STANFORD UNIVERSITY
OFFICE OF THE PRESIDENT

A Strong Endowment Ensures a Strong Stanford

1999 Stanford Annual Report Essay

If you plant for a year, grow rice.

If you plant for a decade, grow trees.

If you plant for a century, grow educated men and women.

—Chinese proverb

Stanford University is a wondrously varied institution—rich in talent and educational opportunities; rich in research and scholarship; rich in athletic challenges and artistic creativity; rich in loyalty of alumni and friends; and rich in past and present contributions to California, the nation, and the world. In addition to unmatched intellectual and academic resources, Stanford is fortunate to have one of the largest financial endowments among U. S. institutions of higher education.

As of August 31, 1999, the value of the endowment was $6.2 billion, an impressive sum even by the standards of today's strong economy. To some, this suggests that Stanford is also rich financially, and on the basis of endowment value alone, that would seem a reasonable conclusion.

Yet as Stanford's president for almost eight years, I know this conclusion is misleading. Every year the University faces increasingly severe budget pressures due to one basic fact—despite appearances, Stanford is actually underfunded from an endowment perspective. Stanford's endowment, while clearly large, is less than half that of Harvard, and approximately three-quarters that of Yale or Princeton. This disparity affects both our current allocation of resources and Stanford's future opportunities. As I prepare to leave this office and return to teaching, I can think of no more important financial issue before us than to communicate clearly to Stanford alumni, friends, donors, parents, and other supporters why we need to be concerned about the size of the endowment.

We must increase the size of the University's endowment for five critical reasons:

1. To maintain access to Stanford for the most talented undergraduates. Stanford is one of only a few private American colleges and universities that admit students without regard to their ability to pay, and then makes it possible for them to attend through generous financial aid programs. In the 1998-99 academic year, approximately 70% of Stanford undergraduates received some form of financial aid from a variety of internal and external sources. Stanford provided scholarship aid totaling approximately $47.3 million. Of that amount, about $34.9 million came from Stanford restricted sources, including endowment income or other donations (such as The Stanford Fund), and an additional $12.4 million came from general funds. The latter amount strains the University budget because general funds must support most day-to-day operating expenses, from faculty and staff salaries to utilities and insurance. In order to continue our commitment to need-blind admissions, Stanford must be able to support a greater percentage of scholarship aid with endowment income.
   
   
2. To ensure that recent improvements to undergraduate education at Stanford become permanent. Enhancements to the undergraduate program, described in "Investing in Undergraduate Education," have initially relied on general funds and one-time gifts for startup resources. Between 1994 and 2000, the budget for undergraduate education initiatives grew from $4 million to $14 million, with $6 million coming from general funds. Although these funds are an appropriate source of seed money for academic innovation, in order for such programs to become permanent, income from endowment gifts designated for support of undergraduate education must take over so that seed money can be available for other initiatives. The work of the University is work that cannot be done unless it is continuously reconsidered. Programmatic renewal and innovation are the lifeblood of the institution, but neither is possible without sustained support from endowment funding.
   
   
3. To continue attracting the highest caliber faculty and graduate students. Soaring rental rates and home prices in the local real estate market are threatening the University's ability to recruit and retain outstanding faculty and students. The area surrounding the University is among the most expensive residential real estate markets in the country, where even the most modest home costs a least half a million dollars. Stanford has a long history of providing housing assistance for faculty to aid in recruitment and retention; however, in recent years, the University has had to increase its spending in this area significantly. Stanford's current balance of loans outstanding for housing assistance programs is $134.6 million, a figure that has more than doubled since 1992-93. And in fiscal year 1998-99, Stanford committed an additional $10 million to ensure that the high-caliber faculty on which the University depends would not be deterred from coming here, or from staying, by the high cost of housing.
   
   Graduate students, who more typically rent than own homes, are being squeezed by rising rental rates, which in Santa Clara County have climbed 38% in just the past three years. In the coming year, Stanford will use more than $3 million in general funds to subsidize 349 off-campus rental apartments for 609 graduate students to help address this problem, even as we work aggressively to increase the supply of graduate student housing on campus. To meet the financial challenges posed by these extraordinary costs, and still support the day-to-day expenses of the University, Stanford needs increased endowment income.
   
   
4. To reduce the University's reliance on federal funding. In 1997, Stanford launched an ambitious new program known as Stanford Graduate Fellowships, as described in "Investing in Graduate Education." Our goal is to raise $200 million in endowment funds for this initiative. The payout from these restricted funds will provide annual support for a minimum of 300 graduate students in the sciences and engineering when the program is fully implemented. While Stanford's overall revenue from government grants and contracts has grown over the past decade, individual grant renewal periods are often out of sync with University research programs or an individual student's doctoral pursuits. The endowment support we are seeking would equal roughly half our current federal funding for research assistantships, allowing the University to become much more self-reliant in this area.
   
   
5. To ensure that Stanford's contributions to the great stream of blessings that has flowed to society from research-intensive universities will continue. Universities promote the public welfare through the increase of knowledge. This understanding was inherent in Jane and Leland Stanford's founding gift, which established the endowment on which the University depends today and to which so many others have given over the years. While few of the University's supporters could have envisioned the extent to which students from Stanford, ideas from Stanford, and in many cases, breakthroughs from Stanford would shape the close of this century, all shared a deep commitment to supporting the continued search for knowledge that is our mission.
   

If we are to increase Stanford's endowment so that the search can continue, we have the responsibility and the challenge to explain in the clearest manner possible what role endowment plays in the complex financial life of the University. Below are answers to questions most often asked by alumni, students, donors, friends, and other supporters of Stanford:

What exactly is the endowment?

