Endowments in the Spotlight

Colleges and universities face pressures today on multiple fronts. Political scrutiny over institutional priorities is threatening formerly reliable sources of revenue. Meanwhile, long-simmering challenges like unfavorable demographic shifts and rising skepticism about the value of a degree continue to pose challenges. As a result, many higher education institutions are grappling with tough decisions about fiscal sustainability.

In this context, college and university endowments are garnering more attention than ever. Endowments have long played a stabilizing role in the financial structure of higher education, particularly during challenging times. But, contrary to what some may believe, they are not merely slush funds. In fact, laws intended to reinforce “prudent management” of institutional funds effectively restrict the free spending of endowment dollars.

Truly understanding an endowment’s potential—and its limitations—requires a close look at how endowments function, what risks they face, and how they can be managed with discipline to fulfill their purpose.

The Roles and Limitations of Endowments

Endowments are essential resources for most higher education institutions. These pools of donated funds typically accumulate over time and are often invested in capital markets for growth. Their overarching purpose is to help finance critical activities such as scholarships, academic initiatives, faculty salaries, research, and campus operations, both today and into the future.

Balances tend to be sizeable, particularly for some of the largest and most prestigious institutions. An annual report published by the National Association of College and University Business Officers tracks endowments and education-related foundations across the U.S. and Canada. The 669 endowments who reported 2024 data vary in size, from Harvard University at nearly $52 billion to American Baptist College at $1.2 million.

But appearances can be deceiving. Headline figures are substantial, but endowments are hardly blank checks. The ability to withdraw funds to supplement spending is usually restricted by policies that align with law guiding the management and use of institutional endowments.

Legislatures in 49 states have enacted versions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). This law provides guidelines for the investing and spending of endowment funds by nonprofit organizations like colleges and universities, as well as other institutions such as religious and cultural nonprofits.

The key to UPMIFA is the assumption that institutions “will act to preserve ‘principal’ (i.e., to maintain purchasing power of the amounts contributed to the fund) while spending ‘income’ (i.e. making a distribution each year that represents a reasonable spending rate, given investment performance and general economic conditions).”[1] The intent is to provide sufficient funding for today’s needs while preserving the ability to support future needs.

To that end, institutions usually adopt spending policies that limit annual withdrawals to 4-5% of an endowment’s average market value over a trailing period, typically the past 20 quarters (or 5 years). Using an average trailing value like this has a smoothing effect, so that short-term fluctuations in market value have less impact on an institution’s policy level of spending in any given period. This helps establish more dependable expectations as to what an allowable level of endowment spending will be.

In terms of the level, a 4–5% spending policy may sound arbitrary. But, it’s grounded in sound financial logic: a simple diversified investment portfolio of 60% stocks and 40% bonds has tended to deliver around 7% return per year over the past few decades, while inflation has run between 2-3% on average. Do the math, and it becomes evident that limiting spending to 4-5% has preserved the purchasing power of endowment funds.

Furthermore, the structure of some endowment funds complicates the freedom to spend. Many endowments consist of various individual donor-restricted funds, earmarked for specific use by donors. These restrictions can put additional limitations on uninhibited spending from endowments to fund general needs.

Risk Management for Endowments

Even with limitations from spending policies and donor restrictions, endowment draws still constitute a vital part of the financial structure for more colleges and universities. As endowments are typically invested in capital markets for growth, managing risk associated with these assets is essential.

Traditional investment risks such as capital loss, illiquidity, inflation, and concentration are all obvious to consider when participating in capital markets. But these risks are all associated with and derived from the single paramount risk for all endowments: the potential inability to fulfill current or future spending needs.

Endowments are invested in the first place in hopes of growing to support important spending needs both today and tomorrow. But intertemporal spending desires can conflict: any dollar spent today takes away from the ability to save, invest, and spend more in the future, and vice versa. Supporting both interests requires striking balance between both sides of the ledger and maintaining discipline, even in difficult times.

Genuine risk management means accounting for obstacles that might prevent institutions from achieving their desired expenditure goals. Whether developing the most appropriate diversified asset allocation for an institution, accounting for an adequate level of liquidity to provide a margin of safety should hard times come, or determining an appropriate spending policy, it all starts with the goal of meeting both present and future obligations.

At Alesco, we work with over 120 nonprofit institutional foundations and endowments, including those of many small and mid-size colleges and universities. Our investment philosophy—developed over years working with nonprofit institutions like colleges and universities—centers on aligning portfolio risk with institutional needs, not just seeking to maximize return at any cost.

That means understanding spending policies and needs, respecting liquidity constraints, and building portfolios that we believe can endure a variety of uncertain market environments in the long-term. It also means helping boards and investment committees remain focused while grappling with an increasingly complex landscape.

Given the recent threats to traditional revenue streams, some institutional clients have inquired about the level of liquidity in portfolios. When we construct portfolios, we balance the pursuit of returns with considerations for liquidity, knowing that challenging times may require the portfolio to be sufficiently nimble to adapt to shifting needs.

We’ve also heard concerns about the rising costs of funding the critical services they provide, and clients have asked about how the portfolio can be positioned to meet those needs. We are keenly aware of the importance of asset allocation and risk management, and we work with our institutional clients to understand the benefits and costs associated with adjusting allocations to meet increasing obligations.

A well-managed endowment can be a stabilizing force during these challenging times for higher education institutions. It must be balanced with an institution’s spending needs and maintained with discipline, especially in the most challenging conditions.

Endowments can’t be expected to solve every problem. But managed appropriately, they can provide a source of strength and stability needed to navigate through difficult and uncertain times, allowing our institutions to thrive for years to come.

[1] National Conference of Commissioners on Uniform State Laws (2006).

The content in this blog post is provided for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Alesco Advisors, LLC is a Registered Investment Advisor. The strategies and information described may not be suitable for all individuals and should not be considered as a recommendation to buy, sell, or hold any specific investment or adopt any particular strategy. 

The data and information used in the preparation of this blog post have been obtained from sources believed to be reliable; however, Alesco Advisors does not guarantee the accuracy, completeness, or timeliness of the data and information provided. Past performance is not indicative of future results, and all investments involve risk, including the potential loss of principal.