What drives pay for chief investment officers at endowments?

Nonprofit organizations play vital roles in modern societies across a wide spectrum, including the arts, medicine and education, and their endowment funds provide billions of dollars annually to support the missions of the organization they serve. Due to their typically low liquidity needs and infinite investment horizons, endowments can invest in illiquid asset classes, such as private equity and venture capital. However, such an approach to investing, often referred to as the endowment model pioneered by David Swensen at Yale University, presents additional challenges, such as managing capital calls, rebalancing and manager due diligence.

These complexities create the need to hire in-house investment professionals, or chief investment officers (CIOs). How are nonprofit endowment managers compensated? Do endowment CIOs get paid more than public pension fund managers for managing funds invested in alternative assets, and what impact does compensation have on endowment performance? These are some of the questions Bob Harris, a finance professor at the University of Virginia Darden School of Business, and I tried to answer.

Our research, which was published as a Kenan Institute of Private Enterprise Research Paper, analyzed the compensation of endowment CIOs using previously unexplored compensation data from the Internal Revenue Service (IRS). We examined how the characteristics of the endowments and CIOs affected the level and structure of pay. While there is a large body of literature on compensation to managers of public securities, typically based on mutual fund data, there is limited evidence when investment managers face the added complexities of alternative assets that are often illiquid, not easily scaled, and have high search and monitoring costs.

Endowment CIOs rake in three times more than public pension fund peers. What's behind the pay gap?

Our study found a striking compensation gap between endowment CIOs and their public pension fund counterparts. On average, endowment CIOs earn a whopping $800,000 in total annual compensation, three times more than their peers at pension funds. Incentive compensation makes up a significant portion of their pay, with more than 40% being tied to incentives —almost four times more than pension plan CIOs.

Size, complexity, governance and labor market: What determines CIO compensation?

Size most certainly plays a role in explaining pay differences across endowments, with endowments in the top quartile of size paying their investment managers much more than their smaller counterparts. But even a $2 billion university endowment for a state university pays their CIO five times more than what the CIO of a $40 billion state pension fund makes. It's clear that being a CIO of a large endowment fund has its perks, and a hefty salary is one of them. But why the disparity with pensions?

It turns out size and human capital play a role. Despite endowments managing assets that are 10 times smaller than those at pension funds, endowments are attracting more talented people thanks to their higher pay packages. Endowments hire more talented CIOs, who graduated from colleges with substantially higher SAT scores compared to pension CIOs. In fact, top-earning endowment CIOs graduated from colleges with an average SAT score over 1400, compared to 1320 for their pension fund peers. Not only that, but higher compensation packages also play a role in attracting and retaining top talent. Endowment CIOs stay in their jobs for twice as long as public pension CIOs, with an average tenure of 10 years — substantially longer than the average of six years for pensions.

When it comes to CIO compensation, size matters, but so do complexity and governance. Endowments with more complex portfolios (e.g., more hedge funds and private equity investments) and higher percentage of independent governing bodies tend to earn more. Additionally, labor market considerations such as location and cost of living play a role.

Interestingly, this raises questions about pension plans, which are often based in remote state capitals. Would the same labor market factors apply? And could the location of these plans impact their ability to attract and retain top investment talent if compensation is inadequate?

Does astronomical pay lead to higher endowment performance?

It does, and it does not. Higher compensation does lead to higher future performance, but the effect is driven by the underlying determinants of pay (size, talent, location, etc.). This suggests that the endowment CIO labor market effectively structures contracts to attract and motivate talent needed for a particular endowment. This contrasts with outcomes for public pension funds where frictions constrain pensions from offering competitive compensation to attract talent, resulting in lower pension performance.

Swensen's legacy continues: CIOs trained under investment guru outperform peers

David Swensen, the former CIO of Yale University's endowment, is widely considered a legend in the world of endowment investing. (In 1985, he was tapped as Yale’s CIO at the age of 31. He served in this role for more than three decades prior to his death in 2021.)

Swensen pioneered the endowment model involving large allocations to alternatives. Such experience might provide skills and networks over and above those captured by our other measures and not readily duplicated. We found this experience is not linked to compensation but is associated with significantly higher future endowment returns even controlling for all other factors.

The effects are large and imply that Swensen’s trained CIOs outperform other CIOs at large endowments by about 130 basis points per year. Because there is a small sample of CIOs who previously worked for Swensen, the results are only suggestive but do point to the importance of specialized networks and skills when investing in alternative assets.