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Business Officer Magazine

Breaking the Surface

Reflecting the stock market’s recent signs of life, results of the NACUBO-Commonfund Study of Endowments show a turn in the investment tide.

By Kenneth E. Redd

*After two years of negative returns, investment performance finally turned positive in FY10. A nascent recovery in the financial markets began to take hold, and investors regained their appetite for risk despite the sovereign debt crises in Greece and other member countries of the European Union. This was true for higher education endowment managers as well, reports the recently released 2010 NACUBO-Commonfund Study of Endowments (NCSE).

Low interest rates and prospects for near-term economic growth particularly favored financial assets in the United States and emerging markets. The Standard & Poor's 500 Index, which returned 14.4 percent in the July 1, 2009, to June 30, 2010, time period, outperformed the Morgan Stanley Capital International (MSCI) Europe, Australasia, and Far East Index by more than 8 percentage points. Stocks in emerging markets, as measured by the MSCI Emerging Market Index, jumped 23.5 percent, while commodities and corporate and high-yield bonds also posted double-digit gains in FY10.

READ AN ONLINE EXTRA, Volatility Dominates Endowment Forum Discussion,” in Business Officer Plus.

With these improving market conditions as a backdrop, it is instructive to look at the asset allocation, rebalancing, endowment spending, and other decisions that college and university investment professionals made to survive the difficulties of the past two years and position themselves for gains in the emerging recovery. As the following review of the results of the 2010 NACUBO-Commonfund Study of Endowments will show, the actions taken at the depths of the downturn by many college and university chief financial officers and investment managers—especially those at smaller institutions—helped turn the tide toward a return to gains in FY10 and perhaps in the future. This year's survey includes 850 U.S. institutional participants, the highest number in the history of NACUBO's endowment study series.

Some Surprising Results

On average, U.S. college and university endowments and affiliated foundations achieved an investment return of 11.9 percent (net of all fees and expenses) in FY10, according to the 2010 NCSE, sponsored by NACUBO and Commonfund Institute. This represents a huge improvement over the -18.7 percent return in FY09 and -3 percent return in FY08.

Given the strong 2010 performance achieved by the S&P 500 and other indices, it is not a revelation that endowments generally did well. What is surprising is that smaller and larger investment pools performed at nearly an equal rate.

Normally, when market conditions improve, endowments of more than $1 billion generate substantially greater returns than those at or less than $100 million. However, as Table 1 shows, the 12.2 percent average return posted by the largest endowments in FY10 was nearly identical to the 12 percent performance of those between $25 million and $50 million. Funds below $25 million did nearly as well, at 11.6 percent. Still, over the long term, larger-sized endowments had higher rates of return. The over-$1 billion funds had average annual investment returns of 5 percent over the past 10 years, compared with returns of less than 3 percent for funds of $50 million or less.

Nevertheless, smaller endowments benefited from several factors:

Strength in equities. Smaller-sized endowments particularly gained from their investments in U.S. stocks during 2010. On a dollar-weighted basis, endowments of $50 million or less had 35 to 40 percent of their assets in domestic equities, compared with just 11 percent for those over $1 billion. Conversely, endowments of $50 million or below had less than one quarter of their assets invested in alternative strategies (such as private equity, hedge funds, and so on).

The larger allocation to traditional asset classes paid off for the smaller-sized endowments. As Table 2 shows, the U.S. stock investments held by college and university endowments outperformed all other major asset classes during the fiscal year, including alternative strategies. "In broad terms," says Celia Dallas, co-director of research and a managing director of Cambridge Associates, "the performance differential between the largest and smallest endowments is largely attributable to small institutions generally holding higher allocations to bonds and cash and using a less-diversified approach to investing in equities that tends to be concentrated in U.S. equities. Therefore, when U.S. equities outperform other equity and equity-like investments, or when bonds and cash prove to be defensive, small institutions tend to outperform. Given the nearly universal strong performance of the capital markets in fiscal 2010, it is not surprising that the performance gap was narrow."

