Massive Endowment Returns Make Rich Universities Even Richer
- The stock market yielded the largest endowment investment returns in 35 years.
- The richest colleges realized an average gain of 34%, adding billions to their coffers.
- Some accuse wealthy colleges of not doing enough to increase access for low-income students.
- The government taxes schools with the largest endowments, though some object to the tax.
The nation's richest universities became even richer last year thanks to incredible returns on endowment investments, widening the gulf between the haves and have-nots in higher education.
Meanwhile, Uncle Sam wants a fair share from these schools, though not everyone thinks that's a good idea.
Record Returns on Large University Endowments
To say it was a banner year for university endowments would be quite the understatement.
Thanks to a healthy stock market and strong returns on alternative investments, endowments grew a median of 27% in fiscal year 2021, which ended June 30. That's the highest rate in 35 years. At the nation's wealthiest universities, those with endowment assets exceeding $500 million, the median rate of return was 34%.
The numbers at those rich schools boggle the mind. Washington University in St. Louis realized a 65% gain in fiscal 2021, which swelled the institution's endowment by about $6 billion to a total of $15.3 billion — in one year. Bowdoin gained about 57%; Duke, about 56%. Brown had a return of over 50%, while the University of Minnesota and University of Virginia each saw 49%. Penn realized a 41% return, increasing its endowment by $5.6 billion to $20.5 billion.
Endowments grew a median of 27% in fiscal year 2021, the highest rate in 35 years.
By contrast, fiscal years 2020 and 2019 saw median returns of 2.6% and 6%, respectively. The average rate over time has been 7.5%.
"Last fiscal year ... the stock market, as measured by the S&P 500, did about 40.8%, which is astounding," said Ken Redd, director of research and policy analysis at the National Association of College and University Business Officers. "So whenever you get a major stock index like that rising, we tend to get very high endowment returns."
The Rich Get Richer and the Financial Gap Widens
At Washington University, leaders are salivating over the prospect of an extra $285 million annual windfall. How do we arrive at that figure? Take the one-year endowment growth, $5.7 billion, and apply the typical 5% spending allocation, which nets this amount.
It's not exactly that simple, however. Most universities target endowment spending around 5% of a three-year rolling average of market value. Every $1 million in endowment funds thus yields $50,000. The spending rate can vary based on market returns and other complicating factors.
So schools like Washington University won't see an immediate influx of cash, but suffice it to say fiscal fortunes have changed dramatically. Barring a market collapse, they'll enjoy a considerable boost in endowment income in the near future. It just might take a while for students to benefit.
What will institutions do with all this money? Washington University is investing in student financial aid, earmarking $800 million for undergraduates so the university can adopt a need-blind admissions policy. An additional $200 million will support graduate and professional students.
Some in Congress believe schools like Washington University have a moral obligation to turn profits into opportunity.
“Universities should be using these record gains to lower tuition and make higher education more obtainable for everyone.” — U.S. Representative Tom Reed, R-N.Y.
"Universities should be using these record gains to lower tuition and make higher education more obtainable for everyone," said U.S. Representative Tom Reed, R-N.Y.
Harvard, which anticipates a 49% return, plans to increase funding to its operating budget by 2.5%, meaning funds will support a wide range of activities, including student aid.
Yet the financial picture isn't as rosy for poorer institutions. Colleges with larger endowments are more apt to invest in venture capital and private equity — where there's higher risk but greater reward — while those with smaller endowments invest more in stable U.S. equities. Plus, a larger portfolio yields a greater net return. More zeroes in means more zeroes back.
The result is that wealthy institutions get even wealthier and broaden the gulf between the richest schools and everyone else.
"We have talked for several years ... about that growing bifurcation between the haves and the have-nots — the highly selective institutions with the huge endowments, and then the smaller, less selective schools that don't have as much fundraising capability," said Jessica Wood, a credit analyst at S&P Global. "We've seen that gap continue to grow. We saw it even widen further during the pandemic."
A 'Punitive Tax' on Huge Endowments
For years, Congress has kept a watchful eye on how wealthy universities manage their endowments. As tuition and related costs continue to skyrocket, endowments at these schools have mushroomed, causing some to criticize universities for hoarding resources while reducing accessibility, or at least not broadening it.
Chuck Grassley, R-Iowa, started investigating university endowments just before the stock market crash of 2008, when 76 institutions had endowments worth $1 billion or more. In a 2011 press release, he accused colleges of "hoarding assets at taxpayer expense."
The issue gained political steam on both sides of the aisle, culminating with the 2017 Trump Tax Reform Plan that instituted a 1.4% tax on wealthy colleges. Specifically, the tax applies to colleges with at least 500 students and more than $500,000 in endowment per student. In 2019, the IRS estimated this tax would affect up to 40 colleges, though given last year's financial returns, that number could swell.
How much money does 1.4% translate into? Harvard paid $49.8 million in federal taxes for the 2019 fiscal year, and Stanford paid $42.9 million.
Such totals may seem paltry given the endowment war chest at these institutions, but higher ed leaders say the tax will have a deleterious effect, and they've joined forces to lobby for a repeal. In 2018, officials from 49 schools sent Congress a letter decrying the "misguided policy."
A 1.4% tax applies to colleges with at least 500 students and more than $500,000 in endowment per student.
"The net investment income tax will impede our efforts to help students, improve education, expand the boundaries of knowledge, advance technological innovation, and enhance health and well-being," the letter stated.
Although Congress didn't expressly indicate the purpose of the tax, some speculate it's a message to wealthy universities that they need to step up their efforts to enroll a more economically diverse student body.
Andy Hirsch, a spokesman for Swarthmore College, one of the schools impacted by the tax, doesn't agree with the logic.
"Swarthmore is one of only a few colleges in the country that's able to offer need-blind admissions," Hirsch said. "That's only possible through the support of our endowment, and this tax diminishes our ability to do so. In essence, it's a punitive tax that threatens to reduce access to a college education for students from lower-income families."
Even some in Congress question the wisdom of the endowment tax. In 2019, Representative Brendan Boyle, D-Pa., introduced the "Don't Tax Higher Education Act," a measure to repeal the excise tax on endowment income. Co-sponsored by 17 Democrats and three Republicans, the bill never gained enough traction to receive a vote.
Spending Rates Increased During the Pandemic
To be fair, colleges did, in fact, dip deeper into their endowments during the COVID-19 pandemic to support students and campus operations. Colleges cannot dictate how endowments are spent — they are restricted by donor intent — but they can change the payout rate based on financial circumstances.
In fiscal year 2020, endowment spending was up 4% over the prior year. Seven in ten institutions increased their spending rates, which on average rose from 4.36% to 4.59%.
Some institutions extended their payout policies into fiscal 2021. Citing "pandemic-driven needs and opportunities," the University of Pennsylvania set its 2021 target rate at 7%.
In fiscal year 2020, endowment spending was up 4% over the prior year.
Almost half (48%) of endowment expenditures in fiscal 2020 went to student financial aid, a critical need during the pandemic.
Now that colleges largely have returned to normal operations, we can expect endowment payout rates to regress somewhat. We can also anticipate that the incredible market returns won't continue.
"I don't have a crystal ball," said S&P Global's Wood, "but looking back on several years of precedent endowment returns, another year with these types of major returns is unlikely."
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