February 26, 2008

Here's a hypothesis, you do the work

There's been a lot of attention paid lately to the vast endowments piled up by the most prestigious universities. Harvard's endowment recently hit $35 billion, which generates so much return each year that tuition is an afterthought in Harvard's budgeting process.

One reason is that Harvard graduates tend to be richer, so they can afford to give more to dear old Harvard. And people try to get their kids in by giving money. Another reason is that a lot of charity is just an excuse to get together with rich and influential people. Where are you more likely to meet a useful business contact -- at a fundraising cocktail party for Cal State Northridge alumni or for Harvard alumni?

But, something else that has been going on is that at least some of the most exclusive, most famous universities have been earning remarkable returns on their investment. Harvard earned 23% on its endowment in the fiscal year ending last June. Yale's endowment manager wrote a book on how he beat the market for some incredible number of years in a row.

I'm sure he's 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?

Somebody might want to see if there is a correlation between endowment ROIs and various measures of admissions exclusivity, such as are collected by USN&WR.

My published articles are archived at iSteve.com -- Steve Sailer


Anonymous said...

i think it is largely a function of how old the school is, with older schools being more "on the ball" when it comes to block & tackle basics like endowment management. so, if you have a responsible program in place since 1950, get burned in the 1970s (ie, learn your lessons), and then fix your foolish errors just in time to participate in the greatest bull market of all time (1984-2001) while taking advantage of all the clever innovations your graduates have come up with ("alternative" investments and cross-asset diversification), well, I can imagine how they would do much better than average. But being first, rather than smartest, is a big part of the advantage.

Anonymous said...

You know, there's an obvious explanation here.

If the best schools really do get the kids with the highest IQ's, and if IQ does correlate almost perfectly with income & wealth, and if high IQ alumni donate at least proportionally as much to their alma maters as do low-IQ alumni to their alma maters, then it would stand to reason, that, over time, the best schools would be hauling in the most loot.

You know, I bet that Michael Jordan wasn't much more than 5% or 10% better in any one skill than was Dominique Wilkins, or Scottie Pippen, but that slim percentage advantage allowed him to be the greatest player who ever laced up the sneakers, and left them as merely very competent also-rans.

Likewise, a person with an IQ of 150 is only "7%" smarter than a person with an IQ of 140 [10 / 140 = 0.7142857], but maybe that's all the margin you need to pull away in the limit [as money making endeavors tend to infinity].

PS: I know this isn't quite the point you were trying to make, but, at the same time, you musn't be scared of following your arguments to their logical conclusions.

I.e. if high-IQ people really are better at making money than everyone else, then, well, in the long run, they're gonna end up with most of the loot.

Anonymous said...

I think the returns are just too high and too consistent to be plausible. Are the Harvard/Yale managers so much better than the Goldman Sachs people (who get paid more)?

I suspect there's another factor at work. Doesn't Harvard "farm out" most of its holdings to other fund managers and just "manage the managers"? And if you're one of those outside managers---with children planning to apply to Harvard---wouldn't you "make sure" that Harvard's money did very, very well, and never suffered any losses? After all, if you're a wealthy fund manager, having your son or daughter admitted to Harvard is worth a lot more to you than ticking off some pension fund with some "bad luck" investments.

Anyway, that's my guess.

Anonymous said...

Maybe they've just been piling on the excessive risk and one of these years it will all come crashing down. Maybe.

You are channeling Nicholas Nassim Taleb and the Black Swan. NNT is of the opinion that securities investors operate under the illusion that they can beat the market consistently -- nothing new there, just standard efficient market theory -- but NNT has a twist. He feels that it is only a matter of, by definition, unknown time, before a Black Swan event occurs. Therefore successful investors now are borrowing against their future losses.

If you haven't read the Black Swan, you really should. Much of it is applicable to the subjects you routinely write on.

Anonymous said...

In Harvard's case, it helps to have participated in the looting of the Russia at the collapse of the Soviet Union. Do some Googling to find some shady characters associated with Harvard and Russia.

Antioco Dascalon said...

I agree with rku. It seems fishy. If they really could pick winners at this rate over market averages, they could make 10-100x more working on Wall Street. Perhaps they don't have to pay transaction costs? That can eat up a lot of gains. Still, they seem to be making much more than other large non-profits.

Anonymous said...

The answer is Private Equity. Harvard and Yale were two of the earliest endowments to invest in private equity vehicles when those investments generated high returns. Now, other endowments and pension funds are doing so, but of course, the market is now in a down turn, and it's harder to find new investments that generate those returns.

Ali said...

Yale and Harvard's endowments don't depend much on tapping connected people for inside info. They decided to focus on asset allocation rather than stock-picking and invested in real estate and private equity when nobody else was. Their advice to private investors is to essentially ignore managed funds and put relatively equal proportions of money into domestic stock, foreign stock, bonds and real estate.

Anonymous said...

