Endowments nationwide are increasingly echoing Yale’s investment strategies, two recent studies suggest.
The average U.S. educational endowment grew approximately 10.7 percent in the 2006 fiscal year, according to the 2007 Commonfund Benchmarks Study and preliminary results from the Fiscal Year 2006 NACUBO Endowment Study. Adopting alternative investment strategies years ago helped Yale reach a class-leading 22.9 percent return last year, analysts said, and other major endowments are following in Yale’s footsteps with increasingly large commitments to investments other than traditional stocks and bonds.
Average rates of return are up from last year’s 9.7 and 9.3 percent, according to the Commonfund and National Association of College and University Business Officers studies, respectively. Differences in the two studies can be attributed to different sampling, said Richard Anderson, head of the endowment consulting group at Hammond Associates. The Commonfund Institute, the educational arm of an investment firm catering to nonprofit organizations, polled 741 endowments, while the NACUBO study included 765 institutions.
Endowments are seeing continued success by moving away from traditional stocks and bonds in favor of “alternative investments,” such as hedge funds, real estate, and energy and natural resources. Alternatives now make up 39 percent of endowment investments, up from 35 percent last year, according to Commonfund. NACUBO also reported increases from 2005 levels for each of the alternative categories they track.
The Commonfund study was released on Jan. 10, and the NACUBO study was released on Jan. 13.
Yale is one of a handful of endowments at the forefront of the alternative sector, having invested in leveraged buyouts in 1973 and becoming the first university to target absolute returns, a type of alternative investments, as a separate category in July 1990. Roger Kaufman, an economics professor at Smith College who studies endowments, said that Yale, along with Harvard, Princeton, Williams and Amherst, pioneered the strategy of alternative investing.
“Now you see that’s filtering down — more and more schools are cutting down on bond portfolios and stocks,” he said.
The move into less traditional investments has proven profitable for endowments. Energy and natural resources investments returned 39.9 percent on average last year, the highest of any category, according to Commonfund. Alternative strategies overall returned 14.6 percent, though international investments yielded even larger gains at 24.7 percent. But newcomers looking to capitalize on the same strategies as the leading endowments may not gain as much, since there are only so many opportunities for highly profitable investments.
“In theory, one can anticipate returns will decrease as the low-hanging fruit is picked off,” said Donald Basch, an economics professor at Simmons College. “One will only know in retrospect, but as money increasingly rushes into the alternative investments, returns are likely to decrease.”
All three experts attributed Yale’s extraordinary performance to Chief Investment Officer David Swensen, but Basch said the modest Swensen makes his strategies seem easy to imitate when his talents are actually rare.
Basch said larger endowments such as Yale’s, which are the most profitable according to Commonfund and NACUBO, invest far more of their money in these strategies than the smaller endowments do.
“For most colleges and universities, there’s still a lot of room to move in that direction,” he said.
The new trend among innovative endowments is to invest in India and China, Anderson said. Last April, Yale became the first educational institution to receive a special license from the Chinese government granting the University access to the country’s highly restricted domestic markets. But no single asset class may catch on anymore, Anderson said.
“It’s almost hard for there to be a next big thing,” he said.
Even as endowments continue to flood the alternatives market, the real problem is that large public pension funds — which change slower than endowments — are beginning to move into the sector, Anderson said. Far larger than most endowments, they dilute the market and can make it harder to find profitable investments.
The NACUBO study is slated to be released in full by the end of the month.