June 17, 2009
The largest endowments in the U.S. may face $38 billion in collective losses — or more — by the time their fiscal year ends on June 30, a FundFire analysis shows. The losses from last year’s brutal market turmoil, some of which are estimated to be up to 30%, have prompted some experts to question whether the endowment investment model is broken.
The fiscal year is not yet complete, and the data isn’t either. But the analysis indicates clearly that the nation’s top university endowments lost billions and billions of dollars to the market crash, in spite of their usually more aggressive investment approaches. Their returns, while in the red, still outperformed the broad equity markets and most public pensions.
Endowments that lost the greatest percentage of assets over the past year include Harvard University, Stanford University, Princeton University and the University of Chicago, each of which has indicated 30% losses for fiscal year 2009. Based on its projection of losses, Harvard, which holds the country’s richest endowment, would also have the largest dollar loss of nearly $11 billion.
The Massachusetts Institute of Technology, the University of Michigan, Texas A&M University System and Foundations and the University of Notre Dame are also among the largest endowments in the U.S., but were not included in the analysis because they have not publically discussed their year-end losses.
The starting asset levels for the FundFire analysis are those reported by the National Association of College and University Business Officers as of June 30 of last year.
The market continues to change, of course, making the conclusions by no means hard figures.
Additionally, the projected losses come from varying timeframes. For example, Yale University projected in February that its endowment assets would drop by 25% for the entire fiscal year, while Stanford said in May it believes its endowment will have declined 30%. Stanford’s fiscal year ends Aug. 31. The University of Texas System has the most current figures, which it provided in its June 2009 financial report.
One of the most widespread consequences of the down market was the liquidity drought many endowments suffered. Some schools issued bonds to cope, including Cornell University, Duke University, Harvard, Princeton and Stanford.
Reductions in credit ratings complicated some of those efforts. Dartmouth College’s endowment, for example, has fallen to $2.6 billion from $3.7 billion at the end of June 2008; losses led Standard & Poor’s to cut the school’s long-held triple-A rating to “AA”-plus ahead of its $400 million bond issuance. That is expected to increase interest rates the college must offer by up to 20 basis points.
Others dealt with the liquidity issue by selling their private holdings on the secondary market, with varying success.
Some schools have decided to squirrel away more cash to stave off future liquidity problems. Michael Sullivan, CIO of the University of St. Thomas in Minneapolis, said in early spring that the cash allocation of the school’s $400 million endowment was 15%. The policy target, he said, is zero.
“I’ve been slowly raising cash over the last nine months,” he told FundFire then. “I’m just so cautious about the liquidity and security issues in the market. Until this market settles down, I’m just cautious about putting anything into it.”
At the annual NACUBO meeting in January, some officials speculated that endowments will reconsider their taste for illiquid alternative investments, which have historically helped generate hefty returns but exacerbated last year’s losses.
Whether that is true has led to some heated debate. In a recent FundFire column, Bill Gross, co-CIO of PIMCO, says endowments should move assets away from alternatives and into securities that offer stable income. Lou Morrell, Wake Forest University’s outgoing treasurer and v.p. for investments, disagrees in a rebuttal column published in FundFire last week, saying that what endowments really need is a strong liquidity strategy.
Other experts agree with Morrell, saying the only major change they expect is a new approach to liquidity.
“If by ‘endowment model’ we define a preference for illiquid investments in the expectation that they’ll provide diversification and provide excess return, then I don’t think the endowment model is broken,” says William Jarvis, managing director of the Commonfund Institute.
“The question is, now that we know what can happen, how should university investment committees adjust their investment policies to take into account the fact that liquidity can disappear? We’re seeing a number of things institutions are considering, though there’s not a consistent model,” he says, adding that some endowments are setting up special lines of credit with banks or setting aside one or two years worth of operating cash in a cash or near-cash account.
Endowments will also keep a better watch on risk, says Mike Hennessy, managing director at Morgan Creek Capital Management. He says some will hire specialist risk managers, or use tools like ETFs, to do so.
“The model isn’t broken. Yes, last year was disappointing, but when correlations go to one, endowments’ returns aren’t that bad,” he says. “Over the long period of time, they’re still way ahead. What would they do differently? Go to stocks and bonds? That doesn’t look good. Go to cash? Then you’d lose money every day. Endowments will learn lessons, but I don’t think they’ll do anything drastic.”
Hennessy notes, however, that few endowments have rebalanced back to their original policy targets so far.
“There’s still fear and nervousness and confusion. We went through the biggest market crisis of our lifetime. The outcomes are very unclear. It could be a v-shaped recovery. It could be a w-shaped recovery,” he says. “There’s a little bit of — I don’t want to call it paralysis — but confusion about how to rebalance.”