The nation's 76 richest colleges earned a market-beating 21.3 percent on their billions of dollars in tax-free endowment funds in the fiscal year ending last June 30, according to a report issued today by the National Association of College and University Business Officers.
That continued a remarkable run of at least a decade in which the wealthiest colleges have racked up outsize profits. But the large endowments' secret weapons--increasingly exotic alternative investments such as overseas companies, hedge funds, oil well leases, and timberlands--are drawing growing criticism and calls for regulation:
-- Even endowment insiders are worried that the generous rewards of the past are tied to big risks that may drain colleges' funds during today's tumultuous markets. Many are especially fearful for the financial stability of small colleges that have been trying to mimic the hedge-fund strategies of Harvard and Yale, without the Ivies' troops of investment gurus.
-- A growing number of students and others charge that colleges are pushing ethical and, possibly, even legal boundaries to earn such large profits. Some student groups say the colleges are reporting big returns in part because they've invested, for example, in highly profitable Chinese oil companies exploiting Sudanese oil fields. And in a lawsuit in Massachusetts, a real-estate developer charged that a fund backed by Harvard, Yale, Princeton, and other schools charged him an interest rate that added up to about 40 percent a year--and violated the state's usury law.
-- There are calls in Congress to regulate this $411 billion pool of college savings. Proposals want the often secretive funds to reveal more about how they are investing the money and spend more of the money they earn on students' education and financial aid.
These controversies do not appear to be reversing the flow of school funds to alternative investments, however. And no wonder. The NACUBO report showed that the funds holding more than $1 billion outearned the market. This was partly because they are bigger and thus got better deals offered to them. But the profits also result from the fact that the schools put about 40 percent of their money in alternative investments such as hedge funds, real estate, private equity, and natural resources.
Carlene Miller, who as treasurer of Pomona College oversees a $1.8 billion endowment, says that the Southern California school's diversification into alternative investments such as timberlands, gold, and commercial real estate has buffered the effects of recent market declines. In the year ending December 31, Pomona earned 17 percent, she noted. But the recent declines in the values of all types of foreign and domestic investments may signal an end to the years of double-digit growth for endowments, she predicts. "We wouldn't be surprised or unhappy" with future annual returns in the 7-to-10 percent range, she says.
Less wealthy schools, however, do not have such great returns of the past to protect them against future troubles. The 411 colleges with endowments below $100 million, for example, put only 5 to 25 percent of their funds in alternatives and reported subpar returns for the year ending June 30, according to the survey. On average, they earned 15.6 percent, less than the 20 percent the U.S. stock market returned at that time and less than the 17.8 percent a standard diversified portfolio of stocks and bonds would have earned. Smaller schools have underperformed the stock market and a standard diversified portfolio for the past five years.
No wonder then, that other surveys have found that endowment managers plan to keep moving out of plain-vanilla American stocks and bonds. That trend is worrying some of the most knowledgeable endowment insiders. John Griswold, executive director of the Commonfund, a nonprofit that manages many college endowments, says that the double-digit profits reported by the Ivies have lured lots of colleges into similar alternatives "later in the game" when there is less opportunity for growth--and more risk of a drop. In addition, he notes, while the Ivies have large staffs of researchers to keep eagle eyes on their exotic investments, endowments with less than $1 billion have, on average, just two employees, which may not be enough. Even Mohamed A. El-Erian, who led Harvard's endowment to a 23 percent investment return in fiscal 2007--in part, thanks to booming emerging and commodities markets--tells U.S. News he worries about those who are trying to copy his methods. In an E-mail sent before he left Harvard to take a co-CEO job at bond giant PIMCO, he says that smaller colleges face a "risk that they will go too far" afield with alternatives that they don't have the staff to manage.
Others worry that the pressure to keep reporting such record-breaking profits is pushing many endowment managers to take questionable risks. Fred Fahey, a Massachusetts-based real-estate developer, says he is a victim of universities' drive for higher profits. In a lawsuit filed in a Massachusetts state court, he alleges that a partnership funded by Harvard, Yale, Princeton, and other nonprofits charged him the equivalent of about 40 percent annual interest for a loan to fund a golf-course housing project. Fahey couldn't repay the loan at that high rate and ended up losing the project to the partnership. "I can see how they get those returns," he says.
The colleges have replied that since they were limited partners, they are not responsible for the partnership's actions. Endowment officials say they adhere to ethical standards for their investments and that a portion of the alternative investment profits has gone to good causes, such as increasing financial aid.
Whatever the merits of Fahey's case, many students are concerned that it reveals a larger, long-hidden problem with endowments. Morgan Simon, executive director of the Responsible Endowments Coalition, says that many colleges refuse to reveal how they invest their funds, making students worry that the profits may be coming from, for example, companies like PetroChina. That company, which has operations in Sudan, returned almost 80 percent in 2006 and an additional 30 percent in 2007. What's more, if colleges stake too much money on oil wells and oil companies, "they aren't dealing with global warming, and that, in the long term, is a bad investment," Simon says.
And bad endowment investments, after all, are bad for students, too, because colleges typically pull out about 4.6 percent of their endowments to spend on better dorms, better professors, and bigger scholarships.
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