The Current Landscape of
Nonprofit Spending
Methodologies & Investment Strategies for Foundations & Endowments
An increasing number of
conversations around the tables
of nonprofit institutions have
been focused on finding the
right level of spending in the
face of lower expected returns
from investment markets and
higher demands for the use of
endowment assets. Whether it’s
colleges and universities that
have to offset government budget
cuts and higher demand for
scholarship support, or community
foundations that have a perpetual
need to help their local causes,
the concerns are similar. What is a
sustainable level of spending that
can be realistically achieved from
the supporting asset pools?
Like most budgets, there are a limited number
of resources to reconcile inflows and outflows.
On the positive side of the ledger, there is
fundraising (where relevant) and investments.
However, many nonprofits are asking
themselves how many, if any, donations are
expected to flow into the endowments? And
are investments best positioned to earn enough
to meet long-term return objectives without
taking on too much risk? If the long-term return
objective, sometimes referred to as a “hurdle
rate,” includes the spending rate, long-term
growth and/or inflation assumptions, and
possible fees, what can actually be controlled to
keep the numbers in check? The answer often
lies on the outflow side of the ledger –
the spending of the institution.
2
The Current Landscape of Nonprofit Spending
Adding to the complexity of spending needs
are liquidity demands. When it comes to
investing the endowment portfolio, most
nonprofit investment committees have a higher
risk appetite in selecting asset classes due to
the long horizons of their portfolios. However,
long-term strategies must also meet short-term
liquidity needs for annual spending outflows
and operations. Some organizations will keep
aside cash for near-term spending needs for
12, 18 or 24 months so the corpus of the assets
can have more flexibility to invest in illiquid
asset classes, with the hope of earning a higher
risk-adjusted return. After the global crisis of
2008, approximately one-third of nonprofits
used some type of spending immunization
strategy as described above.i Cash “buckets”
are replenished with rebalancing activity and/or
cash flows over time to lessen the need to
sell out of the long-term portfolio so that
securities do not need to be sold as quickly
in down markets.
To better understand the current landscape
for nonprofit spending practices, SEI’s
Nonprofit Management Research Panel
recently conducted a survey on spending
methodologies in Spring 2013. The survey
was completed by 260 U.S. nonprofit leaders,
finance executives and investment committee
members overseeing endowments ranging in
size from $25 million to $6 billion in assets.
None of the participating organizations are
clients of the SEI Institutional Group.
This perspective will provide an overview of the
spending rates and methodologies currently
being used by various types of nonprofits
in the U.S., and the key considerations for
investment committees in determining the
spending strategy for the organization. The
Uniform Prudent Management Institutional
Funds Act (UPMIFA) clearly outlines the fiduciary
responsibility of the stewards of these asset
pools. Conducting relevant analysis, paired
with risk-reducing diversification strategies and
maintaining good decision records, are all part
of this process.
Q:
Spending Rates and Methodologies
What spending rates were reported by nonprofits?
The average spending rate among nonprofits
surveyed is 4.8%. However, there is a range of
averages that varies by type of organization.
As shown in Chart 1, private foundations, which
are generally required by the IRS to pay out a
minimum of 5% of assets each year, show the
highest average spending rate of 6.32%. There
was wide dispersion in the rates reported by
private foundations ranging from 5% to 8.75%.
Some foundations are funded for a very specific
purpose and may have a shorter life than the
typical perpetuity span, and therefore may be
in “spending down” mode, allowing higher
spending. It is important to maintain a strong
audit trail with higher spending rates as the
scrutiny of the IRS on this topic has increased.
CHART 1: Spending Rates by Organization Type
Overall Average
4.80%
Private
Human or Social
4.86%
Community
4.57%
Cultural or Arts
4.46%
Education (non-higher ed)
4.18%
College or University
4.08%
Faith-based
3.91%
Environmental
Q:
6.32%
On the opposite side of the spectrum are
spending rates under 4%. Some organizations
have been able to curb expenses, tighten
payouts, or benefit from new sources of inflows
or higher asset values. In the latter case, it is
not uncommon for nonprofits to actually lower
spending rates as market values increase,
yielding a consistent dollar payout and
minimizing the volatility in the grant-making
process, while putting more funds back into
the asset pool to help with future years when
markets may not be so rewarding and/or
fundraising efforts may not be as successful.
