Record returns from university endowments are cut both ways
Some of America’s biggest university endowments have shown jaw-dropping annual earnings over the past week. Duke University reported a 56% return for the fiscal year ended June 30. Washington University in St. Louis generated a 65% gain.
These top performing endowments can thank alternative assets, especially venture capital, for the record year, which would be the best since 1986. But this short-term success could prove to be a double-edged sword.
Endowments performed well across the board, with the median return standing at 27% for the period, according to the Wilshire Trust Universe Comparison Service. Funds managing over $ 500 million did much better, posting median gains of 34%, thanks to private investment.
Venture capital holdings of the University of North Carolina’s nearly $ 10 billion endowment returned 142% for the year, Pensions & Investments reported. The endowment gained 42.3% overall, and its private equity holdings grew to 44%.
On the one hand, the news of this windfall reinforces the case of the endowment model which favors alternative investments. It also provides a fitting coda to the legacy of David Swensen, the highly influential former Yale endowment chief who died earlier this year.
But returns can become a headache for endowment asset managers: Growth could be more of a mirage than an oasis, and it provides ammunition for various critics of the endowment system.
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Unlike editors, endowments don’t care about year-over-year returns. Their job is to provide financing in perpetuity, even and especially when the markets go haywire.
Venture capital and private equity funds posted historically high distributions last year, but many of the gains reported by universities are likely to be fueled by the rise in paper-only private valuations. The price tags of today’s startups might not stand up to public market scrutiny in years to come.
Additionally, the annual snapshots are further distorted due to an artificially low baseline, which represents a shift from the coronavirus-battered markets of June 2020. And the low interest rate environment has pushed upward asset prices, both public and private.
Even if the gains are long-lasting, the figures put the wind in the sails of the most critical of endowments.
Many students and other campus activists want their endowments to divest from fossil fuels or offset tuition fees. Politicians are currently deciding the fate of a Trump-era tax on the richest university funds. The Securities and Exchange Commission this week proposed to require more disclosures about executive compensation for endowments.
Each of these groups could use the annual windfall as proof that endowments should be more transparent, more generous or more accountable.
For private markets more broadly, the disparity in returns between large and small endowments underscores the highly exclusive nature of top performing funds. The elephant in the room is that most endowments do not have access to the best PE and VC managers, which raises an issue of fairness.
Endowments of over $ 1 billion allocate more than a quarter of their portfolios to PE and VC asset classes, according to the 2020 NACUBO-TIAA College Endowments Study. For those under $ 250 million, this allowance drops to less than 8%.
Yale, for example, held around 38% of its portfolio in buyout and venture capital funds last year, with plans to increase that share.
There are obvious and innocent reasons for this division: Large endowments may invest in larger funds, which tend to raise capital from a small number of LPs. They also often have access to networks of former students who work in the best funds.
Smaller endowments wishing to increase their allocation to alternatives would most likely have to settle for less successful or unproven managers. And these institutions may lack the knowledge and personnel necessary to appropriately manage complex and illiquid investments.
Fairness is an issue that people in the industry clearly want to see corrected. In the wake of the protests following the death of George Floyd last year, many called on major venture capitalists to provide historically black colleges and universities with access to their funds. And various managers have asked LPs advance racial equity through their allowances.
The performance disparities show how the clubby nature of LP-GP relationships can cement existing inequalities. When venture capital has a year of disruption, the richest schools get richer.