endowment fund management
primer in endowment fund management

Endowment Fund Management: A Primer for Vestries and Clergy

The Rev. Canon Michael P. Stephenson

Differing perspectives
Clergy and lay leadership face many challenges in parish administration, and there are a number of issues that may strain relations between a rector and his or her vestry. However, of all the possible sources of conflict, the control or use of money has to be somewhere near the top of the list, and endowment management is one that seems particularly problematic. There does not appear to be any empirical data to indicate why this is so, but on an intuitive level some possible reasons come to mind.

The first and most obvious explanation could be a disparity between clergy and laity in their education and interest in financial matters. While one should be careful generalizing about the specific skills that vestry members might have, the anecdotal evidence suggests that administrative and financial abilities appear far more frequently among laity than clergy. According to one study, only 12% of clergy find administrative duties satisfying, while even fewer (7%) feel satisfied with their financial responsibilities.[1]

But, not only do clergy dislike administration and finance, only 15% are interested in learning skills that would assist them with financial resource management.[2] The data strongly suggest that clergy are unlikely to develop an insatiable interest in financial matters any time in the foreseeable future.

A second reason could be different goals regarding the uses of the endowed funds. A businessperson might seek to retain investment income in order to accelerate the fund’s growth, while clergy might advocate that earnings be distributed to advance the church's ministries. These do not need to be mutually exclusive alternatives, but there is an unavoidable tension between the desire to accumulate wealth and the need to fund ministry.

Still another possible cause could be a lack of understanding by both laity and clergy with respect to widely held principles of endowment management. In a study by Hoge and Mead, only 14% of Presbyterian churches having a small endowment ($500,000 to $2 million) had written policies concerning fund management. Similarly, the investment choices indicated by the study reflect a general avoidance of accepted fund management practices.[3] This indicates that endowment managers are either unaware of or not interested in a best-practices approach to endowment management. It is intuitively inconsistent for a lay leader to be uninterested in the well being of the church, so for the purposes of this discussion, a lack of awareness will be presumed.

Contributing to the problem, regardless of cause, might be the lack of a common vocabulary regarding endowments. The investment world has its own language, as do the clergy. "Exegesis," "hermeneutic," and the “synoptic problem” would likely be as foreign to the financier as "basis points," "survivorship bias," and "triple witching" to a cleric. Given the Anglican penchant for esoteric language, this could be an opportunity to develop an entirely new, shared language for discussing endowments. That project, however, might best be left to humorists or others with excessive time on their hands.

It is also possible that clergy and lay endowment managers find themselves in disagreement or conflict because each group makes its decisions in isolation, e.g., without any knowledge or consideration of the others goals and motives. If this is the case, a process to facilitate communication and education between the two groups could have a significant impact on avoiding or resolving contentious issues.

Inter-dependent decisions
A final consideration regarding clergy/laity issues in endowment management is the interrelationship among investment choices, spending decisions, and the uses of endowed funds. In many congregations, lay managers or trustees first decide how and where to invest the money. Next, based on the anticipated investment return, they decide the amount that may be used to support ministry (the distribution or spending rate.) Then, once the distribution rate has been determined, decisions are made about the ways in which the funds will be used.

This sequential decision-making process, although common, ignores the mutual dependencies that exist among the three decisions. Changes in investment strategy impact distribution decisions, while changes in the distribution rate require new investment choices. Perhaps most important, advancing the ministries of the church should be foundational to any decisions regarding either investments or distributions.

These decisions are so interrelated that prudent choices are impossible to make without considering all three factors in combination. Although it may be impossible to make them simultaneously, an iterative process, which will be explained later in this paper, might facilitate cooperation and understanding about the endowment among all interested parties.

By presenting basic endowment principles in a format and vocabulary understandable to both laity and clergy, this paper will attempt to present information in a way that reduces confusion and may help to resolve some of the issues affecting endowment management practices. In addition, the paper will suggest ways in which clergy and lay endowment managers might better understand the inter-relationship between goals for ministry and fund management.

Back to basics
Every congregation that holds invested funds, regardless of whether they are called "the endowment," must make three fundamental decisions: 1) how to invest the money, 2) how much of it to use, 3) what to spend it on. Following a brief review of some basic concepts and definitions, these concerns will be the primary focus of this paper.

A church’s endowment fund is a specified amount of money, investments, or property that has been donated by individuals over time to provide an ongoing source of income to the church. An endowment fund often is held in a separate bank or investment account or accounts and may have several restrictions on the ways in which both principal (the original gift or gifts) and earnings from the fund may be used. A true endowment requires that the principal be held in perpetuity.

