Endowments: Reaping the Rewards of Risk
Risk is paying off for endowments. From 1991 to 2005, endowment growth at top-tier schools outpaced colleges and universities as a whole. The primary reason for the larger profits: greater portions of the elite schools’ endowments were allocated to “alternative” assets such as private equity, venture capital, and hedge funds. That’s the conclusion of a new study conducted by Harvard Business School Professor, Josh Lerner along with two co-authors as reported in The Boston Globe.
The research paper entitled, “Secrets of the Academy: The Drivers of University Endowment Success,” shows that when it comes to investing, risk has paid off for the nation’s elite colleges and universities. The bottom line: $1 billion invested at the end of 1991 by the average U.S. college or university endowment grew to $3.68 billion at the end of 2005. That’s 268% gain over 14 years (and slightly less than the 278% compounded growth of the benchmark Standard & Poor 500 stock index in the same period.)
In contrast, $1 billion investment by “Ivy Plus” (Harvard, Yale, Brown, Columbia, Cornell, Dartmouth, Princeton, and Pennsylvania - plus the Massachusetts Institute of Technology, Duke University, Stanford University, and the California Institute of Technology) school endowments grew to $5.88 billion, a gain of 488%
According to the study, endowments at the “Ivy Plus” schools earned average annual returns of 13.8% over the 14 years, while all schools (including the Ivy Plus group) earned average annual returns of just over 10%. Ivy Plus endowments had an average of 26.6% of their investments allocated to buyout, venture, and hedge funds between 1993 and 2005, more than double the 12.4% allocated to those alternative assets by all schools.
That said, it may come as no surprise that the Lerner’s paper also indicates that elite universities offered higher compensation to their endowment staffs, had more effective investment committees, and also outperformed average college and university endowments in traditional asset classes, such as stocks, bonds, and real estate.
Elite schools have been among the best performers among all institutional investors in the past two decades, surpassing the returns of many pension and insurance funds. Lerner warns however, that as other endowments seek to raise their returns by boosting investments in alternative funds, whether or not that strategy will continue to generate larger gains in the future is not clear. In fact, he says, elite endowment managers have shifted shares of their investment portfolios in recent years into new categories like timber and natural resources such as water and alternative energy.
“Viewed as a whole, the past 25 years have been a benign environment for many alternative funds,” the report said. According to Lerner, “Whether these conditions will continue in the decade to come remains to be seen. You see a lot of people out there who are very attracted to the success the elite endowments have had and will try to mimic that success, but it’s not clear the investment philosophy these guys had will be as well-suited to the period going forward.”
The world’s wealthiest private investors, however, view alternative investments as a good bet. They are planning to inject more money intosuch investments over the next three years. That’s according to a new study issued by Barclays Wealth. The study, which polled 790 wealthy individuals from around the world, indicates that wealthy individuals around the globe are increasingly attracted to private equity and hedge funds. The reason cited by respondents for the rising popularity of these alternative investments: more stable returns.
Executive search firm, A.E. Feldman, says that demand is on the rise for alternative investment professionals who have a comprehensive understanding of the risks and benefits of the various asset classes and investment strategies.