Additionally, as Heather Myers, director of endowment and foundation strategy for Russell Investments, suggests, small institutions benefited from "asset allocations that included an increased focus on the importance of liquidity in their portfolios following the financial crisis that began in late 2008. Nimble investors also benefited from tactical shifts to areas of opportunity such as high-yield and distressed credit markets."

Attention to diversification. Ferris State University, Big Rapids, Michigan, is one smaller-sized endowment that performed at an above-average level in 2010 because of its equity and bond investments. The university's $28.9 million foundation had a 17.4 percent investment gain during the year, according to the NCSE. Jerry Scoby, vice president for administration and finance, credits the institution's broadly diversified portfolio for this performance. "Our diversified asset allocation helped us to manage risk and balance returns. Our overall return in 2010 was helped most by strong gains in large- and small-cap equities and emerging markets, as well as a slice in the high-yield bond space."

Timely rebalancing. At the same time, many smaller-endowed schools also benefited from timely reallocations of assets to more risky investments during the year. "We made a strategic allocation to emerging market equities that was most beneficial to our portfolio performance," says Curtis Ryan, vice president of finance and administration for Westminster College, Salt Lake City. "We also took an underweight position relative to target in developed international equities and added positions in several illiquid asset classes—private capital, distressed debt, and natural resources—all of which experienced very strong performance." Westminster College's $50.8 million endowment returned 13.1 percent in FY10.

Post-Downturn Priorities

As a result of such strong gains, total higher education endowment assets from NCSE participants grew from about $306.4 billion in FY09 to $346.4 billion in FY10. While the 13 percent gain in endowment market value will certainly be helpful to college and university finances, it bears noting that median endowment assets among participants in NACUBO's endowment study series have declined from $88 million in FY08 to $72.9 million in FY10. Still, the improving endowment performance allows institutions to make certain choices, including:

  • Rebuilding underwater funds. Longwood University, Farmville, Virginia, like many other institutions, has thus made recovering losses from the prior two years a priority. The Longwood University Foundation, which reported a $35.9 million market value in FY10, had a 14.2 percent net investment return during the fiscal year. "The investment gains received during FY10 are first being used to rebuild underwater funds and then replenish reserves that were used to buffer the endowment distributions of the underwater funds," says Hazel Duncan, the foundation's chief financial officer. This approach has already generated positive results for her institution, as the percentage of endowments underwater fell from 75 percent in 2009 to 25 percent in 2010. Overall, the share of underwater endowments fell from about 22 percent to 14 percent, with the smaller institutional funds seeing larger average declines in underwater assets (see Table 3).
  • College and university CFOs, endowment managers, and investment committees will face enormous pressures to use more of their endowment income to meet short-term institutional budgetary needs.

  • Rethinking spending rates. With the focus on rebuilding underwater funds has also come a more careful eye on endowment spending rates. Average withdrawal rates at endowments below $50 million declined slightly from 2009 to 2010. Westminster College changed its spending policy from a 12-quarter moving average to a weighted average or hybrid method starting in FY09. "This change was made to provide more predictable and stable spending over time," says Ryan. "We certainly experienced the downside protection in FY09 and the upside moderation in FY10." Ferris State University is also taking a modest approach regarding the use of endowment income for spending purposes. "We are not planning to alter our spending formula," says Scoby. "We had some long and hard discussions on the underwater issue. We feel very strongly that the long-term success of the endowment is far more critical than any one year that could suffer from the down markets."
  • Other priorities. But the focus on rebuilding endowment funds while monitoring endowment withdrawals has not meant that other priorities are being ignored. Increasing financial aid and other services for students continues to be a major initiative at many colleges and universities. Some institutions, such as Longwood University, plan to continue to increase financial support to students. "As we continue to strengthen our endowment," Duncan says, "we will be able to give more scholarships using the existing spending model, which will at least help the students. That is our ultimate concern." Others have been able to make up for any reductions in endowment spending with increased fundraising and other efforts. Ferris State University, for one, launched the Opportunity@125 campaign, part of its 125th-anniversary celebration, which "raised funds from faculty, staff, alumni, and other friends to help students while some of the endowments were under-water," Scoby says.

