Though many people don’t think of schools as investing powerhouses, some university endowments have an enviable legacy of portfolio returns. Using strategies with titles like “the Yale model” or “the Harvard approach,” some investors even try to directly replicate the process for themselves.
However, most endowment funds have a number of advantages the average investor simply does not have. Here are some of the factors that have made these endowments successful and how they compare to the opportunities of the individual investor.
Both Yale and Harvard are over 300 years old and are showing no signs of failure. They have a boundless time horizon, meaning their endowments can take on much riskier investments than what would be prudent for an individual. It is also important to note that, over time, the volatility of these investments are “smoothed out” since an endowment fund on this scale has time to recover from down markets.
Lesson: Investors who start investing early in life have a better chance of reaching their retirement goals than those who wait. The more time an investor has, the more risk (and potential growth) he or she can take on. Conversely, those goals with a short time horizon should take less risk, as the potential for downside is magnified.
Direct investment in vehicles such as limited partnerships, private equity, and business development corporations, just to name a few, can help fuel an endowment’s impressive returns. It also helps to drive the diversification of the portfolio, as these investments will react differently to markets than traditional equity investments.
Lesson: These types of investments can be available to the individual investor, but normally only those with over $1 million in investable assets with no liquidity. The average investor can take advantage of the same philosophy through liquid alternative mutual funds. Regardless of your portfolio size, look to alternative investments as a source of diversification.
Tax-free exemption is by far the biggest advantage that endowments have over the everyday investor. With long-term investment taxed at 15 or 20 percent, a school’s tax exemption makes a significant difference in returns each year and an enormous difference when compounded over several decades.
Taxes are what ultimately cause imitators of the “Yale model” and “Harvard method” to fall short of the actual endowments’ success. Even if managers were able to carefully track and copy the schools perfectly, returns would still fall short of the Ivy League’s model.
Lesson: For the individual investor, cost plays a big role. Focus on funds with the lowest internal cost, and utilize a financial planner who can clearly explain fees. Your portfolio should always be managed with the most tax efficient strategy in mind.