Excellence Gone Missing

May 12, 2023 by Richard M. Ennis

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.


            For much of the 20th century, institutional investors, such as pension plans, endowments and nonprofits, held stocks, bonds and high-quality mortgages. Through the 1950s most investing was of the low-cost, buy-and-hold variety. Performance investing caught on in the 1960s, and fees began to rise. It was then that the novel, glossy Institutional Investor magazine appeared on the scene to chronicle the era. We read of glamour stocks, story stocks, and go-go mutual funds with their “gunslinger” managers, several of whom were named Fred (viz., Alger, Carr, Mates).[1] And there, institutional investing took on a zeitgeist of its own. We in the investment community believed that beating the market was a reasonable expectation for the hardworking analyst. No less a pillar of our profession than Ben Graham had assured us it was so.


            Modern capital theory began to make inroads in the 1970s. Practitioners learned how to describe and measure risk, and how to evaluate investment performance. Academics were advancing the efficient market hypothesis. They began reporting that mutual fund managers were not beating the market. In fact, they were not even covering their costs.[2]Some institutions began to use stock index funds in the 1980s as the reality of market efficiency and the erosion of value through investment expense became apparent. Then along came alternative investments.


            CIOs and consultants encouraged trustees to invest in private real estate equity, hedge funds, venture capital and leveraged buyouts as a surefire way to beat the market. The funds would profit from investing in less efficient areas via skillful managers. They would earn an illiquidity premium. And they would benefit from a diversification effect owing to lack of correlation between alternative investments and traditional assets. It worked for much of the 1990s and 2000s. During what I have described as the Golden Age of Alternative Investments (June 30 fiscal years 1994-2008), large endowments in the US outperformed indexing by more than four percentage points per year.[3] Trustees of all types of institutional funds bought in enthusiastically. To this end, many incorporated active investment strategies, such as hedge funds, as asset classes in their investment policy statements. In doing so, trustees entered the arena of investment strategy, forsaking their traditional role of merely setting risk and liquidity parameters for asset managers. For many funds today, it is difficult to know where traditional investment policymaking (trustee work) leaves off and active investing (manager work) takes up. As this occurred, the accountability for performance became muddied.[4]


            Money was channeled from vast public markets into much smaller private ones and into hedge funds, the latter with comparatively small proven capacity.[5] Private markets became more competitive and better integrated with public ones. Diversified portfolios of alternative investments began behaving like combinations of stocks and bonds.[6] It became apparent that what had been hailed as diversifying asset classes were in fact pseudo asset classes, mostly representing different flavors of equity with returns smoothed by stale pricing.[7] As this became apparent, the allocation architecture of the so-called endowment model, with its reliance on uncorrelated assets, was called into question.[8]Hedge funds lost their edge as assets under management swelled.[9] Private market real estate began to underperform conspicuously under the burden of high cost.[10] And while private equity remained a competitive (if controversial) area of investment, the experience there was nothing like it had been prior to the Global Financial Crisis of 2008 (GFC).[11]The GFC marked the end of the salad days of alternative investing. 


            Even as alternative investments, or alts, began to lose their luster, they still cost about 10 times as much as traditional stock and bond strategies.[12] And institutions continued to hold plenty of them. Alts now account for about 60% of the assets of large endowments and 30% of those of large public pension funds.[13] The annual cost of managing public pension funds typically runs 1% or more of asset value.[14] For endowments the figure is more than 2% a year owing to their much heavier reliance on pricey alts.[15] Not all that long ago, spending this much on the management of fiduciary funds would have been unthinkable. In the wake of the GFC, institutional investors began to underperform by the full margin of their very substantial costs.[16] And through it all, markets became ever more efficient as extraordinary technology and resources were brought to bear in the effort to exploit mispricing wherever it might exist.[17]


