November 4, 1998

Endowments Hedging Their Bets
by Louis Corrigan (TMF Seymor)

Part III: Proper Asset Allocation

Of course, all of this raises a question: What is a proper asset allocation for a university endowment?

Tom Petzel, chief investment officer for the Common Fund, told the Providence Journal-Bulletin that most endowment funds have 60% to 75% of their assets in stocks, though it's not clear what percent of that is invested in U.S. stocks. Given that U.S. equities have outperformed other asset classes over the last century, endowments might do well to follow the general Foolish precept of putting 100% of long-term investment dollars in equities, preferably U.S. equities. Since endowments also have short-term spending requirements, not all of their assets should be marked as "long-term investments." However, a mix of something like 80% U.S. stocks and 20% fixed income/cash equivalents seems reasonable.

Despite all the alleged benefits of diversifying into international stocks and bonds, playing fancy arbitrage games, or trying to time the market by shifting assets among various classes, I'd bet there are few university endowments that have delivered results superior to what such an 80/20 mix has produced over the last few decades.

Consider that U.S. endowments celebrated an impressive 20% gain last year according to a report issued in February by the National Association of College and University Business Officers. Yet, the S&P 500 index returned 33.4% for 1997, assuming dividends were reinvested. Meanwhile, even your basic no frills money-market account would have returned at least 4.5%. Basing the 80/20 split on the S&P 500 would have produced at least a 27.3% return for 1997. Although we don't necessarily want endowment funds all chasing the S&P 500, these figures at least suggest that universities could have enjoyed even better results with far less exotic investment strategies.

Of course, excess caution can produce results as bad as those generated by extreme risk-taking. Consider the case of New York University's endowment, which has become a classic example of how even well-regarded professional investors can produce lousy results.

For years, NYU's trustees included a list of Wall Street pros led by chair Lawrence Tisch, head of Loews Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LTR)") else Response.Write("(NYSE: LTR)") end if %>, and including Maurice Greenberg, head of American International Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AIG)") else Response.Write("(NYSE: AIG)") end if %>, Alan Greenberg, a Bear Stearns trader, and Leonard Stern, a real-estate developer. However, since Tisch assumed the leadership of the university's board in 1978, NYU had invested mainly in high quality bonds, missing one of the most profitable periods ever for U.S. equity investors because Tisch consistently thought that stocks were too expensive. Indeed, over the past few years he has used Loews' capital to establish massive bets against major U.S. indexes as well as specific stocks.

During this period, NYU sacrificed hundreds of millions of dollars in potential gains. For the five-year period ending in July 1997, the endowment (now valued at $950 million) returned just 9% annually versus 20.6% for the S&P 500, according to a 1997 article in the Journal. Tisch's management was so conservative that NYU's Institute of Fine Arts (IFA) finally pulled its share of the money out to be managed separately. In fact, the endowment had just 15% of its total capital invested in equities early in 1997, with the IFA's stock portfolio accounting for most of that amount.

Since then, retired hedge fund manager Michael Steinhardt has taken over as chair of the investment committee and hired chief investment officer Maurice Maertens, the former head of Ford's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> pension fund. Steinhardt has gradually raised the endowment's exposure to stocks to 40%, with 15% in hedge funds according to a recent article in the Journal. A March report in Pensions and Investments noted that NYU's goal is a portfolio consisting of 50% equities, 25% fixed income, and 25% "alternatives." The latter category includes a $25 million investment in Odyssey Investment Partners, a buyout fund, and an undisclosed commitment to hedge fund Ulysses Partners.

That's preferable to being nearly 100% invested in bonds. Still, it seems odd that even relatively stodgy endowments have trouble imagining a larger, straight-up commitment to stocks despite the fact that Jeremy Siegel (author of Stocks for the Long Run) and others have produced reams of data showing that investing in American business has been the best bet for long-term capital appreciation.

Sure, valuation is always a concern, and I'm sure I can't fully appreciate the pressures and challenges of investing a billion bucks. Still, some university endowment funds seem to have embraced the potentially quite dangerous Wisdom of Wall Street that holds that big-money institutions need exotic investment portfolios so they're diversified into every imaginable high-risk situation. It just ain't so. The donors who sign the checks are getting smarter and will increasingly demand greater accountability before they transfer part of their Dow Four profits to a university endowment fund anxious to bet on the Thai baht. You know, if you lose $20 million here and $5 million there, sooner or later you're talking about real money.

If you want to encourage an endowment fund to exercise more Foolish prudence in managing your donations, consider sending them a copy of The Motley Fool Investment Guide. The money they save may be your own. We can even include a Foolish message from you so they know whom to thank.

Talk About this Feature (Web)

Recent Articles by Louis Corrigan:
-- Inside Business Week's "Inside Wall Street"
-- A Short Course on Short Squeezes
-- JDA Software and the ERP Washout
-- Ziff-Davis Crushed by Debt
-- A Boston Chicken Autopsy