Intro – understanding endowments unique opportunities and constraints
Marcus Schafer (00:01)
Hey everyone, welcome back. Today is me, Marcus Schaeffer, Greenspring’s Director of Growth, here with Pat Collins, our CEO. We’re going to start today off with a quote and then quick discuss it. And that quote is, I have seen further, it is by standing on the shoulders of giants. By Sir Isaac Newton. One thing we do at Greenspring all the time is we’re looking for the best research, the best ideas, the best people that have done this before. What lessons can we learn?
Today we’re going to talk about endowments, what lessons can we learn, what lessons can actually apply to the investors that we work with.
Patrick Collins (00:43)
Thanks, Marcus. Yeah, it’s, it’s always interesting looking at some of these endowments that are managing billions and billions of dollars have employed some of the smartest people in the industry. So as you would expect, not only Greenspring, but many in the industry want to understand what they’re doing, why they’re doing it, how they’re doing it. So I think we’re going to dive into that. Hopefully we can talk about.
the lessons we’ve learned looking at endowments and also maybe some things that you should be thinking about that maybe don’t make sense for you as an investor that has different constraints and needs and whatnot than maybe an endowment for a university or a nonprofit or some other large organization. So looking forward to getting into the conversation.
Marcus Schafer (01:26)
Yeah, it’s a, endowments are really fascinating because one, it’s like a biography. You never read a biography of somebody that’s not famous, right? They only write biographies about famous people and we only read biographies about famous people. So why are we looking at endowments? Well, it’s because they’re famous. It’s because they’ve had awesome, absolute performance. And as such, that kind of attracts
a lot of people to understand, what are they doing that’s really, really interesting? I do think it’s a little bit of a misnomer because endowments is an incredibly broad group of investors. They’re not all the same. So Pat, maybe you can talk about some of the differences of endowments.
Patrick Collins (02:15)
Yeah, we’re lucky enough at Greenspring to work with many endowments, foundations. So I think you find some, and maybe the majority I’ve found that we work with tend to be set up to fund some kind of long-term goal operation of an organization. So it could be, if it’s a university, maybe it’s funding scholarships or funding a program at a university. If it’s…
you know, at a, you know, a larger maybe nonprofit organization, it might just be a lot of them are being used to supplement their operating expenses. The organization doesn’t raise enough money to run their organization just from maybe donations. So they need to have an influx of, you know, cash flow from the endowment and they set that up. And then others, you know, you’ll see even individual families that will put together foundations, you know, maybe they have a liquidity event, they sell a business, they have
a lot of wealth and they decide they want to give back in a more perpetual, meaningful way and they’ll set up their own family foundation, typically, maybe going with the wishes of the family, not necessarily funding an actual organization, if it will. So that might be whatever their particular charitable intent is. So I think there’s a lot of different types of endowments and foundations that are out there. They tend to be
others focused, I think that’s the commonality is that they’re there to serve a greater purpose, hopefully to make the world a better place in some way. And they also have some other unique characteristics that we as individual investors don’t really have. I think some of the ones that are really evident would be the fact that they don’t pay taxes. That is a…
massive structural difference that they have. And that’s actually, if you kind of read through some of the news out there, there’s certainly politicians that don’t like that aspect of certain foundations and endowments, and they want to try to change that. But for now, under our current tax code, they can invest in ways and not have to worry about tax ramifications. You and I and all of our clients that are individuals and families, we don’t have that luxury, we have to think about after tax returns. I think the other thing
just on foundations versus individuals that we want to just keep in mind is that foundations, and we’ll probably come back to this, but foundations have a perpetual timeframe for the most part. So most of the time they say this thing should be lasting as long as the organization and because maybe that organization hopefully has a long-term succession plan in it that’s going to stay around for a long time, that you want that endowment to last forever. So whereas you and I, we have our families and maybe we want to think about
generational wealth if we have a lot of wealth, but for most people, they care about their own lifetimes. I want to make sure my money lasts as long as I do, and that’s probably a factor in how they invest their assets. So I think it’s important that we not look at foundations and down and say, want to replicate exactly what they’re doing because we’re not like the foundation in several different ways that I just mentioned.
Marcus Schafer (05:26)
Yeah, it’s great. I’ll kind of summarize, you know, purpose to serve others. They have this huge longevity aspect, right? Where it tends to be perpetual in nature, but at the same time, they need cash flows today. Now, why is that interesting to study? It’s interesting to study because you can make decisions differently knowing that you have this really long time horizon. Maybe, maybe not because you kind of…
for that to assume you have the same manager in there for that same time horizon and managers turn over. So that’s maybe not it. And the other thing I think is really, really interesting is the independent nature of these foundations and endowments where it really is, hey, it’s not an asset manager trying to sell you something. It’s people out there trying to make really good decisions. And it’s one of the few lenses we have where we can go out there and look and say, how are people assembling?
the best of what everybody else is producing. So I think that independent aspect is at least interesting for me. And as you mentioned, the needs of the endowments, the spending, there’s a huge variation. So we tend to focus on kind of what I’ll call elites and how the academic literature describes elites. You have your Ivy Leagues. They also sort by SAT scores and say, hey, give me the
highest SAT scores or size of foundation is another way. And that’s what a lot of the focus from the media is on. But if you kind of go behind the scenes, we have data on another 750 foundations and endowments that aren’t there. And then that’s just people that want to willingly report. So there’s this whole cross section of investors that have different spending needs and have different timelines.
