Who received more cash from Yale’s endowment last year: Yale students, or the private equity fund managers hired to invest the university’s money? http://www.nytimes.com/2015/08/19/opinion/stop-universities-from-hoarding-money.html?smid=tw-nytimes&smtyp=cur&_r=0
It’s not even close.
Last year, Yale paid about $480 million to private equity fund managers as compensation — about $137 million in annual management fees, and another $343 million in performance fees, also known as carried interest — to manage about $8 billion, one-third of Yale’s endowment.
In contrast, of the $1 billion the endowment contributed to the university’s operating budget, only $170 million was earmarked for tuition assistance, fellowships and prizes. Private equity fund managers also received more than students at four other endowments I researched: Harvard, the University of Texas, Stanford and Princeton.
Endowments are exempt from corporate income tax because universities support the advancement and dissemination of knowledge. But instead of holding down tuition or expanding faculty research, endowments are hoarding money. Private foundations are required to spend at least 5 percent of assets each year. Similarly, we should require universities to spend at least 8 percent of their endowments each year.
University endowments have surged in recent years as markets recovered from the financial crisis. Yale’s endowment now tops $24 billion, up 50 percent from 2009.
Income inequality has left elite endowments heaving with cash. Following the tradition of Gilded Age philanthropists like Rockefeller, Carnegie and Vanderbilt, financiers are steering large charitable gifts to elite universities.
Kenneth C. Griffin, a hedge fund manager, gave Harvard $150 million in 2014. In May of this year, Stephen A. Schwarzman, the chairman and co-founder of the private equity giant Blackstone, pledged $150 million to Yale toward a new student center. John A. Paulson, another hedge fund manager, topped them both when he gave Harvard $400 million in June.
While nobody has suggested that quid pro quos were involved in these cases, these gifts highlight the symbiotic relationship between university endowments and the world of hedge funds and private equity funds.
Investors compensate fund managers through an arrangement known as “2 and 20,” referring to a 2 percent annual management fee and a 20 percent share of the investment profits, or carried interest.
The arrangement is doubly beneficial, from a tax perspective: Many institutional investors, including universities, are tax-exempt, and fund managers’ carried interest is taxed at lower capital gains rates instead of ordinary income rates.
Universities won’t disclose the amount of carried interest paid to fund managers. But one can estimate the amount by hand-collecting data from annual reports, financial statements and tax forms, as I did for the Yale figures above.
Despite the success of its endowment, in 2014 Yale charged its students $291 million, net of scholarships, for tuition, room and board.
In 2012, Harvard spent about $242 million from its endowment on tuition assistance; in 2014, it paid $362 million in private-equity fees, and nearly $1 billion in total investment management fees.
Smaller institutions aren’t any better. The University of San Diego spent about $2 million from the endowment on tuition assistance in 2012, compared with $5 million in private-equity fees in 2014 and $13 million in overall investment management fees.
Endowment managers argue that premium fees offer premium performance. It’s true that, over the past 20 years, under the brilliant guidance of its chief investment officer, David F. Swensen, Yale’s private-equity portfolio earned an astounding 36 percent per year. It’s also true that Yale’s financial aid policy is generous, and that Yale spends money from its endowment on things that benefit students indirectly, like buildings, faculty salaries and research. In the 2014 fiscal year, Yale’s endowment provided $830 million for expenses including funding professorships, subsidizing research and maintenance.
But the amount universities pay to private equity reveals the deeper problem: We’ve lost sight of the idea that students, not fund managers, should be the primary beneficiaries of a university’s endowment. The private-equity folks get cash; students take out loans.
As part of the reauthorization of the Higher Education Act expected later this year, Congress should require universities with endowments in excess of $100 million to spend at least 8 percent of the endowment each year. Universities could avoid this rule by shrinking assets to $99 million, but only by spending the endowment on educational purposes, which is exactly the goal.
Eight percent is not as scary as it might sound. Remember that endowments benefit from new gifts as well as investment returns. The average endowment, small or large, has grown by 9.2 percent per year over the last 20 years, even after accounting for annual spending of about 4 percent. Last year, only 14 of the 447 university endowments with assets over $100 million failed to net at least 8 percent growth.
Under my proposal, endowments would grow, only at a slower pace. They would shrink when markets crash, but recover, and then some, when the market rebounds.
Think about it this way. In 1990, Yale’s endowment was worth about $3 billion. If my suggested spending rule had been in place, it would be worth about $10 billion today, instead of $24 billion.
But under my proposal, the sky-high tuition increases would stop, and maybe even reverse themselves. Faculty members would benefit from greater research support. University libraries, museums, hospitals and laboratories would have better facilities. Donors would see the tangible benefits of philanthropy. Only fund managers would be worse off.