Deep Cuts in Desperate Times

Some of the nation’s largest charitable institutions suffered major losses to their endowments in 2008, forcing them to make deep cuts in operations that would have been unthinkable only a year ago.

After its endowment lost more than $3-billion in 2008, Shriners Hospitals for Children decided not to reopen a hurricane-ravaged hospital in Galveston and is postponing construction of two other hospitals. The J. Paul Getty Museum, in Los Angeles, may cut its budget by 25 percent, after the endowment that serves as its primary source of income lost a similar share of its value. And the Salvation Army is trimming the size of the majority of the 30 community centers that it plans to build with a $1.5-billion bequest from Joan Kroc, after the endowments made up primarily of her bequest dropped 30 to 40 percent last year.

“Every nonprofit has got to be rethinking its plans for the next year,” says Major George Hood, a Salvation Army spokesman. “You have to pull the reins in and make smart decisions without pushing the panic button.”

The losses are also forcing charities to reassess how they think about their endowments, and some managers are reducing risk by moving as much as 30 percent of their funds into cash-like investments that can be used to cover payouts over the next few years.

Indeed, this downturn has been humbling even for the best-endowed charities — especially colleges — which had for several years in a row reported endowment returns that trumped those earned by smaller, less wealthy charities. A study of endowment returns at 435 colleges by the National Association of College and University Business Officers found an average decline of 23 percent for the five months ending in November 2008.

Attracting Government Scrutiny

The economic turmoil is forcing charity boards and executives to make difficult decisions about where and how to cut budgets in order to weather the crisis. Last month, Brandeis University said it would close its Rose Art Museum and consider selling more than 6,000 artworks, including paintings by Willem de Kooning and Andy Warhol. The university’s endowment fell 25 percent in 2008, to $549-million.

The Massachusetts attorney general’s office said it plans to conduct a detailed review of Brandeis University’s decision. The uproar over the Brandeis decision has prompted many charity leaders to emphasize that they are doing everything possible to shield their primary charitable focus from the brunt of their budget cuts.

The endowment at Lincoln Park Zoo, in Chicago, declined by $7.6-million, more than 20 percent, during the nine months ending in December.

The zoo, which charges no admission, is seeking to cut its $21-million budget by about 5 percent, according to Sharon Dewar, a zoo spokeswoman. The zoo has instituted a hiring freeze and may lay off some employees, and its chief executive, Kevin Bell, has vowed to take at least a 10-percent pay cut in his $352,500 salary.

But zoo officials say they will not make cuts that threaten the care of its animals. “We don’t want to impact the wildlife,” Ms. Dewar says.

As the endowments shrink, and other sources of revenue wither, some endowment managers are hunkering down and hoping to ride out the storm in the markets.

Troy D. Baresel, chief financial officer at the Lincoln Park Zoo, says the endowment is for the long term and the zoo plans to stay the course. Its investments in small-cap and international equities slightly underperformed their benchmarks during 2008, but those declines were offset by better-than-average performance by its managers who oversee large-cap stocks and alternative investments like hedge funds.

“Everyone is hoping for the markets to quiet down and quit these wild swings,” Mr. Baresel says.

Investment Advice

Some investment advisers are proposing strategies to their clients that have the potential to reduce volatility, while still providing strong returns if the market rebounds.

Typically, managers rebalance at least once a year to bring the endowment back in line with the asset allocation set by the board’s investment committee. After a year like 2008, that would mean taking some money out of the year’s best-performing categories — such as high-quality bonds and cash — and putting more money into laggards like stocks.

But Todd E. Petzel, chief investment officer of Offit Capital Advisors, an investment advising firm whose clients include nonprofit endowments, says charities should think about taking the money they would normally shift into stocks and put it into corporate bonds, including so-called junk bonds that have a risk of defaulting.

Those bonds currently offer big yields due to fear of widespread bankruptcies, and they will rally just like stocks if the market rebounds. But bonds also offer some protection if the market continues to weaken, as bondholders typically are paid off in a bankruptcy before the owners of the stock see any return of their money.

“We would advocate that investment committees erase the hard lines between the asset categories and think about where the opportunities are,” Mr. Petzel says.

Five-Year View

It’s not so much today’s troubles that concern the American Red Cross, as the picture in the next five years.

At the Red Cross, where the endowment dropped 22 percent during 2008, to $630-million, Tina Samson, the charity’s chief investment officer, says she and her staff are focusing on what the world’s markets will look like in 2013.

She expects to make changes to the endowment’s asset allocation in coming months.

“One of the things we’re thinking about is which asset classes will rebound first and most, and how improvements are likely to cycle from the U.S. to the rest of the world, or from the rest of world to the U.S.,” Ms. Samson says. “We’re trying to think in thoughtful ways about where the world will go, and how we’ll get there.”

For the Red Cross, the endowment is truly long-term money. The amount the charity takes from its endowment each year accounts for about 1 percent of the charity’s budget, according to officials at the organization.

Other charities aren’t so lucky — they rely heavily on their endowment to support their activities.

Shriners Hospitals for Children, which operates 22 hospitals, appears to have lost at least $3-billion of its endowment last year.

The endowment was worth nearly $8.9-billion at the end of 2007, according to the charity’s informational tax return — roughly two-thirds of its assets were invested in stocks, with most of the rest in bonds.

