The money managers who run university and college endowments may be the smart money, but this year they are barely getting passing grades.
The median U.S. college or university endowment returned just under 5% in fiscal 2019, lagging behind both the stock market and a diversified portfolio of stocks and bonds over the same period.
In the fiscal year ended on June 30, 2019, the S&P 500 index returned 10.4%, while a 70/30 mix of U.S. stocks and bonds grew 9%. Harvard, Yale, Princeton, and Stanford all failed to crack a 6.5% return over the same period. The only market beater among the Ivies was Brown, which had a 12.4% return on its endowment in fiscal 2019.
University endowments had been a class act for years, producing stellar returns even during the financial crisis. They succeeded by aggressively diversifying—pouring money into hedge funds, private equity, real estate, and other alternatives—while shying away from U.S. stocks. The approach was pioneered by longtime Yale Chief Investment Officer David Swensen.
Source: Cambridge Associates; company reports
Now, endowments’ underperformance in recent years raises questions about that model.
“I think there is a general trend of exaggerating how well universities do,” says David Yermack, professor of finance at New York University Stern School of Business. “Even the very top performers are lucky to do average, and as a group they do worse than average. They would all be better off if they just owned index funds.”
Yale’s target allocation for the 2020 fiscal year devotes just 2.75% of its portfolio to U.S. stocks, with an additional 13.75% in foreign equities and 7% in bonds and cash. Absolute return funds get 23%, venture capital gets 21.5%, leveraged buyout funds get 16.5%, and real estate and natural resources get a combined 15.5%.
Stocks and bonds have taken a back seat as managers sought new sources of favorable risk-adjusted returns. Those alternative investments also tend to be heavy on fees.
“To be better in terms of performance, you have to be different,” says Margaret Chen, global head of endowment and foundation practice at the investment firm Cambridge Associates. “Many of our institutions with which we work were leaders in investing in alternative assets, which had distinct advantages [before the financial crisis].”
Cambridge Associates helps manage endowments for institutions, including pension funds, foundations, and colleges. Unfortunately for those institutions that shunned equities, the past decade’s bull market run has led that asset class to outperform nearly all others.
The S&P 500 has produced annualized returns of 14.7% in that span, and a stock/bond mix has posted 11.4% gains a year—but the average return of 149 colleges and universities analyzed by Cambridge Associates was 8.6%. Princeton was the only Ivy to surpass the stocks/bonds mix, with a 11.6% annualized return over the past decade. Yale earned 11.1% a year. The Yale endowment office said that the 10-year return “is well above the mean for colleges and universities, currently ranking fifth out of 151 reporting institutions.”
“Yale gains exposure to U.S. equities through marketable securities, leveraged buyouts, and venture capital,” the office added. Other endowments declined to elaborate on their strategy.
Schools with the biggest endowments have tended to perform better than endowments on average. That’s thanks to their ability to devote greater allocations to private-equity and venture-capital assets, Chen says.
Yet Yermack’s research finds that a larger sample of university endowment fund returns have on average underperformed those of other types of nonprofit institutions, including museums and hospitals.
Chen says she sees three main options for endowment managers. First is to “stay the course”—namely rebalance and continue the status quo. Second would be to throw in the towel and chase returns in the strategies that have done the best over the past decade: index investing and private investments. The third choice she describes as a hybrid, “be ready” approach.
“Endowments are positioning themselves to be opportunistic when a situation arises,” Chen says. “We see endowments raising and sitting on a bit more cash than they have in the past, the idea being to limit downside risk but also capture some of the upside when…the market turns and distressed opportunities, credit opportunities might appear.”
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