Dismal Endowment Returns Shed Light on Faulty Financial Model

BY BRIAN C. MITCHELL

Last week, National Association of College and University Business Officers (NACUBO) and Commonfund released their report on the endowment performance of the 805 colleges and universities who responded to their survey. The outlook was fairly dismal and sheds light on the precarious foundation on which American higher education’s financial model is based.

Endowment Returns Fall to Average of -1.9%

According to the report, net return on endowments has continued to decline for the second year, returning on average -1.9% in fiscal 2016. The returns dropped the 10-year average annual returns to 5 percent, down from 6.3 percent in the previous fiscal year. Last year’s average return lowered the five-year average rate to 5.4 percent, down from 9.8 percent a year ago.

Both numbers are lower than the 7.4 percent median annual return that most colleges and universities believe are necessary to maintain their purchasing power – supporting “student financial aid, research, and other vital programs” — over time.

Expenses Increase Even As Endowment Returns Fall

As endowment returns fall, expenses on college and university campuses continue to rise. It is not surprising, therefore, that most respondents reported increasing the money that they spent from their endowments, boosting spending at an average of eight percent which took most colleges above the rate of inflation.

There are a couple of ways to look at this anemic endowment growth. Colleges and universities hold endowments over the long-term. If endowment performance is cyclical, then historical trends suggest that the problem will self-correct over time. The second possibility is more troubling.

The plain facts are that the world has become a less comfortable place with rules and protocols that are uncertain. While some aspects of the market continue to do well, general global and national volatility and growing income inequality – among numerous other factors — may affect the complexity that impacts endowment earnings.

Should the courts decide against lifting the immigration ban, the impact on labor and enrollment in college and university settings alone could be dramatic and disruptive.

Further, most colleges and universities do not have the $34.5 billion in endowment that Harvard enjoys, even when Harvard has also slashed the number of its employees in its endowment office.

Colleges and Universities with Smaller Endowments at Greater Risk

Small institutions are particularly at risk, noted John G. Walda, NACUBO’s president and CEO:  “…if we have another couple of years of stagnant returns…they’re going to have to seriously consider cutting back on the amount of dollars that are spent at their institutions….” The question that logically arises is from where will this money come?

Can Schools Make Up Endowment Losses with Debt?

One possibility is that colleges and universities with some level of endowments could borrow to cover lean times, especially to replace depreciated facilities or build new ones. Yet the picture on institutional debt was not particularly encouraging either.

Almost 75 percent of the colleges and universities surveyed carried long-term debt. Among these institutions, the average total debt was $230.2 million as of June 30, 2016, up from $219.1 million in the previous fiscal year. Median debt also rose to $61.5 million from $58.2 million. Two-thirds of those surveyed reported decreasing their overall debt; however, indicating a reluctance to make new investments in areas like infrastructure.

Raising Tuition or Fees is Risky Proposition in Current Climate

Another source of income is, of course, the comprehensive fee that consists of revenue generated by tuition, fees, room and board. Political and consumer voices make large tuition spikes impractical and even dangerous.

It is unlikely that many colleges will package comprehensive fee increases much above the rate of inflation, presuming that they are competently managed institutions. Next year’s tuition numbers will begin to be posted after board meetings over the next few months.

Cold Truth: Higher Ed’s Financial Model is Unsustainable

American higher education must face up to the cold truth that it is operating on an unsustainable financial model, one developed in an era of different demographics, political and consumer concerns, and funding options that originated in the post-Vietnam era of rapid enrollment growth.

The world has changed even if the way that we imagine college and university finances has not.

But there is a more pressing, immediate question for American higher education to address. Some Congressional leaders are working to link endowment spending to student scholarship and debt levels, the danger of which is aptly demonstrated by the fiscal 2015 endowment returns.

Consumers who vote with their feet to reject the historic value proposition of high sticker priced four-year colleges will also affect this brave new world. And the Trump Administration is casting a heightened level of uncertainty with its first actions on immigration and the possible appointment of special groups to look at “higher education reforms.”

We live in interesting times. Now is the time to prepare for them.

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