Harvard reported a $77 million budget surplus in the fiscal year that ended June 30, a slight increase over the previous year, but Thomas Hollister, the University’s chief financial officer and vice president for finance, said the positive results came at the start of a challenging financial environment for higher education that he expects to continue.
That environment includes a difficult investment climate that contributed to last year’s 2 percent drop in endowment returns, the impact of which will likely be felt on University spending over the next several years.
Hollister, who met with the Gazette for a question-and-answer session to talk about the 2016 Financial Report, said he was confident the University has the planning structures in place to navigate the years ahead, and he nodded to donors past and present whose gifts are providing nearly half of Harvard’s revenue this year.
GAZETTE: What are the main takeaways from the 2016 financial report and what does it say about the University’s overall strength?
HOLLISTER: It was a solid year and reflects careful planning and prudent management by all of Harvard’s Schools and affiliates. Our results are a consolidation of all of the activities throughout the University, and our goal is to have an operating surplus. It’s important over time to keep our revenues in excess of our expenses. The Harvard Campaign continues to propel the University’s mission and our financial results. This year’s cash receipts were the highest annual amount in the course of the campaign. This past year we were also able to reduce our debt levels from $5.4 billion to $5.2 billion, which strengthens the balance sheet.
GAZETTE: There are financial challenges common to universities across the nation. What are they, and how is the University planning to meet them?
HOLLISTER: The outlook for the traditional sources of revenue for all universities in the United States appears to be quite constrained in the next few years. Let me just touch on each. First, tuition growth will likely be restrained because of affordability pressures. Second, based on recent trends, federal funding for research is likely to continue to be essentially flat from year to year. And third, most economists are forecasting that we have entered an era of lower returns in the capital markets due to a number of factors, including low interest rates, low-risk premiums, and low economic growth around the world. So it looks to be a challenging environment in the next several years for all other research universities as well as Harvard.
GAZETTE: Speaking about lower returns, the Harvard Management Company reported a 2 percent loss in its investments for fiscal 2016. What are the ramifications to the rest of the University for that?
HOLLISTER: We certainly want to see positive investment returns for the endowment, as distributions from the endowment earnings represent our largest source of annual operating revenue. Harvard was not alone for the past year. Most colleges and universities have also reported negative results, but not all.
Low investment returns mean there’s less earnings from the endowment to be distributed into the revenues of the University’s operating budget.
GAZETTE: Is it expected that the Corporation will maintain the current payout rate?
HOLLISTER: Harvard aims to pay out between 4 to 6 percent of the endowment annually, with a target of approximately 5 percent. I believe this past year we were at 5.1 percent. The Corporation board determines the exact amount of the distribution. If you look back through history, Harvard has been careful with endowment distributions, and tried to strike the balance between the current needs of the University while maintaining capacity for future academic and research requirements.
GAZETTE: Ordinary investors have seen their stocks rise. What happened with the endowment? Why are endowment returns different from what someone would get in a retirement account invested in stocks?
HOLLISTER: We, as individuals, do not have the ability to invest in a broad set of asset classes. It’s difficult for individuals to get into hedge funds, for example, or commodities, private equity, or venture activities. Endowments have the ability to diversify amongst asset classes, which is very positive, because diversification protects against really bad times in any one asset class in any one year. More importantly, over time, a broadly diversified portfolio in different asset classes outperforms a narrower investment approach of just domestic stocks, for example, or domestic stocks and bonds, or even global stocks and bonds.
During this past fiscal year, U.S. stocks had a positive year while almost every other asset class suffered. This will happen sometimes. Global equities were down, commodities were down, emerging markets were down dramatically, hedge funds lost money, as well as several other asset classes. Again, however, over time, flexibility and diversification pays off.
GAZETTE: Those same dynamics affected other universities?
HOLLISTER: Oh, yes, the exact same issue. That is why the majority of them had negative returns for the year. This was also true for pensions. Pensions have a different reporting period with calendar year results, but they had similar difficulties during this period.
