How A Small Foundation Trounced The Big Guys

A foundation I work with asked me to compare its performance with that of other foundations using the most recent data available. The news was quite good.

This relatively small foundation (“Foundation X”) managed to beat the return averages for all size foundations and even the top 10 percentile of performance of all foundations. Yet it is the story of how it achieved this that is most compelling, as any individual or foundation can do the same.

I started working with the Foundation in late 2008, shortly after the stock plunge. At the time, Foundation X had three active managers. Rather than benchmark its performance against other foundations, I benchmarked against the broad stock and bond ETFs. Specifically, the key benchmarks were:

• Vanguard Total Stock Index Fund (VTI)
• Vanguard FTSE All World Ex-US (VEU)
• Vanguard Total Bond Fund (BND)

What happened over the subsequent few years was that two of the three active managers were let go due to substantial underperformance. Not surprisingly, those were the two with the highest fees. Rather than find new managers, Foundation X decided instead to own the benchmarks itself, giving it a huge cost advantage over other foundations.

An Update

Foundation X still has roughly 40% of its assets in the low-cost active manager and, over the five-year period, that active manager did underperform the benchmarks by a bit. This foundation also owns a REIT index fund, a low-cost precious metals and mining fund, and a very tiny investment in a private equity fund.

The core of the passive portfolio was in these three ETFs originally selected as benchmarks, with one minor change. That change was switching from the Vanguard FTSE All World Ex-US to the Vanguard Total International fund (VXUS) shortly after the ETF was launched, since it was a bit broader, owning small-caps.

It would be logical to assume that in the up market that occurred during the five-year period, taking on more risk would be part of the explanation for achieving top-decile performance. But Foundation X had a much greater percentage of its portfolio in high-quality bonds than other foundations. This allowed the foundation to get an extra boost from rebalancing, meaning it was buying stock funds on dips and selling on surges.

Bottom Line

Foundation X trounced the big foundations while taking on less risk. It did so by minimizing expenses and emotions, and maximizing discipline and diversification. The board and executive director of Foundation X understood the arithmetic of active management and went with the odds. That allowed it more money to fund its critical charitable mission rather than fund the financial services industry.

There is certainly no guarantee that this foundation will be in the top decile of performance over the next five years. But with such a cost advantage over its peers and a track record of disciplined rebalancing, the odds are great that it will continue to outperform its peers and have more money to fund its mission.

The logical conclusion of correct benchmarking is to own the broadest benchmarks at the lowest costs and have the discipline to rebalance. This means ignoring forecasts, whether they’re of market surges, dives or even bond bubbles.

This simple strategy will work just as well in funding the goals of your portfolio.

At the time of writing, the author owned positions in the securities mentioned. Allan Roth is founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected] or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter