Yale Provides Update On Its Asset Allocation

There's a lot to learn from college endowments but very little to directly copy.

The Yale Endowment posted its results and its asset allocation. It said the return was 12.3% for the year ending June 30th, 2018 which almost identical to the return of the S&P 500 but the endowment's allocation looks nothing like 100% in that index. The reported allocation as follows;

Absolute Return: 26.0%

Venture Capital: 18.0%

Foreign Equity: 15.5%

Leveraged Buyouts: 15.0%

Real Estate: 9.5%

Bonds and Cash: 6.5%

Natural Resources: 6.5%

Domestic Equity: 3.0%

The asset classes are a mix of exposures that are or are not accessible to individual investors. Venture capital is an example of something that isn't really available. There have been funds or other types of holdings that go down the road toward venture capital (or similarly private equity) but they don't typically capture the true effect.

Absolute return, the largest weighting is accessible but it requires a discerning eye because there are a lot of funds that seek some sort of absolute return but don't do a great job at it. Absolute return targets a steady return no matter what is going on with the market cycle like the rate of inflation plus X% or something simpler like 3%. Yale disclosed the performance of its absolute return allocation at 4.8% which I think is a strong result. Such a good result could be attributable to the manager being very good or maybe having too much equity exposure. Where we're talking about Yale I would lean to the former. If you are looking at absolute return fund to buy in a brokerage account I would suspect the latter. Yale or any of the other endowments has access to better managers than you or I will at a brokerage. That doesn't have to be a bad thing, that's just how it is and if you realize that then you can make a more informed decision if you want absolute return in your portfolio.

I am a huge believer in absolute return and include it in client portfolios for two purposes, managing equity volatility and as a fixed income proxy (fixed income proxy as a way to manage interest rate risk). Yale's willingness to use absolute return is something to learn from but a 26% allocation is probably too much for someone relying on long term "normal" stock market appreciation, it won't keep up. If it does keep up, it probably isn't really absolute return.

The most individual investor-like exposure is probably the 6.5% to natural resources. The argument for having natural resources is the potential for a low correlation to equities and 6.5% might be a tad higher than I would typically prefer but it's not that heavy of an exposure. To the extent the stock market correlates to the economic cycle (pro-cyclical), commodities with more industrial uses like nickel or aluminum are also pro-cyclical so depending on how you access commodities you could be diluting the correlation benefit.

The chart compares the Invesco DB Commodity Tracking ETF (DBC) to the SPDR Gold Trust and the S&P 500.

DBC is a broad based commodity proxy. ETFreplay.com reports the correlation ranging from zero to 0.50 so that is quite low but in looking at the chart it seems to track the S&P 500 a little closer than that. The SPDR Gold Trust (GLD) is the proxy I use for clients and appears to have a lower correlation to the S&P and that is corroborated by ETFReplay. My interest in commodity exposure is to have something that might go up if equities go down. I think gold has a better chance of doing that than something like DBC.

Leveraged buyouts (LBO) could be one of a few different strategies and trying to mimic Yale is probably not a great idea. A strategy that my guess is not included in LBOs is merger arbitrage. This strategy is available through quite a few traditional mutual funds and ETFs. I have owned the Merger Arbitrage Fund (MERFX) for clients for quite a while. It has almost no volatility and very modest returns (this strategy is in the absolute return realm). Owning it, or any absolute return fund requires a lot of patience during a bull market. The stock market is up a ton so absolute, like merger arbitrage, has lagged far far behind equities because it is not an equity proxy (repeated for emphasis).

The utility of absolute return and commodities is that they don't behave like the equity market. They can go up when stocks go down. Modest exposure to these attributes can smooth out the ride over the entire stock market cycle but too much will cause you to miss out on bull market returns.

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