Dealing with Wrong-Way Risk: A University Endowment’s Perspective

Mike Edleson

This chapter considers the rationale for protecting investment portfolios against extreme left-tail risks in the context of managing a university endowment fund. The challenges faced by universities in the global financial crisis of 2007–09 were just as real as those faced by other institutions. Top US endowments were down –16% to –28% in 2009 (nearly all endowment fiscal years end in June, consistent with the academic cycle), averaging a loss of just over 21%. Looking at peak-to-trough drawdowns, and adjusting for some investment and accounting quirks that are endemic to endowment investing, the losses were even worse. For the “typical” large endowment, the true economic loss from late 2007 to early 2009, correcting for lagged valuations of private investments, was –40% to –45%. For the largest endowments it was even higher, exceeding –50% in at least one case.

While endowment management is considered a long-run endeavour, the supposedly long-term investment horizon of these universities did not make the extreme and extended pain of their losses any less destructive – and, in relative terms, immediate spending needs became nearly double the draw on the endowment compared to the