Foundations & Institutions: Bigger Wasn’t Better Last Year

Large endowments have become the envy of the investing world. With deep pockets and dedicated investment teams, these institutions have shown a willingness and ability to lean into less liquid asset classes that have historically produced higher returns. So, it’s no surprise that the results of larger institutions have handily outpaced their smaller counterparts over time.

But the latest NACUBO-Commonfund Study has turned the tables. In fiscal year 2023,¹ small and medium-sized institutions’ investment returns topped those of larger institutions, on average. We look behind the headline numbers, while focusing on how smaller organizations can capitalize on their recent success.

Challenge and Recovery

Each year, the National Association of College and University Business Officers (NACUBO) and the Commonfund Institute release a joint report covering asset allocation, spending, and investment returns. While the study is relatively narrow (spanning just under 700 institutions of higher learning with long-horizon portfolios), key takeaways and best practices gleaned from these sophisticated endowments can be applied to a diverse range of institutions.

The fiscal year 2023 study encompasses both 2022’s equity bear market lows and a portion of the subsequent recovery. During this period, global equities rose by roughly 17%² while bond returns came in slightly negative as economic strength put a floor under yields.³ Commodities also lagged while interest-rate sensitive assets like real estate were marked down.

How did participants fare? The study found that the average one-year return for all respondents was 7.7%, a relief after the previous year’s 8.0% pullback. Additionally, the three-year returns improved from 7.5% to 9.3%.⁴

Small Comes Out on Top, for Now

But amid the rising tide in public equity markets, not all endowments were lifted equally. Surprisingly, the smallest endowments (under $50 million) posted an average return of 9.8%, while the largest endowments (over $5 billion) only added 2.8%. The middle cohorts showed a downward trend as endowment size increased.⁵ This contrasts with longer-term results, which have historically shown larger endowments (9.1%) outperforming smaller entities (4.8%) (Display). It also marks a sharp departure from FY2022—a distinctly challenging period for markets—when larger endowments saw a 4.5% decline while the smallest endowments suffered a 10%+ pullback.⁶

What accounts for the difference? Mainly asset allocation—especially exposure to alternatives like private equity and venture capital. Note that both private equity and venture capital underperformed public equities during the fiscal year. Because they’re less liquid, these asset classes have taken longer to adjust to higher interest rates and lower valuations. Public equities, on the other hand, digested those headwinds in 2022 before rallying sharply in 2023. Given the lags, it is better to evaluate performance over longer periods of time.

The largest endowments allocated roughly one third of their portfolios to private equity and venture capital alone, compared to less than 4% for the smallest endowments. Ultimately, their overweight to public equities made all the difference this fiscal year.

Avoid Overgeneralizing

But looking at one-year returns for longer horizon asset classes misses the point. In fact, part of the attraction of alternatives like private equity and venture capital is that they are inherently long term. What investors give up in liquidity and fees has historically paid off in the form of a hefty return premium, with private equity earning a 4% premium versus public equities over the last 20 years. Large endowments’ superior long-term returns reflect in part their outsized allocation to these asset classes.

What’s more, leaning into alternative asset classes can help dampen volatility. Whereas small endowments must endure the inevitable fluctuations in public markets, larger endowments take a long view with an eye toward more consistent returns. True, sacrificing liquidity requires a deliberative cost-benefit analysis. But many portfolios have sufficient liquidity to tolerate a meaningful allocation, in our view.

Beyond Risk and Return

Beyond investment allocations, the NACUBO study highlighted that endowments of all sizes are weighing more than just returns. They’re also focused on how they get there. And despite increasing scrutiny around responsible investing in recent years, respondents remained constant on two key fronts. First, the majority (51% in FY23 versus 52% in FY22) incorporated responsible investing into their manager selection, due diligence, and evaluation process. And just shy of 10% reported having a DEI policy for investment manager selection in the two most recent reports.

Consistent with prior years, potential impacts on investment performance and possible conflicts with mission and fiduciary duty were among the top reasons that respondents did not pursue responsible investing (Display). For institutions considering whether this approach may be right for them, Bernstein’s research is worth exploring.

Leveling the Playing Field

This year’s NACUBO study leaves us with three takeaways for smaller institutions looking to capitalize on their recent success:

1. Put money to work—Long-term portfolios do the heavy lifting in terms of delivering inflation-adjusted growth. Deliberately defining short- and medium-term cash needs can help boost returns by freeing up capital for the long-term portfolio.
2. Consider alternatives—Last year aside, large institutions’ adoption of alternatives has helped to drive their attractive long-run results. Smaller institutions can also benefit. Adding strategies with different sources of both risk and return—sized appropriately to account for liquidity and risk constraints—can enhance reward potential while reducing volatility.
3. Choose your roadmap—Responsible investing and mission alignment mean different things to different organizations. To build an allocation that will help your organization reach its goals, start by defining your investment priorities. This will guide you in determining the best path to achieve success in the way that aligns with your organization’s values.

Whatever your choices, transparency with your advisor is key. A skilled advisor can be a partner in weighing both the risks and rewards of different approaches and can help to build understanding around how strategies fit together in a cohesive whole.

Invest for the Future, Today

Sometimes, bigger isn’t better. There will be periods where lower-cost, publicly traded securities outperform private and marketable alternatives. But one year of returns doesn’t change the big picture. In fact, with public market returns expected to face challenges in the coming years, it’s more crucial than ever to explore different return streams to support your investment goals. By diversifying your portfolio and considering a range of investment options, you can position your organization for success—regardless of size.