Foundations are nonprofit institutions set up to make grants to support specified charitable causes.
The focus of this reading is on private foundations set up by individual donors and their families. Foundations can also be community foundations set up by and for the good of the local community, operating foundations set up to fund a specific not-for-profit business, or corporate foundations set up from the profits of an existing company.
The main objective of private foundations is typically to maintain purchasing power in perpetuity and earn returns sufficient to support the grant-making activities of the foundation.
|Bill & Melinda Gates Foundation||Focus on global health and poverty. In US focus on education.|
|Ford Foundation||Focus on inequality.|
|Robert Wood Johnson Foundation||Improve health and health care of all Americans.|
|Lilly Endowment Inc.||Support religion, education, community development.|
|William and Flora Hewlett Foundation||Help people build measurably better lives by focusing on education, the environment, global development, performing arts, philanthropy, and population. Also supports disadvantaged communities in San Francisco.|
The stakeholders of a private foundation may include the founding family, donors to the foundation, recipients of grants from the foundation, and the wider community that the foundation’s activities may benefit. Intergenerational tensions may exist like those of an endowment where the needs of current recipients and future recipients of spending from the foundation need to be balanced. The government could also be considered a stakeholder due to the favorable tax treatment of foundations.
Board members of foundations are less likely to have professional investment experience than alumni on endowment boards. This difference in experience may result in less rigorous board oversight or greater delegation to investment staff. This may affect the quality of investment decisions, particularly in more sophisticated markets such as alternative investments.
Mission-related investing (also known as impact investing) is a technique increasingly adopted by foundations whereby investments are made into projects that promote the foundation’s mission. The challenge with such investments is maintaining a sufficient return on assets to meet the foundation’s long-term objectives.
Foundations typically have an investment horizon that is perpetual. There is a trend toward limited-life foundations that are mandated to spend down assets within a limited time frame of the founder’s death, which would shorten the investment horizon.
In the United States, tax laws require private grant-making foundations to pay out a minimum of 5% of assets (on a 12-month trailing basis) plus investment expenses. Foundations must also spend any donations in the year the donation is received (known as flow through).
Unlike universities, which have other sources of revenue outside the spending of their endowment, foundations are relied upon almost exclusively to meet budgets. This, along with the higher liquidity requirements of foundations, means they typically have a lower risk tolerance than university endowments.
As mentioned previously, U.S. foundations are legally required to spend 5% of assets. Foundations should maintain sufficient liquidity to meet near-term spending, capital calls from private limited partnership fund investments, and any margin calls on derivatives employed by the investment portfolio.
From a legal and regulatory perspective, foundations are subject to similar laws, such as UPMIFA in the United States and the Trustee Act in the U.K., which demand investment on a total return basis, diversification, and a duty of care from the board and investment staff.
Foundations typically have similar tax-exempt status to endowments, but this status depends on the minimum spending rules mentioned in the previous section. Failing to meet the spending requirement results in a 30% tax on undistributed income. Most U.S. foundations are also subject to a 2% tax on net investment income.
The investment objective is to generate a real return over consumer price inflation of the spending rate (minimum 5%) plus investment expenses, with expected annual volatility in a reasonable range (approximately 10% to 15%) over a three- to five-year period.
There may be a secondary objective of outperforming a policy benchmark based on a tracking error budget.
Foundations have a lower risk tolerance than university endowments due to higher liquidity requirements and the heavy reliance on the foundation’s spending. However, their overall risk tolerance remains high and, with a long-term objective of beating inflation, larger U.S. foundations allocate about half of the portfolio to alternative investments. Smaller foundations tend to have a higher allocation to domestic equities and fixed-income securities.
|US FOUNDATION||US UNIVERSITY ENDOWMENT|
|Purpose||Grant-making for social, educational, and charitable purposes; principal preservation focus.||General support of institution or restricted support; principal preservation focus.|
|Stakeholders||Founding family, donors, grant recipients, and broader community that may benefit from foundation’s activities.||Current/future students, alumni, university faculty and administration, and the larger university community.|
|Liabilities/Spending||Legally mandated to spend 5% of assets + investment expenses + 100% of donations (flow-through).||Flexible spending rules (headline spending rate between 4% and 6% of assets) with smoothing.|
|Other liability considerations||Future gifts and donations, or just one-time gift?||Gifts and donations, percentage of operating budget supported by endowment, and ability to issue debt.|
|Investment time horizon||Very long-term/perpetual (except limited-life foundations).||Perpetual|
|Risk||High risk tolerance with some short-term liquidity needs.||High risk tolerance with low liquidity needs.|
|Liquidity needs||Annual net spending is at least 5% of assets.||Annual net spending is typically 2% to 4% of assets, after alumni gifts and donations.|