The Chronicle: Colloquy Live Transcript

The Financial Outlook for Higher Education in 2004

Thursday, December 18, at 1 p.m., U.S. Eastern time

How will colleges and universities negotiate a rocky business landscape in the coming year?

Higher-education balance sheets have deteriorated in recent years, and few observers are predicting a significant recovery in the next 12 months. Revenues from fund raising, endowments, state appropriations, and federal grants are likely to decline, stay flat, or improve only slightly next year. On the cost side, institutions are under pressure to build new facilities, and to keep up with rising costs for insurance, employees' health care, and computer security, among other expenses. To make ends meet, some institutions have trimmed staff, raised tuition and fees, and limited enrollments and academic offerings. What is the outlook for 2004 for fund raising, endowments, and other business issues in higher education?

» The Big Squeeze (12/19/2003)

John A. Palmucci is chief financial officer and treasurer of Loyola College in Maryland. A longtime member of the National Association of College and University Business Officers, Mr. Palmucci was one of two recipients of the 2003 Nacubo Distinguished Business Officer Award, the association's highest honor.

John Griswold is executive director of the Commonfund Institute, the educational arm of Commonfund, which manages endowments of higher-education institutions and other nonprofit organizations.

Vance T. Peterson is president of the Council for Advancement and Support of Education. CASE supports the work of alumni-relations, communications, and fund-raising professionals at more than 2,900 schools, colleges, universities, and related organizations in 45 countries.

They will respond to questions and comments about these issues on Thursday, December 18, at 1 p.m., U.S. Eastern time. Readers are welcome to post questions and comments now.

A transcript of the chat follows.

John L. Pulley (Moderator):
Hello, and welcome to The Chronicle's live colloquy on the business outlook for higher education in the coming year. Thanks to our guests, John Griswold, John Palmucci, and Vance Peterson, for joining us today.

I'm John Pulley, an editor here, and I'll be moderating today's chat. Readers, we look forward to your comments and questions.

Okay, let's get started.

John Griswold:
This is John Griswold, executive director of Commonfund Institute. I'm a glad to be here today and anxious to answer your questions if you have any. We look forward to beginning our dialog.

Question from John L. Pulley:
What will the endowment-management landscape look like in the coming year?

John Griswold:
Following what looks like a very good calendar year for stocks and a satisfactory year for bonds, next year's return environment looks like it may be less satisfying, which will pose some further challenges to endowment managers. We are predicting a mid-to high single digit return for stocks for the next few years, as the stock market appears fully valued on most measures. Sector and stock picking will be the key to adding excess return over the indexes, so choosing managers wisely will be at a premium. Interest rates will most likely rise as the governement deals with the twin deficits (federal budget and foreign trade), and in that environment it will be difficult to make more than the coupon on high grade bonds. Alternatives will provide good diversifaction and many strategies should provide returns in the low-to-mid teens, but again selection of the right strategies and managers is key to realizing them. Private capital investments (venture capital, private equity and natural resources) should be returning to their traditional return ranges as the economy improves, but the quality of the managers will continue to be the most important determinant of return. Private real estate is also an area of opportunity as long as an investor is selective both geographically and in the type of property selected.

Problems will continue as far as spending is concerned. We saw an average 3.1% return for the 657 institutions in our most recent Commonfund Benchmarks Study, which covers the fiscal year ending June 30, 2003. Many institutions have cut budgets due to the lingering effects of the three-year bear market, and unless they end the current fical year with much higher returns than last year, they will have to go through another round of cuts unless they reduce their spending rate. Many schools are doing just that, studying the various alternative policies and calculating the effects of low-to-mid single digit returns on their endowments going forward. Many are also looking at increasing their allocations to alternatives, especially hedge funds and enhanced index strategies, which many of the largest endowments have used successfully for many years. The problem for those entering the alternatives arena for the first time is one of management: does the institution have sufficient re! sources, both human and financial, to conduct proper due diligence, monitoring, and risk management. For example, there are over 6000 hedge funds, and choosing the right ones and enough of them to achieve adequate diversification can be a daunting task even for experienced investors.

