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Business Officer Magazine

Can Equities Correct the Course?

Public-private partnerships for the development of student housing have evolved since the early days. Here’s what campuses can expect from these relationships today.

By Mimi Lord

A total of 741 public and independent institutions participated in the 2004 NES, representing $267 billion in combined assets. Conducted for NACUBO by TIAA-CREF, the NES provides information on many aspects of endowment management, including performance, asset allocation, operational practices, and spending rates.

The equal-weighted average return of FY04 participants was 15.1 percent, the highest since 1998. The dollar-weighted average return of those same institutions in FY04 was 17.4 percent, which reveals the tendency of larger endowments to outperform smaller endowments. Larger endowments generally have more sophisticated investment staffs and greater allocations to alternative investments. In FY04, the category of endowments with $500 million to $1 billion in assets chalked up the highest average returns—17.9 percent—enhanced in part by their aboveaverage allocation to small-cap equities.

Short-Term Boost as Equities Excel

The variance in the list of top performers from year to year tends to reflect stronger market performance in the asset classes they over-weight and weaker market performance in asset classes they under-weight, relative to average allocations. In FY04, equities greatly outperformed fixed income, meaning institutions with large equity-type allocations and minimal fixed-income allocations generally fared the best. Over the 12 months ended June 30, 2004, the Russell 3000 Index (representing about 98 percent of the U.S. equity market) returned 20.5 percent and the Lehman Brothers Aggregate Bond Index returned only 0.3 percent. Within equities, small-cap stocks and international stocks posted strong returns of 33.4 percent (Russell 2000 Index) and 32.4 percent (MSCI EAFE Index), respectively. A number of small asset segments—such as timber and certain other natural resources—also had outsized returns.

Table 1 lists averaged data from the top 10 performers compared with averages of all NES participants. The top performers had considerably higher allocations to equities (national and international), 69.9 percent, compared with the equal-weighted average of all participants, 59.9 percent. Conversely, the top performers had considerably lower allocations to fixed income (national and international), 15.1 percent, than the average endowment, 22.1 percent.

Table 1
Comparison of Top 10 and Average Participant in 2004 NES

2004 Endowment Assets (millions) FY04 Returns U.S. Public Equity Allocation Non-U.S. Public Equity Allocation Fixed Income Allocation
Average of Top 10 Performers
258 24.1% 55.4% 14.5% 15.1%
Participants' Equal-weighted Average
361 15.1% 48.9% 11.0% 22.1%

Asset allocations aren’t the entire story. An institution’s strong performance can also result from a particular money manager’s stellar results. For example, Pitzer College’s mid-cap manager posted an impressive 39.4 percent return in FY04 and Pitzer had a sizable allocation to that manager (32.5 percent). Since the end of the fiscal year, the college’s investment committee has pared back the position through its rebalancing guidelines, according to Vicke Selk, vice president of administration and treasurer at Pitzer in Claremont, California. Pitzer’s endowment, valued at $53 million at the end of the fiscal year, posted an enviable 23.8 return in 2004.

Exceptional performance by several managers propelled Baylor University’s endowment—with its 25.2 percent return—to the top of the list in FY04. Chief Investment Officer Jonathan Hook indicated that strong manager performances occurred particularly in international equities, small-cap equities, and distressed debt. In addition, a number of alternative investments started paying out after several years of funding. Hook joined Waco, Texas-based Baylor four years ago and has led the process of retooling the endowment. It morphed from a traditional portfolio of publicly traded stocks and bonds to its current 30 percent allocation to alternatives, which are composed almost equally of private equity, absolute-return hedge funds, and real assets. Baylor’s endowment stood at $672 million as of June 30, 2004.

In each of the past three years, at least 5 of the top 10 highestperforming endowments had assets of less than $100 million, so FY04 was not unusual in that regard. What is unusual about the list of strongest performers in 2004 is that it does not include a single endowment with $1 billion or more in assets. Large endowments, nevertheless, maintained their domination of longer-term superior returns, as reported in the 10-year annualized results. All but one of the top 10 longer-term performers had assets of more than $1 billion.

The one smaller institution posting such strong longer-term results was Transylvania University, an independent liberal arts college in Lexington, Kentucky, with 1,100 students and an endowment of $122 million. Remarkably, Transylvania has landed in the top range of highest 10-year performers for the past three years (see sidebar, “Small Wonder, In for the Long Haul”).

