A New Investment Concept: Total Return
VICE PRESIDENT AND TREASUREROF THE COLLEGE
WITH the approval of the Board of Trustees, the College has adopted a new concept for determining the amount of annual financial support that its invested funds will provide for current operating expenses.
This new concept will apply to substantially all of Dartmouth's invested funds and will be effective for the first time for the fiscal year beginning July 1, 1969. It is popularly known as the "total return" concept. Its adoption and implementation were approved by the Trustees after prior review by the Executive, Investment, and Budget Committees of the Board.
"Total return" consists of two elements, "yield" and "appreciation." "Yield" represents dividends, interest, rent, and other forms of ordinary investment income. Until now only yield has been used in support of current operations. "Appreciation" is enhancement in the market value of the investments held by the College. Appreciation may be either realized or unrealized. A concomitant of appreciation is "depreciation" or decrease in market value. Although the long-term trend in stocks and other equities has been upward, in any given fiscal year there may be depreciation rather than appreciation. Hence, this factor has to be taken into account.
Dartmouth's primary objective in adopting the total-return concept for most of its invested funds is to deal on a more rational basis with the ever-present problem of determining the amount of support from the College's invested funds for present budgetary needs and the amount of such support to be reinvested to provide for future needs. An investment policy which has as its objective maximizing current yield necessarily favors the present at the expense of the future, because investments with a high current yield usually do not offer much promise of higher yield in the future. As a result, high yield investments in the long run generally fail to maintain the purchasing power of the dollar. Conversely an investment policy of maximizing growth of a portfolio will normally penalize current yield and thereby deny the Dartmouth of today its proper share of financial support in order to help provide for the Dartmouth of tomorrow. The total-return concept is an important step toward achieving a more equitable balance between these two concerns.
In the past, Dartmouth has utilized only yield for current operating purposes. For the most recent ten years, the annual average yield rate, computed on a compounding basis, has been about 3.6% per annum as compared with an average total return rate of 10.7% for the same period. The range in this ten-year period was from a high of 22.8% in one year to a low of minus 8% in the year ended June 30, 1962. The median was 15.0% for the ten-year period, which indicates that the ten-year average rate was unduly affected by the very low market values on June 30, 1962, the year-end.
Under the total-return concept, as it will be applied by Dartmouth, yield and appreciation will be added together to compute total return. Of this total a prudent portion will be used to support current operations. For 1969-70, for example, how much of this support will come from yield and how much from appreciation will not be known until after the fiscal year has ended on June 30, 1970. During the year the Investment Committee and the College's investment manager will be free to shift investments so as to maximize total return without being concerned as to the effect of investment shifts on current yield. For example, a particular common stock currently yielding 5% but promising little or no increase in yield and little or no appreciation in market value may be sold and the proceeds invested in another stock yielding as little as 2% but with good prospects of appreciation, without any detrimental effect on the current budget resulting from the reduced yield.
The portion of total return to be used for current operating purposes in any given year will not depend on the actual yield and appreciation (or depreciation) for that year. This portion will be determined by the Trustees year by year on the basis of what a prudent man would deem to be reasonable. Factors to be taken into account in this decision include the average total return over the three- to five-year preceding period, the anticipated average total return for the next three to five years, long-term trends in investment performance generally, trends in the general economy (especially the rate of inflation), trends in yield rates on both fixed income obligations and equities, and other relevant factors. For any ten-year period and for most single years in such period the portion of total return utilized currently is expected to be less than the full amount of total return both for the entire period and for most single years. In some single years, however, the amount used currently may exceed the actual total return for those same years.
