Endowment Management Trends

After a second consecutive year of investment losses, college and university officials continue to monitor and adjust endowment management practices. Officials are paying particular attention to asset allocations, internal asset management organizations and donor-advised giving programs.

In relative terms, the nation’s educational institutions have managed their endowments well, generally doing better (or losing less) than the stock market and other institutional investors. A recent study by the National Association of College and University Business Officers (NACUBO) found that college and university endowments lost an average of six percent in value during 2002 and 3.6 percent in 2001. By comparison, the S&P 500 stock market index fell 18 percent in 2002, and the largest 10 pension funds recorded a collective loss of 7.2 percent.

But endowment managers cannot afford to judge performance by comparing results with other investors. A pension fund, for example, generally seeks long-term investment results that will meet future needs of beneficiaries. But an endowment must strive for consistent positive returns to satisfy annual spending priorities and to avoid invading the ‘corpus’ or principal assets in the fund.

In 2002, for example, colleges and universities spent an average of 5.3 percent of the market value of their endowments, according to NACUBO. These expenditures supported financial aid, faculty salaries, building maintenance, research and development, and a variety of other institutional needs. A fund that lost five percent on its investments and spent five percent on operations may have seen an overall portfolio decline of 10 percent.

The Move to Alternative Investments

The pressure to achieve positive returns has led endowments to rely increasingly on alternatives to traditional investments in stocks, bonds and money markets. Alternative investments include hedge funds, real estate, venture capital, private equity and natural resources. While lay observers might view these alternatives as risky, industry experts contend that risk and reward are relative concepts dependent on the conditions prevailing in the marketplace.

In any event, a recent study by the Wilton, Conn.-based Commonfund Institute, an educational and research organization serving the nonprofit community, has found that educational endowments and foundations have increased their allocations to alternative investments substantially through the past two years. As a percentage of overall portfolios, alternative investments increased to 32 percent in 2002, up from 26 percent in 2001. During the same period, the percentage of endowment assets invested in stocks fell from 41 percent to 32 percent. By contrast, pension funds tend to allocate 10 percent of their assets to alternatives.

Analysts say that the focus on alternative categories has enabled endowments as a class to perform better than other institutional investors. ‘Institutional funds that are being hurt the least are those that are more diversified into alternative assets,’ says Tony Ryan, a partner in charge of global business development for Boston-based GMO, an asset management firm that invests approximately $26 billion on behalf of institutional clients.

Aiming to Reduce Management Fees

Endowments as well as other institutional investors typically rely on outside asset management firms to execute investments. Through the last quarter century, however, a handful of schools with large endowments have established their own asset management firms. Harvard University began the trend in the 1970s, with the formation of the Harvard Management Company. During the 1980s, Stanford, Yale, Princeton, Notre Dame and Duke followed suit. Recently, Columbia and the University of North Carolina established asset management firms.

In-house asset management aims to reduce investment fees. ‘Clearly, it can be expensive to hire third-party specialists to manage different asset classes in a large portfolio,’ says Lyle W. Brizendine, a vice president with TIAA-CREF Trust Company in St. Louis. ‘Still the vast majority of endowments do not have the resources required to establish their own companies.’

Observers say that an endowment must have more than $1 billion under management to benefit from in-house management. While approximately 650 of the nation’s 4,070 institutions of higher education have endowments, fewer than 50 have reached the $1 billion threshold.

Redoubled Fundraising Efforts

Most investors must rely solely on prudent asset management to increase holdings. Endowments, as well as foundations, have a second option: soliciting gifts. ‘Institutions are redoubling their efforts to gather assets from donors to offset negative returns in the markets,’ Brizendine says.

The Commonfund Institute study found that 24 percent of 651 institutions polled logged increases in gifts during 2002. On the other hand, 39 percent reported no change in donations and 33 percent saw a decline.

To increase gifts to endowments, managers are investigating new fundraising techniques. Among these are donor-advised-giving funds.

According to Brizendine, such funds enable donors to make irrevocable gifts and take immediate income tax deductions. At some point in the future, donors designate various recipients for investment income generated by the gifts. Used by community foundations for decades, the concept has been adopted widely by commercial investment managers in recent years. Commercially managed donor-advised funds make it easier for donors to distribute gifts, but Brizendine notes that these funds can also make it difficult for endowment managers to maintain relationships with important contributors.

To overcome this problem, some colleges and universities are adding donor-advised funds to their planned giving programs. Although institutions do not receive all of the income from these funds, they generally require that some percentage of the proceeds flow through to the endowment.

As 2003 begins to unfold, endowment managers foresee continuing challenges in the investment markets, and the search for new and better ways to manage endowments will go on.