University of Michigan Endowment Q&A
U-M endowment supports future academic excellence
The University of Michigan’s endowment creates a predictable revenue stream to support the University’s academic and other programs and needs. Endowment funds are invested for the long term, and the earnings from those investments are used to sustain the University’s academic excellence by supporting outstanding faculty, innovative programs and student scholarships. Below are answers to some frequently asked questions about the U-M’s endowment funds.
Q. What are endowment funds?
A. The University’s permanent endowment funds are received from donors with the stipulation that the principal remain untouched, and that it be invested in perpetuity to produce income to support the purposes specified by the donors.
The University’s endowment is essential to sustaining our academic quality because it provides a guaranteed source of income in perpetuity to support professorships, student scholarships, and innovative programs and learning opportunities. Donors who make endowment contributions do so because they want to support our programs in perpetuity, having a positive impact on U-M students and academic programs whether 25, 50 or 100 years from now.
Q. How large is Michigan’s endowment?
A. The total endowment has grown substantially over the last decade, from $1.6 billion in 1996 to $7.1 billion at June 30, 2007, based on a one-year return of 25.6 percent. These figures represent endowment funds for all three campuses of the University. The University has realized meaningful growth in its endowment primarily as a result of generous donations and strong investment performance.
Q. How important is the University’s endowment to its overall budget?
A. For fiscal year 2007, the University’s endowment spending rule allowed for distributions to support operations of approximately $300.2 million, which represents approximately 7 percent of the University’s revenues for operating activities.
Q. How does Michigan’s endowment compare with the endowments of peers?
A. U-M’s endowment is the 9th largest in the country and the 3rd largest among public according to data compiled by the National Association of College and University Business Officers.
Q. How does stock market volatility affect the endowment?
A. The University manages stock market volatility by maintaining a diversified portfolio, which includes stocks, bonds, absolute return, real estate, venture capital and other investments.
In addition, our endowment distribution policy insulates the University’s budget from short-term fluctuations in the financial markets by using a spending rate formula. The University’s endowment spending rule smoothes the impact of volatile capital markets by providing for annual distributions of 5 percent of the average seven -year market value of endowment shares, up to a maximum of 5.3 percent of the current value of endowment shares. This will improve the University’s ability to budget and plan for its revenue streams.
Q. Since U-M has a relatively large endowment, why doesn’t the University use the endowment to replace the millions of dollars in state funds that have been lost during the recent budget difficulties?
A. The endowment provides a margin of excellence for the University, but it does not replace the unrestricted funds coming from state appropriations and student tuition dollars. The use of endowment funds usually is restricted by the donor—such funds can only be used for the specific purpose for which the endowment was established. The endowment is actually made up of more than 5,100 separate accounts, each of which is designated for a specific use. Endowment earnings normally are not available to support general operating expenses.
Q. Why don’t you increase the rate of spending from endowment earnings during years when state funding is cut?
A. Although the endowment spending rate has not been increased in recent years, the distributed amounts available to University units have increased significantly as the market value of the endowment has grown through positive investment returns. The effect of that growth is to increase the dollar amount of earnings available to University units to support their academic programs.
Our endowment spending rate is based upon the historic track records of the capital markets and inflation. It is designed to support operations in a way that strikes a balance between generating a predictable stream of annual support for current needs and preserving the purchasing power of the endowment funds for future periods.
It is essential to protect and grow the value of our endowment for the future, because it is an investment in the long-term quality and health of this university. Our students, our alumni and the people of Michigan would be poorly served if we did not act as responsible stewards of this tremendous asset.
Q. If you can earn more than 25 percent on your endowment, why are you spending 5 percent (or less)?
A. This year’s 25.6 percent earnings are exceptional. Our annualized return over the last 10 years was 14 percent (still in the top quartile of all endowments as reported by Cambridge Associates) and we are anticipating somewhat lower returns going forward. It’s also important to realize that in 2001 and 2002 the rates of return were negative (– 4.4 percent and –5.5 percent, respectively) and a positive payout of about 5 percent of the market value of the endowment was nevertheless available.
The earnings from invested funds are used for two purposes: a portion is spent (5 percent of the average market value), and anything above that amount is added back to the invested principal in order to preserve the fund’s long-term purchasing power against normal inflation and volatility in capital markets. For example, an endowed professorship established in 1987 with $2 million would have to be worth $3.64 million today to be equivalent. Reinvesting a portion of the earnings helps make such growth possible, and ensures that we can meet ongoing needs reliably in perpetuity.
Q. Why don’t you use more of your $7.1 billion endowment to reduce tuition?
A. The majority of the payout from the 6,200 separate funds in our endowment is restricted to specific uses by donors, and it helps us serve a very broad population. About $2 billion (or 28 percent) of our $7.1 billion endowment is restricted for use by our health system, for example, which serves the needs of more than 1.6 million patients a year. The portion available for university operations supports the education of over 40,000 students.
