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Business Officer Magazine

Old Principles, New Rules

Results of the 2003 NACUBO Endowment Study suggest the importance of applying established principles in a new environment.

By Mike McNamee

This year's survey of 723 institutions—with endowments ranging from $321,000 to $18.8 billion—found investment officers enjoying positive returns after two years of declines. That's particularly remarkable in light of the fact that the survey period—the 12 months ended on June 30, 2003—included only three months of the stock market surge that began in April. For the fiscal year ending June 30, the average institution's endowment funds earned 3 percent—outpacing inflation (2.1 percent) as well as such market indices as the Standard & Poor's 500-Stock Index (up 0.3 percent) or the Russell 3000 (up 0.8 percent).

But treasurers aren't celebrating just yet, because 2003's gains weren't enough to offset the investment losses of 2001 and 2002. Over the three years, the average institution's investment pool suffered a 2.3 percent loss. The result: For the vast number of institutions that draw funds from their endowment based on the fund's three-year average market value, endowment contributions to the budget will fall for one of the few times in most business officers' memories. "This is clear evidence that the predominant spending policy, using a three-year rolling average, doesn't protect you from absolute declines" in budget dollars, says Liz Williams, treasurer of Southern Methodist University.

Declining dollars from endowments will compound colleges' and universities' economic woes. The three-year bear market for stocks, which began in March 2000, also drained parents' and students' savings, so demand for services and financial aid is rising. But fewer funds are available from any source. Donors are definitely feeling the pinch, too. And state revenues went down with the deflating bubble, making higher education a prime target of statehouse budget cutters.

The 2003 NES, conducted for NACUBO by TIAA-CREF, and followup interviews with a sampling of investment chiefs show that colleges and universities are adapting to the topsy-turvy markets they've just lived through. They are adjusting their mix of investments, looking for new approaches that can better buffer them from the market's volatility. And they're intensely studying endowment spending policies, seeking the formula that will provide steady support for current programs while preserving assets to support future generations of faculty and students. "We definitely know now that the rosy days of the '90s are gone," says Richard M. Norman, vice president for finance and business services for Miami University (Ohio). "We have to face the realities of the new century."

Average Asset Class Composition of Total Investment Pool Assets for FYO3

Investment Pool AssetsEquity
Fixed Income
Real Estate
Hedge Funds
Private Equity
Venture Capital
Natural Resources
Greater than $1.0 billion 44.8 18.6 4.2 1.8 19.9 5.2 3.0 1.9 0.7
$501 million – $1.0 billion 54.4 18.2 4.2 1.4 13.4 4.2 2.7 1.1 0.4
$101 million – $500 million 56.5 23.5 2.9 2.7 8.3 2.2 1.3 0.8 1.8
$51 million – $100 million 58.7 27.2 2.8 4.9 4.3 0.6 0.3 0.1 1.1
$25 million – $50 million 60.2 27.7 2.6 3.5 4.2 0.2 0.2 0.1 1.4
Less than $25 million 57.0 29.8 2.2 6.6 1.6 0.2 0.1 0.0 2.5
Public 58.1 27.9 2.1 4.0 4.3 0.9 0.5 0.4 1.6
Independent 56.7 24.9 3.1 4.0 6.9 1.5 0.9 0.4 1.6
Dollar-weighted average 49.4 21.4 4.5 1.5 13.5 3.8 2.7 2.4 0.8
Equal-weighted average 57.1 25.9 2.8 4.0 6.1 1.3 0.8 0.4 1.6
705 institutions provided investment pool asset class data. Table data are equal weighted unless noted otherwise.

New Assets

The 2003 NES shows some familiar patterns. Thanks to their balanced approach to investing, endowments' returns fall squarely between the highs and lows of the various asset class market sectors. Endowments' 3 percent average return outpaced stocks, but fell far short of the 10.4 percent return on bonds, as measured by the Lehman Brothers Aggregate Bond Index.

