Endowment Returns in Context

In a recent report from the National Association of College and University Business Officers (NACUBO), it was revealed that the average return for American endowments was 11.2% for the past year. While this figure may initially seem impressive, it falls short when compared to the performance of a standard global 70/30 equity-bond portfolio, which yielded better results in the same timeframe.

Moreover, when examining a longer time horizon, endowments—valued collectively at $874 billion—have posted an average annual return of only 6.8% over the past decade. In contrast, the same 70/30 portfolio achieved a slightly higher average return of 6.83%, presenting a challenge to the effectiveness of endowment management strategies which often lean heavily into alternative investments.

The Limitations of Alternative Investments

Investment consultant Richard Ennis has voiced concerns regarding the sustainability of alternative investments within institutional portfolios. His research critiques the Yale Model, a strategy popularized by the late David Swensen that advocates for a heavy allocation to alternatives, such as private equity and hedge funds.

“Alternative investments, or alts, cost too much to be a fixture of institutional investing. A diverse portfolio of alts costs at least 3% to 4% of asset value annually,” Ennis notes.

These investments often provide meager returns compared to their exorbitant costs, particularly post-Global Financial Crisis (GFC) of 2008, leading to significant underperformance for many institutional investors. Ennis’s analysis indicates that large endowments in particular have struggled to match the performance of traditional pension funds, underperforming by approximately 143 basis points annually.

Market Dynamics and Changing Strategies

Ennis identifies a fundamental shift in the landscape of alternative investments, suggesting that prior success in this asset class has given way to challenges due to increased competition and asset crowding. The influx of capital into alternatives has diluted potential returns while maintaining high management fees, leading to a decreased likelihood of enduring value creation.

The very investor enthusiasm that drove returns prior to the GFC began transforming the markets generating those returns,” Ennis explained.

Despite the widespread adoption of the Yale Model among endowments, many have failed to replicate the historical successes associated with it. Ennis argues that this could lead to a reevaluation of such strategies, particularly as cost pressures mount and performance expectations are unmet.

Challenges Ahead for Endowment Management

Ennis presents several compelling reasons why the current paradigm of alternative-heavy investment strategies may be nearing a tipping point:

• Many endowments have not met their stated investment goals.
• Performance relative to low-cost indexing strategies has substantially declined.
• Liquidity concerns are growing, as institutions increasingly borrow against their portfolios.
• Trustees are becoming more aware of agency issues and may recalibrate compensation structures based on genuine performance metrics.
• Increased transparency in investment costs is prompting scrutiny among trustees.
• Market pressures and changing interest rates may expose vulnerabilities in alternative investment frameworks.

Looking Forward

While Ennis speculates that the decline in popularity of alternative investments could occur over the next decade, he notes that momentum is often slow to shift within established financial practices. The resistance to change underscores a broader challenge within finance: the tendency to cling to traditional methods even in the face of emerging evidence.

In conclusion, the data indicates that institutional investors, particularly large endowments, face a critical crossroads regarding their investment strategies. As benchmarks evolve and more institutions examine their costs and performance, a potential shift toward lower-cost, index-based portfolios may usher in a new era of institutional investing.