Private equity, venture capital turbocharge endowment returns

University endowments in the U.S. reaped the benefits of spectacular equity and venture capital returns during the fiscal year ended June 30.

Those with the highest private markets allocations, particularly those with mature venture capital programs, benefited even more, driving record-smashing returns exceeding 50% and 60%.

"It was an unprecedented year with unprecedented results," said Margaret Chen, global head of Cambridge Associates LLC's endowment and foundation practice in Boston."There is no question that this fiscal year was a welcome gift to institutions."

Considering the market hit bottom in March 2020, "had the low been three months prior or three after, then the returns would have been slightly different," Ms. Chen said. "Timing matters, and while the fiscal-year returns are fantastic, they were helped by when the pandemic started and when the shutdown occurred, and of course the very swift action by central banks to right the ships."

Public equities and private investments, particularly in venture capital, drove results.

For the year ended June 30, the S&P 500 returned 38.6%. While precise venture capital index data for the year ended June 30 is not yet available, the Cambridge Associates LLC U.S. Venture Capital index returned 50.1% for the year ended Dec. 31.

"The last time we saw returns like this in venture capital was in 1999," Ms. Chen said, "and there are some structural changes that contributed to this fiscal year's environment that I think helped the performance."

"One is that companies are staying private longer (due to) their need for capital, and the private markets are providing more of that capital. So that has been helpful. The second is that this market has been helpful for IPOs. Those that did go out, the market welcomed them, and that has been helpful," Ms. Chen said.

Of the 40 university endowments with more than $1 billion in assets tracked by Pensions & Investments as of Oct. 27, the median return for the year ended June 30 was 36.7%, well above the median return of 27.3% for the 96 public pension plans tracked by P&I over the same period.

Washington University in St. Louis posted the highest net return among tracked endowments at a net 65%.

The $15.3 billion endowment's extraordinary overall return was driven by its private capital and global equity portfolios.

Its private capital portfolio, which consists of buyout, distressed debt, growth equity and venture capital, returned 82%, while global public equities returned 72%.

Scott L. Wilson, chief investment officer of Washington University Investment Management Co., which oversees the endowment, said that while he and his staff have definitely built up the endowment's venture capital and growth equity portfolio since his arrival in December 2017, "It's a smaller portfolio than our peers."

"We still have a decent chunk of the portfolio, but it's overall less than half of our private exposure."

He declined to provide the endowment's allocation.

What truly contributed to the endowment taking the top spot in an extraordinary year was its public equity portfolio, particularly in emerging markets, he said.

"We have great partners on the public side, and where we can, we like to invest alongside them in their highest-conviction ideas," Mr. Wilson said. "For us, it was really emerging markets. We found really interesting ideas in investing in frontier markets and that's been a huge source of alpha for us." He declined to name the managers.

Five other universities have reported fiscal-year returns of more than 50%: Bowdoin College, Brunswick, Maine (net 57.4%, $2.7 billion in assets); Vanderbilt University, Nashville, Tenn. (net 57.1%, $10.9 billion); Duke University, Durham, N.C. (net 55.9%, $12.7 billion); Massachusetts Institute of Technology, Cambridge, Mass. (net 55.5%, $27.4 billion); and Brown University (net 51.5%, $6.9 billion).

While not all of the five universities provided asset class information, Vanderbilt disclosed an actual allocation to private capital of 35% and Brown University disclosed that its private equity asset class portfolio (with an actual allocation of 39%) returned a net 86.8%.

The five universities either declined interviews or did not respond to requests for further information.

Nolan M. Bean, head of institutional investments at Fund Evaluation Group LLC, Cincinnati, agreed the story of the fiscal year was venture capital.

"There were phenomenal, phenomenal returns out of venture capital, which I think some of that was driven by COVID and the acceleration of the adoption of technological solutions, many of which are venture-backed," he said.

Mr. Bean said that endowments with mature venture capital portfolios that performed so spectacularly now have an issue with which to contend in the future.

"They have the high-class problem of venture becoming a much larger percentage of their overall asset allocation, combined with the acceleration of fundraising cycles. A lot of folks size their commitments to any one fund, where they expect a fund every three years, but they've been coming back after 12 months," Mr. Bean said.

Kristin Reynolds, Boston-based partner and co-head of the foundations and endowments practice at NEPC LLC, echoed Mr. Bean's concerns.

"It's the exits that people are really going to be worried about," she said. "In seven to 10 years, if capital markets remain fairly liquid and fairly robust, the venture commitments today will remain in good shape."

Endowments also benefited from moving away from hedge funds, Ms. Reynolds said.

"While hedge funds posted pretty strong numbers," she said, endowments have been moving away from hedge funds ''probably for three, four, five years at this point and really adding capital to their private investments."

Ms. Reynolds said it will be interesting to see if midsized institutions — those with between $100 million and $700 million in assets — will follow the larger universities in hiking their allocations to private investments, much as they did following the 1999-2000 venture capital boom.

