The Best and the Brightest Fail at Investment ManagementAdvisor Perspectives
Non-profit endowments, particularly those of elite academic institutions, have failed to deliver investment outperformance. Those colleges and universities have significantly underperformed a passive benchmark on an absolute and risk-adjusted basis.
Despite the fact that about 35,000 nonprofit organizations (NPOs) have endowment funds, with a total of $800 billion in assets under management, little is known about how NPO endowment funds invest or what returns they earn. Sandeep Dahiya and David Yermack contribute to the literature with their March 2020 study, Investment Returns and Distribution Policies of Non-Profit Endowment Funds. Their comprehensive data sample was 29,892 NPOs drawn from Internal Revenue Service filings for 2009-2017. Their calculation of annual percentage investment returns for each fund was based on an assumption that inflows of gifts and bequests, as well as outflows of distributions occur halfway through the fiscal year. Thus, they calculated the return by dividing net investment gains by the beginning-of-year assets plus half of new contributions minus half of distributions. Following is a summary of their findings:
- Within the universe of nonprofits that file with the IRS, colleges and universities accounted for 6% of the observations and 54% of the assets.
- The typical endowment size is quite small, with a mean of $26.8 million and a median of $1.2 million, but the largest funds run into the tens of billions.
- The “large” cohort of endowments, those worth more than $100 million, accounted for 4% of the observations and 78% of the assets. The very smallest endowments, those with asset values below $1 million, comprised 41% of the observations but only 0.5% of the assets invested.
- Systematic risk decreases with endowment size – estimates for the market return factor declined from 0.63 to 0.44 across the size cohorts.
- The mean annual net investment return was 5.68%, the median annual net investment return was 4.84%, and the median distribution ratio was lower, 2.41%.
- The largest endowment funds, those with assets greater than $100 million, exhibited the highest median returns. However, they produced lower risk-adjusted returns.
- Nonprofit endowments underperformed market benchmarks – holding a zero-investment portfolio (long endowment and short 60-40 mix of U.S. equity and Treasury bond indexes) generated a mean -3.61% annual return.
- Regression estimates of four-factor (beta, size, value and momentum) models found statistically significant alphas of -1.12% per year, with 61% of the alphas being negative.
- Smaller endowments had less negative alphas than larger endowments, but all size classes significantly underperformed market benchmarks. This finding is at odds with other research, including the March 2020 study, The Risk, Reward, and Asset Allocation of Nonprofit Endowment Funds, that found either positive or statistically insignificant excess returns in the National Association of College and University Business Officers (NACUBO) sample. The explanation for the different findings might be methodological differences, including the choices of benchmarks, measurement of fiscal years, and selection of endowments into the sample. That said, the NACUBU data indicates a marked downturn in the success of college and university endowments’ investments over the past decade.
Read the full article here by Larry Swedroe, Advisor Perspectives