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Colleges Brace for Investment Losses as Tuition Pushback Mounts

  • Some endowments that spend more than 5% a year will cut rate
  • With fiscal year over, schools consider belt tightening

U.S. university endowments aren’t making money like they used to. And now some aren’t going to spend as much.

Schools are reducing annual payouts from their endowments as they brace for investment losses. With less money to spend on financial aid, faculty and other costs, colleges may have to search for other revenue. Most endowments ended their fiscal year on June 30 and will report annual returns in the fall.

“Unless universities want to start eating into the growth, we have to decrease our spending,” said Bruce Arick, assistant treasurer of Indianapolis-based Butler University. The $184 million endowment’s investments declined 0.9 percent in the year ended June 2015 and Arick said he expects a loss for fiscal 2016.

The timing couldn’t be worse. Representative Tom Reed, a New York Republican, is considering a proposal that calls for the wealthiest colleges to devote 25 percent of their annual endowment income for financial aid or lose tax-exempt status.

Colleges are facing push-back over rising tuition bills. States have been reducing funding of public universities as their budgets are crimped by slow economic growth and anti-tax sentiment.

For more on the riches that U.S. endowments have amassed, see our QuickTake.

Annual payout rates are based on a spending target, often determined by an average of three to five years of investment returns. Schools typically spend 4 percent to 5 percent annually and they need to earn that much in a year plus inflation.

‘Ratcheting Down’

Butler’s trustees voted in May to decrease the spending rate in the 2016-2017 year to 4.9 percent from 5 percent. Further reductions are likely in coming years, Arick said.

“We need to begin ratcheting down,” he said. “The days of double-digit returns are gone for the foreseeable future.’’ Butler’s fiscal year ended May 31.

Endowments saw four years of average double-digit gains since 2010. The gain for college endowments in fiscal 2015 was 2.4 percent on average, according to the National Association of College and University Business Officers and Commonfund.

Negative Shock

A handful of the wealthiest schools, including Princeton, Amherst and Grinnell College, derive about half their operating budgets from endowment income. The median reliance on endowments for all private schools is about 8 percent, according to Moody’s Investors Service.

For schools that rely on their endowment to pay for significant operations, “any negative shock causes more problems now than it did before,” said Geoffrey Woglom, an economist at Amherst College who has studied endowment spending.

Less wealthy schools are likely to feel the pinch the most. They may cut back on merit aid to higher-achieving students, making them less competitive. Duke University, Pomona College and Grinnell are among the richer schools that spent more than they earned in fiscal 2015.

“It puts more pressure on the college to try to find savings or other sources of revenue,” said Carl Vance, chief investment officer of Lewis & Clark College, whose trustees voted to decrease spending in February. “We’re trying to give less discounts.” 

The Portland, Oregon-based liberal arts college, with a $228 million fund, had a 0.1 percent gain in fiscal 2015, Vance said. The 5.4 percent spending rate will be reduced annually by 0.2 percent until the 2020-2021 school year until it reaches 4.5 percent, he said.

No Solution

“It’s going to be a combination of whatever can be identified,” Vance said about any spending cuts. “There’s no immediate solution here.”

Although large endowments have more of a cushion, they aren’t immune to monitoring spending rates -- and even taking action. Lawrence Summers, former president at Harvard University, suggested in an April speech that the school, the richest in higher education, take into account the drop in interest rates when deciding on its payout.

Harvard’s Payout

“If it makes sense for Harvard University to pay out 5 percent of its endowment in 1999 when the real interest rate was 4 percent, it’s really quite unlikely that it makes sense to pay out 5 percent of its endowment in 2016 when the real interest rate is zero,” Summers said in the speech to a group of economists.

Harvard’s endowment disbursed $1.8 billion in fiscal 2015, resulting in a payout of 5.1 percent. The school said its target is an annual payout of 5 percent to 5.5 percent of market value. A Harvard spokesman declined to comment further.

Michigan State University trustees in April voted to cut its spending rate to 4.8 percent from 5 percent for fiscal 2017 and 4.6 for subsequent years. The $2.3 billion endowment gained 3.7 percent in fiscal 2015 and Philip Zecher, chief investment officer, said it’s likely to post a loss for 2016.

“We wanted to be a little bit more proactive and do this gradually over the next two years,” Zecher said. “We thought it was better to take it now and with this anticipation of soft markets to come for a while.”

Congressional Review

Congress is examining how tax-exempt endowments are managed and spent at the richest 56 private schools, and two committees are reviewing responses to an inquiry that began in February. According to data from 49 schools provided to Bloomberg, they spent 4.5 percent in fiscal 2015, 4.8 percent the previous year and 4.96 percent two years prior.

Lehigh University spent the most -- 6 percent on average for the three years. The school said it doesn’t plan to change its policy. The University of Rochester, which spent 5.3 percent over the three years, and Duke, at 5.4 percent in the same period, said they also won’t make adjustments.

“We’re raising money for the endowment through giving,” said Douglas Phillips, chief investment officer of Rochester’s $2.2 billion fund. “We think of the return on the endowment is not just what our markets are giving us but what are donors are giving us.”

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