Reassessing University Endowments and Alternative Investments
Recent data from the National Association of College and University Business Officers (NACUBO) indicates that the average return on American endowments was 11.2% in the past year. While this figure seems commendable, it falls short of the returns from a traditional passive global equity and bond portfolio, which yielded slightly better results at 11.3% for 2024.
Analyzing the long-term performance, the average annual gain for the $874 billion in endowments reporting to NACUBO over the last decade is 6.8%. In contrast, a global portfolio composed of 70% equities and 30% bonds achieved a marginally higher return of 6.83%. This comparison particularly favors endowments due to their significant exposure to the US market during a period when American assets have performed exceptionally well. The Norwegian sovereign wealth fund, notable for its low management fee of just 4 basis points, has outperformed too, achieving a 7.3% return.
The Challenge of Alternative Investments
Investment consultant Richard Ennis has highlighted concerns regarding the sustainability of the alternative investment-heavy strategy, often referred to as the “Yale Model,” which was popularized by the late David Swensen. In his analysis, Ennis argues that alternative investments, or alts, carry excessive costs that diminish their attractiveness as a core component of institutional portfolios.
“Alternative investments bring extraordinary costs but ordinary returns —namely, those of the underlying equity and fixed income assets,” Ennis states, emphasizing the detrimental impact of such investments on institutional performance since the 2008 Global Financial Crisis (GFC).
Ennis’s research reveals that 65% of typical large endowments are allocated to alternative investments, including private equity and hedge funds, striving to replicate Swensen’s earlier success. Unfortunately, many have failed to achieve comparable results, with endowments underperforming public pension funds by an average of 143 basis points annually when adjusting for various risk factors.
Reasons for a Shift Away from Alternative Investments
Ennis articulates several critical reasons why the current trajectory of alternative investments is unsustainable:
- Failure to meet investment goals for many institutions, including insufficient returns to meet actuarial standards.
- Long-term underperformance compared to simple index strategies, leading to diminished fund values.
- Issues of liquidity, where reliance on private market investments hinders operational flexibility.
- Growing recognition among trustees of governance problems inherent in complex investment strategies.
- Emerging data showing superior performance from undergraduate investment clubs against elite university endowments.
- Increased pressure from regulatory requirements mandating full transparency in investment expenses.
- Acknowledgment by CIOs that certain alternative investments have consistently underperformed.
- Rising interest rates making leveraged investment strategies less viable.
- Institutional memory leading trustees to reconsider previous investment decisions.
- Concerns about excessive fees outweighing any perceived benefits from alternative investments.
- Trustees facing the stark reality of declining market values relative to reported net asset values (NAVs).
- The threat of lawsuits for fiduciary duty breaches due to poor investment choices.
- Potential backlash from taxpayers against public pensions, prompting shifts towards defined contribution plans.
The Future Landscape of Portfolio Management
Ennis suggests that the inevitable shift from alternative investments to more straightforward, low-cost portfolios will occur over the next 10 to 20 years. However, the institution of traditional investment practices can be resistant to change, often due to inertia in the financial sector.
This analysis brings to light the complexities of institutional investing and the potential pitfalls associated with heavy reliance on alternative strategies. As the financial landscape evolves, endowments may find themselves at a crossroads, needing to reassess their investment philosophies to adapt to new realities.
In conclusion, while endowments have historically pursued alternative investments, recent data and economic challenges suggest a reassessment may be necessary to ensure sustainability and meet the long-term goals of their stakeholders.
