David Swensen Portfolio: Yale Endowment Fund Model – Analysis And Performance

David Swensen was the President and Chief Investment Officer of Yale University endowment from the mid-1980s until his death in May 2021. Swensen, along with Dean Takahashi, invented The Yale Model. Let’s take a look at the David Swensen Portfolio (Yale Model).

The David Swensen Portfolio is a diversified investment strategy developed by David Swensen, the chief investment officer of the Yale endowment fund. The portfolio is designed to maximize returns while minimizing risk by diversifying investments across a variety of asset classes, with a focus on alternative investments such as private equity, real estate, and hedge funds.

In this post, we take a look at the David Swensen Portfolio (Yale Model). At the end of the article, we make a backtest of the portfolio to show its performance and historical returns.

You might also want to take a look at our other articles about investment strategies. We have written hundreds of both short- and long-term strategies!

Introduction to the David Swensen Portfolio

The David Swensen Portfolio is a well-known investment strategy developed by the late David Swensen, the chief investment officer of the Yale endowment fund for over 30 years. During his tenure, he transformed the Yale endowment from a small, poorly performing portfolio that typically used the 60% stock and 40% bond model into one of the world’s largest and most successful endowments.

The portfolio is based on diversifying investments across various asset classes, focusing on alternative investments such as private equity, real estate, and hedge funds. It also emphasizes the importance of low-cost index funds and passive investment strategies.

The key to Swensen’s success was his ability to identify and invest in undervalued assets, and his willingness to make unconventional investments. He also strongly emphasized risk management and believed that a diversified portfolio was the best way to achieve long-term returns while minimizing risk.

The David Swensen Portfolio has been widely adopted by endowments, foundations, and high-net-worth individuals, and has become one of the most popular investment strategies in the world.

The History and Philosophy of the Yale Model

The history of the Yale Model begins in the mid-1980s when David Swensen was appointed as the chief investment officer of the Yale endowment fund.

At the time, the endowment was a small, poorly performing fund with a portfolio heavily invested in traditional stocks and bonds based on the 60/40 model. Swensen recognized the potential of alternative investments and began to shift the endowment’s investments toward these types of assets. Over the next three decades, he transformed the endowment into one of the world’s largest and most successful endowments.

Swensen based his Yale Model portfolio on diversifying investments across various asset classes, focusing on alternative investments such as private equity, real estate, hedge funds, and natural resources. The philosophy behind the model is that these types of investments have the potential to generate higher returns than traditional investments such as stocks and bonds while also providing a degree of diversification and reduced volatility.

One of the key elements of the Yale Model is the emphasis on low-cost index funds and passive investment strategies. Swensen believed that these types of investments were the most efficient way to achieve long-term returns and that actively managed funds were unlikely to outperform the market in the long term.

Another important aspect of the Yale Model is the focus on risk management. Swensen believed that a diversified portfolio was the best way to achieve long-term returns while minimizing risk. He placed a strong emphasis on identifying and investing in undervalued assets and was willing to make unconventional investments that other investors were avoiding.

Benefits of the David Swensen Portfolio

The David Swensen Portfolio offers several benefits for investors looking for a diversified and long-term investment strategy. These are some of the benefits:

• Diversification: The portfolio is designed to diversify investments across a variety of asset classes, including stocks, bonds, private equity, real estate, hedge funds, and natural resources. This diversification helps to spread risk and reduce volatility in the portfolio.
• Alternative investments: Alternative investments such as private equity, real estate, and hedge funds have the potential to generate higher returns than traditional investments such as stocks and bonds. By including these types of investments in the portfolio, it can help to increase the overall returns of the portfolio.
• Low-cost index funds: The portfolio emphasizes the importance of low-cost index funds and passive investment strategies. These types of investments are considered to be more efficient than actively managed funds, which are unlikely to outperform the market in the long term.
• Risk management: The David Swensen Portfolio strongly emphasizes risk management. Diversifying investments across multiple asset classes helps minimize risk and maximize returns over the long term.
• Long-term approach: The David Swensen Portfolio is designed for long-term investors and does not focus on short-term performance. It’s better to consider the portfolio as a long-term investment strategy, rather than trying to time the market.
• Flexibility: The David Swensen Portfolio is flexible and can be customized to suit the individual investor’s needs, goals, and risk tolerance.

Understanding the Asset Allocation

The David Swensen Portfolio is characterized by its diversified asset allocation, with a focus on alternative investments. The asset allocation of the portfolio looks like this (with our suggested ETF allocations):

• 30% Total Stock Market (VTI)
• 15% International Stock Market (VEA)
• 5% Emerging Markets (EEM)
• 15% Intermediate Treasury Bonds (IEI)
• 15% TIPS (TIP)
• 20% REITs (VNQ)

There is no ETF for alternative investments in the list. The reason is that the history for any relevant ETF is short. However, an example of alternative investments could be KMLM, for example, a trend following ETF that tracks the mt. Lucan Managemant Index.

