NPOs should focus risk assessment on expenses
Too often, the review of strategic financial policy consists of reviewing only investment allocations without reviewing expenditure policy. Therefore, reviews do not take into account the dependence of an educational institution’s operating budget or expenditures on endowment. This is a mistake, as expenses can be affected by the volatility of endowment returns.
Educational institutions tend to default their spending models to calculations that are based on rolling averages of spending over a rolling 12 or 20 quarter average, with some adjusting their calculations for inflation or changes in the market value of the prizes. According to Staffing Spend Theory: Often Overlooked, But Critical to Long-Term Successa report by Wilton, Connecticut-based asset management firm Commonfund.
But in the absence of these conditions, spending and investing activities can diverge, leading to missed opportunities. The authors of the report suggest that spending managers consider several aspects of their disbursement policy. Basic considerations include the percentage of coverage of operating budget endowment distributions and how this percentage has changed over the years, whether the endowment’s role in covering expenses will increase and the pace and size of the flow. donations in the endowment.
Additional financial resource questions include consideration of annual fund donation levels, the mix of restricted and unrestricted donations, and the educational institution’s access to other sources of funding, such as lineups. credit.
The report’s authors also recommend setting clear goals for spending policy, whether maximizing long-term spending, maximizing short-term spending, focusing on spending consistency by limiting volatility and declining spending or a balance between the three considerations.
In addition, those controlling spending should perform liquidity analysis and financial stress testing at least annually, with greater emphasis on the potential impact of a one-off spending cut. or systematic. Underlying considerations could also include the maximum tolerable reduction in institutional support.
Even before all this, there needs to be better communication between the stakeholders. Entities within an institution that control spending are not under the aegis of – or even in communication with – the investment committee. As a result, spending is slower to reflect real opportunities.
“As a means of potentially increasing operating budget support over time, endowment portfolios may be able to increase allocations to growth assets – and therefore increase the likelihood of success at term – without the commensurate increase in ‘risk’ by decoupling the spending formula from market value,” the report authors write.
According to the authors of the report, the expenditure policy of an educational institution should ideally:
- Provide a constant and increasing amount of annual support for most years
- Support current operating budgets while leaving enough capital in the endowment to enable compounding benefits for future generations
- Allow the institution to take as much risk with its endowment as necessary to achieve its long-term performance goals
- Enable consistent allocations, particularly during periods of significant adverse market activity.
A full copy of the report is available here: https://info.commonfund.org/endowment-spending-policy