Introit

Portfolio Challenge: End of Fiscal 2012

It is time for the annual report on my "porfolio challenge" (aka an independent school endowment held entirely in gold bullion, just for the fun of it), I wanted to provide a year-over-year comparison, given that we recently closed the fiscal year 2011-12

The stats from June 30, 2011 (one year ago):

June 30, 2011 marked the end of the second fiscal year of my portfolio challenge. As a reminder, my fictitious endowment for Independent Academy is based on holdings of 2,447.9 troy ounces of gold. My figures from the past year are as follows:

Dollar Value as of 6/30/2010: $3,106,000  (New York close of $1,242.40) +33.8% from 6/30/09

Dollar Value as of 6/30/2011: $3,672,584  (New York close of $1,500.30) +18.2% from 6/30/10

A return of 18% was pretty good, given the state of the economy. Independent Academy did well. There remained two matters to address before entering the 2011-12 fiscal year.

1. Annual Draw. Per the original agreement of the Portfolio Challenge, we will take 4.5% of the US Dollar value of the corpus and sell that many ounces of gold. Based on a New York Spot close on 6/30/11 of $1500.20, our endowment was valued at $3,672,584.

SOLD: 110.2 oz = $165,266

Endowment Balance = $3,507,018 [2,337.2 oz. of gold bullion]

2. Annual Purchase, based on 15% of Annual Fund donations. Our Annual Fund brought in $500,000, 15% of which equals $75,000.

BOUGHT: 50 oz. of gold

Endowment Balance = $3,581,277 [2,387.2 oz. of gold bullion]

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2011-12 Portfolio Challenge Results

June 30, 2012 marked the end of the third year of my Portfolio Challenge. My figures from the past year are as follows:

Dollar Value as of 6/30/2011: $3,672,584  (New York close of $1,500.20) +18.2% from 6/30/10

Dollar Value as of 6/29/2012: $3,817,372  (New York close of $1,599.10) +3.9% from 6/30/11

*close was 6/29 instead of 6/30 because the 29th was the last business (trading) day of month.

A return of 3.9% is quite modest, compared with some of the gains in domestic equities. At one point, gold had touched $1,900, but it has since pulled back from those highs. Nevertheless, our corpus is worth more in dollars than it was one year ago. This report marks the third year in a row that our endowment has been in positive territory, and that is good news. Now let's turn our attention to the Annual Draw and the Annual Purchase, per the original Portfolio Challenge.

1. Annual Draw. The agreement calls for a draw of 4.5% of the US Dollar value of the corpus, meaning that we will sell the corresponding troy ounces of gold to cover the amount in dollars. Based on the closing New York spot price of $1,599.10 on 6/29/12, that means we need the equivalent of $171,782, or 107.4 troy oz. of gold.

2. Annual Purchase. Again, per the agreement, we are funneling 15% of Annual Fund dollars into gold purchases for the endowment. Our Annual Fund saw a 5% increase this year to $525,000. Fifteen percent of that figure equals $78,750.

BOUGHT: 49.2 oz. of gold.

Endowment Balance = $3,724,304 [2,329 oz. of gold bullion]

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THOUGHTS

Last year, I mentioned that it might make sense for the board to consider a constant endowment balance of 2,500 troy ounces. Any purchase of gold at the end of the fiscal year would have to bring the balance back up to 2,500 ounces, so that that amount (weight) would be consistent over time.

On March 23, 2012, the Board voted unanimously to approve this measure, recognizing that it would need to re-think how Annual Fund dollars are deployed. Clearly, given the dollar's continued reduction in value versus gold, more Annual Fund dollars would have to be spent in order to maintain an endowment corpus of 2,500 troy ounces of gold. However, the Board believed that the concept of intergenerational equity called for this kind of stewardship. It stood to reason that, if the US dollar (the currency our families use to pay tuition) is losing value, then it is the school's responsibility (via stewardship) to think long-term about the financial stability of the education it offers families.

With this measure in mind, we need to add 171 troy ounces of gold to our corpus, to return to the level of 2,500 ounces. That will cost us $273,446 from the Annual Fund, meaning that we had to allocate 67% of our Annual Fund to endowment purchases. So, the new balance is 2,500 ounces with a value of $3,997,750 on 6/29/12.

