Ivy League Endowments Finally 'Dumb'

The markets finally found a way to stump the Ivy League.

The largest college endowments, long the envy of their smaller rivals for their sophisticated and profitable investment strategies, were left behind over the past year by the performance of smaller schools with far simpler approaches.

The fiscal year for most endowments ends Tuesday and nearly every one has had big declines, but smaller endowments are poised to outperform heavyweights like Harvard University and Yale University by significant margins. Endowments with less than $1 billion generally held up better by putting more money in fixed income and less in alternative investments like hedge funds.

Their superior performance is a sharp reversal from most years, when elite colleges profited from investments like hedge funds, private equity and real estate to finish at the head of the class. Even during the period after the dot-com bust, when most endowments had substantial losses, Harvard saw only modest declines. Yale eked out gains.

This fiscal year, alternative investments failed to offer much diversification, falling alongside the plunging stock market.

The five largest single-school endowments, which in addition to Harvard and Yale, are Stanford University, Princeton University and the Massachusetts Institute of Technology, have said they are planning for declines of 25% to 30% for the fiscal year.

By contrast, the median decline for an endowment or foundation for the first 11 months of the fiscal year was 20%, according to Northern Trust Corp. Foundations and endowments with less than $100 million in assets did even better, down 16% for the period. The Chicago financial firm is custodian for 90 endowments.

"People have discovered the weakness of the model, the lack of true diversity," says Larry Johnson, investments manager at the Idaho Endowment Fund Investment Board. He has considered hedge funds and private-equity investments but recently has become more leery, sticking to stocks and bonds. The $881 million fund was down 18.1% for the fiscal year through May.

The so-called Yale approach espoused that endowments -- as long-term investors unconcerned about redemptions or short-term market fluctuations -- were the ideal candidates for alternatives. Yet in 2008, many of these assets became hard to sell, forcing schools to either dump their best-performing securities or funds, or borrow money, to meet their obligations.

Ivy League schools, more reliant on investment gains to fund daily operations, also suffered more from these drops. The average college relies on its endowment for 5% of its operating revenue, while at Ivy League schools the number ranges from 25% to 45%. That caused the type of asset-liability mismatch that has long bedeviled financial firms.

"A lesson from this crisis is that following what the larger guys have done is not necessarily road map to success," says Daniel Jick, head of HighVista Strategies, a Boston-based firm that manages endowment money for small schools.

Yale officials point to the endowment's 15.9% average annual return over 20 years through 2008. David Swensen, Yale's chief investment officer, has said that despite the school's warning of a 25% decline, he isn't changing his investment approach. "That would require moving away from equity-oriented investments that have served institutions with long time horizons well," he said in an interview earlier this year.

Randy Livingston, chief financial officer for Stanford, agrees it would be premature to write off the Yale model because of one tough stretch. But he adds that the credit crisis underscored that the investment team will look for ways to enhance the portfolio's liquidity.

Data from Commonfund, a Wilton, Conn., nonprofit that advises colleges and schools, shows the smaller the endowment, the higher on average was its investment in fixed income.

Endowments with more than $1 billon in assets had on average 11% in fixed income and 57% in alternatives in December 2008. Yale was even more skewed with only 4% in fixed-income and 70% in alternatives. Endowments with total assets of $51 million to $100 million had 19% in fixed income, and 27% in alternatives.

"Smaller endowments tend to have a stronger preference for liquidity, so they have more money in domestic stocks, bonds, foreign stocks," says William Jarvis, head of research, at Commonfund.

Write to Craig Karmin at craig.karmin@wsj.com