Imagine earning an average of 93% over each of the last 20 years. I’m not talking about one lucky year of outsized returns like those experienced by many hedge funds and money managers.
These are breathtaking returns, no matter what the benchmark.
Nothing Illegal Or Unethical
One of the first things we learn as investors is that if it seems too good to be true, it probably is.
The truth is that there is nothing illicit or wrong about these huge profits, and they are in fact, 100% legitimate. These are the returns of one of the private equity investments of the large and respected Yale University Endowment.
The most exciting thing is that it is possible to build a similar portfolio as an individual investor.
The large Yale University Endowment Fund is the second largest university endowment in the United States with nearly $26 billion under management.
Managed by David F. Swensen Ph.D., the fund is built from thousands smaller of funds with a wide variety of purposes and restrictions. Over the past three decades, Yale’s investments overall have produced an average annual return of close to 13%, which is how they built that $26 billion in value.
The University structures its investments via a combination of informed market judgment and academic financial theory.
Yale has been steadily moving away from domestic marketable securities, such as stocks and bonds, to non-traditional asset classes. Thirty years ago, over four-fifths of the endowment was invested in U.S. stocks, bonds, and cash. Today, these asset classes only account for one-tenth of the total portfolio. Instead, private equity, absolute return strategies, and real assets make up the remaining nine-tenths of the Yale Endowment.
The reason for this radical change is the fact that today’s portfolio is designed to produce significantly higher returns and lower volatility than in 1985. Non-traditional asset classes are less efficiently priced than domestic stocks and bonds, which means there are greater opportunities to exploit inefficiencies via active management.
In addition, the inherent long-term nature of non-traditional assets such as oil & gas, venture capital, real estate, and leverage buyouts, matches more favorably with Yale’s long-term perspective.
Here’s a closer look at the Yale Endowment’s primary asset classes.
This is where Yale’s earned the best returns. Private equity is ownership in companies That dramatic 93% in annual returns for the past 20 years all came from Yale’s private equity investments. Early Investments in Google (now Alphabet Inc (GOOGL) and LinkedIn Corp (LNKD) helped create these massive returns. Private equity currently makes up about 16% of Yale’s holdings.
An absolute return strategy is one that seeks to be profitable regardless of the underlying markets or benchmark. Anthony McDonald explained absolute return strategies to Morningstar this way, “The strategy aims to make a positive absolute return for investors, so mainly to make money. The key point being that they should be making money regardless of the underlying market condition in the asset class, be it equities, be it bonds, that they primarily are investing in. So where they differ from your normal long-only equity or bond fund that most retail investors and advisors still use at the core of their portfolio is that they should be less dependent upon the direction of the underlying markets.”
Specific absolute return strategies include long-short equities, relative value, event-driven, global macro, and funds of funds hedge funds.
By not being tied to any benchmark or the bullish performance of equities, absolute return strategies seek to produce consistently positive returns over the investment time horizon.
Absolute return is Yale’s largest strategy, accounting for 20%-plus of fund allocation in 2015.
Real assets made up 14% of the Yale Endowment allocation map in 2015. Yale helped pioneer real estate investing as a major part of a diversified investment portfolio. Real estate fits the long term and illiquid nature of the University’s investment goals.
Risks To Consider: Although individual investors can seek to replicate the investments of the Yale Endowment, don’t forget that Yale has access to massive resources and investment brain power simply not accessible to most of us. These ideas should be taken as broad strokes as to how to build a diversified portfolio rather than particular buy/sell suggestions.
Action To Take: Take to heart Yale’s long-term perspective and massive diversification whenever building an investment portfolio. Investors who are seeking to build a similar portfolio can start by looking at the following ETFs:
— Private equity — PowerShares Global Listed Private Equity Portfolio ETF (PSP)
— Absolute Return — First Trust Alternative Absolute Return Strategy ETF (FAAR)
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