Endowment Funds and Investment Policies

This article on endowment funds originally appeared in September 2014 on Smith and Howard’s web site.

Endowment funds are a big deal. Creating a sound management strategy for this important fund can be intimidating. A comprehensive policy for a nonprofit’s investments should include policies focused on asset allocation, spending criteria and performance monitoring. With a solid foundation from these building blocks nonprofits can ease their minds about endowment management. Smith and Howard Wealth Management serves nonprofit organizations in this capacity and provides the following notes for creating a strong strategy for managing your endowment fund.

Investment policy

Every endowment should have a comprehensive investment policy that drives the management of the fund. According to the Uniform Prudent Management of Institutional Funds Act (UPMIFA), investment decisions must be made in relation to the nonprofit’s overall resources and purposes. And the endowment investment policy should be different from the policy for other investments of the organization.

“Prudent” investment decisions must consider the entire portfolio and be made as part of an investment strategy with risk and return objectives reasonably suited to the fund and the organization. UPMIFA also permits “only investment costs that are appropriate and reasonable.” (UPMIFA applies only to “true” endowments funded by donors, not “quasi” endowments created by boards.)

The endowment’s objectives should guide its investments and management. For this reason, it’s important not to simply adopt a generic objective but to articulate an objective that reflects the organization’s own circumstances. For many not-for-profits, the primary goal is to preserve and grow funds for the organization’s long-term stability while providing a predictable contribution to support current activities. As a living document, the investment policy can change over time as objectives or other factors change.

Asset allocation

The investment policy will include an optimal asset allocation. The investment committee must analyze the risk and return of potential investments (including stocks, bonds and alternative investments such as hedge funds and private equity) to determine the best mix and to obtain the total desired return. To maintain flexibility for responding to changes in the investment environment, it’s best to establish ranges for each asset class instead of set percentages.

On a quarterly basis, the investment committee should review information on the performance of each asset class. Allocations can then be adjusted based on both performance and any change in circumstances.

Spending policy

The investment policy should include a spending policy for the endowment, setting a percentage that can be spent annually. The spending policy will impact the performance of the fund, as well as its ability to fulfill the donor’s intent.

UPMIFA sets standards for endowment fund spending. It provides that an organization can spend as much of a fund as it determines to be prudent for the “uses, benefits, purposes and duration” for which the fund is established. UPMIFA lists seven criteria to guide annual spending decisions:

Duration and preservation of the endowment,

1. The purposes of the organization and the fund,
2. General economic conditions,
3. Effects of inflation/deflation,
4. Expected total return from income and appreciation,
5. The organization’s other resources, and
6. The organization’s investment policy.

Unlike its predecessor, the Uniform Management of Institutional Funds Act, UPMIFA allows nonprofits to adopt a “total return” strategy that bases the spending rate on the endowment’s total value (including appreciation) rather than on only income. To ensure reasonably consistent cash flows, many organizations using a total return spending policy apply “smoothing” mechanisms to minimize the effect of market volatility. An organization might, for example, use a three- or five-year rolling average calculation.

Performance monitoring

The investment policy should include benchmarks for evaluating the performance of investments and managers, too. Performance should be assessed over both full market cycles (seven to 10 years) and the shorter time periods that compose them.

An internal investment committee can meet quarterly to review performance, consider recommendations for changes to the investment strategy and rebalance asset allocation as necessary.

Help is available

Endowment management can seem overwhelming, especially for volunteer board members with many other demands vying for their time. As financial advisors to nonprofit organizations, we can help with many of the critical decisions, including asset allocation, vetting of fund managers and financial reporting compliance. For more information, call 404-874-6244 and speak with a member of Smith and Howard Wealth Management’s nonprofit group or Sean Taylor or Marc Azar of Smith and Howard’s nonprofit team.