Content provided in partnership with

Government Industry

University endowment returns are underspent - Higher Education - Statistical Data Included

Challenge, July-August, 2002 by Donald Frey

WITH THE BOOKS CLOSED ON THE 1990s, it is obvious that that decade provided exceptionally generous returns to university endowments. However, spending rates from endowment utterly failed to reflect that prosperity. Spending from several of the largest endowments dropped below a meager 4 percent rate in the late 1990s, and one college received national attention because it was so unusual in sharing its prosperity with students by freezing tuition for a year. (1)

Most Popular Articles in News: The Ten Best Laptop bags; Tata plans cheapest-ever car for Indian market; GLOBALIZATION AND THE DEVELOPMENT OF UNDERDEVELOPMENT OF THE THIRD WORLD; Corn is good for you; Corn is not only a tasty treat, but also a cereal that ...; THE 50 BEST STYLISH HANDBAGS TO CARRY; More »

Colleges and university endowments during the decade of the 1990s returned an average 12.9 percent annual rate (still a robust 12.2 percent for the ten fiscal years 1991-2001, the most recent data available). The average inflation rate over the decade was only 2.9 percent (2.7 percent from 1991 to 2001), yielding a real return of about 10 percent. Despite this generous real return, universities on average withdrew a mere 5.4 percent of endowment value in fiscal year 1999, a figure that appears relatively stable over time. (2) After subtracting portfolio management fees, which are generally included in the spending figure, educational spending likely amounted on average to less than 5 percent of endowment. Thus, the average spending rate was barely one-half of the inflation-adjusted return for the decade of the 1990s. The largest endowments tended to pay out even smaller proportions. (3)

Such large discrepancies between endowment returns and spending rates expose an obvious problem, for endowments exist for the benefit of higher education and not as ends in themselves. Although the exceptional investment returns of the 1990s starkly highlight the discrepancy, the problem does not disappear if one approximates endowment returns with more modest long-run averages. Endowment spending at a 5 percent rate falls well below expected returns even if endowment managers merely achieved the long-run average real return on equities of approximately 7.5 percent. (4) The 2.5 percentage point gap between return and spending (7.5 minus 5) means that spending could be half again as large while leaving intact the real value of the endowment's principal.

If an extra 2.5 percentage points had been spent from the ten largest university endowments, as reported for June 2001, an extra $1.95 billion would have been generated that year. That is about $4,600 per student enrolled at those ten universities, funds that could have been used for a variety of worthwhile purposes. An extra 2.5 percent would have added slightly more than a breathtaking $23,000 per student for the ten private universities with the largest per-student endowments at the end of fiscal year 2000. (5)

What Is the Right Spending Rate?

Three norms are relevant in judging the appropriate spending rate for endowments. The first is intergenerational equity: Should endowment spending favor the future at the expense of the present? The second is donor intent: Did donors intend that spending occur at a faster rate than practiced by universities? The final norm is efficiency: Does spending on programs or reinvesting endowment revenue achieve the greater return?

Equity: What Do Universities Owe the Future?

Endowment spending represents a trade-off of the welfare of present students for that of future students. Most universities nevertheless choose to favor future generations over the present generation by withholding and reinvesting part of their endowments' real returns.

This future-bias cannot be justified by usual standards of distributive equity because future generations almost certainly will be better off materially than the present generation. Economic historians have documented a persistent trend of rising real incomes over at least the last two centuries. (6) This trend is unlikely to falter. Indeed, the revival of productivity in recent years strengthens the view that the future will be much richer than the present. Few notions of equity would justify spending on the rich (future generations) at the expense of the relatively poor (present generation).

Writing in another context, Robert Solow suggested we clarify our thinking about the future by thinking about the past. He stated that a "fair-minded judge," who knew how things had turned out, would have concluded that our relatively poor American ancestors deprived themselves, by saving and investing for the future, more than equity would have required. (7) By the same norm, a fair-minded judge would find it inequitable to restrict current endowment spending for the benefit of future, richer students.

The future-bias of universities could be justified if the future were to be worse off than anyone expects. However, impoverishment of the future would require reversing powerful, well-documented trends. Such a reversal would require war, economic depression, social disintegration, resource depletion, environmental collapse, or something similarly dramatic. And that kind of scenario surely would leave any financial portfolio in shambles as well. The effort to transmit financial wealth to worse-off future beneficiaries is highly likely to be futile.

Government Industry

University endowment returns are underspent - Higher Education - Statistical Data Included

Challenge, July-August, 2002 by Donald Frey

Find Research Guides for:

Find Featured Titles for: Business

Most Popular Articles in News

Most Popular Publications in News