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Fees and short horizons eroded compounding
Swensen's model
Swensen, a Hall of Fame investor from Yale, invented the asset allocation approach more than 30 years ago. Investors moved into private equity, venture, real estate, oil and gas, and hedge funds, and people did extremely well pivoting away from the traditional 60 percent US equity, 40 percent bond portfolio.
Short horizons and fees
As the approach spread, short-termism took hold. Private equity and venture funds became three-to-five-year players, and hedge funds were marked to market on an hourly basis. The standard 2 percent and 20 percent fee structure takes much of the benefit of compounding away from the investor, and Mitch Rales came to see the whole process as co-opted and broken.
The blueprint paper
That led him to write a paper for himself and his foundation, titled Reimagining the Blueprint for the Long-Term Investing Model. It starts from Sequoia, whose returns compounded at a rate in the neighborhood of 30 percent for many decades, and asks what architecture would make something similar possible.
How did Swensen change endowment investing?
David Swensen became chief investment officer of the Yale endowment in 1985 and moved it away from mostly stocks and bonds into private equity, venture capital, real estate, and other alternative assets. He described the approach in his 2000 book Pioneering Portfolio Management. Many university endowments adopted similar portfolios, and the approach became known as the Endowment Model or Yale Model. Swensen led Yale's investment office until his death in 2021.
Why do 2 and 20 fees weigh on returns?
The two refers to an annual management fee of about 2 percent of assets, charged whether or not the fund makes money. The twenty refers to carried interest, a 20 percent share of profits. Money paid in fees leaves the account and stops compounding, so the drag grows with the years. Hedge funds popularized the structure, and private equity funds adopted it.
Why do popular strategies lose their edge?
When more money chases the same kinds of assets, prices are bid up and future returns fall. Economists describe this as crowding. Early in the Yale model's history, the number of institutions investing in private equity and venture capital was small. By the 2000s, endowments, pension funds, and sovereign wealth funds all competed to place capital with the same top managers.