Elite foundations with heavy allocations to alternative assets underperform and lose ground to easy index strategies. High costs, increasing competition and outdated notions of superiority are taking their toll. Isn’t it time for a reset?
Endowments with large allocations to alternative investments have underperformed comparable indexed strategies. The average return for Ivy League schools for the reason that 2008 global financial crisis has been 8.3% per 12 months. An indexed benchmark of 85% stocks and 15% bonds, the Ivies’ signature allocation, returned 9.8% annually over the identical 16-year period. The annualized difference or alpha is -1.5% per 12 months. This adds as much as a cumulative opportunity cost of 20% in comparison with indexing. That’s a whole lot of potential wealth lost.[1]
“Endowments within the Casino: Even the whales lose on the alts table(Ennis 2024) shows that alternative investments comparable to private equity, real estate and hedge funds are accountable for the entire underperformance of enormous endowments.
Why do some foundations proceed to rely heavily on something that has proven unsuccessful? Endowment managers with large allocations to alternative investments suffer from what I call endowment syndrome. Symptoms include: (1) refusal to compete, (2) willful cost blindness, and (3) vanity.
Conditions of competition
When David Swensen (Yale) and Jack Meyer (Harvard) worked their magic within the Nineties and early 2000s, alternative investment markets were comparatively small and undeveloped. Since then, many trillions of dollars have flowed into alternative investments, increasing total assets under management greater than tenfold. There are actually over 10,000 alternative asset managers vying for a chunk of the motion and competing with one another for the perfect deals. The market structure has developed accordingly. In short, private market investing is way more competitive than it was once way back When. Mostly, nonetheless, large asset managers work as if nothing had modified. They deny the truth of their markets.
Cost
Current studies paint an increasingly clear picture of the prices of different investments. Private equity costs at the least 6% of the asset value. Non-core real estate amounts to 4 to five% per 12 months. Hedge fund managers make 3 to 4% annually.[2] I estimate that enormous foundations with over 60% of legacy funds will incur total operating costs of at the least 3% per 12 months.
Now hear this:. Foundations that not report their costs and not I even discuss them so far as I can tell work When it involves cost, we see no harm.
vanity
There is a perception that stewards of faculty assets are exceptional. About a dozen schools promoted the concept that their investment offices were as elite because the institutions themselves. Others liked to appeal to the leaders be drawn right into a special class of investment professionals. Not way back, a veteran institutional investment observer claimed:
Endowment funds have been around for a very long time been thought to be the perfect managed asset pool on the planet of institutional investing and employ essentially the most capable people assign Assets to managers, conventional and alternative, who can and do truly deal with the long run.
Foundations appear to be particularly suitable for this [beating the market]. They pay well and attract talented and stable employees. They exist within the immediate vicinity Business schools and economics departments, many with Nobel Prize winners. Managers from everywhere in the world reach out to them and consider them highly desirable customers.[3]
This is heady stuff. No wonder, many equipment Managers imagine that it’s their responsibility, whether by legacy or tradition, to be, or at the least act like, exceptional investors. At some point, nonetheless, the illusion of superiority will give technique to the truth that competition and price are the dominant forces. [4]
The awakening
The awakening could come from above if the trustees determine that the established order is untenable.[5] This can be an unlucky final result for foundation managers. This may lead to job losses and reputational damage. But it not has to occur like this.
Instead, foundation managers can begin to gracefully navigate their way out of this dilemma. You could easily arrange an indexed investment account with a stock-bond allocation of, say, 85-15%. They could then direct money from gift additions, account closures, and distributions to the indexed account as institutional money flow needs permit. At some point, they may adopt an approach to asset allocation where they usually adjust their asset allocation in favor of the strategy – lively or passive – that’s performing best.
Or as Senator James E. Watson of Indiana liked to say, “If you tilt Lick her, lick her. To that I would add, “And do it as quietly as you like.”
References
Ben-David, Itzhak and Birru, Justin and Rossi, Andrea. 2020. “The Performance of Hedge Funds. NBER Working Paper No. w27454, available from SSRN: https://ssrn.com/abstract=3637756.
Bollinger, Mitchell A. and Joseph L. Pagliari. (2019). “Another Look at Private Real Estate Returns by Strategy.”, 45(7), 95–112.
Ennis, Richard M. 2022. “Are Foundation Managers Better Than the Rest?”, 31 (6) 7-12.
—— . 2024. “Foundations in the Casino: Even the Whales Lose at the Alts Table.”, 33 (3) 7-14.
Lim, Wayne. 2024. “Access to Private Markets: What Does It Cost?”, 80:4, 27-52.
Phalippou, Ludovic and Oliver Gottschalg. 2009. “The Performance of Private Equity Funds.” 22 (4): 1747–1776.
Siegel, Laurence B. 2021. “Don’t give up the ship: The future of the foundation model.” (Investment Models), 47 (5)144-149.
[1] I actually have corrected the 2022-2024 fund returns for biases attributable to lags in reported net asset values. To do that, I used regression statistics for the last 13 years combined with market returns for the last three years. (The adjusted returns were actually 45 basis points per 12 months higher than the reported series.) I created the benchmark by regressing the common Ivy League return series on three market indexes. The indices and their approximate weights are Russell 3000 stocks (75%), MSCI ACWI Ex-US (10%) and Bloomberg US Aggregate bonds (15%). The benchmark is predicated on returns for 2009-2021.
[2] I created the benchmark by regressing the Ivy League average return series on three market indices. The indices and their weights are Russell 3000 stocks (75%), MSCI ACWI Ex-US (10%) and Bloomberg US Aggregate bonds (15%). The benchmark is predicated on returns for 2009-2021.
[3] See Ben-David et al. (2020), Bollinger and Pagliari (2019), Lim (2024) and Phalippou and Gottschalg (2009).
[4] Lake Seal (2021).
[5] My research consistently shows that enormous endowments generate lower risk-adjusted returns than public pension funds, which spend much less on lively investment management and, specifically, alternative investments. See Ennis (2022).
[6] My guess is that Harvard pays its money managers greater than it takes in tuition, with nothing to indicate for it.
