What Would Yale Do If It Were Taxable?

Abstract

The distinctive financial goals and constraints of ultra-high net worth individuals together with their aggregate growth in assets have led to the emergence of “New Institutional” investing, which includes the best practices from institutional investors but incorporates the critical element of tax management. We design New Institutional asset allocations that incorporate traditional investment metrics in a tax-aware setting. Specifically, we show how risk and after-tax returns need to be combined from inception when seeking optimal after-tax asset allocation. Diversification is especially important for a taxable investor, as low asset-class correlations can facilitate the inclusion of attractive but tax-inefficient asset classes in a tax-aware allocation.

Keywords: asset allocation, taxes, ultra-high net worth investors, endowments, hedge funds, tax-advantaged indexing, reverse optimization, equity-hedge fund correlation

JEL Classification: G11, G12, H24, H31