Endowments are a vital source of funding for many educational institutions, especially in times of economic uncertainty and budgetary constraints. Endowments are funds that are invested to generate income, while the principal is preserved in perpetuity. The income from endowments can support various purposes, such as scholarships, faculty salaries, research, academic programs, and campus facilities. Endowments can also enhance the reputation and prestige of an institution, as well as its ability to attract and retain talented students and faculty.
However, managing endowments is not a simple task. It requires a careful balance between the needs of the present and the needs of the future, as well as a prudent and strategic approach to investment, spending, and stewardship. In this blog post, we will discuss some tips and best practices for managing endowments for educational sustainability and long-term financial health.
Investment Strategies
The primary goal of endowment investment is to achieve a return that can support the spending policy and preserve the purchasing power of the principal over time. This requires a diversified portfolio that can withstand market fluctuations and inflation risks. According to a survey by the National Association of College and University Business Officers (NACUBO), the average asset allocation of U.S. college and university endowments in fiscal year 2020 was:
- 53% in alternative assets, such as hedge funds, private equity, venture capital, and real assets
- 21% in domestic equities
- 15% in fixed income
- 11% in international equities
While K-12 schools may have endowments, they are generally smaller in size and have different spending priorities compared to higher education institutions. The allocation of endowment funds for K-12 schools can vary widely based on individual school policies, donor preferences, and financial circumstances. Here is a general overview of how endowments for K-12 schools may be allocated, but please note that these percentages can vary significantly:
- 10% in alternative assets
- 30% in domestic equities
- 20% in fixed income
- 10% in international equities
- 30% in cash and short-term investments
Alternative assets have become increasingly popular among endowments, as they offer higher returns and lower correlation with traditional asset classes. However, alternative assets also entail higher fees, lower liquidity, and more complexity. Therefore, endowments need to carefully assess their risk tolerance, time horizon, and objectives before investing in alternative assets.
Another key aspect of endowment investment is asset allocation rebalancing. Rebalancing is the process of adjusting the portfolio weights to maintain the desired risk-return profile and align with the strategic plan. Rebalancing can be done periodically (e.g., quarterly or annually) or based on certain triggers (e.g., when an asset class deviates from its target weight by a certain percentage). Rebalancing can help endowments capture market opportunities, reduce portfolio volatility, and avoid drifts from the long-term goals.
Spending Policies
The spending policy is a set of rules and guidelines that determine how much income from the endowment can be spent each year. The spending policy aims to strike a balance between the needs of the current beneficiaries and the needs of future generations, ensuring intergenerational equity and long-term financial sustainability.
There are different types of spending policies that endowments can adopt, depending on their specific needs, goals, and financial situations. Some of the most common spending policies are:
- Payout rate policy: This policy sets a fixed percentage of the endowment value to be spent each year. For example, a 5% payout rate policy means that 5% of the endowment value at the beginning or end of the year (or an average of several years) will be distributed. This policy is simple and predictable but may not be responsive to market changes or inflation.
- Total return policy: This policy allows spending from both income (e.g., dividends and interest) and capital gains (e.g., realized or unrealized) of the endowment. This policy provides more flexibility and stability but may require more complex calculations and accounting.
- Inflation-adjusted policy: This policy adjusts the spending amount based on inflation or a certain target growth rate. For example, a 5% inflation-adjusted policy means that 5% of the endowment value will be spent in the first year, and then increased by inflation or a target growth rate in subsequent years. This policy preserves the real value of the spending but may result in large fluctuations in nominal spending.
According to NACUBO, the average effective spending rate of U.S. college and university endowments was 4.6% in fiscal year 2020. The majority of endowments used a total return policy (69%), followed by a payout rate policy (18%), an inflation-adjusted policy (7%), or a hybrid policy (6%).
Stewardship of Endowment Funds
Stewardship of endowment funds is the process of ensuring that the funds are used in accordance with the donors’ wishes and the institution’s mission. Stewardship involves communicating with donors, acknowledging their gifts, reporting on their impact, recognizing their contributions, and cultivating their relationships.
Stewardship is essential for building trust and loyalty among donors, as well as for attracting new donors and increasing their giving levels. Stewardship also demonstrates accountability and transparency to internal and external stakeholders, such as board members, faculty, students, alumni, regulators, and auditors.
Some of the best practices for stewardship of endowment funds are:
- Establish a clear and consistent policy for naming, acknowledging, and recognizing endowment gifts, such as naming opportunities, plaques, certificates, letters, events, etc.
- Provide regular and meaningful reports to donors on the performance and impact of their endowment gifts, such as financial statements, investment updates, spending summaries, beneficiary profiles, stories, etc.
- Invite donors to visit the campus, meet the beneficiaries, attend the programs, and participate in the activities that their endowment gifts support.
- Solicit feedback from donors on their satisfaction, expectations, and preferences regarding their endowment gifts and stewardship activities.
- Express gratitude and appreciation to donors for their generosity and commitment to the institution’s mission and vision.
Endowments are a vital source of funding for many educational institutions, especially in times of economic uncertainty and budgetary constraints. However, managing endowments is not a simple task. It requires a careful balance between the needs of the present and the needs of the future, as well as a prudent and strategic approach to investment, spending, and stewardship. By following some of the tips and best practices discussed in this blog post, endowments can enhance their long-term financial health and sustainability, as well as their contribution to the educational excellence and social impact of their institutions.
Chazin & Company
With over 19 years working exclusively with nonprofits, we pride ourselves in having a unique understanding of nonprofit accounting needs. We believe that nonprofits deserve personalized, quality service and should not settle for a one-size-fits-all approach. We collaborate with you to provide a fully virtual and customized solution that is not only cost-effective but also strengthens your accounting function. We offer a team of industry experts at your disposal to provide advice, leading technology, and to supplement existing staff to improve efficiency and compliance.