Many institutions will therefore use a rolling
average of three-to-five years of market value to
smooth the spending dollars each year.
Other types of foundations, notably colleges
and universities, have both restricted and
unrestricted funds that make up the endowment,
usually based on donor stipulations. Spending
rates can differ for each type of pool, but are
generally aggregated for the formal spending
policy, which is reported here.
3.65%
What spending methodologies are being used?
Most nonprofit organizations determine the annual spending rate using one of three strategies:
1
Moving average: The most common
formula (used by 79% of poll participants) to
calculate spending is based on a stated portion
of the portfolio value at the end of the prior year.
A smoothing calculation is then applied using the
average ending portfolio balances over a number
of previous years or quarters.
According to the poll, 59% of participants use a
three-year smoothing average and 20% use a
five-year smoothing average formula. Using this
moving-average methodology, spending levels
have less variability from year to year.
The Current Landscape of Nonprofit Spending
3
2
Banded inflation: The least popular
method, banded inflation, starts with
a dollar amount of spending that is typically
expressed as a percentage of the initial
portfolio in year one. The spending amount
for each subsequent year is then determined
by multiplying the prior year’s spending by an
inflation factor, such as the Consumer Price
Index, or HEPI (Higher Education Price Index) in
the case of colleges and universities. This type
of policy typically provides stable year-to-year
spending levels in the short-term, but as there is
no adjustment for spending downward in poor
markets. Of the 6% of poll participants using the
banded-inflation method (Chart 2), college and
universities implemented it the most (14%).
3
Hybrid or Yale Model: This approach
combines the above two strategies. The
level of annual spending is determined by
combining a fixed percentage using the bandedinflation model and a fixed percentage using a
moving average formula with three- or five-year
smoothing. As a result, a portion of the spending
varies based on the markets (inflation formula)
and a portion is more predictable (moving
average). Of the 15% using the Yale Model,
private foundations represented the largest
portion of implementers (33%).
Because markets, portfolios and financial needs
change frequently, investment committees
should be monitoring and potentially changing
their spending policies at least annually to
ensure that they are spending enough to meet
their short- and long-term goals, but also not
spending in excess and compromising the
financial health of the endowment.
4
The Current Landscape of Nonprofit Spending
CHART 2: Spending Methodologies 79% Moving average
6% Banded inflation
15% Hybrid
CHART 3: Last Change to Spending Policy
21% Within the past year
23% 2-3 years ago
17% 3-5 years ago
36% Greater than 5 years ago
3% Not sure
In light of a challenging
and volatile investment
environment in recent
years, more than half (61%)
of poll respondents said
their organizations most
recently made a change
to their spending policies
since 2008. More than onethird (36%) haven’t made a
change in more than five
years (Chart 3).
Investment Considerations for Creating
an Effective Spending Policy
Q:
Are we using the best spending methodology to meet our goals?
A moving-average methodology with three-year smoothing formula is the most popular among
survey respondents, but does that mean it’s the right spending approach for your nonprofit? If your
organization reviews its spending policy annually, but hasn’t made a change in more than five years,
how do you know when the time is right to adjust your spending? Often, these questions can be
answered through an analysis of past and future spending scenarios. A nonprofit’s endowment
portfolio and spending approach should be unique to the goals, financials and risk profile of the
organization; there is no one-size-fits-all approach. One way to be sure your organization has
chosen the best methodology moving forward is to take a look at actual past performance and
spending to project future outcomes.
Below is an example of a nonprofit foundation with a starting market value of $59,000,000 on January
1, 2000, whose actual spending over a ten-year period (using a five-year moving average formula) is
compared to a spending rate using the Yale Model, for which 70% is calculated using prior year’s dollar
spending adjusted for inflation (Consumer Price Index) and 30% is calculated by 5% of the prior year’s
market value.
