Appalachian spring

A shrewdly managed $862 million endowment enables Berea College to charge no tuition. Only needy students may apply.

Perched on a ridge where Kentucky’s Bluegrass region meets the Appalachian foothills, tiny Berea College, 35 miles south of Lexington, stands tall among America’s institutions of higher learning. Founded by abolitionists in 1855, Berea was the South’s first coeducational, interracial school. Today the lone private liberal arts college in the U.S. to charge no tuition, it provides an education only to those who can’t afford it. Most of its 1,500 or so students hail from Appalachia, which Berea defines as stretching from northern Mississippi to southern Pennsylvania and encompassing part or all of nine states. The typical Berea student’s family gets by on $27,000 a year.

“It’s a noble mission,” says Catharine Hill, provost and professor of economics at Massachusetts’ Williams College, which charges $31,548 a year in tuition. “Berea makes a quality higher education available to students whose families don’t have very high incomes.”

“It was my cheapest option and the place I wanted to go,” says Rebecca Trembula, a senior from Cub Run, Kentucky, who is majoring in Japanese studies and Spanish. “I can study without the stress of taking out loans and constantly worrying about money.”

Berea provides a top-notch education. In the U.S. News & World Report college ranking published last month, it is listed as the top comprehensive college in the South.

The school stands out as well for its approach to finance and investment. Unlike most colleges and universities, which rely on tuition payments for about 60 percent of their operating budgets, Berea draws on its endowment (though it does charge each student $5,496 a year for living expenses and insurance). By order of its trustees, the college spends about 5 percent of its endowment each year.

In the year ended June 30, Berea harvested $36 million in dividends and capital gains from the endowment. It used $27.5 million to cover roughly three quarters of its $36 million operating budget; the school made up the balance through donations and students’ federal and state scholarships. The remaining $8.5 million of endowment income went to debt servicing -- mostly for capital projects -- and to outreach programs and other special purposes.

Berea’s endowment -- $862 million as of June 30 -- happens to be one of the richest of any small liberal arts college, much larger than those of such better-known schools as Bowdoin College ($578 million), Carleton College ($536 million) and Oberlin College ($615 million). The figures are more impressive still on a per-student basis: about $575,000 for Berea versus some $361,000 for Bowdoin, $282,000 for Carleton and $220,000 for Oberlin (which, incidentally, supplied Berea with its first teachers).

The National Association of College and University Business Officers (Nacubo) ranked Berea’s endowment 64th nationwide and eighth among private liberal arts colleges as of June 30, 2004, the latest reckoning available. Considering that Berea alumni who strike it rich can’t, by definition, send their children to their alma mater and thus don’t have a legacy tie, building such an ample endowment was no easy task. It took a combination of dedicated fundraising -- and, on the investment side, some savvy market timing.

Small donations, 80 percent of them from individuals who did not attend the school but applaud its mission, have built up the endowment over the decades. But the growth, which began in the mid-1980s, took off in the early 1990s, a few years after the college, in an effort to kick-start the endowment’s performance, began to recruit finance professionals to serve on the trustees’ eight-person investment committee. Guided at first by venture capitalist James Bartlett and eventually by a group of Goldman, Sachs & Co. veterans -- current committee chairman Glenn Fuhrman ran that firm’s special investments division -- the committee has steered what was a decidedly staid investment portfolio into some eye-opening alternative investments.

In the mid-1990s, Berea made well-timed bets in venture capital that led to stakes in Cisco Systems and JDS Uniphase Corp., both of which the investment committee shrewdly cashed out of, for the most part, before the technology bubble burst. Then in the late 1990s, the college moved into some top-performing hedge funds. As a result, Berea’s endowment soared from $312 million in 1992, when Bartlett became chairman of the investment committee, to $861 million in June 2000. In fiscal 2000 the endowment returned 38 percent.

“The 1990s were the heyday. The returns allowed us to set up a separate income stream for capital projects and emergencies,” says Larry Shinn, 63, the Methodist minister and scholar of world religions who has served as Berea’s president since 1994. But, he adds, “if you ask what keeps me awake at night, it’s the market. I don’t worry about having enough students, but I do worry about the endowment. It’s the tuition replacement stream for us.”

Helping Shinn sleep at night is the goal of Fuhrman, who has chaired the investment committee since October 2003. The former Goldman Sachs managing director is comanaging partner of MSD Capital, based in New York, which invests more than $11 billion of the wealth of personal computer kingpin Michael Dell. His work at Berea, Fuhrman says, is something special: “You meet these kids and you just kind of fall in love with the place and the mission. It’s easy to get hooked and try to help out.”

