Doing the Yale Model ETF-style?
Swensen's approach gets the passive treatment.
March 28, 2013
By far, my favourite story on the exchange-traded fund (ETF) scene this week comes from Seeking Alpha, where blogger Brian Abbott spends time figuring out a way to replicate the Yale Model using ETFs. Made famous by Yale Endowment's chief investment officer, David Swensen's 2000 book, Pioneering Portfolio Management, the model relies heavily on a fundamental switch away from traditional stocks and bonds and into alternatives such as hedge funds, private equity and real estate.
The strategy made Swensen a star and the Yale Endowment a model for other institutional investors to follow. But 2008 wasn't kind to Yale—in that year, it posted a massive 30% loss, driven mainly by private equity investments that forced the university to cut $150 million in spending. Yale has bounced back somewhat since 2008, and Swensen continues to remain a dominant figure in the investment landscape. Abbott's attempt to create an ETF mirror of the Yale Model is particularly interesting—plan sponsors have long been trying to find transparent and lower-cost ways to access the very alternatives that are a staple of the Swensen model. Finding accessible ways to invest in alternatives, however, is tough for pension funds, and often money is left on the table because there is simply no place to put those desired allocations.
So could ETFs be a good route? Abbott gives it a try. Here is how he allocated in an effort to replicate the Yale Model ETF-style:
- Absolute return: Wisdom Tree Managed Futures, (WDTI), IQ Hedge Macro Tracker ETF (MCRO), 14.5%.
- Domestic equity: Vanguard Total Stock Market ETF (VTI) or SPDR S&P500 Trust (SPY), 5.8%.
- Fixed income: iShares Barclays Aggregate Bond Fund (AGG) or Vanguard Total Bond Market ETF (BND), Vanguard Extended Duration ETF (EDV), 3.95%.
- Foreign equity: iShares MSCI EAFE Index ETF (EFA) or Schwab International Equity Index Fund (SCHF), 7.8%.
- Natural resources: iShares S&P Natural Resources Index Fund (IGE), SPDR Gold Trust (GLD), 8.3%.
- Private equity: Blackstone Group (BX), American Capital (ACAS) or Gladstone Capital (GLAD), 35.3%.
- Real estate: Vanguard REIT ETF (VNQ) or iShares Dow Jones U.S. Real Estate Fund (IYR), 21.7%.
- Cash: 1.7%.
At a glance, Abbott's got plenty of exposure to absolute return strategies (14.5%), private equity (35.3%) and real estate (21.7%). Like Yale, he is also light on U.S. and global stocks.Here's where Abbott's analysis let me down: some of these products (particularly the absolute return ETF) are too new to be back-tested. Some are also pretty disappointing from a return standpoint. Kind of disappointing: I was hoping he would be able to run his data side by side with Yale's performance and show me that ETFs could indeed beat the master investors over time. Sadly, we'll just have to revisit this in a few years.
In the meantime, however, Abbott does something interesting: he shifts his focus to creating a Yale ETF Model that cuts out all alternatives except for real estate and tilts toward fixed income. He also adds a healthy dose of global and U.S. equity to the mix—domestic equity: VTI, 30%; fixed income: EDV, 15%; natural resources: GLD, 5%; foreign equity: EFA, 30%; and real estate: VNQ, 20%.
This yields some relative success:
A three-year buy-and-hold backtest of the above allocation model, compared with SPY, produced the following statistics: CAGR 13.8% (versus 13.4% for SPY), maximum drawdown -13% (versus 18.6% for SPY), and a volatility of 14.9% (versus 18.3% for SPY). In plain English, the simplified portfolio produced slightly higher returns than SPY, and with lower volatility, too, resulting in superior risk-adjusted three-year buy-and-hold returns.
Not bad for a passive model, especially given the volatility that's evident in Yale's last three years of returns: 8.9% for 2010, 21.9% for 2011 and just 4.7% for 2012.
As for me, I can't wait to see how some of these ETFs measure up on the alternatives front—it might just open up some new doors for institutional managers and pension funds to finally add an extra layer of diversification in a playing field that has been dominated by the giants.