            The crux of the problem is inefficient diversification. Large institutions use scores of active managers and partnerships, with each representing a diversified portfolio in its own right. Oof! Offsetting active bets, not uncorrelated asset classes, are the diversifying influence at work. This violates the First Law of Active Management: Do not use active managers to diversify. Losers cancel out winners, and you are left with the return of market exposures, minus cost. Doing this is a recipe for failure![18] And the failure of institutional investing today is writ large, as it was in 1975 when Charley Ellis dubbed stock portfolio management a loser’s game.[19] I estimate the collective waste is in excess of $100 billion a year. Stakeholders of these institutions — taxpayers, pension beneficiaries, current and future scholars, philanthropies, and shareholders — are in no position to appreciate all this. Nor do they have a say in the management of the funds. Many of the fiduciaries responsible for day-to-day management of these funds are subject to serious agency conflicts.[20]Others, trustees in particular, appear to be blissfully ignorant re this state of affairs.


            Poor performance since the GFC has largely been obscured. It has become the norm for institutional investors to use performance benchmarks of their own devising rather than comparing themselves to passive-management benchmarks, as theory and common sense dictate. These “custom” benchmarks are opaque and hypothetical, and do not represent any investment reality that might have been. Custom benchmarks, in the main, exhibit a downward return bias of about 1.5 percentage points a year compared to proper (passive) ones.[21] Biased benchmarks paint a rosy picture of active management where, in fact, a generally bleak one exists, with most funds underperforming indexing by a wide margin. Institutional CIOs get bonuses for outperforming slow benchmarks they have a hand in creating. This is a failing of the governance of institutional investing that must be rectified.[22]


            While institutional investors chase alpha, individuals largely appear to have wised up. Mutual fund investors now have more than half their assets in index funds.[23] Their expenditure for equity funds fell by more than half between 1996 and 2020, from 1.04% to 0.50% of asset value.[24] The main difference between individual investors and institutional managers is, of course, that the former are managing their own money while the institutions are managing the money of absent others—about $10 trillion of it in the US alone.


            Missing from institutional investing today is excellence. Complexity and supposed sophistication abound. But these are not the same as excellence. As relates to excellence, most institutional investors today underperform passive management by 1 to 2 percentage points a year. They rely on dubious asset allocation architecture predicated on mythically “uncorrelated” asset classes to justify large commitments to alts. They invest in countless active management strategies to their detriment. They run against their own slow rabbits. Missing, too, it seems to me, is the spirit of stewardship. None of this reflects well on our profession.


            Institutional investors have two paths to excellence. One is to engineer consummately efficient passive investment portfolios that operate at next to no cost. The $1.3 trillion sovereign wealth fund of Norway is an exemplar of this strategy.[25] Any institution can do this with expert help, and it would be a fine accomplishment for any that did. Institutions just need to start looking for the right kind of help. The other path is to get serious about active investing. This means using vastly fewer investment managers along with enough indexing for efficient diversification. Among those with an activist bent, there would be losers, of course. But overall, with institutional investors taking one of these two paths, stakeholders would get a much better deal. And taking it all in, we devotees of the art and science of investment management would have plenty of excellence to celebrate.





I appreciate the helpful comments of Brian Bruce, Elroy Dimson, Charles Ellis, Barry Gillman, Antti Ilmanen, Jeffrey McCurdy, Joseph Pagliari, William Sharpe and Rodney Sullivan.





Bollinger, M. A., & Pagliari, J. L. (2019). “Another Look at Private Real Estate Returns by Strategy.” Journal of Portfolio Management, 45(7), 95–112.


Center for Retirement Research, Boston College. 2023. “Public Plans Data.” https://publicplansdata.org.


Chambers, D., E. Dimson, A. Ilmanen. 2012. “The Norway Model.” Journal of Portfolio Management, 38 (2) 67-81.


Ellis, C.D. 1975. “The Loser’s Game.” Financial Analysts Journal, Volume 31, Issue 4, pp. 19-26.


Ennis, R.M. 2020. “Institutional Investment Strategy and Manager Choice: A Critique.” Journal of Portfolio Management (Fund Manager Selection Issue): 104-117.


——. 2021a. “Endowment Performance.” The Journal of Investing,” 30 (3) 6-20.

