The $5.7-billion endowment here at Washington University in St. Louis is a nest egg that makes a lot of things possible.
Endowment proceeds begat the whimsical, stainless-steel spherical sculpture now hanging in the lobby of the sleek new art museum, which gives off a funhouse-mirror effect from below; the sprawling collection of books on the Third Reich that fills more than a room in the library; scholarships for medical students that allow them to graduate with lower levels of debt than the national average; and hundreds of endowed professorships that give deans of the seven schools here the means to reward longtime professors and recruit hot stars from other places.
The endowment also underwrites a vast and respected medical-research operation, a $490-million enterprise that, while producing prestige and medical breakthroughs (like a recent finding that links genetic factors to cigarette addiction), costs the university more than $1.20 for every dollar it brings in.
Still, to critics in the U.S. Senate and some experts elsewhere, Washington University, along with dozens of other wealthy universities, is far too stingy with its endowment.
Concerned about the spiraling costs of attending college, some U.S. senators are considering new tax proposals designed to pressure universities to spend more of their assets.
At a hearing in September, an influential Republican senator, Charles E. Grassley of Iowa, said requiring wealthy universities to spend a higher percentage of their endowments could help “more working families see the benefits” of lower tuition bills. Those bills are getting bigger. This week the College Board announced that the average price of tuition again rose higher than the inflation rate this year, even as student aid failed to keep pace.
The Senate proposal, which has yet to be introduced as legislation, could require rich universities to spend at least 5 percent of their endowment, as private foundations are now required to do, or lose the tax exemption they enjoy on their endowment earnings.
It is not that colleges don’t spend their endowments. They do, but many of the wealthiest universities spend closer to 4 percent than 5 percent a year. That difference of one percentage point is significant. The 10 richest universities as of 2006 together now hold more than $142-billion in their endowments. If they collectively spent 5 percent rather than 4 percent, that would be an additional $1.4-billion.
Washington University, which had the 15th-largest endowment in 2006, hasn’t spent more than 5 percent of the annual value of its endowment in any of the past 20 years. In the 2006 fiscal year, when the average spending rate for university endowments of $1-billion or more was 4.6 percent, its rate was 4.4 percent. In the most recent fiscal year, which ended June 30, its rate was 3.9 percent.
This spotlight on endowment spending comes as more and more institutions—and not just the Harvards and the Yales—are amassing greater and greater wealth in those funds. At the end of the 2006 fiscal year, 62 institutions had endowments worth more than $1-billion, up from 20 a decade earlier. Given the strong returns many institutions have experienced for the 2007 fiscal year, membership in that billionaires club is likely to swell.
An Indicator, but of What?
Determining how much can be spent from an endowment is not as simple as some outsiders might think. It is the makeup of the endowment—how much has been specifically donated or designated for student aid, for research, or for art acquisitions—that matters.
The institution’s aspirations and management culture, issues like how much financial power trustees give to individual schools and deans, also play a significant role.
The spending rate can help measure whether an institution is spending enough on the students and faculty of today, or hoarding for the future.
But as the recent experiences of Washington University and a comparable institution, Emory University, demonstrate, it is an imperfect indicator.
In 2003, Emory, which has an endowment, enrollment, and educational mission similar to Wash U.'s, spent 6.7 percent of its endowment, a figure that might win it plaudits from those who want to see universities spending more. But for Emory, “it was a little scary,” says James W. Wagner, who became president in 2003.
In that year, the actual payout that went into Emory’s operating budget ($230-million) wasn’t substantially greater than the amount that had gone into the budget a year earlier, with a lower spending rate of 5.2 percent. Because of investment losses, the overall size of Emory’s endowment fell, so it was spending a larger percentage of a shrinking pot. Emory was able to weather the financial squeeze with belt tightening, cutbacks, and drawing down some reserves.
During the same period, the value of Washington University’s endowment dropped as well, and its spending rate was lower than Emory’s too. But Wash U. was able to steadily increase its annual spending from its endowment, more than doubling it over a decade, to $197-million in 2007. Much of that is attributable to the fact that the university set an intentionally low spending rate that produced a steadily increasing payout from its endowment, even in the early 2000s, when the endowment’s value dropped by 16 percent.
Cautious but Steady
Washington University’s spending rate averaged less than 4 percent over the last decade, producing a cumulative payout of nearly $1.5-billion. The Emory spending rate, which ended up averaging just under 5 percent, generated more than $2-billion over the same period.
While any number of factors come into play, perhaps one reason Washington University trustees can afford to keep the institution’s spending rate lower is that the university gets higher revenues from other sources. One of those is gifts. The university saw an uptick in giving as a result of a $1.5-billion fund-raising campaign that ended in 2004. Gifts have accounted for between 4 percent and nearly 8 percent of Washington University’s annual budget since 2000. At Emory, which hasn’t been in a campaign since the mid-1990s, gifts accounted for about 3 percent to 5 percent of annual revenues during roughly the same period. Emory expects to publicly announce a campaign next year.