GAZETTE: We talked about the endowment — a down year there — but as you said earlier, the University overall had a solid year financially. What are the positives?
HOLLISTER: Although the outlook for traditional revenues is muted or constrained, Harvard is showing promising areas of growth. One example would be non-federal-sponsored research, which was up this past year 9 percent. In the face of stagnant federal funding for research, Harvard professors and principal investigators have been successfully finding other sources of research funding — foundations primarily, but also individuals and corporations. Another area of growth I would describe as “lifelong learning.” Harvard’s traditional strength in this area has been the Harvard Business School, with executive education programs, and the Faculty of Arts and Sciences, with continuing-education offerings.
But in the last several years, many other Harvard affiliates have been active in this area. Overall, this less-traditional form of tuition grew last year by 10 percent, and a significant portion of the activity is online. So, it is pedagogically exciting, as it provides people of different demographic and geographic locations … access to Harvard’s exceptional faculty.
Finally, we have seen rapid growth in revenue from royalties and license fees from life-sciences research, technology transfer, and publishing.
GAZETTE: Does that represent increasing success commercializing the work of Harvard faculty?
HOLLISTER: Yes, exactly: intellectual property, patents, publishing, licensing.
GAZETTE: Is this growth a one-year phenomenon, or do you see it continuing?
HOLLISTER: All three of those have been rapidly growing. It’s important to note, though, that these are not as large as some other areas of our revenue. But most of the graduate schools are projecting this to continue.
GAZETTE: Let’s talk about the campaign. How have things been going?
HOLLISTER: The current campaign has materially helped the financial condition of the University. Current-use giving is up 45 percent from levels prior to the campaign. Gifts for the endowment and buildings are up 130 percent from the period prior to the campaign. It’s hard to overstate the importance of philanthropy to the University. If you look at our revenues, 36 percent is distributions from the endowment, which is thanks to the generosity of past donors. Another 9 percent is current-use gifts, thanks to the generosity of current donors. Combined, that’s 45 percent, almost half of our revenues, so Harvard’s aspirations — affordable education for undergraduate and graduate students, groundbreaking research, transformative teaching, beautiful collections — are all made possible because of the generosity of graduates and friends of the University.
GAZETTE: How important is reducing debt to the University?
HOLLISTER: Well, we want to avoid paying unnecessary interest costs, but we also strategically use debt as part of the capital sources of the University. Harvard’s debt is at manageable levels. It peaked at $6.3 billion back in 2010. We have steadily paid that down to $5.2 billion this past year, and, subsequent to the fiscal year’s end, we refinanced about half of our debt to take advantage of lower interest rates. That refinancing should save the Corporation roughly $35 million in annual interest costs, which will be reinvested in University priorities.
GAZETTE: Is there an optimum level of debt for an institution like this, or is it: just as low as possible?
HOLLISTER: Borrowing at appropriate levels is a long-term source of capital in support of the academic mission. So some level of borrowing is perfectly acceptable and sensible. You just shouldn’t do too much. Harvard currently has manageable debt levels, appropriate for our AAA rating, with additional flexibility if needed.
GAZETTE: Let’s talk a little bit more about federally sponsored research. Your forecast was for relatively flat revenues from this area going forward, but we did see a little bit of a bump up this year for the first time since 2011. Is that good news?
HOLLISTER: It’s great, and represents a lot of hard work, and it is a tribute to the Harvard faculty and principal investigators who apply for and compete successfully for peer-reviewed grants and awards. Harvard wins more than its share, but the pool of awards available for peer competitions depends on National Institutes of Health funding as well as other federal research agency budgets.
GAZETTE: So you don’t see an increase in this source of funding in the years to come?
HOLLISTER: I think most informed observers, looking at the political climate in Congress and the federal government’s financial picture, are not encouraged, although the bipartisan support around biomedical research seems to be one bright spot — but without any guarantees.
