May 24, 2014

Piketty and college endowment ROI

An economist points out:
There is a gem in Piketty's book for you on page 447. Piketty discusses returns on university endowments. Harvard, Princeton and Yale earned an average of 10% real return 1980-2010 while smaller colleges got 6-8%. Piketty shows that normal colleges invest in normal assets like bonds and stocks, while the abnormal returns for the elite colleges come from "alternative investment strategies" such as private equity, unlisted stocks, real estate etc with inside deals.  
Economics professor Pikettys naively concludes: “How can these facts be explained? By economies of scale in portfolio management.” 
This interpretation is fairly important to Piketty's model, which assumes the rich earn higher rates of return due to economies of scale in portfolio management. His evidence is college endowments. For investments funds, there is no evidence size relates to returns.

When it comes to beating the market, shouldn't it work the other way around -- with declining chances to beat the market as the number of billions goes up -- according to the Efficient Markets Hypothesis? It’s easier to beat the market if you are investing only in the highest alpha investments you've dredged up, which often are odd little assets that aren't on the radar of the Big Boys. But if you are, say, Vanguard, you can’t expect to beat the market because you kind of are the market.

If you put just $10,000 into Vanguard's index mutual fund, they'll give you a microscopic expense ratio. Warren Buffett puts some of his heirs' trust funds into Vanguard because he wants in on Vanguard's economies of scale in portfolio management. But, Vanguard won't beat the market.

Maybe some guys can beat the market regularly, but is their secret sauce really "economies of scale?"

And maybe, exclusive colleges are an interesting phenomenon because they have something to trade for tips, something that doesn't get reported on the books.

Back in February 2008, I blogged "Here's a Hypothesis, You Do the Work." There seemed to be a correlation between how hard it was to get into a college and how well its endowment manager did.
I'm sure [Yale's endowment manager is] really good at his job, but I'm wondering, though, if there might not be another factor at work in the most exclusive colleges getting the highest returns on their investments. 
Maybe they've just been piling on the excessive risk and one of these years it will all come crashing down. Maybe. 
Or, maybe, the top universities' fund managers are getting a little help, maybe they are being passed a tip or two about future financial news by the parents of no doubt worthy but not quite exceptional children in return for a little pull at the admissions office?

I haven't seen anybody look into this, so maybe I'm nuts to assume some insider trading, but it sure seems like there are wheels within wheels, and Harvard and Yale are more likely to be in an inner club than Cornell, which is more likely to be in an outer club than Gonzaga.
      

32 comments:

Anonymous said...

http://www.nytimes.com/2014/05/24/books/eduardo-galeano-disavows-his-book-the-open-veins.html?_r=0

Now that cappies are funding the 'lefties'

Anonymous said...

Yale has a famously good endowment manager in David Swensen who has been genuinely innovative. Others are trying to copy him now.

Dave Pinsen said...

You're right that, in general, portfolio size is a drag on returns - Buffett has said, for example, that if he only had $1 million under management, he could generate 50% annual returns. So Pikkety has that backwards.

But I think there's another explanation for the high stated performance of the elite schools' endowments: it's semi-bogus, because it's based in part on valuations of illiquid investments such as timberland, and those valuations are subjective and can be fudged. That's not true of liquid stocks & bonds.

Steve Sailer said...

This timberlands thing you always hear just seems like they are intentionally yanking our chains. Uh, yeah, uh, we get rich investing in ... uh ... timberlands!"

What is this, 1850 and the world can't get enough railroad ties and firewood?

Dave Pinsen said...

Well, here's an example of why I think it's BS: look at a 5-year chart for The St. Joe company (JOE), which owns a bunch of timberland and other real estate in the Florida Panhandle. It was in the investing news a lot a few years ago because a prominent fund manager, Bruce Berkowitz, had a large position, and a prominent hedge fund guy, David Einhorn, was short. As you can see, JOE has kind of been a bust since '05. If timber were such a great investment, you figure it would've done better.

Anonymous said...

What is this Pueblo Indian times? It's not like you can build houses out of wood. No woods only value was from the transcontinental railroad.

Anonymous said...

Members of Congress are just as fabulous investors as hard-to-get-into universities. Anything large that consistently beats market = insider deals. Bet on it.

Sam Hardwick said...

In the Warren Buffett biography Snowball there are some detailed accounts of how he tips Grinnell College's fund into investments he can't make himself for whatever reason (conflict of interest in one case).

Anonymous said...

I think some of the supposed better performance stems from the fact that valuations of private securities are somewhat subjective and the managers may be overvaluing the positions to get better fees.

Chubby Ape said...

