Weak returns for endowments: but don’t hit the panic button

Although the most recent fiscal year saw disappointing returns for the average educational endowment, the long view tells us this is no cause for panic. Returns will inevitably fluctuate. Of course, there’s more to taking the long view than simply being able to stomach market fluctuations.

Taking the long view

When the legendary investor (and mentor of Warren Buffett) Benjamin Graham was asked what keeps most individual investors from succeeding, he replied, “The primary cause of failure is that they pay too much attention to what the stock market is currently doing.”¹—And he said that in 1972, before the internet, before 24-hour financial news channels, before Jim Cramer.

Overreacting to short term variations is a buy-high sell-low strategy, and one which costs investors dearly. Retail investors are renowned for piling into the best-performing funds and asset classes, only to find out—yet again—that past results are a poor indicator of future experience. But institutions do it too. We all need protection from ourselves sometimes. We need to take the long view.

Among the different types of investors, it is perhaps endowments that have the longest view of all: they are designed to provide support in perpetuity.

So as NACUBO’s latest report tells us that the average endowment earned a disappointing 2.4% in the Fiscal Year ending June 30, 2015, there’s no reason to change direction. Taking the long view, the below-expectation 2.4% tells us no more than the above-expectation results of 11.7% and 15.5% in the previous two years.

The basis of a sound strategy

There’s more to taking the long view than simply being able to stomach market fluctuations, of course. For endowments, a realistic return objective is essential: the latest NACUBO study cites a median long-term target of 7.5%. That’s not obviously unrealistic, but neither is it a sure thing. It’s certainly not going to always be met over the short- or medium-term. So spending policies need to take into account how the inevitable fluctuations in returns will be handled.

In pursuit of these return targets, endowments and the nonprofit sector in general have seen a transformation in recent decades, evolving from an approach dominated by legal restrictions and the avoidance of anything that might be deemed speculative into the very broad-based return-oriented approach that has now become associated with endowment investment.

As highlighted in Russell Investments’ latest nonprofit newsletter, the long-term view allows endowments to seek a broad range of return sources: different asset classes as well as different sources of return premium (markets; illiquidity; active management; opportunistic or dynamic strategies.) Not everyone has the resources to emulate the high-profile teams at Ivy League schools, but the same principles can be applied no matter the setting.

¹See “Benjamin Graham: Thoughts on Security Analysis”, Financial History magazine (March 1991). Cited by Jason Zweig in his commentary on chapter 8 of “The Intelligent Investor” (revised edition, 2006. Harper Collins.)