After the crash

The following story includes a clarification of the story published in the Dec. 9, 2009, edition.

In the depths of the financial crisis last year, Andrew Golden, the president of the Princeton University Investment Co. (Princo), changed his playbook. Usually, declines in the stock market led him to become more aggressive, using Prince­ton’s endowment to make new investments on the cheap. Not this time. “Markets tend to overreact to news when they first hear something. We had a sense this was actually as big a deal as the markets were indicating,” he says. “We didn’t want to be catching a falling knife.”  

While Princo wasn’t using the downturn to make new investments, its options to get out of existing investments, plummeting in value, were limited. Princeton’s endowment, valued at $16.3 billion in June 2008, was largely in hard-to-sell investments such as private equity and real estate. All Golden could hope was that Princeton’s investment strategy — making long-term commitments of capital in hopes of better-than-average returns — would prevail. “There are adjustments you can make at the margin, but our whole approach is predicated on the sense that flexibility in any one given time is an overrated commodity,” Golden says.  

Ultimately, the dollar value of Princeton’s endowment declined 22.7 percent in the year ending June 30, about in the middle of the declines experienced by Ivy League schools. The fallout continues. Princeton borrowed $1 billion to avoid selling endowment assets at sharply reduced prices. About 200 staff positions have been eliminated, including 43 layoffs, and salaries were frozen for all employees paid $75,000 or more per year. Nearly $1 billion was cut from the Univer­sity’s 10-year capital plan, and some key projects, including the construction of new neuroscience and psychology buildings, have been delayed. Faculty hiring has slowed dramatically. The Woodrow Wilson School will shut its Policy Research Institute for the Region at the end of the academic year.  

The “new normal” at Princeton — where departments no longer can spend lavishly nor can the University imagine new programs virtually without limit — is here to stay. “I don’t think we have a choice,” President Tilghman says in an interview with PAW. “We will just simply grow more slowly.”

Tilghman and Golden say they do not have significant regrets about the financial path the school has taken under their watch; even after the recent decline, the value of the endowment has grown from $3.5 billion when Golden arrived at Princo in 1995 to more than $13 billion today. But they say they are exploring a strategy to avoid the type of challenge they faced in the downturn: creation of a fund that would serve as a source of cash in a crisis.  

Andrew Golden

Courtesy Princo

For much of Princeton’s history, deciding how to invest the University’s money largely was an informal exercise, as trustees with experience on Wall Street invested the endowment mainly in stocks and bonds. In 1987, the University created Princo so that it would have a professional team of employees to manage its money. This team initially invested most of Princeton’s money in stocks and bonds, fairly conventional investments that would track the overall rise or fall of the markets, but over time started to move into some of the less conventional investments that distinguish Prince­ton’s strategy today.  

Golden had been schooled in this unconventional approach. Working at Yale’s investment company, he reported to David Swensen, whose strategy — later emulated by many university endowments and other large investors — included buying shares in assets like oil wells around the world, real estate, or private companies in the United States. “I did my internship and residency learning under him,” Golden says, in one of two recent interviews with PAW.  

At Princo, Golden successfully made the case that if Princeton wanted to have the financial resources to grow aggressively over the years, it too should adopt this approach. “Only through an aggressive investment posture did we have any hope of achieving our goals,” he says.  

Today, Princo has 28 employees who work out of offices at 22 Chambers St. Princo outsources virtually all of its investing to more than 100 private funds. Its employees spend most of their time choosing among, monitoring, and sometimes terminating relationships with these investment managers. (Princo pays about $215 million a year to its managers, the University said.) Princo’s board of directors and the investment committee of the University’s board of trustees oversee this process.  

Princo generally avoids betting on overall trends in the financial markets — for example, guessing whether stocks in the United States will fall or rise broadly in a given year. Instead, it has concentrated most of the endowment in three types of investments: private equity, real assets, and independent return. Private equity refers to investments in companies not publicly traded. Real assets include real estate and natural resources, such as oil or timber. Independent return refers to investment funds that bet on specific circumstances, such as whether a company will file for bankruptcy protection or what government approval of a new drug might mean for a biotechnology company.  

These strategies, in general, have required a long-term commitment of funds. The University, with an endowment meant to exist in perpetuity, felt it could pledge funds for many years at a time. Golden and Tilghman both say that they strive for “intergenerational equity.” “The endowment is here to support today’s program at the University, but also to support the program of generations far off into the future,” Golden says.  

