How to invest like an endowment fund

Almost all major universities, including Ivy League schools such as Harvard, Yale, Princeton, and MIT, have opened some of the largest and most successful endowment funds in the world. In fact, between 1992 and 2005, the actual annual growth rate of the top 20 university endowments exceeded 9%. However, after the U.S. economic crisis in 2008 ushered in negative returns, many university endowments re-adjusted their investment strategies.

Successful University Endowment Fund

University endowments have traditionally been funded by donations. The size of each endowment fund depends on a university’s shrewd spending on its current number of students. However, most universities do not put all of their capital into actual use, but instead use most of the donated funds for investment in order to create future income. In fact, on average, universities only withdraw 4% to 5% of their endowment funds each year for current purposes. Interestingly, 2008 was an extraordinary year. According to a study by the National Association of University Business Officials (NACUBO), endowments accounted for an average of 15% to 20% of university income.

Key points

  • Almost all major universities rely on endowments funded by donors to cover daily operating expenses.
  • Most of the investment portfolio of the endowment fund is used for investment to generate continuous income.
  • The asset allocation model is usually determined by the investment committee of the endowment fund.
  • Endowment funds allocate the largest proportion of their investment portfolio to alternative asset classes, such as hedge funds, private equity, venture capital, and physical assets such as oil and other natural resources.

The endowment fund strives to achieve two main goals. First and foremost, they try to generate high enough actual returns to pay for their annual withdrawals without involving their principal. Second, the university aims to maintain the true value of the principal, which actually requires an increase in the principal amount to combat inflation. In fact, endowment funds rely heavily on their own inflation measure, the Higher Education Price Index (HEPI), which takes into account the prices of goods and services specific to higher education costs. It is generally believed that HEPI exceeds the consumer price index of all urban consumers by 1%.

Eat cake with one hand and bake with the other

From 1985 to 2008, Harvard University’s endowment fund generated a return of 15.23%, while Yale University’s rate of return was 16.62%. The performance of these two endowments easily surpassed the S&P 500 index, which rose by only 12% in the same period. However, there is no magic formula behind the success of any school. In fact, each university describes its unique investment story in its annual report, which details the overall asset allocation model, although they rarely disclose individual investments in specific asset classes.

Concern for alternatives

In the decades before the economic crisis, from 1985 to 2008, endowment funds with assets of US$1 billion or more generally invested a small portion of their funds in traditional stocks and bonds, while most of their funds were invested in hedge funds and private equity And other alternative assets. , Venture capital, and physical assets such as oil and natural resources. Many of these alternative investments outperform traditional stocks and bonds, but usually have longer gestation periods and higher minimum investments—especially in extremely low-liquid markets. This type of investment is suitable for larger endowment funds that can lock in billions of dollars in the long term. This gives larger participants an advantage over smaller donors, who cannot take advantage of such non-traditional asset classes.

Write everything down and leave it to others

The endowment fund strictly follows the well-documented investment policy prescribed by the Investment Committee, which is traditionally composed of university alumni. The endowment fund has its own employees, led by the chief investment officer, and has an internal investment manager on the payroll to handle daily portfolio management tasks. Endowment funds must also follow written donor guidelines regarding the distribution of donated income for current use.

Invest like a donation

Those who try to imitate the investment strategy of university endowments should keep the following in mind:

  1. Although the assets are under 1 billion U.S. dollars
  2. University endowments benefit from the expertise provided by the investment committee, which is usually not available to individual investors.
  3. The university has a huge social network, which allows them to gain more access to many important investment opportunities.
  4. Donation funds are exempt from government tax.
  5. The best performing endowment funds can obtain alternative investments, which require a longer gestation period and higher minimum investment than most individual investors can afford.

Bottom line

A successful endowment fund can help reduce the financial burden of the university by generating a steady stream of income. Although the endowment fund has widely disclosed its asset allocation details, investors may not be able to replicate the historical success of the endowment fund.

[Important: Many economists believe the 23% drop endowments collectively suffered in 2008 was the worst decline since the 1970s.]

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