With my children approaching college, I know firsthand how tough it is to get into Ivy League institutions like Harvard, Yale, Princeton, and Columbia. The competition is so intense, these colleges are forced to turn down thousands of applicants with perfect SAT scores. So applicants need an edge to get in, such as successfully starting a business, championing a charitable cause, or displaying outstanding athletic or musical talent.
Interestingly, the same heated competitive spirit found among applicants is just as widespread among the managers of these colleges’ endowments. It’s not just about bragging rights. How much financial aid an institution can offer to highly sought-after students or raise to finance new buildings helps separate it from the rest of the pack.
Right now, Harvard has the largest endowment fund (just short of $38 billion), but has recently posted rather substandard returns. Over the past four years, the performance of Yale’s endowment has been 4% better on an annual basis. That’s billions left on the table.
To put things in perspective, $1,000 invested in the Yale endowment in 1995 would be worth about $13,000 today. That’s impressive.
What Makes the Difference?
To begin, let’s explore how these investment offices approach investing in contrast to the average investor.
First, while most individual investors focus on short-term stock picks and chase funds with the highest recent returns, endowment funds focus on asset allocation. That means figuring out what percentage of their capital is allocated to different assets such as U.S. large-cap and small-cap stocks or bonds.
A key difference is the variety of assets endowments use to diversify to meet their goals of lowering risk and volatility and increasing returns.
For example, below is Yale University’s asset allocation, which was recently described in a New York Times article. This goes to show how much long-term thinking and creativity an endowment exercises in spreading its capital around.
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The major difference between endowment managers and average investors is that endowments allocate more capital to what is referred to as alternative assets. These include private equity, venture capital, real assets such as timberland and precious metals, venture capital and hedge fund, covering all sorts of assets from frontier markets and currencies to global macro.
There are an infinite variety of hedge funds, but they can be broken down into two categories. Some seek absolute returns by using a long/short approach and tend to generate steady but unspectacular returns. Directional funds allocate assets using only limited hedging. Both categories seek better returns than a benchmark from the investment process, fund manager’s skill or, let’s face it, just plain luck.
Yale said in a statement that its highest returning asset class over the past decade was venture capital at an average annual gain of 18%. MIT’s annual financial report (released last month) shows steep increases in investments in foreign equities.
Now, you can’t invest in these alternative assets one day and sell the next. Along with the potential for high returns comes less liquidity and the tying up of capital for several years. This is why endowment funds carefully pick their money managers.
Some of you may have the resources to invest directly in these funds, so I encourage you to be very careful and selective if you choose to do so.
Build Your Own Endowment Fund
Finally, let’s explore how you can build your own endowment fund using transparent, low-cost, and flexible exchange-traded funds (ETFs).
The portfolio below contains 12 ETFs that would need to be adjusted for your personal financial situation (you should consult your advisor as to the individual weightings), but it’s a good start toward building your own endowment strategy.
The percentage allocations are a bit conservative and based on my personal preference only, and what I see as tapping into the best value opportunities for 2016.
You could consider this strategy for your core portfolio, and further build around it with your own stock picks, to get the best of both worlds.