Monday, January 29, 2007

Alpha in University Endowments

While I'm sure most of my readers have already devoured this piece at The Economist, I want to take it from a different angle. (Thanks to Abnormal Returns for the lead in analysis that started me down this path.)

First, I have to say that I love this line:

"Perhaps they can stay solvent longer than the market can stay irrational."

We shall see.

Anyway, we all know the story of the big endowments. The Economist article throws out a few stats to help support that story - the big funds have the best returns from employing the best, most swashbuckling managers and occasionally even paying them well. (I'm sure Jack Meyer might disagree with that assessment, which is the cause of the "occasionally" in that sentence.)

But what about the smaller endowments, the ones not blessed with the girth of Harvard, Yale, Stanford, Duke or MIT? How are they looking on the alpha generation front? I imagine the picture is not as pretty.

I stumbled across this link while doing a search on the topic of the endowment of the university I attended (Howard University in Washington, DC). A few hundred million in your endowment does not provide access to the best resources, the best talent, or the best vehicles, clearly. So how does a small endowment go about generating returns even approaching those of the the largest endowments? Is it even possible? I mean, if Meyer's guys could take enough flak to make it more worthwhile to leave Harvard, how is a small private university, or an HBCU, supposed to attract the talent necessary to drive the returns of its endowment?

Now, of course, the answer is probably "it isn't supposed to". That leaves these institutions even more beholden to the well known public markets - equities, bonds (maybe, especially Treasuries), and the other usual suspects. However, participation in true alternative investment markets remains sorely lacking, I'm sure.

A small university endowment (< $1B) should have some flexibility to generate better absolute, risk adjusted returns, however, even if not being able to exploit the same level of alpha generation as the big boys. There are (unfortunately?) hedge funds in this size range. Maybe the optimal approach is the application of so-called "portable alpha" strategies? Maybe its about shelling out the extra compensation for the proper talent, even if it is a small group of individuals (ex-Amaranth traders, maybe)? Of course, the numbers could get big quickly, and if Harvard alumni had the temerity to protest the compensation of one of the best (THE best?) manager in the endowment universe, how can a small liberal arts school or HBCU even fathom hiring a team of such people. How much risk is there for a college or university president, at this level, of such a move?

Anyway, this is something that bothers me on a personal level. Although it fundamentally has little to do with alternative investments and access to them, that is a symptom of a much more pervasive problem. I don't believe it to even be a "race" issue (in the case of HBCUs). It is really a class and size issue. But I still don't like it.

Whew! Finally done. Until next time, gentle readers...

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