University Endowments

In Inside Higher Education this morning a National Association of College and University Business Officers report highlights the differences in performance between well endowed and less well endowed institutions. An endowment is a poorly undersood thing but very important to charitable institutions, especially colleges and universities. It represents the accumlated gifts from all sources that are permanently dedicated to sustaining the institution through good times and bad. It is like a savings account, although some of this savings account has to be spent on specific projects (that is called restricted endowment).

The numbers looked like this:

Endowment Size 1-Year Average Increase
Greater than $1 billion -- 15.2%
$501 million — $1 billion -- 12.8%
$101 million — $500 million -- 11.9%
$51 million — $100 million -- 10.0%
$26 million — $50 million -- 9.3%
Up to $25 million -- 7.8%

The differences in return are entirely predictable. A good friend of mine, who was president of Claremont McKenna College, once said to me that investing endowment funds should always be done like you were a young investor because the funds in an endowment are to last the lifetime of the institution. The differences in return can be keyed on one thing and one alone - diversification. The largest endowments put about 45% of their money in equity (stocks and bonds) while the smallest put almost 59%. But the smallest put 29% of their endowments into fixed income (like bonds) while the largest put only about 12.5% into the same category. The biggest put their funds into all sorts of things including hedge funds and private equity (venture capital funds).

At this point some of you may be saying, OK, so why is this important to me. Let me answer in two ways. First, there is a simple principle here that should be instructive to both institutions that you care about and to individuals. Diversification of investments is a good idea. If you cannot do it for yourselves you should find someone who can. There are all sorts of "experts" (The one that comes closest to mind is the radio financial "guru" Bob Brinker who I have heard argue that for a 20s something person who came into a small inheritance that it was just dandy to put most of his windfall into fixed income instruments and thus condemning this caller to safe but inadequate returns) who come up with the bizarre theory that one should increasingly invest only in fixed income as you age. Caution in investing and limiting your horizons to fixed income are two different things.

Second, in the Congress there is beginning to be some talk about taxing "excess" endowments. US college and university endowments vary in size by significant proportions. To be in the top 25 you need a bit over $2 billion in assets. The largest endowment is Harvard (at $29.2 billion) and their endowment could run the university for several years if spent down or at current spending rates could cover a lot of the current operating costs. Of the top 25, 18 are independent institutions. Also in the top 25 are 3 California institutions (Stanford at $15.2, UC at $5.8, and USC at $3.1). There are two problems with this rhetoric. First, the definition of excess is a hard thing to characterize. A lot of the discussion about endowments rests on why can't they are not being used to bring down tuition costs. That is problemmatic because a lot of endowments are restricted thus can only be used for specific purposes. Colleges use a lot of their unrestricted funding for scholarships which lower the price for needy students. But the use of outside funds to charge differential prices increases complexity (albeit with good motives) for consumers. (No student ever pays the full cost of higher education - which the National Commission on College Costs found.)

The returns on investments in colleges in the top 25 ranged from a high of 22.3% to a low of 6.8% (due in part because of the non-diversification of that university's endowment). That is a pretty impressive difference but as noted above, the consistent differences in returns based on size of endowment is even more impressive. While the ones who are larger than $1 billion have had some real dips in performance on a long term basis their returns, based on their diversification of investments, is pretty consistently higher than the ones under $25 million.