Endowment vs Pension Returns
By Michael Karris (EndowBridge Capital)
Does the Endowment Model still work?
Judging by large endowments’ steady outperformance of a 70% global stock /30% US bond index, THE ANSWER IS YES. Versus a 60% US stock / 40% US bond index, the answer is not as clear cut.
Even so, the Endowment Model still adds value for a long-term portfolio that uses alternative assets, especially venture capital. The lucrative illiquidity premium has generated superior returns for U.S. endowments versus other investors, especially through the 1990s internet bubble, and until the 2008 financial crisis.
However, the outperformance gap between large endowments and U.S. public pensions has shrunk since 2008, as pensions have increased allocations to alternative assets hoping to copy the investment success of endowments. Asset allocation has also helped pensions’ recent good performance.
Besides capturing an illiquidity premium, the Endowment Model uses greater diversification, an equity bias, and a tilt towards riskier assets (e.g., small cap and emerging markets stocks, oil, and timber) compared to a 70/30 portfolio.
In the spirit of the more aggressive nature of the Endowment Model, a well-designed, index fund based strategy could possibly also earn superior, long-term risk-adjusted returns versus a balanced benchmark. By excluding alternative assets and focusing on beta to streamline the Endowment Model, it could avoid many of the drawbacks of the Endowment Model by:
• improving liquidity and transparency,
• reducing fees and complexity, and
• eliminating lock-up provisions and investment gates.
An index fund strategy could be suitable for small to mid-sized long-term investors who struggle with implementing the Endowment Model.