Stepped Up Endowment Spending Could Spark a Flight from Risk

February 8, 2008 (PLANSPONSOR.COM) - Continuing public pressure on university endowments to help worthy students fund their educations is likely to cause the endowment money managers to scale back their risk appetite - and potentially miss out on higher returns that can flow from increased risk.

A new Watson Wyatt Worldwide study says an endowment flight from risk toward investments with more predictable returns could pinch the endowments’ future performance, according to a news release. The consultant pointed out recent decisions by Harvard and Yale to increase endowment spending will likely compel other universities to boost their own outlays to compete for students.

“Whether by mandate or natural competitive forces, the prospect of increased annual spending raises significant investment strategy issues for endowments,” said Carl Hess, director of Watson Wyatt’s investment consulting in North America, in the news release.
Watson Wyatt said one reason endowments have performed so well in past years is that they have been able to take on greater investment risk than other institutional investors such as pension funds because they typically have conservative spending policies and more flexibility in setting annual outlays. As a result, they traditionally have been able to offset investment losses with lower spending.

By comparison, pension funds need to structure their investments to provide predictable annual benefits for retirees. “The price of this predictability is lower returns,” said Mark Ruloff, director of asset allocation at Watson Wyatt, in the news announcement. “And higher endowment spending would necessitate more predictability.”
The pressure to increase endowment spending means universities will have to pay more attention to the spending side of the equation in setting investment strategies, Watson Wyatt asserted. “One way or another, it’s time for most universities to review investment strategies, spending policies, and related governance issues,” said Hess.