Another huge goodie the Ivy League schools has to give out, apart from undergraduate admissions for the children of the Wall Street insiders, is their names. They can give gravitas and polish to dodgy oligarchs and questionable schemes. How much would a recovering boiler-room trader pay to be described in glowing terms at some "economic summit" hosted by Harvard or one of the other A-list schools? It's the modern equivalent of a rich man buying a title. The rich but oily outsider buys goodwill with a set of well-connected folks. Everybody wins, everybody's happy and wonderful new social connections are made.

James B. Shearer said...

You're right that, in general, portfolio size is a drag on returns - Buffett has said, for example, that if he only had $1 million under management, he could generate 50% annual returns. So Pikkety has that backwards.

I doubt Buffett is accounting for his time in calculating those 50% annual returns. Piketty's point is that if you only have a small amount of capital you can't afford to hire someone like Buffett to manage it. Nor will it usually make financial sense to devote substantial effort to managing a small amount of capital yourself as the added returns that you can reasonably expect to generate won't adequately compensate you for your time.

Psota said...

Don't know about HYP, but out here in Silicon Valley it's hard to avoid concluding that Stanford makes major returns on its endowment. It's a major land owner up and down the Peninsula with properties including a high end mall, hospitals, a luxury resort, etc. it was also an early investor in Google and other companies that began In its graduate departments. All of these are opportunities that the average investor would have to hope of grasping.

Douglas Knight said...

More context from Piketty:

"[a billionaire] has greater means to employ wealth management consultants and financial advisors. If such intermediaries make it possible to identify better investments, on average, there may be “economies of scale” in portfolio management that give rise to higher average returns on larger portfolios...Indeed, I will show in a moment that around the world, the largest fortunes (including inherited ones) have grown at very high rates in recent decades (on the order of 6–7 percent a year)—significantly higher than the average growth rate of wealth.

"...economies of scale in portfolio management. Concretely, Harvard currently spends nearly $100 million a year to manage its endowment. This munificent sum goes to pay a team of top-notch portfolio managers capable of identifying the best investment opportunities around the world."

He also has a chart of university endowment returns as a function of size.

Anthony said...

Any kind of real estate allows for lots of subjectivity in valuation. If you own a house which you rent out, what's it worth?

What you paid for it? What if you bought it in 2006? Or 1976?

What the tax assessor says it's worth? Even if you're in California, with prop 13?

What your bank will let you borrow against it?

Something based on your net income from the property? At what rate of return? At what vacancy rate?

At what similar houses are being listed for? How similar are they? That problem gets worse for commercial property.

You don't need something exotic like timber land to have scope for all sorts of creative accounting. The exotic stuff may have weird tax treatments that allow for even more shenanigans, though.

DPG said...

If anything, larger endowments mean diseconomies of of scale: when you try to execute your trades, the buy/sell pressure tends to move the market price against you as you're buying more and more blocks of stock.

For example, Renaissance Tech, probably the most renowned algorithmic trader, has not accepted new investors to its flagship fund for years. There are only so many arbitrage opportunities that will produce 25% returns annually.

Anonymous said...

Don't forget that somewhere along the line last century the large universities starting creating intellectual property portfolios based on the patents of their faculty.

Licensing these brings in Big Money. This includes investing in startups relating to these licenses (see Stanford in particular in Silicon Valley).

The deal at Stanford seems to be that there's something wrong with a CS professor who doesn't have his own startup(s) that he's placing his grad-students into... and of course under the watchful eye of the university Legal department, who often owns the core IP).


An example of this sort of mechanism: "Innovation marks UW-Madison contribution to vitamins, drugs, medical supplies":


"...University of Wisconsin-Madison builds on a rich history of discoveries related to drugs and nutrition: Vitamin A and B were discovered here in 1914.

...Facing considerable commercial interest... founded the Wisconsin Alumni Research Foundation (WARF), which opened in 1925 as the nation's first university technology transfer office.

...WARF remains one of the most successful university technology offices: by now it has patented 1,900 university inventions and contributed $1.07 billion to university research, programs and initiatives. In harmony with its origin, WARF's largest source of revenue has been the many vitamin D inventions by biochemistry professor...

...part of the reason why UW-Madison has a $12.4 billion annual impact on Wisconsin's economy that helps support 128,146 jobs across the state."


(UWM owns/ed the patents on putting vitamin D in milk.)

There are very tight personal links all around, with the key players often wearing many hats. (The profs are often CEOs or CTOs of their own startups and soon in position to become angel investors,as is the University.) For example, Stanford CS Prof "David Cheriton" at Stanford:

"...an estimated net worth of US$1.7 billion (as of March 2013)...

