Academic excellence

19Jan07

The Economist has an interesting piece on the seemingly extraordinary investment performance of university endowments in the past decade. Some of the country’s biggest endowments, like Harvard and Yale, have also been the best performers. This high profile success has spawned wholesale changes in the way other university endowments invest.

It begs the question, what is the source of this extraordinary investment performance? The article speculates that their unique investment goals and a more free-wheeling intellectual approach have allowed them to excel. This is due in large part to their early adoption of alternative investment vehicles prior to their general use by other investors.

Their early moves into hedge funds, venture capital, private equity, property, distressed debt and the like brought outsized profits. Universities and foundations have also benefited from geographical diversification, especially into emerging markets. Foreign equity was their best-performing asset class last year, making 24.7% according to a survey by the Commonfund Institute, which manages pooled investments. Endowments have also revolutionised commodities.

The question is now that these once revolutionary investments are now commonplace in institutional portfolios can they continue to be elite investors? The article notes the difficulty in keeping investment talent in light of compensation constraints. However it highlights the question of whether there is a limited amount of alpha out there to be captured.

The always insightful All About Alpha picks up on the Economist piece as well and notes how portable alpha strategies have been at the heart of these university endowment portfolios. For portable alpha strategies to succeed there has to be sufficient alpha. We have noted on a number of occasions the challenges of generating real alpha. Generating alpha is neither cheap nor easy.

The big question for cutting-edge investors like the university endowments is whether they have already plowed the most fertile fields of alpha including hedge funds, private equity, commodities and the emerging markets? In that light, sources of exotic beta are now becoming commoditized. Absent finding new, novel asset classes these funds will need to continue seeking out managers that can be relied upon to generate real alpha.

However, the democratization of alternative investments continues apace. With the Fortress Investment Group public offering on deck, with undoubtedly more firms soon to come, everyone with a brokerage account will soon be able to invest alongside some of the same managers who were the source of university endowments’ prior success. In that light, the job of finding alpha generators may very well become more difficult.

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