For years, the so-called endowment model could do no wrong. Pioneered by large private colleges, it calls for broad diversification, including plenty of “alternative investments” like hedge funds, private equity, timber, and real estate.
Through 2007, the big colleges and foundations that mimicked trailblazers like Yale and Harvard posted investment returns that crushed those earned by smaller endowments.
Then came the 2008 financial crisis, and many of the colleges and foundations that embraced the endowment model fell just as far, if not further, than those that took a more traditional approach.
Now, as stocks roar higher, the endowment model appears to be faltering once again.
For example, Harvard University’s endowment, which has a large internal staff scouring the world for top investments, has produced returns since the stock market bottomed in 2009 that are no better than those earned by the United Way of Metropolitan Dallas. The United Way farms endowment management out to staid TIAA-CREF, which puts about 70 percent in investments that track stock indices and most of the rest in bond funds. (See below)
Many small- and medium-size endowments have been funneling money to expensive alternative-asset managers over the past decade in a bid for higher returns. New evidence suggests that their efforts have been for naught.
A new report by the Vanguard Group found that small and medium-size college endowments—those with assets of $1-billion or less—would have fared better over the past five years, and over the past 25 years, by simply investing in the same low-cost mutual funds available to individual investors.
“A lot of people make the assumption that more alternative assets by the larger endowments has led to their success,” says Daniel Wallick, a portfolio strategist at Vanguard. “Our analysis would suggest that that’s not true. What really drives their success is their ability to pick managers.”
Mr. Wallick’s takeaway—perhaps not surprising for an employee of the world’s largest provider of index mutual funds—is that endowments with fewer resources should avoid complexity and stop trying to outperform the public markets. “The only thing that’s certain when you buy an investment is what it costs you,” he says. “Compounding those low costs is probably the most certain way to accumulate a higher corpus.”
The rebound in the stock market has lifted the value of nearly all foundations, even the smallest ones. A new study of more than 230 grant makers with assets under $50-million, conducted by the Foundation Source, saw their holdings grow by 48 percent from 2008 to last year.
But since virtually all endowments have some assets in bonds or cash, the strong stock market is leaving nearly everyone behind. The S&P 500 returned 29.6 percent last year and was near all-time highs as of mid-November. Of the 232 groups that participated in The Chronicle’s annual endowment survey, only 3 percent topped the S&P 500’s return during their most recent fiscal years.
Many of the consultants that have long advocated for alternative investments are finding that they’re suddenly a tougher sell, especially given the weak performance of hedge funds recently. The California Public Employees’ Retirement System announced in September that it would sell all of its $4-billion hedge-fund holdings. The giant pension system’s decisions are closely watched by endowment managers.
“I’ll admit that the enthusiasm for alternatives has dampened a bit,” says Chris Adkerson, who leads Mercer Hammond’s endowment-consulting business. “The U.S. market is doing so well, and there’s this element of parochial thinking: ‘Why stop what’s working?’ ”
Yet advocates for the endowment model argue that its time will come again—precisely because the stock market is doing so well today. All bull markets eventually end, and that may be the time when alternative investments shine.
“Are you willing to take the risk of a big allocation to stocks after the big run-up?” asks John Griswold, executive director of the Commonfund Institute, the research arm of Commonfund, an investment firm that has long extolled the benefits of alternative investments. “Markets don’t go to the sky. This just gets riskier and riskier.”
Even Mr. Wallick concedes that the endowment model can work for the biggest endowments, which have the leverage to negotiate cheaper management fees and the connections to obtain access to the best investors. Yale’s endowment earned 20.2 percent for the year ending in June, putting it among the handful of endowments that beat the S&P 500.
The Institute for Advanced Study, a research center that keeps a whopping 89 percent of its $730-million endowment in hedge funds and private equity, earned 14 percent for its fiscal year ending in June.
Mark Baumgartner, the institute’s chief investment officer, says he’s “very pleased” with the performance and plans to keep the endowment’s holdings.
“While we will not share any specifics on the mix of strategies we employ,” he notes, “we can say that they are very diversified and that achieving substantial diversification is a primary objective for the portfolio.”
Harvard Endowment’s Investment Gurus Struggle to Keep Up
A More Complex investment Strategy ...
Harvard University’s $32-billion endowment holds a wide variety of illiquid, “alternative investments.”
The United Way of Metropolitan Dallas’s $29.4-million endowment sticks to an old-school investment policy, with nearly three-quarters of assets in stock index funds and the rest in bonds.
... Doesn’t Necessarily Produce Better Results
The complicated, high-cost investment process pursued by Harvard hasn’t translated into stronger returns since the stock market bottomed in 2009.
