Small Endowments Lose Money on Hedge Funds, Trailing Big Schools

  • Endowments under $25 million lost 0.5 percent in alternatives
  • Hedge funds received $2.5 billion in fees in 2015, study says

Smaller U.S. college endowments lost money on their hedge fund investments in the most recent year, trailing larger universities that often have access to better-performing managers.

Endowments with assets under $25 million lost an average 0.5 percent on hedged strategies in the year ended June 30, according to a survey by a trade group that represents college business officers. Overall these funds gained 2.3 percent, just below the average for endowments of all sizes. The Standard & Poor’s 500-Stock Index gained 4.6 percent in that time.

These returns, along with high fees, are of concern to Hedge Clippers, a group that says pension funds and endowments aren’t getting their money’s worth by investing with these managers. Shifting assets away from such high-fee investments means an endowment could pay out more money to lower tuition costs, according to a separate report set for release Monday.

“Given hedge funds’ poor performance in the last few years and the increased scrutiny that hedge funds are under by institutional investors, university endowments should be looking very closely at this and exploring lower-cost investment vehicles,” Elizabeth Parisian, the study’s author who is also chief economic strategist for the American Federation of Teachers, said in an interview.

High Fees

The Hedge Clippers study’s author estimates that hedge funds collected $2.5 billion in fees from endowments in 2015 and $16.7 billion from 2009 to 2015. In that time period, schools paid 60 cents to hedge fund managers in fees for every dollar of return on the investments, according to its study. The group used an estimate of 1.8 percent for the management fee and 18 percent for the performance fee.

Hedge funds bet on rising as well as falling securities prices, and command fees of 2 percent of assets and 20 percent of the fund’s annual profit, or more. Hedge funds on average lost 1 percent in 2015, but dispersion among the returns was sizable. Hedge funds have underperformed the S&P 500 index for seven calendar years, according to data compiled by Hedge Fund Research Inc.

The largest endowments, with assets of more than $1 billion, in fiscal 2015 had an average 21 percent invested in “marketable alternatives,” which include hedge funds, and event-driven and long/short investments, according to the National Association of College and University Business Officers and investment manager Commonfund. Those schools posted an average return of 4.3 percent in fiscal 2015, beating the 2.4 percent average for all schools reporting to NACUBO. The 812 schools that reported survey results had endowments of $529 billion in assets.

Michigan State University, with its $2.3 billion endowment, said its hedge fund allocation is roughly 30 percent and there aren’t any plans to reduce it, said Philip Zecher, chief investment officer of the endowment. The school posted a return of 3.5 percent for the year ended June 30.

“We’re getting the return that we expect and need” for the fees that are paid, said Zecher, a former hedge fund manager.

Smaller schools have been following in the footsteps of larger universities, but have had mixed results.

The Shepherd University Foundation’s $23.1 million endowment had a 3.2 percent decline in investments for fiscal 2015. The decline in the endowment’s value from $25.2 million was partly due to its payout for the school’s operating expenses. However, the Shepherdstown, West Virginia-based public liberal arts school had expected a 6 percent return from its investments in hedge funds, said John Wolff, chief executive officer of Capital Fiduciary Advisors, who manages the fund. Investments in three funds of hedge funds averaged 1.8 percent, he said.

Risk Management

“It was certainly well under our expectations,” Wolff said. “We don’t use hedge funds for return enhancement. We use them for risk management and reducing volatility.”

Lewis & Clark College’s endowment posted a 0.1 percent gain in the year ended June 30, lower than the 2 percent return for schools of $101 million to $500 million. The Portland, Oregon-based college, with a $228 million fund, was disappointed in the performance of its hedge fund managers, said Carl Vance, chief investment officer.

He said the funds, which made up 23 percent of the portfolio as of June 30, lost 1.9 percent, and didn’t provide the protection “we assumed we’d find.” The allocation to hedge funds was raised to 24 percent in 2015 from 20 percent in 2013 in the belief that the asset class would provide protection in a down market, he said.

“A number of managers didn’t succeed in that goal,” Vance said. “As energy plummeted, a lot of our hedge funds had exposure to energy stocks and have not done as well.”

Expenses, Fees

Some schools say they can control expenses and fees. Trinity College’s $562 million endowment has 25 percent to 30 percent in hedge funds, higher than the 22 percent for endowments of its size in marketable alternatives, according to NACUBO. The fund returned 7.7 percent in the year ended June 2015, the school said.

The Hartford, Connecticut-based school’s outside investment firm, Investure, is “notoriously aggressive in negotiating fees,” for its clients, said Kevin Maloney, chairman of Trinity’s investment committee and also co-chief investment officer at global asset manager Gottex Fund Management Holdings.

“If managers don’t earn their fees, then at the end of the day they’re not going to have assets,” Maloney said. “It’s going to be hard to retain their clients.”

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