After experiencing rising markets in FY14, college and university investment returns hit turbulent currents in FY15 and FY16. The July 1, 2015, to June 30, 2016, period, was particularly challenging for institutional investors. In August 2015, China devalued the yuan, which adversely affected commodities, high-end brands, and emerging markets. In addition, financial markets in the U.S. and abroad were continually pressured by speculation as to when the Federal Reserve might raise interest rates, and by falling oil prices.
January 2016 did not bring reprieve, as the Dow Jones Industrial Average declined 5.5 percent and the Nasdaq sank nearly 8 percent. The year continued with negative influences created by China’s economic slowdown, slumping oil prices, and the U.K.’s vote in favor of Brexit.
College and university investments were especially affected by this financial environment. After experiencing strongly positive returns in FY13 and FY14, of 11.7 percent and 15.5 percent, respectively, endowments averaged returns of just 2.4 percent in FY15, slipping further in FY16 to an average return of –1.9 percent (net of fees), according to the 2016 NACUBO-Commonfund Study of Endowments (NCSE). The FY16 investment performance was the lowest since recession-level returns in 2009, and this trend could potentially continue.
The following overview of the 2016 NCSE results considers viewpoints of campus endowment managers by looking at the issues that they have handled over the last year and the future challenges that could bring turbulence to college and university finances.
Sinking Returns
The 805 colleges, universities, and affiliated foundations that participated in the 2016 NCSE held more than $515 billion in endowment assets as of June 30, 2016 (see Table 1). About 11 percent of these participating institutions had endowments of $1 billion or more; these schools accounted for almost three quarters of the total endowment dollars for all 2016 NCSE participants. Another 11 percent had endowments below $25 million; these participants accounted for less than 1 percent of total endowment dollars. The average endowment among all participating institutions was nearly $640 million, while the median was $116.2 million.
Regardless of endowment size, college and university endowments, on average, saw negative returns on their investments in FY16 (see Table 2). This fiscal year’s negative returns follow FY15’s low returns, demonstrating a continued trend of lower-than-expected investment returns. The largest endowments reported an average FY16 return of –1.9 percent compared with a 4.3 percent gain in FY15. Institutions with endowments between $101 million and $500 million had the largest average investment losses (–2.4 percent), followed by those in the $501 million to $1 billion category ( –2.2 percent). Colleges and universities with the smallest endowments, those with under $25 million, saw the “best” average return of –1.0 percent.
TABLE 1 Number of Respondents to the 2016 NACUBO-Commonfund Study of Endowments, by Endowment Size and Type of Institution
| Size of Endowment | Number of respondents | Percent of total respondents | Total endowment value in FY16* ($1,000s) | Percent of total dollars |
| Over $1 billion | 91 | 11.3 | 382,538,589 | 74.3 |
| $501 million to $1 Billion | 75 | 9.3 | 54,064,633 | 10.5 |
| $101 million to $500 Million | 264 | 32.8 | 60,472,069 | 11.7 |
| $51 million to $100 Million | 163 | 20.3 | 12,078,690 | 2.3 |
| $25 million to $50 Million | 121 | 15 | 4,545,969 | 0.9 |
| Under $25 million | 91 | 11.3 | 1,409,177 | 0.3 |
| Type of institution | ||||
| All public institutions | 299 | 37.1 | 165,100,708 | 32.1 |
| Public college, university, or system | 71 | 8.8 | 89,525,248 | 17.4 |
| Institution-related foundation | 169 | 21 | 32,872,251 | 6.4 |
| Combined endowment/foundation | 59 | 7.3 | 42,703,209 | 8.3 |
| All private colleges and universities | 506 | 62.9 | 350,008,420 | 67.9 |
| Total (all institutions) | 805 | 100 | 515,109,128 | 100 |
| Average endowment | N/A | N/A | 639,887 | N/A |
| Median endowment | N/A | N/A | 116,196 | N/A |
Alfred University, Alfred, N.Y., was one of the institutions to feel the steadily ebbing tide of endowment returns. After a return of 1.86 percent in FY15, it experienced a return of 0.40 percent in FY16. Giovina Lloyd, vice president for business and finance, and CFO, Alfred University, says that this year was also a “year of transition for the endowment,” as the institution has shifted its investment strategy. Lloyd notes that the return for the first quarter of FY17 is 3.75 percent.
