Vanguard Studies the Performance of College Endowments


Every Year, the National Association of College and University Business Officers (NACUBO) releases its study of the performance of college endowments. From the data in their press release, we created this chart showing that for the ten-year period ending 6/30/2013, endowments of different sizes underperformed IFA Index Portfolios of comparable risk.

Vanguard recently completed its own study of endowment performance based on the NACUBO study, and they concluded that, "Over the analysis period [25 years], the majority of endowments would have been better off had they simply invested in low-cost, diversified, transparent public mutual funds." The authors said "majority" rather than "all" because the largest endowments had substantially better performance than the small-to-medium size endowments. It is important to note that the large endowments, even though they control 72% of endowment assets, only represent 10% of the total number of endowments, as shown in the chart below.

The annualized returns of endowments based on size for the 25-year period ending 6/30/2013 are shown below.

One distinguishing attribute of large endowments is their sizable commitment to alternative asset classes such as private equity, hedge funds, venture capital, private real estate, energy, and natural resources. The bar chart below shows the stark difference in allocations to alternative investments.

From this data, one may think that the obvious next step for smaller endowments is to increase their allocation to alternative investments. Not so fast say the authors of the Vanguard study who point to three distinct advantages enjoyed by the large endowments.

First, they have a deep bench of in-house investment expertise. The average large endowment has a staff of ten credentialed professionals, and the largest endowments (e.g. Harvard and Yale) have twenty-five or more. These people are working solely for the benefit of the endowment and not for some investment consulting firm that has been hired by the endowment. 

Second, the large endowments have pricing power which allows them to negotiate fees with fund managers. Smaller endowments have to settle for being price-takers or relying on funds of hedge funds, which add on another layer of fees. The Vanguard authors cite the NACUBO study in saying that 95% of the alternative investments made by large endowments are placed directly with a manager while 47% of alternative investments made by smaller endowments are through a fund-of-funds structure.

Finally, the large endowments tend to have deep alumni networks that give them access to opportunities like initial public offerings or managers who are not accepting new investors but will make an exception for an Ivy League endowment. The large endowments have enjoyed the first-mover advantage when there were excess profits to be made in little-known strategies like convertible bond arbitrage. However, the more recent returns received in alternative investments indicate that these opportunities have largely evaporated.

All this explains why the father of the endowment model of investing, Yale University's David Swensen, has admonished* smaller investors (including other endowments) against attempting to replicate what he has done: "Unless an investor has access to incredibly high-qualified professionals, they should be 100% passive—that includes almost all individual investors and most institutional investors." We could not agree more.

*1/31/2012 - John C. Bogle Legacy Forum, Bloomberg BusinessWeek.