Most col­lege en­dow­ments don’t make cum laude

Volatil­ity across global mar­kets has hurt short-term re­turns “There aren’t a thou­sand good buy­out funds”

Bloomberg Businessweek (Asia) - - CONTENTS - −Janet Lorin

The man­agers of U.S. col­lege en­dow­ments try hard to earn more for their schools than a plain-vanilla port­fo­lio of stocks would. That’s never easy, and lately it’s been es­pe­cially tough.

Fif­teen en­dow­ments that pro­vided Bloomberg with to­tal re­turns for the se­cond half of 2015 lost 3.6 per­cent on av­er­age. In the same pe­riod, the Stan­dard & Poor’s 500-stock in­dex earned a slight gain with div­i­dends. While global mar­kets have re­vived re­cently, en­dow­ments may strug­gle to make up for lost ground by the time their fis­cal year ends in June.

“At this mo­ment in time, it doesn’t look like it’s go­ing to be a fan­tas­tic year,” says Tim Jarry, chief in­vest­ment of­fi­cer for the Col­lege of the Holy Cross in Worces­ter, Mass. The pri­vate col­lege’s en­dow­ment saw a loss of 4 per­cent from July through De­cem­ber. In­vest­ments con­trib­ute to a school’s an­nual op­er­at­ing bud­get, though schools de­ter­mine spend­ing based on av­er­age re­turns over a few years. In­vest­ments used for di­ver­si­fi­ca­tion were mainly a drag. The $3.1 bil­lion Univer­sity of Wash­ing­ton fund, down 3.8 per­cent, was hurt by emerg­ing mar­kets. The Univer­sity of Iowa, with $1.3 bil­lion, lost 4.6 per­cent, thanks in part to global bonds and real as­sets, in­clud­ing nat­u­ral re­sources. Hedge funds, which can bet on a va­ri­ety of se­cu­ri­ties ei­ther ris­ing or fall­ing in value, con­trib­uted to the Univer­sity of Cal­i­for­nia’s 2.5 per­cent loss on its $8.7 bil­lion port­fo­lio.

En­dow­ments have ex­panded the range of their in­vest­ments to in­clude not only com­modi­ties and hedge funds but also ven­ture cap­i­tal and pri­vate equity, or buy­out, funds. This is the Yale model, named for that school’s leg­endary $26.5 bil­lion fund, which has earned a 10 per­cent an­nu­al­ized re­turn over the past decade. (Yale hasn’t re­ported re­turns for the lat­est six-month pe­riod.)

De­spite this shift, there re­mains a per­sis­tent long-term per­for­mance gap be­tween large en­dow­ments such as Yale’s and smaller ones. Schools with funds of at least $1 bil­lion have earned 7.2 per­cent an­nu­ally over the past decade, com­pared with an av­er­age of 6.2 per­cent for those from $101 mil­lion to $500 mil­lion. “A one-point dif­fer­ence over 10 years is pretty sub­stan­tial,” says Ken Redd, di­rec­tor of re­search

and pol­icy anal­y­sis for the Na­tional As­so­ci­a­tion of Col­lege and Univer­sity Busi­ness Of­fi­cers, which helped col­lect the data. For an en­dow­ment start­ing with $200 mil­lion, the dif­fer­ence adds up to $36 mil­lion over that time.

Ex­e­cut­ing the Yale model re­quires skill, but also re­la­tion­ships with man­agers of hedge funds and other so­called al­ter­na­tive in­vest­ments. That makes it hard for other schools to catch up. “You can’t go back 20 years and build those re­la­tion­ships,” says Karl Scheer, chief in­vest­ment of­fi­cer for the Univer­sity of Cincin­nati’s fund.

Many of the best al­ter­na­tive port­fo­lios are un­avail­able sim­ply be­cause they’re closed—not tak­ing new money. “There aren’t a thou­sand good buy­out funds,” says Erik Gor­don, a pro­fes­sor of busi­ness and law at the Univer­sity of Michi­gan. “There aren’t a thou­sand good VC funds. You have to find them, and you have to get in. The play­ing field tilts to­ward the en­dow­ments that are the big­gest and the ones that got into al­ter­na­tives early.”

It doesn’t help that hedge funds of­ten come at a high cost. On top of an­nual fees of about 2 per­cent, funds may take a share of any prof­its earned.

The in­vest­ment pol­icy at Muh­len­berg Col­lege’s $257 mil­lion en­dow­ment calls for 20 per­cent of as­sets in hedge funds. Kent Dyer, the en­dow­ment’s chief busi­ness of­fi­cer, isn’t sure whether that strat­egy has paid off. Over a decade, the en­dow­ment has earned an an­nual 5.7 per­cent, vs. 6.2 per­cent for those of sim­i­lar size. “I can re­mem­ber years back, all the fi­nance and in­vest­ment com­mit­tee dis­cus­sion be­fore dip­ping into hedge funds,” he says. “Are th­ese higher-fee ve­hi­cles do­ing us any fa­vors?”

The bot­tom line Col­lege en­dow­ments face low re­turns in the short run. In the long run, there re­mains a big gap be­tween haves and have-nots.

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