$2
CHART 4: Nominal Market Values (Bars) vs. Spending Rates (Lines)
$65,000,000
14.0%
$60,000,000
12.0%
$55,000,000
10.0%
$50,000,000
8.0%
$45,000,000
6.0%
$40,000,000
4.0%
$35,000,000
2.0%
$
$30,000,000
2000
2001
2002
2003
5-Year Moving Average
2004
2005
Yale Model
2006
2007
2008
5-Year Moving Average
2009
2010
$
$
0%
Yale Model
As you can see in Chart 4, the Yale Model provided more consistent spending and protected the
portfolio assets after 2001 and 2008, but would have meant less spending dollars available. The
Moving Average Spending Policy was able to provide more total spending than the Yale Model, but
was subject to high spending rates during down markets. The foundation could use this information
to help formulate its spending methodology moving forward.
The Current Landscape of Nonprofit Spending
5
A different example shows how
a similar analysis can be applied
to determine the best spending
methodology. Consider that at the
beginning of the fiscal year, another
sample foundation’s endowment
had a beginning market value (BMV)
of $73,750,000 and a budgeted
spending dollar amount of
$4,250,000. The foundation’s policy
spending rate is 4.8%, which was
determined by taking the average
spending rate over a ten-year
period. Using these figures,
different methodologies are applied:
1 Current methodology
(does not adjust for inflation; latest
annual market value)
Projected spending:
$73,750,000 x 4.8% = $3,540,000
Potential shortfall:
$3,540,000 - $4,250,000 = ($710,000)
2 Moving-average methodology
Projected spending:
5-Year Moving Average x 4.8% = $3,638,342
Potential shortfall:
$3,638,342 - $4,250,000 = ($611,658)
3 Hybrid or Yale methodology
Projected spending:
[(Previous Year’s Spend x Inflation Adjustment) x
70%] + [(5-Year Moving Average x 4.8%) x 30%]
= $4,020,871
Potential shortfall:
$4,020,871 - $4,250,000 = ($229,129)
6
The Current Landscape of Nonprofit Spending
In reviewing the outcomes of these various
methodologies, it’s clear that should this
sample foundation use its current spending
methodology as in past years, its spending
shortfall would be substantial in the subsequent
year. Using a moving average provides a better
match by reducing the amount of shortfall at
year-end, but the hybrid model clearly produces
the best results in more closely meeting the
budgeted spending needs of the foundation.
Another strategy to consider in addition to
the spending methodology is immunizing of
a portion of the portfolio, which can provide
protection against downside losses in the
short-term. Since liquidations are made from
the immunized account that in effect operates
like a saving account, there is less need to sell
securities in down markets to meet liquidity
needs. The immunization accounts need to be
replenished from the main pool, but the time
horizon is more flexible. To determine whether
an immunization strategy would be a valuable
addition to your organization’s investment
strategy, try shocking different scenarios with
an extreme drop in markets to see what the
spending results are over the subsequent few
years and what the impact could be to the
long-term health of the asset pool.
For example, Chart 5, on page 8, shows a
$100 million sample portfolio invested in 60%
equity and 40% fixed income and the difference
after 20 years (in nominal terms) if invested
to achieve a 7% hurdle rate versus a more
aggressive 8.5% hurdle rate. The latter includes
two years’ worth of spending set aside in an
immunization account invested in short duration
bonds. Assuming a five-year rolling average to
calculate the 4% spending rule, the portfolio with
the higher return will naturally grow more, by
about $50 million after 20 years. Both portfolios
will “spend” 4% a year but the 7% hurdle-rate
portfolio needs the cash every year while the
immunized portfolio can pause when there is
a market shock and spend out of the funds set
aside for that purpose.