Fuhrman and his investment committee are doing their job well for Berea. In the 12 months ended June 30, 2005, the endowment returned 10.8 percent, outdoing the 5.6 percent gain for the Standard & Poor’s 500 stock index. For the five years ended June 30, 2004, the endowment returned an annualized 6.74 percent, compared with the average 4.9 percent return for educational endowments of $500 million to $1 billion, according to Nacubo. Over the ten years through the middle of last year, the endowment returned an average annual 10.8 percent, exactly matching the average.

Berea’s asset allocation targets are fairly typical of an endowment its size: 60 percent domestic and international stocks, 19 percent fixed income, 10 percent private equity (including venture capital, buyouts, distressed debt and real estate), 10 percent hedge funds and 1 percent cash. The private equity allocation hit 32 percent at its peak in 2000. The college’s public and private equity targets are both slightly higher than the 57 percent and almost 7 percent averages, respectively, for similar-size endowments. On the other hand, Berea’s targeted 10 percent hedge fund allocation is below comparable plans’ 14.4 percent average. The school’s actual allocations are close to their targets -- except in the case of hedge funds, where Berea is trying to catch up from a recent level of 4.8 percent. A desire to invest only with top managers and a distaste for hedge funds’ high fees have been holding it back. The school indexes all of its large-cap stock holdings and one third of its small-cap; these passive funds make up 38 percent of its portfolio.

Berea spends about $24,000 per student annually, placing it in the middle ranks of private liberal arts schools. It must run ever faster to keep up with accelerating costs. It lays out about one third of its operating budget for faculty, allowing it to maintain a low student-teacher ratio of 10-to-1 and an average class size of 16. Another third of this year’s budget supports administrative staff; the rest is absorbed by maintenance, fuel and other costs.

Berea’s growing endowment has enabled Shinn to give every student a personal computer (a Dell, though the program began before Dell money manager Fuhrman arrived), admit more foreign students and spend millions of dollars on educational outreach programs in Appalachia. Lacking tuition revenue, Berea feels extra pressure when its endowment performs poorly. Shinn, who had to leave some faculty positions unfilled following the tech stock crash in 2000, worries that over the next decade it will be increasingly difficult to earn the 8 percent annual returns needed to prevent the endowment from eroding: 5 percentage points to cover spending and 3 percentage points to offset inflation.

Nor is fundraising a surefire way to make up any shortfall. “For those who didn’t graduate from Berea, we’re usually the second, third or fourth charity,” Shinn says. “They have to get a sense of why they should give here.” What’s more, he adds, Berea faces tough fundraising competition from public colleges and universities that anticipate cutbacks in state aid.

Then, too, there’s what might be called the golden-beggar’s-bowl syndrome. With its $862 million endowment, Berea may not seem particularly needy. “Harvard, Swarthmore and Oberlin don’t feel at all uneasy about asking people to donate to their endowments,” sighs Shinn. “There’s a certain irony we face in having to apologize for an endowment even when we have no tuition income.”

Nonetheless, in the 12 months through June, Berea managed to raise $25 million, in large part because Shinn spent some 100 days on the road, often staying in the homes of donors.

BEREA COLLEGE BEGAN IN 1855 AS A ONE-ROOM schoolhouse. John Fee, an abolitionist clergyman, built a simple wooden structure on ten acres of land donated by a local resident, Cassius Clay, who favored emancipation. Although Kentucky was a slave state, half of the early students were freed slaves; the other half were mostly white mountaineers loyal to the Union. The school, which first aimed to provide vocational education, was named after a biblical town known for its open-mindedness. In 1859 pro-slavery sympathizers forced Berea to close. It reopened after the Civil War.

At first Berea charged tuition, although students and faculty worked to help pay the bills. They farmed, raised cattle, made bread, sold handicrafts and constructed campus buildings, several of which are still in use. The school paid students 12 cents an hour for labor in 1892 -- the year it abolished its $15 annual tuition to further its mission of serving the neediest students.

After the Kentucky legislature passed a law in 1904 that banned interracial education, black students were forced to leave Berea College. (About one fifth of its students today are African-American.) That year Berea gave $200,000 to the Lincoln Institute, an all-black college near Louisville, which steel magnate Andrew Carnegie matched. The result was two schools that were equally funded.

The Great Depression challenged Berea’s no-tuition policy. College president William Hutchins was forced to cancel admissions for new students for the 1932'33 school year. The school decided to put all bequests into an endowment rather than use them to pay current expenses. As the depression ground on, Hutchins sought to enrich students’ lives by shifting Berea’s focus away from vocational education toward professional training and liberal arts. During World War II the Navy sent sailors to Berea for training.