All in all, we are collectively in better shape than we were a year ago due to the rebound in the equity markets, but we are a long way from being comfortable.

Question from John L. Pulley:
What is the outlook for higher-education fund raising in the coming year?

Vance T. Peterson:
I would say that, while some dark clouds may remain for some institutions in certain regions of the country for a while longer, on the whole the outlook is much brighter for higher-education fund raising than it has been for the past couple of years. While annual giving held up reasonably well for most institutions during the recent slowdown, the 1.2 percent decline we experienced in overall giving in FY2002, as well as the anecdotal evidence from individual campuses, would suggest that major giving was quite soft everywhere. My current sense, however, is that major-donor confidence is returning with the recovery of the stock market and other leading indicators, and this should translate readily into larger numbers of new and increased gifts in the coming year. Also, if historic patterns hold true once again, we can expect good things in 2004. For example, following a three-year downturn in giving to education during the mid-1970's, during a much deeper recession and stock-market decline than we experienced recently, support for higher education increased by double-digit percentages during five of the next six years. -- I have often felt that one of the best times for institutions to launch new campaigns, or new major-giving programs for that matter, is in the early recovery phases following an economic downturn. This is often the time when institutions will find the best receptivity among donors and the strongest updrafts for nascent programs looking to capitalize on renewed optimism about the future.

Question from John L. Pulley:
Could you provide an overview of the major business challenges facing institutions of higher educatin in 2004?

John A. Palmucci:
The special section of The Chronicle dated December 19 does an excellent job of answering this question.
Limited Debt Capacity and a decline in credit ratings
Limited Federal and State support
Delays in gift giving for current pledges as well as a reluctance to make new committments
Higher costs associated with operations such as utilities and contract services
Personnel costs associated with benefits
Concerns over price that affects the revenue stream
Facility cost for impovements and upkeep
are but a few of the challenges.
At the same time, student populations continue to grow, they are better prepared and are making more demands of us both in and out of the classroom. The real issue will become "How do we meet the needs of the new student without additional revenue as expenses increase above the level of tuition increases.

Question from John L. Pulley:
Some financial experts have said that a projected intergenerational transfer of wealth will be a boon to higher education. When will institutions see tangible benefits?

Vance T. Peterson:
I think we have to be a little careful about describing the intergenerational transfer of wealth already underway as an outright financial "boon" for higher education. Estimates of the transfer over the 55-year period from 1998 to 2052 range between $41 and $136 trillion (Schervish and Havens). The potential for some of this wealth to be contributed, either outright or through bequests and deferred-gift plans is high. The 55-year estimate for bequests to charitable causes ranges between $6 and $25 trillion. How much of this will come to higher education, and when, is dependent upon several complex factors, including social attitudes about the role and impact of higher education, the ability of institutions to make the case for support, and the levels of investment made by individual institutions in major and planned giving staff to do the work required. If we look at estimates for bequests alone, which logically would factor significantly into inter-generational movement of wealth to charitable causes, the Schervish and Havens estimates are that between $6 and $25 trillion will be contributed by bequest during the 55-year period. If higher education receives a proportional share of this amount in relation to its historic percentage of total annual philanthropic support, then somewhere between $589 billion and $2.45 trillion could be expected to come to higher education over the 55-year span. Exactly when that support would come in is anybody's guess. On an annualized basis, the amount that higher education could potentially realize through bequests would be in the range of $10.7 to $44.6 billion. That's obviously a lot of money, but spread over many institutions, the numbers aren't as large as they may at first seem. Assuming that additional sums will find their way into planned-gift arrangements and even outright commitments, the picture for continued increasing support of higher education is bright. My best guess is that we will see a continued steady rise in philanthropic support for our institutions, but that huge periodic windfalls affecting the entire sector, emanating from the intergenerational wealth transfer phenomenon will be more of a distant hope than a reality for most institutions.

