Good Year for College Endowments

Study finds average investment return of 16.9%, up significantly from last year -- while spending rate falls slightly, to 4.4%.
January 18, 2008

At a time of increasing scrutiny of colleges' endowments, institutions are enjoying the results of a very good year. In the 2007 fiscal year, the average endowment increased by 16.9 percent, according to new data from Commonfund, which invests money for colleges and other groups.

By way of comparison, last year's increase was 10.6 percent. The study also found increases in average three-year returns (up to 12.8 percent, from 12.3 percent last year) and average five-year returns (up to 11.5 percent, from 6.8 percent last year, when the impact of drops in 2002 was still part of the equation). The multi-year figures are particularly important because many colleges make decisions on how much to spend of their endowments based on returns from more than one year. This year, the spending rate on endowments fell slightly, to 4.4 percent from 4.5 percent, the Commonfund found.

The definitive survey on endowments has for years been conducted by the National Association of College and University Business Officers, which will release its data next week. In recent years, the overall averages of the two studies have been quite close. The NACUBO survey comes with endowment totals for individual institutions, unlike that of the Commonfund. However, many of the wealthiest institutions have already released their endowment reports for fiscal 2007, showing significantly higher gains than they had last year. Harvard University's endowment, the nation's largest, earned a 23 percent return during fiscal 2007, reaching a total of $34.9 billion. Yale University, which follows Harvard in endowment size, saw a larger percentage gain (28 percent) to bring its endowment up to $22.5 billion.

It's not surprising that Harvard and Yale would see gains larger than the national average. Historically, institutions with larger endowments -- with enough money to take some risks -- see larger gains than smaller, typically more conservative institutions. In the Commonfund study, the wealthiest again outperformed other institutions, but across the spectrum of endowment wealth, institutions were doing better in 2007 than 2006.

Endowment Returns by Size, 2007 and 2006

Endowment Size 2007 Return 2006 Return
More than $1 billion 21.0% 15.2%
$501 million to $1 billion 19.4% 13.1%
$101-500 million 17.8% 12.0%
$51-100 million 17.1% 9.9%
$10-50 million 15.6% 9.1%
Under $10 million 13.6% 7.7%
All institutions 16.9% 10.6%

Another way that the Commonfund analyzes the data is by looking at characteristics of top performing endowments -- grouping together top decile and top quartile performers. One characteristic of these groups is that they were large to start with. But the top performers also invest in different ways.

Top decile endowments had about 52 percent of their investments in "alternative" allocations -- meaning hedge funds, venture funds and so forth -- instead of the more traditional mix of stocks and bonds. For top quartile funds, the alternative percentage was 47 percent. For everyone in the study, the percentage was 42 percent. Leading endowments tended to keep only small percentages of their funds in cash, and to be reducing investments in energy and natural resources.

Over the past two years, there has been a shift -- across most endowment sizes -- away from domestic equities and fixed-income investments and toward international equities and alternative investments.

Asset Allocations of College Endowments, 2005-7

Asset class 2005 2006 2007
Domestic equities 28% 26% 23%
Fixed income 16% 13% 12%
International equities 18% 20% 20%
Alternative strategies 35% 39% 42%
Short-term securities and cash 3% 2% 3%

John Walda, the president of NACUBO, warned in an interview not to read too much into trends of any one year. Endowments are "so dependent on the state of the economy," he said, and colleges' dependence on endowments relates to factors such as state appropriations, so any one-year period can be deceptive. For example, while the investment market had a healthy 2007, many are concerned about the outlook for 2008, and there are many reports that state institutions will be facing tighter budgets. In that environment, the earnings from 2007 may not be the windfall they might appear to be, he suggested.

In the last year, a growing number of critics have suggested that it's time for colleges to spend more of their endowments on current needs. The size of the largest endowments has grown so much, these critics say, that society would be better served by lower tuition or other changes that might come about through spending more of the funds.

Walda said these arguments are much too short term in nature. "You need to be looking at the viability of an endowment over decades," he said. "The challenge is for endowment managers to maintain intergenerational value, and they need to tuck money away to deal with effects of inflation and the increased costs of some of the cost drivers in higher education," he said.

While Walda did not discuss details of the NACUBO survey, he said that he has seen much evidence of the trend of greater interest in alternative investments. College investment managers are becoming "less conservative and more creative" in what they do, he said.

And while that trend has been most evident in the past at larger funds, he said he sees it in smaller funds too. "I think they've seen what can happen with endowment diversification," Walda said.


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