February 2, 2017

New Report Finds College Endowments Underperforming, Divestment Riskier Than Ever

According to a newly released report by the National Association of College and University Business Officers (NABUCO), hundreds of U.S. college endowments suffered financial losses in FY 2016 despite an overall strong performance from both the S&P 500 and the Dow Jones industrial average. The annual report also finds that, despite suffering lower returns, these endowments are increasingly being relied upon to support day to day college activities.

Given this increased reliance on University endowment funding the question is why, with endowments already struggling, would universities allow their investment decisions to be increasingly influenced by politics rather than sound investment policy. This shift away from a return oriented investment policy is most evident in the increasing amount of endowments that are being pressured to sell off their investments in fossil fuels, despite the fact that these investments have historically been better performing and are an integral part of most passive indices – the exact type of low fee indices that many investors are turning to.

According to the new report on 800 participating schools, endowments lost an average of 1.9 percent for FY 2016, a drop from the 2.4 percent positive return observed in FY 2015. Despite this drop, the study found 74 percent of participants increased the endowment dollars spent on supporting the schools’ academic mission by an average of 8.1 percent. While increased spending on student life and research is no doubt a good thing, lowered endowment returns threaten a school’s ability to secure and guarantee this type of financial support in the long-term. According to NACUBO President and CEO John D. Walda:

“These substantial increases in spending from endowments demonstrate the deep commitment colleges and universities have to student access and success. Nonetheless, this year’s results are cause for concern. Continued below-average investment returns will undoubtedly make it much more difficult for colleges and universities to support their missions in the future.”

So just why did universities under-perform as the S&P made substantial gains and the Dow ended up posting its best annual gain in three years?

According to the Associated Press and Financial Times, this falloff occurred for a few reasons, including market volatility, poor performance of stocks outside the U.S., and – for wealthier universities – investments in “alternative strategies such as hedge funds, which on average led to losses.” Investments in these types of alternative funds impose higher management fees for universities and, in turn, carry a heavy weight when they underperform as they did in 2016.

Universities like Harvard are looking to move away from these funds, in large part because of the management fees they impose – not unlike the management fees divestment can impose to keep a fund within the changing definition of “fossil-free.”  According to Harvard Management Company’s new endowment chief N.P. “Narv” Narvekar in the Wall Street Journal, “We can no longer justify the organizational complexity and resources necessary to support the investing activities of these portfolios,” referring to hedge funds.

Investments in energy and natural resources also impacted market losses over the short term due to a dip in commodity prices, a fact often manipulated by divestment activists as a reason to sell. Yet selling at the low is not wise for any investor, and especially not when energy stocks seem poised for a rebound. As divestment activist Naomi Klein herself explained in 2015, “Fossil fuel stocks aren’t performing very well right now. So opponents {of divestment} have just lost their best argument. They won’t lose it for long.”

In fact, fortunately for the pensioners and students these endowments support, the S&P Energy was the best performing index in 2016, rising more than 25 percent with room to move higher in days ahead. Divesting in the current environment would deny these endowments the potential for substantial gains while causing an actual increase in costs to construct a portfolio without a fossil fuel component.

This reasoning is exactly why large endowments have rejected divestment time and again. Columbia University’s Advisory Committee on Socially Responsible Investing said it would be mere “symbolic speech” while Harvard President Drew Faust stated, “35 percent of our operating budget comes from the endowment. That is why people gave their funds to create the endowment. It should not be used as a weapon to exert pressure on one group or another.” The NACUBO study still finds these two universities were hit hard by market forces and alternative fund fees, but it is safe to say divestment would only hinder their future financial stability by imposing more fees and diversification losses moving forward.

Rejections from top-tier schools also echo the findings of the report’s authors who believe administrators must take prudent and fiscally responsible steps when considering endowment investment policies. As William F. Jarvis, Executive Director of Commonfund Institute, noted:

“At the governance level, the duty of boards and investment committees to balance current and longer-term demands, which is fundamental to the goal of maintaining equity among present and future generations of students, will be even more important in the next few years.”

As the Financial Times states, “university finance is becoming a political issue. Many academic bodies are restive about the fees they are paying.” Symbolic policies like fossil fuel divestment—which have been proven to lower university endowment returns overtime and impose substantial managements costs —stand in stark contradiction to the role and mission of a school’s endowment.