Yale Endowment Portfolio – David Swensen Investing
The Yale Portfolio, pioneered by the late endowment fund manager David Swensen, has gained attention and admiration for its unique investment strategy and long-term outperformance.
As the Chief Investment Officer of Yale University’s Endowment, Swensen helped popularize the endowment investing approach to other market participants (e.g., hedge funds, traders), reshaping traditional approaches and creating a legacy.
This article looks at the Yale Endowment Portfolio, David Swensen’s investment and portfolio construction philosophy, and the benefits and drawbacks of adopting this strategy.
Key Takeaways – Yale Endowment Portfolio (David Swensen Investing)
- The Yale Portfolio, pioneered by David Swensen, has gained recognition for its unconventional investment strategy and long-term outperformance.
- It emphasizes alternative investments alongside traditional equities and fixed income.
- Swensen’s investment philosophy focuses on diversification, active management, and a long-term horizon.
- The strategy aims to achieve high risk-adjusted returns through its allocation and by understanding and managing risk effectively.
- While the Yale approach has delivered strong performance, it may not be suitable for all investors because it necessitates a high level of due diligence, active management, and access to alternative investments.
- Individual investors can consider a simplified version, such as the David Swensen Lazy Portfolio, with a focus on six core asset types.
- We ran a backtest of an example allocation of the David Swensen Lazy Portfolio in this article.
Yale Endowment Portfolio
The Yale Endowment Portfolio is the investment strategy utilized by Yale University’s endowment fund, which is one of the largest and most successful endowments in the United States, along with that of Harvard University.
Over the past few decades, the endowment has consistently outperformed its peers and benchmarks by adopting an unconventional approach to asset allocation.
Unlike traditional portfolios that rely heavily on stocks and bonds, the Yale Portfolio emphasizes alternative investments, such as private equity, hedge funds, real estate, and natural resources (generally through equity and credit investments, both public and private), alongside traditional equities and fixed income.
David Swensen Investment & Portfolio Construction Philosophy
The cornerstone of David Swensen’s investment philosophy is diversification and a long-term investment horizon.
He believed that investors should hold a diversified portfolio of assets, each with a different risk and return profile.
This approach helps to minimize the impact of any single asset class on overall performance, while maintaining an attractive risk-adjusted return.
Swensen emphasized the importance of understanding and managing risk and focuses on achieving superior returns through active management, especially in alternative investments.
David Swensen Lazy Portfolio
The David Swensen Lazy Portfolio is a simplified version of the Yale Endowment Portfolio, designed for individual investors who may not have access to the same resources or investment opportunities as Yale.
It consists of six core asset classes/types of assets:
- domestic stocks
- foreign developed stocks
- emerging market stocks
- real estate
- US Treasury bonds, and
- inflation-protected securities (TIPS)
The allocation is based on Swensen’s recommendation for a well-diversified portfolio that requires minimal maintenance.
There is not a specific allocation, as it depends on the individual.
What Does Yale Do Differently with Their Portfolio Compared to Other Endowments?
Yale’s approach to endowment investing differs from its peers in several key aspects.
Focus on Alternatives
It has a more substantial allocation to alternative investments, which allows for greater diversification and access to higher-return opportunities.
Access to Top Managers
Yale’s investment team is known for its exceptional manager selection, often partnering with top-performing managers early in their careers.
This active management approach has contributed significantly to the endowment’s outperformance.
Long-Term Time Horizon
Yale maintains a long-term investment horizon and focuses on generating sustainable returns, rather than chasing short-term gains.
Who Is the Yale / David Swensen Approach Best For?
The Yale / David Swensen approach is best suited for long-term investors who are comfortable with a somewhat higher level of risk, understand the importance of diversification, and have access to alternative investments (if they want to go beyond the public markets).
This strategy requires a high level of due diligence and active management, making it more appropriate for sophisticated investors, such as institutional endowments and high-net-worth individuals.
Benefits of the Yale / David Swensen Portfolio
The primary benefits of the Yale / David Swensen Portfolio are its strong long-term performance, high level of diversification, and potential for superior risk-adjusted returns.
By allocating to various asset classes, including alternative investments, the strategy has historically outperformed traditional portfolios, while also reducing risk and volatility.
However, some of this volatility reduction is due to investing in private markets, where volatility is concealed.
Drawbacks of the Yale / David Swensen Portfolio
One significant drawback of the Yale / David Swensen Portfolio is that private investments, such as private equity and venture capital, may not be practical for most individual investors due to high minimum investment requirements and limited access.
Additionally, the strategy requires a higher level of due diligence (i.e., requires professional expertise), active management, and a long-term investment horizon, which may not be suitable for all investors.
Also, one would have to consider the tax efficiency of the approach versus something else.
Performance
While there is no specific allocation, we used the following based on the six core holdings:
| Asset Class | Allocation |
|---|---|
| US Stock Market | 15.00% |
| Long Term Treasury | 25.00% |
| TIPS | 25.00% |
| REIT | 10.00% |
| Global ex-US Stock Market | 15.00% |
| Emerging Markets | 10.00% |
And we compared it to a 100% stocks approach:
| Asset Class | Allocation |
|---|---|
| US Stock Market | 100.00% |
Results
Here are the results from 2001 forward (TIPs data only goes back so far):
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Yale Portfolio | $10,000 | $41,281 | 6.55% | 9.06% | 22.75% | -20.17% | -28.89% | 0.59 | 0.86 | 0.78 |
| S&P 500 | $10,000 | $50,099 | 7.48% | 15.79% | 33.35% | -37.04% | -50.89% | 0.45 | 0.64 | 1.00 |
We can see that the Yale Portfolio has better risk-adjusted returns (as evidenced by the higher Sharpe ratio and Sortino ratio) due to the greater diversification, lower drawdowns, and lower volatility.