While extreme, note that it is a one-time "charge". In other words, Independent Academy had to make up for three years of not observing the policy of a stable corpus of 2,500 ounces. Had that policy been in place and the Academy had had a balance of 2,500 ounces on 6/29/12, the Annual Draw would have been $179,899, or 112.5 ounces of gold, and the corresponding Annual Purchase would have equaled 112.5 ounces of gold, or $179,899, representing 34% of Annual Fund dollars.

TRENDS/ISSUES

• With gold continuing to climb against the dollar, it will take more dollars to maintain the corpus of 2,500 ounces. That means that, each year, a growing percentage of the Annual Fund will need to be used to keep the endowment at stable levels.
• Because gold continues to climb against the dollar, the purchasing power of the 2,500-ounce endowment will continue to increase.
• The numbers end up being easy to deal with, in terms of annual purchases, etc. The draw is fixed at 4.5% (which may not be tenable over the long haul, by the way; it may have to be reduced), and it will always equal 112.5 ounces of gold to be sold, followed by 112.5 ounces of gold to be purchased.
• What other things should the Board begin planning for? I would like to hear from readers!

 

Portfolio Challenge: End of Fiscal 2011

Although I havn't reported in some time on my "porfolio challenge" (aka an independent school endowment held entirely in gold bullion, just for the fun of it), I wanted to provide a year-over-year comparison, given that we recently closed the fiscal year 2010-11.

The stats from June 30, 2010 (one year ago):

June 30, 2010 marked the end of the first fiscal year of my portfolio challenge. As a reminder, my fictitious endowment for Independent Academy is based on holdings of 2,500 troy ounces of gold. My figures from the past year are as follows:

Starting Dollar Value as of 6/30/2009: $2,321,250   (New York close of $928.50/oz.)

Dollar Value as of 9/30/2009: $2,515,000    (New York close of $1,006) +8.3% from 6/30/09

Dollar Value as of 12/31/2009: $2,741,250   (New York close of $1,096.50) +18.1% from 6/30/09

Dollar Value as of 3/31/2010: $2,781,500   (New York close of $1,112.60) +19.8% from 6/30/09

Dollar Value as of 6/30/2010: $3,106,000  (New York close of $1,242.40) +33.8% from 6/30/09

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At that time, we did the following:

1. Annual Draw. As promised we will take 4.5% of the US Dollar value of the corpus and sell that many ounces of gold. Based on a New York Spot close on 6/30 of $1,242.40, our endowment was valued at $3,106,000.

SOLD: 112.5 oz = $139,770

Endowment Balance = $2,966,230 [2,387.5 oz. of gold bullion]

2. Annual Purchase, based on 15% of Annual Fund donations. Our Annual Fund brought in $500,000, 15% of which equals $75,000.

BOUGHT: 60.4 oz. of gold

Endowment Balance = $3,041,230 [2,447.9 oz. of gold bullion]

June 30, 2011 marked the end of the second fiscal year of my portfolio challenge. As a reminder, my fictitious endowment for Independent Academy is based on holdings of 2,447.9 troy ounces of gold. My figures from the past year are as follows:

Dollar Value as of 6/30/2010: $3,106,000  (New York close of $1,242.40) +33.8% from 6/30/09

Dollar Value as of 6/30/2011: $3,672,584  (New York close of $1,500.30) +18.2% from 6/30/10

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A return of 18% is pretty good, given the state of the economy! Independent Academy has done well. Now, two matters remain before we launch into the third fiscal year of an endowment based entirely on gold bullion.

1. Annual Draw. As promised we will take 4.5% of the US Dollar value of the corpus and sell that many ounces of gold. Based on a New York Spot close on 6/30/11 of $1500.20, our endowment was valued at $3,672,584.

SOLD: 110.2 oz = $165,266

Endowment Balance = $3,507,018 [2,337.2 oz. of gold bullion]

2. Annual Purchase, based on 15% of Annual Fund donations. Our Annual Fund brought in $500,000, 15% of which equals $75,000.

BOUGHT: 50 oz. of gold

Endowment Balance = $3,581,277 [2,387.2 oz. of gold bullion]

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Looking Ahead to FY 2011-12

1. Our ounces of bullion are diminishing, yet our dollar value of the endowment corpus is increasing. Don't you find that interesting? The dollar buys less than it did, which you can see in our purchases of bullion: we're not buying as many ounces as before.

