The College relies each year on drawing five percent from our endowment to cover approximately 50 percent of our operating expenses. This means that for the endowment to be able to support future students to the degree that it does current students, the endowment has to grow in the long run by an average of five percent plus inflation. Our office’s goal is to hit this target while incurring a manageable amount of risk.
Two questions often arise about the endowment, which I’ll try to explain here. Why does the College invest in funds rather than in the securities (e.g. stocks and bonds) of individual companies? And why do we not know every single company that those funds are invested in?
So, first, why does the College have 97 percent of its endowment in funds and only three percent in direct holdings?
The entire endowment is managed by outside investment managers, mostly in fund structures. The Investment Office does not buy or sell individual stocks. We use commingled funds rather than separate accounts (which would allow us to hold stocks directly) because many of the best-performing managers use this structure.
The funds they manage are diverse, covering different geographies, assets and the public and private markets. These funds also benefit from economies of scale, since they take what the College invests and commingle it with often much larger investments from other institutions, pension funds, etc. This combination of diversification and economies of scale can provide a higher return for lower risk.
To see how much higher a return, let’s look at the past 10 years. Between 2004 and 2014, the College’s endowment grew by an annual rate of nine percent. Over the same period, a standard portfolio of 60 percent stocks and 40 percent bonds averaged annual returns of 6.9 percent. What does this mean in dollar terms? That on June 30, 2014, the endowment was at least $300 million larger than it would have been if were invested in a simple stock/bond portfolio. And since the College spends five percent per year from the endowment, there would have been at least $15 million less to spend in the current year alone.
Over a longer period of time, those differences would compound further.
This higher return has been earned with lower risk (or volatility) than a standard portfolio because of the greater diversification of commingled funds. Volatility is important to the College. Following a down investment year, the College can’t decide to cut back on the number of students or, as a business would, the number of programs or employees. The lower volatility of the College’s endowment certainly came in handy during the dramatic drop in financial markets in 2008, after which some peer schools had to cut more than the College did or had to borrow at adverse rates that will have long-term effects.
The College is fortunate to be among institutions able to invest in these funds. These are open to us because our endowment is relatively large, because the College is considered a desirable, reliable investor and because we’re able to benefit from the knowledge and connections of our alumni.
Why do we not know every single company that our funds invest in?
Each fund has a unique mix of investments, which is generated through detailed research and often constitutes a fund’s competitive advantage. Divulging the mix would, in some ways, be like Coca-Cola divulging its recipe. While we certainly understand a large extent of what our funds are investing in, we may not know every last investment in a timely manner. Funds do provide information to us on their investments, but we generally don’t receive that information on a real time basis.
We don’t disclose the list of our fund managers because of agreements we have entered that relate to confidentiality.
I hope this helps clarify why the College is invested in commingled funds (doing so allows us to create a diversified portfolio that earns higher returns with lower risk) and why the confidentiality of those funds contributes to their ability to provide those advantages.
Abigail Wattley ’05 is a Director in the Williams College Investment Office.