BOSTON (TheStreet) -- Aside from large losses at the height of the recession, university endowments have enjoyed long-standing prosperity and superior returns. Can the average investor take cues from the inner workings of these financial powerhouses?
For years, the answer has been a resounding "no." Mohamed El-Erian, the one-time head of Harvard University's endowment, once quipped that it would be "like advising my son or daughter to drop out of school and play basketball with the goal of becoming the next Michael Jordan."
But the rapid rise of the ETF marketplace and the ever-increasing creativity of specialized mutual funds mean retail investors can now take inspiration from, if not replicate, these institutional strategies.
The modern era of endowment strategy is usually credited to David Swensen.
Swensen headed to
endowment offices in 1985 with a reputation for creativity. At 27, while working for Salomon Brothers, he invented the derivative instrument known as the "swap."
When Swensen arrived, Yale's endowment was locked into a conventional 60/40 split between stocks and bonds, earning an average return of only 6.5% annually. Over time, he would reinvent it as a diverse and complex mix of alternative asset classes, private equity, hedge funds, commodities and real estate. This set the stage for an impressive average return of nearly 12% a year, building its value to more than $16.3 billion. Nearly all university endowments have adopted a similar strategy and moved away from the safe, vanilla allocation models of the past.
Translating that for street-level investors has been viewed as a fool's errand, with many of the alternative asset strategies used by institutional investors either ill-advised or out of reach.
Matthew Tuttle is author of
How Harvard and Yale Beat the Market: What Individual Investors Can Learn From the Investment Strategies of the Most Successful University Endowments
. He said his desire to tackle the topic came after reading Swenson's book,
Unconventional Success: A Fundamental Approach to Personal Investment
, which was promoted as offering his advice for Main Street investors. But between its pages, readers were steered away from considering most endowment strategies.
"I was excited and couldn't wait to read it and see what insights he had," Tuttle says. "But the book basically said, 'You guys can't do what we do here at Yale, so you might as well just buy index funds.' I was disappointed, to say the least."
Tuttle decided that there were ways to mimic endowment-style strategies. The rapid rise to prominence of ETFs has made this approach even easier to deploy for the average investor.
"Yes, I can't access some of the hedge funds that they have access to," he says. "Maybe I can't do things at the same price and structure, but there are investment vehicles out there where I can construct an endowment type of portfolio just using funds that are available to everybody."
Nicholas Vardy, chief investment officer of the investment firm
, launched its Harvard Investment Program product two years ago to imitate the portfolio and asset allocations of the top university endowments through index funds and ETFs.
His advice is to "think of your retirement portfolio as your own 'endowment' and be much more diversified than standard asset allocation models would suggest." Investors, on their own or through a money manager, can build a portfolio index funds and ETFs that, with low fees, can closely approximate the mix of endowments.
"There has been an explosion in the range of asset classes that you can by as an individual investor through ETFs. It was only about two years ago that you could actually begin to replicate those in your portfolio," Vardy says.
Yale University's endowment, as itemized last year: absolute return, 24%; domestic equity, 7.5%; fixed income, 4.0%; foreign equity, 9.8%; private equity, 24.3%; real assets, 32%; cash, negative 1.9%.
That straightforward breakdown may obscure its true complexity, which contains thousands of funds with a variety of designated purposes and restrictions.
For Yale's endowment, as with most, transparency is not a strong suit and determining investments on a granular level is difficult. But, in terms of real assets, real estate, oil, gas and timberland -- the acreage owned by Yale globally would be roughly the size of Connecticut -- are used as a hedge against inflation and can easily be approximated.
Timber, for example, can be represented by the
iShares S&P Global Timber & Forestry Index Fund
Claymore/Clear Global Timber Index ETF
, as well as the timber-related REITs
Plum Creek Timber
A wide variety of real estate investment trusts and absolute-return funds are also easy to research.
The recession hit endowments particularly hard last year.
College and university endowments in North America collectively lost $93 billion during fiscal 2009, according to a study by the
. The study found that the average institution lost 19% after fees.
endowment, the nation's largest, dropped from more than $36.5 billion in 2008 to $25.6 billion, a 30% decline. Yale's endowment plummeted 29% to $16.3 billion.
Other top endowments taking a similar hit were Stanford University (a 27% loss), Princeton (down 23%), the University of Texas system (25% gone), Columbia University (down 20%) and the University of Chicago (minus 23%).
Tuttle views the lack of flexibility and liquidity in their holdings as key villains.
"The endowments were in a ton of private equity and a lot of different private commodities deals," he says. "They were in hedge funds that have lockups. When they needed cash in a pinch, it wasn't easy for them to get it."
Vardy sees individual investors having a key advantage over endowment managers: They can implement an effective exit strategy.
"What we have that these endowments don't is liquidity," he says. "They are not able to make a huge switch and take a private-equity allocation from 14% down to 5% because things are getting tough. They are in illiquid limited partnerships and tied up with big investments. Both Harvard and Stanford were trying to sell a couple billion dollars' worth of their limited-partnership assets around the time Lehman Brothers collapsed just to raise some cash. They weren't able to and ended up floating bonds. But for me, that would have just taken the click of a mouse. I get to be liquid and nimble, and that's a big advantage retail level as opposed to the institutional level."
-- Reported by Joe Mont in Boston.
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