Principles of Nonprofit Investment Management - Commonfund

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They could then calculate the payoutrate as a percentage of the investmentfund’s total net asset value. The overridingconsideration is the relevantsection of the Internal Revenue Codestipulating that foundations mustdistribute at least 5 percent of theirassets every year if they are to preservetheir status as tax-protected entities.The calculation of the 5 percent isbased on the average of the marketvalue of the foundation’s portfolio atthe end of each month of the previouscalendar year. Once that is known, thepressure is on to debit at least 5 percentof that average from the foundation’sbalance sheet and to make sure themoney has been spent – deposited intothe bank accounts of qualified grantees– by the end of the current year.Making this calculation even morecomplex are the regulations concerningattribution of administrative and overheadexpenses, as well as excise taxes.The calculation must be timely enoughto facilitate accounting and execution.Overhead and all other expenses mustbe precisely defined to determinewhich are attributable to distribution.Program expenses and staff time spentin grant making may be included.Meanwhile, another factor enters theboard’s deliberations about its distributionrate: the excise tax that the federalgovernment imposes. The tax amountsto 2 percent of annual net investmentincome and realized gains, unless totaldistribution reaches a certain tippingpoint which then brings the tax ratedown to 1 percent. Because the formulaused to determine qualificationsfor the reduced rate is so complicated,relatively few foundations apply forthe reduction. The new legislationproposes to reduce the rate to 1percent overall.As it has stood, the two-and-onepercent excise-tax formula has tendedto motivate foundation decisionmakers to raise their distribution ratehigher than they might have otherwise;better to pay more to grantees and lessin tax. The old tax formula could alsoinfluence decisions about when totake investment gains or losses.And so, the foundation’s financialteam determines its optimum course,weighing income, distribution andtax issues.To be sure, distributions are not theonly payout impacting a foundation’slife expectancy. Expenses related tomanagement of the foundation’sinvestments are counted outside ofthe distribution allotment.These include not only fees paid tooutside consultants and investmentmanagers but also related investmentoverhead expenses, e.g., administrativesalaries, space costs, and expenses ofthe board and investment committee.Inevitably, ambiguity arises. Someadministrative expenses are not clearlyclassifiable as part of either distribution,administration or investmentmanagement: certain costs of research,for instance, or conferencing. If a foundationsponsors a forum for grantees,is that counted as part of the 5 percentdistribution requirement?In recent years, new federal legislationhas been proposed (the timing ofpossible passage is unclear) that couldeliminate the attributable administrativeand overhead expenses that can now beincluded in the 5 percent total. Such alaw would tend to accelerate the rate oftotal payout of most foundations, possiblybringing some of them to depletionsomewhat sooner than they would haveplanned or wished.Aside from these pressures, a foundationmay be impelled by its mission todistribute more than 5 percent of itsassets. The needs of its grantees and theurgency of their work may demand it.A foundation so inclined must recognizeit may ultimately be limiting itstime horizon.- 12 -
Payout PolicyPayout Policies for Health CareHealth care organizations differ fromendowments both in how assets areobtained and how funds are spent.First, health care organizations generaterevenue from the services provided.These funds are obtained from insurancecompanies, government programsand patients. Additionally, some healthcare organizations receive donationsfrom individuals or organizations thatwish to support overall operations or toassist in funding a specific project (i.e.,a cancer wing). Both of these fundingsources serve to build the long-terminvestment assets of the organizationand are needed to support the missionof providing health care services.Health care organizations typicallyhave significant capital requirements.The capital is spent on items such asmedical equipment, construction orremodeling of the physical structure,information technology, etc. Mosthealth care organizations review theircapital needs on an annual basis andthen determine which projects willbe funded. Projects can be fundedthrough cash generated from operations,issuing tax-exempt bonds,fundraising initiatives and/or withdrawingfunds from the long-terminvestment assets. Typically, a mixtureof these funding sources is used topay for the capital expenditure.While there is no predetermined‘‘payout policy” for health care organizations,one important consideration ishow the funding method impacts theoverall strength of the organization’sbalance sheet. One way to measure thisstrength is by the number of ‘‘days cashon hand.” A day of cash on hand isequal to the amount of money it takesto operate the health care organizationfor one day and is indicative of theliquidity of the entity.Days cash on hand is one of manyindicators used by the rating agencies(e.g., Moody’s, Standard & Poor’s, etc.)to assign a rating (i.e., AA) on the taxexemptdebt issued by the health careorganization. For example, an AA-ratedhealth care organization typically has175 days cash on hand or greater. Manyconsider it advantageous to obtain thehighest rating possible as the best-ratedhealth care organizations typically paya lower interest rate on debt.Another important indicator is thedebt-to-capitalization ratio. This ratiois also closely monitored by the ratingagencies to ensure that the health careorganization does not utilize unreasonableamounts of leverage to pay for itscapital expenditures. A health careorganization with a AA rating, forexample, normally has a debt-tocapitalizationratio of 30-40 percent.The next section, Principle Three –Asset Allocation, discusses the keyissues in managing investment strategy.- 13 -
Page 1: Principles of Nonprofit Investment
Page 4 and 5: Contents3 BasicsBeginning at the be
Page 6 and 7: PRINCIPLE ONEObjectivesThe governin
Page 8 and 9: The committee’s deliberations wil
Page 10 and 11: PRINCIPLE TWOPayout PolicyThe board
Page 12 and 13: Payout Policies for EducationalInst
Page 16 and 17: PRINCIPLE THREEAsset AllocationAllo
Page 18 and 19: Since the introduction of the UMIFA
Page 20 and 21: Many such analytical tools are avai
Page 22 and 23: PRINCIPLE FOURManager SelectionThe
Page 24 and 25: Selecting investment specialists ha
Page 26 and 27: PRINCIPLE FIVERisk ManagementYou sh
Page 28 and 29: PRINCIPLE SIXCostsContinually ask:
Page 30 and 31: PRINCIPLE SEVENResponsibilitiesTo p
Page 32 and 33: References andResourcesDow 36,000:
Page 34 and 35: About CommonfundCommonfund provides
Page 36: Commonfund15 Old Danbury RoadP.O. B

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