Vanguard has an interesting whitepaper out about how Endowments performance differs based on their size (sorry all those in the, “it’s not the size of the boat, it’s the motion of the ocean” camp… the large ones do much better), and there’s some interesting tidbits in it even though it’s a glorified ad for the type of low cost indexing Vanguard is known for. But instead of their normal tilt toward the retail investor, they’re targeting the endowment space – breaking down small, medium, and large endowments vs low cost index funds and concluding that small and mid size endowments shouldn’t try and replicate large endowments success – they should just do low cost index funds (otherwise known as talking your book).
First, some of their cool charts:
- Endowment breakdown (90% of all endowments are small/large)
Chart Courtesy: Vanguard
- The growth of Alternatives amongst Endowments of all sizes, with Large Endowments having moved significantly above 50% after 2008 and having stayed there.
- The huge outperformance, and current underperformance of large endowments versus the traditional 60/40 portfolio:
(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Vanguard
We applaud Vanguard for the piece, and for the thoughts it brought to mind… including in no particular order the following:
- When do alternatives start to lose their name… If 60% of a portfolio is alternative, then it’s not so alternative… it’s the core holding.
- A lot of the Alternatives they talk about aren’t so alternative. See our “Truth and Lies in Alternative Investments” for more on how some of these aren’t so alternative.
- While the rolling 5-year Annualized returns might have suffered in 2012 and 2013, how about Yale and Harvard’s huge outperformance of the traditional 60/40 portfolio over the past 25 years highlighted on page 2. Yale has done about 5% better (per year!) and Harvard 3% better (per year!) over the traditional 60/40 portfolio.
- This whole exercise ignores RISK… and assumes small and medium size endowments are after the highest possible returns, only. There is a chart showing sharpe ratios, but it has well known problems (see here and here).
- This whole exercise ignores the fact that we’ve been in a 40 year bull market for bonds, across the entire history of this study, skewing the “40” in the 60/40 portfolio beyond what one could reasonably expect moving forward given how low interest rates are.
- They conveniently leave large endowments out of their chart showing endowment returns (and sharpe) against low cost funds.
- This is quite the opportune time to be highlighting a non diversified portfolio versus the 60/40 portfolio, given it has been one of the best 5 year runs perhaps ever for the 60/40 portfolio. The comparables won’t be as rosy when looking out 5 years from now, when aren’t coming off the 2009 lows.
- Digging in a little deeper on Figure 5, showing the excess return of small and large endowments over 60/40 portfolios – you can see that the endowments out perform during low periods for stocks (2000-2005 and 2008) and tend to underperform during big moves up in stocks (late 90’s, past 3 years). This is not by accident – and it’s only to be expected that when allocations to alternatives get bigger, the performance will deviate from the 60/40 performance more and more. The endowments aren’t diversifying into alternatives in order to beat the 60/40 portfolio during bull markets. Their diversifying in order to avoid being down -50% during down turn.
All in all, this looks to be another argument that diversification is dead. Call us skeptical, but we always get a little nervous when hearing “this time is different.”