In response to the endowment’s falling value amid the financial crisis, the rate of spending from Yale’s endowment is on course to hit its upper limit of 6 percent in 2011 and 2012, according to administrators’ current projections.
The marked rise in the spending rate — up from 3.7 percent of the endowment’s value last year and 5.1 percent in the current fiscal year — will sustain the income from the endowment, withdrawals from which contributed 44 percent to Yale’s fiscal 2008 operating budget. The University’s built-in endowment spending cap — as well as a two-year lag in the rate’s calculation and redistribution of funds from the endowment’s growth last year — explain Yale’s projected budget gaps of $100 million in the 2009-’10 academic year and $300 million in 2010-’11.
The endowment’s value remained relatively flat last fiscal year, with a 4.5 percent return, but it is expected to plunge 25 percent for the year ending this June, according to administrators.
The endowment’s contribution to Yale’s $2.7 billion operating budget is governed by a formula that factors in inflation, the endowment’s return and the endowment’s contribution from the previous year. The purpose is to smooth over market trends in order to stabilize the endowment’s yearly contribution and steadily support University operations while still preserving the long-term value of the endowment, Yale investment czar David Swensen said in an interview Monday.
“The idea behind the spending policy is that you spend from the endowment an amount that’s sustainable in the long run,” Swensen said. “If we’re to overspend, then we fail in our mission of preserving purchasing power for future generations. If we were to under-spend, then we may well accumulate purchasing power, but we’d fail in our mission to support operations today to the greatest extent possible consistent with the idea of preserving assets.”
Finding that balance has been an ongoing challenge, especially with mounting political pressure for Yale and other universities to spend more of their wealth during recent years. Last January, in addition to announcing an expanded financial aid policy, the Yale Corporation, University’s highest governing body, changed the spending rule to raise the target payout from the endowment to 5.25 percent and set a floor of 4.5 percent.
The Corporation also added an upper cap that stops the spending rate from exceeding 6 percent. The cap was put into place to freeze drawing from the endowment should its return fall so much that spending more than 6 percent would seriously — and possibly irreversibly — erode the fund’s value.
Because it takes two years for the endowment’s performance to manifest in the operating budget, the effects of the recent plunge will strike in the 2011 fiscal year. And that is why current projections for both fiscal years 2011 and 2012 hit the ceiling, according to David Soper, director of operating budget management.
The $100 million gap in the coming 2010 fiscal year, meanwhile, is the result of the endowment’s modest 4.5 percent rise last year, which, after accounting for inflation, is effectively flat growth. That 4.5 percent return in 2008 produced a contribution to the operating budget in the 2010 fiscal year that would have been enough to cover the $100 million gap.
But administrators decided to withhold some of that money, about $118 million, and instead spread it out over the successive years in the hopes of tempering those later gaps.
“Funds that were made available when the spending rule was last adjusted can be spread out over a period of years in order to mitigate the full impact of the current downdraft,” Provost Peter Salovey said in an e-mail last week.
In other words, administrators decided to start making moderate cuts earlier in the hopes of defraying the impact of the reductions over several years.
Administrators are also expecting the endowment to remain flat during the 2009-’10 school year and to resume growth after June 2010. If that projection bears true, it means, because of the lag, that the operating budget will feel the pinch of the current financial crisis well into 2012.
With such a large endowment — still valued at an estimated $17 billion and the second-largest in higher education — it may seem as if Yale could afford to spend as much as it needed from the endowment to cover the operating budget in full and be able to skirt any kind of budget cuts whatsoever. But, Swensen said, that would be neither sustainable nor prudent.
“If you don’t have a disciplined spending policy, then there’s just no sense of budget discipline at all,” Swensen said. “If you spend whatever it is you want to spend, then I guess you’ve always got a balanced budget.”