Class Notes

David Swensen – CIO of Yale University

• Arrival in 1985 – handled Yale’s endowment

• 2nd largest university endowment in the world
• From $1bi to $23.9 bi at the end of 2014

• Unconventional approach

• Rather than keeping substantial share of assets in domestic equities and bonds – Yale made significant investments in PE  (VCs and buyouts), real estate, natural resources and hedge funds

• Enviable returns till the financial crisis

• Investment philosophy:

• Equities (public or private)

• Claim on a real stream of income (versus a contractual sequence of nominal cash flows @ bonds) – long run advantages
• Salaries (inflation) – bonds perform poorly during rising inflation

• Diversification

• Risk could be more effectively reduced by limiting aggregate exposure to any single class, rather than attempting to time markets

• Less efficient markets

• Difference in performance between managers – wider gap
• Incomplete information and illiquidity
• Only 24% in public stocks, bonds and cash!

• Outside managers

• Chosen carefully after analysis of abilities, comparative advantages, performance records and reputations - given autonomy

• Incentives facing outside managers

• Tried to structure innovative relationships and fee structures with external managers to align interests

Recent allocation and results

• Planning: Investment Office performs mean-variance analysis of expected returns and risks from current allocation and compares with those of Yale’s past allocations and the current allocation of other universities

• Relied on assumptions about expected return, volatility and correlation among assets

• Primary reason for Yale’s superior long-term performance record – excess returns generated by the portfolio active managers

• Greatest in the least efficient markets

Management of marketable securities

• Bonds = 5%

• Liquidity reserve – provide “non disruptive liquidity” to cover obligations without forcing the sale of illiquid assets
• Managed internally

• Domestic Equity = 6%%

• Indexed (passive) in the late 70s → Confident in ability to find superior managers and eliminated the passive portfolio in favor of active equity managers

• Disciplined approach to investing
• Smaller independent organizations owned by investment professionals
• Managers willing to co-invest and to be compensated commensurate with the investment performance

• Absolute return (hedge funds) = 20%

• Funds specialized in eclectic mixtures of strategies designed to exploit market inefficiencies
• Understand strategy and invest in groups where there is a clear return generation strategy and LPs are treated fairly
• Event driven (merger or bankruptcy settlement) & Value driven (changing fundamentals or market awareness) – equity like returns not highly correlated with any particular financial market
• Separate accounts

• Foreign equities (developed and emerging markets) = 13%

• Diversification

• Difficult to transfer US model – fewer sophisticated managers
• Focused on small cap stocks – less efficiently priced

• Emerging markets: opportunity due to inefficiency, dynamic and growing economy

The Management of Private Equity

• Domestic and International Venture Capital and Buyout Funds

• Consistent with overall investment policy

• Investment Office placed a premium on building long-term relationships with a limited number of premier organizations
• Emphasized PEs that took a value-added approach to investing

• Firms that build fundamentally better businesses
• Value-added operational experience

• Select organizations where incentives were properly aligned
• PE firm could cover ongoing costs from annual fee, earning all of its economic returns from the “carry” tied directly to investment performance