Over the ensuing decades a steady stream of small donations added to the college’s endowment. In 1985 it was up to $150 million and ranked 50th among all U.S. colleges. At about that time, Berea began to recruit financial professionals for its investment committee. A longtime trustee, Kate Ireland, the scion of a wealthy Cleveland coal mining family and a supporter of Appalachian causes, set the process in motion. In 1986 she placed a call to Bartlett, then a partner at Cleveland private equity firm Primus Venture Partners. Ireland knew his mother-in-law, with whom she had served on the board of Frontier Nursing Service, a Kentucky-based family health care system. Bartlett had never heard of Berea, so Ireland invited him to visit the campus in May, amid the splendor of an Appalachian spring.

“That first encounter was something great,” says Bartlett, 68. “It is such a marvelously pure mission in every respect.”

Thoroughly won over, Bartlett joined the investment committee in October 1986 and the following year enlisted R. Elton White, a Berea graduate and then-president of computer company NCR Corp. In Bartlett’s first few years on the committee, the endowment, like those of most of Berea’s peers, continued to be conservatively managed, but it delivered good returns, reflecting strong markets for both stocks and bonds. By 1989 it was valued at $252 million, with 13 percent of assets in cash, 55 percent in large-cap stocks, 30 percent in bonds and only 2 percent in alternative assets (specifically, real estate).

Though the endowment was growing at a good pace, Bartlett hoped to spark a more aggressive investment approach. To that end he brought in further outside financial expertise. In 1990 he recruited as new trustees and investment committee members Martin Coyle, thenexecutive vice president and general counsel of defense contractor TRW (his mother had attended Berea); and David Swanson, then a senior vice president and director of Procter & Gamble Co. Two years later Frederick Dupree Jr., vice president of Dupree & Co., a Lexington-based manager of single-state municipal bond funds, joined. By the time Bartlett became chairman of the investment committee in 1993, seven of its eight seats were filled by people with business or finance backgrounds.

In 1993, Berea invested $3.5 million in a venture capital fund of hedge funds run by Wilton, Connecticutbased Commonfund that invested in Greylock Partners, Kleiner Perkins Caufield & Byers, Sequoia Capital and other Silicon Valley venture capital stars. The Commonfund investment eventually netted the college $13 million, an internal rate of return of 48 percent through March 31, 2005. “We could never have gotten into those as little old Berea College,” says Bartlett, “but Commonfund had clout and a history of helping colleges.”

Berea next moved into two venture capital funds that launched in 1995. Matrix IV, managed by Waltham, Massachusettsbased Matrix Partners, netted Berea $57 million, an internal rate of return of 250 percent through March 31 (the fund has since closed), thanks chiefly to timely sales of shares of Cisco, and Sycamore Networks in 2000. Summit IV, run by Boston-based Summit Partners, generated $18.5 million in net proceeds for Berea through March 31, 2005, an internal rate of return of 96 percent. The gains largely reflect sales of JDS Uniphase stock in July 2000.

In early 1996, in a move that would modernize the management of Berea’s endowment, Shinn recruited William Gruver to the investment committee. The pair had met several years earlier at Bucknell University, where Shinn spent ten years as a professor of religion and vice president for academic affairs and Gruver taught courses in investment and international relations. Before that, Gruver had spent two decades at Goldman Sachs, rising to become chief administrative officer of the equities division.

Gruver told Berea’s investment committee that the asset mix was, as he says now, “far too limited and too conservative for a place that was going to live on its endowment.” Even though Bartlett had moved some funds into venture capital, the bulk of the assets remained in stocks and bonds, almost all domestic.

Gruver, Bartlett and the other members of the investment committee also believed that they were not qualified to select money managers. “We were running about $450 million and needed professional help,” Gruver says.

Because Berea couldn’t offer a salary that would attract a qualified in-house CIO, the committee decided in the summer of 1996 to outsource the position. The finalists were Berea’s consulting firm, Boston-based Cambridge Associates, and Hirtle, Callaghan & Co., a West Conshohocken, Pennsylvania, firm set up in 1988 by several Goldman alums, in which Gruver had a small equity stake. Gruver, a member of Hirtle Callaghan’s advisory board, recused himself from the committee’s discussion, which ended in a decision to hire the firm. After the vote Gruver resigned from the investment committee, although he continues to serve as a trustee.

“Cambridge was preaching diversification and had gotten us pointed in that direction. But we knew Hirtle Callaghan would really pay attention,” says Bartlett.