The non-federal portion of research funding that I mentioned has been growing at a 9 percent clip the last several years. What we’re seeing is a shift from federal to non-federal sources. Combined, about the same percentage of the University’s revenues comes from overall research funding.
GAZETTE: Is there a limit to the amount of non-federal funding out there? Even if it grows for a few years, is there a smaller pool than for federal funding and a point at which it would start to decline? Or is this a resource that’s only begun to be tapped?
HOLLISTER: There is no replacing the role of the federal government as the leading source of basic research funding, but Harvard is increasingly diversifying its sponsored research funding through strong partnerships with non-federal sources. The diversification is increasingly important not just as a funding source, but also as a way to collaborate with foundations and industry partners to translate discoveries into new technologies, treatments, and therapies. Often, non-federal sponsors support work that may be more applied, more targeted, and restricted in purpose. But I do think it’s a significant and positive trend that our faculty are winning awards from foundations and to some degree corporations as well.
GAZETTE: Looking at the spending side of last year’s budget, what are the main takeaways for this year compared to last, and are there any new drivers of expenditures we should be aware of?
HOLLISTER: I would say the proportions are about the same. Happily, revenue growth was 5.6 percent, and expense growth was 5.3 percent. Like all organizations, we have to balance our annual operating budget, and we want revenue growth to match or exceed expense growth.
GAZETTE: How about health care costs? That’s been a driver of personnel costs in the past. I saw a number of 3 percent. That seems a fairly modest increase compared to recent years. Is that the case, and how did the University manage that?
HOLLISTER: Overall, our employee benefits were up 6 percent, and, as you point out, active health was less this past year, at about 3 percent. I think that’s a fortunate result, because we self-insure these costs, and our results depend on our population’s health experience in the course of a year. I would say that health benefits are the most challenging expense category for every for-profit, not-for-profit, or governmental entity across the country. The good news at Harvard is that we have comparatively generous programs, and we can provide our faculty, staff, and students with access to superb health care. The bad news is that national and local medical cost expense trends are running in the 6 to 7 percent range. Finding a way to sustain excellent health and medical benefits for our faculty, staff, and students and also keep a rein on these costs will continue to be a challenge.
GAZETTE: How important is financial aid, and what are the trends there?
HOLLISTER: Thanks to the support of donors, Harvard has among the most generous aid programs in the country for both undergraduates and graduate students. At the undergraduate level, one in five families are not required to pay any tuition because they make less than $65,000. Over half of undergraduates receive aid, and on average they and their families together pay less than $12,000 a year. Also at the undergraduate level, Harvard gives only grants — it does not require any loans — so Harvard students can graduate from the college debt-free.
GAZETTE: How does last year’s financial performance affect the budget going forward?
HOLLISTER: Harvard has advanced processes and disciplines around financial planning. We have annual budgets and annual capital budgets, as well as rolling five-year forecasts looking out into the future, including liquidity planning and reserves for facilities renewal. We try to be ready to manage for all seasons.
This past year’s result is in the rearview mirror, and the Schools and affiliates are now doing five-year planning and factoring in the kind of adjustments that will be necessary in the face of lower revenue growth rates.
GAZETTE: So it’s hard to tell the exact impact until those five-year plans come in?
HOLLISTER: Remember that each School and affiliate is unique. If traditional revenues are down, Schools will have to adjust to that reality, but they may also see faster revenue growth in other areas. The Harvard Campaign is also a strong positive factor. The overall outlook, however, suggests more restraint on spending will be called for than in the last few years.
GAZETTE: How about the University’s growth and construction projects? Anything in particular you want to call out?
HOLLISTER: I think the signature projects are well known. The Chao Center is complete, the Smith Center is well under reconstruction, the Kennedy School’s new buildings are coming together before our eyes, and Winthrop House is surrounded by construction crews. Next up, of course, is the new Science and Engineering Complex in Allston.