How university endowments invest in the capital markets

University Institutions of higher learning have a long history of leveraging financial donations to support professorships, research and boost operational revenue. The first recorded endowment traces its origins all the way back to ancient Rome when philosopher Marcus Aurelius established academic chairs for the study of philosophy across Athens in A.D. 176.

In the modern era, however, college endowments operate a bit differently. While their financial frameworks  budget for university operations, considerable funds are managed by teams of finance professionals and invested in the stock market through private equity portfolios. 

In 2021, university endowments in the US made up a majority of these funds, maintained at some of the wealthiest institutions. The top five Ivy League colleges posted a combined value of roughly $213 billion, according to the 2021 NACUBO-TIAA Study of Endowments.

But what is an academic endowment, and how has its meaning and significance evolved over time? Here we’ll take a closer look at the history of these funds, their investment frameworks and how equity generated from their portfolios serves universities.

What is a university endowment?

A university endowment is formed when one or more donors gift a large sum of money or another economic asset to generate financial support for a nonprofit institution. Monetary donations are added to a diversified fund portfolio and invested in various asset classes, such as fixed income securities, bonds, hedge funds, real estate and more. The bulk of investment returns are held in perpetuity to ensure the institution’s autonomy and survival.

Alongside pension funds, sovereign wealth funds, and insurance companies, university endowments are categorized as institutional investors that manage large-scale assets with long-term investment horizons.

A brief history of endowments

Following the establishment of chairs in Athens, the concept of endowing professorships formally took hold in 1502. That year, Cambridge and Oxford universities created their first academic chairs conferred by the Countess of Richmond, who subsidized study of philosophy, economy, Latin and other academic disciplines.

In the US though, the concept of endowments didn’t gain prominence until the end of the 19th century, as a handful of private universities recognized their autonomy and survival depended on adequate financial capital. Universities that expanded their financial safety net at that time, underwritten by the philanthropy of Leland Stanford, Andrew Carnegie, John D. Rockefeller and other millionaires, manage some of the wealthiest endowments in the US today.

Types of academic endowments

Restricted endowments
Restricted endowments are created by a donor to exist in perpetuity. The principal amount is never utilized, while gains from invested assets are tapped based on donor stipulations. These endowments are intended to fund specific areas, such as faculty salaries.

Unrestricted endowments
Funds in unrestricted endowments can be spent or saved at the discretion of the recipient and are not time-bound or subject to the donor’s wishes. They are usually started by the institutions that benefit from using unrestricted endowments.

Term endowments
Term endowments stipulate that the principal can be spent after a particular occasion or period has passed.

A quasi-endowment is used to fund a specific purpose. The principal is retained while the earnings are spent in alignment with the wishes of the donor.

How do endowments support universities?

The principal of the endowment or the “corpus”, is not spent—rather, a percentage of annual returns, based on the donor contract or financial agreement, are budgeted for operations, such as tuition, financial aid, fellowships, research, campus programs and charitable donations.

What is the endowment model?

The late David Swenson, CIO of Yale’s endowment from 1985 until 2020, and Dean Takahashi, Senior Director at Yale University, pioneered the “Yale Model” of modern-day endowment investing.

In managing Yale’s endowment, Swenson invested 75% of the university’s $1 billion portfolio in stocks, bonds and cash. Today, the $30 billion endowment is one of the nation’s largest, second only to Harvard’s endowment.

This methodology revolutionized investing, which increased exposure to alternative assets such as private equity, hedge funds and real estate. Although not always successful, many endowments and foundations that adhere to the David Swenson model have boosted their returns through alternative asset allocations, with private equity bets and hedge funds playing a primary role in the portfolio.

Who manages academic endowments?

Academic endowments of $1 billion or more are run by university investment offices and led by a chief investment officer (CIO) who manages assets, daily operations and liaises with the board of trustees on risk mitigation and investment strategy. The CIO also hires a team of external investment fund managers who provide oversight on each portion of the endowment, advising on how and where to invest. These managers, who are either individuals or represent a firm, buy and sell market shares in a variety of asset classes and monitor fund performance.

How did endowments perform in 2021?

The stock market boom ushered in enormous returns for the fiscal years 2020 and 2021, which led the wealthiest university endowments to flourish. According to an annual survey conducted by TIAA and the National Association of College and University Business Officers (NACUBO), the average college endowment returned 30.6% in fiscal year 2021. And the biggest endowments posted an average of 50% returns during that period for their private equity and venture investments.

University endowment quick facts

A university endowment is the aggregate of several donations into a single investment fund—in this way, academic endowments operate similarly to mutual funds

With the exception of specific cases, “invading” an endowment or breaking its terms for a restricted purpose, such as paying off debt, is uncommon

US tax code requires endowments to spend up to 5% of their annual principal on operational revenue

An Investment Policy Statement (IPS) outlines donor constraints and policies on how the university can invest and use the donation and codifies the institutional investor’s objectives

The “payout” is the endowments quarterly distribution for operational revenue, with percentage amount decided on by the board of trustees in alignment with state regulations

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