Disclosure – Non-substantive Research
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour.
Over the decades, investors’ ideas about how to build the perfect investment portfolio have evolved. Large independent pension fund investors have typically led the way, with consultants and smaller pension funds following, and then discretionary private client wealth managers followed by individual retail investors echoing trends as they trickle down.
Markowitz is identified as the architect of modern portfolio theory and, to an extent, over time investors have been working with and adapting this theme to their portfolios. The recent death of David Swenson, a pioneer in the evolution of institutional portfolios and CIO of the Yale Endowment, gave us cause to examine what the future might hold for discretionary wealth managers’ or retail investors’ portfolios.
We believe that the Yale Endowment highlights where the future might be headed for non-institutional investors. Yale’s objectives, and its willingness to look to the very long term echo the objectives of many SIPP investors. The key lessons from Yale for such investors is to embrace equity risk and illiquidity, to enable underlying managers to exploit inefficiencies and generate superior long term returns than listed indices. Whilst Yale’s largest allocation is to venture capital, listed fund investors do not have a particularly deep sector to pick from to access this asset class. At the same time, Yale anticipates it carries nearly twice as much risk as listed equities, and so investors wishing to emulate the Yale model might do well to focus more on the other significant private market allocation – that of leveraged buyouts.
The LPE sector has a wealth of options for investors wishing to access this area of investment, and the historic returns generated by the peer group have broadly matched those generated by Yale’s portfolio. We believe most traditional investment portfolios only have a cursory exposure to these areas, and so most investors trying to shift towards a Yale model could start by replacing conventional (i.e. public market) equity exposure with LPE trusts. Short term, the effect at a portfolio level is unlikely to be felt significantly – for better or for worse – but over periods measured in the decades, the compounding effect of private equity value creation should add considerably to portfolio returns. That many LPE trusts are on a discount is an indication that UK investors have not caught up with Yale’s long held philosophy. If they do, it may be that LPE’s superior returns are reflected in premiums rather than discounts to NAV. As Yale has experienced, having first mover advantage can have a lasting impression on your portfolio’s returns.
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