Endowment funds looking longer-term

By Frank Goad

Endowment management must reflect the long-lived nature of postsecondary institutions such as Transylvania University, whose Old Morrison Building (above) is one of the oldest college buildings in the state. It was built in 1833.
Endowment management must reflect the long-lived nature of postsecondary institutions such as Transylvania University, whose Old Morrison Building (above) is one of the oldest college buildings in the state. It was built in 1833.

Bookstore shelves today present many volumes whose sole purpose is to instruct how to invest like top university endowment managers. That people will pay to learn their ways says much about the skill of those guiding these funds.

Kentucky college and university endowments still change strategy only slowly and in small steps. There is a trend, though, toward longer-term private equity investments, often in physical product-based sectors such as real estate and energy whose underlying assets retain their relative value should inflation depreciate the direct worth of currency.

Endowments are not a traditional money-in, money-out proposition. As reported a year ago in a two-part look at Kentucky college and university endowments by The Lane Report, standard practice is to use part of returns earned annually from savvy investing and leave the principal to grow long-term and produce larger returns in the future.

An endowment’s two principle functions are: to provide literally perpetual financial stability and income to a school; and to enhance today’s learning with endowed chairs, with targeted support for scholarships, visiting teachers and academic specialties such as research grants, and with other donor-designated avenues of support for students and faculty.

Endowment stewards know their success starts and ultimately rests with the school’s supporters, the individuals who donate the money they manage.

A successful endowment is a testament to the generosity and loyalty of the school’s alumni and admirers. Their financial support is a vote of confidence in the school and its mission – it’s how many honor a place and time they regard as central to their success.

“No matter how well we invest and manage our endowment’s assets, the generosity of our supporters and alumni remains the most critical part of our success,” said Bob Jackson, president of the Murray State University Foundation.

Volatile markets, incremental change

More than five years after the severe economic downturn in 2008-2009 that saw some endowments’ publicly traded equities lose 40 percent to 50 percent of their value, all Kentucky schools are still cautiously eyeing the financial investment markets.

Scott Owens, assistant controller for Centre College, reflects this careful nature in explaining endowment strategy at the nearly 200-year-old Danville institution.

“While looking at the agenda for our next investment committee meeting, it became obvious that very, very little will change, and the changes to be made are small indeed,” Owens said.

While cautious, small changes are the strategy being followed by most schools, they also keep in mind that computerized-trade-driven markets now move much faster than even a few years ago and, in a matter of seconds, an investment gain can turn into a loss.

“The days of ‘swing for the fences’ are gone – the markets are so volatile,” said Susan Krauss, interim treasurer for the University of Kentucky. UK’s board of trustees recently approved a shift in asset allocation.

Complicating the management task further, the very long-term outlook they maintain means funds must invest a substantial portion of their assets in lower-risk opportunities, and therefore the gains they earn are often small. To capture those gains, fund managers today must have the authority to move more quickly than in the past. Many investment committees overseeing endowments have given their fund managers more authority to make quick decisions and seize any possible gains. Previously, fund managers had to wait for the next investment committee meeting, meaning many opportunities were lost.

Private equity commitments increasing

Most Kentucky schools maintain a traditional 65 percent stock and equities, and 35 percent bond strategy long favored by more conservative advisors. Those interviewed for this story have made only small changes to their investment strategies since last year.

Students on the way to graduation ceremonies at Centre College in Danville walk past Old Centre, built in 1820. Today’s students and administrators benefit from the returns on investments the school’s endowment fund made decades ago.
Students on the way to graduation ceremonies at Centre College in Danville walk past Old Centre, built in 1820. Today’s students and administrators benefit from the returns on investments the school’s endowment fund made decades ago.

Although, echoing the need for quick action, each said they are looking harder at their tactical investment opportunities. They are retiring or reducing long-term bonds and fixed-income investments since the typical return on them is lower than average. This move also helps to balance portfolios and, in Krauss’ words, “ensure appropriate vintage year diversification” and avoid holding too many older investments that are underperforming the markets.

Schools are investing more of their money in private equity transactions outside the publicly traded markets that require long-term commitments of funds. Each Kentucky school interviewed said it was doing so. They said they are moving into equities in a wide range of sectors such as oil, gas and other types of inflation-protected commodities; real estate is prominent for all endowment funds. Private equity maturities range from short- to long-term to provide tactical advantages while offering better returns and varying degrees of liquidity.

“(Our) foundation is maintaining traditional investment exposure, but is gradually tilting towards private placement investments as a complement,” James Shaw, vice president of university advancement at Morehead State University, said.

Jackson of Murray State echoed that.

“While we’ll always hold bonds as part of our portfolio, we’ve been moving more money out of them and into private equities,” Jackson said. “Our endowment’s 13.9 percent return for fiscal year ’12 is evidence that has been a good decision.”

Morehead State’s balance is typical of what many schools are doing, too.

“(Our) foundation portfolio is made up of 41 percent stocks, 25 percent fixed-income and cash, and 35 percent alternative investments,” Shaw said. “One year ago our allocation was 37 percent stocks, 31 percent fixed-income and cash, and 32 percent alternative investments.”

UK charting a bolder course

The University of Kentucky is taking a different tack than most by adopting a hybrid policy for the disbursement of money back to the school. In the past, specific amounts were set out and the money disbursed regardless of the markets or inflation. Under the new model (approved at June’s fund committee meeting), allowances for inflation (based on the prior year) and the endowment’s total market value are calculated regularly, and distributions are recalculated accordingly. This allows the school to trim spending when inflation is low.

The school is also aligning its portfolios more aggressively than other schools. The accompanying chart is a summary of the asset allocation changes approved. The new asset allocation is designed to achieve a goal of a 7.5 percent long-term average annual return, with low volatility.

The changes, deemed necessary due to today’s lower-return investment environment, include reducing the UK endowment’s long-only equity and fixed-income allocations, increasing its private equity and real estate investment, and putting 20 percent of funds into new “global tactical multi-asset” and “long-biased long/short equity” categories. This change will be implemented in two phases, Krauss said.

Phase One, involving the liquid strategies, is currently underway and will be fully implemented by Jan. 1, 2014.

Phase Two, involving the illiquid strategies (private equity, private real estate and other private real assets), will be implemented slowly over the next several years to ensure appropriate vintage year diversification.

Of particular interest is the new Global Tactical Asset Allocation category that combines U.S. and non-U.S. equities into a single category that is to be managed by a single investment group. This allows the fund managers to respond more quickly to market changes worldwide.

“UK is working to empower the fund managers and give them more freedom to capture opportunities on behalf of the school,” according to Krauss.

While UK has made the most changes, it has the largest endowment. The smaller Kentucky schools are still reeling a bit from the market drop and are investing in an accordingly cautious manner. Shaw of Morehead summed it up the best: “The foundation is maintaining a relatively neutral risk posture today,” and that seems to be the common wisdom.

Frank Goad is a correspondent for The Lane Report. He can be reached at [email protected]