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Big Endowments And Underwhelming Returns At Kentucky Universities

University of Louisville
J. Tyler Franklin
University of Louisville

When it comes to depth of curriculum, breadth of research and impact on the state economy, the University of Kentucky and the University of Louisville lead the way among public colleges in the Bluegrass State.

When it comes to investing donors’ dollars, though, leadership might be best found outside of the state’s money centers, in college towns like Bowling Green, Morehead and Murray.

The Kentucky Center for Investigative Reporting examined five years’ worth of investment returns of 11 collegiate endowments across the state. The chief takeaway? Bigger is definitely not better. The public colleges in Kentucky that have amassed the largest war chests of public donations are nowhere near the winner’s circle when it comes to making money.

UK -- whose $1 billion endowment is the state’s largest -- ranked a mediocre sixth in generating returns on donors’ money over five years. The U of L Foundation’s ranked ninth.

The endowment that generated the best three- and five-year returns as of Dec. 31 was the College Heights Foundation at Western Kentucky University. The smaller of two endowments at Western, College Heights posted an average annual return of 7.4 percent on its investments from 2011 through 2015. It was also the second-best performer in 2015 alone, when a flat stock market, low bond yields and plunging commodity prices sent most endowment balances into reverse.

Throughout the United States, universities solicit donations to their endowment to help fund academic programs, faculty recruitment, student scholarships, construction and other missions. Endowments have become more critical as states reduce taxpayer funding of higher education, and how colleges invest their donors’ largesse has likewise grown in importance.

Unlike UK and U of L, College Heights doesn’t boast its own investment staff. The foundation board’s five-person investment committee relies on outside counsel, the Ridley Group of Wells Fargo Advisors in Bowling Green. That advice? Tread lightly on the more exotic -- and more expensive -- places to put money, like hedge funds, commodity futures and Wall Street’s latest concoctions, and stick to basic stocks, bonds and mutual funds.

Donald Smith, president of the College Heights Foundation, said its board takes a long-term view. As in 50 or 100 years.

“When we know that these endowments have to be preserved forever, when we guarantee donors that something’s going to last in perpetuity, that’s a long time and we want to make sure that we treat the investments accordingly,” Smith said.

College Heights manages an endowment of $53 million -- 1/20th the size of UK’s. Less than 2 percent of its money is tied up in so-called “alternative” investments like hedge funds. The Murray State Foundation has even less appetite for alternatives. There are none on its plate. Yet it racked up a 6.4 percent average annual return on its portfolio of stocks and bonds over the last half-decade, good for third best in Kentucky.
University of Kentucky
The UK endowment, on the other hand, reflects a national trend among colleges with more than $1 billion to invest. The school is putting its cash in exotic, expensive and risky funds. Almost two-thirds of its money -- 64 percent -- is in alternatives, slightly higher than the 57 percent average for U.S. institutions that size. UK does it to spread its risk.

But by doing so, UK has depressed its investment returns. By that measure, UK has done worse than the smallest of Kentucky college endowments -- Morehead State, Murray State and Kentucky State -- over five years. Over 10, UK has failed to match its own investing benchmarks.

Some investors are backtracking from hedge funds, a vehicle aimed at institutional investors and the wealthy. The public employees pension fund in New York City -- where most hedge funds are based -- declared last month that it was ditching hedge funds. California's public pension fund, the nation’s biggest, began vacating hedge funds in 2014 and later pledged to reduce its private equity managers by two-thirds. It saved $217 million in fees in its latest fiscal year.

“When you look at the returns over a long period, hedge funds have not done what they were theoretically meant to do and nor have other forms of alternative investment,” said Sebastian Mallaby, author of “More Money Than God,” a 2010 book about hedge funds. “These custodians of the public’s money would be better off paying lower fees and going into more straightforward investment vehicles.”
University of Louisville
At least UK knows how much it pays the 27 different outside managers of its money -- $8.5 million in fiscal 2015. The University of Louisville Foundation, which manages that university’s $730.5 million in investment assets, does not. It was unable to provide an annual dollar figure based on its fee terms with 104 fund managers.

“Our returns are net of fees so we do not receive an invoice for management fees to be paid,” said Jason Tomlinson, the foundation’s chief financial officer. “Those 104 managers move funds in and out of a multitude of investments with varying fee structures.”

Kentucky Retirement Systems, the state’s $16 billion public pension fund, found a way to count what it pays to its 104 managers. Its tab in the first nine months of the current state fiscal year? $76 million.

Chris Tobe, a Kentucky Retirement Systems trustee from 2008 to 2012, says donors and the public should be disturbed by the lack of fee disclosure by U of L. Moreover, he says trustees at U of L and UK are probably in the dark about their endowment’s returns relative to other schools.

“They may not even know they’re underperforming that badly,” said Tobe, an investment consultant living in Anchorage. “Everything is presented in such an industry-friendly way by the consultants that I think sometimes they are captive to the hedge fund and private equity industries.”

According to the National Association of College and University Business Officers and Commonfund, alternative investment returns have lagged behind U.S. stocks -- badly -- in each of the past six college years. The last time alternatives outperformed U.S. stocks in college was in the bear market of 2008-09. U.S. stocks lost 25.5 percent of their value that year. Alternatives lost 17.8 percent.

The Murray State Foundation has refrained from buying alternatives. It prefers low-cost stock index funds, said foundation President Robert Jackson.

“Historically, hedge funds and alternatives have had high fees, and the risk-reward ratio has not been that good,” he said. “We have not gone that route and, to be honest, we have not considered that route.”

It isn’t known how the investment returns of Kentucky college endowments compared with the national average in periods ending Dec. 31. The NACUBO-Commonfund study only compiles returns for school years ending June 30.

Mallaby, a senior fellow at the nonpartisan think tank Council on Foreign Relations in New York City, says there could be many reasons for Kentucky’s less-than-sprightly dance with alternatives.

“Maybe a small state like Kentucky is just not well set up to access the best at alternatives,” he said. “Maybe they get tripped up by middlemen. Maybe they wind up paying an extra layer of fees they really shouldn’t pay. Maybe they choose the bad alternative managers, not the good ones.

“If you’re going to try the alternatives strategy, you’ve got to be very good at it,” he said. “Maybe your data is showing you that Kentucky isn’t, and therefore it’s not a good idea to try it.”

Reporter James McNair can be reached at jmcnair@kycir.org and (502) 814.6543.

Disclosure: In October 2014, the University of Louisville, which for years has donated to Louisville Public Media, earmarked $10,000 to KyCIR as part of a larger LPM donation.

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