To illustrate the total-return principle, for 1969-70 the Board of Trustees approved 4.9% as a prudent rate for determining the amount of support for current operations from most of Dartmouth's invested funds. This rate was used in preparation of the preliminary budget for 1969-70. It will be applied under a formula to the total of (1) the average market value of the College's investments (excluding the investments of life income trust funds and the investments of certain other special or unique funds) computed for the three prior fiscal years set back one year (for 1969-70 the average of the three years ended June 30, 1968, 1967 and 1966), plus (2) the average annual amount, on a net basis, of new or additional invested funds derived from gifts, bequests, additions to principal, and other sources, again computed as the average of the three prior years set back one year (fiscal years ended June 30, 1968, 1967 and 1966). This formula is designed to smooth out the sharp fluctuations in total market value which occur from year to year and which would make it undesirable to use the market value of any single June 30 fiscal year-end. This averaging process with a one-year set back, moreover, is in itself a prudent approach to determining the amount of support for current purposes. An additional practical advantage of this method is that it makes possible the determination of available revenue from invested funds at least six months prior to the beginning of a new budget year at the time the budget for the new year is being prepared.
It should be stressed that the portion of total return used annually for current operating purposes must be prudent in amount. In determining what is a prudent amount various safeguards will be applied. Among these is the averaging process set back one year referred to above. Another is the historical record of average total return over preceding periods, as, for example, the immediately preceding ten-year period. Conceivably, if this average total return on the ten-year basis falls below the 10.7% referred to earlier, it might be deemed prudent to reduce the 4.9% rate for current spending. On the other hand, if the total return rises above 10.7%, this spending rate might also be increased within this rule of prudence.
Two other tests which may enter into determining what is a prudent amount of the total return to be expended for current purposes are the yield rates on the fixed income and equities segments respectively of the portfolio. If the prevailing yield on bonds and other fixed income obligations of good quality is, as it is today, over 4.9%, use of a 4.9% factor would clearly seem to be prudent so long as these rates prevail. Turning to the equities segment a similar test is the "computed yield" on the basis not only of distributed earnings by the companies whose stocks are held by the College but on the total of the distributed and retained earnings of those companies. This test was applied in arriving at the 4.9% rate for 1969-70 and the total earnings, distributed and retained, of the equities segment was in excess of 5%.
The total-return concept has been adopted in varying forms by a number of educational and other charitable institutions and is under active consideration by a considerable number of additional institutions. In some of these instances the total-return concept is applied to all or substantially all the institution's investments. In Dartmouth's case the concept will apply to about 85% of its total invested funds. The publication of the Ford Foundation-sponsored legal study, entitled The Law and the Lore ofEndowment Funds by William L. Cary and Craig B. Bright, in April of this year supports this "across-the-board" approach. Moreover, it is probable that a second Ford Foundation-sponsored study, currently being made by a special ad hoc committee on college and university investment policies and operations, will lend further support to this approach. This latter report is expected late this summer or early this fall.
Other institutions have partially adopted the total-return concept. One leading institution computes its total return on the basis of all its investments but supplements the use of yield by appreciation for current operations by utilizing appreciation only from approximately 20% of its invested funds which are in the nature of expendable funds. A number of other major universities use the total-return concept in an even more limited manner by applying it only to the segment of their invested funds which fall in the category of funds functioning as endowment. In none of these instances is the segment more than 30% of total invested funds.
The Dartmouth Board of Trustees felt that for investment policy reasons Dartmouth should apply the total-return concept to substantially all its invested funds except the relatively small proportion (1) which are subject to life income trusts, (2) which hold special or unique investments for which it is impractical to apply the total-return concept, and (3) to which the total-return concept should not be applied for special policy reasons. Application of the total-return concept to the bulk of its invested funds is believed to be necessary to achieve optimum investment results.
The application of the total-return con- cept to Dartmouth's invested funds will be explained in further detail in Dartmouth's financial reports for 1968-69 and subsequent years.
Treasurer John F. Meck '33
A Hanover tradition, dear to the hearts of thousands of Dartmouth men, is nomore. Tanzi's has closed its store and gone out of business. Harry, Harriet andCharlie Tanzi (l to r) are shown in front of the little emporium that has existed onMain Street since 1897. All the Tanzis have now retired, and beer, fruit, maplesyrup, and fancy foods must be sought elsewhere in town.
