One of the silliest TV comedy sitcoms when I was growing up was Gilligan’s Island. The show ran for just four seasons in the mid-1960s. Now ancient and cringingly bad, the show had a near cult viewing audience via syndicated re-runs in the ‘70s and ‘80s.
I remember the show well and also the adolescent boy talk: Mary Ann or Ginger? I was partial to Mary Ann; Ginger’s sequined evening gowns seemed gauche to me, even as a lad.
The funniest character on the show was Thurston Howell III, the pretentious millionaire buffoon who flashes cash around the island, avoided manual labor and, based on his extensive hob-knob wardrobe, over-packed for a three-hour tour.
Thurston was the stereotypical New England elite snob, a "Haaaavard man" and married to the daffy socialite Lovey. I ran across a funny Forbes list of the richest fictional characters in history – and the Thurston landed at # 9. In case you’re interested, Willy Wonka is #10, Jed Clampett is #7 and Santas Claus is #1.
Sadly, five of the seven actors from Gilligan’s Island are now deceased; only Ginger and my girl Mary Ann still survive.
Sticking with the Ivy League theme, I have long admired the investment approach and success of many college endowment funds, but especially the efficacy of Yale University’s endowment fund. Sorry Thurston, but unlike Yale, Harvard’s long-term endowment return record is okay but not orchestra seats good. Yale’s sitting in the front row.
The Yale endowment fund exceeded $29 billion in assets as of June 2018 – second only to Harvard’s endowment in size - and has been exceedingly well-managed by Dr. David Swensen since 1985.
Under Swensen’s leadership, the Yale endowment was in the forefront of bucking staid / conventional investment policy guidelines – e.g. stocks, bonds and cash – and he designed a progressive approach to institutional portfolio management that has transformed endowment investment management business – and offers lessons for individual investors as well.
Swensen’s pioneering work for the Yale endowment has produced an impressively successful investment track record for more than three decades, a record marked by consistent outperformance over the endowment universe and capital market indices. The Yale investment model superior has been copied across the endowment landscape; even Harvard eventually became a convert. Many endowment funds are now managed by Swensen acolytes.
Swensen’s track record speaks for itself: Per its website, the Yale endowment returned 11.8% per year for the past twenty years ending June 30, 2018. For perspective, the average college endowment average annual return was 6.8% over the same period.
What is Swensen’s secret investment sauce? It’s simple but complex: Pairing broad portfolio diversification using an array of uncorrelated alternative asset classes managed by outsourced third-party investment firms.
Swensen believes that traditional portfolio management limited to just stocks and bonds can lead to sub-par investment outcomes over time, due to the human obsession with short term results, bad corporate governance, closet indexing and the investor herd dynamic.
You think I’m kidding about the degree of Swensen’s portfolio diversification? Again, per their website, at June 30th, 2018 the Yale endowment had only 4% invested in US stocks, 15% in foreign equities (emerging markets) and a mere 4% invested in bonds! That means 77% of the massive money pot was invested in alternative investments, directed into semi-weird asset classes like absolute return (hedge funds), natural resources, venture capital, private equity and real estate.
Furthermore, up to fifty percent of the portfolio can be invested in illiquid investments. The objective is to produce above-average returns over time while eschewing short-term benchmark index chasing.
Interestingly, Swensen views investment manager track record as an over-rated factor. He’s not shy to allocate capital to an upstart money manager if he likes their niche, process and philosophy. We disagree with this element of his investment model.
He disdains the bad corporate governance displayed by so many publicly traded corporations managing their business to survive the next quarterly report. A material allocation is invested in private equity and venture capital, non-public businesses managed on a five-to-seven-year plan without outside capital market interference.
Swensen is concerned about the future adverse effect of massive US deficits and indebtedness. Accordingly, he has shifted the portfolio allocation away from bonds to hard assets like timber, energy and real estate to hedge against future inflation, US currency and bond market risks.
Harvard was late to adopt Yale’s endowment investment model, especially when it came to outsourcing money management. After a persistent period of relative underperformance, however, Harvard got on board and now farms out its money management as well.
Yale’s unconventional endowment investment approach may seem radical at first blush, but it comports well with modern portfolio theory. MPP’s founding principal is that a portfolio’s investment return will vary mainly based on its construction and level of diversification, fancy terms for asset allocation. Less correlation among portfolio investments can translate into better risk-adjusted returns over time. We agree.
Our clients reading this blog may be thinking the Yale investment model sounds very familiar: Double-wide portfolio diversification using a broad mix of asset classes, many with strange sounding names, some less liquid and all managed by independent managers. That model happens to mirror our investment process and that’s not a coincidence. Imitation is the greatest form of flattery and if I’m going to peek at someone else’s investment work, Swensen is the best choice.
Unlike an endowment, however, Baby Boomers do not have a perpetual time horizon and they should find the risk management benefits of the Yale endowment investment model appealing, especially as they contemplate retirement at the end of the longest bull market in history.
One of the great advances in the investment industry is the availability of so many alternative asset classes for retail investors that traditionally were only available to endowments and other large institutional investors.
We use them every day in our practice just like an endowment manager, without the Yankee accent or ascot of course.
Until next time, be well…Tim