Average U.S. Endowment Earns 0 Alpha in 20 Years

zero scoreUniversity endowments led by stars like Yale and Harvard have long been thought to be among world’s best investors. David Swensen, manager of the Yale endowment popularized the “endowment model” of investing in his book, Pioneering Portfolio Management. But a new paper by Brad M. Barber Gallagher Professor of Finance Graduate School of Management UC Davis and Guojun Wang,  Ph.D. Student Department of Economics UC Davis takes on the notion that university endowments in the U.S. are superior investors.

In their paper, “Do (Some) University Endowments Earn Alpha” the authors come up with some surprising results – using data from 1991 to 2010, the researchers find that the average endowment earns an alpha close to zero.

In short, U.S. endowments on average earned no alpha during a period spanning nearly two decades.

It’s not encouraging news for active managers because it calls into question the value of the portfolio management theories espoused by high profile figures like Swensen. You can read the full paper here.

Zev Frishman is a CIR board member who recently retired from Teachers’ and who is now Senior vice-president, Investment Management with Open Access Limited here in Toronto. He wasn’t overly surprised by the results, which show how hard it is for all but the largest investors to benefit from active management. “Without the resources to find truly great managers, it’s a losers game,” he says, adding that such resources are unavailable to many small- to mid-sized pension funds and endowments.

Fund size is one thing, according to Frishman – another is the right governance structure, which can allow a fund to hire and compensate qualified staff and allow the organization to follow a truly long-term investment philosophy.

So what explains the stellar performance of Yale and Harvard? Alternatives like private equity and hedge funds delivered well for big endowments like these – but it’s likely they realized big gains because they got in on the ground floor and were able to negotiate good deals with lower fees. Today, says Frishman, those deals are gone – “They’re too expensive now,” he notes.

Where does this leave pension funds focused on earning alpha in Canada? The paper raises tough questions. It could open the door for more passive approaches in the future. And it could as Frishman suggests mean plan sponsors should be looking carefully at how they hire (and fire) active managers in the future.