A critically important asset for many nonprofit organizations is their endowment, sometimes referred to by a different name such as long-term investment fund. So important is this pool of financial assets that for many institutions it is the difference between fulfilling their missions and being forced to lower their aspirations or even ceasing to operate.
That makes wise management the essential task for those charged with responsibility for these funds: boards of trustees, members of the investment (or finance) committee and senior staff members. There are fundamental principles of effective endowment management that we have organized into what we call “the Six Ps of investment Stewardship.” Following is the first blog in the Six Ps series outlining these principles.
Principle I – Purpose
What is an Endowment Fund?
More than 2 million registered nonprofit organizations serve a diverse spectrum of societal needs, including education at every level; healthcare and human services; arts, culture and humanities; the environment; and community services, among others. Many nonprofits are fortunate enough to have an endowment, and for these organizations this pool of assets is the financial cornerstone supporting their primary objective: the fulfillment of their mission.
Endowments are composed of individual funds given by donors over time, usually to support particular activities or programs of a nonprofit organization. These are referred to as restricted funds, and they generally comprise the greatest share of an institution’s endowment. That is to say, an endowment is not monolithic, but composed of a great many smaller endowments. Donors sometimes give with no restriction as to purpose—that is, gifts in support of the broad mission of the institution and referred to as unrestricted. In addition, institutions themselves may elect to treat operating surpluses, unrestricted bequests and other similar amounts as what is known as “quasi-endowment.”
These differing purposes influence the investment strategy for endowment funds. For example, a fund dedicated to providing scholarships at a college requires a steady flow of cash, year in and year out; ideally, the amount should not only remain steady but rise with inflation. A fund that is intended to cover the cost of awarding a prize every five years does not have the same need for ready cash. These two funds have different tolerances for year-to-year fluctuations in their value and their need for liquidity.
Increasingly today, nonprofit organizations are taking a holistic view of their financial resources and commitments. In this approach, long-term funds (endowment), annual operating budget, development capabilities (fund raising) and forecasted capital needs (facilities expansion, for example) are considered together. The demands on long-term funds and annual operating fund needs vary widely across the nonprofit spectrum; educational institutions, for instance, will have very different needs than foundations and they, in turn, will have very different needs than nonprofit healthcare institutions. This requires closer communication and coordination between the investment committee, financial staff, facilities management and development office.
Historically, most donors to endowments have contemplated a perpetual life for their funds. In recent years, however, some endowments—including some very large ones such as the Bill and Melinda Gates Foundation—have been established with a finite life. The expected lifespan, or term, of a fund is an important factor to consider when crafting an investment policy.
What are the top 10 critical issues to consider when crafting an investment policy?
In this context, the maintenance of purchasing power becomes a key issue for a perpetual fund. For example, a series of funds to endow the conductor’s and section chairs’ positions at a symphony orchestra will need to be invested with a perpetual horizon in mind. On the other hand, a fund dedicated to constructing a new concert hall for the symphony 10 years from now does not need to generate any cash during its life and should, accordingly, be invested using a different strategy (although a fund for ongoing maintenance of the hall would be perpetual).
Authority over institutional investment pools such as endowments resides with the governing board. There is general agreement that it is the responsibility of the investment or finance committee—with the advice and consent of the full board of trustees and in consultation with the administration or chief executive—to determine the objectives of the endowment and to establish policies that will guide its management. These objectives and policies should be articulated in a written statement with which all trustees are familiar and that is periodically reviewed and updated.
The members of the governing board—and the investment committee—are fiduciaries. If you are on the board of a nonprofit, you have a particular responsibility in that you are a fiduciary with regard to financial matters.