Endowment Returns Spike

Educational endowments saw their largest returns in four years, with top performers diversifying their alternative investments, a study reported.

For its 2005 Benchmarks Study, Commonfund—an organization that manages funds for nonprofits—surveyed the investments of 707 endowments held by colleges, universities, and other educational institutions in the United States.

“The significantly improved returns seen this year build upon the successes of last year, which pulled educational endowment returns back into the black after three very difficult years,” said Commonfund Institute Executive Director John S. Griswold in a press release.

Endowments’ total returns for fiscal year 2004 averaged 14.7 percent overall, while the top tenth among them saw an average return of 21.5 percent, which exceeds Harvard’s returns this year, the survey found.

The returns were up from losses for 2001 and 2002 and a 3.1 percent return in fiscal 2003.

In size, Harvard leads higher education with its $22.6 billion coffers. The Harvard Management Company, which invests the endowment, achieved a 21.1 percent return during fiscal 2004—a return it says leads the endowments of other large universities. Around a third of the University’s annual budget comes from the endowment payout.

Commonfund’s survey also analyzed where institutions invested their assets. Compared to other endowments, the top performers had more diversified alternative-strategies investments—a class of investments that includes hedge funds, private and public equity real estate, distressed debt, venture capital, and energy and natural resources. Last year’s top performers allocated less to hedge funds and more to energy and natural resources, as well as private equity real estate, the study found.

“We continue to see educational endowments and foundations working at the cutting edge of asset allocation, diversification and risk management,” Griswold said. The changes in allocation “may signal a broader industry recognition of the need for more due diligence, risk management and proper diversification of an alternatives portfolio.”

Harvard is known for its breadth of investments; BusinessWeek last month called the management company’s strategy “diversification writ large.” But the magazine noted that the University’s money managers can still make “huge bets,” like a commodities investment of over $2 billion in timber, or around one tenth of the total endowment.

Across all institutions, the survey reported “modest” changes in asset allocations, including an increase in high-yield bonds. But the top performing endowments decreased their investments in alternative strategies and fixed income, and increased their allocations to domestic and international equity, as well as cash.

Most endowments don’t expect to change their asset allocations this year, but nearly a third plan to increase their alternative investments, the study said.

On average, institutions reported slightly lower spending rates, showing a drop to 4.8 percent from 4.9 the previous year. The percent of institutions’ operating budgets funded by their endowments increased at the largest institutions but decreased for small institutions, yielding an overall decrease from 13 percent to 11 percent.

At Harvard, endowment payout is responsible for a much larger share of revenue. About a third of the University’s budget is funded by payout from the endowment. For the Faculty of Arts and Sciences (FAS), that figure is even higher, at 47 percent.

Institutions expect to see lower returns in fiscal 2005—endowments over $1 billion expect, on average, a return of 8.6 percent. In a September interview with The Crimson, management company president Jack Meyer warned of lower returns to come.

—Staff writer Nicholas M. Ciarelli can be reached at ciarelli@fas.harvard.edu.