Slammed. Feeling the sting. Hitting the skids. That is a sampling of how some have described the impact of the economic collapse on college and university endowments.
A survey of 144 colleges conducted by Cambridge Associates LLC reported average investment losses ?of 22.5 percent over the last six months of 2008, causing many institutions to re-evaluate spending, tweak operating budgets and reconsider how they invest.
These startling statistics about endowments lead to many questions. What is their purpose? How are they managed? ?Are things really as bad as they seem?
No one is in a better position to provide answers about Franklin & Marshall’s endowment than Tony Kreisel ’66. Kreisel, who retired as the chief investment officer, ?large cap value, from Putnam Investments Inc. in 2000, ?has served on the College’s Board of Trustees since ?1998 and has chaired the Investment Committee for ?the past five years.
“Retired” is clearly a misnomer in this case. Kreisel directs the College’s endowment strategy full time, working in conjunction with Elizabeth Dunlap, the College’s investment officer.
A Strategic PurposeAn engaging, affable person, Kreisel is surprisingly upbeat given the market turbulence. His experience has taught him: Don’t focus too much on short-term problems.
“Endowments are perpetual, intergenerational and ?not a rainy-day fund, but a pool of resources to be used ?for the strategic benefit of the College over the long term,” Kreisel says.
Endowments provide institutions with a permanent ?source of income typically used to support financial aid, academic research and instruction, athletics and other ?vital educational missions.
They are complex entities comprising numerous funds ?created from philanthropic gifts. These gifts generally ?are either restricted (at the request of the donor to ?a specific purpose) or unrestricted (they can be used ?at the discretion of the institution).
Each college or university develops a formula for determining how much of the endowment’s market value is withdrawn each year to support its annual operating budget. For many, this “draw” is their largest source of revenue. That’s why an economic downturn can create severe budgetary issues for colleges large and small.
Bad News, Good News“The bad news is we are small, but the good news ?is we are small,” Kreisel says with a smile. It is a puzzling response borne out by the facts.
The bad news is that Franklin & Marshall’s pooled endowment—the portion of the total endowment excluding trusts, real estate and non-cash assets—?closed out the 2008 fiscal year with a market value of ?$315 million, reflecting investment losses of 3 percent and spending of 5 percent from its 2007 value of $341 million. By comparison, the S&P 500 dropped 13.1 percent.
The deepening recession drove the value down even further, resulting in a 25 percent investment loss for ?the first six months of fiscal year 2009. After investment returns and spending, the Dec. 31, 2008, market value ?was $229 million. In response, the College directed ?its employees to tighten their belts and look at ways ?to reduce operating costs.
"Ideally, we could just press an investment reset button, but instead we will have to reorient our portfolio."
The good news is that the College still was able ?to increase funding for financial aid. That’s because the College’s 2008 endowment draw of $16.7 million represents only about 14 percent of its operating budget. The draw at many larger institutions represents up to 50 percent of their operating budget, forcing them to make dramatic cuts as endowment values have plummeted.
“During times like these, we are fortunate that a lower percent of the draw is applied to operating expense ?than at many colleges,” Kreisel explains. “Because we ?are less dependent on those funds, our budget comes under stress, but is not severely damaged.”
Doing the MathThree factors affect an endowment’s size and health. ?First, an endowment grows through the performance ?of its investments. Second, it increases through philanthropic gifts. Finally, it is depleted by the ?draw the college makes each year.
Ideally, as is the case at many other institutions, new gifts offset the payout. Unfortunately, at Franklin & Marshall, ?this has not been the case.
Using data provided by the National Association of College and University Business Officers (NACUBO), Kreisel keeps close tabs on the endowment’s investment performance, benchmarks its performance against peer institutions and evaluates higher-education trends.
The success is credited to the College’s strategy of diversification into private equity, hedge funds and other alternative investments. “Our approach has served us ?well in both generating returns and dampening volatility,” Kreisel says. “Although even this was not enough to help us during the current crisis.”
Historically the College’s investment performance has ?been good, but philanthropic gifts to the endowment ?have not kept pace (see graph above).
In fiscal year 2008, gifts to Franklin & Marshall’s endowment totaled $1.2 million and increased the over-all market value by a mere 0.3 percent. By comparison, 4.0 percent was the annual increase in market value through philanthropic gifts enjoyed by institutions with endowments between $100 million and $500 million, according to the 2008 NACUBO Endowment Study.
“The result is that we are at a competitive disadvantage compared to many of our peer institutions,” Kreisel says. “Because our endowed funds are not sufficient to cover expenses like financial aid, we are forced to use a larger portion of our other revenues to meet these costs.”
The final piece of the puzzle is the draw the College ?makes from the endowment each year. Currently the ?Board of Trustee’s Finance Committee has determined ?that 5.5 percent of the three-year Dec. 31 average market value of each named fund in the endowment will be withdrawn annually. This policy is designed to ensure ?that the real dollars spent today equal the real dollars ?to be spent in the future.
A Glimmer of HopeSticking to its focus on the long term, the Investment Committee is looking for the silver lining in all of this. “Ideally, we could just press an investment reset button, but instead we will have to reorient our portfolio,” ?Kreisel says.
That is a task made easier by the manner in which the College’s assets are allocated. “Because our endowment is smaller, we do not have as much of it as some bigger institutions in alternative investments, such as private equity and venture capital, that can lock your money up for five or 10 years,” Kreisel says. “We are, by comparison, quite liquid.
“Right now we have the flexibility to buy financial assets cheaper today than yesterday,” he adds.
So Kreisel’s bad news-good news scenario comes full circle. The current turbulence presents a real issue for the College, but not a catastrophic one. In fact, there is even an opportunity for stronger performance in the future.
“We must continue to operate with our eyes on the horizon,” Kreisel says. “We are focused on the next five ?to 10 years, not our quarter-to-quarter performance.” It is that long-term thinking that has paid dividends for ?the College in the past and will likely serve it well into ?the future. As Kreisel makes clear, it is not about tomorrow ?or next year, but about generations of students to come.