Thursday, January 25, 2007

University endowments are kicking the market's butt

News coverage of an annual report on U.S. university endowments (released this week) has tended to focus on either the gaudy totals, or the related news that Princeton has decided to freeze its tuition for a year. (It turns out that while a few other endowments are larger in total, Princeton has the most endowment dollars per student.)

The Economist wants to know how American universities are managing to invest better than even hot-shot hedge-fund managers? That's not a new or unusual outcome, apparently, and the schools aren't paying successful investment managers the same level of wild salaries and bonuses that for-profit firms do. (Though a few universities do pay their investment chiefs a lot more than their professors or even presidents, which has caused some public controversies that have in turn chased away some managers.)

The Economist thinks that the big university endowments represent "capitol [that] is extremely patient....unlike pension funds, they do not have to fret about matching assets with liabilities. This means endowments can tolerate lots of volatility, which in turn allows them to make, and stick to, contrarian bets....Perhaps they can stay solvent longer than the market can stay irrational." Hence "America's endowments were among the first to look beyond the staid mix of domestic equities, bonds and cash. The idea they helped develop in the 1970s and 1980s—deemed eccentric at the time—was to break the portfolio into a mix of standard and “alternative” assets, as uncorrelated with each other as possible so as to spread risk. This strategy is sometimes referred to as “portable alpha”. Their early moves into hedge funds, venture capital, private equity, property, distressed debt and the like brought outsized profits...."

University investment managers may also have identified a couple of interesting competitive advantages: " “Whereas pension trustees are naturally risk-averse, universities are all about innovating, financially as well as intellectually,” says James Walsh, who runs Cornell's $5 billion endowment. Investment constraints are kept to a minimum. Alumni with Wall Street experience are encouraged not only to donate money but also to sit on investment committees. Many are happy to oblige. “This gives us access to minds we couldn't otherwise afford,” says Mr Walsh." "

One thing I'd like to see some data on, which would help inform the current debate about mission-related investing of foundation endowments, is how university endowment returns have been correlating with divestment decisions. The NACUBO report doesn't address that, unfortunately.


sdrone said...

They're doing well, at least in part, 'cause they're hiring big name managers. Either Harvard or Yale (cover story in Fortune last summer) managed to hire away Legg Mason's biggest rising star.

It's an opportunity to run a huge "mutual fund" without having to answer to shareholders. Like you said, there can be more leeway to make the bets they want to make.

a fundraiser said...

Doesn't anyone else have big huge red lights and sirens going off in the head while reading these stories?

I fear that the returns some endowments enjoyed in 2006 will put more schools in the risky position to push their luck.

It's one thing to try and keep up with the Jones on a fundraising campaign... it's quite another to gamble with the endowment.

Paul Botts said...

Actually it isn't just a 2006 story -- I doubt that one year's results would generate any media attention. What's so striking about the universities' investing results is that they've been consistently beating the market for many years now -- the 10-year comparisons in the Economist charts are just as strong as the 1-year ones.

So if they are indeed gambling with their endowments they are apparently really good at it. Or else maybe at some point consistent success makes "gambling" an unfair description of their investment strategies.

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