Endowments and foundations (E&Fs) navigate a unique financial terrain, characterised by perpetual investment horizons and dual mandates to fund current mission activities while preserving capital for future generations. Strategic Asset Allocation (SAA) stands as the paramount determinant of long-term investment success for these institutions, demanding a careful balance between growth objectives, risk tolerance, and liquidity needs. The “endowment model,” pioneered for its high diversification and alternative asset allocations, has delivered historical success but faces contemporary challenges, including periods of underperformance relative to simpler benchmarks and difficulties in replication for smaller institutions.
This environment necessitates a critical examination of investment approaches, moving beyond a one-size-fits-all model to strategies tailored to each institution’s specific context, dependency on endowment income, and resource capacity. For institutions highly reliant on their endowments, an overly conservative SAA can paradoxically increase the long-term risk of mission failure by failing to outpace inflation and spending needs.
Integrating mission into the investment portfolio is a growing imperative. Approaches range from ESG screening and integration to thematic and impact investing, including Mission-Related Investments (MRIs) from the endowment’s corpus and Programme-Related Investments (PRIs) that can count towards payout requirements. Compelling case studies, such as that of the Nathan Cummings Foundation, demonstrate that aligning the entire endowment with institutional values can be achieved without financial sacrifice, and may even enhance returns.
A well-defined spending policy is the linchpin of intergenerational equity, requiring careful selection from models like moving average, constant growth, or hybrid approaches. The chosen policy must align with long-term return expectations and inflation to ensure sustainable support for the mission. Disciplined rebalancing is crucial for maintaining strategic intent and controlling risk, acting as an active implementation of the long-term SAA.
Ultimately, effective endowment management hinges on a holistic framework where SAA, spending policy, mission alignment, and rebalancing are viewed as interconnected components of an integrated strategy, guided by a “living” Investment Policy Statement (IPS). Professional analytical support, through consultants, Outsourced Chief Investment Officers (OCIOs), or advanced modelling platforms, can significantly enhance strategic capabilities, enabling fiduciaries to test scenarios, manage complex assets, and make more informed, data-driven decisions. In a dynamic world, continuous review, learning, and adaptation are essential for charting a course for sustainable impact.
Endowments and foundations (E&Fs) operate within a distinct financial ecosystem, shaped by mandates that extend far beyond typical investment horizons and objectives. Their core purpose is to serve societal needs, often with the intention of doing so indefinitely. This long-term, or even perpetual, outlook is a cornerstone of their investment philosophy and operational framework. These institutions, typically non-profit entities such as universities, cultural organisations, healthcare systems, and charitable foundations, are stewards of asset pools established for sustained investment and impact. The perpetual nature of many E&Fs fundamentally differentiates their investment strategies from those of individuals or entities with finite timelines, allowing for a different calibration of risk, a greater capacity to absorb short-term volatility, and the ability to consider asset classes with longer lock-up periods.
The primary financial purpose of an E&F portfolio is typically twofold: to generate a consistent and reliable stream of funds to support near-term operational needs and programmatic activities, and simultaneously to preserve, and ideally grow, the real value of the institution’s capital in perpetuity. This dual mandate is often formalised through annual spending requirements. For instance, U.S. private foundations are generally required to distribute approximately 5% of their investment asset value annually, while university endowments commonly adopt spending rates between 4% and 6% to support their operating budgets, student aid, or research initiatives.
Crucially, the preservation of capital is not merely about maintaining its nominal value, but about safeguarding its purchasing power against the erosive effects of inflation over the long term. This ensures that the institution can continue to fulfil its mission for future beneficiaries to the same extent it does for current ones. This inherent tension—balancing the immediate need for distributable income with the long-term imperative for capital growth sufficient to outpace both spending and inflation—forms the central challenge in crafting and managing the strategic asset allocation for endowments and foundations.
The commitment to perpetuity is not a passive aspiration but an active pursuit. It demands that investment strategies are designed to generate returns that consistently exceed spending and inflation, thereby maintaining the endowment’s relevance and capacity for impact across generations. If an endowment’s investment returns merely match its nominal spending rate, inflation will inexorably diminish its real value and, consequently, its ability to support the institution’s mission over time. This effectively means that the “perpetuity” mandate would fail in a practical sense.
This creates a “perpetuity paradox”: an excessive focus on short-term stability to guarantee current payouts can, if it leads to insufficient long-term growth, jeopardise the very perpetuity the institution seeks to achieve. Therefore, investment committees must explicitly define what perpetuity signifies for their institution in real, inflation-adjusted terms and ensure that their strategic asset allocation and spending policies are robustly aligned with this enduring vision. This often translates into a strategic imperative for a significant allocation to growth-oriented assets, even if it entails accepting a higher degree of interim market volatility.
Strategic Asset Allocation (SAA) stands as the cornerstone of long-term investment success for endowments and foundations. It is the process of determining the long-term target allocations to various asset classes within a portfolio, based on the institution’s financial goals, risk tolerance, and, critically for E&Fs, their often perpetual investment horizon. The profound importance of SAA is underscored by landmark research, notably the 1986 study by Brinson, Hood, and Beebower, which found that asset allocation decisions account for over 90% of the variability in portfolio performance over time. This finding emphasises that for long-term investors like E&Fs, the SAA is a far more significant driver of outcomes than attempts at market timing or the selection of individual securities. For fiduciaries, therefore, establishing, implementing, and adhering to a sound SAA is arguably their most critical and impactful responsibility in achieving the institution’s enduring financial and mission-related objectives.
The development of an SAA for an E&F involves a delicate balancing act. Institutions must reconcile the imperative for portfolio growth necessary to meet ongoing spending requirements, outpace inflation, and preserve intergenerational equity with their specific tolerance for investment risk and the practical need for sufficient liquidity. Liquidity is essential not only to fund annual payouts but also to meet potential capital calls for illiquid investments, which are increasingly common in E&F portfolios.
