Making the Grade: Investing Like the Ivies

Jan. 24, 2008 — -- The major university endowments have recently received much attention for their stellar investment records, and deservingly so.

The fiscal year that ended in June proved to be another banner year for the colleges, with Yale scoring an amazing 28 percent return, by far trumping the 18 percent return for the S&P 500 during the same period.

What is more remarkable is that in the last decade, Yale delivered an 18 percent average annual return while the S&P 500 averaged only 5 percent.

What's the secret? Two simple ideas: diversification and long-term thinking.

Like most people, you have probably heard and read a lot about diversification, but most of this tends to focus on only two asset classes: stocks and bonds, and focuses on common questions. Is now a good time for large cap or small cap stocks? Growth or value? U.S. or foreign?

The key to building a well-diversified portfolio akin to that of Yale, however, is not just to diversify within public equity and fixed income but to diversify across asset classes into so called "alternative" asset classes, such as absolute return, private equity, real estate and natural resources such as oil, metals and timber.

The purpose of this is to assemble a portfolio of investments that will perform differently in different market environments. Many of the sectors within public equity and fixed income tend to be highly correlated, as buying frenzies and selling panics tend to move these investments within these asset classes in lock step. Diversifying only across stocks and bonds, therefore, may provide limited benefits.

High net worth investors, with the help of their investment advisers, can accomplish Yale-like diversification by accessing private funds in each of these alternative asset classes. For the average investor who may not be able to access private funds, either because of investment minimums or liquidity, another way to emulate Yale's diversification strategy may be through exchange-traded funds, known as ETFs.