Professors question endowment spending policy

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In light of recent articles by the New York Times regarding Swarthmore’s unwillingness to divest from fossil fuels and its limited commitment to the promotion of socioeconomic diversity, the college’s endowment has been under increasing scrutiny from both internal and external critics. Last year, an analysis conducted by Cambridge Associates, a financial advising firm that specializes in endowment management, published data indicating that the college spends the endowment at a lower rate than most private colleges and universities with comparable and even smaller endowments. This media coverage prompted some members of the college community to conduct their own analyses, revealing further concerns, particularly whether or not the college is spending enough of its endowment on present students and whether or not this is revealing of chronic intergenerational inequity.

According to the National Association of College and Business Officers, the market value of the college’s endowment as of June 30th, 2014 was $1.88 billion, a 14.8 percent increase from the previous year. This growth — which represents an aggregation of donor gifts, investment gains and losses, endowment management fees, and withdrawals to fund institutional expenses — outperformed that of many financially comparable institutions including Williams College, Wellesley College, Harvard University, and the Massachusetts Institute of Technology.

Furthermore, the college has consistently received AAA certification from the financial ratings services Moody’s and Standard & Poor’s, indicating the highest degree of financial stability. The Moody’s report states, “the AAA rating reflects the strength of Swarthmore College’s financial resources and liquidity, as well as its prestigious reputation and position as one of the most selective liberal arts colleges in the nation.” This liquidity refers to the $586 million of unrestricted cash — reserves that may be used instantly for any purpose — that the college possessed as of June 30, 2012.

The college’s considerable financial security is perhaps more profound given the immense volatility of the market over the past decade. Since 2004, the college’s endowment has increased by $797 million or 43 percent, notwithstanding the effects of the 2008 financial downturn. This growth rate puts the college financially in the company of much larger universities such as Princeton, Yale, and Stanford. Still, some worry that the magnitude of the college’s endowment could actually be evidence of financial mismanagement.

Given the college’s impressive financial profile and clear capacity to fulfill its financial obligations, some faculty members are concerned that the college is not spending nearly enough of its endowment. Worse is the potential that this trend of conservative spending has been occurring for decades.

“The endowment has grown faster than the budget has grown during this period,” explained Peter Collings, professor of physics and a member of a recently established committee assessing the college’s endowment spending practices. “This is an indication that every year a larger fraction of the budget comes from the endowment. Still, we have spent less than a large majority of other institutions, including ones with large endowments.”

According to Mark Kuperberg, professor of economics, who has studied the endowment extensively, the average rate of return on the endowment over the past 10 years has been around 8.9 percent, while the growth rate of the budget has been only 2.72 percent. The analysis conducted by Cambridge Associates LLC explained that most colleges and universities expect to average between 5 percent and 7 percent in annual returns, indicating that the college’s endowment is outperforming peer institutions.

For the past 10 years, nearly half of the college’s annual operating expenses have been supported by the endowment. Given the growth of the endowment and stability of the budget over this period, there appears to exist some inequity in endowment spending from one generation to the next. According to Kuperberg, if the college had been spending a higher rate of its endowment over the past 40 years, but maintained the same percentage of budget support from the endowment over this period, it could be in an equally secure financial position today but could have spent considerably more on previous and present students.

“Future generations are very well-off, but in some sense it’s on the backs of present generations,” Collings agreed. “That can’t just happen and everyone will think it’s hunky-dory.”

According to Collings, the high rate of return on the endowment coupled with the college’s conservative spending practices indicate that the college is more concerned with protecting the real value of the endowment for future generations than it is with making sure the endowment meets the needs of present students.

“The college could have a much higher take-out rate than it currently does,” explained Kuperberg. “Basically the story is this: we take out a lot less than our guidelines, and other schools generally take out more than our guidelines.”

According to Greg Brown, vice president for finance and administration at the college, the college aims to spend between 3.5 percent and 5 percent of its endowment each year on operations. This rate is calculated annually based on a number of factors, including expected returns on the endowment, the predicted inflation rate for the year, and the endowment’s market value. The college’s primary goal in establishing these spending guidelines is to ensure that the endowment will be sustainable in the future and that the operations needs of the college can be met in the present. Despite the upper bound of 5 percent for this guideline, the spending rate has never exceeded 4.5 percent.

According to Kuperberg, there are two major problems with the calculation for endowment spending guidelines. First, it ignores the impact of gifts, which provide 1 percent of the endowment annually. Kuperberg believes that this added 1 percent should increase the midpoint of the spending guideline accordingly to 5.3 percent. Second, Kuperberg believes that the data being used to make these calculations is not contemporary or relevant because it does not focus enough on the successes of recent years. Because of the stock market’s favorable performance over the last ten years and how little the college’s budget has grown, Kuperberg has calculated that the college could be spending its endowment sustainably at a rate of 7.2 percent per year.

“If everything going forward were to happen like it has in the last 10 years, you could take out over 7 percent forever,” Kuperberg said.

Collings agreed that the college could be taking out far more of the endowment than it already does. He cited the analysis conducted by Cambridge, which stated that the average private college or university in the U.S. spent their endowment at a rate of 5 percent per year in 2013. Cambridge surveyed over 300 schools including Swarthmore, and on the whole, most institutions — even those with smaller endowments than the college — spent their endowment at a higher annual rate than the college did. Collings worries that the college’s efforts to spend conservatively and ensure endowment growth are in some sense depriving present students from facilities and services to which they should have access.

