Mutual Funds

The Ivy Endowment-Fund Portfolio

You can keep risk under control by replicating the investments of university endowment funds.

By Andrew Tanzer, Senior Associate Editor, Kiplinger's Personal Finance

August 12, 2009

David Swensen is the Albert Pujols of the money-management world. Over his career, Pujols, the power-hitting first baseman of the St. Louis Cardinals sports a freakishly low ratio of strikeouts to home runs. When baseball historians observe statistics such as these, along with Pujols's consistently high batting average and the lofty number of runners he has driven in, they compare the slugger's career figures to those of such legends as Lou Gehrig and Ted Williams.

Swensen is the chief investment officer of Yale University's endowment fund. From June 1985 through June 2008, Yale's endowment returned an annualized 16.6%, an average of five percentage points per year better than both Standard & Poor's 500-stock index and a balanced index holding 60% in stocks and 40% in bonds. That's a 40-fold multiplication of wealth.

He achieved that feat with one-third less volatility than the S&P 500. He had only one down year (losing 0.2% in the year that ended in June 1988, a period that included the crash of 1987) and compiled a Sharpe ratio of 1.12 over that 24-year span. The Sharpe ratio is academic lingo for risk-adjusted return. A ratio in excess of 1 for a long period is a relatively rare event-kind of the statistical equivalent of Pujols's high homer-to-strikeout ratio.

Alas, even Swensen is mortal. Yale's endowment suffered terribly over the 12 months that ended last June. The school hasn't yet reported performance figures, but we'll guess that the endowment lost 25% to 30%, not a surprising conclusion given that virtually all financial markets collapsed in tandem during last year's unpleasantness.

Swensen, who in the bond arena seems to prefer only government securities (both the traditional and inflation-protected sort), appears to have allocated only 4% to Treasuries, one of the few asset class that held up during the financial crisis. A lack of financing and liquidity crushed alternative investments, such as venture capital and leveraged buyouts, longtime staples of Swensen's strategy. But even though the endowment sank 30% the past year, it still returned about 14% annualized from June 1985 through June 2009.

Can individual investors learn and borrow ideas from Swensen? Mebane Faber says yes. Faber, a money manager in El Segundo, Cal., analyzed the "super endowments" of Yale and Harvard (Harvard's endowment gained an annualized 15.2% from June 1985 through June 2008 with even lower volatility than Yale's). He published the results in The Ivy Portfolio (John Wiley & Sons, 2009), a book that he coauthored with his colleague Eric Richardson.

Understand, though, that you can't precisely replicate the Ivy endowment portfolios. When Benjamin Franklin opined that the only certainties in life are death and taxes, he evidently wasn't thinking about university endowments. Unlike the rest of us, the funds pay no taxes and never perish. Moreover, the endowments have huge staffs and access to investments, such as private-equity partnerships and hedge funds, that are unavailable to the common folk.

Still, Faber thinks you can learn much from endowments' risk-management techniques -- for example, the way the funds combine portfolios of risky but uncorrelated assets in a way that should, over time, produce respectable risk-adjusted returns. Portfolios such as these are prepared for almost any scenario (for example, inflation or deflation; dollar strength or dollar weakness) and should enjoy much of the fruit of bull markets while dampening the downside of bear markets.

Based on his study of the Ivy endowments, Faber has constructed a low-cost portfolio of ten exchange-traded funds (see the table below) that draws on the Ivies' methods of allocation, diversification and risk management. Faber recommends periodic rebalancing of the portfolio. If you're interested in adding his market-timing strategies to the mix, check out his book or visit www.theivyportfolio.com.

10-ASSET CLASS SIMPLE IVY PORTFOLIO
ETF	Symbol	% to own
Vanguard Total Stock Market	VTI	10%
Vanguard Small Cap	VB	10%
Vanguard FTSE All-World Ex-US	VEU	10%
Vanguard Emerging Markets Stock	VWO	10%
Vanguard Total Bond Market	BND	10%
iShares Barclays TIPS Bond	TIP	10%
Vanguard REIT Index	VNQ	10%
SPDR Dow Jones International Real Estate	RWX	10%
PowerShares DB Commodity Index Tracking	DBC	10%
iShares S&P GSCI Commodity-Indexed Trust	GSG	10%

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