The extended, often perpetual, investment horizon of E&Fs provides a distinct advantage: the capacity to tolerate higher levels of illiquidity in their portfolios. This allows them to strategically allocate to asset classes such as private equity, private debt, real estate, and other alternatives that may offer an “illiquidity premium” potentially higher returns as compensation for locking up capital for extended periods. However, this embrace of illiquidity must be carefully managed. An institution’s reliance on its endowment for operational funding, its flexibility in adjusting spending levels during market downturns, and the availability of other liquid resources are crucial factors in determining the appropriate level of illiquid assets in the SAA. An SAA that overly prioritises growth through illiquid assets without adequate consideration for near-term cash needs could force an institution to sell assets at inopportune times, potentially realising losses.
Conversely, an excessively conservative and liquid SAA may fail to generate the returns necessary to meet long-term spending and preservation goals, particularly for institutions with high payout dependencies.
While SAA is inherently a long-term framework, it should not be viewed as an immutable blueprint. The capital market assumptions that underpin SAA, such as expected returns, volatilities, and correlations across asset classes, are not static. Similarly, an institution’s financial needs, spending requirements, or even its mission emphasis can evolve over time.
The investment opportunity set itself also changes. This dynamic environment implies that the SAA review process should be a periodic and disciplined undertaking, rather than a “set it and forget it” exercise. The concept of “active asset allocation,” which involves making tactical tilts within strategic asset class bands in response to evolving market conditions or outlooks, reflects this need for adaptability.
Furthermore, principles like “Attribute and Adjust,” which call for continually evaluating whether portfolio components are delivering expected value as market opportunities shift, underscore the importance of a responsive SAA framework. A failure to periodically reassess and, if necessary, recalibrate the SAA can lead to a gradual misalignment between the portfolio’s risk/return profile and the institution’s evolving financial requirements or mission objectives.
Over time, such a disconnect can result in the underfunding of programmes, an erosion of real capital, or a drift from the core mission the endowment is intended to support. Consequently, investment committees should establish a formal, regular process for reviewing the SAA, taking into account updated long-term capital market forecasts, any changes in spending policies or institutional needs, and the observed performance and evolving characteristics of different investment strategies, including the endowment model itself.
The “endowment model” of investing, largely popularised by the pioneering work of David Swensen at Yale University beginning in the 1980s, represented a significant evolution from the more traditional balanced portfolios, such as the 60% equity/40% bond structure that was prevalent at the time. This approach has profoundly influenced how many large endowments, foundations, and other institutional investors manage their assets.
The core tenets of the endowment model, often exemplified by the Yale Model, are rooted in leveraging the unique characteristics of perpetual institutions. These principles include:
Historically, institutions that effectively implemented the endowment model, particularly large, well-resourced university endowments such as Yale, Princeton, and the University of Chicago, often achieved risk-adjusted returns superior to those of traditional market benchmarks. The Yale endowment, for instance, is cited as having achieved an impressive annualised gain of 13.7% during David Swensen’s 36-year tenure. The model’s approach to diversification was often aimed more at return enhancement through exposure to a wider range of return drivers, rather than solely at volatility reduction. This strong and sustained track record led to its widespread adoption and established it as a “gold standard” for institutional investing in the eyes of many.
Despite its historical success and influence, the endowment model has faced growing scrutiny and a number of challenges in more recent years:
These contemporary issues suggest that the very success and widespread adoption of the endowment model may have sowed the seeds for some of its recent challenges. As significantly more capital began to pursue similar strategies, particularly in private markets like venture capital and growth equity, the potential for outsized returns in those areas may have become compressed. Early adopters often gained preferential access to leading managers and unique opportunities; however, as capital flooded into these asset classes, fund sizes grew, and returns, on average, may have become diluted. The model was, in part, built on exploiting market inefficiencies and accessing unique sources of alpha. Its increasing popularity may have, to some extent, diminished some of those original inefficiencies.
Furthermore, the inherent complexity of the endowment model, with its numerous alternative investment strategies and relationships with multiple external managers, can place considerable strain on the governance capacity of investment committees and boards. This is particularly true for institutions that rely heavily on volunteer members or have limited in-house investment expertise and staffing.
The model implicitly requires a significant investment in human capital and oversight resources. Adopting such a complex investment framework without commensurate governance capabilities can lead to ineffective oversight, an inability to properly assess and manage the nuanced risks involved, or even a “diworsification” where the portfolio becomes overly complex without achieving true diversification benefits. This suggests that institutions must critically assess their internal expertise, resources, and governance structures before committing to, or continuing with, a highly complex endowment model.
For some, a simpler, more transparent approach that can be executed efficiently and overseen effectively might lead to superior long-term outcomes. The five principles outlined by Neuberger Berman for improving performance Attribute and Adjust, Balance Liquidity, Consolidate Manager Relationships, Directly Invest (where feasible), and Eliminate Silos, offer a potential roadmap for institutions looking to adapt and refine their approach to the endowment model in the current environment.
While the endowment model has been influential, its recent challenges and the diverse nature of endowments and foundations underscore the need for investment approaches that are carefully tailored to each institution’s specific circumstances. Not all E&Fs possess the scale, resources, risk appetite, or liquidity profile suited to a high-alternatives, high-illiquidity strategy.
For institutions with a lower tolerance for risk, greater immediate liquidity requirements, or limited internal resources to source, diligence, and monitor complex alternative investments, a more traditional asset allocation may be more prudent and effective. Such allocations typically place a greater emphasis on publicly traded equities and fixed income, and may hold higher cash balances.
For example, a conservative allocation model might feature 20% equities, 50% fixed income, and 30% cash investments, while another “Conservative Income Portfolio” example details a 20% equity and 80% fixed income structure. Opting for a simpler, more liquid, and potentially lower-cost strategy can be a sound fiduciary decision if it aligns better with the institution’s operational realities and long-term objectives, ensuring that the chosen strategy can be implemented effectively and governed appropriately.
