Yale University Investments office: August 2006
1. What are the main principles of Swensen’s investment philosophy?
a. Describe and critique each principle.
1. Strong believe in equities. Equities are a claim on areal stream of income while the bonds have low expected returns but poor performance with uncertain inflation. The long-run returns of equity is tremendous than the long-run return of bond. This principle is reasonable for the equity can bring risk premium return for the portfolio.
2. Diversify Portfolio. Risk could be more effectively reduced by diversify the portfolio to different kinds of asset classes rather than pile on the single asset class. With the diversified strategy, the portfolio can prevent extremely loss when the market is down unexpected.
3. Seek opportunities in less efficient markets. There are far greater incremental returns in nonpublic markets with incomplete information and illiquidity through selecting superior managers. Therefore, The Investment Office devote large portion of fund in illiquid investments. This principle sounds good but the Investment Office should pay attention to potential large risk.
4. Utilize outside managers for all but the most routine or indexed of investments. For the outside managers can be given considerable autonomy to implement their strategies with relatively little interference from Yale. However, it’s not an easy task in finding excellent managers in foreign equity market, especially in emerging market. Also, we will face the problem of interest conflict between Yale and the external managers.
5. Focus critically on the explicit and implicit incentives facing outside managers. Because rarely asset management business had good incentive alignments built into typical client-manager relationships. It is necessary for Investment Office to construct good innovative relationships and fee structures with various external managers to consist the managers’ interests with Yale’s. But the Investment Office sometimes should give up some large institutions which have excellent managers and good strategies but conflict interests with Yale.
b. Can you find a couple of examples in the case showing that the Investments Office does not follow Swensen’s principles (or at least the way they are stated in the case)?
1. Yale actively rebalanced its portfolio to maintain its target asset allocations and this led to frequent short-term adjustments in its holdings. For instance, as equity values rose in the summer of 1987, Yale sold stocks in order to return to its target allocation level. After the stock market crash later that year, the endowment repurchased many of the same securities as it sought to raise its asset allocation back to the target level. This does not follow their principle two.
2. The bond portfolio is managed internally, which is against the Investment Office’s