As University Chief Investment Officer David Swensen’s investment model began to yield unprecedented endowment returns in the 1990s, more and more universities adopted the Yale model by shifting toward investing in alternative assets. Two professors at the School of Management are now arguing that this trend reflects universities’ tendencies to mimic their closest competitors, but their report also raises questions over where the “herd” will move next — and who will lead it.
Sharon Oster and William Goetzmann presented a paper, entitled “Competition Among University Endowments,” at a National Bureau of Economic Research conference in September about how the recession affected higher education. The authors said their findings have received a positive response, and several economists and finance experts interviewed said the report’s explanation for the shift to alternative, illiquid assets and away from public equities is logically sound, though they added that it remains to be seen whether the shift will be beneficial for universities in the years ahead.
The Investments Office has increased its allocation toward alternative asset classes — such as private equity, real estate and hedge funds — over the past two decades to almost 90 percent of Yale’s target investment portfolio today. In the same period, Yale’s endowment has grown from $2.8 billion to $19.3 billion under Swensen’s leadership, delivering an average return of 10.6 percent over the past 10 fiscal years. But experts said universities with smaller endowments that have shifted toward alternative assets and away from public equities have not seen as much success.
“Professor Swensen’s insight worked beautifully when endowment managers were able to find inefficient markets,” said Charlton Reynders, a financial advisor with Reynders, McVeigh Capital Management, referring to the process through which investment managers identify and exploit situations where assets are under- or overvalued. “When everybody started investing in the same opportunities, however, markets very suddenly became more efficient as more dollars chased the very same opportunities.”
Swensen declined to comment for this article, but other finance experts interviewed agreed that the alternative asset category has become overcrowded and that universities are unlikely to see the high returns that were initially possible. Hedge funds, in particular, have done poorly since the financial downturn.
Scott Clemons, chief investment strategist of New York-based investment bank Brown Brothers Harriman, said alternative assets are theoretically a good investment option for schools with large endowments because they can afford to have the best managers and to trade liquidity for better returns later on. But experts agreed that many of the schools that jumped on the bandwagon of alternative strategies did not have access to the best managers and did not have large enough endowments to withstand the risks of the Yale model and thus found themselves without enough liquidity during the recession.
Oster and Goetzmann’s report sheds light on how these universities got in over their heads.
“There is certainly a powerful ‘herd mentality’ in institutional money management,” said Clemons. “In the same way that Yale wants to beat Harvard on the football field, they want to beat them on the endowment field too.”
The report arranges universities into groups based on the caliber of prospective students and provides evidence to support the hypothesis that universities keep the closest watch on the schools that are competing for the same students. Oster and Goetzmann’s data show that when one school makes an investment decision — such as the decision to switch to another school’s investment model — its peers tend to follow suit for fear of losing their position in the hierarchy. Because of the competition between universities, the report observed that universities lose out even when their endowments remain stable if another university’s endowment spikes in value.
“If the real value of Harvard’s endowment doubles in the next 10 years, and Yale’s remains flat, Yale will no longer be able to compete for the same quality of students that it attracted earlier,” the report explains, characterizing the data as suggestive of an endowment “arms race.”
But experts said it is too soon to know whether the shift toward alternative assets will be seen as a mistake in the future.
After getting hit hard in the recession, Harvard has reconsidered its reliance on alternative strategies and has taken steps in the past three years to make its investments less illiquid, said William Jarvis ’77, managing director of the Wilton, Conn. investment firm the Commonfund Institute.
“With perfect hindsight we and most other investors would have started this year in a more liquid position and with less exposure to some of the alternative asset categories that were hardest hit during FY 2009,” said Jane Mendillo, president and chief executive officer of the Harvard Management Company, in a 2009 report.
Still, Swensen made it clear in a 2009 interview with the News that Yale is staying the course, when he said the financial crisis had not altered his investment strategy at all.
Experts agreed that endowment managers nationwide are struggling. Reynders said the best managers will always be able to find obscure opportunities, even in the crowded sector of alternative assets, though he said most institutions should be investing elsewhere.
The University posted a 4.7 percent return on its investments in the most recent fiscal year.