Alternatives-heavy endowment funds keep their promise
American endowment funds delivered an average return of 5.3% (in USD, net of fees) from 1 July 2018 to 30 June 2019. This was lower than the previous year due to the decline in market returns in Q4 2018. However, endowment funds’ long-term performance remains strong. The 10-year average return stood at 8.4%, with large larger funds (AUMs of over USD1 bn) managing 9.1% thanks to a strong recovery in financial markets in the decade since the financial crisis. Larger endowment funds’ risk-adjusted returns are close to those of a 60/40 portfolio, but with higher average annual returns (9.1% versus 7.7%).
Low liquidity needs allow endowments to tolerate relatively high short-term volatility and focus on the long-term pursuit of superior returns. US endowment funds, especially the larger ones, have sizeable allocations to alternative assets, providing the benefits of diversification and a higher risk premium. By nature, alternative assets offer opportunities to exploit inefficient market pricing through active management.
Overall, except for the 2007–2009 period (the years of the financial crisis), endowment funds’ asset allocation has been very stable over time, especially for the largest investment pools. On average, institutions have held approximately 30% in alternative investments and 50% in equities, with the remaining 20% allocated between fixed income and short-term securities and cash.
As stated, the decline in US endowments’ average returns in FY2019 from FY2018 (to 5.3% from 8.2%) was largely due to the equity sell-off in Q4 2018. The S&P 500 declined by 4% over the same period (1 July 2018-30 June 2019). However, the S&P 500 posted a total return of 31% in calendar year 2019. On the basis of the market’s rebound since late-December 2018, endowments’ returns in calendar year 2019 are estimated to have been much higher than in FY2019. Our estimate, based on average asset allocations for all endowments, is for an annual return of around 14% in calendar year 2019.