David Swensen’s Yale Endowment shows how Venture Capital is good for your portfolio asset allocation

Summary

• In 2019, Swensen’s Yale endowment fund’s asset allocation to Venture Capital grew over the years to 19% from 13.7% in 2013.
• This is a major strategic change that shows how diversifying in VC has been an effective investment strategy.

I have recently surveyed a few endowment funds asset allocation and to my surprise, a good portion of their holdings are in VC. More than that, Bloomberg announced last March that Swensen’s legendary Yale endowment fund increased its VC allocations to almost one-fifth of its total holdings.

Some history

A little bit of history first: Until 1985, Yale had invested in mainstream U.S. stocks and bonds with foreign stocks and real estate. Aware of the tenet of modern portfolio theory stating that asset allocation explains over 90% of a portfolio’s investment returns, Swensen shifted the bulk of its investments into alternative assets like natural resources, venture capital, real estate, and foreign stocks.

Up until 2008, Yale’s endowment provided a solid 15.6% average annual returns through 2007 stretching back to 1987, with no down years.

After the downturn, the Yale endowment returned 8.1% per annum over the last 10 years. That still beats the S&P 500’s average annual return of 7.5% over the same period.

If we adopt a long time horizon view we can see how Swensen's strategy is preferred to investing following the S&P 500. Over the last 30 years, the S&P 500 has generated an annual return of around 10%. Yale’s 12.9% average annual returns over the past 40 years beat the S&P 500 by just under 3% per year.

Something is going right, and the strategy of increasing its VC holding has definitely something to do with it.

The allocation and the changes in the mix

In 2016, Yale was holding about 14% of its assets in VC.

The majority of holdings was Absolute Returns (22%), but VC was very close to Real Estate (13%), Foreign Equity (14%) and Leveraged Buyouts operations (16%). If we actually consider VC and Leveraged Buyout together — a big indicator that the fund likes holding private companies directly or thru entities investing in them- then we reach 30% of assets.

Historically, the majestic $29.4 billion fund held 13.7% of its assets in VC in 2013, growing to 14% in 2016, 17.1% in 2017 and finally 19% by June 2018. (Check out FC Hu great post that analyses Yale’s current Yale allocation).

It is important to notice that Yale hit some home runs such as Linked where a $2.7 million investment produced $84.4 million in gains after the company went public in 2011.

According to Bloomberg, the mix is also changing:

• Leveraged buyout funds shrunk to a 14.1 percent allocation as of June 2018 from 19.3 percent since fiscal 2014.
• Real estate was down to 10.3 percent from 17.6 percent in that period.
• Hedge funds increased to 26.1 percent from 17.4 percent.

Conclusions

So, what can we learn from these major strategic changes?

Diversification is still a good way of thinking

Globally speaking, it is safe to conclude that asset allocation plays a major role and diversification has been proven to work in the long time horizon. Investors that do not diversify are majorly exposed to a continually evolving market.

Investors need VC

VC has become an increasingly popular asset class and, despite the fact that a lot of people are still skeptic about it, the latest strategic decisions of big players validate this idea.

VC funds the future economy and is high risk but exposure is beneficial for the investor that plays the long game.