Yale Endowment Proves, Once Again, That A Free Lunch is Not a Thing of the Past

Sue BerginSue Bergin, President, S Bergin Communications

In 1952, Harry Markowitz, an unknown 25-year old graduate student at the University of Chicago, defined risk mathematically for the first time. He also explained how investors could lower volatility while preserving expected returns if they incorporated different investments that are not highly correlated. He went on to explain, “diversification is a kind of free lunch at which you can combine a group of risky securities with high expected returns into a relatively low-risk portfolio, so long as you minimize the covariances, or correlations, among the returns of the individual securities.”

YaleThe most prominent institutional investor in developing the multi-asset class investment model was, and remains, David Swensen, chief investment officer of the Yale University Investment Office. The power of diversification to act as a free lunch is described in his book Pioneering Portfolio Management. Swensen, the long-term Chief Investment Officer at Yale University and father of the Yale Endowment Model, believed in avoiding liquidity rather than seeking it, since it comes at a cost of lower returns. The Yale Endowment Model emphasizes broad diversification and makes the case for allocating only a small amount to traditional U.S. equities and bonds and more to alternative investments.

Today, multi-class investing means different things to different people. Initially the Yale Model was based on an asset class composition that included six asset classes. It currently uses seven asset classes: domestic equity, foreign equity, fixed income, absolute return, natural resources, real estate, and private equity.

When it comes to achieving purity of asset class composition, Swensen had to say this:

Purity of asset class composition represents a rarely achieved ideal. Carried to an extreme, the search for purity results in dozens of asset classes, creating an unmanageable multiplicity of alternatives. While market participants disagree on the appropriate number of asset classes, the number should be large enough so that portfolio commitments make a difference, yet small enough so that portfolio commitments do not make too much of a difference. Committing less than 5 percent or 10 percent of a fund to a particular type of investment makes little sense; the small allocation holds no potential to influence overall portfolio results. Committing more than 25 percent or 30 percent to an asset class poses danger of overconcentration. Most portfolios work well with around a half a dozen of asset classes [1].

Swensen’s views on diversification and asset allocation continue to pay off. According to the preliminary 2014 results of the NACUBO-Commonfund Study of Endowments, larger, better-diversified endowments have outperformed their smaller, equity heavy peers.

On average, the 426 university and college endowments in the study returned 15.8%, while endowments with more than $1 billion returned on average 16.8%, and endowments with between $500 million and $1 billion, saw investment returns of 16.2%.

Free LunchYale University led the group, posting 20.2% gains. Further proof that the free lunch concept is alive in well in 2014.

The principles and benefits of diversification are well supported by academic thought. When selecting an investment manager, advisors and investors should consider a firm that believes in the value of the free lunch by taking a multi-asset class investment approach.

[1] Swensen, D. (2009). Asset Allocation. In Pioneering Portfolio Management (p. 101). New York: Simon and Schuster.

The views expressed are those of Brinker Capital and are for informational purposes only. Brinker Capital, Inc., a Registered Investment Advisor.

An Ode to Barnes & Noble

Dan WilliamsDan Williams, CFP, Investment Analyst , Brinker Capital

On July 8, 2013 the CEO of Barnes & Noble, William Lynch, abruptly resigned. His rise and fall were tied largely in part to his belief that the future of B&N was in its NOOK digital reader. Lynch also felt that being a brick-and-mortar business would overcome the technology headwind of competing with Google, Amazon, and Apple on their turf, the tablet space. In fairness, he is likely right that people do derive a lot of benefit from being able to physically visit their book store. Still the struggle for B&N, and Borders prior to their demise, seems to be compensation for this social benefit. Now the debate is whether the physical book stores can survive in the Amazon age. In my biased opinion, I believe the answer is yes.

