What is an Endowment? — Key Takeaways
– An endowment is a gift of money or property to a nonprofit that is invested to generate a lasting source of support for the organization’s mission. (Source: Investopedia)
– The donated amount (the principal or corpus) is generally preserved; the investment return is spent according to donor restrictions and institutional policy.
– Endowments are governed by three core policies: investment policy (how assets are invested), withdrawal/spending policy (how much may be spent each year), and usage policy (what the money can fund).
– Common users: colleges and universities, museums, libraries, hospitals, religious institutions, private schools and community foundations.
– Legal/tax rules matter: many grant-making foundations must distribute 5% annually; private operating foundations have different rules; certain large private university endowments owe a 1.4% excise tax on net investment income. (Source: Investopedia)
Understanding Endowments — how they work
– Principal vs. income: The principal (corpus) is intended to be preserved; investment income (interest, dividends, capital gains) funds operations or programs. Some endowments allow limited access to principal in exceptional circumstances.
– Restricted vs. unrestricted: Donor restrictions determine whether earnings can be used for general operations, specific purposes (scholarships, endowed chairs), or must be preserved in perpetuity.
– Long horizon & diversification: Because most endowments are intended to last indefinitely, their investment policies typically emphasize diversified, long-term asset allocation and may accept illiquid asset classes (private equity, real assets) to increase expected returns.
Policies of Endowments
1. Investment policy
– Defines permitted asset classes, target return, risk tolerance, liquidity needs, manager selection process, and governance.
– Larger endowments often have separately managed pools or many subfunds to match donor restrictions and objectives.
2. Withdrawal (spending) policy
– Sets the annual payout rate or formula (common practice: a percentage of a trailing average of market value, commonly ~4–5%).
– Aims to balance current needs with preserving purchasing power for future years.
3. Usage policy
– Documents donor restrictions (e.g., scholarship, professorship, building upkeep) and institutional rules for applying endowment proceeds.
– May include rules for redirecting restricted funds only by court order (cy pres) or under extraordinary circumstances.
Types of Endowments (common categories)
– Permanently restricted / true endowment: Principal must be kept intact in perpetuity; only income may be used.
– Term endowment: Principal is held for a specified period or until a stated event; after that the principal may be spent.
– Quasi-endowment (board-designated): Funds the board designates to function as an endowment; the board may later decide to spend the principal.
– Temporarily restricted endowment: Donor restrictions lapse after a specified time or event, after which funds become unrestricted.
Requirements and Legal / Tax Rules (high level)
– Grant-making foundations: generally required to pay out ~5% of assets annually for charitable purposes or risk tax consequences.
– Private operating foundations: higher payout requirements for income (e.g., 85% of investment income for certain types).
– University endowment excise tax: under the Tax Cuts & Jobs Act, certain large private colleges and universities pay a 1.4% excise tax on net investment income if they meet thresholds (e.g., >500 students and net assets per student above a statutory limit).
– Extraordinary changes: courts can apply cy pres to alter donor restrictions when original purposes become impossible or impracticable; drawing down corpus (“invading” the endowment) is rare and often legally constrained.
Endowments and Higher Education
– A central part of U.S. academia: endowments fund scholarships, professorships, research, facilities, and operating shortfalls.
– Older, well-endowed schools (e.g., Ivy League) benefit from sustained donations and sophisticated investment management.
– Example facts: Harvard University maintains thousands of separate endowment funds—over 14,600 subfunds for different purposes—and its endowment is often cited as a model for institutional investing and also a focus of public scrutiny. Smith College supports its botanical gardens with an endowment. (Source: Investopedia)
Where Do Endowments Get Their Money?
– Primary sources: individual donors (living gifts), alumni giving, bequests and planned gifts, corporations and foundations, special fundraising campaigns, and retained investment returns.
– Once established, endowment growth depends on net investment returns and continued donor support.
Who Manages Endowments?
– Governance: board of trustees/governors, finance and investment committees set policy and oversight.
– Day-to-day: chief investment officers (CIOs), internal investment staff, and external investment managers/consultants execute portfolio strategy.
– Reporting and audits: regular financial reporting, compliance checks, and donor stewardship are part of management responsibilities.
Who Is Eligible for an Endowment?
– Eligible recipients are nonprofit entities with legal standing: universities, colleges, museums, libraries, hospices/hospitals, religious organizations, community foundations, and other charitable institutions.
