Commonfund Institute Online

Welcome to Commonfund Institute Online, dedicated to the advancement of investment knowledge and the promotion of best practices in financial management. In this program, the role of the endowment, what it exists to do, and how that purpose should shape the way it is invested. But the landscape has changed. The return to a higher rate environment has challenged assumptions embedded in many investment policy statements. Geopolitical shifts have introduced risks that historical return distributions don't capture well. Technology is reshaping investment management at every level. And governance scrutiny, demographic headwinds, and operational risk all press on the same balance sheet. We start where every committee should start, with purpose. An endowment is a portfolio of assets gifted or donated to a nonprofit institution to help support its mission, typically with the expectation of perpetual institutional life. Notice what that does not say. It does not say outperform the S and P 500. Endowments are typically composed of individual funds given by donors over time. Most are restricted, given to support a particular activity or program, scholarships being the typical example. Some are unrestricted, given in support of the broad mission, and institutions themselves may elect to treat operating surpluses and unrestricted bequests as quasi endowment. There are many purposes for an endowment and many forms it can take. Those differing purposes shape investment strategy. But for a perpetual fund, one issue is common to all of them: the maintenance of purchasing power. Sustainable consumption means the endowment continues to support the same set of activities it supports today. The Board and Investment Committee are responsible for investment policy decisions. Its members are fiduciaries, entrusted with the property of another and charged with a high degree of responsibility, the duty of loyalty, the duty of care, and the duty of obedience. With the Prudent Investor Rule and the Uniform Prudent Management of Institutional Funds Act, UPMIFA, those duties form the framework for prudent endowment management. Which brings us to the central obligation of every endowment fiduciary: intergenerational equity. It was best expressed by the Nobel laureate James Tobin, The trustees of an endowed institution are the guardians of the future against the claims of the present. Their task is to preserve intergenerational equity. Both practical experience and economic modeling show it is rarely possible to spend more than 5% a year without eroding purchasing power, and roughly 2% for inflation and 1% for costs. And an 8% total return target is often cited. For higher education, HEPI may reflect cost increases more accurately than CPI. To illustrate, we build a simple model. Start with $100 in 1966, invested in a seventythirty portfolio. Take out 5% every year for spending and adjust for inflation. Ideally, the portfolio tracks that $100 real value as closely as possible. In reality, it didn't track it at all. Achieving intergenerational equity is hard. After sixty years, the $100 is worth just $108 in real terms. High inflation hurts. In the 70s, this portfolio lost more than half its real purchasing power. And the line spends far more time below the $100 line than above it. Now add 100 basis points of return a year. Thanks to compounding, instead of barely breaking even, you end with $196 The model shows how difficult it is to maintain real value over the long term and how important policy decisions are. So how should a committee set policy? First, a quick riddle. Three institutions walk into a bar: a university, a museum, and a foundation. Each has the same endowment. Each spends 5%. Which one is the university? Of course, you can't tell. It's a trick question, and that's the point. Yet so many allocation and policy decisions get made on endowment size and spending rate alone. Here is what does tell them apart: the degree to which mission is supported by the endowment. The university depends far more on tuition. The museum has admissions and memberships, but the bulk of its revenue comes from the portfolio. The foundation has little to no other sources of income at all. Which reframes risk? For mission based organizations with perpetual time horizons, risk is best defined as the inability of the institution to meet its financial objectives, not simply standard deviation. And it should be treated as a primary input to policy, not a byproduct of investment decisions. Return targets, risk tolerances, and liquidity budgets cannot be set without evaluating these metrics. An institution with little dependence on its endowment can take more risk in pursuit of long term return. One that depends heavily on it needs stability, liquidity, and a smoother spending policy. Which leads to the most neglected decision of all. Spending policy is the only permanent link between the endowment and the institution it supports. Formulas fall into three families: simple, inflation based, and smoothing, or hybrid. The twelve quarter moving average is the most widely used, but institutions should evaluate whether it is still the right methodology for their circumstances and stress tested at least annually. Which is why the most useful question at the committee table is a simple one. What percentage of the operating budget is covered by the endowment distribution, and is that reliance growing? For many institutions, the endowment is the difference between fulfilling a mission and curtailing it. Thinking through return objectives, risk profile, liquidity, and spending will shape its long term sustainability far more than picking managers. And meeting that obligation in a changing landscape asks for one thing more, the wisdom and institutional courage to evolve. Thank you.