<p>Dad or JHS- Would you reconsider an application to one of these “endowment-impaired” schools…What exactly would occur in a worst case scenario?</p>
<p>What about the argument that the investment decisions drove the value of the endowments way UP before they caused them to go down? (I know, it sounds a bit like being for something until you’re against it). Is it possible to justify their actions (and the decision to keep them on now) by taking a bit longer view?</p>
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<p>That is a great question. Applications are cheap so, unless you are talking binding early decision, it doesn’t lock you into anything and you really don’t know what your options are until acceptances roll in, anyway.</p>
<p>I think I would:</p>
<p>a) Cast a wider net within tiers of colleges and give very heavy weighting to the fnancial situation. For example, we can all name groups of colleges that offer different flavors of the same quality product. Within a grouping like that, I would try to fall less in love with this or that flavor and pay much more attention to the cuts that are going to be made. Not to name names, but if I liked Amherst before, I’d be taking a much closer look at Williams, Swarthmore, and Pomona (I think) because Amherst’s cuts are going to be twice as big, and therefore twice as painful. So, even though you may not like this or that about Williams, the financial situation may offset that. It’s all about specific situations at specific schools. Within any given tier, some are going to be relatively OK and some are going to be relatively hurtin’.</p>
<p>b) The data is going to come in slowly and will require paying pretty close attention to the schools of interest. Set up Google News alerts for those colleges so you snag the Bloomberg finacial articles. Check the campus news paper every week between now and April. Check the website for Presidential updates and finciancial reports.</p>
<p>c) The next big wave of news will be the release of the June 30th year end financial reports. They were mostly signed off on by the auditors in September. Those will tell you the year end endowment. Last year’s endowment spending rate. The amount of debt. The amount of variable rate debt. The operating budget. And the outstanding cash calls. Plus management discussion in many cases.</p>
<p>d) The next item will be the budgets for the year starting next July. Those are usually approved in the December to February time frame. Most colleges currently have ad hoc committees recommending three year budget cuts. The reports of those committees should be rolling in by December and will give a lot of information.</p>
<p>e) One of the key indicators (for private colleges) will be the endowment spending rate this year. What is budgeted to be spent from the endowment as a percentage of the endowment on June 30, 2009? Anything under 5% in this economic mess is fantastic. 5% to 6% is OK. Anything above 6% is trouble and means the college will be under severe cost-cutting pressure including layoffs. Anything above 7% is a trainwreck. You aren’t even allowed to spend 7% under PA state law. To put that in context, Swarthmore estimated that, if their endowment spending were 7.0% this year (the highest in the history of the school was 5.4%) with anticipated increases, they would deplete their entire endowment in 22 years. That’s pretty sobering. So far I’ve seen Vassar weigh in at 7.6% which means the nest few years have to see some major cuts.</p>
<p>f) Look at how well positioned a school is to absorb the cuts. Was their already deferred maintenance or was the place in tip-top shape? You can slide for a few years if everything was good. Did they get their buildings done? New science center? Dorms? Have they got the new academic programs ramped up? Did they get Arabic up to speed? Obviously, there will be no new programs for the next few years, so anything that didn’t get done is not going to be there and some stuff that was marginally added will probably be pulled back.</p>
<p>g) How many more students are they planning to add? What does that really mean in terms of dorms, faculty size, number of classes. For example, Amherst’s Econ dept has already doubled up making two seniors work on a thesis together because they don’t have the faculty to handle the thesis advising load. If the enrollment is going up and the size of the faculty is not, the class sizes and quality will suffer, no matter what kind of happy talk spin the Presidents put on “protecting the core mission, yadda yadda”. Be skeptical.</p>
<p>The information provided by hawkette in post #9 updated to June 30 09 would be very helpful to me. Does anyone have any idea of where I could find the update information.</p>
<p>I finally tracked down interesteddad’s repeated statement that Pennsylvania law forbids paying out more than 7% of endowment. That’s . . . maybe a little true.</p>