Rather than a binary choice between the full endowment model and a purely traditional allocation, many institutions may find value in hybrid approaches. These strategies seek to incorporate beneficial elements of the endowment model, such as enhanced diversification through judicious allocations to certain alternative asset classes, without necessarily replicating its most aggressive or complex features.
For instance, the “Advanced Endowment Model” proposes diversifying the portfolio’s ‘safety net’ beyond solely relying on government bonds by including absolute return hedge funds and real assets, alongside a dedicated component for inflation protection. Another framework suggests building portfolios around five key elements: diversified market beta (global public equities and bonds, real assets, return-seeking credit), illiquidity premia (from private capital), specialised alpha sources (from superior manager selection), alternative risk premia (factor exposures), and dynamic management (tactical adjustments).
Such tailored or hybrid approaches allow institutions to leverage principles like diversification into less correlated asset classes while managing overall risk and complexity in line with their specific capabilities and constraints.
A crucial, and perhaps counterintuitive, consideration is that for institutions highly dependent on their endowment to fund a significant portion of their annual operating budget, an overly conservative asset allocation can, in fact, be the riskier long-term strategy. In such cases, the primary risk shifts from short-term portfolio volatility to the long-term risk of failing to achieve the organisation’s mission. This occurs if the endowment’s returns consistently fall short of the combined impact of the spending rate and inflation, leading to an erosion of its real purchasing power over time.
For these high-dependency institutions, a more growth-oriented SAA may be necessary to sustain the required level of support, even if it entails accepting greater interim fluctuations in market value. This highlights the importance of defining “risk” not merely as investment volatility, but as the potential for long-term mission impairment.
The optimal SAA is not a universal template but rather one that is meticulously crafted to be “fit-for-purpose,” deeply aligned with an institution’s unique DNA. This includes its specific mission and programmatic goals, its degree of financial dependency on endowment payouts, its prevailing risk culture and tolerance, the resources it can deploy (including investment staff, expertise, and budget for external managers or consultants), and its governance capacity and structure.
A mismatch between the chosen SAA and this institutional DNA can lead to a number of adverse outcomes, such as strategic drift where the portfolio no longer supports the mission, unmet financial goals (e.g., inability to fund the spending policy), or an incapacity to effectively execute the chosen strategy (for instance, a small foundation attempting to manage a complex private equity portfolio without the requisite internal expertise or external support). Therefore, a thorough internal assessment of these unique institutional characteristics should precede any decision to adopt or significantly modify an SAA. This internal due diligence is as fundamental to long-term success as the external due diligence conducted on investment managers or strategies.
The following table provides a snapshot comparison of the traditional endowment model versus a more conservative/traditional asset allocation approach:
Feature | Endowment Model | Conservative/Traditional Allocation |
Typical Equity Allocation | High (often >50-60%, including private equity) | Moderate to Low (e.g., 20-50%) |
Typical Fixed Income Allocation | Low (often <30%, may include private credit) | High (e.g., 50-80%, primarily public) |
Allocation to Alternatives | Significant (private equity, venture capital, real assets, hedge funds) | Low to None |
Emphasis on Illiquidity | High; seeks illiquidity premium | Low; prioritises liquidity |
Liquidity Profile | Lower overall liquidity, requires careful management | High overall liquidity |
Complexity | High; many asset classes, managers, and strategies | Low to Moderate; simpler structure |
Typical Risk Profile | Higher volatility, aims for higher long-term returns | Lower volatility, more stable but potentially lower long-term returns |
Primary Return Driver | Equity risk, illiquidity premia, manager alpha | Market beta from public equities and income from fixed income |
Suitability | Larger institutions with long horizons, high risk tolerance, strong governance, and access to top managers | Institutions with lower risk tolerance, higher liquidity needs, or limited resources/expertise |
Integrating alternative assets, a key feature of the endowment model and many modern institutional portfolios, introduces a distinct set of considerations that must be addressed within the SAA and Investment Policy Statement (IPS). The following table outlines key factors:
Consideration | Key Challenges | Best Practices / Policy Adjustments |
Defining Objectives for Alternatives | Lack of clarity on role (return enhancement, diversification, inflation hedging); unrealistic expectations. | Clearly articulate specific objectives for each alternative asset class within the IPS; align with overall portfolio goals. |
Liquidity Management & J-Curve | Long lock-up periods; unpredictable capital call timing; initial negative returns (J-curve) impacting short-term performance. | Establish maximum illiquidity tolerance; maintain sufficient liquid assets; develop cash flow forecasting and commitment pacing strategies; educate committee on J-curve effect. |
Due Diligence (Investment & Operational – IDD/ODD) | Complexity of strategies; opacity of some funds; assessing manager skill vs. luck; operational risks (e.g., back office, compliance). | Mandate rigorous, specialised IDD and ODD for all alternative managers; utilise expert consultants if needed; verify track records and alignment of interests. |
Valuation Complexity | Lack of daily market pricing for private assets; reliance on manager or third-party valuations; potential for stale valuations. | Establish clear valuation policies in the IPS; understand manager valuation methodologies; seek independent verification where appropriate; be aware of smoothing effects on reported returns. |
Access to Quality Managers | Top-tier managers often capacity-constrained or have high minimums; difficulty for smaller institutions to gain access. | Leverage consultant relationships; consider fund-of-funds for diversification and access (though with added fees); build long-term relationships; explore emerging managers. |
Commitment Pacing & Cash Flow Forecasting | Managing the deployment of capital over time to avoid over-concentration in specific vintage years; forecasting distributions. | Develop a multi-year commitment pacing plan; model expected capital calls and distributions; maintain a “liquidity ladder” to meet commitments. |
Co-investments & Direct Investing | Requires significant internal expertise, resources for due diligence, and deal sourcing capabilities; potential for adverse selection. | For sophisticated E&Fs, can lower fees and improve alignment; often pursued via partnerships with lead GPs; requires robust internal governance and expertise. |
Governance & Oversight | Increased complexity requires more sophisticated oversight from committee/staff; monitoring a diverse set of managers and strategies. | Clearly define roles (committee, staff, consultants); establish regular, detailed reporting requirements for alternative managers; conduct periodic deep-dive reviews of alternative asset programme. |
A transformative shift is underway in the E&F sector, moving beyond the traditional separation of mission-driven activities (typically funded by the ~5% annual payout) and investment management (the other ~95% of assets, often invested without explicit regard for mission). There is a growing recognition that an institution’s fiduciary responsibility extends to its mission first and foremost, and that the entire endowment can, and perhaps should, be a tool for advancing that mission. Mission-Aligned Investing (MAI) encompasses a range of strategies to achieve this, aiming to generate positive social and/or environmental impact alongside appropriate financial returns.
