A reader writes:
I’m contacting because I’ve shared your work on simple or complex investments for endowments and it looks like I haven’t missed it this year. I have shared the 2018 and 2019 articles you have done with our Foundation investment committee. I may have missed your 2020 review of the NACUBO endowment study this year.
I missed my annual review of the NACUBO 2020 endowment study.
I came into the world of endowment in the first part of my career and I always felt annoyed by the sheer amount of complexity that was used in that space. So over the last few years I’ve been comparing complex college endowment portfolios to a simple Vanguard 3-fund portfolio.1
Before you get to the performance numbers, here’s a look at college and college endowment allocations by size:
You can see the ratio of equities and alternatives to bonds ranging from 90/10 to 70/30 for these funds. This makes sense when you consider that most of these endowments are set to last in perpetuity.
Because there are differences in allocations depending on the size of the endowment, I have included a handful of Vanguard benchmarks ranging from 60/40 to 80/20 for comparison purposes:
Get another win for Jack Bogle.
The simple Vanguard three-fund portfolio not only exceeded the average endowment for 3, 5, and 10 years, but also ended up in the upper quartile during the same periods. The yields of the upper quartile of these endowments were 6.2%, 5.8% and 8.0%, respectively, during the 3, 5 and 10 years ending June 30, 2020.
Not bad for a silly index fund portfolio.
To be fair with these endowments, they must manage liquidity and cash flows. Subsequent tests do not have these restrictions. They also have to manage committees, board members, alumni, donors and many investment manager relationships.
It is not an easy task.
Low-cost index fund portfolios solve many of these problems, but they don’t magically make them go away permanently.
Managing an endowment fund requires as much political knowledge as investment skills.2
But these investment skills also don’t have to be overly complex to be successful. Portfolio management and risk are often overlooked rather than selecting the manager in terms of long-term performance.
Rebalancing is a simple risk management tool, but it can become a real source of overcoming when adhered to in a disciplined manner.
For example, these are the ten-year annual returns of the Vanguard fund portfolio for the 10 years ending June 30, 2020:
- Total US fund index: 13.6%
- Fund total bond index: 3.7%
- Total international fund index: 5.2%
If you simply multiplied the weights of the 80/20 portfolio (48% US stocks, 32% international stocks, 20% bonds) by these returns, you would get an overall annual return of 7.6%.
But the real ten-year annual return on the 80/20 portfolio is 9.1%.
How can this be?
The difference here is the rebalancing bonus. I used a simple annual rebalancing to score weights here and that made a big difference for a decade.
These are the returns of each of these funds during this time period:
At the end of the 2010 queue, the stocks experienced an intense furious result of a correction. At the end of this rally, this portfolio sold some shares to buy some bonds that had fallen far behind. Luckily, bonds outperformed 2011 by a wide margin.
Then you would have sold some bonds to buy some shares just before the shares had a recovery year in 2012 and an even bigger year in 2013.
After getting strong returns in 2019 for stocks, you would have bought better ones just before a stock market crash in 2020.
Viously, obviously, these things don’t always work so well. Sometimes what worked has been sold to buy what has been left behind and these trends are not reversed.
Rebalancing is not so much about timing the market, but about restoring the original risk parameters of your portfolio.
This is actually one of the biggest benefits of a simpler portfolio structure.
There are no liquidity restrictions on index funds. No closures. There is no 300-page brochure to read. There are no illicit funds from which you cannot get out. No wealthy portfolio manager to close their funds to “spend more time with family.”
You know exactly what these funds contain, there are daily prices and it costs nothing to change them.
It is true that there are some psychological benefits of illiquid private funds that have many endowments. It is bound to take a long-term view on private equity, venture capital and hedge funds due to the way these funds are structured.
It’s like owning a home in many ways. You don’t see the value changing on a day-to-day or minute-by-minute basis. This can be helpful in terms of long-term thinking and acting.
But it is much more difficult to rebalance these background structures. Cash flows in and out of them are erratic. They are difficult to plan. And you can’t exactly rebalance your private fund structures when markets offer a big tone or launch your asset allocation.
Rebalancing isn’t very exciting, but investing doesn’t have to be exciting to work with.
To read more:
Simple vs. Complex, 2019 edition
1As with the previous incarnations of this analysis, I used the total Vanguard equity fund, the total bond, and the total international funds (with a weighting between the United States and others at 3 to 2 in favor of the United States). , as this is approximately how these funds are). assigned on average).
2If you are interested in learning more about my views on institutional asset management, check out my short book on the topic: Organizational Alpha
Sometimes we include links to online retail stores. If you click on one and make a purchase we may receive a small commission.