Yale Capitulates

Eli President Richard C. Levin signals deeper endowment losses and spending cuts. What are the implications for Harvard's finances?

Yale University, which had maintained a (relatively) rosy view of its prospective endowment losses and resulting spending cuts, on September 10 announced weaker than anticipated investment results for the fiscal year ended last June, and is therefore imposing broader, more draconian budget reductions. President Richard C. Levin's announcement noted that forecasts made last December and February had anticipated a decline in endowment value from $22.9 billion as of June 30, 2008, to about $17 billion (reflecting both investment losses and Yale's much-accelerated spending from its endowment)—a figure now revised down to approximately $16 billion, reflecting "losses in the value of our illiquid investments in private equity and real estate," which are more difficult to value than securities traded on public markets. That would make the one-year reduction in the value of Yale's endowment approximately 30 percent—in line with the 29.5 percent decline in Harvard's endowment (driven by a negative 27.3 percent investment return) announced on the same day.

Yale pioneered much of the highly diversified, alternative-asset investment strategy that it, Harvard, and other large educational endowments have pursued in recent decades—hitherto yielding much higher returns on investment than conventional stock-and-bond portfolios, but also imposing greater penalities in terms of reduced liquidity. (Harvard Magazine's report on the Harvard endowment covers these performance and liquidity issues in greater detail.)

Levin made these points which cast further light on Harvard's and other universities' situations in the wake of endowment losses:

• "Only a small fraction of our endowment is invested in publicly traded securities, so the recent stock market rebound has not had a substantial effect on that number. The bulk of our endowment remains invested in illiquid assets, which have not begun to recover their value."

Harvard implication: The University's endowment is also heavily invested in illiquid assets, and suffering the same performance penalty as Yale's funds; in reporting results on September 10, Harvard Management Company (HMC) president and CEO Jane L. Mendillo forecast slow growth in some segments of the market, and a level of economic activity lower than that in the pre-crash environment--and therefore warned of a very long period of recovery in the value of the endowment overall. In a June 29 cover story, "The Big Squeeze," Barron's reporter Andrew Bary wrote that Yale was even more heavily weighted toward illiquid assets (hedge funds, private equity, and real assets such as real estate and commodities) than Harvard: 74 percent of the New Haven portfolio vs. 57 percent of the Boston-Cambridge assets. (This investment leverage is explored further here.)

• Levin forecast $150-million deficits for fiscal years 2011 through 2014, driven by now-necessary deeper cuts in the distribution of funds from the endowment to support Yale operations. For the current fiscal year 2010, Yale had already cut its endowment distribution by 6.7 percent. For the succeeding fiscal year, the distribution will now be cut an additional 13 percent --"and remain at that level for the next several years."

Harvard implications: The University has imposed an 8 percent reduction in the endowment distribution for the current fiscal year, and at least that large a reduction in the succeeding year, but has not provided further details. In fiscal year 2008, the last period reported, Harvard derived 34.5 percent of its operating revenues from endowment distributions; Yale's budget that year was approximately 37 percent endowment-funded, according to the 2008 Yale Endowment report. For fiscal year 2009, Harvard's endowment dependence increased somewhat, and Yale—which put in place a strategy of increasing spending dramatically a few years ago (it raised spending from $616 million, or 31.9 percent of the budget, in fiscal year 2006, to $850 million, or 37.3 percent of the fiscal year 2008 budget)—had planned to spend $1.16 billion from the endowment in the year just ended, or 44 percent of the university's revenues (a total of approximately $2.6 billion). That would suggest that Yale is more tightly squeezed than Harvard.

But it is less constrained than Harvard's Faculty of Arts and Sciences (FAS), which has become nearly 60 percent endowment-dependent; after identifying $77 million of cost reductions during fiscal year 2009, FAS still faces cost cuts of nearly twice that much, on a total budget of $1.1 billion. Given FAS's commitment to hold financial aid harmless, and its requirements to conduct externally financed research and to pay large debt-service costs, it must in fact try to find those cost reductions within only about $700 million of remaining outlays.

• Levin's projection for future spending restraint—sharp reductions in the endowment distribution, followed by several years of level funding—"reflects our assumption that the endowment will remain flat during the current year and begin to grow after June 30, 2010, at the rate we have historically used in our budget modeling." This message is consistent with the decision by Stanford (which relies on the endowment for about 30 percent of revenues) to cut its distribution 10 percent in this fiscal year and 15 percent next year, in the hope of being able to begin increasing the payout in three or four years.

Harvard implication: The University has neither specified the exact reduction in endowment distribution for fiscal year 2011 nor projected for the years thereafter. In the fiscal year just ended, $1.7 billion was distributed from the endowment (details are not yet available on operating distributions, "decapitalizations," and the size of the "strategic infrastructure fund" assessment heretofore used to defray central administration spending on Allston campus development). But even the current, reduced spending rate of perhaps $1.4 billion to $1.5 billion would roughly equal investment returns if HMC is able to earn 6 percent on assets in the current fiscal year. That would be a conservative outcome--and below the longer-term expectation of 8.25 percent annual returns--but it may be prudent for forecasting and budgeting purposes, given that returns on commercial real estate, private equities, and other significant assets may continue to be depressed.

With peer institutions Yale and Stanford--more and less dependent on their endowments, respectively, than Harvard--envisioning flat returns and endowment growth now, and a multiyear workout of the problems caused by last year's sharply negative investment returns, University planners may be working toward an extended period of reducing costs and achieving a lower but sustainable level of revenues. How FAS proceeds on its cost-cutting--as a one-year massive resetting of operations, or a more extended adjustment--will be critically important. FAS dean Michael D. Smith is set to review these issues with his faculty colleagues during the next few weeks, and President Drew Faust may do so as well in her September 24 address.

• Levin declared financial aid off-limits for cutting, but said nothing else was sacrosanct. He noted in particular that faculty hiring would be significantly slowed, and that spending on a new science campus would also be ramped down somewhat. Spending on capital projects has been frozen for any initiative which is not fully funded, but Levin specified three programs that will proceed, each of which has an interesting Harvard analogue. First, Yale just opened its renovated Calhoun College (the New Haven name for undergraduate residences), and will continue with the planned renovations of Morse and Stiles Colleges, completing its multiyear, multihundred-million-dollar overhaul of college housing. Second, donors have funded the final phase of the Yale University Art Gallery renovation, so that construction has been authorized. Finally, although construction of two new residential colleges (and the resulting expansion of Yale's undergraduate enrollment by 800 students) has been pushed off into the future, funds have been secured to continue design and begin site clearance, so those steps are proceeding.

Harvard implications: Although College administrators have thoroughly examined Harvard's Houses and planned their renewal, the work itself—expected to cost well more than $1 billion—is not yet budgeted, is not expected to begin earlier than 2012, and then is expected to take a dozen years to complete. In creature comforts, Harvard College may be at something of a competitive housing disadvantage for the foreseeable future.

The Fogg Art  Museum remains closed, awaiting a complete reconstruction as planned by Renzo Piano; although significant gifts for the project have been announced, and fundraising has apparently continued at an encouraging pace, construction has not begun and no firm announcement has been made about whether the original schedule--which envisioned a reopening in 2013--remains intact.

Finally, Harvard continues to explore whether to defer, redesign, or mothball its $1.3-billion science complex in Allston, meant, like Yale's science-oriented West Campus, to accommodate growth in laboratory researchers. Broader plans to relocate Harvard's public-health and education schools to Allston and perhaps build new Houses there are clearly on indefinite hold.


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