Diversification's benefits also show clearly when endowment returns are broken down by the size of the funds. The 39 largest endowments—with market values exceeding $1 billion—enjoy the best returns, averaging 4.1 percent on an equal-weighted basis (see chart, "Average Investment Pool Compounded Nominal Rates of Return"). Much of that success can be traced to the large funds' heavier reliance on alternative investments, or assets other than stocks and bonds, and agile asset diversification. The billion-dollar endowments have 63.4 percent of their funds in equity and fixed-income securities, versus 72.7 percent for endowments valued between $501 million and $1 billion. Funds valued at less than $500 million keep 80 percent or more of their assets, on average, in the two traditional classes (see chart, "Average Asset Class Composition of Total Investment Pool Assets for FY03"). From 2002 to 2003, the share of traditional equity investments fell for all fund sizes over $25 million—but the drop was greatest for the biggest endowments.

Where is the money going? The big endowments are pouring their money into hedge funds. For the billion-dollar-plus endowments, hedge funds' share of their assets rose from 17.8 percent in 2002 to 19.9 percent in the latest survey, while the next largest endowments boosted hedge funds from 11.4 percent to 13.4 percent.

The Texas A&M University System made an even bigger leap: It moved 7 percent of its portfolio from domestic large-capitalization stocks to hedge funds, lifting the hedge funds' share to 17 percent. The funds that A&M bought follow an increasingly popular strategy called "alpha transport" or "portable alpha." That approach links an investment that replicates the return of a market index, such as the S&P 500—thus maintaining the endowments' equity allocation, to share in overall market gains—with a hedge fund that strives for above-market returns. (That extra kick—the difference between a money manager's performance and the general market's returns—is called the manager's "alpha.") "If the stock markets are down, we can conceivably still do better than the market averages," says Treasurer Gregory R. Anderson.

Hedge funds have appeal because their managers have wider discretion to invest—including the power to short, or sell borrowed stock. That lets the funds hedge against declining prices. "The advantage is a better protected investment," says Miami's Norman. "The downside is that the funds aren't transparent at all. All you know is that the manager has a wide latitude on how to use the funds."

Hedge-fund investors should gain additional investment insights in the coming year: The U.S. Securities & Exchange Commission is considering new rules to require more disclosure of how funds invest. That—and the hope for an added boost to returns—could make hedge funds even more attractive for endowments, spreading perhaps even to smaller funds.

Spending Just Enough

The expected approach of a negative return averaged over three years has forced many business officers to re-examine their endowment spending policies. Miami of Ohio, in response to the dramatic spending increases of the 1990s, reduced its spending rate in 2001. Some endowments that were donated to the university during the boom years are currently worth less than their original gift value, says Norman. "It's a challenge to manage," he says.

Other institutions are taking a hard look at the three-year average, or at the underlying idea of basing spending entirely on the endowment market value. "We all have known that the three-year smoothing rule isn't very smooth in a really bad patch," says John R. Curry, executive vice president of the Massachusetts Institute of Technology. "But now that's perfectly clear."

Texas A&M has moved to a 20-quarter, or five-year, rolling average for computing its spending. MIT and SMU are considering another alternative based on a spending policy pioneered at Yale University. Each year's spending rate would be based on two figures: a percentage increase in the previous year's spending, and a percentage of the endowment's market value. The first figure would be based on the rate of inflation, plus 1 or 2 percentage points to allow for real growth. The remainder of the spending figure would be based on an average market value calculation. The two figures could be weighted—with, say, inflation driving two-thirds of the spending hike, and market values determining one-third. Or the spending could be based entirely on a steady inflation-adjusted growth rate, with market value considered only in very strong or very weak markets.

"It's difficult for academic budgets to handle large swings, either up or down, based solely on the markets' performance," says Curry. "We're looking to find a more stable path." Both MIT and SMU are modeling the new policy to determine the best market conditions for making a change. "If you start at the wrong time, you could end up spending far too much," says SMU's Williams. "That would undercut our basic mission of intergenerational equity—making sure endowment support is available to future students as well as today's."

