In fiscal 2024, large US college and university endowments reported a return of 9.6%. At first glance, that might sound decent, but when you compare it to the market benchmark return of 18.7%, it becomes clear that there’s a significant gap—an underperformance of 9.1 percentage points. This discrepancy prompts some critical questions about the investment strategies these endowments are employing, especially given their heavy reliance on alternative assets. Could it be that, despite those seemingly positive returns, the long-term implications of these choices might actually be harmful? After all, the lessons learned from the 2008 financial crisis are still relevant today.
Contextualizing Endowment Performance
In my experience at Deutsche Bank, I’ve learned that understanding the nuances of asset valuation is absolutely essential. The National Association of College and University Business Officers (NACUBO) recently pointed out a stark reality: endowments with assets over $1 billion are struggling to keep up with the performance of low-cost indexed portfolios. The fiscal year ending June 30, 2024, marks the third consecutive year where return smoothing has distorted the reported outcomes for these institutions. But what exactly is return smoothing? It’s a method where the accounting value of assets doesn’t quite match up with real market conditions, making it hard to get an accurate picture of performance.
Take the downturn in late fiscal 2022, for example. We saw significant losses in equity values that weren’t reflected in the net asset values (NAVs) used to assess institutional funds. This lag creates a skewed perception of how well these endowments are really doing. As the market rebounded in 2023, the valuations for private assets continued to lag, dampening any potential gains and further misrepresenting the endowment’s health.
A Closer Look at Investment Strategies
Diving deeper into the performance metrics reveals a troubling trend: the annualized excess return of the endowment composite stands at -2.4% per year, a figure that echoes previous reports. Over the past 16 years since the global financial crisis, endowments have only managed to retain 70% of the value they would have achieved had they opted for a comparable index fund. This raises a critical question: why do these institutions continue to invest heavily in alternatives, despite the evident drawbacks?
Data indicates that large endowments are increasingly putting their money into equities, known for historically yielding higher returns. However, the relationship between exposure to alternative assets and excess returns is concerning. For every percentage point increase in alternative investments, there’s an associated 28 basis points decrease in excess return. This trend underscores the high costs tied to these investments, averaging between 2.0% to 2.5% of asset value. As history has taught us, particularly from past crises, high fees without corresponding returns can significantly erode financial stability.
Regulatory Implications and Future Outlook
The implications of these findings stretch far beyond mere performance metrics; they raise serious questions about compliance and governance within these institutions. As the financial landscape evolves, regulators and stakeholders must closely examine the investment practices of endowments to ensure they align with fiduciary responsibilities. The lessons of the 2008 crisis are still fresh in the minds of investors and regulators alike, underscoring the necessity for due diligence and transparency in investment strategies.
Looking ahead, the sustainability of these endowment strategies seems precarious. If the current trajectory continues, we may see an erosion of wealth within these funds over the next 12 to 15 years, potentially reducing their value to half of what it could have been had they chosen a more conventional indexing approach. The numbers speak clearly: a reevaluation of asset allocation strategies and a shift towards more traditional investment vehicles may be essential for these institutions to regain their footing in an increasingly competitive financial landscape.