Yale Finance Guru Out Front Of Rocketing Endowment Growth

This story was written by Robert Quigley, The Yale Herald
Although his last raise brought his salary up to $2.7 million a year, David Swensen is, by many measures, still grossly underpaid. Swensen, GRD '80, is Yale's Chief Investment Officer (CIO), head of the University's Investments Office, and manager of Yale's endowment.

This past fiscal year, the Yale Endowment led national institutions with a 28 percent annual return and an astounding $5 billion in investment gains, according to the Investments Office's 2007 Endowment Update. And last year was no fluke: Since Swensen took the helm in 1985, Yale's endowment has trumped that of every other major university with a compound annual growth rate of 16.3 percent, ballooning from $1.3 billion to $22.5 billion.

According to a Feb. 18, 2007 New York Times profile of Swensen, there is a wide consensus in the world of finance that he could easily earn many millions of dollars a year more if he left Yale and set up his shingle on Wall Street.

The scale of Swensen's success in financial management is part of a larger narrative about the changing role of university endowments and money management across the country. The lofty benchmarks achieved by the Investments Office betoken the degree to which university endowment managers have become increasingly important actors in the investment world since the '80s. In recent years, their success has far outpaced traditional indices of growth such as the Standard & Poor's 500. According to the National Association of College and University Business Officers (NACUBO), college and university endowments had an average rate of return of 17.2 percent in 2007 and an average compounded annual growth rate of 8.6 percent over the past 10 years, compared to S&P 500 rates of 5.49 and 6.38 percent, respectively. Swensen and other members of the Investments Office declined to comment due to an office policy of not speaking with the press.

For university endowments, the role of financial mover and shaker is, historically, a fairly new one. When endowments came into vogue in the nineteenth century, colleges were simply a lot less wealthy, with their endowments serving as rainy day funds of sorts, intended to give schools a buffer when operating budgets came up short. As Swensen recounts in his 2000 book Pioneering Portfolio Management, in 1880 Yale had to dip into its endowment to prevent premier physicist Josiah Willard Gibbs from leaving to teach at Johns Hopkins; though strapped for cash, Yale managed to scrape together enough to increase Gibbs' salary from zero dollars per year to $2,000 per year.

Because endowments were traditionally seen as a fund of last resort, and because the bulk of their funds came from wealthy alumni whom schools couldn't afford alienating, they continued to be managed and invested conservatively well into the twentieth century, even as their size increased. As late as 1985, when the Yale Endowment was valued at $1.3 billion, 80 percent of it was committed to relatively low-risk -- and low return -- holdings, including domestic stocks, bonds, and cash.

Enter David Swensen and his deputy, Dean Takahashi, BK '80, SOM '83. "Dave and Dean together are responsible for a long list of innovations to how things were done," explained Andrew Golden, SOM '89, who worked alongside the two in the Investments Office between 1988 and 1993.

Now the president of the Princeton Investing Company, Golden credited Swensen and Takahashi's phenomenal success in part to their diversification of the endowment into asset classes, such as real estate -- a practice that other universities tended to avoid at the time due to its dual threats of higher risk and low liquidity. However, such diversification offered the possibility of much greater returns. In rethinking his strategy, Swensen changed how everyone -- from other universities to Wall Street -- thought about inestment.

"Dave really helped foster the development of what Yale called 'absolute return investing,'" Golden said, referring to an investment strategy that is today commonly associated with certain types of hedge funds. "The Yale Office is actually responsible for coining that term. That's become a very big part of the landscape today."

According to Golden, Swensen's achievements were as much the result of his strong interpersonal skills as of his investment acumen.

"He has very clear thinking, which allows him also to communicate very clearly, which was certainly confidence -- inspiring at the board level," Golden said. In the boardroom and in the Investments Office, "he just set a tone that assured people that our decisions were going to be made on quality of analysis and not Dave's sense of art."

