The Endowment Syndrome: Why Elite Funds Are Falling Behind
Are Institutional Investors Meeting Their Goals? Spotlight on Earnings Objectives
Elusive Alpha, Corrosive Cost
Hedge Funds: A Poor Choice for Most Long-Term Investors
The Long-Run Performance of Public Pension Funds in the US
How Hidden Costs Undermine Public Pensions in the US
Public pension plans in the US incur exorbitant asset management costs. Most spend a lot and get nothing for it. High cost has hindered efforts to realize their actuarial return requirement. It has resulted in poor performance pretty much across the board. And yet, very few plans provide a full accounting of the costs they incur. Some still fail to net all their investment expenses from the returns they report. High cost is the Achilles heel of the public pension system in the US. It’s time to bring costs down, way down.
Unexceptional Endowment Performance
Second-Guessing CalSTRS on Investment Strategy: A Case Study
“CalSTRS to Weigh New Opportunistic Sleeve,
Eliminates 55% Limit on Private Assets”
So goes the headline of a recent article in Pensions & Investments, the industry newspaper for institutional investors. The article describes a proposed new allocation of up to 5% of fund assets. P&I reports, “The new portfolio would give CalSTRS flexibility ‘to identify, research and incubate new and compelling strategies’ that may fall beyond existing asset classes because of their structure, their benchmark or their thematic focus.” [1]
California State Teachers Retirement System (CalSTRS), with $319 billion in assets at June 30 of 2023, has long been an investor in alternative asset types. Its allocation to alternatives rose from about 10% of assets in 2001 to about 44% in 2023. The recent alts figure compares to an average of 34% for large public pension funds in the US. Upon reading the P&I article, I decided to explore the merit of CalSTRS’s proposed strategic shift, which is likely to place even greater emphasis on controversial alternative asset types.[2]&a
Hogwarts Finance
CIOs and consultant-advisors oversee about $10 trillion of institutional assets in the US. They have underperformed passive management by one to two percentage points a year since the Global Financial Crisis of 2008 (GFC).[1] They rely heavily on expensive alternative investments; and the more they have in alternatives, the worse they do.[2] Large institutions use scores of managers, making them high-cost closet indexers. Inefficiency abounds.
What is lacking in institutional fund management today? Intellectual rigor, for one thing. The professionals are ignoring their canon. Lawyers coming before the bar are expected to know the law. Physicians, conspicuously, in my experience, attempt to adhere to the best medical science. Engineers do not improvise when designing bridges. But the people managing institutional assets behave not like they attended the Booth, Säid or Wharton schools to study finance but Hogwarts School of Witchcraft and Wizardry.
[1] I estimate public pension funds have underperformed passive management by 1.2 percentage points per year since the GFC. The figure for large endowments is at least 2.2 percentage points. See Ennis (2022a).
Endowments in the Casino: Even the Whales Lose at the Alts Table
The alternative investments of college and university endowments have detracted from the schools’ performance across the board since the Global Financial Crisis of 2008. Large endowments—ones with greater than $1 billion in assets—appear to have handled their alternative investing better than the smaller ones. But whatever skill the big ones might bring to bear has not been enough to make them winners with these controversial investments.
Have Alternative Investments Helped or Hurt?
Despite all the attention paid to alternative investments in recent years, there has been little study of their impact on the performance of institutional investment portfolios, e.g., those of pension plans and endowed institutions. This paper attempts to help fill the void. It shows that, since the Global Financial Crisis of 2008, US public-sector pension funds realized a negative alpha of approximately 1.2% per year, virtually all of which is associated with their exposure to alternative investments. While exposure to private equity neither helped nor hurt, both real estate and hedge fund exposures detracted significantly from performance. Institutional investors should consider whether continuing to invest in alternatives warrants the time, expense and reduced liquidity associated with them.
Excellence Gone Missing
Managers of institutional portfolios have long been seen as among the elite in the investment field. They typically possess advanced degrees and/or other professional credentials. They are fiduciaries for the largest and most complex investment portfolios on the planet. Many are paid fabulously. In terms of the collective merit of their work, however, I see room for improvement. Indeed, I question the excellence of much of institutional investing as it is practiced today.
Disentangling Investment Policy and Investment Strategy for Better Governance
An Open Letter to Investment Consultants
Lies, Damn Lies and Benchmarks: An Injunction for Trustees
A Universal Investment Portfolio for Public Pension Funds: Making the Most of Our Herding Ways
Are Endowment Managers Better Than the Rest?
- I compare five aspects of investing large educational endowments and public employee pension funds: (1) operating environment and culture, (2) institutional characteristics, (3) expense ratio, (4) risk habitat and (5) risk-adjusted performance.
- The most significant measurable differences between the two types of investing institutions are: (1) the amount they spend on investment management and (2) the degree of risk they take. In terms of risk-adjusted performance, endowments have underperformed public funds for the 13 years ending June 30, 2021.
- There is no evidence that endowment managers have an edge over public fund managers of a type or magnitude that might translate to a performance advantage.
The Modern Endowment Story: A Ubiquitous United States Equity Factor
The endowment model, presumed to be a paradigm of value-adding asset class diversification, is a thing of the past. Large educational endowment funds in the United States have heavily concentrated their investments—public and private—in ones that are moderately to highly correlated with the Russell 3000 Index. I estimate that large endowments have underperformed by 2.24% to 2.5% per year over the 13 years ending June 30, 2021. I estimate that their annual cost of investing is approximately 2.5% of asset value. Given the extreme diversification of the composite, which comprises more than 100 large endowment funds with an average of more than 100 investment managers each, there is every reason to believe that cost is the principal cause of endowments’ poor performance. During the most recent 5–7 years, which I refer to as the Modern Era, endowments have exhibited an effective US equity exposure of 97% of asset value, with frictional cash accounting for 3%. The overwhelming exposure to the US equity market raises important strategic questions related to risk tolerance and diversification for trustees and fund managers.
The Fairy Tale of Alternative Investing
Advocates of alternative investments, such as private equity, real estate and hedge funds, ascribe various benefits to alts. These include volatility dampening, little or no correlation with stocks and bonds, and powerful diversifying effects. Some say that it is alts’ supposed defensive character that has prevented them from keeping up with stocks and bonds during the bull market following the Global Financial Crisis of 2008, and that there is reason to believe alts will be particularly good performers in the event stocks experience a bear market. None of these claims stands up to critical analysis.
Cost, Performance, and Benchmark Bias of Public Pension Funds in the United States: An Unflattering Portrait