MAI is not a monolithic concept but rather a spectrum of approaches:
Within impact investing, two key categories relevant to foundations are:
The traditional paradigm saw foundations compartmentalise their activities: the ~5% annual grant payout was dedicated to mission, while the remaining ~95% of assets (the endowment corpus) was typically invested with the sole objective of maximising financial return, sometimes in industries or companies whose practices directly contradicted the foundation’s mission. A significant and growing movement challenges this dichotomy, advocating for the alignment of the entire endowment with the institution’s values and mission. This perspective reframes the endowment not merely as a financial engine to fund grants, but as a powerful and substantial asset that can be proactively deployed to advance the institution’s core purpose. This approach recognises that fiduciary responsibility is ultimately to the mission.
A primary concern often raised by fiduciaries considering MAI is the potential for financial sacrifice that aligning investments with mission will inherently lead to lower returns. However, evidence and experience increasingly suggest this is not necessarily the case, particularly for market-rate seeking strategies. Many ESG integration and MRI strategies are designed to achieve competitive, market-rate, or even superior risk-adjusted returns. Proponents argue that companies with strong ESG practices may exhibit better operational performance, lower risk, and enhanced resilience, contributing positively to financial outcomes over the long term.
Several foundations that have embarked on comprehensive mission alignment journeys report positive financial results.
For example, the Nathan Cummings Foundation and the Wallace Global Fund, both of which have committed to 100% mission alignment of their endowments, have stated that this approach has not led to financial setbacks and, in some instances, has resulted in performance that met or exceeded traditional benchmarks. The Wallace Global Fund specifically notes that its fossil-fuel-free, mission-aligned portfolio has consistently beaten the market. While “impact-first” PRIs may intentionally accept concessionary returns to achieve a specific programmatic outcome, the broader suite of MAI strategies, especially MRIs and ESG integration, aims to disprove the myth of an inherent financial trade-off. This growing body of evidence can provide comfort to boards and investment committees, enabling them to more confidently explore and implement MAI.
The journey toward mission alignment can be viewed as an enhancement of fiduciary duty rather than a detraction. The Uniform Prudent Management of Institutional Funds Act (UPMIFA), which governs many E&Fs, requires fiduciaries to manage and invest funds “in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances”. This standard can be interpreted to encompass the consideration of mission-related factors, especially if those factors—such as climate risk, social inequality, or poor governance—have potentially material financial implications for investments. If ESG factors represent tangible risks or opportunities, then their consideration is a component of prudent investment management. The positive financial outcomes reported by foundations pursuing deep mission alignment further support the argument that such strategies are not inherently imprudent and can, in fact, align all of an institution’s resources with its core purpose.
However, a significant hurdle in the broader adoption and assessment of MAI is the “impact data challenge.” While financial returns are well-defined and universally measurable, quantifying and reporting on “impact” is a more complex, less standardised endeavour. The lack of consistent, comparable impact metrics can be a barrier for institutions wishing to demonstrate the non-financial outcomes of their MAI strategies.
Data sources can be ad hoc, and methodologies for ESG scoring or impact assessment can vary widely among providers. Some institutions, like the Ford Foundation, adopt a pragmatic approach, relying on their investment managers’ integrity to define and track relevant impact metrics while also developing internal dashboards with key performance indicators for their thematic impact areas. This highlights an evolving field where the development of robust, credible, and comparable impact data and reporting standards is crucial for continued growth and accountability. Foundations engaging in MAI must therefore be intentional about defining their specific impact objectives and developing a framework for measuring progress, even if perfect, standardised data is not yet available. This may involve collaborating with managers who have strong impact reporting capabilities and contributing to broader efforts to advance data standards in the field.
The Nathan Cummings Foundation (NCF) provides a compelling example of an institution undertaking a comprehensive journey to align 100% of its nearly $500 million endowment with its mission focused on racial, economic, and environmental justice.
Impetus for Change & Board Engagement: The NCF recognised that traditional grant-making alone was insufficient to tackle deeply entrenched systemic issues like climate change and social injustice. A core motivation was the desire to avoid a scenario where the foundation’s investments might inadvertently support companies or practices that caused harm in the very communities it aimed to serve, a sentiment encapsulated by the question, “Why give with one hand while taking away with the other?”. Furthermore, there was a proactive desire to make investments that could amplify and reinforce the work of its grantees. In November 2017, the NCF Board made a unanimous and ground-breaking decision to commit to deploying 100% of the foundation’s assets, both its grant budget and its financial investments, in service of its mission. This decision was also rooted in the belief that philanthropic institutions, as active participants in financial markets, have a responsibility to help transform those markets to be more sustainable and fair.
Evolution of Investment Policy and Strategic Asset Allocation: NCF’s journey into mission alignment began with shareholder activism, a practice it continues to this day, having filed over 250 shareholder resolutions on a range of ESG issues. Following the 2018 board commitment to 100% alignment, the foundation developed a framework to categorise its investments:
A critical first step was the removal of almost all “no-go investments” from its portfolio. Subsequently, NCF began strategically shifting increasingly large portions of its assets into companies that actively prevent harm, benefit a broad range of stakeholders, or directly contribute to solutions for systemic problems. Beyond the nature of the investments themselves, NCF also deepened its approach by scrutinising who was managing its capital, placing an emphasis on increasing allocations to diverse-led fund managers, particularly those led by women and people of colour, recognising the market inefficiency of underinvestment in such funds.
