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Endowment Growth Not Keeping Up With Need

By Mark Hrywna - February 1, 2013

Long-term performance of endowments continues to improve but lags the necessary growth needed to keep up with inflation and expenses amidst volatility in recent years. Endowments among more than 800 colleges and universities in the United States saw an average return of -0.3 percent for the fiscal year that ended in June, after a 19.2-percent boom in 2011.

The 10-year return ending last year was 6.2 percent, up from 5.6 percent in Fiscal Year 2011, according to the 2012 NACUBO-Commonfund Study of Endowments (NCSE), released this morning.

The 831 colleges and university in this year’s study are very diverse and that diversity had something to do with the results, said John Walda, president and CEO of National Association of College and University Business Officers (NACUBO). The largest endowment in the study was over $30 billion while the smallest was less than $1 million. The average was $492.9 million and the median was just over $86 million.

It was only the eighth time in the 38-year history of the NACUBO study that the average one-year return was +/- 3 percent. The only endowments to show positive returns last year were the very smallest endowments – with assets less than $25 million at 0.3 percent — and the two largest categories — over $501 million returned 0.4 percent and over $1 billion, 0.8 percent. The lowest return was found among endowments of $51 million to $100 million, which were down an average 1 percent.

Overall three-year net returns improved from 3.1 percent in 2011 to 10.2 percent last year but five-year returns dipped to 1.1 percent, from 4.7 percent the previous year. The largest endowments also had the best returns over three-, five- and 10-year averages.

“The size of endowments has a lot to do with performance,” said Walda.

The top decile of endowments reported an average one-year return of 4.9 percent compared with 25 percent the previous year, and the top quarter reported 2.9 percent versus 23.5 percent last year. The difference between the highest and lowest one-year returns, according to the study, was unusually small this year, at 180 basis points, compared with 250 last year.

Factors attributed to the largest endowments’ success included:

  • Well-diversified portfolios with an equity bias;
  • The ability to make long-term commitments to less liquid strategies;
  • Access to top-tier investment managers: and,
  • Greater resources, including larger staffs, leading-edge technology and experienced investment committees.

An average 8.7 percent of operating budget comes from endowments overall, but the bigger the endowments, the more that percentage increases. For those with $1 billion or more in assets, the average was nearly twice that, at 16.2 percent.

There have been “a couple of good years since the 2008 market crash but universities are still not back to where they need to be in terms of rate of growth of the endowment,” said Verne Sedlacek, president and CEO of Commonfund. Universities have lost ground when adjusted for inflation, he said, needing a rate of return of better than 7 percent over the past decade. An average 10-year return of 6.2 percent falls short of the roughly 3.8 percent inflation rate of the last 10 years, on top of the 4 to 5 percent that endowments pay out annually.

“You have to view endowments as one part of the solution of financial pressures on colleges and universities of all types,” said Walda, encouraged by the increased dollars to operating budgets from endowments. “The solutions to stress on revenue lies in other places as well,” he said. “The ways universities have been able to add revenues are changing. Expense control in your system is something that’s going to be among the key themes over the next 10 years or so,” Walda said.

Volatilty has been a hallmark of the last decade, routinely seeing huge swings in one-year returns starting in 2007. “Volatility is something the managers of endowments have learned to live with, and deal with and it’s a part of reality going forward as well,” said Walda.

Small endowments have much less impact on institutions because it’s easier to make decisions to not increase spending while large endowments are dependent up on it. Smaller institutions see spending decisions made on an annual basis versus many commitments from endowments for a longer period of time at larger endowments, Walda said.

The largest endowments reported an average of nearly 11 full-time employees (FTEs) to manage their endowments while the overall average was 1.6 FTEs. The smallest endowments reported an average 0.3 FTEs and 82 percent of participants reported using an outside consultant.

About 39 percent of institutions reported they received less in gifts than the previous year while 41 percent reported more gifts. The median total of new gifts was $2.2 million and the average total of new gifts was $8 million, according to the study. Gifts were correlated with the size of the endowment, with both the average and median being by far the highest among endowments of $1 billion or more.

Most of the damage to portfolio returns was done by international equities and commodities and managed futures, which saw negative returns across the board. Making up anywhere from 14 to 18 percent of all portfolios, international equities had an average -11.8 percent return overall. Commodities and managed futures was down an average -10.1 percent. The only other asset allocation that was down consistently among endowments, regardless of size, was marketable alternative strategies, down an average 1.2 percent overall.

Private equity real estate led all allocations with a 7.5 percent average return overall, followed by fixed income at 6.8 percent. Endowments over $1 billion returned an average 9.1 percent on fixed income while all other categories were returned closed to 7 percent or less.

International equities were perhaps the most consistent asset allocation across endowment sizes, ranging from 14 to 18 percent, but others had a much more stark difference.

There’s a dramatic difference in asset allocation between very large and very small endowments. Those with assets of more than $1 billion had only about 12 percent in domestic equities and 9 percent in fixed income while 61 percent was in alternatives. Of that 61 percent, more than quarter of allocated to private equity.

One of the major decisions made by larger institutions, they want to take their equity exposure on the private side, not public, and will get higher returns with private versus public, according to Sedlacek. “That’s a substitute for public equity that you might see in smaller endowments. The smaller your endowment, the more exposure you have to hedge funds,” he said.

Fixed income was just 11 percent overall, and 9 to 12 percent among the largest endowments compared with 24 and 29 percent among the smallest endowments. Conversely, alternative strategies made up 48 and 61 percent of the two largest endowment categories but just 11 and 19 percent among the smallest (while 54 percent overall). Smaller endowments generally were invested more heavily in domestic equities and fixed income.

Within alternatives, private equity did well but it was a very bad year for hedge funds, said Sedlacek. Within hedge funds, generally active stock pickers did poorly relative to passive pickers. After a pretty modest decade for venture capital, returns seem to be picking up the last two years, he said, after the Initial Public Offerings (IPOs) of some big names like Facebook and LinkedIn. “Lot of its still in the market, not in cash,” he said, sitting in stocks like Facebook. There’s been some reinvestment “but not a continued full allocation of it,” he said.

Ninety-four percent of participants also were in last year’s survey and more than 800 have been in the study every year since the NACUBO-Commonfund partnership began four years ago. Of the 831 institutions in the survey, 525 are private and 306 are public, representing total endowment assets of $406.1 billion. The effective spending rate for participating institutions was 4.2 percent last year compared with 4.6 percent in 2011.

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