Endowment Matters

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.

Portfolio Challenge Update: End of Fiscal '10

June 30, 2010 marked the end of the first fiscal year of my portfolio challenge. As a reminder, my fictitious endowment for Independent Academy is based on holdings of 2,500 troy ounces of gold. My figures from the past year are as follows:

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 6/30/09

Dollar Value as of 12/31/2009: $2,741,250   (New York close of $1,096.50) +18.1% from 6/30/09

Dollar Value as of 3/31/2010: $2,781,500   (New York close of $1,112.60) +19.8% from 6/30/09

Dollar Value as of 6/30/2010: $3,106,000  (New York close of $1,242.40) +33.8% from 6/30/09

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A return of 34% is pretty good, given the state of the economy! Independent Academy has done well. Now, two matters remain before we launch into the second fiscal year of an endowment based entirely on gold bullion.

1. Annual Draw. As promised we will take 4.5% of the US Dollar value of the corpus and sell that many ounces of gold. Based on a New York Spot close on 6/30 of $1,242.40, our endowment was valued at $3,106,000.

SOLD: 112.5 oz = $139,770

Endowment Balance = $2,966,230 [2,387.5 oz. of gold bullion]

2. Annual Purchase, based on 15% of Annual Fund donations. Our Annual Fund brought in $500,000, 15% of which equals $75,000.

BOUGHT: 60.4 oz. of gold

Endowment Balance = $3,041,230 [2,447.9 oz. of gold bullion]

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Some Thoughts (Obvious or Otherwise)

When I announced the portfolio challenge, I knew that the sell-buy strategy (1x/fiscal year) was not balanced. However, I wanted to wait for the full set of data to allow me to point out the obvious issues that Independent Academy now needs to study and act on, as does any independent school with an endowment. My point is that most independent schools are not doing enough for/with their endowments in terms of replenishment and building. I have chosen not to allow new gifts to the Independent School endowment, only replenishment. Permit me some thoughts below, which are meant to prompt those of you reading this blog to follow suit.

1. Sustainability. Although Independent Academy's endowment is exceedingly healthy, and although our draw was not immediately deleterious to the Academy, my concern now is that we bought 60 ounces of gold after selling 112 ounces. Over the long term, that inverse relationship could be deleterious, as we must plan for the natural volatility of gold prices. If gold moves downward in the future, we would have to sell more ounces in order to meet our draw. If it continues to rise, we will benefit from the good fortune.

2. Risk. This category is tied into the first, as my last sentence (above) demonstrates. Independent Academy must carefully assess and manage its risk with the endowment; just because it is based on gold--a rising asset over the past ten years--does not mean that it will continue to benefit from increases, despite continued economic instability domestically and internationally.

3. Complexity. Independent Academy wishes to avoid a complex endowment, and it has done so, successfully. However, risk assessment will call for some data modeling. Nevertheless, the Academy's trustees will insist that this data modeling be kept focused on a gold-only endowment.

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Fiscal Year '11

In this new fiscal year, Independent Academy will begin to track a separate data point: the synchronous full replenishment model. This model would have the Academy sell X ounces at 6/30, then simultaneously buy the same number of ounces. The funds to purchase these ounces will, as always, come from the Annual Fund. This approach will cause the Board to reconsider the flexibility of the Annual Fund and how those resources might be better allocated within the operating budget. When we look at the final data on FY 11, it will be interesting to see what the Board thinks at that time.