2. It may make sense to change our policy, so that we always maintain a "balance" of 2,500 troy ounces of gold. However, word to the wise: that may become prohibitively expensive.

3. If you haven't believed me before, in terms of my own work and presentations on endowment -- including paying special attention to inflation, can you see it now? How do schools deal with that?

Caveat Emptor!

Buyer beware!

From a perusal of many independent school websites, it seems clear that the financial crisis that began in Fall 2008 spurred donor interest in providing money to schools for the purpose of financial assistance for students. To be sure, such funding is a noble objective, and schools should be glad for the gifts.

Yet a number of schools should remain cautious about employing too many of those dollars. The reason? Those funds could leave just as easily as they arrived. Donors are making these gifts on an annual basis (or even on an as-needed basis), not by means of a longer-lasting vehicle, such as a planned gift.

If a school is accepting, let's say, $100,000/year from a wealthy alumnus to provide financial assistance, that represents a good chunk of change for most schools. Such schools are able to stay afloat financially--and keep enrollment at certain levels--precisely because the alumnus is giving that gift. What happens, though, when that gift goes away? How does the school absorb the $100,000 in its already-weakened operational budget?

So I say: caveat emptor!

Despite the best intentions of all donors and schools, this financial arrangement promotes a certain level of risk for the institution. The intentions are the very best, but the model is flawed. The best case scenario would be for the school, before entering into such an agreement for funds for financial assistance, to work with the donor to set up a planned gift that will continue to provide such funding in perpetuity. In other words, unless a school and its prospective donor can set up 1) an endowed financial aid fund or 2) a charitable trust (lead, remainder, or dynasty), the annual gifts for financial aid should be counterbalanced in the annual operating budget. Do not back out those amounts from the budget!

Caveat emptor!

How to Grow a Monumental Endowment: NAIS Presentation

Tim McIntire (senior consultant at Carney Sandoe & Associates and co-founder of the Santa Fe Leadership Center) and I (Tower Hill School) will be presenting "How to Grow a Monumental Endowment" at the 2011 NAIS Annual Conference in National Harbor, Maryland, on Friday, February 25 at 8 a.m.

The download (PowerPoint) of our presentation can be found below. Also, it is posted on the NAIS Annual Conference page dedicated to our session.

Download Building a Monumental Endowment

Click here for more information on the endowment forecasting software we used.

Caveat: depending on your monitor, it may be challenging to see the screen shots of the endowment management software that is used. Best viewed on a large monitor!

Effects of Inflation on Independent Education: Prepare Now

The consensus appears to be that the Federal Reserve is intent on creating inflation as a means of staving off the threat of deflation. With all the talk of QE-2 (not the ocean liner, but rather, Quantitative Easing Part II), we as independent schools ought to be planning for the consequences.

What are those consequences?

• Higher prices for basic necessities (food, clothing, shelter) for families
• Basic necessities will cost schools more as well; dining plans will have to increase in price
• Utility costs will increase
• Increased prices (price appreciation) will bring pressure to bear on governing boards to increase faculty and staff salaries, as a means of keeping up with overall price appreciation for families
• Tuition increases will become a super-sensitive lever for schools. We will face internal and external price appreciation, yet be scrutinized by families who are price-sensitive (since many schools are at the price-saturation point already), and who will expect any tuition increase to be equal to or less than CPI.

The question becomes: "how do we plan for high inflation?"

First, we need to speak with those individuals who were heads of school during the inflation of the late '70s and early '80s. They lived through a significantly inflationary period. Almost any one of them will say that a 7% increase for faculty was unwelcome, as it was too low, relative to overall price appreciation. Their experience of having lived through it would be some source of comfort, perhaps, for school heads and boards.

If your school is already at the price-saturation point for your market, what is the board's plan to counter the effects of inflation that is being created on purpose by the Federal Reserve? For example, your school's endowment will suffer, since a high rate of inflation means that any return you might have will be forced into negative territory in actual dollars.

