A few years ago investors and financial journalists extolled the strategies of university endowment funds. Led by David Swensen, Yale University’s chief investment officer, top university endowments eschewed classic allocations of equities and fixed income and put huge chunks of their money into private equity, venture capital, hedge funds, real estate, and hard assets like timberland. Under Swensen’s guidance, Yale posted annual returns of 11.4% over the past two decades, more than quadrupling Yale’s endowment, to $30.3 billion as of June 30th.
But it turns out Swensen is as sui generis as Warren Buffett: Recent research shows that university endowments vastly underperform a plain-vanilla stock-bond portfolio. And, except for a tiny group of elite institutions, the larger the endowment, the worse it does.
That was the stunning finding of a paper by Poets&Quants’ Professor of the Week, Sandeep Dahiya of the McDonough School of Business at Georgetown University, along with David Yermack of New York University Stern School of Business. Their working paper, “Investment Returns and Distribution Policies of Non-Profit Endowment Funds,” was published in May by the European Corporate Governance Institute.
UNDERPERFORMING: RETURNS ON COLLEGE ENDOWMENTS
The study is the most comprehensive to date, covering “substantially all” of the $700 billion of endowment assets in the U.S.; colleges and universities account for more than half that total. Dahiya and Yermack tracked annual filings with the Internal Revenue Service for 29,762 organizations from 2009 to 2017.
Dahiya and Yermack found that during this period, the median annual investment return (including capital appreciation, dividends, and interest) of all endowments was 4.78%, underperforming a standard mix of 60% stocks and 40% Treasury bonds by a hefty 4.5 percentage points a year. For all their effort and expense, these endowments returned barely more than ten-year U.S. Treasury notes.
Higher education institutions underperformed the standard stock and bond mix by almost 1.5 percentage points a year. The 20 most highly ranked colleges and institutions (the Ivy League plus schools like MIT, Stanford, and Georgetown) did better, earning about as much as the 60/40 generic stock/bond allocation, but about what they’d make if university treasurers put the money into fixed-allocation mutual funds like target-date funds or old-fashioned balanced funds, or just by throwing darts.
‘HIGHLY RANKED SCHOOLS EARN ALMOST CLOSE TO ZERO ABNORMAL RETURNS’
“These highly ranked schools earn almost close to zero abnormal return (minus 19 basis points per year), a result that gives no indication of superior performance but is nevertheless much better than other colleges and universities as a whole,” Dahiya and Yermack write. “However, they also support the conclusion that the investment wisdom of top universities is largely a myth… Frequent mentions in the media of the out-performance of top schools seem likely due to the outsized success of just one university, Yale.” So, Yale’s Swensen does appear to be one of a kind.
Even more notable: The group of “higher education institutions significantly underperforms the community of other non-profit endowments that support organizations in diverse areas such as the arts, human services, health care, and religion,” the researchers conclude.
Dahiya, 52, is the Akkaway Associate Professor of Entrepreneurship at Georgetown McDonough but also has a secondary appointment as an adjunct associate professor in the Department of Biochemistry and Molecular & Cellular Biology at the Georgetown School of Medicine. His research focuses on corporate finance, corporate governance, venture capital, banking, and financial institutions. He teaches classes in entrepreneurial finance and venture capital and financial markets and corporate decision making.
Dahiya got his bachelors’ degree at the Indian Institute of Technology in New Delhi, India, and his master’s from the Indian Institute of Management in Bangalore. He went on to get another master’s degree and then his Ph.D. from NYU Stern. Before launching his academic career, he worked for the Indian bank ICICI and later joined McKinsey & Company’s corporate finance and strategy practice in Washington, D.C. He has taught at Georgetown McDonough consecutively since 2003.
Howard R. Gold is a contributing writer to Poets and Quants and a columnist at MarketWatch. He also has written for Forbes, Barron’s, Money and USAToday. Follow him on Twitter @howardrgold.