Policy | Principle II | Commonfund Institute | Principles of Investment Stewardship
An investment committee can have talented members, a well-diversified portfolio, and a thoughtful manager roster — and still make poor governance decisions. Often, the missing element isn't expertise or effort. It's a clear, current Investment Policy Statement (IPS).
The IPS is the subject of Principle II of Commonfund Institute's Principles of Investment Stewardship for Nonprofit Organizations whitepaper — and for good reason. It functions as the investment committee's strategic plan: asset allocation, annual spending, risk tolerance, and how liquidity is managed across the balance sheet all flow from it.
There is no universal template for an IPS. Each board has to build a statement suited to its own institution's needs and its trustees' risk tolerance and preferences. In the whitepaper we recommend drafting the IPS in partnership with a financial advisor, and having legal counsel confirm it conforms to the version of UPMIFA adopted in the institution's state.
What a Sound IPS Actually Covers
A well-built IPS does something meeting discussion alone can't: it locks in shared, documented expectations that survive committee turnover, market cycles, and leadership transitions.
The paper identifies five areas that deserve specific, detailed treatment:
Return objectives. An institution aiming to preserve the purchasing power of its investment pool has to make explicit assumptions about its long-term spending rate, expected inflation, and investment costs. For colleges and universities, Commonfund's Higher Education Price Index® (HEPI) is often a better inflation gauge than the standard CPI — historically, HEPI has run around 3 percent annually. Combining a roughly 5 percent spending rate with about 2 percent inflation and 1 percent in costs is where many institutions arrive at their commonly cited 8 percent total return target, often expressed as a range (say, 6–9 percent) or as inflation plus an increment (CPI + 5.0%, for example).
Spending policy. Spending — sometimes called "payout" — is the annual withdrawal that funds institutional operations, and it's the only permanent link between the endowment and the institution it supports. It's also frequently the most under-examined part of policy review, with committees devoting disproportionate attention to asset allocation instead. Spending rates typically run between 4.5 and 5.5 percent of net asset value; private foundations, under IRC Section 4942, must distribute at least 5.0 percent of market value annually. Restraint on spending, over time, improves the odds that the fund grows in dollar terms and holds or gains purchasing power.
A well-designed spending policy should try to accomplish several things at once: deliver support that's consistent and growing in most years (rather than frequently cutting), fund enough of the operating budget without starving the endowment of capital that needs to compound for future generations, permit enough risk-taking to hit the long-term return target, and let the committee stick to its allocation plan during downturns instead of being forced into reactive cuts.
Spending formulas generally fall into three families: simple approaches (a flat percentage of beginning or year-end value, or income-based spending — easy to run but very sensitive to market swings); inflation-based approaches (prior-year spending adjusted for inflation, often with floors and ceilings, e.g., no less than 3.5% and no more than 6.5% of market value — steadier, but able to drift from actual market values over time); and smoothing or hybrid approaches (a percentage applied to a multi-year moving average of market value, commonly a 12-quarter average, or a blend of prior spending and current value, as in the Yale or Stanford Rule). The moving-average method is the most common choice among educational institutions, though the brochure notes it's worth periodically confirming it's still the right fit.
Key questions to consider when evaluating spending:
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How reliant is the institution on the endowment, and is that reliance growing as a share of the operating budget?
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Is the spending policy's primary goal to maximize long-term spending, maximize short-term spending, or minimize volatility?
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What's the largest year-over-year drop in institutional support the organization can tolerate?
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What other sources of financial flexibility exist — annual giving, credit lines, unrestricted reserves?
Asset allocation. A widely cited study found that more than 90 percent of the variation in investment returns comes from how a portfolio is allocated across asset classes — not manager selection or market timing. The IPS should lay out the "policy portfolio": target weightings for each asset class, along with acceptable ranges around those targets.
Risk management. The paper treats risk tolerance as one of the most consequential topics an IPS must address — not a downstream byproduct of other decisions, but a starting input. For an institution built to last in perpetuity, the more useful definition of risk isn't volatility or standard deviation; it's the chance that the institution fails to meet its financial objectives.
Liquidity. The IPS should address liquidity needs in light of the institution's balance sheet and long-term plans. Assets are typically grouped into three buckets: liquid (cash within a month or less), semi-liquid (one month to a year), and illiquid (more than a year to convert).
The stress-testing gap
One area where the paper pushes committees further than most currently go is spending-policy stress testing. We recommend refreshing the endowment's liquidity analysis at least annually, folded into the institution's broader financial stress tests, and modeling scenarios well outside normal market conditions:
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A sustained 30–40 percent equity bear market followed by a slow recovery
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A prolonged stretch where HEPI inflation exceeds 5 percent annually
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New gifts to the endowment declining materially for five-plus years
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A combination shock — a market downturn hitting at the same time as an enrollment or revenue decline
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A scenario requiring higher spending for one or several years, and what that does to the endowment's value over time
Once a committee settles on the right spending approach, we stress educating everyone with a stake in it — trustees, investment committee members, finance and development staff, and donors — on the formula and the reasoning behind it. A spending policy nobody understands or has bought into is much less likely to survive contact with a difficult market.
Policy as a Living Document
The central reframe on Policy is that the IPS shouldn't be treated as something written once and filed away. It's meant to be revisited — at minimum every one to two years — so that it keeps pace with the institution's evolving strategy rather than staying anchored to the assumptions in place when it was first adopted.
Progression and Policy
Governing documents, including the IPS, work best when they're treated as living statements of where the institution is and where it's headed — not static records of where it once was. As institutional priorities shift, the IPS should shift with them. That doesn't mean reacting to every market swing, but it does mean the document should capture genuine, longer-term changes in strategy. Annual or biannual review is the mechanism we recommend for keeping the two in sync. Progression, as a lens, also pushes institutions to treat newer approaches — mission-aligned and impact investing among them — as legitimate candidates for formal inclusion in policy, not just informal side conversations.
Questions Your Committee Should Be Asking — Policy
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When did we last review our IPS, and does it still reflect our institution's current risk tolerance, spending needs, and strategic priorities?
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Does our spending policy undergo formal stress testing against adverse capital-market and institutional scenarios?
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Does our IPS set expectations for cybersecurity and operational risk at our investment managers and service providers?
