What drives the growth of large endowments?    

 From hedge funds to investment banks, private equity firms to university endowments, virtually no financial institution has emerged unscathed from the ongoing economic turbulence.  While written before universities reported their disappointing year-end returns, the 2008 study “Secrets of the Academy: The Drivers of the University Endowment Success” by Josh Lerner of Harvard University and Antoinette Schoar and Jialan Wang of Massachusetts Institute of Technology identifies several factors that may be responsible for the disparities in endowment size across a wide range of educational institutions.
    

     An endowment is the reserve of money that provides a university with a source of perpetual income; thus, it is important that their managers invest well to produce high returns year after year. The median return for the 1,300 schools surveyed was 6.9 percent, but some schools have clearly surpassed all the others. In 1993, the Ivy League had endowments of greater than 30 times the median size of those at public universities; in 2007, this gap increased to 70 times the median. 
    

    
     The researchers concentrate on investment performance as the biggest source of change in endowment size, with annual expenditures and donations being the other two major factors. Investment performance is naturally driven by the skill of the university’s endowment managers. The authors speculate that schools with large endowments and students with high SAT scores tend to attract managers with more sophisticated knowledge of financial practices. While higher SAT scores are not strongly correlated with endowment size, they may serve as proxies for attractive features such as the prestige, administrative skill, and alumni network associated with the university. These are all important incentives for more skilled managers to leave their jobs in the financial industry and lead Ivy League investment teams.

     The study found that having specialized, as opposed to generalized, asset managers running the endowment did have an immediate and tangible effect. The most obvious of these has been Ivy League endowment managers’ aggressive and conspicuous investment in alternative and illiquid assets such as timber and private equity funds over the period from the early 1990s to the mid-2000s. Previously, most managers had allocated an average of 11 percent to these asset classes; by 2007, the figure was around 21 percent.

     If alternative assets have generated such impressive returns for the Yale and Harvard investment funds, why have so few others followed this strategy? The answer reveals something of a self-perpetuating cycle: since academic prestige seems to be correlated with large endowments, the most exclusive universities are able to attract the most talented investment managers, who have not only the access but also the requisite experience to make the most of these specialized investment opportunities. In addition, as “pioneers” of alternative asset investment and holders of vast capital reserves, the Ivy League schools are able to gain access to the top echelon of alternative funds, which have been highly profitable for the past 25 years. With priority access to the best investment professionals and the most lucrative opportunities, it’s no wonder that the rich appear to be getting richer. And yet, as recent events have reminded us, there are limits to extraordinary returns, and even the investment professionals of the wealthiest schools cannot wipe away all risk.