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‘Game over’: Investors hunt for new model after years of broad gains 

Institutional money managers are grappling with a grim investing outlook, sending them on a hunt for the next big idea decades after the late David Swensen triggered a revolution when he arrived at Yale’s endowment in 1985.

It is a pressing problem. Asset allocators like Swensen — who steer big institutional pools of money like pension plans, endowments or sovereign wealth funds — are facing one of the trickiest investing landscapes in history.

The bond bull rally, which has pulled down yields, has meant that there are precious few sources of income left across global markets. Even European junk bond yields are now below where 10-year US government debt was a decade ago.

The high prices for fixed-income assets mean bonds, typically a ballast in portfolios, are unlikely to offer much protection should stocks quake again. Meanwhile, equity markets now trade at elevated valuations in many countries, limiting their scope for further gains. 

“Falling interest rates were the engine of a twin bull market. You couldn’t lose for 40 years. But that game is over now, so what do you do?” said Stan Miranda, chair of Partners Capital, which manages $40bn on behalf of endowments, family offices and charities. 

It is a question many investors are now asking, and few have any good answers. But some think the future may look Canadian, where some large pension plans have pioneered an in-house DYI approach to big investments.

Based on historical valuations and returns, AQR, the investment group, now estimates that a traditional 60/40 portfolio — split between 60 per cent in equities and 40 per cent in bonds — will return just 2.1 per cent a year after accounting for inflation over the next five to 10 years. A US 60/40 portfolio will return a miserly 1.4 per cent in the coming years, compared to an average of nearly 5 per cent since 1900.

As far back in the 1980s, Swensen realised that a 60/40 portfolio was a bad idea for institutions like Yale. Investors with longer time horizons and no risk of redemptions can stomach more short-term volatility, don’t need much safe but low-yielding fixed income, and can lock up their money in investments for years.

Following that premise, Swensen ratcheted back Yale’s allocation to bonds in favour of stocks, and ploughed billions into more aggressive but diversified investments in private equity, venture capital, hedge funds and even timber land. That helped secure Yale average annual gains of over 12 per cent for the past three decades.

Yale’s endowment grew strongly under Swensen’s stewardship

The challenge is that Swensen’s Yale model has been imitated by many, but successfully replicated by few.

Copying Yale’s asset allocation is in theory straightforward, but part of Swensen’s “secret sauce” was his ability to unearth money managers who could consistently outperform, and invest early enough to be able to keep Yale’s money with them. But many top-tier hedge funds nowadays are closed to new investments, and the best venture capital and private equity firms cap the size of their funds.

Moreover, what was once pioneering is now commonplace. The average US foundation now has over half its money in alternative and “real assets” like property and infrastructure, according to the National Association of College and University Business Officers. Two decades ago it was under 10 per cent.

Yale endowment's asset allocation

This tide is showing no signs of slowing. Most investors are increasing allocations to alternatives to counter the dimming outlook for mainstream markets, notes Mohamed El-Erian, a former head of Harvard’s endowment. “The reasons these vehicles have gotten so popular is that they allow you to use leverage without showing that you’ve used leverage, because it is within the vehicle itself,” he says. 

Some industry insiders fret that doubling down on trendy areas will at best erode their returns, and at worst prove dangerous, fuelling bubbles. Instead, some are advocating that the next big evolution of the “Yale model” of institutional investing will have a Canadian flavour.

Bar chart of Ten-year annualised returns (%).  showing Canadian pension funds pack a punch

Several Canadian pension plans have built big internal investment teams to buy companies and infrastructure projects directly, either alongside a private equity partner or replacing them altogether. In-house teams can be costly, but not as expensive as the juicy fees charged by private equity. 

The results are favourable. Partners Capital estimates that the five biggest Canadian pension plans have averaged annual returns of almost 10 per cent over the past decade, comparable to Yale’s performance and well ahead of the 7.3 per cent average for US endowments.

Nonetheless, copying the Canadians may prove to be as thorny in practice as copying the Yale model, warns Mark Anson, the head of Commonfund, a non-profit group that manages $26bn on behalf of charities and endowments too small to have their own investment teams. 

He points out that directing investments requires big internal teams and their pay has to be competitive to attract experienced, top-quality staff — which can be controversial in some endowments or public pension plans. Moreover, the bad publicity if an investment goes sour can be hard to stomach for many institutions. 

“When you get into the devilish details, it’s a lot harder to do than people think,” Anson says.


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