Question from Barb, state governing board:
How can public/state universities better demonstrate to elected officials and other citizens their value -- that they are worthy of public investment?

John A. Palmucci:
The real issue is the competition for limited state funds. Elected officials are reacting to increases in tution for public universities and perhaps the strategy is to convince them that the operations are efficient as a result of cost savings etc and that the increases can be avoided by additional investments in the educational enterprise. A survey of what the graduates are doing in the local economy has also been an effective tool.

Question from John L. Pulley:
In terms of asset allocation, what changes do you foresee institutions making in the coming year?

John Griswold:
Following up on the answer I gave earlier, the topline findings of the 2004 Commonfund Benchmarks Study suggest that we will see a continuing move toward alternative strategies. These include venture capital, private equity, natural resources, hedge funds, private real estate, public real estate, distress debt, and others. Given the likelihood of a rise in interest rates due to the growth in the economy, we anticipate a decline in allocations to fixed income, since investors in that asset class can expect to make no more than the coupon on bonds and may suffer losses on longer duration securities. The allocation to equities will probably remain stable or increase slightly as investors act on their optimism that we have seen during this calendar year and continue to diversify their equity holdings between various cap sizes domestically and among EAFE and emerging markets internationally.

Question from Katharine Watts, Shepley Bulfinch Richardson and Abbott, architecture firm:
What will the impact of this business climate be on new construction on campuses? What kinds of buildings will be constructed, what will go on hold? Is this a regional phenomenon? Will the recent trend to "signature architecture" on college campuses fade with the current tight fiscal situations at colleges and universities?

John A. Palmucci:
I think the major shift will be away from the facilities that are not essential to the educational delivery system such as classrooms and technology. The focus over the past several years has been on recreational and sports facilities. We probably have reached our limit on residential facilities as well. The impact is felt as a result of lower endowment values, debt capacity and certainly gift giving to support the facilities. I agree that signature architecture on many campuses will fade or be put on hold until the financial situation is more certain.

Question from John L. Pulley:
Vance, what are expectations for corporate giving and foundation grants in 2004?

Vance T. Peterson:
With the rapid recovery of corporate earnings we have seen in the past few months, I believe we will see some expansion in corporate giving. We at CASE continue to see strong interest in preserving or extending corporate matching gift programs, along with some creative new approaches by companies interested in focusing their approaches on specific corporate goals. On the foundation side, most continued to honor previous commitments even when investment earnings dropped off the table for a while, so I would expect foundation giving to recover somewhat more slowly. On the whole, however, I would say that increases in individual giving will lead the way next year.

Question from Heather Webster, U. of Rhode Island:
What are some differences between public and private with respect to financing?

John A. Palmucci:
Depending on the state that you are in, the old story about being state supported in the 70's, state assisted in the 80's and state located in the 90's may be the answer to your question. Certainly the main difference is the level os state support granted to the public universities. That has been on the decline so many have increased tuition or fees to make up the difference. On the private side, the revenues are derived from tution, gifts and endowment. Tutions make up on average according to recent ratios approximately 72 percent of the revenue and the rest is from gifts and endowment. Since the publics have not had the time or need to build gift giving or endowments, this represents considerably less of their revenue.

Question from Heather Webster, University of Rhode Island:
What does this rocky business landscape mean for consumers of higher education (Students, parents, employers)? How (or should) is public higher education going to address these financial issues while remaining true to their original mission?

John A. Palmucci:
I think you are correct, the landscape will be very rocky. I believe on the private university side, there will continue to be real competition for both quality as well as quantity of students with enough diversity to accomodate students who are inclined to enroll. On the public side the issue is somewhat different because decreases in state support means either a curtailment of enrollments without effecting quality or an increase in price which effects access which most have as a mission. The problem continues to be to find ways to work with the legislature to convince them to fund at appropriate levels in times of tight fiscal constraints. Not easy since education has been the historical "easy" target for state budget cuts. They have been viewed as the most flexible.

