Introit

Endowments at K-8 Schools

K-8 schools have a particularly difficult time creating endowments that provide meaningful support for operations, scholarships, and the like. The usual complaint of development directors, heads, and trustees is that, without a grades 9-12 component that keeps graduates better tied to the school over the years, growing a serious endowment is simply not possible.

What compounds the issue further is that most K-8 schools are small, either by design or by market choice. With fewer families, so the argument goes, the opportunity for gifts to endowment is diminished.

Tuition levels at K-8 schools, however, are not so different from K-12 schools, or, for that matter, from 9-12 schools. After all, it takes money to run the school. From this perspective, K-8s are very much on similar footing with their counterparts. Similar footing equals similar needs; simply adjust for scale.

So, what to do?

1. Adjust institutional mindset. In other words, choose to stop pointing the finger of blame at factors other than what you can control. K-8s are invaluable. Invert your thinking. You're no longer at the bottom of the mountain, you're at the summit. Read Carol Dweck's book on mindsets and choose to have a growth mindset! The fixed mindset gets you nowhere.

2. Adjust your operational budget to accommodate a line item for endowment building. Don't skimp. Few are the K-8s that can run advancement offices with results similar to large K-12s. Choose not to! This line item may hurt; that's OK. It should. If you want a meaningful endowment, this annual number has to be just as meaningful. For instance, if you want to hit $1 million within 10 years, you'd better be allocating $100K per year to this line item. That's your baseline.

3. Reconfigure your Annual Fund so that a certain percentage feeds into your endowment. I would recommend a minimum of 10%, but 25% would be a nice goal. Even higher would be better. For the truly brave and innovative: stop using your annual fund to support your annual budget for a period of five years. If your modest annual fund brings in $300K per year, in five years, you will have accumulated $1.5 million.

4. Ignore the fact that a donor may provide you with a major or planned gift. That being said, choose to pursue these gifts as complements to your other funding. In other words, don't count on them in your data projections: count on hard dollars only, combined with a percentage of your Annual Fund.

5. Ignore the potential endowment campaign. As with #4 above, decide to pursue an endowment campaign as a complement to your other funding, not as a replacement for that funding.

6. Establish a threshold at which point you will begin to draw on your endowment. For instance, maybe once you reach $2 million. That figure will be different for each school. (n.b. That's right...I'm suggesting that you NOT take a draw on your endowed funds until the corpus reaches a target size. With the deleterious effects of inflation, you really can't afford to take a draw on anything less than $1.5 million.)

In case you didn't notice, over the course of 10 years, steps 2 and 3 will produce an endowment of $4 million. And that figure doesn't include any appreciation of assets, dividend payments, or interest payments.

Endowment Plan

Many advancement (development) offices have a written plan for the various functions of the office, ranging from one year to three or even five years. Plans are invaluable when it comes to mapping a trajectory to follow: setting goals, establishing metrics, etc.

Why don't schools do the same for their endowments, specifically? To be sure, the overarching advancement plan may include sections on major and planned gifts, both of which feed into endowment growth (or so I would hope), but why not take the time to develop a standing endowment plan? Clear goals and data-driven metrics will help school leaders to determine whether more attention to the endowment is needed.

And in most schools, more attention is needed.

Hope Is Not a Strategy for Endowment

Overheard in the Board Room

"I hope that our endowment performs better this year than last year."

"I hope that we can increase our draw next year in order to provide more financial aid."

"I hope that we can decrease our draw next year in order to counteract our portfolio losses."

"I hope that the new endowment manager will bring our endowment back to what it was pre-2008."

"I hope that the new development director will put together a tremendous capital campaign that will build our endowment into something more meaningful."

"I hope..."

HOPE IS NOT A STRATEGY!

Our Endowment is Fine, Thank You

"Our $15 million endowment is fine. As a school, we're comfortable with it. It helps our operations, and it gives us a bit of a cushion in the event that something nasty happens."

Really?

Have you considered the fact that your endowment will lose 1/3 of its purchasing power by 2020, only 10 years from now? Its face value may still appear large, but, due to inflation, you will have lost a minimum of 3% to 4% each year in terms of purchasing power.