A few years ago, top officials at Princeton began to believe they might be worrying too much about the future and not enough about the present. The endowment had had strong returns, up 24.7 ­percent in 2006–07 and 19.5 percent in 2005–06. “When we think about the endowment, that is often interpreted primarily as preserving the spending power for future generations,” Tilghman says. “Frankly, the other half of it is that we are not sacrificing the current generation and their opportunities.”  

As a result of the endowment’s growth and long-term projections, University trustees decided that a higher percentage of its assets could be spent each year. While the range had been 4 to 5 percent, now the upper limit was raised to 5.75 percent. At the same time, Golden says, Princo offered a warning: “We took the opportunity to illustrate how markets, and therefore the endowment, were likely to experience greater volatility than had been the case in the past.”

In 2000–01, the endowment funded 30 percent of the University’s $671 million annual operating budget; in 2008–09, the endowment supported 48 percent of the $1.3 billion budget. Among the factors in spending growth were the decision in 2000 to increase enrollment by 11 percent and the 2001 move to a no-loan financial-aid policy. Princeton also announced an ambitious 10-year, $3.9 billion capital plan, to finish in 2016, which called for the creation of new arts, environmental, and neuroscience facilities, among other projects.

Ronald G. Ehrenberg, an economist at Cornell who studies higher education and is a member of Cornell’s board of trustees, says the financial crisis could prompt questions about spending by universities. He says elite schools were spending significant sums to build lavish facilities in the years before the crisis. “These universities are competing with each other to attract the very best students, and the competition is not just the quality of the faculty and libraries, but it’s the quality of the atmosphere of the institution,” Ehrenberg says. “You might ask, is that the socially responsible thing to do?”

Tilghman, however, says she is committed to building the “robust” and “premium” structures — such as Whitman College — that were emblematic of Princeton’s financial golden age. “If all your horizon is five years, we paid a premium for Whitman College,” she says. “But if you’re on this campus 100 or 150 years from now, Whitman College is still going to be standing.”

Like most investors, Princo was blindsided by the ­near-collapse of the financial system in fall 2008. By its own planning, Princo was not in a position where it could react in any significant way to the sharp market decline. The University, which already had several billion dollars in outstanding multiyear commitments to private equity and other illiquid investments, cut back on new commitments.

Moreover, Princeton couldn’t be sure that the Wall Street firms it was dealing with would survive the crisis. “Truth be told, I found this moment particularly scary not because of Princeton, but because I was concerned about the capital structure of the country,” Golden says. “It wasn’t a question of whether Princeton was going to do OK. It was a question of what environment Princeton was going to be operating in.”  

Golden says that Princo’s senior staff and trustees talked much more frequently: “We know any day things can get worse. We want to make sure there’s a shared understanding.”

By November 2008, Tilghman and other University officials worried that the endowment could decline as much as 30 percent, and they met constantly. “It was just a matter of what extent were we going to have to reduce endowment spending,” she says. “It was just a matter of what number was it going to be and over what period of time.” The University concluded that it would embark on two years of budget cuts totaling $170 million and reduce the level of endowment spending by 8 percent a year for two years.  

To avoid liquidating parts of the endowment at deeply distressed prices, Princeton borrowed $1 billion in January to pay for operating expenses. The University received an attractive interest rate compared to that achieved by most other universities that borrowed money during this time. But it also means that Princeton’s annual interest payments increased $53 million, to a total of $120 million, on a total of $2.5 billion in debt. “You have to weigh that cost against the losses we would have incurred had we had to liquidate,” Tilghman says.

Another pressure was capital calls. As part of its long-term arrangement with investment managers, Princo could be asked periodically to invest more money with particular firms. These calls continued into the crisis, though they slowed substantially. While no money from the bond issuance went to meet the capital calls, the proceeds allowed Princo to avoid tapping its endowment to pay for the Univer­sity’s operating expenses, freeing up cash for capital calls. As of June 2008, Princeton had $6.1 billion in commitments to outside investment funds. Golden declines to provide a current figure, citing regulatory limits on what he can disclose, but says it is much less than that.  

Tilghman says the University’s three most significant budget decisions were freezing salaries for higher-paid employees, raising financial aid for students and families who suddenly found themselves unable to pay (the financial-aid budget increased by $12.3 million this year), and curtailing the capital plan so significantly. “We had to face some Sophie’s choices about which of these projects could not be completed,” Tilghman says. As one example, she cites the decision to move forward with a $100 million renovation of Firestone Library while putting off work on Frick Laboratory following the chemistry department’s move to its new home next fall. Also delayed were an art museum satellite, renovation of Green Hall for the humanities and social sciences, landscaping projects, and a new stormwater catch basin.  

