Qatari Businessmen’s Association Investment Fund Conference 2007
“Harvard vs Yale: Internal vs External Investment
Management Styles”
November 26, 2007
1) The Contrast of Styles
1.
What do you want to build?
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Internally managed operation: Harvard has 120 investment
professionals managing 65% of their capital
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Externally managed operation: Yale has 20 investment professional
who have allocated 100% of their capital to external funds
2.
Do you want to pursue the quest for alpha?
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Active management – try to beat the indices
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Passive management – index and asset allocation
3.
The sources of returns:
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Asset Allocation
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Manager Selection
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Leverage
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FX
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Sector Allocation
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Security Selection
4.
A key success factor: do things differently
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Both Harvard and Yale embrace alternative investments well before it was
customary to do so and had much larger allocation to those asset classes
2) Effectiveness
1.
Track records (1985-2007)
AUM
Average
Std Dev
Sharpe
Best Year
Worst Year
Correlation
Harvard
$35B
15.9%
9.7%
1.18
32.2%
-2.7%
73.9%
Yale
$22B
17.1%
10.3%
1.23
41.0%
-0.2%
59.5%
2.
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S&P500
14.2%
14.9%
0.65
35.8%
-18.0%
Both endowments outperformed the
average endowment by ~500bp per
annum over a 20 year period.
Completely different skill sets:
3.
Harvard: picking securities
Yale: picking people
Key issues to consider in the
Internal vs External
approaches
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Minimum Efficient Scale
Agency Cost
Optionality of Capacity
The Problem of the One-Way
Ratchet
Reputational Issues
Seeding Risk
Costs
3) Key Questions for any Investment
Model
1. What is your investment objective?
2. Asset allocation: what is the right mix of asset
classes?
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Risk vs Volatility
Diversification
Market/sector movements account for 70%+ of
returns of most funds.
Differential results by asset class: In some asset
classes, the spread in returns between the Top Quartile
and the Bottom Quartile
•
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is vast (REITs, Private Equity),
in others it’s inconsequential (bonds)
3) Key Questions for any Investment
Model (cont)
3. Investment managers: how do you identify skill?
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Intellectual flexibility
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–
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You need to find managers who can make money through a
series of market conditions.
The Lake Wobegone Problem
The greatest challenge is knowing what risks were
taken to produce the results. The best performer last
year is not necessarily who you want to back.
Luck vs Skill: You need to understand the processes that
produced those results. How did they sourced the idea and
do the research? Is their process/strategy scalable?
Consistency: second quartile performance every year =
top decile over time.
4) Capacity
1. The Groucho Marx Problem: The challenge is
identifying those managers early and being able to
get sufficient capital into those funds.
2. Balance between analytical resources and being
nimble
3. There is a lot of capital chasing a small number
of highly skilled investors.
5) Internal Asset Management
1. To a greater degree, there is more flexibility in
asset allocation decisions.
2. However, there are a lot more questions and a
lot more headaches.
3. You don’t have as much of a capacity issue, but
you have to build a high performance
organization.
6) The Barriers to Success
1.
2.
3.
Stable investment/leadership team: It is near impossible to
build a performance organization without stability in the core
leadership team
Deep analytical training: This is an apprenticeship business;
processes and mental models need to be learned early
Prudent risk-taking needs to be encouraged
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4.
Bar bell theory
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5.
6.
Failure needs to be accepted (and encouraged)
Batting average vs slugging average
Scale to do all the work that is necessary
Nimble enough to exploit it
Flexibility of mandate: To go where opportunity is most
bountiful and sit on cash if the well runs dry.
Stable capital base
7) Our Advice to QBA
1. Invest in building these relationships now.
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It takes years to find the right partners that you can trust. It
may take engaging dozens of managers to find the one or
two that will make sense for you.
David Swensen (Yale) ensured superior ongoing results by
being early in his funding of several world class funds. He
now has a permanent advantage over other endowments;
he can still get capacity into skilled firms that others cannot.
2. Use stable capital as an advantage.
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Capital is plentiful but it can be differentiated
The right capital, ie long-term focused capital that allows
the investment managers the opportunity to exploit their
skills, is very valuable.
3. Study the models to find one that fits you