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Endowment 101 is an introduction for those interested in a basic explanation of what an endowment is and how endowments work here at Dartmouth. For more details please see the endowment brochure.
The endowment is composed of donations made to the College with the understanding that the original value of the gift (the principal) will be invested and never spent, and a portion of the investment earnings (the distribution) will be used to fund the educational mission of the College. An endowment fund contributes revenue to the operating budget of the College every year, forever. The College must decide how much of these earnings to spend, while retaining enough growth of the endowment to keep pace with inflation and program growth in future years.
Endowment funds are often restricted to a specific purpose by the donor, such as student scholarships, an endowed professorship for a faculty member in a specific field, or to further an academic or recreational program. Other funds are unrestricted and can be used for the best use as determined by the College. The College honors any restrictions on the use of the fund forever, and has a legal requirement to do so. Less than 20% of Dartmouth's endowment is unrestricted; the majority of the endowment supports specific research, social, cultural, athletic, and recreational activities at the College, as well as financial aid. Figure 1 shows the percentage of the total endowment supporting various areas and activities at the College.
Figure 1: Dartmouth's Endowment by Designation (June 30, 2009)
How does the endowment work?
A traditional endowment fund's value can change in one of only three ways:
1) Gifts to the fund will increase the market value,
2) Investment returns can increase or decrease market value, depending on market returns, and
3) Endowment distributions can decrease the market value.
When we receive an individual gift to the endowment, it is combined with other gifts/funds and managed by the investment office as a single investment, called the "Total Return Pool" (TRP). The endowment is similar to a mutual fund where each individual fund is treated like an investor whose funds are combined with those of other investors. Currently, the College's endowment is made up of over 5,400 individual funds. Income and appreciation is credited to each fund depending on the investment performance for the entire endowment. For example, if the return for the whole endowment is 12% in a year, then each individual fund also has a return of 12%.
The College's Investment Office manages the investment, with oversight by the Trustee Investment Committee. The Investment Office works with over 50 external fund managers to choose assets in which to invest in order to create a well-diversified mix of assets that offers the best opportunity for maximum return with acceptable risk over time.
The College uses a formula to set a distribution rate applied to each fund, which provides revenue for the operating budget. This distribution is calculated using a formula that blends a combination of the current year's spending, adjusted by an inflation factor, and the endowment's market value over a period of time. The formula takes into account the market value of the endowment, so any changes in the market value will have an impact on future distributions. A large change in the value of the endowment, positive or negative, will have a large impact on the amount available for the operating budget.
The College's overall goal is to generate sufficient returns to support the current operating needs while maintaining the long-term purchasing power of the endowment fund. An additional goal is to generate return that exceeds inflation, achieving "real" growth of the endowment.
When the College creates its budget, it tries to estimate what the return on the endowment will be, and the impact of new gifts on the endowment, and thus how much money will be available for the budget.
Historically Dartmouth has done better than the market average, with a 10-year average annual return rate of 8%. In recent years, Dartmouth has enjoyed significantly better than average returns, with a return of 23.7% in 2007. However, the downturn in the economy that has occurred over the past year is unprecedented. Like nearly all other institutions, including our peers in higher education, Dartmouth has experienced a significant decrease in the value of the endowment over the past 24 months.
In fiscal 2009, Dartmouth's endowment fell 23% to $2.8 billion (a decline of 19.6% due to investment performance, with the balance as a result of spending from the endowment, somewhat offset by new gifts to the endowment). This loss, of $835 million, equates to approximately a $50 million reduction in annual operating revenue available to the College.
While the stock market has recovered somewhat in recent months, college and university endowments, because of their asset allocations, generally have not rebounded as quickly. Dartmouth's endowment, with only 26% of assets invested in public equities, is no exception. We do not expect our endowment to return to its fiscal year 2008 level of $3.66 billion for quite some time.
Long-term endowment performance, however, has been excellent. Dartmouth’s 8% annual return over the past decade, when the performance of the broader stock market was flat, places it in the top 5% of all endowments and foundations.
