You wouldn’t run your 401(k) like this.
But America’s most elite university endowments have slashed their exposure to the stock market to the lowest levels since before the crash of 1929. And they’re betting half the farm—or, I guess, half the campus—on secretive, illiquid and high-risk private-equity funds and hedge funds.
So says an astonishing new study by University of Cambridge business school professors David Chambers and Elroy Dimson and researcher Charikleia Kaffe, appearing in the latest edition of the Financial Analysts Journal.
And it raises some obvious questions. Like, are the people running these things crazy? Geniuses? Do they know something we don’t?
After all, self-made multibillionaire Warren Buffett reminds everyone that hedge funds and other fancy, high-fee funds are very unlikely indeed to perform as well over the long term as plain, boring old stocks in low cost funds.
So, for that matter, says some very simple math.
Chambers, Dimson and Kaffe looked at America’s top 12 long-term university endowments, including all the Ivy Leagues plus a few extras like Stanford and the University of Chicago, and studied how they’d handled their vast portfolios over the past 100 years.
In a nutshell: Pretty well. They trailed the S&P 500
but they weren’t trying to follow it anyway. Early in the period it was normal for such institutions to invest mostly in bonds.
Their data showed that the university endowments since the early 1900s have generally beaten a mixed portfolio of stocks and bonds. Their so-called ‘Sharpe ratios,’ meaning how much their portfolios earned in relation to their volatility, were much higher than you’d get in the stock market. That’s been true even in the booming stock markets since World War II. Best performer? Princeton, beating the stock market by an average of 0.3 percentage points a year. Yale was just behind.
Harvard came seventh. Go on, have a chuckle.
The sting of the story, however, comes in the tail. Over the past decades, these endowments haven’t dipped their toes in the waters of private equity and hedge funds. They’ve dived in head first.
“Alternative assets [in other words, hedge funds and private-equity funds] were introduced into endowment portfolios in the 1980s, and they have today replaced equities as the dominant asset class in the largest university endowment portfolios, with an averaging weighting close to 50% or their endowment wealth.”
What could possibly go wrong?
This, the trio add dryly, has continued “notwithstanding the challenge to illiquid assets posed by the GFC [Global Financial Crisis] and by rising concerns about the asset class’s alpha-generating capability.”
Love that British understatement. They forgot to mention the eye-watering fees.
Meanwhile the endowments have slashed their allocation of plain old boring stocks to around 26%, the lowest levels since the 1920s according to Dimson’s research. In the decades after the second world war they typically held over half their money in stocks. Where will this end?
The trio note that recent research has shown two other things that are relevant. The first that endowments overall have just had a disappointing decade, in part because of the diminished performance of these “alternative” investments. The second is that a 2013 study found that private-equity funds did just great for university endowments—but only until about 2000, when they started becoming more widely available, and flooded with new money.