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What We Can Learn From the Yale Endowment

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Written by: Tim Clift | Envestnet

Those in the investment community’s inner circle acknowledge that David Swensen, who runs the Yale Endowment, has an enviable investment record—who wouldn’t want the kudos that accompany running a $25 Billion fund and outperforming by close to 30% more than its nearest competitor in 2015?

Most individual investors’ portfolios won’t grow to that size, but they can benefit from Swensen’s approach, principles, and process. First, he espouses diversification—not merely between traditional stocks and bonds, but among a mix of low-correlated asset classes comprising of alternatives, such as private equity, real estate, and hedge funds. Access is easy to these investments, given the explosive growth of exchanged-traded funds.

Swensen encourages his team to debate investment ideas, ensuring each member has a point of view. Similarly, investors should articulate why an investment makes sense—and write it down before buying it. Swensen says, “I think that if you write your argument down, you might recognize flaws in it.”

A manager’s long-term track record is vital, but sometimes new managers, with little significant performance to speak of, can have an excellent investment thesis and generate solid returns. It also makes sense to give managers time to perform—too many investors are focused on short-term results, rather than viewing managers as long-term partners. Patience is not just a virtue—it’s a necessity when it comes to investing. Yale’s average manager relationship is 13 years.

Swensen also shines a spotlight on leverage, preferring managers whose returns derive from bottom-line growth rather than financial engineering. He is not alone: The sage of Omaha, Warren Buffet, says, “Just about the only way a smart person can go broke is to borrow money.” The Yale Endowment is guided by the debt-to-equity ratio for the S&P 500—a modest 1.1, which has averaged 1.7 on a historical basis. Anyone who doubts the validity of low debt need only recount the chronicle of highly leveraged Long Term Capital Management’s demise in the 1990s, when none other than the Federal Reserve organized a consortium of brokerage firms and banks to pony up $3.6 Billion to avert a financial meltdown. (Yes, it’s pocket change compared to the bailouts in 2008, but it was real money back then.) Borrowed money can inflate returns, but it works both ways: When stocks slide, lenders still expect to be paid.

Investing is as much about the people as the numbers. Investors would do well to pay attention to personalities and temperament, and not be afraid to trust their instincts. One Yale Endowment analyst, noting elevated arrogance in a potential manager, passed on investing. A manager’s dismissive attitude in the sales process doesn’t bode well for the requisite handholding when the inevitable tough times surface. 

In a nutshell, a diversified portfolio of investments with a clear thesis, adequate time to perform, low leverage, and quality managers won’t guarantee success, but it can put investors on a more level playing field with the experts.

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