Wednesday, October 10, 2007

Capital Flows - The Implications of Yale's Asset Allocation

David Swensen, Yale University's Chief Investment Officer, is widely recognized as one of the world's great investors

For Fiscal 2007, Yale reported a return of 28%. Over the last decade Yale's return is 17.8% and assets have grown from $5.8bn to $22.5bn.

For 2008, Yale plans the following asset allocation:
  • real assets (oil, timber, real estate) 28%
  • absolute returns (hedge funds) 23%
  • domestic equity 11%
  • fixed income 4%
  • foreign equity 15%
  • private equity 19%
Read the numbers one more time - domestic equity is only 11% and alternative assets (real, absolute, and private) make up 70% of the portfolio.

Today's NY Times noted that pension fund managers plan to increase asset allocation to alternative investments from 14.4% to 19.4%, a 35% increase, over the next three years. The article cited a survey of 50 of the world's largest pension fund managers and found:

Current Allocation to Alternative Assets: 14.4%
  • 4.5% to real estate, 4.3% to hedge funds, 4% to private equity, 1.6% to other
Planned 3-Year Allocation to Alternative Assets: 19.4%
  • 6% to real estate, 4.6% to hedge funds, 6.3% to private equity, and 2.5% to other.
The incremental 5% allocation is equivalent to $1.2tn dollars flowing into alternative assets over the next three years. This is a staggering sum.

What is more is that the pension fund managers' planned19.4% allocation is still only 27% of Swensen's allocation to alternative assets. Too match Yale's returns, pension fund managers would need to increase their allocation by 3.6x. If a 5% increase is equivalent to $1.2tn, a 50% increase, ie matching Yale's allocation, would represent another $12 trillion dollars of allocation.

Where will this money go?

To compound the capital flow dynamic, Morgan Stanley reports that sovereign funds (gov'ts of China, Russia, Kuwait, Singapore, etc) are sitting on $2.8 trillion and that the figure will grow to $15 trillion by 2015. $12 trillion here and $15 trillion you are talking about real money:)

If the stewards of the world's capital look to Yale as a model there will be a massive flood of capital into non-traditional, alternative vehicles over the next decade. China's investment in Blackstone and Abu Dhabi's investment in Carlyle are harbingers of what is to come.

The chase for returns will continue unabated and Yale's approach suggests that relying on equity and fixed income markets will not suffice.

The recent sub-prime meltdown led many pundits to believe that institutional investors would shy away from private equity and hedge funds. The data above suggests that they will have no choice but to do much more investing with alternative managers, not much less.

1 comment:

  1. Anonymous11:57 AM

    thanks for bringing this up. i dont think the benefits of diversified (and prudent) portfolios can ever be stressed enough. so many are after the next big thing that a pause to reflect on the successes of those that think before they leap is warranted.

    the other side of the yale story (and what can't be examined as easily as their broad allocation) is that they probably do a great job of selecting the right managers for each of their buckets and doing the proper DD.

    lets keep watching and seeing how long their winning run lasts.