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What Harvard Can Teach You About Investing

Breakout

The Ivy League consists of eight schools that are widely regarded as being some of the finest in the United States. Where the SEC is synonymous with football and the PAC-12 is known for the stereotypical "Left Coast" lifestyle, the Ivies are known for both their rigorous athletics and inflated self-esteem.

Some of the reputation is bluster, but when it comes to their endowments, the Ivies are everything they're cracked up to be. Five of the top 10 largest university endowments in the U.S. belong to Ivy League schools — Harvard topping the list at $32 billion, Yale in second at $19 billion, and Princeton third, with a fund of $17.5 billion as of October 2011.

Larry Swedroe, director of research for Buckingham Asset Management and author of Investment Mistakes Even Smart Investors Make, joined Breakout to walk us through the endowment investment process.

Why do schools have endowments?

Generally consisting of money from donations, endowments are typically put to work funding construction, scholarships, and other operational needs not fully covered by school tuition.

Money sitting idle or parked in Treasuries earning next to nothing does no one any good. The greater the return, the larger the endowment, and the bigger the buffer between the schools and poverty. Essentially, schools have endowments for the same reason people have savings.

What strategies do they use?

Schools with larger endowments have more than they need for annual operations. That excess gives them an investing time frame of as as long as the school may exist. (Harvard was founded in 1636 and has no plans to close up shop.) "Eternity" is longer than even the staunchest buy-and-hold investor, but that doesn't mean there aren't lessons to be learned.

Endowments differ from individuals with larger investments abroad, Venture Capital plays, and hedge fund investments. Swedroe says they also invest in esoteric, illiquid assets like "rubber plantations in Indonesia." Presumably, the last is a more extreme example.

How successful are they?

Though all the schools were hit by the downturn late last decade, endowment returns tend to be strong. Harvard boasts a 20-year track record of 12.9%, and each of the Big Three topped 20% for the most recent 12-month reporting period.

That said, Swedroe thinks the returns aren't all they're cracked up to be. "I think there's a bit of a mythology around them," he says. "The center of attention has been the Yale and the Harvard endowments, which have done exceptionally well relative to others. And of course, the ones that have performed poorly, you don't hear much about."

Can their strategies be replicated?

Individual investors aren't going to be able to get access to the same deals as at $20 billion endowment, but some aspects of the schools' approach are quintessential investing 101. Diversifying holdings into foreign, growth, and value plays are boilerplate ideas, but Swedroe says the discipline of the endowments is what really gives the institutions an advantage over mom and pop.

Endowments have written investment policies for their allocations. As an example, there might be a mandate that not less than 8% or more than 12% should be allocated to real estate. "So when real estate does better than the rest of the portfolio, they'll come in and sell some of it to make sure it doesn't exceed 12% — and that means they're selling high," Swedroe explains. When real estate falls under 8%, the endowment will buy — in effect, buying low. "That's exactly the opposite of the way most retail investors invest, and it's one of the reasons they do poorly."

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