Taxing Endowment ?
May 25, 2016
To our minds, taxing endowment is very short term thinking. Lately, US media and politicians have called for taxation of the larger endowment funds. As lawmakers look for sources of funds amid declining tax base at the local level, along with rising tuition costs, the presence of large, successful and growing university endowment funds have become an enticing target.
Most endowments, including the Ontario Arts Foundation’s, saw the market values of funds under their stewardship decline during the 2008 economic crisis. Legislators and the media seem to have forgotten the impact. Endowment distributions dropped or in many cases, had to be suspended for a year. Since that time, a combination of improving security markets over the last 5 years, sound investment management and new donations have seen the aggregate value of funds held in endowments grow significantly. Lawmakers in states where the large universities are located ( Harvard, Yale, Princeton ) are making statements that the school endowments should be ‘forced’ to make mandatory payouts to reduce education/tuition costs or help offset deficits in education budgets.
Not surprisingly, we are not supporters of this for several reasons:
Recent history of a time when the market value of endowments declined below the original principal, resulted in an inability to make the annual distributions that the arts organizations we support rely upon. Our investment strategy looks to mitigate that risk by growing the capital and maintaining a reserve to ensure we are able year over year, to make distributions. But no Board or investment manager has control over global markets.
Taxing investment profits, or challenging tax exempt status of endowments will mean that donors intending to provide long term support to an organization may use other vehicles, or not make the gift. One of the advantages of an endowment is the pooling of multiple funds to lower investment costs. Taxing an endowment and driving donors elsewhere may increase costs, which impacts the amount available for distribution.
What is forgotten in the dialogue is that many individual endowments, collectively managed by the foundation, or a university have very specific purposes (i.e. fund an arts award). The governing organization does not have the ability to re-direct the capital or income to the purposes external bodies are suggesting.
Endowments are an attractive tool for generating sources of income that are separate from government funding, operations/arts programming. The stability of returns is an important part of an organization’s finance’s.
Taxing an endowment may be attractive to the media or a politician, but it truly is short term thinking at its worst.
Wall Street Journal article March 28, 2016
Bloomberg article March 23, 2016
Forbes article August 25, 2015
What Drives a Payout Decision?
March 07, 2016
At the beginning of each year, the Foundation Board meets to review investment performance and decide on the payout percentage. This determines the actual income arts organizations holding endowments with the OAF will receive. What does the Board consider in making this decision?
The majority of endowments we administer are permanent. The original capital can never be paid out and income is based on returns (cash income and market appreciation). So rule # 1 is to invest the portfolio so that annual returns increase each fund’s value, which creates income available to pay out. Our investment objectives are to earn consistent returns that support annual distributions, to preserve the capital in real dollar terms (protect against inflation) and cover investment management and our administration expenses. We invest for the long term, and aim to be able to pay out 3 to 5% returns consistently. We seek returns that exceed 5% over a 5 year period.
The Board looks at investment returns for the past year ( 2015, 7.2% ) and returns for 5 years ( 9.0% ) and 10 years ( 6.7%). This confirms that market growth is well in excess of our policy objective and that the difference between the original endowed value and current market is growing. We want that difference to be going up each year. As that happens, the board can with confidence strike a payout percentage that is stable and consistent.
A consistent income year over year is helpful for arts organizations in setting their operating and program budgets. We believe that consistency is more important than maximizing a payout in a given year then having to lower it in a future year. We recognize that arts organizations need the income from their endowments, and we try to pay as much as we can while being mindful of the long term.
Another way we look for stability is to base the distribution rate on the average market value of the funds over the previous three years. This is helpful both as markets grow year over year or experience a decline.
The Board is mindful of future return expectations, which is reflected in the asset mix strategy and decisions on investment managers. As a long term investor, our investment strategy has a bias towards equities, and we choose managers having a long term investment focus. That focus examines economic themes emerging across the world, and identifies businesses that will benefit from these themes and are well managed to excel in their particular business and marketplace. These strategies mitigate short term volatility and position the Foundation for sustained long term growth. We believe we are achieving success in this regard. The OAF investment portfolio has achieved higher long term returns with lower volatility than most managers following a similar strategy. The OAF annualized 5 year returns are approximately 10% vs a 7.6% from a universe of comparable balanced portfolio managers.
Lastly, we seek returns that are decent versus excessive as we strive for that long term continuity, and avoid significant year over year variations in returns.
The debate at the Board is always lively, as it seeks to balance a sustained, increased amount each year, while also marshaling resources for the long term in order to deliver stability. For 2016, all factors resulted in a decision to maintain a 4.5% payout. Ontario arts organizations will receive just over $3.0 million in endowment income this year.
Common Issues Facing the Arts in Canada and the U.S.
December 16, 2015
Canada does not have an annual gathering of arts funders that embraces private, government and public funders similar to Grantmakers in the Arts in the U.S. Therefore, it is always interesting to monitor the dialogue coming out of the organization’s annual fall conference. At the 2015 meeting, a couple of key themes were tabled that we feel are equally relevant to the Canadian arts sector.
The discussion revolved around actions funders can consider to help arts organizations achieve long-term sustainability, and access capital resources to help weather economic fluctuations in the hopes of achieving stable operating revenue that is close to meeting operating expenses year over year. Many organizations are simply unable to move beyond the annual scramble to fundraise and/or meet earned revenue targets for the arts programs they deliver.
Building sufficient capital reserves is a strategy that is desirable, but seems today to lack the ‘sizzle’ of current themes of funding social enterprise/social impact investing. Practically, raising funds to meet current operations is critical to the delivery today’s arts programming (as well as the employment of artists, delivery of arts education etc.). The allocation of scarce resources is a common challenge. The attention paid by some funders to social impact/ social enterprise initiatives (totally laudable) inevitably means funding for operations gets squeezed.
Allocating funding between established arts organizations and new and emerging organizations is also a common refrain. Where to place funds so that they do the most ‘good’ is a challenge, particularly at the government funding level where demand increases and funding dollars are flat or declining.
The dialogue continues...do we fund the established, well know organizations at the expense of investing in new, often culturally diverse arts organizations, or the reverse – insist on greater financial independence from the larger organizations and help support the next generation of artists and arts organizations? There is no common answer to the issue. Finding a balance between established and emerging is a continuing dialogue. Funding that reflects the cultural evolution and diversity in our communities does seem a reasonable approach.
- Other topics raised at the U.S. conference included:
Tenure – how long should a funder support an organization? Should there be an expectation of achieving financial independence and allow funding to move to a new organization?
Reporting – understanding the effectiveness and impact of grants made to arts organizations. Has the investment generated positive results (a subtext is over what time should that be assessed).
Capitalization – helping organizations establish financial reserves to weather changing times and economic cycles. This is where the topic of endowment plays a role.
Where should the strategic emphasis be? Capacity, sustainability and engagement – what is a reasonable time frame for each?
The GIA website does not have open access to all conference presentations, but there are excellent blog summaries by Barry Hennius and Lara Davis on the conference proceedings. Always worth a read.