Why the Nobel Prize payout is shrinkingJune 14, 2012: 10:52 AM ET
The endowment for the prestigious prize fell so short on its returns that it was forced to do what seemed unthinkable. Here's why it happened.
FORTUNE -- In 1895, Alfred Nobel, the late inventor of dynamite, left much of his fortune in a fund dedicated to recognizing the world's greatest geniuses. Over the years, his gift paid for hundreds of awards attached to the Nobel Prize. Yet his donation has worn thin.
Earlier this week, the Nobel Foundation, which awards the Nobel Prize, announced it was reducing its cash prizes. Each one now will be worth about $1.1 million, down from last year's $1.4 million, a result of disappointing returns on investments.
Stocks haven't been paying out like they used to. And like many endowments and public pensions, the foundation finds itself adjusting to a period of record-low interest rates and a volatile stock market.
"We went into the lost decade with a fairly high share [invested] in equities," said Lars Heikensten, the Nobel Foundation's executive director, referencing what investors called the dismal showing of the U.S. stock market since the early 2000s. "That had its basis in the idea that since we were in it forever we would take risks."
The assumption of decent returns and risk appetite has not paid off. As of December 31, the foundation had $419 million in invested capital. During the past 10 years, annual returns have averaged 1.5% to 2%, said Heikensten, speaking over telephone from the foundation's office in Sweden. That's markedly less than the at least 3.5% to 4% return the foundation needs to cover costs of the prizes and related operating expenses.
When it comes to stocks, the foundation appears to have become more risk averse in recent years. Whereas 67% of the Nobel Foundation's capital in 2007 went toward equities (the bulk of which U.S. and European companies), that share fell to 47% in 2011.
Capital toward fixed income investments including bonds have stayed roughly the same during the same period, while the share of capital going into so-called alternative investments including properties, as well as hedge funds and private equity funds, more than doubled to 33% in 2011, compared with 12% in 2007.
Last year, the foundation named 13 Laureates, adding to the 853 (830 individuals and 23 organizatons) that have received a Nobel Prize or the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
Going forward, the Nobel Foundation will be taking steps to improve its returns: Unlike public pensions and large university endowments, investment decisions are made in-house by the foundation's chief investment officer rather than an outside money manager. However, the foundation recently created a committee of Swedish financiers to help determine how to reallocate the portfolio, Heikensten said.
Among other changes, the foundation also plans to streamline investments, bringing them down from about 40 to about 20 to 25, he added. It also plans to invest in funds that charge lower fees.
Above all, the foundation has changed expectations of the investing environment, given troubling debt in industrialized countries including the U.S. and parts of Europe have pushed interest rates to record lows.
"There is good reason to believe that we are in an adjustment period … and that returns will continue to be fairly low over that period, " Heikensten said.