Criticism and Investment Controversies
– “Hoarding” critique: critics argue large endowments sometimes prioritize preserving the endowment over current institutional needs, particularly during crises.
– Payout reductions: many endowments cut distributions during the Great Recession, prompting debate over institutional priorities.
– Divestment activism: students and alumni have pressured institutions to divest from objectionable holdings (e.g., South Africa apartheid-era investments; fossil fuels). Hampshire College’s 1977 divestment from South Africa is a noted example.
– Refusal of aid: some wealthy institutions declined certain federal emergency relief funds (e.g., some top universities declined CARES Act or other aid, sparking debate on whether large endowments should accept relief meant for cash-strapped institutions).
Historical notes and examples
– Early endowments: Marcus Aurelius (176 AD) established an early recorded endowment for philosophical schools; in England, the Countess of Richmond and Henry VIII established enduring university endowments and professorships at Oxford and Cambridge.
– Contemporary controversy: Harvard, Princeton, and Stanford are frequently cited in debates about endowment size vs. social responsibilities (e.g., divestment, student aid, use of rescue funds).
Practical Steps — For Donors Who Want to Establish an Endowment
1. Decide the purpose and restriction level (permanent vs. term; restricted to scholarships, faculty positions, facilities, etc.).
2. Select the recipient institution and discuss donor intent with its development office to confirm alignment.
3. Choose the vehicle: outright gift, bequest, charitable remainder trust, charitable gift annuity, or other planned-giving instrument.
4. Determine initial funding amount and future funding plan (seeding gifts, pledge schedule, matching).
5. Negotiate and document the gift agreement: naming rights, reporting, stewardship, and spending rules.
6. Understand tax implications and consult counsel or tax advisor to maximize benefits and compliance.
7. Establish monitoring expectations (receipts, annual reports, how earnings are used).
Practical Steps — For Institutions Setting Up or Managing Endowments
1. Create clear governance: assign board oversight, establish an investment committee and define roles/responsibilities.
2. Adopt written policies: investment policy statement (IPS), spending policy (payout formula), spending reserves, and conflict-of-interest rules.
3. Set an appropriate spending rule: e.g., a fixed percentage of a smoothed market value (commonly 4%–5%) to stabilize distributions across market cycles.
4. Design asset allocation to balance return objectives and liquidity for spending needs; include rebalancing discipline.
5. Select managers and perform due diligence on external managers and alternative investments.
6. Maintain transparency and donor stewardship: regular reporting, annual reports, and donor communications.
7. Prepare for stress scenarios: document when corpus invasion might be considered and the legal path (cy pres or court approval).
8. Monitor legal/tax compliance and prepare for excise taxes or payout rules applicable to foundations or large institutions.
Practical Steps — For Students, Alumni, and Activists Seeking Change
1. Understand the endowment: request the institution’s endowment policies and holdings summaries where possible.
2. Build a coalition: students, faculty, alumni, and community groups amplify influence and legitimacy.
3. Propose clear demands and alternatives (e.g., partial divestment, shareholder engagement, climate-aligned investment options).
4. Engage governance: present proposals to trustees, investment committees, or development officers.
5. Seek transparency: push for public reporting and regular meetings on endowment strategy and social-responsibility policies.
6. Use tools: shareholder resolutions, public campaigns, and constructive engagement with managers and board members.
The Bottom Line
Endowments are a vital, long-term financial tool for nonprofit sustainability. Properly governed and invested, they provide perpetual support for mission-driven work—scholarships, faculty positions, research, and cultural preservation. However, endowment size and use are frequently debated: donors, boards, beneficiaries, and communities must balance preserving capital for future generations with meeting current needs and ethical responsibilities. Clear policies, prudent investment strategy, transparent governance, and ongoing donor/institutional dialogue are essential for endowments to serve both current and future stakeholders.
Source
– Investopedia, “Endowment,” Jake Shi. https://www.investopedia.com/terms/e/endowment.asp
(Continued)
Top U.S. university endowments — who’s largest
– Large, long-established private universities and public university systems dominate the list of biggest endowments. Institutions that frequently appear among the largest by assets include Harvard, Yale, Stanford, Princeton, MIT, the University of Texas System, the University of California system, Columbia, University of Michigan, and Northwestern. Reports and rankings are published annually by NACUBO (the National Association of College and University Business Officers) and by federal datasets such as NCES. (See Sources.)