Harvard and Yale have been generating such outsized returns, and their network is so good, it may seem this is how they make money, but the problem is, when you make money on size, secrets are not so important. That is, if I tell you the XM and Sirius merger is going through, that won't do much to a $15B fund. But their outsized returns are curiously large.

As per Taleb, I think he's a crank, who makes a bunch of inconsistent and untestable assertions and tries to make them profound (eg, 'we don't know what we don't know'). See this review here

Unknown said...

This is why I'm opposed to giving tax breaks for charitable deductions. Rich people give to charities that benefit other rich people, like Ivy League Universities, art museums, etc.

Anonymous said...

Here's a partial explanation: some of the returns are due to allocations to illiquid investments, where annual return calculations are somewhat subjective. The big endowments aren't putting all of their money with managers who invest in publicly traded stocks; some of it goes to alternative investments such as real estate, venture capital funds, etc.

When you are running a portfolio of stocks, your annual return calculation is easy to verify. If investors know your holdings, they can go to online and see what the market is willing to pay for them. There isn't such easy price discovery with, say, a venture capital investment, or a thousand acres of timber lands, since there isn't a liquid market for them. So somewhat subjective methods are used to appraise their value.

Anonymous said...

As a follow up to the suggestion that influential alumni are giving inside info, here is a blog post describing US Senator investment aptitude:


I know this post is just paraphrasing the real source of the data, but it matches the articles I remember from a few years ago.

Anonymous said...

I'm pretty sure the Harvard numbers reflect astute mgt.; first of all, part of the excess return results simply from investing more in equity and alternative investments vs. less volatile but lower yielding (Treasuries, straight bond investments, etc., allocations to which are often made by conservative trustees, yet non-sensical for a long-lived investment fund) and it's plausible that a fully rational, high IQ approach could account for the remaining difference. The high 2007 return of 23% probably resulted from astute, but risk controlled credit market investments (where harvard has had a hedge fund style approach) which paid off when subprime mortgages lost value. The increased asset base suggests Harvard's excess return will drop going forward. Ever-naive academics have always had it wrong; truly massive opportunities for excess return existed in the 80s and 90s, when efficient market theory was orthodoxy; the market "anomalies" literature and academic exploration of inefficiencies has now become mainstream, but the increase in astutely managed funds (resulting from growth in hedge and private equity funds) has reduced opportunities. One of the most positive developments in america in the last 20 years has been the increase in astutely managed capital (which anyway has always been a strength vs. Europe and Asia). It's not just the benefit you get from, say, a private equity fund improving mgt. of a particular firm, but all competitive firms are forced to match the effort, astuteness, etc. in order to compete. anyhow, harvard's endowment isn't going to implode and even ordinary returns should be sufficient for a handsome funding of the university for the forseeable future. If only Summers had played it better politically, a lot more of that money would probably have been dumped into science research; well it was a rare planetary alignment of astute endowment mgrs, an astute university president, and astute scientists; like a blown bubble, it couldn't last.

Anonymous said...

Hedge funds are a lousy investment if you pay 20 and 2, but they give discounts to prestigious colleges so that they can brag about having them as clients. A diversified portfolio of non-fraudulent hedge funds with low management fees is a pretty good investment.

Anonymous said...

I have intimate knowledge of this subject, so here’s my chance to repay Steve for the great insights I’ve read on his blog.

>>The answer is Private Equity.
That’s part of the answer. Endowments (and other large institutional managers) have access to asset classes -- like private equity, venture capital, and hedge funds -- that others, especially retail investors, do not. There is considerable opportunity for higher returns in these asset classes b/c their markets are far less efficient than, say, the U.S. stock market. On top of that, endowments have access to the very best managers operating in these markets. Their access comes from a variety of reasons, among which (1) endowments were among the first to invest with these managers, and (2) endowments have a reputation for being long-term investors with stable commitments to a given asset class (unlike pension funds, for example), which managers find attractive. The issue of first-mover advantage is important in terms of access: this is why you see the larger endowments generating better returns than the smaller ones – b/c they were there first.

>>And if you're one of those outside managers---with children planning to apply to Harvard---wouldn't you "make sure" that Harvard's money did very, very well, and never suffered any losses?
Doesn’t happen. The process is way too transparent, with independent auditors looking over the books of the managers and the endowments. Besides, these managers are all Ivy League graduates themselves (usually at both the undergrad *and* MBA level). They do not need some jerk in the endowment office, who typically has no pull with admissions, to help get their kids admitted.

>>... but they give discounts to prestigious colleges
Very rare. Discounts on fees are usually negotiated only when the endowment is a lead investor, i.e., takes an unusually large position with the manager. It's essentially a volume discount. Plus, the endowment is taking on some reputational risk by linking itself so closely with a money manager, for which it ought to be compensated.

There is no shady business going on. Endowment returns are generated from a better mix of asset classes and from access to the best-performing managers.