YALE ENDOWMENT.docx
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YALEENDOWMENT
YALEeNDOWMENT
BUFN755GroupCase1
RuiJian
112542931
ManlinGong
112709921
YijiaoLi
112518998
Summary
Forthepast20years,Yaleendowmenthadprovedagreatsuccessofitsassetallocationmodel,whichhadasignificantinvestmentinlessefficientassets.However,duringtherecentfinancialcrisisYalesufferedabiglossof24.6%in2009,andbothabsolutelyandrelativelyitwasbeatenbyitscollegepeers.Itisbecomingincreasinglyconcernedwhethertoreduceitsexposuretoilliquidassets,howtoadjustthepositionofotherassets,andwhattheaftermathisofcontinueinvestingininefficientassets.
Inthiscase,wereachedthefollowingconclusion.
First,Yaleshouldmaintaintherelativelyhighexposureinilliquidassets,butreallocateitspositionswithineachilliquidclasses.Thoughhigherriskitbrings,illiquidassetssatisfiedthehighreturncollegespendingrequires.Collegeendowmenthadalong-terminvestmenthorizontalanditsinvestmentstrategyneedtofocusonthevalueassetsinsteadoftimingthemarket.ButcomparedtoLBO,VCandrealestateindicatedalowerreturn-to-riskinthelong-term,itissuggestedtorelocatethepositionofthesetwosectionswiththereasondiscussedbelowinQ1.
Second,wecarefullycomparedtheeachassetclassindifferentcategoriesandreachedthefollowingopinions:
inrealassetscategories,weprefernaturalresourcesthanrealestate;inprivateequitycategory,wefavorLBOoverVCandkeepaconservativeviewoninternationalPE;inmarketablesecurities,wesuggestSwensenconsidermoreofforeignequityandabsolutereturn.RelativedetailevidencesareprovidedinQ2.
Finally,benefitsofinvestingmoredeeplyininefficientassetsarediscussed,includingtakingtheadvantageofmispricedassetsandpurchasingmorewhenpriceislow,anddeployingthelong-terminvestmentandsqueezingoutinvestorswithfinancing-orientedortiming-orientedstrategies.RefertotheQ3.
Question1.
Yaleshouldmaintaintherelativelyhighexposureinilliquidassets,butshouldreallocateitspositionswithineachilliquidclasses.
Forthepast20years,Yaleharvestedheavilyformitsallocationphilosophy,alargeexposuretoilliquidassets,andhadproducedanannualizedreturnof13.1%,exceedingthereturnofallcollegesanduniversities.Exhibit1showsthelongtermperformancesofalluniversityendowment,Yaleendowmentandbenchmarkindexes,indicatingthateventhoughYalewasconfrontedwithlargeriskinilliquidassets,itstillhadthehighestriskadjustedreturn.
Also,maintainingahighpercentageofilliquidassetswasinlinewithYale’slong-terminvestmenthorizontal.It’sagoodopportunitytopurchaseundervaluedassets,particularlyintimesofmarketstress.Ontheotherside,thepartnershipwiththetop-flightfirmswouldbeharmed,ifYalestoppedcooperatingwiththemjustforashort-termdownturn.
ItwasnotnecessaryforYaletodecreaseitsilliquidallocationrapidlyjusttoensuretheliquidity.Yalehadalotofotherways,suchascommercialpaperandreverserepoagreement,toensureitsliquidity.Astheredemptionneedsdecreased,theliquiditywouldnotbecomeabigissueinthefuture.
ItwouldbemorereasonableforYaletoadjustilliquidassetsallocationwithineachclass.ThefinancialcrisishadpummeledYale’sreturnfor2009,andthereturnin2010laggedbothinabsolutetermsandinrelativetoitspeergroup.MuchofthiswasduetoYale’sallocationtowardprivateequitysectionandtherealestatesection.Therefore,anadjustmentofpercentagewasnecessaryintheseassetclasses.
ForPEinvestments,certainchangeswithintheindustryhadinfluencedthereturnsandtheriskofYale’sinvestment:
largerinvestmentscalewhichmightcomprisewithloweroverallreturns,moreinvestorswhomightcongestthereturns,thetrendofVCsintolater-stageinvestmentwhichloweredthereturnmultiples.ThePEsectioncontributedalotofreturns,buttheperformanceofventurecapitalsraisedincreasingconcerns,requiringanadjustmentwithinthesectionitself.
Exhibit2showsthatVChadabetterlong-termperformancethanLBOandinternationalPE,however,afterconsideringthehighrisk,venturecapitalhadamuchlowerreturntoriskthanothertwo.Exhibit3isthemed-termperformanceofPEsection,whichalsosupportsthesameindicationthatpercentageamongprivateequityclassneedtoshiftmoretoLBO.Becauseofalackofinformationininternationalprivateequitymarket,especiallyindevelopingcountries,andalsootheruncertainness,itwouldbemoreprudenttoholdthecurrentpositioninthisassetclass.