The NES reveals substantial differences in asset allocations between the large endowments and the numerous smaller endowments. Dollar-weighted asset allocations indicate the overall allocations of the total $267 billion in the study, thus giving more weight to institutions with larger endowments. Equal-weighted allocations are a simple average of all 741 institutions’ allocations to each asset class. Table 2 shows the difference between the two methods as well as the average allocation of the largest 47 institutions with endowments greater than $1 billion. In general, larger endowments have considerably higher allocations to alternative investments— and smaller allocations to conventional equities and fixed income—than smaller endowments.

Table 2
Endowment Asset Allocations in FY04

Asset Class Equal-weighted Asset Allocations Dollar-weighted Asset Allocations Largest Endowments' Asset Allocations (>$1 billion)
Equity (U.S. and non-U.S. publicly traded) 59.9% 50.9% 46.3%
Fixed Income (U.S. and non-U.S.) 22.1% 17.2% 15.2%
Real Estate (public and private 2.8% 4.0% 4.0%
Hedge Funds 7.3% 14.7% 20.2%
Private Equity 1.3% 3.5% 4.9%
Venture Capital 0.8% 3.1% 4.9%
Natural Resources 0.6% 3.0% 2.6%
Cash 3.7% 2.6% 2.7%
Other 1.6% 1.1% 0.7%

Average Asset Class Allocation of Total Assets (PDF)

Ups and Downs

The NES reveals that from FY00 to FY04, the percentage of overall endowment assets managed internally declined from 17.5 percent to 11 percent. The category of endowments with assets of more than $1 billion still manages the biggest percentage of assets internally (16.7 percent) but has dropped significantly from 30.6 percent in FY00.

Another trend that continued in FY04 was that of greater average allocations to alternative investments. Over the past 10 years, the average endowment’s allocation to alternative investments— combining hedge funds, private equity, venture capital, and natural resources—has grown from 2.7 percent to 10.0 percent, calculated on an equal-weighted basis. In FY04, alternative investments made up 31.2 percent of overall assets of endowments greater than $1 billion. Hedge funds continue to dominate the alternative asset class category, accounting for 61 percent of all alternative assets in the study.

An interesting trend occurring in spending rules is that the largest endowments—those with more than $1 billion in assets— have increasingly shifted toward a policy of reconsidering the spending rate each year rather than abiding by a pre-specified rate. In FY04, 16 percent of the largest endowments reported that they reconsider the spending rate each year, up from 6 percent in FY00. More than 80 percent of all participants continue to spend a prespecified percentage of a moving average of market values. The most common method is to spend 5 percent of the recent threeyear average of endowment values.

Thanks largely to the market appreciation in FY04, the average endowment value per student rose from about $35,000 to $40,000. At independent institutions, the average endowment per student is $101,000 compared with $15,800 at public institutions.

Maintaining Morale Through a Bear Market

In particular, institutions that felt the effects of the bear market were those that rely on endowment spending for a significant portion of the operating budget. Middlebury College, whose endowment spending constitutes about 20 percent of the annual operating budget, felt the crunch and was determined to avoid cuts in staff, programming, and capital projects. Before the stock market began its collapse, the western Vermont college had embarked on a multipronged initiative to increase student enrollment and the caliber of students and to construct new residence halls and other buildings.

Average Investment Pool Compounded Nominal Rates of Return (PDF)
for Fiscal Years Ending June 30, 2004, and for Selected Three, Five, and Ten-year Periods

As a result of the expansion, the college was incurring greater staffing, operational, and debt servicing expenses. As Vice President and Treasurer Robert Huth explained, the trustees did not want the shrinking endowment to cause Middlebury to lose its positive momentum. “We could have taken a butcher knife and cut some programming, but we didn’t want to do that. We thought we were in a good place and could manage our way through this,” he said, adding that the trustees were instrumental in raising gifts of $30 million to meet the requirements of a $10 million challenge gift in 2002 from an anonymous donor. In addition, they decided to relax the spending rate temporarily to avoid budget cuts that would hurt morale. In FY03, the trustees authorized the long-standing 5 percent spending policy to be stretched as high as 6.5 percent in that year and the next, with a reduction to 5 percent by FY09. As it turned out, only a 5.8 percent spending rate was required in FY04, due to significant fundraising and expense controls. The endowment’s 22.7 percent return in 2004, fueled by 39 percent gains in its private equity portfolio, also makes it easier to achieve future spending rate targets.

