University endowments’ record returns cut both ways

Some of America’s largest university endowments unveiled eye-popping annual gains in the past week. Duke University reported a 56% return for the fiscal year ended June 30. Washington University in St. Louis generated a 65% gain.

These top-performing endowments can thank alternative assets—in particular, venture capital—for the banner year, which is said to be the best since 1986. But that short-term success could prove to be a double-edged sword.

Endowments performed well across the board, with the median return coming in at 27% for the period, according to Wilshire Trust Universe Comparison Service. Those funds managing more than $500 million did much better, notching median gains of 34%, on the back of private investments.

The VC holdings of the University of North Carolina’s nearly $10 billion endowment returned 142% for the fiscal year, Pensions & Investments reported. The endowment gained 42.3% overall, and its private equity holdings came in at 44%.

On one hand, news of this bonanza bolsters the case for the endowment model that prioritizes alternative investments. It also provides a fitting coda to the legacy of David Swensen, the highly influential former Yale endowment chief who died earlier this year.

But the returns may become a headache for asset managers of endowments: The growth could be more mirage than oasis, and it provides ammunition to the endowment system’s varied critics.
 

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Unlike headline writers, endowments don’t care about one-year returns. Their job is to provide funding in perpetuity, even—and especially—when the markets go haywire. 

VC and PE funds notched historically high distributions last year, but many of the gains that universities are reporting are likely to be juiced by private valuations rising on paper only. The price tags of today’s startups may not stand up to public market scrutiny in years to come.

Moreover, the annual snapshots are further distorted due to an artificially low baseline, representing a change from the coronavirus-battered markets of June 2020. And the low-interest-rate environment has pushed up the prices of assets, both public and private.

Even if the gains prove lasting, the figures put wind in the sails of those most critical of endowments.

Many students and other campus activists want their endowments to divest from fossil fuels or to offset tuition costs. Politicians are currently deciding the fate of a Trump-era tax on the richest university funds. The Securities and Exchange Commission this week proposed requiring more disclosures around executive pay for endowments.

Each of these groups could seize on the annual windfall as proof that endowments should be more transparent, more generous or more accountable.

For the private markets more broadly, the disparity of returns between large and small endowments underscores the highly exclusive nature of top-performing funds. The elephant in the room is that most endowments lack access to the best PE and VC managers, raising a question of fairness.

Endowments of over $1 billion allocate more than a quarter of their portfolios to the PE and VC asset classes, according to the 2020 NACUBO-TIAA study of college endowments. For those under $250 million, that allocation drops to less than 8%.

Yale, for instance, held about 38% of its portfolio in buyout and VC funds last year, with plans to increase that share. 

There are obvious and innocent reasons for this divide: Large endowments can invest in the biggest funds, which tend to raise capital from a small number of LPs. They also often have access to networks of alumni who work at top funds. 

Smaller endowments that want to increase their allocation to alternatives would most likely have to settle for lower-performing or unproven managers. And those institutions may lack the knowledge and staff required to appropriately manage complex and illiquid investments.

Equity is an issue that people in the industry clearly want to see corrected. In the wake of protests following George Floyd’s death last year, many called on leading VC firms to provide historically black colleges and universities with access to their funds. And diverse managers asked LPs to advance racial equity through their allocations.

The return disparities show how the clubby nature of LP-GP relationships can cement existing inequalities. When venture capital has a breakout year, the richest schools get richer.