Challenges Encountered and Lessons Learned: The NCF’s journey has yielded valuable lessons. They emphasise that achieving full values alignment is an ongoing process, advising others to “start simple”. Addressing internal and external scepticism about potential financial sacrifices was crucial. The foundation also recognised the need for courage and creativity to support emerging impact leaders and innovative solutions. They identified gaps in the marketplace, noting that some Outsourced Chief Investment Officers (OCIOs) might lack sufficient motivation or established processes for fully integrating DEI, ESG, and impact considerations. Finally, they saw an opportunity to improve the rigor and transparency of impact reporting across the field.
Financial and Mission-Related Outcomes: Four and a half years into its new investment strategy, the Nathan Cummings Foundation reported having invested more than 95% of its endowment assets in alignment with its mission categories. Critically, the foundation stated that this comprehensive mission-aligned investment approach did not lead to financial setbacks or require any financial sacrifice. In fact, they believe their new mission-aligned strategy produced stronger returns in 2020 than their traditional approach would have, despite market challenges. Beyond financial performance, NCF has achieved significant mission impacts through its shareholder activism, such as successfully pressing Occidental Petroleum to assess its long-term impact on climate change. The foundation’s grantmaking and Programme-Related Investments (PRIs) continue to directly support its interconnected goals of racial, economic, and environmental justice (REEJ).
The Nathan Cummings Foundation’s experience provides a powerful and transparent case study, demonstrating that deep mission alignment of a substantial endowment is not only feasible but can be achieved without compromising financial objectives, offering inspiration and a practical roadmap for other institutions considering a similar path.
The spending policy is a critical mechanism through which an endowment or foundation translates its investment returns into tangible support for its mission. It dictates the amount of funds withdrawn from the endowment each year for operational expenses, grants, or other programmatic activities. A well-crafted spending policy is the linchpin of intergenerational equity, striving to provide a consistent and sustainable level of support for both current and future generations of beneficiaries. This involves balancing the immediate needs of the institution with the long-term imperative to preserve the endowment’s real (inflation-adjusted) purchasing power.
Several spending policy models are commonly used by E&Fs, each with distinct mechanics, advantages, and disadvantages:
Percentage of Moving Average: This is a widely adopted method where the annual spending amount is calculated as a fixed percentage (e.g., 4-5%) of the endowment’s average market value over a specified trailing period, typically three to five years (or 12 to 20 quarters).
Pros: This approach helps to smooth out the impact of short-term market volatility on annual spending amounts compared to using the current market value. A longer averaging period (e.g., five years or 20 quarters) generally provides greater smoothing. It is relatively simple to implement and explain.
Cons: Despite smoothing, spending levels remain significantly correlated with market value fluctuations, which can still lead to undesirable volatility in budget support, making long-term planning difficult. This model may not provide adequate revenue diversification during market crises when other income sources (like gifts or tuition) might also decline. Furthermore, it can result in a “long tail” of reduced spending for several years following a significant market downturn.
Constant Growth (or Inflation-Adjusted) with Collars: Under this model, the prior year’s spending amount is increased by a predetermined growth rate, which is often linked to an inflation measure (like the Consumer Price Index (CPI) or the Higher Education Price Index (HEPI)) or a fixed percentage. To prevent spending from becoming too disconnected from the endowment’s actual market value, this method frequently incorporates “collars”—a floor and a cap—which define a permissible range for the spending rate as a percentage of the current market value (e.g., spending must remain between 4.25% and 5.75% of the year-end market value). The Stanford Rule, for example, aims for equilibrium by setting the target spending rate ($\alpha$) equal to the expected long-term real return of the endowment (ρ) minus the institutional cost rise (c), or α=ρ−c.36
Pros: This method typically provides the most predictable and stable stream of spending, which greatly facilitates institutional budgeting and financial planning. It helps to separate the growth in endowment spending from short-term market volatility and can act as a revenue diversifier, potentially allowing for relatively higher spending (as a percentage of a depressed market value) during bad times and constraining spending during market peaks.
Cons: If the collars are too wide or not diligently applied, the spending amount can drift significantly from the endowment’s capacity, potentially leading to overspending in prolonged bear markets or underspending (and thus underutilising resources for current mission) in strong bull markets if not carefully calibrated.
Hybrid (e.g., Yale Model): Hybrid models attempt to capture the benefits of both the moving average and constant growth approaches by blending them. A common formulation involves giving a significant weight (e.g., 70-80%) to the prior year’s spending adjusted for inflation, and a smaller weight (e.g., 20-30%) to applying the long-term target spending rate to a moving average of the endowment’s market value.
Pros: These models aim to provide smoother spending than a pure moving average approach while still maintaining some responsiveness to significant changes in endowment value. They offer flexibility in design, can be customised to an institution’s specific needs, and are intended to provide protection during market declines while helping to maintain the endowment’s purchasing power.
Cons: Hybrid models are inherently more complex to design, implement, and explain than simpler methods. They may not be as immediately responsive to rapid changes in market value as a pure moving average system. Finding the optimal weighting and parameters for a hybrid model requires careful judgment and ongoing assessment.
Other less common methods include spending only the current income (dividends and interest) generated by the portfolio, which is generally unsuitable for endowments aiming for long-term growth and inflation protection, or an ad-hoc approach where the spending amount is decided each year without a formal rule, which lacks predictability and discipline.
The selection of a spending policy involves navigating inherent trade-offs. There is no single policy that is universally optimal for all E&Fs. The primary tension lies between the desire for highly stable and predictable budget support versus the need for spending levels to remain reasonably aligned with significant and sustained changes in the endowment’s market value.
