A League of Their Own

Surprisingly, that may be beginning to change. We've taken a close look at these endowments and at the new investment vehicles now available to the rest of us. Our conclusion: Even average investors can mimic Harvard or Yale in their portfolio, with access to some of the Ivy League's most exclusive and esoteric asset classes. We'll show you how and illustrate our method with a model portfolio. But first, a simple question. Should you?

No one argues that individual investors should slavishly copy the Harvard and Yale models, and not even very wealthy individuals have access to the kind of top-performing managers who work for Harvard and Yale, with their endowments of $29 billion and $18 billion, respectively. Still, the two fathers of the universities' successful investment policies, former Harvard endowment manager Jack Meyer and David Swensen at Yale, offer their qualified endorsement.

As Meyer puts it, "The most powerful tool an investor has working for him or her is diversification. True diversification allows you to build portfolios with higher returns for the same risk." While cautioning that it would be unrealistic for individual investors to match or outperform the major university endowments, Meyer, who now runs a Boston-based hedge fund whose charter investors include Harvard's endowment, endorses the goal of diversifying into a wide variety of asset classes. "Most individuals have never had true diversification," he says. "Coming close is an admirable goal."

Swensen agrees that diversification should be the "bedrock" of every investor's portfolio. "Most investors, institutional and individual, are far less diversified than they should be," he says. "They're way overcommitted to U.S. stocks and marketable securities." In his 2005 book for individual investors, "Unconventional Success," Swensen advocates much greater diversification than most investors have in their portfolios, even though he also questions their ability to match the returns of Harvard and Yale.

IF YOU HAVEN'T been following the Ivies' investment strategies over the years, you may be surprised by how Harvard and Yale allocate their endowment assets. Their portfolios are most likely radically different from yours, or from the models advocated by most financial planners, which are still heavily weighted toward traditional asset classes like stocks, bonds and cash.

Until about 20 years ago, Harvard's and Yale's portfolios looked like that too. Then, beginning in 1990, Yale, soon followed by Harvard, moved aggressively into new categories of investments. What's most striking about their portfolios today is how little they have invested in U.S. stocks and bonds, the mainstay of most individual portfolios. As of June 2006, Yale had less than 12% of its portfolio in U.S. stocks and a mere 4% in fixed income. At Harvard the portions were 17% and 19%, respectively.

So where do they put their money? Yale and Harvard divide their endowments into seven broad asset classes: domestic stocks, foreign stocks, fixed income, absolute return, private equity, real assets and cash. Absolute return consists of assets that are expected to perform well in good and bad markets and aren't correlated to broad market averages. Most hedge funds fall into this category, including so-called long/short funds (which try to profit from both rising and falling markets), merger arbitrage and distressed securities. Private equity covers both buyout and venture-capital investments. Real assets are real estate, oil and gas, timber and other commodities. The percentages Harvard and Yale allocate to each category are shown in the charts below.

Since both Harvard and Yale adjust their targets annually, their actual holdings often differ. Still, it's striking how aggressively they've moved into nontraditional categories. As of June 2006, real assets were the largest category at Yale, accounting for nearly 28% of the portfolio. At Harvard it was nearly 21%. Yale's allocation of 23% to absolute-return strategies was double its commitment to U.S. stocks.

As might be expected at big research universities, this aggressive move away from traditional assets was rooted in academic research suggesting that investors can earn a higher long-term rate of return with less risk by diversifying beyond the traditional mix of stocks and bonds. Economists James Tobin and Harry Markowitz each won a Nobel Prize for work they did on this topic while at Yale. Meyer, who ran Harvard's endowment for 15 years before leaving in 2005, and Yale's Swensen put those theories into practice.

Over the past decade, Harvard and Yale have turned in some of the best returns anywhere, but almost no one expects this level of performance to continue. Based on historical data, most asset classes are fully valued, if not overvalued. Yale expects a long-term annual return of about 6%, adjusted for inflation.