There are two other type endowments. Term endowments function like true endowment, but allow the church to spend principal after a specified time. Quasi-endowment funds, also known as board-designated endowment funds, also function like a true endowment, although there is no legal obligation to preserve principal.

Endowed funds benefit a church in several ways. They provide a long-term, stable source of money to support a church’s ministries, especially during times of economic uncertainty. They might also allow a church to develop ministries beyond the current financial ability of the membership.

Long-term perspective
An endowment, by definition, is designed to continue in perpetuity. This requires a long-term focus when making decisions. It is not uncommon for managers to make investment decisions or set spending rates based on short-term rates of return or the current rate of inflation. However, these practices are counter-productive to creating a long-term, stable income stream—a key reason that churches create endowments. As a practical matter, a 50-year to 80-year timeframe should be used for determining long-term investment returns, the rate of inflation, and spending policies. Those numbers, then, become the basis for evaluating various investment and distribution options.

Total return
Significant changes in investment theory and practice became necessary with the onset of chronic inflation following World War II. Long-term inflation continually reduces purchasing power. Over time, real dollars, that is, after adjusting for the effect of inflation, are significantly less, acquiring the church to increase its budget in order to deliver the same level of ministry or services. So, in order to maintain purchasing power of an endowment, the rate of return must be at least equal to the anticipated long-term spending rate plus the long-term rate of inflation.

Prior to the onset of constant inflation, investment return was defined as income (dividends from stock plus interest from bonds) divided by principal. However, income alone is rarely sufficient to counteract the impact of inflation and provide an acceptable rate of return to most investors, including churches. As a result, financial managers began investing on the basis of "total return," which is dividends and interest plus changes in the value of the investment, all divided by principal. This practice explicitly recognizes the importance of price appreciation and depreciation when making investment decisions.

Total return is now generally accepted by fund managers and governing boards as the most appropriate measure of investment performance. The Uniform Management of Institutional Funds Act, approved in 1972 and adopted by forty-seven states, gives explicit legal permission to not-for-profits to use a total return spending policy.[4]

The total return approach is essential for sound endowment management. With stocks, many companies pay a modest dividend and retain their earnings for reinvestment. In those situations, a large portion of the investment return is reflected in the stock’s market price. Similarly, with bonds a portion of the interest payment actually offsets the loss in value caused by inflation.

Tax considerations
For most people, income and capital gain taxes play an important role when making investment decisions. Capital gains and losses are those associated with the sale of any asset, including investments. Stock purchased for $1,000 and sold for $1,200 would have a capital gain of $200, and depending upon how long the investor owned the stock, he or she would be subject to either long-term or short-term capital gains tax.

Churches are exempt from these taxes, so endowment managers do not need to consider issues like realized or unrealized gains and losses. Realized gains and losses are those that occur when an asset is actually sold. An unrealized gain or loss is one implied by a change in the market value of an asset that has not been sold. For example, if a home was purchased for $100,000 and has an appraised value of $250,000, the owner has an unrealized gain of $150,000. If the house is sold, the gain becomes realized.

Realized gains are taxable to those individuals and organizations subject to taxes. So, those investors often take advantage of the different tax rates on capital gains by carefully timing the buying or selling of specific investments. Churches don’t need to do this, and as a practical matter, when making investment decisions, a church should treat all gains as though they were realized.

Asset allocation and diversification
Also called the portfolio mix, asset allocation refers to the type and quantity of different investments held in the endowment; for example, how much of the fund is comprised of cash, stocks, bonds, etc. It is important to have several different investment categories, since each asset type responds differently to changing economic conditions. This is called diversification of the portfolio, and it is essential to managing economic risk. Portfolio is the word commonly used by investment professionals when referring to the aggregate assortment of the assets in the endowment).

It is not unusual to see a church with a modest endowment hold all its funds in high-yield government bonds. There is a mistaken but widely held belief that bonds are safe while stocks (equities) are risky. This is not necessarily true, since in recent years long-term bond prices have experienced similar volatility to stock prices.[5] Those who advocate investing exclusively in bonds often ignore the reduction in bond prices that occurs during periods of rising interest rates. A church may, of course, hold bonds to their maturity, but this practice essentially turns the bonds into illiquid assets (ones that cannot readily be sold). In that case, they should be evaluated in a category similar to real estate.

According to Arnott and Ryan, "Stocks have outpaced bonds by about 5% per annum for a 74-year span and have produced real returns [i.e., adjusted for inflation] north of 7% for an entire century."[6] Historical investment strategy referred to the higher return from equities as a “risk premium,” an analysis that has less validity today.[7] In the current worldwide investment markets, all asset categories are subject to significant fluctuations in price and return.

