In a Volatile Economy, Colleges' Endowment Returns Fall Flat

February 01, 2013

The value of college endowments fell back to earth in 2012, just a year after soaring an average of 19.2 percent, according to a new survey released on Friday.

The Nacubo-Commonfund Study of Endowments, which looks at data from more than 800 education institutions in North America, found that endowments for the fiscal year that ended on June 30, 2012, were essentially flat, returning an average of minus-0.3 percent.

John D. Walda, president of the National Association of College and University Business Officers, said that in the endowment study's 38 years, the returns have been within plus or minus 3 percent just eight times.

"One of the lessons from looking at these numbers from over the past 10 years is that we are in a period of great volatility," he said. "I would predict that we will continue to have some big swings in performance as we go forward in the next few years."

Mr. Walda and John S. Griswold, executive director of the Commonfund Institute, advised colleges to take the long view on endowment strategy.

"Short-term thinking is dangerous in this business because it usually leads to some bad decisions," Mr. Griswold cautioned. "Don't panic. Stick to your guns. Stick to the policy that you hopefully spent a lot of time to create and write down, so that you could pass that along to your successors."

Indeed, Mr. Walda pointed out, the average gain in value of college endowments over 10 years is 6.2 percent, meaning they outperformed the Standard & Poor's 500 stock index, which he said returned 5.3 percent over the same period.

The key, Mr. Griswold and Mr. Walda agreed, is maintaining a varied investment portfolio. "No one can know year to year which asset class or strategy is going to turn out a winner or a loser," Mr. Griswold said. "That's the message here: Stay balanced, stay diversified, and for heaven's sake do the best job you can to find the best managers in each of these sectors."

Performance by Classes

The Federal Reserve Board's decision to hold down interest rates made "fixed income" the most reliable asset class in 2012, with bond investments returning an average of 6.8 percent across all sizes of endowments. The biggest loser was international equities, with Europe's dismal economy and uncertainties about growth in China resulting in an average return of minus-11.8 percent across endowments of all sizes.

Generating small gains were domestic equities, or stocks, short-term securities, and "alternative strategies," an asset class that includes a mix of subclasses like private equity, private-equity real estate, venture capital, commodities, and distressed debt. Among those subclasses, private equity, private-equity real estate, and venture capital posted respectable gains, while commodities and managed futures posted an average loss of 10.1 percent.

While the study does not report the endowment returns of individual institutions, it does reveal how groups of institutions representing six sizes of endowments—from more than $1-billion to less than $25-million—allocated their investment dollars and how each of those asset classes performed.

For example, institutions with endowments worth more than $1-billion invested 61 percent of their money in alternative strategies, which generated an average return of 3.1 percent. Institutions with under $25-million invested just 11 percent in alternative strategies, for an average return of minus-1.4 percent.

The 68 institutions with assets in excess of $1-billion posted investment returns of 0.8 percent, the highest of any group. Institutions with $501-million to $1-billion saw average returns of 0.4 percent, and the next three asset cohorts—$101-million to $500-million, $51-million to $100-million, and $25-million to $50-million—all posted small losses. The institutions with less than $25-million gained 0.3 percent, largely because they had the bulk of their money invested in stocks (39 percent) and bonds (29 percent).

'Big Increases' in Spending

Harvard University was, once again, the wealthiest institution, with $30.4-billion in endowment funds. Although the university reported an investment return of 0.05 percent, the total value of Harvard's endowment fell by 4.1 percent as the net result of institutional expenditures and investment fees as well as the slight investment gain and incoming gifts.

That negative 4.1 percent amounted to nearly $1.3-billion in 2012, a figure that is greater than the value of all but the 55 largest endowments.

Yale University's $19.3-billion endowment was the second-biggest, with a return of 4.7 percent on its investment. The University of Texas system was third, at nearly $18.3-billion. Stanford University's $17-billion endowment was fourth, and Princeton's was fifth, with just under that amount. The Massachusetts Institute of Technology, which has an endowment valued at $10.1-billion, reported an 8-percent rate of return.

One reason that endowment values dipped, Mr. Walda said, is that 57 percent of the institutions increased their expenditures on campus operations, spending an average of 7.1 percent more in 2012 than they did a year earlier. The wealthiest class of institutions spent 15.7 percent more.

"Those are some big increases," said Mr. Walda, a response he attributed to reduced support from state and local governments, a sense that tuition has hit a cost ceiling, and fears of diminished federal support for research and student grants and loans.

Mr. Griswold said conventional wisdom holds that endowment spending above 5 percent is not sustainable. "But for short periods it probably is," he said.

Mr. Walda said calculating how much money to spend from an endowment depends on how big the pool of money is and what percentage of a college's operating expenses it is expected to cover. "In one school it might be a margin of excellence," he said, "but in another school it might be a way to keep the doors open."