In boom times, a foundation can spend the mandated five percent of its endowment on grants and expenses, cover inflation and still earn enough interest income to grow.
But in a bust, when interest income is gone, assets are shrinking and grantees need even more money to meet societal needs, the balance between asset preservation and grantmaking takes on particular gravity.
“Should trustees spend down in a time like this to maintain support for grantees,” asks John Griswold, executive director of the Commonfund Institute, which analyzes endowments’ investment performance. “Or is it better to make sure the foundation can continue to support its mission for a long time? There’s no clear answer.”
The asset side
On average, foundations in the U.S. have lost as much as about 30 percent of their asset value since the beginning of 2008, Griswold estimates.
Far from the 8 percent to 9 percent they must earn annually simply to stay even, foundations now are shrinking.
History shows markets recover fairly quickly from downturns, but much depends on the length and depth of the recession, Griswold says.
It took only about six months for endowments to recoup the 17 percent loss incurred in the second half of 1987, he says, but it took almost two decades for Harvard and Yale to claw their way back after the economic and market declines of 1973-82.
The consensus view of economists is that the economy may begin to bottom out and turn around by the third quarter of this year, Griswold says, with the markets inching up six to nine months in advance.
“But you’ve got a longer climb going uphill than you did going down,” says Griswold.
While there’s still risk in jumping back into the markets right now, the time will come for long-term investors to search for bargains.
“At some point you have to step out into traffic a little bit and buy something you think will be a terrific turnaround opportunity,” he says. Until that turnaround materializes, foundations are left considering whether to sell off some their assets to maintain grantmaking levels, in the process making themselves smaller.
The spending side
The five percent payout mandate, introduced in 1969, was designed to prevent private foundations from hoarding assets, while retaining enough to grow during booms so they can help out during busts, says Hodding Carter III, university professor of leadership and public policy at the University of North Carolina at Chapel Hill and former president and CEO of the John S. and James L. Knight Foundation.
Since then, however, many funders say asset growth must outpace inflation to keep up with increasing needs the future will bring, he says.
Carter understands the obligations of foundation boards to be stewards of the money they oversee, he says, but that’s not their only responsibility.
“What, ultimately, are we guarding,” he asks. “The jobs of the expanded foundations that grew during the good times? The status that comes with being the fifth-biggest or 50th-biggest? Or are we guarding what is the essence of philanthropy, the commitment to those we serve?”
Carter says foundations should avoid cutbacks in grants, and even encourages them to give more when times are bad.
Griswold shares that view.
“In good times you should spend less on a proportionate basis and more in bad times,” he says. “Because you’re there to serve the needs. The demand right now is up, not down, and nonprofits need to support society as much as they possibly can.”
And new philanthropies are being created routinely, to help fill today’s needs and future needs. The Gates Foundation, born only 15 years ago, now dwarfs old-guard funders like the Ford Foundation.
“Old money” should focus on today’s problems, trusting that “new money” will be available for tomorrow’s problems, says Carter.
“Right now, you know people are in desperate need and this is the time to prove why you’ve been an ant and not a grasshopper all these years,” he says. “You’ve made it through the winter, you’ve got the money, now use it.”
When creating a grantmaking budget, Carter recommends a “real payout” of five percent, one that does not include expenses, and see what efficiencies that brings.
“There are foundations that pay out more than five percent,” he says. “They’re alive and thriving and haven’t gone out of business.”
And it might have the effect of making people more careful about their administrative costs, he says.
Griswold suggests following the lead of Yale or Stanford, both of which calculate their spending based the pervious year’s level, plus an adjustment to cover inflation, and a tie to the endowment’s market performance.
“To justify a big cut in the budget because of volatility in your endowment is a tough job,” he says. “If it’s dramatic and catastrophic to the charities, that’s a tough challenge from a management and a public-relations standpoint.”
Rip Rapson, president of the Kresge Foundation, agrees but concedes that might not be possible for small foundations, for which market losses could threaten their very existence.
Funders in that situation will be required to “pay more attention to this tension zone between maintaining your grant level and dropping it to preserve assets,” he says.
The question is different for larger foundations, says Rapson. They must consider whether lowering grantmaking to preserve assets is worth the disruption it would cause grantees.
Kresge, whose funding traditionally has come in the form of challenge grants, distributed about $181 million last year.
If it were to track payout levels this year, it would award significantly less, about $140 million, says Rapson.
“How important is it for us to preserve $40 million in principal,” he asks. “And how important is it to signal to our grantees that we will maintain some constancy of effort? Ideally, the maintenance of predictable grant efforts trumps asset preservation.”
So far, Kresge has fared better than its peers, losing only about 18 percent of its endowment, which now stands at $3.1 billion, down from a high of $3.8 billion, says Rapson.
But should the downturn continue much longer, as the funder’s investment committee fears, Rapson says he may have to change his tune. Some forecasters say the endowment could see a drop of 10 percent a year for the next few years.
“Then one has to wonder if all my high principles get called to the carpet,” he says. “I may have to make a very different set of choices.”
For the time being, Rapson hopes to maintain grantmaking for 2009 at the 2008 level.
The foundation also is willing to be creative and flexible where possible.
Kresge is considering expanding its use of program-related investments, or low-interest loans to grantees, a tool that can aid nonprofits without permanently depleting the foundation’s assets.
And it is carefully weighing requests from grantees for extra time to meet their challenge-grant deadlines, and for permission to count additional sources of revenue toward their challenge goals.
Until this year, Kresge calculated its grantmaking budget based on five percent of the previous year’s assets.
That’s going to change, says Rapson.
“This is the first year since I arrived that our assets haven’t gone up,” he says. “We’ve never had to face down the question of should we pay six percent.”
The foundation’s board is working on an investment formula it hopes will be comfortable in all scenarios, and that Rapson hopes will allow him to adhere to his principle of “constancy of effort.”
But good intentions may have to make way for reality.
“My bias is that in 2009, we should all make as much effort as we can to maintain levels of support,” says Rapson. “But going forward two or three years, you’re probably going to have to modulate down and use a greater bias toward asset preservation.”