Aligning Spending Policy with Your Institution’s Long-Term Goals

Commonfund has designed a set of questions to help guide a committee—and staff—toward selecting the most appropriate spending policy. We have used these questions as a guideline for conversations with our Outsourced Chief Investment Officer (OCIO) clients and, through thoughtful examination of these considerations, many institutions have determined that a 12-quarter moving average policy may not be the most appropriate policy to achieve their long-term goals.

For many institutions, Commonfund believes that an ideal spending policy is one that offers some combination of the following:

• Provides a consistent, and growing, level of annual support in most years (i.e., a policy that minimizes negative spending).
• Offers a sufficient amount of long-term, total support of the operating budget while leaving enough capital in the endowment to compound for future generations.
• Allows the endowment to prudently take as much risk as needed to meet its long-term return objective.
• Allows an investment committee to stick with an allocation plan, especially during periods of sizable market drawdowns.

Once an ideal spending policy is determined, all key constituents (trustees, investment committee members, finance staff, development staff, donors, etc.) should be educated on the formula and the rationale for employing that methodology.

Question to Consider:
How reliant is the institution on the endowment?

Commonfund Guidance:

• What percentage of the operating budget is covered by the distribution from the endowment?
• What has been the trend of this support?
• Will the endowment be relied upon more in the future?
• What has gift flow been as a percent of the endowment? Has this grown?

Question to Consider:
What is the overall goal of the spending policy?

Commonfund Guidance:

• Maximize long-term spending
• Maximize short-term spending
• Consistency of spend (i.e., limit spending volatility and drawdown)
• Balance between the three options above

Question to Consider:
How would the institution be affected if the spending declined year over year? What would the impact be if this occurred consistently? What’s the maximum drawdown in institutional/organization support that can be tolerated?

Commonfund Guidance:

• An endowment liquidity analysis and stress test should be refreshed at least annually to help answer these questions.
• This should be incorporated within the institution's overall financial stress tests to gain a comprehensive understanding of the reliance on the endowment.

Question to Consider:
How about financial flexibility?

Commonfund Guidance:

• Annual fund giving
• Restricted/unrestricted endowment
• Access to other sources of liquidity (lines of credit)