Returns to long-term investing
From Challenger Chief Economist Dr Jonathan Kearns
Two weeks ago Graph of the Week reported that larger US university endowments have higher returns as they invest more in private equity, alternatives and venture capital (with less in equities and fixed income). These patient investors who don’t face withdrawal risk have achieved impressive returns reflecting their ability to invest in illiquid and long-term assets.
Another long-term investor, Berkshire Hathaway reports an impressive 19.8% nominal annualised return over 58 years, beating the 10.2% for S&P 500 (including dividends). However, this higher return has come with greater volatility and the Sharpe ratio (ratio of return to standard deviation) for Berkshire Hathaway at 0.61 is almost identical to the 0.60 for the S&P 500.
Yale university pioneered the approach of its endowment fund investing in less liquid assets, recognising that their advantage relative to other investors was not facing withdrawal risk. The Yale fund is renowned for its strong returns, with an average of 10.3% over the past 23 years beating the 6% return on a portfolio of 60% equities and 40% bonds (a common benchmark and closer to the portfolio of the smallest US university endowments). While this higher return has come with more volatile returns, Yale has achieved a higher Sharpe ratio 0.84 than the 0.66 on a 60/40 portfolio.
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An investor that can afford to be patient in Australia is the Future Fund, which was established in 2007. Over the past 16 years it has returned an average of 8.3%, beating the 6% return on a domestic 60/40 portfolio. The Future Fund has achieved this with less volatile returns and so a higher Sharpe ratio of 1.2 versus 0.65 for a 60/40 portfolio.
Overall, it seems that fund managers who don’t have to worry about their investors withdrawing funds can obtain higher returns through their asset selection which includes investing in assets with higher illiquidity and term premiums.