From the Chief Financial Officer
2011-12 Financial Report
It is not every year that a school concludes a successful campaign or earns double-digit investment returns, so we are not surprised that Fiscal 2011-12 was more challenging than its two preceding years, especially when the world outside our gates is contending with such peril. Fortunately for Lawrenceville, we came into the year in a position of strength, thanks to a campaign that exceeded its $200 million goal by nearly 10% and back-to-back endowment returns of 16.3% and 20.2%, respectively. This tailwind allowed us to consolidate the gains of these last few years and to continue steps that will gradually improve the finances and physical condition of our School over time.
As of June 30, the School’s endowment stood at $314.8 million (after reclassifying $13.3 million of local property assets from investment to operating), and this endowment is sixth in size among our 40-plus U.S. boarding school peers. From an investment perspective, 2011-12 was a difficult year, marked by significant macroeconomic challenges around the world, with the consequence to Lawrenceville of a 1.3% decline in its portfolio, following 16.3% and 20.2% increases in the previous two years.
This result was not unusual among institutions with diversified portfolios. The Morgan Stanley All World Index declined by 6.5% during the year. Developed markets outside the U.S. declined by 13.8%, while emerging markets performed even more poorly at a negative 16%. Although the past year rewarded U.S. domestic investors, with a 5.4% increase in the S&P 500, our Investment Committee has created an “all weather” portfolio, which we think will serve us well through various market ups and downs, with exposure to different markets and asset classes, both domestic and international.
Looking at the longer-term results for the endowment, over three years our average increase has been 11.3% per annum, and over five years the increase has been 2.5% per annum, compared with 0.2% for the S&P 500 and -2.7% for the All World Index. Within the Cambridge Associates universe of independent schools, we have been a top-quartile performer over the most recent five-year period.
Although the Endowment Committee made a number of manager changes during the year, both adding and subtracting, the broad outlines of our asset allocation have remained consistent with prior years. We have significant equity exposure, in the U.S. as well as elsewhere, but we have moderated the related risks by including a meaningful exposure to less volatile hedge funds. We also have a strong commitment to private equity, including venture capital, which was highlighted for the School this year by the success of an initial, early-stage investment in Facebook, through Accel Partners. We also had further benefit from Facebook through our investment in Tiger Global, one of our best-performing hedge funds over the years, which had a 28.1% return in 2011-12.
The following was our basic asset allocation as of June 30:
Long-Only Equity – 27%
Hedged Equity – 16.5%
Absolute Return – 12.7%
Private Equity – 17.2%
Real Assets – 15.6%
Fixed Income – 8%
Cash – 3%
Within these asset classes, our managers have generally out-performed their related indices. For example, over the last year we outperformed the emerging markets index by 5.4 %, our hedged equity managers outperformed their index by 10.4%, and our domestic long-only managers outperformed the S&P by 1.8%. And, although our overall returns were hurt by our exposure to natural resources, where we had a negative return and trailed the index for the year, this has been our most successful investment area over the last five years, with an average return of 24.4%.
The hard-working chairman of our Investment Committee continues to be Michael Chae ’86. In addition to Michael, the Committee consists of a core group of trustees who are senior figures in the world of finance and investments. Advisory consulting services are provided by Cambridge Associates and Bill Bardel ’57, the School’s former CFO.
Looking forward, the Committee would expect that there will be some rotation back to parts of the world that were shunned in 2011-12, particularly if the European situation is clarified. Nonetheless, the risk of bad geopolitical events in the world remains high, and asset prices have increased in recent months, so we continue to focus on the defensive quality of our portfolio. July and August were positive contributors to the endowment, with a gain of 1.8% and assets rising to $329.1 million, which perhaps portends a stronger 2012-13 for endowment growth.
The magic of a Lawrenceville education derives from our outstanding faculty, staff, and students and magnificent facility. Our expenses, therefore, are appropriately focused on people, financial aid and facilities, which comprise 53%, 16% and 16%, respectively, of our total annual cost per year. However well this profile suits our mission, there is a financial downside: these costs are more exposed to the expensive elements of the inflation index (Consumer Price Index or CPI), and less to the CPI’s cost-reducing elements, such as automation and technology, which are hard for a school like ours to leverage. This lopsided exposure accounts for why, in general, private school costs, as well as college and university costs, tend to go up slightly faster than the CPI and why revenues must go up commensurately to balance annual budgets.
In the last fiscal year, we continued to manage our costs aggressively without cutting into our remarkable program, and we once again closed the year with our budget in balance. Although a challenge, we are proud to have contained the growth of all but three of our cost categories to the CPI rate or below since 2003. Consistently putting pressure on our budgets, however, has been the rise of a key “people cost,” the cost of employee benefits led by health insurance, which has increased at nearly triple the rate of inflation across this period, pulling up our total cost profile. Financial Aid has also increased in lock-step with tuition to help us retain the same percentage of students on aid. Energy costs had out-paced them all until the 2008-09 recession tempered the surge in that category. While there is little we can do to fight the strong national trend in health insurance costs, and while maintaining and growing our Financial Aid program is a priority, we did manage to reduce our $1 million cost of electricity last year by 35% and lock in a lower price for 20 years. We accomplished this by commissioning a 30-acre, 6-megawatt solar field on our adjacent farmland, an array that is now producing roughly 90% of our power supply in an ultra-green form. Cost control, therefore, has been one of our strong points, and this remained the case in fiscal 2011-12.
