Endowment gains slow amid turmoil

U. outperforms peers in a rough year

By and
Friday, September 26, 2008

Outperforming the market and many peer institutions, the University earned a 6.3 percent return on its endowment in the fiscal year ending in June, Brown’s top financial officer said Wednesday. While the gain represents a definite step back from the greater returns seen in recent years, it reflects a relatively strong performance in a difficult economic year.

Over a period in which major market indicators posted double-digit losses, the University’s endowment posted modest gains, surpassing $2.8 billion, said Elizabeth Huidekoper, executive vice president for finance and administration. Brown realized a better return in the recently concluded fiscal year 2008 than several of its competitors, including Stanford University (6.2 percent), Yale (4.5 percent) and the University of Pennsylvania (negative 3.9 percent).

It also outpaced the Massachusetts Institute of Technology (3.2 percent) and Cornell (2.7 percent). Among Brown’s closest competitors, Harvard (8.6 percent) has so far reported a better proportional return.

The numbers for fiscal 2008 include almost a full year of deteriorating market conditions, reflecting the credit crisis touched off by defaulting subprime mortgages in the third quarter of 2007. But they leave unanswered the effect of the dramatic events of recent weeks – which included the abrupt sale of Merrill Lynch, the collapse of the investment bank Lehman Brothers and an emergency government loan to rescue American International Group, the insurance giant.

With Congress nearing a deal on an unprecedented $700 billion bailout of Wall Street firms, the possibility of a prolonged period of small gains for institutional investors in coming years remains real.

“This is not going to be a fun time, across the board,” Huidekoper said.

She added, though, that the University’s endowment had “hardly any” exposure to Lehman and said she could not point to any significant investment that had yet resulted in dire losses.

However it may compare to the performance of its peers or the market as a whole, the endowment’s return is disappointing compared with that seen in the recent past. In the preceding fiscal year, which ended in June 2007, the University earned a robust 21.7 percent on its endowment.

The decline in the rate of endowment growth has already had serious implications for the University’s strategic plans, and could continue to affect them adversely. Recent strong returns have fueled aggressive growth, as the University upped spending and took on debt to finance a spate of academic and capital projects.

The University’s agenda still includes pushing ahead with the physical expansion of the campus, including new buildings along the Walk, and expansion of the faculty and Graduate School, although the pace of any of these initiatives could slow if revenue growth proves sluggish in the down economy.

The Plan for Academic Enrichment, President Ruth Simmons’ blueprint for bolstering Brown’s academic profile, for example, had called for expanding the size of the faculty to 700 for this semester. But the University was able to add just 9 of the 20 new positions that would have been required to meet that goal, Huidekoper said.

The Corporation voted in February to temporarily increase the payout to nearly 6 percent of the endowment’s three-year rolling average. That payout, the highest in decades, helped support a broad expansion of financial aid, which University officials deemed necessary to remain competitive with a wave of peer schools, led by Harvard, that announced dramatic financial aid boosts last year.

Rising expenses and tightening revenues in the difficult economic landscape may force payouts to remain high in the near future.

While the uncertain market could ultimately force the University to temper its ambitions, Huidekoper said that there are no plans to cancel any of the building projects slated for the next several years. Target completion dates could be pushed back if necessary, she added.

“Everything on the capital list, we absolutely intend to do,” she said.

In a volatile credit market, the University is also forced to hold more cash reserves, she said. The tight credit market of the past few weeks has not significantly driven up interest payments on the University’s roughly $500 million in outstanding debt, Huidekoper said.

The University continues to expect taking on more debt to finance upcoming construction but will not need to do so until late winter or early spring, Huidekoper said, allowing time for spiked interest rates to ­- hopefully – settle in the meantime.

Huidekoper said Brown had benefited in the last year from its asset allocation strategy, which included relatively weighty investments in hedge funds, a sector that has performed well throughout the national economic downturn that began more than a year ago. Such funds made up 32 percent of Brown’s investments in fiscal 2008.

Kenneth Redd, director of research for the National Association of College and University Business Officers, said a survey conducted by his organization found that schools with endowments over $1 billion invested, on average, 20 percent of their assets in hedge funds in fiscal 2007, the most recent year for which NACUBO has such data.

Universities with large endowments, such as Brown, are often best positioned to weather economic downturns and continue to post gains in a volatile market, Redd said. Wealthier schools have the luxuries of more actively managing their assets and diversifying over a broader range investment classes than do those with fewer resources, he said.