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With the market value of MIT's endowment and other invested funds at more than $2.1 billion, why don't we use more than about 5 percent a year in income from these funds to help pay for the costs of our activities?
Questions such as this about the endowment - especially the relationship of operating expenses to the invested assets of the Institute - were directed to Glenn P. Strehle, MIT vice president and treasurer.
These were his answers.
Briefly, what is the endowment?
The endowment consists of certain invested funds whose annual income is available to meet expenses, but whose principal we cannot spend. While we talk about the endowment as if it were a single entity, it is actually made up of many individual endowed funds, each given to MIT for a specific purpose, such as professorships, scholarships or fellowships, or for the general endowment. Each endowed fund is invested, and for most of them, we are legally permitted to expend only the annual income and not the principal itself. Furthermore, our goal is to maintain the purchasing power of these funds over time. I'll say more about that later.
The current market value of our endowment funds is $1.75 billion. In addition, we have other invested funds with a current value of $370 million. Taken together, these are what we call the total investments of the Institute, with a value of more than $2.1 billion.
Isn't MIT's endowment one of the largest in the nation?
Compared to many other leading colleges and universities, MIT is significantly underendowed. Although it ranks seventh among leading private institutions in total endowment, MIT ranks about 20th in endowment per student and about 30th in endowment per faculty member. This underendowment results in part from our relative youth: we have not had as much time as some other institutions to build our endowment.
Let's talk about operating costs. How much investment income goes toward the operating budget, which last year was more than $1.1 billion?
About 8 percent of the operating budget is funded from investment, including both endowment income and the income earned on other funds. Gifts and other receipts, together with the revenues from our auxiliary activities such as Housing, Dining and the MIT Press, account for about 14 percent. Tuition and related income supports about 16 percent of the operating budget. Virtually all of the rest, about 62 percent, comes from sponsored research revenues.
If we take out the revenues and expenses related to sponsored research and auxiliary activities, however, and look at the expenses associated with our educational activities, we see that investment income provides a much higher proportion. It is important to mention, of course, that sponsored research is an important part of the educational experience for most of our students.
How much of the cost of an MIT education can be covered by investment income? Where does the rest come from?
The investment income that we have available for this purpose covers only about one-fourth of these costs. In recent years, tuition income has covered about one-half of the costs of educating our students. The remaining one-fourth must be met by using expendable gifts.
If we look back some 30 years, more than one-third of these educational expenses were covered by investment income. Then came a period in the 1970s when our investment returns, and those of most other investors, lagged behind the long-term expectations. That situation stabilized in the 1980s, but the favorable relationship of the past has not returned.
A major challenge facing MIT is to increase endowment income in order to support a larger portion of our educational expenses.
Our operating costs have been increasing, but haven't our assets been growing, too?
Yes, but not on a par with our growth. The need for a bigger endowment does not imply that our investment income or gift levels have been low over the years; this is true only in comparison to the growth in our operating budget. Endowment and other invested funds of the Institute have shown remarkable growth both in recent years and over the long term. This growth resulted from the appreciation of the investments held in the endowment and from new gifts available for investment stimulated by the success of MIT's recent fundraising campaign.
If our fundraising campaign was successful, why do we still have a problem?
A great deal of the Campaign effort was directed at raising funds to support faculty and students. For faculty, this meant endowed funds for professorships-in line with our goal of supporting faculty much more from Institute funds, rather than relying on sponsored research funding for a substantial portion of their salaries. This is a costly decision in the near term, but it will serve us well in the long run, given the moderation and changes in federal research funding. Another major goal was to increase our endowed and expendable funds for financial aid. Still other funds were raised to support new academic initiatives-an important element in maintaining our excellence.
Could you give an example of the gap between endowment and budget growth?
The best way to look at this is in terms of relative rates of growth. The market value of our total investments increased 5.1 times over the past two decades (from $420 million to $2.1 billion, to give you an idea of the scale we are talking about.) Over the same period, the investment income that we used to support our activities increased 5.5 times, although the unrestricted investment income (that is, the income that we are free to use for any purpose) grew by just 3.3 times. While all of these increases are impressive, they must be compared with the growth in the expenses which are covered in part by investment income. For example, over this 20-year period, the expenses for instruction and unsponsored research increased by 7.3 times and the cost of services that support both teaching and research increased over 5.4 times. In addition, the amount that MIT spends for scholarships and fellowships has simply skyrocketed in the past two decades.
What can be done?
One thing we do is try to keep our assets growing at a rate which matches the growth in our expenses. If we don't, our investment income will cover a smaller portion of our expenses over the long term.
We increase our assets in two ways: first, by keeping some of our gifts as endowed funds rather than spending all of them, and second, by spending only that portion of our total investment return (from income and capital appreciation) that exceeds the rate of inflation. By following such a policy, we expect both the value and the spendable income from our endowment to keep pace with inflation.
How does this work, for example, with individual endowed funds, such as endowed professorships?
When a donor endows a professorship, he or she expects that it will be funded forever. This means that its market value must increase at least at the rate of inflation, because the professor's salary and related expenses will grow over time. We hope to invest wisely and produce investment returns over time that are greater than the rate of inflation. To simplify things, suppose that we earn an average of 9 percent per year on the market value of the endowment, and that the rate of inflation is 4 percent. We would keep the earnings that correspond to the rate of inflation and add them to the endowment, thereby increasing it and keeping its purchasing power constant. The rest, 5 percent, would then be made available for the support of the professorship. The same process would be true for scholarship and other endowed funds.
Who decides how much of the investment return should be allocated for operating expenses? Is this done year-to-year?
Both the income earned and the rate of inflation can vary substantially from year to year, so the actual percentage of earnings on endowment that we expend is set by examining trends over many years. This means that the rate we expend does not follow the rapid year-to-year fluctuations of the securities market or of inflation, but is smoothed out to perform more predictably over time. Projections are updated each year and the amount of earnings that can be spent is determined by the Executive Committee of the MIT Corporation, after reviewing the recommendations of the Investment Committee.
The New York Times reported recently that colleges and universities throughout the nation are being squeezed financially. It said that some are in the process of refinancing debts at lower interest rates. Are we doing this?
The staffs in the Treasurer's Office and in Financial Operations continually review our borrowings, including those tax-exempt bonds issued to help us pay for the construction of academic facilities. We do refinance when it is advantageous to take such action. In March of this year, we took advantage of the low interest rates and sold $87 million of tax-exempt bonds at an average interest cost of just over 5 percent. Of this amount, some $33 million was used to refinance some outstanding bonds at an annual cost saving of 2 percent, and the remainder was used to finance a portion of the costs of the new biology building.
Aren't we perhaps overreacting to what may be a short-term outlook? Can't we wait until we can get a better reading on long-term results?
The yearly changes in our operating budget combined with the large fluctuations in the securities markets can make it difficult to analyze trends using short-term data. But we have taken a look at long-term results, and what we see is that MIT's expenses are growing faster than its invested assets. We need to slow the growth in our expenses while continuing the strong increase in the value of our investments. If we can do this, we will be in a better position to support our current faculty and students and provide a strong foundation for future generations as well. And we will be able to do so in a way that preserves the quality that we all associate with MIT.
A version of this article appeared in the November 22, 1993 issue of MIT Tech Talk (Volume 38, Number 15).