In my fourth post on Criteria for Philanthropy at its Best®, I'll discuss NCRP's prescriptions for how a foundation should spend and manage its endowment or other assets. The Criteria require that a foundation (a) pay out at least 6 percent of its assets annually in grants and (b) invest at least 25 percent of its assets in ways that support its mission.
NCRP starts from the unimpeachable premise that a foundation should take account of its mission in considering these matters. But the devil is in the details, and if the devil's task is to sow confusion, he's done a good job here. The central question is this: Should a foundation spend all of its assets today, or spend only the income they generate in order to preserve its ability to make grants in the future--perhaps in perpetuity. Hal Harvey and I devote a chapter of Money Well Spent to the contentions on both sides, which can be summarized as:
•the needs of the present versus those of the future;
•the growth rate of your assets versus the escalation of the problem you seek to address;
•the existence of a strong actionable theory of change versus the likelihood of a better strategy in the future;
•jump-starting versus sustaining fields and movements;
•perpetuating institutional knowledge, culture, and reputation versus fossilization;
•trusting future generations versus binding them to your views; and
•various personal concerns.
Although there are good reasons for a foundation to spend down its assets today, there are also legitimate reasons for it to continue its work in perpetuity. NCRP acknowledges this in principle, but--characteristically of the Criteria--only puts forward one side. In fact, its mandate to pay out 6 percent of a foundation's assets in grants probably requires the foundation to spend down and therefore decapitalize.
The question here is what percent of its endowment a foundation can pay out annually and still maintain its value over time. The received assumptions are that, in the long run, a foundation can expect a return of 8 percent on its endowment, that inflation will average 3 percent, and that therefore the maximum payout to maintain the endowment's value is 5 percent. Here's what NCRP says about the issue:
Studies demonstrate that 5 percent is not the highest sustainable payout rate and that foundations could pay 7 or even 8 percent and maintain their endowments. NCRP acknowledges that some well-intentioned leaders in the sector disagree with these findings and believe honestly that 5 percent is the highest sustainable payout rate. However, NCRP and others believe higher payout and perpetuity are not mutually exclusive...
DeMarche & Associates analyzed investment returns for a hypothetical foundation and concluded that 5 percent may be too high a payout rate for a foundation to exist in perpetuity. Cambridge Associates also concluded that their findings supported a maximum 5 percent payout. These findings merit some robust debate and frank criticism. Foundation growth during the years in which the DeMarche study was conducted was so robust that the researchers acknowledged that foundations could have increased their payout rates to 6.5 percent with minimal to no impact on their corpuses. Moreover, when Perry Mehrling applied his own methodology to DeMarche's hypothetical foundation, he found that over the course of 20 years a payout rate as high as 8 percent would have maintained the foundation's asset size. Yet, DeMarche & Associates insisted that 5 percent was the maximum sustainable payout rate for any foundation seeking to exist in perpetuity.
That's the sum of NCRP's analysis of this issue: It references studies that conclude that 5 percent is the most foundations can pay out without decapitalizing and cites critics of the studies who say they can pay out more. Then, with a condescending nod to "some well-intentioned" people who might disagree, but without any argument, NCRP asserts that foundations can pay out more. If NCRP intended to help foundation leaders reach their own conclusions, its Criteria might have included a coin for flipping. (Watch out, though, for a hidden weight on one side.)
In any event, the analyses cited were done in relatively good times. Although the Criteria were published in March 2009, they say nothing about the last half year's precipitous decline in the markets that has reduced most foundations' endowments by a third. Not surprisingly, perpetuity has its bad times as well as its good ones.
Let's suppose that we do flip the coin and decide that a foundation can afford to pay out 6 percent a year without decapitalizing. But NCRP requires more than this: the 6 percent must be paid out in grants. Any administrative costs, such as rent and salaries, must be in addition to this amount, so that a foundation's annual expenditures are necessarily greater than 6 percent.
NCRP's refusal to include administrative costs in a foundation's mandated payout is inconsistent with its absolutely correct view that foundations should pay their fair share of a nonprofit grantee's administrative costs, of which staff salaries are the largest component. Good staff members are as essential for a foundation to achieve its mission as they are for its grantees. Moreover, fulfilling NCRP's mandate for mission investing (discussed below) takes even more staff time, paid for on top of the 6 percent payout for grants.
Even for someone who agrees that a foundation's payout policy should take account of its mission, NCRP provides only one side of the story. The Criteria cite an article by two McKinsey partners who apply the investment concept of discounting to argue that a dollar spent today has more than a dollar paid out in the future. They quote a participant in a symposium moderated by Michael Klausner to support this view. But they neglect to mention Professor Klausner's own strong rebuttal of the McKinsey argument.
In any event, the Criteria provide little guidance on when a foundation's mission calls for spending down and when not. Perhaps that's because--in contrast to grantmaking to mitigate climate change or nuclear proliferation--it's quite plausible that a foundation can benefit marginalized communities just as well in the future as by spending now.
If NCRP's discussion of mission investing is somewhat muddy, that's because, other than the traditional vehicle of below-market program-related investments (PRIs), the ideas in this area are still works in progress. While I claim no expertise here, my own research suggests far more uncertainty than NCRP allows. And nothing in the Criteria justifies the requirement that 25 percent of a foundation's investments be mission related.
The fundamental issue, especially when coupled with NCRP's payout mandate, is how much a foundation must sacrifice in endowment income when it makes mission investments. PRIs, which usually sacrifice income for mission, are accorded special treatment by the tax code. At the other end of the spectrum are investments in publicly traded companies: When such investments are consistent with a foundation's mission, they may make a foundation feel and look good, but they have no effect on the market or the behavior of companies.
The complicated question is the extent of mission investment opportunities that can really make a difference at the same time as they get market-rate returns. As is its wont, NCRP cites only the scenarios that support its case.
NCRP adverts to the possibility that low returns on mission investments, together with a high payout, would require a foundation to spend down its endowment. Nonetheless, the Criteria demand that a foundation that hopes to exist in perpetuity must "pay out 6 percent in grants only while also ensuring that at least 25 percent of its assets are invested in ways that support its mission." If it is possible to keep the endowment candle intact while burning it at both ends, NCRP does not say how.
Somewhere, in a parallel universe, there's a planet almost like earth, but whose markets yield a high enough return on investment to meet NCRP's demands. In other ways as well, the Criteria might fit that planet better than ours. But for better or worse, we don't live there.