No, You Shouldn't Invest Like Yale
The Yale University endowment recently announced its return for the year ending June 30th, 2016 as well as its asset allocation targets for the current year. The endowment netted 3.4% but the overall size of the endowment declined slightly as the withdrawal exceeded the investment performance.
They published allocation targets as follows:
Absolute Return: 22.5%
Venture Capital: 16.0%
Foreign Equity: 15.0%
Leveraged Buyouts: 15.0%
Real Estate: 12.5%
Bonds and Cash: 7.5%
Natural Resources: 7.5%
Domestic Equity: 4.0%
A look at the allocation seems like a logical follow up to last week’s post titled Allocation Efficiency. In years past we have looked at the allocations from Harvard as well as Yale and a couple of other similar pools of capital.
Zooming out a little, Yale says it wants a minimum of 30% in non-correlated assets which it believes includes cash, bonds and absolute return. It limits 50% of the portfolio to illiquid assets which it says includes venture capital, leveraged buyouts, real estate and natural resources. Back when Jack Meyer ran the Harvard Endowment he might have included timberland in illiquid asset bucket. Jeremy Grantham has been a fan of timberland in recent years as well.
It is not practical for the typical advisory client or individual investor to emulate Yale’s portfolio for a couple of big reasons; endowments have infinite time horizons and access to some of these market segments is either unavailable or the choices that are available aren’t so great. Venture Capital is an example of this. The press release does not mention private equity but I am assuming that they mean venture capital and while there are quite a few exchange traded products (funds and individual issues) that seek to track the private equity space one way or another there are far fewer that I am aware of that track venture capital. The one that I do know (mentioning names becomes tricky for compliance reasons) went down with the broad equity market during the crisis but hasn’t really participated in the bull market since (up 28% since March of 2009 vs up 194% for the SPX).
If you’ve been reading this blog for a while then you know that I believe in small allocations to things like gold, merger arbitrage, certain forms of hedge fund replication and funds that sell short all in order to help manage correlation. There can be no assurance of infallibility but the track record and firsthand experience is good enough for me.
While I began to seek these out before the financial crisis, the alternative space has continued to evolve along with just about everything else. Over the weekend Barron’s touched on catastrophe bonds which help insurance companies manage reinsurance risk for events like hurricanes and pay relatively high interest rates while waiting for the next tornado to hit…or not. Barron’s contends that by virtue of being tied to catastrophic events they don’t take on interest rate risk. There was also a column in Barron’s on floating rate loans which are probably more familiar to most investors even if they played a smaller part in the typical portfolio up to this point.
I believe the need for alternatives exists because many traditional segments of the fixed income market face a serious threat from rising rates. The decline from double digit rates to now zero percent rates can’t be repeated. Rates can stay where they are (absolutely a possibility) but then investors are getting inadequate yields or rates can go higher which threatens to impair capital, perhaps permanently in some instances. Some believe the US Ten Year Treasury will go to 1% which is possible of course but the capital gain from 1.60% would not be anywhere near the tailwind of the last 35 years.
I’ve written a lot of posts about fixed income substitutes in this context but there will also be “new” bond market segments to learn about and possibly include like funds that hedge in such a way to manage duration including negative duration strategies and maybe there will be catastrophe-bond fund at some point (the market might be too small right now). I think portfolio construction will by necessity evolve into needing alternative fixed income strategies (still part of the fixed income asset class but not straight aggregate index or treasury exposure) as well as actual alternatives like absolute return and the others I mentioned above.
Successfully navigating whatever might come in the bond market (inadequate yields or falling prices) will require a willingness to learn about new segments and strategies as well as possibly allocating to them after reasonable and sufficient diligence.