How Vanguard’s investing approach can strengthen nonprofit endowments
This three-part series examines the challenges colleges, universities, and private secondary schools encounter when investing with the endowment model strategy and discusses how Vanguard helps educational institutions improve performance to grow endowments.
The Vanguard outsourced CIO difference
In Part I, I discussed the compression and flagging returns seen by educational institutions using alternative-heavy investment strategies popularized by the Yale endowment model. Part II offered some reasons underlying these diminishing returns.
In this final chapter, I present Vanguard’s alternative to the endowment model. Our approach has proven competitive across time while cutting out some of the challenges, uncertainties, and costs that come with a heavy focus on alternative strategies.
Vanguard’s outsourced CIO model
At Vanguard, we believe in a handful of key pillars that drive success when acting as a co-fiduciary on an organization’s (or investor’s) behalf.
First: Clearly articulate a firmwide investment philosophy
We believe first and foremost that a firm needs an investment philosophy that goes beyond the commonly cited “maximize returns while minimizing risk.” Is there an investor in the world who doesn’t try to follow that “philosophy?”
To us, an investment philosophy encompasses the core beliefs of a firm. Those beliefs cannot vary from one consultant or portfolio manager to another. We’ve seen many instances where inconsistency with the implementation of a prior outsourced CIO has negatively impacted results.
At Vanguard, everything we do is driven by our philosophy. We believe in being compensated for the risks we take in a portfolio and minimizing idiosyncratic or uncompensated risks. We believe in identifying the strategic asset allocation that best reflects the objectives and constraints stated in an Investment Policy Statement. And we believe that periodically rebalancing a portfolio back to that allocation is the single most impactful ongoing investment task of an outsourced CIO.
Second: Maximize the effectiveness of operational scale
At $5.1 trillion globally,¹ Vanguard is a leading asset manager. Underlying that $5.1 trillion are dedicated teams and processes that benefit the organizations we advise. This includes an in-house investment management team responsible for $4.5 trillion globally across active, passive, and liquid alternative strategies; a manager search and oversight team responsible for nearly $600 billion in Vanguard active funds allocated to a who’s who list of external subadvisors; a world-class risk management organization (winner of the risk.net Asset Management Risk Manager of the Year award in 2016); and a global team of economists, investment experts, and portfolio construction strategists. These teams are channeled through Vanguard’s outsourced CIO organization and wrapped in a boutique service experience.
Third: Focus on cost
Research shows that cost is the only reliable predictor of future (relative) performance.² The lower the cost, the greater the chance that you will outperform higher-cost counterparts. Cost is also the most controllable factor in investing. Yet organizations often fail to minimize investing costs.
Cost is multifaceted: Investment management fees, custody fees, and advisory (or staff) fees are just a few. Many times there are also a slew of ancillary fees that are difficult to tease out. Vanguard’s laser focus on fees helps ensure that our clients retain more of their earnings than their higher-cost peers.
Fourth: Maintain discipline
Finally, we champion what we call “behavioral ballast.” Humans err. While intentions are often noble, any solid asset allocation policy can be undermined through a constant turnover of managers and strategies and a focus on tactical or dynamic allocations. Policy can also be thrown off course by significant bets on idiosyncratic opportunities that come with the allure of exclusivity and the promise of outsized performance.
This danger has been substantiated time and again through academic and industry research.³ And yet the urge to just do something is strong. Among asset managers, institutional consultants, advisors, and investment committees, human behavior is nondiscriminatory.
At Vanguard, our clients’ success is driven by our commitment to—literally—preventing humans from doing human things.
