Swedroe: Questioning Value Of Endowments

December 03, 2014

Educational institutions hold billions of dollars in endowment funds. As of June 2013, the most recent data available, the five largest educational endowments (Harvard University, Yale University, The University of Texas system, Stanford University and Princeton University) collectively managed nearly $110.5 billion. All educational endowments managed in excess of $448 billion.

While they are often critical to funding educational institutions, we actually know very little about the performance of endowments. The poor performance of many of these funds, however, has led to questions about whether the “endowment model” actually delivers superior results.

Under The Microscope

Brad Barber and Guojun Wang—authors of the 2013 paper, “Do (Some) University Endowments Earn Alpha?”—set out to examine the following three questions:

  1. Does the average endowment earn an abnormal return (alpha) relative to standard benchmarks?
  2. Do elite institutions earn alpha?
  3. Is there evidence of performance persistence in endowment returns?

To find the answers, the study’s authors analyzed the performance of a large set of institutions for the 21-year period ending June 2011.

Initial Verdict

The following is a summary of their findings:

  • A simple factor model (which did not include the size and value factors) that shows a 59 percent exposure to stocks (the S&P 500 Index for U.S. stocks and the Morgan Stanley Capital Index ex-U.S. for international stocks) and a 41 percent exposure to bonds (Barclays Capital Aggregate Bond Index) explains virtually all (99 percent) of endowment returns.
  • Even before adjusting for exposure to small and value stocks, endowments’ small positive alpha of 0.4 percent per year wasn’t statistically different from zero. And, given that in the U.S., the size premium was about 2.6 percentage points a year and the value premium was about 4.5 percentage points a year over the period studied, it seems likely that if returns were adjusted to account for exposure to small and value stocks, the alpha earned by endowments would have been zero or negative.
  • Despite taking on more risks in the form of opaque investments (such as hedge funds), lack of liquidity (hedge funds and private equity) and other incremental risks (such as with venture capital), there was no evidence that the average endowment is able to deliver alpha relative to public stock and bond benchmarks.
  • Using both the two- or three-factor models, there is strong evidence of persistence in performance. The endowments in the top-performing decile earned returns that were roughly 4 percentage points a year higher than the endowments in the bottom decile.

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