Do (Some) University Endowments Earn Alpha?

Abstract

The authors analyzed the returns earned by U.S. educational endowments using style attribution models. For the average endowment, models with only public stock and bond benchmarks explain virtually all the timeseries variation in returns, yield no alpha, and generate sensible factor loadings. Elite institutions perform better than public stock and bond benchmarks because of large allocations to alternative investments. The authors found no evidence that manager selection, market timing, and tactical asset allocation generate alpha. E ducational institutions hold billions of dollars in endowment funds. As of June 2011, the top five educational endowments (Harvard University, Yale University, Stanford University, Princeton University, and the University of Texas) managed a total of $102 billion and all educational endowments in the United States and Canada collectively managed in excess of $408 billion. 1 These funds are often critical to the finances of educational institutions, but we know very little about the performance of endowments. Our lack of knowledge regarding their performance, largely a result of the limited availability of data, is remarkable given the legendary performance of some institutions, most notably the Yale endowment. David Swensen, the long-time manager of the Yale endowment, has long advocated the so-called endowment model 2 of investing popularized in his book Pioneering Portfolio Management (2009). Following the principles that he espouses, the Yale endowment earned double-digit returns for over a decade, through 2008, before dropping by 24.5% for the year ending June 2009, which placed Yale in the bottom decile of endowment performance.Yale is not the only elite institution that was hit hard by the market woes of 2009. Harvard and Stanford also saw the value of their endowments drop by more than 20%. Many universities, including such elite institutions as Princeton and Harvard, that rely heavily on endowment funding for ongoing operational expenses were forced to slash spending in the wake of steep losses. 3 The losses incurred by endowments in 2009 caused plan sponsors to question their ability to deliver superior returns using the endowment model.In this article, we shed light on the strong returns (and sharp correction) experienced by many endowments. We analyzed endowment returns for a large set of institutions over the 21 years ending in June 2011 and addressed three questions: (1) Does the average endowment earn an abnormal return (alpha) relative to standard benchmarks? (2) Do elite institutions earn alpha? (3) Is there evidence of performance persistence in endowment returns?To answer these questions, we used simple assetclass attribution models pioneered by Sharpe (1992). The intercepts from these models can be interpreted as the additional return earned by endowment funds relative to the best-fit replicating portfolio. We began the analysis with simple two-and three-factor attribution models. The two-factor model uses benchmarks for publicly traded U.S. stocks (S&P 500 Index...

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