Cheap funds that tracked the US stock market over the past decade outperformed the 60 leading US university endowments, a group of sophisticated institutions that have championed more costly alternative strategies as a way to enhance returns.
Many US universities have followed the example of Yale, whose chief investment officer David Swensen and senior director Dean Takahashi helped pioneer the “endowment model” where private equity managers and hedge funds play a larger role in an investment portfolio.
Several other institutional investors globally have drawn inspiration from the endowment model of US universities and raised their allocations to alternative assets to boost returns.
But none of the investment portfolios run by the eight Ivy League universities and 52 other endowments outperformed a basic US stock market tracker fund over the past decade, according to data from Charles Skorina, an Arizona-based consultant.
Vanguard’s VFIAX tracker fund, which offers exposure to 500 of the largest US-listed companies and costs 4 basis points a year, delivered annualised returns of 14.7 per cent net of fees over the 10 years ending June 30. Other trackers with low fees also had similar performance.
Over the same period, the top-performing US endowment Bowdoin, a private liberal arts college in Maine, delivered annualised returns of 12 per cent. Last place went to the endowment of Texas-based Southern Methodist University, which reported returns of 7.4 per cent.
Harvard, the largest endowment with assets of $40.9bn, ranked 50th after delivering returns of 8.5 per cent. Three of other Ivy League endowments — Princeton, Yale and Dartmouth — ranked in the top 10 for returns over the past decade.
The data have fuelled debate over whether endowments are receiving value for money from private equity strategies where a 2 per cent management fee and a 20 per cent performance fee is the norm.
“I’m paying a fortune in fees, commissions and carry [performance fees]. Why shouldn’t we just index and be done with the hassle,” said an endowment board member who declined to be named.
Simon Hallett, head of the European endowment and foundation practice at the consultancy Cambridge Associates, said US universities with higher allocations to private equity and venture capital tended to outperform those that favoured hedge funds over the past decade.
“Endowments have to deliver real [after inflation] returns of about 6.6 per cent to meet universities’ spending requirements and to avoid cuts to payouts. Private equity has been a ‘good trade’ for endowments in helping them meet their objectives, even if their 10-year returns look disappointing compared with the S&P 500,” said Mr Hallett.
Steven Kaplan, a professor at the University of Chicago Booth School of Business, said comparing endowments with US equity trackers over the past decade was unfair because it coincides with an unprecedented bull run for Wall Street.
A study by Mr Kaplan published this year concluded that US buyout funds run by private equity managers had generated additional returns of 350bp over the S&P 500 between 1986 and the end of the third quarter of 2018.
“US buyouts have historically outperformed the S&P 500 by a fairly wide margin,” said Mr Kaplan.
Ludovic Phalippou, professor of finance at Oxford Saïd Business School, said that although returns from public equities over the past decade have been boosted by the Federal Reserve’s quantitative easing, the policy has also helped private equity performance to “skyrocket”.
“QE has also favoured private equity big time, but unlike Vanguard, they captured it all in fees,” said Mr Phalippou.
A portfolio made up of 60 per cent in global equities and 40 per cent in bonds is an often-used benchmark for endowments. Vanguard’s LifeStrategy Moderate Growth fund, which is based on that portfolio and costs 13bp, has delivered annualised returns of 9 per cent, a level that 18 endowments, including Harvard and Cornell, failed to match.
Mr Skorina said a common benchmark for endowments was “really tricky” because each university has specific needs. “Some need a lot of money from the endowment each year but others do not. So that affects the return targets set by each endowment’s governing body,” he said.
Mr Skorina added that US colleges and universities are highly competitive. “Endowment board members and trustees at these schools look at their peers and say, ‘why aren’t we doing better? Look at what Seth Alexander at MIT and Paula Volent at Bowdoin are earning for their schools.’ Questions about the value of an investment office are becoming more widespread among endowment board members,” he said.
These questions are becoming more pressing due to mounting uncertainty over the outlook for private equity.
Private equity managers are paying record prices to secure deals and combining these investments with high levels of debt. They are also sitting on a record amount of unallocated capital, known as dry powder, which is close to $2.5tn, suggesting that profitable deals are becoming harder to find.
“In the past, realised returns from private equity buyouts have been lower when [unallocated] capital and [deal valuation] multiples have been high,” said Mr Kaplan.
These concerns were shared by Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, who said the “best days are behind” private equity managers.
“A decade of double-digit returns for private investment funds has ended. Current and future [private equity fund] vintages are likely to have annual returns below 10 per cent,” she added.
The debate about US universities’ endowment model and its large exposure to alternatives, particularly private equity, has a lot further to run.