Index Funds Outperform College Endowments

By Eric Nelson

Investors often believe there is a set of investments available to extremely wealthy and sophisticated investors that generate returns far in excess of traditional stocks and bonds.  If there were such investments, we would expect to see them in the portfolios of college endowments.  These investment portfolios typically have assets that range in size from tens of millions to tens of billions of dollars while employing some of the smartest and most experienced managers in the market.

Yet evidence from the returns that college endowments report seem to indicate that these sophisticated investments don’t exist, as endowments tend to underperform simple broad-market index fund portfolios that are available to average investors with no initial minimums.

TABLE 1: Annualized Portfolio Returns Through June 30th, 2012






FY 2008

Average College Endowment






60/40 Index Portfolio






60/40 Asset Class Portfolio






Table 1 shows that the average college endowment produced a loss of -0.3% over the last 12 months, a gain of +10.2% and +1.1% for the last 3 and 5 years, and a gain of +6.2% for the last 10 years, all through June 30th, 2012.  Over that same period, a simple balanced index fund portfolio comprised of 60% stocks and 40% bonds (“60/40 Index Portfolio”) earned a higher return in each period. 

Often we find higher returns are a result of greater risk, but when we look at the worst annual decline for the average college endowment, during "Fiscal Year 2008” (July 2008 through June 2009), we see a loss of almost 20% compared to just -12.6% for the index.   So the average college endowment pulled off the impressive feat of underperforming a simple index fund portfolio while taking even more risk.

Not all endowments performed as poorly as the average.  Those schools with portfolios greater than $1B in assets had returns of +7.6% for the last 10 years.  But much of this result is attributable to negotiating lower fees from their investment managers and taking even greater risks amongst alternative assets like hedge funds and private equity.

But Table 1 also shows that it isn’t necessary to hold these opaque and unreliable strategies to generate better returns.  The “60/40 Asset Class Portfolio” maintains the index fund mandate of the previously mentioned 60/40 portfolio, but includes additional exposure to smaller and more value oriented asset classes in the US, International, and Emerging Markets, while holding higher-quality 5YR treasury notes to offset some of the additional risk.  This allocation earned almost 9% per year over this stretch, and only declining by about 9% during FY 2008. 

So even at the multi-billion dollar level of the most prestigious college endowments, we find a simple index portfolio with greater asset class diversification was vastly superior.

Finally, special attention should be paid to the smallest endowments, those with “only” $50M to $100M in assets.  Their 10YR returns were the most embarrassing of the bunch, earning just +5.7% per year over the last decade.  This return trailed the index portfolio by a full 1% per year, and the asset class portfolio by over 3% per year.  If this harsh reality isn’t indication enough that these schools need to abandon their truly dismal investment process, nothing is.


Source: Average College Endowment ; DFA Returns Program 2.0

60/40 Index Portfolio = 42% Russell 3000 Index, 18% MSCI All Country World ex. US Index, 40% Barclays Aggregate Bond Index, rebalanced annually

60/40 Asset Class Portfolio = 9% S&P 500 Index, 12% DFA US large value index, 21% DFA US targeted value index, 6% DFA international large value index, 6% DFA international small value index, 6% DFA emerging market value index, 40% Ibbotson 5YR T-Note index, rebalanced annually

Past performance is not a guarantee of future results.  The returns and other characteristics of the allocation mixes contained in this article are based on model/back-tested simulations to demonstrate broad economic principles.  They were achieved with the benefit of hindsight and do not represent actual investment performance. There are limitations inherent in model performance; it does not reflect trading in actual accounts and may not reflect the impact that economic and market factors may have had on an advisor’s decision-making if the advisor were managing actual client money. Model performance is hypothetical and is for illustrative purposes only. Model performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. Advisory fees and other expenses incurred in the management of portfolios would reduce client investment results.  Indexes are not available for direct investment.


Eric Nelson is a CFA charterholder who has worked in the investment industry for 15 years.  He is the co-founder of Servo Wealth Management, an independent RIA in Oklahoma City, Oklahoma.  Eric has a passion for educating investors about how capital markets work and helping his clients achieve and maintain financial independence while “simplifying complexity”.  Eric’s research and commentary on investing can be found on his website  at the “Servo Thoughts” blog and the “Factors in Focus” newsletter.




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