Estimating Endowment Losses at Harvard

Harvard is cutting expenses. They are speculating a $6 billion drop in the endowment.

It is too early, and the markets are far too volatile, to know what the assets will be worth at the end of fiscal 2020. As a hypothetical exercise, assume that the endowment records a negative 10 percent investment return during the year; that new gifts added to the corpus are negligible; and that distributions across the University during the current year total $2 billion. That would reduce the value from $40.9 billion last year to about $35 billion at the end of this fiscal year. The Corporation uses a formula to set endowment distributions that smooths out high and low investment returns in any given year, so deans can plan in some orderly way. Inevitably, however, so severe a decline in the endowment’s market value, if realized, would lead, at best, to a leveling out of funds distributed to the faculties. Ignoring gifts received, for an academic unit like FAS, level-funding of the distribution for fiscal 2021 (again, this is hypothetical only) would reduce operating funds by $20 million or so, and likely more than twice that in the following year: more than a percent the first year, and escalating thereafter—at a time when other expenses are rising, and other revenues may be declining.

Harvard Announces Salary, Hiring Freezes and Other Spending Cuts, Harvard Magazine

The school’s administration is trying to avoid dipping further into their endowment.

“Some of you may be wondering why we can’t just dip into the endowment to support us through these difficult times. We do intend to distribute as much from the endowment as we responsibly can, but there are limitations to the endowment’s capacity,” they wrote. “Because of the recent declines in the markets, the endowment, while still large, is not as large as it was previously. As it shrinks, it has less capacity to support our existing operations, especially as other shortfalls in revenue sources loom.”

Harvard’s endowment — its largest financial asset — consists of more than 13,000 funds, according to the University’s website. The largest categories of funding are restricted to being spent on specific programs, departments, and purposes, which includes professorships, fellowships, and financial aid for undergraduates. The funds have to be used according to the terms set by the donor.

Harvard Announces Salary and Hiring Freezes, Discretionary Spending Reductions, Potential Deferral of Capital Projects, and Leadership Salary Cuts, The Harvard Crimson

The more you spend now, the less there is to earn a return in the future.

[University CFO Thomas J.] Hollister said that there are other “limitations” to drawing funds from the endowment. The first limitation is the make-up of the endowment, which consists of over 13,000 separate funds.

“Each is an underlying legal contract with the donor to use the money as the donor requires, and so it’s restricted,” Hollister said. “There’s a lot less flexibility in the use than people imagine.”

The second limitation is the need to generate future endowment returns.

“The money was given to the university for future generations, and not just the current generation,” Hollister said. “Consequently, what we try to do is spend roughly 5 percent a year, because the rest of it hopefully is earning returns to be available for future generations.”

Hollister said past generations of Harvard affiliates used the endowment sparingly in times of crisis, citing the World Wars, the mid-1970s, and Great Recession in 2008.

“In past downturns, previous generations have lived with hardships and adversity to protect the endowment so that it’s available for today’s students,” Hollister said. “To honor that tradition, Harvard — consistent with the donors’ terms and with that fiduciary responsibilities — needs to protect some of it for future generations. You can’t take it all and spend it now because it’s restricted as to purpose and restricted as to when it can be used.”

Harvard Has The Largest University Endowment in the World. CFO Hollister Says It Has Its Limits., The Harvard Crimson

The school has been expecting a recession for some time.

Some of the important decisions, Bacow emphasized, had been taken in prior years, as Harvard adapted new policies and procedures in the wake of the financial crisis and ensuing severe recession in 2008-2009. He enumerated decisions to “de-risk” the central bank (the University’s checking-account-like short-term funds, which had been invested along with the endowment during the early 2000s, to achieve higher returns—but at the cost of becoming illiquid), and, more generally, to increase liquid funds on hand. He also noted the accumulation of financial reserves across the institution. He observed that no one could have predicted the current circumstances—a pandemic, prompting burgeoning unemployment and enormous economic losses worldwide—but that he and his team had expected some sort of recession sooner or later.

A President Mended, A University Challenged, Harvard Magazine

The University President and Deans already have a recession playbook prepared.

We are looking at literally every expenditure within the University. The deans and the vice presidents are all working with us at the moment to limit spending and to ensure that that we are coming into alignment with what we know are going to be diminished sources of revenue. We’ve already spent a lot of money that we would not have otherwise in helping students go home. We are rebating room and board for students throughout the University. We have seen a decline in continuing and executive education revenues — a precipitous drop. So the immediate effects are significant already. And then we’ll see what the market delivers to us in endowment returns going forward.

The good news is that we anticipated that at some point we would face a recession. We were cognizant of the fact that we were already in the longest peacetime economic expansion in history. Several years ago, we began planning for the next recession. We didn’t know when it would come, but we knew that it would arrive at some point, and so we created a recession playbook, produced by our financial planning staff under (chief financial officer and Vice President of Finance) Tom Hollister’s guidance, with the participation of all of Harvard’s deans and vice presidents. We also tried to make sure that we understood the lessons of 2008 so that we could be better prepared the next time around. We took measures to ensure that we had more liquidity than we had going into 2008. We built reserves. All these things will help cushion the impact, but the impact will still be felt. The city of Cambridge and the city of Boston have already put restrictions on construction projects right now, so construction on the campus is on hold at the moment. Lots of things are going to be delayed, and there will be belt-tightening across the board.

‘I thought: This is going to be interesting’, The Harvard Gazette

Read more about how the school is surviving the pandemic here.

Harvard Will ‘Apply the Tourniquet’ On Non-Essential Spending, Per CFO Hollister, The Harvard Crimson

Radcliffe Institute and Divinity School Particularly Vulnerable to Endowment Decreases, The Harvard Crimson

Harvard Faculty of Arts and Sciences Suspends Capital Projects and Faculty Searches After University-Wide Freezes, The Harvard Crimson

How Harvard’s Professional Schools Will Cope with the Economic Crisis, Harvard Magazine

Inside the Wertheim Gallery at the Harvard Art Museums.
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Post by Marcelino Pantoja