Why the “endowment model” is not for you

Allocators tend to love stuffing portfolios full of prestige investments, justified by references to the Endowment Model, popularized in the early 2000s by David Swensen, manager of Yale’s endowment fund.

Following a long period of exceptional performance by Yale’s portfolio, it became all the rage to follow the model pioneered by Swensen, which grew the university’s endowment fund over thirtyfold in a few decades, making it second in size only to Harvard’s.

The model itself is based on having a lot of equity exposure—but not through traditional public markets. Over time, Swensen moved the fund from having the vast majority of its assets in public market stocks and bonds to having those assets make up only 10 percent of the portfolio. Where did the money go? Into all sorts of unlisted assets—hedge funds, private equity, private debt, venture capital, real estate, natural resources, and a host of other strategies and asset classes. Exotic stuff, inaccessible to almost all ordinary investors.

The Yale endowment was so successful that Swensen copycats arose everywhere… first in other Ivy League schools, then other nonprofits and institutions, and finally popping up in the private wealth realm, with packaged products that promised to deliver Yale-like returns to the everyman.

But here’s the deal. Swensen was a genius. And he had a lot of capital to work with, many pre-existing relationships with excellent external managers, and a vast and capable team to help him implement the strategy. This is not easy stuff. And so the copycats have understandably failed to replicate the success of the Yale endowment.

However, that doesn’t stop the HNW Industrial Complex from using it as a marketing gimmick. First of all, who wouldn’t want to be associated with Ivy League schools like Yale and Harvard? This is instant marketing gold!

Second, the exclusivity factor is a huge draw for those marketing to the 1 percent. Not only are these strategies used by Ivy League schools, but, more importantly, the funds they’re going to use in order to invest in these strategies are also accessible only to the wealthiest investors! The sales pitch often highlights access to managers you are only able to invest with thanks to the connections of the investment advisor (and the wealth of the other prestigious families with whom they work).

Aside from high fees, illiquidity, and complexity, another key fundamental problem with applying the Endowment Model in the private client sphere is that the goals of institutions and their investment boards have nothing to do with the goals of individuals and their families.

Swensen himself was critical of the firms who have co-opted this strategy as a marketing tool. In his book Pioneering Portfolio Management he wrote, “Consultants express conventional views and make safe recommendations. Selecting managers from the consultant’s internally approved recommendation list serves as a poor starting point… Clients end up with bloated, fee-driven investment management businesses instead of nimble, return-oriented entrepreneurial firms.” He went on to write that “active management strategies demand uninstitutional behavior from institutions, creating a paradox few successfully unravel.”

So, in the very book he creates to let others know how he accomplished what he did at Yale, he basically explains why it will be extraordinarily difficult, even impossible, to replicate.

And while it’s easy for foundation and endowment boards to remain emotionally detached from the process (they’re investing other people’s money, after all), it’s much more difficult for private clients to do so. At the end of the day, not being able to sit down with the individual managing your money to ask questions and get answers about your life savings can be a frustrating experience. If my advisor is just a sales arm for a Bridgewater fund that is crapping the bed, I want to speak to one of the portfolio managers at Bridgewater, not a sales guy or a “relationship manager” who has probably never met the actual fund manager.

And, frankly, Swenson was a unique talent who made something difficult look easy. In less capable hands, the Endowment Model simply doesn’t work. In an October 2020 draft paper titled “Failure of the Standard Model of Institutional Investment,” Richard Ennis concludes that large endowments have underperformed passive portfolios by 1.6 percent per year. His data notes that there was indeed a “golden age of alts,” as he puts it, but this era lasted just a decade and a half and was ushered out with the 2008/09 financial crisis—precisely the time that asset managers began to peddle the Endowment Model to family offices and private investors as a way to counteract public market volatility.

Here’s my recommendation: if anyone starts pushing the Endowment Model to you or starts talking about investing like an “institution,” be very wary. They don’t have Yale’s resources. And you’ll want to know what this strategy is costing you to implement all in. Without the Yale fund’s scale, the costs of implementing these strategies would be proportionately higher, further cutting into your returns.

Ultimately, the Endowment Model has the potential to work for institutions. It checks a lot of boxes that help them achieve their particular objectives and give board members the cover they need from day-to-day market volatility. But for the private client, it’s a marketing gimmick—one that far too many wealthy investors fall for.