What You Can Learn From Harvard's, Stanford's And Yale's Investments (2024)

What if some of the smartest peopleon the planet had tens of billions to invest? What would they do with it? Well, it turns out that major universities do, in fact, have billions of dollars in endowments and some extremely smart people to manage that money for them. Also, fortunately for us, they publish detailed reports each year on how they invest it. So how are places like Harvard investing their money?

Now, of course, universities have specific needs. They are looking to support the university for generations and so have a long-term perspective. They typically pay out sum of their endowment each year to fund expenses. This because tuition fees do not cover the full cost of university expenditures at many universities. Universities may also run into legal risks should they pay out over 7% of their endowment in any year (the UPMIFA rule), and they have a unique set of costs to manage in terms of salaries and facilities.

Nonetheless, similar to many of us, universities are essentially looking for a healthy long-term return on their money with some degree of stability. So though how a university investsmay differ considerably to a shorter term savings goal such as a deposit on a home in a two years, if you have a long term savings objective such as saving for retirement in a few decades, then there's a lot to be learned from what places like Harvard are doing with their money.

The main difference is that universities and individual investors is that universities are looking to pay themselves an income from their endowment in most years. If you're interested in reading more about how universities manage the size and overall risk of their endowments, Thomas Gilbert and Christopher Hrdlicka of the University of Washington have a thoughtful theoretical paper on the topic here.One of their findings is that in certain cases, university endowments may be too large, and that universities that have attractive opportunities to do so, should invest more from their endowment in growing the university.

How Universities Invest

You can see belowhow some of the top academic universities invest, specifically Harvard, Stanford and Yale. These are the most recently available numbers, typically from 2016. The percentages show what percentage of the portfolio are allocated to a particular asset class, and the different colors are the different universities.

Diversification

First off, it's clear that universities take diversification to heart. Their eggs aren't all in a single basket. Money is allocated across four major asset classesthat should move differently depending on how the markets and the economy performs. Stocks are key to how universities invest - whether domestic, foreign public or private most universities have about half their endowment in different types of equities.

That's not too surprising as the long-term returns to stocks are generally considered to be very goodfor the long-term and these universities are making long-term investments. The other large buckets of exposure are: real assets such as commodities and real estate; bonds and cash; and, last but not least, absolute return strategies such as hedge funds. All of these move in slightly different ways depending on factors such as the strength of the economy, interest rates and inflation so the result is overall returns should be smoother at the portfolio level once these different parts are combined.

For example, if stocks have a bad year as the global economy enters recession then bonds should still deliver a reasonable performance and absolute strategies may hold up well too given they should be mostly unaffected by overall stock market returns if strategies are implemented correctly. Thus, the main parts of the portfolio can move in different directions depending on what the future holds and the result is likely to be steadier portfolio performance.

Foreign Exposure

Universities make sure that they invest globally, this is unlike the average US investor who has "home bias" by investing mostly, and sometimessolely, in the US. Most universities have around a third of their equity exposure internationally. This makes sense because there's the diversification benefit of being exposed to different countries, and international stocks may be better value than other markets currently. Theinternational exposure of major endowments has increased in recent years, again this may make sense as US stocks have done well whereas other regions have lagged, helping create the valuation gap we now see. You can replicate this approach relatively easily. For example, the Vanguard FTSE All-World ex-US ETF (ticker: VEU) offers a broad range of international stock exposure via large companies such as Nestle and Toyota for a fee of 0.11% per year. It can be a simple way to get international exposure into your portfolio quickly andeasily.

Private Equity and Venture Capital

Universities include a big chunk of the stock allocation to private equity, whether leveraged buy outs or venture capital. This carries liquidity risk because you can't necessarily sell these assets when you need to, as opposed to public equity which trades routinely. Also, these investments can be hard for smaller investors to access, and historically the better private equity funds have done much better than the average fund,whereas its not clear that an average private equity fund is necessarily better than the stock market, especially after all fees are paid.