Asked what she most regretted losing, Tilghman says it was plans for a new day care center. “I understood how important good child care is for recruiting faculty, how important it is for graduate students and postdoctoral fellows,” she says. “I tried to keep it in as long as I could.”  

With a smaller endowment, life will be different — though only modestly — for students and faculty. “They are going to feel it on the margins,” Tilghman says. As examples, she points to closing down some dining halls on weekend nights for a semester at a time, and offering fewer visiting fellowships. “The intellectual community created by those visitors will be a less busy and active one,” she says.  

Even with the cutbacks, the University expects to spend 6 percent of its endowment this year. “We will still be at the very top of our spending policy,” Tilghman says. “That’s not a place you can live for a very long period of time.” Moreover, most of the endowment’s money is restricted to certain uses, whether it be providing a professorship or financial aid.

For this reason, Tilghman says, Annual Giving and fundraising are all the more important. She is heartened that the rate of Annual Giving donations through the economic downturn has not changed significantly. And though the University for a time put less emphasis on big capital gifts in talking with potential donors, it is now having more typical conversations with alumni and parents, she says.

In the aftermath of the downturn, Golden is leading a review — to be completed this academic year — of how Princeton invests its money. The overriding lesson already appears to be emerging, however — that the University needs a better way to access cash when markets suddenly decline. “This is something that we hadn’t really focused on to the extent that we are now,” Tilghman says.  

Tilghman and Golden say they are considering creating a new liquidity fund to ensure that in times of crisis, the University has cash available to meet its obligations. This fund would be invested much more conservatively — for example, in government bonds that have a life of a few years. “It’s probably better to have a more explicit accounting of that strength, so that in the heat of tough times ... you’re able to react with greater confidence,” Golden says. This fund “is likely to have lower expected returns over the long term,” he says. But he maintains that Princeton still can expect to see 10 percent annual returns on its endowment overall. It is likely to take more than five years for the endowment to return to its 2008 valuation, he says, but perhaps not the decade that University officials had cited earlier in the year.

The endowment recovered a little more than 5 percent by Sept. 30, Golden says, which would trail the stock market significantly. He says that private-equity investments have recovered, but not as much as the overall market. “I suspect our managers are going to be reluctant to mark up assets that have been so recently marked down,” he says.  

Golden says Princo also has made modest adjustments to the asset allocation of the endowment. The target for the current fiscal year is 25 percent independent return, 23 percent private equity, 23 percent real assets, 9 percent emerging markets, 7.5 percent domestic stocks, 6.5 percent ­developed-country stocks, and 6 percent bonds. As of June 30, 2008, the portfolio included 25 percent private equity, 25 percent independent return, 22 percent real assets, 8 percent domestic stocks, 8 percent emerging markets, 7 percent developed-country stocks, and 5 percent bonds.

Some alumni would like the University to do more. “There is certainly a group of alumni who believe that the University’s investment strategy over the past 20 years has incorporated into it too much risk, and the risk is the reason why the endowment fell 23.5 percent this year,” Tilghman says. “I understand why someone might come to that conclusion, but the reality is you can’t view it in isolation.” Had Princeton taken a less risky approach, Tilghman says, “our analysis suggests that the endowment today would be significantly smaller than it is, even having taken the 23.5 percent haircut.” The University says that even factoring in the decline, the 10-year annualized rate of return — 9.7 percent — puts Princeton’s performance among the top three or four of the 40 largest endowments in the country.  

Golden says no major shifts are occurring at Princo, but he is pushing employees harder to play devil’s advocate to any new proposals. He acknowledges that he made some modest mistakes in the last several years, saying they mostly involved choosing certain investment advisers.

Though a new era has dawned on Princeton financially, Tilghman says she believes in each of the decisions made   in the years leading up to the crisis. “If I had the power to re-run the clock, I’m not sure I would have done anything differently,” she says.

Zachary Goldfarb ’05 is a financial writer at The Washington Post.

(CLARIFICATION: The dollar value of the endowment declined 22.7 percent in the year ending June 30, 2009; during that period, the endowment's return on investment declined by 23.5 percent. The original story reported that the endowment declined by 23.5 percent.)