University Endowments

University endowments are funds set up by gifts and donations, which are invested to earn returns that provide ongoing support to the university’s operating budget. The main objective is to balance the needs of the university today against its needs in the future.

UniversityAssets (US$ bn)
Harvard University34.5
Yale University25.4
University of Texas System24.2
Stanford University22.4
Princeton University22.2
Select US University Endowments

The stakeholders of a university endowment are current and future students, alumni who contribute gifts and donations, and university employees whose livelihoods depend on the university.

The need to maintain intergenerational equity and the unlimited life of the university mean endowments have a perpetual investment horizon.

The endowment’s liabilities are the future payouts promised to the university, presented in an official spending policy. The endowment’s spending policy should ensure intergenerational equity while smoothing payouts to insulate the university from market volatility.

To achieve this, the dollar amount of spending each year can be stated as a weighted average of the previous year’s spending (adjusted for inflation) and a spending rate (usually between 4% and 6%) applied to a moving average of assets under management (AUM). This can be formulated as:

  • spendingt+1 = w × [spendingt × (1 + inflation)] + {(1 − w) × (spending rate × average AUM)}


w = weight of the prior year’s spending amount

Three different types of spending policies result from different values of w:

  1. Constant Growth Rule: The endowment provides a fixed amount annually to the university, typically adjusted for inflation (the growth rate). The inflation rate is usually based on the Higher Education Price Index (HEPI) in the United States or a more general consumer price index elsewhere, possibly with an additional spread. A shortcoming of constant growth spending rules is that spending does not adjust based on the endowment’s value. If the endowment experiences weak average returns, the spending amount expressed as a percentage of assets may become very high. This spending rule is therefore commonly complemented with caps and floors, typically between 4% and 6% of average assets under management (AUM) over one or three years.
  2. Market Value Rule: The endowment pays a pre-specified percentage (the spending rate) of the moving average of asset values, typically between 4% and 6%. Asset values are usually smoothed using a 3- to 5-year moving average. A disadvantage of this spending rule is that it tends to be pro-cyclical; when markets have performed well, the overall payout increases .
  3. Hybrid Rule: Spending is calculated as a weighted average of the constant growth and market value rules. Commonly referred to as the Yale spending rule, weights can range from 30% to 70%. This spending rule was designed to strike a balance between the shortcomings of the respective spending rules.

Other liability-related factors that need to be considered are as follows:

  • Fundraising from donors. Gifts and donations coming into the endowment mean that the net spending rate is closer to 2% to 4% of assets rather than the 4% to 6% spending rate applied.
  • Reliance of the university on the spending from the endowment. All else equal, if the endowment spending comprises a larger proportion of the university’s operating budget, then the risk tolerance of the endowment is lower.
  • Capability of the endowment or university to issue debt. Access to debt markets increases the risk tolerance of the endowment because the institution can borrow to meet spending in times of poor investment performance.

Low liquidity needs plus the perpetual time horizon mean endowments usually have a high risk tolerance and absorb relatively high volatility in the short term in pursuit of longer-term returns.

From a legal and regulatory perspective, regulation varies by jurisdiction; however, endowments are typically subject to laws that require:

  1. Investment on a total return basis and diversification according to modern portfolio theory.
  2. Investment committees or boards and staff who have a fiduciary duty of care in overseeing investments.

Endowments typically have tax-exempt status when generating investment returns. Universities are not typically taxed on payouts from the endowment, and donors to endowments usually can deduct gifts from their taxable income.

The investment objective is to preserve the purchasing power of the assets in perpetuity (while achieving returns adequate to maintain the level of spending. As discussed previously, spending policy can be formulated in different ways; however, a typical spending rate target is 5% of average assets.

Given endowments need to beat inflation, they tend to have a significant allocation to real assets with expected returns that meet or beat inflation. Some endowments use a liquidity risk band representing an upper bound for the fund’s exposure to illiquid investments, including the endowment’s uncalled commitments in illiquid alternative asset funds.

Most large U.S. university endowments follow the endowment model, which involves a majority (>50%) allocation to alternative investments, an allocation that has increased over the past two decades. Smaller U.S. university endowments tend to allocate less to alternatives and more to domestic equities and fixed income, with some evidence of home bias causing U.S. equities to be overweighted in these portfolios relative to non-U.S. equities.

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