Former Harvard University President Lawrence Summers suggested that the school consider curbing annual payouts from its world-record $37.6 billion endowment to reflect the likelihood of lower investment returns.
Real, or inflation-adjusted, short-term interest rates have been falling steadily since 1999 and are effectively projected by financial markets to be around zero percent in the long-run, Summers said in a presentation Friday to a National Bureau of Economic Research meeting in Cambridge, Massachusetts, where Harvard is based.
“If it makes sense for Harvard University to pay out 5 percent of its endowment in 1999 when the real interest rate was 4 percent, it’s really quite unlikely that it makes sense to pay out 5 percent of its endowment in 2016 when the real interest rate is zero,” said Summers, a former U.S. Treasury secretary who is now a professor at Harvard.
Harvard disbursed $1.8 billion from its endowment in the fiscal year that ended June 30, 2015, equivalent to a payout ratio of 5.1 percent, the university said in a memorandum to U.S. lawmakers dated March 31. Much of the money went to faculty salaries and financial aid for students, including some $175 million for undergraduates. The university’s financial-aid packages are among the most generous in the U.S. for undergraduates, with families that earn less than $65,000 annually paying nothing.
Most endowments are seeing lackluster investment gains in the most recent year and some paid out more than they earned, raising chances that schools may have to review how they operate with less income from holdings. School endowments determine an annual payout rate based on a spending target, often determined by an average of three to five years. In years in which investment gains exceed the payout, the excess typically remains in the endowment.
At the same time, the funds’ high values have drawn interest from Congress as returns aren’t taxed and the cost of college skyrockets. The estimated cost to attend Harvard for the 2016-2017 school year is at least about $67,000, including items not directly billed by the school such as books and laundry, according to the university’s website.
Two U.S. congressional committees that determine tax policy sent a letter of inquiry to the richest 56 private schools about their endowments.
The Ivy League school said it targets a long-term, annual endowment payout rate of 5 percent to 5.5 percent of market value. The fund rose 3.3 percent in the 2015 fiscal year, which includes fund-raising and investment returns. The returns were 5.8 percent, the third lowest in the Ivy League.
“In considering the long-term payout target, a key factor is the expectation of future inflation,” Harvard said in its memo. “As the university’s costs increase with inflation over time, the value of the endowment must increase apace in order to maintain its contribution, in real terms, to the university’s mission.”