Shriners is suspending repairs at its Galveston, Tex., hospital, which has been closed since Hurricane Ike struck the city last September. The charity is also delaying construction of new hospitals in St. Louis and Los Angeles.

Ralph Semb, chief executive of Shriners Hospitals for Children, told reporters in St. Louis and Houston last month that the endowment had shrunk to $5billion, which would imply a loss of nearly $4-billion in 2008.

Marlena Lagina-Kleine, the charity’s vice president for communications and development, said the loss was not that big, but she declined to provide further details and she said she was unable to arrange interviews with Mr. Semb or Keith Gardner, the charity’s chief financial officer.

Shriners hospitals do not accept insurance payments, and they provide services to all eligible patients at no charge.

“Our endowment, and how our endowment grows, is vital to our operation,” says Ms. Lagina-Kleine. “There is no other funding.”

25-Percent Drop

The J. Paul Getty Museum, in Los Angeles, is considering cutting its fiscal 2009 budget by roughly 25 percent, after the J. Paul Getty Trust, which provides the vast majority of the museum’s revenue, dropped by 25 percent, to $4.45-billion, in the six months ending in December.

Ron Hartwig, a spokesman for the museum, which charges no admission fee, says the budget cuts have not yet been determined but the museum will probably lay off workers. “We have to take action based on the realities of our income situation,” he says.

Eric W. Bailey, managing partner at CapTrust Advisors, which provides investment advice to charities and foundations that own assets worth about $6-billion, says charities that rely as heavily on their endowments as the Getty should divide their assets into three pools: short term, intermediate term, and long term.

The short-term money — which should be big enough to cover 12 to 18 months of spending — would go into safe and liquid investments like money-market funds.

The intermediate pool — which includes funds that a charity might need in one to five years — should go into assets that provide some upside but without the volatility of stocks.

One example is funds that invest in convertible bonds, which allow the bondholder to convert the investment to stock under certain conditions.

“You’re putting your toe in the water but not jumping in,” Mr. Bailey says.

The long-term pool, which might account for half to three-quarters of the total endowment, should still be heavily invested in stocks.

Mr. Bailey says that by establishing the different pools, board members on investment committees are better able to muster the courage to stay with stocks in the long-term pool.

“We see our role as educators,” he says. “People are inclined to do the opposite of what traditional investment philosophy would suggest. Right now, because of what you read in the newspapers, it feels like you should be avoiding risk and not seeking it.”

But he abides by the famous quote from Warren E. Buffett, the investing legend and philanthropist: “Be fearful when others are greedy, and be greedy when others are fearful.”

Cash Investments

Direct Relief International, a charity in Santa Barbara, Calif., with a restricted fund, or quasi-endowment, worth $34-million, has taken roughly a quarter of the fund — money that it may spend in the next two to three years — and put it into cash-like investments.

Direct Relief uses the restricted fund to covers its administrative and fund-raising expenses, so that it can promise prospective donors that their entire gift will support the charity’s efforts to provide medical supplies in 59 countries.

“We put that money aside because we want to give confidence to our supporters that any donations we receive over the next few years are not going to be used to fund any administrative costs,” says Bhupi Singh, the charity’s chief financial officer.

Mr. Singh says that more than two-thirds of the endowment remain invested in the stock market, and that the charity is looking for new opportunities. For example, Direct Relief recently committed money to a fund that invests in distressed debt.

“We’re not panicking and pulling out,” Mr. Singh says. “On the other hand, we’re not risking everything we have on the expectation that we can get it back when we need it.”

Those charities that began fund-raising campaigns well in advance of the current market meltdown are in a better position than some others.

The Salvation Army of Marion and Polk Counties, in Salem, Ore., began seeking money for a Kroc center shortly after Ms. Kroc’s bequest became public.

The region has great needs — 63 percent of the children in the Salem-Keizer school district live below the poverty line — and the city of 150,000 quickly rallied around the project.

The Salvation Army awarded its Salem affiliate a center in 2006, with the proviso that the community was responsible for raising some of the money on its own.

Patricia Cuff-Smith, the lead fund raiser for the project, benefited from a slam-dunk fund-raising pitch: If the local chapter could raise $9-million, the Salvation Army would put up $70-million — a nearly 8-to-1 match. (Roughly half the funds will go into an endowment to provide for upkeep of the building.)

Some 1,700 local residents have given to the project, and Ms. Cuff-Smith says the group has received more than enough cash and pledges to cover the required $8-million of local money.

“We were really blessed to have completed the majority of the fund raising prior to the economic crisis,” she says.

Construction has already started, and in September, the $40-million community center is scheduled to open.

It will feature an education wing, a competition-size swimming pool, and even a “lazy river” that cycles around a leisure pool.

The Salvation Army has approved plans to build 30 Kroc centers around the country, but only two have been completed, and a handful more, including the Salem center, are currently under construction.

The declines in the Salvation Army’s endowments may force most of the affiliates that have been awarded centers to go back to the drawing board to conceive smaller centers, or perhaps abandon their building plans altogether, says Mr. Hood, the Salvation Army spokesman.

Pause in Building

The Salvation Army has a national organization and five separate regional groups; each one received a share of the Kroc money, and each has seen its endowment drop by 30 to 40 percent in the past year, Mr. Hood says.

The charity won’t begin construction on any new centers, he says, until it has a “clearer picture” of what the economy will look like in the next few years.

“We’re putting on the brakes, that’s for sure.”