S. publicly traded stock allocation to 23% of total assetsfrom 59%.
Yale now has about 50% of its assets in sometimes-illiquid, non-marketable investments such as private equity, real estate and absolute return vehicles like hedge funds, long-short strategies and distressed securities.
The asset allocation is 23% in domestic equities, 13% in foreign equities, 12% in fixed income, 12% in real estate, 20% in private equity and 20% in absolute return vehicles.
While in 1987 index funds represented half of the fund's stock, bond and international holdings, now the fund is 100% actively managed.
The changes were made based on Chief Investment Officer David Swensen's belief that alternative investments offer inefficiencies and therefore potential returns not found in the public securities markets. He thinks the markets pay dearly for liquidity, and institutions are uniquely positioned to buy less liquid securities at a much lower cost than public stocks and bonds, and often with less risk.
Yale's public equity allocation is significantly less than the average for endowments and foundations, which was 47% for domestic equities and 9% for international equities as of Dec. 31, according to Hammond Associates Inc., a consulting firm in St. Louis.
Mr. Swensen doesn't talk to the press about his endowment's investment strategy. But at a conference sponsored by publisher James Grant, Mr. Swensen said he still favors equities, just not publicly traded ones.
That's an about-face from a speech he gave at a Grant's conference in November 1987, when he was bullish on public equities just weeks after the Oct. 19 stock market meltdown. At that time, the fund had about $1.8 billion in assets and 59% in U.S. equities, 11% in foreign equities, 17% in fixed income, 8% in real estate and 5% in private equity - representing 87% in public market securities.
The fund now has only 48% in public market stocks and bonds.
"You can be paid for accepting illiquidity. The markets overvalue liquidity to a degree that's hard to understand," Mr. Swensen said at this year's conference.
At the end of 1987, Mr. Swensen planned to increase foreign equities to 15% of the portfolio and reduce domestic equities to 50%. But that strategy wouldn't hold up to his new standards of diversification.
In fact, he plans to further raise his already generous 20% private equity allocation to 22.5%. (According to the 1995 NACUBO Endowment Study by Cambridge Associates, a consulting firm in Cambridge, Mass., the dollar-weighted mean allocation to non-marketable securities including venture capital, buy-outs and oil and gas was 7% for endowments with more than $400 million in assets as of June 30.)
Mr. Swensen said from 1973 to the present, Yale's private equities have returned a compound annual rate of more than 25%.
"We have achieved true diversification in the portfolio," he said.
But most U.S. pension funds have not.
They "still have 40% to 60% in domestic equities and 70% to 90% in domestic marketable securities. It's hard for me to understand how that could be true diversification," he said.
Noting that pension funds and other investors are overweighted in stocks, he said: "When you're that comfortable (with financial risk assets) it's about time for the investment markets to punish you.
"My fundamental concern is (institutions') increased overdependence on domestic marketable securities."
Why has he converted to active management? "More than half the portfolio is in asset classes where you couldn't or wouldn't want to buy the market," such as oil and gas and leveraged buy-outs, he said. "Active management will be an important determinant of Yale's returns."
"We started out owning the market, but over time we convinced ourselves that we have the ability to find people who can beat the market. We will continue to manage the portfolio 100% actively," he said.
Mr. Swensen did not provide returns, but said each of his six asset classes has outpaced its respective benchmark over one-, three-, five- and 10-year periods "by a meaningful margin."
Mr. Swensen said since Jan. 1, Yale's portfolio has gained 15% to $4.6 billion as of March 29, adjusting for withdrawals by the university.
In international investments, "I'm most excited about emerging markets equity and debt," he said.
He said real estate is "a diversifying asset and a nice inflation hedge," except when the market was in "disequilibrium."
Now, he said, the inflation-hedge characteristics should return since we're "getting to a balance between demand and supply in real estate."
In the alternative investments arena, Yale maintains extensive relationships with outside managers and limited partnership funds: 10 to 12 for venture capital; 10 to 12 for buy-outs; and eight to 10 for absolute return. In late March, he made his biggest ever single commitment - $70 million - to an unnamed private equity firm.
But in the absolute return area, one of Yale's relationships accounts for $300 million.
He considers such investments, in merger-arbitrage and distressed securities, "very conservative," compared to private equity funds. "I wouldn't put that much with a buy-out firm" he said.
Mr. Swensen said absolute return investments "exploit inefficiencies in the securities market. There is not a meaningful correlation with stocks or bonds. They're intended to outperform domestic equities by a small margin and domestic fixed income by a somewhat larger margin."
Yale's buy-out funds use less leverage than many others. The leverage ratio ranges from 3: 1 or 4: 1, compared with 8: 1 to 10: 1 for some other funds, he said. He said Yale's ratio is still high but "it's not a pure financial engineering approach."
Even in publicly traded securities, Yale's approach is unorthodox. Mr. Swensen sometimes hires domestic stock managers that have never before served institutional clients. And in real estate, he put together a 25-year partnership with The Shorenstein Co., San Francisco, a real estate developer, an unusual move for a tax-exempt fund.
