All Those Studies Showing Endowments Lost to 60/40? Cherry-Picked Data, Academic Says

New research is firing up the debate about whether endowments would be better off with or without the billions they have locked up in private equity and other alternative investments. 

Hossein Kazemi — a professor of finance at Isenberg School at the University of Massachusetts Amherst and a senior advisor to the CAIA Association — argued in a paper jointly produced with CAIA that previous studies showing that endowments have been beaten by a simple portfolio of stocks and bonds used improper benchmarks to reach their conclusions and don’t account for cash in the portfolio. 

Once these significant adjustments are made, Kazemi argued, the results are very different. Endowment returns outpace the results of a portfolio invested in 60 percent stocks and 40 percent bonds Kazemi said in an interview with Institutional Investor. 

Multiple studies — including one by Richard Ennis, retired chairman of consultant EnnisKnupp, and another by quantitative research firm Markov Processes International — have reached a different conclusion, finding that a classic 60-40 U.S. portfolio has beaten endowments, which are among the largest investors in alternatives, over two decades. These authors and other critics have pointed to the results to argue that investing in private equity, venture capital, and other assets that aren’t part of the public markets isn’t worth the effort, because they are expensive, complex, and have added little to returns. Endowments started investing heavily in alternatives around 2000 and are still among the largest investors in private markets. 

First, Kazemi argues that the data have to be looked at in comparison with a portfolio of global securities, rather than one simply focused on the U.S. Endowments are also big investors in international equities. 

Since 2000, according to the study, endowments have significantly outperformed a globally diversified benchmark. The excess returns range between 2.2 percent and 3.8 percent annually since 2010, depending on the size of the endowment, the report said. 

U.S. stocks have outperformed global equities by a large margin, particularly since the global financial crisis. As a result, the U.S. index is a tough one to outperform. 

“In 2000, every endowment was talking about international diversification,” said John Bowman, senior managing director of CAIA, which provides professional licensing for alternative investments similar to the CFA Institute’s. “Yes, after the fact the U.S. has outperformed global stocks in that time period. But in 2000, no one knew that.”

Bowman acknowledged that the so-called illiquidity premium — earning a higher return for investing in longer-term assets — has decreased, and that alternative investments have produced less alpha in recent years.  

“We’re not telling endowments to plow all their money in now,” he said. “But we are saying [some studies] are cherry-picking time periods and making bad assumptions.”  

Kazemi added that if researchers insist on contrasting endowment returns to the domestic benchmark, then they should also note that endowments’ underperformance may not have come from alternatives at all. Since 2000, a diversified portfolio of only alternatives has beaten a 60-40 set-up over every ten-year window, according to the study. That means U.S. equities or fixed income could be to blame. (Endowments don’t provide enough timely and detailed information for researchers to determine the cause of the underperformance.)

II Deep Dive: Are Alternatives Bad for Endowments?]

“The figures suggest that endowments should have increased their allocations to alternatives. If there is any underperformance, the blame lies somewhere else,” Kazemi wrote in the study. 

In the interview, Kazemi stressed that the average performance of a portfolio of alternative investments has done well, but many endowment investment offices may have missed out on these types of returns by not having access to the best managers. The difference between the top and bottom private managers is vast, he said. Many endowments, particularly smaller ones, don’t have sufficient staff or a prestigious enough brand name to get into the best funds. 

“Our point is not to say that the solution is alternatives, but alts could potentially add value as long as you have the skill set,” he said. 

“The dispersion is really important and could be particularly frustrating when access seems a function of who you know,” Bowman added. “For the average endowment, they have to be even more sophisticated about how to get access to the illiquidity premium. A small endowment manager told me, ‘GPs don’t answer my phone calls’.” 

Kazemi found that large endowments generated annualized returns of 9 percent between the fiscal years of 2010 and 2019. That beat the global 60-40 portfolio’s return of 7.4 percent during the same period. (The U.S. 60-40 returned an annualized 10.5 percent.) But even small endowments generated a 7.7 percent annualized return during the period, beating the global benchmark. 

Kazemi also said researchers have ignored the role of cash, which they assume can be invested immediately. The study cited industry statistics that endowments hold around 2.5 percent to 4.1 percent in cash. 

“I think endowment managers deserve a raise,” wrote Kazemi. “Using the global benchmark and assuming five-year rebalancing, endowments have outperformed the benchmark by 2.2 percent to 3.8 percent per year since 2010.”