University endowment provides for future while funding present

During the 2003-04 academic year, Washington University celebrated its sesquicentennial — 150 years of providing higher education to St. Louis, the nation and the world. It was quite a milestone, but 150 years is a mere fraction of the ages of some of the great universities of the world. Harvard is heading toward 400; Oxford is more than 800. The late Clark Kerr, president of the University of California, once said that only 60 entities have survived continuously since the Middle Ages, and 50 of these are universities.

“Universities exist in perpetuity,” Chancellor Mark S. Wrighton said. “They do not come and go like businesses and other institutions often do. As such, universities take a long view of how they operate and persist over decades and centuries.”

To provide for the future of an organization with such a lifespan, universities must be managed with an eye toward balancing the current requirements of scholars and students with the needs of those who will walk the same pathways and hallways hundreds of years in the future. To do that, it is essential that a university have a significant endowment — a fund (actually a great number of individual funds) created by gifts that can never be spent. From these funds, only the earnings can be used to support the work of the institution and its faculty and students.

“The endowment plays a critical role in supporting research that has a benefit for America and the world,” Wrighton said. “Medical discoveries, exploration of ancient cultures, nanoscience, alternative energy, much-needed research and classroom facilities — all are directly or indirectly supported by endowment income, as are many of the endowed professorships that make it possible to attract and retain the talented faculty who carry out this work.”

At Washington University, the endowment provides the fourth- largest revenue stream, accounting for 10 percent to 12 percent of annual income in a typical year. Because of the School of Medicine’s health and biomedical research mission, the University’s largest sources of income are patient care and research grants. These are followed by tuition and then endowment spending.

According to Vice Chancellor and Chief Financial Officer Barbara A. Feiner, University trustees adopt endowment spending policies that are designed to maintain a smooth spending course over time while making sure that future generations of students and faculty will receive at least the same level of support from the endowment as the current generation enjoys.

“When investment returns are robust, spending rules help to ensure that any increased spending can be sustained into the future,” Feiner said. “The resulting financial stability is crucial to long-term academic programming.”

Most universities aim for a 4 percent to 5 percent payout of their endowment each year. In some years, they exceed that goal, and in others, they do not — depending on many factors, including market conditions. An annual average investment return of approximately 8 percent to 9 percent is needed to achieve a payout rate goal of up to 5 percent and, at the same time, to maintain the endowment’s value relative to an annual inflation rate of 2.5 percent to 3.5 percent. The endowment also incurs investment management costs that must be recovered.

Over the past 10 years — a period that includes both strong and weak investment markets — the Washington University endowment returned an annualized 8.8 percent per year. For the 2007 fiscal year, Washington University distributed $197 million in earnings from its endowment, which was valued at $5.66 billion June 30, 2007. Over the past decade, the University has increased annual endowment spending by more than 150 percent.

Unlike most charitable foundations that are required by federal law to spend a minimum of 5 percent of their assets each year and have only one source from which to spend assets, a university endowment is strikingly different. A university endowment is only one of many sources of income that must be relied upon, it is composed of many separate restricted funds, and it must support an everlasting institution.

“University endowment investment and spending is done with a long-term view in mind,” Feiner said. “Foundations do not have the enduring obligations faced by Washington University, which has 13,000 faculty, researchers and staff who work in more than 150 buildings utilized by more than 13,500 full- and part-time students.”

Minimizing market fluctuations

According to the University’s chief investment officer, Kimberly Walker, the University’s endowment is managed to strike a balance between the competing demands of funding current operations and preserving purchasing power to fund future needs. It is managed for the long term.

“This permits access to high-quality investment vehicles and provides a broader set of investment possibilities,” Walker said. “It also allows institutions to better manage risk because they are not focused on near-term performance results and market fluctuations. During the academic year 2000-01, for example, endowments nationally lost an average of 3.6 percent, and they lost 6.0 percent over 2001-02.”

“Careful stewardship governs the ways in which the University’s endowment is managed to flatten economic hills and valleys, such as the recent dramatic downturn in the stock markets here and abroad,” Wrighton said. “Good years like 2006-07 can be followed by equally strong market declines, and a wisely managed endowment is structured to reduce the negative impact of the bad years by conserving resources in the good ones.”

Nearly 2,500 individual funds

An unusual aspect of university endowments is that they are not just one fund that is steered by the university administration, but rather guided by the wishes of hundreds or thousands of different donors who often place restrictions on how their endowment gifts may be used by the institution.

Indeed, the “endowment” of Washington University actually comprises nearly 2,500 individual endowments — most with their own sets of restrictions and guidelines as to how they may be used. Some of these endowments are more than a century old and reflect a donor’s wishes based on what was known or expected at the time the gift was made.

Although the University has limited latitude to interpret donor wishes, it cannot redirect those funds to totally different purposes contrary to donor instructions. That is why a donor’s gift restricted to supporting medical research could not be repurposed to support undergraduate scholarships. Likewise, a gift clearly intended for an endowed professorship in English literature could not be spent on need-based grants to undergraduate English majors.

The University has received gifts for endowed scholarships in every school and college, as well as for other important intellectual resources, such as special library collections, laboratories, student services, lectures and seminars, museum collections, capital projects and support of academic programs.

Supporting scholarships and more

About $500 million of the University’s endowment is designated to generate resources for more than 2,000 students. Of this, about half can be used to generate income for undergraduate financial aid. Any other funds for financial aid must come from nonendowment revenues, including annual gifts and tuition. For example, gifts to the annual fund provide scholarships to more than 1,000 students. Income from federal research grants and from patient-related reimbursements cannot be used for undergraduate financial aid.

“Because much of the endowment cannot be used for student financial aid, one of our most important challenges for the future is meeting the growing need for scholarships,” Wrighton said. “We are working hard on the development of annual and endowed scholarship gifts that will enhance access to higher education for students from low- and middle-income families.”

Beyond scholarships, the endowment provides the University with much-needed funds to support academic programs and faculty salaries. These additional resources allow the University to continue to charge tuition rates that are well below the actual cost of educating a student, regardless of whether she or he receives financial aid.

A challenge to self-determination

In recent times, universities across America have come under fire from various sources, most recently the U.S. Senate Finance Committee, for not spending more of their endowments to meet the needs of education today. Some policy makers have suggested imposing mandatory minimum spending requirements for university endowments, as there are for charitable foundations. More to the point, some believe universities should be spending more of their endowments to ease the cost of tuition.

“While that’s understandable and something about which we all need to be concerned, we also must be good stewards of what has been given to us in the past and provide for the future of an institution that effectively must plan to exist forever,” Wrighton said. “Throughout its 155-year history, Washington University has served as a good steward of this essential resource. For many, the endowment makes a critical difference in the ability of our students and scholars to learn, create and discover new knowledge.”