Friday, May 21, 2010

University Endowments Contributed to the Financial Crisis

No. This is not a condemnation of the advice given by economics and finance professors in elite universities. Rather, it is a critique of the high-return investment model in elite universities’ endowments.

The Tellus Institute recently released a report based on a study of six private New England colleges and universities, which included Harvard, Dartmouth, and MIT (and by implication other Ivies and Stanford). It concluded that the investment model in their endowments contributed to the U.S. financial crisis.

The famous Yale and Harvard model invested heavily in illiquid and risky assets such as private equity, venture capital, hedge funds, commodities, private real estate, and timberland. These investments had generated high returns, well above market averages, for a short period. However, the financial crisis of 2008-09 crushed the value of their endowments. Universities were forced to undertake layoffs, postpone building projects, impose salary and hiring freezes, cut benefits, cut student services, and make other budget reductions. To meet current expenses, endowments were forced to sell some of their liquid holdings into falling markets, magnifying falling prices. (Disclosure: Stanford offered faculty and senior fellows a temporary faculty retirement incentive program (FRIP) to reduce its operating budget, which I accepted. As the Hoover Institution’s endowment is merged into Stanford’s investment pool, it suffered a similar percentage loss).

The report noted an unhealthy link between trustees of endowments, some of whose firms had managed funds in the endowment during the past few years. These trustees may have encouraged high-yield alternatives, dismissing the risk associated with exotic, illiquid investments, that were normal in their private practices.

The report concluded that the alternative investment endowment model is broken (even though some endowment investment managers stand by the model on the basis that alternative investments are long-term allocations that over time should generate higher returns than market averages). It recommends that universities return to responsible institutional investment, consistent with their commitment to “sustainability.”

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