And so their portfolios are going to look different. So we talk in averages, but I think it really is important to recognize that everybody is unique. Every institution is unique. So we should expect their portfolios to be unique.
Patrick Collins (07:34)
Yeah, I agree. think in doing this research for this podcast, it’s been interesting to dig in a little bit deeper into the numbers of what’s happening in the endowment world. And, you know, to your point, there is some big differences. I think that was one of the things I took away was that there is not a one size fits all, that there’s obviously different sizes of endowments, there’s different styles, they’ve approached it differently. And I think one of the things I’d love to
Performance or Process1 – process and governance offer more tangible lessons for investors
dig into a little bit in this podcast is what can we learn from these different foundations that we can take away as investors and implement in our portfolios, but then also just understanding maybe the differences in how they approach things and how there isn’t a one size fits all. So maybe we could start by talking about what are some of the major things that we could learn.
that maybe that we learn from foundations and endowments and what we think investors can learn from it. So anything, any takeaways on your end that you think we should be starting with?
Marcus Schafer (08:39)
Yeah, I think for me, there was two major takeaways. There’s process and there’s performance. And when you get into finance, everybody wants to talk about performance. But what’s fascinating is the more you get into it, the more you learn, it’s all about process. The more you think, Hey, this is a really cool thing that somebody’s doing to invest. It’s pretty legal. It’s pretty technical. It’s not, Hey, I have this great idea. Let me go invest in it. So for me.
What was fascinating more so was, can we learn from the process of these endowments? What can we learn from the successful one? How do they go about managing portfolios on a day-to-day basis? And then what are some of the lessons we can learn from performance? And really it’s, what can we do? And what, as you mentioned earlier, is just unique to them that, you know, the world’s not fair. We don’t all have the same advantages and it’s okay.
So maybe we could start with process just because I think that’s actually the more relatable, even though it’s probably not as much fun to talk.
Patrick Collins (09:48)
Yeah, the governance of an endowment or foundation is really interesting. And I agree with you that that is probably the biggest takeaway for individual investors is how can you take some of the governance and structure that they put in place and process they put in place and bring it down to your portfolio. I think this is something we talk about all the time at Green Spring in our investment committee and how we manage portfolios. I think
You know, it’s interesting that we’re having this podcast today. had two meetings yesterday where I was able to sit in on two of our foundation institutional clients investment committees. And that’s typically how these endowments and foundations work is there’s a committee that is in charge of making decisions on behalf of the overall endowment. And I think it was a case where process saved them to a degree in both cases.
both endowment committees were really talking quite a bit about interest rates in this example of they saw interest rates, thought they were going to rise. They said, maybe we should reposition our bond portfolio in light of that. And we were able to take them back to kind of our governance and our process, which we have an investment policy statement, which is just a standard document that most of these organizations develop that helps them make decisions on things like
when to rebalance, to allocate, how to allocate assets, how do you hire and fire managers, when you make changes, things like that. And in both cases, we were able to kind of say, you know, is this in line with our investment policy statement? And it wasn’t. And so we’d have to have changed that document, changed our governance. And I think they came back and realized, you know, this maybe isn’t the right time to do this or the right way to do this. And I think
what it came down to was they were, and I think this is where investors have to be careful, they were making decisions based on a prediction of the future. And that is really, we’ve talked about that in prior podcasts, how hard that is. That’s why to have this governance and process in place to try to stop you or curb decision-making that maybe is bad decision-making. And I think that
really is what the purpose of it is, is to help you make better decisions if you have good governance and good process in place. you know, I talked to, you when we were talking to these committees, I said to them, I don’t know what the future is going to look like. I don’t know what the next six months of interest rates are going to look like. None of us do. And so we need to make a good decision for the endowment today based on the information that we have. And I think we have put a lot of thought and effort into our process. We should follow that.
Unless something has changed with our overall cash needs, cash flow in and out of the endowment, there hadn’t been. was just, it was in 100 % of prediction of what was going to happen. So it comes back to again, something we talked about in a prior podcast of decisions and results. And I think good process will lead to good decisions. Good decisions don’t always equal
Good outcomes though, that’s the challenge. Because we deal in such uncertainty and such to a degree randomness in the short term, we don’t know what the outcomes are always gonna be. But again, if we make good decisions by having good process and we do that over and over and over again, the averages start to work in our favor and we’re gonna have good outcomes over time. But if you just look at one thing in isolation, it’s really tough to say a good decision will lead to a good outcome in every single circumstance.
Marcus Schafer (13:30)
Yeah, it’s a fantastic example of separation of powers in action, right? Your main focus should be on how can we think about our spending plan? How can we think about this investment policy statement? And our main focus should be on, how do we manage this with the highest likelihood of success? And that separation of power, sometimes that breaking of the emotional aspects can be super, super beneficial because you allow and enable the best idea.
