Research on Endowment Performance in Alternatives

What are the elements of an endowment style of investing?

We have become accustomed to hearing and reading of “the endowment model.” There is, in fact, no canonical model for managing endowment funds. There are, however, certain recurring investment themes often associated with their management. We refer to these themes a bit more modestly as elements of endowment style. They include:

Active Management. The ability of endowed institutions to identify and exploit investment skill is an overarching theme among endowments, which make little use of passive investments (14% of assets in 2018, according to Greenwich Associates). Their willingness to pay for perceived skill is exemplified by their large commitments to hedge funds and private equity, for example.

Equity Orientation. The belief that equity investments, broadly speaking, should predominate portfolio holdings is widespread among endowment managers. That said, equity exposure varies among institutions, largely based on the size of their portfolios. Large funds maintain an average effective equity exposure of 72%, with figures of 80% or more being not uncommon. Small funds average 63% (particulars follow).

Private Markets. Private markets are a central focus of many endowment managers and their advisors. They are viewed as riper for exploitation by skillful investors as well as being a source of diversification. Along with hedge funds, private investments form the core of what are commonly known as alternative investments, or “alts.” Larger endowments avail themselves of private market opportunities and other alts to a greater extent than do the smaller ones.

Value Over Growth. Some observers believe there is, or at least has been in the not-so-distant past, a bias in favor of value stocks over growth on the part of many endowments. Any such bias may have lessened as a result of the underperformance of value relative to growth during the last decade or so.

The endowment style of investing produced superior results in the 1990s and early years of this century, so much so that it has become a subject of enduring interest among investors around the world.

Endowment Performance

Investing in alternatives is not what it used to be twenty years ago.

In an interview with Institutional Investor, [EnnisKnup co-founder Richard] Ennis explained that alternatives have changed considerably since endowments and others first plowed into them en masse in the early 2000s.

“Tremendous amounts of money flowed into what were once tiny markets — $100 billion in hedge funds, $100 billion in private equity,” he said. “Now that’s about $3 trillion. Twenty five years ago, they were doing 50 LBO [leveraged buy-out] deals a year. Now 3,000 LBOs are done a year.”

When less liquid areas like private equity become what Ennis called “liquified,” asset prices behave more like those in public markets. “That’s why the diversification effect disappears,” he said. “The markets become more efficient and what you wind up with is alpha” — risk-adjusted returns over a benchmark — “that is equal to your costs.”

Are Alternatives Bad for Endowments?, Institutional Investor

Studying inside the Rose Main Reading Room at the New York Public Library.
Photo by Robert Bye on Unsplash

Post by Marcelino Pantoja