The stock allocation is diversified across different sectors and geographies, as well as both large-cap and small-cap equities. The bond allocation is diversified across different types of bonds, such as government bonds, corporate bonds, and high-yield bonds. The portfolio also includes a significant allocation to alternative investments, such as private equity, real estate, natural resources, and hedge funds. These types of investments are considered to have a low correlation with traditional investments such as stocks and bonds and have the potential to generate higher returns.

It’s important to note that the asset allocation of the David Swensen Portfolio is not fixed and can be adjusted over time to suit the individual investor’s needs, goals, and risk tolerance. For example, an investor with a higher risk tolerance may allocate a larger percentage of the portfolio to alternative investments.

The Asset Allocation in Practice

There are many ways to implement the Yale Model’s asset allocation in practice, but the easiest way is to use ETFs. Here are six ETFs that can give you the asset allocation of the David Swensen Portfolio and how the capital should be allocated among the ETFs:

• Vanguard Total Stock Market ETF (VTI): Invest 30% of the portfolio in VTI, which focuses on Equity and U.S. Large Cap.
• Vanguard Real Estate ETF (VNQ): Invest 20% of the portfolio in VNQ, which focuses on U.S. Real Estate.
• Vanguard FTSE Developed Markets ETF (VEA): Invest 15% of the portfolio in VEA, which focuses on Equity, EAFE, and Large Cap.
• iShares MSCI Emerging Markets ETF (EEM): Invest 5% of the portfolio in EEM, which focuses on Equity, Emerging Markets, and Large Cap.
• iShares 3-7 Year Treasury Bond ETF (IEI): Invest 15% of the portfolio in TLT, which focuses on Bond, U.S., and Long-Term.
• iShares TIPS Bond ETF(TIP): Invest 15% of the portfolio in TIP, which focuses on Bond, U.S., All-Term.

Long-Term Performance of the Yale Model

The Yale Model Portfolio, which David Swensen oversaw from 1985 to 2020, generated an annualized return of 12.5%, outperforming the S&P 500 index, which returned 9.7% over the same period. That is a massive outperformance!

Although the portfolio has historically generated higher returns over the long term, its performance can vary depending on the market conditions. In fact, the performance has dropped in recent years. Please have a look at our backtest further down in the article.

One of the key reasons for the Yale Model’s long-term performance is its focus on alternative investments such as private equity, real estate, natural resources, and hedge funds. These types of investments are considered to have a low correlation with traditional investments such as stocks and bonds and can generate higher returns. The portfolio’s diversified asset allocation also played a role in its long-term performance. To show you an example, please look at the performance of Brummer & Partner’s Multi Strategy fund:

The red line is the fund and the grey line is the MSCI World Index. Clearly, the red line is less volatile and might serve as an anchor in a portfolio of stocks.

As with any investment, it’s important to note that the Yale Model’s long-term performance should not be taken as a guarantee of future performance. The performance of the Yale endowment fund may not be the same as the performance of a portfolio that implements the Yale Model. Also, the portfolio’s risk and other features may not match your investment goals and risk tolerance.

Backtesting the Yale Model

Backtesting the Yale Model is the process of evaluating how a portfolio based on the Yale Model would have performed in the past, using historical market data. It can be useful to evaluate the portfolio’s performance under different market conditions and to identify potential risks and opportunities.

To backtest the Yale Model, you will need to gather historical data for the assets included in the portfolio, such as stock prices, bond yields, real estate prices, etc. You will also need a portfolio backtesting software or spreadsheet that can simulate the performance of the portfolio based on the historical data.

Once you have the necessary data and tools, you can begin the backtesting process by creating a portfolio based on the Yale Model’s asset allocation and then simulating its performance over a specific period of time using the historical data. For example, you can test the portfolio’s performance over the last 10 years and compare it to a benchmark index such as the S&P 500.

During the backtesting process, you can also run different scenarios such as varying the portfolio’s asset allocation or adjusting the portfolio’s risk management strategy. This can help you identify the portfolio’s strengths and weaknesses and make any necessary adjustments.

Taking the Risk Out of Risky Assets

The Yale Model is known for its focus on alternative investments, which are considered to be high-risk assets compared to traditional investments such as stocks and bonds. However, there are several ways to take the risk out of risky assets in the Yale Model:

• Diversification: One of the most effective ways to reduce risk is to diversify the portfolio across different asset classes, sectors, and geographies. This can help to reduce the overall risk of the portfolio by spreading the risk across different types of investments. In the Yale Model, the portfolio is diversified across different types of stocks, bonds, and alternative investments.
• Asset allocation: By adjusting the asset allocation of the portfolio, it is possible to reduce the risk of the portfolio. For example, increasing the allocation to bonds and decreasing the allocation to stocks can reduce the overall risk of the portfolio. Similarly, decreasing the allocation to higher-risk assets such as private equity or hedge funds can reduce the risk of the portfolio.
• Monitoring and rebalancing: Regularly monitoring the portfolio’s performance and adjusting the portfolio as needed can help to reduce the risk of the portfolio. For example, if a particular investment is not performing well, it may be necessary to sell it and invest in a different investment.
• Risk management: Implementing a risk management strategy can help to reduce the risk of the portfolio. For example, using stop-loss orders to limit losses or using derivatives to hedge against market fluctuations can help to reduce the risk of the portfolio.