Average Investment Pool Compounded Nominal Rates of Return
For Fiscal Year Ending June 30, 2003 for Selected One-, Three-, Five-, and Ten-Year Periods

Endowment Assets1-year
Greater than $1.0 billion 4.1 -0.7 6.9 11.5
$501 million – $1.0 billion 2.9 -2.3 3.9 9.3
$101 million – $500 million 2.7 -2.4 3.1 8.8
$51 million – $100 million 2.7 -2.8 2.1 8.1
$25 million – $50 million 3.1 -2.3 2.4 8.1
Less than $25 million 3.5 -2.3 2.2 7.2
Public 3.1 -2.4 2.6 8.3
Independent 3 -2.3 3.2 8.9
Total equal-weighted average 3 -2.3 3 8.7
Total dollar-weighted average 4.7 -0.8 6.3 11.2
Median 2.9 -2.5 2.8 8.5
Comparative Indexes
Russell 3000 0.8 -10.5 -1.1 9.7
S & P 500 0.3 -11.3 -1.7 10
LB Aggregate 10.4 10.1 7.6 7.2
CPI-U 2.1 2.2 2.5 2.5
Table data are equal weighted unless noted otherwise.

Back to Basics

The 2003 NES's welcome news—that endowment earnings are back in the black—comes with some sobering caveats. Business officers have lived through a harrowing market cycle of wild euphoria and bleak despair. They're emerging with a new appreciation for an old principle: "Diversify, diversify, diversify," says SMU's Williams.

Curry thinks that the boom-and-bust cycle will lead to new policies. "We're long-term investors—not market timers," he says. "But do we believe in just riding a market when the price-earnings ratios are three or four times the historical average? I think even long-term investors will begin to implement some new rules to govern how endowments behave in a bubble."

New assets, new spending rules, new investment guidelines: The six-year cycle just finished will provide ample topics for college and university investment officers to debate for years to come.

All Institutions Ranked by Fiscal Year 2003 Market Value of Endowment Assets (193 KB, PDF)

Thanks to Study Sponsors

The following firms contributed to the 2003 NACUBO Endowment Study. Without their generous support, NACUBO could not publish so comprehensive an analysis of endowment management practices.

Primary Contributors

TIAA-CREF Institute

President's Circle

Trusco Capital Management
Smith Barney Consulting Group
John W. Bristol & Co.
Iridian Asset Management LLC


The Vanguard Group
Goldman Sachs Asset Management


Callan Associates, Inc.
Capital Guardian Trust Company
Evaluation Associates
Fayez Sarofim & Co.
PricewaterhouseCoopers LLP
Nicholas-Applegate Capital Management
Merrill Lynch Investment Managers
Franklin Templeton Institutional
Fund Evaluation Group, LLC


SSI Investment Management, Inc.
U.S. Bank and Trust
Victory Capital Management
KeyBank Public Sector
Rockefeller & Co.
Russell Investment Group


The Investment Fund for Foundations
Mellon Financial Corporation
Lazard Asset Management
Northern Trust Company
Abbot Capital Management
Dimensional Fund Advisors
W.P. Stewart & Co., Ltd.

For the Full Study

The 2003 NACUBO Endowment Study—based on responses from 723 institutions (230 public institutions, 487 independent colleges and universities, and six foundations)—provides extensive data to help colleges and universities benchmark themselves against their peers. The study (Item No. NC2005), presented on CD-ROM, is available for $69.95 for NACUBO members and $194.95 for non-members and will be available this month.

The 2003 NACUBO Endowment Study Executive Summary (Item No. NC2006) highlights the important data and analyzes survey results. The executive summary, which is intended for distribution to presidents and governing boards, is $24.95 for members and $39.95 for nonmembers.

A 35 percent discount is offered for orders of five or more copies of either publication. To place an order, go to or call toll-free 866.348.6300. Participating institutions receive a complimentary CD-ROM and can also view the entire report on the Web. Supporting firms also receive a complimentary copy of the report.

Author Bio Mike McNamee is a Washington, D.C., writer.