Over the past decade, Wash U.'s endowment value has risen by 64 percent while Emory’s grew by only 10 percent. While it is hard to assess how much of that was affected by the influx of gifts and the ups and downs of investment returns at each institution, Washington University’s decision to spend a smaller percentage of its endowment than Emory very likely contributed to the increase in value.
Mark S. Wrighton, Washington University’s chancellor since 1995, says the conservative policy that produced those endowment payout increases has been vital to the many successes his institution has enjoyed.
“Maintaining momentum is my biggest challenge,” says Mr. Wrighton from his office here in Brookings Hall, a castlelike building whose Collegiate Gothic architecture is mirrored across the campus.
For an ambitious university, competing for students and faculty members against other ambitious institutions, increases matter, says Mr. Wrighton. A decline in spending “blunts progress if you value momentum.”
Mr. Wrighton says the senators’ approach is overly simplistic because it doesn’t recognize that universities are different animals from grant-making foundations.
“Foundations don’t have the enduring obligations that we do,” says Mr. Wrighton. “Foundations don’t have the physical and human-resource commitments.” Washington University employs more than 13,000 people and operates more than 150 buildings on its main campus, medical-center complex, and surrounding sites.
“We also have donors with an expectation that what they have given us will be there and be stewarded so that the program they support endures,” Mr. Wrighton adds.
Restricted and Unrestricted Funds
In the abstract, the idea of requiring a spending minimum might seem appealing: If universities put more of their savings toward their existing costs, they wouldn’t need to seek so much in additional tuition from their students.
Yet Wash U.'s endowment isn’t simply a $5.7-billion slush fund. It is actually an accumulation of 2,474 separate funds, ranging in value from $2,200 to $594-million (the latter including many of the gifts from the Danforth Foundation, the university’s biggest benefactor).
All but about $400-million in the endowment is designated for a particular purpose, either because it derives from a gift that was originally made with that restriction (about three-quarters of the endowment) or because the university trustees, over time, have designated unrestricted funds for that use.
Only about 9 percent of the overall endowment is specifically designated for student aid. So simply cranking up the spending rate would not automatically produce millions more for scholarships, unless additional gifts for student aid came in or the trustees chose to put more available money toward that purpose.
That’s part of the tactic Princeton University is using to finance its expanded student-aid programs. Since 2001 it has replaced loans with grants in financial-aid packages. Emory says it hopes to raise more than $75-million for its endowment to cover long-range costs for its version of such a plan, the Emory Advantage, as part of its soon-to-be-public campaign.
But even with the restrictions on how endowment funds can be used, an increase in the spending rate can produce additional unrestricted money, too. For example, if a program that cost $10-million depended on both endowed and unrestricted money for its support, additional money produced by a higher spending rate—say, $50,000—could supplant some of the unrestricted money that had been going to the program. That, in turn, would free up $50,000 in unrestricted funds for another purpose. Stanford University, in fact, has just approved a policy that will use that approach to jump-start spending on key construction projects that are a high priority for the trustees.
At Washington University, however, that tactic would only go so far. That is because this university operates on a decentralized model. And it also operates in a world of ever-heightening levels of competition, where any research university that isn’t continually bringing in hot hires or starting new research ventures—that “momentum” that Mr. Wrighton so values—considers itself falling behind.
So even if a higher spending rate freed up some unrestricted funds, most of the freed-up money would remain with the various schools, where each dean has lots of competing demands for newfound money.
“This is a winner-take-all game,” says John V.C. Nye, a Washington University professor of economics who has questioned whether universities focus too much on building their endowments.
“The best faculty and the best facilities cost way more than ordinary faculty and facilities,” says Mr. Nye, who is on leave and teaching at George Mason University. “If you play that game, it’s not enough to keep up with your expenses. You have to keep up with what your competitors spend.”
Mr. Wrighton makes no apologies for those aspirations, though he is quick to note that the current levels of endowment spending also support today’s students and faculty members, including undergraduates. Over all, the endowment provides about 10 percent of the university’s annual operating revenues. At the four schools that serve both undergraduate and graduate students, it amounts to about 14 percent of the cost of education.
‘Fantastic Things’ in Some Areas
Around the campus, the endowment spending draws few quibbles.
“We’ve made spectacular progress whatever the payout is,” says Barbara A. Schaal, a professor of developmental biology who came to the university 27 years ago. “The university is doing fantastic things.”
Ms. Schaal, who is vice president of the National Academy of Sciences, enjoys some of those firsthand. She holds an endowed chair in biology, and the funds associated with it allow her to conduct some of her own research and help some of her graduate students get started on their research careers at a time when grant money is harder to get. Some are now studying tree diversity in the tropics.
