EDUCATIONAL ENDOWMENTS’ SHIFT TO ALTERNATIVE INVESTMENTS SLOWED IN FISCAL YEAR 2007
Average Investment Return Rose to 16.9 Percent
According to the 2008 Commonfund Benchmarks Study®
WILTON, CT., January 22, 2008 – The secular shift to alternative asset classes that has characterized endowment portfolios during the current decade may have come to a pause, according to the 2008 Commonfund Benchmarks Study® of Educational Endowments. At the same time, the average annual total return earned by the 767 U.S. institutions participating in the Study was 16.9 percent (net of fees), up from 10.6 percent in last year’s Study and the highest annual return in the eight years that the Study has been conducted. Returns and all other data in the Study were for fiscal year 2007, the 12-month period between July 1, 2006, and June 30, 2007.
“After a difficult period from 2000 to 2002, U.S. educational institutions have earned positive returns for five straight years, including three years when returns have been in double-digit territory,” said John S. Griswold, Executive Director of Commonfund Institute, which sponsors the Study.
The Study found that average three-year returns rose to 12.8 percent from 12.3 percent a year ago, and that average five-year returns jumped to 11.5 percent from 6.8 percent last year. The big gain in trailing five-year returns resulted not only from FY2007’s strong performance but also from FY2002’s -6.0 percent returning dropping out of the return calculation.
Performance by individual asset classes was led by international equities with an average return of 28.3 percent. In descending order, other asset class returns were: domestic equities, 19.5 percent; alternative strategies, 16.8 percent; short-term securities and cash, 6.5 percent; and fixed income, 5.9 percent.
Within alternative strategies, private equity (including LBOs, mezzanine and M&A funds and international private equity) returns were 19.3 percent; energy/natural resources, commodities and managed futures, 18.8 percent; private equity real estate (non-campus), 18.7 percent; distressed debt, 16.9 percent; and venture capital, 13.8 percent.
“One potentially significant development we noted is the possible slowing of the shift in asset allocation that has taken place over the last decade,” Griswold said. “In previous years, the Study has shown that educational endowments have steadily increased allocations to alternative investments and international equity, including emerging markets, while lowering allocations to traditional domestic equities and fixed income. That trend slowed in FY2007, suggesting that we may see more subtle refinements in future asset allocation decisions.”
The positive investment environment and higher portfolio valuations resulted in increased dollar spending by endowments. The average spending rate was 4.4 percent, a decrease of 0.1 percent from last year.
A record 767 educational institutions participated in the Study, which categorizes and analyzes data by size of institution and by type: private colleges and universities, independent schools, and public educational systems and their related foundations (“SIRFs,” or state institution-related foundations). The combined value of the 767 educational institutions’ endowments was $341.3 billion at June 30, 2007.
Benchmarks Leaders
For the fifth year, the Commonfund Benchmarks Study Educational Endowment Report includes an analysis of the Top Decile (top 10 percent) and Top Quartile (top 25 percent) performers in the overall Study population. The objective of this analysis is to allow educational institutions to gain insight into the practices and policies of their “best of breed” peers.
Top Decile institutions in the Study returned an average of 22.6 percent, while Top Quartile institutions returned an average of 20.8 percent. By comparison, those returns in last year’s Study were, respectively, 16.8 percent and 14.8 percent.
While many factors contribute to investment performance, the fact that many of the most successful endowments are large endowments (with assets over $1 billion) points to the considerable advantages that size offers. Among the most important is the ability of large endowments to gain access to top managers and manage large and well diversified allocations to alternative asset classes.
Top Decile institutions allocated fully 52 percent of their endowment assets to alternative strategies; for the top quartile, the allocation was 47 percent. This compares with 42 percent for the Study population overall. Conversely, the Benchmarks Leaders have smaller allocations to domestic equities and fixed income securities, and are roughly even with the entire Study population in their international equities allocation. Benchmarks Leaders also keep cash to a minimum – 1 percent versus 3 percent for the overall Study group.
The Study showed a noticeable reduction in allocations to energy and natural resources among the top decile – possibly indicating that money was reallocated from this asset class after the strong returns of recent years. There was a significant increase in the private equity allocation of both Benchmarks Leaders and the Study universe, reflecting the increased attention being paid to private equity.
Summary of Overall Study Findings
Asset allocation
Participating institutions increased their alternative strategies allocation to 42 percent from 39 percent last year and had 3 percent in short-term securities and cash compared with 2 percent a year ago. All other asset class allocations either remained unchanged or decreased moderately: domestic equities were 23 percent, down from 26 percent; international equities were unchanged at 20 percent; and fixed income was 12 percent, down from 13 percent.
Large endowments with assets in excess of $1 billion allocated the most to alternative strategies – an average of 47 percent – and the smallest institutions (those with assets under $10 million) allocated the least at 7 percent. Allocations correlated with size of endowment: The larger the endowment, the larger the allocation to alternative strategies.
Larger endowments also had bigger allocations to international equities. Smaller institutions had the largest allocations to traditional domestic equities and fixed income, as well as to short-term securities and cash.
Rebalancing
Seventy-three percent of participating institutions reported rebalancing their investment portfolios during FY2007. Eighty-six percent of endowments in the over $1 billion cohort and the $501 million to $1 billion cohort rebalanced, while only 46 percent of the endowments with assets under $10 million did so.
