College presidents can be forgiven if they find themselves staring out windows, dreaming of what they could do with Harvard University's nearly $40 billion endowment. Or Yale's $29 billion, or Princeton's $26 billion.
Private colleges and universities from those Ivy League powerhouses to Grinnell, Bryn Mawr, Rice and more than a dozen others are able to fund at least 30% of their operating revenue with investment income from their endowments, according to Moody's. In an era of constrained enrollment and price pressure on tuition, that level of endowment wealth can provide financial flexibility, security and some level of operational certainty.
But endowments, at the end of the day, are investment portfolios. They rise and fall with the markets for the assets they contain. And while for the past 10 years endowments have enjoyed a bull market, most business economists expect a recession by the end of 2021, which could bring with it a downturn in financial markets.
During the 2008 financial crisis, college endowments collectively lost nearly a quarter of their wealth and saw many of their investments become harder to sell off. A 25% drop in a 401(k) would be a stomach-turner for a worker approaching retirement, but colleges and universities have the advantage of being essentially everlasting entities by design.
"We often compare our own investment portfolios (to endowments)," said Emily Wadhwani, a director with Fitch Ratings' U.S. Public Finance division. "But we don't expect to have our investment portfolio forever." On the other hand, she added, university endowments are "supposed to exist in perpetuity and be a permanent source of income."
Playing the long game
Endowments' long-term focus gives colleges leeway to manage their portfolios aggressively, with a mind for the long run over near-term dips and crashes.
But dips and crashes happen. Harvard's endowment lost 22% of its value by early December 2008 after financial markets tanked that fall. Harvard, which at the time derived 35% of its operating budget from its endowment, warned stakeholders that the losses could seriously affect the university's operating budget, The New York Times reported at the time.
Harvard would make up for the endowment losses in the short term by borrowing $2.5 billion through a bond offering that year. As Wadhwani explains, that kept Harvard from having to break form and reduce spending. It also allowed the university to hold onto assets in its endowment rather than sell them at a major loss, she added. That would have represented a breach of investment philosophy by essentially taking income from future generations to cover short-term losses.
Harvard's endowment has since recovered. It is the largest in higher ed and today contributes even more to the university's operating revenue — accounting for about 40%. In a February note, Moody's analysts described the university's wealth as "substantial" with a "strong capacity to fund high levels of financial aid, diverse and specialized academic programming, and significant ongoing capital investments." They noted, though, that Harvard's reliance on endowment spending "can pressure the university's fiscal operations in the event of prolonged market weakness."
Yet institutions like Harvard, which have wealthy endowments and strong brands, are "positioned well to manage disruptions" such as the major market downturn seen in 2008, said Jeffrey Kaufmann, vice president and senior credit officer with Moody's. Among them is tuition, which he said Harvard currently relies on for about 20% of its revenue. "You also have to remember Harvard has tremendous fundraising capacity," he said. "That provides a strong safety valve."
To that point, the university concluded a $9.6 billion fundraising campaign in September. It came in about $3 billion over its own goal and the amount raised by the previous higher ed record-holder, Stanford University.
An endowment-rich institution such as Harvard also considers what costs it could afford to cut in a downturn, said Susan Fitzgerald, an associate managing director with Moody's. "Harvard recognizes that it's a business and it has to maintain expenses in line with revenues," she said. Endowments also frequently use formulas to balance spending over multiple years to limit the impact of one or two years of poor performance, Fitzgerald and other Moody's analysts noted in a February report.
