One thing that Yale’s new endowment director Matthew Mendelsohn might want to examine is the university’s ultra-low allocation to U.S. stocks of just 2.3%.
The paltry exposure to U.S. stocks reflected the philosophy of former endowment chief David Swensen, who favored more illiquid asset classes like private equity, venture capital, natural resources and real estate over public equities.
Swensen’s widely imitated alternatives-heavy approach was dubbed the Yale model. Swensen died in May, and Yale recently named Mendelsohn, who has worked at the endowment since 2007, to succeed him as chief investment officer.
Most big endowments have small allocations to domestic stocks with Stanford and Princeton below 10%, but Yale may be the lowest. Yale has one of the country’s largest university endowments at $31 billion as of June 2020.
Yale’s big underweighting in U.S. stocks didn’t help the endowment in the 10 years ended in June 2020 when domestic equities had a great run, and it likely dampened performance in the year ended June 2021, when the S&P 500 returned 40.8%.
Big endowments like Yale are expected to report their investment returns for the year ended June 2021 in September and the result are apt to be stellar, reflecting big gains in private equity, venture capital and public equities.
There is speculation that some large endowments could have returns over 30%. In an indication of strong private equity returns,
(BX) said its funds had gross returns of 52% in the year ended June 2021.
One indication of strong endowment results is that Wilshire Trust Universe Comparison Service (TUCS) reported in August that large institutional funds that it tracks returned a median of 25.3% in the June 2021 year, the strongest results in 35 years. The big endowments generally top the Wilshire TUCS figures.
Under Swensen, who ran the Yale endowment starting in the mid-1980s, the university vastly outperformed its benchmarks until 2010, but the comparisons have gotten tougher since then mostly due to strong performance of U.S. stocks.
Yale’s endowment returned 6.8% in the year ended June 2020 and 10.9% in the prior 10 years.
The 10-year returns were behind the 14% yearly return on the S&P 500, meaning that a buy-and-hold investor in an S&P index fund beat Swensen’s returns.
Yale’s 20-year annualized returns of 9.9% handily topped those on domestic stocks of 6.2%. Yale’s returns in the year ended June 2020 trailed the endowments at Harvard, Brown and Dartmouth but beat Princeton.
The endowments like to compare their returns to the the Wilshire TUCS average rather than to the S&P 500, which they would argue has more risk than their diversified portfolios.
Some measure themselves against a 60/40 blend of stocks and bonds but that is a flattering comparison considering they tend to have low bond allocations and have portfolios with greater risk than a 60/40 blend.
Yale’s view, which has been echoed by its peers, is that asset classes like private equity and venture capital offer better risk-adjusted returns than traditional U.S. stocks, which was the largest asset class in the Yale endowment in 1990.
“The heavy allocation to nontraditional asset classes stems from their return potential and diversifying power,” Yale said in its 2020 endowment report. “Today’s actual and target portfolios have significantly higher expected returns than the 1990 portfolio with modestly higher volatility. 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 exploit illiquid, less efficient markets.”
The idea that alternatives offer better risk-adjusted returns than U.S. stocks is debatable. The counterargument is that private equity, for instance, represents an illiquid, fee-heavy, leveraged bet on U.S. stocks and that the diversifying power of alternatives is overstated given high correlations between equity-like asset classes.
Some will say that it’s too late now for Yale to plow more into U.S. stocks given their long run.
But Yale essentially has decided to forego an investment in the largest single asset class in the world and some of the globe’s best and most innovative companies. Yale and most other big endowments have favored non-U.S. stocks to domestic ones and that hasn’t been a great move given that U.S. equities have outperformed for a decade.
Given that Mendelsohn was a protégé of Swensen, it’s unlikely that a major change in the U.S. equity allocation will be made.
Mendelsohn declined to talk to Barron’s and didn’t respond to an emailed question about Yale’s U.S. equity exposure. He did say this in an email in response to a question about challenges and opportunities:
“We will face many of the same challenges that other institutions will be facing, and we plan to stay sharp to anticipate and manage them while pursuing the best opportunities out there. Fortunately, we have a fantastic team to tackle both.”
Write to Andrew Bary at firstname.lastname@example.org