Tuesday, January 27, 2009

University Endowments and Drastic Budget Cuts

Brandeis University is the most recent institution of higher education that has announced a major restructuring due to the global financial crisis. Brandeis announced today that they will be closing their art museum and selling their art collection, believed to be worth more than $300 million. Brandeis' actions follow other drastic budget cuts at wealthy schools such as Harvard, Dartmouth, Penn, etc.

Now, everyone certainly understands that these schools with large endowments have suffered large losses in their stock market investments. However, I'm sure many are wondering how and why this is leading to such large budget cuts, given that many still have very large endowments. To answer that, we have to understand how the annual operating budgets for these institutions are set. Basically, each year the universities draw a small percentage (often less than 5%) of their endowments for use in that year's annual operating budget. While this may be a small percentage of the endowment, it's actually a very large number in absolute dollars for a university with a mega-endowment. Therefore, at many endowment-rich institutions, the draw from the endowment represents a very large percentage of the annual operating budget.

At Harvard, for instance, the institution depends on the endowment draw to fund roughly 35% of its annual operating budget. That percentage climbed over recent years, as the endowments at many top institutions grew substantially in value. Thus, when an endowment like this drops by 30-40% due to the stock market crash, then the annual operating budget takes a very, very large hit - perhaps more than 10% in many cases.

In sum, many higher education institutions, while seemingly not using much of their endowment each year, actually were becoming very dependent on their endowments to fund annual operations. Now, that economic model has come apart at the seams due to the equity market crash.

1 comment:

Bob said...

I understand your point. I would only point out that University endowments are professionally managed and most did not sustain 30%-40% losses in the recent downturn. Harvard, for example, lost about 21% according to published reports, implying a portfolio beta of around .5 or less. Still, Harvard's financial manager is under fire because Harvard did not understand that there was even that much risk in the portfolio.

University endowments, because they are a key source of operating funds, should be conservatively managed. Universities that had losses in their endowments of the same magnitude as the stock market losses were taking far too much risk. We can only hope they will learn from this experience.