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Even top endowments struggled last year

(MoneyWatch) David Swensen has been the chief investment officer of the highly successful Yale Endowment Fund since 1985. Because of the fund's success, Swensen is one of the most respected investment managers in the world, and the Yale Endowment, with its heralded track record, has long been held up as a model for institutional investors.

However, the poor performance of the fund, and others like it, during the financial crisis of 2008 began to call into question the Yale Model. Yale's endowment lost 24.6 percent in its fiscal year ending June 2009, considerably worse than the average endowment, which lost 18.6 percent over the same period.

The New York Times reported that college and university endowment returns for the most recent fiscal year, which ended June 30, are starting to roll in and the news wasn't good. The paper said Harvard University's fund posted a 0.05 percent loss, while a simple S&P 500 Index fund returned about 5.5 percent. The endowment's decline of $1 billion "is more than the entire endowments of roughly 90 percent of all colleges and universities."

Even more disconcerting is that for the 2011 fiscal year, large, medium and small endowments all underperformed a simple mix of 60 percent stocks and 40 percent bonds over one-, three- and five-year periods. The 91 percent of endowments with less than $1 billion in assets underperformed in every time period since records have been maintained. Given the weak results being reported this year, that underperformance is likely to be even more pronounced when the fiscal-year 2012 results are included.

The viability of the investment model followed by many endowments received another black eye from a recent study on the performance of the Yale Endowment. This study found that Yale's public stock holdings outperformed benchmark indexes only because of a tilt to small-cap and value stocks. This means they should have been measured against benchmarks that also included such tilts. (The same was true for both domestic and international holdings.)

The study did find, however, that Yale's private equity holdings did outperform. The implication is that it has been the endowment's private equity exposure -- venture capital in particular -- that is the unique source of its excess return. The authors found the same results when they studied the past 10 years of the period. Thus, they concluded that while the conventional wisdom has been that Yale's success is attributed to their ability to hire the top active investment managers, their returns can be explained by consistent exposure to diversified, risk-tilted, stock-oriented assets and extraordinary outperformance in private equity, and venture capital in particular. Outside of private equity, Yale's endowment fund appeared to underperform risk-adjusted benchmarks.

These results, with the possible exception of venture capital, call into question the "Yale Model." It's also important to note that neither Yale's David Swensen nor PIMCO's Mohammed El-Erian (former manager of Harvard's endowment) recommend an endowment model for individuals. For example, when El-Erian was asked if individuals could match the performance of top endowments, he responded: "It would be like advising my son or daughter to drop out of school to play basketball with the goal of becoming the next Michael Jordan."

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