Blindly shoving all your money into Vanguard ETFs is a strategy that works well for almost every individual who's retirement period maxes out at 70 years (for the MMM types).
An endowment is a fund of money designed to sustain operations of it's benefactor forever. Not 10 years. Not 50 years. Literally forever. When you're operating on an indefinite timescale your idea of "risk" changes considerably.
Take a look at the Harvard Endowment report[1], specifically the table on page 2. They are incredibly well diversified, across domestic and international public equities, as well as private equity, commodities, fixed income securities (bonds, etc), real estate, and a category they call "absolute return", which is where they've placed money into external hedge funds. If the US economy tanks, they'll be fine. If Europe falls apart, they'll be fine. A bunch of start up unicorns fail in Silicon Valley? Fine.
My point is that the article completely misses the goals of an endowment. They don't particularly care about matching or beating an index, nor do they care about risk (as measured by volatility). They care about wipe out risk, on the scale of centuries.
Endowments also worry about mapping their endowment to potential future costs or liabilities:
1) When the economy is bad, they need to provide more financial aid, so they want some counter-cyclical assets. (Long term bonds who increase in value when rates decline are an example.)
2) If they want to expand in the future, they don't want to be priced out of their neighborhood, so they're more likely to invest in local real estate.
This doesn't mean that endowments are all optimally managed - many would still be better served with ETFs. It's just not as simple as tossing everything into the S&P500.
> They are incredibly well diversified, across domestic and international public equities, as well as private equity, commodities, fixed income securities (bonds, etc), real estate, and a category they call "absolute return", which is where they've placed money into external hedge funds. If the US economy tanks, they'll be fine. If Europe falls apart, they'll be fine. A bunch of start up unicorns fail in Silicon Valley? Fine.
This does not appear to be true. See page 14 of this paper, which shows the 2008-2009 performance of six privately endowed colleges and universities in New England. The smallest loss was 18%, the largest was 30%. Between January 1, 2008, when the S&P500 was at 1,378.76, and January 1, 2009, when the S&P500 was at 868.58, the S&P500 lost 37%. A reasonable mix of stocks and bonds would have had a similar loss as the endowments.
Right, in 2008 when the entire economy tanked they also tanked. You can't really out-diversify the entire economy tanking. What happened in the years after that? Oh right that paper has no idea because it was last updated in 2010.
You can't really out-diversify the entire economy tanking.
Sometimes you can. Chart [1] shows the ratio of a particular diversified portfolio's value (4x25 Permanent Portfolio) to the three fund portfolio's value starting in 2005. The ratio increases sharply in 2008-2009 and retains its edge through the subsequent stock bull market.
The major point of OPs statement is that while sometimes you can get lucky for a short period of time (which is what you just cherrypicked), for an endowment you can't really do stuff like that because you are so big and have such a long term perspective. Regardless, I'm not seeing the narrative you describe in your graph.
I agree with the OP's point, but you mentioned 2008 and what happens after that and I'm saying you can diversify in a way that handles those kinds of economic events. (The strategy I mentioned also got really lucky in the 70s and held up cumulatively since then. Of course you can make it unlucky by picking different dates, too e.g. ignore the 70s or 2001 or 2008.)
The chart page doesn't explain things very well, so it takes a bit to unpack, but the point of the chart is actually to give a better idea of comparative performance over a time period rather than focusing on a particular number like average return. Basically it's dividing the current value of one portfolio by the other at each point. The ratio shows the ebb and flow of the two portfolios against each other. John Bogle's speech [1] and this forum [2] probably explain it better.
Right, I completely agree with you. You can't really out-diversify the entire economy tanking.
But GP's claim seemed (to me) to be that that's exactly what university endowments do (or attempt to do). GP claimed that universities aren't looking for return or low volatility, they're looking to 'be fine' when the economy tanks. To check whether they succeeded, I looked at university endowment performance during a period when the economy tanked, and found that they still didn't do any better than an average index fund investor would have.
>If the US economy tanks, they'll be fine. If Europe falls apart, they'll be fine. A bunch of start up unicorns fail in Silicon Valley? Fine.
I think you're probably unfamiliar with the Harvard endowment's performance over time. They were badly hosed during the recession, despite their diversification.
> They care about wipe out risk, on the scale of centuries.
Perhaps they should, but they don't. They could easily put all their money in TIPS, after all.
The various college endowments are quite competitive with one another, with all the risk taking that implies. It's very silly.
