Nonprofit Endowment Research Articles

Study shows few grantmakers funding endowments, despite their advantages

New research shows that fewer than a third of grantmaking foundations fund nonprofit endowments, despite the fact that endowments can be a “powerful grantmaking tool that not only can address longstanding racial inequities but also represents a direct transfer of power,” according to the Bridgespan Group and the Center for Effective Philanthropy.

A novel approach to legacy donations with long‐term benefits supported by numerical illustrations

AbstractPhilanthropic donors face challenges in matching the causes to which they donate, the time horizon—and thus impact—of their donations, and the charitable vehicles they choose for making contributions. Wealthier donors may elect to create their own foundations and customize their charitable support. Less wealthy donors have limited choices: they may contribute to a nonprofit's current operations or to existing nonprofit endowments. We present a novel approach for making charitable donations, blending aspects of each of these strategies. Our approach has potential long‐term financial benefits, allows donors to control their charitable donations in a convenient and easy‐to‐implement manner, can be established through an existing nonprofit organization, expands opportunities for more donors because it requires a smaller corpus contribution with lower management costs than creating a foundation, provides tax savings in the United States and other countries (e.g., the UK, Canada, and Australia) comparable to other planned giving vehicles, and may be implemented during one's lifetime using donor advised funds or as part of a legacy plan through the donor's estate documents, which is when the long‐term benefits accrue.

Warren Buffett’s Advice … Good for Nonprofit Endowments?

Owing to their personal success, affluent individuals are often asked to serve as nonprofit board members to help guide endowment investment policies. The coming wealth transfer, combined with a low-yield financial environment, adds importance to endowment financial management. Standard financial management favors a 60/40 allocation between equities and bonds. Warren Buffett, however, rejected this standard financial advice and directed the trustees of his estate to invest in a 90/10 allocation; 90% invested in the S&P 500 Index and 10% in short-term bonds. This article tests this strategy against various allocation methods for nonprofit endowments using a 5% payout. The heavier stock-weighted portfolios provide a higher likelihood an endowment balance will stay above the nominal initial balance and the inflation-adjusted balance, leading to more certainty the endowment can be relied on for operational expenses. The tipping point appears to be the 80/20 allocation. Allocations with more than 20% bonds perform noticeably worse and allocations with less than 20% bonds perform marginally better.

The Effects of Spending Rules and Asset Allocation on Nonprofit Endowments

The long-run impact and implications of an endowment’s spending policy and asset-allocation decisions are examined. Using a dynamic model, the authors explore how different endowment spending rules (SRs) influence the dynamics of an endowment’s size and future spending. They find that different parameters within each SR have significant long-term impact on wealth accumulation and spending capacity. Using Merton’s (1993) endowment model and compiled asset-allocation data, they estimate the intertemporal preferences and risk aversion of several major endowments and find significant variation across endowments in their propensity to increase portfolio risk in response to increased spending needs.

The Effects of Spending Rules and Asset Allocation on Non-Profit Endowments

The Effects of Spending Rules and Asset Allocation on Non-Profit Endowments

Practical Applications of Should Endowments Continue to Commit to Private Investments?

In <b><i>Should Endowments Continue to Commit to Private Investments?</i></b>, from the December 2020 issue of <b><i>The Journal of Investing,</i></b> author <b>Dennis Hammond</b> (of <b>Veriti Management</b> in <b>Boston</b>) analyzes whether private equity, venture capital, and private real estate provide superior investment returns for nonprofit endowment funds. Endowments have increasingly allocated assets to private investments, due to their superior historical returns. However, these returns have slowed over the past 10 years–leading the author to question whether private investments are still worth it. Hammond uses publicly available data to calculate whether endowments have earned higher net returns from private or public investments–and whether private investments held by large or average endowments (those with more or less than $1 billion) have done better or worse. He finds that large endowments’ private investments have outperformed those of average endowments and have outperformed the S&amp;P 500 stock index, while average-size endowments’ private investments have underperformed the S&amp;P 500. He says this difference stems from the fact that only large endowments can afford to hire the best private investment managers. He says average-size endowments therefore should consider reallocating assets to publicly traded investments–and offers reasons why large endowments might do the same. <b>TOPICS:</b>Private equity, equity portfolio management, foundations &amp; endowments, volatility measures, fundamental equity analysis, real estate, manager selection

The Risk, Reward, and Asset Allocation of Nonprofit Endowment Funds

We collect tax return data from all 311,222 public NPOs in the United States over the 2009-2017 period to study the asset allocation choices and investment returns of their endowment funds. One in nine public NPOs have endowment funds. The majority of funds allocate their assets conservatively to low-risk assets, and as a result, earn an average annual return of 5.3%. There is substantial heterogeneity in investment returns across funds. Large funds significantly outperform small funds across all return measures and nonprofit sectors. Endowments in NPO sectors devoted to public and societal benefit, the environment, and the arts are among the top performers. High returns among higher education endowments are explained by size, while hospital endowments significantly underperform. Higher investment returns are associated with better governance, more highly paid management, lower discretionary spending, and lower investment management fees. Lastly, when faced with volatile contributions, endowment funds hold more cash and invest more conservatively.

