Outsmarting the Ivy League?

Each year, the National Association of College and University Business Officers and Common Fund Institute produce a study on the returns of college endowments.[1]  This study tracks the results of University investment portfolios by size of their endowments.  Of the schools participating in the study in 2016, more than 93 had endowment assets exceeding $1-billion.² Schools such as Harvard, Yale, Stanford, Princeton and Notre Dame all have endowments over $1-billion and their returns were contributed to the study.

Obviously, the Universities with endowments over $1 billion have many resources, alumni, faculty and trustees to help them guide their investment decisions.  It is probably also safe to assume they employ the most-esteemed consultants, money managers and portfolio strategists that money can buy.

One would then guess that those institutions should be outperforming the market on a relative basis if they have all of the best and smartest resources at their disposal.  However, it turns out that is not the case.

Consider these returns for all Universities with endowments over $1 billion:

These returns are pretty decent, all things considered.  However, for comparison purposes, here are the indices for those periods as well.

While at face value it is hard to compare one asset class to a diversified portfolio, if we extrapolate a weighting to each index we can show what a blended portfolio of indices would have done against a blended portfolio of endowments.

To come up with a relative portfolio blend, let’s assume a 75% equity and 25% bond portfolio.  Of that, let’s assume approximately 25% of the equity component is international.  So, a blended index portfolio we could assume would consist of 55% Russell 3000 (US Broad Market), 20% MSCI World ex U.S., and 25% Barclays US Aggregate Bond.  This hypothetical allocation would not be unreasonable for funds with a very long-term time horizon looking to grow.  In contrast, the group of endowment over $1 billion carried a 13% US equity, 10% bond, 19% international equity, and 58% alternative asset allocation.  Alternative assets is a very broad space, but generally consists of hedge funds, private equity funds, private real estate and other assets such as art.  If we compare these returns we get the following:

So in three of the four time periods, the blended index won and in the longer 10 year figure, it was a dead heat.  I always say that if you show me portfolio returns for anything, I can mix and match a portfolio that will beat it with the ability of hindsight.  We did not do that, in this instance.  We carried a slightly higher weight to international equities, which had a dismal 10 years and also carried more bonds in the allocation, which carry lower degrees of risk than equities (and thus lower expected returns).

This is not a complex portfolio, but one we all could replicate because of the advent of index funds.  You can bet, however, if someone would have walked into Yale’s investment committee with a straight forward 55% US equities, 20% International equities, and 25% blended bond allocation proposal, they would have been laughed out of the room.  Does that mean the advice would have been wrong?  Using simple, diversified, low-cost investments and taking the time to control what you can.  Controlling behavior, allocation, goals, and taxes in the context of a financial plan isn’t bad advice, it is just not complex.

The truth of the matter is the market does not care how smart you are, how many initials you have behind your name, or how much money you have to invest. The capital markets deal in absolutes.  Adding complexity doesn’t necessarily increase returns as we see in this comparison.  Keep in mind, the more complex something is the higher degrees of monitoring, understanding, costs, and potential tax implications there may be.  These institutions have some of the brightest minds in finance on their committees overseeing those complexities and an organizational framework to monitor.  While they search out complexity, I think it is our goal to make the complex simpler.  We all still need to plan, monitor, and understand, but it all doesn’t have to be uber-complex to generate return.  We’ll see what the next 10 years brings, but don’t make the mistake of assuming complex is always better.

¹ http://www.nacubo.org/Documents/EndowmentFiles/2016-NCSE-Public-Tables_Average-One-Three-Five-and-Ten-Year-Returns.pdf

² http://www.nacubo.org/Documents/EndowmentFiles/2016-Endowment-Market-Values.pdf

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