Outlook on Endowments 2010 to 2014

The next several years will be incredibly difficult ones for endowments, in terms of generating substantial returns. With nothing but economic uncertainty in front of us, here are some suggestions as we muddle through:

• Expect volatility, sometimes severe. Geopolitics will play a role in your endowment portfolio like never before.
• Be sure that your endowment has a good portion of equities with a history of on-time payment (and/or increase) of dividends.
• Do not expect a significant increase in the prices of your assets, what is termed "price appreciation." If there is price appreciation, take it to the bank, but plan for little to none.
• For the fixed income portion of your endowment, screen out as many mortgage-backed securities as you can. This market is exceedingly volatile, and there could easily be further changes to the MBS (mortgage-backed securities) that would be deleterious to the MBS industry.
• Consider allocating some percentage of your fixed income portfolio to TIPS, treasurys that are inflation-indexed.
• Don't put great stock in the CPI numbers that are released, which will indicate low inflation. Some reports have identified inflation as being expected to average 1.6% (approx) over the next ten years. Don't forget that "core inflation" numbers do not reflect food and energy costs; these are expected to rise. Independent school families need food and energy, which means that these prices affect what they will be willing to pay for tuition more than the CPI figures, the prediction of which is questionable at this point. Read my white paper, "The Deleterious Effects of Inflation" for more information.
• Continue to maintain a portion of your endowment in cash. Your investment committee should determine what this allocation should be, but try to make it significant. Here is the reason: should your school need immediate access to cash, it's nice to have it on hand without having to worry about liquidation of equities at a loss. A basic guideline to use is to determine how many days in cash you would need to be in order to continue operations for three to six months. Then, look at your projected cash flow from normal tuition payments, discount it by 25% and use that 25% figure as the target for how much cash you should have. This projection would give you enough cash to continue operations should 1/4 of your tuition payments cease for a period of three months (or six, if you wish to be extra-conservative financially).
• Continue to funnel dollars into your endowment via a budget line item in your annual operating budget plus a minimum of 10% of your annual fund (25% would be better).
• If your endowment is small (<$2 million), don't plan for an endowment draw. There is no IRS rule (not yet, at least) which states that you must take a draw. If your endowment is >$2 million, convince your finance committee to take as small a draw as possible: perhaps 2%. Since these amounts are very small, it would be better to plan for them in terms of hard dollars (tuition revenue) rather than taking a draw from your endowment. Remember: you need to maintain the endowment for the long haul, and it's not going to grow if you continue to draw it down. Short-term pain = long-term gain.

Maintaining stability is the name of the game right now. Recent economic history (the last twenty years or so) shows us that we have a recession, on average, about every four to six years. That means that--potentially--we'll be due for another one sometime between 2011 and 2013. Take the time now to revisit your endowment strategy, and, if you haven't altered course, consider the implications of a possible recession in the short-term and how that might affect your operations. Then plan for it.