Simpler models, like a basic moving average, are easier to understand and communicate but may exhibit undesirable volatility or pro-cyclical behaviour in certain market environments. More sophisticated models, such as inflation-adjusted rules with carefully calibrated collars or complex hybrid approaches, may offer better long-term outcomes in terms of balancing intergenerational equity and spending stability, but they demand more sophisticated oversight, modelling capabilities, and clear communication to stakeholders. Fiduciaries must carefully weigh these trade-offs in the specific context of their institution’s operational needs, financial planning processes, and governance capabilities.
A cornerstone of a sustainable spending policy is the fundamental alignment of the chosen spending rate with the endowment’s expected long-term investment returns, after accounting for inflation and investment management fees. For an endowment to maintain its real value and support intergenerational equity, the effective spending rate (payout plus administrative fees) plus the expected long-term rate of inflation should ideally be less than or equal to the expected long-term nominal return of the investment portfolio. As succinctly stated, investment return objectives must cover spending, fees, and inflation.
Intergenerational equity remains a paramount objective for most E&Fs: the commitment to provide a similar level of real financial support to future generations as is provided to the current generation. Inflation is the primary adversary in this pursuit, steadily eroding the purchasing power of both the endowment corpus and its distributions if not actively countered by investment growth. Some theorists, like Mehrling, have proposed concepts such as a “stabilisation fund” – an internal reserve that can absorb fluctuations in investment returns, allowing both the spending payout and the core endowment corpus to remain relatively constant in real (inflation-adjusted) terms over time.
This underscores the sophisticated thinking required to truly manage for perpetuity. Overspending relative to sustainable capacity will inevitably erode the endowment’s purchasing power, jeopardising future mission support. Conversely, chronic underspending may fail to maximise the institution’s current impact and could be seen as unfairly privileging future beneficiaries over present needs.
A well-defined and consistently applied spending policy serves not only as a financial management tool but also as a critical behavioural governor for investment committees and boards. In buoyant market conditions, there can be pressure to increase spending beyond sustainable levels. Conversely, during market downturns, fear can lead to drastic and potentially premature cuts to essential programmes. A formal policy, adopted after careful deliberation, helps to insulate spending decisions from these emotional responses, promoting discipline and adherence to the long-term strategic plan.
The Hartford Foundation’s spending policy, for example, which utilises a 20-quarter moving average with clearly defined floor and cap percentages, exemplifies a structured approach designed to provide stability and predictability despite market volatility, thereby reinforcing disciplined decision-making.
Furthermore, the choice of spending policy should never be made in isolation. It is intrinsically linked to the Strategic Asset Allocation and the overall financial health and dependency of the institution. An SAA must be constructed to generate a level of expected return and risk that is consistent with the chosen spending policy. For instance, an institution with a relatively high spending rate or a high dependency on its endowment for operational funding may find it necessary to adopt a more growth-oriented (and thus typically higher-risk) SAA to sustainably support that level of payout.
Conversely, an institution in a very strong overall financial position with low dependency on endowment income might opt for a lower spending rate, allowing for greater capital accumulation and potentially a more conservative SAA. This highlights a dynamic interplay: the SAA enables the spending policy, the desired spending level influences the required return from the SAA, and the institution’s broader financial context moderates both decisions. Therefore, discussions about spending policy should be part of a comprehensive, holistic strategic financial review that integrates SAA, fundraising projections, operational budget requirements, and long-term mission objectives. The following table compares common spending policy models:
Model Type | Brief Description of Calculation | Typical Spending Rate Range | Pros | Cons | Impact on Budget Predictability | Implications for Intergenerational Equity |
Percentage of X-Year Moving Average | Spending = Rate % (Avg. Market Value over X prior years/quarters) | 4-6% (often targeting ~5%) | Smoothes short-term market volatility; simple to implement and explain; longer averaging period (e.g., 20 quarters) provides more smoothing. | Spending still correlated to market value; can lead to undesirable spending volatility; may not provide revenue diversification in crises; can result in a long tail of reduced spending post-downturn. | Moderate; less volatile than % of current MV, but more than constant growth. | Can be pro-cyclical, potentially underfunding in down markets and overspending in up markets if not carefully managed. Smoothing helps but doesn’t eliminate this risk. |
Constant Growth/ Inflation-Adjusted (with Collars) | Spending = Prior Year Spending (1 + Inflation/Growth Rate); often with floor/cap % of current MV. Stanford Rule: α=ρ−c. | Typically 4-5% effective rate, adjusted by inflation. Collars e.g., 4.25%-5.75% of MV. | Highly predictable spending; facilitates budgeting; separates spending growth from market volatility; acts as revenue diversifier; protects purchasing power if growth rate matches inflation. | Can become disconnected from market value if collars are too wide or not used; may overspend in prolonged bear markets or underspend in strong bulls if not well-calibrated; requires careful setting of growth rate and collars. | High; very stable year-to-year spending if within collars. | Strong if growth rate appropriately reflects inflation and collars prevent excessive erosion or accumulation of capital relative to market value. Aims to provide consistent real support. |
Hybrid (e.g., Yale Model) | Spending = Weighted Avg of (Prior Year Spending (1+Inflation)) AND (Target Rate % | Typically aims for an effective rate of 4-5.5%. | Smoother spending than pure moving average; more predictable; flexible and customisable; provides protection in declines; aims to maintain purchasing power. | More complex to design and explain; not as responsive to market value changes as pure moving average; finding optimal weights and parameters requires judgment and ongoing review. | Good; generally stable with some market responsiveness. | Aims to balance current stability with long-term preservation by incorporating both inflation and market value elements. Can be effective if well-calibrated. |
Simple % of Current Market Value | Spending = Rate % * Current (e.g., year-end) Market Value. | 4-6% | Directly reflects endowment capacity. | Highly volatile spending; makes budgeting extremely difficult; can lead to severe cuts in down markets or excessive spending in up markets. | Low; spending can fluctuate significantly year-to-year. | Poor; high volatility makes it difficult to ensure consistent support. Can lead to rapid erosion of capital in bear markets if rate is too high. |
Once a Strategic Asset Allocation (SAA) has been established, the task of maintaining its integrity over time falls to the discipline of portfolio rebalancing. As different asset classes generate varying returns, the original target allocations within a portfolio will inevitably drift. For instance, a strong bull market in equities might cause the equity allocation to grow beyond its intended target, while the fixed income portion shrinks proportionally. Rebalancing is the systematic process of selling assets that have become overweight relative to their targets and using the proceeds to purchase assets that have become underweight, thereby restoring the portfolio to its strategic weights.
