Archives for the month of: October, 2013

Some of the institutions I am visiting confront what I will call a challenging demand scenario. That is, what used to be a lock for, say, 400 new students is now in the low 300s.  The reasons for this drop-off are many and vary with diverse institutional profiles.  In this installment, I want to share some ideas about how to stem the tide of declining enrollments and to share an idea for schools to use in reducing faculty headcount without cutting programs.

Unique Programs

We have heard it time and again that distinctives are what drive institutional success.  That is, you want to be one of but a handful of institutions that are known for ________.  Programs that are unique and have a good deal of demand will draw in students who are less concerned about “the deal” and more focused on the experience.  Now, this is not just about finding a program of any sort and being the best there is.  I am not sure that Klingon studies will bring in much in the way of student demand, for example.  And, if it does, it will not boost the inventory of datable guys on your campus.  Rather, of the many programs that students are flocking to these days, pick one or two and stick with them. It will likely take a few years for each to reach its potential but when they do, it will contribute to the health of the institution.

One of my institutions decided to invest in a Christian Contemporary Semester program and offered other institutions the opportunity to spend a semester studying that genre; even to the point of offering it as a one-semester minor in that area.  You may respond that this seems run-of-the-mill. Why would one program be any better than another?  Well, consider that the institution offering the program is located in Nashville and that some of the leadership is closely aligned with popular artists and labels.  The lure of such an offering becomes quite appealing.  Over time, it will be a strong draw and a contributor to the University’s bottom line.

Find program candidates by unlocking the creativity of your faculty.  Work on the structure to ensure that it is financially contributory.  Then, roll it out with proper promotion, recognizing that it takes three years anyway to establish a reputation.  You will need to advertise / market the program in the same way you market the entire institution.  This is called product marketing, versus the brand marketing that most institutions spend all of their advertising budget on.  I could go on and on about that but will save it for a later submission.

When you have a couple of premier programs that are known far and wide for their quality, discount rates for those who want to be majors (but have to compete for a slot) will be lower and academic success will be stronger.  You can find these programs.  Get cracking!

Cooperative “Flip” Classes

The flipped classroom has grown to be a common topic of conversation amongst strategists and futurists alike.  The idea is that the lecture and accompanying notes can be made available online, to be called up by students whenever they want to see it.  Physical proximity gatherings can be associated with such a delivery method so that students can have questions answered and for working together on research and other projects. My son-in-law is a seminary student who watches some of his lectures on a large TV in his living room.  Pretty impressive and, in a number of ways, better than the one-time shot of a lecture that we were all exposed to back in the day.

Let’s take it to the next level.

Presume that five colleges of similar size and mission band together to share curriculum and courses.  Major required courses would be aligned amongst the group, with each participating institution offering a couple of courses in the flipped format to, collectively, cover the entire major requirement.  Ten, three hour courses total thirty hours; the typical requirement for a Bachelor of Arts major.

And so students who are taking a major or minor in history will take courses from up to five different professors who each teach two major level courses using the flipped model.  Study groups on each campus will have a half hour or more of access to the professor each week to ask questions and interact about projects or research.  Specific questions via email can also be raised.  An upper level course that would normally have five to seven students in it would have twenty or more in total from the participating schools.  Utilization of professors who are the highest paid but who have had the fewest students in their upper level classes winds up going up materially.

There could be resistance from certain perspectives over this kind of a strategy.  After all, it would require far fewer faculty to deliver major level courses than is currently the case.  What it offers the student, however, is exposure to the best faculty from five institutions, each teaching in areas where they have specific expertise.  It also affords a greater list of potential recommendations for jobs or grad schools and it increases the student to faculty ratio by multiples.

Contrast this to each institution being fully self-sufficient – employing a full complement of faculty to teach each major level course directly, even if only five take the class.  Courses are offered every other year, in an attempt to bunch up upperclass students and bolster class sizes.  Students are then exposed to as few as two faculty members for an entire major course of study.  If a student is not excited about one of the faculty members, a transfer may be in the offing.

