The investment returns of university endowments remained a hot topic throughout 2007.  And their managers, such as Yale’s David Swensen, often make it into Halls of Fame of the investments world.  However, little is known of the goose that lays the endowments’ golden eggs.  While in Boston at the “unnamed absolute return event” earlier this year (see related posting), we saw a presentation by Cristian Tiu of the State University of New York (SUNY) at Buffalo.  Tiu, together with his co-authors Keith Brown and Lorenzo Garlappi, had something to say about this fabled goose.  He also brings a real-world perspective to his research from previous work at The University of Texas endowment (UTIMCO).  

The Troves of Academe – or how university endowments make their money

Special to AllAboutAlpha.com by Cristian Tiu, Assistant Professor, State University of New York (SUNY) Buffalo

In a recent paper, my colleagues and I asked what is, and then what explains the performance of university endowments.  We found that while the average endowment performance across the years has been around 10%, the risk adjusted returns (or alpha) are not statistically significantly different from zero.  Exposure to momentum stocks seems to be the main driver of the returns.  Once this is accounted for, endowments don’t seem to have – on average – any alpha producing capabilities.

However, some endowments obviously perform better than others.  Why?  To begin with, all endowments are relatively unconstrained, tax exempt and large enough to hold different asset classes; they are near academic centers; and there is a huge volume of academic literature on asset allocation.  Hence asset allocation seems to be one of the first things to look at as a possible determinant of performance.  But can asset allocation itself generate alpha?  We found that the passive hedge fund index we used to benchmark the performance of hedge funds as an asset class has positive and significant alpha.  Therefore, an endowment invested 100% in hedge funds really should have generated alpha.  So if asset allocation is “smart” enough, it could generate alpha by itself.

But does it?  Is their asset allocation “smart enough”?  And does it help performance?

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