Yale University, which invented the Yale Model of investing, but is it any good anymore?
Investment

Family offices probably shouldn’t follow the investment ideas of endowments anymore

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US education endowments are the latest group of institutions to come under fire by producing lower returns than low-cost passive investors.

According to an analysis by retired investment consultant Richard Ennis, large endowments failed to beat passive funds over the eleven years to June 2019, occasionally by a significant margin.

Endowments are in a bad place because they are more concerned with retaining their wealth than growing it

Endowments have been held back by the expense of using alternative strategies, as well as their own upkeep. Costs ranged up to 2%, according to his report.

Endowments can argue the S&P 500 has become an incredibly difficult index to beat, due to the growing number of its stocks which benefit from tech disruption. Quite why they did not allocate more of their funds that way is more surprising, given recent events.

Over the last decade, the US Federal Reserve has kept down interest rates and pumped liquidity into the system to revive animal spirits following the financial crisis of 2008.  All this money, quite naturally, followed the path of least resistance, into tech stocks which had easily the best chance of generating growth by disrupting other sectors. 

Technology now comprises 25% of the S&P 500. The proportion of companies making effective use of tech may account for nearly the same weighting. Increasingly, passive performance has been driven skyward by tech-driven growth. The flow of funds has also done no harm to passive bond strategies.

In a recent analysis, put together with PwC, Family Capital found the S&P 500 index has been beating US-listed family businesses for the first time in recent history. In the past, listed family businesses have tended to outperform their non-family counterparts. In Europe, that’s still happening, but no longer in the US. 

Endowments are in a bad place because they are more concerned with retaining their wealth than growing it. To achieve this, they follow a strategy they perceive as safety-first even though right now, it is anything but.

Alternatives, led by hedge funds and private equity are popular with endowments because they promise to protect clients against loss in down markets, while offering some growth on the way up.

To an extent, this has been true. But cheap passive fund flows have lately been protected against permanent loss by the Fed’s money at zero charge to punters, in stark contrast to the hefty fees and costs levied by alternative managers, many of whom also appear to be managing too much money.

In a recent analysis, Ludovic Phalippou, professor of finance at Oxford Said Business School pointed out a yearly net 11% return from big private equity funds lagged the US market and produced $230 billion in performance fees.

In aggregate, hedge funds have performed even worse. They provided downside protection during the first quarter of this year.  But nothing compared to the subsequent surge in tech stocks, thanks to renewed stimulus from the Fed.

As tumbleweed blows through the value sector, tech-driven plays are out to make the Fed’s money work even harder.

Pending IPOs include insurer Lemonade ($2 billion); cloud specialist Snowflake ($20 billion) and Peter Thiel’s data firm Palantir ($40 billion). Airbnb CEO Brian Chesky has declined to rule out an IPO. 

Zoominfo’s value has doubled to $17 billion since its June float.  

Family offices have been involved in a series of venture capital deals in recent years, and benefited accordingly. But endowments, strangled by over-delegation and groupthink, are showing no sign of changing course.

Richard Ennis concludes: “It is likely that the great majority of endowment funds will continue to underperform in the years ahead.” 

In current market conditions, it is hard to disagree.

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