Negative secular (long-term) and cyclical (short-term) trends contributed to the poor return performance over the last two years, according to Peter Rup, CEO and CIO, Artemis Wealth Advisors LLC, who also sits on investment committees of several institutions of higher education. When looking at the secular backdrop, Rup explains that years of declining interest rates (beginning in the 1980s) prompted increased borrowing. Now, many households, corporations, and global governments are working to reduce debt; as Rup notes, “Every one dollar devoted to repaying indebtedness is one less dollar utilized for consumptive growth.” This scenario, Rup says, “will continue to hamper economic activity and expected returns for the foreseeable future.”
When looking at the cyclical backdrop, Rup explains: “The collapse of oil prices and commodities, the appreciation of the dollar, and the U.S. dollar funding crisis facing many emerging economies further stunted the growth and led to a ‘profit’ recession in the U.S. Further, a struggling Chinese economy, a European banking crisis, and fear of the Eurozone demise led to extreme volatility and losses on most international equities.”
Asset Allocations Remain Steady
As institutional leadership works to pilot the rough waves of low returns, asset allocations have essentially remained constant over the last year, with only minor adjustments between FY15 and FY16. The shares of assets invested in U.S. stocks (16 percent), international stocks (19 percent), and short-term securities (4 percent) remained stable. In addition, investments in fixed income fell only one percentage point, from 9 percent to 8 percent, and allocations to alternative strategies grew by only one percentage point, from 52 percent to 53 percent.
TABLE 2, Average One-, Three-, Five-, and 10-Year Returns* for U.S. Higher Education Endowments and Affiliated Foundations for Periods Ending June 20, 2016 and 2015
| <>1-Year | 3-Year | 5-Year | 10-Year | |||||
| Endowment size | 2016 N=792 | 2015 N=804 | 2016 N=774 | 2015 N=739 | 2016 N=721 | 2015 N=717 | 2016 N=598 | 2015 N=573 |
| % | % | % | % | % | % | % | % | |
| Over $1 billion | – 1.9 | 4.3 | 6 | 10.8 | 6.1 | 10.4 | 5.7 | 7.2 |
| $501 million to $1 billion | –2.2 | 2.8 | 5.4 | 10.2 | 5.7 | 9.9 | 5.3 | 6.7 |
| $101 million to $500 million | –2.4 | 2 | 4.9 | 9.7 | 5.1 | 9.5 | 4.8 | 6.2 |
| $51 million to $100 million | –1.8 | 2 | 5.1 | 9.4 | 5 | 9.4 | 4.7 | 5.9 |
| $25 million to $50 million | –1.6 | 1.9 | 5.2 | 9.9 | 5.3 | 9.8 | 4.7 | 5.6 |
| Under $25 million | –1.0 | 2.3 | 5.5 | 9.9 | 5.8 | 10.6 | 5 | 6 |
| Type of institution | ||||||||
| All public institutions | –1.7 | 2.3 | 5.3 | 9 | 5.4 | 9.7 | 5 | 6.2 |
| Public college, university, or system | –1.4 | 2.5 | 5.8 | 1.1 | 5.5 | 9.7 | 5.5 | 6.5 |
| Institution-related foundation | –1.6 | 2.2 | 5.2 | 9.8 | 5.3 | 9.7 | 4.9 | 6.1 |
| Combined endowment/foundation | –2.0 | 2.4 | 5.2 | 10 | 5.3 | 9.7 | 4.7 | 6.1 |
| Private, non-profit college or university | –2.1 | 2.4 | 5.2 | 9.9 | 5.4 | 9.8 | 5 | 6.3 |
| All institutions | ||||||||
| Average | –1.9 | 2.4 | 5.2 | 9.9 | 5.4 | 9.8 | 5 | 6.3 |
| Median | –2.1 | 2.2 | 5.1 | 9.8 | 5.2 | 9.5 | 4.9 | 6.2 |
| 75th percentile | –0.7 | 3.7 | 6.1 | 10.9 | 6.2 | 10.6 | 5.6 | 6.9 |
