The Yale Endowment Model
The Yale endowment model incorporates the mean-variance approach described in Modern Portfolio Theory (MPT) designed by Harry Markowitz and James Tobin (Yale Investment Office, 2017). Markowitz (1952) based his theory on minimizing investment risks within the investment portfolio by enhancing diversification strategies designed to optimize an investment portfolio given any level of risk. The Yale Endowment Model, using this method, has changed its mix of investments from nine-tenths in stocks, bonds, and cash to just one-tenth in recent years. The Yale Endowment model uses an alternative investment mix for most of its investments, including private equity, real estate, leveraged buyouts, venture capital, absolute returns, foreign equity, domestic equity, fixed income, and cash and its equivalent. Endowment models, in general, usually have a long-term investment horizon, but the use of alternatives far exceeds most other mixed model portfolios. Consequently, the performance of the Yale model, under the current investment manager, has continued to outperform most other traditional investment models. For example, the Yale model earned an 11.3% annual return net of fees in 2017 compared to traditional domestic equities at 7.5% (Yale Investment Office, 2017).
The Yale model might not be a good source to mimic since the endowment is tax-exempt. However, with a few adjustments, the Yale model might offer insight into similar investments with more advantageous tax treatments or simply placing high-tax investments into a tax-deferred account (Geddes, Goldberg, & Bianchi, 2015). For instance, direct real estate ownership offers superior tax advantages over publicly traded Real Estate Investment Trusts (REITs). REITs are taxed at nominal rates, which depend on the investor’s tax bracket. One method to overcome this high tax environment is to place REIT assets into a tax-deferred account to optimize the performance of the assets. On the other hand, direct ownership of real estate needs to be held outside of a deferred account to reap the benefits of expense write-offs and lower capital gains tax rates. The one major problem with tax-deferred accounts is that the taxman will eventually call once the investor withdraws his funds. By deferring the taxes, the investor accepts a partnership with the IRS. The IRS partner will also want to draw down their investment funds.
Naturally, to offset the correlation to domestic equities further and increase the overall performance of the assets, the Yale endowment model invests globally. Because the endowment model is a long-term strategy, investment managers can afford to accept greater illiquidity to increase the overall performance of the assets with less correlation (Akintona, 2017). Nonetheless, the Yale model meets the objectives of the endowment. The challenge is incorporating the Yale model into individual asset allocation models, which may require a shorter investment horizon and a tax haircut.
As always — let me know if I can help.
You faithful servant
References
Akintona, M. (2017). Investment management strategy: Yale University endowment model 2005–2016. SSRN Electronic Journal. doi:10.2139/ssrn.2895114
Geddes, P., Goldberg, L. R., & Bianchi, C. S. (2015). What would Yale do if it were taxable? (corrected January 2016). Financial Analysts Journal,71(4), 10–23. doi:10.2469/faj.v71.n4.2
Markowitz, H.M. (1952). Portfolio Selection. The Journal of Finance, 7, 77–91. doi:10.2307/2975974
Yale Investment Office (2017). Our Strategy. Retrieved from http://investments.yale.edu/our-strategy-2/ Our Strategy. Retrieved from http://investments.yale.edu/our-strategy-2/