Spending Policies1 – how separation of powers enables sustainable withdrawal rates throughout market cycles
to come forwards. it’s, you know, if you look at the US government, it’s a great example. We have separation of powers, have checks and balances. Those things create something that can last for a really, really long time. So by having that embedded in how you manage your finances, whether it’s an institution or an individual, that should enable a longer term, a longer term vision. And I think you kind of outlined kind of, hey, what are some of these different
responsibilities and I just alluded to it, one of the major responsibilities of the actual board, university board, endowment board, foundation board, that’s really thinking about an effective spending policy that can last over time. Maybe just talk a little bit about what spending policies are.
Patrick Collins (14:54)
Yeah, almost every foundation and endowment typically have something written about the spending, how they’re going to spend money. I think because of their perpetual nature, you have to think long and hard about spending because, you know, if you overspend out of a portfolio, you run the risk of depleting that asset over time and make it no longer make it perpetual. So I think that’s a really important aspect. We see lots of different
strategies around spending with policies. Typically, it’s a percentage of the portfolio can be, it could be a set dollar amount. Oftentimes, you’ll see things like we’ll take maybe the last three years average balance and then take a percentage of that to smooth it to some degree. But I think the point is, is that there is a spending policy, meaning a plan, they don’t come in and say, we
you know, let’s spend this much this year and then let’s spend some other amount next year. We need more money. Let’s just spend it. we had a good year. Let’s take all the profits out of it. They have governance and process around how they’re going to spend money. And I think as investors, we can take a lot away from that. We do have differences. We talked about this in the beginning. They want to stay perpetual. We have a finite kind of timeframe on how we, how long we need to spend money out of a portfolio. But there is still a lot of similarities in the sense that
We want it to be sustainable. don’t want to run out of money at some point, so we have to have a plan in place. It was interesting reading through the latest research on these endowments from NICUBO. Do know what NICUBO stands for? I don’t recall.
Marcus Schafer (16:35)
National Association of College or University of Endowments Some accumulation of those words.
Patrick Collins (16:44)
Great. So I think they probably have the most exhaustive, it seems like, study on things like asset allocation spending policies. I know it’s self-reporting. These organizations will report back to them on these. But it’s telling. And one of the things that they showed in that study was that last year, the average percent of withdrawal from a portfolio from a percentage standpoint was 4.7%. The year before that, it was 4%.
So if we take that, it’s kind of a starting point. know that endowments tend to be 4 5 % of the value of that portfolio. Somewhere in that range, they’re taking out each year. That’s probably part of their spending policy. And it’s not that dissimilar from investors. We have to think about things like how much can we take out of a portfolio to make sure it’s sustainable? I think the one
big difference that I see with spending policies with universities, other nonprofits and individuals is oftentimes the spending policies at the organizational level and an endowment tend to be a percentage of the portfolio. So you’ll start to see swings, decent amount in spending based on the value of the portfolio. So you go through a long stretch and maybe a down market, poor investment returns.
you could see spending significantly curtailed inside of an endowment. So you can see spending down 20, 30%. Most individual investors, that’s a challenging thing to tell a retiree, hey, we’re going to have to cut your spending by 30 % because the market is down. what we found is most investors want to have a little bit more safety in the spending amounts so that they don’t have to reduce their lifestyle.
And so that changes things like asset allocation, how you take risk in the portfolio versus maybe an endowment, how they would do it. Because I think there is just this real desire to not have significant spending cuts in retirement. Whereas I think an endowment smooths that out and they can also kind of maybe have other funding sources to think through.
Marcus Schafer (18:59)
Yeah, I mean, that’s, that’s one of the differences. If you kind of just think about one of the things we talked about earlier, accumulation withdrawal, those are kind of distinct phases. Whereas endowments are, you also get donations. You do get revenue every single year, and then you also have expenses. And one of the things I found really interesting, you’re right, four to 5 % per year, like clockwork, 30 years going back, we can kind of see this. So there is a ton of consistency.
Asset Allocation Insights2, 3, 4, 5 – the research shows average endowment does not add alpha over simple indexes
And what’s fascinating is I think that separation of powers is also really helpful, if you’re talking about in the great financial crisis, we actually saw a lot of endowments increase their spending and try to smooth that out. And what that shows to me and what shows to the researchers is, when you have this perpetual long-term nature, it’s not saying, hey, overreact and harm this group of students adversely. It’s…
Hey, you know, we did have a bunch of really good years on the front end. We expect to have some good years on the back end. So it’s also some of the power to be able to spend. And we see that sometimes with retirees too, where it’s a little bit helpful to say, hey, you can actually spend more money. We’ve modeled it out. Here’s our expectations of the future. And so that separation of powers, I think it’s really helpful to have conviction in what is the right amount of spending policy, what is sustainable. So you don’t have to take a
Take a step back.
