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December 11, 2012
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Endowments: High Returns, Broad Impact

Part II: Future Profits

By Frank Goad

Kentucky’s college endowments, a two-part series: Part one last month examined the unique nature of super long-term investment oversight. Part two this month focuses on the strategies Kentucky endowment managers use.

It is said the people who guide Kentucky’s college and university endowment funds have the toughest jobs in higher education.

Imagine managing a savings account to build needed financial security for this generation of your family – and the next one, and ones after that for as long as you can picture. You can only ever use the interest earnings from what you’ve set aside, no touching the principal, and you must constantly add funds.

Sound daunting?

The importance of a robust endowment operation in the face of budget cuts, rising costs and an uncertain economic future cannot be understated. Endowments are more crucial than ever to schools and critical to their ability to ensure long-term viability, employ high-caliber faculty, educate students, expand opportunities and promote Kentucky’s economic growth. Endowments are schools’ bulkhead against turbulent economic times and provide a financial foundation that keeps them stable and viable long into the future.

Students and parents paying rising tuition bills might question the policy of not spending the millions of dollars mounting in endowment funds. However, ensuring support in the decades ahead requires that today’s spendable income comes from earnings. Over time, annual income expectations are often the Consumer Price Index plus 4-5 percent. The result: Endowments typically have a “spend rate” of 4-5 percent of total funds, after earnings. This provides money for scholarships, endowed chairs, research and other current academic efforts.

Last month’s Part I reported that endowments at Kentucky schools showed investment returns ranging from 10.4 percent to 25 percent for fiscal year 2011. For FY 2012, though, that range is down, ranging from a high of 4 percent to as low as -0.9 percent, which is in line with schools across America, according to preliminary figures from the National Association of College and University Business Officers. NACUBO’s early reports show an average of -0.3 percent for all reporting schools.

Because endowment managers usually employ a five-year rolling average for earnings, spending should not change this year at most schools despite the 2012 investment numbers.

Alternative vs. conventional investing

The trend for schools with larger endowments is to invest in “alternative strategies.” These more complex investments include: private equity (e.g., financing leveraged buyouts, and merger and acquisition funds); “marketable alternative strategies” (e.g., hedge funds and derivatives); venture capital; private equity real estate; commodities; managed futures; buying distressed debt; and other opportunities.

Schools with smaller endowments tend to be more conservative and conventional. They stay with the traditional investment mixes of 60 percent stocks and 40 percent bonds and avoid alternative investments.

Because it takes considerable acumen to manage endowments, schools employ outside firms; large funds use several firms, each handling an area of expertise like commodities or real estate. Schools’ boards of trustees do review and have to approve outside experts’ plans for their endowments; investment or finance committees first consider the advice and bring recommendations to the full board.

Huge returns for Kentucky

Kentucky higher education spending benefits all of the commonwealth. A 2011 study by the Campaign for College Opportunity in California showed that every dollar that a state spends in higher education yields a net return of $4.50 for its economy.

People completing college average at least $1 million more lifetime income versus those with a high school diploma. As more people graduate college, states get better skilled workers who contribute more to local economies and state revenues; there is less poverty, thus less related government aid services cost, which frees those dollars for other public needs.

Endowment contributions, therefore, produce amazing returns in many ways for all of a state’s citizens.

Reconsidering philanthropy

Endowment operations require a change in thinking by charitable donors, who often like to see immediate, tangible results from their gifts, such as their name on a new building, property or program – and schools welcome that type of support, too. Endowment donations, though, are often the result of someone’s desire to affect lives directly for as long and as often as possible.

Jamey Leahey, associate vice president of legal affairs and gift planning at Centre College in Danville, related a story of one person’s endowment gift.

“While reviewing their will with their children, they discussed how best to donate to something powerful that would change lives,” Leahey said. “They considered their church, a hospital and other possibilities, and settled on a Centre scholarship fund because they knew the school is solid, would always be there, and their donation would change many lives over the years.”

