A Financial Framework for the COVID Crisis

Despite the fall semester looking much better than the worst-case scenarios contemplated in early summer, higher education in America continues to grapple with the enormous challenges that the COVID-19 pandemic has posed. In fact, many people believe that the pandemic has served to accelerate some of the issues that have been looming over higher education for years, including unsustainable cost structures, declining enrollment, negative demographic trends and real questions about the campus-based delivery model of learning.

With this as a backdrop, governing boards and investment committees face having to respond to the current crisis while simultaneously addressing huge strategic questions about the future of the industry and their institution. We have developed a simple three-by-three framework to assist them as they grapple with these challenges and consider the role of the endowment in helping to solve them. The framework considers asset allocation, endowment spending and development programs -- in both the short term and the long term -- and some of the key questions to ask about each of them.

Asset Allocation

Short term. With a strong recovery in capital markets, investment portfolios and endowment values are in much better shape relative to where they were in the spring. As a result of strong equity markets, you are likely overweight risk assets if you haven’t already rebalanced. A natural question therefore is what to do now.

While the path forward is always unknowable, it is certainly important to understand and be intentional about your tactical positioning, your risk profile and your liquidity positioning rather than simply passively allowing them to be a function of market behavior. This is even more important as we continue to deal with the economic impacts of the COVID-19 pandemic, and as we experience what may be one of the more uncertain and turbulent presidential election cycles in recent memory.

Long term. Without question, the higher education institutions that our endowments support are in a different financial position than they were only a few months ago. Understanding the long-term strategic role of the endowment is more important than ever. Ask yourself the following:

• Does your strategic policy, which the board and committee probably adopted pre-COVID, still reflect the needs, constraints, risks, objectives and the like of your institution now that we understand the world has changed for longer than we would have expected?
• What has changed and do those changes warrant revisiting the long-term investment strategy?
• Have you become more, or less, reliant on endowment?
• Have your liquidity needs increased or decreased, and how has your operating environment changed?

Asking, if not answering, these questions now, before the next inevitable market downturn, will lead to better decisions.

Endowment Spending

Short term. If there were ever a present need, or a current generation of constituents that would benefit from an increase in spending from the endowment, one could argue that it is the current generation. Private foundations have been considering the idea of “meeting the moment” -- in other words, increasing spending to meet the current challenges, whether they be related to health, social justice or other pressing issues. In fact, several large and prominent foundations have committed to spending 10 percent, double the typical 5 percent, and many other nonprofits are considering special appropriations or emergency draws.

The short-term need across higher education is great, without a doubt, although in fairness, it has always seemed to be that way -- long before COVID. Your institution can choose to increase spending in the short term for defensive purposes, for example to address a budget shortfall. Or you can go on the offense and spend more in order to, for example, invest in a marketing campaign. Either way, and however it is described, an increase in current spending does not come without a cost … which leads to the long-term considerations.

Long term. The operating environment in which most colleges and universities are working will possibly, if not probably, be challenged for the foreseeable future. The need for support from long-term resources, such as endowment spending, is more likely to grow than to decline. Whatever the reason your institution may have for making short-term additional draws, it will often be difficult to roll back those draws. And having fewer dollars in the endowment to compound over time will be costly over the long term and lead to lower future spending levels.

We have built models that allow our clients to understand these tradeoffs, the costs and benefits of spending more or less today. These models help committees wrestle with difficult questions such as:

• How much more could we realistically draw in the short term?
• What are the liquidity implications of increasing short-term spending?
• How do we quantify the long-term cost of increasing spending today?
• How much more could we have in future spending if we reduced the draw today?

There is no “right” answer, but the concept of intergenerational equity is based on balancing the infinite needs of today with the unknowable demands of tomorrow given a finite set of resources at your disposal. Any decisions on the table should be made with consideration of both.

Development Programs

Short term. With the recent strong performance of equity markets and growth in their personal wealth, affluent donors have probably seen greater recovery in their personal portfolios than colleges and universities have seen in their financial outlook. In fact, the gap between the financial stresses facing higher education and the wealth of affluent donors may be the widest in recent memory. Put simply, the financial health of many nonprofits may be at an all-time low, while the wealth of many of their donors may be at all-time highs.

Given that gap, and the dynamic that donors have historically responded to “crises” with increased giving, your institution probably has a strong opportunity to engage with donors now. While development doesn’t fall under the purview of the typical investment committee, collaboration across both efforts -- investing and fundraising -- is critical to meet short-term needs. For example, when evaluating any potential additional short-term draws from the endowment, consider which challenges can and should be solved with fundraising efforts and which should be addressed with endowment assets.

Long term. As noted above, colleges may very likely rely more heavily on resources that were earmarked for the long term in order to thrive or even survive the short term. This situation demands thinking about development from a long-term strategic perspective. The baby boomer generation is the wealthiest in the history of our planet, and as they shift from wealth accumulation mode to wealth transfer mode, there will likely be the largest transfer of wealth we have ever seen. Whether that transfer goes to the next generation, to taxes or to charity is unknown. But nonprofits would do well to increase their likelihood of capturing their share of that wealth transfer.

For an investment committee, that means understanding the strategic priorities for institutional fundraising and determining if the endowment has a role -- for example, a special appropriation to invest in development -- in achieving those priorities. It also means understanding the importance of contributions to the growth of the endowment and ensuring that the entire community appreciates that future transformational endowment growth, and thus the future endowment support of the institution, is more likely come from contributions than investment returns.

As we come to the end of one of the most unusual semesters in the history of higher education, we must first take the time to applaud our institutions, our board members, our administrative teams, our staff, our faculty and our students and parents for making the most of a difficult situation. The uncertainty of the future for higher ed, both over the short term and long term, demands that we quickly get back to the mission-critical work of navigating our beloved colleges and universities through the challenges we can see and preparing for the ones that have yet to emerge.