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Portfolio > Alternative Investments > Hedge Funds

Hedge Funds for Yale, but Not for Everybody

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NEW YORK (–Yale University’s hedge fund investments returned 18% for the past fiscal year. Other alternatives did even better for the school.

The overall portfolio made more than 22% in the fiscal year ending June 30, 2005. But institutions or individuals aspiring to follow the US$15 billion endowment’s example have been forewarned by Yale investment chief David Swensen.

Replicating his approach would require not only high-end expertise but also willingness to rebalance every day and stay with some very illiquid assets.

The portfolio has target allocations of 25% to absolute returns, 25% to real assets like natural resources, and 17% to private equity, with the remainder in traditional stock and bond investments.

Yale’s success certainly attracts attention. A client of First Atlas Capital, a London-headquartered US$5 billion alternative investment business, recently asked just how does Yale make higher returns.

Oscar Gil, senior associate at First Atlas Capital, points to the endowment’s long time horizon, its risk profile, and asset size as factors in the extraordinary performance.

Mr. Swensen highlighted the key question at a National Association of College and University Business Officers’ forum. If you can find the right managers that pursue the right strategies, then you can succeed in active investing, he told an audience of investment professionals.

He presented data and studies to show that individuals in general can’t do that, a point he also made in his recent book, Unconventional Success : A Fundamental Approach to Personal Investment. Moreover, it looks like many institutions don’t have the capacity to make what Mr. Swensen calls high-quality active investment decisions.

He emphasized that picking hedge fund managers is a very tough business and that a small organization without the dedicated full-time staff doesn’t have the ability to make the right choices.

A team of 20 investment professionals, most of them with Yale degrees and presumably warm feelings of allegiance to their alma mater, tend to the university’s endowment. Mr. Swensen regards loyalty to the institution as an important ingredient.

He does not see funds of funds as a solution. They add fees on top of fees and suffer from adverse selection because top managers don’t want to be in funds of funds, he said. From his viewpoint, fund of funds investors may be paying extra fees to invest with low-quality managers.

Not that it’s easy to find the winners in other types of active investments. The median returns from venture capital and leveraged buy-outs are no higher than what one gets with the Standard & Poor’s 500 stock index, Mr. Swensen has found.

Since venture capital and leveraged buy-outs involve much greater risk, these investments as a whole fail dramatically in a risk-adjusted comparison.

As for conventional stock and bond investing, active managers in the top quintile can add a couple of percentage points to the index return, but one’s chance of beating the market is one in seven, according to another study Mr. Swensen cited.

His recommendations are not novel. Unless you can pick the very best managers, stay away from active investing and put your money into index funds. Using indexes, build a portfolio of maybe half-a-dozen broad asset classes, tilted to equities.

It’s simple and boring, and investing should be that way, he suggests. But whether you’re seeking plain vanilla index trackers or exotic hedge fund strategies, he adds a caveat: “Pay attention to fees. Worry about them.”

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Contact Bob Keane with questions or comments at [email protected].


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