January 16, 2009

University endowment loses quarter of value

[img id="77142" align="alignleft"] The University’s endowment is thought to have lost a quarter of its value in recent months, according to a University-wide e-mail detailing upcoming budget and spending cuts from Provost Thomas Rosenbaum.

Budget cuts that were discussed hypothetically last month have become a reality. Academic departments have been asked to cut between 2.5 and five percent of their spending, while administrative units will make cuts in the range of three to nine percent. The Medical Center has already taken steps to reduce spending by seven percent.

In addition, some construction projects will be delayed. University spokesman Steve Kloehn could not comment as to what projects are being considered.

The endowment is designed to provide a steady source of income to the University’s budget, according to the University’s 2007 annual report. Each year, University trustees determine how much to draw from the endowment, based on the average returns over the past three years with a on- year lag. Therefore, ample funds available from years of high returns are available for current spending, and losses during the 2009 fiscal year will be spread over 2010, 2011, and 2012. Rosenbaum said that this approach “reduces the payout in years of robust earnings in order to protect the flow of funds in leaner years” and will therefore limit the effects of the financial crisis.

Nevertheless, University officials said, cuts must be made. While the trustees’ endowment spending limits minimizes the effect of endowment losses on spending, other effects of the financial crisis, such as increased demand for financial aid, the difficulty obtaining loans for new projects, and increased competition for government funding will all limit the University’s spending ability more immediately.

The endowment’s decline is comparable to losses at other universities. Harvard’s endowment lost 22 percent of its value from June 30, and Yale has reported a 25 percent decline in its endowment. Northwestern’s endowment has lost a third of its value.

Endowment funds are invested by the University Office of Investments, and the investments are overseen by the Investment Committee of Board of Trustees. The committee is largely comprised of alumni with significant investment experience, and includes recent business school donor David Booth (MBA ’71).

As of last spring, the endowment’s market value was at its highest point, $6.391 billion, up from $2.031 billion in 1997. From 1997 to 2007, the endowment earned an average annual return of 12.9 percent, and a total of $639.8 million in gifts.

According to Chicago Booth finance professor Steve Kaplan, recent decades have brought a shift in University investment strategies nationwide. University investors have followed a strategy pioneered by Yale’s Chief Investment Officer David Swensen, moving away from fixed income investments such as bonds. While fixed income investments are more reliable, universities have favored more profitable investments in equity—direct ownership stakes in corporations such as stocks—often through private equity and hedge funds.

“It has had over the years, spectacular performance. Most of the top schools and research universities have pursued the same strategy,” Kaplan said.

According to Peter Stein, the University’s chief investment officer, about 80 percent of the University’s portfolio is invested in diversified equities and equity-like investments, including equities from the U.S., international developed markets, and emerging markets, private equity, absolute return assets. The remaining 20 percent is invested in real estate, natural resources, bonds, and cash.

“The University of Chicago manages its endowment funds carefully and tracks the performance of its investments as closely as possible,” Stein said in an e-mail statement.

“People who have invested in just stocks lost 40 percent; we’ve only lost 25 percent. It’s perfectly normal,” Booth School professor emeritus Roman Weil said. “After the fact, it always looks like you wish you were not in equities. But we would have missed the runup.... We would be back where we were in 1993.”

It is difficult to determine the exact losses the endowment has sustained. “Some asset categories, most notably private equity, have a significant lag time in reporting market value. In addition, the current market environment has been highly volatile,” Stein said. “Any specific estimates we might make of our endowment value would be highly speculative and inaccurate.”

The estimate is based on what’s known of the performance of the endowment’s assets, as well as assessments by ratings agencies such as Moody’s. Moody’s estimates that university endowments in general have lost 25 to 35 percent of their value throughout the market’s recent decline. “We do not have any reason to believe we are significantly different than our peers in this regard, and we believe our endowment has suffered a loss of comparable magnitude,” Stein said.

Stein noted that despite the downturn, the University is still on solid ground financially. The University was evaluated by all three major ratings agencies in preparation for a $425 million tax-exempt bond-issue and maintained high ratings, an indication of creditworthiness and financially sound.