In August 1998, Stanford students Sergey Brin and Larry Page met with Bechtolsheim on Cheriton's front porch. Bechtolsheim wrote the first cheque to fund their company, Google, at the meeting, and Cheriton matched his $100,000 investment."




I don't know exactly what you call this. It's not insider trading, just being an all-around insider in the whole process and wearing multiple hats in the end-to-end technology transfer process.

Technology transfer is hard, so this collapsing of the pipe-line pays off. The whole deal might be well worth it to society. Of course, at the end of the day it is just another one of those "old boy's networks" that we hear are so evil, ugly, non-PC, and in the past. Or maybe those were just the wrong old boy's networks.

Anonymous said...

"When it comes to beating the market, shouldn't it work the other way around -- with declining chances to beat the market as the number of billions goes up "

Yes. The HYP endowments are tiny compared to actively invested capital. Fidelity Contra Fund is a relatively well know, relatively large mutual fund with investments of $80 Billion, more than HYP combined.

Also, the ever-present selection bias.

The top three colleges (HYP) wouldn't have remained the top three without their investment returns.

Anonymous said...

This timberlands thing you always hear just seems like they are intentionally yanking our chains. Uh, yeah, uh, we get rich investing in ... uh ... timberlands!"

Excellent timberland is a great investment. It is relatively uncorrelated with other investments and would make a nice addition to anyone's portfolio.

BUT ... there is very little of it. I have tried and don't like the REITs that invest in it. And it isn't like there are a lot of dumb farmers lift with large wood lots that will sell the land and let you pay for it and make an immediate profit by cutting the valuable Walnut trees.

And it isn't like Apple stock or something. It is just the possibility of moderately higher returns over long periods.

And yea ... Dave Pinsen is right, but St Joes has been a fantasy for more like decades than years. It is sort of like waiting patiently since 1961 for Cuba to open up for gambling again. A great idea that may happen in someone else's lifetime.

International Jew said...

Is that 2 percentage point difference between HYP's investment return and the rest statistically significant? Until we establish that it is, there's nothing worth talking about.

Anonymous said...

It is easy to see that Piketty has very little understanding of the real world of investing.

The entire concept of buying investment expertise that will outperform markets may be a wonderful idea, but it is harder to accomplish than just trying to beat the lottery or Las Vegas.

People have been trying to identify and purchase "alpha". Like people have been trying to find oil and gold more or less forever.

The 'after the fact' over performance of the three largest college endowments ignores the fact that if they hadn't over performed, they wouldn't be the largest. Penn and Columbia COULD have been in the top three if they had done better and HYP had done worse.

And the 2% or 3% performance over the last three decades over all other college endowments combined .... seems pathetic when they are the absolute most connected and theoretically intelligent people in the richest country in the world.

If they could package and sell their 'secret sauce' they would look more like sovereign wealth fund.

Whiskey said...

Economies of scale in portfolio management? Like Deutsch Bank? Like Credit Suisse? Like UBS? Like Lehman Brothers? Like Behr Stearns? Like Long Term Capital Management? Like Goldman Sachs? Like Citibank?

All subjects of massive bailouts or failures due to getting caught in various financial investment implosions. All with considerable size and scale of investment management.

Anonymous said...

There is a rich, fully documented history of Harvard and Yale's endowments.

I have constantly run across discussions, beginning with the chapter on Paul Cabot in John Train's Money Masters.

Paul was very vocal and never quit talking about the subject -- mostly how he was brilliant and other people were stupid or reckless. Here is his obit:

http://www.nytimes.com/1994/09/04/obituaries/paul-c-cabot-95-financial-strategist-began-mutual-funds.html

And the Ford Foundation famously promoted investments in common stocks at the height of the 'Nifty Fifty' boom of 1970.

"The performance game spread to all kinds of investing institutions. Just as some policymakers in the late 1990s were touting common stock investing as a way to shore up the Social Security system, so in the late 1960s, business managers asked whether they might be able to reduce their current retirement expenses by switching more of their pension funds from bonds into common stocks with exciting growth possibilities. Even university endowment-fund managers were pressured to strive for performance. McGeorge Bundy of the Ford Foundation chided the portfolio managers of universities:
It is far from clear that trustees have reason to be proud of their performance in making money for their colleges. We recognize the risks of unconventional investing, but the true test of performance in the handling of money is the record of achievement, not the opinion of the respectable. We have the preliminary impression that over the long run caution has cost our colleges and universities much more than imprudence or excessive risk-taking."

Anyone following Bundy's advice was led to slaughter over the next decade.

Another reason that smaller endowments underperform Harvard and Yale is that they copy Harvard and Yale AFTER their innovative ideas are no longer innovative.

I would not be surprised if the performance of all college endowment funds is similar to that of actively vs passively managed mutual funds. That is, 80% do worse than average and fail to beat the S&P 500.

