Mid-February can be a challenging time of year. For sports fans, the lull between the end of the football season and the beginning of baseball season can feel like an eternity. For many, February weather is the worst of the year. According to the Weather Channel, there have been 57 named winter storms in February since 2013, the highest monthly total by a long shot. When did we start naming winter storms? But for those who love studying endowments, it is the most exciting time of the year due to the annual release of the NACUBO-Commonfund Study of Endowments (NCSE) that reports all kinds of interesting data, statistics and trends from higher ed institutions. This year’s study, the 51st, didn’t disappoint and is a must-read for anyone involved in endowment management.
Naturally the headlines came and went and, as usual, tended to focus on short-term performance. I have bemoaned this focus before (see here and here) and continue to believe that the one-year performance numbers are the least interesting in the 174 pages, particularly for investment portfolios that are intentionally designed to generate multi-generational returns. The big story, other than the 11.1 percent average return being higher than last year’s 7.7 percent average return, was that the smaller the endowment, the higher the return. For the second year in a row, the largest endowments underperformed their smaller brethren.
The story behind the fiscal year’s performance trends is a relatively simple one. The more public equity you owned, the better you did. The more U.S. equity you owned within public equity, the better you did. The more large cap, the more tech, and the more Mag 71 you owned, the more likely you won the performance derby this year. Indeed, U.S. equities were the best performing asset class for the fiscal year and the Mag 7 accounted for 51 percent of the S&P 500 index’s return. So, while the headlines focused on size, the real story, as it always is, was asset allocation.
Although this is the second consecutive year smaller institutions reported higher returns than larger institutions, it is a dynamic that is not all that common. Over the past 20 years, the smallest size cohort has outperformed the largest only four times, including the last two. The two other years were fiscal years 2016 and 2009. However, if instead of 1-year returns we look at 10-year, 15-year, and 20-year returns, arguably more relevant time periods for perpetual pools of assets, the smallest size cohort has never outperformed the largest. Why? Again, it’s not because of size but rather asset allocation. As the saying goes, correlation does not necessarily equal causation. Many of us are probably familiar with the studies that demonstrate the importance of asset allocation and our research at Commonfund suggests that the biggest determinant within asset allocation of long-term performance is exposure to illiquid strategies.
New to this year’s Study was a question about top concerns facing higher ed. In Viewpoint II, which begins on page 38, respondents were asked to select two top concerns out of a list of 20 and the results are reported by both endowment size and institution type. Perhaps not surprisingly, the top concern across all respondents was student enrollment, as summarized here. However, if we look a bit deeper there are interesting trends based on endowment size.
And in this case, the size of endowment absolutely matters. Those with larger endowments and thus typically more dependent on the spend from those endowments would naturally be more concerned about the investment environment, the liquidity profile of their portfolios and the ability to meet long-term return objectives. As the Study cites, 144 of the 658 respondents have endowments over $1 billion and while only accounting for 22 percent of the number, these institutions hold 86 percent of total endowment assets. Conversely, for the other 80 percent of higher ed institutions that are more dependent on net tuition revenue than endowment income to fund operations it makes perfect sense that they would be most acutely concerned with enrollment.
This data points to what institutions are concerned about, raising the natural question of what they are doing about these concerns. We are firm believers that fiduciaries should be having discussions around the challenges they face and consider both the challenges they know about as well as the ones they can’t predict, like a global pandemic or a global financial crisis. To aid in those discussions, we continue to work on a framework or a playbook to help investment committees prepare for the next crisis, whatever that may be.
Click here to learn more about how your committee can prepare for the unseen.
As always, we would welcome the opportunity to engage with you, your staff, and/or your committee on all the important topics of the day.
1. Mag 7 is shortened for the Magnificent seven, a group of technology stocks including Microsoft, Nvidia, Tesla, Amazon, Google, Meta, and Apple.
