To create value, don’t look to Yale

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To create value, don’t look to Yale


Barry Ritholtz

For a long time, the fund managers at Yale’s endowment were the industry’s gold standard. Inevitably, as in so many things Ivy, this was noticed by rival Harvard. The so-called Yale Model, developed by David Swensen and his colleague Dean Takahashi, was rich with alternative investments, private equity, commodities and real estate, and other items that weren’t plain vanilla stock and bond investments.

The success of the Yale Model led to lots of copycats. The problem was that other schools could duplicate the look, but not quite the feel of Yale’s endowment investments, but without Swensen’s unique talents. He even wrote a book explaining how to be like Yale’s endowment titled, “Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.”

For a while, Harvard came close to matching Yale’s success. It had a worthy rival for Swensen in investment chief Jack Meyer. At one point, Harvard Management Company was throwing off superior returns. Fortune observed that the “120 or so people who work there are masters of short-term trading, initiating as many as 250,000 transactions a year. Their bets have often focused on undervalued situations and arbitrage opportunities in global stock and bond markets.”

But as Fortune reported in 2005, Meyer was paid more than $7 million dollars a year - seven times what Swensen was making. Paying successful managers handsomely looked justifiable. But it ran up against certain notions of Ivy League decorum. The negative perception of a richly compensated managerial team led to the sort of touchy-feely academic posturing that most of us in the real world find silly. Offended by the high cost of this talented team of managers, the brain trust that is the Harvard professorial class, with encouragement from alumni, forced changes that ultimately worked to the detriment of the endowment - and the university as a whole.

Which leads us to today’s discussion.

During the financial crisis, Harvard’s endowment lost as much as a third of its value and was forced to make layoffs. Its five-year annualized returns were 1.7 percent.

About now, most of you who didn’t go to Harvard (me included) might be saying “Who cares about Harvard and its $30 billion endowment?” You are right that this probably won’t matter to you. However, if you were interested in the discussion about the California Public Employees’ Retirement System’s decision to exit its $4 billion investment in hedge funds, you might want to keep reading.

Harvard now looks like it’s having regrets about its move to purge Harvard Management of employees who were capable of generating market-beating returns. The expectation that the team at Harvard is going to find the next David Swensen or another Jack Meyer is slim at best. Indeed, finding and keeping talented asset managers is almost impossible in a setting where unaccountable tenured academics agitate against paying market rates to people who generate billions of dollars in returns.

Which leads us back to the recent actions of Calpers.

I want to suggest that Harvard’s endowment shouldn’t follow the Yale Model, and shouldn’t even attempt to recreate the model created by Meyer. Instead, the new team leading the endowment should consider something closer to the changed direction we see at Calpers. Rather than creating a highly paid team of traders to execute complex high-risk strategies that work until they don’t, why not use what we know about finance to create something that will work?

A long-term, low-cost, simple approach to managing assets may not be the most intellectually satisfying style - it gives you nothing to talk about at cocktail parties - but it does create value over the long haul.

Each year, the Hauser Institute at Harvard’s Kennedy School of Government holds a conference on this approach as part of its Initiative for Responsible Investment. Perhaps the folks at Harvard’s endowment might consider attending one of these events.

* The author is a Bloomberg View columnist.

BY Barry Ritholtz

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