There’s a reason why Brown University beat every other Ivy League endowment for the 2020 fiscal year ending June 30, but it’s not the endowment’s allocation to alternatives or just a winning selection of hedge funds. Brown outperformed because it had outsize exposure to technology, producing large gains for multiple years, according to a returns-based style analysis by Markov Processes International.
“It is quite plausible to assume that technology is the missing factor that could explain the performance of Brown’s stable of long-short hedge fund managers when all ‘longs’ cancel out with all ‘shorts,’” MPI said in a report this week on the endowment.
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“What can happen with hedge funds, especially long-short portfolios, is that all of their bets cancel out,” Michael Markov, chief executive officer of MPI, said in an interview. “You can see that there is overexposure to technology.”
MPI’s proprietary technology leverages a returns-based methodology that evaluates hidden factors in public returns data that was initially developed by William Sharpe, the Nobel Prize winner. MPI’s dynamic style analysis also can evaluate hedge funds, total return and unconstrained fixed income strategies.
Using publicly available data and additional information from a Wall Street Journal article on hedge funds in Brown’s portfolio, MPI homes in on technology as the likely reason behind the university’s outperformance. MPI notes that Brown has one of the largest absolute-return allocations of all the Ivies. In addition, equity market-neutral strategies represent one-third of the absolute return portfolio. The research firm also found that Brown doesn’t rebalance its portfolio as frequently as its peers.
“This allows for their best-performing segments to grow and less performing to dwindle over time – a momentum approach vs. a more disciplined approach of a pension fund that has stricter investment guidelines and horizons,” according to the report. In the last three years, MPI also found that Brown’s exposure to technology almost doubled.
“Over the past two years, private equity, venture capital, and technology dominated the endowment’s return with selection being negligible. And while 2019 was ‘the year of private assets’ for Brown, this FY20 was clearly ‘the year of tech.’ Whether known or unbeknownst to the investment team, they seem to have accumulated a significant overexposure to tech stocks which, regardless of the skills of their managers, could be valuable information for their risk team,” wrote MPI in the report on Brown.
Brown’s performance has been the subject of scrutiny as the endowment beat all other Ivy League schools for the second year in a row, returning 12.1 percent in fiscal 2020. Dartmouth College ranked a distant second with 7.6 percent returns for the same period.
Brown is the only one of the group of endowments that beat a traditional U.S. portfolio made up of 60 percent stocks and 40 percent bonds for two years. There’s been a competition of sorts in recent years between a 60-40 portfolio and more complex — and expensive — portfolio models that include alternative investments such as private equity.
Brown’s performance this year pushed the university to the top ranks over ten years. Brown delivered 10.2 percent annualized returns for the ten years ending June 30. For comparison, Yale University returned 10.9 percent annually for the ten years, while Princeton University posted 10.6 percent annual returns, and Dartmouth generated 10.2 percent each year during the period.
According to MPI, industry observers have said Brown’s performance is attributable to private investments. But, for example, Brown had 31.2 percent in private equity and venture capital, while Yale had a target allocation to alternatives of 41 percent. Nonetheless, Brown handily beat Yale, a pioneer in alternatives.
“Never underestimate the power of diversification, especially with hedge funds. A portfolio of hedge funds typically diversifies at a faster rate than a portfolio of stocks and traditional investments,” according to the report.