For families seeking to sustain and grow wealth across generations, investing poses a unique set of opportunities and challenges. As family wealth accumulates beyond the needs of the current generation, traditional asset allocation strategies, such as a 60/40 portfolio, may not produce optimal investment outcomes. Instead long-term endowment strategies, like the Yale Model, which emphasize diversification, active asset allocation, and a focus on alternatives, provide a better blueprint.
Traditional Asset Allocation: The 60/40 Portfolio
The development of the 60/40 portfolio marked a significant milestone in modern portfolio management. Originating in the mid-20th century, this investment strategy was based on the allocation of 60% of a portfolio's assets to equities and 40% to fixed income. Its creator, Harry Markowitz, advocated for a balanced approach to investing that aimed to capture long-term growth in stocks while mitigating risk through the stability and income provided by bonds.
The 60/40 portfolio is regarded as a way to achieve a reasonable balance between capital appreciation and capital preservation, especially during market fluctuations. The 60/40 portfolio has become a cornerstone in investment advice and portfolio construction, serving as a foundation for diversified asset allocation strategies that seek to optimize risk and returns. This strategy, however, is not ideal for families whose assets are multi-generational.
The Yale Model
The Yale Model is an investment strategy developed by the Yale University Endowment under the guidance of David Swensen. This model is characterized by its emphasis on diversification, active asset allocation, and alternative investments. By incorporating a wide array of assets such as equities, fixed income, real assets, and alternatives like private equity, the Yale Model aims to reduce risk and enhance returns through exposure to various uncorrelated markets. This diversification is designed to mitigate the impact of market volatility - protecting assets during downturns while capitalizing on opportunities during upswings.
As Figure 1 clearly demonstrates, Yale University's endowment began dramatically outperforming its prior historical returns from the time David Swensen took over as Chief Investment Officer and incorporated the Yale Model.
Figure 1: Yale University Endowment Value Pre- and Post-Implementation of the Yale Model
Furthermore, the Yale Model significantly outpaced inflation during the prior decade and consistently outperformed the mean returns of other college and university endowments.
Figure 2: Comparative Growth of the Yale University Endowment
Benefits of the Yale Model for Generational Wealth
Generational wealth involves the transfer of financial resources from one generation to the next, helping families maintain a desired standard of living and creating opportunities for successive generations. Typically, generational wealth is managed with the aim of preserving the principal investment in real terms with a portion of the returns allocated to support the family's ongoing cash needs. Most families intend to hold onto the principal for the very long term, often with the intention of doing so indefinitely. This extended investment horizon distinguishes generational wealth from short-term investing, as families can afford to accept illiquidity and may not require immediate access to their invested capital.
A long-term endowment strategy, like the Yale Model, aligns well with the objectives of investing generational wealth. The essence of this strategy lies in its patient and disciplined approach to investing. Rather than chasing short-term market trends, a long-term strategy focuses on remaining invested throughout market cycles, Generational wealth, by definition, is designed to provide for beneficiaries over extended periods, making the Yale Model well-suited for this objective.
By holding investments for extended periods, a long-term strategy reduces transaction costs, minimizes the impact of market volatility, and captures the benefits of compounding over time. This steadiness is especially advantageous during economic cycles, enabling families to weather market downturns and ultimately capitalize on growth opportunities as markets recover. A long-term perspective also fosters greater alignment with the family's overall objectives, ensuring that investment decisions remain in line with the beneficiaries' needs and goals.
Inflation can profoundly impact generational wealth and asset allocation strategies typically characterized by a 60/40 portfolio may not yield returns that outpace inflation. As a result, the real value of these assets can diminish over time, negatively affecting the wealth passed down to beneficiaries.
One key aspect of the Yale Model is the use of private investments, such as venture capital, private equity and real assets. Private investments can help to reduce volatility and increase the overall risk-adjusted return of the portfolio. While public investments can be bought and sold daily, private investments are illiquid for some period of time, often 7-10 years. To offset this illiquidity and entice investors, private investments must offer a disproportionately higher return relative to similar public investments. For families investing across generations, often a majority of the wealth is not needed for years to come. Therefore, it can be highly strategic for these families to allocate meaningfully to private investments and capture this premium.
Superior Diversification Through Alternative Investments
In contrast to the 60/40 Portfolio, the Yale Model places significant emphasis on alternative investments. Alternative investments do not fall into one of the traditional asset class categories like equities or bonds; instead, they encompass private equity, real assets (including real estate), hedge funds, and commodities. Alternative investments are generally less correlated to traditional asset classes, meaning that the price movements of alternatives do not closely follow the same trend or direction as traditional assets. The low correlation between alternative and traditional investments reduces the overall volatility of portfolios. As a result, diversified portfolios with exposure to alternatives can better withstand market corrections and minimize the risk of portfolio drawdowns, thus preserving invested capital over the long term.
To this end, after seeing the striking success of the Yale Model, countless endowments have incorporated significant allocations to alternative investments.
Figure 3: Mean Endowment Portfolio Asset Allocation from FY 2018 - FY 2022
*Harvard did not report asset allocation for FY 2022, so the mean excludes data from that year.
**Notre Dame did not report asset allocation for FY 2018, so the mean excludes data from that year.
Long-term endowment strategies, like the Yale Model, hold numerous advantages for families whose assets are multi-generational. Traditional investment strategies, such as the 60/40 portfolio, while historically significant, may not align with the long-term goals of generational wealth. The Yale Model's emphasis on diversification, active asset allocation, and alternatives offers a more effective investment strategy. In addition, the long-term endowment strategy aligns with the very essence of generational wealth – securing financial well-being for generations.
About Two Ocean Trust
Two Ocean Trust was founded to serve private clients whose assets are multi-generational. We provide investment management and trust services to ultra-high net worth individuals, private family trust companies, and foundations. Based in Jackson Hole, Two Ocean Trust is uniquely positioned to provide access to Wyoming's tax advantages, modern trust laws, and enhanced privacy and asset protections.