Recent Financial Events and University Endowments
Accuse me of fiddling while Rome burns, but I’ve been thinking about what the current financial situation means for university endowments. Over the summer I blogged about how endowments are coming under increasing scrutiny from the Senate Finance Committee. The latest round was a panel discussion in early September that was sponsored by Senator Charles Grassley (Iowa Republican) and Representative Peter Welch (Vermont Democrat). Some of the discussion focused on the possibility of enacting mandatory spending requirements, such that institutions would be required to spend five (or more) percent of their endowment assets each year. (You can watch the discussion here.)
I suspect that recent economic events have made the possibility of mandatory spending requirements a non-starter, at least for now. Universities have long argued that they need the flexibility to save more during good times, so that they will have necessary resources on hand during bad times. The current financial crisis has given this argument a saliency that it lacked just six weeks ago. Moreover, it’s not difficult to shock the public conscience when universities sit on multi-billion endowments that grow by more than 20 % in a single year. But the politics will be a bit trickier if university endowment sheets bear any resemblance to my last TIAA-CREF statement.
If the financial crisis discourages Congress from considering mandatory spending requirements, this is one small spot of silver among the dark clouds. Even in a world of mandatory spending, universities are likely to try to maintain the size of their endowments. To do so, usually the endowment yield must at least equal the annual institutional budget increase and the required payout amount. Higher education has been increasing at a rate of roughly 6 percent each year, so the typical university might aim for a yield of 11 percent (to cover the 5 % annual payout and the budget increase). This would likely push universities with conservative endowment management policies toward strategies that offer the possibility of higher returns. These same strategies are likely to have higher risk and greater yield variability.
Professor Mark Schneider of Grinnell College has begun to study endowment patterns at universities and colleges. His very preliminary results demonstrate that high-yield endowments are also more variable. For example, NYU, Cornell, Grinnell and MIT had endowment yields over 10 years of 8.8 %, 10.3 %, 12.4 % and 15.1 %, respectively. Grinnell and MIT had the two highest one-year yields (38 % and 55.6 %), but also the two largest one-year losses (-12.2 % and -10 %). NYU, which had the smallest return over the ten-year period, did not have a single year of negative returns. (Professor Schneider discussed his research in remarks that were submitted after the Congressional panel discussion.)
So what’s the problem with high-risk, high-yield investments, particularly for universities and colleges with endowments that are large enough to withstand the years with negative returns? One persistent criticism of university spending is that some of it actually increases the cost of higher education, because it fuels an arms race for the best facilities and student amenities. (Think of it as keeping up with the Grinnells. Less wealthy institutions believe that they have to make similar expenditures on their physical plants and campuses in order to compete for students.) The naming opportunities that attract large donors often are seen as contributing to the arms race, and the same may be true of the sort of “one-time” spending that a university is likely to undertake after a high-yield year. Although proponents of mandatory spending see it as a means of reducing tuition, a five percent rule may have the opposite effect.
Congress made private foundations subject to a five percent rule to help ensure that they actually served the public good. But no-one seriously doubts that universities and colleges serve the public good. Rather, the question is whether they could do a better job of using their endowments to reduce the cost of higher education and to foster research. Simple one-size-fit-all payout rates are unlikely to provide a satisfactory solution to this complex question.