Yale Cuts Hedge Fund Portfolio to Up Private Equity

(March 19, 2010) — Yale University’s $16 billion endowment will trim hedge fund investments to increase its percentage in private equity and real estate, Bloomberg reported.

“Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management,” the report released yesterday stated. “The endowment’s long time horizon is well suited to exploiting illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas,  timber and real estate.”

According to the university’s annual report, Yale, the second-richest university after Harvard University, has dramatically reduced its dependence on domestic marketable securities over the past two decades by shifting to nontraditional asset classes. In 1989, 70% of the endowment was invested in stocks, bonds, and cash. Today, only 11.5% is invested in domestic marketable securities. Foreign equity, private equity, absolute return strategies, and real assets, which include real estate and commodities, represent 88.5% of the target portfolio, Yale’s endowment report noted.

The fund will increase its investment in private equity to 26% from 21%, while targeting an increase in its investment in real assets to 37%, up from 29% as of June 2009.

Both private equity and real estate contributed to Yale’s investment loss of 24.6% in fiscal 2009, when US college and university endowments lost nearly one-fifth of their value with an average endowment loss of 19%. Yet, in the decade through June, Yale generated an average annualized net investment return of 11.8%, surpassing Harvard’s 8.9% gain.

Yale’s CIO David Swensen, one of the best-regarded investors and champion of the “Yale Model,” the investments style that relies heavily on diversification into the so-called illiquidity premium offered by alternative assets, has also expressed no interest in allotting more money to fixed income investments. Swensen, Yale’s CIO since 1987, stands by the endowment’s 4% target asset allocation to fixed income. “Yale is not particularly attracted to fixed income assets, as they have the lowest historical and expected returns of the six asset classes that make up the Endowment,” the university’s report stated. “In addition, the government bond market is arguably the most efficiently priced asset class, offering few opportunities to add significant value through active management.”

In recent news, Swensen has also criticized the fee structures at large buyout firms, highlighting concern over the rise in management fees. “As funds get bigger, the percentage of fees stays constant, but the number of people involved does not correspond,” said Swensen, according to Financial News. “Management fees become a profit centre and the goal becomes to protect the franchise rather than deliver great investment returns.”