Harvard & Yale's alternative asset investments

By Neil Behrmann

July 2007:- Harvard and Yale's annual reports are published late but still give useful insights into their asset allocation strategies.

The most interesting aspect is that they began to cut their stock investment targets in 2006. Both have been exceptional performers over the past two decades because they have applied unconventional and flexible asset diversification policies, compared with the vast majority of pension funds, institutional managers and most private investors. Since some of these assets have generally not done well recently, it will be interesting how the endowments fare in 2007. Harvard and Yale, however, invest in the top managers.



Harvard's endowment, which finances the university's medium and long-term requirements, dropped slightly during the bear market of 2000 to 2003, but surged to $29 billion in the year ended June 2006.

Harvard's 2006 annual report states that the endowment intended slashing the domestic and international equity portfolio that comprised 32.5% of assets in June 2006. The average investment target which was 51% in 1997 fell to 37% in 2000 to 25% in the years 2002 to 2005 was reduced further to 23%. Emerging market equities, totalling $3 billion or 9% of the portfolio in 2006 had a target of 8% in 2007. Total domestic and foreign fixed income, including high yield bonds were 19% of the portfolio, but the average target was cut to 13% in 2007 from 21% in the previous four years.

At the end of June 2006 total alternative investments amounted to more than two fifths of the total portfolio. The break down by asset category was: hedge funds and special situations 14.6% of the total portfolio, private equity, 8.9%, commodities, 8.6% and real estate 7.5%. The 2007 policy target for private equity is 13%. Real estate, commodities and inflation indexed bonds were lumped together in real assets which accounted for 20.5% of the portfolio at the end of the June financial year. The target for real assets was 31%.

Harvard's managers, who are paid millions, have become increasingly aggressive and sophisticated in the management of the university's portfolio. They make use of futures and options and currency dealings to hedge or insure against losses and boost the fund's portfolio. They take a view on market conditions and asset valuations and adjust the actual investment of the portfolio against medium and long-term investment policy targets.



In 1989, nearly 75 per cent of Yale's endowment was committed to US stocks, bonds and cash. But over a period of 15 years, the university shifted exposure from traditional stocks and bonds to unconventional investments.

In July 1990, Yale became the first institutional investor to pursue
hedge funds as a distinct asset class, the 2006 annual report claims. The alternative investment allocation in selected specialist managers amounted to two thirds of the endowment's assets at the end of June 2006, far in excess of the average American and international endowment and pension funds.  But in the fiscal year ended June 2006, the $18 billion endowment cut its hedge fund portfolio to 23.3% or $4.2 billion from 25.7% in 2005. In 2004 the absolute return mandates accounted for 26.1% of the portfolio.The hedge fund allocation was the lowest since the years 1999 to 2001. 

In contrast, real assets, including real estate and commodities rose to 27.8% or $5 billion compared with 25% in 2005 and 18.8% in 2004. The private equity allocation was 16.4% of the total portfolio or $3 billion.

Yale managed by David Swensen has cut its domestic equity portfolio to 11.6% or $2 billion from 14.1% in 2005 and 14.1% in 2005. But the foreign equity proportion of the portfolio rose to 14.6% from 13.7%. The fixed income allocation was slashed to a mere 3.8% in 2006 compared with 4.9% in 2005 and 7.4% in 2004.The percentage of US and international stocks in the portfolio was around 30 per cent, but the holdings of bonds and cash fell to only 11 per cent. Hedge funds accounted for 26 per cent of the portfolio; property and natural resources 19 per cent; and private equity 14 per cent.

Formula tested over time, although prestige helps

The size of the portfolios and prestige of the universities ensure that Harvard, Yale, Princeton and Stanford can outsource the management of equities and other investments to the very best fund managers.

But regardless of that advantage, their asset allocation formula has been tested over time. In confusing market conditions, it is prudent to spread risk over a variety of assets, so that if one or two fail to meet expectations, the others will lessen the pain.

With interest rates rising in the US, bonds are unlikely to boom, unless there is a sharp slowdown in the economy. Relatively illiquid commodities are volatile and unpredictable, and have been subject to excess speculation.

Real estate is somewhat overblown in the US, Europe and parts of Asia-Pacific. Hedge funds are finding the going tough.


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