Endowments retool investments

By Todd Cohen

Endowments at U.S. educational institutions and foundations last year absorbed the one-two punch of the gloomy economy and skidding markets by adjusting their asset mix, rebalancing their portfolios and revising their spending policies, a new report says.

Most educational endowments also enjoyed a steady or slightly higher flow of gifts from donors, and some dipped into assets to sustain their spending levels, says the 2003 Commonfund Benchmarks Study, a survey of 637 endowments and foundations at colleges, universities and independent schools.

“We seem to have weathered most of the storm so far,” says John S. Griswold, executive director of the Commonfund Institute in Wilton, Conn. “They’ve kept spending under control, continued to diversify, the total return isn’t horrible and gifts have held up really well in many cases.”

Harvey Dale, who tracks best practices in managing endowments as director of the National Center on Philanthropy and Law at the School of Law at New York University, says endowments generally have been “moving toward greater recognition of the need for asset allocation, periodic rebalancing and manager selection if active management is desired.”

Many endowments further diversified their portfolios in the second half of the 1990s “and became comfortable accepting higher risk for higher reward,” says Dale, who also serves on the investment committee at Cornell University.

But since the extended market boom ended in March 2000, he says, “there’s been some retrenching because, psychologically, people get more nervous when markets decline.”

While portfolio values fell at educational endowments, which posted negative returns for the second straight year, an investment shift to alternative asset classes slowed the drag of the plunging equity market and helped endowments outperform major indexes, the study says.

The Institute — the research and publication arm of the Commonfund Group, which manages nearly $30 billion in assets for 1,600 educational institutions, foundations, hospitals and operating charities – says total assets at endowments responding to the study totaled $184 billion, up from $182 billion a year earlier and $200 billion in fiscal 2000. Twenty new endowments responded to new study.

Educational funds reported an average total annual return of negative 6 percent for fiscal 2002, down from negative 3 percent a year earlier, the study says – but outperformed three major equity indexes, which posted declines for the third straight year.

Average annual returns for those indexes as of June 30, 2002 – the end of the fiscal year for most educational endowments and foundations that support public education — were negative 10.3 percent for the Dow Jones Industrial Average, negative 17.97 percent for the S&P 500 and negative 32.29 percent for the Nasdaq Composite.

“The good news is that not only did people not get hit that hard, but they did not get hit nearly as bad as the indexes,” Griswold says

A key to cushioning the blow from the economy and markets, he says has been a continuing shift in asset allocation.

Alternative investments as a share of portfolio assets at educational endowments and foundations grew to 32 percent from 26 percent a year ago and 23 percent in 2000, the study says, while domestic equities fell to 32 percent of portfolio assets from 37 percent a year ago and 41 percent in 2000.

“You should diversify your portfolio, and people have done that,” Griswold says. “You’re seeing a big shift in the proportion of alternatives,” including private capital, venture capital, hedge funds, real estate, natural resources, distressed debt and high-yield debt.

Fixed income holdings were flat at 21 percent of total portfolio assets and international equity holdings were flat at 13 percent for the third straight year.

Endowments also remixed their equity investments, with the larger institutions moving out of large-cap value and growth and into passive/index investments.

Educational funds reduced large-cap value as a share of overall equity holdings to 25 percent from 30 percent a year ago, and reduced large-cap growth to 22 percent from 26 percent, while passive/index holdings grew to 23 percent from 14 percent.

At the biggest institutions – with assets of more than $1 billion – passive/index holdings more than doubled to 33 percent of equity portfolio assets from 14 percent a year ago.

Another positive trend, Griswold says, has been a rebalancing of portfolios to maintain the targeted mix of asset classes by shifting money from those that performed well to those that performed less well.

Sixty-two percent of the endowments and foundations surveyed rebalanced their portfolios in fiscal 2002, up from 55 percent a year earlier.

Rebalancing was done by 88 percent of funds with assets of more than $1 billion, and 40 percent of funds with less than $10 million.

“It’s a healthy thing to do and it’s a fairly recent phenomenon that you’re seeing such a high proportion of endowments do it,” Griswold says. “Smaller endowments need to do it more often, and they are doing it more and more each year.”

Two of three funds that rebalanced said market forces prompted the changes, while three in eight said the changes were made because of investment policy requirements – although Griswold said market forces often drove investment-policy changes.

Spurred by negative returns and lower portfolio values, the study says, spending rates grew to 5.1 percent from 4.8 percent a year earlier and 5 percent in fiscal 2000.

The increase resulted in part from the market decline, which raised spending rates for endowments that tried to maintain their spending in actual dollars, Griswold says.

Rates did not rise even more quickly, he said, because endowment officials resisted pressures for higher spending to cope with government funding cuts, rising costs and a slowdown in the growth of gifts resulting from the weak markets.

“The decision a trustee has to make is to balance the needs of today’s students with the needs of the next generation,” Griswold says. “They’re acting prudently.”

Fourteen percent of institutions revised their spending policies during the year – for an average revised spending goal of 5 percent.

Nearly eight in 10 institutions operate with spending rules based on a pre-specified percent of a moving average of market values – and nearly nine in 10 of those institutions based that average on a three-year period.

Twelve percent of institutions responding to the study said they had dipped into endowment assets in fiscal 2002, spending an average of 6.8 percent of their endowment funds.

“It’s just more evidence of stressful times,” Griswold says. “It’s higher than we’d have in normal times, but not that much higher.”

That practice was most common among the smallest institutions – less than $10 million in assets — with 15 percent invading their endowment corpus and spending an average of 8.4 percent.

Nearly two in three institutions said gifts from donors either were flat or grew, with increases reported by nearly one in four overall, and by more than one in three of the smallest institutions.

Nearly four in 10 reported no change in gifts, and one in three reported a decrease.

“We’re cautiously optimistic because we see both the economy and the markets recovering, albeit slowly,” Griswold says. “We’re pleased that endowments seem to have positioned themselves to come through a stressful period such as this without major crises.”

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