Monday, September 17, 2012

Yale Endowment Fund Asset Allocation

An endowment fund or what is popularly known as a financial endowment is the name given to the money which is transferred to an institution which can differ from academic, to cultural and religious institutions. One of the most common and known names in this category is the Yale Endowment Fund. Yale endowment fund is known as the pioneer in the approach which followed the process of investing heavily in investments like real estate and private equity. David Swensen, in his career spanning 25 years, is credited with starting this

Yale Endowment Fund management.
Asset allocation allows investors to manage risks and their portfolio’s volatility. Portfolio owners can maximize their returns only by allocating their assets appropriately. It is not the funds or individual stocks in your portfolio that count but the manner in which investors chooses to combine the assets and give a proper structure to their portfolio so that they can increase their returns.

Yale Endowment Fund Asset Allocation approach has been received well by many investors. The model has produced great returns for many investors. A look at the Yale Endowment Fund Asset Allocation model suggests that the fund uses simple allocation methods and is yet amazingly effective.

Yale Endowment Fund Asset Allocation model focuses on investing in multi-asset class (including cash, bond or equity), which offers higher annual returns and reduces risk and volatility since the investor does not depend on one particular class of assets. The Yale Endowment Funds accesses the leading private equity, hedge and institutional fund managers, which is what makes them so successful and assures the investors of greater returns.

The Yale Endowment Funds Asset Allocation model relies mainly on the modern portfolio theory. The modern portfolio theory was designed by Professor Harry Markowitz who also won the Nobel Prize for designing the theory. The theory basically portrays how by simply diversifying assets that are variedly co-related with each other, investors can minimize risk and improve the returns from their portfolio.

The Yale Endowment Fund managers focus on five basic principles, which has become the very basis of the Yale Endowment Fund Asset Allocation model. These principles include, investing in equities, as being an owner is much better than being a lender, holding a portfolio that is diverse, fine-tuning asset allocations at extreme valuations and avoiding market timing, investing in private markets that do not have complete information and low liquidity to enhance returns on a long term basis, using managers from outside for all except the most indexed or routine investments and allocating capital to investment organizations managed and owned by people who actually do the investments on their own to minimize conflicts of interest.

Based on these very principles, the Yale Endowment focuses on diverse assets and has always invested primarily in equities. The success of the Yale Endowment Funds Asset Allocation model resulted in other lager endowments following the same model. In a matter of a decade that ended on 30th June 2008, Yale Endowment offered a return of 16.3 per cent on an annual basis to its investors. Yale Endowment Funds increased to 22.9 billion dollars from a mere 6.6 billion dollars in ten years.

The Yale Endowment Funds Asset Allocation model has been consistent in achieving higher investment returns and less volatility owing to its approach of investing in multi-asset class. Therefore, those investors who chose to shun the traditional model of investment and adopted the Yale Endowment Funds Asset Allocation have realized that the application of multi-asset class principles to a portfolio that is based on index is what that can help them in maximizing their returns.

The fund follows the following principles which are being described briefly below:

Increased Diversification, and re-allocation during the period of extreme valuation for the asset classes.

This model was followed for diversifying the endowment fund into different other portfolios for providing a cushion to the losses that might be in the offing for the fund. This model followed a simple principle of diversified portfolio carrying lower risks with higher returns.

Allocation of more funds to equity.

The principle behind this model was that it is always better to own something in return of your investment rather than lending money out as a mode of investment.

Using active managers rather than following an easy method of investment.

Yale actively pursued the policy of active approach of management strategies, with the planning to stay ahead of the market by some percentages year on year.

Hiring of outside investment firms.

This model was followed to ensure that there remains no conflict of interest between the managers handling the fund and the income generated by the fund. To ensure the same, Swensen hired external investment firms and other primary investors for handling the fund.

Increasing the fund allotment to private markets along with non-asset classes.

Non-asset classes or the commodities were added to the fund’s portfolio as it was believed and these commodities provide a better value than the normal equity as this class of investment carries low risk due to their low dependence on the equity and other markets.

Though these principles gave good results to Yale in the beginning but gradually they were criticized by financial gurus and fund managers world -wide. It had a bad year in 2009 with the fund suffering losses and was not left untouched by the financial crisis which had shaken the world market. Still, the consolation remains that though Yale suffered losses during FY09, it had always maintained that most of the fund is invested into asset classes which come with risk along with returns on a comparable table with private equities. Though, it is true that diversifying the fund can definitely provide with the shock absorbers that are required for protecting a fund as big as held by Yale, but still one cannot fight the abnormalities of the market. This fund comes with some important lessons for other big funds while also providing some important insights with small investors though it is advised not to blindly follow these models.

[The following is a guest post]

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