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The Yale Method

May 22, 2013

Drama. The “Yale Method” is based on the “Yale Model” and, despite their similar names, they are quite different. The “Yale Model” has been used for more than thirty years but there are only two investors, David Swensen, Yale’s Chief Investment Officer, and Dean Takahashi, Senior Director of Investments, that are known to have used it successfully to boost investment returns over the long term (but certainly not year-to-year, and possibly not when one needs the money) and they’ve written a book, long ago, called Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, May 2000, The Free Press, New York, New York, to describe what they’ve done and how they did it.

More recently, Mr. Swensen has suggested that investors might use “Treasury Inflation Protected Securities” (TIPS) to guard against the ravages of inflation (Bloomberg, May 23, 2009, Yale’s Swensen Recommends TIPS to Hedge ‘Substantial Inflation’) which simply has not materialized, as yet. But, these are early days of a long investment horizon, and one might challenge the government to produce it.

The book flew off the shelves when published and became an instant best-seller among professional investors and the portfolio managers of 100’s of college and university endowment funds, and public and private pension plans, who hoped to do what they were doing, which was to shift a significant portion of their investments away from traditional stocks and bonds and into carefully selected hedge funds, private equity, real estate, and other alternatives, now called “Alternative Investments” and a significant portion of the promise of many public pension funds which are taking ownership positions in retail malls, apartment blocks, land, toll-roads, utilities, manufacturing, and other such illiquid investments that are thought to be holding future value yet to be produced and pending a future buyer.

Pioneering Portfolio Management

In the book, Mr. Swensen presents an overview of the investment world populated by institutional fund managers, pension fund fiduciaries, investment managers, and the trustees of universities, museums, hospitals, and foundations. He offers (it is said) penetrating, candid, and anecdotal insights from his experience managing Yale’s endowment fund (currently about $20 billion) that range from the broad issues of goals and investment philosophy to the strategic and tactical aspects of portfolio management suggested by Modern Portfolio Theory (MPT).

Mr. Swensen’s exceptionally readable book (it is said) addresses critical concepts such as handling risk, selecting investment advisers, and negotiating the opportunities and pitfalls in individual asset classes, and fundamental investment ideas are illustrated by real-world “concrete” (so to speak) examples, and (it is said) each chapter contains strategies that any manager can put into action.

On Their Way To The PGA

On Their Way To The PGA

In contrast, the “Yale Method” has developed on its own, proselytized by many investment professionals who have also bought a putter, some irons, and a wood, and think that they’re on the way to the PGA (Forbes, August 16, 2012, The Curse of The Yale Model). Mr. Swensen is right about one thing. There are many who try but only a few who can.

In our view, of course, the book is rubbish and provocatively fails to understand the most basic understanding of any investment “strategy”: an investment is just and only the purchase of “risk”, and like anything else that we might buy, we ought to know the price of it, that is, we ought to know the “price of risk”. And the “risk” is that we might not get a non-negative real rate of return, or access to our funds when we need them.

Nevertheless, the “Yale Method” has developed into a powerful investment vehicle that is widely used and provably guaranteed (absent some random success or “surprise”) to assure that donors get as little value for their donations as possible, absent a celebration and publicly burning their money in the Common Area or Town Square, and that the colleges and universities which receive these gifts, will always be chronically short of funds and have a reason to solicit more.

Borax Mule

More Debt Than The Borax Mule

It also ensures that tuition fees remain higher than they might be and that college graduates will carry more debt than the borax mule when they graduate; and that there are fewer scholarships for able but needy students; and that special programs are kept as small as possible, or simply cut out altogether.

Moreover, the “Yale Method” ensures that the Endowment Committee will need to raise money every year, just to fund the investment activity, and it keeps a full-time administration staff and many advertising agencies and magazines (for ads) busy, profitable, and motivated. It’s really a gift that keeps on giving.

The Price of Risk

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2009) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation – and the properties of portfolios of such stocks.

Stock prices that are less than the price of risk can be said to be “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”; on the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

To see what else “risk averse” investing can do for us, please see our recent Posts, The Wall Street Put, April 2013, and earlier Posts such as The Dow Transports, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, and for a more colorful description of investment risk and the application of the “price of risk” to mergers & acquisitions, please see our Post, Bystanders & Collateral Damage, April 2013.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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