College endowment funds: who is in charge?

College and university endowments have grown rapidly during the last 20 years. Today, the top 200 funds total more than $164.6 billion and are a significant funding source for many universities (Pulley, 2000). In fact, during the 1990s, college and university endowment funds grew at an unparalleled rate and their assets climbed to levels beyond the most optimistic forecasts. This phenomenon paralleled the record gains of the stock market over this period. Endowment investment committees and their advisors were held in high esteem and their actions appeared to be beyond reproach as the coffers grew rapidly during this period. Investment meetings often took on the appearance of love-fests with members congratulating each other for their shrewd investment expertise.

The status quo of the 1990s changed in March 2000. That point in time marked the start of the greatest stock market decline in the last 100 years. This decline, triggered by the collapse of the dot com companies, was further fueled by the economic collapse of energy giant Enron Corporation, and the public's concern over the role that the international accounting firm Arthur Andersen played in facilitating this collapse. Other recent high profile business failures such as Global Crossing, Inc., Halliburton, and WorldCom have only made matters worse. The market repercussions were in large part due to the scandals surrounding the dubious accounting and reporting practices that led to these failures, leading one investor to describe them as a "moral cancer and a governance cancer, which must be cut out if our economic health is to be restored" (Flanigan, 2002).

The present investing environment mandates that fiduciaries take a fresh look at how their funds are managed. Endowment committee members undoubtedly recognize that managing a portfolio requires expertise well beyond that needed in an ongoing bull market. They now face pressure to reverse the erosion in their funds' asset values that has taken place over the past few years. The big question that they (Endowment Committee members must answer is whether their investment committees have the knowledge, skills, and abilities to carry out the fiduciary responsibilities for which they are held accountable.

Our purpose for this study is twofold. First, we seek to better understand the policies, rules, and procedures of college endowment committees. In doing so, we will have a basis for assessing whether the inherent structure and practices of these committees facilitate effective discharge of their fiduciary responsibilities. Second, we seek to determine facts and circumstances that prompt investment committees to utilize outside money managers to assist in fund management and the extent to which these outside experts are employed. This should provide further insight into the decision making processes and the implications for the effectiveness of investment committees.

Method

In order to obtain information regarding the above-referenced activities of college investment fund committees, we mailed a portfolio questionnaire to the administrators of the top 200 US college endowment funds. Follow-up requests were mailed to non-respondents eight weeks after the initial mailing. Responses received within 12 weeks of the initial mailing were included in the study, by that time we received 112 (56 percent) usable responses. (1)

The questionnaire consisted of 39 items related to portfolio and investment committee characteristics, investment policy statements, and reasons for selecting professional managers. In each of these areas we solicited survey responses using objective questions with multiple response options and YES/NO questions. Over 73% (n=82) of the respondents indicated their endowment fund portfolios exceeded $100,000,000, 16% of respondents' portfolios were between $50,000,000 and $100,000,000, and nearly 11% reported portfolios with assets totaling less than under $50,0000,000.

Results

Committee Composition and Preparation

Typically, an endowment committee is established to oversee management of the fund's assets. Members of the endowment committee are charged with the fiduciary responsibility of carrying out the goals and objectives of the fund. To assess committee composition, the respondents were asked to identify the size and composition of their respective endowment committees. Sixty respondents (54%) reported that the investment committees consisted of more than seven members, 38 (34%) indicated that the size of its investment committee was between five and seven members, and 14 (12%) reported membership between three and five individuals.

Since endowment funds represent a significant resource for universities, it is important that qualified individuals serve on the committee that is charged with its oversight. In order to function effectively, investment committee members must have a clear understanding of the fund's investment philosophy, goals, and objectives. Quite often this is accomplished by providing new members with a formal orientation program. Accordingly, the survey asked whether the sponsoring organization had an investment orientation program for new committee members. Over 64% (n= 72) indicated that no formal program was offered to new members. As to whether a minimum level of investment expertise was used as a criterion for selection to the investment committee, 56% (n=63) reported having no such criteria, while 44% (n=49) indicated that investment and/or portfolio management expertise is required. Another strategy would be for investment committees to recruit individuals outside of the organization to fill this void. Seventy-two respondents (64%) indicated that their endowments utilize individuals outside of the organization to serve on the investment committee.

Investment Policy Statement

Sound portfolio management practice requires the existence of an investment policy statement. An endowment's investment policy statements should include its philosophy, goals, return objectives, risk tolerances, and constraints. Nearly 96% of respondents (n=107) reported having a written investment policy statement in place, all of whom confirmed that their documents included a section on investment philosophy, goals, and guidelines.

Typically, portfolio managers allocate funds between categories of financial assets to ensure that a portfolio is not too concentrated in any one sector or security. When asked whether their endowment placed a limit on such investments, 90% (n=101) responded that the investment policy statement specified a permissible asset allocation range, interestingly, only half of this group specified a maximum limit on the amount that can be invested in one security. While the maximum limit varied widely among respondents, 81% was the maximum percentage allowed to be invested in equities, 73% was the maximum percentage allowed to be invested in fixed income securities, and 44% was the maximum percentage allowed to be invested in cash and equivalents. Seventy-four respondents (72%) indicated that their investment policy statements explicitly contain a statement addressing risk tolerances.

Evaluation Practices

Endowment committees are periodically expected to review the performance of the investment fund as well as its managers. A section of the questionnaire explored how often investment performance is formally evaluated. Eighty-one respondents (72%) reported that they review endowment fund investment performance on a quarterly basis, 21(19%) reported reviewing performance on an annual basis, seven (6%) reported that they review performance semi-annually, and three (3%) reported monthly performance reviews. It is also good practice to review the investment policy statement periodically since the goals and/or objectives may change over time. Table 1 reports the answers to the question as to how often the investment policy statement is reviewed.

As Table 1 indicates, the majority of respondents (53.3%) reported that the policy statement is reviewed annually, 35.3% indicated that the statement is reviewed every one to three years, and 10.5% indicated that they reviewed the investment policy statement between three and five years. Only one respondent reported reviewing the statement every five to seven years.

Employment of Money Managers

Early in the life of an endowment fund a question arises as to whether the management should make investment decisions internally or seek the advice of professional money managers. The next series of questions were intended to shed light on this question. The survey asked whether the size of the portfolio was related to the decision to hire a professional money manager. Out of the 92 administrators who answered this question, 40 (44%) indicated that a minimum size did not apply. Of the 52 respondents who indicated that a minimum size is an issue, two (3.8%) indicated that the fund should be at least $100,000, eight (15.4%) indicated that the fund should be at least $1 million, 15 (28.8%) indicated that the fund should be at least $5 million, and 27 (52%) indicated that the fund should be at least $10 million.

The respondents were asked whether they used one or more outside managers. Table 2 reports the percentage of endowment firms using one or more outside fund managers.

As Table 2 indicates, 93 (83%) of the funds using outside professionals reported that they used four or more money managers. A follow-up examination looked at the relationship between the size of the portfolio and the number of management firms employed. The results are shown in Table 3.