For those who are still unsure about the wisdom of such an arrangement, let me share with you that unless effective ways are found to shrink instructional costs to a fraction of what is currently being spent, there are institutions that will no longer be alive in but a handful of years.  Some have moved from a healthy size, defined as an enrollment within few students of their historic breakeven point, to a level that is permanently below breakeven by a large margin.  Without a rethinking of how the most expensive component of their institution is delivered, programs of all shapes and sizes will have to be eliminated, along with the students who are attracted to them.

In Closing

Find the strongest, unique programs you can, with the help of creative faculty, and then deliver them to the market that is clamoring.  Also, consider collaborating with other institutions on flipped classes, to save material sums of money on your most expensive component of the operation.  Oh, and you may want to begin these discussions soon.  Demand is not expected to get better all of a sudden.


Stocks can have a lot of overhead

So you are entrusted with investing an endowment and are looking at the various options thinking there has to be a better way.  After all, the overhead in stock investing is quite significant.  Think about how much boards are willing to bestow on their CEO in the form of cash and stock compensation.  If the organization does well, employees receive generous bonuses.  If the company doesn’t do so well the company may want to give those being let go a large chunk of dough.  Blackberry is a recent example, disclosing that the release of 4,500 employees will cost in excess of $450 million.  At $100,000 per released employee, I have to think there could be a line of tickets purchased for that gravy train.

Perks are another interesting sidelight.  Taxpayers were not impressed with the private jets the CEOs of the Big Three arrived in for hearings in Washington back in 2008.  Junkets to exotic ports of call for leadership meetings or shareholder gatherings, expensive real estate with corporate dining rooms and fitness centers, and company bashes for employees that use up huge sums of cash round out the laundry list of excesses.  All of these items diminish what is left over for the shareholder.

But wait … there’s more.

Wall Street and our government love to get in on the action as well.  Wall Street wants a company to have glossy brochures encouraging people to invest.  There are whole departments dedicated to shareholder relations, expensive visits with money managers, filing of various reports with the SEC and myriad other shareholder communications, even research on the stock that the company pays for – called “sponsored research reports.”  Added to this is a cost structure amongst investment firms to cover analysts and brokers and we have created a nifty way to strip off a good chunk of a company’s earnings.  And, let’s not forget healthy commissions here and there.

Mind you, some CEOs and leadership teams deliver the goods and are deserving of a good measure of quid pro dough.  Still, many view the largesse of corporate America with such disdain that they are reluctant to participate in what appears to be a phony approach to enriching those who happen to reach the halls of power.  Recall all the CEOs who make out like bandits while laying off thousands and posting losses.

Owning Income Producing Real Estate

So, a number of well-heeled investors have moved from passive investments in garden variety stocks to a more active, direct approach to making money.  After all, those who made it big in business didn’t tend to do so solely through the stock market.  One of the more appealing areas to invest in at the moment is commercial real estate and multi-unit residential property.  It is a leveraged investment in that a mere 20% down will control 100% of the revenue generation.  This doesn’t mean that your institution is saddled with managing these assets directly– that is something well beyond the capability of the skill set of most administrators.  Capable management companies are engaged to be operators and deliver cash flow and appreciation over time.

Yes, one could use a REIT to provide a similar form of diversification but the costs of such organizations can be quite significant relative to the revenue generated by the underlying assets.  Also, they are subject to the ups and downs of the market.  My interest in real estate relates in part to residual influences from the collapse of the residential market in 2008 and the dearth of new construction thereafter.  Population keeps rising and stringent mortgage requirements are keeping buyers at bay.  People will live somewhere, particularly when young people get married and hope to raise a family.  Over the coming years, the need for additional housing represents a staggering number.  Most of it will be made up of commercial apartments, particularly with interest rates on the rise.

