Alts hamper endowments' fiscal returns

College and university endowments chalked up single-digit positive returns for the latest fiscal year ended June 30, no thanks to private markets, which dragged down the performance of some of the largest endowments.

The period was defined by a dramatic recovery in public equities, particularly in the first half of 2023, following significant volatility arising from recessionary fears connected with inflation and the Federal Reserve's actions to raise interest rates.

The recovery led to outsized returns in public equities. For the year ended June 30, the Russell 3000 index and MSCI EAFE index returned 19% and 18.8%, respectively, far above the respective -13.9% and -17.8% for the fiscal year ended June 30, 2022.

"You could probably take the story last year and write something exactly the opposite for fiscal year 2023," said Kristin Reynolds, partner and co-head of the foundations and endowments practice at NEPC.

The story of fiscal year 2022 was endowments that had more exposure to public equities underperformed those with more exposure to private markets, Reynolds said.

During that period, endowments with large, robust private investment programs benefited from valuations set during the fiscal year ended June 30, 2021, which saw record-setting double-digit returns.

For this latest fiscal year, however, private investment returns suffered from adjusted valuations from the miserable public market experience of fiscal year 2022, Reynolds said.

“Because private equity is priced on a lag and is lagged also in client portfolio returns, what we saw was an unwinding of the valuations of 2023 in private markets and being priced more closely with the experience of public markets a year earlier,” Reynolds said.

Those endowments with large allocations to private equity saw significant underperformance, she added.“And those that had leaned more into venture capital rather than buyout underperformed even more,” she said.

Among the 37 college and university endowments with $1 billion or more in assets whose most recent fiscal-year returns have been tracked by Pensions & Investments as of Nov. 1, the median return was 4.4%.

That was below the median return of 7.6% among the 65 public pension funds tracked by P&I for the period.

At the same time, all plans including corporate and public pension funds and endowments and foundations in the Wilshire Trust Universe Comparison Service posted a median return of 8.1% for the year ended June 30.

Harvard University, the largest endowment, returned 2.9%, above its prior fiscal year return of -1.8%.

Despite its positive return, Harvard’s portfolio declined to $50.7 billion from $50.9 billion the year before, due to the $2.2 billion the fund contributed to the university’s operating budget for the period.

N.P. “Narv” Narvekar, CEO of Harvard Management Co., which oversees the Cambridge, Mass.-based university’s investments, in his annual letter to the Harvard community said: “Fiscal year 2023 was a year of generally muted returns for asset classes outside of public equities.”

He noted the endowment’s limited allocation of 11% to public equity meant it could take little advantage of strong public equity performance. He also cited the issues with private market valuations.

“In FY22 private managers did not reduce the value of their investments in a manner consistent with declining public equity markets,” said Narekar in the university’s 2023 financial report. “Accordingly, those private asset managers did not subsequently increase the value of their investments in the context of rising public equity markets in FY23. Given the continued slowdown in exits and financing rounds over the last year, it will likely take more time for private valuations to fully reflect current market conditions.”

As of June 30, the endowment’s actual allocation was 39% private equity, 31% hedge funds, 6% bonds/Treasury inflation-protected securities, 5% each cash/other and real estate, 2% other real assets and 1% natural resources.

Yale University, with the second-largest endowment at $40.7 billion, on Oct. 10 reported a net return of 1.8% for the fiscal year ended June 30. The university also noted its annualized net return over the 10 years ended June 30 was 10.9%, but did not cite specific asset classes as drivers for its endowment performance.

In its 2023 financial report, Yale reported a total of $10 billion in venture capital assets, which was down from $11 billion the year before. Leveraged buyouts, meanwhile, increased to $10 billion from $8.9 billion the year before.

Yale did not specify which asset pools were represented by the investments, which could be allocated to the endowment or the university’s $2 billion pension fund.

Margaret Chen, global head of Cambridge Associates’ endowment and foundation practice, said private investments were indeed a performance challenge and there has been significant dispersion in returns between the large and smaller endowments.

“That’s something you see particularly on the largest endowments because they tend to have the highest exposure to private investments,” said Chen, “and I think you see that from the universities that have reported.”

Among the 11 endowments with $10 billion or more in assets, eight saw their returns for the year fall below the P&I universe’s median return of 4.4%.

