Yale University, one of the most-watched and best-performing college endowments, defended the fees it pays to external managers, saying in an annual investment report that a low-cost passive strategy would have “shortchanged’’ the Ivy League school’s students and faculty.
While declining to provide details about how much the fund pays, its managers earn “large performance-based fees,’’ the report said. The $25.4 billion endowment, the second largest in higher education behind Harvard, has been run since 1985 by David Swensen and returned 3.4 percent for the most recent fiscal year when college endowments lost 2 percent on average.
Fees for private equity and hedge fund managers, some of whom command 2 percent for management and 20 percent for performance, or even more, have become a heated topic. Berkshire Hathaway Inc.’s Warren Buffett and writer Malcolm Gladwell have taken public shots at the structure, and Gladwell specifically targeted Yale two years ago.
Congress, concerned about the rising price tag of college, also has raised questions about tax-exempt endowments and asked about manager fees in an inquiry to the richest 56 private colleges last year, a question most schools didn’t fully answer.
‘Terrible Outcome’
The annual endowment report often provides nuggets of insight into the fund’s philosophy, outlook and performance, last year showcasing its prowess in venture capital. This time, Yale made the case that it can spend hundreds of millions of dollars annually on generous financial aid because of its endowment’s outsized returns.
“What Buffett, Gladwell and other fee bashers miss is that the important metric is net returns, not gross fees,’’ the report said. “Weak or negative returns would result in low or no performance-related fees, but would be a terrible outcome for the university.’’
Yale’s investment strategy emphasizes long-term active management of equity-oriented, yet often illiquid assets, with more than half the fund in alternative investments. Almost a third of Yale’s 2016 allocation is in private equity, including 16.2 percent in venture capital and 14.7 percent in leveraged buyouts. About 22 percent is in absolute return with hedged-like strategies.
“Performance-based compensation earned by external, active investment managers is a direct consequence of investment outperformance,’’ it said.
Buffett has long railed against fees and promoted low-cost passive indexes, which can be used by investors who don’t have access to the kind of top-tier managers Yale has cultivated for decades.