August 4, 2005 | Read Time: 7 minutes
Chart: Annual investment returns for Vanderbilt U.’s endowment
Chart: Where Vanderbilt U.’s endowment is invested
Chart: Where Vanderbilt U.’s endowment goes
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Like top financial officers at colleges across the country, William T. Spitz spends most of his time figuring out how the endowment can earn high returns in a low-return environment. The types of investments that enriched Vanderbilt University in recent years will probably become less lucrative over time, says Mr. Spitz, who as the university’s treasurer has managed its endowment for two decades.
“This is something that everybody is thinking about,” he says.
Mr. Spitz spent 10 years on Wall Street before taking over Vanderbilt’s endowment, which had a value of $300-million in 1985. Since then it has grown to about $2.6-billion, an almost ninefold increase that is the result of intensive fund raising and savvy investments.
But today it is harder to find investment opportunities that will easily match such results.
“What are we going to do next?” he says. “We haven’t a clue.”
At Vanderbilt Mr. Spitz took over a portfolio that was pure vanilla, its assets invested primarily in domestic stocks and bonds, with a smattering of holdings in international stocks, real estate, and venture capital. In the two decades since then, the endowment has become much more diversified. Most college endowments have undergone similar transformations.
Today Vanderbilt’s portfolio has about 23 percent of its assets in U.S. stocks and 11 percent in fixed-income investments, like bonds. The rest is in nontraditional types of assets: 20 percent in hedge funds, 15 percent in equities from outside the United States (mostly in Europe), and 10 percent each in private equities and so-called hard assets, such as timber, real estate, and energy. An additional 9 percent is invested in emerging-market equities, and the final 2 percent is in cash.
The approach has worked well. The endowment posted average annual returns of 7.5 percent over the five years ending in June 2004. The median annual return for all endowments surveyed by the National Association of College and University Business Officers during the same period was 3.5 percent. For the past 10 years, Vanderbilt’s average return was 12.9 percent, compared with a median of 9.9 percent.
In recognition of Mr. Spitz’s “exemplary investment management performance and unwavering professional ethics” over three decades, he was awarded the Hirtle Callaghan Investment Leadership Award in April. Recipients are nominated by their peers and selected by Hirtle, Callaghan & Company, an investment-services firm that works with nonprofit endowments and other large institutional investors. (Vanderbilt is not a client of the firm.)
The honor came with a $50,000 cash prize, which Mr. Spitz has donated to the Owen Graduate School of Management at Vanderbilt, where he teaches a course in securities analysis. The money will pay for a conference on conflicts of interest in capital-markets research. “We worry about whether the interest of [fund] managers and ours are really aligned,” he says.
Nontraditional investments have been a boon to many endowments in recent years, as the stock market has produced anemic returns. Larger endowments, which have generally shifted to alternative investments sooner and more aggressively than their smaller counterparts, have reaped the greatest rewards.
But that strategy, Mr. Spitz says, is becoming a victim of its own success. “All these nontraditional asset classes have become very popular, and in some people’s view there is too much money in them,” he says. “Many people, including me, think that the great returns have gone away from those categories.”
In the past five years, for example, the hedge-fund industry has doubled in size, to at least 8,000 funds, with an estimated $1-trillion under management. Total assets managed by venture-capital firms have quadrupled, as have institutional investments in real estate, Mr. Spitz wrote in the Vanderbilt endowment’s most recent annual report.
“We’re looking for new and interesting things where the herd hasn’t gone yet,” he says, “but we haven’t found anything.”
Some new investment approaches might yield good returns, Mr. Spitz says, but they are largely untested. What’s more, few of them offer enough investment opportunities to accommodate the billions of dollars that college endowments must invest, he says. Among the new categories are art-investment companies, funds that buy drug royalties, and airplane leasing, he says, but “it’s hard to imagine that you could put a lot of money in those.”
Timber, the big new thing a few years ago, “has pretty much arrived,” Mr. Spitz says. “It’s pretty significant in a lot of portfolios, and we still think the category makes sense. But when you invest in timber, you don’t know how you’ve done for 10 to 15 years.”
The long-term goal for endowment managers is to earn returns high enough to allow spending levels to be maintained and protect against the effects of inflation. Most institutions spend 4 to 5 percent of their endowments’ value each year. Another 4 to 5 percent annually is lost to inflation, which is typically higher for colleges than for the rest of the economy because of the labor-intensive nature of education. Endowments, then, must earn 9 or 10 percent annually in the coming years to meet their goals, Mr. Spitz says. Experts predict returns of 6 to 8 percent for U.S. equities and 4 to 5 percent for bonds, which means that alternative investments that have had their “competitive advantage eroded by too much money” must perform better than expected to make up the difference.
Otherwise, he says, institutions might be forced to cut their spending rates or accept a temporary weakening of their endowments’ spending power.
“If you think returns are going to be more modest than they have been, then that points to a lower spending rate, but few endowments are willing to take on that battle,” Mr. Spitz says. “Universities get very accustomed to having income flow. If you suggest cutting it, that’s very painful.”
Vanderbilt’s endowment contributes about 14 percent of the university’s annual operating budget. Of that contribution, 29 percent goes to scholarships, 28 per-cent to operations of the university’s nine schools, and 20 percent to professorships and endowed chairs. The remaining 23 percent goes to general operations and other needs.
The endowment’s spending rate for Vanderbilt’s operating budget is determined by a formula that calculates 4.5 percent of the endowment’s average value over three years. Soon after Mr. Spitz’s arrival, he persuaded the university to lower the rate from 5.5 percent to help preserve the endowment’s value. He would cut it again if he could.
“I would like to lower it, but I don’t think it’s likely,” he says. “Vanderbilt is in an exciting growth phase, so I don’t think we could wean the university off that money.”
Given the extraordinary gains the endowment has produced in recent years, it could withstand a period in which returns did not fully offset the effect of inflation, without devastating the institution’s financial stability.
“We’re way ahead of the game,” Mr. Spitz says, “but you hate to give up ground.”
The prudent course, he says, is to abide by solid investment principles:
- Maintain a diversified portfolio.
- Keep costs low, using index funds and other so-called passive-management approaches to investing.
- Invest in more expensive actively managed funds only when the reasonable expectation for superior returns justifies the added expense.
- Don’t be afraid to buy investments that cannot be easily liquidated and take a long time to show returns. Time is on the side of endowments, which are designed to operate forever.
“We may be pleasantly surprised by the returns the market gives us,” he says, “but the prudent thing to do is to make modest assumptions and hope you get a pleasant surprise.”
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VANDERBILT U.’S ENDOWMENT: ANNUAL INVESTMENT RETURNS
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WHERE VANDERBILT U.’S ENDOWMENT IS INVESTED
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WHERE VANDERBILT U.’S ENDOWMENT GOES
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Section: Endowments
Volume 17, Issue 20, Page B16