So, universities may be using private equity and venture capital because they can access funds with strong investment processes relatively cheaply. It's not clear that the average investor can do this, because universities are investing hundreds of billions even in smaller asset classes. This gives them a clear scale advantage in finding good managers and lower fees. Also in private equity there is evidence that performance persists, whereas for mutual funds the data is much less convincing, so if universities can access funds with strong pedigree, that's likely to help their performance. This is an area where it's hard for the individual investor to follow and so buying stocks, such as via as a well diversified ETF (Exchange Trade Fund) may be a better course.

Real Assets

Universities hold around 20% of their exposure in the form of real assets. This may involved owning property and collecting income from the lease, or owning a forest, mine or other resource producing asset and collecting income as the resources are sold. These investments can deliver an attractive return in their own right and are also considered to be well-protected from inflation, because property or commodities can simply rise in price as inflation increases, whereas bonds don't have this protection and stocks or absolute return strategies may not be able to either. Thus, real assets can be helpful should inflation reemerge at some point in the future. This is something investors can replicate relatively effectively with Exchange Traded Funds. For example, Vanguard has a REIT (Real Estate Investment Trust) ETF that owns around 150 US property firms for an expense ratio of 0.12%, the ticker is VNQ and the international version holding international property companies has the ticker VNQI with an expense ratio of 0.15%.There is a debate as to how closely funds that own companies that manage real estate track the performance of owning real estate directly, but though it's not perfect the correlation is reasonably good.

For diversified commodities, iShares have a fund (ticker: GSG) that tracks a broad set of commodities, with the largest exposure being energy. Unfortunately here the expense ratio of 0.75% is relatively high, but that is the case for many commodity ETFs currently, commodity ETFscan also complicate your tax filing a little due to K-1 forms. The iShares Gold Trust, holds only gold for an expense ratio of 0.25% so it's significantly cheaper but gold behaves quite differently to other commodities.

Absolute Return Strategies

Absolute return strategies have many variations, but attempt to deliver returns that are largely independent of the market rising. Generally this involves owning some stocks that seem attractive, but at the same time selling short (having negative exposure to) less attractive firms such as companies that are expensive or seeing profits fall. This removes market risk from the portfolio, so that returns depend entirely on manager skill, not the market rising. For example, you may buy a firm that's expected to be acquired in 6 months by another firm, and sell other securities so that you aren't exposed to the risk of the stock market. In theory you are left with just the risk of the acquisition happening, and you make money if it does. You build a large portfolio of these sort of events, and you can achieve a return that doesn't depend on the stock market going up, but hopefully is still fairly steady and positive.

In practice it's challenging to completely remove stock market returns from creeping into these strategies, for example if the market crashes, then many firms may decide not proceed with planned acquisitions and instead look to cut costs. However, generally these strategies can deliver returns that are different to how the stock market performs, yet still offer positive performance. Often the issue for the individual investor is high fees and effective replication of this strategy. So this is one where universities as with private equity and venture capital may have an edge. In seeking to replicate this strategy investors may do well to simply consider using more bonds in their portfolio, bonds certainly aren't a perfect match for absolute return, but are easy for the individual investor to access.

Bonds and Cash

Finally, universities allocate a relatively small amount of their investment to bonds and cash. This provides stability in certain markets and a stable reserve to draw from if needed for near term spending. This is relatively simple for an individual investor to replicate. For example, the Vanguard Total Bond Market ETF (ticker: BND) holds over 8,000 different bonds for an expense ratio of 0.05% so is a simple way to get US bond exposure. A similar fund (ticker: BNDX) provides international exposure, though the expense ratio is a little higher at 0.12% and international bonds generally over lower yields at the moment, so this is an area where international diversification is a little less compelling relative to stocks.

Conclusion

So, if as an individual to you were to broadly mimic a university portfolio, the below is what your portfolio would look like. The key changes are in the cases of the asset classes that are hard for individual investors to access well, so swapping bonds for absolute return investments and public stock market investments in exchange for private equity and venture capital. The core concepts are making sure you have international stock exposure, in addition to domestic, and using a combination of commodity, bond and real estate exposure to manage the risk of a bad market environment. Interestingly, this portfolio is perhaps more conservative than how many individuals actually invest, even though universities have a longer time horizon and are perhaps better able to bear risk than an individual investor. As we've seen in the major market declines of 2000 and 2008 this may be a signal that individual investors concentrated in US stocks may be taking on more risk than they realize.