US college and university endowments had the worst returns of any insitutional investor in the year ended 30 June 2012. Even Grinnell College’s endowment suffered a 4% loss, as the school’s CIO, David Clay, revealed in September. That negative result is more startling considering that, until last year, Warren Buffett was one of Grinnell’s trustees and for 40 years served on both the finance and investment committees of the fund as an investment philosophy adviser.

In all, US endowments and foundations earned just 0.37% in the 2011-12  fiscal year, according to a study by Wilshire Associates, while in the same period the Standard & Poor’s 500 index posted a 3.1% gain, and a traditional portfolio (60% in equities, 40% in fixed income) would have returned approximately 6.71%. In the 2010-11 fiscal year, the average endowment’s gain on investment was 19%, and many universities target annual returns of 8-9%. Results differ between schools, but generally the wealthiest institutions had the poorest performance because they invest heavily in alternative assets, versus the smaller institutions that tend to invest more conservatively, which turned out to be a better strategy this past year.

As endowments dropped sharply after the 2008 financial crisis, some universities have deferred expensive projects, and are scaling back financial assistance for students. These poor results are fuelling a debate about the soundness of endowment investment philosophies. A recent academic paper by two professors at the Yale School of Management, William N. Goetzmann and Sharon Oster, ‘Competition Among University Endowments’, asks whether the shift to alternative investments is a good thing in the long term, or whether it is due more to ‘keeping up with the Joneses’ rather than to a well-considered analysis of opportunities.

A case in point is Harvard University, the world’s richest school – its $30.7bn (€23.6bn) endowment posted a 0.05% loss in the 2011-12 fiscal year. Even though it had a strong 2% return in 2010-11, for the past three-year period, its annualised rate of return was 10.42%, lagging the 12.82% traditional portfolio’s return. As a consequence, Harvard’s endowment is still well below the $36.9bn it reached in mid-2008, just before the financial crisis.

Both Harvard and Grinnell are committed to illiquid investments such as private equity, hedge funds, natural resources and real estate.

Almost half of Grinnell’s portfolio is in illiquid assets (according to the latest available data, 30 June 2011): 16.4% in commingled funds, funds with long-only equity strategies, but also long/short strategies and exposure to the credit markets; 16.8% in private equity; 10.5% in distressed assets (debt securities and other obligations at substantial discounts to their original value, due to episodes of financial distress for the underlying company); 2.8% in real estate.

More than half of Harvard’s endowment is in illiquid assets: 16% in private equity; 15% in absolute return strategies; 10% in real estate and 13% in natural resources. The remaining 46% is in bonds (11%), publicly traded commodities (2%) and equities (33%), which are divided among domestic, developed foreign markets and emerging markets.
Emerging market equities lost 17% last year and was the major cause behind the fund’s poor performance. Two-thirds of all assets are managed externally and one-third in-house by a staff of around 200, under the leadership of Harvard Management Company (HMC) president and CEO Jane Mendillo, who has been in charge of the fund for the past four years. Mendillo is a strong believer in investing directly in natural resources – especially forests and farms – and she may increase HMC’s policy-portfolio exposure to this asset class by a few more percentage points in the next years, while reducing absolute-return and fixed-income investments, she told Bloomberg.

Goetzmann and Oster demonstrate the dramatic changes in the portfolios of Harvard and the other large endowments over the past 25 years. The allocation to US publicly traded equities has decreased from over 60% to about 10%, in favour of alternative assets. The change, say the academics, is very much associated with the allocation policies and investment performances of the near competitors in recruiting students and teachers. Similar to families ‘keeping up with the Joneses’, the universities have
reallocated their assets to respond to competitive pressure. “Is it a benefit?” they ask, and must conclude that the answer is not clear.