Fortherealassetssection,especiallytherealestateinvestment,itwassufferingfromthefinancialcrisis,generatingnegativereturnstothewholegroupwhileincreasingthevolatilityoftheportfolio.AsExhibit4shows,HousingMarketIndexplummetedcontinuallyaftercrisis,itwashardtotelltherighttimetopurchaselow.Atthesametime,theinformationasymmetryofrealestateindustrymadeitmoredifficulttofindapartnershipwithalignedinterests.Therefore,lowertheinvestmentallocationinrealestatesectionisrecommended.
Thethreeevidencesaboveshowthattheilliquidassets,consistingoftheprivateequitysectionandtherealassetssectionshouldbereallocated.
Question2.
1)RealAssets
Realestateandnaturalsourcesaretwogroupsinrealassets.Wewouldprefernaturalresourcesthanrealestate.
Asmentionedabove,therealestatemarketshowsalargeuncertaintyinashorttime,andcontinueinvestingmayincreasetheriskofthetotalendowmentasset.Onthecontrary,Yale’sallocationstrategyonnaturalsources,especiallyonoilandgas,performedverywell.The10-yearannualizedreturnshowsthatYalegeneratedareturnof17.5%innaturalsources,muchhigherthanthatofentirerealassetclass10.9%.Alsothe“hedgeagainstinflation”functionmakesnatureresourcesmoreimportantwhenpricerising.
2)PrivateEquity
TherearethreeclassesinPE,venturecapital,LBOandinternationalPE.WefavorLBOoverVCandkeepaconservativeviewoninternationalPE.
AsmentionedinQuestion1,thereturnofventurecapitalisnotsowellcomparedwithLBOwhenwetakeriskintoconsideration.WecalculatedriskadjustedreturnofventurecapitalandLBOsinceinception.ItisobviousthattheriskadjustedreturnofLBO95.85%ismuchhigherthanthatofventurecapital33.92%.Inaddition,the2010riskadjustedreturnofventurecapitalismuchlowerthanthatofLBO.
Itismuchhardertofindaventurecapitalfirm,whichstillperuseshigherreturnthantofindaLBOfirm.Fromincase(Ex.9),wecanfindthattotalfundraisedbyVCisabout50billionin2010,whilethesizeofLBOisabout230billion.
AlthoughaveragereturnsinceinceptionofVCishigherthanLBO,itisbelievedthatduetosomeextraordinarysuccess(e.g.700%returnin2000),whichcanhardlybeduplicated.Werecalculatedmulti-annualreturnusinggeometricmeantoseetheinfluenceoftheseextraordinarysuccesses.AfterremovingtheinfluenceofextraordinaryreturnthedifferencebetweenVCandLBObecomessmaller.(RefertoExhibit5.)
AlthoughrecentperformanceofinternationalPEisgood,itisstillveryriskytobeinvestedin.ItisdifficultforYaletoevaluateforeignprivateequityfirmssincetheylackedastrongnetwork.YaleshouldbecarefultoinvestininternationalPEmarket,especiallyinemergingmarket.Inemergingmarket,Yalewillfaceahighbar,lackoftransparency,lessethicalstandardsandhigherreturnvolatility.WebelieveYaleshouldpaymoreattentiononlocalmarket.
3)MarketableSecurities
Therearefourassetclassesunderthiscategory:
bond,domesticequity,foreignequityandabsolutereturn.WerecommendYaleconsidermoreofforeignequityandabsolutereturn.
Theyhavehigherreturnsthanotherclasses.Asitisshowedincasematerial(Ex.7),the10-yearannualizedreturnofforeignequityandabsolutereturnis13.8%and11.1%respectively,whicharemuchhigherthanthatofbondanddomesticequity.
Byinvestinginforeignmarketandabsolutereturn,Yalewilldiversifyitsportfolioandreducetherisk.Foreignmarketandabsolutereturnarealllesseffectivemarkets.Thisstrategymeetsthethirdprinciple-seekopportunitiesinlesseffectivemarketsandworksverywell.Ex.7incasematerialshowedthatthereturnsofforeignmarketandabsolutereturnnotonlyoutperformedthatofbondanddomesticequitybutalsooutperformedreturnsoftargetbenchmarks.ThusYaleshouldsticktoitsstrategytoinvestinforeignmarketandabsolutereturn.
Question3.
AlthoughwesuggestDavidSwensentokeepthecurrentexposuretoilliquidassets,theredoexistsomebenefitsofdeeplyinvestingratherthanpullingback.
Yalehadbeenfocusingonvalue-addedinvestmentsforyearsandhadbenefitedfromthisstrategyinbothitsassetallocationtargetanditsspecificinvestmentwithineachclass.ThehistoricalsuccesssuggestedthatYalenotbedistractedbytheshort-termfluctuations,andinthelongrun,theilliquidassetsaremorelikelytoaddvalues,therebygeneratinghigherreturns.
TherewerealotofbenefitsforYaletoinvestininefficientmarkets.Althoughpullingbackandinvestingmoreincashandotherhighlyliquidassetscouldensurethattheseassetswereefficientlypricedandthereforeensurenonegativereturnsduringthedownfall,theinefficiencyinsomeothermarketslikePEandrealestatemadeitpossiblethatduringcrisistheassetsweremispriced.Inthiscase,notpullingbackduringdownturnandactivelylookingforinvestmentopportunitiesintheilliquidassetsclasswouldbeagoodchoice.
W