Patrick Collins (20:31)
Yeah, and it’s that is a tough, I will tell you having counseled clients, that’s a tough conversation to have with clients. But I think one of the things I’d love to dive into a little bit more on this Nakubo study is just a variation in what endowments are doing. I think one of the things that we found was, you know, and it’s interesting in the study, they’re going to look at things like asset allocation, but they’re going to look at it by size of the fund. So
If you have a $25 million endowment, it looks a lot different, according to a study on average, than say a billion dollars or a $5 billion endowment. But anything that you took away from the, I guess, the asset allocation decisions when you looked at endowments and maybe how it relates to investors?
Marcus Schafer (21:23)
Yeah, I think some of the big takeaways from asset allocation is one, which you just alluded to, the variation. mean, with any individual, with any like kind of type of investment. So take hedge funds, you’re seeing zero to 80 % of a portfolio in hedge funds. Alternatives, zero to 60%. What is an alternative, right? That’s like a question. you see this massive variation. I would say that generally what we see is
there tends to be kind of this linear march up in size, but the things that the leader institutions are doing a billion dollars and up tend to be much more of what you read about on the headlines, right? So it’s, they’re investing in private equity, private credit, venture, that tends to increase a whole lot more. And I think what’s like,
fascinating to think about for individuals is what type of hurdle do you really need to hit to be able to have access to some of these more esoteric type of investments.
Patrick Collins (22:34)
Yeah, I think there’s also a question of whether it’s good, whether it actually adds tremendous amounts of value for both the endowments and for individual investors. So there’s a couple of things I wanted to touch on on that. First off,
that is only a one year study, but it was really interesting, like looking at the last year in the Kubo, the highest performers of the endowments were all the smallest endowments. And why is that? Well, it’s because they have a much larger allocation to public investments like stocks and bonds, and the largest endowments were their worst performers, and they have a much larger allocation to private investments. So it’s not an automatic, if I invest in these complex
private investments, I’m going to have better performance. So I think that’s the first thing to understand. Not to say that, again, performance is not, especially one year performance is not something that you should be really making any decisions around. But I do think it was just an interesting data point. The other one, we started to kind of dig into the numbers too. We found that these were just averages and there are managers and there are endowments.
that do things vastly differently. I’d love to spend a few minutes talking about one of the managers we researched was the head of the Nevada State Pension Plan. And this would definitely be one of these managers that is in the very, very large kind of space. Their endowment or pension was $60 billion. It is just a gigantic number of how much they invest.
And when we started to look into it, what we found was this would be somebody that would definitely be on the kind of eligibility for access to any types of private investments that he would think might be appropriate. But what we found was, first of was really fascinating. He was the only, for a long time, the only employee at the company. He was investing all $60 billion himself. Just recently, they hired a second employee.
So you compare that to something like a Harvard or a Yale endowment and you know, there’s dozens and dozens if not hundreds of people that are working at those organizations. So how is it that he could manage 60 billion dollars on his own and what you find out when you get into it is that he has basically for about 90 % of the portfolio he has put it into index funds and
as I read his story and he’s had phenomenal performance. think when he joined the fund, they had 15 billion of assets and they’re now over 60. And so one of the things that I took away just reminded me of a story or a movie that many of our listeners might have seen or read the book is Moneyball. And if you think about the story of Moneyball,
It is a story essentially about the Oakland A’s and the GM of the Oakland A’s baseball team that didn’t have much money. They’re in a small market. They had to compete with the Yankees and the Dodgers that all had all of this money. And what they were finding was the Yankees and the Dodgers and all the major organizations, they were making decisions based on, you know, kind of the old way of doing things. This is the way it’s always been done. This is how everybody else does it. So it must be right.
this guy from the A’s decided, you what if we look at the data and the evidence? And what I kind of compare that to is this manager who said, you know, if you read kind of what he says is there’s really just a couple of things that matter a lot in our in our performance. One is our asset allocation. How do we allocate the assets between stocks, bonds, you know, other types of investments? And then the second was fees.
That matters a lot. Can we reduce the fees? Because every dollar we pay in fees is less that’s going to the retirees here. And so when I looked at the numbers at their level, they were paying for 90 % of the portfolio, they were paying one basis point. That is 0.01%. It’s almost not paying for the management of these assets. And you compare that to…
these large endowments that have gone heavily into hedge funds and privates and other types of investments like that. And they have dozens and dozens of analysts that are doing manager due diligence and whatnot. And I wonder how much of it is these studies that we read like Nucubo that all these other managers are reading it too. And they say, oh, a billion dollars. We have over a billion dollars. It looks like the average manager here has X percent in private investments. I guess we should too. And instead of kind of just
Revisiting the Three Sources of Alpha3, 6, 7 – the evidence suggests any advantages from endowments do not come from informational alpha, it comes from asset allocation decisions
following what everybody else does, I think there’s an element that I think all of us can learn is let’s first start with the data and the evidence and make sure the decisions that we’re making are rooted in that evidence before we start making decisions just because everybody else is doing it. So that was one of the things I thought was really fascinating in some of the research we did.
