An endowment is created by a donor from a gift containing a legal stipulation that the original gift may never be expended. These gifts are held and invested in perpetuity by The Regents of the University of California and the UC San Diego Foundation for the purpose of generating a permanent expendable income stream from the return on the gift for the purpose the donor desires.
Endowed gifts may be for restricted or unrestricted purposes and are particularly important to UC San Diego due to their permanency. These gifts permit planning for programs into the far future.
The UC San Diego Foundation, pursuant to its Endowment Investment Policy and Guidelines and the Uniform Prudent Management of Institutional Fund Act (or any subsequent governing laws or regulations), combines endowment funds for investment purposes and deducts annual costs of administration from the endowment portfolio total return. Each endowed fund holds units in the combined portfolio. New gifts to an endowment fund are added to the principal of the fund and invested the pooled portfolio.
The Endowment “Spending Policy” (or payout) is set from time-to-time by the UC San Diego Foundation’s Board of Trustees. The payout is the amount of expendable distribution made available to the endowment fund holder or endowment chair holder on an annual basis from the endowment. The payout is used by the fund holder or chair holder for the purpose intended by the donor, subject to the appropriate university policies.
Total return earned by the endowment fund, less the payout provided for distribution by policy, is retained in the principal of the endowment fund to protect the fund from the effects of inflation and to allow for growth. Payout may be added back to the fund’s principal when the distribution is not needed for the stated fund purpose.
100% of all gifts to UC San Diego and the UC San Diego Foundation benefit the campus.
Endowment funds exist in perpetuity. The Chancellor of UC San Diego has the authority to redesignate the purpose of the payout from an endowed fund and, if necessary, to seek approval from the UC President for this redesignation. This would occur only if there are unforeseen circumstances in the far future that render the purpose of the fund difficult to use effectively or appropriately. Should this occur, the new purpose of the fund will be aligned as closely as possible with the original purpose.
The Regents of the University of California (“The Regents”) and the Board of Trustees of the UC San Diego Foundation (“the Foundation”) each have fiduciary responsibility for investment of their respective endowments. Both The Regents and the Foundation are guided by basic principles in endowment management as follows:
To accomplish this goal, both The Regents and the Foundation, like many large educational and non-profit organizations, invest their endowment using diversified portfolios of assets comprised of primarily of equity, fixed income, and alternative asset classes (most of which are equity based). Most larger institutions recognize that while the equity markets can be volatile in short runs, over the long-term they produce the greatest total return. Total return in any given period is defined as the sum of cash earnings on investments, such as dividends and interest, plus the realized or unrealized appreciation or depreciation in the market value of those investments for that period.
The Regents have received and manage endowed gifts directly for the benefit of each campus, including UC San Diego, and those funds are invested by the Treasurer’s Office of the Regents in their General Endowment Pool (GEP). The Treasurer’s Office has achieved good long-term returns on the endowment, with an investment management fee of only .09% per annum.
The Foundation’s endowment is separate from that of The Regents, and is invested based on a policy approved by its Board of Trustees, and carried out by its Investment Committee. All ten UC campus foundations have the option of hiring the Treasurer’s Office of the Regents as a manager and of investing in the UC Pools, including the GEP, or of hiring completely external managers, making their own determination of investments, or a combination of them all. The Foundation uses the GEP as a core investment in its endowment investment strategy, and has added additional vehicles as well. The Foundation has achieved good long-term returns similar to that of the GEP, at a low cost.
The actual mechanics of endowment investment and management are very similar to that of a mutual fund. Endowment, whether held by The Regents, or by a campus foundation, is accounted for using a unitized investment pool. Each individual endowment owns units in the pool, revalued at each month-end. Only at month-end periods, using the month-end value of a unit, may new endowments enter the pool. New endowments “buy into” and receive a certain number of units in the pool given the amount being invested and the value of a unit on the buy-in date. As the value of a unit in the pool grows, new endowments purchase fewer units in the pool.
