Endowment Erosion


Like many of our personal investments, nonprofit endowment funds have suffered from erosion caused by the national and international economic downturn. Some of the largest nonprofit endowment funds have experienced losses of principal in the range of 15 to 30%. Nonprofits depend on the income from their endowments to provide operating income and long term financial stability.

Erosion takes place when the performance of the endowment produces less income for the institution. A decrease in market value often means less income.

Organization Y has an annual operating budget of $30 million and an endowment of $30 million. The organization uses a “total return” of 4% and withdraws that amount ($1.2 million) from the endowment for operations. The organization increases its budget by 4% to $31.2 million, while the endowment market value dropped to $24 million. The 4% rule still applies, which means the endowment can only produce $960,000 for operations. This is an erosion of $240,000 in needed income. Generally, in situations such as this, the institution adjusts its spending rate, seeks to raise more money in annual contributions to cover the short-fall. Little attention is given to a gifting rate.

Gifting Rate:          
   

There is a need for nonprofit organizations to establish a gifting rate. A gifting rate is the percentage to which the endowment must increase in order to meet the increases in operations.

In the scenario mentioned above, where the organization has a budget of $30 million and an endowment of $30 million and the budget is increased by 4% or $1.2 million, the endowment will need to produce another $48,000, just to keep even. Therefore, the gifting rate, the amount of new gifts needed to produce the $48,000 at 4% is $1.2 million. The endowment must grow from $30 million to $31.2 million just for the budget to increase. Each institution will have its own set of guidelines, spending rate, and savings rate. We are able to assist institutions in establishing a gifting rate.

As an endowment manager, we first conduct a readiness assessment and determine the understanding of the nature of an endowment, the willingness of the governing board to take responsibility for endowment management, and the ability of the board and administration to secure new contributions to grow the endowment fund.

Our goal is to minimize erosion, when downturns occur, by using effective investment strategies and by developing a consistent fund raising effort. The latter involves training and managing the fund raising process including planned gifts. This offering is unique to endowment management.

The largest educational endowment, Harvard University, experienced 27% erosion in market asset value during the 2008-2009 financial crises according to published reports. The market value dropped from $36.9 billion on June 30, 2008, to $27.6 billion June 30, 2009. In 2008 the endowment contributed $1.66 billion while in 2011 the contribution was $1.4 billion. This was a dramatic drop in income of $260 million. The extreme volatility of the financial market had its impact on the Harvard endowment’s contribution to the operations of the University.

It was recently announced that Harvard’s endowment has increased to $32 billion due to a return on investments and the influx of new contributions, which together totaled $4.4 billion. It was also reported that Harvard University receives 35% of its operating budget from the school’s endowment fund. While not all nonprofit organizations can compare to Harvard, much can be learned from their example:

  • Even the best institutions can have set-backs,
  • Prudent management and effective strategy can improve performance,
  • Gift income is critical to responding to economic challenges and endowment erosion.