Marcus Schafer (27:46)
Yeah, it’s, you know, pick the game you want to play. If you want newspaper articles written about you, there’s a way of investing that’s going to get more eyeballs. That’s going to get more newspaper articles written about you. If you’re just doing it for, for your individual constituent, there’s a host of different ways to accomplish that. When you look over, I was reading a study, was about 20 years and the average endowment performance.
Just a 60 % S &P 500 to 40 % bonds beat by four basis points, 0.04 % per year. 60-40 is like one of the hallmark portfolios for most investors out there. And across the spectrum, average is doing exactly that. It explains 94 % of their performance. When you add international stocks in, explains 99 % of the performance. So this gets to your point. It’s, what really matters? What matters is the asset allocation.
Can you stick with it? And then the secondary consideration is how are you going to go out there and implement these different ideas? And as we of like get into this a little bit, it’s this question of what’s your game? How are you playing it? So if we go back to something we talked about before, there’s kind of this framework, three sources of alpha about performance, right? And I thought it would be really, really interesting to break down.
What are these elite institutions doing? What’s the fun stuff? What’s the exciting stuff? Through these three different sources of alpha. So again, we have traditional, which is more informational alpha. I’m smarter than you, I’m better than you. We have two, which is risk-based alpha. I can just take different risks than you can. And then three, I’m just a different investor than you are, and I can do things.
What do Elite Institutions Do Differently: Alternatives2,3,7 – the real debate is whether they are taking different risk or more risk
that you can’t do. You mentioned taxes, this is like a great one as an example. So let’s go through that framework because I will point out, again, the reason why we’re talking about them, the elite institutions tend to outperform, that’s 60-40 the average, by two or three percent per year. So if you kind of think about what that means for this really long pay, if you’re spending policies five percent a year, somebody else can get another half of that.
This is why we see investors kind of chasing because you start thinking about how that compounds. It’s incredibly powerful. There’s a lot of incentive in markets to beat the market even just by a little bit, which is why we see so much people running and going into it.
Patrick Collins (30:29)
Yeah, so thinking about those three sources of alpha, the traditional alpha, which I would kind of put in there, finding, you know, most endowments are not managing the investments themselves, they’re picking managers and whatnot. how successful are they at finding managers that can outperform the market because of stock selection, market timing, things like that? I don’t think we’ve seen
at least when we did our research, we didn’t see any evidence that they’re getting alpha from superior kind of stock selection, market timing, other types of trading type strategies. Would you agree with that?
Marcus Schafer (31:11)
Yeah, most of the outperformance seems to be from asset allocation decisions. And if you kind of like think about the evidence why, if you look over a 20 year time period, something like 15 % of bonds, actively managed bond portfolios for public markets can beat a benchmark. 20 year period for stocks, it’s about 20 % of active managers have outperformed. That’s not just the magnitude, right? Because the magnitude matters also.
So it’s like, why would we expect something so different in these really, really tough to compete asset classes? And here’s a lesson that I think for individuals, you don’t have to play that game. And a lot of endowments do play that game. And I think it hurts them. Something like 60 or 70 % of their public stock and bond portfolios are invested actively. You don’t have to do that. All the evidence is saying, hey, we cannot do this. Now, if you kind of think about
Does somebody like Yale maybe have a different game that they could play? Well, who would potentially be the best managers for these asset classes? They would probably be people that went to these elite institutions that tend to have a disproportionate amount of the people in high finance. Yale is also a trophy asset class, right? So this gets into what’s unique about Yale and these Ivy League schools that’s not unique about us.
They’re not a commodity. They’re something special. If you go to the next investor and say, hey, Yale invested with me, they’re going to say, hey, I’ve read a lot about though. They’re pretty smart. I would love to invest. And then here comes the character. Well, you get different terms, right? Yale can negotiate. They do things a little different. You get different terms.
Patrick Collins (32:59)
So
nobody’s come to you and said, wow, it’s a huge marketing asset for us to say that Marcus Schaeffer is invested in our fund. That hasn’t happened yet for you,
Marcus Schafer (33:09)
It has not, but you know I have a brand to protect. not sure I could be out there enforcing it
Patrick Collins (33:14)
Well, maybe so if we know that kind of the traditional alpha is no different with an endowment as it is with an individual investor, that it’s really difficult, the evidence is stacked against you. What I think what you had mentioned was the asset allocation decisions where we see that they’ve made some headway in developing some of this alpha that they’ve been able to generate. So what are some of those decisions that you’ve seen with
endowments from an asset allocation decision that has caused them to be able to maybe outperform. And I think probably it’s also good for us to talk about the risk associated with those, whether it and whether the access and the implementation can even be done at the individual investor kind of level. So any thoughts there?
Marcus Schafer (34:06)
Yeah, it looks like the, I’m going to generalize the major difference in asset allocation decision appears to be coming from alternatives. Now alternatives mean a bunch of different things. In this case, I’ll kind of say private equity is an example and, and hedge funds also. And to your point, the question is really, is it luck? Is it skill?
