Alpha can be generated in many ways. Since asset allocation plays a big role in determining portfolio returns, it is interesting to see how beta (or index fund) portfolios compare to sophisticated institutional investors. Given its complexity, the Endowment Model is not a one-size-fits-all strategy, and is best suited for larger investment teams with considerable resources. For those institutions constrained by limited resources, using a balance of alternative assets and beta could achieve the best of both worlds.
While a US 60/40 continues to be a formidable benchmark to beat, it is not nearly as diversified for the modern needs of our global world. The Endowment Model is constantly evolving to find new sources of alpha, so don't count it out just yet.
However, a one size solution does not suit all investors, and even a well-designed beta portfolio of index funds could deliver alpha.
Whether building a first class Endowment Model portfolio or an index fund strategy, both risk and return expectations must be considered when hoping to achieve one's long-term investment goals.
This paper takes a close look at the performance differences between the Endowment Model and Public Pensions across various cycles. The lucrative illiquidity premium has generated superior returns for U.S. endowments versus U.S. public pensions, mainly during the 1990s internet bubble, and until the 2008 financial crisis. Smaller investors struggle to run an endowment portfolio, proof that a one size strategy does not fit all investors. Thus, the possible alternative option could be a well-designed index fund strategy that focuses on superior risk-adjusted returns and doesn’t have the same pitfalls that the endowment model inherently has.
Some alumni recently recommended placing half of Harvard’s endowment into the S&P 500. They have good intentions as they look to save on fees. They are also inspired by Warren Buffet winning his bet on the S&P 500 beating hedge funds over a 10 year period, and by the S&P 500 trouncing Harvard since 2008. Yet, investing now is chasing past performance.
Moreover, the S&P 500 would introduce much more risk into the mix, while substantially reducing diversification. And it assumes they can successfully time the markets, something even the best managers cannot consistently do. Instead, the Harvard community should give the current team time to transform the portfolio into a world class endowment once again.
Trusted Insight posted a second interview with Steve Edmundson, CIO of Public Employees' Retirement System of Nevada. I find inspiring parallels between NVPERS’ investment philosophy for their $38.5 billion pension, and my own strategy, the EndowBridge Legacy Strategy.
Some investment industry folks run endowment performance comparisons, and others perform public pension return comparisons. Here's an interesting comparison of returns of 20 of the largest US endowments to 20 of the largest US public pensions. I know it's an apples to oranges comparison, given the different mission/investment style of each investor group. However, they both were influenced historically by a 60/40 benchmark, and their investment styles have converged over time.
Investment manager performance is often initially ranked using returns, but equally important is how risky are those investment returns. Performance assessment is often time period dependent, and as such rolling periods of risk-return analysis could be helpful to see longer-term trends. Other metrics also should be considered, like to what degree could illiquidity and complexity affect an endowment portfolio during a financial crisis.
By now most endowment industry followers have read the articles detailing Yale endowment’s David Swensen’s response to the critics of fees, which was the subject of this Bloomberg article by Janet Lorin, and this article by Nir Kaissar.
The message in the article "Endowment Sweepstakes: How Tiny Houghton College Beat Harvard" supports the premise of the EndowBridge Legacy Strategy, that a well designed passive strategy of index funds can deliver superior results (than the traditional 60/40 mix) for smaller endowments and foundations.
In his article, Why Colleges Are Getting a 'C' in Investing, Mr. Lowenstein makes a comprehensive list of very thoughtful observations regarding the challenges faced by the modern endowment model. I would like to expand upon the subject of “unnecessary complexity,” cited as one of the reasons for poor endowment performance.
Lots of articles and books discuss backtested index-fund-based portfolios that try to replicate the fabled modern endowment model.
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