Ivy League Endowments Finally ‘Dumb,’ The Wall Street Journal reported on June 30th. Well, I beg to differ. Often categorized as “Smart Money” due to their success, Ivy League endowments have benefited historically from investment strategies anchored in alternative investments like hedge funds, real estate and private equity. Unfortunately, these endowments are not immune to a poor market and are expected to report dismal returns for the 2009 fiscal year.
Citing data from Northern Trust, the Journal reports that the largest university endowments, including those of Harvard, Yale, Stanford, Princeton and MIT, are expecting declines of 25%to 30% for the June 30, 2009 fiscal year, compared to the median endowment decline of approximately 20% and smaller endowment declines of 16%.
This is not an indictment of the Ivies’ strategies in theory. Ivy League endowment investment strategies are geared toward the long-term, and long-term oriented portfolios will often be volatile; they are conceived to support spending and to bolster purchasing power over decades, not over a single fiscal year. As long as near-term liquidity needs are met, the portfolios should be able to withstand short-term fluctuations and will likely exploit opportunities created by the current economic environment.
In a 2007 Sentinel article, I referred to this long-term approach, rooted in the expectation that return patterns will ultimately normalize, as “the five-year rule of thumb.” Two years later, the rule of thumb remains the same. Based on data going back to 1926, there is a very high likelihood that any dollar invested in the S&P 500 today will be worth at least one dollar five years hence.
Unfortunately, the Ivies’ near-term budgets are dependent, irrationally, on the year-to-year performance of their endowments. In fact, the Journal reports that Ivy League schools rely on their endowments for 25% to 45% of their operating revenues, compared to just 5% for the average college.
Pointing fingers at their endowments, Ivies are now trying to justify near-term budget cuts ranging from reductions in dining services at Cornell and Dartmouth to staff layoffs at Harvard and Brown. Even popular programs and classroom perks—like new course offerings and visiting faculty lectures at Princeton—are being cut or suspended until the market picks up again.
In a 2008 budget letter to his colleagues, Yale’s president, Richard C. Levin, said the 25% decline in the university’s endowment was to blame for “an annual budget shortfall on the order of $100 million next year (2009-10) and growing to over $300 million by 2013-14,” despite the fact that Yale’s “endowment spending policy spreads the effect of market changes over several years, allowing [it] to respond gradually.”
With individual university endowments that rival the GDP of countries like Bolivia and Paraguay, the quality of an Ivy League education should not diminish because the S&P 500 had a bad year. Though long-term oriented, these endowments should always place a portion of their assets into short-term reserves in order to meet expected near-term distribution needs, just as we do for retired clients and wealthy families. If these reserves were to then dry up, universities could ultimately receive larger distributions from their enormous endowments, which is the point of endowments after all.
So while Ivy League endowments may have earned a poor grade this fiscal year, we must wait five, ten or even fifteen years to accurately reflect on — and grade — their investment performance. In the meantime, serious adjustments should be made to endowment policies to account for near-term needs so budget cuts won’t reduce the quality of the college experience for students across the country.