Bogle vs. Goliath

Every year the National Association of College and University Business Officers (NACUBO) puts out a study on the investment performance of college endowment funds. It’s a comprehensive report that goes through the asset allocations and performance numbers of funds ranging from a few million dollars to funds with many billions of dollars (in the latest report there were over 800 funds in total).

Institutional investors are obsessed peer comparisons so they all eagerly await these performance numbers to see how they stacked up against the competition.

Here’s the latest batch through June 30, 2015:

In the hierarchy of institutional investors you won’t find a more competitive group than college endowments. They’re in constant competition with not only trying to beat the market, but also beat each other. It’s almost like a bizarre finance version of a heated college football or basketball rivalry.

Endowment funds are constantly looking for the best money managers — utilizing both the public and private markets — to find the best investment opportunities. They’re well-staffed and well-educated. They have access to the best and brightest minds in finance and are able to invest in funds that are reserved only for those with many millions of dollars. I decided to see how these endowment funds matched up with one of the simplest, low-cost portfolios out there today — the Vanguard Three Fund Portfolio.

For a total cost of just 0.19% (even less if you used the ETF versions of these mutual funds) you can put together a broadly diversified portfolio the John Bogle way. This portfolio consists of 40% in the Vanguard Total U.S. Stock Market Index Fund, 20% in the Vanguard Total International Stock Market Fund and 40% in the Vanguard Total Bond Market Fund (basically a traditional 60/40 fund). Here’s how the Bogle portfolio stacks up against the endowment funds over the past 5 and 10 years (1 and 3 years returns are mostly noise):

Vanguard beat the average over the past 5 years for every endowment size and came up just shy of the $1 billion and over group over 10 years while besting the rest of the group averages. Think about these results for a minute — these endowment funds hire the biggest investment consultants, have huge investment committees, connections with alumni at some of the best money managers in the world and fully-staffed investment offices in many cases. All that work, all of those due diligence trips, all of those extra fees paid to money managers and the majority of these funds still couldn’t beat a low-cost Vanguard index portfolio that was simply rebalanced once a year.

And that’s not to mention the risk that these funds tend to take in more private, highly levered, illiquid securities and fund structures. The Vanguard funds have full transparency, daily liquidity and employ no leverage, performance fees or lock-ups. It’s a far more operationally efficient portfolio with no headline risk to speak of.

A few thoughts on these numbers and what they may mean:

1. It’s becoming harder to outperform. The early adopters in many of the more illiquid alternative asset classes earned a huge first mover advantage in those markets and were paid handsomely as a result. Private equity, real assets and hedge funds are now extremely competitive with a late push from sovereign wealth funds, large pensions and the rest of the endowment and foundation community scouring these markets for investment opportunities. Premiums in these markets have all but vanished save for a handful of the top funds in each category.
2. These numbers show the average returns so there were obviously some endowments that outperformed. In the past these outperformers were basically same schools year in and year out. My guess is the competition and copycat nature of the industry means that, while there will still be certain funds that outperform, the roster will likely change from year to year and the amount of outperformance will compress versus historical averages. There’s an old saying that, “nothing fails on Wall Street like success.” The Yale Model may be a victim of its own success.
3. Passive investing has had a pretty nice run in the past few years. That could have some bearing on these numbers. Active management has struggled mightily, especially of the hedge fund variety, and endowments have a higher allocation to hedge funds than anyone. It’s possible there could be a reversal of this relationship at some point in the future, but time will tell how long that would last.
4. Costs and behavior matter. You don’t always get what you pay for in life and that’s more true in the financial markets than anywhere. The high fees that endowments are willing to pay their alternative money managers had to take a toll eventually. And when many of these funds failed them during the financial crisis, instead of changing course many simply doubled down and invested even more in the space. They lost in both directions.
5. These endowments would be much better off if they spent more time focusing on organizational alpha than trying to outperform their peers. A focus on governance — lowering costs, decreasing complexity, making better long-term decisions, documenting their investment process, defining their goals, focusing on asset allocation instead of money manager due diligence, matching their investments with their longer-than-average time horizons and ensuring they have enough liquidity to meet short- and intermediate-term spending needs — would pay better dividends than peer performance reviews.

There’s a ton of ego involved in the college endowment world. No one wants to admit that there’s a much simpler way to be better than average.

Source:
NACUBO Endowment Study

Further Reading:
Goals-Based Investing