CHART 5: 20-Year Nominal Fund Value
4% Spending Policy of a 5-Year Moving Average of Market Values
$280,000,000
$230,000,000
$180,000,000
$130,000,000
$80,000,000
$30,000,000
2013
2015
2017
2019
7% Hurdle-Rate Portfolio
2021
2023
2025
2027
2029
2031
2033
8.5% Hurdle-Rate Portfolio with 2-Year Spending Immunization
Chart 6 shows the results when there is a market shock of over 22% in one year and spending
continues at a consistent amount out of the immunization account, although the replenishment halts
for one year to give markets time to recover, while the 7% portfolio is forced to sell securities to
raise cash for its spending needs. The spending in dollars is naturally smoother with the immunized
strategy, and the portfolio overall has almost $20 million more in assets after 20 years.
CHART 6: Shock Year 2016 with 22% Loss
4% Spending Policy of a 5-Year Moving Average of Market Values
$170,000,000
$6,000,000
$150,000,000
$5,000,000
$130,000,000
$4,000,000
$110,000,000
$3,000,000
$90,000,000
$2,000,000
$70,000,000
$1,000,000
$50,000,000
$30,000,000
2013
2015
2017
2019
2021
7% Hurdle-Rate Portfolio
7% Hurdle-Rate Portfolio Spending
2023
2025
2027
2029
2031
2033
$0
8.5% Hurdle-Rate Portfolio with 2-Year Spending Immunization
8.5% Hurdle-Rate Portfolio with 2-Year Spending Immunization
The Current Landscape of Nonprofit Spending
7
3
Q:
Do we have the hurdle rate and portfolio to support spending?
A critical consequence of the selected spending policy is how aggressive the portfolio’s long-term
return objective needs to be. These long-term return objectives need to not only cover spending,
but should include an assumption for inflation to maintain purchasing (or spending) power into
perpetuity, or at least 20-30 years, which is a reasonable proxy for analysis.
Some institutions have a strategic goal to reach a certain asset target, so additional growth may
need to be built into the long-term return objectives. Others may include fees associated with
running the investment portfolio (e.g., asset management and consulting fees) or may charge a fee
at the donor level for administrative purposes. Some examples of different hurdle rates and their
various components are shown below:
$6,000,000
Hurdle Rate Breakdowns
Chart 7: Hurdle Rates by Organization Type
$5,000,000
$4,000,000
4.5% spending policy
2.0% long-term inflation assumption
$3,000,000
1.0% additional growth objective
1.0% fees
$2,000,000
8.5% Hurdle Rate
Overall Average
Human or Social
Community
5.0% spending policy
2.5% long-term inflation assumption
$0
7.5% Hurdle Rate
nding Immunization
nding Immunization
4.86%
6.30%
4.57%
4.18%
College or University
4.08%
Faith-based
3.91%
Environmental
7.30%
4.46%
6.12%
Education (non-higher ed)
4.0% spending policy
2.0% long-term inflation assumption
6.32%
6.99%
Private
Cultural or Arts
$1,000,000
4.80%
6.95%
3.65%
7.47%
7.03%
7.03%
6.66%
1.0% fees
7.0% Hurdle Rate
Spending Rate
Hurdle Rate
Poll participants reported hurdle rates that ranged from a low of 3% to a high of 13.5%. When
grouped by organization type as shown in Chart 7, the averages ranged between 6%-7.5%. Overall,
about 32% reported hurdle rates in the 8%-9% range, and another 31% between 7%-8%. The
median or middle point in the distribution was 7%. Not surprisingly, the average hurdle rates are
generally about 2%-3% over the reported spending averages.
One point to consider in evaluating the expected hurdle rate is what percentage of the return should be
spent if, for example, the goal is to have the same assets in 20 years (adjusted for inflation). In this case,
rather than grow the assets, the spending portion of the hurdle rate could be revised year to year.
8
The Current Landscape of Nonprofit Spending
Once a hurdle rate is determined, it drives the strategic asset allocation decision, balanced by the
risk objectives of the organization. Generally, a more aggressive policy will be required for higher
hurdle rates and vice versa, but the less-liquid alternatives bucket can offer some risk-reducing
characteristics, which can mitigate the volatility of the overall portfolio if liquidity conditions are
flexible. The example below shows a sample of what different portfolio allocations might look like
based on unique hurdle rates for different organizations and the standard deviation associated
with each allocation. For simplicity’s sake, Chart 8 shows return-enhancing types of asset classes
(e.g., equity, high yield, emerging markets debt), risk management types of asset classes (e.g., cash,
short duration fixed income, core fixed income, TIPS) and alternatives (e.g., hedge funds, real assets,
private equity, private real estate).
