Writing in the August 19th edition of the New York Times, Victor Fleischer issued a call to "Stop Universities from Hoarding Money." The dizzying scale and unique composition of the largest few endowments that were the subject of his scrutiny distract from the real issues at stake in mandated spending rates.
Most colleges and universities have little discretion over how the vast majority of endowment money is spent. Among public institutions, 98 percent of true endowment funds are restricted by donors for particular purposes. Among private institutions, 93 percent of true endowment funds are donor-restricted. Even if federal regulation required institutions to spend more of their endowment each year, this would have little impact on the purposes funded. It would simply mean that in years of robust investment performance more funds would go to donor-designated purposes. For example, the fund supporting a faculty chair would be unduly generous in good years, fall short in bad years.
Fleischer acknowledges that 8 percent is a "scary" spending rate. He believes that the erosion of endowments that would almost certainly result from the proposed 8-percent requirement would be offset by future donations. This is a cheery scenario but ignores the fact that university endowments are actually pools of hundreds or thousands of separate funds, contributed for distinct purposes by individual donors who gave with the understanding that their specific charitable purposes would be fulfilled in perpetuity. New gifts might sustain or grow the value of an institution’s total endowment pool, but the purchasing power of individual endowment funds would be eroded to the point where the donors' intended purposes could no longer be fulfilled.
Second, while governing boards of colleges, universities, and affiliated foundations have discretion regarding endowment spending rates, the Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted in some form by every state except Pennsylvania, imposes a prudence standard for spending from endowment. The guiding principle is that boards have an obligation to maintain the long-term purchasing power of endowment funds unless otherwise stipulated by the donor of the fund. Only the most optimistic of investors would see an 8 percent spending rate (over 10 percent when compounded by management costs and inflation factors) as sustainable and prudent. The average return for all college and university endowments in the past 10 years was just over 7 percent.
In an era when public and private institutions alike are struggling to develop sustainable business models, board need to be prudent and forward looking in the use of assets. Mandating spending flies in the face of sound financial strategy, fiduciary responsibility, and good stewardship.
Thanks to Flickr user Roger for the image.