c










  ! 



"
 "#$  


" #

Swensen͛s investment philosophy is based on five principles. They are:

1. Equities outperform fixed income assets. According to him, not only do fixed income assets give lower returns
but they are also affected by rising or highly fluctuating inflation. Exhibit 7 shows that for 2006, the returns for
domestic as well as foreign equity were much higher that fixed income, which showed negative returns. Also,
Swensen has referred to actual cumulative long-run returns of stocks vs. US treasury bonds and Treasury bills to
demonstrate this.
The 2006 returns and the 10yr annualized return structure of Yale has shown that this principle works indeed.
2. Hold a diversified portfolio mitigates risks. They tried to build the portfolio without attempting to time the
market, rather by having strong disciplined approaches to investing. The inclusion of emerging markets in their
foreign equities provides diversification, along with potential for high returns (due to the rapid growth in these
markets). This aspect led the fund to generate good returns even during years of financial crisis.
3. Seek opportunities in less efficient markets which provide more opportunities for arbitrage. This is proved by
the bigger spread in returns between the fund managers in the 25th and the 75th percentile.
Although this area provides huge opportunities, it is difficult to provide meaningful benchmarks against which they
could reliably measure the performance of managers and the success of their investment strategies in this area.
4. Use external managers for everything except the most routine of investments. This would ensure that the
expert knowledge of capable managers is used to build Yale͛s investment decisions.
However, choosing the managers is not an easy task, especially in the less efficient markets which lack any
benchmarking system. And this in turn may jeopardize the investment decisions made. So this is deemed as one of
the most important tasks undertaken by the Investments Office.

5. Focus on the incentives of the managers. Unlike current industry standards, Yale tried to align the incentives of
the managers with their performance of the funds and not the size of the funds.

However, if this is way of incentivizing the managers is an industry trend, then it will be difficult to pull managers
into this kind of a structure.

Overall, this philosophy is based on strong and clear fundamentals and hence stands the chance of providing great
returns in the years to come.

$  


 

% "
% 


"&
 
%


%
' ' %
 "
 (
    # 
 )"
 
   


# 
   

&#

*&
 + 
 The office eliminated passive portfolios and engaged small number of 
 (
   .
These managers were

"
 ,
 owned by their investment professionals. The office tried
to select managers 



and & "
  
 

" .
Overall, the office was willing to give enough breadth to the fund managers in managing the portfolio.
-
.

The office selected real estate operators who had a competitive advantage, either by property type or
market, and a     
''  
. The office sought partners who targeted distressed sellers, and
those who had operating expertise to implement value-added strategies that could realize substantial returns over
the medium term. The office wanted most of the real estate principal͛s compensation to come at the end of the
fund and to be linked to the investor͛s returns. Although the office found such firms, they were not well-known,
even by knowledgeable real-estate investors; this was a starkly different form Yale͛s PE funds.

 /  Yale focused on two different investment models: focus on partnerships in the business of acquiring
existing oil-fields, and investing in partnerships pursuing PE investments in oil-and-gas and service companies.
*
 .(
 For its PE investment, the office maintained long-term relationship with a   " 
 ,
 . It emphasized on organizations that took a value-added approach to investing as it felt that value-
added operational experience is more important in LBO investing. The office was willing to give considerable




   to define the PE deals they wanted to do. The office also chose firms where incentives were
properly aligned, and hence 
    
 

  ,
 . Yale preferred the
individual fund structure to be such that the PE firms could 0


 
 
 , and
 



  
 
&


" .
Although there are some differences in the strategies adopted in each investment category, there is an inherent
underlying idea of properly aligning the incentives of the fund managers and the office.

1 $   
 

   
  "&
 
% 
 

% 
'   %  "

(


#
)"
 
 


#
  
&#

The office had weighted their investments in less efficient markets. Within the investment options available, they
always had a compelling category to invest in, mostly based on the market conditions. They generally invested
heavily in markets when they were going through a change or turmoil. Because that͛s when the office felt that the
efficiency of sound investment principles would reap the best results. Also that is the time when the markets
become less efficient and increases chances of arbitrage.
However, with the heating up of the illiquid markets, it will become more difficult to find god investment options,
as demand would be higher than supply. Also, as the incentives of the larger financial institutions are not aligned
with those of Yale, it will be difficult to find suitable investments if demand increases.

2$  *. #

 "

  
  c
#
 
3   #

The unprecedented growth of the PE industry appeared to have changed the industry in some permanent ways:
1. 4 
  
 *. "  "
 With money flooded into the industry, multi-billion dollar funds
have become the norm. Yale feels that this would result in the PE groups in pursuing low-risk,low-return
investments, in order to ensure the ability to raise a follow-on fund, thus hindering the pursuit of innovative
strategies. LBO firms have explicitly reduced their hurdle rates. Some PE groups positioned themselves as asset
managers. Some venture groups formed affiliations with overseas groups. All this affects the incentives of PE
organizations as they lowered their return expectations and undertook safe investments.
2. 4   
   
  

 
. Numerous overseas institutions and state pension funds
invested heavily and in PE, and many of these investments were made in an undisciplined manner. This huge
capital inflow had two significant consequences: (a) the influx of capital suggested intense price competition that
would affect the PE industry in years to come; (b) deploying capital became increasingly challenging as there was
intense demand for quality PE funds from the limited partners.
Although Yale was willing to invest in a fund raising capital from institutional investors for the first time, many of
these situations carried large ͚manager risks͛.
In such circumstances, the international PE market was of growing interest, where far fewer firms were competing
for deals, suggesting possibility of attractive valuations. However, even this option had certain challenges, but Yale
managed to identify some emerging market funds, that seemed attractive by normal standards.
If Swensen wants to stick to Yale͛s basic investment philosophy, then the office may consider continuing to
maintain its relation with the premier PE organizations, and maintain a healthy mix of LBOs and venture capital
funds. Even they are highly competed, it makes sense to stay in the PE business, so as not lose the relationship
with these premier organizations. Along with that if they continue investing in quality funds, even if they are few
and far between, they have the chance of reaping good returns. Also, when these institutions grow their expertise
in international markets, Yale can partner with them for International PE ventures, which will be much less
competed. And with the growth in emerging markets, there are opportunities of great deals in those areas waiting
to be tapped.