Endowments & Foundations

The stock market continues to reach new highs and philanthropic giving has more than fully recovered from the fall during the credit crisis of 2008-2009. According to the Foundation Center’s “Key Facts on U.S. Foundations” report, grants from private and community foundations were estimated to have reached a record $54.7 billion in 2013, and is forecasted to continue to grow in 2014. This is welcome news for charities, non-profits and other recipients, but begs the question: can grant-markers keep up this level of giving? As we have seen over the last several years, giving has proven to be anything but steady.

Can grant-makers help ensure a steadier source of income for their recipients? For organizations that have discretion in how to structure their giving, now may be the time to consider taking on longer-term grant-making commitments. One-year (i.e., one-time) grants are a common way to structure grant-making. Each year, recipients submit grant request, offering the grant-maker a chance to reevaluate its financial capacity before making a commitment. Nevertheless, grants can also be structured as multi-year (i.e., long-term). An organization can make an up-front commitment to provide a consistent annual gift over several years, providing recipients with a steady source of long-term income. Certainly, foundations and other grant-makers should consider their philanthropic mission before making any commitment. But what else should be considered from a financial and investment standpoint?

We’ve developed a framework to help our clients assess their grant-making goals and align their investments appropriately. Ask yourselves:

What is your organization’s annual spending target?

Establishing a target is an important first step. Here, it might be relevant to note the tradeoff between growing investable assets into the future and making generous grants today (i.e., spending). As one might expect, higher spending implies fewer assets will be left to potentially grow over the long-term. Reconciling these conflicting goals with the mission of your organization is a top concern.

What percent of this annual spending target will be dedicated to multi-year grants?

The tradeoff that organizations face is that multi-year commitments generally imply less financial flexibility. To illustrate, let’s use a hypothetical foundation with assets of $1,000,000 and a spending target of 5%. Suppose right now that this foundation pays out only one-year grants, but there is a proposal to accept $50,000 worth of multi-year grants—which would constitute 100% of its spending target for the next year ($1,000,000 * 5% = $50,000). Here is how the first year’s spending would play out under scenarios of: (1) choosing to keep all grants as one-year commitments, or (2) choosing to accept $50,000 in multi-year commitments:

Now, suppose that in year two, market volatility causes the value of the Foundation’s portfolio to fall to $800,000. How might the Foundation’s spending play out in both scenarios?

As you can see, having only one-year commitments allows the foundation to re-evaluate its financial obligations each year and adjust these to suit its investment portfolio. The foundation still achieves its 5% spending target despite spending less in year two, because the value of its portfolio has fallen. However, under the multi-year commitment scenario, the Foundation has already committed to grants worth $50,000 per year and cannot proportionately reduce their spending to compensate for market performance. Spending ends up surpassing their target ($50,000 / $800,000 = 6.25%). While the foundation provides a larger gift in year two ($50,000 instead of $40,000), its ending value is smaller relative to the one-year grant making scenario ($750,000 vs. $760,000). Although every organization is different, many foundations choose to devote only a portion of their spending target to long-term commitments in an effort to mitigate the risk of spending a significant percentage of their portfolio in any given year.

How might your grant-making structure impact your investments? Effective asset allocation is designed to provide an appropriate level of diversification, while also properly balancing a portfolio’s capital growth and preservation needs. There are many factors to consider when settling on a long-term asset allocation, including time horizon and risk tolerance. But for grant-making organizations, withdrawal needs may be the most important. Portfolio withdrawals are used to fund an organization’s grant-making efforts. Generally, multi-year grant-making commitments are designed to provide added stability and assurance for a recipient, and therefore require a more stable portfolio withdrawal to fund them. The bigger the multi-year commitment, the more stable your withdrawals and investment portfolio should be. This is a factor that favors capital preservation in a portfolio’s asset allocation. By placing a relatively higher emphasis on preservation, a portfolio can hopefully avoid large drawdowns in its value and safeguard the assets needed to support multi-year grants. In contrast, an organization using only one-year grant-making commitments has more flexibility to proportionately reduce their grants, and avoid a double hit from market volatility and the need for higher withdrawals.

In aggregate, grant-makers appear to have recovered from market losses suffered in 2008-2009. Many are in a stronger financial position and may be ready to consider multi-year commitments. From a philanthropic standpoint, trustees and board members are likely in the best position to determine how to structure their spending and meet their mission. However, from an investment standpoint, undertaking a dedicated spending and investment analysis to evaluate the impact of such a decision is critical. Clearly, no one approach will fit the bill for all grant-making organizations. Multi-year commitments should be evaluated on a case-by-case basis, but given the uptick in the market, it may be an option that will gain more traction in the coming years.