Why you should care
You may not get 15 percent on your money like Harvard does, but you might be able to copy some of its strategies.
The author is an investment lawyer in Charlottesville, Virginia.
Every year at this time come reports of the latest annual investment performance by leading university endowments. As always, there’s a media splash focused on the relative returns of top colleges in tones reminiscent of the sports pages. For example, The Wall Street Journal just ran a story, with the headline “Harvard vs. Yale: Which is the Best Investor” — with its box score (Yale leads, 19-10-1, since 1985). One Harvard alum is quoted as saying, “For some alumni, the important thing is how big the endowment return is. For others, it is more important to just beat Yale.”
The sports analogy is all too common in the world of university investments. When he was hired, an investment officer at Ohio State told me he received one simple message from a university trustee: “I don’t care how you do just as long as you beat Michigan.” But the Sturm und Drang seems overblown considering that university returns are typically well ahead of relevant public benchmarks. Harvard’s reported return for the year ending June 30 was 15.4 percent. How far ahead of your portfolio is that? Wouldn’t you hire Harvard to manage your money if you could?
The best investment minds are in high demand, of course, and a university has obvious advantages.
Thus begins for many individual investors the second stage of this annual announcement: hand-wringing and self-recrimination. How did our returns fail so miserably, again, versus the top universities? One might call it “Ivy League performance envy.”
Like many neuroses, though, this one is treated by looking at the facts. That is, to borrow a phrase from Fitzgerald, universities are different from the rest of us. Yes, they have more money, as Hemingway would respond. But they also invest it differently, and they invest it differently because they can. Let’s look at how they do it.
“Mom, I Got Accepted at Harvard! (To Manage Its Money)”
The best investment minds are in high demand, of course, and when it comes to choosing clients, a university has obvious advantages over you or me. Whether a money manager is an alum or simply as a supporter of higher education generally, she can feel good about helping a college succeed financially. Or, for a manager seeking social status, amassing universities and other classy clients — museums, hospitals and the like — can be the ticket to the society page. This is what tax lawyers call “psychic income,” or what you and I would call bragging rights.
The opportunity for a status jolt as I just described might help a university get in the door with a top money manager. But what the best universities offer is something more important to most managers’ business: College endowments invest for the long term. A university’s desire for “intergenerational equity” — so that the benefits of a healthy endowment (scholarships, quality faculty, a functional physical plant) are best poised for future generations — means a focus that allows a manager to pursue a multi-year strategy or ride out short-term market volatility. This makes university money more stable capital. More stable money means a reliable fee base and less distraction from having to find new clients.
The average return on investment for the Ivies was 17.9 percent, with an average total endowment of $14.25 billion.
Yale University – Gain: 22 percent; Total: $23.9 billion
Princeton University – Gain: 19.6 percent; Total: $21 billion
Dartmouth College – Gain: 19.2 percent; Total: $4.5 billion
Columbia University – Gain: 17.5 percent; Total: $9.2 billion
University of Pennsylvania – Gain: 17.5 percent; Total: $9.6 billion
Brown University – Gain: 16.9 percent; Total: $3.2 billion
Cornell University – Gain: 15.8 percent; Total: $6.2 billion
Harvard University – Gain: 15.4 percent; Total: $36.4 billion
by Nathan Siegel
Even the best money managers have rough spots. As long-term investors, endowments can overlook poor short-term performance versus the overall market or a manager’s benchmark. Endowments are also more immune to market volatility than the rest of us and may even welcome it. During last month’s brief market swoon, a top endowment officer at a Southwestern University told me, “Now is when we excel. We’re the ones who run into the burning building.”
Locking Up Capital — for Years
Universities can invest in multi-year strategies without access to their capital. Real estate, private equity and venture capital all typically lock up client cash for five to 10 years, or even longer. This makes sense given the nature of these strategies. A VC firm that is building up new businesses can’t give back cash or profits until after the businesses become viable, which may take years, or never. For that reason, these strategies can last as long or even longer than many marriages, and it’s often even harder for the “spouse” (the client) to get out if things go bad. Therefore, clients typically will invest with private-strategy managers who can show the promise of outsize returns to offset the risk of locking up client capital for years. This is known as the “illiquidity premium.”
Similarly, universities may directly invest in illiquid strategies, say by developing real estate themselves. This takes the kind of capital, patience and skill that most individual investors lack.
Yes, you were expecting this one. But it’s a fact that universities were among the first and most successful investors in this asset class as it gained traction in the late ’80s and ’90s. Indeed, the so-called “Yale model” for endowment investing features hedge funds as a prominent element in the overall asset allocation. Being among the first and most prominent hedge fund investors, Yale’s endowment, led by the legendary David Swensen, has found great success by backing many of the best hedge fund managers during and following the asset class’s infancy.
It’s time to stop comparing personal returns to those of endowments.
But good luck trying to get in on this: Most hedge funds are not offered to retail investors. Under securities laws, hedge funds can be offered generally only to institutions and high-net-worth individuals, in part because of their risks and the need to lock up an investor’s funds for long periods.
Universities have business schools with investment experts generating ideas. They regularly hear from alums and others at banks, think tanks and elsewhere who are leaders in the investment community. Their endowment offices can mull all of these ideas for the best strategies.
I get investment ideas from my brother-in-law. Enough said.
Thanks to proponents like John Bogle of Vanguard and Jason Zweig of the Wall Street Journal, retail investing has become more and more fee conscious. There is plenty of data to show how low-fee investing through index-based funds and ETFs offers the greatest chance of the best returns for people investing for retirement. Just this week the WSJ reported on the continuing retreat from higher fee mutual funds.
Contrast this with institutional investors like universities. Since many of the best investment firms can ignore the retail market, they can charge high fees to institutions based again on the promise of outperformance, often buttressed by their historic returns. Thus, institutions can bear the historical “2 and 20” model as it has evolved more or less over the years. (“2 and 20” means the investment firm collects a 2-percent annual fee on assets under management as well as 20 percent of profits.) Since universities can still beat public benchmarks after the fee “haircut,” the fees can be absorbed, offering top investment firms outsize revenue versus peers who cater to retail investment.
So Stop Moping
It still might be fun to root for your university’s endowment to excel. After all, good performance is a good thing. More money helps the institution, its students and its faculty. But it’s time to stop comparing personal returns to those of endowments. Instead the key is to focus on following the sound advice offered by folks like Bogle and Zweig to retail investors: Save more; keep fees low; don’t chase outsize returns if you have to pay outsize fees; be patient during short-term downdrafts.
And don’t listen to my brother-in-law.