US universities, young millionaires welcome alternatives

Two separate studies show that many American institutions of higher education and high-net-worth investors are increasingly willing to allocate to alternative assets like private equity and hedge funds.

The National Association of College and University Business Officers (NACUBO) and the financial services organisation TIAA-CREF have released a joint report that a diversified investment strategy has helped colleges and universities in 2006. The institutions saw an average rate of return of 10.7 percent last year, the report said.

“The investment performance provides colleges and universities with income to help support their educational and operating expenses, as well as offset their endowment management fees and reinvest a share of the income to preserve the value of the endowment against inflation,” the report said.

Though 78 percent of higher education endowments invested only in equities and fixed income in 2006, alternative assets have become increasingly popular, the study found. “Allocations to traditional assets have declined 1 to 2 percentage points a year over the past ten years,” according to the study.

In the past 10 years, the percentage of endowment portfolios dedicated to alternative assets has increased more than three times, from approximately 5.4 percent to 17.3 percent.

Between 1997 and 2006, private equity investments by colleges and universities saw an increase of about 533 percent, from 0.3 percent of endowment investments to 1.9 percent. Venture capital investments saw a much smaller increase—just 29 percent—over the same time period, comprising 0.7 percent of investments in 1997 and 0.9 percent last year.

Other investment types also increased between 1997 and 2006. Natural resources jumped up 400 percent from 0.3 percent to 1.5 percent of investments, hedge funds increased by 336 percent from 2.2 percent to 9.6 percent of investments and real estate increased by 84 percent from 1.9 percent to 3.5 percent of investments.

Millionaires, particularly those between the ages of 27 and 41, have also been confident in the ability of alternative assets like private equity to generate returns for them.

“Despite a discernable slowdown in US economic growth in the second half of 2006 and a continuing steady stream of often disconcerting geopolitical headlines, investors continue to embrace risk across equity, fixed income and alternative asset classes with remarkable calm and tenacity,” said John Skjervem in a statement. Skjervem is the chief investment officer for the Personal Financial Services Division of integrated financial services provider Northern Trust, which conducted the survey.

More wealth correlated with an increased willingness to invest in alternatives, the survey found. People with $10 million or more to invest said that they have set aside 31 percent of that money for private equity, hedge fund and commodities investments. Those with less than $10 million to invest had allocated an average of just 7 percent for such investments.

Younger wealthy people are also more willing to invest in alternatives. Twenty-seven percent of “genX millionaires” between the ages of 27 and 41 are more likely to invest in them, while only 17 percent of “Baby Boomers” between the ages of 42 and 60 will. Only 11 percent of “mature millionaires” older than 60 will do so.

“Alternative asset class investments, particularly hedge funds and private equity, often have lock-up provisions and other limitations on liquidity,” said Skjervem in the statement. “These types of investments also do not typically generate any current income. So it really comes as no surprise to find allocations to alternative assets inversely correlated with age. Younger investors, presumably still working, can afford to invest a larger proportion of their portfolio in an illiquid, non-income producing asset class. On the other hand, older investors, particularly retirees, usually rely on their investment portfolios for at least some part of the income needed to support their lifestyles. Older investors place a premium on liquidity too.”

Northern Trust also found that 40 percent of millionaires surveyed had not set aside any money at all for alternative investments. Of those, 37 percent hesitated to do so because they had concerns about product complexity or didn’t feel confident in their understanding of alternative investments. Thirty-two percent said they did not believe the returns on the investments would correlate with the risks.

Nearly half of the millionaires said they have allocated at least 10 percent of their portfolios for alternative investments. Fifty-three percent of those people said they did so for portfolio diversification and 34 percent have confidence in the ability of the alternatives to bring back higher returns.