Investment lessons from the big endowments

Investment lessons from the big endowments

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For many years now, investors have looked enviously at the apparent ability of certain institutions, such as the huge endowment funds which support some of the large US universities, apparently to earn returns far ahead of those of the majority.  Their success has been attributed to the fact that controlling several hundred billion dollars tends to open doors which remain closed even to some institutions and thus affords them access to more restricted opportunities.  Such ‘alternative’ asset classes include private equity, venture capital, unlisted real estate investments and that old favourite, hedge funds.  In some instances, the allocations to such alternatives come close to 60% of the total.

Such institutions typically display some consistency in terms of their approach:

  • They are willing to pay more for what they perceive as skilled managers, to the extent that they make little use of lower cost passive investments;
  • They are typically heavily weighted towards equities;
  • They have higher than average allocations to alternative investments, principally private investments and hedge funds;
  • There has been a historic bias towards value over growth investments, although this may have reduced as this factor has underperformed in the last decade.

Unsurprisingly, the published returns of these institutions encouraged other investors to jump on the bandwagon and seek to claim some of this for themselves.

It may therefore be of interest to discover that over the years, there has been some academic research into the ways that the large endowments earn their returns.  This includes studies published in 2013, 2018 and two studies in 2020.  It turns out that all these studies found that the variations in performance between the various endowments are almost all explained by their exposure to structural risk factors.  By this they mean the factors identified by Nobel laureate Eugene Fama and others, such as exposure to the broad market, to small companies, value stocks and profitability.

Those familiar with other work in this field may find themselves remembering the famous studies by Brinson et al which were published in 1986 and 1991 and considered the variations in returns between a universe of US pension funds.  Both those studies concluded that around 90% of the variability was attributable to the funds’ exposure to broad asset classes, namely cash, bonds and equities.

The 2020 study by Richard Ennis, ‘Endowment performance’, looked at 43 of the largest endowments over the 11 years to the end of June 2019 (so following the global financial crisis).  He drew several conclusions:

  • None of the endowments demonstrated any statistically significant outperformance although a quarter of them showed statistically significant underperformance;
  • Their use of ‘alternative’ assets did not deliver diversification benefits and actually reduced performance;
  • There was no evidence, once adjusted for risk, that larger funds performed any better than smaller ones;
  • Risk-adjusted returns (known as alpha) were negative and consistently below -1%;
  • The endowments’ returns were highly correlated with those of their benchmarks;
  • Underperformance occurred across both the equity exposure and the diversification;
  • Finally, the underperformance was generally associated with the holdings of alternative assets and their high costs – the risk-adjusted returns reduced as the exposure to alternatives increased.


There is no investment which offers an entirely free ride and in every case, return is accompanied by some risk.  This is as true of storing cash under the floorboards (fire, mice and theft come to mind) as it is of investing in the often somewhat opaque strategies pursued by some hedge funds.  One of the important factors that investors (at any level) should also consider is the costs of their approach.  While it is undoubtedly true that larger investors can often negotiate lower costs by dint of their buying power (and it need not cost ten times as much to manage a £500m portfolio as a £50m one), sometimes a larger chequebook can give access to the sort of expensive investments that smaller investors are denied access.  As these studies show, that isn’t always a good thing.

I’ll end with a quotation from the 2007 Barclays Capital Equity Gilt Study, which neatly encapsulates why increasing a portfolio’s allocation to private equity (one of the leading ‘alternative assets’) is not what it might seem.

“….. private equity is simply public equity with additional layers of leverage; it is therefore likely to be a good deal more risky than quoted equity markets, while several orders of magnitude more expensive in management fee structures….. private equity might appear to be a lower-risk investment than quoted equities, while delivering historical returns that display low correlations with equities.  In the real world, nothing could be further from the truth.”

Perhaps we should not be so surprised that, whether privately or publicly owned, the characteristics of equity investments remain subject to common principles.