After strong financial market returns in 2017, many endowments and foundations have continued to increase their effective spending rates since 2015. According to the 2017 National Association of College and University Business Officers (NACUBO) annual study, average spending rates among university and college endowments rose in fiscal 2017 to 4.4% from 4.3% in fiscal year 2016. Institutions with endowment assets of more than $1 billion accounted for the largest increase in spending rates with a spending rate of 4.8% (compared with 4.4% in 2016), with smaller endowments rising slightly.
The increase in spending largely reflects the strong average annual return of 12.2% in 2017 compared to -1.9% and 2.4% average returns in 2016 and 2015, respectively. However, the challenge of achieving real returns that cover spending needs and preserve endowment assets over time has posed a difficult task for organizations over the last ten years. Based on the 2017 NACUBO study, the average annual returns for the last ten years fell to 4.6% vs. 5.0% at the end of 2016. Looking ahead, we believe the next decade could present similar challenges for endowments as the long-term expected returns of traditional asset classes are declining.
We recommend that endowments review their spending policies and asset allocations to ensure that the policy is reasonable and reflects the realities of lower prospective returns. A 4.5% spending rate coupled with an expected inflation rate of 2% means that the portfolio needs to generate at least a 6.5% return to maintain purchasing power over time. We averaged the capital market assumptions of three financial institutions, including ours, and found that global equities and fixed income are expected to return 6.2% and 3.1% over the next ten years, respectively. Based on these assumptions, a portfolio of 70% global equities and 30% fixed income would have an expected return of 5.3%, far short of the 6.5% needed.
Certainly, the market environment looks challenging for institutions hoping to preserve the support of their endowments. However, there are concrete steps an organization can take to improve the odds of success:
1. Asset Allocation – Establish your organization’s risk and return objectives to build a strategic long-term asset allocation based on your spending policies and inflation outlook.
2. Spending Policy – Review your spending policy in conjunction with your asset allocation review and forward-looking return expectations.
3. Alternative Strategies – Utilize strategies that offer diversification and access to non-traditional sources of
4. Private Markets – Utilize private markets strategies that provide return premium and opportunities above and beyond that of public markets.
Sources: NACUBO - 2017 Commonfund Study of Endowments; National Association of College and University Business Officers; 2018 2017 NBOA Commonfund Benchmarks Study: Independent Schools report; National Business Officers Association; February 2018