Real-world case studies and examples
Harvard University
– One of the largest university endowments in the world, Harvard’s endowment is subdivided into thousands of separately restricted funds. The endowment’s size and spending support financial aid, faculty positions, research, facilities, and many academic programs. Harvard’s decisions over accepting government relief during crisis periods and its investment practices have sparked public debate and student activism.
Yale University (the “Yale model”)
– Yale’s management under the late David Swensen popularized a heavy allocation to alternatives (private equity, hedge funds, real assets) for long-term return and diversification. Yale’s investment approach influenced many other endowments and institutional investors, though it has also been criticized for complexity, fees, and illiquidity.
Hampshire College and divestment history
– Student activism has driven many universities to alter endowment allocations for ethical or political reasons. Hampshire’s divestment from South Africa in the late 1970s is an early example; more recent movements have targeted fossil fuels, private prisons, and other sectors.
Smith College (example of a program-specific endowment)
– Smith’s endowment supports a botanical garden fund and illustrates how donors designate funds for specific institutional priorities (gardens, museums, scholarships, chairs).
Legal flexibility in exceptional circumstances
– Courts can apply the cy pres doctrine to modify donor intent when the original purpose is impossible or impracticable (for example, if the named program no longer exists or if the institution is insolvent). “Invading” the corpus (spending principal) is typically a last resort, often requiring court approval or strong legal justification.
Regulatory and tax environment — key facts
– Private foundations: generally required by federal tax law to distribute at least 5% of their assets annually for charitable purposes (failure to do so risks penalties).
– Private colleges/universities: under the Tax Cuts and Jobs Act (effective 2017), private colleges and universities with at least 500 students and net assets of more than $500,000 per full-time equivalent student are subject to a 1.4% excise tax on net investment income (check current IRS guidance for precise applicability and exemptions).
– UPMIFA (Uniform Prudent Management of Institutional Funds Act): enacted in most U.S. jurisdictions, UPMIFA modernized rules governing investment and spending from endowments, emphasizing prudence and total-return investing. It gives institutions guidance on how to balance donor intent against current needs (see Sources).
Common criticisms and controversies
– Perception of hoarding: critics say large endowments underutilize funds that could immediately aid students or programs.
– Misalignment with institutional mission: overly conservative spending rules or large allocations to preserve corpus can prioritize endowment health over current needs.
– Transparency and governance concerns: donors and public stakeholders sometimes challenge opaque reporting or conflicts of interest in investment decisions.
– Ethical investing vs. fiduciary duty: student and donor pressure to divest from certain industries can create tension with fiduciary duties to maximize long-term returns.
– Payout cuts in crises: during downturns (e.g., Great Recession), some endowments reduced distributions, which can hurt current operations and lead to criticism.
Practical steps — for institutions creating or managing an endowment
1. Define purpose and donor intent
– Document whether the gift is unrestricted, restricted (purpose-limited), term, or temporarily restricted.
– Obtain clear written donor agreements specifying allowable uses, naming rights, reporting requirements, and successor plans if purpose becomes impracticable.
2. Choose legal vehicle and governance structure
– Establish the fund as part of the institution, a separate trust, or a private foundation, depending on tax and control considerations.
– Form an investment committee, establish roles (board oversight, CIO, external managers), and ensure appropriate fiduciary training.
3. Create an Investment Policy Statement (IPS)
– State objectives (return target, liability matching, inflation protection), risk tolerances, permitted asset classes, target asset allocation and rebalancing rules, and manager selection criteria.
– Include ESG or screens if required by donor or governing body, but note fiduciary duties.
4. Adopt a spending (withdrawal) policy
– Common approaches: fixed percentage of market value (e.g., 4–5% spending rule), smoothed payout (multi-year average market value), or total-return-based rules that combine income and realized/unrealized gains.
– Consider inflation protection (spending plus inflation adjustment) to preserve purchasing power.
5. Implement appropriate investment mix and manager strategy
– Large endowments commonly use diversified allocations including public equities, fixed income, private equity, real assets, and hedge funds. Allocation must reflect liquidity needs and time horizon.
– Decide on active vs. passive management and direct vs. commingled funds.
6. Ensure transparency, reporting, and stewardship
– Provide regular financial reports to donors and stakeholders, annual audited financial statements, and impact reporting for restricted funds.
– Maintain records to demonstrate compliance with donor intent and legal requirements.
