One way to improve your wealth is to observe how the rich invest their money, learn why, and potentially follow suit. University endowments are some of the world’s wealthiest institutions. Endowments
One of my tenants joined a massive private university endowment as an analyst, so I asked her about their alternative investment allocation (real estate, absolute return, private equity, etc). She responded, “It’s well over 50%.” I was surprised because I don’t know many regular folks who have that high of an allocation in alternatives. Maybe 5-20%, but certainly not 50%+.
She said, “They’ve got no problem investing a majority of their assets in alternatives because they don’t need the liquidity, have invested in alternatives for a long time already, are comfortable with the risk profile, and they’re only shooting for a 5% annual return.”
I thought her response was interesting because it somewhat parallels my own liquidity and desired return situation. More than 50% of my net worth is illiquid due to my long-term property investments, private equity/fund investments, and pre-tax retirement accounts such as my 401k, SEP IRA, and Rollover IRA. If I could get a steady 5% overall net worth return every year, I’d probably take it. Once you build a large enough financial nut, small percentages make a big difference. I don’t need liquidity because I live way below my current income streams.
In this post, I’ll be profiling Yale University’s ~$24 billion endowment fund to see where they invest their money. Yale Endowment helped pioneer investing up to around 20% in real estate as part of a diversified investment portfolio. We can all add real estate to our portfolios much more easily and cheaply through real estate crowdsourcing platforms like Fundrise. Fundrise allows you to invest as little as $1,000 in an investment property around the country.
Let’s see what else the Yale endowment has.
Besides being the home of the Skull & Bones secret society, Yale University also boasts one of the nation’s largest endowments led by David F. Swensen, PhD.
About 26 years ago, Yale became the first institutional investor and university endowment to define absolute return strategies as a distinct asset class, beginning with a 15% target allocation. Absolute return strategies is code word for hedge funds, as hedge funds look to provide a positive return in both bull and bear markets.
Who did Yale look towards first for absolute return strategies? Tom Steyer’s Farallon Asset Management based right here in San Francisco. Tom Steyer received his bachelor’s degree from Yale. Before starting Farallon in January, 1986, he worked at Morgan Stanley, Goldman Sachs in the risk arbitrage department under Bob Rubin, and Hellman & Friedman in private equity.
In 1987 Steyer approached David Swensen, Yale’s CIO, to manage a portion of Yale’s endowment for no fee to prove himself. After Farallon’s initial success, other college endowments followed Yale’s example. By then, hedge funds were now charging 2% of assets under management and 20% of the profits.
It’s a small world because I literally see Tom, who is now retired from Farallon, at our tennis club every week. He’s been making political waves and announced in July 2021 that he’s running for president in 2021 and spending $100 million of his own money on his campaign!
Whether you’re a billionaire or a recent graduate, we’re all the same on the tennis court, so learn a social sport already. And for those of you still spending lots of your money on a car, Tom drives a ~7 year old Honda Accord!
Here is historical performance data from the Yale Endowment Report. If you can consistently make 5% – 10% on billions of dollars, you’re going to do fine despite underperforming the S&P 500 during some years.
In addition to steady returns, notice the gradual increase in asset allocation to Absolute Return, Venture Capital, and Foreign Equity and the gradual decrease in exposure to Real Estate, Domestic Equity, Natural Resources, and Leveraged Buyouts since 2011.
Here is Yale’s 2021 planned asset allocation as stated in their latest newsletter.
Yale’s asset allocation is so diversified compared to the typical investor who might only invest in stocks and bonds. The reason for Yale’s diversification is due to their size, access, experience, and time horizon.
Read what Yale has to say about their own asset allocation.
Over the past 25 years, Yale dramatically reduced the Endowment’s dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1990, over 70% of the Endowment was committed to U.S. stocks, bonds, and cash. Today, domestic marketable securities account for approximately 10% of the portfolio, while foreign equity, private equity, absolute return strategies, and real assets represent nearly nine-tenths of the Endowment.
The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power. Today’s actual and target portfolios have significantly higher expected returns and lower volatility than the 1990 portfolio. 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 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.
Today, the absolute return portfolio is targeted to be 20 percent of the Endowment, below the average educational institution’s allocation of 24.4 percent to such strategies. Absolute return strategies are expected to generate a real return of 5.25 percent. Unlike traditional marketable securities, absolute return investments have historically provided returns largely independent of overall market moves. Since its 1990 inception, the portfolio exceeded expectations, returning 11.2 percent per year with low correlation to domestic stock and bond markets.
Over the past two decades, the Endowment returned a cumulative 1,152 percent relative to the Cambridge median of 402 percent, an outperformance of 5.1 percent per annum.
I find it amazing that Yale’s domestic equity and fixed income only account for less than 10% of their overall portfolio. Most of us won’t have such diversification because we don’t have the resources or the expertise in investing in so many different asset classes. But I do strongly recommend following a proper net worth allocation by age that incorporates real estate and alternatives as part of your net worth.
Please also check out an appropriate stocks and bonds allocation by age as well if your investments are relatively straightforward.
Ever wonder what universities use their massive endowment funds for, especially private schools with their mind-boggling tuition rates? For Yale University, it looks like almost all income generated is spent supporting school activities, although “Miscellaneous Specific Purposes” and “Unrestricted” looks like a large chunk of the pie that might make people wonder.
Individuals can easily replace Maintenance, Professorships, Books, Scholarships, etc with Housing, Food, Travel, Taxes, Charity, etc as part of their investment fund allocation.
I hope this post gives you a glimpse into how wealthy institutions and high net worth individuals invest their money so the rest of us can make better investment decisions. So many times I read negative commentary about alternative investments from people who’ve never invested in alternatives before. It’s as if we automatically attack what we don’t understand. Please keep an open mind with a focus on learning new things. There’s a reason why the rich are rich and tend to stay rich!
We can all easily build a portfolio of stocks, bonds and speciality ETFs through an online brokerage for way less than in the past with much better risk parameters. We can also buy REITs or physical property to create a similar asset allocation to the endowments. But so often we over-allocate towards property because our primary home tends to be so much more valuable than all our other investments.
We’ve also got digital wealth advisors like Betterment to manage our public investments for us for much lower fees (0.25%) than traditional money managers. In the past, we’d need $1M in assets and have to pay 1-2% for such service. Slowly, but surely, new companies are further democratizing access to investments that were once accessible only to the rich. It’s up to us to understand and take advantage.
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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He is aggressively investing in real estate crowdfunding to arbitrage low valuations and take advantage of positive demographic trends away from expensive coastal cities.
Updated for 2021 and beyond.