Or is this just a different type of risk? And when you really start to unpack all these different alternatives, some of the things that researchers have done is they’ve started to understand, is this, even though we call it something different, if we were to say it was a bond or say it was a stock, what would your stock percentage of the portfolio be? What’s your equity like risk? And this is where we really start to see those that are out
they’re actually taking a lot more equity like risk. So a big portion of this is just taking risk in a slightly different way, all the way up to 85 % equity type portfolios, which leads a lot of researchers to say, hey, I’m not sure we can compare you to a 60-40, right? We might have to compare you to an 85-15 because you’re using leverage inside of the vehicles.
So there’s a big portion of it that looks to be taking a little bit more risk.
Patrick Collins (35:39)
I think that’s a really important aspect for individuals to understand is that when you hear, they’ve outperformed, you really have to make sure you understand the benchmark and you have to understand why they’re outperforming. so if they are outperforming, mostly because they’re taking a lot more risk, that is something really to think through on whether you would want to take that kind of risk as an investor to try to get outperformance because there’s a downside to risk, which is
volatility typically and everybody loves risks when things are going up but it you know manifests itself in some pretty tough tough times when things go bad so i think that’s a really important aspect i think the other when you invest in private investments as well i think there can be an illusion of stability in the sense that when i you know come in in the morning and i look at my tickers and i tell you know search what they you know
Democratization of Alternative Investments – questions to ask to determine if the alleged benefits of an investment transfer to you as the investor
stock or ETFs have done over the course of the day, I get real-time updates. But if I own a private equity fund that has 20 different businesses they’ve invested in, I don’t know what those businesses are worth today. If they signed a new contract yesterday or lost a big client, it doesn’t immediately get reflected in their price. They don’t have to report earnings like a public company does. So I guess my point there is you just have very little kind
price discovery on what the value actually is. So it looks like it stays pretty flat for the most part. But if you were to have to go buy or sell that stock or that company in the open market on any given day, there’d be widely different prices. So there’s this illusion that these private investments are stable. And I think that’s just something for us to keep in mind is that they’re just priced so differently. It’s really hard to compare them to a public equity.
Marcus Schafer (37:32)
Yeah. And the data is getting a lot better, but the way I think about this is our houses, right? If these were publicly traded houses, and you could see it, people all the time were bidding on, I want 1 % of Pat’s house. I want 1 % of Marcus’s house today. We would expect our value to fluctuate pretty dramatically. But when we think about what’s my house worth, we have these anchors.
that we’re kind of anchored to. And since we’re not going to market and saying, how much would you pay for my house today? That’s going to be a difference. So you’re right. It’s kind of, you do have to do these gymnastics. Risk is one of these things that’s really, really difficult to measure. It’s like, it’s always there, but it’s never there. You you only experience it once. And that’s something with prices, know, prices are kind of moving all the time, but you might not see them. And again,
the data is getting a lot better and the way that these bigger institutions invest. And I think this is what is really kind of one of these challenges for how much can these ideas be democratized down. The price fluctuation of kind of matters a little bit less to them because they’re mostly concerned about, when you sell it, give me the cash back. Right. Whereas the way a lot of retail investors, individual investors are, let me check my account balance every single day.
But kind of this concept of the democratization of alternative investments is something you were alluding to where you’re saying, hey, all these endowments are, here’s what the top performers are doing. So let me think about how I can do that too. And I think one of the major challenges, their size, some of the unique characteristics I would call this financial intermediacy alpha, they can just command.
differences and they can access things like if you have over a billion dollars you can kind of build a broadly diversified private investment pool. The minimums tend to be pretty high just per investment but if you have a lot of money you can start to get the average which is just really really hard to do in privates and so the dispersion of returns you might get this great outcome but there’s also the same chance you can get a really terrible outcome.
You can kind of get more towards the average, which is an advantage of the larger institutions.
Patrick Collins (40:06)
Yeah, obviously been, we’ve thought about this a lot here at Greenspring for our clients, always looking for, you know, how can we make improvements to portfolios? And obviously we like to see what endowments are doing and whatnot. And I would say the vast majority, for some of the reasons you just mentioned, also some of the reasons I’m sure we’ve talked about earlier around taxes and whatnot access, have kind of caused us to stay away from some of the…
private investments that have been marketed, I guess, to retail or individual investors. But I think there’s a lens that we tend to think through adding asset classes to portfolios that it would be maybe helpful to go through for investors to understand how should I think about, well, if Harvard’s doing it, is it good for me to do it? And so I think the way we think about it first and foremost is, is this investment
is the outperformance or the performance of this investment reliant on a manager or some level of skill for it to be successful. So you tend to see that with things like hedge funds, for example. So many hedge funds have strategies that are all around, all about the idea of, you know, I’m going to buy all the stuff that we think is going to do well in the future. We’re going to sell or go short all the things that we think are going to do poorly.
