David Swensen and Yale's Endowment

[bender]

Yale formalizes spending policy. Spending rate to rise

changed the spending rule to raise the target payout from the endowment to 5.25 percent and set a floor of 4.5 percent.

The Corporation also added an upper cap that stops the spending rate from exceeding 6 percent.

current projections for both fiscal years 2011 and 2012 hit the ceiling [6%]

This is interesting given the return assumptions discussed in the "underfunded pensions" thread. However, Yales returns will likely continue to be herculean.

[tidal]

Harvard alumni seek refund of $21m in bonuses

A small group of Harvard University alumni is protesting the multimillion-dollar bonuses paid to the money managers of the university's endowment, which has lost more than $8 billion since the end of the last fiscal year.
...
Harvard's endowment, which stood at $36.8 billion last June 30, had shrunk to about $28.7 billion as of Oct. 31, though Harvard is still the world's wealthiest university. Faust has warned the university to brace for a total 30 percent drop in the endowment's value by this June 30 - a prospect that forced the Faculty of Arts and Sciences, Harvard's largest academic body, to freeze professors' salaries and postpone nearly all searches for tenure-track faculty to make up a more than $100 million shortfall. The university relies on the endowment to fund more than a third of its operating costs.

The five highest-paid executives at Harvard Management Co., which oversees the endowment investments, earned between $3.9 million and $6.4 million each - made up mostly of bonuses - for their performances during the last fiscal year, according to a university announcement last month. During that time, the Harvard endowment earned 8.6 percent. In comparison, college endowments lost an average of 3 percent in that period, according to an industry survey released this week.

File under "can of worms"...

[parvus]

File under "can of worms"...

But not before determining how many Harvard alumni are selfless, low-sense-of-entitlement socialists and how many live and die on the proceeds of the market: as lawyers, lobbyists, physicians, fund-raisers, company managers ...

[Taggart]

February 19, 2009

Interview with David Swensen:

[url=http://www.heralddeparis.com/yale%E2%80%99s-financial-wizard-david-swensen-says-most-endowments-shouldn%E2%80%99t-try-to-be-like-yale-2/24263]I figured out when I revised Pioneering Portfolio Management that the most important distinction isn’t between the institutional investor and the individual. It’s between those that are set up to make high-quality active management decisions and those that aren’t. The investment management world is a strange place in that the right solution is not in the middle. The right solution is at one extreme or the other. One end of the spectrum is being intensively active. The other is being completely passive. If you end up in the middle, which is where almost everybody is, you pay way too much in fees and end up getting subpar returns.

At the active end of the spectrum, you’ve got institutions like Yale and Harvard and Princeton and Stanford and others, who’ve really built high-quality investment teams that have a shot at making consistently good active management decisions. But there’s a vanishingly small number of such investors. Those on the passive end of the spectrum have figured out that they don’t know enough to be active. The passive group is not nearly as big as it should be. Almost everybody should be there.

But indexes aren’t much fun.

Yeah, they love the excitement. And they all think that the next guy is making it happen. Because that’s what they hear at cocktail parties, so they want to make it happen too. But it’s just basic arithmetic. When you pay out a point and a half or two points or two and a half points, and you give away 20 percent of the gains, that gets extracted from you the investor. If you’re in an index fund, you’re paying tenth of a percent and no percentage of the profits. But the assets that you get when you index are pretty much like the assets that you’re invested in with all these fancy fee schemes. So it’s just basic arithmetic. It’s not complicated.[/url]

[bender]

Yale endowment update 2008

Its very similar to past reports, with some brief commentary about the current situation.

Equity orientation makes sense for investors with long time horizons. In the midst of financial crises, some argue for higher allocations to risk-free assets, no doubt wishing after-the-fact for the now unattainable before-the-fact protection. Yet those who argue for greater protection against financial trauma ignore the opportunity costs of maintaining a substantial allocation to fixed-income assets.