Chart 8: Hurdle Rates and Asset Allocation
Client A
Client B
Client C
Client D
Client E
Client F
Client G
Client H
Client I
Total Return
Enhancement
41.2%
46.2%
50.1%
50.4%
50.5%
52.0%
58.0%
72.3%
75.0%
Total Risk
Management
36.5%
26.8%
19.9%
36.1%
28.8%
16.0%
32.0%
9.7%
0.0%
Total Alternatives 22.3%
27.0%
30.0%
13.5%
20.7%
32.0%
10.0%
18.0%
25.0%
Client HurdleRate Objective*
6.4%
7.1%
7.6%
6.2%
7.3%
7.9%
6.9%
8.0%
8.7%
Standard
Deviation
9.5%
11.0%
11.9%
7.9%
11.0%
12.3%
11.0%
13.8%
13.7%
Sharpe Ratio
0.50
0.50
0.50
0.56
0.51
0.51
0.47
0.46
0.51
*Client Hurdle-Rate Objective is the long-term return needed by the client to cover its spending rate + inflation expectations + any related fees.
Standard deviation is shown as one way to show the volatility of the return, but other risk metrics
should be considered in a full analysis, such as VAR (Value at Risk), liquidity measures, headline risk,
enterprise risk, etc. The Sharpe Ratio shown is a measure of risk-adjusted return, or efficiency of the
portfolio. Generally, the higher the number, the more efficient, but there are many decisions built
into that outcome, so highest is not always optimal.
The Current Landscape of Nonprofit Spending
9
Conclusion
Pairing today’s volatile markets with lower expected returns means identifying a
sustainable spending strategy is more critical than ever. Since spending needs
drive hurdle rates, and hurdle rates drive strategic asset allocation decisions, it’s no
wonder that the spending question is a top focus for investment committees that
have a fiduciary responsibility to safeguard these endowed assets. The inherently
conflicting demands to support short-term cash needs while still achieving longterm growth can be reasonably reconciled with the appropriate analysis and
asset allocation decisions. Spending can vary significantly from organization to
organization, from year-to-year and by using different calculating methods. So it
is imperative to partner with your investment provider to integrate your specific
needs as you build out your portfolio and monitor the progress on a regular basis.
10
The Current Landscape of Nonprofit Spending
NONPROFIT MANAGEMENT
Research Panel
The Nonprofit Management Research Panel, sponsored by the SEI Institutional Group,
conducts industry research in an effort to provide members with current best practices
and strategies for the investment management of nonprofit foundations and endowments.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of
SEI Investments Company. This information is for educational purposes only. Not intended to be
investment, legal and/or tax advice. Please consult your financial/tax advisor for more information.
Disclosure: SEI develops forward-looking, long-term capital market assumptions for risk, return, and
correlations for a variety of global asset classes, interest rates and inflation. These assumptions are
created using a combination of historical analysis, current market environment assessment and by
applying our own judgment. We believe this approach is less biased than using pure historical data,
which is often biased by a particular time period or event.
The asset class assumptions are aggregated into a diversified portfolio, so that each portfolio can
then be simulated through time using a Monte Carlo simulation approach. This approach enables
us to develop scenarios across a wide variety of market environments so that we can educate our
clients with regard to the potential impact of market variability over time. Ultimately, the value of
these assumptions is not in their accuracy as point estimates, but in their ability to capture relevant
relationships and changes in those relationships as a function of economic and market influences.
i
How Nonprofits Are Addressing Current Investment Challenges. SEI Nonprofit Management Research Panel Quick Poll 2011.
http://www.seic.com/docs/Institutions/SEI-FNP-Quick-Poll-How-Nonprofits-Address-Current-Investment-Challenges-Sept-2011.pdf
The Current Landscape of Nonprofit Spending
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