Investment Highlights from Charles A. Kennedy, Chief Investment Officer

Overview

Built on a foundation of generous gifts from alumni and other supporters to the university, Carnegie Mellon University’s endowment serves as a key contributor to achieving the institution’s long-term mission. Providing a permanent and consistent source of funding, the endowment enables Carnegie Mellon to pursue research and education initiatives, including sponsoring student scholarships that would not otherwise be available. Consequently, keen university stewardship of these funds is essential.

Fiscal year 2018 marks the sixth consecutive year in which endowment support as a percentage of the operating budget increased, starting with 4.5 percent of the university’s operations in fiscal year 2013 and rising to 6.8 percent in fiscal year 2018. This relatively higher support was achieved while the overall university’s operations continued to grow. However, the university’s endowment contribution to operations is only about one-third that of other universities with endowments greater than $1 billion, and even smaller when compared to a more select group of peer institutions. This leaves CMU more dependent on tuition and sponsored research than its peers, reducing its financial flexibility. This shortfall is being addressed through a greater focus on building the endowment over the long-term.

Strategy and Allocation

The endowment portfolio is managed with a long-term, growth-oriented view and evaluated by its effectiveness in achieving — over time — two fundamental objectives: (1) generating steady and substantial financial support for students, faculty and programs; and (2) balancing the current needs of various constituencies with the minimum goal of maintaining the endowment’s real purchasing power for future generations (i.e., preserving intergenerational equity). To maximize long-term expected returns within acceptable levels of risk and liquidity, Carnegie Mellon designed its policy asset allocation to use a combination of academic theory, quantitative analysis and informed market judgment.

Fiscal year 2018 marks the 14th anniversary of the university’s decision to better position the investment portfolio to achieve its long-term performance goals by shifting the focus from traditional, publicly traded investments to private investments, particularly private equity funds, including some within rapidly growing international markets. Investing through private equity funds encompasses a lengthy process of selecting allocation targets for various asset classes (e.g., venture capital, buyouts and real assets), evaluating and selecting fund managers, and ultimately making commitments to long-term private partnerships as fund managers come to market periodically.

After a commitment to a fund is made, investors are called upon to provide capital as the fund manager discovers, acquires and invests in companies during an investment period that generally lasts several years. After fund investments are made, the fund manager, whose own interests are generally well-aligned with fund investors, will seek to add value to each underlying company in several ways, including increasing sales and profitability, improving capital management, and otherwise improving long-term prospects so that the businesses can be sold for more than the purchase prices. While these acquisition, value-add and harvesting processes may take several years each, we believe that over the long-term, private equity investment returns will exceed the returns available from investing in public securities, thereby, enabling the endowment to better contribute to the university mission.

Investing in private funds is a lengthy process that takes many years to achieve a target allocation with a mature underlying portfolio of companies. At this 14th anniversary of the university’s commitment to the new strategy, Carnegie Mellon’s private portfolio is maturing. However, recent contributions to the endowment have resulted in below targeted private investment allocations. Achieving the target again will require several years of commitments, capital calls, and the maturing of underlying investments. Fortunately, Carnegie Mellon’s endowment is still of a size that permits new commitments to investment managers to be sized appropriately for the managers while making a meaningful contribution to the endowment’s asset allocation and investment return.

The following table details the asset allocation targets and the actual allocation as of June 30, 2018:

Figure 1 – Policy Allocation Targets and June 30, 2018 Allocations

As depicted in Figure 1, a 10-percentage point over-allocation (compared to target) to U.S. and international public equities was offset by a similar under-allocation to private investments in private equity and real assets. This misallocation is primarily due to a large cash influx to the endowment in fiscal year 2017 that was invested in public equities for capital appreciation pending reallocation of an appropriate share to new private investment opportunities to be identified and funded in coming years. 

Investment Performance 

As shown in Figure 2, the university’s investment performance for fiscal year 2018 was 11.2 percent net of all fees and expenses.

More significantly, given the long-term goals of the investment strategy and the tension often associated with short-term equity results, Carnegie Mellon’s three- and five-year returns were 7.7 percent and 9.6 percent, respectively. The university’s one-year return followed a return of 13.2 percent for fiscal year 2017 and -0.9 percent for fiscal year 2016. (Note: Some institutions report results reflecting a lag of one quarter for private investment funds. When incorporating this lag into the return for fiscal years 2018, 2017 and 2016, the university returns would have been 10.3 percent, 13.0 percent, and -0.1 percent, respectively.)

Figure 2 – Endowment Ending Value and Annual Investment Return

Endowment Attribution

The endowment’s market value increased to $1,886.8 million as of June 30, 2018, from $1,719.7 million as of June 30, 2017. This net increase of approximately $167.1 million reflects the collective impact of $62.3 million from gifts and other sources, plus $185.8 million from investment gains, less $81.0 million of distributions to support the university’s operations. Cash distributions from the endowment (i.e., the draw) provide a key source of support for various university activities and programs ranging from general operations to specific needs, such as scholarships and professorships. As previously pointed out, the endowment remains significantly smaller — both in absolute terms and on a per student basis — relative to our peer institutions, resulting in a high reliance of the operating budget on tuition and private support. The endowment’s size and influence will not increase exclusively through investment returns. The level of future gifts to the university will significantly influence the endowment’s level of future impact.

The historical activities of the endowment, including the draw and its support expressed as a percentage of annual operations, are summarized in Figure 3.

Figure 3 – Endowment Attribution

During the last decade, the draw from the endowment has contributed, on average, approximately 5.5 percent of the university’s annual operating budget. For fiscal year 2018, the draw from the endowment provided 6.8 percent of the university’s operating budget. Viewed as a percentage of the annual budget, the relative support from the draw is affected not only by the growth in the endowment and the draw formula (see Note 6 on p. 24 of the consolidated financial statements), but also by the growth in the university’s annual operating budget, which increased by an average of 3.9 percent annually for the past decade. 

The Dietrich Foundation

The Dietrich Foundation, established by Pittsburgh industrialist and longtime university trustee William S. Dietrich II, was created to manage in perpetuity his gift of approximately $500 million in assets intended to benefit the university and other higher education and charitable institutions. The Dietrich Foundation’s assets are not reflected in the university’s financial statements (see additional information regarding the foundation in Note 16 on p. 44 of the consolidated financial statements). The university’s share of the annual distributions from The Dietrich Foundation is 53.5 percent. If this percentage is applied to the estimated value of The Dietrich Foundation’s assets of $933.0 million as of June 30, 2018, and the result added to Carnegie Mellon’s endowment of $1,886.8 million, the combination would total $2,386.0 million. Annual distributions from The Dietrich Foundation over time equal 3 percent of the value of the foundation’s net assets as measured on January 1 of each year. The Dietrich Foundation’s gift added to Carnegie Mellon’s endowment for fiscal year 2018 was $12.8 million, and cumulative gifts since the initial gift in fiscal year 2013 total $64.6 million.

Summary

Carnegie Mellon’s endowment provides a permanent source of financial and operational stability, which helps university leadership to perpetuate academic and research excellence in a rapidly changing and increasingly competitive world. Enduring generosity of alumni and friends and an investment program focused on compounding net returns for the long-term should continue to increase the value of CMU’s endowment over time, providing ongoing support for the university’s operating needs while preserving purchasing power to support future generations of students, faculty and programs.

Charles A. Kennedy
Chief Investment Officer
October 15, 2018