6 ms·

>If a school's endowment had the same return and volatility of the S&P 500, that would be quite disturbing. Why? I understand why this is the case for smaller

by slg 6y ago

>If a school's endowment had the same return and volatility of the S&P 500, that would be quite disturbing. Why? I understand why this is the case for smaller investors like individuals, but for a school endowment isn't the sheer size of the endowment and the theoretically near infinite investment time horizon part of the risk management? Some years or even some decades it will be down, but they aren't investing with the intent to spend any sizable portion of that money anytime soon.

TheCoelacanth 6y ago
Maybe for somewhere like Harvard that has an absolutely ludicrously sized endowment, but a more normal university can't really afford to absorb losses like that. They need to withdraw from the endowment every year to pay expenses. If the stock market plunged and then they locked in losses by selling to pay expenses, they would run a real risk of having long term losses.
- zhoujianfu 6y ago
  I’m on the investment committee of the board of a small school with a $300M endowment, and every year 4% is budgeted to be withdrawn to go towards school expenses. I am new, but I find it silly they pursue this very active management, diversified across tons of different (managed) funds. I feel like they should be putting everything in whatever has the highest long term return (they have access to sequoia funds and those have consistently beat the market, yet only 1-2% goes to them), regardless of illiquidity, since their time horizon is infinite. And use borrowing to handle yearly distributions. But due to the management structure (40+ board members, 8 on the investment committee, a team of 6 professionals who manage the money), this sort of strategy would never be considered “prudent” enough to make it through all the approvals needed.
  - throw0101a 6y ago
    Even most Ivey League endowments haven't beaten a 60/40 portfolio over the last ten years (the S&P 500 has been on a tear): * https://www.markovprocesses.com/blog/ivy-league-endowments-fail-to-make-the-grade-in-fiscal-2019/ https://www.markovprocesses.com/blog/ivy-league-endowments-f... A 2018 study: > Dahiya and Yermack found that the performance of the typical endowment fund [in 2009-2016] was so poor that it would have earned substantially higher returns if its trustees had followed a simplistic investment strategy of holding 100% Treasury bonds and taken no equity market risk whatsoever. * https://www.etf.com/sections/index-investor-corner/swedroe-when-endowments-lag https://www.etf.com/sections/index-investor-corner/swedroe-w... Study: * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3291117 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3291117
  - throwawaygh 6y ago
    Harvey Mudd? 300M at a small college is actually a quite large endowment, and HMC is tiny even by small college standards. The institution I work with has less than 100M and is on the larger side of small. If we had 300M and a faculty/facilities layout built for ~700 instead of ~3000 then life would be completely different. I agree with you in general -- both that the active management is dumb and also the most probable reason small colleges pursue this strategy. But HMC can probably afford investment strategies that most others cannot.
    - zhoujianfu 6y ago
      Yeah, but it seems like any sort of “permanent fund” where the timeline is infinite should be doing really aggressive, long-term, illiquid stuff, right? Investing like a 22 year old. And then any liquidity needs you need for annual distributions you handle via loans. I feel like I could make an investment product where I pay you 4% of whatever you invest, per year, forever... but you can never get your original investment back. It seems like this would be a product all endowments/permanent funds would use. And then I just put it all in the s+p 500. I guess I’d need to be the government for endowments to trust me forever though.
      - ac29 6y ago
        Paying 4% of an initial investment would over time become a relatively worthless amount of money due to inflation. You could get about that return by just buying a ETF or mutual fund that focuses on dividends without having to give up the value of your principal (which would also grow over time).
      - smabie 6y ago
        Corporate debt often looks like what you're describing. The principle is rarely called and the loan can be extended virtually forever (unless the bank decides you're too risky). There are certainly other ways a school could run its endowment, sure. In fact, the way things are usually done is perhaps far from optimal. But you don't want to that guy who gets fired because you did some crazy stuff. These institutions are perversely risk adverse, and the investment through consensus model makes it hard to do anything different.
- slg 6y ago
  The whole point of an endowment is that it is supposed to be an ongoing investment and the percentage withdrawn every year is minimal. Over a long enough time line does "locking in losses" mean anything when averaged out with all the gains? You can look at the best and worst rolling averages for various investments here[1]. The worst 20 year span for the S&P 500 is better than the worst 20 year window for bonds. https://www.thebalance.com/rolling-index-returns-4061795 https://www.thebalance.com/rolling-index-returns-4061795
- robjan 6y ago
  Depends on whether you measure the profit and loss on a first in-first out basis, which is the norm, or not. If you measure it as FIFO then it's very unlikely that you are locking in any losses and are just cashing out earlier gains.
throwawaygh 6y ago
Cash flow. Endowments are used to fund operating expenses. At all but the richest institutions, you need to think of the endowment more like the retirement fund of a retiree. You can't just not pay your faculty / demand 50% more tuition / defer fixing a roof leak for a few months just because you were down in Q2, even if you expect to be back up in Q1 of the next year.
- jjk166 6y ago
  If you expect to have the money at a future date and you can secure a low interest rate, it makes much more sense to fund operating expenses with debt than lowering future returns. Certainly for the past decade a large institutional investor with significant assets like a university would have no issue securing an extremely low interest rate.
  - throwawaygh 6y ago
    Sure. Two things: 1. Almost all colleges and universities use debt to finance capital projects. 2. At least some endowment distribution is tied to restricted gifts.

