Endowment performance likely to falter, experts say
The 253 endowments in The Chronicle's annual survey enjoyed their fifth straight year of strong investment returns in 2007, but that streak may come to a halt in 2008.
The endowments in the survey earned a median return of 15.7 percent in 2007 — meaning that half of the endowments achieved higher returns and half lower — helped by a rising stock market and good returns on other types of investments.
Yet given the way markets have acted in the past year — the Standard and Poor's 500 index was down 13 percent for the 12 months ending June 30 — endowment managers may soon be forgoing the champagne and reaching for the Maalox instead.
Lowered Expectations
In 2008, even the largest endowments, which tend to have more-sophisticated investing strategies, will be lucky to eke out a positive year, experts say.
"We're all going to be happy if we have low single-digit returns for our respective fiscal years," says D. Ellen Shuman, chief investment officer of the Carnegie Corporation of New York, a foundation with a $3.1-billion endowment. (Carnegie's endowment earned 25.9 percent for the 12 months ending in September 2007, but it grew only a few percentage points for the eight months ending in May 2008.)
That is a far cry from the double-digit returns many endowments have been enjoying since the 2000-2 bear market ended. Many of the biggest endowments — those with assets of $1-billion or more — made it through that decline with relatively few scars. The big endowments were already widely diversified, sprinkling bets among international markets and "alternative investments," by the time the American stock market began to drop. Some of the alternatives they favored, such as timber and real estate, outperformed stocks during the last bear market. And others, like hedge funds that can "short," or bet against, stocks, profited in equities.
Meanwhile, most small and midsize endowments — many of which entered this century with two-thirds or more of their assets in American stocks — absorbed steep losses during that downturn. But they took notice of the bear-proof portfolios that mega-endowments like Harvard and Yale Universities seemed to have assembled, and over the last six years, those smaller endowments have revised their asset allocations to try to better prepare for the next sharp decline in the stock market.
The Arizona Community Foundation, in Phoenix, maintained roughly the same investment mix for nearly two decades, with 60 percent to 70 percent of its assets in stocks and the rest in bonds. But last year, a new investment committee on the foundation's board voted to commit 20 percent of assets to alternative investments.
The group has already put 10 percent of its $465-million endowment in two "long-short" hedge funds, which go "long" — or buy stocks that the managers think will do well — and short less promising stocks.
Given the tumult in the stock market, those funds have been the foundation's best performers over the past year, says Paul Velaski, the foundation's chief financial officer. Mr. Velaski recently met in New York with managers of private-equity funds; the foundation plans to gradually move about 10 percent of its endowment into private equity.
"We're trying to put a little more diversity into the portfolio to take out some of these big swings," Mr. Velaski says. "We've seen many other foundations be able to do that successfully."
The Arizona Community Foundation had among the worst returns in The Chronicle's survey this year, with a loss of 2.6 percent, but part of the poor return can be attributed to the foundation's fiscal year. Its year started in April 2007 and ended in March 2008, and so, unlike other endowments in the survey, its return reflects the steep losses that stocks endured at the beginning of 2008.
Biggest Performers
Nearly every other endowment in the survey earned a positive return during 2007.
As usual, colleges topped the charts, with a median return of 21.5 percent. Fifty of the colleges and universities in the survey all have endowments worth $1-billion or more.
Yale, whose $22.5-billion endowment is headed by David F. Swensen, who is known for diversifying broadly and has a strong long-term record, earned the highest return among all endowments in this year's survey, with a 28-percent increase for the 12 months ending in June 2007.
Five other broad categories of endowments — environmental and animal-welfare groups; arts groups, museums and libraries, and public broadcasting groups; education groups; Jewish federations; and private foundations — all earned median returns of 16 percent to 17 percent.
Youth groups and religious groups were the laggards among the 15 broad categories, earning returns of 7.5 percent and 6.6 percent, respectively.
Since the first half of 2007 was a much better period for stocks than the second half, some of the difference in return can be explained by when an endowment's fiscal year ends. However, one could argue that the 67 endowments whose fiscal year ended in December 2007 (and provided information about investment returns) did better, on a relative basis, than the 114 endowments whose fiscal year ended in June 2007, although the June group had better raw returns.
The June group earned a median return of 18.2 percent for the 12 months ending in June, lagging the stock-market return of 20.6 percent for that period, as measured by the S&P 500 index. The December group had a median return of 9.5 percent, surpassing the S&P's 5.5-percent calendar-year return.
