UPMIFA and Endowments - Financial...

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Endowments, the Marketplace and the New Rules under UPMIFA Financial Managers’ Meeting February 25, 2009

Transcript of UPMIFA and Endowments - Financial...

Endowments, the Marketplace and the

New Rules under UPMIFA

Financial Managers’

Meeting

February 25, 2009

What We’ll Cover

• Concepts of principal, income, and payout

• Effect of UPMIFA on– Endowment payout– Market value of endowments– Utilization of hard-to-utilize funds

• Effects of current market conditions

Background

Land = Principal

• Medieval gifts to the Church– Consisted of land that would produce income

through agriculture, minerals, rents, etc.– Were given to relieve poverty, to provide

medical care, and to promote religion and education

• Sale of gifted land – Might bring immediate gain.– Would diminish long term yields.

Shift to Investments

• Over time, investment of capital became primary means of earning income for charities.

• Laws were developed to govern investment of charitable gifts.

• Early emphasis was placed on preservation of gift principal.

Early Ideas about Prudence

• Emphasis on preservation of capital and minimization of risk

• Stocks considered risky– Might lose value (diminution of

principal)– Dividends not assured

• Safe but low-yielding investments such as bonds favored– No diminution of principal– Interest payments assured

The Prudent Investor

• Ideas have shifted over time.– Ideas about what constitutes prudent behavior– Ideas about what behavior requires regulation– Ideas about acceptable risk – development of

portfolio theory– Ideas about payout – total return concept

• New laws have been drafted to reflect developments in these areas.

Types of Invested Fund

• True endowment– Donor states that principal is to be invested and not

spent– Condition obtains for period specified by donor, often in

perpetuity• Quasi Endowment or FFE

– (FFE = Fund Functioning as an Endowment)– Investment of principal usually determined by

charitable institution, not by donor– Principal may be invaded or dissolved at discretion of

institution

Book and Market Value

• Historic Dollar Value (HDV or book value)– original amount given– Used to purchase shares

• Market Value– Value of purchased shares at any point in time– Historically will continue to increase but will periodically

decrease

Changes in Market Value

• Increases over historic dollar value– May be unrealized (remain invested in shares)– May be realized – cashed in for spending

• Decreases below historic dollar value– Imperils the integrity of the original gift– Fund is considered underwater– Those fund that have most recently been invested

are those in greatest danger of going underwater.

Income

• Includes earnings: – Dividends– Interest– Rents– Royalties

• Does not include gains in market value of shares.

Old Payout Theory

• Payout is what beneficiary actually receives for spending

• Gains are increases to the original principal.– Principal may not be spent.– Therefore gains must remain invested

unless donor states otherwise.

• Only income may be paid out.

Total Return Theory

• Enabled under UMIFA (1972)

• Payout may consist of:– Income– A prudent portion of gains

• Considerations of Prudence– Some gain should not be paid out. They should grow

principal or be held in reserve against lean times.– Should Historic Dollar Value be preserved? If so,

should gains be diverted from payout to shore up HDV?

Recent Model Laws

• Model laws are laws developed by non- governmental professional associations and offered for adoption by states.

• UPIA (1961, 1994, 1997) – Uniform Prudent Investor Act

• UMIFA (1972) – Uniform Management of Institutional Funds Act

• UPMIFA (2006) – Uniform Prudent Management of Institutional Funds Act

UPMIFA (2006)

• Uniform Prudent Management of Institutional Funds Act• Provides statutory guidance for the management and

investment of funds by charities organized as nonprofits.• Drafted by National Conference of Commissioners on

Uniform State Laws, to be enacted by individual states.• Enacted in California under SB1329, September 30, 2008,

effective January 1, 2009)• Supersedes earlier UMIFA and application of UPIA

Links for UPMIFA

• UPMIFA document http://www.law.upenn.edu/bll/archives/ulc/umoifa/2006final_act.pd

f

• State of California SB 1329: http://www.leginfo.ca.gov/pub/07-08/bill/sen/sb_1301-

1350/sb_1329_bill_20080930_chaptered.pdf

Invested Funds at UCSF

True Endowments and funds functioning as endowments (FFEs)

Invested by Regents and by UCSF Foundation

Principal not readily expendable

Payout disbursed annually at end of fiscal year

Payout from Invested Funds

Includes both dividends and gains in market value

Paid out annually at end of fiscal year

Based on a rolling average of past market values– 36 months for UCSF Foundation– 60 months for Regents

Expressed as a percentage of rolling average– 5% for Foundation– Currently 4.75% for Regents (varies)

Impacts on Payout

• UCSF Foundation may satisfy 4% gift fee from payout.

• Spending taxed by Foundation at time of spending: 1% of amount spent

• Under UMIFA, for any underwater true endowment, gains were reinvested when market value dipped below book value (not true under UPMIFA)

In a Bad Market

• Dividends may be diminished

• Market values decline– Gain may not be available for payout

What happens to payout?

FY0708

• Governed by UMIFA

• When a fund is “underwater”

when market value has declined below book value –

gain could be diverted away from

payout and applied to shore up principal.

• New-ish

invested funds are most vulnerable to underwater status.

FY0708 –

Regents Funds

• Underwater true endowments limited to dividends only

• Underwater non-chair FFEs received both dividends and gain

• Endowed chair payout on underwater funds limited to dividends only so that all chairholders received the same treatment

FY0708 –

Foundation Funds

• Some combination of income and gain returned to principal for underwater endowments

• Endowments and FFEs that support chairs were not treated differently from other invested funds.

Under UPMIFA

• Gain need not be applied to underwater fund principal

“Section 4 allows an institution to maintain appropriate levels of expenditures in times of economic downturn or economic strength. In some years, accumulation rather than spending will be prudent, and in other years an institution may appropriately make expenditures even if a fund has not generated investment return that year.”

The Near Future: Payout

• Regents and Foundation no longer required to return gains to principal for underwater funds

• Shares may be sold to meet payout rates

• Payout rates may be lowered– Regents meet in May; current thinking is to retain

4.75% rate– Foundation board meets in March; current thinking is to

maintain 5% payout rate.

The Near Future: Market Values

• Rolling average will blunt the immediate effect of market decline.

• Longer averaging period for Regents– Curve will be less severe– Effect will last longer

Hard-to-use Funds

Some older funds have donor imposed restrictions that are now unlawful, impracticable, impossible, or wasteful.– Law offers limited ability to make changes while remaining as

close as possible to donor’s original intent.– Donor may release restrictions.– Court may release restrictions on petition.– Notice to Attorney General is required (previously, permission of

the Attorney General was required).– If fund is older than $20,000 and less than $100,000 in value,

institution may modify purpose with 60-day notice to Attorney General and donor.