Alternative Investments. Black Keith H.

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СКАЧАТЬ investments, investors need to allocate to managers who deliver returns far above the median manager in each asset class.

      3.4.3 First-Mover Advantage

      It appears that the largest endowments have significant skill in selecting the top-performing managers within each asset class. Lerner, Schoar, and Wang (2008) explain that this ability to select top managers may be related to the first-mover advantage (i.e., benefits emanating from being an initial participant in a competitive environment): large endowments invested in many alternative asset classes years earlier than pension funds and smaller endowments did, and may therefore have an advantage. For example, Takahashi and Alexander (2002) explain that Yale University made its first investments in natural resources in 1950, leveraged buyouts in 1973, venture capital in 1976, and real estate in 1978. In contrast, Lerner, Schoar, and Wang explain that corporate pensions began investing in venture capital only in the 1980s, while public pension plans did not make their first venture capital investments until the 1990s.

      Many of the funds of managers who have earned top-quartile performance in these asset classes have been closed to new investors for many years. Newer investors seeking access to top managers in alternative investment asset classes, especially in venture capital, are destined to underperform when the top managers allow commitments only from those investors who participated in their earlier funds.

      Lerner, Schoar, and Wongsunwai (2007) show that endowments earn higher average returns in private equity, likely due to the greater sophistication of their fund-selection process. Endowment funds have higher returns than do other investors when making allocations to first-time private equity fund managers. Once an endowment fund has become a limited partner in a private equity fund, it seems to be more efficient at processing the information provided by each general partner. The follow-on funds that endowments select for future investment outperform funds to which endowments decline to make future commitments.

      Mladina and Coyle (2010) identify Yale University's investments in private equity as the driving factor in the endowment's exceptional performance. It can be difficult to emulate Yale's outperformance in private equity and venture capital investments, as its venture capital portfolio has earned average annual returns of 31.4 % since its inception through fiscal year 2007. In fact, this study suggests that without the private equity and venture capital investments, the returns to the Yale endowment would be close to that of the proxy portfolio.

      3.4.4 Access to a Network of Talented Alumni

      Perhaps the first-mover advantage and the manager-selection skill of top endowments can be attributed to the superior network effect. An institution has a positive network effect when it has built relationships with successful people and businesses that may be difficult for others to emulate. Alumni of the universities in Exhibit 3.1 are noted for being among the most successful U.S. college graduates, in terms of both academics and business. As measured by scores on the SAT® exam,20 Harvard, Yale, Stanford, Princeton, and the Massachusetts Institute of Technology routinely select from the top 1 % to 5 % of students. In 2003, the median SAT score for all college-bound students, including both verbal and mathematics scores, was approximately 1,000. Top universities attract students with average scores exceeding 1,400. Graduates of these schools also tend to have the highest initial and midcareer salaries.

      A study by Li, Zhang, and Zhao (2011) correlated manager-specific characteristics to the returns of the hedge funds they managed. In contrast to the median SAT score of all college-bound students of 1,000, Li, Zhang, and Zhao found that the middle 50 % of hedge fund managers attended colleges and universities with average SAT scores between 1,199 and 1,421 (the 79th and 97th percentiles, respectively), demonstrating that the majority of hedge fund managers attended the most competitive colleges and universities. Within the group of studied hedge fund managers, the research showed that those who attended undergraduate colleges with higher average SAT scores have higher returns and lower risk. For example, a 200-point difference in SAT scores, such as that between 1,280 and 1,480, was correlated with higher annual returns of 0.73 %. Not only did managers who attended top universities have higher returns, but they did so at lower risk and earned greater inflows during their tenures as fund managers. The authors suggest that talented managers are attracted to hedge funds due to the incentive fee structure, which rewards performance over asset gathering. In contrast to their studies on hedge fund managers, Li, Zhang, and Zhao found that SAT scores did not seem to affect the asset gathering or excess returns earned by mutual fund managers, as these managers are compensated for gathering assets, not for earning excess returns.

      Many alumni of top universities wish to continue an association with their alma mater, the university from which they received their undergraduate degree. The ability of top endowment funds to outperform can be perpetuated by this important network of relationships, to the extent that these talented professionals either choose to work for the university's endowment fund or guarantee the endowment investment access to the funds they manage.

      Barber and Wang (2013) show that the strong returns earned by endowments are directly traced to the size of their alternative investment exposure. Alphas earned by Ivy League schools exceed 3 %, while 30 other schools with top SAT scores earned an alpha exceeding 1.7 %. There is a reliably positive alpha and return spread between schools with top SAT scores and schools with average scores.

      3.4.5 Acceptance of Liquidity Risk

      Endowments have a perpetual holding period. With low spending rates and limited liabilities, endowments have a much greater tolerance for risk, including liquidity risk. When viewed in light of the age of leading universities, which for Harvard and Yale now surpasses 300 years, the 10-year lockup period of private equity vehicles appears relatively short term. As the longest-term investors, charged with protecting the real value of endowment principal for future generations of students, universities are seeking to earn liquidity premiums, which are higher returns earned by investing in less liquid assets that require long lockup periods. The idea is that the perpetual nature of endowments allows them to easily handle this liquidity risk. Anson (2010) estimates the liquidity premium for private equity at 2 % and for direct real estate at 2.7 %, while other studies estimate liquidity premiums as high as 10 %.

      Swensen (2009) explains that less liquid investments tend to have greater degrees of inefficient pricing. On average, investors overvalue liquid assets, which leaves undervalued and less liquid assets for investors with long-term investment horizons. Investors making commitments to long-term assets, such as private equity and private real estate, know that these investments are typically held for 10 years or longer and so require a significant due diligence process before making such a long-term commitment. Investors in more liquid asset classes may not take their investments as seriously, knowing that the investment may be exited after a short-term holding period. Investments that appear to be liquid in normal markets may have constrained liquidity during times of crisis, which is when liquidity is most valued.

      3.4.6 Sophisticated Investment Staff and Board Oversight

      All investors need a process by which asset allocations are set and managers are selected. Traditionally, an institutional investor would have an internal staff that would make recommendations to an investment committee, which would then vote on recommendations at quarterly meetings. The quality of the votes and recommendations depends on the experience and composition of the members of the endowment's staff and investment committee.

      Investors with smaller assets under management tend to have smaller staffs. In 2011, NACUBO estimated that college and university endowments with less than $100 million had just 0.4 staff members dedicated to endowment issues, meaning that a single staff member, such as the chief financial officer or treasurer, was responsible for the endowment along with a wide variety of other budget and financial issues. In contrast, the endowments with over $1 billion in assets СКАЧАТЬ