About $1.4 billion in funds (or 20 percent of the total) are restricted to direct student financial aid. Other endowed funds have an indirect effect on tuition as well. The income from another $4 billion in endowed funds is used to pay for faculty, academic support, research and building maintenance, so that tuition increases are not required to cover the full cost of faculty salary increases, for example.
Q. Why does University of Michigan tuition go up each year?
A. The single biggest reason for recent increases in tuition has been the sharp cuts in state funding (13% of base funding cut from fiscal 2003 to fiscal 2006, or nearly $54 million). Our tuition increases also are driven by increases in costs such as energy and employee health benefits, and partly by the need to innovate and produce high-quality instruction and cutting-edge research.
Even with these pressures, the average rate of growth in our tuition over the past five years has been the lowest among public universities in Michigan and in the Big Ten. This has been achieved in part because we have other financial resources that can help reduce the burden on tuition, including distributions from the endowment. We have also taken extraordinary measures in cost-cutting.
Q. What are you doing to contain costs?
A. Controlling costs is a top priority at U-M. The Ann Arbor campus has trimmed more than $117 million from its annual operating costs in the last five years, and we continue working to control health care costs, boost energy efficiency, make optimal use of existing space, and eliminate non-core activities.
Q. U-M is currently in the midst of a major fundraising campaign that has raised $2.8 billion—how will that benefit students?
A. Funds contributed by donors are usually designated for specific purposes, and are not available to support the general operating costs of the University. Students benefit directly from our fundraising campaign in two ways. First, the funds raised will go to support our academic programs, our faculty and our students, thus ensuring the long term quality of our instruction.
Second, financial aid has been a major focus of the campaign. Over $442 million in new funds have been earmarked for student financial aid. Since the start of the campaign, new gifts and investment earnings together have increased the total endowment available for student financial aid by 90 percent, to $1.4 billion. We are also strengthening our outreach to alums to generate further support for this area.
Q. Why does going to the University of Michigan cost so much?
A. There is generally a significant difference between the “sticker price” and what people actually pay out of their own pockets after receiving various forms of financial aid. Full tuition in 2007–2008—the“sticker price”—for a Michigan resident is $10,756 per year, and for a non-resident it is $30,502. Financial aid in effect discounts tuition to many people based on what they can afford. Nearly 80 percent of undergraduate students who are Michigan residents receive some form of institutional financial aid (including grants, work-study, and loans). They receive an average of $10,330 a year, an amount equal to 96 percent of resident tuition and required fees. Ranked among the nation’s top universities, U-M is a bargain for Michigan residents even at full price, compared to others of similar rank.
Q. Why is tuition increasing faster than the cost of living?
A. There are two interrelated issues here: operating costs and tuition rate-setting.
Overall operating costs are driven by the fact that education as an industry is both labor-intensive and capital-intensive. Sixty-five percent of the University’s total costs are for labor, and Michigan is in a competitive salary environment, particularly for faculty. Health benefits have soared at a rate three times faster than general inflation, and utility costs have doubled over the last ten years. In addition, state-of-the-art laboratory facilities in a wide range of technologies are needed to support education and research in emerging fields.
Tuition rates are set as part of the University’s annual budgeting process, taking into account all the needs the University must meet to fulfill its mission, including the commitment to serve the public interest by keeping tuition rates appropriate and reasonable. Tuition is just one source of revenue for the University, together with state appropriations, gifts, investment earnings, and indirect cost recovery on research contracts. In the last six years, our state appropriation has declined by 11 percent—a $40 million drop. If the appropriation had grown at the rate of inflation over the same time period, the University would be receiving $100 million more in annual support.
It is important to note that U-M has been able to increase spending on centrally awarded undergraduate financial aid by an average of 6.6 percent per year over the last 10 years, while holding tuition and fees to an average increase of 6 percent per year over the same period.
Q. Are University of Michigan employees paid too much?
A. U-M’s standards for teaching, research, and administrative performance are among the highest in the nation, and competition for top talent is strong. At all levels, we work to ensure that our salaries are competitive in the marketplace. The real question is whether the highly paid people here are contributing value beyond what they cost. A scientist’s skill and reputation can attract six- and seven-figure research contracts that help pay for facility and administration costs. And at the same time, an effective fundraising operation can raise many, many times more than it costs each year.
U-M is a $4.5 billion enterprise in terms of annual income and expense—an amount roughly comparable to the gross revenues of a small Fortune 500 company. It takes top talent to manage the exceptional scope and complexity of a major research university.
Updated 4/15/08