Case 1
The Yale Investment Office manages the university’s endowments, growing it at a 15.4 annualized rate over the last 20 years. The Investments Office is responsible for managing the endowment’s fixed income assets, setting the investment philosophy and strategies, determine the target asset allocation mix for future investment periods, and many more duties. Yale’s Investment Office’s target allocation is unconventional for a university endowment. The asset allocation itself focused on unconventional assets such as international private equity funds, equity funds, and domestic venture Capital Funds, Buyout funds, and real estate funds. According to Swensen’s investment philosophy, equities outperform fixed income assets. Fixed income assets not only give lower returns but are also affected by rising inflation. Yale’s Investment office wanted to hold a diversified portfolio with a strong disciplined approach to investing. The inclusion of emerging markets in foreign equities provided diversification and had the potential of high returns due to the rapid growth in the markets. By seeking opportunities in less efficient markets, Swensen was able to determine that there was a bigger spread in returns between the fund managers in the 25th and the 75th percentile compared to those in the stock and bond market. This led to Yale using mostly external managers to manage most of the university’s endowment. This would make sure expert knowledge is used to build the investment decisions. When deciding when to make private equity investments, a key principle for the Investment Office was to select organizations in which the incentives were properly aligned. Yale for example was reluctant to invest in an organization affiliated with larger financial institutions where a potential conflict of interest or lack of incentive could exist. The Office also uses a different strategy with its private equity manager than it does with other asset classes. For private equity, the firms Yale used were usually established top-rated, premiere firms who were given the discretion to invest as they pleased because their strategy would be consistent with the investment philosophy. Even when they did not want to, the Investment Office kept investing with their private equity managers because they wanted to be a reliable partner instead of cashing out when the times get tough. As for with the real asset classes, Yale primarily used small, newly established, or unheard of firms. This was because the managers at Yale recognized that large real estate funds relied on fees and would lock up investor’s money for long periods of time with low returns. To avoid this and to keep the endowments fund as liquid as possible Swensen made the decision to go with independent and less widely known firms. Unlike with the private equity firms, Yale would not hesitate to cash out if they felt the need to do so. Yale wanted to expand its private equity investments to emerging markets. Yale had been able to identify a number of these emerging markets funds that had good incentives and were run by managers who were not bothered by coinvestment or the compensation approach taken by Yale’s Investment Office. However there were differences between the performance of Yale’s international and domestic private equity investments. One explanation to the differences between the performances of the two could be that there was more risk involved with foreign equity managers. Since most foreign private equity investors were subsidiaries or affiliates of large financial institutions, there was the potential for problems with the compensation structure and a conflict of interest problem. Secondly, the Investment Office found it difficult to evaluate the foreign private equity organizations. Most times Yale was unsure just how to evaluate positive and negative feedback it