The opportunity presented by a direct ownership strategy is that established complexes in convenient locations will be all the more in demand as time marches on.  Newly constructed units will have to either develop vacant parcels further away from population centers or will pay up for existing real estate that is closer in.  Rent will likely increase as the cost of commuting continues to head upwards and expensive projects are undertaken in less convenient places.  For a longer term investment of, say, ten years or more, owning multi-unit residential real estate could be a solid play, providing current income and greater than average appreciation.

And, there is the same benefit that I mentioned when talking about bonds.  Owning real estate means that the vagaries of interest rates and market valuations are not reflected on your balance sheet.  A long-term investment is not subject to frequent revaluation but delivers cash flow and appreciates until it is time to realize the gain.

Commercial real estate is similar to residential, although it is subject to greater swings in occupancy rates. So often when visiting potential sites for a commercial lease, I learn that a pension fund owns the facility.  I don’t think that is a coincidence.

Structured Financings

Here’s one I stumbled on a few years ago.  It is a mechanism used by higher net worth individuals to generate solid annual cash flows and some upside appreciation.  There are myriad variations of this but one that is common looks something like this:

A corporation has some net operating loss carryforwards, meaning that it can earn a bunch of money without paying tax on it.  It also owns some real estate – say, a factory – that has appreciated in value, even though it has been depreciated down to a low value.  Because of past operating losses, the company wants some cash to spend but it’s a little difficult to glean dollars from a typical lender relationship.

Enter the structured financing – kind of a sale leaseback.  The company sells the factory to a lending consortium including accredited investors and institutions, agreeing to lease the factory from the new owner, with an intrinsic interest rate substantially higher than a normal mortgage.  There is also the opportunity for the company to repurchase the asset – at a guaranteed premium that provides a nice capital gain to the investor.

What makes this interesting is that it is, again, a leveraged investment.  The accredited investor borrows about half the value of the asset from a bank at a low rate.  An example is in order.

The deal is for $10 million and the interest rate intrinsic in the lease is 12%, with no principal reduction during the lease term.  The investor can borrow $5 million for this kind of an arrangement at 6%.  The gross interest income is thus $1.2 million but the interest paid for the half borrowed by the investor is $300,000. The net interest income (NII) is thus $900,000.  Dividing the NII by the $5 million of cash put up by the investor yields a rate of return of 18% per year.  Not bad work, if you can get it.

Five years into the arrangement, the original owner wants to buy back the facility and the contract allows for a 5% premium above the original sale amount.  So, the investment is unwound with an additional $500,000 given to the investor, representing a 10% premium on closing out the contract.  The rate of return winds up being 28% that year.

There are banks that work these deals, along with other variations on the theme.  It is a good way to generate solid returns without being subjected to the vagaries of the market.


Rather than owning mutual funds supported by precious metals, it may be preferable to hold the metals themselves.  This is for a minority portion of your portfolio (maybe 5%) but it is a hedge against inflation and has the potential for short-term appreciation from what I will term peak production.  At times, the economy grows faster than certain metals can be extracted from the ground, causing a surge in prices.  Certain processes have to use precious metals.  Car production relies on platinum and palladium for catalytic converters.  Computers use silver.  Gold is used in car airbag actuation switches and other high tech applications where conductivity and lack of corrosion are needed.

With interest rates continuing to be held down at abnormally low levels and countries fighting to make their currencies cheaper than their trading partners, room exists for growth in precious metals, if only from monetary policy influences.  Also, as the economy grows and production remains somewhat constant, peaks will happen, particularly with growth in cars, smartphones and other technologies.

Other Investments and strategies

Let me add a list of a few ideas here for consideration. Active trading strategies use the abilities of experienced traders to move in and out or positions frequently to make money.  Venture capital funds can be risky but if only one in fifteen hits the jackpot, the return can be quite attractive.  Hedge funds are most commonly of the long-short fund of funds variety.  There is a lot of overhead in these deals but they have performed well for the most part, with 2008 a glaring exception.

The point is that investment in the market may make up the majority of your portfolio but some enhancement from other strategies is a good way to smooth out market ups and downs with more consistent returns over time.

Enjoy the ride!

“Invest in a broad array of stocks and bonds and hold them for the long term.” 

