Yale endowment model architect Hunter Lewis calls time on it

The famed university endowment investment model is “backward looking, outdated and worn out,” says Hunter Lewis, the co-founder of Cambridge Associates, a Wall Street gatekeeper advising on half a trillion dollars worth of institutional assets.

He should know — he was one of its architects.

The model, which came into existence almost half a century ago, is defined by a heavy equities weighting and chunky allocations to private equity, venture capital and hedge funds. Such was its success early on that it was widely adopted, including by pensions funds, private foundations and family offices. 

But Lewis now believes parts of the framework — which is sometimes called the “Yale model” for the involvement of the Ivy League university’s legendary chief investment officer David Swensen in shaping it — have failed to keep up with the times. Lewis argues that private equity and venture capital have become too crowded and the so-called illiquidity premiums have been eaten up by large fees, casting “doubts that this is the way to go for the future”.

As universities and pensions adopted the endowment model, demand for private equity and venture capital exploded. As of last year, the largest university endowments with more than $1bn in assets, had, on average, more than a quarter of their portfolios sitting in such funds, according to the National Association of College and University Business Officers. Calpers, the largest public pension in the US, has been eager to boost its 8 per cent target allocation to private equity further.

But at the same time, returns from the asset class have converged significantly with those of public equity markets, which are cheaper and easier to access. For the period ending June 2019, the S&P 500’s 10-year annualised performance beat buyout funds for the first time in a decade, according to a report from Bain, the consultancy.

“It doesn’t mean that individual private equity deals don’t make sense because they can. But as an area . . . the fees are too high. The competition is too great,” says Lewis, who retired from Cambridge in 2018 and has since focused on his family office. “These pension funds that are thinking this is going to solve our problem — well, it’s not.”

At his family office, which last year opened up to outside investors, Lewis says he tackles the problem by directly investing in venture deals instead of investing via funds. To date, the fledgling firm has invested in Sudoc, which uses technology to cut hazardous chemical contaminants, and in a regenerative farm in Alabama. 

For Yale, large allocations to private investment funds have fared well, Lewis says, but not necessarily for other institutions.

“First of all, it’s run by David Swensen, who is a genius at this,” says Lewis. Beyond that, Yale has a vast alumni network in investment circles, and fund managers “want to be associated with Yale, which can lead [them] to offer lower fees”.

Beyond the private equity conundrum, Lewis also warns that universities and other investors do not have sufficient inflation hedges in place to protect them against one of Wall Street’s most fretted over risks at the moment.

“I never know about the next few months, but I do think that all investors need a bigger inflation hedge,” Lewis says.

Lewis was instrumental in shaping the beginnings of the endowment model when he and his then-roommate and later Cambridge Associates co-founder James Bailey overhauled the Harvard endowment in 1973. 

While a Harvard undergraduate, Lewis spent his time outside of class working as a journalist, landing interviews with then New York City mayor John Lindsay for Playboy magazine, and Martin Luther King Jr shortly before his assassination. That work ended when Lewis joined the Marine Reserves in 1969.

After six months of active duty, he joined asset manager Boston Company. Three years into the job, Lewis and Bailey, who also attended Harvard, secured a deal with their alma mater’s treasurer, George Putnam, to review how the endowment allocated its assets.

Most schools back then stuck to a simple, domestic stocks-and-bonds portfolio. The duo recommended a larger allocation to equities, including into global stocks and illiquid parts of the asset class, such as venture capital and private equity. Not long after, other universities, including Yale and Massachusetts Institute of Technology, made contact and Cambridge Associates was born. 

“When we started working with Harvard, nobody thought of universities as leaders in the investment field,” Lewis says. The endowment model, he adds “all really began there, and then it evolved over time, until David Swensen came along at Yale and perfected it.”

Lewis grew Cambridge into a global institutional gatekeeper that today advises universities and other institutions on how to invest assets worth $503bn. He stepped away from day-to-day operations in 2000 and since retiring from the business in 2018, his investment thesis has diverged from the business he founded.

Cambridge remains a strong advocate for the model, often recommending heavy allocations to illiquid funds through its network of private and venture fund managers. To wealthy clients, Cambridge recommends they consider allocating north of 40 per cent of their portfolios to private equity and venture capital, if they can tolerate their capital being locked up for years.

For his new venture, Lewis has been pitching a different approach to clients, via video chat from the farm on which he’s been sitting out the pandemic. Despite the challenges of bringing on new clients remotely, he says he’s thankful that he got to spend the past year surrounded by plenty of space and nature.

“It’s a lot harder when you’re in the middle of New York City, on the top of a high rise,” he said. “I’m very lucky.”

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