David Swensen on Inflation

" David F. Swensen’s leadership as Yale’s Chief Investment Officer from !$%& until '"'! had an extraordinary impact on the university’s endow- ment value and hence on its financial stability and its ongoing pursuit of uncompromising excellence. The endowment’s investment return during his thirty-five-year tenure averaged an unprecedented !(.) percent per annum, advancing from *!.( billion on his arrival to *+'.( billion at the close of the '"'! fiscal year. The support provided by endowment funds is widely considered to be a key to the stability and prominence of major nonprofit institutions, par- ticularly the country’s major private colleges and renowned research uni- versities. The academic standings of Yale, Harvard, Princeton, MIT and other prominent universities, as ranked in surveys and among peers, show a strong correlation with the relative market value of their endow- ments. For the past generation at least, Yale has consistently been among the handful of universities topping both those scales: recognized academ- ic distinction and proven financial strength. As a student of economics, and of Yale’s economics, Swensen was keenly aware of the damage caused by the inflation of the !$)"s and the need for the university’s investments to have a strong equity orientation. In the !$$" Endowment Report, Swensen presented a numerical demon- stration concerning an ongoing challenge to Yale’s purchasing power. Even the strong market returns of the !

$%"s, he indicated, had been insufficient to outweigh the inflation and bear markets of the !$)"s along with the university’s high spending rates. The FY !$$" endowment mar- ket value of *'., billion, despite more than doubling in five years, still fell *,! million short of the minimum that would have been needed by !$$" to outpace inflation. Strong endowment returns would be required to ensure Yale’s long-term stability. Results promptly confirmed that the challenge was being met: Yale’s !$$& results reflected an average annual return of !+.& percent for the dec- ade since !$%&. In another milestone, the decade had shown an increase in distributions to the operating budget from *,,., million in FY !$%, to *!+$.( million in FY !$$&, an annual growth rate of !'+ percent. This would remain the keynote in Yale’s financial fortunes for the rest of Swensen’s tenure: strong annual returns increasing value, with steady growth in the rates of support to university operations. By '"'! the total market value of the endowment had advanced to a new high of *+'.( bil- lion and provided ((.( percent of budget spending (compared to !+.) per- cent in FY !$%,). His successful stewardship of Yale’s net worth for more than three dec- ades was buttressed by disciplined adherence to core investment princi- ples.

higher education, as noted in press reactions, curricula in leading business schools, and the reception of Swensen’s books about institutional and per- sonal investing principles. He frequently appeared as a speaker or pan- elist, won prestigious awards, and, hailed for his stewardship for the pre- vious twenty-four years with “a record unequaled among institutional investors,” he was appointed to President Barack Obama’s Presidential Economic Recovery Board in "##$. In David Swensen, Yale had an investment chief who was also uniquely involved in the life of the institution, educated in its doctoral program, active as a teacher, proud of Yale’s record of accomplishment and committed to its unique standards. Above all, Swensen was always aware of the essential link between resources and the university’s capac- ity to pursue its role in the vanguard of research and educational institu- tions. Working closely with the Yale Investment Committee as advisers, he was guided less by mere numbers, important as they are, than by service to the institution’s mission. He regularly stressed the necessity “to balance the demands of tomorrow against the needs of today” by provid- ing “substantial levels of cash flow to the operating budget for current scholars, while preserving endowment purchasing power for future gen- erations.” His professional commitment to his work and to Yale was acutely personal. A leader of his scope and impact leaves a strong legacy.

The Yale Model depends on rigorous attention to risk analysis and to the shifting proportions of individual asset classes in the endowment invest- ment portfolio, proportions that change over time depending on market factors and institutional requirements. Given the high inflation rate of uni- versities and the need to ensure excellence and solvency in perpetuity, Yale’s strategy relies on equity investments, broadly defined. This means that over 1. percent of the portfolio includes global equities and the illiquid asset classes of leveraged buyouts, venture capital, real estate and natural resources—“inefficient” asset classes in which active management can add significant value. The model also leverages the perpetual character of endowments to invest with longer-than-usual time horizons. In applying Spending from Post-*,-. Endowment Gifts Inflated *,-. Spending Inflated Actual Spending “A masterful work by the master himself,” Harvard’s investment chief Jack R. Meyer called Swensen’s book. First published in +..., the classic work on the Yale Model appeared in a revised and expanded edition in +..,. !",#$$ !",%$$ !",&$$ !",$$$ !'$$ !#$$ !%$$ !&$$ !$ Millions "()$ "()) "(#$ "(#) "(*$ "(*) "('$ "(') "(($ "(() &$$$ &$$) &$"$ &$") &$&$ Spending Growth Surpasses Inflation *,-.–+.+*

” Another crucial factor in the Yale Model is the role of the Yale Investment Committee, which has been responsible for oversight of the endowment since !"($. The Committee consists of at least three Fellows of the Corporation and other persons with particular investment expertise. The Committee, currently consisting of eleven members, meets quarterly to review policies and endowment performance, proposed objectives and strategies, and adjustments to spending or asset categories. Adherence to this array of principles and practices that make up the Yale Model is a matter of ongoing adjustment among competing considerations such as risk and return, as well as strong working partnerships with outside managers. The model’s success at Yale for more than three decades was a function not just of analytical rigor but also, as former Yale President Levin pointed out, Swensen’s “extraordinary judgment about people.” !) By focusing on less efficient markets, and pursuing less liquid, value-oriented opportunities, inves- tors increase the odds of winning the loser’s game.…Markets with inefficiently priced assets ought to be favored by active managers; markets with efficiently priced assets should be approached by active managers with great caution. –Pioneering Portfolio Management !"#$ !""% !""$ &%%% &%%$ &%!% &%!$ &%&% !&,$%% !%,%%% ',$%% $,%%% &,$%% % Endowment Mean of Broad Universe of Colleges and Universities Inflation Growth o ff (!%% Yale’s Performance Exceeds Peer Results July !

We dis- cussed the various aspects of the Yale Model ranging from long- term horizons, the need to generate strong inflation-adjusted returns, diversification, asset allocation, alternative asset classes, alignment of interest, and partnering with extraordinary invest- ment managers. In essence we taught right from David’s book Pioneering Portfolio Management. In !""", when David first wrote that book, many wondered if it was a mistake to publish the playbook for the Yale Model. Why give away all of Yale’s intellectual property? Listening with amazement at the quality and thoughtfulness of our guests who had all been trained by David, I realize that the real secret ingre- dient was not just David’s conceptual framework for the invest- ment endowment portfolios, but vitally, his extraordinary invest- ment in people. The Yale Model needs highly intelligent, com- mitted, and selfless team players to excel. David’s investment in people—that is the secret sauce! !" ...he cared deeply about Yale, got such joy out of teaching classes and hearing back from students years later about their career, and deci- sions they needed to make.