For the Full Study

The 2004 NACUBO Endowment Study—based on responses from 741 institutions (227 public institutions and 514 independent colleges and universities)— provides extensive data to help colleges and universities benchmark themselves against their peers. The study (Item No. NC2007), presented on CD-ROM, is available for $69.95 for NACUBO members and $194.95 for nonmembers and will be available this month.

The 2004 NACUBO Endowment Study Executive Summary (Item No. NC2008) 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 800.462.4916. 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.

State-supported institutions have faced other issues stemming from cuts in state appropriations for higher education. The University of California’s state funding, for example, was cut an additional 6 percent this year after several years of reductions. Over the past four years, the university’s state-funded budget has fallen 16 percent while its student enrollments have grown 16 percent, requiring increases in tuition and other fees as well as salary freezes. The institution has seen its share of the state general fund decline from 7 percent in 1970 to a current level of 3.5 percent, according to a university report.

“We’re experiencing a growing population of college-aged people and have a master plan to admit all state applicants who graduated from high school in the top 12.5 percent of their class,” said Joe Mullinix, senior vice president for business and finance. “We are pressed hard in the current budget environment to be able to do that.” He added that Governor Arnold Schwarzenegger and the university recently signed a compact that will stabilize state funding to the university and provide modest funding increase over the next few years.

During the financial squeeze, the University of California sought ways to increase the endowment through greater donor giving and a plan to increase allocations to alternative asset classes. In addition, the university began a process to hire external managers in an effort to improve performance. Until 2000, said Mullinix, the endowment was managed internally except for private equity.

Building Blocks

Following annualized returns of -2.3 percent over the previous three years, the solid returns of 2004 provided welcome relief to virtually all higher education institutions. During the bear market, institutions undertook various approaches to try to boost their endowments. Said John Mazur, treasurer and chief investment offi- cer at Carnegie Mellon University in Pittsburgh, “There are only three ways to build the endowment: one, take less out; two, put more in; and three, make it grow faster.”

Thanks to Study Sponsors
The following firms contributed to the 2004 NACUBO Endowment Study. Without their generous support, NACUBO could not publish so comprehensive an analysis of endowment management practices.

Primary Contributor

President’s Circle
Trusco Capital Management
Morgan Stanley Investment
Smith Barney Consulting Group
John W. Bristol & Co., Inc.
Iridian Asset Management LLC
Babson Capital Management LLC
U.S. Trust
The Vanguard Group

PricewaterhouseCoopers LLP
Dimensional Fund Advisors
Nicholas-Applegate Capital
Callan Associates Inc.
Fayez Sarofim & Co.
Capital Guardian Trust Company

Deutsche Asset Management
Merrill Lynch Investment Managers

Russell Investment Group
Goldman Sachs Asset Management

Northern Trust Company
Lazard Asset Management
The Investment Fund for Foundations
Abbott Capital Management, LLC
Mellon Financial Corporation

Asset Strategy Consultants
Montag and Caldwell
Denver Investment Advisors, LLC
OFI Institutional Asset Management
Legg Mason Asset Management
The Private Bank of Bank of America
State Street Global Advisors
Brandywine Asset Management, LLC
Ariel Capital Management, LLC
Morgan Keegan & Co., Inc.
RockBridge Capital, LLC
Virchow, Krause & Company, LLP

Carnegie Mellon attacked the issue on all fronts. Over the past several years, the institution has lowered its spending rate from 5.5 percent to 5.0 percent; revamped its asset allocation to larger commitments of equity-based assets including more alternative, illiquid assets; and increased its efforts to attract gifts. The asset allocation was considerably more conservative when Mazur joined Carnegie Mellon four years ago. “My view was that we should try to position the portfolio so that it could have a chance to win, rather than position it simply not to lose. We previously had about one-third of our portfolio allocated to fixed income, which I thought was too high based on our risk profile.” By the end of FY04, the fixed-income allocation was down to 14.2 percent of the endowment’s $768 million in assets. The endowment experienced a strong performance of 20 percent in FY04.