Kuperberg agreed.

“The key here is really how little our budget has grown,” he said. “If you look at the endowment support to the budget ratio — so how much of our total spending is supported by the endowment — it’s increasing … It was something like 25 percent in 1960 and now it’s 49 percent, but if you think about all these kids in the middle, they got less than students now.”

Part of the reason the college has adopted a generally conservative spending policy is due to the high portion of the operations budget that is financed by the endowment. While operating in this manner means that the college shoulders many of the costs that might otherwise be borne by students, the market-value based policy, which dictates how the endowment is spent, leaves the budget susceptible to market volatility. In the event of a serious financial crisis, there is the concern that the college would not be able to support its operations budget as it has in previous generations, necessitating more conservative spending practices in the present.

David Singleton, a member of the college’s Board of Managers since 2000, explained this rationale.

“We could certainly be spending more now, but I think what we’re providing today is very high quality,” he said. “The real harm would be if we spent more now and in the future we have to throttle back because the money just wasn’t there … I think anybody on the board would say that on that scale from big spenders to tightwads, we’re not tightwads, but we’re certainly more in that direction than we are at the write a check for anything level. We want to be sure that the resources will be there in the future to maintain what we’re doing now.”

Stephen Golub, professor of economics at the college and another member of the Ad Hoc Committee on the Endowment, agreed, stressing the volatility of endowment income and the difficulty of cutting back college spending during downturns. He argued that it is therefore imperative to be cautious in raising spending when endowment returns are high.

“You don’t want the endowment return to control the academic program on a short-term basis,” Golub explained. “People look back after the fact and say, ‘Oh, we underspent,’ but you just don’t know. You could have ten bad years after ten good years, and you have to be prepared for that.”

According to Harold “Koof” Kalkstein, a member of the Board of Managers since 2008 and the chair of the college’s Finance Committee, the college’s preparedness for future market volatility was a major factor in the relative ease with which the institution was able to navigate the 2008 financial downturn. While other institutions were forced to make layoffs and pay cuts, the most drastic change to the college’s financial practices was the installment of salary and hiring freezes. This preserved the spending power of the endowment per student over time, which Kalkstein explained is the primary aim of the college’s financial decisions.

“If we didn’t have the endowment covering roughly half the budget, either tuition would be much higher or we would have to cut back dramatically on programs,” Singleton agreed. “Every student — not just those students receiving financial aid — receives a direct financial benefit from the endowment. That is close to $2 billion helping to support their education.”

Each year, the first part of the operations budget supported by the endowment is financial aid. Over the past 20 years, the college has gone from providing roughly one third of the student body to over 50 percent of the student body with financial aid packages. Today, the average financial aid package is around $40,000. This increase has occurred in synchrony with the growth of the endowment.

“If you’re accepted and want to come here, the college will find a way to make the numbers work for you,” Singleton said. “This is something we value very highly and clearly the endowment is critical to that. With half the budget coming from endowment earnings, if the endowment income declined, the need-blind philosophy would be the first thing in peril.”

Despite the merits of conservative endowment spending in regards to the provision of financial aid, concern remains that the college could be spending more of the endowment on present generations and still be able to maintain present financial aid policies in the future.

“Are we spending a lot of money? Sure, we are spending a lot of money, but whether you are spending too much or too little bears some relationship to how wealthy you are,” Kuperberg said. “Would I say Bill Gates spends too much even though he has this huge, elaborate house? I would say he doesn’t spend too much. He probably spends too little because he’s got so much wealth. We are the Bill Gates of liberal arts colleges.”

Kuperberg explained that the college could be investing in improving facilities, adding more faculty, building more labs for the sciences, and increasing salaries, especially for staff.

Collings agreed.

“You’re not giving the same opportunity to one generation over the other,” he said. “I felt that there were needs that were not being met … some of these can be facilities needs. Some of these can be curricular needs. For example, during those past 25 years, we could have easily put together a much stronger environmental studies program. I felt something was being lost.”

This is where the issue of intergenerational equity is most profoundly felt. Those who criticize the college for spending too conservatively argue that because endowment support to the budget is increasing faster than the growth rate of the budget, and the spending rate of the endowment is low, future generations will have far more access to endowment spending than present generations. If the college maintained the percentage of endowment support to the operations budget at a constant, sustainable level each year, the college could be spending far more on its present students.

According to Kuperberg, last year, the college took out $67 million of its endowment. If the college had established a stable and sustainable rate of support from the endowment to the budget, it could have taken out another $40 million last year. Instead, this money will be saved, growing the endowment for the future and further increasing the college’s financial liquidity.

“If you slightly underspend, the worst thing you’ve done is give more to future generations,” Singleton explained.

In the coming years, the board anticipates that some of the financial gains from past decades of conservative spending will be used to support the construction of the new Biology, Engineering, and Psychology building as well as the renovations occurring in Dana and Hallowell.

Collings sees this as evidence of the college’s endowment spending behaving in a self-correcting way.

“You go long enough and not spend enough, your buildings fall down, your programs aren’t competitive with other institutions, you can’t hire the right employees,” he said. “Well guess what? You have to spend some money to get back to where you were … My point is, this could have been done a lot earlier.”

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