Success Story: University Endowments

University endowment managers may be little-known, but they invest more than $340 billion and have an uncanny knack for beating the market.

Over the last four years, endowments and foundations as a group have beaten both the S&P 500 and a mix of the S&P and the Lehman Aggregate Bond Index. Over the last 10 years, endowments worth more than $1 billion averaged returns of 11.4 percent per year compared with the S&P’s 8.3 percent.

“The endowments and foundations don't have the incentive to go public in quite the way that other investments managers do,” said Brett Hammond, chief investment strategist for TIAA-CREF. “Their job is to work behind the scenes to develop options, asset allocation alternatives that can do well for them.”

As such, these managers lead the push into alternative investments like private equity, hedge funds, real estate and natural resources, helping them earn an average one-year return rate of 10.7 percent for fiscal year 2006.

In fact, allocations to traditional assets have declined 1 to 2 percentage points a year over the past ten years, according to a study by the National Association of College and University Business Officers (NACUBO) in conjunction with TIAA-CREF. As a result, the portion of investments in asset classes other than equities and fixed income has more than tripled over the last decade from 5.4 percent to 17.3 percent of investment portfolios.

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.

Some institutions, like Princeton University, have done so well that the schools have eliminated all loans for students, replacing them with outright grants. But can they maintain those returns and the subsequent grants now that the investing climate has changed? Already, many of these endowments are heading overseas to infrastructure investment in China, India and other investments like private equity in developing nations.

“The question is now, where is the long-term return going to come from?” Hammond said. “What I think you'll see now is some of the big institutions leading the way as they enter international.”

© 2009 CNBC.com