Hirtle Callaghan began with the basics. After the consulting firm took over from Cambridge in July 1997, it asked the investment committee to write a statement of Berea’s investment goals and policies. That led to a broadening of the college’s investments into hedge funds and international stocks.

In July 1998, Hirtle Callaghan eased Berea into the top echelon of hedge funds with a $10 million commitment to AQR Capital Management, a firm set up earlier that year by Clifford Asness and other exGoldman employees. When Long-Term Capital Management blew up a month later, the Berea investment committee had a few anxious moments but stood by its commitment to hedge fund investing, as did Hirtle Callaghan. “We believe in strategic thinking, not hot money,” declares the firm’s co-founder, Donald Callaghan. Berea’s original stake in AQR, which had lost about 20 percent at one point in the late 1990s, was valued at $14.8 million on June 30, 2005. In December 1998, Berea committed $10 million to Duquesne Capital Management, a fund run by Stanley Druckenmiller, the former lead portfolio manager of Soros Fund Management.

Hirtle Callaghan viewed those two investments as long-term, but the firm also recognized hot money when it saw it. In 2000, Berea’s venture capital partners -- in addition to Summit and Matrix, the group included Austin Ventures of Austin, Texas, and Centennial Ventures of Denver -- began distributing stock in Level 3 Communications, Nortel Networks and Sycamore Networks. Hirtle Callaghan advised the endowment to sell as quickly as possible. “We didn’t hold a single position any longer than the hours it took to trade it out,” says Bartlett. For the 12 months ended June 30, 2000, Berea had net proceeds of $200 million from sales of stock distributed by its venture partners. “We took a huge amount off the table and moved to rebalance, rebalance and rebalance,” Bartlett recalls.

Rebalancing cushioned the blow from the bubble’s bursting. Still, Berea’s endowment felt the shock waves. In the 12 months through June 30, 2001, it lost 6.5 percent, compared with a 5.2 percent average decline among endowments of similar size, according to Nacubo. Over the next 12 months, Berea’s investments fell 7.5 percent, versus a 5.3 percent average decline for its peers. And in 2003 it gained 0.3 percent, compared with 2.9 percent for the typical endowment of its size.

Berea soon dusted itself off and resumed its search for alpha. The endowment is using whatever connections it can to boost its hedge fund allocation. Investment committee chairman Fuhrman, whose group at Goldman invested in private equity and distressed real estate, helped Berea channel $17.5 million to New Yorkbased Eton Park Capital Management, the hedge fund started last November with more than $3 billion -- a record launch -- by former Goldman partner and proprietary trading whiz Eric Mindich.

“Glenn Fuhrman made sure that Eric knew of Glenn’s relationship with Berea, and he knew that I was associated with it as well,” says Andrew Derrow, a Hirtle Callaghan director and former portfolio manager in Goldman’s private wealth group who helps manage Berea’s endowment. Other investors in Eton Park include Harvard University and Goldman Sachs, he adds.

The search for other hedge fund managers goes on. “Part of Hirtle Callaghan’s marching orders was to find us some hedge funds to fill our allocation,” says Lexington fund manager Dupree, who at 78 retired from the investment committee in May. “But they’ve been unable to find what they regard as quality management and funds,” he says. Adds Hirtle Callaghan’s Derrow: “It’s not something that’s killing anyone. If the opportunity arises, then there will be ample opportunity to fund additional managers.”

Berea will likely have to take on more risk in the coming years to deliver the 8 percent returns putatively needed to keep up with inflation while continuing to dispense with tuition payments. If the money spun off by the endowment were to decline significantly, Shinn would no doubt scale back the college’s $1.4 million outreach program, which helps Appalachian students prepare for college and provides support for medical clinics and other nonprofits. Jobs might also be cut.

“We could handle a 5 to 10 percent decline in the budget without destroying our program,” says Shinn. “But if we must cut 30 percent, then that would be a different question.” At that point, Berea could enroll fewer students. Charging tuition, the president says, would be a “last resort.”

“I’m not sure what we would do differently if there were a downturn,” says Bartlett, who resigned from the investment committee in May to devote more time to his big fundraising campaign at the Cleveland Museum of Art. “Where do you run and hide in a world like this? The salvation for an endowment like Berea’s is diversification and good managers.”

Ironically, the more successful the college’s high-power investment committee is at increasing the endowment, the more trouble it could cause for the president. Shinn could encounter an even greater fundraising test when Berea’s endowment eclipses $1 billion. “That will be a real challenge,” he notes. He’s sure that his best bet will be to invite prospective donors to the leafy campus to talk to students. “They’re the reason to be giving to Berea,” he says.