Diversification, called a free lunch by Nobel laureate Harry Markowitz, allows construction of portfolios with superior risk and return characteristics. In the midst of a capital market dislocation, investors hoping for the protection provided by a diversified portfolio of assets frequently express disappointment at the crisis-induced tendency of risky assets to move together. The correlations between risky asset classes move toward one during periods when investors dump holdings of risky assets of all types to fund purchases of risk-free U.S. Treasury bonds. In a binary world where only risk and safety matter, otherwise dissimilar risky assets behave similarly. In the Crash of 1987 and LTCM crisis in 1998, flights to quality led to temporary market disruptions that caused diversification to lose its power. After the panics subsided, diversification once again mattered, as fundamental drivers of return determined results, not the overriding concern with safety. The crisis of 2008 differs from the crises of 1987 and 1998 in breadth, depth, and intensity. Yet, after the current crisis passes, prudent investors will reap the benefits of a well-diversified portfolio.

[George$]

Some recent comments from Swensen that I believe are likely to be true - we only don't know when. (TIPS are the same a Real Return Bonds here in Canada.)

Yale’s Swensen Recommends TIPS to Hedge ‘Substantial Inflation’

and some text ...

May 23 (Bloomberg) -- David Swensen, the top-ranked college endowment manager in the past decade, said individual investors should own inflation-protected Treasuries because U.S. economic recovery efforts may lead to an increase in consumer prices.

“We’ve had this massive fiscal stimulus, massive monetary stimulus, and it’s hard to see how that doesn’t translate into pretty substantial inflation, or at least pretty substantial risk of inflation,” Swensen, Yale University’s investment chief, said in an interview on the “Consuelo Mack WealthTrack” television show that aired yesterday. Treasury Inflation- Protected Securities “should be in every investor’s portfolio," he said.

......

Crisis Thinking

Swensen, who updated his first book in January, said the collapse of the real estate markets and ensuing financial market losses has required him to broaden his investment analysis.

“The crisis forces you to think top-down in ways that would, I think, be unproductive in normal circumstances, or absolutely necessary in the midst of a crisis,” Swensen said. “You have to think about the functioning of the credit system. You have to think about the potential impact of monetary policy on markets over the next five or 10 or 15 years.”

[tidal]

Ivy League Endowments Finally 'Dumb'
online.wsj.com/article/SB124631834157970855.html

The largest college endowments, long the envy of their smaller rivals for their sophisticated and profitable investment strategies, were left behind over the past year by the performance of smaller schools with far simpler approaches.

The fiscal year for most endowments ends Tuesday and nearly every one has had big declines, but smaller endowments are poised to outperform heavyweights like Harvard University and Yale University by significant margins. Endowments with less than $1 billion generally held up better by putting more money in fixed income and less in alternative investments like hedge funds.

[George$]

Recent update at Bloomberg for the Yale academic year to June 30, 2009 ...
Yale’s Swensen Model Unbroken by 30% Endowment Drop, Levin Says

Levin, the longest serving president in the eight-school Ivy League, said the investment model devised by Chief Investment Officer David Swensen has performed “spectacularly well” for Yale, in New Haven, Connecticut. The strategy, which includes private equity, hedge funds and real estate, returned $11 billion more than a hypothetical portfolio of stocks and bonds over 10 years, Levin said in an interview yesterday in New York.

Yale’s endowment, which it estimated was $16 billion on June 30, is the second-largest in higher education after Harvard University, in Cambridge, Massachusetts. While Harvard President Drew Faust said the recession is driving permanent cost cuts and reorganization, Levin said the economy only delays Yale’s growth.

My bet is that almost all of the Yale downturn will come back to it as markets evolve.
And 5% of the 30% drop is due to $ payout - not market loss.

[George$]

And some prior thoughts from Bill Gross about the Yale and Harvard tilt towards illiquid alternative assets
Pimco’s Gross Says Harvard, Yale May Need to Alter Investments

May 29 (Bloomberg) -- Yale University and Harvard University may have to cut investments in hedge funds and private equity because the risks of holding the hard-to-sell assets outweigh the returns, said Bill Gross, co-chief investment officer of Pacific Investment Management Co.

“The Yale and Harvard portfolios, which have succeeded enormously over the past 10 or 20 years in terms of the emphasis on illiquidity and private investments and risk-taking -- you have to question that model,” Gross said yesterday at an industry conference in Chicago.

The two Ivy League schools had more than half of their endowments in hedge funds, private equity, real estate and hard assets such as commodities at June 30. Gross, who manages the $150 billion Pimco Total Return Fund, the world’s biggest bond mutual fund, recommended in March buying securities that provide stable income this year rather than more speculative and illiquid investments, as slowing economic growth and higher unemployment depress returns.

