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Best Practices to Ensure the Effective Management of Private School Endowments

As with all financial management, the protection and management of endowed funds requires rigorous oversight, meticulous planning, collaboration and a strategic approach. School with the discipline to implement these best practices will ensure a greater chance for successful management and future growth.

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As with all financial management, the protection and management of endowed funds requires rigorous oversight, meticulous planning, collaboration and a strategic approach. School with the discipline to implement these best practices will ensure a greater chance for successful management and future growth.

One of the most crucial assets possessed by private educational institutions is the endowment, because of the role it plays in the school’s annual operating budget, in support of strategic objectives and in financial sustainability. For this reason, regardless of the type of endowment funds held (true endowments, quasi-endowments or term endowments), effective endowment governance relies on comprehensive plans and policies and clear lines of communication to protect and grow these investments. Below are some best practices to achieve a successful outcome.

Collaborative Governance Structure 

The protection and growth of the endowment is an absolute board responsibility, and how it executes is a critical component to effective management. This fiduciary responsibility is often delegated to a qualified investment committee, which executes on the board’s objectives by establishing and implementing the investment strategy and overseeing management of the portfolio. Management/staff provide much-needed and valuable administrative support, and outside investment advisors are relied upon to provide assessments and information useful in making investment decisions.

Some institutions have chief investment officers on staff and others outsource this responsibility. If outsourced, proper oversight of the advisor must be maintained and documented. Legal counsel will periodically be sought to review policy and procedure to ensure adherence to the law. Regardless of the structure, clearly defined responsibilities and collaboration in support of the institutional mission while protecting its fiscal integrity is essential.

Prudent Spending and Underwater Funds Policy Monitoring

Responsible endowment management dictates that the Investment Policy Statement include a prudent spending policy and that the application of that policy be monitored. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) sets forth criteria to guide endowment fund spending, centered around duration and preservation of the endowment, expected total return and several others. The intent is to ensure reasonably consistent cash-flows and to sustain the fund. Too large of a distribution in one year could have a negative impact on future distributions from the fund.

Additionally, continuous draws can have an impact on preserving the endowment’s future purchasing power. The investment committee should, at least annually, review and assess the spending policy. While the formula may not change, additional drawdowns—those amounts which go over and above the regular distributions allowed under the spending policy—should also be monitored. The key is to balance the risk through its spending policy and long-term asset mix.

In the quest to meet mission objectives and maintain the endowment’s purchasing power, a sound practice is to formalize or update policies relating to the school’s position on spending from underwater funds. Given the possibility of a sustained low-return environment and increasing market volatility, underwater endowments can be problematic for institutions that rely heavily on the spending distribution to fund operational programs such as financial aid and scholarships. Although UPMIFA allows spending from a fund that falls below its initial value, the board and its investment committee should take into account the seven guiding factors outlined by UPMIFA in setting these policies.

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The policy isn’t required to be all or nothing. Many institutions have established an underwater floor below which spending from an endowed fund would be suspended until the appropriate market recovery occurs. The key is to manage endowed funds and underwater policies in a manner that balances short-term needs and meets long-term objectives.

Due Diligence Process – Alternative Investments

Schools with significant endowments generally include alternative investments such as private equity, hedge funds, real estate investment trusts, venture capital, funds of funds and commodities as part of its asset allocation strategy to achieve diversification and manage market volatility in their portfolio. Some of these funds do not provide extensive transparency regarding the underlying assets and their activities. Many others have foreign domiciles, which present additional potential risks which need to be assessed.

An established due diligence process will outline steps to be taken to vet a new fund manager, monitor existing positions and understand the tax and foreign reporting considerations of a particular fund. Such a process will also help to ensure adequate controls are in place for proper accounting and valuation of such investment vehicles.

Appropriate Resources

Effective endowment management is not only about investment strategy. Advancement teams with the skills necessary to foster relationships with current families, alumni and prospective donors will be more successful in contributing to the endowment’s growth and maintenance by securing current or future gifts through planned giving programs. The advancement office should also collaborate with the business office on gift processing system and reporting protocol.

When it comes to the tactical management of endowed funds, the use of spreadsheets is generally appropriate where the number of funds in the endowment is limited. It’s important to note, though, that relying on spreadsheets for unitization of the endowment will require adequate controls to mitigate the risk of formula errors. However, for institutions with a significant number of endowment funds, investing in endowment software is highly advisable. Among the many benefits, one of the most important is accuracy of fund balances for stewardship reporting. Incorrect balances and accounting issues resulting from spreadsheet errors can have an detrimental impact on donor relationships.

Endowments allow educational institutions greater flexibility in delivering value and quality. As with all financial management, the protection and management of endowed funds requires rigorous oversight, meticulous planning, collaboration and a strategic approach. School with the discipline to implement these best practices will ensure a greater chance for successful management and future growth.

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