Spending
While the average spending rate declined slightly to 4.4 percent, the good investment performance of FY2007 and other recent years allowed 73 percent of Study participants to increase spending in dollar terms. Only 8 percent of participants lowered spending in dollars, while 15 percent left it unchanged. Of those increasing dollar spending, the average increase was 18.5 percent; among those spending fewer dollars, the average decrease was 13.7 percent.
Gifts and Donations
Half of Study participants reported an increase in gifts and donations, up from 46 percent in last year’s Study. Twenty-seven percent reported decreased gifts, while 19 percent reported no change.
In dollar terms, the average amount of new gifts to endowment for all participants was $8.0 million, up from $7.2 million last year. The gain was driven by gifts to endowments with assets over $1 billion, which rose to an average of $66.5 million from $61.1 million a year ago. For all other size categories, giving in dollars varied moderately or was unchanged.
Debt
Among Study respondents reporting that they carry debt at present, average total debt increased to $101.4 million from $87.1 million in FY2006. Average debt service as a percent of the operating budget declined slightly, however, to 4.9 percent from 5.0 percent. Public institutions, which generally have larger enrollments, operating budgets and physical plants, reported average debt of $511.6 million, up from $409.5 million, while total debt for private colleges and universities and independent schools averaged $102.6 million and $17.1 million, respectively.
Resources and Governance
Participating endowments increased their average full-time equivalent (FTE) staff slightly to 1.4 FTEs in FY2007 from 1.3 FTEs in FY2006 and 1.2 FTEs in FY2005. The only changes in average staffing levels among size cohorts were a slight decline among endowments with assets between $501 million and $1 billion (2.1 FTEs to 2.0 FTEs) and a slight increase among endowments with assets under $10 million (0.2 FTEs to 0.3 FTEs). Institutions with assets over $1 billion kept their average staffing level at 11.5 FTEs. Staffing levels showed no change in other size cohorts.
The average size of the investment committee among participating endowments has decreased somewhat over recent years. This year, the average investment committee had 7.6 voting members on it, down from 7.8 last year and 8.2 members in both FY2005 and FY2004. This year’s decrease can be attributed to the largest endowments, which reduced the size of their committees to an average of 8.9 voting members from 10.2 a year ago and 11.3 in FY2005.
Endowments report that the cost of managing their funds has continued to increase, rising to an average just below $2.30 million for all institutions from $1.98 million in FY2006 and $1.62 million in FY2005. This reflects the higher management and incentive fees associated with larger allocations to alternative assets and international equities.
Research Process and Methodology
The review of the 2007 Study and the design of the 2008 Commonfund Benchmarks Study of Educational Endowments took place in the spring of 2007. Field interviews with the participating institutions followed in the third and fourth calendar quarters of 2007.
Participating institutions were interviewed by telephone, a research technique that assures greater integrity in the data gathering process. Interviewers spoke directly with the ranking business officers at participating institutions. Data from the overall Study population of 767 institutions was segmented into six size categories to permit analysis of the policies and practices of endowments of differing sizes. The six categories were:
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Largest endowments – endowment assets in excess of $1 billion
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Very large endowments – endowment assets between $501 million and $1 billion
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Large endowments – endowment assets between $101 million to $500 million
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Mid-sized endowments – endowment assets between $51 million to $100 million
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Smaller endowments – endowment assets between $10 million to $50 million
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Smallest endowments – endowment assets under $10 million
As noted earlier, data were also sorted by type of institution: private colleges and universities, independent schools, public systems and SIRFs.
About Commonfund Institute
Commonfund Institute was founded to house the education and research activities of Commonfund and to provide the entire nonprofit community with investment information and professional development programs. Commonfund Institute is dedicated to the advancement of investment knowledge and the promotion of best practices in financial management. Commonfund Institute provides a wide variety of resources, including conferences, seminars and roundtables on topics such as endowments and treasury management; proprietary and third-party research and publications including the annual Commonfund Benchmarks Study® and the Higher Education Price Index (HEPI); and events such as the annual Commonfund Endowment Institute and the Commonfund Prize for outstanding contribution to endowment investment research. Its broad range of programs and services is designed to serve financial practitioners, fiduciaries and scholars. In addition to the Educational Endowment Report, Commonfund Institute conducts Commonfund Benchmarks Studies of foundations, operating charities and nonprofit healthcare organizations.
About Commonfund
Founded in 1971, Commonfund is devoted to enhancing the financial resources of educational and other nonprofit institutions including endowments, foundations, healthcare and service organizations through superior fund management, investment advice, and treasury operations. Directly or through its subsidiaries, Commonfund Capital, Commonfund Realty, and Commonfund Asset Management Company, Commonfund manages approximately $43 billion for approximately 1,900 nonprofit educational institutions, foundations, healthcare and other nonprofit institutions, representing one of the largest pools of educational endowment and operating funds in the world. In response to the growing needs of nonprofit institutions, Commonfund, together with its subsidiary companion organizations, offers more than 45 different endowment investment programs including funds for the management of short- and intermediate-term operating cash reserves. All securities are distributed through Commonfund Securities, Inc. www.commonfund.org
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