“Everything in this ‘new normal’ world should be questioned in terms of the returns going forward,” Gross, 65, told the audience at Morningstar Inc.’s annual fund-industry conference.

“New normal” in the global economy means heightened government regulation, slower growth and a shrinking role for the U.S., Mohamed El-Erian, who shares the position of investment chief with Gross at Newport Beach, California-based Pimco, said earlier this month.

These conditions will force people to question traditional strategies, such as putting 60 percent of their money in riskier investments including stocks and hard-to-sell assets and 40 percent in bonds and cash, Gross said.

[parvus]

Of course, Mohamed El-Erian is ex-CEO of the Harvard endowment.

[tidal]

Well, it ain't Harvard or Yale... but as a data point, still kinda interesting:

Greensboro College puts up campus to back loan

Greensboro College, $19 million in debt, has put up its campus and the lion’s share of its endowment as collateral to Bank of America, school officials said Friday.

And a month before classes start, the small liberal arts college is offering four years of free tuition to freshmen honors recruits in an aggressive effort to boost enrollment.

Wow, that sounds like a winning plan! And, boy, I'll bet the donors are thrilled that the endowment is now pledged to BofA! Betcha the alumni will be writing contribution checks like mad now! What? What's that you say? They turned off the taps a while ago? Hmmm...

I think a lot of US educational institutions and hospitals are in deep trouble.

A birdie tells me that UofToronto president David Naylor had some rather interesting comments in the annual pep talk to large donors last month... w.r.t. to the intention of being "stewards" of the donations and endowments... as opposed to loading up on hedge funds!

Oh, well... this should be a nice condo development/golf course some day...

[Doug]

I've read David Swensen's book "Unconventional Success", and thought it was persuasive. However, I'm not as enthusiastic about long term government bonds as he is. He is also against having corporate bonds. It should be noted that his doctoral economics thesis from Yale was on pricing corporate bonds. Does anyone know of a recommended reading list from David Swensen?

[George$]

Does anyone know of a recommended reading list from David Swensen?

I've not seen any and I try to follow his articles and presentations.
As you must have gathered he certainly has nothing nice to say about expensive mutual funds.

[Taggart]

Financial Times

By Chrystia Freeland

Published: October 8 2009

Lunch with the FT: David Swensen

The larger point, Swensen believes, is that even though moments of radical disruption, such as the 2007 financial crisis, reward investors who make a big bet on major change, “ultimately, market timing is an exercise in futility. When you’ve got dramatic movements in the markets you can identify after the fact a handful of investors that succeeded in the short run. But making big, aggressive asset allocation moves isn’t a strategy that’s likely to prove successful in the long run.”

-----------------------------------

He says the crisis has reinforced his view that the most important investing advice is “you should invest only in things that you understand. That should be the starting point and the finishing point.”

-------------------------------------

For most investors the practical application of this axiom is to invest in index funds (low-fee investments that aim to mirror the performance of a particular stock market index). “The overwhelming number of investors, individual and institutional, should be completely in low-cost index funds because that’s easy to understand.”

---------------------------------------

Even after the battering of 2007 and 2008, Swensen is not optimistic that many will follow his advice: “The investment community is hopeful – hopeful’s probably too weak a word – wildly optimistic about their particular chances ... Never underestimate the gullibility of large pools of money.”

[George$]

Financial Times
By Chrystia Freeland
Published: October 8 2009
Lunch with the FT: David Swensen

Thanks Taggart - I was surprised to read that Swensen loves the Canadian cold and almost came to Canada after receiving his PhD from Yale - but for our bureaucratic slowness in hiring a non Canadian ....

The speed of that transaction – especially compared with the bureaucratic hurdles the Bank of Canada had to clear to justify hiring a foreigner – lured Swensen to Salomon: “I thought it would be great to work for a place that could make a decision in five minutes as opposed to a place that would make a decision in five months

[parvus]

Just adding some context:

Harvard and Yale Report Losses in Endowments

Harvard and Yale disclosed on Thursday just how many billions their endowments had lost in the last year, signaling yet more belt-tightening at the nation’s wealthiest schools.

