When the billionaire investor Warren Buffett put down $320,000 of his own money in 2008 betting that the S&P 500 — an index documenting the performance of the 500 largest publicly traded American companies — would outperform a collection of actively managed hedge funds, officials managing university endowments across the country opted to stick to their traditional strategies.
But the average university endowment might have yielded better returns over the past decade if top officials had invested in low-cost S&P 500 index funds rather than delegating investment decisions to highly paid money managers. Over the past decade, the classic 60 percent U.S. equity and 40 percent U.S. bond index fund portfolio had an annual return of 5.3 percent, while the average university endowment saw a return of 4.6 percent. Yale, however, is a notable exception, having outpaced returns on the 60–40 portfolio with a 6.6 percent annual return over the last 10 years.
Over the past 30 years, Yale’s Endowment Model — a widely used diversified portfolio strategy that emphasizes alternative investments such as private equity and venture capital as opposed to stocks and bonds — has maintained a clear edge over index funds. According to the 2016 annual report issued by the Yale Investment Office, if Yale’s assets had been invested in a classic 60–40 equity-bond portfolio for the past 30 years, the strategy would have resulted in lower spending and a smaller endowment, “reducing by more than $28 billion the support to Yale’s educational mission.”
For many universities, though, relying on external money managers has proven less fruitful. Harvard, which decided last year to align its strategies more closely to Yale’s model, has seen returns trailing the national average in recent years. In response to unsatisfactory endowment performance — and multi-million dollar compensations received by Harvard’s money managers — a group of Harvard alumni penned an open letter to the university’s new president Lawrence Bacow following his selection in February.
A number of Harvard alumni — most of whom are members of Harvard College’s Class of 1969 — have for the past 15 years attempted to persuade their alma mater to consider a series of changes to its management of the university’s $37.1 billion endowment.
In the recent open letter, 11 alumni called for Harvard to invest half of its assets in S&P 500 index funds, arguing that such a practice would save the annual multi-million dollar fees paid to money managers and has the potential to yield a better return.
“We have argued for about a decade and a half that the endowment of the nation’s greatest university should not be used to enrich private interests on a massive scale,” the alumni wrote. “Our new proposal would address that problem. In addition, it would bring a huge fiscal benefit to Harvard in the short run, and there is every reason to think that it would do so in the long run as well.”
David Kaiser, a historian and informal ringleader of the alumni group, told the News that Bacow immediately wrote back and indicated that he would consider their suggestions. According to Kaiser, Bacow’s response marked the first time in 15 years that any Harvard president responded to the group’s various suggestions.
Charles Skorina, an endowment executive recruiter who runs a newsletter for institutional investors, told the News that while some investors may allow the historical performance of different investment strategies to inform future planning, the best investment officers are always on the lookout for original ideas.
“The best chief investment officers — and I’m thinking of Swensen among others — are looking out beyond the horizon and making decisions that are not crowd sourced or popular,” Skorina said. “That’s one of the many reasons why the job is so tough. They are looking for the anomalies, the little-know opportunities, and the out-of-favor investments.”
Nir Kaissar, founder of an asset management firm and a columnist for Bloomberg, said although he saw the benefits of investing in index funds, the alumni’s proposal of investing only in funds that track S&P 500 is flawed because it is not a diverse approach.
Kaissar said a diversified portfolio of different index funds would save the large fees paid to money managers while preserving the benefits of diversification.
“[Alternative investments] are not going to do well enough to justify their fees, so I think a portfolio of index funds is a better idea than the Endowment Model,” Kaissar said.
Some universities across the country do invest part of their endowments in index funds. Ken Redd, a senior director of research and policy analysis at National Association of College and University Business Officers, said a quarter of the universities surveyed in his endowment study use index funds in their U.S. stock investments and over a half use index funds in their U.S. bond investments.
Still, the vast majority of universities predominantly employ active money management and some form of the endowment model pioneered by Yale. According to Redd, belief in the Endowment Model has not wavered over the past decade.
The group at the helm of Harvard’s endowment, the Harvard Management Company, which has undergone substantial leadership turnover in past decades, has promised to adopt key features associated with the Yale model. In a September email to the Harvard community, HMC President Nirmal Narvekar said the investment team would part ways with its previous practice of significant in-house management and outsource most of their investments to external managers.
According to Kaiser, the alumni letter to Bacow was also prompted by the tax on large endowment investments that Congress approved at the end of last year. By using low-cost index funds, the alumni said, Harvard could pay the annual taxes on endowment returns estimated at $43 million with fees previously paid to money managers.
“That is an attack on the richest institutions. If they had used their riches to hold down cost of students aggressively, they would be in a much stronger position to complain about the tax, but they haven’t done that,” Kaiser said.
Harvard saw an 8.1 percent return on its endowment in fiscal year 2017.
Jingyi Cui | firstname.lastname@example.org