Those who held General Motors stock and/or bonds in 2006 might disagree.  Same goes for WorldComm, Enron, Kodak, AT&T, Adelphia Cable, RIM/Blackberry, JCPenney and a host of other disasters.  Corporate bonds are not exempt either, with their tendency for weaker returns over time and being subject to a complete wipe-out in a bankruptcy reorganization, let alone a wholesale liquidation.  The longer term variety can make you money as interest rates decline (principal values increase) but are also be subject to principal erosion when rates head back upwards.  Companies can be affected by changes in technology (Kodak), or outright greed (Enron) and wind up with stock prices in the pennies per share. It a’int pretty out there.

An important question is why you are investing.  For an endowment, the answer is to provide a steady source of income while growing the overall value by an amount that exceeds inflation.  We don’t invest because we believe in the stock or bond markets and want capitalism to spread the wide world over.  We don’t believe in certain companies or industries as the exemplification of goodness.  Our goal is to make money – legitimately, mind you – but still make money.

In my travels, I find it fascinating how few endowments ever exceed the performance of the S&P 500 index.  The reason, I posit, is that this index captures the influence of the overall economy while allowing participation in some of the super star stocks of any given time period.  That is, out of these 500 stocks, a few are bound to break out and deliver returns that far exceed economic growth.  You know the stories of companies that experience a doubling or quadrupling in one year.  Chances are your value-based investment manager will not pick them.  The S&P 500 does, however.  Mind you, the influence of one stock on your overall return is quite small but it is an influence, nonetheless.

Consider that the average annual rate of return for the S&P 500 was 9.63% over the 38 year period from the beginning of 1975 through the end of 2012.  Since losses have a greater impact on returns than gains (see explanation below), the compound annual growth rate was 8.32% for the same period. By contrast, compound annual growth for CPI was 3.99%. Not to beat a dead horse but you could have had an annual spending rate of 3.3% over that period of time and covered inflation while adding 1% of real growth to endowed assets.  Instead, institutions were busy spending 6% and had to curtail spending when endowments inevitably went underwater during the loss years.

Let’s consider more specifically the influence of losses versus gains and why compound rates are preferred over average rates.  Presume you had a personal portfolio of $3,000 at the end of 2007 but then lost a third of its value during 2008.  At the end of the year, your value wound up being $2,000.  You got beat up.

To get back to $3,000, an increase of one-half is needed ($1,000 / $2,000).  I call this the law of diminishing denominators where a loss of 1/a (1/3rd) requires a subsequent gain of 1/(a-1) (1/2) to get back to the original value.  This is why compound rates are more accurate than using average returns.  In our example, the average rate of return for the two years (2008 and 2009) is +8.33% (-33.3% + 50%) / 2.  Since the investment wound up unchanged between the two years, the average rate sends the wrong message.

So, what do I suggest?  Well, along with moderating your spending rate, it makes sense over time to use an S&P 500 fund for your equity component.  It avoids the cost of an investment adviser (up to 1% from your return) and beats a majority of money managers.  This is particularly appropriate for smaller endowments of under $15 million.  As the invested value exceeds $15 million, other strategies are possible.  I’ll talk about those in the next installment.

What about bonds?  I recommend the ownership of a diverse representation of specific bonds, versus a bond fund.  The reason for this is how math and the markets intersect.  In a bond fund, the overall portfolio is priced every day and that overall value is what you will receive if you sell your shares.  If I buy a specific bond instead, it is priced at purchase based on a market determined rate of return.  This is the rate I will receive if I hold the bond until maturity.  If rates go up, the value of the bond will decline – but it doesn’t matter. I’m not selling.   My rate of return remains fixed at the value established when I purchased it and, if I hold the bond to maturity, that is the rate I’ll receive. Conversely, if rates decline materially, the bond will increase in value.  This offers the opportunity to sell the specific bond and glean capital appreciation.  If you plan to have bonds as a part of your portfolio, I recommend a market basket of quality corporate bonds versus a bond fund.  The risk of value depreciation is reduced measurably, versus participating in a fund.