<p>What Pennsylvania has is an election for trustees of charitable trusts which provide for different dispositions of income and principal (like charitable lead trusts, or trusts which prohibit payment of principal). If they make the election, they are not bound by technical definitions of income and principal, and can set (and adjust) an annual percentage payout based on the value of the trust assets. That payout cannot be less than 2% or more than 7%. Without making that election, under current circumstances, a charitable trust to which it applies might have little or no income at all, and thus could not make any payout. (Note, however, that capital gains and losses are not generally taken into account in determining “income” for these purposes.)</p>
<p>I would be surprised if this statute applied to all of Swarthmore’s endowment. It surely applies to some of it, and I suppose Swarthmore may have structured its endowment so it applies to everything. Even if it doesn’t, however, the legislative history and official commentary on the provision makes clear that the legislature considered anything about 7% (or even as much as 7%, for other than a short period of time) as being inconsistent with a trustee’s duty to manage for “total return”. Even if Swarthmore fiduciaries don’t have that precise duty, they would have to / want to make a determination that that wasn’t the appropriate goal if they were going to spend more than 7%, and that would be a tough determination to make.</p>
<p>As for Swarthmore’s statement that a 7% spending rate would wipe out its endowment in 22 years, that’s also only somewhat true. Under a conventional fiduciary assumption that one can earn a 4% annual return over time, if Swarthmore paid out 7% of its endowment this year, and continued paying at the same level for 21 more years, the endowment would be gone when it ended. If, however, it paid out 7% of assets each year, not 7% of this year’s assets each year, the endowment would be depleted but not eliminated.</p>
<p>Thanks, JHS. Swarthmore explicitly states that they manage their endowment on a “total return” basis. Otherwise, the endowment wouldn’t function as a smoothing mechanism to provide predictable funding in both up and down markets. I tend to think Swarthmore’s pretty good on Pennsylvania law. Their Chair of the Board is Babara Mather, partner and emeritus head of the litigation department at Pepper Hamilton, an 11 office, 500 lawyer firm headquartered in Philadelphia. Her firm touts her as specifically experienced in college and university law and touts college and university law as a firm specialty:</p>
<p>[Law</a> Firm Of Pepper Hamilton LLP | Barbara W. Mather](<a href=“http://www.pepperlaw.com/LegalStaff_Preview.aspx?LegalStaffKey=98]Law”>http://www.pepperlaw.com/LegalStaff_Preview.aspx?LegalStaffKey=98)
[Law</a> Firm Of Pepper Hamilton LLP |Representation of Colleges, Universities and Other Educational Institutions](<a href=“http://www.pepperlaw.com/PracticeArea_preview.aspx?PracticeAreaKey=12]Law”>http://www.pepperlaw.com/PracticeArea_preview.aspx?PracticeAreaKey=12)</p>
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<p>That was not their statement and I was careful not to state it that way. Their statement didn’t refer to a flat 7% spending rate. It refered to their financial models, including assumptions about endowment returns and spending increases over time and what would happen with various levels of spending for THIS YEAR, the starting point for those models. Their statement was that, if they plugged in a 7% spending rate FOR THIS YEAR into those models with the assumptions about spending increases over time, the college would blow through its entire endowment in 22 years. </p>
<p>The problem – and it appears to be widespread – is that these colleges all have structural spending increases in the near-term out years that send the budgets through the roof. I don’t fully understand all the issues, but fundamentally, excessive spending this year gets compounded down the road. The upshot is that they really want the budget cuts to hit sooner rather than later. Starting out at 7% makes things very difficult. I think some of this has to do with projections of zero growth endowment return for the next two years. You spend down the endowment quickly spending with no investment return, leaving you a smaller endowment to generate returns going forward.</p>
<p>Their analysis is in this PDF slide show (which was prepared back in April and is now dated):</p>
<p><a href=“http://www.swarthmore.edu/Documents/administration/finance_investment_office/Endowment_Presentation_April_2009.pdf[/url]”>http://www.swarthmore.edu/Documents/administration/finance_investment_office/Endowment_Presentation_April_2009.pdf</a></p>
<p>At the time, they were looking at a spending rate this year in excess of their highest ever (5.4%). As it turns out, they reduced the operating budget by $7 million compared to last year and the endowment came in $129 million higher than April’s number, so their spending rate this year (4.1%) will be below their long-term target of 4.25%. That’s really astonishing compared to the way things looked six months ago. </p>
<p>There are a lot of colleges breathing a big sigh of relief – in some cases because it saved them from having to make some hard cuts, in other cases because it saved them from financial disaster. Vassar is at 7.6% spending rate after the endowment recovery. What were they looking at last April? Stanford is at 6.6%. What were they looking at?</p>
