Is the US endowment model dead?

Executive summary:

• Large US endowments typically have allocations to alternative investments, while small US endowments have more traditional portfolios with high allocations to public equities. The strong performance of equities over the past two years has led small endowments to outperform large endowments.
• However, looking back further, it's a different story, as the larger gains made by smaller endowments the past two years were offset by significant losses in fiscal year 2022. Over the past three years, there were no significant dispersions in returns between small and larger endowments.
• Over the longer-term—a much more important barometer of success for endowments—large endowments continue to achieve meaningful outperformance relative to their smaller peers.  

For two years in a row now, the smallest endowments have significantly outperformed their much larger peers. This is causing some to question if the typical endowment model is still working. Is all of the complexity that larger endowments undertake by diversifying their investments even worth it? In other words, is the endowment model dead?

Our answer: Not in the slightest.

At Russell Investments, we strongly believe that diversification is critical to the ultimate success of endowments. To understand why, let’s examine the factors that have led to the recent outperformance of smaller endowments—and how their performance stacks up against larger endowments over the long term.

How do small endowments differ from large endowments?

One key difference between small and large endowments is their allocation to public equities. Large endowments typically have allocations to alternative investments, while small endowments have maintained relatively traditional portfolios with high allocations to public equities. Exacerbating this is that while large endowments typically have diversified their exposure to public equities globally, small endowments have typically maintained a home-country bias within their equity portfolios in an environment in which U.S. equity has outperformed non-U.S. equity.

Public equities vs. private assets: The tale of 2022

Given the strong performance of equities over the past couple of years, it’s hardly surprising that portfolios with large equity exposures have done quite well. Endowments with portfolios structured this way should be very happy with the returns they’ve achieved over the past two years. However, that’s not the whole story. As it turns out, a significant portion of these gains are merely making up for the losses experienced by these portfolios during fiscal year 2022, when equities—as measured by the benchmark MSCI ACWI Index—plunged 15.4%.

Contrast that with the performance of private assets during this time frame, where the losses were generally much smaller or non-existent. How can this be? Simply put, in 2022, private investment managers did not write down losses the same way the were experienced in public markets. The net result of this was that portfolios with allocations to the private sector did not need to generate large positive returns to recover their losses—because there wasn’t much to recover from in the first place.

Putting this all together, there were no significant dispersions in returns between smaller and larger endowment over the past three years. Ultimately, the larger gains made by smaller endowments the past two years were offset by the significant losses they experienced in 2022.

Large endowments have had a smoother ride

From our vantage point, this makes the real story over the past three years the smoother ride that large endowments have enjoyed when compared to their smaller counterparts. As the charts below illustrate, large endowments have experienced significantly less volatile returns over the past five years.

Exhibit 1: Annual returns over the past five fiscal years¹

However, it’s still fair to question if the significant additional complexity used by large endowments in their portfolios is worthwhile, given that both large and small endowments ended up with similar returns. So, let’s zoom out a bit and look at the longer-term results—a much more important measure of success for endowments.

Large endowments have outperformed small endowments over the long term

Importantly, the data reveals that over both 5- and 10-year time horizons, larger endowments have achieved meaningful outperformance relative to their smaller peers despite their recent underperformance, as shown in the table below.

Exhibit 2: Median universe returns over time³

It is worth noting that over a 10-year horizon, the median endowment in the three smallest categories— under $50M, $51-100M and $101-250M—didn’t just underperform the median endowment in the over $5B (i.e., largest) category. The median small endowment would also have been among the worst 5% of performers if lumped in with the largest endowments. This demonstrates that although their very recent performance differs, large endowments have been rewarded for their more complex portfolios through time.

The outlook for endowments moving forward

This leads to a final slew of questions: After the volatility of the past few years, what kind of returns can endowments expect from their portfolios moving forward? Is diversification still worth it? What if U.S. equities stay dominant for a long time?

To be blunt, we’re highly skeptical of the view that U.S. equities will outperform for years to come. History has shown us that although certain areas of the market can maintain dominance for long periods of time, returns often come in cycles and no one area of the market consistently outperforms, as shown in the exhibit below.

Exhibit 3: Experienced returns through time of asset classes and endowments^{4 5}

¹ Data based on the NACUBO-Commonfund and NACUBO-TIAA Studies of Endowments from 2020-2024
² For Fiscal Years 2020-2022 the Under $50M universe is the $25-50M universe and the $1-5B universe is the over $1B universe
³ Data based on the 2024 NACUBO-Commonfund Study of Endowments
⁴ Data Based on the NACUBO-Commonfund and NACUBO-TIAA Studies of Endowments from 2015 through 2024. Asset class returns represent the experienced returns of NACUBO study average annual returns in the asset class, not benchmark returns. As categories changed through time in the NACUBO studies U.S. equities represents U.S. equities active and U.S. equities, Non-U.S. equities represents Non-U.S. Developed active, Non-U.S. developed and Non-U.S. equities, Private Real Estate represents Private Real Estate, Real Estate and Private Equity Real Estate, $1-$5B Endowments represents $1-5B Endowments and Over $1B Endowments and Under $50M Endowments represents Under $50M Endowments and $26-50M Endowments.
⁵  In 2021 the large endowments were able to outperform all asset classes shown as they achieved significantly higher returns than was achieved on average within venture capital, private equity and marketable alternatives.