Question from Bruce Rollier, University of Baltimore:
Will there be a trend toward cooperative ventures and strategic alliances among universities as has happened in other industries, for sharing of resources? This seems particularly appropriate for online programs, and may lead to a need for standardization.

John A. Palmucci:
I see evidence that the trend is becoming more widespread among colleges and universities. In fact there is a in Section of Title I which addresses college costs a proposal to authorize competitive grants to consortia that engage in cost reduction efforts. Of course there are some hooks such as agreeing not to raise tuition more than twice the rate of inflation during the life of the grant as well as to agree to pass on a least 50 percent of the savings to students. We see more and more of the sharing of recources and joining together for pricing as well as quality standards.

Question from John L. Pulley:
Amid several years of poor investment returns, endowment-spending formulas have failed to prevent drastic fluctuations in the size of annual payouts to institutional budgets. Will colleges and universities change the "smoothing" formulas they have been using and, if so, what will replace them?

John Griswold:
Commonfund Institute issued a white paper on this very subject in March and has updated it this month. To summarize the thesis of the white paper, most institutions are using a "5 percent of a three-year moving average" spending formula. During the bear market of the last three years, this formula proved to be inadequate to prevent a sharp downturn in spending this past year, which of course hurt many operating budgets. Our analysis of the spending formula based on a proprietary asset allocation modeling tool reveals that most schools using this popular formula would be better served by using a target spending percentage (4 or 5 percent) which is then inflated annually by CPI or even HEPI. The basic problem with the popular formula is that it ties spending to asset values, which are subject to market volatility. In the bull market of the 90s, this formula produced overspending as it reflected the rapid increase in the market values of endowments. We feel our proposed formula, particularly the use of CPI, will provide a more consistent and predictable stream of withdrawals from the endowment to the operating budget, and would be better at preventing the kind of crises now being experienced by many institutions facing a spending shortfall.

Copies of the white paper can be obtained from Commonfund Institute through our Web site at http://www.commonfund.org

Question from Eric Woodworth, DSM Capital:
Hi, I was wondering if you think schools have made/will make fundamental changes to their operating structures due to the budget woes to reduce costs and improve efficiency, or if they will simply try to get by until the money starts flowing again and revert to their old ways. Thanks.

Vance T. Peterson:
Great question! I think a lot of people are beginning to think there may be some structural limits to what consumers of higher education can afford, or states would be willing to pay for. So, I think there may be some significant limitations coming (and perhaps are already here) on the revenue side. The effect on the cost side will inevitably have to be a change in approach, involving new structures and greater operating efficiencies since fund raising, no matter how successful, simply can't make up the difference. -- The really intractable problem, as I see it, is how institutions with missions involving small faculty-student ratios and vast underutilization of facilities and equipment will be able to make it in the long run. The answer may lie in the development of auxiliary academic and other enterprises that essentially pay for, and shield, the core teaching and learning enterprise that is by definition inefficient but absolutely essential to a quality learning experience. I don't think business as usual is going to be an option much longer, but my crystal ball is pretty fuzzy on how things may look in ten or twenty years.

Question from John Jobson, Michigan State University:
With limited debt capacity and falling state funds, what are the prospects for institutions to address issues such as deferred maintenance of aging academic buildings and remodeling student housing to remain competitive with off-campus options?

John A. Palmucci:
The first step in the process has to be a complete inventory of what the deferred maintenance issues are and what the remodeling needs are in both housing as well as academic facilities including the costs as well as the timeling. Next a priority of what is important for the institution in light of their mission and the competitive factors for attracting and retaining students. These costs are then to be evaluated in light of operating as well as capital funds. No question, the competition for funds within the university will be greater than ever before.

