Endowment and Foundation Spending Guidelines
Two other factors that can make the decision particularly challenging
are the changing levels of both revenue and liability streams.
Managing changing liabilities and revenue
Liabilities
Another important consideration in selecting a spending policy is
the growth rate to use for liabilities. The liability stream depends
on the mission of the institution and may or may not be linked to
a traditional growth rate, such as the change in the CPI. Assessing
liability growth is important, because increases in liabilities work
like asset returns in reverse (or to put it another way, adverse
investment returns are similar to adverse cost increases). Like a
negative spell in the markets, a surge in liabilities can jeopardize
the corpus of the portfolio. As a result, any correlation between
liabilities and investment performance should be factored into
the asset allocation decision.3
Revenues
A final consideration when selecting a spending policy is the
expected level and volatility of future revenues or contributions.
This expected income is an asset similar to any other, and “returns”
(i.e., future revenues) can deviate from expectations. In years when
contributions fall short of expectations, spending commitments
may require that additional funds be taken from the portfolio. If
such shortfalls happen frequently enough, the long-term viability
of the portfolio may be jeopardized.
Therefore, the correlation between contributions and investment
performance should be factored into the asset-allocation decision.
When stocks are performing well, institutions may receive higher
contributions than expected; when stocks perform poorly, the
reverse may occur. If such a correlation exists, holding stocks
in the portfolio may be riskier to the institution’s spending plans
than if there were no relation between revenues and the market.
Endowments and foundations typically can address this risk
by making minor changes in their asset allocation to reflect the
strength of the correlation.4
Best practices
Flexibility is the one word that best describes a solid spending
policy. Rigid spending rules cannot eliminate investment volatility;
they simply push it into the future. Spending policies insensitive
to returns are risky, inasmuch as they rely on the assumption that
the portfolio will recover before the endowment level reaches a
crisis point (at which time much more dramatic reductions in
spending would be necessary). Hedging that assumption, at least
in part, by accepting some reduction in current spending is an
appropriate response to market volatility.
If prudent, returns-based reductions in current spending are a
reasonable, acceptable part of a spending policy, then prudent,
returns-based increases in spending are also reasonable when
investment returns are more favorable.
If the portfolio is to include volatile investments that are expected
to produce high average returns, then administrators must either
accept continuous, relatively smaller changes in spending or else
run the risk of having to make abrupt and significantly larger
adjustments later. The more an institution can tolerate some shortterm fluctuations in spending, the more likely it is to achieve its
longer-term goals.
Conclusion
In conclusion, our analysis illustrates that there is no optimal,
“one size fits all” spending policy for endowments and foundations.
Which policy should be implemented depends on what is most
important to the institution. There is an inherent tradeoff between
maintaining constant spending levels and achieving long-term
asset growth to support future spending. The right spending policy
should meet the needs of both current beneficiaries and future ones.
Volatility is measured as the average absolute deviation of spending below the initial level of $2.5 million over the 45 time paths for each method.
For more on this topic, see Donald G. Bennyhoff, 2005: Preserving a Portfolio’s Real Value: Is There an Optimal Strategy? Valley Forge, Pa.: Investment Counseling
& Research, The Vanguard Group, 20 p.
4
For a technical treatment of this issue, see Robert C. Merton, 1993: Optimal Investment Strategies for University Endowment Funds. In Studies of Supply and
Demand in Higher Education, Charles Clotfelter and Michael Rothschild (ed.). Chicago, Ill.: University of Chicago Press.
2
3
www.conferomag.com | 25