The private colleges most reliant on their endowments
|Institution||Cash investments||Percent operating revenue from investment income|
|Princeton University||$26.4 billion||62.7%|
|Grinnell College||$2.1 billion||59.8%|
|Franklin W. Olin College of Engineering||$392.7 million||53.8%|
|Amherst College||$3.2 billion||51.9%|
|Williams College||$2.8 billion||50.4%|
|Swarthmore College||$2.2 billion||48.4%|
|The Juilliard School||$1.1 billion||46.3%|
|Bowdoin College||$1.9 billion||43.8%|
|Berea College||$1.3 billion||42.6%|
|Wellesley College||$2.3 billion||42.4%|
|Rice University||$6.7 billion||41.6%|
|Harvard University||$45.1 billion||40.2%|
|University of Richmond||$2.7 billion||38.8%|
|University of Notre Dame||$12.2 billion||35.6%|
|Yale University||$31.7 billion||35.4%|
|Hamilton College||$1.1 billion||33.3%|
|Macalester College||$808.5 million||32.9%|
|Dartmouth College||$6.7 billion||32.8%|
|Washington and Lee University||$1.2 billion||32.2%|
|Bryn Mawr College||$994.2 million||31.2%|
Source: Moody's Investor Service
Those tools — fundraising, tuition hikes, cost cutting and careful spending — are not exclusive to Harvard. And Harvard ranks in the middle of the pack among institutions that depend most heavily on their endowments for revenue. At the top is Princeton University, with an endowment valued at around $26 billion, pulling more than 60% of its operating revenue from investment income. (Public universities typically derive a much smaller portion — less than 10% — of their revenue from their endowments, Kaufman said.)
The strategies listed above are likely to be deployed, at differing degrees and success rates, by colleges across the board to manage downturns. Many private colleges have also been building their available liquidity since the financial crisis, which "will provide a cushion as investment market volatility, weak tuition pricing power and rising expenses pose risks to financial flexibility," according to another Moody's report.
Yet liquidity still remains "thin" for around 6% of the private institutions Moody's rates, with less than 90 days cash on hand. Wealthier colleges are still devoting a significant share of their portfolios to relatively illiquid investments, including private equity and venture capital. (Assets are also often gifted to an endowment, which means investment managers don't necessarily get to decide how liquid they are. "If it's a tree, it's a tree. We donated you a tree. Congratulations," Wadhwani quipped.)
When it comes to available cash, it pays to be a rich university. In fiscal 2018, the 20 private institutions with the largest share of revenue tied to investments had a median operating cash flow margin of nearly 20%, compared to 13% for everyone else, and 703 days cash on hand, according to Moody's. Liquidity levels that high can act as a "balance sheet buffer" and buy time to respond in the event of financial crises, analysts noted.
Appetite for risk
How endowments approach risk and returns also matters in times of crisis, and that approach might well need shaking up.
Endowment managers have long looked to each other, and to the largest endowments, for their cues. "Comparisons to other peers are natural, but not productive," wrote N.P. Narvekar, CEO of Harvard Management Company (which oversees Harvard’s endowment), in a 2017 letter to the campus. "In my opinion, misdirected pressures caused by peer return comparisons contributed meaningfully to the challenges experienced by leading endowments during the financial crisis. A more sophisticated lens will always focus first upon risk appetites rather than simply returns."
It's an easy trap to fall into. After all, much of the universe of endowment sizes and returns are available for peers to see, and making comparisons among peer groups is a common strategy for evaluating performance, said Simon Robinson, head of product management for RiskFirst, an analytics firm that specializes in pensions, foundations and endowments. But not every institution's investment risk appetite is the same, nor are their investment goals.
"Incorporating risk is great, but then it should be a risk measure or risk approach that is most appropriate for the problem at hand," Robinson said.
The colleges that endowments serve can vary greatly based on the student population and how dependent the institution is on investment income, Robinson and colleagues point out in a recent white paper. "Clearly, portfolio risk should reflect these factors," they write. "This is not happening — indicated by the tight distribution of asset allocation."
While a market crash, especially a deep and long one, presents a nightmare investment scenario, returns to endowments are already slowing after a volatile year in the stock market. And they are falling while colleges as a group are relying on them more for spending.
Endowment returns in fiscal 2018 were 8.2%, down from 12.2% in 2017, according to data from the National Association of College and University Business Officers (NACUBO) and TIAA Endowment and Philanthropic Services. Ten-year returns stayed positive, growing to 5.8%, but missed the 7.2% average target for colleges.
That rate incorporates inflation, so falling short of it could reduce an institutions' purchasing power, Moody's analysts explained in a report after the data was released. It also incorporates spending out of the endowment, meaning falling short of targets could put downward pressure on the levels colleges set for endowment spending.
NACUBO President and CEO Susan Whealler Johnston in a January statement raised concerns about slowing returns, saying they could pose a barrier for colleges that want "to increase endowment spending to support their missions."