Page 1 of 3

When Walter Burke took over as chairman of Denison University’s investment committee in January 2009, the financial markets were in free fall. Even before his first board meeting, Burke huddled with committee members to make sense of the devastation suffered by the school’s endowment, which had dropped in value from $693 million at the end of 2007 to $536 million just 12 months later. “We decided the plan was to hunker down and focus on shoring up liquidity,” Burke says.

Unlike most university endowment committee chairmen — typically, alumni with financial or business backgrounds — Burke is a clinical psychologist and has spent most of his career as a professor in the division of psychiatry at Northwestern University’s Feinberg School of Medicine in Chicago. Given the market devastation in January 2009, “I thought that it might make sense to have a psychologist in the chair position,” jokes Burke, a member of the Denison class of 1971 and a trustee since 1997.

It was no joke when Denison’s return came in at a dismal –19.6 percent for the academic fiscal year ended June 30, 2009. Yet the small, Granville, Ohio–based liberal arts school — with just 2,185 undergraduates — emerged from the market meltdown in better shape than Harvard University, whose once-$36.9 billion endowment lost 27.3 percent, or Yale University, which saw its $22.9 billion fund fall by 24.6 percent. Even more unexpected: Tiny Denison continued to outperform Harvard, Yale and many of the U.S.’s largest educational endowments over the next four years.

Denison is not alone. A select group of 20 midsize endowments with $500 million to $1 billion in assets schooled their larger peers from June 2007 through June 2012. Annualized returns for the high performers ranged from 1.86 percent to 5.36 percent, besting both Harvard (up 1.24 percent a year) and Yale (up 1.83 percent). The midsize stars outshone the 1.7 percent median return for endowments with more than $1 billion in assets, according to the Washington-based National Association of College and University Business Officers (Nacubo).

At first glance, it is easy to dismiss the outperformance of midsize endowments during the fateful 2008–’09 fiscal year as the result of being in the right place — that is, the right asset classes — at the right time. Entering the financial crisis, endowments with $500 million to $1 billion in assets had, on average, more money in fixed income and less in private equity, hedge funds and other illiquid alternatives than their larger brethren did, according to Nacubo. For big endowments“2008–2009 was a disaster,” says André Perold, co-founder and CIO of Boston-based HighVista Strategies, which manages $3.6 billion in endowment assets. Perold, an emeritus professor of finance and banking at Harvard Business School, points out that big endowments take a lot more risk to get high returns and that “there are periods when there’s a cost to that.”

Charles Skorina, founder and president of an eponymous San Francisco–based executive search firm specializing in financial services and asset management, says the successes of the smaller schools are usually overlooked because their returns are generally not reported in any prominent way. His view is supported by an October 2012 report by Vanguard Group that found that from 2009 through 2011 an investor was nearly ten times more likely to see a story about one of the ten largest endowments than to read one about any of the others. In the first half of 2013, Skorina dug into the 2012 Nacubo-Commonfund Study of Endowments (NCSE) to identify the top midsize performers — and he shared his data with Institutional Investor. “Why are so many smaller endowments, with their more modest resources, punching above their weight, and why hasn’t anybody noticed?” he asks.

The five years that followed the financial crisis have been challenging for all U.S. college and university endowments, which managed to eke out only low-single-digit returns. Still, Stephen Nesbitt, CEO of alternative-investment consulting firm Cliffwater, based in Marina del Rey, California, believes that more midsize schools have been positioning themselves to outperform the largest schools since the crisis. “Midsize endowments had been a little sleepy,” and 2008 was a wake-up call, explains Nesbitt, who consults with a dozen endowments averaging $750 million in assets. As a result, schools are allocating more resources to their endowments: establishing professional investment offices, changing compensation to attract and retain investment staff, upgrading investment committees and hiring top-notch consulting advice.

It turns out that great contacts and investment committees are not exclusive to the Ivy League. “How you structure your committee, who you recruit — that’s a very important, often forgotten element,” says John Griswold, executive director of Wilton, Connecticut–based Commonfund Institute, the educational arm of Commonfund, which manages $25 billion for 1,400 nonprofit organizations. “If you don’t get the governance process right, it’s going to be very difficult.”

