Say What?!

Universities that routinely spend 5 percent of their endowment assets per year or more have learned that doing so during periods of poor market performance can have serious implications later on, similar to the “sequence risk” faced by retirees taking systematic withdrawals from investment portfolios. Less than stellar portfolio returns over the past decade have thus created some very difficult issues for these endowments, especially those unwilling or unable to curb spending.   

William Jarvis, Managing Director of the Commonfund Institute (which sets out to support endowments with respect to their investments), argues that being an endowment fiduciary in this environment requires active management. Really.

The role of the fiduciary is to think in the longest terms – intergenerationally at the least, in perpetuity if possible – on behalf of yet-unborn generations of beneficiaries.

Pure indexation represents an abdication of that responsibility, given that reasonable means exist to obtain access to managers who can diversify the portfolio and enhance risk-adjusted performance over time. It is not active management but rather the siren song of indexation that leads, over the long term, to underperformance. A better way exists, for those thoughtful fiduciaries who choose to take that path.

Given the factual context, that’s an astonishing claim.  As a reminder, consider the following.

1. As Charley Ellis has pointed out, “research on the performance of institutional portfolios shows that after risk adjustment, 24% of funds fall significantly short of their chosen market benchmark and have negative alpha, 75% of funds roughly match the market and have zero alpha, and well under 1% achieve superior results after costs — a number not statistically significantly different from zero.”
2. The institutional subset of endowments doesn’t do any better. On November 6, preliminary data was released concerning endowment performance for the fiscal year ending June 30, 2013, during which endowments averaged 11.7 percent return. Over that same period, the S&P 500 gained 23.42 percent. Over the ten years ended June 30, 2013, endowments averaged 7.1 percent per annum, as compared with 7.17 percent for the S&P 500. Moreover, until this past year, more than 90 percent of endowments with less than $1 billion in assets underperformed in every time period since such records have been kept. Zero alpha there, at best.
3. The bloom is off the hedge fund rose too. The HFRX Global Hedge Fund Index gained just 3.5 percent in 2012 and has returned just 1.7 percent per annum over the past 10 years. The S&P 500 has outperformed the HFRX for ten straight years, with the exception of 2008 when both fell sharply. More significantly, a standard 60/40 portfolio has delivered returns of more than 90 percent over that same period compared with a meager 17 percent after fees for hedge funds. That’s negative alpha.

In other words, according to Mr. Jarvis, it is imperative as a matter of fiduciary duty for endowments to keep doing what, in the aggregate, endowments have been unable to do and what hasn’t been working for decades. Einstein may not have actually made the claim, but it is insane to keep doing the same thing repeatedly and expecting different results. Rather than following Mr. Jarvis, most endowments would be wise to follow the advice of Yale’s David Swensen, the intellectual talisman of endowment investing:  those without Yale’s access and expertise shouldn’t try to emulate its investment strategies.