How Yale Beat the Market

The Yale Endowment released their 2017 report, taking a victory lap over their 20-year returns.  In their hubris, the endowment’s management team let slip the secret to beating the markets.  “[A]ctive management can be a powerful tool for institutions that commit the resources to achieve superior, risk-adjusted investment results.”  If only Harvard had thought to commit the resources to achieve superior, risk-adjusted investment results!

What’s happening here is two of the planet’s greatest active managers disagree about passive investing.  Warren Buffett says most individual and institutional investors would be better off indexing.  Yale’s David Swenson argues that institutional investors with the resources to do so should just pick good funds.

Check out this gem of a footnote in the report:

“Yale’s 106.3% venture capital return over the past twenty years is heavily influenced by large distributions during the Internet boom. Since such a calculation assumes reinvestment of proceeds from the portfolio during the period at the same rate of return for the rest of the period, it is inappropriate to compound the 106.3% return over the twenty-year time horizon. For reference, the twenty-year time-weighted return of Yale’s venture capital portfolio is 25.5%. Returns for other illiquid asset classes are not subject to large distortions.”

I’m not saying that you will never achieve a 100+% VC return or 25% over 20 years, but wow these are really tough numbers to hit, especially factoring in taxes an individual would pay that endowments do not.  This is the sort of data that should convince most people/institutions not to invest like Yale.  Their Private Equity returned 34% annualized for the ten years ending in their fiscal 2007.  This is not normal and Yale’s asset class return expectations reflect this.  They expect VC to return “just” 16% going forward and Leveraged Buyouts a mere 10%.

I understand what Swenson is saying, but he seems to understate how monumentally special the investing environment at Yale is.  Just throwing “resources” at the problem of investment management doesn’t result in outperformance.  Buffett’s point isn’t that passive investing outperforms active, it’s balancing need versus want.  Investors may want to beat the market, but is that really necessary to achieve their goals?  Until recently, outperforming their peers was a stated goal of Harvard’s endowment.  That didn’t work out despite having the most resources to deploy out of any of their peers.

If all this talk of Yale curb-stomping the benchmarks has you feeling down, take a look at the 10-year numbers.  Yale’s 6.6% annualized return lands it in the top 4% of its peers.  A portfolio of 70% S&P 500 and 30% Barclays Aggregate would have returned 6.7% over the same time.  The ability to “achieve superior, risk-adjusted investment results” is within reach of everyone, not just hedge funds with colleges attached to them.