Indeed, the only persistent complaint about the endowment is that it is insufficient in certain areas, particularly for student aid. Most of the $122-million the university spends annually on financial aid comes from tuition or direct gifts. About half the students receive aid. The university has no plans to introduce aid packages that would reduce or eliminate loans.
Neil Patel, a senior who is president of the student government, says the lack of money has an immeasurable cost. “You never know the students who did not come here” because the aid package offered wasn’t sufficient, he says. “As long as that’s the case, the student body is suffering in some way.”
Mr. Wrighton acknowledges the problem. “Financial aid is a huge issue,” he says. But the chancellor says the way to solve that is with more money, not a higher payout: “I want a bigger endowment.”
Nonetheless, the question of whether wealthy institutions like Washington University spend enough remains an issue because the colleges’ wealth makes them far more visible players in the worlds of investing and philanthropy.
At Wash U., trustees set spending each December, increasing the payout by at least the rate of inflation. Under their spending rule, the amount of the payout can exceed inflation at their discretion, but it cannot be lower than 3 percent of the average value of the endowment over the previous five years, nor higher than 5.5 percent of that value.
The five-year look back tempers payout increases when the endowment value rises, and helps to minimize decreases when it falls, or avert them altogether, as it did in 2001, 2002, and 2003.
Even as a percentage of the endowment’s five-year average value, however, Washington University’s spending rate has exceeded 5 percent only once in the past 20 years, back in 1987. Over the past decade, it has ranged from 3.8 percent to 4.8 percent.
John H. Biggs, a Washington University trustee who plays a key role in setting the rate as well as directing endowment investment policy, says he is “very comfortable” with the level of spending. “I think we’re right where we want to be,” he says.
Mr. Biggs, who is chairman emeritus of the giant educators’ pension fund TIAA-CREF, says spending at the level of Washington University’s, coupled with expectations of annual inflation increases of about 3 percent, preserves the overall purchasing power of the endowment over time.
His assessment assumes the endowment will earn a return of about 8 percent over time, similar to the rate of return big corporations like Boeing now assume for earnings on their pension plans. (Mr. Biggs sits on the Boeing Board of Directors.)
Some experts, however, say that an 8-percent expectation may be too conservative, particularly in light of the investment success the wealthiest institutions have been enjoying. Rates of return for university endowments valued at more than $1-billion averaged 11.4 percent for the 10-year period ending June 30, 2006, the most recent for which data are available. During the same period, Washington University earned 9 percent.
William F. Massy, president of the Jackson Hole Education Group, a consulting company, says his research on endowments suggests a 6-percent target spending rate could be easily justified in light of the potential for big gains that have become available to these large and sophisticated endowments.
Bigger Payouts at Some Institutions
A few institutions, including Stanford and Princeton Universities, are moving in that direction.
In June the trustees at Stanford voted to increase the targeted payout on its $17.2-billion endowment. The rate will go from 5 percent to 5.5 percent during the 2008 and 2009 fiscal years, and possibly for longer than that. (Despite having a target rate of 5 percent, Stanford’s actual spending rate has been in the range of 4.3 percent to 4.6 percent over the past four years because each year it ended up earning more than it expected to.)
Randy Livingston, Stanford’s vice president for business affairs, says the trustees were comfortable raising the rate because they have “confidence in the ability of the Stanford Management Company to come back with a level of strong returns” in the future. The higher spending rate is based on an assumed rate of return of 10 percent; the endowment’s return for the past four years was 20 percent.
At Princeton trustees last fall raised the upper limit on its spending rate from 5 percent to 5.75 percent. The move was a deliberate attempt to raise the actual spending to an average rate of 5 percent. In the past few years, with the combination of a lower top target rate and strong investment returns, Princeton’s actual spending rate had ended up consistently below 5 percent.
“There’s no other reason to have an endowment than to use it,” says Andrew Golden, president of the Princeton University Investment Company, the university’s investment arm. Mr. Golden says the higher spending can be accomplished because the endowment assets are now positioned to produce steady returns of at least 10 percent over time.
At Emory, even after seeing the fluctuations in payout that the institution rode out over the past decade while pursuing a target spending rate of 4.75 percent (the actual spending rate went as low as 3.24 to a high of 6.73), officials say they too believe there is a danger in setting the spending rate too low.
“The risk of underspending is almost as great as overspending,” says Michael J. Mandl, executive vice president for finance and administration. “We’re not trying to be so conservative that we completely protect against flatness or a decrease” in endowment payouts.
But at Washington University, described by one influential dean as having a “belt and suspenders” management culture, even the 22-percent return the endowment enjoyed in 2007 is not likely to shake the thinking about the value of conservative spending policy.
“It’s just better management practice” to have the commitment be stable, says Mr. Biggs, the influential trustee.