Portfolio Management Unit – II Session No. 15 Topic: Foundations & Endowments Unit – II Session No. 15 Topic: Foundations & Endowments

Session Plan Recap the Previous Session Foundations & Endowments IPS formulated in Foundations IPS formulated in Endowments Summarizing and Q & A

Foundations & Endowments Foundations and endowments provide vital support for much of today’s philanthropic and charitable activities. Foundations are typically grant-making institutions funded by gifts and investment assets. Endowments, on the other hand, are long-term funds generally owned by operating nonprofit institutions such as universities and colleges, museums, hospitals, and other organizations involved in charitable activities.

Foundations & Endowments Private foundations typically are created and funded by a single donor to fund philanthropic goals. The investment portfolio provides the dominant source of revenue, and the purchasing power of its corpus is either maintained or eventually given away (e.g., the Ford, Rockefeller, and Gates foundations). Endowments, by contrast, are often built up over time by many individual gifts to the endowed institution. Spending distributions are determined by the beneficiary institution, supplementing other revenue sources such as tuition, grants, fees, or gifts for current use.

Foundations & Endowments Foundations: Background and Investment Setting Foundations provide essential support of charitable activity. In broad terms, four types of foundations exist: independent, company sponsored, operating, and community. a)Independent foundations, also referred to as private or family foundations, are grant-making organizations funded by an individual donor. b)Company-sponsored foundations tend to have a short-term investment focus to facilitate philanthropic funding from the corporation to grantees. c)Operating foundations, much like endowments, provide income to support specific programs. d)Community foundations draw upon broad support for donations to fund a variety of grants.

Foundations & Endowments Investment Setting: 1. Risk Objectives Because foundations’ goals differ from traditional DB pension funds and other asset pools. Foundations can have a higher risk tolerance. Foundations have no defined liability. The desire to keep spending whole in real terms, or to grow the institution, is simply that: a desire. If risky, for foundations to try to earn a higher rate of return than is needed to maintain the purchasing power of assets

Foundations & Endowments Investment Setting: 2. Return Objectives Foundations differ in their purposes, and so vary in their return objectives. Some foundations are meant to be short lived; others are intended to operate in perpetuity. Short lived foundations with an indefinitely long horizon, the long-term return objective is to preserve the real (inflation-adjusted) value of the investment assets while allowing spending at an appropriate (either statutory or decided- upon) rate.

Foundations & Endowments Investment Setting: 3. Liquidity Requirements A foundation’s liquidity requirements are anticipated or unanticipated needs for cash in excess of contributions made to the foundation. Anticipated needs are captured in the periodic distributions prescribed by a foundation’s spending rate. To avoid erosion in the portfolio’s real value over time, many foundations try to spend only the minimum or else set a maximum that only slightly exceeds the minimum.

Foundations & Endowments Investment Setting: 4. Time Horizon The majority of foundation wealth resides in private and other foundations established or managed with the intent of lasting into perpetuity. Some institutions are created to be ‘‘spent down’’ over a predefined period of time; therefore, they pursue a different strategy, exhibiting an increasing level of conservatism as time passes. All else equal, investors often assume that a longer time horizon implies a greater ability to bear risk because a longer horizon affords them more time to recoup losses.

Foundations & Endowments Investment Setting: 5. Tax Concerns The income that is not substantially related to a foundation’s charitable purposes may be classified as unrelated business income and be subjecting to different from corporate tax rates. 6. Legal and Regulatory Factors Foundations may be subject to a variety of legal and regulatory constraints, which vary by country and sometimes by type of foundation. 7. Unique Circumstances A special challenge faces foundations that are endowed with the stock of one particular company and that are then restricted by the donor from diversifying. The asset value of such an institution is obviously subject to the large market fluctuations attendant to any one-stock position.

Foundations & Endowments Case let: The Fund for Electoral Integrity A group of major foundations has endowed a new organization, the Fund for Electoral Integrity, to supervise elections and political campaigns in countries undergoing a transition to democracy. The fund is headquartered in a developing country. It has received initial grants of $20 million, with $40 million expected to be received in further grants over the next three years. The fund’s charter expressly decrees that the fund should spend itself out of existence within 10 years of its founding rather than trying to become a permanent institution. Determine and justify appropriate investment policy objectives and constraints for the Fund for Electoral Integrity.

Foundations & Endowments Endowments: Background and Investment Setting Endowments play a critical role in the vitality and success of today’s charitable activity. As the long-term investment portfolios of nonprofit operating institutions, endowments provide a significant amount of budgetary support for universities, colleges, private schools, hospitals, museums, and religious organizations. An endowment is simply the long-term investment portfolio of a charitable organization. Legally and formally, however, the term endowment refers to a permanent fund established by a donor with the condition that the fund principal be maintained over time.

Foundations & Endowments Endowments: Background and Investment Setting Many schools and nonprofit organizations will supplement true endowments with voluntary savings in the form of quasi-endowments, sometimes referred to as funds functioning as endowments (FFEs). Endowments are a vital source of funding for many charitable programs, and spending distributions should be substantial to support such programs’ needs.

Foundations & Endowments Risk Objectives An endowment’s investment risk should be considered in combination with its spending policy and in the context of its long-term objective of providing a significant, stable, and sustainable stream of spending distributions. Endowments that do not use a smoothing rule may have less tolerance for short-term portfolio risk. An institution’s risk tolerance depends on the endowment’s role in the operating budget.

Foundations & Endowments Return Objectives Endowments have high return objectives, reflecting the goal of providing a significant, stable, and sustainable flow of income to operations. Endowments typically provide vital support of ongoing operations and programs, and distributions from endowment to operations should be as large as practical. Endowments often need to generate relatively high long-term rates of return in order to provide a substantial flow of spending to institutions. If returns had no volatility, an endowment could set spending at a rate that equated to the real return—that is, the nominal return net of inflation.

Foundations & Endowments Liquidity Requirements The perpetual nature and measured spending of true endowments limit their need for liquidity. In general, endowments are well suited to invest in illiquid, nonmarketable securities given their limited need for liquidity. Time Horizon In principle, endowment time horizons are extremely long term because of the objective of maintaining purchasing power in perpetuity. Annual draws for spending, however, may present important short-term considerations, because endowments often use yearly market values to determine spending, and each annual withdrawal of capital has its specific time horizon.

Foundations & Endowments Tax Concerns Although taxation may vary by domicile internationally, taxes are not a major consideration for endowments in general. Legal and Regulatory Factors Few laws and regulations exist regarding the management and conduct of endowment funds. Unique Circumstances Endowments range from the very small, providing financial aid for a day care center, to the very large, supporting a major university. The responsibility of managing the endowment might fall to an unsophisticated board or to a collection of individuals knowledgeable about investments.

Summarizing What is the benefit of Investment in Foundations and Endowments? Give your examples for various types of foundations What is the legal and formal meaning for the term endowment?