| 25th percentile | –3.3 | 0.7 | 4.2 | 8.8 | 4.5 | 8.7 | 4.2 | 5.5 |
| Relative indices | ||||||||
| S&P 500 | 4 | 7.4 | 11.7 | 17.3 | 12.1 | 17.3 | 7.4 | 7.9 |
| Russell 3000 | 2.1 | 7.3 | 11.1 | 17.7 | 11.6 | 17.5 | 7.4 | 8.2 |
| MSCI World ex U.S. (in U.S. $) | –9.8 | –5.3 | 1.9 | 11.1 | 1.2 | 9 | 1.6 | 5.2 |
| Barclays Aggregate Bond | 6 | 1.9 | 4.1 | 1.8 | 3.8 | 3.4 | 5.1 | 4.4 |
| CPI-U | 0.7 | 0.7 | 1 | 1.3 | 1.6 | 1.8 | 2 | 2.3 |
| HEPI | 1.8 | 2.1 | 2.4 | 2.3 | 2.1 | 2.2 | 2.6 | 3 |
Sources: 2016 and 2015 NACUBO-Commonfund Study of Endowments
While allocations were mainly unaltered between FY15 and FY16, institutions saw a second consecutive year of markedly low performance, with a few exceptions, in several asset classes (see Table 3). One exception is that fixed incomes produced a 3.6 percent return in FY16 after only a 0.2 percent return in FY15. In addition, two alternative strategies, while still producing negative returns, did better in FY16 than in FY15: energy and natural resources moved from a –13.3 percent return in FY 15 to a –7.5 percent return in FY16, and commodities moved from a –17.7 percent return to a –7.7 percent return. However, most asset classes produced lower returns in FY16 than in FY15. Notably, international equities produced a return of –2.1 percent in FY15, which fell to –7.8 percent in FY16, and venture capital returns fell from 15.1 percent in FY15 to 1.5 percent in FY16.
Alfred University, which has a $105.8 million endowment as of June 30, 2016, had asset returns that mirrored the national average. Lloyd notes, “Our international equities performed poorly, as did distressed markets. Our hedge funds also continue to underperform.”
Emory University, which has a $6.4 billion endowment, has experienced two years of low investment returns, with a return of 1.9 percent in FY16 that followed a return of –0.5 percent in FY15. Mary Cahill, vice president of investments and chief investment officer, Emory University, Atlanta, notes that the “negative contributors in asset allocations included energy, discretionary macro, and selected actively managed equities.”
Monitoring trends in returns by asset allocation, a priority for institution investment managers, is balanced with a focus on long-term investment strategies. As Cahill explains, “The historical negative returns attributable to certain asset classes are useful observations for establishing the relationship between the returns of those assets and the returns of other asset classes in a diversified portfolio of public and private investment exposures.” When considering the wave of returns across asset classes in FY13 and FY14, followed by a marked decline for the last two years, Rup notes, “we have witnessed a ‘golden age’ of asset returns ushered in by the 30-year bull market in bonds”; however, this age has come to an end, and we are entering an era where the “new normal” will be significantly less generous.
In such a scenario, Rup agrees with Cahill that investment managers need to consider short-term as well as long-term economic trends. Investments supported by long-term trends, such as technology, advancement in health care, global shifts toward urbanization, and changes in demography, will likely benefit the most, Rup says.
