A Bad Year for Institutional Investors
Three Eras of Endowment Performance Between 1974 and 2019
In a follow-up paper (also included below) to the Endowment Performance paper, I provide further insights into the performance of educational endowment funds by extending the analysis going back to 1974. I find:
- Three distinct eras define endowment fund performance since 1974. The first was when they held predominantly stocks and bonds. The second era witnessed spectacular performance from alternative investments. The final era, post-GFC, was one in which alternative investments became a source of deadweight diversification.
- Large funds underperformed by the approximate margin of their costs in the first and third eras. In the middle era, they outperformed by a wide margin. Over the full period, large endowment fund managers, collectively, added value for their institutions.
- Small endowment funds underperformed over the three eras. These assets should be managed passively at next to no cost.
- Endowment funds in the U.S. consistently underperform passive investment across cohorts of fund size. Significant underperformance is also observed in cross-sectional analysis of the returns of the largest individual endowment funds.
- Alternative investments have failed to provide diversification benefits post-GFC and have been a drag on endowment performance.
- Given prevailing diversification patterns, endowments’ investment expenditures of 1-2% of asset value simply overwhelm the opportunity to exploit asset mispricing.
Institutional Investment Strategy and Manager Choice: A Critique
- Large public pension funds underperformed passive investment by 1.0% per year in the decade ended June 30, 2018. The underperformance of large educational endowments was of 1.6% per year.
- The margins of underperformance closely approximate the respective (independently derived) cost of investment for the two fund types.
- Alternative investments ceased to be the diversifiers they once were and became a significant drag on institutional fund performance.
- Public pension funds are high-cost closet-indexers. The vast majority will inevitably underperform in the years ahead
Signature EnnisKnupp Advisory Themes
How to Sell Services
Big Bond Bust
The Uncorrelated Return Myth
The following article was originally published in Financial Analysts Journal, May/June 2009, Vol. 65, No. 3:6-10a.