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Keep Your Client’s Endowment Safe and Secure

These investment opportunities require strict management principles and a clear directive. 

Endowments can be a much-needed resource for non-profit organizations, but managing an endowment is no easy task.  These investment opportunities require strict management principles and a clear directive that sets a framework for the endowment.

Practitioners who work with non-profits need to understand the particular administrative, financial, staff and reporting responsibilities that come with endowments if they’re to maintain long-term stability for their organizations and continued donor, stakeholder and community faith in the managing charity.  If properly invested and maintained, a healthy endowment can cover a group’s operations, building efforts, programs and/or professional development activities.

A non-profit organization that’s careless in managing its investments not only risks the deterioration of its endowment fund, but also a loss of confidence that, over time, could erode its base of loyal donors.  With so many worthwhile organizations competing for donations, it’s critical for nonprofits to keep their supporters close by their side. 

Know Type of Endowment

You should understand the type of endowment your client has, as this will help determine what it may and may not do with the investment.

  • One of the most common endowments is known as the “true endowment.”  It preserves the principal by imposing restrictions on spending. Earnings/income may be restricted to a specific use or purpose or may be unrestricted and used as determined by the nonprofit.
  • There’s also a quasi-endowment, which is typically created by a board resolution and allows the principal to be used, as well as the income.  The board should establish procedures that dictate the allowable distributions of income and withdrawal of principal.

Specify an Investment Strategy

Once any restrictions have been determined, the nonprofit should write a strong investment policy statement (IPS) to outline the framework of the endowment.  This will determine how the investment will support the nonprofit’s mission.  A robust IPS should clearly define:

  • The duties of trustees.  Several groups are assigned important roles in an IPS.  The board of trustees is responsible for seeing that policies governing the management of the portfolio are established and followed.  The investment committee is responsible for implementing the investment policy.  Investment managers implement the strategy set in the IPS.
  • Handling of assets.  A good IPS spells out how the endowment assets should be invested (for example, stocks, bonds and hedge funds) to meet the organization’s needs while effectively managing risk.
  • Use of endowment income.  Because an endowment generates more money, the IPS needs to be clear in explaining the acceptable uses of this income.  How much of the income generated should be spent and where it may be spent are guidelines for any IPS.
  • Withdrawal limits.  The IPS will dictate how much income is allowed to be withdrawn on an annual basis.  This amount will typically depend on whether the investment is a true endowment or quasi-endowment.  Prudent limits are generally between 4 percent and 5 percent annually.
  • Liquidity requirements.  Before the Great Recession, many large universities had their endowments invested in hedge funds and other illiquid investments, where they couldn’t easily convert their earnings to cash. Since the crisis, many non-profit organizations have revisited this practice.
  • The target rate of return.  Generally, a portfolio’s acceptable return will cover the organization’s spending rate and keep pace with inflation.
  • A timeline.  The IPS should clearly define how long the endowment will be in existence, which may be anywhere from a decade or longer to in perpetuity.

Adopt Healthy Management Principles

Once the IPS has been written and approved, help your client implement other established principles of management to keep the endowment healthy and secure for the organization.  This process includes:

  • Hiring an investment manager.  Organizations should remember that they’re only able to delegate investment functions if the decision makers (trustees) exercise reasonable care and caution in selecting the agent.  Too often, members of an investment committee take part for name recognition only, and they don’t take appropriate responsibility for investment manager selection.  At least three people who are knowledgeable of investments should be members of this committee, with others coming from the business world or community leadership positions.
  • Reviewing the investment manager every three years.  Organizations must be careful not to become complacent, as it’s their responsibility to make sure the manager is performing her duties properly and that she’s also the most cost-effective candidate.
  • Involving the board of directors.  The board has a fiduciary responsibility to maintain the investment and should communicate as needed with the investment committee as issues arise.  Many times, the board of directors will call on outside help in the form of a consultant or investment advisor, and although the investment advisor may step in with advice or templates, the board is ultimately responsible for determining how to manage the endowment.
  • Scheduling required audits and filing any necessary tax returns.  While it’s generally recommended that an endowment be reviewed annually, it really should be done at least quarterly and rebalanced if allocations defined in the IPS—large cap, small cap, etc.—are out of alignment, thus restoring the allocations to predetermined levels.
  • Recognizing that an endowment should in no way lessen fundraising efforts.  Endowment builders are some of the best investors in an organization and should be treated that way.  The development department and/or board of directors should be expected to continue their fundraising efforts for the organization, regardless of whether they’re fortunate enough to have an endowment.  An endowment should never be considered the be-all end-all solution to fundraising.

Kimberly Bernatz is a Senior Vice President & Director, Wealth Management Advisory at First American Trust 


TAGS: Philanthropy
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