<p>interesteddad:</p>
<p>I know too much about Barbara Mather and Pepper’s trust practice to be bowled over, but, yes, I think the 7% limit is close enough to right to be right. I would bet that if Swarthmore really wanted to go over 7%, it could, but it shouldn’t want to, and would need much stronger justification that currently appears.</p>
<p>As for the 22-year projection, I suspect it was nowhere near as sophisticated as you say. It so happens that if you start with $100, earn 4% (which is a common, and statutorily approved, income assumption), and pay out $7 a year, you will hit $0 towards the end of the 22nd year. It seems unlikely that a hypersophisticated analysis would produce exactly the same time period.</p>
<p>Except that, in the same document, they specify an 8.75% rate of endowment return as a long-term average – following a -30% growth last year and 0% for the next two years.</p>
<p>I don’t think the models are super sophisticated, but they are real models of out year spending that include known future costs (like bond issue balloon payments, etc.), growth in fiancial aid, and so forth.</p>
<p>Amherst has been posting some glimpses of their modelling, too, buried in these two documents. You can see that the modelling is at least more sophisticated than a simple flat spend rate:</p>
<p><a href=“https://www.amherst.edu/media/view/119548/original/ABC%2BReport%2BFINAL.pdf[/url]”>https://www.amherst.edu/media/view/119548/original/ABC%2BReport%2BFINAL.pdf</a> (page15)
<a href=“https://www.amherst.edu/media/view/121423/original/Amherst_economy_summer_2009.pdf[/url]”>https://www.amherst.edu/media/view/121423/original/Amherst_economy_summer_2009.pdf</a> (page 7)</p>
<p>BTW, I don’t think that Mather has to bowl anybody over, just that I am confident enough in Swarthmore’s management and legal advice regarding a billion dollar endowment that, when the Vice President of Finance writes in public document that the college is limited to a ceiling of 7% endowment spending, there is a legal basis for that. Actually, what they outlined in that document is that spending at the 7% level would trigger an immediate set of actions to bring spending back down. From that, I kind of read that, yes, they could spend 7% on a short term basis, but all kinds of restrictions and a mandatory budget cutting process would kick in. I’m pretty sure they had this discussion in a board meeting, because some of their worst case scenario planning last spring included spending rates above the 6% level. I agree with you that there is nobody on the Swarthmore board that wants to be spending anywhere near 7%, not when their highest year ever (back in the 1980s) was 5.4% and their long term target is a very conservative 4.25%. Back in March, when the endowment was down 30% and still falling, they didn’t know where the bottom was so they had to be working on worst-case plans.</p>
<p>[Investment</a> Indigestion at Stanford - DealBook Blog - NYTimes.com](<a href=“DealBook - The New York Times”>DealBook - The New York Times)</p>
<p>Interesting to see what happens at Stanford. Seems to me though bidders will cherry pick the best funds and Stanford will hold on to the sorriest ones. So I’m not sure it will give a totally accurate guage of what these private investments are worth.</p>
<p>Seems like every time a U issues its endowment figures they justify their strategy based on a 10 year performance, of course that also assumes their private investments are worth what the private companies say they are which everyone knows is false. For once I wish a President would stand up and admit that this was a bone-headed idea and say they are going to take their endowment trustee responsibilities much more seriously.</p>
<p>[The</a> New York Times > Log In](<a href=“http://www.nytimes.com/2009/10/05/business/economy/05simmons.html?_r=3&dbk=&pagewanted=all]The”>http://www.nytimes.com/2009/10/05/business/economy/05simmons.html?_r=3&dbk=&pagewanted=all)</p>
<p>Another excellent NYTimes article on private equity. Seems that one question Harvard and Yale should be asking is is it not only financially irresponsible to be in bed with these guys is it morally irresponsible as well.</p>
<p>interesteddad, I should have reported earlier that I talked to a friend who knows much more about institutional trust law than I, and she thought it was probably correct that the Swarthmore endowment was structured so that the 7% spending cap did apply to it.</p>
<p>Re Tommy Lee: This sort of article has been a staple of business journalism since the early '80s. The article barely changes at all, just the names. Productive assets, and productive workers, don’t vanish because the pieces of paper representing ownership of the enterprise get bought and sold. Unproductive assets and workers are another story. People aren’t getting laid off because Tommy Lee bought Simmons; people are getting laid off because no one is buying the mattresses they make. Certainly a bunch of bondholders got screwed here, but the private equity investors in the Lee partnership seem to have made out like thieves. They no doubt had a big loss this year, but they had already recovered their investment and were playing with house money.</p>