After determining our spending needs and ambitions for each fiscal year, we then determine if and how we can generate revenue to fund them. The material revenues for a nonprofit institution like ours come in two basic forms – gifts and tuition. We think of gifts in two categories: gifts for posterity, which are donated to our endowment and on which we draw and spend about 5% each year; and gifts for use in the current year, which flow directly from donors to our Annual Fund and our Annual Parents Fund.
Turning first to the endowment, we are proud to note that we have earned a compound annual rate of return of 8.19% since we began tracking the endowment’s annual returns in 1996. With inflation of 2.44% during this period, the real annual return earned over the period was 5.75%, which effectively covered our annual draw for operations. In the current financial environment, it feels imprudent to us to maintain a draw rate at or above 5%, so we took the step this year to reduce the rate to 4.75% on our way to potentially lower rates, depending on how market returns evolve. While this reduced draw rate will help our endowment grow, it also reduces the contribution to our cash earnings needed to run the School.
Helping us compensate for this reduced rate of draw, we were delighted that our alumni, parents and friends bucked the national mood of austerity by returning our Annual Fund and our Annual Parents Fund to pre-2008 levels for the first time. Together these gifts provided roughly $5.6 million toward the fiscal year’s operating budget, vital support that is most gratefully received.
In spite of solid cost control over the items we could manage and renewed donor support for our Annual Fund, the combination of our more conservative endowment draw rate and above-CPI growth in some cost categories still left us with a need to raise tuition by approximately 5% across both boarding and day populations. The focus we place every day on making Lawrenceville a great and rewarding school helped us find support for this tuition increase across our growing applicant pool. Of course our goal is not to drive up the cost of a Lawrenceville education; rather our goal is to manage the financial levers we have to preserve the strength of our great School while delivering value-for-money that will continue to attract the highest-quality applicants. With our average annual cost per student still exceeding our boarding tuition by roughly $24,000 per year and our day tuition by roughly $33,000, we are confident that we are delivering on this challenge.
By mid-August, a race was on: trenches that had crossed the campus from the Main Gate to the Pond were being filled and paved while pre-season athletes were at home packing to return to us. Another summer of heavy construction was coming to an end, and our contractors were struggling to get us ready. We won the race, but barely!
Familiar to many by now was the need that emerged six years ago to replace our underground steam heat distribution system of nearly a half-mile of large pipes running beneath our campus. A six-summer, $24 million capital project was launched to replace these lines and, with trenches open, to upgrade our storm water drainage system and replace our fresh water distribution system. In this program we also funded the repair of many building “envelopes,” including our slate roofs that are mandated by our historical status and the roofs and siding of many faculty houses. With five summers gone, we are excited to bring this huge and disruptive project to a close in September 2013.
We are also now mid-stream on the Pop Hall renovation project that we launched early this year. In addition to refurbishing the two main classroom floors, we have blown out the basement to create a student technology center, pulling the soil back from the basement walls to allow plenty of sunlight to stream in through enlarged windows. Those of you who, like me, took classes or tended to School clubs in Pop Basement won’t begin to recognize the floor when we’re finished next June, 2013, and that is a very good thing!
Readers of this report and visitors to campus will have noticed that, in recent years, the School has invested relatively more resources in the repair and maintenance of our campus – failing steam lines sent us a message we couldn’t ignore, in spite of high cost. This year we are adding to our recent investment with the appointment of a new Director of Facilities Services & Campus Safety, Helen Livingston, who hails from the far larger campus system of Rutgers University, where she directed large teams across 9 million square feet of structures compared to our 1 million. We welcome Helen with best wishes, and we thank Gary Skirzynski for his leadership of Buildings & Grounds for the last 10 years; Gary will now specialize as the Director of Capital Projects, responsible for new construction and significant renovations, such as Pop Hall.
Closing my sixth year since I traded my banking career at JPMorgan for the CFO and COO roles here at Lawrenceville, I remain impressed, and still daunted, by the challenges and excitement of working with our Board and with Liz and her most able Senior Staff to run our great School. Our strengths are so many and our exposures so few, but the world is increasingly complex; regulation is driving up our cost of administration, and governments, hurting for cash, threaten our tax-exempt model. Nonetheless, the prospects for Lawrenceville remain excellent. Entering fiscal 2012-13, your School is very strong and our students are among the luckiest in the world. We are working hard to keep it that way.
With very best regards to the Lawrenceville community,
Wesley Brooks ’71 P’03 ’05
Chief Financial & Operating Officer