I have always known about the excellent returns generated by the Yale endowment, but have never dug deeper to find out who is responsible for those returns. Since reading Mr. Biggs book, Hedgehogging, I have come to find out the man responsible is Mr. David Swensen. I recently watched a great lecture by Mr. Swensen and would like to share some of the main concepts he discussed.
Mr. Swensen begins his lecture by stating that when he came to Yale he decided to study what other institutions were doing at that time. He found that most institutions were allocating their funds, 50%-40%-10%; 50% US stocks, 40% US Bonds, and 10% cash or other. Mr. Swensen felt that this was inappropriate, and began to change the way Yale invested its endowment money.
Given some academic results of studies done by Mr. Ibbotson, Mr. Swensen decided that equities were the place to be in the long run, given their superior long term returns compared to other alternative asset classes. Mr. Swensen also began to look for investments in alternative asset classes. It was very interesting how he decided on where he should allocate most of his time and effort in search of higher risk-adjusted returns. Mr. Swensen decided that inefficient markets would offer better opportunities and could generate market beating returns. The way he determined this was by looking at long run returns of managers within various asset classes, and what the returns were of the top percentile compared to the bottom percentile within each category. He then also looked at the dispersion of those returns:
Large Cap Equities 2%
Small Cap Equities 4.7%
Hedge funds 7.1%
Real estate 9.3%
Venture Capital 43.2%
It became clear to him that spending more time in the areas where the dispersion was greatest would pinpoint inefficiently priced markets and better investment opportunities. He stated that there was very little reason to spend a lot of time looking for managers in the bond market, where prices are generally mathematically calculated and pricing is very efficient, compared to other types of markets.
Mr. Swenson discussed three large topics in his lecture; asset allocation, market timing, and security selection. He concluded that asset allocation is the number one driver of returns. He discouraged market timing, and he felt that the system is not a zero sum game. Excessive fees charged by hedge funds, commissions, and consultant fees, have turned a zero sum game into a negative sum game.
Mr. Swensen also warned the students to be very careful when evaluating historical performance results. He stressed that data can be skewed by survivorship bias and back-fill bias. Survivorship bias removes the bad performance of managers who have folded and back-fill bias adds in good performance of managers.
At the time of the lecture the Yale endowment was allocated:
11% US Stocks
15% Foreign stocks
23% Hedge Funds
28% Timber, Oil and gas, real estate
19% Private equity, LBO’s, Venture Capital
This is an excellent lecture and I highly recommend watching it. LINK Mr. Swensen’s long term performance has been exceptional. He did it by becoming equity-oriented, finding great managers who did well in efficiently priced markets, by changing the asset allocation of the total portfolio, and by diversifying the risks. Really quite simple...)