Yale Endowment Blasts Low-Fee Critics, Says Gains Would LagBy
Fund says it identifies top managers for superior returns
Buffett and Gladwell have criticized money managers’ rich fees
Yale University, one of the most-watched and best-performing college endowments, defended the fees it pays to external managers, saying in an annual investment report that a low-cost passive strategy would have “shortchanged’’ the Ivy League school’s students and faculty.
While declining to provide details about how much the fund pays, its managers earn “large performance-based fees,’’ the report said. The $25.4 billion endowment, the second largest in higher education behind Harvard, has been run since 1985 by David Swensen and returned 3.4 percent for the most recent fiscal year when college endowments lost 2 percent on average.
Fees for private equity and hedge fund managers, some of whom command 2 percent for management and 20 percent for performance, or even more, have become a heated topic. Berkshire Hathaway Inc.’s Warren Buffett and writer Malcolm Gladwell have taken public shots at the structure, and Gladwell specifically targeted Yale two years ago.
Congress, concerned about the rising price tag of college, also has raised questions about tax-exempt endowments and asked about manager fees in an inquiry to the richest 56 private colleges last year, a question most schools didn’t fully answer.
The annual endowment report often provides nuggets of insight into the fund’s philosophy, outlook and performance, last year showcasing its prowess in venture capital. This time, Yale made the case that it can spend hundreds of millions of dollars annually on generous financial aid because of its endowment’s outsized returns.
“What Buffett, Gladwell and other fee bashers miss is that the important metric is net returns, not gross fees,’’ the report said. “Weak or negative returns would result in low or no performance-related fees, but would be a terrible outcome for the university.’’
Yale’s investment strategy emphasizes long-term active management of equity-oriented, yet often illiquid assets, with more than half the fund in alternative investments. Almost a third of Yale’s 2016 allocation is in private equity, including 16.2 percent in venture capital and 14.7 percent in leveraged buyouts. About 22 percent is in absolute return with hedged-like strategies.
“Performance-based compensation earned by external, active investment managers is a direct consequence of investment outperformance,’’ it said.
Buffett has long railed against fees and promoted low-cost passive indexes, which can be used by investors who don’t have access to the kind of top-tier managers Yale has cultivated for decades.
A passive strategy would have resulted in dramatically lower net returns over the past 30 years, diminishing the endowment’s ability to support the University, Yale said.
“Such strategies make sense for organizations lacking the resources and capabilities to pursue successful active management programs, a group that arguably includes a substantial majority of endowments and foundations,’’ according to the report. “However, Yale has demonstrated its ability to identify top-tier active managers that consistently generate better than-market returns, after considering performance fees.’’
If Yale’s assets had been invested for the past 30 years in a portfolio comprised 60 percent of U.S. equities and 40 percent of U.S. bonds, the fund would’ve been smaller, reducing by more than $28 billion the support to its educational mission, the report said.
Relative to a 90/10 portfolio, “Buffett’s personal choice,’’ Yale added $26.4 billion over the past three decades, according to the report. About one-third of Yale’s operating budget, including professor salaries and financial aid, comes from endowment income.
“While critics might argue that the classic 60/40 portfolio is a ‘slow rabbit,’ easy to beat, endowments must diversify to weather storms, such as those experienced in 1987, 1998 and 2008,’’ according to the report.
“Strong active management contributes to Yale’s outstanding absolute and relative investment performance,” the authors wrote. “While passive investment strategies result in low-fee payments, an index approach to managing the University’s Endowment would shortchange Yale’s students, faculty and staff, now and for generations to come.’’
Parents of Yale undergraduate students with annual incomes of less than $65,000 and typical assets aren’t asked to pay, and families with incomes of $200,000 and sometimes more also receive aid on a sliding scale.
Yale’s annualized 10-year returns for the year ended June 30 were 8.1 percent, behind schools including Bowdoin at 8.5 percent, Massachusetts Institute of Technology, 8.3 percent, and Princeton, 8.2 percent. Those schools are led by chief investment officers who have worked for Swensen.
The University of Virginia’s fund also is tied with Bowdoin for the best 10-year return, 8.5 percent, according to data compiled by Bloomberg. The 10-year average annualized return for about 800 schools was 5 percent, according to the National Association of College and University Business Officers and money manager CommonFund.
Yale structures its partnerships with managers to align their incentives with the school, which doesn’t always have the bargaining power to negotiate better fees.
“Venture capital and leveraged buyouts present the greatest challenge, as the overwhelming demand for high-quality managers reduces the ability of limited partners to influence deal terms,’’ according to the report.
The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power, according to the report, which didn’t offer specific insight about how the fund returned 3.4 percent, the highest return among at least the largest 100 college funds.
Yale has reduced its allocation to U.S. securities over the past 30 years. In 1986, more than 80 percent of the fund was committed to U.S. stocks and bonds, compared to 11.5 percent in domestic securities and cash, according to the report. The endowment had a 4 percent allocation to domestic equities in fiscal 2016.
At its June 2016 meeting, Yale’s investment committee approved a cash target of 2.5 percent, up from zero, with an actual allocation of 2.3 percent as of June 30, the report said. Foreign equity increased to 14.9 percent, almost double the allocation in 2012.
Because Yale spent more than it earned, the value of the fund declined for the fiscal year, but by less than 1 percent.
The Harvard endowment’s investment loss was 2 percent for the fiscal year. That decline, combined with money spent, amounted to about $2 billion. The $35.7 billion fund has an annualized 10-year return of 5.9 percent, the second lowest in the Ivy League.