Swensen's success did not go unnoticed by other university endowments. By adopting diversification strategies similar to the Investments Office's -- and by fortuitously doing so in the boom years of the late '80s and the '90s -- other universities' endowments across the nation soared, outpacing even the bullish market. In 1985, 66 colleges and universities had endowments of $100 million or greater ($193 million in today's dollars); today, there are 136 college and university endowments with more than $500 million, 76 in excess of $1 billion.

While these swelling numbers evidence the great financial success enjoyed by endowments since the '80s, to many in academia, they suggest a muddling of priorities. Henry B. Hansmann, LAW '74, GRD '78, Augustus E. Lines Professor of Law at Yale Law School and a leading critic of university endowments, argues that the endowments' preference for future savings over present spending has caused universities to lose sight of their original function.

"There's a tendency [at universities] to think that more endowment is a good thing, but there's a question of what it's being saved for, what it's going to be spent on ultimately," Hansmann said in a telephone interview.

Although he readily asserted that the Yale Investments Office's program has been "brilliant" and that David Swensen is "a genius, a gift to Yale," Hansmann took issue not with the way in which money managers at Yale and elsewhere allocate their investments, but with the fact that a comparatively small fraction of their holdings are eventually spent on the universities themselves. According to NACUBO, the average university spent its endowment at a rate of 4.6 percent in fiscal year 2007.

"I've been particularly unhappy with the tendency in recent decades toward spending rules constraining spending out of the endowment to a given fraction of the endowment's income, which tends to make the university's operating budget a buffer for the stock market," Hansmann said. "It should be just the reverse."

It's a trend that has not escaped the notice of Congress. Senator Chuck Grassley (R-Iowa), the ranking Republican on the Senate Finance Committee, has proposed that universities with large endowments should be required by law to spend at least five percent of their endowments each year. Last Thursday, the committee, which is chaired by Senator Max Baucus (D-Mont.), sent letters to Yale and 135 other universities with endowments of over $500 million, requesting detailed information on their financial aid, tuition, and endowment practices. Daniel Virkstis, an aide to Senator Baucus, said that this move was prompted by concern over the rising cost of education.

"This is about American students and their families, and understanding how colleges use their endowments to bring down the cost of tuition, which is increasing at a faster rate than inflation," he said.

Yale, for its part, is receptive to the inquiry, but defends its current policies. On, Mon., Jan. 7, President ichard Levin, GRD '74 announced that Yale was raising its endowment-spending minimum to 4.5 percent from last year's 3.7 percent and would spend the difference on initiatives such as scientific research, financial aid, and recruitment of disadvantaged students.

"As President Levin has said, the same discussion that was going on among some members of Congress has been going on at Yale as well in recent years," said Tom Conroy, Yale's Deputy Director of Public Affairs. According to Conroy, for a number of years "the University already had a target rate of 5.25 percent [of spending from the endowment], but because returns have been so exceptional in recent years thanks to the work of the Investments Office, you have a lag between the actual rate and the target rate."

Because the University was acting in good faith towards its goal, he said, there was no need for an additional rate increase.

According to Hansmann, imposing legal spending requirements on universities is problematic.

"There's something to be said for higher spending rates out of the endowment, but I think tying that to fixed spending rules, or to subsidizing tuitions, is probably not really wise," he said. "It's better left to university discretion, but that discretion could be better used."

On the former part of this score, at least, he is in line with the Investments Office. In Pioneering Portfolio Management and in his scarce public statements, Swensen has made the claim that forced spending from the endowment would hurt the University's ability to plan for its long-term financial sustainability. According to Swensen, the current good times will eventually come to an end, and when harder times hit, the bulked-up endowment may prove necessary; because Yale hopes to prolong its lifespan for centuries more, this issue needs to be thought of on a scale larger than individual investors would typically make reference to, he says.

And while the days in which Gibbs scraped for his $2,000 seem increasingly remote, they are a reminder that a university like Yale has a very long memory. Continuing to save and reinvest as much as Yale does while its coffers are bulging may seem insensible -- and may well prove to be insensible -- but it is motivated by looming concerns that may surface in the future.

But with $22.5 billion to spare, Yale is in a good position to combat whatever challenges arise.
© 2008 The Yale Herald via U-WIRE