Weathering the Economy

Author: Ed Cohen

“Notre Dame’s Investments Quarterback Takes His Team Into the Record Books,” a headline in the Wall Street Journal’s September 13, 2000, issue declared.

Underneath, in a feast of football metaphors that surely made promoters of Notre Dame’s academic aspirations gag, the story marveled at the 57.9 percent return on the University’s endowment investments for the fiscal year ended June 30, 2000. A year “worthy of a Heisman,” the writer called it. The rate was tops among university endowments.

Two and a half years later, much has changed for the stock market and U.S. economy, none of it helpful to Notre Dame or higher education as a whole.

Notre Dame’s investment pool—which includes the endowment, working capital, and funds reserved for operating and maintaining facilities—has well outperformed the stubbornly bearish stock market and continues to outpace nearly all large institutional investors. But over the past two fiscal years the fund is down 15.8 percent. After generating a phenomenal $1.3 billion during its “Heisman” year and peaking at $3.1 billion in value in June 2000, the endowment had given back about $500 million through last September before recovering somewhat the last three months of the year.

For an institution with an investment horizon measured in decades if not centuries, two years of negative returns are no cause for alarm. But the loss of investment income is part of a complicated and challenging financial picture facing the University this year.

Gifts to the University fell in the latest completed fiscal year (fiscal years end each June 30) by about 11 percent or $15.5 million from the record $142.2 million brought in the previous year. Giving was essentially flat the first six months of the current fiscal year.

Demand for financial aid is rising in part because parents who invested in the stock market for their children’s educations have seen double-digit returns evaporate—and, in dire cases, the principal they invested too.

The University’s phenomenal investing and fund-raising successes of the last 10 years, which included the $1.06 billion Generations campaign, allowed it to create an array of new centers and institutes, reshape the campus through construction and renovation, and enlarge the total work force from about 3,000 to about 4,000. Those enhancements made Notre Dame a better university. But they also added millions to the annual budget in the form of expenses like building maintenance and health-care benefits.

Huge new unavoidable outlays loom. Replacing outdated and soon-to-be obsolete computer systems used for accounting, human resources, course-registration, billing, financial aid, fund raising and other areas is expected to cost $30 million to $50 million over the next three to five years. As part of continuing fallout from the 9/11 terrorist attacks, property and liability insurance premiums will rise by $800,000 this year. A hike in sewer rates by the city of South Bend promises to add an immediate $500,000 a year to utility bills.

To cope with the situation, the University’s 57-member Board of Trustees in February approved a budget calling for, among other measures, moderate belt-tightening across the campus and a 6.5 percent increase in tuition and room and board. No layoffs are planned, but many departments with open positions will hold off filling them for at least a year.

Construction continues at the south end of campus on the mostly paid-for $63.6 million Marie P. DeBartolo Center for the Performing Arts; the building is expected be finished in spring 2004. But last fall administrators put the brakes on an elegant new post office and police station building begun near Stepan Center. That facility won’t be completed until more donations are secured. Several other building projects previously given at least a tentative green light—including a new campus hotel, an addition to the law school and a new facility for the engineering college—also have been put on hold indefinitely.

“We are not in a sense of crisis,” Father Edward Malloy, CSC, University president, said in his annual address to the faculty last October. “Indebtedness from our recent past is not driving this. We are financially sound. However, we are not immune from the financial pressures that the rest of higher education faces.”

Indeed Notre Dame is no worse off than most colleges and is in an enviable position compared with many.

“Loyola’s endowment plunges,” shouted Chicago newspaper headlines in January about a 30 percent drop in the value of Loyola University’s endowment for the year ended last June 30. In dollar terms, the Catholic university’s investment fund plummeted in the one year from $283 million to $198 million.

A survey sponsored by the National Association of College and University Business Officers last year found that the average endowment lost 6 percent during the fiscal year ended last June 30. That came on top of an average 3.6 percent drop the previous year. The consecutive negative returns were the first since the association began its survey in 1971. But that news hardly was noticed on Wall Street, which last year witnessed the third straight down year for U.S. stocks, something that hadn’t happened since 1939 through 1941.

“This is probably the most difficult period universities have ever had,” Louis R. Morrell, chief financial officer of Wake Forest University and a member of the business officers association’s Endowment Advisory Panel, told The Chronicle of Higher Education in January. During the two years ended last June 30, when Notre Dame’s endowment fell 15.8 percent, Wake Forest’s investments declined 24 percent.

In another blow believed connected to the staggering economy, donations to all of higher education declined last year for the first time since 1975.

That one-two punch of less gift income and lost investment income has had serious repercussions on campuses, especially at smaller institutions. Notre Dame’s Mennonite neighbor, private Goshen College, in Goshen, Indiana, announced in January that it planned to cut the equivalent of 17 full-time administrators and staff members and 10 faculty positions in response to budget deficits. The college enrolls about a thousand students.

Looking at the elite private universities to which Notre Dame sometimes compares itself, Father Malloy noted in his talk to faculty that Cornell had instituted a hiring freeze on all non-student, non-faculty positions. The Kennedy School at Harvard had cut 30 percent of its adjunct faculty and 11 percent of its administrative staff, and had closed an office in Washington, D.C. Stanford had cut its budget 5 percent and was proposing a 3 percent cut for next year.

“You think of Harvard and Stanford as preeminent in institutional wealth,” Malloy said. “When they make these moves we have to recognize that no one is immune.”

For that reason it probably will surprise many to read that Notre Dame’s $630 million budget this year will actually increase slightly next year. Part of that is due to inflationary pressures and unavoidable expenditures like the hike in sewer rates and interest due on bonds. But new money has been set aside for initiatives that include a plan to hire more fund-raisers (who, over the long term, of course, will be expected to bring in more gift money than they cost in salaries and benefits). The trustees also allocated 1.5 percent to departments for merit pay raises. Supervisors will decide who gets how much.

