Sep 11 2019
The success or failure of an endowment relies on many interrelated and important factors. Some of these factors are impossible to control or predict such as the level of next year’s donations? Or the return of the endowments investment portfolio in the years ahead?
However, foundations should strive to do their best in areas where they can take control and make a difference. An area we often see ignored or misunderstood by nonprofits and foundations is the cost of investment management. A keen eye on these costs can enhance significantly enhance long-term performance.
In our opinion, most investors both institutional and individual pay too much for investment management. When one considers that most endowments strive to distribute 5% of the value of their asset base annually but also incur 1% in administrative expenses, any additional “above normal” expenses for investment management puts pressure on the endowment to take risks that may not be otherwise necessary.
For example, we often see foundations that have hired an outside manager or “consultant” who charges an annual fee, which is normal but then puts the foundation assets in investments that charge additional annual fees. These include mutual funds, exchange-traded funds, or even investments that have to compensate other outside managers.
This layering of fees may not look like much by decimal points or in any given year, but they add up over time and can significantly reduce the endowment’s long-term returns.
For example, consider a foundation that distributes 5% annually in grants, incurs 1% in administrative fees and pays 1.8% annually for investment management (we’ve seen higher fees!). Combined, this adds up to close to 8% flowing out of the endowment annually. The investment manager is almost 25% of the total annual outlay!
Of course, there may be investment managers somewhere in the world who may deserve such a high fee due to their spectacular results. But the fact is, on average, this is not the case. Indeed, given that the average endowment usually has a maximum of 60 to 70% stock exposure at any given time and the historical returns on a 60/40% stock/bond mix over the last 50 years has been a mere 6%, paying a high investment management fee might reduce your effective return to 4% or less.
For foundations and endowments, doing and understanding this math is essential to your long-term survival!
To avoid these fee pitfalls, foundations and nonprofits need to ensure that their investment management costs are competitive based on their endowment’s size. Most importantly, they need to avoid the layered fee arrangements that so often exist and go unnoticed – until it’s too late. Keeping an eye on the costs you can control will put your organization in better shape to remain sustainable for many lifetimes.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.