Question from Tom, Concordia University, St. Paul, MN:
In this interest rate environment, are institutions tending more toward issuing fixed rate debt than they have in previous years?

John Griswold:
I don't have a complete answer to this question, but our 2004 Benchmarks Study contained a question relating to it, which indicated that 82 percent of debt issued in the past year was fixed rate debt. This means that 18 percent was floating rate debt, which leaves one wondering if those institutions have protected themselves from a spike in interest rates by purchasing an interest rate cap or a swap. From what I have read in reports from Moody's and other rating services, debt has increased dramatically in the past several years, but institutions have certainly benefited from low interest rates and one hopes that even those with floating rate debt will be able to either pay it off or protect themselves in some other way before it becomes a burden on their budgets.

Question from Steve , Small Liberal Arts:
Clearly one of the largest cost components is personel. When things get tight in the private sector layoffs help. What impact do the continued difficult times have on tenure in your view.

John A. Palmucci:
In my view, it raises the discussion but most institutions do not view that as something they want to address in the long run. Layoffs are seen as an imediate solution and that those positions can be reinstated at a later date. Tenure is viewed as one of those items that will effect the institution forever in terms of attracting quality faculty.

Question from Steve , Small Liberal Arts:
As we look to the next few years do you agree that we have pretty much reached the limit in what we can charge...if that is the case... and we have cut about all we can cut...and investments are going to return single digits...it seems like a new financial model is required ...any ideas

John A. Palmucci:
I agree, most of us have reached the limits of tuition increases and will have to revisit strategies to work more efficiently and effectively. A new model that takes into account some of the constraints such as a lower level of endowment value which impacts the spending rate that supports your operations, increased cost for utilities since deregulation has hit many of us, increased costs for serivces such as software maintenance etc. as well as health care, building and technology equipment repairs and replacement will have to be carefully factored into the equation. The model has to be brutally honest, include all of the factors that are know and those that might come about. It should include many individuals from the campus depending on you governance structure so that everyone knows and understands the issues .

John Griswold: I agree also that a new model is needed. Since education is a labor intensive activity and has existed virtually unchanged for hundreds of years, perhaps it is time for cost structures to be objectively analysed, taking into account the enormous power of technology. I don't think Americans are ready to abandon the current model of group teaching in person and on campuses, but methods must be found to mitigate the human resource costs that have served to bring us to the point where we have had to raise tuition at a rate far above inflation for literally decades.

Question from Jeanne, private college:
How do you intend to address campus security and safety in light of tight budgets? So many colleges are spending on 'amenities' to attract students, yet our institutions are being subjected to increasing numbers of lawsuits pertaining to security and safety issues.

John A. Palmucci:
It appears from statistics from the last few years that increased amounts of investments in security and safety have been made by most institutions as a result of incidents on campus that have brought national exposure. I do not see any decrease in that investment, not just to avoid lawsuits, but because of the concern for the safety and security of our students as well as our staff. The lawsuits will continue as the expectations from our students regarding this issue become more important. Many institutions are very involved in training of Resident Life Directors and in turn students and others to prevent crime and to provide a more secure environment.

Question from Paul Jacobelli, technology vendor:
Can you comment on why schools are reluctant to outsource services such as technology or why they have yet to form shared services groups?

John A. Palmucci:
I have been involved in several discussions about this issue and the best I can observe is that they want control. They have time and sweat invested in the program and process they currentely operate. The reluctance to change to a new vendor causes severe heart burn. If the technology vendors such as yourself could ever agree on a commom platform, provide modules or add ons that could be attached to the common platform, perhaps we might see more of what you are suggesting. Since most of us provide delivery to students for their learning environment including e-mai, report writing as well as research and in some cases as a learning tool especially in the sciences and business this is a mission critical delivery concern. Following that, we need to meet the needs of faculty to support their classroom activities as well as their research and writing. On the administrative side, there is another whole ball of wax from admissions, registrar, billing and alumni. Not to mention all of the financial billing, payables and accounting. I was involved in a group who thought they might form a seperate entity that would serve educational that would become members of the group. Dead on arrival.

