Investing Like The Yale & Harvard Endowment Funds
Richard Brazenor, July 2nd, 2008
Endowment Investing
By Richard Brazenor (CAIA), Senior Research Analyst
Frontier Capital Management LLP.
Published by permission from Advisors Perspectives
The university endowment funds of Harvard and Yale have been leaders in diversified multi-asset class investing for over two decades. Through this approach to investing and their exposure to alternative asset classes they have consistently achieved high double-digit annual returns with low risk and only moderate draw-downs.
The rationale for investment across multiple asset classes is supported by Modern Portfolio Theory. This theory, which was developed by Nobel Prize winner Professor Harry Markowitz, shows how risk adjusted returns of a portfolio can be improved by diversification across assets with varied correlations. Modern Portfolio Theory is at the heart of the investment philosophy of the Super Endowment Funds and is the foundation upon which their portfolios are constructed.
The Endowment Funds are very well resourced and have access to the best institutional, private equity and hedge fund managers, and this adds to their investment success. However, in this note we show that by adopting asset allocation principles similar to the Super Endowments it is possible for high net worth investors to also obtain high levels of risk adjusted return; superior to traditional equity/bond portfolios and most balanced investment funds.
Overview of US Endowment Funds
US endowment funds are non-taxable vehicles established to contribute towards the future funding requirements of colleges and universities. Their funding comes from a combination of legacies, gifts and investment returns. In the US there are over 750 endowments with an average of $520 million in funds; the largest fund has over $34.9 billion.
Examining the strategies of the US endowment funds is of relevance to investors for a number of reasons. Firstly, US endowment funds have consistently achieved superior investment returns. This is especially the case for the largest endowment funds - those with assets greater than $10 billion comprising Harvard, Yale, Stanford, Texas System and Princeton. They have achieved an average 10 year annualized return of approximately 14.6%, roughly double the returns for traditional 50% equity and 50% bond portfolio while incurring a lower level of investment risk (see Table 1).1
Table 1 - 10yr Annualised Returns by Endowment Fund Size to June 2007 | ||||
| US Equity/Bond Portfolio | Average endowment fund | Endowment funds with assets > $1bn | Endowment funds with assets > $10bn |
10yr Annualized | 6.6% | 8.6% | 11.1% | 14.6% |
Traditional Assets % of Total | 100% | 79.7% | 55.4% | 42.9% |
Source: NACUBO (2007); various university annual reports; Bloomberg; Frontier Capital Management | ||||
Secondly, US endowment funds have innovative portfolios with exposure to multiple asset classes that provide additional diversification benefits. In this arena the largest endowment funds tend to be leaders. Those endowment funds with assets greater than $10bn hold roughly 57 per cent of their portfolio in alternative assets (see Table 1 & Chart 2). In contrast, the average US endowment fund (Chart 1) still holds a roughly 80 per cent in traditional assets. The additional diversification in large endowment portfolios is one of the reasons for their superior long-term investment performance.
Chart 1
Average US Endowment Funds (June 2007)
Chart 2
US Endowment Funds With Assets Greater than $10bn (June 2007)
Finally, endowment funds typically have long-term investment horizons and stable asset allocations over time; allocations that rely less on market timing for generating returns and have lower trading costs.
1. For the purpose of this note, traditional portfolios comprise 50 per cent equities and 50 per cent bonds.