The higher volatility of these markets gives additional support to the need for endowments to adopt a long-term investment perspective. The following table presents the average return over a 70-year period (1925-1995) for various investment choices. During the same period, the long-term inflation rate was 3.1%

Hypothetical asset allocation in an endowment fund.

As the chart shows, if an organization’s investment portfolio contains 50% large company stocks, 10% small company stocks, 10% long-term corporate bonds, 15% long-term government bonds, 10% intermediate-term government bonds, and 5% T-bills, the long-term anticipated average annual total return would be 8.57%. The long-term inflation rate of 3.1% must be subtracted to get the real rate of return, or 5.47%.

A church’s endowment fund trustees often give broad direction to investment managers regarding asset allocation. If the church has established a targeted, long-term rate of return, then that direction is essential to achieving the desired rate while also maintaining diversity among investment classes. It also gives the investment managers some flexibility in constructing the portfolio to achieve the church's stated goals.

Endowment Distributions
As mentioned above, churches have endowments to assure long-term funding for their ministries. Determining the annual distribution is a critical issue and often the subject of much debate among clergy, vestry members, and endowment fund trustees. How should the parish use its assets to properly support ministry while preserving the real value of the invested funds? What guidelines determine the amount to distribute?

Until about 50 years ago, most fund managers as well as lawyers argued that endowment income consisted only of interest, dividends, and rents (some endowments, like Trinity Church, Wall Street, have substantial holdings of rental property.) Under that scenario, gains and losses were considered adjustments to principal and could not be used for current expenditures.[8] In 1969 the Ford Foundation’s Advisory Committee on Endowment Management argued that cash income and gains in capital values are equivalent forms of income, and both may be used for current expenditures. This position, which evolved as the principal source of endowed funds shifted from trusts to outright bequests, was based on a determination that endowments are subject to corporate law rather than trust law.[9]

When an organization uses the total return concept for managing its invested assets, income-based distribution practices no longer are appropriate. Determining withdrawals using income or yield leads either to excessive spending or unnecessary retention of the institution’s capital assets. Instead, the organization should withdraw the amount that, over time, represents the real return on investment, i.e., total return minus the inflation rate. This method provides for the preservation of purchasing power while allowing the maximum prudent spending for ministries and operations.

The "Prudent Man Rule," stated by Justice Samuel Putnam in 1830, provided indirect support for the position taken by the Ford Foundation. The rule suggests that trustees should manage the endowment in ways similar to their own investing activities. This practice assumes that a prudent man does not distinguish between cash income and capital gains, but instead seeks high total returns from his investing activities. When the objective is accumulating wealth, the investor does not hesitate to spend part of the growth in value to accomplish his goals.”[10]

The Uniform Prudent Investor Act of 1994, now adopted by more than 40 states, expresses a more explicit position. The act, which covers more than distributions, states that prudent endowment management demands that trustees adhere to the following five principles.

1. Diversification is fundamental to risk minimization and is therefore ordinarily required.

2. Risk and return are so directly related that trustees have a duty to analyze and make conscious decisions concerning the levels of risk appropriate to the purpose of the fund.

3. Trustees have a duty to avoid fees, transaction costs, and other expenses that are not justified by the objectives of the investment program.

4. The fiduciary’s duty of impartiality requires a conscious balancing of current income and growth.

5. Trustees may have a duty, as well as the authority, to delegate as prudent investors would.[11]

Calculating the distribution rate
In the earlier table, where the hypothetical asset allocation of the endowment generates a total return of 8.57% and the long-term inflation rate is 3.1%, the maximum distribution rate is 5.47%, or the real (after adjusting for inflation) rate of return. This is the percentage of the portfolio’s market value that could be withdrawn each year and still preserve the endowment’s purchasing power.

It is critically important, however, to remember that the spending rate is a function of the investment mix. A portfolio generating low total returns will require a low spending rate, while one with higher returns will allow a higher percentage distribution.

A church should not arbitrarily take the maximum possible distribution, especially during periods when the financial markets are bullish (experiencing an overall pattern of rising prices). A recent study showed that "withdrawals from endowments, on average, tend to converge at 5.5% of the net asset value of the endowment."[12] However, because of capital accumulation, over a 20-year period those institutions using a rate of 4% distributed more than those using a 7% rate.

The church may alter the variables in the formula in other ways. It may elect to use interest and inflation rates over a different time frame, adjust the asset allocation, or use a moving average of the market value to determine the distribution. This latter technique is commonly used because it is especially valuable in stabilizing distributions during periods of rapid fluctuations in the markets.