It is a really tough thing, but you tend to see that that’s kind of, know, those types of strategies tend to be, you know, very much based on the skill of the manager, the analysts that work at those funds. We just tend to stay away from those for a lot of reasons. One, I think, is the risk of the manager retiring or leaving or whatnot. The other is just the ability do we believe, if we believe that markets are fairly efficient, which we’ve talked about in prior episodes.
what’s the likelihood that that’s going to be able to continue with a manager? How can we determine if it was just luck or skill that caused that outperformance? So I think that’s important. I think the other part would be, is this just duplicating more parts of our portfolio in a different way? So if we already own the vast majority of public equities and we buy a manager that is maybe moving in and out of public equities at different times because they have a trading strategy,
What ends up happening is we just kind of overweight certain parts of the portfolio over time based on what they’re buying. So for us, what we’ve tended to kind of focus on is, this truly, you know, is there kind of a, is this asset class that we’re investing in? Is there a reason why it should go up in value and outside of the manager, what not just overall, is there an economic kind of intuition on why this should perform and have, have a positive expected return?
So it has to be kind of a good reason. You can make those examples like stocks is a great example. There’s a reason why stocks should go up in value. People are taking risks. Companies are innovating. They’re more earnings over time. Their value should go up. Bonds have a reason why you should make money in bonds, which is they generate interest. You’re giving your money to an organization or a government. They’re promising to repay it with interest. Real estate is another one. There’s a reason why real estate, you should make money in that over time.
So we want to make sure that it’s not, you know, that there’s a real reason why this should make money. The second part of that is we want to see, does it add value in portfolios? Is it kind of correlated to everything else? If we’re just buying an asset that basically is going to track very similar to the stock market, does it really add any value in the portfolio? We’re just adding complexity and costs. So those are some of the things that when you’re looking at private investments,
You’re looking at other types of strategies. We think, you know, is it relying on manager skill? Is there a reason why it should go up? Does it add value because it has a return kind of stream that is different than the returns that may be of other parts of the portfolio? And when you start putting it through that lens, and then probably the last thing is, is it implementable? Can you buy it in such a way that it’s after fees and expenses and taxes?
Structural Advantages of Endowments – are you the NY Yankees or Oakland A’s? Play your game and you can still be successful
that there’s still a positive expected return over other parts of the portfolio. And if it can get through that kind of screening, then it’s something we’ll consider. And I think investors, and quite frankly, even endowments should have similar kind of lenses to think about these alternatives through. What you’ll find is if you have kind of a philosophy on how you think about those things, you tend to kind of weed out a lot of investments that get brought to you.
Marcus Schafer (44:50)
Yeah, it’s a great example. then you go back to what’s the evidence actually say? it’s, hey, most of the performance, the average performance is essentially a 60 % stock portfolio, 40 % bond portfolio. Like you go through all this complexity just to kind of end up oftentimes at the exact same spot. And I think that there is just some value in
the elegance of simplicity, you know? And simple looking doesn’t mean that it’s simple, simply done. It just means one thing. One of the really fascinating things about markets today is like, could see, hey, you see one ticker in your portfolio, could have 2,500 US stocks in it. You could see another ticker. It could have 10,000 plus, 11,000 plus.
non-US stocks in it, all the way from the bottom of the market caps, or the bottom in value, really, really tiny companies all over the world, to the largest companies. That’s complex, but the way we visualize it is simple. And, you know, if you look at the performance of endowments, and you say, hey, if it’s really tough to copy what the largest, the elite endowments are doing,
What’s the cheapest, most effective way for me to get the average? And it kind of goes back to something we talked about before, which is being an average investor for an above average length of time leads you to be one of the better investors. That’s kind of the secret formula is can you do this every single day, every single year and maintain exposure? And if you can,
there’s a really, really high likelihood that you’re gonna be.
Patrick Collins (46:51)
Yeah. And maybe the last source of alpha, we’ve touched on a lot of these, but I think there’s maybe a little bit just to talk through, which is this kind of financial alpha, if you will, or structural almost alpha, where it’s like as an endowment, you have some parts of your DNA, if you will, that allow you to outperform compared to maybe averages or retail or individual investors.
We already talked about taxes. That’s just a huge one. If I’m thinking about investing in an asset class, and let’s just say I would expect the returns to be 10 % a year, but there’s returns will be fully taxable to me. Well, as an investor, I’m in a higher tax bracket, I might only get a 5 % net return after tax, whereas that endowment is going to get the full 10 % return.
a major difference in how you select investments for an endowment versus an individual investor. You just have to be mindful of the tax piece. Maybe you want to talk a little bit about endowments and some of the other aspects that they can do, especially regarding leverage and other things like that that might be just something that is more challenging for an individual investor.
Marcus Schafer (48:13)
Yeah, think, again, I view them as trophy asset classes, right? That have just these unique advantages and some are because they’re historically well known as investors and some are just in the way that they’re set up. You know, as these nonprofits, a lot of them can access municipal bond markets to help smooth their capital out there. So a lot of them did this in
2010 kind of the market continues where it’s, we want to build X instead of tapping our spending power. Let’s go out there and get a municipal bond loan. And the advantages are like the inverse. You and I, we kind of just did something like this for a client. said, Hey, we need to go get some financing. We’re going to go get a generalized Fed risk-free rate. probably a five or a 10 year.
