What are University Endowments?

An endowment is like a trust fund…

When people create trusts, they generally place conditions on how beneficiaries can use the money. For example, a parent might set aside assets for a child but require that funds be distributed over time. That way, the parent can ensure the money doesn’t disappear during a weekend in Vegas. Similarly, endowments are a way that gifts to universities can provide support over a longer period.

When people want to give money to a university, they can simply make a donation. But some donors want to ensure their gifts keep on giving forever, or at least for a long time. In this case, they can make an endowment gift that stipulates the university will invest the money, leave all or some of the principal untouched, and spend a portion of the earnings. A university’s endowment is made up of many individual endowment gifts.

Endowment gifts can have different degrees of restrictions attached to them. Typically, they require that the gift stay alive indefinitely — with fund managers not spending the principal and keeping a balance between spending and reinvesting returns.

In other cases, the safe is on a timer. Known as “term endowments,” these gifts do not allow the original contribution to be spent until a certain period of time has passed.

Many endowment gifts also mandate that the investment income go toward a specific purpose, such as financial aid, the football team, or a specific kind of scientific research. Other donations are unrestricted, allowing the university to decide how to use the money best.

Each university decides how to manage its endowment. Some rely on their own staff, others use trustees, and others hire professional investment managers.

Endowment managers invest the funds in securities, real estate, venture capital, or other investment vehicles. The goals of managers at different institutions may differ slightly. Some universities try to make as much income as possible, while others focus on total returns (income plus appreciation). Most schools establish rules around investing the endowment to balance three different goals:

• Increasing revenue to fund spending over time
• Making sure enough is left over to reinvest in the fund, so that the endowment keeps up with rising costs
• Smoothing out fluctuations in returns to allow for more predictable budgets

Meeting the short-term goal of funding operations today can sometimes be at odds with the long-term goal of making sure enough is left for future generations. As a result, institutions like the Massachusetts Institute of Technology (MIT) have chosen strategies that produce high returns in the long run while keeping short-term spending pretty even. That way, current students and faculty can pursue their studies and research without being concerned about the market, while managers can be reasonably confident the money is protected for future scholars.

On average, US university endowments distribute 4.5 percent of their fund balances each year.

As of the 2022 fiscal year, the 10 largest endowment funds belonged to:

1. Harvard: $49.4B
2. University of Texas: $42.7B
3. Yale University: $41.4B
4. Stanford University: $36.3B
5. Princeton University: $35.8B
6. Massachusetts Institute of Technology: $24.7B
7. University of Pennsylvania: $20.7B
8. Texas A&M University: $18.2B
9. University of Michigan: $17.4B
10. University of Notre Dame: $16.7B

Source: Higher Ed Dive

University endowments create a steady flow of revenues that provide a university with financial stability. Without that cash flow, many schools would have a harder time providing the services they do.

Without reliable income, universities would have to cut activities and services or increase revenues from other sources. That might include seeking more annual donations, finding additional research grants, or hiking tuition.

Spending more time seeking funding might reduce the time universities have to facilitate research or develop new programs and services. A public university without an endowment may need more state support, which could in turn require higher taxes.

Universities cannot typically use the endowment’s principal (the original gift) to pay for expenses. Instead, they must make a return on those donations, which they can spend.

In 2019, university endowments collectively distributed around $22B for their schools to use. Almost half of that money went toward providing financial aid. The rest funded faculty, academic programs, campus maintenance and operations, and more.

Overall, endowments give universities flexibility and confidence to plan for the future. For students and faculty, endowments can mean a higher-quality education, more financial aid, nicer facilities, and better teaching and research opportunities.

Source: NACUBO US Educational Endowments Report Jan 2020

Every state in the union has a land grant university. Several have more than one. When the US began its westward expansion, the federal government had access to a lot of land and not a lot of money.

One idea at the time was to encourage the development of universities focused on agriculture and mechanical arts across the country to provide blue-collar Americans with access to higher education. Without much money to support the effort, it was a difficult task. The Morrill Act of 1862 helped the process along by giving 30,000 acres of land to each congressional district. The property could be sold or leased, and the proceeds would fund establishment or expansion of universities.

Several public universities got their start with land grants, along with some private colleges, including the Massachusetts Institute of Technology (MIT) and Cornell University.

While many universities got started with land grants, that is rarely what is meant by a university endowment today. These days, an endowment is almost always a protected fund made up of donations from alumni.

Most university endowment funds are invested like a pension fund or the assets of a private foundation. The goal is to protect the principal while generating income for beneficiaries. Balancing the two goals can be a challenge.

A typical endowment portfolio includes some share of safer assets, which typically come with a smaller return on investment. On average, about 12 percent of endowments are invested in fixed-income securities (investments with predetermined interest payments), such as bonds, certificates of deposit, and Treasury notes. Smaller endowments tend to concentrate more of their investments in these lower-risk options: Fixed-income assets make up around 30 percent of the financial assets of funds worth less than $25M.

Larger funds tend to place a greater portion of their money in equity markets, including US stocks, international stocks, and even private equity and venture capital. Larger endowments tend to have a higher risk tolerance: Institutions with endowments of over $1B have nearly 75 percent of their holdings in equities.

Since larger funds are more heavily weighted toward higher-risk investments, they also tend to get better returns. Over the last 10 years, endowments over $1B have earned an average rate of return of 9 percent, while smaller funds saw gains of 7.7 percent on average.

Source: NACUBO US Educational Endowments Report Jan 2020

Some people incorrectly think of endowment funds as rainy day funds. They assume the money can be used for anything at any time, as long as it’s available. However, that’s not the case. The need to preserve funds for future generations means current students and faculty can only access a small portion of it. Restrictions on individual endowment gifts further narrow how money can be spent.

The funding gaps that remain often fall on the shoulders of students. In a time of rapidly increasing tuition costs, critics point to the large fund balances and ask why students are being asked to pay more money for higher education so that a savings account can grow.

Some have also criticized the fact that massive endowment funds were allowed to grow without paying taxes. As public and private 501(c)(3) nonprofits, they have been exempt under the federal tax code. The 2017 Tax Cuts and Jobs Act made an exception and began taxing university endowments worth more than $500,000 per student at certain schools.

Sometimes, the way endowments are invested can lead to scrutiny. Constituents can disagree on how managers are balancing current and future needs, or students and faculty may object to investing in certain companies or industries. For example, 29 US schools divested from fossil fuel stocks between 2011 and 2018 in response to activism from students and faculty. Such controversies can bring negative press and create challenges for fund managers.