RP: Over the years, much has been written about the endowments of prestigious American universities. One endowment in particular, the Yale Endowment run by David Swensen, has been hailed as a big success. The philosophy behind the so-called Yale Model was summarised in Swensen’s book, Pioneering Portfolio Management.
DC: The major characteristics of the Yale model are, that it has a very equity orientated approach. So, it’s looking to invest in equity risk or equity light risks. It has a tilt towards what we call illiquid assets, these would be things like hedge funds or private equity. And, at the same time, it has this belief in a very active style of investing. David Swenson in fact, wrote a very good book quite a few years ago now, called 'Pioneering Portfolio Management', where he sat out, in quite a lot of detail, his investment beliefs and how the Yale endowment went about fulfilling those beliefs in investing the portfolio.
RP: But just because the Yale Model has a good track record, that doesn’t mean investors should try to copy it. Indeed, David Swensen said as much himself in a later book, aimed at ordinary investors, called 'Unconventional Success'.
DC: His later book, 'Unconventional Success', was really trying to tell ordinary investors don’t just pick up the Yale model and apply that to your investment portfolio, because it’s something that requires an awful lot of resources and an awful lot of time in terms of sifting through investment opportunities, looking for the best managers and involves substantial amounts of risk. And, more importantly, costs an awful lot of money, therefore.
RP: As well as recommending what investors shouldn’t do, Unconventional Success also suggested what they should do instead — advice that Swensen has repeated several times since.
DC: If you’re an ordinary investor, you’re much better off starting from the position: “How do I get equity exposure?” So, I can do that for example through passive funds or through ETF’s and look to try and keep your costs as low as possible. Be very careful about investing in illiquid kinds of assets, where the amount of knowledge that is required to go investing in those areas is very substantial.
RP: In recent years, most of the big university endowments have failed to beat the market after costs. Consequently, universities and other institutions are increasingly using low-cost index funds. Unless you have very good reason to think that you can outperform the likes of David Swensen, you should too.
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