“They give us three or four different ways of tackling particular problems,” says Brad Holzberger, chief executive of QIC Asset Management. Evaluating an investment approach which has enjoyed past success is an “intrinsically beneficial” task, Abley says. However it’s essential to do so “with an unclouded and coldly analytical perspective” if institutions taken with the endowments story are to avoid burning capital in ill-fated ventures into alternatives.

Imitation or innovation?

 A sure way of significantly underperforming the top endowments is to replicate their past strategies. In a 2007 paper, Secrets of the Academy: The Drivers of University Endowment Success, Josh Lerner, Antoinette Schoar and Jialan Wang from the MIT Sloan School of Management raise their concerns about the “challenges of imitation”. The authors write that the scrutiny applied to the strategies crafted by endowment managers is unprecedented and the time periods between endowment innovation and mainstream emulation are shortening. The approximate two-year gap between Harvard’s entry into forestland and the mainstream’s implementation of similar investments, for instance, illustrates how closely the endowment is now being watched. After all, it took more than a decade for institutions to grasp venture capital after Harvard first did.

A similar dynamic plays out at the individual product level: “an investment by an elite endowment into a fund can trigger a rush of capital seeking to gain access to the same fund,” the authors write. A premium applies to the astute selection of alternatives managers, and early selection of outperformers can guarantee investors access down the track. As pioneers in the alternatives field, many endowments continue to enjoy a seat at the tables of star managers.

However Lerner, Schoar and Wang have found in research pre-dating Secrets that attractive opportunities do exist for institutions who cannot access the managers they initially aim for. In Smart Decisions, Foolish Choices: The Limited Partner Performance Puzzle, the academics’ analysis of reinvestments in private equity managers suggests that endowments, and to a lesser extent, public pensions, are better than other investors at predicting whether the subsequent funds from established managers will outperform. Here, the endowments’ returns from private equity investments “are not primarily due to endowments’ greater access to established funds, since they also hold for young or undersubscribed funds”.

It appears that endowments usually select the best managers even when access is equal for all investors. Still, since there is usually a limited number of skilled managers in a given sector, a fund beginning an alternatives program now is not likely to access top or even second-tier managers, but will pay the high standard fees regardless of what managers they hire.

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