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Head of the class

Large endowments grab healthy portfolio gains

Yale leads the pack, followed by Texas, California schools

Yale University’s Harkness Hall

A glimpse into the secretive world of large U.S endowment funds reveals strong, benchmark- and index-topping returns of their hedge fund portfolios.

Just six of the 25 largest U.S. endowments provided publicly available, detailed financial information for June 30, the fiscal year-end for many endowments. In examining that information, Pensions & Investments found the six had a collective $89 billion in assets as of June 30, of which $18.4 billion was in hedge funds.

Harvard University, Cambridge, Mass., had the most total endowment assets — $32 billion — but the smallest percentage hedge fund allocation, 16% of assets.

University of Virginia, Charlottesville, with $5.3 billion in endowment assets, had the highest hedge fund allocation — 30.4%.

Of the four that report aggregated hedge fund portfolios, New Haven, Conn.-based Yale's $3.3 billion portfolio performed the best, with a 12.7% return for the fiscal year ended June 30. Yale's endowment had $19.9 billion in assets as of June 30.

Coming in a close second was the Austin-based University of Texas System endowment's $5.9 billion hedge fund portfolio, with a 12.5% return. Third, at 12.3%, was the $1.6 billion hedge fund pool of the University of California, Oakland. The endowment had total assets of $6.7 billion. Harvard's $5.2 billion hedge fund portfolio returned 11.6% for the year.

The $4.9 billion endowment of Cornell University, Ithaca, N.Y., and the UVA endowment report returns separately for the multiple hedge fund portfolios within their funds.

(For comparison, the HFRI Fund Weighted Composite index returned 11.5% and the HFRI Fund of Funds Composite index returned 6.7% for the 12 months ended June 30, while the Standard & Poor's 500 index returned 30.7% and the Morgan Stanley (MS) Capital International World index, 31.2%. The Barclays Capital Aggregate Bond index returned 3.9% for the same period.)

The University of California endowment's hedge fund return trounced its internal benchmark by 980 basis points for the year ended June 30; the University of Texas topped its benchmark by 600 basis points; and Harvard, by 200 basis points. Yale's investment office doesn't reveal the benchmark applied to its hedge fund portfolio.

The University of Texas Investment Management Co., Austin, manages a total of $7.5 billion in hedge funds when non-endowment investments managed for the UT system are included, Bruce Zimmerman, UTIMCO's CEO and chief investment officer, said in an interview.

Highly confident

Mr. Zimmerman said the Texas university system has been investing in hedge funds for more than 10 years and investment staff there maintain “high confidence in our hedge fund” portfolio, noting UTIMCO was one of the earliest investors — and remains invested — in many of the industry's largest and best hedge fund managers. The endowment's portfolio includes about 40 hedge funds managing a wide variety of strategies, including long/short equity, distressed securities, global macro and relative value.

While there aren't specific plans to increase the endowment's hedge fund allocation, which totaled 29.3% of total assets as of June 30, Mr. Zimmerman said as “an investor of choice,” UTIMCO investment staffers get an early look at “new, promising hedge funds” and actively review those opportunities. The UT endowment had $20.1 billion in total assets as of June 30.

At Cornell, the endowment's $540 million hedged equity portfolio had a one-year return of 8%, while its $765 million marketable alternatives portfolio returned 7.7%. The return of the hedged equity portfolio, managed in global and U.S. long/short equity strategies, trailed its internal benchmark by 580 basis points for the period. By contrast, the return of Cornell's marketable alternatives portfolio, which includes event-driven, global macro, relative value and multistrategy hedge fund approaches, beat its benchmark by 240 basis points.

UVA's $1.2 billion long/short equity portfolio returned 16.3% for the year ended June 30, while the much smaller $438 million absolute-return portfolio returned 7.5%. Internal hedge fund portfolio benchmarks were not provided.

The University of Virginia Investment Management Co. manages the institution's endowment and operating funds. Staffers prefer to report the performance of hedge funds with similar investment characteristics rather than aggregate returns, Lawrence E. Kochard, CEO and CIO of the money management firm, said in an interview.

In fact, “our use of hedge funds is really part of the way we view all of our investments; it's very manager-specific, rather than specific to the type of vehicle the strategy is offered in,” Mr. Kochard said.

The long/short equity portfolio, for example, has more beta exposure to equity markets through “unconstrained security selection,” while the absolute-return strategy includes investments “with low correlations to the public equity markets ... (that) generate returns primarily from manager skill than exposure to any single asset class,” according to UVIMCO's 2010-2011 annual report.

The report also noted that UVIMCO's long/short equity allocation was close to 50% of endowment assets in 2003, but was gradually reduced between 2004 and 2008, with assets being moved into private and public equity, and commodity strategies. After the 2008 financial crisis, the long/short equity weighting was further reduced and assets reinvested in bonds and cash to reach its 22% allocation as of June 30.

Officials at the other schools declined comment or did not return calls.

Sophisticated group

Members of this elite group of endowments are among the most sophisticated, earliest investors in hedge funds. They began to “ratchet up their hedge fund investments in 2000 and 2001,” said David Druley, managing director at consultant Cambridge Associates LLC, Boston.

The average hedge fund allocation for these six endowments was 22%, significantly higher than the 20% average allocation emerging from preliminary data being collected by Commonfund Institute and the National Association of College and University Business Officers for their jointly sponsored annual endowment survey, said William F. Jarvis, managing director at Commonfund, Wilton, Conn.

Mr. Druley said the largest U.S. endowments, like the six in P&I's universe, largely reached that 20% industry average by 2003 and have generally maintained that level, because “over the past five or so years, hedge funds did their job, providing endowments with returns with less risk than equities. Over the trailing five years, equity returns were flat while hedge fund returns were significantly better.”

Still, many endowments are constantly monitoring and upgrading their hedge fund managers as fund performance suffers or funds close as part of their natural life cycle or “new opportunity sets appear, such as distressed credit in 2009,” Mr. Druley said.

He added that “there definitely are flows between funds within these endowments' mature hedge fund portfolios, and investors are becoming much more flexible about issues like moderate lockups, while remaining sensitive to liquidity issues after some had problems after the 2008 financial crisis.”