The Real Yale Model

September 7, 2023 by Ted Seides
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Investors following David Swensen too often miss the mark in their interpretation of his theory. Like children playing the game telephone, they listen to other voices and echo beliefs with shakier foundations than Yale’s.

Anyone adopting the “Yale Model” is well served to revisit David’s writing from time to time. I had a chance to do that and found perspectives on illiquid investments, asset allocation, active management, private equity, and rebalancing that differ from the conventional wisdom that defines the Yale Model.

The Yale Model in David Swensen’s Words

David’s ability to articulate and act on an investment philosophy based on academic research was the foundation of his greatness. Reading the revised edition of Pioneering Portfolio Management reminded me of the clarity of his ideas and depth of his insight.

David put forth a framework for thinking about the investment problem and shared how he applied that framework to managing Yale’s endowment. He wrote about an investment strategy for educational endowments with a perpetual time horizon, articulating a series of first principles. This core of the “Yale Model” in his words are as follows:

  1. Equity bias. “Sensible investors approach markets with a strong equity bias, since accepting the risk of owning equities rewards long-term investors with higher returns.”[1]
  2. Diversification. “Significant concentration in a single asset class poses extraordinary risk to portfolio assets. Portfolio diversification provides investors with a “free lunch,” since risk can be reduced without sacrificing expected return.”[2]
  3. Alignment of Interest. “Nearly every aspect of fund management suffers from decisions made in the self-interest of the agents at the expense of the best interest of the principals. By evaluating each participant involved in investment activities with a skeptical attitude, fiduciaries increase the likelihood of avoiding or mitigating the most serious principal-agent conflicts.”[3]
  4. Search for inefficiency. Focus on asset classes with a wide dispersion between top and bottom performers and employ external managers to exploit opportunities.

[1] David F. Swensen, Pioneering Portfolio Management, Fully Revised and Updated, 2009 edition, page 55.

[2] Ibid, page 59.

[3] Ibid, page 5.

[4] Yale University Investments Office: February 2015. Josh Lerner, Harvard Business School Publishing, page 16.

[5] Swensen, page 5.

[6] Ibid, page 4.

[7] Ibid, page 5.

[8] Swensen, page 296.

[9] Ibid, page 7.

[10] Ibid, page 82.

[11] Ibid, page 54.

[12] Ibid, page 51. Swensen cited Brinson et al in his first edition and a 2000 study by Roger Ibbotson and Paul Kaplan in the second edition.

[13] Ibid, page 97.

[14] Ibid, page 73.

[15] Ibid, page 7.

[16] Ibid, page 7.

[17] Ibid, page 224.

[18] Ibid, page 223.

[19] Ibid, page 235.

[20] Ibid, page 220. David’s definition of private equity included both leveraged buyout and venture capital strategies.

[21] Ibid, page 71.