Endowments are not immune to the challenges facing other institutional investors in a low yielding, volatile market. Even the high-yield haven of alternatives is losing its shine, with the illiquidity premium on offer diminishing as money continues to flood into the asset class, arguably driving down returns.
The days of double-digit real returns for endowments, therefore, seem like a thing of the past, even for those usually known for their investing prowess. Certainly, many endowments are experiencing falling returns: Bloomberg reported that university endowment returns for the first six months of fiscal 2016 showed losses of as much as 6.1%.
For endowments, this is a significant problem. Given that colleges typically spend between 4% and 5% of their endowment annually — on scholarships, hiring professors and upgrading facilities, among other areas — annual returns need to exceed this to avoid cutting into the supporting endowment's principal.
At the same time, the U.S. faces an educational crisis. Tuition costs have increased in real terms to such an extent that they might be reaching a ceiling of resistance. Without continual tuition increases, endowment spending might have to be relied upon to plug any funding gaps. And if the economy sours, a double whammy of a drop-off in donations can be expected.
The upshot is that the real value of many endowments has been shrinking in recent years — therefore failing to deliver on the promise of maintaining or increasing the real value of the pot for future generations.
What can be done in the face of these challenges?
A significant step in the right direction would be for endowments to improve how they define and manage portfolio risk over time — and how they use this information to inform asset allocation and manager selection decisions.