This is the second article in our Wall Street Fugazi series intended to arm you against the Wall Street sales machine. [Read the full framework for protecting yourself from Wall Street’s sales culture.]
Over the past couple of decades, “democratizing alternative investments” has been Wall Street’s consistent growth narrative for high-net-worth individuals. Investors are told that traditional liquid allocations like a global public equity and fixed income portfolio are archaic. True “institutional-grade” performance requires private equity, venture capital, private credit, and hedge funds.
The hook for this pitch is generally anchored to the “Yale Model,” developed by the late David Swensen during his 35-year tenure as Chief Investment Officer of the Yale University Endowment. By aggressively shifting capital away from public markets into nontraditional, often illiquid private assets, Swensen achieved compound annual returns exceeding 13% from 1985 through 2020.
Who wouldn’t want that kind of sustained success? Swensen’s achievements at Yale were real, but a Wall Street fugazi has emerged around them. Beneath the promise and hype of the Yale model lie three fatal flaws that turn Yale’s extraordinary past performance into mediocre expected future outcomes for today’s high-net-worth investors.
1. Individual investors suffer from tax drag
Tax efficiency is the most egregious misdirection in selling the Yale Model to individuals.
Yale University is a 501(c)(3) tax-exempt institution. Although its endowment is subject to federal excise tax on net investment income, it does not face the same federal and state income-tax regime that applies to taxable individual investors. For Yale, a dollar of realized capital gain, ordinary interest, or dividend income roughly translates directly into a dollar of balance-sheet growth. Swensen’s portfolio was built without concern for tax drag.
Individual investors, by contrast, generally suffer major tax drag: federal income and capital gains taxes plus the net investment income tax plus state-level taxes (such as California’s 13.3% top marginal rate) can easily push an investor’s total marginal tax rate past 50%.
This is why a distinct set of tax-aware alternative investment strategies have recently, and rightly, become popular. However, most private funds sold to retail clients are fundamentally tax-unaware:
- Private credit: Yields stem from direct lending, distressed debt, or mezzanine instruments. These returns are distributed as ordinary income, taxed annually at the highest possible marginal rates.
- Hedge funds: Active short-term trading strategies can generate frequent realized gains, leading to high ordinary income taxes.
- Private equity: Limited partners can be subjected to phantom income, complex K-1 reporting, cross-border withholding, and forced realizations driven by fund activities rather than the investor’s personal tax strategy.
- Real estate: While real estate funds often offer tax benefits, state sourcing and multi-state filing can be a massive unexpected burden.
When a tax-unaware private strategy generates an apparently attractive pre-fee, pre-tax gross return, the compounding effect of fund-level fees and individual investor taxes can transform what the investor actually keeps into something much more mediocre, say, trimming a 10% gross investment return to a net after-tax investor return of just 6-7%.
2. Individual investors pay higher fees
Yale negotiated custom mandates, wholesale fee schedules, and co-investment rights directly with top-tier alternative asset managers as well as making direct investments off of Wall Street. Retail high-net-worth investors, conversely, are often charged the highest fees while being funneled through layers of intermediary structures, including feeder funds, fund-of-funds, and wealth management platform “access solutions.”
Each step in this chain skims value:
- Management fees: 1.5% to 2.5% of committed or called capital annually, sometimes including on borrowed money.
- Performance fees (carried interest): 15% to 20% of profits or even more, sometimes above a hurdle rate but often charged on all profits.
- Feeder fund and platform fees: An additional 0.25% to 0.50% annually.
- Fund expenses: Operational, legal, and audit costs passed directly to investors.
Fee ranges shown are for illustrative and educational purposes only and are not intended to represent the fees or expenses of any specific private fund. Actual fees, expenses, calculation methods, and payment structures vary by fund, sponsor, strategy, investment vehicle, and investor terms and may be higher or lower than the ranges shown. Certain fees may not apply, may be subject to offsets or waivers, or may be calculated using different bases or methodologies. Investors should review the applicable fund offering and governing documents for complete information regarding fees, expenses, liquidity, risks, and other terms.
In this stacked fee architecture, Wall Street captures big fees plus upside while offloading 100% of the downside risk and illiquidity onto the client. And that is before investors’ tax bills arrive.
For example, suppose a private fund has a 12.5% topline gross return. That seems pretty attractive. But the Fund has a 2% annual management fee, while platform fees and fund expenses eat up another 0.5% of the fund each year. After fees, the return falls to 10%. Fund managers taking 20% of the profits pull the pre-tax return down to 8% (slightly less in reality because investors generally pay a performance fee on profits that actually go to the platform). A blended tax rate of 25% leaves investors with 6% after-fees/tax – less than half the gross return.
3. Decaying endowment returns
The Wall Street sales pitch implies that the Yale Model continues to deliver its historical 13%+ returns. It does not.
During the 1980s and 1990s, private markets were under-allocated and starved for capital. Early institutional investors like Yale captured genuine illiquidity premiums. Today, the space is bloated with trillions of dollars in uninvested “dry powder.” Increased competition for deals has bid up prices, compressing returns.
Even for Yale. Over the last decade (ending 6/30/2025), Yale’s endowment achieved an annualized return of roughly 9.4% – a respectable figure, but far below its golden era. The broader universe of higher-education endowments averaged less than 8.0%. Generally, as an investment strategy attracts more capital, its returns deteriorate.
When you add retail fees and top-bracket personal tax drag to an 8% generic Yale Model return, the net-after-tax return for an individual investor likely degrades to 5% per year, or even less. A far cry from 13%+ that Wall Street likes to focus on.
In contrast, a low-cost, liquid, tax-efficient broad market ETF gives investors market returns while allowing them to defer capital gains indefinitely. Over the past decade, these ETFs handily outperformed the generic Yale Model’s pre-tax returns, while providing investors with far better liquidity and tax treatment.
The stock market isn’t the fugazi. Neither are private funds, necessarily. The fugazi is the sales pitch that better outcomes (higher returns, lower risk, and more wealth) are readily available in private funds.
Continue the Wall Street Fugazi series with Unrecognized Risks in Private Credit.
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Disclaimer:
All investing involves risk, including the potential loss of principal. There is no guarantee that any investment plan or strategy will be successful. Advisory services provided by Hendershott Wealth Management, LLC (“HWM”), an investment advisor registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training.
All written content in this piece is for information purposes only and does not constitute an offer, or solicitation of an offer, or any advice, or recommendation to purchase any securities or other financial instruments–and may not be construed as such. Opinions expressed herein are solely those of HWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. HWM does not provide tax or legal advice.