Staying the Course

As the results from the 2010 NCSE illustrate, endowment investing strategies that feature diversified portfolios can still generate positive results for both large and small institutions. Smaller-endowed schools in particular appear to have benefited from holding to their asset allocation strategies and rebalancing to more risky investments when opportunities arose. These strategies helped colleges and universities achieve gains that are helping them recover from losses incurred over the past two years.

Thanks to Our Study Sponsors

The following firms contributed to the 2010 NACUBO-Commonfund Study of Endowments. Without their generous support, NACUBO and Commonfund could not publish so comprehensive an analysis of endowment management practices.


Commonfund Institute


Bank of America Merrill Lynch

Graystone Consulting, a business of Morgan Stanley Smith Barney LLC

John W. Bristol & Co.

Russell Investments


BNY Mellon Asset Servicing

Callan Associates

Hammond Associates/Mercer Investment Consulting

Pathway Capital Management

Prime, Buchholz & Associates


Baker Tilly Virchow Krause LLP


Asset Strategy Consultants

The Atlanta Consulting Group/Morgan Keegan

And, with the S&P 500 up nearly 17 percent in the first five months of FY11, prospects for additional endowment gains in the near future are promising. As the Washington Post, the New York Times, and many other publications have reported, a number of factors could contribute to further gains over the next year. These include continuing actions by the Federal Reserve Board to keep interest rates low; U.S. companies' increasing profits; and still relatively-low valuations of stocks and other assets, which despite recent gains generally remain below their calendar year 2007 price levels. 

However, even if the financial markets continue their gains, college and university CFOs and endowment managers may still face a daunting series of challenges. Economic growth is predicted to remain relatively weak, while unemployment rates may stay high. In addition, many states continue to experience substantial budget deficits, which could lead to further reductions in higher education appropriations for public institutions. And private donations to colleges, universities, and other nonprofits—which fell nearly 4 percent in 2009, according to Giving USA 2010—may, at best, recover only slowly.

Such trends suggest that college and university CFOs, endowment managers, and investment committees will face enormous pressures to use more of their endowment income to meet short-term institutional budgetary needs, which might require them to pursue less-risky strategies that will generate short-term liquidity until institutional budgets are less stressed and the economic recovery is on stronger footing. This approach, however, may have unintended consequences. "Investors should be cautious not to take defensive positioning too far, as is often the tendency following crisis conditions," says Cambridge Associates' Dallas. "Every dollar allocated to more defensive strategies—while providing resources to meet short-term needs in the event of market turbulence—also increases the likelihood that long-term returns will fail to be adequate to preserve purchasing power over the long term."

With this sentiment in mind, institutions have been more likely to keep to their long-term investment strategies that focus on growth rather than trying to meet present-day challenges. "Our endowment is a nice asset, and yet it is relatively small for an institution of our size," Scoby says. "Our commitment is to see it grow for the long term, not to diminish it with short-term thinking."

Ferris State University and Westminster College, like many institutions, have been meeting regularly with their investment advisory committees to monitor current developments and search for future opportunities for long-term growth. "We plan to evaluate the portfolio regularly to determine if we need to achieve our various asset allocation targets sooner rather than easing into them over time," Westminster's Ryan says. "An example is our allocation to natural resources, which is lower than our policy dictates."

Whatever approach institutions take in the coming year, it is important that they choose strategies that are the best fit for their situation, regardless of their endowment size. "The markets are very dynamic and it is important to be well-informed about the breadth and depth of the available investment opportunities," Myers says. "It is critical for endowments to ensure there are prudent oversight and governance processes in place for the portfolio, and to have well-diversified portfolios."

KENNETH E. REDD  is director, research and policy analysis, at NACUBO.

Get the Full Study Online

The 2010 NACUBO-Commonfund Study of Endowments (NCSE), based on responses from 850 institutions, provides extensive data to help colleges and universities benchmark against their peers. Tables, charts, and graphs include data on endowment size, investment performance, asset allocation, spending rates and policies, management expenses, and institutional debt.

The study (Item No. NC4030), available on NACUBO's Web site, is $100 for NACUBO members and $750 for nonmembers. Purchase of the study allows institutionwide access to the results. To order, visit the NACUBO Web site. Participating institutions and supporting firms receive free access to the Web-based report.

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