The Dubious Finances of University Endowments

Universities' Investment Practices Contributed to Financial Meltdown
Universities' Investment Practices Contributed to Financial Meltdown

Just in time for graduation season, here's a story to give those newly minted degree-holders and their families some nightmares. The New York Times recently profiled a woman with nearly $100,000 in student loan debts, who now faces a financial burden that will take years if not decades to pay back. The article also looks at how college and universities are themselves players in the game of running up debt for their students.

It's just the latest in a series of reports to scrutinize the dubious finances behind higher education. Indeed, a study released last month by the nonprofit Center for Social Philanthropy suggests that many institutions of higher learning were far from innocent victims of the economic downturn. According to the report, risky endowment investing played a major role in the overall financial meltdown.

It points to the "Endowment Model of Investing," used by many top universities, as destroying tens of billions of dollars in school portfolios, "up to 30 percent of endowment value at some of the wealthiest schools."

"It also contributed to the magnification of systemic risk in what economists and policymakers have called the 'shadow banking system,'" the report continues, "a weakly regulated, highly fragile global constellation of institutions deploying capital outside of the regulated banking system in ways that have magnified systemic risks in the capital markets."

Players in Hyperactive Markets

Colleges and universities are a business, says Maclyn "Mac" Clouse, a finance professor at the University of Denver's Daniels College of Business, and they have to be managed like businesses. "All too often," he says, "we'll think that the ivory towers are independent of business-management practices, and that just isn't the case. Many colleges, including our own, have gone through a period where we had little to no raises, and as a result we've had positions that haven't been filled and operating budgets that have been reduced. It's very much like the private sector of business, and that's what faculty members have to remember."

The educational endowment system is centuries old. The earliest U.S. college and universities recognized they couldn't rely on tuition revenues alone or, in the case of state schools, government funding. Generous donors and good investment choices, traditionally in stocks and bonds, helped endowments grow. But starting in the 1990s, Clouse says, "we started to see endowments getting into what we call alternative investments, where. . . they started to invest in private-equity funds. . . in real estate and even into some derivative securities products."

Those endowments became players in the hyperactive marketplace of the time. "Like any other investor, I think universities were looking for the opportunity to earn higher returns," says Clouse. "But what many investors forgot was that with high returns also comes high risks. and so the market reminded us that yes, alternative investments have high risks."

Investing Can Be Easy -- at First

The University of Denver has been teaching some of its students about the high-wire act of endowment investing with a real-world experiment that began a decade ago -- when alumni Tom Marsico and his wife, Cydney, gave $500,000 to the university endowment. Their gift, however, came with the stipulation that it be used for a class of graduate students to manage.

"We try to emphasize to the students they do have a fiduciary responsibility, that they are managing other people's money," says Clouse. "Tom's gift was given to us right about the beginning of 2000. And so for one quarter, until the middle of March 2000, the first class was incredibly successful with their investments, and they thought everything was easy. After that it was very, very difficult."

And how has the student investing performed lately? "Kind of like the general market," he laughs. "This quarter they were down, but their performance was a little better than the S&P 500, which is their benchmark."

Originally published