7. Monitor, review, and adapt
– Annual IPS review, performance benchmarking, and stress testing.
– Periodic reevaluation of spending policy relative to market environment and institutional needs.
Practical steps — for donors who want to create an endowment
1. Decide purpose and flexibility
– Choose whether to give unrestricted funds (institution decides use) or to restrict funds to scholarships, faculty chairs, buildings, programs, etc.
2. Choose the gift vehicle
– Outright gift; bequest in a will; charitable remainder trust (generates income to donor then remainder to charity); charitable lead trust; donor-advised fund; or gifts of stock/real estate.
3. Work with legal and tax advisors
– Understand tax consequences and get a formal gift agreement with the recipient institution documenting intent, terms, and reporting requirements.
4. Consider sustainability and impact requirements
– If you specify ESG or divestment criteria, provide clear, workable language to enable implementation and avoid unintended conflicts.
5. Understand reporting and naming
– Agree on reporting frequency and content. If naming rights are requested, document conditions and duration.
Examples of practical calculations and policies
– Spending-rule example: If an endowment has $100 million and the institution uses a 5% payout policy, the annual distribution equals $5 million. If the endowment earns a 7% total return and inflation is 2%, a 5% payout allows modest growth of principal to preserve purchasing power.
– Smoothing example: To avoid volatility, a university might base payouts on a 3-year moving average of market value. If the market drops sharply, the 3-year average reduces the immediate cut in payouts.
Risks and mitigation
– Market risk: diversify across asset classes and geographies; use long-horizon allocations for illiquid assets only if liquidity needs allow.
– Liquidity risk: maintain a liquid reserve or short-term pool to meet operating cash needs without forced sales.
– Manager risk: conduct due diligence, diversify managers, and set performance benchmarks and fee caps.
– Governance risk: independent board members, conflict-of-interest policies, and transparency reduce reputational and legal risk.
– Legal risk: ensure compliance with UPMIFA, IRS rules, state law, and donor agreements; consult counsel before modifying donor restrictions.
Who manages endowments?
– Management structures vary: some large institutions have internal investment offices (CIO, portfolio managers, analysts), oversight by investment committees or boards, and external managers or fund-of-fund relationships. Smaller institutions often outsource most investment management to external advisors or custodians.
Who can benefit from endowments?
– Nonprofits in education, museums, libraries, hospitals, religious organizations, and social services commonly benefit. Within universities, scholarships, endowed chairs, departmental funds, and campus facilities are typical beneficiaries. Eligibility and use are governed by donor restrictions and institutional policies.
Practical checklist for starting an endowment (summary)
1. Define purpose and term (perpetual vs. term).
2. Choose legal structure (trust vs. part of organization).
3. Draft donor agreement and acceptance policy.
4. Establish governance: board, investment committee, reporting lines.
5. Create an Investment Policy Statement and spending rule.
6. Set up accounting, custody, and audit processes.
7. Select managers/custodians, implement investments.
8. Communicate with donors and stakeholders; publish annual reports.
9. Review IPS and spending policy at least annually.
Further developments and trends to watch
– Increased attention to ESG/sustainable investing and divestment pressures.
– Greater regulatory and public scrutiny of large endowments’ payouts and tax treatment.
– Continued use of alternatives by large endowments, balanced by considerations of fees and illiquidity.
– Innovations in donor-advised funds and planned giving that affect future endowment inflows.
Concluding summary
Endowments are a vital financial tool for nonprofit institutions, designed to provide long-term, often perpetual, support for mission-driven activities. They are governed by donor intent, institutional policy, and legal frameworks (such as UPMIFA), and are managed to balance present spending needs with preservation of real purchasing power for future beneficiaries. Institutions and donors must carefully craft clear agreements, prudent investment and spending policies, and transparent governance to ensure endowments serve their intended purposes while adapting to changing financial, legal, and social environments. Whether you are a donor, administrator, or student activist, understanding the mechanics, benefits, limitations, and risks of endowments is essential for making informed decisions that align philanthropic capital with institutional mission.
Sources and further reading
– Investopedia, “Endowment” — https://www.investopedia.com/terms/e/endowment.asp
– NACUBO, Endowment Study (annual reports) — https://www.nacubo.org/
– Uniform Law Commission, “Uniform Prudent Management of Institutional Funds Act (UPMIFA)”
– National Center for Education Statistics (NCES) data on higher education finance
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