Swedroe: Why Endowments Lag

February 15, 2019

Vanguard also analyzed the performance of small endowments (under $100 million), medium endowments ($100 million to $1 billion) and large endowments (more than $1 billion), with small and medium endowments accounting for about 90% of the population. The following table, which is from the study, summarizes the results:



One important observation is that, with the exception of the most recent five-year period, small endowments (those with under $1 billion in assets) tended to underperform larger ones.

Part of the explanation might lie in the greater negotiating power of larger endowments for lower fees. Another explanation might be that the larger endowments have more resources that allow them to make superior choices. And a third explanation might be that the larger endowments have access to superior managers that the smaller endowments don’t—possibly explained by 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.

Increasing Alternatives Allocations

Vanguard found that, over the decade through June 2013, large endowments had, on average, increased their alternatives allocation from 31% to 59%, medium endowments from 16% to 36%, and small endowments from 5% to 18%. While these figures show that small and medium endowments have more modest allocations to alternatives, the increasing allocations to alternatives 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 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 alternatives.

Another important trend to note is the deterioration of the relative performance of the larger endowments. While they did outperform the simple 60/40 benchmark over the long term, the evidence indicates that much of the outperformance was before accounting for risks.

The superior results of some of the larger endowments generated great interest in the so-called Yale Model, which included large allocations to alternatives. The reality for the small and medium endowments has been disappointing performance as their allocations to alternatives increased.

For example, while the underperformance by small endowments versus the 60/40 benchmark was less than 1% over the past 20 and 25 years, as their allocations to alternatives increased, the relative underperformance increased to more than 1% over the last 10 years and to 2% over the last five years.

The trends are similar for medium and large endowments—as their allocations to alternatives increased, their relative performance deteriorated. It’s important to keep in mind the evidence demonstrates that if we were looking at risk-adjusted returns, the relative performance of the endowments would look even worse.

Vanguard’s findings were consistent with those of Brad Barber and Guojun Wang, authors of the 2013 paper “Do (Some) University Endowments Earn Alpha?” They found that 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 venture capital), there was no evidence that the average endowment is able to deliver alpha relative to public stock/bond benchmarks. They also found that once adjustments were made to include factors that reflect the way the top Ivy League schools invest (such as hedge funds and private equity), they generated negative alphas (-0.7%).


The evidence makes clear that endowments, in general, would be better off focusing their efforts on deciding which factors and sources of returns they want exposure to, and in what amounts. Once those decisions are made, they should use low-cost, publicly available vehicles whose strategies are based on evidence (not opinions), are transparent and are implemented in a systematic manner.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.

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