The Yale Model by David Swensen
What is the secret of the Yale Model, also known as the Yale Endowment Portfolio, or the David Swensen Portfolio?
DAVID SWENSEN
Let’s start with the hero of this story. David Swensen is probably the best-known investor you’ve ever heard of. He is a legendary American institutional investor that grew Yale University’s endowment from $1 billion to more than $23 billion in less than two decades. He is also the author of Unconventional Success: A Fundamental Approach to Personal Investment.
THE YALE MODEL
With his former student Dean Takahashi, he developed what is now known as the Yale Model (Edowment Model / Swensen model), applying modern portfolio theory. He revolutionised how endowments and institutions invest their money by emphasising asset allocation and taking on more equity risk while providing further insights to institutional and individual investors.
The particularity of the model is based on these aspects:
- Focus on long-term strategy
- Focus on broad diversification (emphasis on assets outside the US)
- bias towards equities (stocks) and consequent lower exposure to lower-return assets like bonds or commodities
- avoid liquidity that leads to lower returns
THE PILLARS OF THE YALE MODEL
He advocates asset allocation: he thinks asset allocation explains more than 100% of returns in investing. Market timing is costly: it is a leak in your earnings, while single security selection is just a gamble: no one knows where the markets will go. Quoting the father of Portfolio Theory, Harry Markowitz states that “diversification is the only free lunch” you can get.
His portfolio is based on a growth strategy because of its focus on equities-like (Stocks + REIT) with a long time horizon, while his weight on fixed-income securities is only 30% (treasury):
- 20% US Total Stock Index
- 20% Developed (Foreign) Markets Index
- 20% USD REIT Index (Real Estate)
- 15% Long-term US Treasury Index
- 15% US TIPS (Treasury inflation-protected)
- 10% Emerging Markets Stock Index
WE CAN DERIVE 3 INVESTING LESSONS FROM DAVID SWENSEN:
1. Asset allocation is paramount
When we invest, we have 3 levers to control our performances (returns):
a) Asset allocation: what assets you buy and in what proportion
b) Security selection: which securities you buy within your asset classes
c) Market timing: when you buy those securities and asset classes
Based on research, David realised that Asset Allocation alone matters the most, while Market timing and security selection are negative-sum games. In fact, while some investors in every transaction lose and other wins, fees and commissions ultimately make it a negative sum game.
2. Equity exposure provides you with the desired growth
While we don’t know which future returns of securities or asset classes, we know that equities tend to outperform bonds, commodities, and cash in the long run. This is why Swensen recommends increased exposure to equities for those with longer time horizons.
3. Diversification works in the long run
His exposure to volatile and riskier assets (equity & REITs) does not save your portfolio from temporary losses during financial crises; such a diversified portfolio is designed to perform over the long term. During the short term, you will still feel the bumps along the road.
COMMENTS
The beauty of David’s insights comes from an Institutional Investor looking to improve his beloved university’s strengths; he is both a teacher and the Chief Investment Officer of Yale endowment, and he has a successful track record to prove it. For investors looking at long-term growth, David’s portfolio is an excellent benchmark.
Watch David at Yale, commenting on his Portfolio Allocation.
If you liked this article, don’t miss other Financial Wisdom. Consider sign-up for my monthly newsletter and checking out my previous articles in my Archive.