While many pension funds are switching to passive investments to save money on fees, Yale University’s endowment has staunchly defended its actively managed investing strategy against so-called “fee bashers” in its most recent annual report.
“In recent years, a broad range of market commentators have decried excessive fees paid to hedge funds and private equity funds,” said the Yale Endowment in its 2016 annual report. It went on to say that what the “fee bashers miss is that the important metric is net returns, not gross fees.”
Yale said its investment strategy emphasizes long-term active management of equity-oriented, often illiquid assets. It added that performance-based compensation earned by outside active investment managers reflects the endowment’s outperformance, and boasted that it had the highest investment returns among all colleges and universities over the past 20 and 30 years, citing Cambridge Associates.
“Weak or negative returns would result in low or no performance-related fees, but would be a terrible outcome for the University,” said the endowment. “However, Yale has demonstrated its ability to identify top-tier active managers that consistently generate better-than-market returns, after considering performance fees,” said the report. “Yale’s returns net of fees are superior to the returns of the low-cost index-tracking vehicles.”
The endowment said that over the 10-year period ending June 30, 2016, it earned an annualized return of 8.1%, net of fees, which put Yale among the top 3% of colleges and universities.
“In the past 10 years, nearly every asset class posted superior returns, outperforming benchmark levels,” said the endowment. “Over the past decade, the absolute return portfolio produced an annualized 5.9% return, exceeding the passive Barclays 9- to 12-Month Treasury Index by 4.2% per year, and besting its active benchmark of hedge fund manager returns by 3.5% per year.”
The university acknowledged that instead of paying fees to active managers, it could instead invest in low-cost passive index strategies, which it said made sense for endowments and foundations that lacked the resources and capabilities to pursue active-management programs. It added that although the university would have paid lower fees if it had invested in a passive index strategy over the past 30, it would have meant dramatically lower net returns.
The report said that if Yale’s assets had been invested in a portfolio of comprised 60% of US equities, and 40% of US bonds over the past 30 years, the endowment would have been reduced by more than $28 billion.
“Strong active management contributes to Yale’s outstanding absolute and relative investment performance,” said the report. “While passive investment strategies result in low fee payments, an index approach to managing the university’s endowment would shortchange Yale’s students, faculty, and staff, now and for generations to come.”