How Does Human Capital Affect Investing? Evidence from University Endowments
Matteo Binfarè, Gregory Brown, Robert Harris, Christian Lundblad
Review of Finance, Volume 27, Issue 1, February 2023, Pages 143–188, https://doi.org/10.1093/rof/rfac017
We examine the links between human capital and endowment investing. University endowments spend billions of dollars a year to support higher education in the United States. Rather than rely on investments in public securities such as stocks and bonds to fund this spending, many (and especially large) endowments have substantial allocations to “alternative” assets, such as hedge funds, private equity, or venture capital. Given the mission and profile of nonprofit endowments, these endowments can bear the illiquidity of alternative investments, with the opportunity to earn higher risk-adjusted returns. As most endowments often have an infinite investment horizon, few investment constraints, in-house expertise, and links to successful alumni, they can invest with top performing managers in private assets that would otherwise be difficult to access. These arguments are at the core of the “endowment model”, popularized by David Swensen at Yale, which advocates that endowments hold a low allocation to public markets and high allocations to alternative investments.
This paper studies the role of human capital in the investment management of university endowments by examining links to asset allocations and resulting returns. To measure human capital, we look at the professional backgrounds of endowment investment committee members, whether there is a chief investment officer (CIO), and the size of the in-house professional investment team. These provide broad measures of the skills, knowledge, and experience that the endowment uses in the investment process. We pay particular attention to alternative assets (hedge funds, private equity and venture capital) which play a large role in the “endowment model” and may require specialized expertise for investing.
We document the substantial shift to alternative assets which is especially pronounced for larger endowments. These endowments employ higher levels of specialized human capital in their investment process. We find that higher asset allocations to alternative assets accompany higher levels of human capital in the endowment’s investment process. Moreover, high levels of human capital are linked to larger returns, even on a risk-adjusted basis. The improved investment outcomes arise because endowments i) capture higher returns that can accompany alternative assets, ii) select or have access to high performing managers, and iii) minimize fees by accessing funds directly rather than through funds of funds. For instance, we find that human capital affects how endowments navigate choices between accessing funds directly rather than through funds of funds. Endowments with more human capital resident in their investment committees and professional staffs are more likely to use direct funds to invest in alternative assets.
Lastly, to provide additional insights on how allocations and performance are linked to human capital and networks, we conduct a survey of endowments to dig further into the investment process. We confirm that specialized human capital is central in facilitating alternative investments.