YALE ENDOWMENT.docx

1、YALE ENDOWMENTYALE eNDOWMENTBUFN 755 Group Case 1Rui Jian112542931Manlin Gong112709921Yijiao Li112518998 SummaryFor the past 20 years, Yale endowment had proved a great success of its asset allocation model, which had a significant investment in less efficient assets. However, during the recent fina

2、ncial crisis Yale suffered a big loss of 24.6% in 2009, and both absolutely and relatively it was beaten by its college peers. It is becoming increasingly concerned whether to reduce its exposure to illiquid assets, how to adjust the position of other assets, and what the aftermath is of continue in

3、vesting in inefficient assets.In this case, we reached the following conclusion. First, Yale should maintain the relatively high exposure in illiquid assets, but reallocate its positions within each illiquid classes. Though higher risk it brings, illiquid assets satisfied the high return college spe

4、nding requires. College endowment had a long-term investment horizontal and its investment strategy need to focus on the value assets instead of timing the market. But compared to LBO, VC and real estate indicated a lower return-to-risk in the long-term, it is suggested to relocate the position of t

5、hese two sections with the reason discussed below in Q1.Second, we carefully compared the each asset class in different categories and reached the following opinions: in real assets categories, we prefer natural resources than real estate; in private equity category, we favor LBO over VC and keep a

6、conservative view on international PE; in marketable securities, we suggest Swensen consider more of foreign equity and absolute return. Relative detail evidences are provided in Q2.Finally, benefits of investing more deeply in inefficient assets are discussed, including taking the advantage of misp

7、riced assets and purchasing more when price is low, and deploying the long-term investment and squeezing out investors with financing-oriented or timing-oriented strategies. Refer to the Q3.Question 1.Yale should maintain the relatively high exposure in illiquid assets, but should reallocate its pos

8、itions within each illiquid classes.For the past 20 years, Yale harvested heavily form its allocation philosophy, a large exposure to illiquid assets, and had produced an annualized return of 13.1%, exceeding the return of all colleges and universities. Exhibit 1 shows the long term performances of

9、all university endowment, Yale endowment and benchmark indexes, indicating that even though Yale was confronted with large risk in illiquid assets, it still had the highest risk adjusted return.Also, maintaining a high percentage of illiquid assets was in line with Yales long-term investment horizon

10、tal. Its a good opportunity to purchase undervalued assets, particularly in times of market stress. On the other side, the partnership with the top-flight firms would be harmed, if Yale stopped cooperating with them just for a short-term downturn. It was not necessary for Yale to decrease its illiqu

11、id allocation rapidly just to ensure the liquidity. Yale had a lot of other ways, such as commercial paper and reverse repo agreement, to ensure its liquidity. As the redemption needs decreased, the liquidity would not become a big issue in the future. It would be more reasonable for Yale to adjust

12、illiquid assets allocation within each class. The financial crisis had pummeled Yales return for 2009, and the return in 2010 lagged both in absolute terms and in relative to its peer group. Much of this was due to Yales allocation toward private equity section and the real estate section. Therefore

13、, an adjustment of percentage was necessary in these asset classes.For PE investments, certain changes within the industry had influenced the returns and the risk of Yales investment: larger investment scale which might comprise with lower overall returns, more investors who might congest the return

14、s, the trend of VCs into later-stage investment which lowered the return multiples. The PE section contributed a lot of returns, but the performance of venture capitals raised increasing concerns, requiring an adjustment within the section itself.Exhibit 2 shows that VC had a better long-term perfor

15、mance than LBO and international PE, however, after considering the high risk, venture capital had a much lower return to risk than other two. Exhibit 3 is the med-term performance of PE section, which also supports the same indication that percentage among private equity class need to shift more to

16、 LBO. Because of a lack of information in international private equity market, especially in developing countries, and also other uncertainness, it would be more prudent to hold the current position in this asset class.For the real assets section, especially the real estate investment, it was suffer

