The Modern Endowment Story: A Ubiquitous U.S. Equity Risk Premium

Abstract

The endowment model, presumed to be a paradigm of value-adding asset class diversification, is indeed a thing of the past. Large educational endowments in the U.S. have concentrated their investments — public and private — in ones that are moderately to strongly correlated with the Russell 3000 stock index, to the exclusion of virtually everything else. The effective asset allocation of these investors, collectively, is now purely U.S. equities with frictional cash of 3%. The endowments, however, have underperformed the stock market by more than 400 bps per year consistently over the past decade. Their cost of investing is high. I estimate that it is as much as 3% of asset value, annually. But estimated costs are not large enough to account for the entire margin of underperformance, which is a puzzle.