The investment policies of university endowments are at the heart of the recent US student protests. There isn’t enough money in the world that would make FTAV want to wade into that hot mess, but it’s a decent excuse to look at the $839bn worth of investment funds with schools attached.
This is partly because there was no time to dig into the latest NACUBO study of US university endowments when it first landed back in February. But this was the 50th edition, so it offers an interesting snapshot of some of the world’s most influential investors and how radically they’ve evolved.
Back in the inaugural 1974 report, the 136 endowments surveyed were roughly bucketed by three broad investment approaches: total return, balanced and income-oriented. Today, it’s fair to say that every single one can be categorised as “Swensenian”, with the entire industry to some degree a tribute act to Yale’s late endowment chief David Swensen.
As Charlie Ellis, the former chair of Yale’s endowment, told the FT a few years ago:
The really great painters are the ones that change how other people paint, like Picasso. David Swensen changed how everyone who is serious about investing thinks about investing.
The results were wonderful, but were organised to be no surprise. If you watch a great chef prepare in the kitchen, you know the meal is going to be good.
In (very) broad contours, the Yale model is de minimis allocations to boring stuff like fixed income and big allocations to alternative, often illiquid investments like hedge funds, private equity and venture capital. Over the past two decades, the latter two in particular have become dominant.
Here is what the allocations of US university endowments looked like in 1987, when Swensen was still settling in at Yale:
Here’s what happened subsequently:
Of these alternatives, private equity is by far the biggest (17.1 per cent), followed by hedge funds (15.9 per cent), venture capital (11.9 per cent) and “real” assets like infrastructure (11.2 per cent).
Some big, high-profile endowments are even more extreme. As Stanford Management Company’s Robert Wallace told a conference last month, its endowment is targeting a 57 per cent overall allocation to these three asset classes.
If you include real estate and infrastructure then you get over two-thirds of Stanford’s money being tied up in illiquid assets. That is . . . punchy.
So how has this asset mix performed? Basically fine, but few have blown the lights out, and some have struggled. To stretch one of Ellis’s earlier metaphors (the culinary one), it’s like other endowments have followed Swensen’s recipe, but have failed to source the same quality ingredients and therefore struggled to replicate the final results.
The latest NACUBO study estimates that the 688 endowments that participated returned 7.7 per cent net of fees in the 12 months to end-June 2023, after losing 8 per cent in the 2022 period. The average 10-year return is 7.2 per cent. Larger endowments did worse last year — those with more than $5bn of assets returned 2.8 per cent in 2023 — but have put up average annual returns of 9.1 per cent over the past decade.
Given broad financial market returns of the past decade, that’s pretty mediocre. And remember, these are the endowments that choose to report their returns to NACUBO.
Last year’s NACUBO study of endowments seems to have died of link rot, but the 2021 version showed that the annualised 25 year return was 7.4 per cent (and that was after a smashing 2021 and before the 2022 bear market).
That’s only 1.3 per cent ahead of the Norwegian sovereign wealth fund’s longterm annualised returns of 6.1 per cent, and that’s basically a giant index fund that was until ca 2009 mostly in bonds, and has been less exposed to high-flying US equities. Over the past 15 years Norges Bank Investment Management has returned 8.5 per cent.
Richard Ennis, a doyen of institutional investor performance measurement and analysis, published a paper last month calling the long-term returns of the largest and supposedly most sophisticated endowments “unexceptional”.
Analysing the return patterns of the 41 largest US endowments between 2009 and 2023, Ennis concluded that the best mix of benchmarks for their performance were the Russell 3000, the MSCI All-Country World Index ex US (and currency hedged), and the Bloomberg Barclays US Aggregate bond gauge. His composite benchmark was weighted to these indices by 61 per cent, 22 per cent and 17 per cent respectively.
Ennis found that the average US university endowment underperformed this benchmark in 12 of the past 15 years, for an average annualised relative loss of 0.9 per cent. His conclusion was pretty biting:
Some funds do better than others, of course. And a few do a smidgen better than passive management. But there is no sign of exceptionalism in the performance figures — not for endowments as a class and not within the class. Finance theory predicts that diversified portfolios will underperform properly constructed benchmarks over time by approximately the margin of cost. That appears to be the essence of what we are witnessing. I’ll go with finance principles over the legend and lore of investing. More endowment trustees and CIOs should do the same.
This is echoed by Michael Markov of Markov Processes International, who wrote a scathing report showing much the same earlier this year, with the title summing up the central thrust: Volatility Laundering And The Hangover From Private Markets Investing.
The problem will be if public markets suffer another major tumble. Then the private asset allocations — with their more artisanal, occasional marking — will suddenly become even more extreme and potentially cause liquidity problems for some weaker endowments and the universities that have become increasingly dependent on withdrawing cash from them.
In the 1970s, the average share of university budgets that came from endowments was about 4 per cent, according to NACUBO. By 2009 it had risen to 13.4 per cent, and today it is over 17 per cent for larger, better-endowed universities.
Not that the investment strategy of US endowments is likely to change, even if many already have uncomfortably high allocations to private equity and venture capital, and some have been ditching stakes in funds at a discount to raise money.
There’s just too much inertia for things to change, and too much prestige tied up in the way things have been done over the past two decades. Every endowment head naturally considers themselves a brilliant, Swensenian judge of talent and remains convinced that they can consistently invest in top quartile funds.
Last year Matt Mendelsohn — Swensen’s successor at Yale’s endowment and formerly head of its venture capital investments — said that he had spent the first two years of his stint mulling the “Yale model” pioneered by his mentor and whether it still worked.
Broadly speaking, his answer was ‘yes’. FT Alphaville’s emphasis below:
. . . Our ability to be patient with long-term, illiquid assets will continue to be one of Yale’s key competitive advantages and central to our investment approach. That said, illiquidity does not, in and of itself, produce excess returns, and we must be careful to invest the endowment with an eye toward the stability of its critical support of the operating budget from year to year. Recently, in partnership with the senior leadership of the University, my colleagues and I reconsidered core questions about Yale’s ability to tolerate investment risk.
After extensive modeling and discussion, we affirmed our instinct that we could, and should, maintain a sizeable allocation to illiquid assets. While asset classes such as venture capital and private equity come with greater risk than traditional public markets, they also offer the opportunity for greater returns over the long term. The best investors in these asset classes have differential access to attractive opportunities and the ability to add value to their investments, offering a higher likelihood of sustainable outperformance.
Of course, as Swensen himself said in his 2009 Lunch with the FT: “Never underestimate the gullibility of large pools of money.”
Further reading:
— Is private equity actually worth it? (FTAV)
— David Swensen is great for Yale. Is he horrible for investing? (Institutional Investor)