What to Consider Before Investing in the David Swensen Portfolio

Before investing in the David Swensen Portfolio, there are several factors to consider:

• Your investment goals: It’s important to consider your investment goals and whether the Yale Model aligns with them. The portfolio is designed for long-term investments, so if your goal is short-term gains, it may not be suitable for you.
• Your risk tolerance: The David Swensen Portfolio includes a significant allocation to alternative investments, which are considered to be higher risk assets. It’s important to consider your risk tolerance and whether you are comfortable with the level of risk associated with the portfolio.
• Your time horizon: The Yale Model is designed for long-term investments, so it’s important to consider your time horizon and whether you are prepared to hold the portfolio for a long period of time.
• Liquidity: Some of the investments in the Yale Model, such as private equity, are illiquid, meaning they cannot be easily bought or sold. It’s important to consider whether you are comfortable with the lack of liquidity and whether it aligns with your investment goals.
• Fees: The David Swensen Portfolio includes a significant allocation to alternative investments, which often have higher fees than traditional investments. It’s important to consider the fees associated with the portfolio and whether they align with your investment goals.

How to Create a David Swensen Portfolio

Creating a David Swensen Portfolio involves following the asset allocation strategy recommended by the late David Swensen, who managed the Yale endowment fund. The key elements of the portfolio include a significant allocation to alternative investments, such as private equity, real estate, and natural resources, as well as a diversified mix of traditional investments, such as stocks and bonds.

To create the Yale Model portfolio, here’s what to do:

• Start with a diversified mix of low-cost index funds or exchange-traded funds (ETFs) that track the performance of various stock and bond markets.
• Allocate a significant portion of the portfolio to alternative investments, such as private equity, real estate, and natural resources — these investments have the potential to generate higher returns than traditional investments, but they also come with higher risk.
• Rebalance the portfolio on a regular basis to ensure that the allocation to each asset class remains consistent with the portfolio’s overall strategy.
• Review and adjust the portfolio as needed to reflect changes in market conditions and your investment goals.

In conclusion, the Yale Model, as with all investment portfolios, is not a one-size-fits-all solution. It may not be suitable for everyone. You should consider your own investment goals and risk tolerance and probably consult with a financial advisor before making investment decisions.

David Swensen Portfolio (Yale Model) Backtest – Does It Work?

Let’s backtest the portfolio to evaluate the recent historical performance and results. We base the backtest on the following ETFs and weightings and allocations:

Trading Rules

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

When we put the ETFs and weightings into our trading platform, we get the following equity curve and performance:

The annual returns are 6.23%

We rebalanced daily, however, the backtst shows insignificant variations in the annual returns for weekly, monthly, quartlerly, or annual returns.

The portfolio has underperformed compared to S&P 500:

The reason for the underperformance is the big bond component an the lackluster performance of emerging markets (EEM). However, we need to keep in mind that S&P 500 has risen more than its historical averages over this period. Also, drawdowns for David Swensen portfolio has been lower than for S&P 500 – as expected.

FAQ:

What is the philosophy behind the David Swensen Portfolio?

David Swensen was the President and Chief Investment Officer of the Yale University endowment. He is known for inventing the Yale Model, a strategic investment strategy. The portfolio focuses on diversifying investments across asset classes, including alternative investments like private equity, real estate, and hedge funds. It emphasizes low-cost index funds, passive investment strategies, and risk management.

How does the Yale Model achieve diversification in its asset allocation?

The asset allocation includes a mix of stocks, bonds, and alternative investments. For example, it allocates percentages to Total Stock Market (VTI), Real Estate (VNQ), International Stock Market (VEA), Emerging Markets (EEM), Intermediate Treasury Bonds (IEI), and TIPS (TIP). Diversification across various asset classes, potential for higher returns through alternative investment.

How can investors implement the David Swensen Portfolio in practice?

The Yale Model, overseen by David Swensen from 1985 to 2020, generated an annualized return of 12.5%, outperforming the S&P 500, which returned 9.7% over the same period. Investors can create the portfolio using low-cost index funds or ETFs that track various markets, allocate a significant portion to alternative investments, regularly rebalance the portfolio, and adjust it based on changes in market conditions and personal goals.