Yale’s Annual Endowment Report Defends High Fees for External Managers

Returns and Endowment Size (FY2006-FY2016) Graph
As Harvard moves to rely more on external managers and emulate an investment system in place at Yale, Yale’s Investment Office argued a strong justification of the fees it pays outside funds, directly rebutting outside criticism from some market analysts.

In its annual endowment report, the YIO criticized “fee bashers” like Warren Buffett and Malcolm Gladwell who have argued that Yale, and other clients like it, pays its investment managers too much. Yale argued that paying higher fees to funds is warranted if a the firm performs exceptionally well.

“What Buffett, Gladwell, and other fee bashers miss is that the important metric is net returns, not gross fees,” the report reads. “Performance-based compensation earned by external, active investment managers is a direct consequence of investment outperformance.”

And outperform Yale has. The report notes that Yale’s investment returns are “the highest of all colleges and universities over the past twenty and thirty years, according to Cambridge Associates,” which it says “result[s] in external managers earning large performance-based fees.”

“Weak or negative returns would result in low or no performance-related fees, but would be a terrible outcome for the University,” the report reads.


As Harvard cuts the size of its internal workforce and begins to outsource its funds to more expensive external managers, HMC will begin to more closely resemble investment offices at Yale and other peer institutions. With a staff size of more than 30, Yale’s Investment Office’s staff is a fraction of HMC’s, which will slash roughly half of its more than 230 staffers by the end of the year. Harvard has recently looked to Yale’s investment strategies and Yale’s report offers insight into the approach Harvard may begin to take.

Yale’s report explores the considerations the school makes when setting the fees it is willing to pay its investment managers. According to the report, Yale crafts incentives that will naturally align the interests of its external managers with that of the university, in some cases relying on “material co-investment” in a fund to “create a powerful alignment of interest, especially with regard to taking appropriate levels of risk.”

Explaining its investment decisions, Yale argued that it employs an active management strategy because it “has demonstrated its ability to identify top-tier active managers that consistently generate better-than-market returns.” According to the report, some have suggested that Yale would be better served if it ceased paying higher fees to its “active managers” and invested in passive index strategies instead. In its report, Yale took a different view.

“Such strategies make sense for organizations lacking the resources and capabilities to pursue successful active management programs, a group that arguably includes a substantial majority of endowments and foundations,” the report reads. “While passive investment strategies result in low fee payments, an index approach to managing the University’s Endowment would shortchange Yale’s students, faculty, and staff, now and for generations to come.”

The recent changes at HMC followed several years of disappointing returns; in fiscal year 2016, the size of Harvard’s endowment fell by nearly $2 billion as a result of the endowment’s underperformance and other cash flows at the University. Amid recent changes, more of HMC’s funds may fall under active outside management.

At the same time, Yale returned 3.4 percent on its investments in a year when many large institutional investors saw negative returns. At $25.4 billion, Yale’s is the third largest endowment in higher education, behind Harvard and the University of Texas.

N.P. Narvekar, the new chief executive at Harvard Management Company, wrote in a letter to Harvard affiliates earlier this year announcing major overhauls at HMC and cautioning against comparing investment returns across institutions.

“There’s a natural tendency to compare annual one-year returns among universities,” Narvekar wrote. “However, different universities have different risk tolerances based on their own individual needs. Simplistic comparisons can be not only foolish, but also dangerous.”

—Staff writer Brandon J. Dixon can be reached at Follow him on Twitter @BrandonJoDixon.


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