(Originally published here.)
For more than 100 years, the Nobel Foundation has paid for the annual prizes in the sciences, literature and peace just by investing the original capital provided by Alfred Nobel, the inventor of dynamite. According to an article by my colleagues at Bloomberg News, however, the foundation is now considering accepting outside donations after years of poor returns on its endowment. It has already reduced this year’s prize payouts by 20 percent. The foundation might not have reached this point if it had listened to the many finance academics it has given prizes to over the years.
During the past two decades, the foundation embraced what it calls modern asset management. That worked well in the 1990s, when assets grew by about 8.6 percent each year. Between 2001 and 2011, however, the foundation earned 1.4 percent annually. Had it simply bought an index of Swedish companies on Jan. 2, 2001, and reinvested all dividends until Dec. 30, 2011, the annual average return would have been about 4.4 percent. The foundation would have been even better off buying 10-year Swedish government bonds at the beginning of 2001, which were then yielding about 5 percent, and holding them to maturity.
As a private institution with no outside donors, the foundation isn’t required to tell us exactly why it did so badly. It blamed weak global stock markets and an appreciating domestic currency. The first point may be true, but the second excuse is weak. If you are going to invest abroad you should hedge your currency exposure. The foundation’s failure to do this suggests that it was betting in the foreign exchange markets. (Or that it was incompetent, but let’s be charitable.) Finally, the paltry gains in global equities during the period could have been offset by the strong performance of world bond markets.
A recent news release provides another possible explanation. The foundation has been allocating about a third of its capital to “alternative investments,” including “properties, hedge funds, as well as private equity and unlisted bonds.” Although alternatives can sometimes boost a portfolio’s absolute returns and reduce volatility through diversification, many asset managers do nothing but extract high fees in exchange for replicating returns on index funds. This is especially true for private-equity managers, who, in the aggregate, do about as well as a low-cost mutual fund that focuses on indebted small-cap stocks.
The Yale University endowment, among the best in the business, has outperformed its peers because it is good at picking money managers. That’s great for it but bad for institutions like the Nobel Foundation, which seem to have ended up with the detritus. The following chart, which comes from the Yale Investments Office’s most recent annual report, shows how wide the gap can be between the best and worst alternative investments:
Dispersion of Returns on Alternative Investments
The Nobel Foundation could have avoided this trouble if it had just listened to the finance academics it has given prizes to over the years, most recently the University of Chicago’s Gene Fama, who won this year. You don’t need to be a religious believer in the strong form of the efficient-market hypothesis to realize that it is really hard to do better than passive indices, especially after fees. If the foundation does end up accepting outside contributions, donors should demand that it listen to the wisdom of the economists it has honored over the years and replace its alternative investments with low-cost passive funds.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)