Inevitably, a Small College Will Outperform Harvard. There’s More to That Story.

Every fall or winter, news organizations across the country write a story on university endowments that goes like this: a tiny endowment’s returns beats out giant peers.  

This type of story usually highlights the chief investment officer at a sleepy, small-town endowment who eschews alternative investments in favor of equity markets and is rewarded handsomely for it. It’s David versus Goliath, a coup comparable to – as one reporter put it — when a tiny Pennsylvania college (enrollment: 425) made it to the NCAA’s Sweet 16 in 1953.  

But behind these pieces, many of which draw on an annual study of endowments from the National Association of College and University Business Officers and TIAA, is another story: despite varying wildly in how they allocate assets, most endowments perform the same. 

The data, which covered 744 U.S. colleges and universities and came out Thursday, show that endowments returned 5.3 percent for the year on average.  

And in this case, size really didn’t matter: Endowments managing more than $1 billion returned 5.9 percent, while those only managing up to $25 million returned 5.8 percent for the year.  

Yet their allocation strategies were totally different.  

According to NACUBO, those tiny endowments with $25 million and under had allocated 45.7 percent to U.S. equities on average as of June 30, 2019. Their second largest allocation was 29.7 percent to fixed income. And they allocated just 5.6 percent to “other equities,” which include private equity, venture capital, so-called marketable alternatives. 

Meanwhile, $1 billion-plus endowments funneled 43.2 percent into “other equities” and just 11.2 percent into U.S. equities on average. In fixed income, they averaged 10.1 percent, the survey showed. Mega-funds’ ten-year returns still outperformed the smallest endowments – 9 percent versus 7.7 percent, according to the data. 

[II Deep Dive: Here’s How the Top Endowments Did Last Year] 

Here is where a potential problem arises. The returns reported by private equity firms may be skewed because managers may have used subscription credit lines to improve their internal rates of return. IRR is then reported to endowments, who in turn, use it to determine their year-end returns. 

Data firm Preqin, Carnegie Mellon business school professors, two German researchers with a BlackRock private equity director, and Triago to name a few, have shown that IRR can be a flawed metric for measuring returns.  

If this is the case, the numbers behind those large institutions’ returns may not tell the whole story. Nevertheless, for the endowments at the nation’s largest universities and organizations, it is paying off.