Tuesday, March 15, 2011

Is Yale's Approach Good for Wesleyan?

Last week I had the chance to attend a reception here in Boston for Michael Roth, President of Wesleyan University.

My son Michael is a sophomore at Wesleyan, and is having a terrific time. Not only is he being challenged academically (Michael is actually taking a class this semester from President Roth, who is rumored to be a tough grader), but he is also playing on the Wesleyan tennis team.

Roth's talk covered a wide range of topics, and was both interesting and entertaining. However, his comments at the end of his remarks caught my attention, since they concerned Wesleyan's endowment.

Wesleyan has gone through some relatively rocky times in its handling of its endowment funds. Although they still have a pretty sizeable sum under management (around $525 million), the performance of the portfolio lagged a number of its peers. In addition, at the end of 2010, they filed a lawsuit against its former CIO alleging conflicts of interests in some of his business dealings.

Earlier this year Wesleyan hired Anne Martin from Yale to manage their endowment. A number of schools have hired former investment professionals from Yale in an effort to duplicate the apparent success that David Swensen at Yale has been able to achieve over the years.

As faithful readers of Random Glenings might recall, last week I published a memo that my colleague Barbara Cummings and I wrote to another endowment fund that was attempting to duplicate the Yale model. Specially, Yale emphasizes the use of alternative investments as opposed to the traditional balance approach using publicly-traded stocks and bonds.


The question in my mind: Does the Yale model really work? Are their returns truly superior to the old-fashioned balanced approach?

According to this week's Economist, it appears that maybe the Yale approach really isn't all that is cracked up to be:

Martin Leibowitz of Morgan Stanley has analysed the characteristics of endowment portfolios over the past ten years. He looked at three portfolios: a classic 60/40 US equity/Treasury bonds split; a Yale-like portfolio with seven separate asset classes; and a portfolio with international diversification but without the illiquid private-equity, hedge-fund and real-estate portions. What is remarkable about these portfolios is how closely correlated they all are with the S&P 500. Even the Yale-like portfolio had a correlation of more than 0.9 (where 1 is a perfect fit).

But then there's more:

Sadly for the Yale-like portfolio, its beta {price sensitivity relative to broader market changes} rose sharply in the third quarter of 2008 when the market was in turmoil as Lehman collapsed. The beta then fell again as the market recovered in 2009 and 2010. In short, the benefits of diversification were highly diluted. In beta terms, endowment portfolios traded like a traditional 60/40 fund in the boom and then were more volatile in the bust.


Put another way, as a tuition-paying parent of a Wesleyan student, I sure hope Ms. Martin carefully considers just how much she wants Wesleyan to duplicate the Yale experience.