On the revenue side, the budget calls on such operations as catering, athletics and the bookstore to do more to underwrite the University’s educational mission. These auxiliary enterprises will be asked to increase net revenues by 15 percent or $4 million next year.

Various cost-saving measures include a new contract that throws all of the University’s overnight-mail business to two carriers (Airborne for domestic, DHL for international) for a projected savings of $140,000 next year. Under another deal the University will procure all of its office supplies from one supplier, Office Depot. Expected savings: $71,000 annually.

Adding and subtracting this way means Notre Dame won’t have to raid the endowment while the markets are down. Actually, raiding isn’t much of an option because close to 90 percent of the endowment’s funds are restricted. That means they may be spent only on specific needs like scholarships or the salaries of faculty holding endowed chairs.

The budget-cutting spares the University’s core academic and student life programs and financial aid, notes John A. Sejdinaj, vice president for finance. Thanks to the investing and fund-raising successes of the last decade, Notre Dame’s scholarship aid has grown at an average rate of nearly 20 percent a year since 1997, a period when tuition and fees were rising an average of 5.4 percent annually. As a result, the out-of-pocket cost (tuition minus scholarships) for the average Notre Dame student has remained virtually the same over the seven-year period at about $11,500 a year.

Notre Dame is rated the 14th best value in higher education this year by_ U.S. News & World Report_ magazine. The rankings attempt to relate “academic quality”—determined by a school’s position in the magazine’s overall rankings (ND tied for 18th this year)—to net cost of attendance for a student receiving the average level of financial aid.

Labeling Notre Dame a bargain with its price tag now exceeding $30,000 a year may stretch credulity for some, but the University looks more than competitive by comparison to other institutions of higher education. According to one survey, 79 private colleges and universities are more expensive to attend this year than Notre Dame. That list includes predictable names like Harvard and Yale but also Syracuse University, the University of Miami, Lafayette College and six Catholic schools: Georgetown, Boston College, Villanova, Holy Cross, Santa Clara and Loyola College in Maryland.

Also, the 6.5 percent hike in tuition and room and board boosts Notre Dame’s price tag to a once-unthinkable $34,100 a year before financial aid. But that amount is only $382 higher than it would have been had the average 5 percent annual increases of recent years continued.

If the University has found a navigable course through choppy economic waters, administrators are also hopeful of smoother sailing ahead. Lou Nanni, who last summer became vice president of University relations, the division that includes fund-raising, says gift dollars have yet to rebound from last year’s 10 percent drop. “In the short term, we’re not growing the way we want to grow or we expect to grow.” But the number of gifts is up, as is the percentage of alumni giving.

“Normally we get 50,000 to 55,000 donations a year. That number is up about 2,500,” Nanni said in early February. “The alumni participation last year was about 49 percent. This year it’s in the low 50s.”

Nanni gives at least some of the credit to new football coach Tyrone Willingham, who, he says, “not only restored respectability to the football program but spoke to the values of the institution.”

Meanwhile, in their offices on the ninth floor of Grace Hall, the University’s investment specialists aren’t exactly celebrating the endowment’s negative returns of the past two fiscal years, which could well extend to a third year. But they keep things in perspective. Looking back at the late ‘90s, when the fund was growing by an average of nearly 30 percent a year, the “quarterback” of the Wall Street Journal article’s headline, Chief Investment Officer Scott Malpass, says, “We all knew there’d be a haircut. We all knew those returns were unsustainable and unrealistic and we would be giving some of it back at some point.”

Malpass and his team of investment-sector specialists can take solace in how their performance stacks up long term and against peers. For the three calendar years ended December 31, 2002, for instance, the investment pool returned a cumulative 0 percent. That’s reason to celebrate because during the same period the Standard & Poor’s 500 index fell 38 percent.

Over the last three fiscal years—July to July— Notre Dame’s endowment returns average out to 10 percent a year. During the same period the median yearly return for hundreds of college and university endowments tracked by a consultant was 2.1 percent. And among all endowments, college or otherwise, worth $1 billion or more, Notre Dame’s performance ranks in the top 1 percent for 5-, 10- and 15-year average annual returns. Looking at the past three fiscal years, two of which were negative, it still ranks in the top 10 percent, Malpass says.

The Board of Trustees measures the Investment Office’s performance against a collection of indices that mirror the sectors in which the endowment and other funds are invested. From 2000 through 2002, when the investment pool ended up making nothing, the comparative benchmark lost 14 percent.

Critics point out that some endowments, like New York University’s, have actually made money during the bear market. But most of those funds are heavily weighted in bonds, Malpass says. As such they have eked out steady profits for decades but lost out on the truckloads of gains to be had during the bull market. Most of that bonanza remains in Notre Dame’s coffers.

Malpass says he’s pleased the trustees continue to endorse the Investment Office’s strategy of diversification and measured risk-taking, the approach that fueled the championship returns of the late 1990s. “Stay the course” is his mantra.

Even if the markets don’t rebound this year, administrators have reason to be optimistic. Applications for admission this year smashed the previous record, set in 2000, by 19 percent. More than 12,000 students applied for roughly 2,000 spots in next fall’s freshman class.

The University also is fortunate in that it relies on investment earnings to fund only about 13 percent of its core educational enterprises. At some schools the figure is close to 40 percent, according to reports.

For those institutions the market collapse of the past few years and drop in charitable giving has necessitated drastic measures. For the moment at least Notre Dame doesn’t appear to be suffering any serious bald patches from its haircut.


Ed Cohen is an associate editor of this magazine.