Labor Day has passed and school is officially back in session, but in June back to school was already on Michael Little’s mind as he gathered with some of Gross Mendelsohn’s CPAs to discuss the “4 Big Financial Challenges Facing Private Schools in 2019.” The group talked about fundraising, endowment management, audits, and strategic planning. Below we will focus on the “5 must-do’s” for endowments that Michael discussed.

First off, what is an endowment?

Merriam-Webster defines an endowment as “a grant to provide continuing support or maintenance of a nonprofit organization.”

Investopedia expands on this definition to say “an endowment is a donation of money or property to a nonprofit organization, which uses the resulting investment income for a specific purpose. Most endowments are designed to keep the principal amount intact while using the investment income for charitable efforts.”

4 reasons to have an endowment:

  1. Creates a perpetual stream of support to the organization
  2. Protects the organization by being financially secure and well managed
  3. Provides a legacy to the donors
  4. Used as a method to increase gifting

Commonfund Institute, an organization involved in endowment management, identified 5 principles to abide by when setting up and managing an endowment.

1. Determine the objectives of the endowment

The objectives of the endowment should be defined in a written document, often called a board or investment policy statement. It should include the following:

  1. The role of the endowment in supporting the mission of the organization
  2. The role of the endowment in fortifying the finances of the organization
  3. How much of the endowment will be used to support the organization’s current activities
  4. How much in gifts received by the organization will be used to fortify the endowment, versus being spent to support current operations
  5. Overall investment strategy and asset allocation
  6. Who is responsible for investment decisions, whether internal or external

2. Set up a payout policy from the endowment

This is one of the hardest aspects of management and is all about balancing the needs of today, versus the needs of the future. The needs of today are always abundant in a nonprofit and there’s always the want of getting that money out into the public you’re serving. The other side to that is those who set up the endowment and those who contribute. They want to know that it’s going to be there for a long time.

There are a lot of factors to consider, but the key is making sure the expected rate of return will keep pace with the spending goals or requirements of the organization. This leads us into principle number 3.

3. Determine an optimum asset allocation

Before you can set an asset allocation, you need to determine your payout policy. The payout policy will lead you to a desired level of total return from the portfolio. Then, given the historical expected rates of return for each asset class, you can mix together an allocation to achieve that total return goal. For example, if an endowment is distributing 4% of the fund per year, then you’d want to have an asset allocation expected to achieve at least a 4% historical long-term rate of return. Ideally, maybe a little higher to keep up with inflation.

Modern Portfolio Theory encourages diversification, or the use of a number of different asset classes with different standard deviations of risk. This means that you want to have exposure to different types of assets; large company stocks, small company stocks, international stocks, investment grade bonds, and high yield bonds. The rationale here is that through diversification, a portfolio can achieve more consistent results, with lower overall risk.

4. Select managers to implement your asset allocation

We believe the best approach is to follow the guidance of an independent investment consultant who can give direction for the asset allocation and provide a list of recommended and properly vetted managers. Your investment consultant should be:

    1. Providing recommendations for the specific allocation within each area of the asset allocation policy
    2. Reporting on the background economic conditions and how they impact the particular strategic recommendations for the asset allocation
    3. Reporting on the returns of the investment managers and make recommendations for changes and new areas of investment

5. Provide for systematic review of risks, monitor the costs, and determine the forum for oversight

The endowment then has the final and most important job of overseeing the asset allocation, monitoring of the costs of management, and reviewing manager selection.

This starts with the development of a strong investment policy statement, which should include the target asset allocation and list any restrictions on the various types of assets that could be invested in. The policy statement should also include benchmarks for determining whether the portfolio is performing as expected.

The organization should form an investment committee to manage the consultant and the committee should meet quarterly to review performance and hear any recommendations for changes to the portfolio. The committee should not make the selections, but take a deep look at the activities of the consultant to ensure that those activities fit within the parameters of the investment policy statement.

How Can We Help?

GGM Wealth Advisors is a fiduciary and we employ a customized investment discipline uniquely structured to match the goals and objectives of your organization. We strive to appropriately align the portfolio of your endowment with the current economic climate, as well as set proper risk tolerance parameters utilizing a Nobel prize-winning framework, Riskalyze.

To discuss how we can help your organization, contact us today!