Yale University Investments Office: February 2015 - Case Solution

Question 1: What do you think of Swensen, head of Yale University

Investments Office, overall investment philosophy? How has the strategy performed?

The overall investment policy of David Swensen, head of Yale University Investments Office, is based on five key principles: firstly, Swenson firmly believes in equities since they, in contrast to bonds, are less sensitive to higher levels of inflation which in turn would endanger the finances of the university, whose major cash outflows are personnel expenses.

Moreover, instead of attempting to profit from short-run market fluctuations, Swenson’s policy suggests that a certain asset class should only receive an under- or over-proportional share in case substantial evidence for a misevaluation of that asset class exists. In addition, Swenson’s strategy suggests primarily targeting less efficient markets with incomplete information.

Furthermore, Swenson’s philosophy puts a high emphasis on building relationships with external managers, who, in turn, receive a high degree of decision-making power with regard to almost all the asset classes in which the endowment was active.

Lastly, Swenson highly values the alignment of incentives of the Yale University Investments Office and the aforementioned external managers in order to ensure a common objective. These five principles, in combination, have made Swenson’s investment policy an unconventional one.

At the same time, this strategy has allowed Yale’s endowment to earn abnormal returns (Yale’s annualized returns exceeded those of domestic stocks and bonds) and to thereby outperform its peers (over the last decade, the endowment was ranked first among all colleges and universities) and receive a highly favorable rating. This, in turn, shows the strength of Swenson’s strategy.

Question 2: How has the Investments Office selected, compensated, and

controlled the public market, real estate, oil-and-gas, and private equity fund managers? What explains the differences in their strategy? Are these differences disturbing?

The abovementioned outside managers are selected by the Yale University Investments Office by means of a lengthy assessment process focusing on their reputation, track records, and capabilities.

Moreover, the investment office has a strong preference for those managers focusing on value-based investing and who have specialized expertise in a certain region or asset class.

In addition to this extensive selection procedure, the key to success for the Investment Office is the build-up of relationships with managers as well as the aforementioned alignment of interests.

This, in turn, is achieved by, on the one hand, preferring managers willing to co-invest and, on the other hand, linking the managers’ compensations to the performance of the investments that they initiate.

Hence, through this alignment of interests and extensive selection procedure employed by Yale University, the behavior of managers is…