A University Endowment Got Sued for Lagging the S&P 500. Now, It’s Fighting Back.
A major donor claims that the University of Colorado’s “abysmal” and “fee-laden” active strategy has cost $1 billion.
The University of Colorado has thrown its weight into defending an unusual lawsuit against its foundation, which alleges mismanagement of the $2.4 billion portfolio for lagging the stock market — despite outperforming peers and its own benchmark.
Rich and elderly donor Clarence Herbst sued in July after years of agitating against active management and alternative investments. “He has carried this banner for decades,” foundation president and CEO Jack Finlaw told Institutional Investor at the time.
The university has jumped into the legal fray between its foundation and Herbst to support dismissing the lawsuit. That decision could come down anytime from next week until months from now, Finlaw said Monday in a phone interview. He characterized the university’s participation as “pretty significant,” but wouldn’t predict the outcome of the dismissal request.
“While people can have various opinions on active-versus-passive investing, it really doesn’t rise to a legal issue,” Finlaw said.
[II Deep Dive: University Endowment Sued for Underperforming the S&P 500]
Herbst claims to have donated about $5 million to his alma mater, and is a trustee emeritus with no say over investment strategy — except, potentially, via the courts. The complaint lists three other plaintiffs, all recent graduates of the university.
“Unwise and unlawful investment decisions” have cost CU students, faculty, alumni, donors, and Colorado taxpayers approximately $1 billion, and that amount of money should be paid back to those groups, the updated lawsuit alleged. “Even in the face of a global health pandemic, and what appears to be another recession, the index funds advocated for by plaintiffs are almost certainly trouncing the CU Foundation’s expensive, fee-laden, actively managed, and alternative-investment-dependent investments.”
But the active and alts-oriented strategy is typical for a major U.S. nonprofit fund and has outperformed most of its peers, according to endowment and foundation tracker NACUBO and Finlaw.
Since the lawsuit was filed, the foundation reported 4.2 percent returns on its $1.8 billion endowment pool for the year ending June 30, topping its internal benchmark by 0.4 percentage points.
Herbst used these results as further evidence in his latest claims, pointing out that the S&P 500 returned 7.37 percent and his favored Vanguard fund delivered 6.35 during the same period. “Defendants’ refusal to invest a substantial percentage” or all of the endowment assets “in low cost, passive index funds has likely cost the university tens of millions of dollars thus far in 2020.”
Almost no endowments of CU’s size in the U.S. manage their portfolios passively, despite evidence that most active managers underperform after fees. If this lawsuit succeeds in arguing that active management is a breach of fiduciary duty, U.S institutions — from Ivy League universities to local charities — could potentially be open to similar claims.
Finlaw wouldn’t weigh in on the implications of a Herbst win, except on CU. “I can’t speak on behalf of the university, but anything we have at the foundation, we hold for the benefit of the University of Colorado,” he told II. “So if we were ever asked to pay a judgement from the lawsuit, it would come from the university’s assets.”
Still, he said, “I’m optimistic that active-versus-passive is a matter for conversation, but not really a matter for the courts.”