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8:30 AM EST Monday, April 10, 2006: Today's column is about how Yale invests its $15 billion endowment. There are lessons here for all us. First, the latest results: Up 22.3% in 2005 fiscal. Phenomenal -- An organization that large doing so spectacularly. Truly phenomenal. Here are Yale's recent results.

The key to Yale's sterling results are the allocation of its portfolio. From this chart, you can see how Yale has allocated more to "real assets" (real estate, oil and gas, and timberland).

You'll notice that its goal is to cut its cash down to zero! It figures, justifiably, it can't make any money on cash. Yale figures that about 34.6% of its investment is in "liquid" assets. So it can get cash when it needs it. You'll also notice that Yale's investment allocation goals are very different to the traditional American college/university:

In this chart, you can see Yale's progressive and dramatic reduction in holdings of U.S. equities, i.e. stocks listed on U.S. stock markets.

In the report, Yale writes, "Finance theory predicts that equity holdings will generate returns superior to those of less risky assets such as bonds and cash. The predominant asset class in most U.S. institutional portfolios, domestic equity, represents a large, liquid, and heavily researched market." As a result, says Yale, it can't achieve the competitive edge it can in less well-researched areas (such as real estate).

Writing about its domestic equity portfolio, Yale says it "pays little attention to sectoral allocations. In fact, the current portfolio consists of a variety of specialists seeking to apply in-depth knowledge to concentrated portfolios of securities. The aggregation of individual manager portfolios focused on energy, biotechnology, and technology, along with a number of less specialized managers, bears little resemblance to broad-based market indices. ... Yale's portfolio typically favors value and small-capitalization stocks. Value stocks, securities that are cheap in relation to fundamental measures such as book value, earnings, or cash flow, generally outperform the market over the long term, albeit with higher volatility of returns. Patient investors reap rewards for taking uncomfortable positions in out-of-favor sectors and securities. Yale's overweighting of small-capitalization stocks stems from a belief that larger stocks tend to be better followed and more efficiently priced than small-capitalization stocks, offering better opportunities for superior managers to generate excess returns. In addition, studies indicate that, over the very long term, small-capitalization stocks tend to generate slightly higher risk-adjusted returns than do large-capitalization stocks. Thus small-capitalization stocks have a prevailing, albeit somewhat unreliable, wind at their back."

The following chart is self-serving. It makes Yale's managers feel good , giving them extra motivation for dealing with Yale.

In a section called, "a message from the Investment Committee Chairman," Charles Ellis writes, "

This extraordinary achievement quite naturally attracts all the attention, yet close observers can say that the real secret to Yale's remarkable success is defense, defense, defense. But how, you might ask, can defense be so important to Yale's remarkably positive results? Starting with that great truism of longterm success in investing - if investors could just eliminate their larger losses, the good results would take care of themselves - we remind ourselves of the great advantages of staying out of trouble.

Yale's rigorous defense in investing combines a series of rational initiatives rooted in the powerful body of investment theory developed at Yale and other universities. The architecture of Yale's portfolio structure is designed to locate the Endowment portfolio on the efficient frontier in trade-off between risk and return. Utilizing Monte Carlo simulations, Yale's portfolio is tested using thousands of possible scenarios, with particular attention to avoiding disruptive adversity and untoward portfolio outcomes. Yale's Investment Committee devotes a full meeting each year to challenging every aspect of the portfolio structure in the classic tradition that only the well-tested decision merits strong, sustained commitment. Selection of specific external managers adds another powerful defense -- and has clearly added significantly to Yale's superior returns. The obvious risks in manager selection are two: hiring managers after their best results and terminating managers after their worst.
Yale strongly favors long-term continuing commitments to very carefully chosen managers, often at an early stage in their development. As a result, serial capital additions to each manager's mandates are frequent and turnover among Yale's manager relationships is quite low.

Yale's rigorous defense in investing combines a series of rational initiatives rooted in the powerful body of investment theory developed at Yale and other universities. The architecture of Yale's Yale's process for selecting managers is unusually rigorous, partly because the Investments Office staff is so well experienced and so in touch with the markets; partly because extensive "due diligence" contacts are made; and partly because Yale selects only those managers who demonstrate considerable strength on several criteria: investment skills; organizational coherence; clarity of business strategy; appropriate fees and incentives; and, most importantly, personal and professional integrity.

Each new manager is recommended through a formal memorandum that details all "due diligence" research; explains the manager's record, organization, investment philosophy, and decision- making process; and provides the professional record of each principal. Each of these in-depth background briefings -typically 15 to 20 pages long- provides the basis for a thorough discussion with staff professionals. Quarterly Investment Committee meetings are much like an advanced seminar in investment theory and practice, led by two Yale Ph.D.'s: President Richard Levin and Chief Investment Officer David Swensen.

Swensen has written a couple of books on portfolio allocation -- Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment and Unconventional Success: A Fundamental Approach. Amazon has a sale on the two of them for $40.43, a veritable bargain.

One area of Yale's allocation is "absolute return." Here's what Yale writes:

Absolute return investments seek to generate high long-term real returns by exploiting market inefficiencies. The absolute return portfolio is managed by investment firms pursuing a wide variety of strategies, which can be broadly categorized as event-driven or value-driven. Event-driven strategies generally involve hedged positions in mispriced securities and depend on a specific corporate event, such as a merger or bankruptcy settlement, to achieve targeted returns. Value-driven strategies also entail hedged investments in mispriced securities, but rely on changing company fundamentals or increasing market awareness to drive prices toward fair value.:

To read most of the Yale Endowment 2005 report, Click here.

By the way, the real reason for Yale's sterling performance in 2005 was, I understand, Google and oil and gas.

Education for the wife:
A man was walking down the street when he was accosted by a particularly dirty and shabby-looking homeless man who asked him for a couple of dollars for dinner.

The man took out his wallet, extracted ten dollars and asked, "If I give you this money, will you buy some beer with it instead of dinner?"

"No, I had to stop drinking years ago," the homeless man replied.

"Will you use it to go fishing instead of buying food?" the man asked.

"No, I don't waste time fishing," the homeless man said. "I need to spend all my time trying to stay alive."

"Will you spend this on greens fees at a golf course instead of food?" the man asked.

"Are you NUTS!" replied the homeless man. "I haven't played golf in 20 years!"

"Will you spend the money on a woman in the red light district instead of food?" the man asked.

"What disease would I get for ten lousy bucks?" exclaimed the homeless man.

"Well," said the man, "I'm not going to give you the money. Instead, I'm going to take you home for a terrific dinner cooked by my wife."

The homeless man was astounded. "Won't your wife be furious with you for

doing that? I know I'm dirty, and I probably smell pretty disgusting."

The man replied, "That's okay. It's important for her to see what a man looks like after he has given up beer, fishing, golf, and sex."

Harry Newton

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads. Thus I cannot endorse any, though some look mighty interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
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