Background risk and nonprofit endowment portfolio volatility

AbstractThis article focuses on endowed operating public charities that receive income not only from sources such as donations, grants, and service fees but also from endowment portfolios. Using the Form 990 data between 2009 and 2016, this study examines if the risk from nonendowment income sources, namely background risk, is relevant to endowment portfolio volatility, and if there are any differences across four types of nonprofits where endowment assets are the most concentrated, including museums, universities and colleges, K‐12 schools, and hospitals. The results show that the association between background risk and endowment portfolio volatility is significant and negative for universities; however, it is either nonsignificant or significantly positive for other types of organizations. This study extends research on university endowments to other types of endowed nonprofits. The findings imply different endowment objectives and reflect different asset allocation strategies across types of organizations.

Does Chief Investment Officer Pay Reflect Performance? Evidence from Non-profits

This paper examines the compensation of Chief Investment Officers (CIOs) of nonprofit endowments, which have different economic models and monitoring arrangements than those of other institutional investors. We find that compensation reflects the demands of the job, abilities and experience that individuals bring to the job and how well the endowment performs. Pay relies heavily on bonuses and is positively linked to the CIO's education and professional experience. Large endowments hire CIOs with stronger backgrounds, pay them more and structure pay significantly linked to endowment performance. Even controlling for size, compensation depends on an endowment’s governance and location. The results are consistent with the increased investment skills needed to manage large pools of capital often involving alternative assets, and with differences in labor market and monitoring arrangements across endowments. For large endowments the sensitivity of pay to performance is greater than often reported for mutual fund managers.

Investment Returns and Distribution Policies of Non-Profit Endowment Funds

We present the first estimates of investment returns and distribution rates for U.S. non-profit endowments, based on a comprehensive sample of 35,755 organizations for 2009-2018, a period that saw a sharp drop followed by a lengthy appreciation in public equity values. Non-profit endowments badly underperform market benchmarks during our sample period. Holding a zero investment portfolio (long endowment and short 60-40 mix of U.S. equity and Treasury bond indexes) generates a mean -4.20% annual return. Regression estimates in four-factor models including U.S. stocks and bonds, global stocks, and hedge funds, find statistically significant alphas of -0.39% per year. Smaller endowments have less negative alphas than larger endowments, but all size classes significantly underperform. Distribution ratios are conservative, well below the funds’ long-run returns. Donors increase contributions when endowment returns are strong, with an elasticity of about 0.20 between net-of-market investment returns and new donations.

The Investment Returns of Nonprofit Organizations, Part I

Nonprofit charities and foundations hold endowments and many other kinds of investments. How do these investments perform? Some high‐profile nonprofit endowments, including those of colleges and universities, have been studied previously. This study is the first, to our knowledge, that looks at a large number of the diverse types of nonprofits. We investigate the determinants of investment performance using a large panel data set culled from the 990 forms that nonprofits must file annually with the IRS. In this first part of our article, we discuss our approach and the challenges of using these data to infer investment returns. The IRS data, though less than perfect, yield valuable measures of the investment returns of nonprofits. They reveal that some charities consistently do better in their investment returns than do others.

Principals and Agents: An Investigation of Executive Compensation in Human Service Nonprofits

This study proposes a revised agency theory for the nonprofit sector, distinguishes between the extent of agency and the extent of monitoring, and compares the magnitudes of the two impacts. Using panel data for 1998–2003, the paper tests whether monitoring by principal-stakeholders such as donors, clients, the government, and the board reduces the opportunity for executive misconduct such as extravagant spending on compensation and perquisites. Given the theory, the findings show that two effects influence CEO salaries. First, while nonprofit endowments provide a fiscal cushion in tough financial situations, by offering “organizational slack” they also increase the CEO’s opportunity to steal or raise her compensation (i.e., agency effect). Second, donors utilize monitoring mechanisms such as auditing or direct observations, which limit the opportunity for misconduct and reduce executive pay (i.e., monitoring effect). In the final analysis, the monitoring effect is greater than the agency effect, which implies that even if agency problems are present, the monitoring that donors provide offsets them.

Testing Competing Capital Structure Theories of Nonprofit Organizations

The static trade‐off and pecking order capital structure theories are analyzed and applied to nonprofit organizations. In addition, this paper also considers how nonprofits adjust their leverage over time. The analyses consider the unique role of donor‐restricted endowments in the decision to borrow, as well as different types of borrowing by nonprofits. The results indicate that nonprofit capital structure choices are best explained using the pecking order theory, in which internal funds are preferred over external borrowing. Further, nonprofit endowment is not found to increase leverage. Despite the unambiguous findings across varying definitions of leverage, the results also suggest that a “modified pecking order” is a more apt descriptor of nonprofit behavior.

Why Do Universities Have Endowments?

Why Do Universities Have Endowments?