The benefits of being smaller often go unnoticed. Having fewer assets can work in an endowment’s favor, as Paula Volent has observed in her 13 years as senior vice president of investments at Bowdoin College in Brunswick, Maine. “Small endowments are often by necessity entrepreneurial,” explains Volent, who worked in the Yale Investments Office under its longtime CIO, David Swensen, first as an MBA student in 1996, then as a full-time staffer from 1997 through 2000 before moving to Bowdoin. Small staffs need to be generalists, and that gives them a lot of market knowledge and close relationships with asset managers, she says. In addition, when a top asset manager offers a $5 million allocation in its fund to an investor, for example, a smaller school can make good use of an investment that would be too little to put a dent in the portfolio of a multibillion-dollar institution.

Volent says she learned everything she knows about endowment management from Swensen. But for the five years following the financial crisis, the pupil bested the teacher: Bowdoin’s endowment had an annualized return of 3.10 percent. As schools like Bowdoin apply the lessons learned from the Yale model and their own individual circumstances, the results have been impressive. “There’s been a view that [midsize endowments] have to be more aggressive,” observes Cliffwater’s Nesbitt, who began consulting with Denison after being introduced to the school in 2005 by Jack Meyer, former head of Harvard Management Co. “If there was a skill gap between the largest and midsize endowments, it has closed significantly.”

Colleges and universities in the U.S. have long depended on endowment funds to help cover the steep annual costs of running institutions of higher education. The largest schools have the largest endowments and aim to keep them that way by hiring the smartest investment professionals they can find. One of the very smartest is Yale’s Swensen, who has headed the investment office at the New Haven, Connecticut, university since 1985.

Swensen developed an investment style whose hallmark is seeking out the newest untried investments, then adding these emerging alternative asset classes to Yale’s increasingly diversified portfolio. His 2000 book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, was a runaway bestseller among endowments, foundations, pensions and asset managers of every stripe. Swensen’s success — decades of consistently high returns — became the model for other schools to copy. It also became the bogey to beat.

Following the Yale model, schools large and small began to heap alternative investments into their endowment portfolios. For the fiscal year ended June 30, 2002, institutions with more than $1 billion allocated about a quarter of their portfolios to domestic equity, compared with 40 percent at midsize schools, according to NCSE. By the end of 2012, the biggest schools had halved that allocation, to 12 percent, while the midsize schools cut it even more, down to 18 percent. At the same time, allocations to alternatives, already high at 44 percent at the largest schools, increased to 61 percent; midsize schools brought their alternatives allocation from 23 percent in 2001–’02 to 48 percent in 2011–’12.

It all came crashing down when the financial crisis slammed schools in the 2009 fiscal year. The largest schools, whose allocations to illiquid private partnerships averaged 40 percent of their portfolios, were hit the hardest, caught without enough liquid assets to meet their obligations to the schools’ operating budgets, scholarships and other necessities. Smaller schools, which had about a quarter of their assets tied up, had more room to maneuver. In the five years since then, the Yale investment model has been turned on its head.

Though much has changed in the 28 years since Swensen took up the CIO reins at Yale, one thing in particular has provided an opportunity for smaller schools to add alpha to their portfolios: the increasing importance of manager selection to portfolio performance. In 1986, Gary Brinson, L. Randolph Hood and Gilbert Beebower’s seminal paper “Determinants of Portfolio Performance” established the long-held theory that asset allocation was responsible for 90 percent of fund returns. Last year Swensen, writing in Yale’s annual endowment report, officially acknowledged the end of that theory. As more investors have crowded into the newest asset classes, observes the report, opportunities for returns have diminished. Yale’s research shows that in the 20 years ended June 30, 2012, only 20 percent of Yale’s outperformance (relative to the average endowments monitored by investment consulting firm Cambridge Associates) was attributable to portfolio asset allocation, whereas nearly 80 percent resulted from the value added by active managers.

Single Page    1 | 2 | 3