Stanford's endowment is an accumulation of primarily gift funds set aside and invested to support the University's teaching and research missions in perpetuity. The original endowment was created in 1885 by Leland and Jane Stanford. Over the last 115 years, thousands of other donors who have wanted to provide enduring support for the University have added their own gifts. Today the endowment is comprised of 5,600 individual principal funds, each with a designated purpose, linked to an additional 5,600 parallel funds that hold the income the principal funds generate. By law, most of the endowment funds are required to be invested in perpetuity; only the income and related gains may be used to support each gift's purpose.

Is Stanford's land part of the endowment?

Yes. The land Jane and Leland Stanford gave the University through their original donation is part of the endowment, with the restriction that it can never be sold. The Stanfords intended their property to provide an ongoing source of income to help support the institution. Because the land cannot be sold, the current value of the endowment does not reflect the present market value of comparable land without this restriction. It does, however, reflect the market value of certain properties that have been commercially developed to provide the type of support the Stanfords envisioned, such as the Stanford Shopping Center and Stanford Research Park.

What role does the endowment play in University financing?

Each year, the Board of Trustees approves a payout for the endowment. These funds, which flow to the budget from interest and gains on endowment principal, provide an essential source of income for Stanford. However, because Stanford's endowment is actually less than it should be for the size and scope of its academic and research programs, endowment income provided by the payout ranks only fourth among the University's principal sources of operating revenue, behind government grants and contracts, gifts and non-government grants, and student tuition and fees.

In fiscal year 1998-99, endowment income covered 16% of the University's total operating expenses. Approximately 75% of this amount was designated by donors for specific purposes, including student financial aid (22%) and teaching or research activities in Stanford's seven schools and related departments (53%). Only about 25% of endowment payout did not have a restricted purpose. These critical funds are the University's most flexible source of income to meet current day-to-day expenses, as well as to fund future initiatives.

How does Stanford manage its endowment?

Approximately $6.0 billion of the endowment is invested in shares of the Merged Endowment Pool (MEP), which operates similarly to a mutual fund. The remaining endowment is invested in specific assets, such as real estate and living trusts. Stanford Management Company (SMC) is responsible for managing the endowment on behalf of the University, including investing the funds in the MEP. The goals of SMC are to provide stable budgetary support and to preserve the long-term value of the endowment for future generations. SMC establishes a strategic asset allocation, manages the risk associated with investments, and identifies value-adding strategies.

How does market volatility affect Stanford financially?

The University takes a long-term view of managing its resources and employs specific measures to protect the budget from year-to-year extremes in the financial markets. First, we use a diversified approach in making MEP investments with the goal of managing risk even as we seek optimal returns. Second, we apply a “smoothing” formula to the endowment payout to buffer the annual budget from market volatility. In periods of unusually high returns, smoothing reduces the actual payout. In down markets, smoothing increases the actual payout, so that in either case, year-to-year fluctuations are minimized. However, smoothing cannot protect the institution from a prolonged market downturn, which over time, would create significant financial pressures. We have established a reserve to provide a prudent level of protection should this occur.

If the University needs more money, why not spend more of the endowment?

A university's endowment is not a checking account, but rather a trust fund. We, the current generation, are trustees for all future Stanford generations. Common sense and, in many cases, the law, do not allow us to spend the endowment's principal. And our duty to future generations does not allow us to spend even all of the interest, dividends, and capital gains; we must reinvest enough to ensure that the endowment is not eaten away by inflation.

Historically, financial markets have performed in cycles. In periods such as the present one, when the market is strong and endowment returns above average, it is easy to lose sight of the fact that positive returns are not guaranteed. Over the past 35 years, the real (i.e., inflation-adjusted) annual return on Stanford's endowment has averaged only 6.15%, a figure that compares very favorably with the returns of other university endowments but does not provide for substantial reinvestment relative to a payout rate in the range of 4 to 5%. A closer look at endowment returns from 1964 to 1982 reveals that the compounded real return on Stanford's endowment in this 18-year period was only about 1%, and in eight years, returns were actually negative. When that occurs (and the cyclical nature of the market indicates that it will occur again), it is vital to be able to draw upon previously reinvested gains to provide the current year's endowment payout.

Is Stanford using the financial gains from the recent strong market?

Yes. The percentage of the University's total expenses supported by endowment income has grown from 12% in 1996 to a budgeted 16% in 2000.

How does Stanford compare to other top universities from an endowment perspective?

According to figures published by the National Association of College and University Business Officers, in FY98, Stanford ranked 21^st in a comparison of endowment value per student at private U.S. colleges and universities. Princeton had the third-highest figure, while Harvard ranked fifth and Yale eleventh. Although Stanford has less endowment than its peers, we do more with what we have. Among the private universities with which we most compete, Stanford aspires to excellences across the widest spectrum of endeavor--arts, humanities, social sciences, and athletics; medicine, law, business, sciences, and engineering; and college, graduate, and professional teaching, learning, and research.

I believe one of the most important challenges the University faces at the close of the 20^th century is to address the imbalance between Stanford's endowment resources and the remarkable breadth of its academic and research programs. While the University's overall financial position is very strong, we cannot afford to overlook this critical financial imperative.

Also from the 1999 Stanford Annual Report:

Rebuilding Strength from Adversity, from Board of Trustees Chair Robert Bass

Investing in Undergraduate Education

Investing in Graduate Education

Return to the Speeches of President Gerhard Casper