What is an endowment and should we have one? Nonprofit leaders frequently ask us these questions so we break down the details here.
An endowment is the most recognized strategy an organization uses to invest a large donation typically restricted by a donor to support a specific program either over a set time frame or indefinitely. For example, a wealthy philanthropist could donate multi-year funds to their favorite university to provide financial aid to students studying a specific academic specialty. Or maybe a donor gives one large gift that must be maintained over a number of years to support the homing of senior pets rescued by an animal welfare organization. Endowments can be unrestricted, called board-designated funds or quasi-endowments, allowing leadership to direct funds where the organization most needs it.
The mere existence of an endowment can demonstrate to prospective donors that a nonprofit could support core programs for an extended period of time, thereby encouraging further donations. That point alone is a persuasive argument for starting an endowment. But the management of an endowment is not as simple as socking funds away in a savings account. Because the original invested value or “principal” must be maintained over the life of the endowment, it must be governed by strict policies to ensure a) the wishes of the donor are being satisfied and b) the funds are managed prudently to fund the specific goal. Any nonprofit aspiring to build an endowment must be prepared to dedicate time and resources to adhere to the specific legal provisions.
Investment Policy Statement
When establishing an endowment, it is critical that the board, in its role as a fiduciary, execute an Investment Policy Statement (IPS) to establish clear objectives and management policies. In essence, the Investment Policy Statement sets out standards for the endowment that are maintained throughout the life of the endowment, keeping fiduciaries accountable for its supervision.
The Investment Policy Statement can be broken into two major parts. First, the Introduction
spells out the purpose of the endowment, the roles, responsibilities and standards of conduct expected of the board and any hired investment professionals. The Introduction also sets out the investment goals and the return expectations of endowment. Second, the Investment Management Principles stipulate how much risk the endowment will accept, what investment are permitted and how these principles will be monitored.
Uniform Prudent Management of Institutional Funds Act
If the endowment is funded by donor-restricted gifts, the fiduciaries are required to adhere to the Uniform Prudent Management of Institutional Funds Act or UPMIFA for short. UPMIFA is the law in 49 states, the Washington, D.C and the U.S. Virgin Islands and clarifies spending and investment guidelines for the management of an endowment.
There are three key provisions of UPMIFA.
- Spending and investment guidelines dictated by the donor supersede any standards set forth in UPMIFA.
- The board must use prudence in selecting an investment professional, establishing investment guidelines reviewing performance.
- Spending policies are established to ensure the original intent of the donation is maintained. In CA, spending over 7% of the value of the endowment is considered imprudent unless the organization can demonstrate that excess spending is acceptable.
How does a nonprofit organization achieve “prudent spending” with respect to the endowment? The law stipulates seven factors.
- Assets and distributions should be managed in such a way as to promote the sustainability
of the assets over time. - Spending and distribution policies should be designed to support the mission.
- General economic conditions must be taken into account when determining the annual distribution.
- Spending policy should always account for the effects of inflation or deflation.
- In crafting a spending policy, an institution should consider what returns are realistic relative to the return, risk, and liquidity profile of the portfolio.
- When determining a spending policy, it is important to consider the other financial resources.
- The investment policy needs to be flexible enough to establish sustainable spending.
Not every endowment should be governed by UPMIFA. If you are uncertain, contact a legal professional. Even if you are not required to follow UPMIFA, its guidelines can help to instill discipline in every step of the process, including portfolio construction, scheduled distributions, and ongoing strategic reviews. With some understanding of the requirements, planning, careful implementation and regular monitoring, your endowment can be an effective tool to build a strong foundation for your organization and grow well into the future.
Talk to the financial experts at Fairlight Advisors to learn more about managing your nonprofit’s investments. Schedule a free consultation today!
Fairlight Advisors
