Researchers at UC Merced recently found that infants are able to tell when an adult is acting under a misconception. In an experiment, an adult shakes two rattles and then leaves the room. Another adult enters and breaks one of the rattles. When the first adult returns and shakes the rattles, believing they both will work, infants showed signs of surprise in their gaze.
The Merced team might want to enlist these perceptive babies to get a read on asset managers at the UC endowment, where ever-larger wads of cash have been placed into so-called “absolute return investments” and private equity positions. These categories typically include hedge funds, short-selling, futures, options, derivatives, arbitrage, leverage and unconventional assets, along with positions in privately held companies.
UC donors haven’t yet shown signs of colic in their gaze, but given the new and uncharted risks asset managers have been taking since the end of the Great Recession, it would be understandable if donors were in need of a bottle – though one filled with something stronger than formula.
Coast to coast, university endowments have been taking big risks lately, so the UC endowment is not alone. But this doesn’t make it any less troubling.
Asset managers no longer ponder the ideal distribution among stocks, bonds and real estate, but rather now see the world as either “alternative-strategy investments” or public investments.
Critics contend endowments have essentially become hedge funds, or have given too much of their holdings to outside hedge funds to manage. But it might be worse, since that thinking doesn’t consider their increased involvement in private equity deals and commodities, which have introduced more volatility to the mix.
Of late, endowments have been accused of hoarding money, hiding risk, underperforming, paying exorbitant management fees and creating conflicts of interest as hedge fund managers – sometimes alumni – become trustees, make donations, get buildings named after them and then receive ever bigger pots of money to manage.
In the process, colleges and universities spent an estimated $2.5 billion on fees for hedge funds in 2015 alone. They paid about 60 cents to hedge fund managers for every dollar in investment returns from 2009 to 2015, according to a report by the Strong Economy for All Coalition.
The managed endowed assets held by the UC Regents General Endowment Pool and UC campus foundations, which totaled $14.4 billion, had a weighted average of about 27 percent in hedge funds and private equity positions in 2016. This is more than double the proportion the pool had invested in these categories in 2006. In 1999, it was just 3 percent.
The result of all this new risk?
Let’s look at UC Merced. Over the past five fiscal years, the UC Merced endowment earned an average of 6.3 percent a year. By comparison, a portfolio invested with 60 percent in a U.S. stock index and 40 percent in a bond index over the same period would have earned 8.9 percent annually. Little vexes donors more than index funds outperforming highly paid asset managers.
To top it off, at the end of June 2016, it was reported that UC Merced’s endowment of $38.6 million had fallen in value by 3.5 percent to, by my estimate, $37.3 million. In fact, the endowments at every single UC campus and the regents’ pool fell, too, with losses reported at from 2.2 percent (UC San Diego) to 5.1 percent (UC Riverside).
A report by legislative staffers found that as state funding declined during the Great Recession, UC sought other sources for funding, including donation drives and changing its investment patterns. The latter is now obvious.
From 2008 to 2012, tuition grew by 84 percent. Many campuses, the report found, most notably UCLA, UC San Diego and UC Berkeley, also dramatically increased enrollment of nonresident students, who pay a reported $22,878 more than California students. Campuses get to keep the additional money.
So when frugality was in order, UC passed costs onto students, upped nonresident recruitment and doubled down on risk.
College and university endowments report they need to earn a return of 7.4 percent annually to maintain their purchasing power in light of spending, inflation, and management costs. The weighted average of the combined UC endowment has been 5.5 percent per year over the past 10 years.
This means the combined UC endowment is effectively shrinking – as are UC Merced’s invested funds in the regents’ pool. All the while, the system is mired in new risk.
Donors would have every right to throw down their binkies and pitch a tantrum.
Jeremy Bagott is a former journalist. He writes about land-use and finance issues. He wrote this for the Merced Sun-Star. Email: email@example.com