Wednesday, November 03, 2010

Endowments: The Recession Really Is Over

by: Jonathan Robe

Fall term for colleges and universities across America isn't just the season for new students to arrive on campus. It's also the time for schools to release their official endowment reports for the past fiscal year, and a couple of weeks ago, Princeton University became the last Ivy League school to do so. Given that the recent recession ended right before the beginning of FY 2010, we would expect that university endowments would begin their recovery from the devastating hit they took from the end of 2007 through 2009.

The results so far appear to confirm that these endowments are on the road to recovery. Except for Yale, all of the Ivies (and MIT and Stanford as well) saw double digit investment returns this past year, with Columbia leading the pack with a return of 17%. While these gains are not even close to enough to erase the huge losses these schools experienced during the 2007-09 recession (Harvard's endowment is still well short of its record size of $36 billion in 2007), this large of a rebound is actually unprecedented in recent decades. According to InsideHigherEd this morning, preliminary NACUBO data indicate that the average return this year for all schools was 12.6%, within the range of returns for the Ivies.

As the chart below shows, the 2007-09 recession hit university endowments harder than either the 1990-91 or 2000-01 recessions did. (Median nominal return rates for all institutions included in the 2009 NACUBO report are shown in red; all institutions with endowments in excess of $1 billion are shown in blue; recessions are indicated by the shaded bars).

The battering endowments took in 2007-09 is, of course, not terribly surprising, given that the super wealthy schools had invested in markets which were especially hard hit during the recession. Indeed, the super wealthy schools were, on average, battered more by the recession than the overall national average, but in good years, they tend to do slightly better than average. This year, though, it looks like the smaller endowments were the ones which did better, as endowments of less than $25 million saw above-average returns of 14.1%, probably because schools with smaller endowments take a lower risk strategy with their investments. Nevertheless, schools with at least $1 billion in endowment funds did see, on average, a 12.3% return for FY 2010, a rise of nearly 30 percentage points in endowment returns following a period when those returns plummeted by about 40 percentage points.

Of course, the big question is what does all of this mean for education policy? First off, I think the recession of 2007-09 is an excellent example (though assuredly by no means the only justification) for the case against ever instituting a legal spending requirement for schools, a point forcefully made by Charles Miller in a CCAP discussion paper two years ago. Placing an external and rigid government spending rule can have a number of serious unintended consequences, including hamstringing colleges during tough financial times and proving to be generally pointless during good times. Let us hope that politicians do not, in the near future, revisit this idea which rightly fizzled after 2007.

Second, just because government spending rules should be decried doesn't mean that individual institutions should aim to grow their endowments just because they can. But I do think it is crucial for college endowment officials to be reminded that endowment funds are merely a means, not a goal. After all, colleges aren't (or at least shouldn't be) in the business of building endowments solely for the sake of accumulating more wealth than is produced annually in some European countries and using their favored tax status to do so. Rather, endowments provide a means for colleges to provide educational products and services, first and foremost. This is one reason I like the approach Berea College takes in using endowment income to cover nearly all of the tuition bills for its students. If only more schools would follow this example. What would be a really good area for future research is an estimate of how much of a financial burden it would be on individual schools if they targeted more endowment funds towards tuition reduction for a good sized chunk of their students.

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