Next installment – alternatives to stocks and bonds

If I used the title “retirement account” my following might go up about ten-fold.  All of us are a little nervous as markets reach historic highs and the future seems anything but rosy.  I write this as the government is shutting down its non-essential operations.  Seems similar to when a snowstorm hits and only “essential” personnel are asked to show up.  Hmmm.  What does it say about my organizational value if I stay home?

There are about as many opinions about investing as there are registered advisers.  I plan to offer a few entries on this topic so that each is bite-sized.  Let’s begin with a few myths that should be cleared away.

“Endowments are invested for an unlimited time horizon.”  This is not a healthy strategy.  Much of what an endowment earns is spent annually, often at a rate that far exceeds inflation.  Scholarships, professorships, chairs and general operations are supported by the earnings of an endowment.  For many, if the endowment heads southward, winding up with a principal value below the original donation (aka, it is “underwater”), spending may cease.  In 2009, for a lot of well-heeled institutions, this actually happened, causing some to borrow boatloads in order to avoid drastic cuts.

Indeed, endowments tend to be invested for the long haul but there is a need for some form of intermediate gain so that funding is available for annual distribution.  You thus should avoid rolling the dice by investing the entire endowment on that vacant acreage your board member recently bought where natural gas is known to be underfoot.  It may be decades before it pays off and, in the meantime, you have to pay for a few things every year.  I acknowledge that UPMIFA allows for spending when endowments are underwater but, in reality, such practices remained frowned upon under the guise of intergenerational equity.

“Annual spending should be between 4% and 6% or a rolling, multi-year average.”  This is not workable anymore either.  While we revel in the growth of the market over the past four and a half years, it was rebounding from a catastrophic loss prior to March, 2009.  Only this year have the broader indexes (indices?) reached their former high-point of nearly six years ago.  Using that as a gauge, endowed funds spent during the sustained run-up were extracted at a time when they could have yielded a return of incredible proportions.

As an example, suppose your institution spends 5% of the previous three year average of its endowments.  As of June 30, 2009, the Dow stood at $8,447.  The three year rolling average for the Dow included the prior two June 30 values and was $11,069. That is 31% more than the 2009 value alone!  Applying the five percent spending rate to the three-year average is equal to spending 6.6% of the 6/30/09 value.  At a time when institutions should have been retaining as much as they could, their use of a three year average caused them to spend a good deal more.

But it gets better.  Whatever was in the endowment on 6/30/09 was subject to a huge run-up over the following four years, with the Dow moving from $8,447 to $14,910 as of 6/30/13.  That’s a whopping 76.5% increase.  Whatever was spent in 2009 could have remained invested in the Dow, enjoying that significant increase.  Applying the 76.5% foregone growth of 6/30/09 funds to the 6.6% of value spent on that day, makes the rate of foregone earnings equal to 11.6% of the 2009 values.  That is a lot to give up!

In essence, endowments spent more than their stated spending rate because the three year averages were well in excess of values as of 6/30/09.  Added to this is the extraction of funds that, had they remained invested and tracked the Dow, would have grown by 76.5%.  Spending today takes away a lot of spending tomorrow.

The following table illustrates this:

























As the table indicates, the real rate of spending being given up at 6/30/09 (provided that spending was allowed) was 11.6%.  Had the spending rate been 3% for that year, the rate foregone would have been 6.9%.  Spend less, earn more.  Sounds like a Dave Ramsey tagline.

Another challenge is inflation.  Ideally, an endowment provides sufficient return to cover not only spending but the impact of inflation and the need for real growth over time.  So, if an endowment spends at 5% while inflation is running along at 2% and desired real growth is a mere 1%, the endowment must grow by 8% each year to keep up with expectations. With economic growth running at 1.5%, the double digit growth of the stock market over the past few years must end at some point.  Spending rates need to be closer to 3%.  Otherwise, another 2009 looms large.

Next up will be myths about buying and holding “quality” stocks and bonds.