How the Rich Invest: Inside Yale’s Endowment Fund
Ever wondered how the rich invest? Yale’s nearly $41 billion endowment fund gives us a good idea. Endowments like Yale’s invest similarly to wealthy individuals and retirees. Both seek income to sustain their operations or lifestyles indefinitely, aiming to outperform their peers and achieve strong returns regardless of market conditions. The primary rule of financial independence is to avoid losing money. Consistent losses can quickly shatter your dreams of financial freedom.
If you’re curious about how the rich invest, university endowments are a great case study. Understanding these can also be insightful for anyone planning to retire and live off investments, as the goal is for your investments to outlast you and provide for future generations.
Understanding Endowment Funds and Wealthy Investment Strategies
Years ago, a tenant of mine who worked as an analyst for Stanford’s endowment fund mentioned that over 50% of their assets were in alternative investments. This is much higher than the typical 5-20% allocation seen among regular investors. Currently, my alternative investment allocation is around 15%, with a goal to increase it to 20%.
She explained that endowments are comfortable investing heavily in alternatives because they have a long history with these investments and are familiar with their risk profiles. Their target is typically a 5% to 6% annual return, which aligns with my own investment goals. More than 50% of my net worth is tied up in illiquid assets like real estate, private equity, and retirement accounts. A 6% return on a $5 million portfolio equates to $300,000 annually, enough to support a middle-class lifestyle in a big city.
Yale’s Investment Approach
Yale’s endowment pioneered alternative investments in hedge funds, private equity, and real estate. In 1990, they were the first institutional investor to define absolute return strategies (hedge funds) as a distinct asset class, starting with a 15% target allocation. Hedge funds aim to provide positive returns in both bull and bear markets.
Yale initially partnered with Tom Steyer’s Farallon Asset Management for absolute return strategies. Steyer, a Yale graduate, had a successful track record in risk arbitrage and private equity. This partnership set the stage for other college endowments to follow, eventually leading hedge funds to charge substantial fees for their services.
Yale’s Asset Allocation
Yale’s 2021 asset allocation aimed for a minimum of 30% in market-insensitive assets (cash, bonds, absolute return) to perform well in bear markets and a limit of 50% in illiquid assets (leveraged buyouts, real estate, natural resources). Their diversified approach contrasts sharply with typical investors who concentrate heavily in domestic equities.
In 1990, over 70% of Yale’s endowment was in U.S. stocks, bonds, and cash. Today, less than 10% is in domestic marketable securities, with nearly 90% in foreign equity, private equity, absolute return strategies, and real assets. This shift is due to the higher returns and diversification benefits of alternative assets, which tend to be less efficiently priced, offering opportunities to exploit market inefficiencies.
Minimal Domestic Equities
Yale’s domestic equity allocation was under 10% in 2018, and by 2021 it was just 2.25%. In contrast, many individual investors have the bulk of their portfolios in domestic equities. Yale’s approach includes a higher allocation to foreign equities and alternative investments like real estate and leveraged buyouts, reflecting a broader opportunity set.
Spending and Purpose of Yale’s Endowment
Yale’s endowment funds are used to cover about 30% of the university’s operating budget. The allocation includes professorships, specific purposes, unrestricted funds, scholarships, maintenance, and books. This diversified spending ensures the university’s financial stability and supports its mission.
Investment Insights
Understanding how the rich invest provides valuable insights into improving our own investment strategies. Despite some negative views on alternative investments, they are a significant part of the portfolios of the wealthy and large endowments. Keeping an open mind and learning from these strategies can be beneficial.
Real Estate Investment
Real estate is a preferred investment for achieving financial freedom due to its stability and income generation. Crowdfunding platforms like Fundrise and CrowdStreet allow regular investors to participate in real estate opportunities traditionally reserved for the wealthy. These platforms offer diversified exposure to various real estate types across the country, providing a way to earn passive income and capitalize on market trends.
Managing Investments
Staying on top of your investments is crucial for building wealth. Tools like Empower help manage your finances by providing insights into your portfolio, identifying excessive fees, and offering allocation recommendations. Consistent financial management and planning are key to achieving and maintaining financial independence.
Conclusion
The investment strategies of the rich, especially as seen in large endowments like Yale’s, offer valuable lessons for all investors. Diversification, a focus on alternative investments, and a long-term perspective are crucial elements of their success. By adopting some of these strategies, individual investors can enhance their own financial plans and work towards long-lasting financial security.
