Unhedge University Funds

The wisecrack is right: Harvard really is a $50 billion hedge fund that dabbles in education.

It’s not alone: Many universities across the United States have amassed gargantuan endowments by investing already sizable donations in equity, bonds, and other assets. To be sure, these endowments provide universities with financial stability and help preserve the educational mission in the long term.

But forever building for the future sometimes neglects the present.

A deeper look at endowment data suggests that institutions might have some slack available to increase their annual draw rate. This extra money should be used to reduce the net price of attending college, increase pay for adjuncts and other contingent faculty, and make other improvements to increase overall educational attainment.

But before we delve into the data, we must first understand how the endowment structure works. A university’s endowment is not a rainy day fund. The endowment refers to the amalgamation of many smaller donor-gifted funds, often designated for very specific ventures — say, a particular professorship or a research institute. In many cases, universities’ investment managers are legally obligated to ensure that these donated funds will be able support the specified venture in perpetuity. As a result, universities aiming to preserve the purchasing power of endowment funds over time may err on the conservative side.

Over the past 15 years, the portion of the endowment that most universities spend each year has remained relatively constant. The precise percentage varies by institution and depends on complex formulas, but often, universities set a target spending rate between 4.0 and 5.5 percent of the endowment’s value at the beginning of the year, and then apply it to a moving average of the endowment values over the past three years.

Institutions seem to draw the same annual amount regardless of the endowment’s investment performance in any given year. Take, for instance, Harvard’s fiscal year 2021: The endowment earned an impressive $11.3 billion, but the University contributed only approximately $2 billion to the operating budget.

If those numbers sound like a lot, it’s because they are. Return on investment regularly outstrips institutions’ draw on their endowment, frequently by a significant margin. Although the numbers fluctuate greatly from year to year, the distribution of a sample of institutions with the largest endowments clusters around an 8 percent return. Some of these institutions, though, have even higher average annual return rates, upwards of 13 percent.

Source: Integrated Postsecondary Education Data System. All values are adjusted for inflation. By Zach E. Abrams and Julien Berman

Why, then, do rich universities consistently spend such a small portion of their endowment? Blame “endowment hoarding” — universities often prioritize preserving the value of endowment above preserving the value of the university.

This phenomenon becomes particularly evident during recessions. Rather than increasing spending to smooth over market fluctuations and avoid budget cuts, universities sometimes do the opposite, cutting endowment payouts even further. When institutions receive high rates of return, they tend to leave endowment spending unchanged; but during negative shocks, they often slash spending, opting instead to lay off faculty and staff and reduce hiring.

Endowment hoarding seems particularly problematic once you realize how much money is going to endowment managers compared to students. In 2014, five rich institutions including Harvard paid more to private equity fund managers than they dished out in aid to their entire student bodies. Indeed, despite ballooning endowments, the richest universities have failed to implement corresponding increases in financial aid, with one recent study suggesting that endowment growth has little to no effect on net tuition prices. Although Harvard has increased its institutional financial aid offerings to incoming undergraduates since 2008, that aid has increased at a slower rate than the endowment.

Raising annual spending by a percentage or two isn’t even that scary. On average, 50 of the largest endowments have grown by 4.31 percent per year in real terms, even after factoring in 5 percent annual spending.

At the very least, universities should look for extra wiggle room in their contractual obligations. After all, just because an endowment is held in perpetuity doesn’t mean that it needs to increase in value each year.

Take for example Harvard’s Hollis Professorship of Divinity, the oldest endowed professorship in the United States, established in 1721. Although the University might be obligated to set aside enough funds each year in order to pay out the chaired professor’s salary, the endowment growth has undoubtedly outpaced any increases in professor salary. So, rather than reinvesting all the extra returns into the endowment, Harvard could spend at least some of that surplus without seriously jeopardizing the professorship position.

Ultimately, I understand the need for a certain degree of realism and conservatism when managing such large funds for the future, and I realize that universities do not have limitless discretion when determining how to spend their endowments. But perhaps asset managers overemphasize future improvement at the expense of access today.

An extra percentage or two goes a long way when we’re talking about funds on the order of billions of dollars. That money could be used to fund any number of projects that improve educational quality in the present — investments that will pay greater long-term dividends than simply accumulating money in university hedge funds.

Julien Berman ’26 lives in Canaday Hall. His column, “Toward a Higher Higher Education,” appears on alternate Tuesdays.