Our strong foundation delivers results
Vanguard’s outsourced CIO alpha model may not be as exciting as our tactical or “active” peers, but the evidence is strong that our approach works. Building on the seminal work by Gary Brinson, Randolph Hood, and Gilbert Beebower, Vanguard evaluated the performance of global multi-asset class strategies. Our research found that, on average, such strategies generated negative alpha while realizing greater volatility than their policy benchmark.4
But what about professional asset allocators paid for their robust manager search and oversight capabilities? Recent research suggests that such recommendations add no value and may actually underperform funds that are not recommended at all.5
The Vanguard outsourced CIO alpha model, on the other hand, has delivered meaningful results. See, for example, the chart below, which plots the returns of university endowments relative to the returns for a portfolio using only Vanguard index funds, as well as three different portfolios that also include Vanguard active funds.
It might come as a surprise that we are not dogmatic about indexing being the only way to deliver long-term success. Indeed, Vanguard’s outsourced CIO offer includes low-cost active, factors, and liquid alternatives. What’s different is our obsessive focus on strategic, rather than tactical (or “dynamic”), asset allocation.
Simplicity (and a consistent, validated, transparent approach) is sophisticated!
To learn more about Vanguard’s outsourced CIO services for nonprofits, visit our nonprofit solutions site to submit an RFI, or contact your local Nonprofit Solutions Director at 888-888-7064 or NPOCIO@vanguard.com.
Average annualized returns as of June 30, 2017: NACUBO institutions versus Vanguard Institutional Advisory Services® (VIAS™) model portfolios
Sources: Vanguard using data from NACUBO-Commonfund Study of Endowments as of fiscal year-end June 30, 2017.
Returns are net of fees. VIAS portfolio model returns assume semiannual rebalancing to target allocations and are net of fund expenses and a 0.08% advisory fee (based on a $75.5 million investment). VIAS clients do not pay commissions or brokerage fees, and the model results above therefore do not reflect the deduction of such fees. Advisory fees are subject to change dependent on portfolio size as described in the VIAS advisory brochure. VIAS portfolios are only available to qualified institutional investors with assets starting at $2 million. For additional information on the VIAS advisory fee schedule, please refer to the VIAS advisory brochure.
The VIAS model portfolio returns do not reflect actual trading and may not reflect the impact that material economic and market factors may have had on VIAS decision-making had VIAS actually managed client funds during the performance periods displayed above. VIAS portfolios are subject to fluctuations in value and investment losses. The volatility of the VIAS portfolios is materially different from that of the NACUBO institutions’ portfolios. NACUBO institutions may have had during the time periods noted above, and may currently have, investment objectives that are not consistent with the VIAS portfolios. Please see the Notes below for additional information about Vanguard model portfolios and NACUBO performance.
¹ As of January 31, 2018.
² Walick, Daniel W., Brian R. Wimmer, and James Balsamo. Shopping for alpha: You get what you don’t pay for, 2015. Valley Forge, PA: The Vanguard Group.
³ Bosse, Paul M., Douglas M. Grim, and Frank Chism, 2017. Frank, Duty, opportunity, mastery: Investment committee best practices, 2017. Valley Forge, PA: The Vanguard Group.
4 Scott, Brian J., James Balsamo, Kelly N. McShane, and Christos Tasopoulos, 2016. The global case for strategic asset allocation and an examination of home bias. Valley Forge, PA: The Vanguard Group; based upon research completed by Brinson, Gary P., Randolph Hood, and Gilbert L. Beebower, 1995. “Determinants of Portfolio Performance.” Financial Analysts Journal.
5 Jenkinson, Tim, Howard Jones, and Jose Vicente Martinez, 2016. “Picking Winners? Investment Consultants’ Recommendations of Fund Managers.” Journal of Finance 71(5): 2333-2370.
- All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Diversification does not ensure a profit or protect against a loss.
- Costs are one factor impacting total returns. There may be other material differences between products that must be considered prior to investing.
- Advice services offered through Vanguard Institutional Advisory Services are provided by Vanguard Advisers, Inc., a registered investment advisor.
