The current inflationary environment, coupled with the bond market upheaval caused by interest rates we have not seen since before the Great Financial Crisis and increased global political instability, have prompted many wealthy families to search for more rewarding portfolio solutions compared to the traditional stock/bond portfolio. Some are turning to the trail blazing example of U.S. college endowment funds such as Yale’s and Harvard’s, which have been leaders in the quest for higher returning portfolios.
The returns of such endowments have been enviable. For the 20 years ended June 30, 2022, the Yale and Harvard Endowments earned annual average returns of 12.0% and ~11.0% respectively. These numbers soundly trounce the 8.3% return of a traditional portfolio comprised of 40% bonds and 60% stocks. It isn’t only Yale and Harvard that excelled — the average large U.S. college endowment returned 9.4% annually. To put this into a Canadian context, global balanced mutual funds here over the same period earned an unremarkable 5.95% per annum.
1. The 40/60 Traditional Portfolio is Not Enough
It is the thoughtful pursuit of growth that drives endowments’ stellar returns, but why exactly did endowments shoot ahead of other investors? Because, by patiently hunting for higher long-term returns, they were pioneers in moving beyond the traditional staples of publicly traded bonds and stocks by shifting into alternative asset classes. By investing in real estate, commodities, timberland, farmland, energy, infrastructure, private equity and hedge funds, they were able to create a unique blend of diversification and growth. In fact, alternative assets now account for up to 40-50% of today’s endowment assets, whereas alternatives accounted for a meager 3% in 1992. These days, alternatives are “alternatives” in name only. They are vital to superior long-term risk adjusted performance of portfolios.
2. Bonds Are Not the Low-Risk Investment You Once Thought
The painful losses of the global bond market in 2022, nearing has highlighted that bonds are not as low risk as many people thought. Instead of bonds, many endowments have turned to hedge funds for diversification and a measure of downside protection. In fact, in 2022, 22% of endowment assets were invested in hedge funds. You only have to glance at the asset mix of college endowments to see how different it is from that of the typical investor. Fixed-income assets play a minor role, constituting only 11.1% of the average endowment portfolio in 2021. As noted in Yale’s 2020 Endowment Report, “the university’s vulnerability to inflation further directs the Endowment away from fixed income and toward equity instruments. Hence, more than 90% of the Endowment is targeted for investment in assets expected to produce equity-like returns.”
3. Lengthen Your Investment Time Horizon
Wealthy families are realizing that clipping coupons from a traditional portfolio of bonds and stocks won’t cut the mustard in a period of sky-high inflation. Many are awakening to the reality they share the same challenges as college endowment funds — funding hefty and growing bills year in and year out while still wanting to build their capital over the long-term. Many wealthy investors are now increasing their allocations to private investments, hoping that these funds’ long-term horizon will offer a refuge from volatile public stocks and fixed-income. We’ve found that many of the wealthy families with whom we work are likewise lengthening their investment horizons. With their children now in early adulthood, a truly multi-generational plan is warranted. In turn, a longer time horizon lends itself to a growth-oriented investment strategy that includes a significant global equity weighting as well as alternative assets such a mortgage funds, direct real estate investment and private equity.
However, endowments’ uniquely diversified investment approach does not mean they are immune to the wills of today’s bear market. Yale’s endowment eked out a 0.08% return for 2022. “In such a volatile year for the world’s financial markets, we are pleased to have protected Yale’s capital,” said Matt Mendelsohn, Yale’s chief investment officer. “That said, we expect challenging times ahead as rising interest rates, inflation, and the geopolitical environment provide stiff headwinds.” Indeed, the lessons learned above from today’s major endowments may help your portfolio to weather the storm as well.
- Yale News, “Yale reports investment returns for fiscal 2022”, October 4th 2022.
- The Harvard Crimson, “Missing from Harvard’s Annual Endowment Report This Year: Underlying Data”, November 10th, 2022.
- Pensions & Investments, U.S. Endowment Returns Tracker, 2023.
- BlackRock, “A new era of portfolio construction for endowments”, 2021.
- Yale University, The Yale Endowment 2020.
- The Wall Street Journal, “Wealthy Investors Pile Into Private Equity to Escape Stock Volatility”, May 26th, 2022
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