Jane Mendillo, manager of Harvard’s portfolio since July 2008.
Harvard’s endowment tumbled 27.3 percent in its latest fiscal year, largely because of problems with its private equity and hedge fund portfolios, lopping off $10 billion and shrinking its portfolio to $26 billion. Taking into consideration donations and spending, the endowment shrank by nearly 30 percent.

Yale also suffered about a 30 percent loss in its endowment, to about $16 billion, the university’s president disclosed in a letter Thursday, adding that final figures on performance were still being compiled.

“We want to alert you to the fact that another round of reductions will be necessary,” Yale’s president, Richard C. Levin, wrote in what he called a budget update to the Yale community praising the cost-cutting that had already occurred.

[George$]

More on Harvard's woes with complex investments ..

Harvard’s Bet on Interest Rate Rise Cost $500 Million to Exit

Oct. 17 (Bloomberg) -- Harvard University’s failed bet that interest rates would rise cost the world’s richest school at least $500 million in payments to escape derivatives that backfired.

Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

The transactions began losing value last year as central banks slashed benchmark lending rates, forcing the university to post collateral with lenders, said Daniel Shore, Harvard’s chief financial officer. Some agreements require that the parties post collateral if there are significant changes in interest rates.

“When we went into the fall, we had some serious liquidity management issues we were dealing with and the collateral postings on the swaps was one,” Shore said in an interview today. “In evaluating our liquidity position, we wanted to get some stability and some safety.”

Harvard sold $2.5 billion in bonds in the fiscal year, in part to pay for the swap exit, even as the school’s endowment recorded its biggest loss in 40 years, the annual report said. This is the first time the university has detailed the cost of exiting its swaps.

with my bold emphasis ...

... Harvard’s loss “says that people don’t understand the complexity of the products they are buying and selling and that doesn’t begin and end with mortgage securities,” said Robert Doty, a municipal finance adviser at American Governmental Services in Sacramento, California.

“It shows that with these products that are so highly complex, people are a long way from knowing as much about these products as they think they do,” he said.

Added later -
The link to the 48-page pdf Harvard University Endowment Report for June 30, 2009

[Norbert Schlenker]

George, this sort of reporting about derivatives just aggravates me. Let me pull out one germane sentence.

Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects

In other words, Harvard had a bunch of capital projects that they funded with variable rate debt, they used derivatives to swap that to a fixed rate (undoubtedly a lower fixed rate than they could have gotten directly), and are now crying in public because one side of the transaction resulted in a loss.

What about the other side of the transaction: the variable rate debt on which they have been paying less? They made money on that side but no one notices?

This is very lazy reporting of a bunch of self-serving malarkey. Daniel Shore, "Harvard's chief financial officer", should be ashamed of himself and not because he had to admit to a half billion dollar mistake. There was no mistake. He should be ashamed because he's telling a fib.

[George$]

George, this sort of reporting about derivatives just aggravates me. Let me pull out one germane sentence.

Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects

In other words, Harvard had a bunch of capital projects that they funded with variable rate debt, they used derivatives to swap that to a fixed rate (undoubtedly a lower fixed rate than they could have gotten directly), and are now crying in public because one side of the transaction resulted in a loss.

What about the other side of the transaction: the variable rate debt on which they have been paying less? They made money on that side but no one notices?

This is very lazy reporting of a bunch of self-serving malarkey. Daniel Shore, "Harvard's chief financial officer", should be ashamed of himself and not because he had to admit to a half billion dollar mistake. There was no mistake. He should be ashamed because he's telling a fib.

Norbert, I'm not going to defend the lazy reporting. Perhaps Shore would be fired if his bosses understood the issue as you do. But my guess is they don't and thus he gets away with it. I've seen the same administrative malaise and hubris at my institution. That's the rub. That's the weak link.

I know you understand the derivative world of finance far better than I do - but I'm still inclined to think of derivatives as 'nuclear matter' - fine if you have smart, stable and honest folks using and overseeing them. But otherwise it is a recipe for eventual disaster.

[parvus]

An interest-rate swap doesn't have to lead to Chernobyl. A key question is whether the swap was meant to reduce risks by locking in a fixed future expense (with capital to back it up) or, whether, instead, it was a margin loan à la Citron's Orange County (lovely lemon analogy here, unfortunately repeated in Alabama), where investment returns were supposed to make up for taxes unraised.