Does multi-class investing boost performance for sophisticated investors such as educational endowments? In his June 2020 paper entitled “Endowment Performance and the Demise of the Multi-Asset-Class Model”, Richard Ennis examines recent performance of educational endowment funds, with focus on allocations to alternative assets. Using performance data from a report on 774 university endowments and from hand-collected annual reports for some large individual endowments during June 2008 through June 2019, he finds that:
- For all funds divided into six size categories, ranging from under $25 million to over $1 billion:
- Average allocations to alternative assets (including private equity) increase with endowment size from 7% to 51%.
- Annualized returns are in the range 5.2% to 5.9%.
- Annual alphas relative to benchmarks are in the range -1.1% to -1.8%.
- For a smaller hand-collected sample of 41 endowments with assets over $1 billion:
- Annual alphas range from 2.1% for MIT and 2.0% for Bowdoin to -3.1% for Harvard and -3.6% for Southern Methodist.
- Median annual alpha is -1.1%.
- Even endowments with alternative asset allocations of 70% or more exhibit 90%+ return correlations with a portfolio of stock and bond indexes only. In other words, alternative assets no longer diversify stocks and bonds.
- Annual fees and expenses for conventional (alternative) asset portfolios are in the range 0.5% to 0.7% (2% to 4%) of asset value. Assuming a cost of 0.6% for conventional assets and 2.5% for alternative asset, a portfolio with 50% allocation to alternative assets would incur annual cost 1.5% and have 97% probability of underperforming its benchmark over a decade.
In summary, evidence suggests that the multi-class investment approach used by educational endowments offers no diversification value and significantly underperforms a simple stocks-bonds portfolio over the last decade. More generally, diversification with high costs is a recipe for failure.
Cautions regarding findings include:
- An 11-year sample period is short in terms of variety of market conditions.
- Some assets available to large educational endowments are unavailable to many other investors.
For other research on endowment investing, see results of this search.