TABLE 3 Average One-Year Investment Returns* by Asset Class, FY15 and FY16
| FY16 Asset Allocations + | |||||||||
| Asset Class | FY16 asset class return* (one year) | FY15 asset class return* (one year) | All institutions | Over $1 billion | $501 million to $1 billion | $101 million to $500 million | $51 million to $100 million | $25 million to $50 million | Under $25 million |
| % | % | % | % | % | % | % | % | % | |
| Domestic equity | – 0.2 | 6.4 | 16 | 13 | 20 | 26 | 33 | 38 | 44 |
| Fixed income | 3.6 | 0.2 | 8 | 7 | 9 | 13 | 17 | 20 | 24 |
| International equities | –7.8 | –2.1 | 19 | 19 | 18 | 20 | 19 | 17 | 15 |
| Alternative strategies (total) | –1.4 | 1.1 | 53 | 58 | 45 | 35 | 24 | 17 | 10 |
| Private equity** | 4.5 | 9.3 | 11 | 12 | 8 | 5 | 3 | 2 | 1 |
| Marketable alternative strategies*** | –4.0 | 2.7 | 20 | 20 | 20 | 16 | 11 | 7 | 6 |
| Venture capital | 1.5 | 15.1 | 6 | 7 | 3 | 2 | 1 | 1 | # |
| Private equity real estate (non-campus) | 7.1 | 9.9 | 6 | 7 | 3 | 3 | 3 | 2 | # |
| Energy and natural resources | –7.5 | –13.3 | 6 | 7 | 4 | 3 | 2 | 2 | 1 |
| Commodities and managed futures | –7.7 | –17.7 | 1 | 1 | 1 | 1 | 1 | 1 | 1 |
| Distressed debt | –0.6 | 5.4 | 1 | 2 | 1 | 1 | # | # | # |
| Alternatives not specified | N/A | N/A | 2 | 2 | 5 | 4 | 3 | 2 | 1 |
| Short-term securities/cash/other ++ | 0.2 | 0 | 4 | 3 | 8 | 6 | 7 | 8 | 7 |
Sources: 2016 and 2015 NACUBO-Commonfund Study of Endowments. Due to rounding, asset allocations may not sum to 100 percent.
Rising Endowment Spending
With FY16’s negative returns on endowments, colleges and universities have had to carefully chart spending to support student financial aid, faculty research, maintenance of facilities, and other campus operations that typically receive funding support from school endowments. Despite falling returns, most institutions have had to continue to increase endowment spending to stabilize operational budgets. Over the past fiscal year, 74 percent of colleges and universities have increased endowment spending on campus operations.
The average effective spending rate for college and university endowments increased slightly between FY15 and FY16, from 4.2 percent to 4.3 percent. In spite of lower investment returns, the average dollar amount that schools have spent from their endowments has grown since the financial crisis of 2008, from $16.5 million in 2009 to more than $20 million in 2016. Institutions with endowments in the $501 million to $1 billion, and $51 million to $100 million category sizes, experienced the highest increase in effective spending rates between FY15 and FY16, both increasing to effective spending rates of 4.3 percent.
When considering endowment size, schools with larger endowments tended to have higher effective spending rates; institutions with endowments of more than $1 billion had an average rate of 4.4 percent, while those with endowments of less than $25 million had a spending rate of 3.8 percent.
In addition, the median percentage of the operating budget funded by the endowment for all schools rose from 3.7 percent in FY15 to 4.0 percent in FY16. While the average for institutions with endowments of more than $1 billion decreased from 16.5 percent to 15.9 percent, the average rates increased for other endowment size categories. For example, rates increased from 11.8 percent to 12.8 percent for those with $501 million to $1 billion endowments. Thus, while all institutions have increased the dollar amount they are spending from their endowments, institutions in some endowment class sizes are also increasing the proportion of their endowments to cover institutional operating budgets.
Trends of lower endowment returns are leading some institutions to adjust their spending policies; recent efforts to average out spending at Alfred University can serve as an example. Lloyd explains that, “We compute spending by applying our 5 percent policy spending rate to a moving average of the endowment value. The moving average was increased from a 12-quarter to a 40-quarter moving average. The reason for the change was to further smooth the potential volatility of market cycles and provide steady and predictable spending for the institution.” In addition, Lloyd notes, “More recently, our investment committee has discussed a potential reduction in the policy spending rate that, if approved, would decrease incrementally over a period of years until such time as it reached up to 0.5 percent less than the current spending rate.”