The exceptions were Ann-Arbor based University of Michigan’s $17.9 billion endowment and the $13.6 billion endowment of Columbia University, New York, which posted net returns of 5.2% and 4.7%, respectively, for the fiscal year ended June 30. Stanford University’s $40.9 billion endowment matched the median.The endowment’s portfolio “benefited from strong public markets performance in the United States in fiscal 2023, and was also bolstered by hedge fund outperformance relative to benchmarks,” Kim Lew, president and CEO of the Columbia University Investment Management Co., said in an Oct. 17 news release.

The top performer tracked by P&I was the $1.7 billion University of Nebraska Foundation, Lincoln, which posted a net return of 9.8% for the fiscal year ended June 30.

Brian Neale, chief investment officer, said in an email that the foundation saw “several managers, particularly those with growth mandates, perform exceptionally well. A multiasset manager we added in 2021 exceeded the benchmark by nearly 200 basis points and produced an excellent absolute return as well.”

Neale said the foundation does not disclose the names of its managers.

“Results were also influenced by what we didn’t own — specifically core bonds,” Neale said. “Our liquidity profile remains in excellent condition, and as a result, we removed core bonds from the portfolio two years ago. Avoiding those losses while pursuing alternative short-duration opportunities (i.e. cash earning 5%) has been accretive to our returns in general. We’ve not eschewed core bonds permanently, however, and maintain flexibility within our policies to add when we believe it will be productive to do so.”

As of June 30, the endowment’s actual allocation was 57.7% public equities, 23.8% private investments, 7.7% real assets, 5.9% multiasset credit, 4% transition to equity and private investments, 0.8% cash/fixed income and 0.1% hedge funds.

The second-best performer was the Urbana-based University of Illinois Foundation’s $2.6 billion endowment pool, which posted a preliminary net return of 9% for the fiscal year ended June 30.

The foundation did not provide specific asset class returns, but in a webcast of the foundation’s annual business meeting on Oct. 20, CIO Travis Shore said that “our interest rate exposure is down a lot, our equity exposure is down a little bit, and we’re carrying much more cash in the portfolio to keep a lower risk profile so we can be opportunistic as we have opportunities in the next year and a half.”Shore could not be immediately reached for further information. According to the webcast, the foundation’s long-term targets are 61% equities, 14% credit, 6% each cash and real estate, 5% interest rates, and 4% each commodities and hedged exposure.

Looking to the future, Cambridge Associates’ Chen said that endowment investment offices will now be focusing on finding opportunities in active public equities management following more than a decade of passive strategies outperforming active strategies.

“This has been a year where there have been selective pockets of outperformance by active managers with the exception of the seven tech stocks that have driven the S&P 500,” Chen said.

While the rest of the market outside those megastocks have performed middlingly, Chen said that gives a greater opportunity set for active managers, and colleges and universities will now put in extra effort in finding those managers.

“In a sustained period of market uncertainty, it’s driving colleges and universities to do what I call ‘turning over stones’ to find high-performing managers,” said Chen.” It is a real opportunity to enhance future returns and that has not been the case for the last decade or so.”

Chen also said there is a growing emphasis on dealing with the ongoing struggle between the long-term investing approach and taking advantage of near-term market opportunities.

“You have to have exposure to growth assets, but it’s also acknowledging the near-term market realities, and what I’m alluding to is the barbell between long-term growth assets, for example private investments, or even growth equity in public markets, and cash and short-term fixed income because the yields are so high on a relative basis,” Chen said. “That barbell leads a college and university to think about what is the right positioning ... to evolve and move quickly if market opportunities do arrive.”

“This is a challenging market environment today,” said Chen, “and colleges and universities need to be laser-focused on achieving that 5% real return, which is easier with the higher yields we are seeing, but also acknowledging these yields aren’t going to last forever.”

Those 5% yields in fixed income are also leading endowments to begin discussing how another asset class does or does not fit into their asset allocations, said Nolan Bean, chief investment officer and head of portfolio management at Fund Evaluation Group.

“I would say that one area that anecdotally there’s more conversation on that I recall in the 30 years I’ve been doing this, is hedge funds,” Bean said. “(Clients are asking) if we get 5% to 6% on bonds, do we really need hedge funds?”

Bean said clients are asking about the role of hedge funds, and what their expectations should be in a higher interest rate environment.