We also have some summary statistics for anyone interested:
Summary Statistics
| Metric | Yale Portfolio | S&P 500 |
|---|---|---|
| Arithmetic Mean (monthly) | 0.56% | 0.71% |
| Arithmetic Mean (annualized) | 6.99% | 8.83% |
| Geometric Mean (monthly) | 0.53% | 0.60% |
| Geometric Mean (annualized) | 6.55% | 7.48% |
| Standard Deviation (monthly) | 2.61% | 4.56% |
| Standard Deviation (annualized) | 9.06% | 15.79% |
| Downside Deviation (monthly) | 1.76% | 3.13% |
| Maximum Drawdown | -28.89% | -50.89% |
| Stock Market Correlation | 0.78 | 1.00 |
| Beta(*) | 0.45 | 1.00 |
| Alpha (annualized) | 2.97% | -0.00% |
| R2 | 61.20% | 100.00% |
| Sharpe Ratio | 0.59 | 0.45 |
| Sortino Ratio | 0.86 | 0.64 |
| Treynor Ratio (%) | 12.01 | 7.11 |
| Calmar Ratio | 0.08 | 0.55 |
| Active Return | -0.93% | 0.00% |
| Tracking Error | 10.37% | 0.00% |
| Information Ratio | -0.09 | N/A |
| Skewness | -0.94 | -0.57 |
| Excess Kurtosis | 3.99 | 1.07 |
| Historical Value-at-Risk (5%) | -3.69% | -8.12% |
| Analytical Value-at-Risk (5%) | -3.74% | -6.79% |
| Conditional Value-at-Risk (5%) | -6.02% | -10.01% |
| Upside Capture Ratio (%) | 48.83 | 100.00 |
| Downside Capture Ratio (%) | 39.51 | 100.00 |
| Safe Withdrawal Rate | 7.85% | 5.60% |
| Perpetual Withdrawal Rate | 3.87% | 4.71% |
| Positive Periods | 176 out of 268 (65.67%) | 173 out of 268 (64.55%) |
| Gain/Loss Ratio | 0.94 | 0.81 |
| * US stock market is used as the benchmark for calculations. Value-at-risk metrics are based on monthly values. | ||
FAQs – Yale Portfolio / David Swensen Investing
What is the main difference between the Yale Endowment Portfolio and a traditional portfolio?
The primary difference between the Yale Endowment Portfolio and a traditional portfolio is the asset allocation.
While traditional portfolios rely heavily on stocks and bonds, the Yale Endowment Portfolio emphasizes alternative investments, such as private equity, hedge funds, venture, real estate, and commodities/natural resources, along with public equity (i.e., stocks) and bonds.
Private investments generally have higher returns (when managed well), but require a certain level of expertise to pick and manage them well.
How does the David Swensen Lazy Portfolio differ from the Yale Endowment Portfolio?
The David Swensen Lazy Portfolio is a simplified version of the Yale Endowment Portfolio, designed for individual investors who may not have the same resources or investment opportunities as a large endowment fund like Yale.
It consists of six core asset classes that require minimal maintenance, making it more accessible and manageable for individual investors.
Can individual investors replicate the Yale Endowment Portfolio?
While individual investors may not have access to the same investment opportunities as Yale, they can adopt a simplified version of the Yale Endowment Portfolio, such as the David Swensen Lazy Portfolio.
However, replicating the exact performance of the Yale Endowment may not be possible due to differences in access to private investments and the expertise required for active management.
How does Yale’s endowment consistently outperform other endowments?
Yale’s consistent outperformance is attributed to its unique approach to asset allocation, exceptional manager selection, and long-term investment horizon.
By focusing on diversification, active management, and partnering with top-performing managers, Yale has been able to generate superior risk-adjusted returns over time.
Is the Yale / David Swensen approach suitable for investors with a low risk tolerance?
The Yale / David Swensen approach may not be suitable for investors with a low risk tolerance, as it involves a higher level of risk associated with alternative investments.
This approach is more appropriate for long-term investors who are comfortable with higher risk levels and have access to alternative investments.
How can individual investors access alternative investments similar to those in the Yale Endowment Portfolio?
While individual investors may have limited access to private investments like private equity, hedge funds, and venture capital, there are other alternative investment options available, such as real estate investment trusts (REITs), publicly traded private equity firms, and alternative investment-focused mutual funds and ETFs.
However, it requires thorough research and due diligence before investing in these assets.
How often should I rebalance my portfolio if I follow the David Swensen Lazy Portfolio?
Rebalancing your portfolio periodically helps maintain your target asset allocation and manage risk.
With the David Swensen Lazy Portfolio, you can consider rebalancing annually or semi-annually, depending on your investment preferences and market conditions.
We covered more about rebalancing in a separate article.
However, you should also take into account transaction costs and potential tax implications when rebalancing.
Conclusion
The Yale / David Swensen Portfolio offers a unique and innovative approach to investment management, with a focus on diversification, active management, and alternative assets.
While it has delivered impressive long-term performance for the Yale Endowment, individual investors should carefully consider the strategy’s potential benefits and drawbacks in the context of their own investment goals, risk tolerance, and access to alternative investments.