Other institutions may also need to consider changes to their spending policies. According to Rup, “If the new normal expectations are realized, and the typical 60/40 portfolio generates no more than a 4.5 percent rate of return, then institutions will have to further reduce their spending in order to preserve the endowment market value.”
Charting Rough Waters
These two consecutive years of below-average investment returns demonstrate a trend not likely to subside in the near future; thus, investment managers will likely need to continue to navigate rough waters. Events in the first half of FY17 include the Organization of Petroleum Exporting Countries agreeing to reduce oil production in 2017 in an effort to address falling oil prices; Brexit leading to confusion about the future of European trade and the pound’s value; the Federal Reserve raising interest rates; and the election of Donald Trump to the U.S. presidency. After Trump’s election, the markets experienced a “Trump bump,” in which U.S. stock prices rose dramatically. However, it is too early to tell what the continued influence of a Trump presidency will mean for the markets.
Institutions have begun to react to this uncertainty. Cahill explains, “Because this uncertainty cannot be quantified, Emory has rebalanced the invested endowment portfolio to closely correspond with the baseline policy portfolio allocations, which is to say in the middle of all asset class and subclass allocation boundaries. As the actual policies of the Trump administration begin to materialize and become more visible and tangible, Emory Investment Management will reassess those developments and incorporate them into the analysis and judgment regarding expected risks and returns.” However, Cahill stipulates, until there is greater clarity on the policy changes under the new administration, the election of a new president will not have a meaningful impact on any investment policies.
Yet, this uncertainty hedged within a likely backdrop of continued lower investment returns has already led investment managers to closely consider investment strategies, specifically considering active versus passive investment management. Cahill explains, “We have taken into account the accelerating reflation that is finally promising relief from the experimental central bank monetary policies that dominated markets for risk assets since the financial crisis. Markets are already displaying greater dispersion and volatility, as well as reductions in cross-asset class correlations. In general, this should create an environment which is more conducive for the skilled-based active managers in the endowment portfolio who have been particularly challenged over the past two years.”
Rup echoes the sentiment, noting “Based upon the reality of the new normal environment that we are likely to face, passive and indexed startegies are likely to underperform. Looking forward, active and dynamic portfolio management is going to be paramount in importance to investment success.”
Institutions may need to make changes beyond investments strategies as well, in order to navigate uncertain financial waters. The types of changes institutions are considering demonstrate the need to balance current needs of the endowment with the expectation of the endowment serving in perpetuity.
As institutions strategically plan for the future, there is a focus on generation of new revenues via multiple vehicles—enrollment, fundraising, and so on. Shifts in enrollment at Alfred University illustrate such considerations. Lloyd describes that the enrollment of traditional college students had declined at Alfred University, but the nontraditional enrollment has allowed the university to “fill the [revenue] gap. With regard to diversification of revenue, nontraditional enrollment has been a focus for the institution. We’re also launching off-site degree completion programs.”
Like many schools experiencing tight budgets, Alfred University is focusing on implementing technologies to increase efficiencies and fundraising, and focusing on budget priorities. Lloyd explains, “Our university is particularly concerned about our investment in human talent. A priority for our institution is to ensure that we build a compensation strategy into our long-range planning.”
As investment managers focus on new revenues, consider revising spending polices, and examine the possibility of changes to their endowment investment policies, keeping an eye on the horizon is important. As Cahill describes, the asset allocation process is driven by the collective research and judgment of an investment team. “It would be myopic for a thoughtful, disciplined endowment investor, with a long-term investment horizon, to make impetuous adjustments to the asset allocation predicated on 12 months of negative, or positive, return data unless there was an event or circumstance that had fundamentally altered the foundation of the asset class expected risk and return characteristics.”
LINDSAY WAYT is assistant director, research and policy analysis, NACUBO. lwayt@nacubo.org