When I spoke with Jack Meyer, the former head of Harvard University’s endowment, at the offices of Goldman Sachs on Fleet Street in London back in 2009, he was thoroughly chastened by the recent 25%+ drop in the value of Harvard’s endowment. A month or two later, Stanford University’s President John Hennessy, reflecting his Silicon Valley roots, was more optimistic about Stanford’s similar collapse, telling me: “Look, Nick, it’s not the end of the world. It just puts us back to where we were in 2006.” Hennessy’s optimism notwithstanding, the crash of 2008 turned much of the financial world on its head. This included much-vaunted “Yale model” that had made Harvard, Yale and Stanford tens of billions of extra dollars over the past two decades.
Despite the challenges of the market meltdown of 2008, the university endowment investment model remains one of the most powerful investment strategies around. And thanks to exchange-traded funds (ETFs), today you can duplicate this investment approach in your own personal investment portfolio. It is also an investment philosophy I have implemented with impressive success through the “Ivy Plus” Investment Program for my clients at my investment firm Global Guru Capital.
For a period of more than 20 years, the investment strategies of top university endowments seemed blessed by fairy dust. The top three U.S. university endowments — Harvard, Yale and Stanford — consistently had returned more than 15% per year over the last decade. And even after the onset of the credit crunch in the summer of 2007, the Harvard endowment gained 8.6%, Stanford rose 6.2% and Yale climbed 4.5% through June 30, 2008. That compared with a drop of 15% in the S&P 500 over the same time period.
That all changed once the financial crisis hit in full force in 2008, and the top university endowments plummeted by 25%-30%. The joint losses for Harvard, Yale, Stanford and Princeton hit $23 billion in the 12 months ending June 30, 2009.
Maybe those Ivy League types weren’t so smart after all…
Since the dark days of 2008, top university endowments have staged a comeback. Primed by savvy investments in technology, Stanford’s endowment rose 14.4% in the year ended June 30, 2010, outshining returns at Harvard and Yale, which gained 11% and 8.9%, respectively.
Yale’s David Swensen: The “Babe Ruth of Investing”
You can trace the long-term investment success of top university endowments directly back to the efforts of a single man, Yale’s David Swensen.
As the Yale endowment’s chief investment officer for two decades, David Swensen has earned a reputation as the “Babe Ruth” of the endowment investment world
After taking over the Yale endowment in the mid 1980s, Swensen boasted 15.6% average annual returns through 2007 and no down years going back to 1987.
So, how did Swensen’s success single-handedly change the rules of institutional investing?
In 1985, around the time Swensen took over, Yale had more than 80% of its endowment invested in domestic stocks and bonds. But Swensen, an economics PhD, observed that no asset allocation model ever actually recommended that way. As long as their correlation with U.S. stocks and bonds was low, adding unconventional assets to your portfolio would both reduce your risk and increase your return. This led Yale to emphasize private equity and venture capital, real estate, hedge funds that offer long/short or absolute return strategies, raw materials, and even more esoteric investments like storage tanks, timber forests and farmland.
Until the fall of 2008, this approach worked almost like magic…
The “Yale Model”: Still the Best over the Long Run
But the relatively poor performance of the Yale endowment during the crash of 2008 put Swensen on the defensive. Critics pointed out that during the meltdown, a traditional portfolio of 60% stocks and 40% bonds would have lost only 13% of its value, rather than the 25% or more lost by the diversified portfolios of Harvard, Yale and Stanford.
But as Yale’s President Richard Levin pointed out in Newsweek magazine, that argument is astonishingly shortsighted. Over the past 10 years, including the crash, Yale’s endowment managed average annual returns of 11.7% to reach its current value of $16 billion. A 60/40 portfolio over the same period would have earned 2.1%, producing an endowment of only $4.4 billion. Put another way, Swensen’s strategy had earned Yale an extra $11.6 billion over 10 years. That indirectly made Swensen one of the world’s largest philanthropists, on par with Warren Buffett and Bill Gates.
Throughout the crisis, Swensen remained adamant that the model was viable over the long run. He pointed out that the single worst thing that you can do is to avoid risky assets after a market crash. He knew that Yale had suffered from poor decisions on asset allocations in its past — one that had put Harvard-level wealth out of its reach forever.
You see, at the time of the market crash in 1929, the endowments of Harvard and Yale were roughly the same size. But Yale’s trustees got spooked and invested heavily into “safe” bonds for the next five decades, while Harvard tilted more toward stocks. The result? Over the next 50 years, in relative terms, Yale’s endowment shrunk to half the size of Harvard’s.
Since the crash of 2008, Harvard has implemented the lessons of 1929 well. Leaving its critics aghast, Harvard actually has increased its allocation to high-risk positions in alternatives, at the expense of its “safe,” fixed-income allocation.
Yes, You Can Replicate Harvard’s Success…
In 2005, Swensen published a book, “Unconventional Success: A Fundamental Approach to Personal Investment,” which explains how you can apply Yale’s investment approach to your own portfolio. Swensen argues that Yale’s investment strategy is tough for you to duplicate. After all, Yale has 20 to 25 investment professionals (Harvard at one time had as many as 200) who devote their careers to looking for investment opportunities. Yale also has the deck stacked in its favor. Its sterling reputation allows it to invest in the very best private equity and hedge funds — asset classes that are not readily available to retail investors. As Mohamed El-Arien, a former head of the Harvard endowment put it, attempting to duplicate Harvard’s results “would be like telling my son to drop out of school and play basketball with the goal of becoming the next Michael Jordan.”
Of course, highly paid investment managers like El-Arien have every reason in the world to overstate the impact of their “skill.” But this does not dilute Swensen’s basic message: to focus on the “big-picture” asset allocation decisions and move your money out of U.S. stocks and bonds into global and other asset classes. Swensen himself recommends that you model Yale’s asset allocation through a portfolio consisting exclusively of index funds with low fees.
At my firm, Global Guru Capital, I have run an “Ivy Plus” Investment Program that replicates the investment strategy of the top university endowments using Exchange Traded Funds (ETFs) for the past two years. So far, it has behaved exactly as advertised. In the 12 months between June 30, 2009 and June 30, 2010- dates for which Havard has released performance data – the performance of the fully invested “Ivy Plus” investment program has matched the Harvard endowment almost exactly.
Of course, two years isn’t a long time. But the “Ivy Plus” strategy has outperformed some of the top hedge funds in the world during some of the toughest times ever in financial markets, by sticking to a disciplined, highly diversified asset allocation strategy.
My biggest challenge? The “Ivy Plus” investment program is a hard strategy to “sell” to my potential clients. It just seems too unexciting and straightforward to believe…
The bottom line? You may not have access to the Michael Jordans of the investment world. But diversifying out of a standard U.S. stock and bond portfolio into asset classes like commodities, real estate, and global stocks and bonds can go a long way toward generating Harvard-style returns.
Maybe those guys and gals at Harvard, Yale and Stanford aren’t so dumb, after all…