How Yale Failed

by Nicholas Vardy
Yale_Building

David Swensen is a legend in the world of endowment investing.

Swensen heads the Yale University endowment - widely considered the leader among all top university endowments.

If imitation is the sincerest form of flattery, Yale has flattery in spades.

Each of Yale's academic rivals has adopted the "Yale Model" (also known as the "Endowment Model") of investing pioneered by Swensen in the 1980s.

Moreover, the heads of the Stanford, Princeton, MIT and University of Pennsylvania endowments are each headed by former Swensen deputies.

They're all hoping some of Yale's magic will rub off on them.

You might be wondering whether Yale's experience is relevant to your own investment portfolio.

The short answer is yes.

But not in the ways you may first think...

Let's start by examining Yale's "secret sauce."

Swensen was the first to apply modern portfolio theory (MPT) to massive multibillion-dollar endowments.

A fundamental insight of MPT is that asset allocation explains more than 90% of a portfolio's investment returns. (There is some debate as to whether the percentage is really that high.)

Still, it's clear the decision to invest in specific asset classes matters more than picking the right individual stocks.

By investing in a range of asset classes far beyond traditional U.S. stocks and bonds, you can construct a portfolio for higher returns at lower risk.

(This is the insight behind The Oxford Communiqué's Gone Fishin' Portfolio.)

Swensen took this argument for diversification to an extreme.

In 1987, nearly 80% of Yale's endowment was invested in U.S. stocks and bonds.

Over the past 30 years, Yale shifted the bulk of its investments into "alternative assets," including natural resources, venture capital, real estate and foreign stocks.

As a result, I bet the Yale endowment today looks very different from your investment portfolio.

Until June 2007, it was hard to argue with Yale's success.

During the previous decade, the Yale endowment generated a remarkable annual return of 17.8% percent.

On the other hand, between 2007 and 2017, the endowment returned just 6.6% per year.

That trailed the S&P 500's average 7.3% annual return over the same period.

Put another way...

Yale would have been better off investing its endowment in a low-cost Vanguard index fund.

So the question arises...

Is the Yale Model busted?

I don't think so.

The Yale endowment didn't lag the U.S. stock market because diversification was no longer working...

It lagged because Swensen actively bet against U.S. stocks.

Swensen's negative view of U.S. stocks isn't a recent one.

Yale has been reducing its investment in U.S. stocks for a long time...

It went from 80% in 1987 to 22% in 1995. By 2005, it had dropped to 14%.

Since 2014, only 4% of Yale's endowment has been invested in U.S. stocks.

That means a whopping 96% of Yale's endowment is invested in assets other than U.S. stocks.

The conclusion is clear...

Swensen's bet against U.S. stocks over the past decade proved to be a big mistake.

That's because the U.S. stock market was among the top-performing stock markets in the world during that period.

Swensen's reluctance to invest in U.S. stocks doesn't surprise me.

After all, one of Swensen's friends and colleagues is Nobel Prize-winning economist and Yale professor Robert Shiller. (Swensen regularly lectures to Shiller's introductory investment class.)

And as I've previously written, Shiller has been warning for a long time that U.S. stocks are overvalued.

Shiller does not sit on the investment committee of the Yale endowment. But there's little doubt Shiller's view of the U.S. stock market influenced Swensen.

I have two takeaways for you today.

First, Yale's low allocation in U.S. stocks over the past decade is an embarrassing misstep, one that may have cost the university billions in lost profits.

Second, this misstep doesn't mean that Swensen won't be right... one day.

Still, the next time you are tempted to sell all of your U.S. stocks because you believe the market has topped...

Remember that even the best investment minds on the planet can't time the market.

I've put my money where my mouth is on this one...

I have long-term core holdings in the U.S. stock market that I don't ever intend to sell. And they constitute a big chunk of my net worth.

Yes, it is tempting to time the market.

But no, not even investment legends like David Swensen can do it...

And neither should you.

Good investing,

Nicholas

An American "Main Street" Mainstay

Most likely, today's recommendation is sitting on a corner near you. Retail pharmacy holding companies are recession-resistant big businesses - making them a good investment in a volatile late-stage bull market like the one we're in now.

Chief Investment Strategist Alexander Green introduced Walgreens Boots Alliance (Nasdaq: WBA) to The Oxford Communiqué's Trading Portfolio in February. Here are his thoughts on it earlier this month...

If you're a conservative investor or nervous about the market - or both - now is a good time to gravitate toward larger dividend-paying companies with reliable cash flow and excellent prospects.

Take Walgreens Boots Alliance (Nasdaq: WBA) in our Oxford Trading Portfolio for example.

More than a century old, Walgreens is the largest retail pharmacy across the U.S. and Europe. Based in Deerfield, Illinois, it has more than 13,200 stores in 11 countries.

It also has one of the world's largest pharmaceutical wholesale and distribution networks, with more than 390 distribution centers delivering to more than 230,000 pharmacies, doctors, clinics and hospitals in more than 20 countries.

It also controls a portfolio of well-known business brands, including Walgreens, Duane Reade, Boots and Alliance Healthcare, as well as health and beauty products such as No7, Soap & Glory, Liz Earle, Sleek MakeUP and Botanics.

The company generates more than $120 billion in annual revenue. And those sales are growing 8% year over year.

Banks, pension plans, mutual funds and other institutional investors own nearly two-thirds of the outstanding shares here. The insiders own 15% - and they have bought millions of dollars' worth this year.

We tend to think of Walgreens as a pharmacy that also sells healthcare and other consumer products. But it is also a technology leader.

A couple of months ago, for instance, Walgreens received a U.S. patent for a new proprietary technology that allows its pharmacists to monitor and counsel patients using oral oncology medicines.

Walgreens' interactive system gathers information about daily treatment and allows patients to communicate with pharmacy experts.

Looking ahead, Walgreens is likely to experience both above-average organic growth and expansion through acquisitions.

Last fall, it finally won approval to buy about 40% of Rite Aid's 4,500 stores for $4.38 billion in cash.

Walgreens reported second quarter results and blasted the consensus estimate of $1.55 a share. Net income came in 12% higher.

The retail pharmacy also announced better-than-expected revenue of $33 billion - and the highest sales growth in eight quarters.

The outlook here remains exceptional. Walgreens is increasing volume, improving quality of service and controlling costs. Future profits will only grow as the firm benefits from the acquisition of nearly 4,000 Rite Aid stores.

Walgreens is a profitable and growing company in a recession-resistant industry with a healthy dividend and telltale insider buying.

That makes it an attractive stock in an aging bull market like this one.

- Donna DiVenuto-Ball with Alexander Green

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