University endowment returns are underspent - Higher Education - Statistical Data Included

Challenge, July-August, 2002 by Donald Frey

Different universities might reasonably answer these questions differently and should have the freedom to act on the basis of different answers. Different answers to these questions will produce different spending profiles. For example, actual real returns would exceed spending based on average real returns in some periods, and vice versa, depending on the answers to some of these questions. Such is to be expected and is acceptable. What is important is that universities adopt good-faith policies of spending all real returns based on defensible answers to these questions of implementation.

By all the relevant norms, universities ought to spend more of their endowment returns for the benefit of present students than they do. And in certain circumstances, spending principal may be justified as well. Operating as though the endowment's growth was an end in itself is unjustifiable and violates the university's obligations to its beneficiaries. The words of the late economist Robert Eisner bear repeating. He scorned "the university practice of using endowment to build forever for the future. Jam tomorrow, but never jam today!" (16)

Notes

(1.) See Peter Brimelow, "Professor Scrooge," Forbes, October 19, 1998, pp. 60-61. See Newsweek, February 7, 2000, pp. 28-29, for a report on the exceptional decision of Williams College to freeze tuition.

(2.) Rate of growth is the return on invested endowment funds, and does not include growth due to new gifts. Results on returns to endowment investment pools and spending rates for 1990s are reported by Donna Klinger in "A Double Digit Decade," National Association of College and University Business Officers (NACUBO) Web site (www.nacubo.org). (The article was also published in NACUBO Business Officer, February 2000.) Returns for the ten years 199 1-2001 are reported by Donna Klinger in "Outpacing the Economy" (NACUBO Business Officer, January 2002) on the same Web site. A NACUBO news release of January 17, 2002, also found on the NACUBO Web site, cites 4.5 percent as the "general rule" for spending from endowment.

(3.) The NACUBO Endowment Study for fiscal year 1997 reported that the withdrawal rate from the largest endowments was only 4.9 percent. In fact, endowment wealth and spending were inversely related, with spending from the smallest endowments being 6.3 percent that year. Rapid endowment growth will tend to depress the rate of withdrawal for universities that spend a fixed proportion of a moving average of endowment values. Rapid growth will keep the moving average well below the current endowment value, thus depressing the withdrawal figured as a proportion of current year's value. Although it is likely that large endowment managers spend from a moving average, this cannot explain the low spending rate. For the 1990s, this effect accounted for barely more than half a percentage point of the huge gap between returns and spending.

(4.) From 1926 to 1997, total nominal return on stocks was 10.6 percent. and consumer price inflation was 3.1 percent, giving a real total return of 7.5 percent (Monetary Trends, Federal Reserve Bank of St. Louis, June 1999). Extending the time period through 2001 does not materially change the real return (based on results reported by Bloomberg News Service). Can it be expected that university endowments on average will achieve a return equal to the long-run return on domestic equities? During the ten years ending in mid-2001, the dollar-weighted mean return of endowment investment pools was within 0.4 percentage point of the return of the Russell 3000, and the average for the largest endowments just exceeded it. During the down market of FY 2001, all classifications of university endowment pools did far better than the major averages (Klinger, "Outpacing the Economy," 2002).