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April 29, 2002

Anatomy of Emory's endowment

This is the second in Emory Report’s three-part series on the University’s finances. Part one examined the Educational and General Budget; next week will focus on University fund raising. This second installment takes a look at the University’s endowment.


What is “The Endowment?”
The endowment comprises many investment accounts. Income from some of these can be spent for whatever the University wishes, but a large number of these accounts are designated for specific purposes (the Charles Howard Candler Professorships, the Henry Bowden Scholarships and the Tenenbaum Lectureship are examples of such designated purposes, and designated endowments exist in all the schools of the University). (See pie chart) To use the income from designated endowments for purposes other than those intended would constitute a breach of trust to those who gave the money for those endowments.

On Aug. 31, 2001, the market value of Emory’s endowment stood at $4.3 billion. Of that total, just over $2 billion (including the $1.1 billion Emily and Ernest Woodruff Fund) was assigned to the University in general, and about $2.3 billion was designated for use by the schools, colleges and divisions. The general University portion is further designated for uses shown in the pie chart. Using a formula established by the Board of Trustees for determining how much can be spent from the endowment, the board authorized $203 million in endowment spending for the last fiscal year.

How is “endowment income” determined?
Until a few decades ago, universities were prohibited from spending more than the dividends and interest on their endowments. Since a change in the law, universities are permitted to use net appreciation of the market value of their endowments, exercising, in the language of the law, “ordinary business care and prudence under the facts and circumstances prevailing at the time.” If an endowment’s “book value” is $1 billion, but investment increases that value to $1.5 billion, $500 million—or 33 percent of the “market value”—could be spent.

In practice, however, that would be like someone’s inheriting $5,000 and spending it all without regard to the future. What if she loses her job next year? What if the house needs a new roof in two years? What if she needs an operation? Wouldn’t it be prudent to hang onto some of that inheritance and let it grow through investment?

The Board of Trustees has the fiduciary responsibility of making sure the University will be solvent a decade, a century, a millennium from now. The board has therefore established a policy that the administration may spend no more than 5 percent of the market value of the endowment. Few universities, colleges or foundations spend more than 5 percent of the value of their endowments.

For more than a decade the budgeted spending rate approved by the board has been 4 percent, and for some years an additional 0.75 percent of unrestricted endowments has been applied to a capital matching program, which has allowed the University to attract gifts for projects like the Schwartz Center, Science 2000, the Goizueta Business School and the Whitehead Research Building.

The spending rate, however, does not apply to all $4.3 billion of the endowment; nearly $700 million is sequestered in the Woodruff Health Sciences Center Fund, the income from which underwrites programs in the health sciences. Restrictions on that endowment limit its spending rate.

Similarly, the University’s cash management accounts are maintained on the balance sheet as a part of the endowment but are not available for spending at 4.75 percent. Only about three-fourths of the total endowment can be spent at the 4.75 percent rate approved by the trustees.

Why not spend a higher percentage of the endowment?
The trustees’ spending policy has two purposes: First, it protects the assets of the University for the long haul, ensuring that the source of a significant portion of Emory’s income (20 percent of the budget this year) will be there regardless of unforeseen difficulties (e.g., the unlikely but plausible drying up of funding for research, or a decline in enrollment and tuition, as happened during World War II and the Korean War). Second, the limit on spending prevents our committing too much too fast to programs in fat years, and then not being able to continue supporting those programs in lean years when the value of the endowment declines, as it has in the last two years.

Retrospection—20/20 hindsight—is of course a great aid in suggesting what spending rates could have been during the bull market of the 1990s. Seeing what the market will do next year or five years from now is a bit trickier. Even on the crest of a wave, prudence dictates that we recognize the wave may crash, the bubble may burst and the bull may turn into a bear.

But it is worth noting that even with a cautious policy, during the unprecedented rise in the value of Coca-Cola stock during the 1980s and early 1990s, the University reaped great benefits (see bar graphs). In several years during the 1990s, Emory’s endowment grew by a greater percentage than any other university endowment in the country. And from 1995 to 2000, spending from the endowment grew commensurately. Emory converted much of that growth in endowment spending to additional faculty lines, new buildings, scholarships, research support, much-needed renovation of infrastructure and new equipment. Had Emory not converted some of that extraordinary appreciation of value into capital, we would have failed to realize, or capture, some of that boon before the decline in market value in 2000 and 2001.

Once the market turns around, won’t Emory’s budget crunch be over?
It is worth noting that, as Emory’s endowment shrank in the past 18 months, so did those of nearly every other university and college in the country. Of the major university endowments, only Yale’s grew last year. Of the endowments that shrank, Emory’s did not lose the most in either dollars or percentage. The decline in the S&P 500 (a benchmark for investment performance) for calendar 2001 was 24.4 percent; the decline in Emory’s endowment for that same period was 10 percent. These data suggest that the endowment would have suffered some loss regardless of the asset mix.

As is common in endowment management, Emory uses the average of the past three years of market value to project spending for the next year. The average of the past three years has not been good. And it will be another three years before a market recovery has any impact on the Educational and General Budget, assuming that the recovery lasts.

Even despite the market downturn in 2000, however, income from the endowment this year is greater than it was two years ago. In fiscal year 1997, when the endowment’s market value stood at around $3.7 billion, spending from the endowment amounted to $102 million (of which $45 million went to the Educational and General Budget). In the following years, as the endowment increased in value, the spending rate remained the same but dollars spent from endowment grew with the endowment’s market value, reaching $155 million in 1999. Since then, the market has gone down, and at the end of fiscal year 2001 the endowment was where it stood in 1998. Yet last year endowment spending was more than twice what it was in 1997.