Why have universities diversified into hedge funds and other "alternative assets"?
The inclusion of the broader range of assets in today's endowments derives from the increasing sophistication of money managers and the broader range of investment vehicles that are now available. The movement to include diverse investments such as hedge funds, commodities, and private equity was led by David Swenson, who has managed Yale's endowment since the early Eighties and achieved extraordinary success. Until recently, anyway.
The expansion into a broad range of investments was an effort to improve average rates of return without increasing risk. And, in spite of press about failed investments by some schools in these alternative assets, to date university endowments (including Cornell's) have not declined by as much as broad stock market indices. How recent history will affect the allocation of endowment assets at major universities is an open question, but it is important to emphasize a fundamental rule about investments: past performance matters only to the extent that it is believed to be an indicator of future performance, given perceptions of market conditions.
Who manages the endowment?
In spite of press about failed investments in alternative assets by some schools, to date university endowments (including Cornell's) have not declined by as much as broad stock market indices.At Cornell, fiduciary responsibility falls to the Board of Trustees, and they take this responsibility seriously. The Investment Committee, of which I am not a member, makes decisions on how to allocate the portfolio across broad asset classes and periodically rebalances it. This rebalancing takes into account changes in the portfolio due to differences in past performance as well as the members' judgment on the likely future returns of different assets.
In addition to worrying about returns, the Investment Committee must consider the liquidity of the portfolio. Liquidity is important to help the University meet its cash-flow needs, and during the financial meltdown these were exacerbated because a decline in values can lead to pressure to sell assets for short-term reasons—such as to generate cash for endowment payout—even if such sales do not make sense over the long term. In addition, some asset classes may require commitments to make additional investments in those areas and put limitations on the University's ability to rapidly withdraw funds.
The Investment Committee has been working virtually nonstop to reallocate the Cornell portfolio in a way that makes sense for the long run and provides necessary cash flow. Some universities, including Harvard and Princeton, have decided to use substantial amounts of taxable long-term debt to ensure liquidity and protect themselves from having to sell off assets that they believe will generate returns that exceed the borrowing costs over time. Cornell recently decided to pursue a similar policy, albeit on a smaller scale.
While the Investment Committee allocates the endowment across asset categories, they do not actually manage the money. Most of Cornell's assets are handled by external investment fund managers. The Office of University Investments, which reports to the Investment Committee, allocates assets within each class to a number of external managers. Within a class, high-performing individuals receive more assets to manage, while those who are low-performing will see a cutback.
In your opinion, how will the current financial crisis affect the future of endowments?
Selective private colleges and universities are likely to find that they have reached a turning point and will not have the flexibility to keep increasing tuition at rates substantially higher than the growth of family income, as they have in the past. Thus, developing increased flows of philanthropy to fund their current operations, support capital projects, and build their endowments is likely to be increasingly important if they are to continue to prosper. While many institutions, including Cornell, are fortunate to have loyal alumni, it is likely that increased philanthropy will be contingent upon demonstrating to potential donors that these institutions are good stewards of their funds and that they use them wisely. That will be vital if university endowments are going to recover value and grow.
CORNELL ENDOWMENT UPDATE
In January, President David Skorton reported that Cornell's long-term investments (LTI)— which include the endowment and two smaller funds—had declined by 27 percent between June 30 and December 31, 2008. The LTI was valued at $6.1 billion on June 30, so this decline represented a loss of about $1.6 billion. In March, a further decline was noted in the prospectus for the University's sale of $305 million in tax-exempt bonds for capital projects. It stated: "As of February 28, 2009, the estimated fair value of the LTI has declined by approximately 31 percent from June 30, 2008. This estimate is unaudited and does not reflect updated real estate and private equity valuations for which valuations are provided on a quarterly basis. Approximately 62.4 percent of the LTI is valued monthly with the remaining 37.6 percent valued as of September 30, 2008."
The additional 4 percent brings the total decline to about $1.9 billion since June 30, 2008, yielding an LTI value of approximately $4.2 billion. In addition, the prospectus showed a significant shift in the allocation of the LTI from the percentages shown in the graph on page 46. As of March 13, 2009, Cornell's investment assets, at fair value, were allocated as follows:
| Cash and cash equivalents | 18% |
| Private equities | 18% |
| Real assets | 18% |
| Absolute return | 13% |
| Hedged equities | 13% |
| Fixed income | 11% |
| Domestic equities | 5% |
| Foreign equities | 4% |
| Other | 0% |
Given the nationwide drop in real estate values, a further decline in the value of the real assets is likely, and the value of the University's private equity holdings is similarly in question.
Moving forward, Cornell's investment strategy will be "cautious and defensive," says James Walsh, the University's chief investment officer. "The endowment is fundamentally a long-term investor, but [we have] to be conscious of contemporary market conditions." He says that his office and the Investment Committee of the Board of Trustees are "actively pursuing new investment opportunities to build for a strong recovery in performance over the coming years."
— Jim Roberts '71
For more about Cornell's endowment, its performance, and the endowment spending policy, consult Cornell's 2007-08 Financial Plan: Year-End Variance Report (November 2008), pages 15-18, available online at dpb.cornell.edu . For more general information on endowments and endowment policies, see Chapter 3 of Tuition Rising: Why College Costs So Much (Harvard University Press) by Ronald Ehrenberg.