3 ways to keep endowment investment returns real in 2021

Capital markets are ever-changing and evolving; endowment management must evolve as well
By: | March 8, 2021
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Nolan Bean

Developing an investment strategy for a higher education endowment can seem very complex, however the goal is remarkably simple: generate a real (before inflation) return equal to or greater than the amount spent to maintain purchasing power over time.

In fiscal year 2020, the average effective spending rate was 4.6%. In hindsight, it seems simple enough to achieve a real return, but the current market set up will likely make this goal more challenging in the coming decade.

For more than a century, a simple allocation of 60% U.S. equities and 40% bonds offered a real return of 4.7% on average. This is remarkably similar to the goal for endowments.

Sadly, starting asset prices matter, and since 2000 there has been an increase in the prices of both stocks and bonds. Because prices are inversely related to returns, higher prices will likely decrease future returns.


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At present, a 60/40 allocation is poised to deliver a return of roughly 1% real from current market levels, falling well short of the 4.6% goal.

While that backdrop paints a rather bleak picture, there are some opportunities one can seek out, and other situations one can avoid, to increase expected return. Below are three items to consider for fiduciaries overseeing endowment management.

1. Don’t be passive-aggressive

Many consider a passive index fund investment to be inherently low risk. However, as indicated above, in the context of achieving your organization’s return goals, we believe there is a great deal of “goal” or mission risk in simply buying the market index today.

Additional factors that add to risk include:

  • The first factor to consider is concentration risk. Five stocks make up more than 20% of the S&P 500 Index; an allocation to an index fund could create an unintended bet on those larger names.
  • The second factor is skyrocketing valuations. Tesla has been included in the S&P 500 Index with a valuation of 192x forward price/earnings ratio. As context, the average valuation over time has been in the 15-20x range for the market.
  • One last factor to consider is the impact of retail investors. Recent events such as WallStreetBets on Reddit and Robinhood indicate that retail investors are re-entering the market in force, heavily impacting trading volumes and stock price volatility, which influences the return of index funds.

2. Consider specialists vs. generalists

While the risks within broad market indices are real, we should caution that taking a more active approach to investing is not always easy.

One approach we believe has merit is to search out active managers with a clear focus who specialize in a small subset of the market they know incredibly well (and where specialized knowledge is important). One such example is healthcare in general, and biotechnology in particular.

Specialization is also important in other areas as well. This can include other sectors where technical expertise is important, including technology or renewables.

It is important outside of just sectors, however, and could include country expertise for example when investing outside of the U.S. in countries like China. Lastly, specialization can occur by types of transactions including distressed investing.

3. Go private

For long-term pools of capital with the ability to take on illiquidity, the investment landscape opens to include both public and private assets. A study of historical endowment performance shows that many of the best-performing endowments over the long term have large allocations to private assets.


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This is not a free lunch, however, as private equity and other private assets are attracting large inflows of capital, which may increase prices and decrease subsequent returns. Lastly, it is important to note that manager selection is paramount in private investing; skillful sourcing and stringent diligence is required.

Capital markets are ever-changing and evolving, therefore endowment management must evolve as well. While the pickings are slim in traditional stock and bond markets, there are other approaches and strategies available to skillful investors of endowment assets.

Ultimately, keeping your eye on the prize and focusing on the most reliable ways to generate real returns is necessary to sustain your organization in support of its mission for decades to come.

Nolan Bean is head of institutional investments at FEG Investment Advisors.