I wonder how much of the difference between the "bogle" portfolio and the endowment portfolios can be explained by simply adding Real Asset beta and Alternative beta?
I don't see how these facts are relevant to my statements. Every endowment gets massive donations. Harvard hires very smart people to run their money and they are not beholden to anyone other than themselves for the choices they make, which gives them lots of flexibility.
Anyone who looked at investing knows that you don't compare pure returns, you compare return per risk (say Sharpe ratio or some other measure). 10% return might be truly impressive if it does not involve much risk.
EDIT: For people who look first at comments - the article compared some endowment funds returns with broad market returns and found that funds did not outperform the market. My argument that this is flawed comparison since it ignored risk.
I work in investing and take issue with the standard deviation of returns being taken as equivalent to "risk". For example there were many quant funds that had great Sharpe ratios up until 2008, after which they got completely annihilated. But I have nothing else to add. It is hard to measure risk.
I agree that standard deviation might not be the best measure of risk. That's why there are many other measures exist that try to address issues. But you cannot compare returns without looking at risk.
Comparing fund performance is a tricky business and often you can cherry pick methodology easily to support any conclusion you desire.
The way to look at is that actively managed funds often define their risk profile so that LPs can correctly allocate their money in the risk buckets they are searching for.
How do you respond to the Fama and French paper on luck versus skill in mutual fund performance? They showed that on average, active managers hold a market portfolio, and since they take a cut, ETF portfolios make more money; there was no evidence of skilled managers getting better returns for the investor. Do you believe that institutional managers are better than mutual fund managers?
I agree with many points in Fama and French paper. However its conclusions are based on data more than 20 years old. Lots of things has changed since then. I would be curious to see the results with more recent data.
Some of the data sets used end in 2002 or 2006, and I am not aware of any reason why we would expect different findings from more recent data. Using data from the great recession and the current market situation may also be more confusing than elucidating.
The university with the highest total endowment suffered along with the market. It would be an obvious statement to say that Harvard suffered along with the rest of the market. Of course, they did better than the biggest losers. One could always say they could have done worse and put all their money in Citi.
I have to admit that I have no clue whether the endowment funds did better or worse than an index fund tracking the stock market but I imagine if one has $30B to invest (and you depend on dividends to run a third of one's operations) then surely you can't admit to be completely risk averse without reducing ambitions.
> In a sign of the economic times, Harvard has sent a letter to its deans saying that the university’s $36.9 billion endowment fund lost 22 percent of its value in the last four months and could decline as much as 30 percent by the end of the fiscal year on June 30.
You would think that these massive funds can afford to take on more risk than your average Vanguard investor. So they should be seeing better returns. If they truly have less risk than Vanguard then they're investing too conservatively.
Be wary of reading this as "if endowments fired their managers and invested in Vamguard funds, they'd on average boost their returns". Perhaps true of the smaller, consistently-underperforming ones. But at the endowment side, a lot of planning goes into avoiding your size being felt by the markets.
I think the whole point of the research is to see whether it's worth it to try not to be an underperforming one vs just taking the index returns. Obviously if you restrict your set to the ones outperforming then the index looks bad but you don't know who these are going to be.
(I know your point was also about size and the risk of distorting the market but I think you added in an unnecessary caveat there.)
Non sequitur. The point of active investment isn't to avoid having a market impact but to selectively pick over-performing assets. For example, assets indexed on the S&P 500 represent 2.2 trillions dollar; it's very easy to buy execution services to have limited market impact even if your position is in the tens of billions.
You are only moving massive amounts of money if you are moving massive amounts of money. Having massive amounts of money invested in ETF's doesn't mean you are executing massive trades if you are holding endowments and your only trades occur when you invest new gifts, withdraw a constant income stream, and rebalance your portfolio mix on a regular basis.
The way these index ETFs work though is that broker dealers can trade a basket of securities matching the index for a share of the ETF (and vice versa). Because of this price mismatches get fixed very quickly. S&P announces also changes ahead of time so while there is initial price movement it's not all instantaneous.
Index fund are a market basket of funds. The Index 500 fund is stock in the 500 largest companies in the US. It's intent is to give you the average across all those companies.
Lets look another way. If you are a golfer, the "average" score for a golf round is called PAR. Ask the regular golfer what would they do to be able to play par rounds all the time, most would sell you a beloved grand parent. The index funds are a way to play / invest in the market and get "average" returns.
