March 1, 2009
College and university endowments in the US are rethinking the investment approach that has made them the envy of other institutional investors. As they try to recover from losing a quarter of their assets in 2008, endowments are making adjustments based on multiple factors.
Endowment chiefs and other experts say this will lead to a wider range of portfolio allocations, manager selection processes and return expectations in the space ñ a potentially discomfiting development for investment staff members and trustees who are used to measuring relative performance, not setting absolute performance benchmarks.
“We used to always try to do what Yale does,” said Thomas Heck, chief investment officer of the Ball State University Foundation in Muncie, Indiana. But now, he says, individual endowments will make decisions based on their own concerns and situation, such as whether the fund is supporting the operational costs of the school or is used only for excess programmes, how much of the endowment is unrestricted, how much is needed for current spending and the capabilities of both the board of trustees and the investment office staff.
“The differentiations will become greater as the differences among our institutions are taken into account and thoughtfully considered,” says Mr Heck.
“We may be rethinking the entire structure of asset allocation at this point. That’s a healthy thing to do. It’ll be intellectually interesting, professionally interesting and should achieve better results if we do that in a thoughtful way.”
Endowments in the US are often the first to incorporate new strategies and asset classes into their portfolios.
Even mid-sized endowments, with $100m-$500m (£70m-£348m) in assets, invest half their assets in equities and 16.4 per cent in hedge funds, the National Association of College and University Business Officers (Nacubo) has found. Other institutional investors, such as public and corporate pensions, prefer to put more in fixed income and less in alternatives.
Such aggressive investing has served endowments well; they are known for generating returns that routinely beat other investors — even during much of the down market. For the year ending September 30, endowments and foundations were down an average of 13.2 per cent, compared with the average public and corporate pensions, which were down 14.8 per cent and 15.5 per cent, respectively, says Northern Trust.
But better relative performance aside, endowments’ losses have been stiff. Nacubo estimates most endowments are down about a quarter from a year ago. That coincides with a spate of pressures felt in 2008: a drought of liquidity because of hedge fund gates and other reasons, time-consuming accounting requirements and lawmakers calling for endowments to spend more.
Chief among endowments’ concerns now is whether their portfolios provide real diversification.
“What we have done is chop our portfolio up into smaller and smaller pieces. We might have 20 different asset classes. We spend a lot of time thinking about whether we should rebalance between growth and value,” says Verne Sedlacek, president and chief executive of Commonfund, a nonprofit investment manager for educational and healthcare organisations. “We’ve taken lots of different factors and dumped them all on our asset allocation. We seem to think because it has a different name it’s diversifying.”
He says endowments should return to more traditionally allocated portfolios based on the needs of the institutions they’re connected to.
“As you think about asset allocation, are we making it too hard? Did we lose the concept of protecting the downside for the concept of chasing our neighbour?” he asks.
“We should think about the diversification from the asset side and we should think about the risk factors and manage them separately.” That means taking such steps as establishing how much illiquidity an endowment can endure and setting a currency risk budget.
Also under reconsideration is whether small and mid-sized endowments have invested too much in alternatives or made other decisions based on practices of big endowments, says Daniel Wallick, principal at Vanguard, investment manager.
“There was a large rush to do a variety of things, and now people are regrouping and rethinking whether that was what they really want to do, in particular the move to alternatives,” says Mr Wallick, naming hedge funds and private equity as the two biggest targets for reconsideration.
“People experienced what the true illiquidity of those were over the last year.”
Donald Lindsey, chief investment officer of George Washington University, says he would support that approach.
The school’s endowment portfolio is divided into just a few asset classes with broad ranges and definitions. Speaking at a recent conference in New York, Mr Lindsey urged endowments to use a “thematic” approach to structuring their portfolios.
“Rather than think about asset allocation, think about a macro view of the world. What are the major forces that are going to have a significant impact and really change the world in the next 10 years? Are there investable themes that can be capitalised on?” he said.
Others agree that endowments will reduce the number of managers they use and may eliminate some types of alternative investments. But they say only a few take a thematic approach to their portfolios, and expect most will make short-term moves to a more traditional portfolio, then back to an aggressive stance when markets stabilise.