Non-profit endowments, particularly those of elite academic institutions, have failed to deliver investment outperformance. Those colleges and universities have significantly underperformed a passive benchmark on an absolute and risk-adjusted basis.
Despite the fact that about 35,000 nonprofit organizations (NPOs) have endowment funds, with a total of $800 billion in assets under management, little is known about how NPO endowment funds invest or what returns they earn. Sandeep Dahiya and David Yermack contribute to the literature with their March 2020 study, Investment Returns and Distribution Policies of Non-Profit Endowment Funds. Their comprehensive data sample was 29,892 NPOs drawn from Internal Revenue Service filings for 2009-2017. Their calculation of annual percentage investment returns for each fund was based on an assumption that inflows of gifts and bequests, as well as outflows of distributions occur halfway through the fiscal year. Thus, they calculated the return by dividing net investment gains by the beginning-of-year assets plus half of new contributions minus half of distributions. Following is a summary of their findings:
- Within the universe of nonprofits that file with the IRS, colleges and universities accounted for 6% of the observations and 54% of the assets.
- The typical endowment size is quite small, with a mean of $26.8 million and a median of $1.2 million, but the largest funds run into the tens of billions.
- The “large” cohort of endowments, those worth more than $100 million, accounted for 4% of the observations and 78% of the assets. The very smallest endowments, those with asset values below $1 million, comprised 41% of the observations but only 0.5% of the assets invested.
- The smallest endowment funds make no payouts at all in most years, implying that organizations seek to grow them to a critical mass before tapping them as a permanent funding source. For the largest endowments, those with asset values above $100 million, distributions occur almost every year, with mean and median distribution rates near 4.5%.
- Nonprofits have CIOs only about 0.6% of the time, outsourcing the endowment management function to professional firms in the vast majority of cases.
- There is a negative relationship between investment returns and board size.
- There is a positive association between board accountability and investment performance.
- There is modest but significant correlation between investment performance and the willingness of donors to contribute in future periods. Donors of a nonprofit, such as the alumni of a university, are aware of how well the organization performs as an investor and adjust their donations in a pattern that rewards stock market profits with a supply of new capital, much as one sees the inflows to a mutual fund increase when the fund outperforms the market.
These findings led the authors to conclude: “The investment wisdom of top universities today amounts to little more than a myth, as one could expect to earn these types of returns simply by chance. Frequent mentions in the media of the out-performance of top schools may be due to the publicity about the success of just one university, Yale.” The evidence makes clear that endowments would be better served by establishing an asset allocation plan and implementing that plan using low-cost, publicly available, systemically managed funds (such as index funds) rather than using active strategies and expensive private alternatives such as private equity and hedge funds.
Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.
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Non-profit endowments, particularly those of elite academic institutions, have failed to deliver investment outperformance. Those colleges and universities have significantly underperformed a passive benchmark on an absolute and risk-adjusted basis.