For example, an entire endowment pool may have a market value at December 31, 2012 of $10,000,000, and have 100,000 units in the pool. The market value is therefore $100 per unit. Let’s assume the Jones Endowment began with a $10,000 gift and bought into the pool five years ago when the unit value was only $50, obtaining 200 units in the pool at that time. Given the unit value at December 31, 2014, the market value of the Jones Endowment would be $20,000 at December 31, 2014. If the Smith Endowment gift of $10,000 were received during the month of December 2014, the Smith Endowment would buy units in the pool as of January 1, 2015 at the rate of $100 per unit. Therefore, the Smith Endowment would obtain 100 units in the pool. The same gift five years ago bought 200 units in the pool at the unit value at that time, versus the 100 units it can purchase now, due to the appreciation of the value of a unit in the pool.
Since the principal of an endowed gift may never be expended, then a very significant aspect of any institution’s endowment policy is the question of how much of the total return earned on those gifts may be expended annually. Typically, this is referred to as an institution’s endowment “spending policy”.
Most institutions invest to maximize long-term total return of their endowment, but have very conservative spending policies. That is, in order to ensure the spending made available from the endowment is equal to, or better yet, outpaces the rate of inflation, most institutions set annual spending policies at rates less than their expected total rate of return. By retaining a portion of return in the principal, rather than spending it, the fund will grow. If this inherent conservatism were not in place, an endowed scholarship fund that provided a full scholarship from the spending the first year might only provide one-half a scholarship in its tenth year, due to the effects of inflation and the higher cost of education. Eventually, its value would erode to nothing.
According to an endowment study conducted nationally each year by the National Association of College and University Business Officers (NACUBO), approximately 75% of all institutions set a spending policy rate using an average value of the endowment, generally computed over a three to five year period, to compute annual spending. The use of an averaging mechanism to compute spending helps ensure the amounts are not widely fluctuating, and most likely are slightly increasing, each year. The equal-weighted average spending rate of all institutions in the NACUBO Study was approximately 4.4% of the average fund value.
The Regents and the Foundation have very similar spending policies to each other. The Regents policy is set at 4.75% of the 60-month average unitized market value. The Foundation’s spending policy for fiscal 2016-17 is also 4.75% of the 60-month average unitized market value.
Included in the spending rate of The Regents and the Foundation is a fee of 0.55% that is recovered for annual endowment administration costs incurred internally.
The actual spending for any individual endowment is computed annually using the following information:
Using the Jones and Smith Endowments above, let’s compute the spending that would be made available to each endowment for 2015.
The computation for endowment spending for 2015 would be as follows:
200 units X $85.60 (5 yr. avg. unit value) X 4.75% = $813.20 of gross endowment spending, less $94.16 (at .55% annually) of admin management fee is a net of $719.04 to the fund holder.
(Note: if the market value of the endowment is $20,000 now, it is easy to see that the endowment spending is NOT calculated on the ending value of the endowment at any point in time, but on the unitized value. Taking the gross spending of $813.20 divided by the $20,000 current value, that is an effective spending rate of 4.1% on the most recent market value. This illustrates the important effect of the averaging mechanism on spending.)
100 units X $85.60 (5 yr. avg. unit value) X 4.75% = $406.60 of gross endowment spending, less $47.08 in admin management fee for a net of $359.52 to the fund holder.
Five years ago, the Jones Endowment calculation for endowment might have looked something like this:
200 units X $68.50 (5 yr. avg. unit value) X 4.75% = $650.75 of gross endowment spending
Comparing the Jones Endowment spending five years ago versus now, one can see that a conservative spending policy, coupled with a sound investment policy that achieves long-term maximized returns, will preserve and enhance the value and purchasing power of endowment spending in perpetuity. While it is true that there may be short-term fluctuations in both value, over the long-term, endowments will grow and achieve the donor’s purposes, and the averaging mechanism will provide a smoother increase in spending, and smooth any decreases, should market value be affected by significant changes in overall market value of the fund as whole.