Justin Fox, the author of The Myth of the Rational Market, has a very provocative blog at Harvard Business Review. In a recent comment he discusses Yale’s endowment model and why it works for Yale.
Mr. Fox discusses the broad idea behind David Swensen’s approach: buy a lot of uncorrelated assets and be willing to go far afield to find them. When you read Swensen’s book, it also becomes clear that Swensen prefers assets that can have equity-like returns. He is happy to own alternative assets if he thinks the returns are there. Another thing Mr. Fox points out is that Swensen’s allocations to various asset classes are not fixed. He is willing to change his asset mix and to let the portfolio adapt over time.
Many managers who have tried to emulate Mr. Swensen–and it has certainly become quite popular in the institutional pension community–are disenchanted with the “Yale Model” because 2008 was an atypically bad year. In classic investor fashion, many of the mini-Swensens are “rethinking their approach.” Mr. Fox points out that many in the institutional community were not really following Mr. Swensen’s approach in the first place, but the major reason that his imitators are having doubts (and Mr. Swensen is not) has to do with a loss of nerve more than anything else. Mr. Fox believes that the Yale endowment model will continue to work for Yale because:
…Swensen is still in charge, and has built up enough political capital through the decades that he’ll be allowed to stick to his guns. That hasn’t been true of the managers of Harvard’s endowment since Meyer left in 2005 (to start a hedge fund and take home bigger paychecks). That hasn’t been true of the managers of California’s CalPERS. And it hasn’t been true of 99% of the other institutions that thought they were following the Yale model.
The real Yale model, then, involves more than just an investing approach. It requires finding a very smart, capable person not motivated chiefly by money (Swensen could have made vastly more on Wall Street than he has at Yale) who is willing to stick with the same job for decades. And it involves an institution that puts enough trust in that person to weather a bad year or two without lots of second guessing. (Tellingly, there are echoes here of the way things work at Warren Buffett’s Berkshire Hathaway.)
[The emphasis is mine.]
In the end, it gets back to investor behavior, whether the investors are institutional and retail. Did you do your due diligence on the strategy? Do you really understand what the manager is trying to do? If so, buy it and hang on for the long run. Give the strategy time to work. Flipping strategies every time there is a period of adversity (see DALBAR) is not a winning method in the long run.
Ultimately, Mr. Fox’s point is universal. It is applicable to Yale’s endowment model, but also every other disciplined investment strategy, including Warren Buffett’s. You have to first do your homework and then stick to your guns. There will be challenges along the way, but you’re likely to come out ahead if you can stay focused on a winning strategy.
