Large US endowments may be posting higher returns than their smaller peers—but only because they allocate to riskier assets, research has found.
By studying university endowments—and their size, capital returns, and portfolio allocation—from 2000 to 2013, Columbia University’s Tuo Chen argued size mattered little when it came to investment returns.
“There is no secret recipe [for] outperformers,” Chen wrote. “The higher return of bigger endowments can be attributed to risk compensation rather than to an informational premium.”
When controlled for everything except size, the data showed the biggest endowment’s capital return would be 8% higher than the smallest fund in the dataset. This observation aligns with economist Thomas Piketty’s theory, Chen wrote, that capital return inequality becomes “severe” as more elite universities are able to afford the best management teams and informational advantage.
However, Chen found when adjusted for risk using Sharpe ratios, large endowments performed only as well as smaller ones, and sometimes even underperformed.
Source: Tuo Chen, “Do the Rich Know Better? — University Endowment Return Inequality Revisited”.
Furthermore, risk played a bigger role in larger funds achieving higher returns than information advantage, the author said. When using benchmark indexes’ true returns to calculate risk, the risk channel contributed an average of 3.27% to returns, compared to information channel’s mere 0.6%.
Research showed the correlation between return and size was positive during booming markets, such as from 2004 to 2008, while it turned zero or even negative during bear markets and recessions.
“This piece of evidence suggests that the bigger endowments may just surf on the wave of the market and expose [themselves] to more market risk,” Chen said.
In addition, large funds generally had a heavier allocation to risky assets such as international equity and smaller holdings in fixed income than smaller endowments, the paper said.
“People are willing to bear more risk in investments once they become richer,” Chen concluded, “and this is consistent with the empirical finding in this paper that higher capital return comes from more risk.”
Source: Tuo Chen, “Do the Rich Know Better? — University Endowment Return Inequality Revisited”.
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