How One Man Grew Yale's Endowment From $1 Billion to $30 Billion

To Investors,By chance I came across some lessons about how the Yale Endowment grew from $1 billion to $30 billion between 1985 and 2021. The architect of that achievement was a guy called David Swensen, who was the Yale endowment’s chief investment officer in that period. His strategy for running the Yale endowment is referred to by capital allocators as a case study called the Yale Endowment Asset Allocation Model. Now I nerd-out about this kind of stuff all of the time so I wanted to share what I learned in today's brief letter, because I think capital allocators can take away a lot that will help them manage and grow their own portfolios.The secret to Swensen’s success was that he moved away from the traditional portfolio allocation strategy of 40% bonds and 60% public market equities, and favoured more risk-taking by allocating capital to alternative investments like private equity, hedge funds, and real assets. At its core, the Yale Model is about allocating capital across a wide range of asset classes to maximise returns while controlling risk.Here’s what the allocation would look like:* Domestic Equity: ~10%U.S. stocks, often via low-cost index funds.* Foreign Equity: ~15%International stocks for global exposure.* Fixed Income: ~5%A minimal slice for bonds and cash.* Absolute Return: ~20%Hedge funds aiming for market-independent returns.* Private Equity: ~25%Investments in private companies.* Real Assets: ~15%Real estate, timber, and natural resources for inflation protection.* Other: ~5-10%Venture capital or tactical bets.If you look closely, up to 70% of the portfolio could be allocated towards alternative investments (hedge funds, private equity, real assets, and venture/tactical bets); which many investors would shy away from because those asset classes are illiquid. In my view, a well-managed endowment, with its perpetual time horizon and absence of redemption pressures, should allocate significantly to carefully selected illiquid assets to maximise long-term growth. Unlike traditional funds, endowments face no demands from investors to return capital, as they raise funds through donations and use only a small portion—typically 4.4% annually, as seen in Yale’s spending policy—to support university operations, such as scholarships, faculty salaries, or infrastructure upgrades. This structure allows the chief investment officer to pursue high-return, illiquid investments like private equity and real assets, which have historically outperformed public markets by 3-5% annually over decades, as evidenced by private equity’s 13.5% annualised return from 1986-2020 compared to the S&P 500’s 10.2%. Yale’s endowment, with ~25% in private equity, achieved a 13.7% annualised return from 1990-2020, far surpassing the 8.6% average for peer endowments. By balancing calculated risk with prudent oversight through diversification and top-tier manager selection, an endowment can grow substantially to secure a university’s financial future, though managers must remain vigilant of liquidity risks.Swensen’s Yale Model worked because the strategy hinged on three core beliefs:* Market InefficienciesPublic markets (specifically stocks and bonds) are “efficient” in the sense that prices reflect all available information, making it hard to beat the average. Alternatives, however, operate in less efficient markets. Private equity, for example, involves buying stakes in companies not traded publicly, or where the companies are still young and the public does not yet know how to value the companies correctly, so in that environment, skilled managers can spot undervalued gems. Swensen’s bet: talented managers in these spaces can generate alpha (excess returns).* Diversification Beyond Stocks and BondsAlternatives like real estate or timber don’t move in lockstep with public markets. When stocks tank, your private equity holdings might hold steady–or even thrive. This reduces overall portfolio risk because the investment is not vulnerable to public market price and valuation swings.* TimeAs I mentioned earlier, endowments have forever to invest. This allows them to lock capital in illiquid assets (like private equity or real estate) that may take years to pay off but offer higher returns as compensation for that higher risk. Most investors panic during short-term dips; endowments can ride them out.Yale’s endowment reportedly averaged over 13% annual returns for decades–outpacing many peers. Particularly impressive, in fiscal year 2000 the portfolio returned 41%; and 28% in fiscal year 2007. Swensen’s model became so influential that institutions worldwide adopted similar strategies, making him a legend.What are the downsides of this strategy?* High fees: Asset managers in private equity and other alternatives charge high fees and up to 30% carry so this could eat into your returns.* Illiquidity: During the 2008 global financial crisis, Yale’s endowment produced a negative 24.6% return in the fiscal year ending June 2009; and the value of the endowment went from $22.9 billion to $16.3 billion between June 2008 and June 2009.* Expertise required: It's not easy to be a university endowment manager, let alone an effective one. To be able to allocate to alternatives you need to have access to alternative asset managers, and be able to discern which are the talented managers that put in the work.I would suggest that if you don’t have the experience and expertise to be able to play on Swensen’s level, you’d be better off sticking to allocating to equities, bonds, and real estate. There’s information available for everyone in those asset classes. But that’s just my take!In closing, here are some lessons…Depending on the type of investment firm you’re running, I think you can afford to think outside the box, largely influenced by 1) whether your short term capital needs are taken care of; and 2) how much time you have. My learnings:* Diversify beyond the basics: I see the equity and bond allocation, but perhaps you can afford to tack on real estate, and then maybe look into single company investments such as commodity business; and other alternatives.* Think long term: If you're running an endowment, your horizon is decades. It may be worthwhile to take on more risk such as private equity and venture capital allocations because you have the time to let those investments mature.* Always weigh fees: alternative asset managers may charge up to a 3% annual management fee, and 30% carry. This will limit the amount of money you’re able to put to work as well as eat into the return you get.* Manager selection is an art: if you invest in active funds, choose a manager wisely.* Exploit inefficiencies when you can: you may not have access to private equity, but you can still seek out less efficient markets such as within specific sectors or emerging market opportunities, but you’ll need to do the work.What do you think about David Swensen’s Yale Endowment Asset Allocation model? Is there anything you like or disagree with?On my journey to becoming a master capital allocator, one lesson down, a billion more to go.Hope you all have a great day-MansaThanks for reading Self-Taught MBA! Subscribe for free to receive new posts and support my work. To hear more, visit selftaughtmba.substack.com