The leverage that Vanguard has is that these index funds are pretty easy to manage, so they don't charge a lot of fees. Presently on the Index 500 fund, it's 17 basis points. So not much of your capital or your profit is going back to Vanguard. On the other side the big investment places are taking fees anywhere from 2 to 10 times what Vanguard gets. That can make a big difference in your annual rate of return.
Vanguard also has the advantage that in some cases Fund XYZ will be selling a stock while Fund ABC is buying a stock. So it ends up being an in-house purchase, so there is no brokerage fee, lower cost to both funds.
Mutual funds, and specifically index based mutual funds are a good way to get average results across a long period of time. Sure run wild some with that Gold Fund investment and those Oil funds, but be prepared for the downside)
stupid question, but when it lists 5 year return at 10.7%, does that mean it returned on average 10 % per year for 5 years? So if someone started with 100k, they would now have about 160,000?
1) one may be interested in the opportunity of above-average returns. If the average vanguard return is 7%, and the average self-managed return is 6.9%, on average of course vanguard is in your best interest. But what if you think you can do better? Harvard's ran a 12% return for 20 years, for example. Should they forgo it because the average is a more guaranteed, safe, and on average, better bet? Probably not. Does it signal to weaker funds to simply go with the Vanguard option? Yes.
2) looking at just returns is myopic. You need to look at risk-adjusted returns, for which finance has proposed a whole bunch of measures. I would not be surprised if the endowment funds were less risky than the vanguard, although it's hard to tell. And guess which years generate brilliant performance for risky portfolios that are heavy on stocks? Post-crisis years where the market rebounds. Risk isn't the only thing, there are all kinds of objective funds can set. Most colleges for example set liquidity limits that would be unworkable for traditional hedge funds that invest in high-potential returns in illiquid assets. Limiting yourself like this changes your roi.
That having been said, there's obviously a lot of value in this simple perspective. And it completely confirms a new reality: outperformance is getting harder and harder and investors are less likely to beat the market and add value with their investing know-how. It's pretty recent that this has been happening to this extent.
There is a statistics smell that he initially shows also 1y and 3y performance for the endowments, but then doesn't show these for his alternative. Probably he cherry-picked the data that supported his point and hid the rest.
From the article "1 and 3 years returns are mostly noise". He focuses on a longer term since it's a much better comparison. On a growing market it's much easier to overperform the index but then get wiped when a crash happens.
For the endowments, the 1y and 3y returns didn't look like noise. Hiding the noisy data is hiding the fact that the ETF strategy is more risky than the endowments.
What do you mean ? The shorter term you look the more noise there is. I'm not sure that it's exactly the same 1y period, you are just averaging out a lot of funds. I would say the fact that ETFs overperformed on a long term means they are less risky not more.
The headline is misleading. The vanguard portfolio beats the average of all small endowments (under $1B) and is beaten by average of the large endowments. Endowment performance is impressively correlated to size.
This is true, both my bosses worked for a larger well respected endowment about a year ago. The firms are not doing well and at least this one is not and there is talk if going to the strategy here.
Basically a fund of funds with a bunch of mutual funds. They are facing competition for PE deals and maintaining higher risk trading desks with high cap costs.
I would note that while the numbers in the article did beat performance now could be the best time to have a trade desk. Most indices look like this
/\/\/?
Not
/
/
/
So having a group work on minimizing that could be profitable
That only beats half of the endowments, I'd be more impressed if it be something like 75% to indicate it was truly a top tier product instead of just better than average.
To a first approximation, this is what one would expect of index funds, right? They're literally incapable of beating the broad market (they have some expenses, so they have to lag a little). One point that's not addressed by these statistics is whether any given university endowment consistently beats the market, or whether they all fluctuate around that average over the long term (say, 20+ years).
The underlying question is, why should universities employ big teams of investment experts to manage their investments? (Those salaries are, I suspect, not accounted for in these performance numbers: the source says they are "net of fees", but I assume that's only counting actual fees from the investment products themselves rather than the costs of in-house staff.) If you can get consistently average results with almost no investment strategy at all, what are all those salaries for?
I didn't drill down but are you taking "average" as the mean value of a normal distribution? I'd imagine a few big winners would male it more of a power series.
I wonder if the returns quoted for endowments properly subtract out the salaries, build space, etc for the employees of the institution with the endowment, or just the explicit costs from outside management?