<p>JHS, I wish what you said were true. I think in too many cases it is not. Decisons are made with a short-term view and often run counter to long term interests. Legal rape is still rape.</p>
<p>If the partnership agreements allow it, what you will see is that the general partners will attempt to cause the partnerships to buy Stanford out, and it will be structured in someway that will attempt to insulate the reported valuations from the actual transaction price agreed upon.</p>
<p>This will be tricky, because if the price at which Stanford can exit is too attractive, other investors may wish to become part of the exiting group and not part of the contributing group that is buying out the others. Its a little bit of the problem of yelling “fire” in a crowded theatre, or maybe the emporers clothes…not sure which analogy is best. In any case, Stanford has decided to take the bull by the horns here. I think it is a smart strategy by them, and it will make them persona non grata among all the other investors.</p>
<p>JHS:</p>
<p>The distinction you raised about “total return” was an important one that I hadn’t thought about from the legal standpoint. It makes perfect sense that, if you are willing to limit yourself to spending just interest earnings, then you can spend what you want (but will have to live with zero spending at times). It’s also logical that a state would seek to put some limits on a “total return” approach. Otherwise, an unscrupulous or desperate endowment/pension fund manager could “total return” spend a fund dry in no time at all.</p>
<p>I actually think that this year’s endowment spending as a percentage of July 1st endowment, is probably the most important single indicator potential customers should be looking at, followed by outstanding debt and cash call commitments and the overall liquidity. There are some very high endowment spending rates that are going to trigger some severe cuts, whether mandated by state law or not.</p>
<p>BTW, as we move into October, there are still some schools that are deafeningly silent on their year-end endowments and current year endowment spending. The longer we go, I’m guessing that they schools keeping mum probably don’t have very good news to report. I saw mention in a student newspaper op-ed of a 33% endowment decline. I don’t know if that’s accurate or not. It’s one of the schools that hasn’t said anything.</p>
<p>I atleast give Stanford credit for getting out in front of their problem and coming up with some clever ways of dealing with it. I don’t understand Yale-I mean Rome is burning and they are fiddling.</p>
<p>I wouldn’t call selling illiquid stakes at deep discounts “clever”, especially if you claim you don’t really need the money near-term. </p>
<p>Actually, it’s a lot more clever to take the implied return between a prospective sale price now and the liquidated value in 5-7 years once the funds are aged.</p>
<p>The problem is the cash calls (aka pouring good money after bad). If the colleges keep liquidating their remaing stocks and bonds to meet the cash calls over the next five years, their endowments start to approach 100% allocated to private equity and other non-liquid assets. Without cheap credit markets, can future PE deals even expect to provide much of a return? I mean, without loading up these companies with debt, is there really and advantage over liquid public equities?</p>
<p>I don’t think there’s much stomach for taking every last penny in an endowment and shoving it onto the private equity bet.</p>
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<p>They may be stupid but I can’t believe they are so stupid not to have a spreadsheet that calculates full prospective investment in PE funds as the numerator and total endowment as the denominator and never let that fraction get too high. </p>
<p>Besides, don’t forget past PE funds aging provides liquidity also.</p>
<p>Another article on Stanford:</p>
<p>[The</a> Reason Stanford Is Selling Private Equity - Forbes.com](<a href=“The Reason Stanford Is Selling Private Equity”>The Reason Stanford Is Selling Private Equity)</p>
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<p>Is this a great country or what? Only in America can you point to borrowing $1 billion as an example of your strong financial position and not have everyone bust out laughing. </p>
<p>Notice how conveniently they fail to mention the $43 million debt service on that loan, year after year after year. That’s 400 professors, give or take.</p>
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<p>Cresent:</p>
<p>This article says they have about a third of the endowment in PE now – $4 billion of a $12.6 billion endowment. And, they have $6 billion on unfunded cash call committments to PE. That’s $10 billion potentially tied up in PE (minus whatever cash PE might throw off int he meantime with no credit market and no IPO market to cash out companies). That is a really ugly mess.</p>