Bob Jackson, associate vice president for institutional advancement at Murray State University, echoes that. Endowments “provide schools a margin of excellence. They fill financial gaps and ensure that a department or program can maintain high standards despite changes in (annual) funding to the school. Endowments keep our schools and students from falling behind.”

University fund drive proceeds go into an endowment; for Kentucky’s public universities, all private donations must go into one. Support campaigns are vital.

“As much as 90 percent of the time when people give gifts to the university, it’s during fund drives,” said D. Michael Richey, vice president of development at the University of Kentucky.

When a particular department or college at a university such as agriculture or business seeks contributions, what is received goes into a specially designated fund. The number of different funds within an individual university’s endowment can range from hundreds to thousands.

Why do people give?

“When people give,” Richey said, “it’s generally because they want to leave a legacy and help people and the school advance.”

Someone might donate specifically to the UK College of Medicine, for example, because of a positive experience a family member had at the UK Chandler Hospital, the school’s teaching medical center. Some give because they believe they would be less successful without their college experience and want to see others do well, too.

Want to create a scholarship endowment in your name? Most schools require at least $25,000 to do so because anything less does not generate enough interest to provide significant support. A 5 percent annual return on that amount is $1,250 and, depending on the way the endowment is set up, only a portion of that amount would be available.

Development staffs also encourage contributor interest by helping potential donors understand the financial realities the school faces.

“It used to be that the state gave us 60 percent of our funds, and we provided 40 percent,” said Jim Shaw, vice president for advancement at Morehead State University. “Now, that has reversed, and we’re responsible for 60 percent. Not only that, if I want to build a building, my endowment must include funds for its perpetual maintenance and operation, as the state no longer helps with that.”

Most colleges and universities get a large part of their donations from alumni, including multiple generations of family members who successively attend a school.

Berea College has the largest endowment of all Kentucky schools at $978.7 million in its 2011 report to the National Association of College and University Business Offices. However, multiple generation alumni donations usually don’t happen. As part of its mission, Berea College is one of only a few in the United States that does not charge tuition to its students, who must meet an eligibility requirement of coming from financially challenged families. Some 70-80 percent come from Appalachia. Students help support the college by working for the school while they attend.

Since Berea does not have a tuition and fee revenue stream, endowments are especially critical to the school’s future. But because of its mission, it tends not to develop multigenerational alumni relationships

“Once they graduate from here and go on to their careers, their success makes their children ineligible,” said Jeff Amburgey, vice president for finance.

Rather than alumni, most of Berea’s large donations come from people inspired by the school’s mission and its consistently outstanding results, Amburgey said.

Additionally, many Berea graduates feel compelled to return to their communities and enter service professions such s nursing, teaching and social work – jobs that are important but not high-paying, meaning many alumni who give do so in smaller amounts.

Morehead State shares that alumni characteristic with Berea, said Shaw.

“Educating our constituents about our projects, priorities and our constant push for excellence is a full-time effort,” the Morehead official said. “Today, fundraising and endowments are a requirement, not an option, and donor circles must extend beyond alumni.”

Endowments make a difference

At the University of Kentucky, creating an salary-enhanced endowed chair requires a minimum of $1.5 million to generate the income needed to bring in someone at the top of their field. Endowed chairs help schools attract top students who want to learn from a professor, and they can increase a college’s rankings. Such endowments elevate a school’s status without impacting its operating budget.

All of the development officers agreed, though, upon the need for more unrestricted gifts. Specific endowments have very rigid rules on how money can be spent; even when schools identify another need – academic, capital, maintenance, administrative, or any unexpected situation – endowment funds cannot be used no matter how pressing the issue. Unrestricted gifts allow schools to correct situations no one can anticipate.

Given the returns on every dollar invested and the countless ways they contribute to the state, development officials say donating to Kentucky’s schools might be the most important gift you ever give.

Frank Goad is president of the Frank Communications Lexington, a marketing, advertising and social media consulting firm (linkedin.com/in/frankgoad). He was the first employee of Lane Communications 27 years ago.

 

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Endowments: High Returns, Broad Impact
Part II: Future Profits

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