Other Side of Yale Model: ETFs

Chidem Kurdas
The investment approach associated with David Swensen, the investment chief of Yale University’s endowment, is known for its emphasis on alternatives. But another part of the portfolio contains plain vanilla, low-fee exchange traded funds.

There the largest item is a Vanguard emerging markets ETF. The second largest is the IShares MSCI EAFE fund, which covers developed markets outside the United States and Canada. These come under the endowment’s 11% foreign equity target allocation for fiscal year 2014.

Certainly that portion is smaller than Yale’s 20% target for hedge fund strategies and 31% target for private equity. But the ETFs are a vital part of the portfolio, providing straightforward market exposure – beta return, as people call it – in contrast to the more complex investment strategies that attempt to obtain alpha gains over and above market returns.

Some refer to this as the “barbell” asset allocation paradigm; cheap & easy ETFs on one end, expensive and illiquid alternative strategies on the other. One side saves fees and other costs, the other seeks returns from less accessible sources.

In theory it sounds good. In practice it has not always worked. Famously in the 2008-2009 financial crisis, Yale and others following the same approach faced steep losses as both private equity and the broad market crashed.

Neither did it work last year, but for a different reason—the stock market, stoked by the Federal Reserve, rose so much that any S&P 500 index fund easily trumped the sophisticated Yale portfolio. Still, the latter’s long-term track record remains impressive, though in a stock boom it is at a comparative disadvantage because short positions necessarily lose money.

What Mr. Swensen and his team do is not right for all investors but nevertheless an instructive example. So it is noteworthy that they intend to park a mere 6% of the portfolio in U.S. stocks. They must not expect much of an upside in the domestic market this year.


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