Credit Crisis Driven Changes to Asset Allocation and Spending Rates for College Endowments

The Credit Crisis of 2008 has caused institutional and individual investors alike to rethink their spending and investment strategies and our finding is that asset allocation, expected returns, and variability in correlations are all important factors, but the withdrawal rate may be the most important. Withdrawal in excess of 4% or 5% can cause an endowment to be underwater from historical cost for many years. When inflation is (as it should be) considered, excess withdrawal causes endowments to be even more underwater. Colleges can reduce their budgets thereby reducing withdrawal rates, or colleges can raise funds (not endowment) to meet spending needs. Other factors such as lower equity risk premiums increases the risk of failure to meet spending needs, especially under the real world assumption that 5% is withdrawn for spending by the educational institution. Higher equity risk premiums reduce failure risks, but if returns are lower the risk of failure in greater. Endowments cannot control the magnitude of the equity risk premium, but the net withdrawal rate is controllable. The effects of lower returns on all asset classes as is the current expectation, puts extra pressure on portfolios because spending 5% when average returns are lower than 8% reduces real values of portfolios. These results appear to hold for the historical 1926-2008 period that includes several major periods of market stress. Treasury bonds, both long and intermediateterm, are less correlated with equities especially during stress periods, and adding intermediate term government bonds reduces the risks during stress periods, so increasing the allocation to fixed income (government and corporate bonds) offers protection during periods of stress like the credit crisis of 2008. However the best protection is fiscal discipline.