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April 5, 2001

Trustees change endowment investment formula, retain percentage for spending

Trustees voted last month to diversify Pitt's endowment investments, with the aim of reducing risk while maintaining an expected 9 percent annual return.

But trustees rejected a University Senate committee's recommendation to spend more of Pitt's endowment income to fund scholarships, fellowships and professorships, and otherwise support campus programs.

Pitt spends income equal to 4.25 percent of its $1 billion-plus endowment annually for such purposes. Among the 60 Association of American Universities (AAU) schools, Pitt appears to have one of the more conservative endowment spending policies, according to national studies. Penn State spends income equal to 5 percent of its endowment annually, and Carnegie Mellon spends 5.5 percent.

Last fall, the Senate's budget policies committee (BPC) asked Pitt senior administrators to "seriously consider" adopting a higher endowment income spending rate.

BPC pointed out that Pitt is budgeted to spend $32.4 million in endowment income this year, a payout based on 4.25 percent of the endowment's average market value during the preceding three years ($761 million). Had the payout rate been 5 percent instead of 4.25 percent, this year's endowment spending would have been $5.7 million higher.

Arthur G. Ramicone, Pitt vice chancellor for Budget and Controller, initially called BPC's recommendation "reasonable and prudent." But Ramicone later changed his mind.

"The administration did take BPC's recommendation very seriously," he said in an interview this week.

"Amy Marsh [Pitt's treasurer] and I and the finance staff spent untold hours analyzing this, working with our consultants, Wilshire Associates and Cambridge Associates."

According to Ramicone, Pitt administrators and trustees concluded that a 5 percent-equivalent spending policy was not prudent in the long run.

"Currently, everybody focuses on the last 10-15 years of investment returns, during which we've had a significant bull market, but we can't expect that to continue long-term," Ramicone said. "In our analysis we also looked at other periods like the [high-inflation] 1970s."

This winter's stock market nosedive "would certainly support the idea that one needs to be cautious in making these decisions," Ramicone said.

"The objectives of the endowment," he noted, "are to sustain the real purchasing power for future generations and to provide a predictable revenue source to the schools" — goals that sometimes conflict, Ramicone acknowledged.

Sandra Williamson, one of two faculty representatives on the Pitt trustees' investment committee, said the rejection of BPC's recommendation taught her that it's not enough for professors to study issues, make proposals and attend trustees' meetings.

"If we as faculty really want to have influence on decisions by committees of the Board of Trustees," Williamson said at Tuesday's Faculty Assembly meeting, "we need to lobby the people whose opinions and recommendations are valued by the trustees" — especially deans and senior administrators, she said.

BPC chairperson Philip Wion said he and Ramicone discussed the endowment spending issue on Monday. "I wouldn't leap to the conclusion that, because the decision by the trustees didn't agree with the Senate, our recommendation wasn't seriously considered or that [the trustees' decision] was a bad decision," Wion told his fellow Assembly members.

"Opinions can differ," he added. "It is a complex issue."

While the trustees' investment committee, at its March 15 meeting, did not vote to increase endowment spending, the committee did authorize diversifying Pitt's endowment investments.

Ramicone explained: "We want the broadest possible range of investments because the more you diversify, the more you reduce your risk. By diversifying, we don't expect to increase our assumed return of about 9 percent per year, but we do reduce our risk."

According to a study by the University's consultants, Pitt had been investing more heavily than peer institutions in so-called "traditional" assets such as U.S. and international corporate stocks and low-risk bonds.

Under the plan approved by trustees last month, Pitt will allocate its endowment funds as follows: Equities

* Domestic stocks — 30 percent.

* International stocks — 15 percent.

* Emerging markets stocks (publicly traded securities of foreign corporations in non-developed countries) — 5 percent.

Fixed income

* Core fixed income (highly rated, "safe" fixed income investments such as U.S. Treasury bonds) — 20 percent.

* Satellite fixed income (high-risk, potentially high-yield investments such as junk bonds) — 5 percent.


* Marketable alternatives (hedge funds, merger arbitrage and other investments that exploit inefficiencies in marketable securities prices) — 10 percent.

* Non-marketable alternatives (buyout funds, venture capital and other investments that aren't publicly traded; such investments are locked in for a minimum number of years and can't be traded) — 10 percent.

Inflation assets

* U.S. Treasury inflation-indexed bonds, real estate, natural resources (oil and gas, timber and other commodities) and other assets whose income stream and/or market value rises with inflation — 5 percent.

If necessary, Pitt can also invest up to 2.5 percent of its endowment in cash and equivalents — highly liquid, short-term, fixed income securities.

Prior to the new allocation, Pitt had invested its endowment as follows: domestic stocks (42 percent), fixed-income (33 percent), international stocks (15 percent) and alternative investments (10 percent).

–Bruce Steele

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