Is an Endowment a Nest Egg or a Gambler’s Stake?

College investments dropped 23 percent in 2009, the most disastrous year since the National Association of College and University Business Officers began compiling investment statistics in 1971. Two observations can be made about NACUBO’s report, issued last week:
One is: The richer the institution, the harder the fall, generally speaking. Harvard, the nation’s wealthiest university ($26 billion at the end of fiscal year 2009), lost the most: nearly 30 percent. Yale, second wealthiest ($16 billion), lost almost as much as Harvard: almost 29 percent. It was a dreadful investing year for nearly every college endowment manager in the country, what with the deep recession and the twin collapses of the stock market and credit markets in the fall of 2008. According to the NACUBO study, co-sponsored by Commonfund, U.S. colleges and universities lost a total of $93 billion in endowment value during fiscal year 2009. The average loss was 18.7 percent; in 1974, the second-worst year, endowments lost only 11.4 percent. Not one of the nation’s five wealthiest universities, a group that included, besides Harvard and Yale, Stanford, Princeton, and the University of Texas System, bested that 18.7 percent figure (Princeton emerged at the top of the five, with its $13 billion endowment losing only 23 percent of its value in fiscal 2009, while Stanford lost nearly 27 percent and Texas nearly 25 percent).
According to a Jan. 28 article by Inside Higher Education’s Jack Stripling, smaller colleges with lower endowments fared better than their super-rich cousins only—or at least mostly–because their endowments’ relatively modest sizes barred them from either participating in the riskier investments such as hedge funds and private equity funds and also kept those schools from hiring the kind of sophisticated endowment managers who gambled their way into disaster. They were stuck, so to speak, with portfolios heavy on unadventurous investments in fixed-income securities and cash, which happened to be the only ones performing relatively well last fiscal year. After all, as Stripling’s article points out, the wealthy elite institutions that lost the most remained just as wealthy and elite, comparatively speaking, as they had been before the rolling economic crash that began in 2007—in part because their high-risk investments had paid off royally during the boom years. They thus outpaced their smaller poorer cousins over the long run despite the devastating blows to the rich universities’ endowments during the last two years. “Colleges with endowments over $1 billion have an average 10-year return of 6.1 percent, compared with 3.9 percent for the least wealthy,” Stripling wrote—even though the 52 institutions that fell into that category suffered higher-than average endowment shrinkages of 20.5 percent during FY 2009, according to the Chronicle of Higher Education.

That leads into the second observation: Maybe it wasn’t just the happenstance of being less wealthy that led some of the lesser-endowed institutions to put most of their money into low-risk, low-return securities, but a deliberate strategy of using endowment funds as nest eggs providing economic security rather than as vehicles for generating operating capital, as the richer schools did. That seemed to be the approach of New York University, the best performer of the $1 billion-plus group, suffering only a 15 percent decline in the value of its endowment that left it with $2.1 billion at the end of FY 2009. In an interview with, Martin Dorph, NYU’s senior vice president for finance, attributed his school’s comparatively successful performance to the generally conservative nature of NYU’s investments. NYU had a full 35 percent of its endowment in fixed-income investments at the beginning of 2009 and only 40 percent in hedge funds and private equity (the remaining 25 percent was in stocks and other equities). “Our endowment is seen as more precious because we don’t have as much,” Dorph said.
Leon Botstein, president of Bard College and one of the most outspoken critics of the high-flying investment strategies that led to huge losses for many of the richer institutions, concurred. In a telephone interview Botstein explained that Bard, a liberal arts school in Annandale-on-Hudson, N.Y., that enrolls only about 1,600 undergraduates plus another 600 or so graduate students, is “under-endowed” at $200 million. “Our losses were about average, at 18 or 19 percent,” Botstein said. “We got hit, but not excessively. We had only one risky fund, of $11 million, and that was a security put there by a donor. Our philosophy is that [our endowment] is a cash reserve, not a main source of income for us. Returns on our endowment constitute only about 2 percent of our annual income. We prefer to rely for our operating expenses on tuition and on annual philanthropy, like hospitals and nonprofits dedicated to causes or the arts or social services. That means the money is typically spent within five years of the moment it is given.”
The textbook example of the opposite strategy is Harvard, which lumped together its general operating fund and its endowment for investment purposes—and ended up so strapped for cash after a $1.8 billion loss on its checkbook account for its fiscal year ending last June that it had to turn to the state of Massachusetts’s bond-issuing agency for permission to issue some $2.5 billion worth of bonds, some of them tax-exempt, to meet its obligations and buy its way out of disastrous interest-rate swap contracts with investment banking firms that it had entered into in 2004.
The $2.5 billion, according to a detailed story about Harvard’s woes posted on Dec. 18, was around the total amount that the state usually sells annually for all colleges and universities. The swaps involved Harvard’s trading a locked-in loan rate for the $2.3 billion that it planned to borrow (via bonds) in order to build a massive science campus in nearby Allston, Mass., for variable-rate obligations to be paid by J.P. Morgan, Goldman Sachs, and other Wall Street firms. It was essentially a bet by Harvard that interest rates would rise during the late 2000s (generating a profit for Harvard) instead of plunging to nearly zero as they actually did. Faced with a collateral call of nearly $1 billion from the bankers when the gamble backfired and the market value of the swaps fell, along with a liquidity crisis with respect to Harvard’s cash-hemorrhaging operating accounts, the university hastily stopped work on the Allston campus and paid about $900 million in November to unwind the swap agreements. Analysts of the Harvard debacle treat it as a lesson for university financial managers tempted to dabble—as was the case not only at Harvard but at Cornell and Dartmouth, although with less disastrous results–in the novel and complex investment strategies of investment bankers and hedge funds.
“I don’t think that colleges should be competing with Wall Street,” said Botstein, Bard’s president. “Their focus should be on educating their students.” So perhaps it was not simply good luck that the financial managers of poorer colleges happened to lack the sophisticated wherewithal to enter into high-risk arrangements but their deliberate decision to treat endowments as safety nets and their institutions as pay-as-you-go operations.


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