How should the distributed funds be used?
Making investment choices and determining a spending rate, although possible sources of contention in churches, involve fairly straightforward decisions. The uses for endowment distributions, however, unless the original gift has specific restrictions, may be a purely subjective and emotionally charged consideration. In some churches, particularly those experiencing financial difficulties, the decision may be a crisis-driven one. For others, the endowment distribution might simply be transferred into the operating budget without any discussion of how it might be used.

In the absence of donor-designated restrictions, the process for determining the uses of endowment distributions should be one of prayerful discernment and thoughtful planning. What is the church's vision for ministry? How might additional funds be used to advance the work of the church? What is the church's long-term financial outlook? Will endowment distributions be needed to cover anticipated shortfalls in the budget?

These questions are serious ones and cannot be answered solely by either the rector of a parish or the church's lay endowment managers. All too often, however, investment choices and spending decisions are made without consideration for the ministry of the church. Those involved in making decisions may be good stewards of the endowment fund, but are they being good stewards of Christ's gospel? Unless these three issues—investment choices, spending decisions, and ministry needs—are considered together, the process for sound endowment management is incomplete.

Finding a process that works
How does a church integrate all three considerations into the endowment management process? It is likely that in most churches with endowed funds, current practices are codified or habitual and making substantive changes will be challenging.

The canons of the church give authority in spiritual matters to the rector, while vestries are charged with control of finances.[13] If the endowment fund supports the work of the church, then both spiritual and financial issues must be considered when decisions are made. The rector will bring his or her pastoral skills and spiritual guidance to the process, while lay members offer their expertise in financial matters. If each party is respectful and sensitive to the goals of the other and all decisions are prayerfully considered, then a mutually beneficial collaboration should take place.

Endowment decisions are, at their heart, ethical decisions. Conflict of interest is an issue that virtually all endowment managers must face, and there are many other questions that arise. For example, should the endowment be invested in stocks or bonds that are issued by companies or entities that profit directly or indirectly from war or injustice? Are endowment distributions best used for social outreach ministries or for internal purposes? Should deficit budgets be balanced through withdrawals from the endowment? The list goes on and on.

For Anglicans, ethical decisions are made in community. According to one author, the decision-making process is one where we “must weigh the various alternatives and use reason to help us evaluate the evidence of Scripture, tradition, and our own experience.”[14] In other words, ethical decisions are discerned in community rather than imposed by authority.

Jim Lemler, writing in Anglican Theological Review, suggests that discernment takes place at two basic levels. “The first level includes the ongoing and general practices of the Christian community in prayer and learning,” while the second level is that “of conversation and dialogue necessary at times of challenge and decision.”[15] He adds that “it is the responsibility of the pastoral leadership of the community to provide the means for the practice of discernment and decision.”[16]

A framework for decision making
It is common in many churches to let budgeting considerations dictate decisions about ministry, and in congregations with diminishing financial support, required cuts in spending often are based on expediency rather than conscientious and prayerful planning. Without a clear plan for ministry, decisions in a congregation will by necessity be reactive.

The first consideration, then, is determining uses of endowed funds, is how they fit into the church’s overall ministry plan. If the congregation has strong outreach programs, endowment distributions may be able to make a significant positive impact on the community served. On the other hand, if a congregation is dying, the funds from the endowment may allow for compassionate “hospice” care as the congregation comes to terms with its impending death. There are, of course, dozens of alternatives between these extremes.

When the ministry direction is clear, those charged with managing the endowment fund will better understand how the funds will be used, and can then make decisions regarding the distribution rate and the asset allocation that requires. This will need to be an iterative and often-evaluated process, since changes in ministry needs may signal necessary changes in the spending rate. The congregation’s risk preferences may not allow an investment mix to sustain the desired distribution and changes in the financial markets may require changes to the asset allocation. These and other considerations should be visited regularly.

It is incumbent on the priest to educate endowment managers about discernment and to facilitate its use when making endowment decisions. Prayer and frequent communication among the congregations are essential. In addition, a formal process for soliciting congregational input about the endowment will foster a sense of transparency and encourage additional gifts.

Finally, the endowment trustees and clergy might consider a covenant similar to the one in Appendix I. Used (in slightly different form) by the vestry of St. Paul’s, Indianapolis. It seems to present the Anglican decision-making process very nicely.

• What legal form works best?
• Who makes investment decisions?
• The role of endowment trustees
• Determining risk preferences
• Setting investment goals and policies
• Borrowing from principal
• Starting or building an endowment

As baptized Christians and leaders of this congregation, we believe:

1. The church is the Body of Christ in the world today. As such, God has much to accomplish in and through us as we work together.

