If we were teenage girls, we’d have pictures of Yale endowment manager David Swensen on our walls. He’s that good. Or was–until the value of Yale’s endowment dropped 25% in four months and the university announced that it will have to chop its budget by more than 10%.
Global asset values have been hammered, so there’s no way Yale could have survived unscathed. We also have no problem with temporary losses (a.k.a., volatility), as long as the portfolio has enough liquidity that the investor can meet near-term cash needs.
Our question for David, therefore, is this: In hindsight, did you mismatch the assets and liabilities? Specifically, given that 44% of Yale’s $2.7 billion operating budget every year comes from the endowment, should you have structured the portfolio to have a less volatility, more liquidity, and–obviously–a lower return? Or in a year like this one, and the resulting budget cuts, just simply an inherent risk that had to be taken?
(Swensen could also presumably blast Yale itself for growing its own budget so quickly, but presumably the University was clear about how much cash flow it would need from the endownment every year.)
Put differently: Should David Swensen have structured Yale’s portfolio to return, say, 12% a year instead of the 15% he achieved through June in exchange for the certainty that the cash Yale needs to operate would be there? Will he change the asset allocation in the future to accomplish this?
As Yale alums and Swensen disciples, we can’t wait to hear the response. (For more on David Swensen, see this excellent article by the NYT’s Geraldine Fabrikant. The photo excerpt comes from there as well).
Letter from Yale president Richard Levin below:
December 16, 2008
To: The Faculty and Staff of Yale University
From: Richard C. Levin
I know that all of you are concerned about the effect of current economic conditions on the University, and I recognise that these are trying and uncertain times for all of us. The precipitous decline in housing prices and stock market values has had consequences for many of us personally, and, naturally, for Yale as an institution. The officers and I have spent the last six weeks analysing the implications of the downturn for Yale, and last weekend we recommended a course of action to the Yale Corporation. I write now to describe how we have been affected and how we will respond. By acting thoughtfully and strategically, I am confident that we can weather this storm while continuing to advance our most important objectives, albeit at a slower pace.
Despite the downturn in the economy, it is important to keep in perspective that the University is much stronger than it was a decade ago. Through your devoted efforts, we have made enormous progress. We have renewed our facilities, expanded access by offering more generous financial aid, and built a pre-eminent faculty across the disciplines and professions. We have also provided expanded international experiences for our students, advanced important sustainability projects, and contributed to the renaissance of New Haven. In all these efforts, we are supported and enabled by the thousands of alumni and friends who have contributed to the Yale Tomorrow campaign, and whose contributions have remained steady through the first months of this economic downturn.
It is not our custom to announce the mid-year status of our endowment portfolio, but these unusual circumstances call for a departure from custom. Thanks to the outstanding work of David Swensen and his colleagues in the Investments Office, our endowment has declined significantly less than market indices. Taking into account only the value of marketable securities, our investment return from July 1 through October 31 was a negative 13.4%. But this does not tell the whole story. Our endowment is invested in both marketable securities (chiefly stocks and bonds) and “illiquid” assets, such as real estate and private equity investments that are not traded on a daily basis and are difficult to value with precision. The value of our marketable securities has declined further since October 31, and, even earlier, we began to establish reserves in anticipation of substantial decreases (“write-downs”) in the value of our private equity and real estate investments. As a consequence, our best estimate of the endowment’s value today is $17 billion, a decline of 25% since June 30, 2008, and this is the value we are using for purposes of budget planning. We are also assuming that the endowment will remain flat during the 2009-10 academic year and resume growth after June 30, 2010, at the rate that we have historically used in our budget modelling.
It is important to recognise that $17 billion is still a very large endowment. This was where the endowment stood as recently as January 2006. Still, the 25% decline we have experienced has a very significant impact on our operations because income from the endowment supports 44% of the University’s annual expense base of $2.7 billion. Fortunately, our endowment spending policy spreads the effect of market changes over several years, allowing us to respond gradually. But the ultimate consequence of the market decline is still substantial, causing an annual budget shortfall on the order of $100 million next year (2009-10) and growing to over $300 million by 2013-14. The question before us is this: how much of this pattern of projected future budget deficits should we seek to eliminate by taking action now?
Of course, we have no crystal ball. We need to balance the benefits and costs of acting now against the benefits and costs of postponing action. Markets have been extremely volatile, and the endowment could do better or worse than we are forecasting. Because of this very high degree of uncertainty, it is important that we not overreact. Thus, we deliberately will not reduce our budget immediately to close the entire gap created by the assumed 25% decline in our endowment. Instead, in preparing our budget for the 2009-10 academic year, we will seek to achieve half to two-thirds of the reductions required to close the gap now forecast for the years ahead. If markets rebound significantly, we would need to make no further adjustments. If markets remain flat or decline further, we will need to undertake a second round of actions next year.
In reflecting these past few weeks on budget scenarios, I have had as my principal goals supporting the faculty and staff who are here, ensuring access for the most talented students, and remaining a good citizen of New Haven. To achieve these goals, certain activities will be protected as we reduce overall expenditures. Three in particular deserve mention.