How does that $15 million (or enter your figure here) look now? Its relative purchasing power is $10 million. Imagine how that will impact your operations. How about those scholarships, which are now priced against rising tuition (because you've increased tuition each year at more than CPI, no doubt)?

What is your strategy to continually offset the inflationary factor?

Planning for an Endowment Crisis

Niall Ferguson had a great article in today's Financial Times, addressing the sovereign debt crisis in Greece, which is affecting the European Union. He submits that it's only a matter of time until a similar crisis erupts in the US.

School leaders would do well to consider the potential implications, were such a crisis to occur in the US. The question is this: how can schools best hedge against this kind of crisis in terms of endowment management? If you haven't engaged your asset manager in a discussion of this sort, I would suggest that you do so sooner rather than later, as it may take time for him/her to 1) propose a new asset allocation and 2) execute the reallocation over a fixed period of time. As one example, George Washington University decided last year to reallocate their portfolio to allow 30% of funds to be invested in natural resources and commodities.

How active is your management?

Real Rate of Return

What's your real rate of return?

Your carefully-managed, conservative portfolio returned 8.5% over the past twelve months. Your draw was 4.75% and your management fee was 50 basis points. You still have money to spare, right?

Wrong. Dead wrong.

You didn't factor in the rate of inflation at 3.5%. With that factored in, you LOST money over the last twelve months. You earned -0.25%.

What is your strategy for accounting for the deleterious effects of inflation on your endowment?

Time Preference and Endowment Building

In political economic theory, there is a concept called time preference. A person (or an institution, such as a school) can have a high time preference or a low time preference. High time preference means that the invidividual or institution is markedly reactive to current events and circumstances. By contrast, low time preference means that the individual or institution maintains an even keel, always focused on long-term stability and continued existence.

Schools looking to grow their endowment must come to terms with time preference.

Annual operating budgets reflect an orientation toward high time preference (i.e., new curricular programs, special speakers, environmental initiatives). Endowments, however, are not meant to be high time preference vehicles.

To build an endowment, schools need to have a low time preference. A reactionary approach to finances will not result in endowment growth; in fact, the opposite will result. The school's current needs/wants will override the discipline to increase cash inflows to the endowment, and there will be no sustainable growth. Low time preference guarantees that the school will pursue and maintain regular cash inflows to the endowment, no matter the high time preference issues that may compete for financial attention.

A glance at search announcements for heads of school shows, almost to a school, that heads are being expected to increase endowment as one of their charges. As if growing an endowment were easy! Underlying this desire to increase endowment is a philosophical issue that boards need to grapple with, if they expect to actually experience endowment growth: their time preference.

If schools can't commit to a low time preference vis-a-vis endowment, the next time they search for a new head of school, they will continue to look for a head who can build the endowment. The cycle will not end until the board consciously embraces a low time preference.

Get the time preference right, and get the increased endowment. Get it wrong, and lose current purchasing power to inflation.

Pay Attention to Endowment

For those schools who think they have enough endowment: they probably don't. "But we have $50 million in our endowment," a school might counter. Schools with that kind of endowment, especially day schools, tend to have complex programs and services that have become normal, i.e. expected by families. If, however, the school does not follow a conservative spending policy coupled with a consistent inflow of cash to the endowment, it will not be able to sustain those programs and services in the future. And the future is not as far away as some would believe.

Case in point. Last week, I attended a demo for a software product that allows the user to project endowment corpus based on a number of variables. One variable is the school's spending policy, which is a piece often overlooked by too many schools. Their answer to the downturn in the economy is a simple reduction is spending percentage. This tactic, while arguably effective in the immediate term, is not a silver bullet. Why? Too many of these schools are not pursuing endowment growth as a matter of practice, and that is what will come back to haunt them.

During the demo, we looked at a university endowment valued at $350 million. The size of the corpus is not important for what I'm about to state, so please keep that in mind. When we looked at a 20-year projection of that endowment, we used the following assumptions:

• an annual draw of 4.75%
• an average annual return of 8.5%
• an average annual inflation rate of 3.5%
• an average management fee of 0.5%

With those variables, the endowment began to LOSE its purchasing power, more or less immediately. Each variable led to a loss in endowment, albeit a minimal one (-0.25%). If the variables change slightly (i.e., inflation is higher, or average annual return is lower), it is easy to see how precarious things become.