And -- has anyone checked Piketty figures on endowment performance? Harvard and most (or all) of the largest endowments have publicly available annual reports. At least now. For smaller places? I don't know.

The Beardstown Ladies couldn't measure their returns until they brought in Price Waterhouse. Which showed their performance was below the S&P 500.

http://en.wikipedia.org/wiki/Beardstown_Ladies

jody said...

"You're right that, in general, portfolio size is a drag on returns - Buffett has said, for example, that if he only had $1 million under management, he could generate 50% annual returns. So Pikkety has that backwards."

bill gates has a private company of over 20 people and all they do is manage his money and they get a heck of a return and keep him at number 1. so it's not as hard as buffett makes it out to be, although yeah, it's hard moving around 20 billion or whatever, and would be easier slinging around 20 million instead.

this is why entities the size of countries buy US treasuries and other such instruments. there's only a few places to park THAT much money. volumes in the hundreds of billions range.

bill gates hit 80 billion this year, which means he's worth more than the endowments of harvard, yale, princeton, and columbia combined. a few more years of these kinds of returns and he'll be worth more than the entire ivy league.

David Davenport said...

Here's a magazine piece critical of the Yale investment model:

4/16/2012
The Curse of the Yale Model


What has been a blessing for Yale has been a curse for most other investors. In a true “me too” fashion, thousands of institutional investment funds have switched to the “Yale Model” seeking the outsized returns that the Yale endowment has enjoyed for two decades. However, after spending billions on consultants and hedge funds, most institutions have less to show than if they had bought a portfolio of low-cost index funds...

Anonymous said...

In the early 70s the stock market was overeffeicient in that you could buy a $1 work of stocks for around 70 cents. Those who discovered this did very well.

Anonymous said...

Harvard's endowment:
the endowment rose 6.5 percent, to $32.7 billion, as of the end of fiscal year 2013, this past June 30, Harvard Management Company (HMC) reported today

However: "HARVARD MANAGEMENT COMPANY (HMC) reported today that the University’s endowment was valued at $26.0 billion as of June 30—29.5 percent less than the record $36.9 billion reported for the prior fiscal year. That result reflects a negative 27.3 percent investment return on endowment assets after expenses and fees."

Harvard's endowment from fiscal year 2008 through fiscal year 2013 was $36.9 to $32.7. Ouch.

Anonymous said...

An article from Fortune ... Great School Lousy Investors:

http://finance.fortune.cnn.com/2013/10/31/harvard-great-school-lousy-investor/

"Harvard has been a virtual trainwreck. Its five-year annualized performance is 1.7%. For context, Harvard is the only one of the 25 largest U.S. college or university endowments to have returned less than 2% over that time period, with the next closest being Cornell University at 2.2%. Moreover, investment advisory firm Wilshire Associates reports a median five-year return of 3.38% for the 17 schools within its database that have endowments larger than $500 million "

keypusher said...

I haven't read Piketty's book, but I would be surprised if he had to rely on college endowments to make his case. Pretty much the first thing any investment advisor shows a newbie would-be investor is a chart of the annual return on the S&P starting in 1926 -- about 10%. I remember seeing that chart 30 years ago and thinking that inequality would always increase. The rich could invest, but the poor would rely on wages, which wouldn't go up nearly that fast.

http://financeandinvestments.blogspot.com/2014/02/historical-annual-returns-for-s-500.html

When Piketty's book came out I was surprised by all the fuss -- didn't everyone already know this?

keypusher said...

I haven't read Piketty's book, but I would be surprised if he had to rely on college endowments to make his case. Pretty much the first thing any investment advisor shows a newbie would-be investor is a chart of the annual return on the S&P starting in 1926 -- about 10%. I remember seeing that chart 30 years ago and thinking that inequality would always increase. The rich could invest, but the poor would rely on wages, which wouldn't go up nearly that fast.

http://financeandinvestments.blogspot.com/2014/02/historical-annual-returns-for-s-500.html

When Piketty's book came out I was surprised by all the fuss -- didn't everyone already know this?

Mr. Anon said...

I'd be surprised if insider trading didn't have a great deal to do with it. Academia is mostly a racket nowadays. University administrators, public as well as private, create sinecures for their pals and paramours. Student loans (publicly guaranteed) and tutition conned from the parents pays for it. Universities have become deeply corrupt and crooked.

Grumpy Old Man said...

Didn't the supposedly brilliant Larry Summers lose hundreds of millions of Harvard's endowment?

Anonymous said...

Chubby Ape has it. An honorary Ivy doctorate cleans a lot of sh!t off of a grubby Wall Streeter.