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Endowments

Endowments get needed bounce but cautioned to stay nimble

Heather Myers sees manager selection as a big part of the reason behind the gains.

Strong equity markets and smart asset allocation helped U.S. endowments recover from what was a dismal fiscal 2016.

But industry observers noted investment teams must remain vigilant if they want to maintain those strong returns. All 43 funds tracked by Pensions & Investments had positive returns for the fiscal year ended June 30, with all but two — Harvard University and University of Minnesota — posting double digits.

"It was a good year. They've had a couple of struggling years, so they needed a good year," said Heather Myers, a partner, non-profit practice leader at Aon Hewitt Investment Consulting, Boston.

Ms. Myers noted smart asset allocation and strong equity markets were major drivers of performance for endowments in fiscal year 2017.

Those universities that had global and/or emerging markets equities did well, she said; even some of the riskier fixed income strategies were strong. But it wasn't all just asset allocation. Manager selection also played a role well this past fiscal year. "All those absolutely contributed," Ms. Myers said.

Kenneth Shimberg, U.S. endowment and foundations chief investment officer for outsourced CIO services at Mercer Investments, Boston, agreed. "U.S. endowments and foundations had a very strong fiscal year, one of the strongest in recent years as risk assets had tremendous performance," he said.

Defensive assets had a weaker year, said Mr. Shimberg. The bond market was marginally down, but because endowment portfolios tend to be light on traditional fixed income, this wasn't much of an issue. "It was a year when traditional long only equities were the driver of returns," said he said.

One-year returns for fiscal 2017 ranged from 18.8% for the $1.9 billion endowment of Grinnell College, Grinnell, Iowa, to 8.1% for Harvard's $37.1 billion endowment. By contrast, the returns of more than 80% of the 31 funds tracked by P&I were negative for the fiscal year ended June 30, 2016, ranging from 3.4% to -3.4%. (See P&I's universe of ​ endowments and their returns at www.pionline.com/endowments.)

Although an exact figure was not immediately available, Grinnell's endowment outperformed its performance benchmark. By asset class, most returns were in the double digits. Distressed debt returned 27.4%; public equities, 25.2%; hedge funds, 19.5%; private equity, 18.5%; growth equity, 17.9%; venture capital, 9.7%; and real assets, 8.5%.

The average 12-month return for the large U.S. endowments in P&I's universe as of June 30 was 13.2%, vs. -1% for the prior year. The median return was 13.4% this year.

The Wilshire Trust Universe Comparison Service reported that the one-, five- and 10-year average returns for all endowments were 11.5%, 7.7% and 5%, respectively. Meanwhile, TUCS reported that the one-, five- and 10-year average returns for endowments with more than $500 million were 13.6%, 8.7% and 5.2%, respectively.

Strong equity markets

"Equity markets were very strong in fiscal year 2017," said Mark Brubaker, Pittsburgh-based managing director and head of Wilshire Consulting's outsourced CIO business. "Other areas where endowments have been allocating assets, such as private credit, also did well. High yield was up almost 13%. So, a lot of asset classes were up double digits for the year."

The 435 endowments and foundations tracked by consultant Cambridge Associates Inc., Boston, had an average return of 12.8% for the year ended June 30, compared to an average of -2.4% for the prior year.

"Returns were a role reversal of fiscal year 2016," said Margaret Chen, managing director and head of Cambridge Associates' OCIO business. "But because the returns were so positive, it makes it easy to have a short memory about what happened last year, and it's worth pausing to remember."

Ms. Chen said this year, three factors helped: equity diversification, active management and the lack of geopolitical events on markets.

Following Grinnell College, other schools to see the largest one-year returns were the $129 million University of Houston Foundation, with 16.06%, and the $1.5 billion University of Arkansas Foundation and $2.7 billion Michigan State University endowment, both at 15.4%. University of Houston Foundation's endowment is separate from the University of Houston System's $572 million endowment.

Of the schools that disclosed 10-year annualized returns, the big winners were the University of Houston, at 7.74%; and the $10 billion Columbia University and $8.62 billion University of Virginia endowments, both at 7.3%.

Despite achieving a positive return this year after posting a return of -2% during the 2016 fiscal year, Harvard's endowment — the largest in the country — posted the lowest return among the schools tracked by P&I.

Nirmal P. "Narv" Narvekar, president and CEO of Harvard Management Co., which oversees the endowment for the Cambridge, Mass.-based university, called the performance "disappointing and not where it needs to be" in its annual report.

Mr. Narvekar added, however, that with the changes he has made and plans to make with HMC, he is confident the management company "will be in a far better position" moving forward.

Since taking over as CEO in December, Mr. Narvekar has reorganized the company, reducing staff as part of a plan to change its investment strategy from a specialized or "silo" approach to a generalist investment model in which all members of the investment team take ownership of the entire portfolio.

As a result, HMC has largely ended internal management of public market assets as of June 30. It also shut down its relative value and internally managed equity platforms.

Don't be complacent

Although sources agreed endowments had a decidedly good year, they also warned against complacency.

Ms. Myers said that going forward, endowments need to make sure "to continue to be vigilant in seeking opportunities."

"We believe it will be challenging going forward," she said, adding that endowments need to seek diversified portfolios.

Mr. Brubaker agreed, saying Wilshire anticipates a low-return environment. "And that's been the big challenge for endowments. How do you generate the returns you need to accommodate the spending?" he asked.

Mercer's Mr. Shimberg also noted the headwinds that endowments will face going forward will be "identifying attractive assets."

Another big headwind university endowments could face is the recently proposed tax bill.

Under the House Republican tax reform plan passed by the Ways and Means Committee Nov. 9 and the bill introduced in the Senate the same day, some university endowments would be required to pay a 1.4% tax on investment income. The tax applies to private schools with assets of more than $250,000 per student and exempts small schools. Public colleges and universities aren't included.

Private endowments that pay executive compensation above $1 million also would be required to pay a 20% excise tax on it.

Thomas Conroy, spokesman for Yale University, New Haven, Conn., said in an email that the tax bill "would impose a permanent tax on Yale's resources" and that he found it "disappointing that the legislation relies so heavily on colleges and universities … to raise revenue to enable tax cuts."

"We hope that the House of Representatives will reconsider these proposals," Mr. Conroy added.

Yale's $27.2 billion endowment — the second largest after Harvard — returned 11.3% for the year ended June 30, vs. 3.4% for the year-earlier period.

Opposition to tax proposal

Representatives from other schools also have spoken out against the tax proposal as it is currently written.

Daniel Day, spokesman for Princeton University, said in a statement the Princeton, N.J.-based school, which has a $23.8 billion endowment, is "strongly opposed" to the provision of the 1.4% excise tax. "Endowments are not piggy banks to be drawn on only occasionally. They have to generate payout every year and keep pace with rising costs, like an annuity for someone who will live in perpetuity," he added.

Ricardo Vazquez, spokesman for the University of California, Oakland, $10.8 billion, also said the university opposes "the inclusion of provisions in tax reform proposals that negatively impact the tax treatment of endowments." He added: "The creation of new excise tax liabilities on university endowments sets a bad precedent given the critical role endowments play in helping colleges and universities provide financial aid to their students as well as support for faculty."