Are Harvard and Yale Overpaying Their Money Managers?

(Originally published here.)

Money managers who handle university endowments tend to be the highest-paid employees on campus. (Executives at Harvard Management Co. earn multiples of what Harvard University’s president takes home, for example.) Now a new report from the National Association of College and University Business Officers and the Commonfund Institute reinforces what has been pretty clear for some time: Rather than earning their pay and delivering the superior returns universities are seeking, many of these golden boys (and girls) are underperforming simple index funds.

When it comes to investing, the general rule is that you get what you don’t pay for. It’s hard to make money by actively betting on the direction of stock prices, interest rates, exchange rates and commodity values, so most investors are better served by holding a diversified basket of assets and minimizing fees, taxes and transaction costs.

Yet for the past 25 years or so, university endowments have gone in the other direction. The average school now allocates more than half of its portfolio to private-equity firms, hedge funds and other alternative money managers. The expectation is that the high fees — typically 2 percent on assets under management plus 20 percent of profits — are outweighed by higher absolute returns and diversification benefits.

This hasn’t worked out so well. After fees, the average endowment portfolio generated about 7.1 percent a year from mid-2003 through mid-2013. (The actual size of a university endowment is also affected by disbursements and donations, which weren’t counted in this study.) For comparison, an investor that had simply bought the Standard & Poor’s 500 Index and reinvested the dividends in the index would have made 7.3 percent a year, according to data compiled by Bloomberg News. To be fair, the Harvard and Yale endowments generated average annual returns of 9.4 percent and 11 percent during that 10-year period.

For the five years ended in June, the typical endowment has underperformed the S&P 500 by an average of 3 percentage points a year. (Harvard and Yale did worse than average during this period. Data from annual reports show that Harvard generated annual average returns of about 1.7 percent, while Yale’s portfolio generated an average of about 3.4 percent.) In other words, universities would have made more money — and saved themselves a lot of trouble — if they had just invested in a simple index fund and gotten rid of their expensive endowment managers.

The earliest adopters of the so-called Yale Endowment Model were successful in locking up capital with the best money managers in the 1990s and early 2000s. That led to impressive gains — particularly in the aftermath of the late-1990s equity bubble — which other institutions tried to mimic. The average school now allocates more than half of its portfolio to alternatives. (The biggest endowments allocate a larger share than the smaller ones.)

To be fair, absolute returns aren’t the only thing that investors should care about. Volatility also matters, especially for institutions such as Harvard and Yale University, which use their endowments to fund as much as 40 percent of annual operating expenses. Unfortunately, there is no evidence that diversification into alternatives did much good. Drawdowns on endowments during the financial crisis were often the same as, or bigger than, they would have been had the schools held a simple portfolio of stocks and bonds. Making matters worse, alternatives often can’t easily be turned into cash when you need it, forcing schools to unload more of their liquid assets.

Here’s another oddity: Small endowments (less than $25 million) devoted just 11 percent of their assets to alternative managers from July 2012 to June 2013 and had the same returns during that period as the schools with endowments of $1 billion or more, which allocated 59 percent of their money to alternatives.

So how much longer will our elite universities, many of them publicly subsidized, continue to waste money on underperforming endowment managers?

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)

To contact the writer of this article: Matthew C. Klein at

To contact the editor responsible for this article: James Greiff at


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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