(See my clarification below. I'm talking about the costs only for the employees making investment decisions.)
I don't care about the label, I care for a fair comparison of the question, "Would Universities be better off with a simple mix of index funds or using their current approach?" To answer that question, you'd like to figure out what the performance would have been if universities used that simpler approach, and that might include saving a lot of money on the university employees who select managers or make investment decisions at the university. I hope it didn't seem like I thought you should subtract out the costs of random university employees.
(Rereading my words, I can certainly understand that interpretation. Sorry.)
This is interesting! Shoddy writing int he Fortune piece though.
"The amount handed over [to charity], though, is not likely to be $1 million, because of changes that Buffett and Protégé made in the wager a couple of years ago"
One paragraph later:
"Buffett also issued a guarantee: He will pay the winning charity $1 million if the Berkshire stock bought isn’t worth that much at the bet’s end."
Nitpicky I know, but it sounds like the winning charity is guaranteed $1 million.
Proponents of index funds have been proposing exactly this sort of portfolio for about 40 years. (Well, okay, 40 years ago was the origin of the first index fund, Vanguard's S&P 500 tracker; a portfolio amalgamating three market segments like this would only have become possible somewhat later.) The specific 60/40 stock/bond mix here (with moderate international exposure) is solidly in the "bog standard investment advice" category, too: I wouldn't be surprised if it's what most people would choose if they wanted to avoid accusations of post hoc selection bias. (In fact, that's my only point of concern with the choice: it's a distribution that I associate more with mildly cautious middle aged families than with major institutions. But I think that's the point.)
I think that just about any indexing fan would be perfectly content to say, "Yeah, please feel free to track this mix into the future, too." It's one size fits all investment advice, but again, that's pretty close to what index funds are all about.
It's within a few percentage points of the holdings of the Vanguard LifeStrategy Moderate Growth Fund (VSMGX). There's a little more international in that, and there's an international bond fund included. And there's the 0.16 cost ratio, rather than 0.19.
That's a great point, however his comparison is actually the "standard" 60/40 index fund split, which means he's not retroactively picking a winning mix - he's comparing them to the control group, so to speak.
It would be interesting to see a sensitivity analysis of the mix to see what range of reasonably commonly recommended index strategies would match this baseline. Otherwise, it's very easy to cherry pick a set of funds to prove almost anything.
The overlooked discussion is that universities are supposed to make money by selling quality education. Their goal shouldn't be to make money by risking money.
Perhaps the lower return simply reflects the less aggressive nature of their portfolio. But ironically while waiting in the lobby of a prominent VC I met a college endowment fund manager who was currently using machine learning to trade options. I believe part of the endowment is now traded using his system (not 100% sure about this).
When I asked why his approach won't suffer the same fate as LTCM, an algorithm-based options-trading system run by Noble-prize winner Robin Scholes, he claimed that his approach relied on less leverage. But he didn't address the point on how his system would have predicted the Asian flu and Russian default that ended LTCM. I guess it would have been harmful but not fatal.
What's acceptable risk for a Wall Street fund isn't necessarily appropriate for an endowment fund regardless of the upside.
There is nothing inherently wrong with the LTCM algorithm. Using the same algorithm after the crash, it was eventually liquidated at a profit. The problem was how leveraged the investors were. Banks that invested in LTCM were so heavily leveraged in it that the temporary collapse of the fund was threatening the survivability of a few large institutional investors. The same fund likely would have performed very well for an investor that was not as heavily leveraged. The collapse would still be harmful but not fatal.
An endowment is a fund of money designed to sustain operations of it's benefactor forever. Not 10 years. Not 50 years. Literally forever. When you're operating on an indefinite timescale your idea of "risk" changes considerably.
Take a look at the Harvard Endowment report[1], specifically the table on page 2. They are incredibly well diversified, across domestic and international public equities, as well as private equity, commodities, fixed income securities (bonds, etc), real estate, and a category they call "absolute return", which is where they've placed money into external hedge funds. If the US economy tanks, they'll be fine. If Europe falls apart, they'll be fine. A bunch of start up unicorns fail in Silicon Valley? Fine.
My point is that the article completely misses the goals of an endowment. They don't particularly care about matching or beating an index, nor do they care about risk (as measured by volatility). They care about wipe out risk, on the scale of centuries.
[1]: http://www.hmc.harvard.edu/docs/Final_Annual_Report_2014.pdf