Mercyhurst College in Erie, Pennsylvania, and Indiana Wesleyan University in Marion are examples of independent institutions with smaller endowments that have emphasized donor giving and conservative spending rates to augment their endowments, which are used almost exclusively for scholarships. James Lieb, director of finance and assistant treasurer at Mercyhurst, has been involved in numerous capital campaigns during his 28 years at the college. A portion of each campaign, as well as budget surpluses, has been dedicated to the endowment over the years, which has surged from a meager $80,000 in 1980 to a current level of $19 million. Mercyhurst has also boosted its endowment by reducing its spending rate.

Institutions Listed by Fiscal Year 2004 Market Value of Endowment Assets With Percent Change Between 2003 and 2004 Endowment Assets (PDF)

Elvin Weinmann, financial vice president at Indiana Wesleyan, said the university has benefited from gifts from the Lilly Endowment, which required matching by other donors. Donors met the challenge, and the endowment has jumped from $15 million to $26 million over the past two years. Because of the growth, the institution recently has been able to reduce its endowment spending rate from 5 percent to 4.5 percent.

Despite many institutions’ good fortunes this year, the pendulum can easily swing in the other direction. Just three years ago there was little optimism after disappointing returns. For many institutions, it will take a long time to make up for those losses. The best strategy institutions can employ is to strive for long-term high performance rather than aiming for one year on the list of top performers. Small or large, stability is the name of the game.

Small Wonder, In for the Long Haul

When it comes to investment philosophy, Transylvania University’s investment committee keeps it simple: Buy and hold quality domestic stocks. It’s a strategy that seems somewhat old-fashioned these days given the trend among most endowments of diversifying into alternative investments such as hedge funds and private equity.

Fiscal Year Returns, 1995-1998
Fiscal Year Transylvania Average Endowment, Equal-weighted Average Endowment, Dollar-weighted
1995 29.9% 15.2% 16.8%
1996 28.9% 16.7% 20.4%
1997 34.8% 20.1% 21.7%
1998 29.2% 17.7% 18.6%

Regardless of its fashion status, Transylvania’s endowment has proven that it can compete with the best.

In the 2004 NACUBO Endowment Study (NES), the small liberal arts college in Lexington, Kentucky, landed in seventh place for its 10-year annualized returns of 15.4 percent. That compares with 9.9 percent for the average endowment on an equal-weighted basis and 12.5 percent on a dollar-weighted basis. With $122 million in assets as of June 30, 2004, Transylvania is dwarfed by the other top long-term achievers whose assets all exceed $1 billion. Even more impressive, Transylvania has resided in the top 10 of 10-year best performers since 2002.

“Our investment committee is in love with stocks and largely follows a Warren Buffett philosophy of buying and holding good companies,” said Chief Financial Officer Jerry Ray. As of June 30, 2004, Transylvania’s asset allocation was U.S. equities, 93.3 percent; fixed income, 3.5 percent; and cash, 3.2 percent. Ray noted that the three active members on the committee are experienced investors and manage approximately half of the portfolio themselves, thus eliminating management expenses on that portion. Transaction fees are also minimal since many of the core stocks have been held for several years or more. The rest of the portfolio is managed by three external management firms and also is mostly concentrated in large-cap domestic stocks.

Not surprising given its composition, Transylvania’s endowment significantly outperformed most other endowments during the 1995–1998 stretch when large U.S. stocks racked up enormous gains.

As large-cap stocks went out of favor, so did Transylvania’s performance. The endowment underperformed in 1999 and particularly in 2000 when outsized returns from alternative investments caused huge disparities between high and low achievers. In that fiscal year, Transylvania had a slight loss compared with 12.3 percent returns for the average endowment on an equal-weighted basis and 24.8 percent returns on a dollarweighted basis. But after lagging for two years, Transylvania made a strong comeback in 2001 and 2002, landing in the top- 10 performers’ circle both years. Following a flat, below-average year in 2003, Transylvania posted a 19.6 percent return in FY04. In the 2004 NES, Transylvania reported a targeted asset allocation of 80 percent domestic equities, 15 percent domestic fixed income, and 5 percent cash. However, Ray said the endowment does not have a formal rebalancing requirement; thus, equities have been permitted to climb to their 93.3 percent level. Clearly, the investment committee knows not to tinker with a winning approach.


Author Bio Mimi Lord is associate director at the TIAA-CREF Institute.