The primary objective of rebalancing is not to enhance absolute returns, although it can sometimes contribute positively over certain market cycles. Rather, its fundamental purpose is risk control. By periodically bringing asset class exposures back to their strategic targets, rebalancing ensures that the portfolio’s overall risk and return characteristics remain consistent with the institution’s long-term objectives and risk tolerance, as defined by the SAA. Without rebalancing, a portfolio can inadvertently take on a risk profile significantly different from the one intended.
For example, if equities significantly outperform other asset classes over several years and are not rebalanced, the portfolio becomes increasingly concentrated in equities and thus more vulnerable to a sharp stock market correction. Disciplined rebalancing can also improve risk-adjusted returns, as measured by metrics like the Sharpe ratio, by helping to maintain a more consistent risk exposure and a tighter distribution of returns over time.
Institutions typically employ one of several common rebalancing strategies:
Rebalancing portfolios with substantial allocations to illiquid alternative investments, such as private equity, venture capital, and private real estate, presents unique challenges. These assets cannot be easily bought or sold on a daily basis to adjust exposures. Rebalancing in these segments typically occurs through:
While the Strategic Asset Allocation is a long-term, often “passive” decision in terms of not attempting to time markets, the act of rebalancing is the active implementation step that ensures the strategic intent of the SAA is preserved over time. It is the mechanism that translates the strategic vision into ongoing operational discipline. Without a consistent rebalancing process, the SAA risks becoming merely a historical document, with the actual portfolio drifting into unintended risk exposures. Rebalancing keeps the SAA “alive” and effective.
Moreover, rebalancing provides a significant psychological benefit by enforcing a contrarian discipline. The process inherently involves selling assets that have performed well (winners) and buying assets that have performed poorly (losers) relative to their peers. This can be psychologically challenging for many investors, who might be tempted to let winners run or avoid adding to underperformers. However, this disciplined, contrarian action is essential for long-term risk management and for capitalising on potential mean reversion in asset class returns.
A pre-defined, systematic rebalancing policy removes emotion from these decisions, ensuring that trades are executed based on strategic targets rather than short-term market sentiment or behavioural biases. The Investment Policy Statement (IPS) should therefore clearly articulate the institution’s rebalancing methodology, including specific trigger points (whether calendar or threshold-based) and assigning responsibilities for monitoring and execution, to ensure consistent application and prevent ad-hoc, potentially detrimental, decision-making.
Effective stewardship of an endowment or foundation’s assets requires moving beyond siloed decision-making to embrace an integrated, holistic strategic review process. Strategic Asset Allocation (SAA), spending policy, mission alignment objectives, and rebalancing protocols should not be viewed as independent components but as deeply interconnected elements of a single, cohesive investment strategy.
The overarching investment strategy must be designed to support the institution’s current spending needs while simultaneously working to preserve and grow the future spending power of the endowment, all within the context of its mission. Strategic asset allocation, for instance, is vital for striking the right balance between spending requirements and long-term growth, ensuring the endowment can keep pace with inflation and sustainably support the organisation’s mission over its perpetual horizon.
The Investment Policy Statement (IPS) serves as the primary governance document that articulates and codifies this integrated strategy. A comprehensive IPS should clearly outline the institution’s investment objectives (including target returns and risk tolerance), the strategic asset allocation, the linkage to the spending policy, guidelines for rebalancing, and any specific directives related to mission-aligned investing. Regular, systematic reviews of the IPS and its constituent parts are essential to ensure that these elements remain aligned with each other and continue to effectively support the institution’s evolving goals and the prevailing market environment.
An example of this integration can be seen in the approach of institutions like the Hartford Foundation for Public Giving. Their investment strategy is explicitly “equity-oriented to seek substantial long-term real returns, broadly diversified to control volatility amidst short-term market fluctuations, and designed to provide cashflow in any market environment to support current year spending needs.” Importantly, they state that their “spending policy and investment strategy are designed to work together”.
This explicit linkage ensures that the portfolio is managed in a way that directly supports the foundation’s ability to make grants and meet its operational needs, both now and in the future. Inconsistencies between these critical components can lead to suboptimal outcomes. For example, an SAA might be too conservative to realistically support the adopted spending policy over the long term, or stated mission objectives might not be reflected in actual investment decisions, leading to a disconnect between values and actions.
The IPS should therefore be treated as a “living document,” a dynamic reference point that actively guides all investment-related decision-making and ensures that the various components of the investment strategy—SAA, spending rules, mission considerations, and rebalancing practices—are working in concert. It should not be a static document that is drafted and then filed away. Instead, it warrants periodic, thorough review and, when necessary, updates to reflect significant changes in the institution’s circumstances, the capital markets, or its strategic mission priorities. If the IPS is not regularly consulted and maintained as a relevant guide, the carefully constructed alignment between these strategic elements can erode over time, leading to strategic drift.
A cohesive and regularly reviewed holistic framework fosters more resilient portfolios and significantly increases the probability of achieving the institution’s long-term mission and financial objectives. Conversely, a fragmented approach, where SAA, spending, and mission are considered in isolation, heightens the risk of strategic missteps, internal inconsistencies, and ultimately, a failure to optimise the endowment’s potential for impact. Boards and investment committees should, therefore, schedule periodic, dedicated reviews of the entire investment framework, not just its individual components. These reviews should explicitly address the question: “Are our Strategic Asset Allocation, spending policy, mission integration efforts, and rebalancing strategy all working harmoniously and effectively to achieve our institution’s long-term objectives in the current and anticipated future environment?”
