(July 8, 2013) – Michael Scotto, a partner at consultancy Hewitt EnnisKnupp, hears the same question over and over again from endowment and foundation investment committees: Is the Yale Model dead?
Yale University’s investment office did better than many of its Ivy League brethren in 2012 with 4.7% returns—Harvard lost 0.05%—but has yet to regain its pre-financial crisis footing.
The alternatives-heavy and highly illiquid strategy championed by longtime Yale CIO David Swensen led to catastrophic losses of $6.5 billion in FY 2009—a 24.7% reduction of the endowment’s value.
So is it time to label the Yale Model a failed experiment and move on?
Scotto, who has lead Hewitt EnnisKnupp’s hedge fund research efforts for more than a decade, answered “no” in a recent blog post. But, he pointed out, only a few CIOs should have been experimenting with it in the first place.
“In our view, the full Yale Model approach only makes sense for a limited set of institutions: those with extremely long time horizons, top-tier balance sheets, sophisticated staff, investment committees, and consultants, and not least, the ability to fundraise when needed,” Scotto wrote. “For others, mimicking the Yale approach in its entirety makes less sense.”
Endowments, foundations, and other institutions without the expertise, solid financial footing, and ability to raise cash in a crisis should “think very carefully about the size and timing of less liquid investments relative to overall finances.”
Whereas Yale held just 20.2% of its portfolio in liquid assets (stocks, bonds, and cash) as of June 30, 2012, Scotto contended that institutions don’t have to go all-in on the model to take advantage of its return-boosting capabilities.
Stress-testing and financial metrics would help CIOs determine the appropriate illiquid allocation for a given portfolio, he advised. Once a target has been defined, illiquid exposures should be housed in long-term balance sheet accounts, and offset with more liquid holdings elsewhere.
“Rather than blindly following Yale,” Scotto wrote, “this approach would lead to alternative exposures in sync with the ability of an institution to withstand potential shocks, and in our view, a better experience for most.”