Endowment Matters

Price Increases versus Inflation: The Reality

This weekend's issue of the Financial Times includes a column entitled "The Week in Numbers" at the end of the first section.

A key figure cited: 16%. The index of meat prices of the UN Food and Agriculture Organization is up 16% over the past year. What is more striking, for those who eat lamb somewhat regularly, is that lamb prices have reached a 37-year high.

Yet we are told that inflation is almost non-existent. My understanding of economics is that inflation is an increase in the money supply; that we have, to be sure. The meat figures cited above represent price increases, which are sometime referred to as inflation (I myself use that term loosely, sometimes).

So, we find ourselves in an environment in which, we're told, core inflation is near 0%, yet here we see that the meat index is up 16% in the past year. I have highlighted this issue before: the CPI number, we must remember, excludes food and energy prices.

There are two lessons here:

(1) commodities can be a valuable piece of the puzzle when it comes to an overall endowment strategy

(2) when independent schools set tuition rates based on CPI, boards of trustees might do well to take a broader look at the increase in prices of goods that are not included in the CPI number. If your school is raising tuition at CPI+2, you may be creating a deeper imbalance in families' pocketbooks by overlooking the fact that they're probably paying more for basic needs (food, for example) than ever before.

Question: how might this scenario affect your endowment strategy? Are you still willing to leave endowment growth on the back-burner?

Portfolio Challenge

Just for the fun of it, I'm going to propose a fictitious endowment for a fictitious school, and we'll keep track of the school's endowment value on a quarterly basis of a typical fiscal year.

Some basic parameters of this endowment:

(1) gold = gold bullion, not shares in GLD or similar gold ETF

(2) no dividends or interest

(3) annual draw will be 4.5% of US Dollar value of corpus, taken on 6/30 of the first full fiscal year (in this case, 6/30/2010). X ounces of gold will be sold at spot on that date, corresponding to 4.5% of the value in US Dollars.

(4) school has an annual fund of $500,000, 15% of which will be directed to endowment as of 6/30 (end of fiscal). The 15% will buy x ounces of gold at spot.

(5) this portfolio challenge is not meant to be overly-technical, just fun, and perhaps we'll all learn something in the process (in regards to using gold as an endowment barometer).

Independent Academy

Endowment: 2,500 troy ounces of gold

Starting Dollar Value as of 6/30/2009: $2,321,250   (New York close of $928.50/oz.)

Dollar Value as of 9/30/2009: $2,515,000    (New York close of $1,006) +8.3% from 6/30

Dollar Value as of 12/31/2009: $2,741,250   (New York close of $1,096.50) +18.1% from 6/30

Dollar Value as of 3/31/2010: $2,781,500   (New York close of $1,112.60) +19.8% from 6/30

Our Endowment is Fine, Thank You

"Our $15 million endowment is fine. As a school, we're comfortable with it. It helps our operations, and it gives us a bit of a cushion in the event that something nasty happens."

Really?

Have you considered the fact that your endowment will lose 1/3 of its purchasing power by 2020, only 10 years from now? Its face value may still appear large, but, due to inflation, you will have lost a minimum of 3% to 4% each year in terms of purchasing power.

How does that $15 million (or enter your figure here) look now? Its relative purchasing power is $10 million. Imagine how that will impact your operations. How about those scholarships, which are now priced against rising tuition (because you've increased tuition each year at more than CPI, no doubt)?

What is your strategy to continually offset the inflationary factor?