"Here, the point of the last year is the largest universities have been really leaning into private investments for a very long time and over the past five to seven years increasing those allocations beyond what most people would be comfortable with," Ms. Reynolds said.

"Can we (the smaller institutions) increase that? Can we follow along to what we did 20 years ago and try to catch up to the largest institutions?" Ms. Reynolds said.

All the endowments tracked by P&I were what Ms. Reynolds would consider large institutions. Private equity and venture capital were not the only success stories in their portfolios.

One example is the University of Kansas' $2.2 billion endowment, which returned a net 37.1% for the fiscal year ended June 30.

While private equity/venture capital returned 69%, a positive move toward structured credit at the height of the COVID-19 pandemic also served the endowment well, said James Clarke, senior vice president, investments, for the KU Endowment, a non-profit organization that oversees the Lawrence-based university's endowment, in an email.

"In early April 2020, we pushed capital at structured credit, specifically CLO equity," Mr. Clarke said. "We had been tracking and investing selectively pre-COVID. Somewhat by coincidence, in February 2020, we briefed our trustees that in the next credit dislocation, CLO equity would represent a compelling opportunity. As credit markets froze, we stepped in. Over its first 12 months, this position gained about 70% and has continued to post attractive rates of return."

Meanwhile, the largest of all the institutions, in terms of endowment asset size, was forced to look up at its smaller contemporaries.

Harvard University, which boasts an endowment with $53.2 billion in assets, an annual gain $11.3 billion, returned a net 33.6% for the year ended June 30, below the recorded endowment returns of most other Ivy League schools.

However, Charles A. Skorina, managing partner of the Tucson, Ariz.-based Charles A. Skorina & Co., executive recruiter for endowments, said that, given the circumstances, the Cambridge, Mass.-based university's endowment returns are "spectacular."

"Given where Narv started from five years ago, it appears as though he's done well," Mr. Skorina said, referring to Harvard Management Co. President Nirmal P. "Narv" Narvekar. "I think it's too easy to dismiss what a task he had.''

HMC oversees management of the endowment.

Mr. Skorina added that, "It's really next year when it would be fair to judge his performance, because now, it's his portfolio."

Since taking over as CEO in December 2016, Mr. Narvekar has reorganized HMC's investment strategy from a specialized approach to a generalist model in which all members of the investment team take ownership of the entire portfolio. Over the past few years, HMC has reduced its exposure to real estate, natural resources and equities, to 5%, 1% and 14%, respectively, while increasing its exposure to private equity to 34% and hedge funds to 33%. By comparison, as of June 30, 2018, the endowment's allocation to equities was 31%; hedge funds, 21%; private equity, 16%; real estate, 13%; and natural resources, 6%.

In a note to Harvard associates on Oct. 14, Mr. Narvekar wrote that finding the right level of risk for the portfolio is among HMC's top concerns. HMC even formed a "risk tolerance group" in 2018 to determine the right risk levels for the endowment.

"The level of portfolio risk is ultimately the most important and fundamental aspect of portfolio construction," Mr. Narvekar wrote, adding that while returns were strong for the latest fiscal year, "Harvard's endowment will not produce 33.6% returns each year."

"Indeed, there will inevitably be negative years, hence the importance of understanding risk tolerance," Mr. Narvekar wrote, adding that it is important that the "team, investment process/analytics, organizational structure, culture and aligned incentives provide HMC with the framework for long-term success."

Mr. Narvekar declined to be interviewed.

Michael Karris, founder, president and CIO of EndowBridge Capital LLC, said that if Harvard's endowment returns were below average, it's because Mr. Narvekar has been repositioning the portfolio, and it takes time to transition out of illiquid assets. EndowBridge is a Princeton, N.J.-based outsourced CIO provider for foundations and endowments.

"Narv has been transitioning the portfolio and endowments are such long-term investors it takes a very long time for these home runs to come to fruition, especially when it comes to venture capital," Mr. Karris said. "Venture capital was the star of the show this fiscal year. Investments made 10 years ago really paid off."

"Some of the decisions that affected Harvard's returns were made by the staff prior to Narv (joining), so hard to discern how much is based on decisions they made vs. the prior staff," Mr. Karris added.

The EndowBridge founder, who had previously worked at Columbia University Investment Management Co. when Mr. Narvekar was CEO, added that he believes that "there are two different styles of investing going on" between Harvard and Yale University. Mr. Narvekar managed Columbia University's endowment from 2002 to 2016.

While Yale appears to be consistently aiming for outsized returns, Harvard, on the other hand, "may be just trying to hedge against what happens in a downturn."

Yale's $42.3 billion endowment returned 40.2% for the fiscal year ended June 30.

"It's not clear if Harvard is aiming to achieve Yale-like returns going forward, especially if they're so mindful of risk tolerance," Mr. Karris said. "It might be safe to assume Narv is protecting the endowment for a future crash or downturn, which is similar to what he did at Columbia."