It’s commonly accepted that it’s better to have your money in a passive fund that tracks the market with relatively low fees than to pay more for management that often doesn’t even beat the index, but this advice is usually directed at individual investors. Institutional investors have more resources at their disposal and a longer investment horizon, which could let them take better advantage of strong investment managers.

Endowments can afford to be patient

“Active management for endowments is significantly positively related to higher returns net of fees from U.S. equity allocations over the evaluation period,” write Commonfund Institute chief risk management officer David Belmont and director Irakli Odisharia. “In addition, endowments with CIOs or OCIOs are better able to earn incremental positive returns from active management than those without.”

Endowments are unique among investors. Unlike individuals or even most businesses, they have a theoretically unending investment horizon. They might have to meet some income requirements, but they have much lower liabilities than pension funds. In a sense, endowments are the ultimate in patient capital, able to ride out volatility and take advantage of very low-liquidity opportunities.

Belmont and Odisharia also argue that part of the reason actively managed funds underperform is because so many of them are closet indexers, and that clients aren’t getting much value added for the extra fees.

returns by activeness 0414 Endowments

Size matters – up to about $500 million

The result is that endowments with the largest allocation to actively managed funds outperformed less active peers, and according to the regressions run by Belmont and Odisharia, the level activity accounts for 14% of an endowment’s returns (the study looked at endowment returns from 2006 to 2013). While it’s far from the only thing that matters, they found that it is statistically significant.

Their size also means that endowments may be able to negotiate lower fees and they can develop institutional knowledge on how to identify successful managers, so it’s no surprise that Belmont and Odisharia found that larger endowments benefit more from active management than smaller ones, although the benefit starts to fall off at about $500 million in assets. The presence of a chief investment officer also contributes to higher returns. In addition to whatever skills a CIO might bring to the table, naming one also shows that driving returns is a priority that the endowment is willing to devote resources to achieving.

active returns by endowment size 0414 Endowments