Nonprofit and University Overreliance on Endowments

Following up on Tuesday’s blog concerning endowments and the risks attached to overreliance on their revenue, this Thursday’s blog takes the time to examine several examples that illustrate how invested endowments can rapidly lose market value and leave organizations with massive holes in their budgets. Examining the size of many university endowments, it is clear how endowments are attractive pillars to lean on and use as funding mechanisms for core budget areas. Because their usefulness is tied to their returns, there is risk and inconsistency that must be considered before building endowment dividends into annual budgets as core sources of revenue. 

Because of the sheer size of many universities’ endowments, they offer serious returns with fairly low-risk investment strategies, but the money is still invested and a sudden market downturn can jeopardize the organization’s funding stability. Harvey Mudd College in California possesses an endowment with a market value of $316.8 million that saw returns of 10.4% in the fiscal year concluding in 2018. That is just under $33 million annually. Saint Louis University possesses an endowment of $1.4 billion, and although they do not reveal their returns, with modest returns of 5%, they stand to make $70 million annually. It is easy to see the opportunities for massive growth and the attractiveness of incorporating significant amounts of these returns into an annual budget, but developing the habit of relying on this revenue as a substantial portion of a budget is dangerous. Using the 2008 financial crisis as an example, Colleges and universities saw -18.7% returns on average and endowments fell 23% in market value in the fiscal year ending in 2009. Project these numbers on a university like Harvey Mudd, and their $33 million revenue source is gone along with a quarter of the principle worth of their endowment while the university faces a gaping, several million dollar hole in their budget. 

While less common than a market swing, the total failure of an investment fund due to fraud, theft, or poor decision making is also a potential risk. Arguably the most well-known example, the Bernie Madoff investment scandal was a Ponzi scheme in which Madoff used his firm, Madoff Investment Securities, LLC, as a fraudulent business to acquire $64 billion fraudulently. The Picower Foundation was a prominent charitable foundation invested through Madoff that lost its $1 billion endowment and was forced to close due to their losses. An endowment of $1 billion expresses nothing but strength and the foundation’s founders, the Picowers, chose Madoff because he was a family friend. A truly unexpected failure. Less publicized than the scandal of Bernie Madoff, Tiger Funds failed in 2000 after shorting tech stocks with the belief that they offered nothing but inflated price to earnings ratios and no sign of profits on the horizon. The fund’s $6 billion in assets began to rapidly lose value and the fund failed. Another example of a seeming steady investment fund is Marin Capital. The fund used convertible arbitrage, a strategy where the fund manager purchases convertible bonds, which can be redeemed for shares of common stock, and then shorts the underlying stock in the hope of making a profit on the price difference between the securities. It was considered a safe investment strategy except when the share price goes down substantially and quickly, which is exactly what happened at Marin Capital. When General Motors' bonds were suddenly downgraded to low-grade status, the fund was crushed. Investors were informed that the fund was no longer trading and the remaining wealth was distributed to investors after significant losses. These are just a couple of well-known examples that illustrate a greater point: investments are often out of the direct control of the nonprofit and relying on their returns year to year places whole organizations at risk. 

Although this week’s blogs focused on highlighting the dangers of endowments, the danger specifically comes from overreliance on endowments and failing to recognize that the value they produce will not always be present. Overreliance can apply to many revenue streams and diversification always promotes sustainability and stability. With this in mind, universities can invest prudently and continue to grow their endowment’s worthwhile receiving increased revenue to allow for growth. Endowments are a great tool for experiencing extra cash flow, but they must not become the primary source of revenue when they have a risk of rapid and tremendous failure. Steady funding and responsible growth are key features to building a nonprofit that not only serves its mission in the present but can confidently expect to serve its community in the future. 

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