17、ing from the financial crisis, generating negative returns to the whole group while increasing the volatility of the portfolio. As Exhibit 4 shows, Housing Market Index plummeted continually after crisis, it was hard to tell the right time to purchase low. At the same time, the information asymmetry

18、 of real estate industry made it more difficult to find a partnership with aligned interests. Therefore, lower the investment allocation in real estate section is recommended.The three evidences above show that the illiquid assets, consisting of the private equity section and the real assets section

19、 should be reallocated.Question 2.1) Real AssetsReal estate and natural sources are two groups in real assets. We would prefer natural resources than real estate.As mentioned above, the real estate market shows a large uncertainty in a short time, and continue investing may increase the risk of the

20、total endowment asset. On the contrary, Yales allocation strategy on natural sources, especially on oil and gas, performed very well. The 10-year annualized return shows that Yale generated a return of 17.5% in natural sources, much higher than that of entire real asset class 10.9%. Also the “hedge

21、against inflation” function makes nature resources more important when price rising.2) Private EquityThere are three classes in PE, venture capital, LBO and international PE. We favor LBO over VC and keep a conservative view on international PE.As mentioned in Question 1, the return of venture capit

22、al is not so well compared with LBO when we take risk into consideration. We calculated risk adjusted return of venture capital and LBO since inception. It is obvious that the risk adjusted return of LBO 95.85% is much higher than that of venture capital 33.92%. In addition, the 2010 risk adjusted r

23、eturn of venture capital is much lower than that of LBO.It is much harder to find a venture capital firm, which still peruses higher return than to find a LBO firm. From in case (Ex.9), we can find that total fund raised by VC is about 50 billion in 2010, while the size of LBO is about 230 billion.

24、Although average return since inception of VC is higher than LBO, it is believed that due to some extraordinary success (e.g. 700% return in 2000), which can hardly be duplicated. We recalculated multi-annual return using geometric mean to see the influence of these extraordinary successes. After re

25、moving the influence of extraordinary return the difference between VC and LBO becomes smaller. (Refer to Exhibit 5.)Although recent performance of international PE is good, it is still very risky to be invested in. It is difficult for Yale to evaluate foreign private equity firms since they lacked

26、a strong network. Yale should be careful to invest in international PE market, especially in emerging market. In emerging market, Yale will face a high bar, lack of transparency, less ethical standards and higher return volatility. We believe Yale should pay more attention on local market. 3) Market

27、able SecuritiesThere are four asset classes under this category: bond, domestic equity, foreign equity and absolute return. We recommend Yale consider more of foreign equity and absolute return.They have higher returns than other classes. As it is showed in case material (Ex.7), the 10-year annualiz

28、ed return of foreign equity and absolute return is 13.8% and 11.1% respectively, which are much higher than that of bond and domestic equity.By investing in foreign market and absolute return, Yale will diversify its portfolio and reduce the risk. Foreign market and absolute return are all less effe

29、ctive markets. This strategy meets the third principle-seek opportunities in less effective markets and works very well. Ex. 7 in case material showed that the returns of foreign market and absolute return not only outperformed that of bond and domestic equity but also outperformed returns of target

30、 benchmarks. Thus Yale should stick to its strategy to invest in foreign market and absolute return.Question 3.Although we suggest David Swensen to keep the current exposure to illiquid assets, there do exist some benefits of deeply investing rather than pulling back.Yale had been focusing on value-

31、added investments for years and had benefited from this strategy in both its asset allocation target and its specific investment within each class. The historical success suggested that Yale not be distracted by the short-term fluctuations, and in the long run, the illiquid assets are more likely to

32、 add values, thereby generating higher returns.There were a lot of benefits for Yale to invest in inefficient markets. Although pulling back and investing more in cash and other highly liquid assets could ensure that these assets were efficiently priced and therefore ensure no negative returns during the downfall, the inefficiency in some other markets like PE and real estate made it possible that during crisis the assets were mispriced. In this case, not pulling back during downturn and actively looking for investment opportunities in the illiquid assets class would be a good choice.W