First, we will maintain our commitment to the improvements in financial aid for students in Yale College announced last year. These policies, which offer greatly improved support to low and middle income families, will be especially welcome this year as families experience economic hardship. They are absolutely necessary to ensure that access to Yale remains open to the most promising applicants, regardless of their families’ financial circumstances. Our strong financial aid program in the Graduate School also will be maintained, and I will encourage the deans of the professional schools to make every effort to maintain their financial aid budgets in the coming year.
Second, we will continue to recruit faculty. authorised searches in the Faculty of Arts and Sciences will proceed, and the deans in each of the professional schools will work with the Provost to strengthen their faculties. We do not want to lose the momentum of recent years, and we believe that it will be to Yale’s long-run advantage to continue to recruit outstanding and diverse faculty. This said, we will need to be judicious in authorizing new positions and filling vacancies, and departments will have to make a strong case for searches that are not yet authorised.
Third, although we will proceed at a slower pace, we will continue to develop plans and initiate programs on the West Campus. Because the facilities are already in place and we face no significant capital costs, we should not miss the opportunity to strengthen permanently and substantially Yale’s capacity for path-breaking research in the sciences, engineering, and medicine. Nor should we forego the opportunity afforded by the West Campus to map out innovative uses of our library and museum collections that will support Yale’s excellence in the arts and humanities.
Even closing half to two-thirds of the budget gap that we anticipate over the next few years has consequences that I wish we could avoid. But if we fail to make significant adjustments now, we would inevitably need deeper cuts later. In recent years, we have been in the fortunate position of being able to pursue many new ideas and exciting initiatives. Now we will have to make harder choices. I am confident that faculty and staff throughout the University will rally to the challenge as we make the following adjustments:
1. Effective immediately, all postings of new positions must receive prior approval. In the case of faculty, approval must be sought from the Provost or relevant deputy/associate provost. In the case of staff, positions must be approved by an officer of the university or a deputy/associate provost. In addition, departments, schools, and units should review all open positions, including those currently posted, with their responsible officer or provost. For those staff positions that are authorised, qualified internal candidates will be given priority.
2. We will restrain the growth of salaries. For the 2009-10 academic year, faculty and M&P staff with salaries below $75,000 will be eligible for merit increases of up to 2%. Merit increases for faculty and staff who earn over $75,000 will be capped at $1,500. Employees represented by labour unions will receive the increases scheduled for the final year of their contracts.
3. We will reduce 2009-10 budgets by an amount equal to 5% of the salaries and benefits of all non-faculty staff. We believe that we can accomplish this reduction largely through attrition in all categories of staff: managerial, professional, clerical, technical, service, and maintenance. It is clearly of the utmost importance that this process be handled thoughtfully and carefully. When we undertook a 5% staff reduction five years ago, we achieved the overwhelming majority of our goal by retirements, departures, and leaving vacancies unfilled.
4. We will also need to reduce budgets for all non-salary and wage expenses by 5% for 2009-10 and by an additional 5% the following year. I know that this reduction will be difficult for many units, because we have had no increases in this category for the past several years. The challenge will be to find less critical expenses that can be eliminated. For example, we will find ways to reduce expenditures on outside consultants. Reducing travel, consuming less paper, and decreasing energy use will also help us achieve our sustainability goals. We want to continue to provide training opportunities for staff, but we will save money by conducting more of these programs on campus.
5. All new buildings and renovation projects currently under construction will continue until completion. But we will not be able to issue as much debt for construction projects as we had anticipated in our multi-year capital budget. Consequently, with the exception of essential utilities projects and the renovation of Morse and Ezra Stiles Colleges, we will defer the initiation of construction (both new buildings and renovations) until the conditions in debt markets permit going forward or additional gift funding can be secured. This means, concretely, that the Yale Biology Building will be delayed for one year, while the construction of the new School of Management campus, the second phase of the renovation of the Yale University Art Gallery, the renovation of Hendrie Hall, and the move of Dwight Hall to a renovated 143 Elm Street will not begin until funding is secured or market conditions improve. Meanwhile, we will move forward with design work on these and other pending projects. We will also continue both design and fundraising for the new residential colleges with the hope that we can keep to the current schedule, but postponement may become necessary. I know these delays will be disappointing to those schools and departments that have been awaiting facility improvements, and it is a great disappointment to me. I want to underscore that we are not cancelling any projects that have been approved; we are simply delaying the initiation of construction.
As I mentioned earlier, the actions we are taking at this point, though challenging, will not fully compensate for the decline in the value of the endowment that we have experienced to date. With the exception of the Great Depression, all market downturns of the past century have been followed by at least a partial rebound within one to two years. If such a rebound occurs, we may not need to undertake further budget reductions, but, if such a rebound does not occur, we will need to take additional action. I hope you agree with our decision to avoid a possible overreaction at this time.
Yale University today is an institution of which we can all be justifiably proud. We will manage through this downturn in a way that will preserve our great strengths and seize the most important opportunities for the future, so that Yale can continue to serve the nation and the world by advancing the frontiers of knowledge and educating the most talented and promising students for leadership and service.
I ask all of you to help. We need your assistance in identifying within your own units and elsewhere opportunities for savings that will not impair our ability to advance our most important missions. If you have ideas for achieving our budget reduction targets, please share them with your colleagues and supervisors. The officers would also welcome any suggestions you would wish to make by e-mailing [email protected]. I know that I can count on you to respond to the challenges ahead with renewed dedication and commitment.
NOTE: This official Yale University message can also be viewed at: