The gap between top performing endowment portfolios and the median has been wide of late, and a key indicator of better performance is a 15 per cent or greater allocation to private investments like venture capital, private equity and distressed assets.
That's according to research among a universe of 453 university, college and foundation endowments by investment adviser Cambridge Associates.
The research, published in a new Cambridge report, "The 15 per cent Frontier," finds that endowment portfolios with more than 15 per cent allocated to private investments have outperformed their peers consistently, and for decades.
For the 2015 fiscal year, ended 30 June 2015, the MSCI World Index, which tracks the performances of large- and mid-cap companies across 23 developed countries, returned -0.32 per cent. For the same period, the median return of the endowment universe was stronger at 1.3 per cent. Looking only at endowments with 15 per cent or more of their assets in private investments, the median return was much better at 3.6 per cent.
"The performance impact of substantial allocation to private investments is striking. And it's not just a recent, or occasional, phenomenon," says Philip Walton (pictured), president of Cambridge Associates. "It has been true with significant consistency over the long term, based on data we've collected since the 1970s."
"Not only did institutions with more than 15 per cent in private investments outperform over the past five and 10 years, but they also outperformed by similar margins over the past 15- and 20-year periods. In fact, over the 20-year period, endowments with over 15 per cent allocated to privates outperformed those with less than 5 per cent in privates by a cumulative margin of 182 percentage points, or 180 basis points per year," says Walton.
For the 10 years ended 30 June 2015, venture capital, private equity and distressed securities were the three best performing asset classes, with annualised returns of 12.6 per cent, 11.4 per cent and 10.4 per cent respectively, each outperforming the equity and bond markets on an equivalent basis. The top-performing quartile of endowments had, in the same timeframe, an average private investment allocation of 24.1 per cent, while the bottom quartile only had a 6 per cent allocation, according to the paper.
"It's important to note that the group of endowments with more than 15 per cent in private investments is no longer limited to a handful of very large universities and foundations. For the 2015 fiscal year, almost 40 per cent the report's endowment universe, 174 institutions, reaped the benefits of this larger private investment allocation," says Walton.
"The three main concerns institutions express about adding private investments at a level that might boost returns are a concern about illiquidity, which is a component of long-term commitments to private investments; the belief that private investments can only be made successfully by large institutions with the scale and resources to build a diversified program; and the sense that few investors can access the limited group of top-tier private investment funds essential to a successful programme," Walton says.
"These concerns are certainly understandable – but they are often over-stated. We believe they do not, for most institutions, preclude a private investment allocation of 15 per cent or more," Walton adds.
While the report says every institution with an endowment needs to be certain that the liquidity in its portfolio is adequate for all likely cash flow needs, it also points out that many institutions place a value on liquidity that exceeds actual cash needs, even in worst-case scenarios.
"Many institutions may find that a higher private investment allocation is well within their tolerance for illiquidity," Walton says.
When it comes to concerns about endowment size, the report points out that a number of the outperforming endowments in the report's universe – those with 15 per cent or more in private – are relatively small. Of the 174 in the 2015 top-performing group, 48 have assets below USD500 million, including 26 below USD250 million.
"And the view that private investing requires access to a very small group of tightly closed top-tier firms is a somewhat dated view of the private investment industry. As it has grown and developed, new and developing venture capital funds have frequently appeared at the top of the lists of vintage year returns, often outperforming established funds," says Walton.
