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April 30, 2015

Best Practices for Managing Your Organization's Endowment Funds (article)

Endowment support is a critical piece of a not-for-profit's funding. Given to organizations to invest and manage, these funds can earn rates of return that both finance current-year activities and grow the fund for future use.

A not-for-profit accepts an endowment on the condition it will maintain the fund at a specified level, regardless of the organization's spending policy or the economic environment. A good investment market makes the agreement easy to uphold. But success and failure of the endowment investment affect the not-for-profit in equal amounts. Should an endowment dip beneath its original corpus, the not-for-profit must restore the fund. It may have to transfer some of its unrestricted net assets to the endowment in order to uphold its end of the donor agreement.

A thorough review of your endowment policies and procedures can illustrate if your not-for-profit's investment and spending strategies meet both your organization's needs and your donors' expectations. Below, we have outlined ways you can improve your endowment management in order to maximize the value of your endowments.

Understand the Rules

The Uniform Management Institutional Funds Act (UMIFA), released in 1972, created the first universal guidance for how not-for-profits should sustain their endowments. Among other items, the act required endowments to keep pace with inflation.

UMIFA created the “historic dollar value,” which reflects the fair value of the fund when received, subsequent gifts to the fund and donor expectations for the fund. Under UMIFA, not-for-profits could appropriate interests and dividends that exceeded the fund's historic dollar value. If the fund ever decreased below its historic dollar value, the not-for-profit had to stop appropriations from the fund until the historic dollar value was restored.

In 2006, the Uniform Prudent Management of Institutional Funds Act (UPMIFA) replaced the prior guidance. UPMIFA moved away from historic dollar value and toward an endowment management approach that focused more on preservation of the fund. It established seven criteria to guide yearly expenditure decision-making:

Duration and preservation of the fund - Does the fund exist in perpetuity or did the donor set an expiration date on the endowment? Whatever the case, not-for-profits need to manage their investments accordingly.

Purposes of the institution and the fund - The endowment must support missions and initiatives that forward the organization's tax-exempt purpose. The Financial Accounting Standard Board guidance, FSP 117-1, makes the description of how endowment appropriations forward the not-for-profit's mission a required disclosure on the not-for-profit's financial statement.

General economic conditions - UPMIFA allows not-for-profits more flexibility to recover from a downturn in investments. As stated earlier, if an endowment dips below its required level, the not-for-profit can continue to make appropriations from the endowment, so long as it replenishes the endowment with unrestricted net assets. Underwater endowments have additional disclosure requirements under FSP 117-1.

Effect of inflation or deflation - $50,000 in 1950 does not have the same impact as $50,000 in 2014, so your endowment management should reflect the current inflation rate and grow the endowment accordingly.

Expected total return - In earlier approaches to management, not-for-profits focused on interests and dividends. UPMIFA requires you to consider all forms of return, including realized capital gains and losses and unrealized capital gains and losses.

Other institutional resources - Not-for-profits have other sources to generate income such as fundraising, and the other options should factor into endowment appropriation decisions.

Investment policy of the institution - Your organization's endowment investment strategy should resemble its approach to managing its other investments.

Interconnectivity

Endowment investment policies, spending policies and your organization's approach to soliciting for endowments all need to inform one another.

Your development office and your fiscal office should work together to develop a strategy that benefits the organization and meets donor expectations. For example, your not-for-profit would not want to use a large endowment to fund a program that has a limited spending budget. Make it clear to donors how your organization uses its endowments and outline for them your investment strategy (risk parameters, return objectives, etc.). Your investment strategy should be readily available as it is a required disclosure under FSP 117-1.

Likewise, your spending policy should coordinate with your investment policy. Both should reflect the current economic climate. Take the following example.

Organization A receives an endowment of $100,000. Its spending policy allows 4 percent of an investment to be appropriated. The current inflation rate is 3 percent. The investment policy needs to ensure the endowment receives at least $7,000 in investment returns so it keeps pace with inflation and Organization A receives its appropriations without damaging the endowment level. If the investment environment cannot promise at least a 7 percent investment return, then Organization A should ratchet down its spending policy to avoid driving the endowment underwater.

For best results, your organization should revisit both its investment strategy and its spending policy on annual basis.

Long-Term Benefits

Success begets success. If you demonstrate your endowment policies can adapt to change while protecting the underlying investment, you can prove you are adept at endowment management. This could encourage potential donors to create new endowments with your organization or contribute to your organization's existing funds.

Your CBIZ MHM advisor can review your endowment strategies and management procedures to help you create a value-maximizing approach to endowments. Contact us for more information.


Copyright © 2015, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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