What to do in the meantime? (Figure 18-24 months for inflation to begin to take hold)

1. Endowment -- a) consider whether to decrease your annual draw to a minimal percentage; b) start raising more money for overall endowment; c) be sure that your portfolio includes weightings in areas that will weather inflation, such as commodities, precious metals, and perhaps foreign currencies.
2. Annual Budget -- construct a rubric that will allow your school's commitment to salaries to mimic a marathon: in other words, create estimates of what your competitors will be able to afford to pay faculty in the event of high inflation, over the long-run (say, five years). If your belief is that they will suffer enrollment declines in the event of high inflation, then it stands to reason that they will be unable to offer salary increases that keep pace with inflation. So, will your school be able to offer such increases, i.e., in keeping with CPI? If not, what metrics will you use to determine what your school will be able to afford? Think of it in terms of five years, so as to stretch out faculty salary dollars. Make sure that your faculty will come out ahead of the faculty at competitor schools, and you can use this data to provide some confidence to your faculty during inflationary times. It goes without saying that you should consider avoiding taking on any new debt, unless the opportunity of a lifetime is staring you in the face.
3. Classroom Materials -- prepare faculty with the  mindset of "making do" for a period of several years, cutting down on classroom materials expenses. In terms of textbooks, consider going to all electronic books, which are significantly cheaper.
4. Bricks and Mortar -- give serious consideration as to whether to expand your physical plant. In the event of high inflation, will your school be able to bear the increased costs of additional plant, let alone concomitant price increases in utilities, building materials, and such?
5. How We Do School -- is there a way that we can continue to provide high-quality education, yet by means of a different  model, one that allows us to contain and reduce costs? Where will the price-conscientious families go during a period of high inflation, if they're still willing to pay for an independent education? Do we touch the sacred cow of "18 max in a class"?

As a reminder, "inflation" means "an increase in the supply of money." We have inflation already, as evidenced by the M2 Chart below. The gray area shows how much the M2 increased during the 2008-09 recession (via quantitative easing):

What schools should be anticipating next is price appreciation, as a result of inflation. Did you notice that the M2 continues to increase in the "post-recessionary" period in which we find ourselves?

I'm concerned that schools are still dealing with the effects of the Great Recession, but are about to be whalloped by a significant increase in prices across the board. Families that are already price-sensitive may become even more so.

Price Increases versus Inflation: The Reality

This weekend's issue of the Financial Times includes a column entitled "The Week in Numbers" at the end of the first section.

A key figure cited: 16%. The index of meat prices of the UN Food and Agriculture Organization is up 16% over the past year. What is more striking, for those who eat lamb somewhat regularly, is that lamb prices have reached a 37-year high.

Yet we are told that inflation is almost non-existent. My understanding of economics is that inflation is an increase in the money supply; that we have, to be sure. The meat figures cited above represent price increases, which are sometime referred to as inflation (I myself use that term loosely, sometimes).

So, we find ourselves in an environment in which, we're told, core inflation is near 0%, yet here we see that the meat index is up 16% in the past year. I have highlighted this issue before: the CPI number, we must remember, excludes food and energy prices.

There are two lessons here:

(1) commodities can be a valuable piece of the puzzle when it comes to an overall endowment strategy

(2) when independent schools set tuition rates based on CPI, boards of trustees might do well to take a broader look at the increase in prices of goods that are not included in the CPI number. If your school is raising tuition at CPI+2, you may be creating a deeper imbalance in families' pocketbooks by overlooking the fact that they're probably paying more for basic needs (food, for example) than ever before.

Question: how might this scenario affect your endowment strategy? Are you still willing to leave endowment growth on the back-burner?

Outlook on Endowments 2010 to 2014

The next several years will be incredibly difficult ones for endowments, in terms of generating substantial returns. With nothing but economic uncertainty in front of us, here are some suggestions as we muddle through:

• Expect volatility, sometimes severe. Geopolitics will play a role in your endowment portfolio like never before.
• Be sure that your endowment has a good portion of equities with a history of on-time payment (and/or increase) of dividends.
• Do not expect a significant increase in the prices of your assets, what is termed "price appreciation." If there is price appreciation, take it to the bank, but plan for little to none.
• For the fixed income portion of your endowment, screen out as many mortgage-backed securities as you can. This market is exceedingly volatile, and there could easily be further changes to the MBS (mortgage-backed securities) that would be deleterious to the MBS industry.
• Consider allocating some percentage of your fixed income portfolio to TIPS, treasurys that are inflation-indexed.
• Don't put great stock in the CPI numbers that are released, which will indicate low inflation. Some reports have identified inflation as being expected to average 1.6% (approx) over the next ten years. Don't forget that "core inflation" numbers do not reflect food and energy costs; these are expected to rise. Independent school families need food and energy, which means that these prices affect what they will be willing to pay for tuition more than the CPI figures, the prediction of which is questionable at this point. Read my white paper, "The Deleterious Effects of Inflation" for more information.
• Continue to maintain a portion of your endowment in cash. Your investment committee should determine what this allocation should be, but try to make it significant. Here is the reason: should your school need immediate access to cash, it's nice to have it on hand without having to worry about liquidation of equities at a loss. A basic guideline to use is to determine how many days in cash you would need to be in order to continue operations for three to six months. Then, look at your projected cash flow from normal tuition payments, discount it by 25% and use that 25% figure as the target for how much cash you should have. This projection would give you enough cash to continue operations should 1/4 of your tuition payments cease for a period of three months (or six, if you wish to be extra-conservative financially).
• Continue to funnel dollars into your endowment via a budget line item in your annual operating budget plus a minimum of 10% of your annual fund (25% would be better).
• If your endowment is small (<$2 million), don't plan for an endowment draw. There is no IRS rule (not yet, at least) which states that you must take a draw. If your endowment is >$2 million, convince your finance committee to take as small a draw as possible: perhaps 2%. Since these amounts are very small, it would be better to plan for them in terms of hard dollars (tuition revenue) rather than taking a draw from your endowment. Remember: you need to maintain the endowment for the long haul, and it's not going to grow if you continue to draw it down. Short-term pain = long-term gain.

Maintaining stability is the name of the game right now. Recent economic history (the last twenty years or so) shows us that we have a recession, on average, about every four to six years. That means that--potentially--we'll be due for another one sometime between 2011 and 2013. Take the time now to revisit your endowment strategy, and, if you haven't altered course, consider the implications of a possible recession in the short-term and how that might affect your operations. Then plan for it.

Portfolio Challenge Update: End of Fiscal '10

June 30, 2010 marked the end of the first fiscal year of my portfolio challenge. As a reminder, my fictitious endowment for Independent Academy is based on holdings of 2,500 troy ounces of gold. My figures from the past year are as follows:

Starting Dollar Value as of 6/30/2009: $2,321,250   (New York close of $928.50/oz.)

Dollar Value as of 9/30/2009: $2,515,000    (New York close of $1,006) +8.3% from 6/30/09

Dollar Value as of 12/31/2009: $2,741,250   (New York close of $1,096.50) +18.1% from 6/30/09

Dollar Value as of 3/31/2010: $2,781,500   (New York close of $1,112.60) +19.8% from 6/30/09

Dollar Value as of 6/30/2010: $3,106,000  (New York close of $1,242.40) +33.8% from 6/30/09

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A return of 34% is pretty good, given the state of the economy! Independent Academy has done well. Now, two matters remain before we launch into the second fiscal year of an endowment based entirely on gold bullion.

1. Annual Draw. As promised we will take 4.5% of the US Dollar value of the corpus and sell that many ounces of gold. Based on a New York Spot close on 6/30 of $1,242.40, our endowment was valued at $3,106,000.

SOLD: 112.5 oz = $139,770

Endowment Balance = $2,966,230 [2,387.5 oz. of gold bullion]

2. Annual Purchase, based on 15% of Annual Fund donations. Our Annual Fund brought in $500,000, 15% of which equals $75,000.

BOUGHT: 60.4 oz. of gold

Endowment Balance = $3,041,230 [2,447.9 oz. of gold bullion]

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Some Thoughts (Obvious or Otherwise)

When I announced the portfolio challenge, I knew that the sell-buy strategy (1x/fiscal year) was not balanced. However, I wanted to wait for the full set of data to allow me to point out the obvious issues that Independent Academy now needs to study and act on, as does any independent school with an endowment. My point is that most independent schools are not doing enough for/with their endowments in terms of replenishment and building. I have chosen not to allow new gifts to the Independent School endowment, only replenishment. Permit me some thoughts below, which are meant to prompt those of you reading this blog to follow suit.