Variables aside, though, in simple terms, future dollars do not (will not) hold the value of current dollars. The aforementioned scenario highlights the fact that programs and services supported by the endowment will have to be cut in the not-too-distant future, if schools are not actively stewarding their endowment. Stewardship involves not only investment and risk management, it involves regular injections of dollars into the endowment.

This trend calls for independent schools to pay serious attention to their endowments. Schools with no endowments or small endowments must employ strategies to increase them sooner rather than later; schools that wait will suffer, perhaps dramatically. Schools with larger endowments will need to increase theirs as well, if they count on keeping the same level of programs and services down the road.

This is not a ploy to hire more planned giving officers; that's merely one part of the strategy. It calls for a new, aggressive way of thinking about how to sustain endowments.

Are you still trying to grow your Annual Fund while leaving your endowment on the back burner?

Endowment: Hedging Against Inflation

Some readers may recall my late-August post in which I posed the following question: how do we anticipate/plan for the effects of inflation on our endowment portfolios?

I posited that, as schools, we need to be mindful of the composition of our endowments, and that they should look different from pre-2008 models.

Bloomberg News carried a story today on endowment management, in which it was noted that cautious endowment managers are transitioning their endowments to include significant holdings in commodities as a means of hedging against inflation. George Washington University is considering selling its fixed-income assets as well as some stocks to expand its holdings in commodities - a segment which may end up representing some 30% of the university's portfolio in three to five years (commodities currently represent 13% of the portfolio). Notre Dame and Pepperdine have been hedging in similar ways.

Universities have been much more aggressive with their endowments than the vast majority of independent schools; this time around, though, we need to be with the universities rather than behind the proverbial 8-ball.

Any independent school considering a campaign for endowment in the near future (or, for that matter, any school that is simply interested in the well-being of its endowment) ought to give serious consideration to the composition of its endowment now. No one can predict the timing of inflationary effects on an endowment, so the better strategy is to position the endowment now to handle that kind of pressure.

Strategic Endowment

It seems that almost any posting for a Head of School search for July 2010 highlights endowment growth as a key aspect of the new Head's job. Granted, the Great Recession has made all of us think about our endowments (generally speaking) and the degree to which we rely on them to make budget (specifically).

From my perspective, to say quite simply that we need to focus on endowment growth is to suggest that we merely need raise dollars for the endowment. To be sure, that's accurate - we do need to raise dollars. However, the more challenging aspect of endowment growth, going forward, has to do with the strategy behind the composition of the endowment. In other words, does your school have a strategic endowment?

Endowment management was a growing phenomenon through mid-2008; returns were stratospheric for some, outstanding for others, and quite good for the remainder. It seemed as if all schools were moving to Common Fund or other "boutique" endowment management firms, and that none of them would lose.

Then reality hit. I won't go into the painful details; they are known to us all.

What I've been contemplating lately is, as we struggle through the aftermath of 2008, whether we should approach our schools' investments by thinking of them as a strategic endowment.

By strategic endowment, I mean a group of funds that is invested differently from pre-2008 models. Here is one question as an example: should our funds be majority-invested in American stocks, i.e. stocks that are traded on the American exchanges? In other words, how do we anticipate/plan for the effects of inflation on our endowment portfolios? Should we be invested not solely in "international stock funds" that are run by American financial firms, but invested directly in stock funds in other countries, by means of another currency?

Another way to pose the question might be: should our endowment holdings be in US dollars only? Should we hold several currencies so as to mitigate the risk of inflation inherent in one currency alone? Should we treat currencies as a valuable segment of our portfolios, just as we would address "diversification" as being important in an overall portfolio?

What would such a portfolio look like, and what would be the cost basis to have it managed? Could an American financial firm manage it, or should we look to small endowment management groups to manage such a portfolio? What level of service are we looking for now? Is a passive endowment portfolio appropriate for us, or should we seek out an active portfolio manager? Again, what are the cost implications of such a move?

Given the importance that all schools are attaching to endowment, it seems only logical that, first of all, we ought to determine how to mitigate the downside risks in our extant endowment portfolios before focusing on how to enhance their value. I submit here that the "investment model" approaches that firms have used in the past should be questioned rather vigorously before a board's investment committee gives the go-ahead for a strategy.