University endowments are at a crossroads

A year ago, university endowments were basking in bumper returns, which for some schools exceeded 50% for fiscal year 2021.

Now, they’re facing their worst performance since the financial crisis: Endowments and foundations reported median losses of 7.8% for the fiscal year ended June 30, according to an estimate by Cambridge Associates. That’s actually good news, since those results handily beat traditional stock-and-bond portfolios.

Thanks to their high exposure to private markets, endowments have been sheltered from the worst effects of the market sell-off. It will take several months, or even longer in the case of venture capital funds, for public and private asset prices to reach an equilibrium, assuming stocks and bonds remain depressed.

“Privates have done their job,” said Matt Bank, a partner at Global Endowment Management, which acts as an outsourced chief investment office for endowments.

However, that job of smoothing out investment returns may simply delay inevitable losses. With each interest rate hike, the Federal Reserve alters the easy-money environment that shaped endowments’ portfolios over the last decade.

 

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Within private asset portfolios, some strategies are faring better than others. High exposure to VC helped some endowments outperform in prior years, but some of those same VC funds are now a drag on returns.

Recent losses add to systemic stressors, from rising costs to declining enrollment and the expectation for lower future returns. These challenges suggest that university endowments need to ensure their portfolios are ready for an investment and spending outlook that leaves less room for error.

 

The volatility of the last two years has given financial sleuths some insights into what private markets strategies the largest endowments have pursued.

Real assets have provided strong downside protection, as have commodities, especially oil and gas, according to MPI, a quantitative research company. The fossil fuel industry’s strong showing is a bit of a sore subject for endowments, several of which have pledged to divest from those assets in order to align with climate goals.

The boom-bust cycle has also exposed schools that had bet heavily on venture strategies, which provided less cushion than buyout funds, said MPI co-founder and CEO Michael Markov.

The result is that endowments that were last year’s leaders are now laggards. For example, MPI attributes Bowdoin’s wild swing—from 57.4% gain to 7.1% loss—to high exposure to VC funds.

 

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In an annual letter, Harvard Management Company CEO N.P. Narvekar signaled further declines from VC: “We expect that the end of the current calendar year might present meaningful adjustments to these valuations, as investment managers audit their portfolios.”

For endowments, which invest with indefinite horizons, one or two years of returns is trivial. The long-term increase in exposure to privates is likely here to stay, Bank said. Still, university endowments’ appetite for riskier strategies like venture may fall victim to a desire for a more balanced mix of assets that reflects the realities of a new market landscape.

As they examine their portfolios to optimize returns, university endowments must also contend with a litany of demands: Republicans want to tax them more; Democrats want to cut tuition and increase transparency; and author Malcolm Gladwell wants Princeton to run entirely off its endowment returns.

Rising college costs, as well as generalized inflation, mean the demands on endowment distributions will rise—in fact, several endowments announced more generous spending following last year’s windfall. And endowment heads indicate that lower returns are likely here to stay.

Meanwhile, smaller and less prestigious universities are facing additional challenges. National undergraduate enrollment has fallen 4.2% since the pandemic began, according to research from National Student Clearinghouse. Moreover, US birth rates have declined since 2007, indicating a sustained decline in future enrollment. Donations are also likely to fall this year, since they tend to correlate with market returns, according to the NACUBO-TIAA study of endowments.

These challenges suggest that university endowments can’t afford to rest on the laurels of relative outperformance. Instead, this down market offers a chance—indeed, an imperative—to reassess the portfolio that is most likely to succeed in a very different economic environment.

Featured image by Jenna O’Malley/PitchBook News