Turning the corner

By Todd Cohen

After several declining or flat years, investment returns on educational endowments surged in fiscal 2004, two reports say, while a poll says donors to college and university endowments are upbeat on endowments and confident they are managed well.

Returns averaged 15.1 percent for 741 college and university endowments in the U.S. and Canada with $267 billion in holdings, up from 3 percent a year earlier and the highest since 1998, says the annual survey by the National Association of College and University Business Officers, or NACUBO, in Washington, D.C.

And returns averaged 14.7 percent for 707 endowments with nearly $227 billion in assets at private colleges and universities, public institutions, independent schools and private foundations, says the 2005 Commonfund Benchmarks Study by the Commonfund Institute in Wilton, Conn.

The new poll, conducted by Hart Research for the Goldman Sachs Markets Institute, found donors would like more conservative management practices and greater investment disclosure for education endowments.

Strong equity performance in the U.S. and abroad drove the improved endowment returns, and institutions that allocated a big share of assets to publicly traded equities and a small share to fixed income ranked among the top performers, NACUBO says.

It says large endowments generally perform better than small endowments over longer periods of time because they tend to allocate more of their assets to alternative investments and their performance within the alternative-asset classes far exceeds that of smaller institutions, on average.

And because the largest endowments generally employ bigger and more sophisticated staffs, NACUBO says, it is not surprising that they post better returns, especially in less-efficient segments of the market.

The survey says endowments increasingly have used external managers, with the percentage of overall endowment assets managed internally declining to 11 percent in 2004 from 17.5 percent in 2000.

Spending rates, which usually are based on recent annual performance data and represent the share of endowment used each year to support an institution’s operating budget, fell by 0.1 percentage point to 5 percent, reversing four years of growth.

Counting inflation and annual spending rates, returns averaged 3.8 percent over five years for institutions surveyed, resulting in a decline in investment earning potential over time, NACUBO says.

Institutions that depend on endowment spending felt financial pressure as their endowment values fell, NACUBO says, with public institutions also suffering steep drops in state appropriations.

“As a result of these financial strains, colleges and universities have been forced to cut certain expenses and raise tuition,” NACUBO says, with tuition and fees in the current academic year climbing 10.5 percent on average for in-state students at public four-year schools and 6 percent at independent four-year schools.

The Commonfund Benchmarks Study says the increase in returns on educational endowments, following a much smaller return of 3.1 percent in 2003 and losses of 6 percent and 3 percent in 2002 and 2001, respectively, reflected continuing innovation involving asset allocation, diversification and risk management.

Institutions that posted the best returns reported lower-than-average allocations to hedge funds and broader diversification, with higher-than-average allocations to private equity real estate, and to energy and natural resources.

Institutions overall also reported they expected annual returns averaging 7.9 percent this year, the survey says.

Average allocations changed slightly from fiscal 2003 to fiscal 2004, it says, with 31 percent allocated to domestic equity, down from 32 percent; 15 percent to fixed income, down from 21 percent; 16 percent to international equity, up from 13 percent; 34 percent to alternative strategies, up from 32 percent; and 4 percent to cash/short term, up from 2 percent to cash.

The average spending rate for fiscal 2004 fell to 4.8 percent, down from 4.9 percent in fiscal 2003 and 5.1 percent in fiscal 2002, with larger institutions generally reporting a higher spending rate than smaller institutions.

Forty-two percent of institutions reported growth in gifts, compared to 34 percent a year earlier, while 26 reported a decline in gifts and 29 percent reported gifts were flat.

Forty-eight percent of institutions reported a decline in their debt level, with smaller institutions more often reporting declines.

Average total debt totaled $86.7 million, ranging from $617 million on average at the largest institutions to $7.5 million on average at the smallest institutions.

As endowment portfolios have become more diversified, grown in size and pursued more complex strategies, they also have generated challenges for their management and staffing, the Communfund study says.

Greater diversification in endowment portfolios has created the need for more managers, in turn requiring more sophisticated staff and board oversight, the survey says.

And growth in portfolios and in the complexity of their strategies also requires more staff, although institutions overall report the equivalent of only 1.2 full-time professionals, on average, dedicated to investment management.

The Global Markets Institute poll also found that donors believe making socially responsible investments is nearly as important as seeking the highest possible returns.

Donors responding to the survey also support a relatively conservative approach to endowment spending and investment, and three in four donors responding believe university endowments should invest onlyu in funds that disclosure which companies they invest in.

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