And then we’re going to pay two and a half percent above that. They get the exact opposite. get, they give me 1 % less than that number as my cost of financing. So it enables them as you kind of think about their buckets between the board and the endowment, it gives them additional flexibility on really, really favorable terms to figure out, Hey, in any given year, how can we help smooth our cashflow?
to the best position ourselves. So that’s, I think, one advantage in the way they implement that. And then again, as a trophy asset class, if you do find a manager and you say, I’ve determined that this manager is actually skilled, what that manager will do is they’re gonna increase their fees, right? Because they’re the skillful manager, right? Hey, we’re generating all these returns. You should be happy to pay us more fees.
And by being some of these trophy asset classes, they can help negotiate against that. If those managers are within a broader organization, they want to go out on their own. Hey, we would love to be a seed investor. So there’s just a bunch of, you know, there’s some of the most famous investors out there. And when you’re a really, really famous investor, you have this power and this willingness. And again, if your portfolio is 50 billion, you’re willing to contribute 50 million to meet these minimums, to be a large anchor, a hundred million.
If you only have even 50 million, but half of it’s taxable or most of it’s taxable, and these are really tax inefficient investments, you don’t have kind of the same power. And I think that’s just a fact of life. They have these advantages and we have to think about what advantages do we have and play to those strengths and set.
Patrick Collins (51:03)
And I think even we see it at Greenspring in a smaller scale. mean, our firm manages approximately $8 billion or so of assets. And we have access even for our clients to investments that maybe have, in a few cases, I’m thinking of $15 million minimums where we can get our clients into those investments basically at any price, but we aggregate as a firm and those organizations allow it.
Whereas if you’re an individual investor and you wanted access to some of these investments that we have, you’d have to, it’s a $15 million minimum. so, these are, these are investments that we might only allocate two or three or 4 % of a portfolio to. So you can do the math and you’d have to have a lot of money to be able to access these things. So I do think that’s a takeaway from the endowment model is, you know, the size does give you access oftentimes to investments.
Access isn’t always good. Let’s put it that way. I do want to stress that it doesn’t automatically mean just because you have access, you’re going to have higher returns. You have to understand what that underlying investment is, but it does provide you some opportunities that you probably would otherwise not have. So maybe we can kind of wrap some of this stuff up. What are kind of the big conclusions that you think based on what we talked about today that individuals should take away from thinking about
endowments, how they invest, what are the things that we really want people to understand and take away from that.
Marcus Schafer (52:40)
Yeah, I think, kind of one of the first frameworks we introduced, is process over performance. How can you design a process that enables you to be a really long term investor? And endowments have kind of given us a roadmap. mean, we have data on them going back 50 years to evaluate, Hey, how has their spending changed over time in different various conditions? And I think it’s a testament to a lot of these policy statements that
we talked about earlier, which is, if you design something, you put it in writing and have checks and balances and separations of power, you’re going to be able to be a long-term investor. And that’s kind of the unique trend, maybe not the name is, hey, are you doing these process things? I think that’s it. And then I loved your moneyball example, which is figure out what game you’re playing and go out there and play that game. And if you’re not in New York,
Yankees figure out what you can do successfully and what we see from the average performance is a super low cost diversified portfolio can get you there. And there some really big names that are doing it. It’s just we don’t talk about them because you can only write one or two articles before you’re going to say the same thing. The third or fourth article, right? So those are my big takeaways. What about you?
Patrick Collins (54:03)
Yeah, I think you hit on the two big ones. I think the other ones that we talked about that I think is just really important for people to think through is have, maybe it goes back to process, but it’s just a little bit more on the endowment side around these alternatives that they invest in. Have a lens that you send everything through when you’re thinking about alternative investments and make sure that there’s a reason why there should be a positive expected return over stocks or bonds or whatever that is that you’re looking at.
Make sure that it’s implementable after fees taxes all costs and expenses and make sure it’s not dependent on a manager to you know their skill to be able to to to Replicate it over time so I think making sure if you’re going to add asset classes to a portfolio of a process you have a Like a framework to send these things through before you make a decision I think that’s probably the big thing and then the last thing would be
just to keep in mind, these are endowments, they’re not humans, they’re not individuals, they have advantages that we don’t, and we should keep that in mind as we invest so we don’t just go and say, what is Harvard doing? I’m just gonna replicate that. So I think that’s important. So I think the long and short takeaway I think is there’s just so many great takeaways we can take away from endowments. There’s also things that we have to be mindful of that we can’t do as investors. And…
Both of those things are experiences for us as investors. So those are my big takeaways.
Marcus Schafer (55:32)
I love it, yeah. It is pretty tough to replicate Harvard. That’s why there’s one of them, right? Thanks for the discussion today. We’ll see you soon.
Patrick Collins (55:39)
That’s right. That’s right.
Yep, thank you.
Sources
2 NACUBO Allocations and Performance (2024)
3 Do (Some) University Endowments Earn Alpha? (Barber, 2013)
4 What Does Nevada’s $35 Billion Fund Manager Do All Day? Nothing (WSJ)
6 The Three Ways to Beat the Market (And Why Most Investors Don’t) | GS #2
7 Endowments in the Casino: Even the Whales Lose at the Alts Table (Ennis, 2024)
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