1. Sustainability. Although Independent Academy's endowment is exceedingly healthy, and although our draw was not immediately deleterious to the Academy, my concern now is that we bought 60 ounces of gold after selling 112 ounces. Over the long term, that inverse relationship could be deleterious, as we must plan for the natural volatility of gold prices. If gold moves downward in the future, we would have to sell more ounces in order to meet our draw. If it continues to rise, we will benefit from the good fortune.

2. Risk. This category is tied into the first, as my last sentence (above) demonstrates. Independent Academy must carefully assess and manage its risk with the endowment; just because it is based on gold--a rising asset over the past ten years--does not mean that it will continue to benefit from increases, despite continued economic instability domestically and internationally.

3. Complexity. Independent Academy wishes to avoid a complex endowment, and it has done so, successfully. However, risk assessment will call for some data modeling. Nevertheless, the Academy's trustees will insist that this data modeling be kept focused on a gold-only endowment.

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Fiscal Year '11

In this new fiscal year, Independent Academy will begin to track a separate data point: the synchronous full replenishment model. This model would have the Academy sell X ounces at 6/30, then simultaneously buy the same number of ounces. The funds to purchase these ounces will, as always, come from the Annual Fund. This approach will cause the Board to reconsider the flexibility of the Annual Fund and how those resources might be better allocated within the operating budget. When we look at the final data on FY 11, it will be interesting to see what the Board thinks at that time.

Portfolio Challenge

Just for the fun of it, I'm going to propose a fictitious endowment for a fictitious school, and we'll keep track of the school's endowment value on a quarterly basis of a typical fiscal year.

Some basic parameters of this endowment:

(1) gold = gold bullion, not shares in GLD or similar gold ETF

(2) no dividends or interest

(3) annual draw will be 4.5% of US Dollar value of corpus, taken on 6/30 of the first full fiscal year (in this case, 6/30/2010). X ounces of gold will be sold at spot on that date, corresponding to 4.5% of the value in US Dollars.

(4) school has an annual fund of $500,000, 15% of which will be directed to endowment as of 6/30 (end of fiscal). The 15% will buy x ounces of gold at spot.

(5) this portfolio challenge is not meant to be overly-technical, just fun, and perhaps we'll all learn something in the process (in regards to using gold as an endowment barometer).

Independent Academy

Endowment: 2,500 troy ounces of gold

Starting Dollar Value as of 6/30/2009: $2,321,250   (New York close of $928.50/oz.)

Dollar Value as of 9/30/2009: $2,515,000    (New York close of $1,006) +8.3% from 6/30

Dollar Value as of 12/31/2009: $2,741,250   (New York close of $1,096.50) +18.1% from 6/30

Dollar Value as of 3/31/2010: $2,781,500   (New York close of $1,112.60) +19.8% from 6/30

Endowment Portfolio: Passive Versus Active

Schools with endowments in the small to medium range (say, $2 million to $50 million) should charge their investment committees with studying how their endowments might fare with more active investment oversight, rather than the passive investment policies that so many of these endowments follow.

It's safe to say that The Great Recession had an effect on those schools with passively-managed endowments. Witness the schools that found themselves facing temporarily frozen assets--the ones that were supposed to be liquid. Given the spectacular performance of the markets in the lead-up to Fall 2008, most passively-managed endowments had low liquidity ratios...a real danger for those schools that must have an endowment draw to make the operational budget work properly.

When a school with a $15 million operating budget, 12-15% of which stems from endowment draw, discovers that its endowment liquidity has been compromised, one can imagine the panic which ensues.

Lesson #1 -- increase liquidity levels in your endowment.

Lesson #2 -- encourage more active management of your endowment; be sure that your portfolio manager(s) will be able to sell, reallocate (and so forth) with relative ease, rather than locking you into strict rules about when assets can or can't be sold, etc. Ongoing reallocation is a strategy to be embraced, from here on out.

There is a place for passive portfolio management, but that place is not for independent schools, as we must go out of our way to maintain inter-generational equity for our students and families. Active portfolio management will help us ensure that, by always questioning market trends.

Not unlike our university counterparts, we will have to become much better at managing our endowments.