8.1.13_Williams_BookstoresTo say that I am a regular at my local B&N is an understatement. Over my career, I have studied for various FINRA licenses, the CFP designation, and all three levels of the CFA exams. The vast majority of this studying was done at my local B&N. On the rare occasions when I did not have anything to study for, I could not help but continue to go to B&N as it had become such a part of my life. This amounts to a total of about ten years of trips to my local B&N, usually multiple times per week. During this time, I have witnessed a lot of life from my table in the crowded B&N café.  From college interviews, job interviews, dates, people doing quasi-library research (most often on vacation destinations) and people who are clearly looking at books to purchase—of course, not at B&N, but later at a discount from Amazon.com. You can see them all at B&N. And for the most part, these people did not purchase anything from B&N outside of the food items in the cafe. It was fairly typical for me to spend three to four hours on a Saturday studying but only purchase an iced tea and a sandwich. Often, I would grab a new book off the shelf to read, and often I would end up reading a whole book without ever taking it out of the store. It is clear the store was being used less as a place for B&N to sell books and more like a community center or an improved library.

This social benefit of this institution is echoed by Lydia DePillis in her July 10, 2013 Washington Post article “Barnes & Noble’s troubles don’t show why bookstores are doomed. They show how they’ll survive” when she notes:

8.1.13_Williams_Bookstores_2“Here’s the thing: Bookstores, more so than movie rental and record stores, are oases in the middle of cities (and even in suburban malls). We go there to kill time, expose ourselves to new stuff, look for a gift without something specific in mind, and maybe pick up something on impulse while we’re there. Even Borders’ disorganized warehouses left holes in the urban fabric when they disappeared, and Barnes and Nobles would do the same–they’re a kind of public good, at a time when the public is getting less good at supporting libraries.”

However, the free-rider problem is also a known challenge as Lauren Hazard Owen in her July 9, 2013 paidContent.org article “Barnes & Noble throws out its CEO, but that won’t save the company” writes:

“While everyone likes the idea of a neighborhood bookstore, that doesn’t translate into business success. While Barnes & Noble is, in fact, the only neighborhood in a lot of areas, consumers who advocate shopping local may still think of it as a big box store, and they’re not likely to show the same loyalty to it as they might to the charming indie bookstore on Main Street. Instead, they’ll keep doing what they do now: Go in to the store to browse and for the AC, then go home and order books on Amazon.”

The clear lesson here is that providing service to society is only good business if you can be compensated for supplying it. I, however, also know that providing something that people want is a great place to start a business. Ultimately, I think that in ten years we will still have Barnes & Noble at least in some tangible form. First, as I noted above, the café part of B&N works. People who are enjoying their time here are drinking a coffee while doing it. In many ways it is an improvement on the Starbucks experience by having this attachment to the book store. Second, Amazon clearly benefits from B&N existing as an uncompensated partner in many of their transactions. Third, publishers and authors don’t want to be left with an Amazon-only world as book stores represent their physical retail outposts to host book-signings, book-release frenzies, and the like. Fourth, our society seems to value physical book stores (even though they will try to free-ride if they can) as something beyond a retail space.

8.1.13_Williams_Bookstores_3When you have this many interested parties wanting something to exist, I expect it to exist. Maybe B&N survives through a business model with a leaner book store and larger café business model. Maybe Amazon buys B&N and accepts that they will barely break even on the physical book store, but their overall profit will be improved for having B&N around. Maybe B&N, in name, does go away, but Starbucks opens a book store/coffee house location type, recognizing it as part of their positive social image campaign to improve the Starbucks experience—or maybe just the hubris that they can make it work. Some publishers may even band together to create some physical retail super store to replace B&N or cut some deals with to keep them around. The hard part is that it seems best for all parties involved to have someone else step up.

I could be delusional and perhaps thinking with my heart rather than my head as many a beloved business have been washed away by the waves of retail climate change. With that said, as long as there is a B&N,  you can find me sitting there drinking an iced tea blend known locally as “The Dan” (told you I was a regular), reading a book I am perpetually thinking of buying but never do, and watching yet another awkward college interview.

Security mentioned is shown for illustrative purposes and is not owned by Brinker Capital