—— . 2021b. “Failure of the Endowment Model.” Journal of Portfolio Management 47 (5): 128–143.


——. 2022a. “Cost, Performance and Benchmark Bias of Public Pension Funds: An Unflattering Portrait.” Journal of Portfolio Management, April, 48 (5) 138-150.


____ . 2022b. “Cutting through the Fog of Asset Class Labels.” The Journal of Investing, 31 (2) 6-10.


____. 2022c. “Overexposed? Public Pension Funds Have a Lot Riding on the U.S. Stock Market, Possibly Even More Than They Realize.” The Journal of Investing.


——. 2022d. “The Modern Endowment Story: A Ubiquitous Equity Factor.” Journal of Portfolio Management, November.


——. 2023a. “Lies, Damn Lies, and Benchmarks: An Injunction for Trustees.” The Journal of Investing, forthcoming. Available at SSRN: https://ssrn.com/abstract=4253186.


——. 2023b. “Disentangling Investment Policy and Investment Strategy

for Better Governance.” Forthcoming in The Journal of Investing. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4317131.


Grinold, R.C. 1989. “The Fundamental Law of Active Management.” Journal of Portfolio Management, 15, 30-37.


Huang, D. 2022. “Passive Investing, Mutual Fund Skill, and Market Efficiency.” SSRN: https://ssrn.com/abstract=4190266.


Ilmanen, A., S. Chandra, and N. McQuinn. 2020. “Demystifying Illiquid Assets: Expected Returns for Private Equity.” The Journal of Alternative Investments 22 (3): 8–22.


Investment Company Institute. 2021 “Mutual Fund Expense Ratios Have Declined Substantially over the Past 24 Years.” https://www.ici.org/news-release/21_news_trends.


Jensen, M.C. 1967. “The Performance of Mutual Funds in the Period 1945-1964,” Journal of Finance, Vol. 23, No. 2.


L’Her, J.-F., R. Stoyanova, K. Shaw, W. Scott and C. Lai. 2016. “A Bottom-Up Approach to the Risk-Adjusted Performance of the Buyout Fund Market,” Financial Analysts Journal, July-August.


National Association of College and University Business Officers (NACUBO). 2023. “2022 NACUBO-TIAA Study of Endowments (NTSE), Public Tables.” https://www.nacubo.org/Research/2022/Public-NTSE-Tables


Phalippou, L. 2018. Private Equity Laid Bare. Kindle.


Sharpe, W.F. 1966. “Mutual fund performance.” The Journal of Business, 39, 119-138.


Sullivan, R.N. 2020. “Hedge Fund Alpha: Cycle or Sunset?” The Journal of Alternative Investments.


Swedroe, L.E. And A.L. Berkin. 2020. The Incredible Shrinking Alpha: How to Be a Successful Investor Without Picking Winners. Harriman House.

[1] The latter fact led a future critic of the era to attribute its excesses to “too many Freds.”

[2] See Sharpe (1966) and Jensen (1967).

[3] See Ennis (2021a).

[4] See Ennis (2023b).

[5] See Sullivan (2020).

[6] See Ennis (2020).

[7] See Ennis (2022c and 2022d).

[8] See Ennis (2021b).

[9] See Sullivan (2020).

[10] See Bollinger and Pagliari (2019).

[11] See L’Her et al. (2016), Phalippou (2018, Chapter 11) and Ilmanen et al. (2020).

[12] See Ennis (2022a).

[13] See NACUBO (2023) and Center for Retirement Research (2023).

[14] See Ennis (2022a).

[15] See Ennis (2022d).

[16] See Ennis (2020).

[17] See Swedroe and Berkin (2020) and Huang (2022).

[18] The First Law of Active Management (my coinage) is not to be confused with the more esoteric Fundamental Law of Active Management (Grinold, 1989).

[19] See Ellis (1975).

[20] See Ennis (2023a).

[21] See Ennis (2023a).

[22] See Ennis (2023b).

[23] See Huang (2022).

[24] See Investment Company Institute (2021).

[25] See Chambers, Dimson and Ilmanen (2012).