VIAS model portfolio underlying fund returns as of March 31, 2018
Vanguard Index (70/30 index portfolio)
Vanguard index/active 1 (70/30 Quantitative portfolio)
Vanguard Index/active 2 (70/30 Diversified portfolio)
Vanguard index/active 3 (70/30 Concentrated portfolio)
The performance data shown represent past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, so investors’ shares, when sold, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at www.vanguard.com/performance. Performance data for periods of less than one year does not reflect the deduction of purchase or redemption fees that may apply. If these fees were included, performance would be lower. All other performance data are adjusted for purchase and redemption fees, where applicable. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Portfolio returns assume semi-annual rebalancing to target allocations and are net of fund expenses and a 0.28% annual advisory fee (based on a $10 million investment). Portfolio equity allocation is 49% U.S. and 21% international equity through December, 2014; 42% U.S. and 28% international equity thereafter; portfolio fixed income allocation of 30% U.S. fixed income through May 2013, 21% U.S. fixed income and 9% international fixed income thereafter. Returns for Total International Stock Index reflect Investor Shares through November, 2010, Admiral Shares thereafter. Return since inception for Total International Stock Index are for Admiral Shares.
* Benchmark is 49% Spliced Total Stock Market Index; 21% Spliced Total International Stock Index; 30% Spliced Bloomberg Barclay’s US Aggregate Float Adjusted Bond Index through May, 2013; thereafter, fixed income portion is 21% Spliced Bloomberg Barclay’s US Aggregate Bond Index, 9% Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index Hedged; after December, 2014 equity portion of the benchmark is 42% Spliced Total Stock Market Index, 28% Spliced Total International Stock Index. Please see Benchmark descriptions for additional information.
** Expenses are Investor Shares for International Value, Strategic Equity, and Mid-Cap Growth Funds; Admiral™ Shares for remaining funds.
Spliced Total Stock Market Index: Wilshire 5000 Total Market Index (formerly known as the Dow Jones Wilshire 5000 Index) through April 22, 2005; MSCI US Broad Market Index through June 2, 2013; CRSP US Total Market Index thereafter.
Spliced Total International Stock Idx: Total International Composite Index through August 31, 2006; MSCI EAFE + Emerging Markets Index through December 15, 2010; MSCI ACWI ex USA IMI Index through June 2, 2013, FTSE Global All Cap ex US Index thereafter. Benchmark returns are adjusted for withholding taxes.
Spliced Bloomberg Barclays U.S. Aggregate Float Adjusted Index: Bloomberg Barclays U.S. Aggregate Bond Index through December 31, 2009; Bloomberg Barclays U.S. Aggregate Float Adjusted Index thereafter.
NACUBO stands for the National Association of College and University Business Officers. The 2017 NACUBO-Commonfund Study of Endowments® (NCSE) shows data gathered from 809 U.S. colleges and universities, with 97 institutions in the $1B cohort.
The NACUBO institutions’ portfolios performance was reported to NACUBO voluntarily by NACUBO member institutions and the performance reported may have been affected by changes in conditions, objectives, or investment strategies during the time period of performance displayed. The NACUBO institutions’ portfolios included in this chart have the following asset allocation on average. For the $1B cohort: 32% equities, 7% fixed-income, 57% alternative strategies, and 4% in short-term securities, cash, or other types of investments. For the total institution cohort: 35% equities, 8% fixed-income, 53% alternative strategies, and 4% in short-term securities, cash, or other types of investments. 86 percent of the $1B cohort and 82 percent of the total study participants reported rebalancing at least once in 2017.
NACUBO portfolios performance is net of fees. The fees deducted from NACUBO portfolios include: (i) management fees paid to direct asset managers for investment and management services excluding performance fees, which can vary widely and may not be indicative of expected rates for a given period; (ii) fund-of-fund fees, which represent aggregate blended management fee rates paid directly to fund-of-fund providers; (iii) advisory fees, which may include consulting fees in addition to fees for investment advisor services; (iv) fund operating expenses; and (v) custody fees. The NACUBO Report notes that individual institutions may pay more or less in fees than is represented by the performance figures set forth above and that NACUBO’s fee deduction method is intended to provide a representation of average fee levels rather than what any individual institution pays.