The complexity of managing endowment and foundation portfolios, particularly in an environment of evolving market dynamics, diverse asset classes, and increasing calls for mission alignment, underscores the value of sophisticated analytical capabilities and professional expertise. Leveraging advanced analytics, financial modelling, and external advisory services can significantly enhance an institution’s ability to make informed, data-driven decisions regarding its Strategic Asset Allocation (SAA) and spending policy.
Modern data analytics platforms and financial modelling software offer powerful tools for E&Fs. These technologies can provide deeper insights into historical and potential future portfolio performance, identify and quantify risk exposures with greater precision, and model the behaviour of various asset classes and strategies under different economic scenarios. By automating routine tasks like data collection and report generation, and employing advanced algorithms for tasks like portfolio rebalancing optimisation or scenario analysis, these tools can improve accuracy, reduce operational costs, and free up fiduciaries’ time to focus on higher-level strategic considerations.
Specifically for SAA, robust analytics can help institutions assess long-term risk and return expectations for a wide range of traditional and alternative asset classes, model correlations, and evaluate the potential outcomes of different allocation mixes under various market conditions. For spending policies, sophisticated modelling can illustrate the long-term implications of different spending rules (e.g., moving average, constant growth, hybrid) and various payout rates on the endowment’s projected market value, the stability of annual distributions, and the preservation of intergenerational equity. These capabilities allow for decision-making that is more rigorously grounded in quantitative analysis, moving beyond reliance on historical averages or simplistic rules of thumb.
A key benefit of these analytical tools is the ability to conduct scenario testing and stress testing. As highlighted in the user query, E&Fs can use such platforms to test various allocation scenarios and spending rules, helping them to identify an optimal strategy that concurrently supports their mission and financial goals. Stress testing, in particular, can reveal how a portfolio might perform under extreme or adverse market conditions (e.g., a sharp rise in interest rates, a prolonged equity bear market, or a liquidity crisis). This process helps to identify potential vulnerabilities in the current strategy and can inform adjustments to enhance portfolio resilience and risk management practices. Proactive testing allows institutions to anticipate potential challenges and build more robust, all-weather portfolios.
Many endowments and foundations, particularly those of small to medium size, may not possess the in-house resources, specialised staff, or technological infrastructure to conduct highly sophisticated financial modelling, manage portfolios with extensive alternative investments, or navigate the complexities of mission-aligned investing on their own. In such cases, leveraging external expertise can be invaluable.
Investment consultants and Outsourced Chief Investment Officers (OCIOs) offer a range of services, including tailored investment advice, assistance in developing or refining Investment Policy Statements, strategic guidance on asset allocation, rigorous manager due diligence and selection (especially for alternative assets), and specialised support for implementing mission-aligned investment programmes. OCIOs can function as co-fiduciaries, taking on the day-to-day management and oversight of the investment portfolio under guidelines established by the board or investment committee. This can free up committee members and internal staff to concentrate on broader strategic issues such as fundraising, grant strategy, and overall institutional governance.
Furthermore, specialised analytical platforms are emerging to support institutional investors. For example, platforms like Acclimetry are designed to assist institutions, particularly those with significant allocations to alternative assets, in areas such as refining their investment policies for alternatives, defining appropriate benchmarks, managing liquidity and capital call forecasting, and enhancing governance and oversight for these complex asset classes. Other platforms, such as AlternativeSoft, provide tools for fund screening, peer group analysis, portfolio construction, risk analysis, and customised reporting specifically tailored for endowments managing alternative investments. Accessing such external expertise and technology can significantly augment an institution’s strategic capabilities, leading to more robust analysis, better-informed decisions, and potentially improved long-term investment and mission outcomes.
The increasing availability of powerful analytical tools and sophisticated advisory services, such as OCIOs, offers endowments and foundations of all sizes access to capabilities that were previously the preserve of only the largest and most heavily resourced institutions. This “democratisation” of advanced analytics presents a significant opportunity for E&Fs to enhance the quality and rigor of their investment decision-making. However, this opportunity comes with a corresponding responsibility. Fiduciaries must be educated consumers of these tools and services. They need to understand the underlying models, the key assumptions that drive the analyses, and how to critically interpret the outputs. It is crucial to conduct thorough due diligence on any external providers or platforms. The goal of leveraging such support should be to augment and inform fiduciary judgment, not to abdicate it. An over-reliance on “black box” models or a passive deference to external advisors without full comprehension of the strategies and their implications can itself become a source of risk.
The stewardship of endowment and foundation assets is a profound responsibility, demanding a sophisticated and nuanced approach to investment strategy. The unique mandate of these institutions—to serve their missions in perpetuity—requires a long-term perspective that carefully balances the needs of current beneficiaries with the imperative to preserve and grow capital for future generations. This report has explored the critical elements that fiduciaries—Endowment CIOs, Foundation Investment Committee Members, and Non-Profit Board Trustees—must consider in crafting and overseeing an investment strategy that aligns financial objectives with institutional mission.
Professional analytical support, whether through expert consultants, OCIO partnerships, or sophisticated modelling platforms like Acclimetry, can play a vital role in helping endowment boards and investment committees test various allocation scenarios, refine spending rules, and navigate the complexities of alternative assets and mission integration. By leveraging such resources, fiduciaries can enhance their capacity to make well-informed, data-driven decisions that optimise the alignment of their portfolio with both their mission and their long-term financial goals.
Ultimately, charting a course for sustainable impact requires diligence, strategic foresight, and a commitment to aligning every aspect of the investment enterprise with the enduring purpose of the institution. By embracing a holistic, adaptive, and mission-centred approach to strategic asset allocation, endowments and foundations can best position themselves to meet the challenges and opportunities of today while safeguarding their capacity to serve generations to come.