Here is the conventional wisdom: Investments by university endowments deliver excellent returns. Yet that is hardly the conclusion of a novel study by Sandeep Dahiya, associate professor of finance at Georgetown’s McDonough School of Business.
In the recently published paper, “Investment Returns and Distribution Policies of Non-Profit Endowment Funds,” Dahiya and collaborator David Yermack, professor of finance at New York University’s Stern School of Business, highlight an alarming underperformance among more than 28,000 U.S. nonprofits. Their sample includes virtually every college and university with an endowment.
Nonprofit endowments in the United States manage more than $700 billion, with an average endowment of $27.2 million and a median of $1.2 million. Although higher education makes up less than 10 percent of nonprofit organizations with an endowment, they account for over half of the total endowment assets. By dissecting IRS filings between 2009 and 2016, the study found the median annual endowment return was only 3.75 percent. A passive portfolio of 60 percent stocks and 40 percent Treasury bonds, on the other hand, would have generated 9.28 percent. Furthermore, higher education institutions “significantly underperform” when compared with other nonprofit entities.
Georgetown Business spoke with Dahiya about the study.
What prompted this research?
Evaluating nonprofit endowments is such a blank canvas. Past studies looked only at universities with large endowments and found that returns are quite good. But the data came from an annual survey sent to universities that could choose to report their data or not. Plus, there is no audit of the data. Until this paper, glossy headlines about endowments made no mention about self-selected, self-reported data.
How shocked were you by the findings?
When we got our first results, we were scratching our heads. Really? Is anyone minding the store? When we adjusted for risk factors, we found that larger endowments are not doing as well as smaller ones. To be clear, they all do badly, but the median return was a shocking 3.75 percent. If you put the money in 10-year Treasury bonds, you could probably do that.
Did your study look at how endowments are invested?
Unfortunately, IRS filings do not require nonprofits to disclose what they invest in. The 60/40 stock to bond mix is the traditional benchmark, and endowments are nowhere near that. Large endowments frequently invest in private equity investments such as venture capital partnerships, whose value is hard to assess. The chief investment officer of an endowment has a pretty wide latitude in reporting how much such investments are worth.
You accessed publicly available Form 990 data downloadable online from the IRS. How onerous was that task?
Our overall sample included 167,675 annual observations for 28,696 endowments. It took David and me, along with two student research assistants, more than two years to search and gather the data, clean it up, and see what was there. We had lots of quirks to resolve. Interestingly, a number of industry practitioners have been calling us about our data.
Did you determine, or theorize, why endowments underperform?
We withhold judgment on that, because as empiricists, David and I would like to have some inkling about how endowments invest. But the data that the nonprofits are required to disclose does not provide that type of visibility, so all we can say is that it is probably poor asset allocation. The money allocated to stocks, bonds, CDs, and whatever other assets class that they invest in is not optimal. We do not know if they are paying savvy investment managers who are delivering subpar results.
Another counterintuitive finding involves endowments of universities in large versus small cities.
The closer you are to the major financial centers in New York, Boston, Chicago, or San Francisco, the worse you do — at least the large endowments. The large endowments are precisely the endowments you would expect to hire Wall Street big guns to achieve high returns. Yet the pattern is reversed for smaller endowments, which tend to perform better when they are located closer to expert financial advice.
Do you anticipate the criteria for reporting endowment data changing based on your findings?
We would love to get better data on how endowments invest their assets, which is currently not reported in a consistent manner. If this study leads to more transparent data reporting, and more disclosures, that would be great.
Reversing the Trend
Dahiya estimates that underperforming endowments leave nearly $80 billion on the table each year. While his study did not recommend changes, here are his suggestions:
• Adopting a passive indexing investment strategy can increase returns by billions of dollars.
• The IRS should require managers to report what they invest in so returns can be better analyzed.
• Managers should communicate clearly their investment strategy and follow it. Fifty years of finance research shows that it is very hard to beat the passive buy and hold strategy.
Published in Georgetown Business magazine, Spring 2019