Education & Workforce Development and Philanthropy

ERODING FOUNDATION: Endowment's assets fall with Lilly stock; heavy sale of shares dim chances for rebound

December 12, 2005
Endowment's assets fall with Lilly stock; heavy sale of shares dim chances for rebound Wall Street is chipping away at Indianapolis' most-venerable philanthropic institution.

The value of Lilly Endowment's primary asset-Eli Lilly and Co. shares-has dropped by more than half since 2000, forcing leaders to sell additional shares in order to give away hundreds of millions of dollars as required each year.

Still, the privately run endowment remains a major Eli Lilly shareholder, with nearly 148 million shares of the company's stock. Now hovering around $50, Lilly's slumbering shares are down dramatically from the $93 they fetched five years ago.

As a result, the endowment's value tumbled from $15.5 billion to $7.5 billion, renewing questions about whether it should diversify its investments.

"It is a sizable drop," said Daniel Borochoff, president of the American Institute of Philanthropy in Chicago. "A non-profit could be accused of acting irresponsibly by letting their funds fall so drastically."

To make matters worse, the endowment has sold 21 million Lilly shares to fund its grantmaking in the past five years, which will make it more difficult to rebuild the asset base even if the stock regains value.

At the $93-per-share level, the endowment would be worth about $2 billion less than its 2000 value. And regaining that lost ground will be an uphill battle, Borochoff predicted.

For beneficiaries of the endowment's largesse, the decline in assets means there is less money to go around than in past years. The Internal Revenue Service requires foundations to distribute at least 5 percent of their assets each year. So a poor-performing Lilly stock takes its toll on assets and grants alike.

Indeed, Lilly Endowment's annual grant payments dropped from $579 million in 2000 to $422 million last year. Grants are expected to increase to $432 million this year, but likely will be lower in 2006, as a result of Lilly shares slipping from a 52-week high of $58.47 in April to a low of $49.79 in October.

"We do the best with what we have," endowment spokeswoman Gretchen Wolfram said. "It's still a big chunk of money."

To be sure, the endowment has been a blessing for not-for-profits in Indiana and elsewhere. Since it was founded by members of the Lilly family in 1937, it has doled out $5.6 billion in grants while ranking among the wealthiest foundations in the nation.

And most of its money stays close to home. In 2004, more than two-thirds of the $422 million went to Indiana organizations, ranging from American Cabaret Theatre to the University of Indianapolis.

Is diversifying the answer?

Still, the debate continues over whether the endowment should diversify its holdings to avoid the volatility of relying on a single company.

Among the 10 largest foundations in the country, the Michigan-based W.K. Kellogg Foundation is the only major organization that holds stock in a single company. It isn't experiencing the same problems, however; its assets grew more than 15 percent last year, according to The Chronicle of Philanthropy.

Another large endowment, the David and Lucile Packard Foundation in California, chose the diversification route in 2002 after the organization's assets fell from $13.1 billion to $4.8 billion.

The Packard Foundation scaled back its ties to computer-maker Hewlett-Packard and spin-off Agilent Technologies, which had represented 80 percent of its assets. They now make up about 10 percent, said foundation spokesman Chris DeCardy.

Although founder David Packard, who died in 1996, encouraged the foundation to invest in Hewlett-Packard stock, it was not legally bound to do so, DeCardy said. Foundation managers made the move to avoid large swings that can occur with a single investment, he said.

The Lilly Endowment also isn't legally bound to a single stock, and Paul Coan, managing partner of locally based Wealth Planning & Management LLC, doesn't think it should.

"Anytime you're talking about a billion dollars, and it's on the negative side, it should be a concern," Coan said of Lilly Endowment's free fall. "A $7 billion loss in a portfolio-even Bill Gates would feel that."

With $27 billion in assets, the Bill & Melinda Gates Foundation in Seattle ranks as the nation's wealthiest foundation. Lilly Endowment occupied the top spot on the Chronicle's list in the late 1990s, before the Microsoft founder launched his foundation.

Last year, Lilly Endowment dropped from second place to fourth as its assets plunged more than 20 percent, the sharpest drop among any of the top 10 foundations.

Wolfram said endowment directors have stuck with the Lilly stock concentration after receiving investment advice from numerous sources. Historically, she said, the focus has served the endowment well. She noted that when she came aboard in 1992, assets totaled just $2.9 billion.

Efforts to speak directly with endowment directors and executives were unsuccessful. Calls left for them were channeled to Wolfram.

John Mutz, who served as endowment president from 1989 to 1993, successfully advocated diversification at the Indianapolis-based Lumina Foundation for Education, a $1 billion not-for-profit formed in connection with Sallie Mae's purchase of USA Group in 2000. But Mutz, now Lumina's chairman, said it would not be appropriate for him to question the endowment's judgment.

John Griswold Jr., a senior vice president at Connecticut-based Commonfund, a fund manager for more than 1,500 not-forprofits, advises all his clients to diversify.

"They're taking a big concentration risk when they invest in one fund, no matter how strong the company," he said.

Believers in Lilly

As its assets have declined, Lilly Endowment has needed to sell more shares to meet grant demands. Proceeds from the sales augment the more than $200 million it collects each year in cash dividends on Lilly stock.

The foundation sold roughly 2.9 million shares in 2004 to help cover $432 million in grants this year. Because Lilly stock is trading at lesser amounts than last year, the endowment so far in 2005 has unloaded about 600,000 more shares to prepare for 2006 payments.

It has sold as many as 5 million shares in a given year.

With fewer resources, the endowment has scaled back grants directed toward its three areas of focus-community development, religion and education.

All told, the endowment awarded $78.6 million to community development endeavors in 2004, compared with $187.4 million in 2000. It gave $108.4 million to religious activities and $234.9 million to education interests last year, down from $141.5 million and $249.9 million, respectively, in 2000.

Despite the risk of volatility, Brian Payne, executive director of the Central Indiana Community Foundation, understands why the endowment remains so closely tied to Lilly.

"There is a comfort knowing a hometown charitable organization controls a significant amount of Eli Lilly stock," he said. "Like anything, there's the good and bad in any investment. I believe Lilly stock will rise again, and we'll be huge beneficiaries of it."

That prospect seems dim in the short term, according to an analyst at UBS Investment Research. The firm on Dec. 7 lowered its Lilly price target to $56 from $58, citing tempered forecasts for depression treatment Cymbalta and lingering risks to schizophrenia drug Zyprexa.

But Gene Tempel, director of the Center on Philanthropy at Indiana University, said the endowment's 13-percent stake in the drugmaker provides benefits beyond the financial, reducing the likelihood the company will sell or move its headquarters.

Indeed, Eli Lilly requires that any merger proposal opposed by its board must win 80-percent shareholder approval. That provision, combined with the endowment's big stake, makes the company difficult for unwanted suitors to penetrate.

"The holding of this endowment in a local corporation has some value in the community, in trying to help that local corporation stay local," Tempel said. "All of us would have a tough time imagining Eli Lilly not being here."
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