Question from Karen Billings, non-profit association:
What effects are the for-profit post-secondary schools having on the public and private colleges and universities?

Vance T. Peterson:
I think the for-profit sector is having a much greater impact on traditional institutions than many might wish to admit. We have already seen mainline institutions develop large distance learning programs in response to competition, and we are beginning to see more flexible scheduling, cohort grouping, better utilization of technology, and even some degree of price flexibility creeping into many traditional non-profit institutions. I personally think this is all to the good and may even be some early signs of some consolidation in approaches that will lead to greater overall efficiencies and value for our students.

Question from Eric Woodworth, DSM Capital:
Hi, I was wondering if you could comment on what usually takes the biggest hit in terms of % and/or absolute dollars when schools are under budget duress? Is it maintenance, is it courses, is it athletics, etc.? Thanks.

John Griswold:
Our 2004 Benchmarks Study topline contained a new question regarding cuts to operating budgets this past year. It revealed that cuts were made fairly broadly to a number of areas, including academics, athletics, administration, buildings and maintenance, and even financial and investment staff. About 40 percent of institutions in the survey indicated they had not had to make cuts, and roughly two-thirds of respondents indicated that they did not anticipate making cuts in the next fiscal year. Please keep in mind that these responses were based on the last fiscal year ending June 30, 2003.

Question from Will Thorpe, The Mason Companies:
Are institutions effectively marketing their planned gift options to potential donors or could donor/potential donor education be improved across the country?

Vance T. Peterson:
I believe donor/prospective donor education could be greatly improved. So many people still don't have any idea about the benefits of various planned-gift options. Many CASE institutions work with local tax advisers and estate planners to make them more aware of the options, but I believe some sort of unified approach by several different professional groups might be worth exploring. Most major- gift fund raisers are engaged in teaching about philanthropy. Ideally, however, this could be done as part of a larger effort to develop greater social awareness and responsibility.

Question from James M. Devaney, PhD. Pres Amer Higher Educ Devel Corp:
It has always amazed me that the academic world has a problem using the theories of management and budget restrictions that they teach in their business classes; and not implementing in the college operations. It would benefit the coleges if they would 'practice what they preach'.

John A. Palmucci:
Very true. The reality is that those who are teaching are not the ones that are resonsible for managing. The real issue is that we manage the expense side of the ledger by cutting costs rather than improving productivity. That issue is a very important one and my feeling is that we do not address it because we are very reluctant to change our student faculty ratios. It seems that smaller classes is one of the benchmarks that is used by parents, students and the media to rate and rank us. I do think the colleges in general practice what they preach in the operational side of the industry.

John Griswold: I agree with John's answer. I would only add that colleges and universities particularly have made enormous strides in raising the productivity of their revenue-generation activities, including endowment management, fundraising, merchandising of athletics and brand names, and in many cases use of technology. The basic problem is that the model of the university on the academic side will not lend itself to productivity increases until there is a financial or political crisis that threatens the very existence of the model. These institutions, while receiving criticism due to enormous hikes in tuition, are still highly respected and even revered by thought and opinion leaders in this country, many of whom are graduates. I don't see this situation changing in the near future.

Vance T. Peterson:
Thanks for all the great questions, and for the opportunity to participate. It was a pleasure!

John Griswold:
I've enjoyed the dialog. Thanks very much.

John L. Pulley (Moderator):
Thanks to everyone for your comments. We're sorry if we didn't get to your question. And thanks to Mr. Griswold, Mr. Palmucci, and Mr. Peterson for joining us for our Colloquy Live. Happy holidays.

John A. Palmucci:
I hope it went well from your perspective. Enjoyed the experience.