2. God is an active and living presence among us as we meet.

3. We must seek the mind of Christ when making decisions on behalf of our congregation.

4. Insight into God's call for us flows from our trust in God and our commitment to listen for God's guidance on all issues before us.

5. We must respond with love and humility to what we understand to be God's call for our congregation.

6. Prayer is central to our work. We commit ourselves to ongoing prayer and formation so that we continue to progress toward greater self definition and renewal in the Body of Christ   offering ourselves in service for the good of those we serve.

To best serve God, we will:

1. Be clear and intentional in determining which matters we will decide and which matters we will delegate to others;

2. Own and support all prayerful decisions made as a body;

3. Not revisit a decision, once made, unless important new information becomes available or a majority agrees it is in the best interest of the congregation to reconsider;

4. Delegate authority to others as appropriate, trust those to whom we have delegated, embrace their service, and hold them accountable for appropriate action; and

5. Not disturb the decisions of those to whom we delegate responsibility unless they have violated our expectations for decision making or the canons of the church.

We will trust and support any person or group that we have asked to take responsibility for decision making, provided this person or group has:

1. Prayed for God's guidance on the matter;

2. Gathered as much information as the decision maker believes is reasonable, given the time and resources available;

3. Worked to ensure that all decisions and actions are consistent with God's call to service;

4. Made a genuine effort to consult those known to care most deeply about the matter (stakeholders); and

5. Acted in accordance with the canons of the church, in the best interest of our faith community as a whole, and within the authority delegated by the Vestry.

We will collectively hold all decision makers, as we hold ourselves, accountable to these tenets. If the nature of the delegated authority is not clear, we will return to the Vestry for clarification or additional authority. In this way, we pray to deepen our love and our trust as we resolve issues and make decisions.

To serve God and encourage the presence of the Holy Spirit, we commit to:

1. Respect one another's time   beginning and ending meetings on time;

2. Attend all meetings unless genuinely unable to attend   having given advance notice and reason for the absence;

3. Be guided foremost by the interests of our congregation and by God's call to service to others, rather than by our individual or affiliated interests;

4. Express our prayers and opinions openly and without reservation, feeling free to disagree (without being disagreeable);

5. Respect and honor one another and affirm each person's right to express a different view;

6. Listen   to each other and to others;

7. Recognize that conflict is normal, essential, and capable of being managed;

8. Address points of conflict directly, not through murmurs or triangulation, and insist that others do so as well;

9. Respect confidentiality; and

10. Trust God to empower us to do our best, knowing that God asks us to be faithful, not perfect.17

[1] Conway, Daniel. "Clergy as Reluctant Stewards of Congregational Resources." Financing American Religion, Mark Chaves and Sharon L. Miller, editors. Walnut Creek:  Altamira Press, 1999, pp. 95-101.

[2] Ibid.

[3] Hoge, Dean R. and Loren Mead.  “Endowed Congregations.” Financing American Religion, Mark Chaves and Sharon L. Miller, editors. Walnut Creek:  Altamira Press, 1999, pp. 87-94.

[4]“The Endowment Goose and Its Golden Eggs” by Susan L. Prenatt, The Journal of Accountancy, September 1995.

[5] Shiller, Robert J. Market Volatility. MIT Press, Cambridge MA, 1989.

[6] Arnott and Ryan "The Death of the Risk Premium: Consequences of the 1990s".

[7] Ibid.

[8]Financial Management in Nonprofit Organizations, Second edition by Richard F. Wacht, Ph.D. (Georgia State University, 1991).

[9]The Ford Foundation Advisory Committee on Endowment Management, Managing Educational Endowments (New York: The Ford Foundation, 1969).

[10]Financial Management in Nonprofit Organizations, Second edition by Richard F. Wacht, Ph.D. (Georgia State University, 1991).

[11] Train, John and Thomas A. Melfe. Investing and Managing Trusts under the New Prudent Investor Rule: A Guide for Trustees, Investment Advisors, and Lawyers. Harvard Business School Press, 1999.

[12] Commonfund benchmarks study, 2003 issue.

[13] Title III, Canon 9, Sec. 5 (a) (1); Title I, Canon 14, Sec. 2

[14] Bays, Patricia. Meet the Family: Welcome to the Anglican Church. ABC Publishing, excerpt found on-line.

[15] Lemler, James B. “A pastoral response to ‘creation, preservation, and all the blessings….’” Anglican Theological Review, Fall 1999.

[16] Ibid.

[17] “St. Paul's Episcopal Church 2004 Vestry, Expectations for Decision Making.” St. Paul’s Episcopal Church, Indianapolis, Indiana.