Wednesday, January 28, 2009

Endowments and Unpronouncable Laws

"Fortunes Falling" is the title of an Insidehighered article chronicling the rapid unwinding of university endowments. As the market value of investments tumbled, so did the payouts for institutional uses like financial aid. Even with a three-year trailing average (the standard), payout amounts will dip appreciably. The common fund is used by many colleges. Their recent study jointly with NACUBO shows that for university endowments generally:

Institutions and their affiliated foundations reported an average rate of return of -3 percent for the fiscal year ending June 30, 2008, and the results of the Follow-up Survey show that endowments fell an additional 22 percent in the first five months of FY09.
In fact, the tables in the report show that across all sizes and types of endowment, the returns were close to -22% from July 1 to November 30, 2008. Of the surveyed institutions, 27% planned to decrease draws, and 1% increase. The rest were status-quo or unknown. Interestingly, the survey was for amounts, not percentages. This must be because policies calculating the annual draw fixed the number before October. Next year the trailing average will come into play. For most, it looks like this would reduce payout by one third of the 22% drop, or about 7%. This obviously means more for institutions that depend heavily on large endowments.

Davidson College is one of those that requires a hefty endowment draw to keep the lights on. And it has the misfortune to be in a state that has not (yet) passed a new law governing endowment draws called UPMIFA, which updates UMIFA (this is the unpronounceable bit--try it). The Uniform Management of Institutional Funds Act, dating from 1972, prevents funds from selling off parts of the corpus of the endowment to raise cash if that would cause the total amount left to dip below its original donated value. The act is quite readable, despite using vocabulary like "eleemosynary." The new act inserts the word "prudent" between "uniform" and "management", and allows the management of the fund to be less prudent (!) but more beneficial to the holder. Specifically, it allows the fund to be drawn down even if it's under water.

With the precipitous drop in market values, the 1972 shift from fixed income endowments to higher return (and higher risk) instruments led to some good years for endowments. But the law only really works when the balloon is going up. Just like the real estate market, bad things happen when values quickly. So North Carolina and the handful of other states that have not yet passed UPMIFA are not good places to have endowments that you depend on in thick and thin. One can imagine that some hard lobbying is going on in NC. According to a notification from NC Center for Nonprofits, it is pushing to have the law passed early in the 2009 session.

Even the new law is no panacea. It requires the institutions spend "prudently" even if it allows dipping into the original corpus of the endowment. What exactly this means will lead to some interesting conversations. One thing is for sure: the conventional wisdom that the stock market is the best place for such investments has surely been shaken. There are risks and there are risks. The risk of staying out of the market is that one has to accept less than optimal returns in the good times. But full investment in even a "balanced" portfolio of equities means taking it on the chin during some part of the business cycle. In some ways this is no different from the dilemma faced by the average investor, but if the university payroll depends on the endowment, the stakes are much higher. If you have to let good people go because you can no longer afford them, that damage takes a long time to repair.

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