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David Swensen and the Yale University Investments Office staff are faced with the challenge of deciding whether to continue allocating a greater part of the endowment of the university to illiquid investments-hedge funds, private equity, real estate considering the recent market turmoil. This case study analysis discusses the advantages and disadvantages of a different asset allocation strategy. It also tackles some ways of classifying different assets.
Harvard Business Review (815124-PDF-ENG)
April 07, 2015
Case questions answered:
- What do you think of Swensen, head of Yale University Investments Office, overall investment philosophy? How has the strategy performed?
- How has the Yale University Investments Office selected, compensated, and controlled the public market, real estate, oil-and-gas, and private equity fund managers? What explains the differences in their strategy? Are these differences disturbing?
- How has the Investment Office decided when to make public market, real estate, oil- and gas, and private equity investments? What explains the differences in their strategy? Are these differences disturbing?
- How is PE changing? What implications does this have for Yale? What should David Swensen do?
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Case answers for Yale University Investments Office: February 2015
Question 1: What do you think of Swensen, head of Yale University Investments Office, overall investment philosophy? How has the strategy performed?
The overall investment policy of David Swensen, head of Yale University Investments Office, is based on five key principles: firstly, Swenson firmly believes in equities since they in contrast to bonds are less sensitive to higher levels of inflation which in turn would endanger the finances of the university, whose major cash outflows are personnel expenses.
Moreover, instead of attempting to profit from short-run market fluctuations, Swenson’s policy suggests that a certain asset class should only receive an under- or over-proportional share in case substantial evidence for a misevaluation of that asset class exists. In addition, Swenson’s strategy suggests to primarily target less efficient markets with incomplete information.
Furthermore, Swenson’s philosophy puts a high emphasis on building relationships with external managers, which in turn receive a high degree of decision making power with regard to almost all the asset classes in which the endowment was active.
Lastly, Swenson highly values the alignment of incentives of the Yale University Investments Office and the aforementioned external managers in order to ensure a common objective. These five principles in combination have made Swenson’s investment policy an unconventional one.
At the same time, this strategy has allowed Yale’s endowment to earn abnormal returns (Yale’s annualized returns exceeded those of domestic stocks and bonds) and to thereby outperform its peers (over the last decade the endowment was ranked first among all colleges and universities) and receive a highly favorable rating. This, in turn, shows the strength of Swenson’s strategy.
Question 2: How has the Investments Office selected, compensated, and controlled the public market, real estate, oil-and-gas, and private equity fund managers? What explains the differences in their strategy? Are these differences disturbing?
The abovementioned outside managers are selected by the Yale University Investments Office by means of a lengthy assessment process focusing on their reputation, track records and capabilities. Moreover, the investment office has a strong preference for those managers focusing on value-based investing and that have specialized expertise in a certain region or asset class.
In addition to this extensive selection procedure, a key to success for the Investment Office is the build-up of relationships with managers as well as the aforementioned alignment of interests. This, in turn, is achieved by on the one hand preferring managers willing to co-invest and on the other hand by linking the managers’ compensations to the performance of the investments that they initiate. Hence, through this alignment of interests and extensive selection procedure employed by Yale University, the behavior of managers is…
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