College Endowment Contracts as Uncertainty Clouds Market

Author: Devin Zatorski News Editor

Amidst a broad economic downturn, college and university endowments collectively plunged billions of dollars in the 2001 fiscal year, posting negative returns for the first time since 1984.

While signs of economic vulnerability were evident in the summer months, the terrorist attacks of Sept. 11 may push the nation's economy into a deeper recession, ultimately compelling some college officials to re-evaluate their investment strategy to temper the risk of further losses.

According to a report released by Commonfund, which manages $30 billion on behalf of non-profit entities, 74 percent of surveyed colleges and universities reported static or negative returns for the fiscal year, which ended June 30.

Middlebury is no exception: statistics compiled by Investment Administrator Derek Hammel show that the market value of the College's endowment stood at $638 million on June 30, 1999, peaking at $719 million a year later and then declining to $674 million at the end of the 2001 fiscal year. The most recent data available pegs the endowment's value at $629 million as of Sept. 30, a $90 million slide over a two year and three month period.

Vice President of Administration and Treasurer Robert Huth said the wide range of investments represented in the endowment portfolio, including more secure alternatives like hedge funds and private equities, has "dampened the decreases we have seen in domestic equity [the stock market]."

A good hedge fund, explained Hammel, "captures most of the upside, but limits losses on the downside" of economic fluctuations. Private equity, on the other hand, involves investing in mature companies that are seeking capital for expansion.

Because of the endowment's diverse portfolio, Huth said, it has particular strength in down markets. "We did not see the 85 percent returns like the NASDAQ in 1999, but we also have not had the negative 30 percent year-to-date losses [like most of the broad stock market indexes]," he explained. "We are betwixt and between those extremes."

Hammel added that the endowment returns have outperformed national markets, with a six percent decline this fiscal year-to-date contrasting with a 31 percent plummet in the NASDAQ, 15 percent drop in the Dow Jones Industrial Average and a 15 percent loss in the Standard & Poor's 500 Index.



Endowment Management:

Stay the Course



An investment committee comprised of three trustees is charged with overseeing about $600 million of the endowment funds and making key strategic decisions about investment allocation. Committee Chair Rick Fritz '68, Garrett Moran '76 and Kendrick Wilson, a Middlebury parent, are "extremely well positioned [businessmen who] have a great deal of experience in guiding investment strategy," Huth noted.

Within the committee, discussions about changes in the allocation of investments were underway even before the terrorist attacks on the World Trade Center and Pentagon. Huth said the "most critical decision an investment committee can make relates to the allocation of the endowment [because] it has the most impact over time."

Huth indicated that the committee sees opportunities in international equities, which have not figured prominently in the endowment to this point, but it may eliminate investment in emerging markets. Channeling more endowment into less risky options like hedge funds, fixed income and absolute return investments may also be on the horizon, said Huth. All of these possibilities, however, are subject to review with the consulting firm the committee has retained for guidance.

"There's no thought of making any rash, quick reallocations," he maintained, saying "if you were comfortable with your allocation on Sept. 10, you ought to be comfortable with it on Sept. 12."

Citing an economic maxim that declares "buy low and sell high," Huth said that the numerous lows in stock prices brought on in part by the terrorist attacks would indicate that unloading stocks now would indeed be "selling low," contrary to the widely accepted investment principle.

In the financial management field, he said, "there is a propensity to stay the course instead of making rash changes," a philosophy Middlebury plans to follow. "You look at the merits of the investments and do not [succumb] to knee-jerk reactions … because the market beats up on big changes," Huth elucidated, warning "there is a lot of room to do that" in times of economic uncertainty.

Among possible strategies portfolio managers may adopt, said Alan R. Holmes Professor of Monetary Economics Scott Pardee, is shifting into a "defensive mode by increasing the percentage of the portfolio held in treasury securities, AAA bonds and less risky parts of the stock market."

But Pardee also notes that professional investors are "rather careful about making quick decisions about change."

Their goal is to "sustain the spending power of the school both now and in the future," which is often achieved through "solid growth with a conservative risk profile."

Because the market is a "study in exaggerations," however, the market will ultimately gravitate towards a mean, which makes a case for emphasis on the long term, Huth said. "We do not invest from year to year" because the endowment has "perpetual life."

Pardee concurred, saying that in the medium to long run markets "would eventually turn around."

The statistics confirm long term stability. For the five years ending June 30, 2001, the endowment return totaled 12 percent, the same return earned over the 10 years leading up to that same date.

While he advocates "letting the psychology of the market do its thing," Huth also said the College should be wary of "putting its head in the sand."

He continued, "Every organization exists with a need to look at what is happening in its environment," and "we do not know how long this economic malaise will continue."

The College looks at a minimum of a three-year horizon, since most recessions last 18 months and economic recovery is realized after two and a half years at the most. "At least for now," Huth concluded, the College is staying the course.



The Fundraising

Dynamic



The economic slump has also fueled concerns among college fundraising executives who fear that economic instability might dip into charitable giving totals. Moody's Investors Services issued words of warning: "Our most serious concern is that fundraising will suffer as a result of the further declines in already sluggish financial markets, economic uncertainty and the distraction of recent events," The Chronicle of Higher Education reported.

Sally Holland, vice president for College Advancement, has found that annual giving levels to date are on par with last year's numbers.

Annual Fund gifts, solicited from parents and alumni, fund seven percent of the College's operating budget every year.

She said it is too early to tell whether there will be a drop off in capital fundraising, which supports the endowment and building projects.

"My past experience indicates that not all donors will be affected in the same way by the softening economy, and that we will only know what individuals are able to do for the College by talking to them individually," she explained.

Since the majority of donors make their gifts in December, winter will be the best time to gauge the effects of political and economic uncertainty on annual giving through comparison with last year's figures.

The economic context "adds another layer of complication," said Huth, "but at the same time the momentum [generated by the Bicentennial Campaign] needs to continue. Nobody is willing to admit defeat," he maintained. "We are all interested in rising to the chall
enge."

Reported The Chronicle, "It is too soon say whether 2001 ended a golden era of outsized fundraising and investment success by higher education institutions, or if the current period is simply a lull. A lot may depend on whether the already weakened economy is driven into full-scale recession in the wake of the Sept. 11 attack."