Swedroe: Endowment Returns Are Worsening

December 05, 2014

Even before adjusting for exposure to common factors—such as size and value and endowments' allocation to riskier and less-liquid investments—overall we don't see any evidence of superior performance.

And during the last 10 years, a period when endowments' allocation to alternative investments has increased, we see evidence of underperformance—even before adjusting for risk.

Vanguard also analyzed the relative performance of small endowments (under $100 million), medium endowments ($100 million to $1 billion) and large endowments (more than $1 billion). Small and medium endowments account for about 90 percent of the total population.

  5 Years (%) 10 Years (%) 15 Years (%) 20 Years (%) 25 Years (%)
Small Endowments 3.9 6.1 4.9 7 7.7
Medium Endowments 3.6 7.2 6 8.1 8.8
Large Endowments 3.8 8.5 8.1 10.1 10.4
60% Stock/40% Bond Benchmark 5.9 7.4 5.7 7.6 8.3

Small Endowment Underperformance

One important observation is that, with the exception of the most recent five-year period, small endowments (under $100 million in assets) tended to underperform larger ones.

Part of the explanation might lie in larger endowments' greater negotiating power for lower fees. Another explanation might be that the larger endowments have greater resources, allowing them to make superior choices. A third explanation might be that the larger endowments have access to superior managers unavailable to smaller endowments.

That latter possibility might be due to larger endowments' long-standing relationships with top managers who aren't accepting new assets. Or, it could be that the larger endowments have higher allocations to alternatives.

Problems With Increased Exposure To Alternatives

Vanguard found that during the decade through June 2013, large endowments had, on average, increased their alternatives allocation to 59 percent from 31 percent, medium endowments to 36 percent from 16 percent, and smaller endowments to 18 percent from 5 percent.

While these figures show that small and medium endowments have more modest allocations to alternatives, increasing allocations of that type hasn't helped performance relative to benchmarks, even before adjusting for factor exposures and liquidity risks.

We also know that over time, the markets have become more efficient, making it more difficult for alternative investment vehicles, such as hedge funds, to deliver alpha. The performance of hedge funds, for example, has deteriorated dramatically over the last 25 years. Unfortunately, as Vanguard noted, the smaller- and medium-sized endowments didn't benefit from the strong earlier performance of alternative investments.



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