Principles of Nonprofit Investment Management - Commonfund

Payout PolicyPayout Policies for FoundationsFoundations have very special legalrequirements concerning theirminimum payout level, currently aminimum of 5 percent of the endowmentvalue (subject to possible legislativechange as this is being written).Further, there are fairly technicalrequirements as to what types ofspending may be counted against the 5percent minimum. In the most recentCommonfund Benchmarks Study, 39percent of foundations responding –the largest proportion – indicated thatthey set their spending rate by targetingthe 5 percent distribution requirement.In other words, it appears thatthe most they plan to spend is the minimumrequired by law.However, in practice the 5 percenttarget is often exceeded. The sameBenchmarks Study found that the averagespending rates for all foundationswas about 6 percent, ranging from6.1 percent for the largest foundationsto 5.5 percent for foundations withbetween $50 million and $100 millionin assets.Several factors account for the differencebetween the traditional targets of5 percent and the actual level of spend-ing. The items allowed in computingthe statutory spending level includepayments to support the operatingbudget, distributions to grantees, thecost of services the nonprofit mayprovide grantees, and the overheadand administrative costs incurred inrunning the nonprofit.The relatively high spending rate of6 percent is also due to a number ofother factors, including the effect oflower market values of the underlyingfunds during a prolonged bear market.Multi-year commitments to granteesand an unwillingness to reduce thevolume of new grants to increasinglyhard-pressed charities has also played apart in keeping spending rates higherthan the legal minimum, in spite of thedeclared policy of many foundations tospend no more than 5 percent.In deliberating and managing its payoutrate, the board navigates throughrocks and shoals. Are there legal orregulatory changes ahead? Mightenvironmental or societal changescreate pressures to modify the foundation’smission? Are the number ofgrantees and their needs increasing?A community foundation is likely tohave a regular fundraising programthat, in good times, can make up thedifference. A private foundation mayreceive further donations, in time,from the founding family.Many foundations spend down theirassets in about fifteen years. A foundationthat aspires to a longer timehorizon or to perpetuity, unless it willreceive further infusions, is driven totake a more conservative payout policy– and a more aggressive investmentstrategy.It appears that a large proportion ofthe nation’s foundations are striving torestrain payout and project a long timehorizon. But the distribution goal doesnot encompass all payout. Investmentcosts must be counted outside the payout.Whether you count those costs asa deduction from total return or anaddition to payout, they are weighingagainst mission.Foundations often face the challengeof managing a large amount of thedonor’s stock and developing anacceptable diversification process.In addition, in the course of makingtheir decision concerning payoutpolicy, boards must keep in mind theprevailing definition of “distribution”and the current legal restrictions underwhich their foundations function.- 11 -