by slg 6y ago

TheCoelacanth 6y ago

Maybe for somewhere like Harvard that has an absolutely ludicrously sized endowment, but a more normal university can't really afford to absorb losses like that. They need to withdraw from the endowment every year to pay expenses. If the stock market plunged and then they locked in losses by selling to pay expenses, they would run a real risk of having long term losses.

zhoujianfu 6y ago
I’m on the investment committee of the board of a small school with a $300M endowment, and every year 4% is budgeted to be withdrawn to go towards school expenses. I am new, but I find it silly they pursue this very active management, diversified across tons of different (managed) funds. I feel like they should be putting everything in whatever has the highest long term return (they have access to sequoia funds and those have consistently beat the market, yet only 1-2% goes to them), regardless of illiquidity, since their time horizon is infinite. And use borrowing to handle yearly distributions. But due to the management structure (40+ board members, 8 on the investment committee, a team of 6 professionals who manage the money), this sort of strategy would never be considered “prudent” enough to make it through all the approvals needed.
- throw0101a 6y ago
  Even most Ivey League endowments haven't beaten a 60/40 portfolio over the last ten years (the S&P 500 has been on a tear): * https://www.markovprocesses.com/blog/ivy-league-endowments-fail-to-make-the-grade-in-fiscal-2019/ https://www.markovprocesses.com/blog/ivy-league-endowments-f... A 2018 study: > Dahiya and Yermack found that the performance of the typical endowment fund [in 2009-2016] was so poor that it would have earned substantially higher returns if its trustees had followed a simplistic investment strategy of holding 100% Treasury bonds and taken no equity market risk whatsoever. * https://www.etf.com/sections/index-investor-corner/swedroe-when-endowments-lag https://www.etf.com/sections/index-investor-corner/swedroe-w... Study: * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3291117 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3291117
- throwawaygh 6y ago
  Harvey Mudd? 300M at a small college is actually a quite large endowment, and HMC is tiny even by small college standards. The institution I work with has less than 100M and is on the larger side of small. If we had 300M and a faculty/facilities layout built for ~700 instead of ~3000 then life would be completely different. I agree with you in general -- both that the active management is dumb and also the most probable reason small colleges pursue this strategy. But HMC can probably afford investment strategies that most others cannot.
  - zhoujianfu 6y ago
    Yeah, but it seems like any sort of “permanent fund” where the timeline is infinite should be doing really aggressive, long-term, illiquid stuff, right? Investing like a 22 year old. And then any liquidity needs you need for annual distributions you handle via loans. I feel like I could make an investment product where I pay you 4% of whatever you invest, per year, forever... but you can never get your original investment back. It seems like this would be a product all endowments/permanent funds would use. And then I just put it all in the s+p 500. I guess I’d need to be the government for endowments to trust me forever though.
    - ac29 6y ago
      Paying 4% of an initial investment would over time become a relatively worthless amount of money due to inflation. You could get about that return by just buying a ETF or mutual fund that focuses on dividends without having to give up the value of your principal (which would also grow over time).
    - smabie 6y ago
      Corporate debt often looks like what you're describing. The principle is rarely called and the loan can be extended virtually forever (unless the bank decides you're too risky). There are certainly other ways a school could run its endowment, sure. In fact, the way things are usually done is perhaps far from optimal. But you don't want to that guy who gets fired because you did some crazy stuff. These institutions are perversely risk adverse, and the investment through consensus model makes it hard to do anything different.
slg 6y ago
The whole point of an endowment is that it is supposed to be an ongoing investment and the percentage withdrawn every year is minimal. Over a long enough time line does "locking in losses" mean anything when averaged out with all the gains? You can look at the best and worst rolling averages for various investments here[1]. The worst 20 year span for the S&P 500 is better than the worst 20 year window for bonds. https://www.thebalance.com/rolling-index-returns-4061795 https://www.thebalance.com/rolling-index-returns-4061795
robjan 6y ago
Depends on whether you measure the profit and loss on a first in-first out basis, which is the norm, or not. If you measure it as FIFO then it's very unlikely that you are locking in any losses and are just cashing out earlier gains.

throwawaygh 6y ago

Cash flow. Endowments are used to fund operating expenses. At all but the richest institutions, you need to think of the endowment more like the retirement fund of a retiree. You can't just not pay your faculty / demand 50% more tuition / defer fixing a roof leak for a few months just because you were down in Q2, even if you expect to be back up in Q1 of the next year.

jjk166 6y ago
If you expect to have the money at a future date and you can secure a low interest rate, it makes much more sense to fund operating expenses with debt than lowering future returns. Certainly for the past decade a large institutional investor with significant assets like a university would have no issue securing an extremely low interest rate.
- throwawaygh 6y ago
  Sure. Two things: 1. Almost all colleges and universities use debt to finance capital projects. 2. At least some endowment distribution is tied to restricted gifts.