Big and Small
The biggest endowments continued to outperform their smaller counterparts. Endowments holding assets worth more than $1-billion earned 19.4 percent, compared with 18.2 percent for endowments between $500-million and $1-billion; 15.7 percent for endowments between $100-million and $500-million; and 10.9 percent for endowments with less than $100-million.
Even with the increasing appeal of alternative investments, most small endowments still look and act nothing like their bigger brethren. Consider the different approaches of the United Way of Central Maryland, in Baltimore, which has an $18-million endowment, and the $3.8-billion Kresge Foundation, in Troy, Mich. Both had good years in 2007, but the United Way organization's performance was tied to the stock market, while Kresge relied on multiple approaches that, in the past 18 months, have enabled it to outperform stocks.
The United Way of Central Maryland has nearly three-quarters of its assets in stocks, with the rest in bonds and cash. It earned 17.3 percent for its fiscal year ending in June 2007, up from single-digit returns in 2005 and 2006.
"I'd like to say that we were brilliant and we did something strategically that shot the lights out, but the strong result was more than anything else a reflection of a nice strong year in the market," says Lee S. Owen, co-president of Alex. Brown Investment Management, in Baltimore, and manager of the United Way organization's endowment.
For Kresge, strategic bets mattered most. While many endowments invest primarily in American stocks, Kresge has just 15 percent of its endowment in funds focused on domestic stocks, and twice as much invested in international equities, including emerging markets, according to Robert J. Manilla, a senior investment director at Kresge. Kresge's in-house investment staff also bet that the dollar would decline against other currencies and that the yields on riskier bonds would rise. Those moves helped power the foundation to a return of 21.6 percent in 2007, nearly four times the calendar-year return of the S&P 500.
Now, in a much bleaker market, Kresge is again outperforming the averages. The endowment's value increased by a few percentage points from January through May, thanks in part to its purchase several months ago of options that rise in value as the American market declines.
"The 100-year flood happens a lot more often than every 100 years," Mr. Manilla says. "People need to protect their portfolios from these big risks."
For the United Way of Central Maryland, with its large holdings in American stocks, returns are sure to be negative for the 2008 fiscal year, says Patti Kelt, the organization's chief financial officer. The United Way of Central Maryland recently considered moving into alternative investments like hedge funds.
But instead, its board's investment committee decided that hedge funds — which assess high fees and often use lots of debt — were too risky.
"This is about safeguarding donor funds that are supposed to be used for health and human services," Ms. Kelt says. "It's not necessarily about taking big risks with that money, searching for returns."
Real-Estate Values
Given all the troubles facing the declining housing market in the United States, it may seem risky to heavily invest endowment assets in real estate. Fewer than a quarter of the endowments in The Chronicle's survey held any real estate. But, surprisingly, those organizations say their investments have performed well.
The Carnegie Corporation of New York, which has 11.6 percent of its assets in real estate, favors managers who know about a property type or a local market, or both, says Ms. Shuman, the foundation's chief investment officer.
Many of the managers, she says, were selling properties near the top of the market in 2006. "You could argue that they sold too early, but I'd rather have them do that than sell too late," she says. "And we're seeing them now start to go back into the market to take advantage of motivated sellers."
Ms. Shuman says Carnegie may eventually raise its allocation to real estate as high as 15 percent.
David R. Brief, chief investment officer of the Jewish Federation/Jewish United Fund of Metropolitan Chicago, says that currently about 8 percent of its endowment is in real estate, and that those investments have returned about 18 percent per year for five years, including in 2007.
More than 60 percent of its real-estate investments are with managers who invest in foreign countries, where Mr. Brief believes values are easier to find. "So far, we have largely avoided the effect of the bursting of the bubble in both the U.S. residential and commercial markets," he says.
Returns from investing in international equities have been augmented in recent years by the dollar's slide against other currencies, which means profits made abroad buy more in the United States. But some investing experts believe the dollar may soon stage a rebound.
Eric W. Bailey, co-founder and managing principal of CapTrust, an investment consulting firm in Florida whose clients include nonprofit endowments, says he has favored international equities over American stocks for several years.
But when investing in the United States, Mr. Bailey favors large companies, which tend to have steadier earnings during a slowing economy than do smaller stocks.
"In this environment," Mr. Bailey says, "it's as much about controlling risk as it is about reaching for return."