COVID-19 has hit a special category of institutional investors in the US hard – college and university endowments. In fact, higher education institutions are facing a decline in revenues because of fewer students enrolling and paying tuition, as well as current students asking for more financial aid. Colleges and universities are withdrawing substantial amounts from their endowments to cover these extra expenses. How is this affecting endowments’ investment strategies?
“Among our clients we don’t see major shifts in their investment planning,” says Michael Stellato, senior vice-president in Callan’s New Jersey Fund Sponsor Consulting office. “In fact their time horizon is very long, at least 10 years. One short-term concern is the need to have sufficient liquidity to pay for extra expenses. If endowments have substantive illiquidity in their portfolios, they may ask for lines of credit or issue bonds, like they did in 2008-09.”
That is the approach, for example, of Brown University: it has issued $700m (€596bn) in bonds this calendar year, while its $4.7bn endowment has not changed its long-term investment strategy. “Our flexible, balanced portfolio is designed to anticipate multiple future scenarios that may unfold over many years, and to include multiple engines of return that should compensate for each other in a diverse array of circumstances,” a spokesperson told IPE. “COVID-19 was precisely the type of unforeseen event that validates this approach.”
Currently, 88% of Brown’s portfolio is invested in ‘risk assets’: 37% in private equity, 33% in absolute return, 14% in public equity, and 4% in real assets. Only 7% is in fixed income and 5% in cash. The results of this strategy – implemented until last July by chief investment officer Joseph Dowling, and continued by his successor Jane Dietze – have been stellar: 12.1% for the fiscal year that ended in June, much better than the 2.6% median return of US endowments in the same period, according to Wilshire Trust Universe Comparison Service. It was also better than the $41.9bn Harvard endowment and Yale’s $31.2bn, which achieved 7.3% and 6.8%, respectively. In the long term, annualised returns for Brown’s endowment for three, five, 10 and 20 years are 12.6%, 9.8%, 10.2% and 8.1%, respectively.
In all, US college endowments total about $630bn and typically seek to earn at least 7% annually to account for spending rates of 4-5% plus inflation. Large funds tend to have less of their money invested in US equities – 6.1% compared with 37.5% for the endowment universe, according to Wilshire – so they have not benefited from the S&P 500’s recent pricing surge. In fact, endowments with more than $500m in assets gained 2.4% before fees in the 12 months to June 2020, the second consecutive year in which larger funds failed to beat their smaller peers.
“Endowments are very-long-term investors and their diversification in assets that are not correlated to the stock market, such as alternative credit, real assets, hedge funds, and private equity, works well during periods of market high volatility,” says Jon Pliner, senior director Investments at Willis Towers Watson. “That’s why we still recommend endowments to continue holding a well-diversified portfolio, while looking for new opportunities and potential changes in the new post-COVID environment. For example, because the pandemic is making companies rethink the future of offices, and universities rethink the future of campus learning, we suggest rotating away from real estate in favour of more interesting real assets like logistic, life sciences and data centres.”
While some public pension funds are leaving hedge funds and private equity because of concerns about their fees and opaque structure, large endowments are not. “They are more tolerant of high fees because they have more patience for long-term results and they are not under the same political pressure for performance,” says Stellato.
Small and large endowments are under stress because of higher COVID-19 expenses, says Texas Hemmaplardh, partner at Mercer. “Today the role of an endowment portfolio is even more important than before,” he says. “Many institutions have accelerated or increased distributions from their endowments, so there is greater focus on short-term liquidity and intermediate-term investment opportunities, all with the expectation that long-term returns from markets will be lower than they have been over the past several decades.”
However, core problems were pre-existent, according to Brian Caldwell, CEO at ITC Fintec, a firm that advises endowments. “The existential threat to endowments’ sustainability comes from the loss of revenue due to the decline of the number of people pursuing higher education,” he says. “My advice to endowments is, first of all, to understand their cashflow and liquidity needs. Then, embracing broadband connectivity and making the technological leap to transform their assets and their relationships with their communities is at the top of the list of things they can do to insure they can be sustainable.”